UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

	
 	
FORM  10-K
 
(Mark One)
 
      x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2018
 
OR
 
o             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	 	Registrants; State of Incorporation;
Addresses; and Telephone Number	 	IRS Employer
Identification No.	
1-8962	 	PINNACLE WEST CAPITAL CORPORATION
(An Arizona corporation)
400 North Fifth Street, P.O. Box 53999
Phoenix, Arizona 85072-3999
(602) 250-1000	 	86-0512431	
1-4473	 	ARIZONA PUBLIC SERVICE COMPANY
(An Arizona corporation)
400 North Fifth Street, P.O. Box 53999
Phoenix, Arizona 85072-3999
(602) 250-1000	 	86-0011170	
 
Securities registered pursuant to Section 12(b) of the Act:

					
 	 	Title Of Each Class	 	Name Of Each Exchange On Which Registered	
PINNACLE WEST CAPITAL CORPORATION	 	Common Stock,
No Par Value	 	New York Stock Exchange	
ARIZONA PUBLIC SERVICE COMPANY	 	None	 	None	
 
Securities registered pursuant to Section 12(g) of the Act:
ARIZONA PUBLIC SERVICE COMPANY             Common Stock, Par Value $2.50 per share
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act

		
PINNACLE WEST CAPITAL CORPORATION	Yes  x   No  o	
ARIZONA PUBLIC SERVICE COMPANY	Yes  x   No  o	
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

		
PINNACLE WEST CAPITAL CORPORATION	Yes  o   No  x	
ARIZONA PUBLIC SERVICE COMPANY	Yes  o   No  x	
 
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.

		
PINNACLE WEST CAPITAL CORPORATION	Yes  x   No  o	
ARIZONA PUBLIC SERVICE COMPANY	Yes  x   No  o	
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

		
PINNACLE WEST CAPITAL CORPORATION	Yes  x   No  o	
ARIZONA PUBLIC SERVICE COMPANY	Yes  x   No  o	
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):

	
			
PINNACLE WEST CAPITAL CORPORATION	 	 	
Large accelerated filer  x	 	Accelerated filer  o	
 	 	 	
Non-accelerated filer  o	 	Smaller reporting company  o	

 	 	Emerging growth company ☐	

			
ARIZONA PUBLIC SERVICE COMPANY	 	 	
Large accelerated filer  o	 	Accelerated filer  o	
 	 	 	
Non-accelerated filer  x	 	Smaller reporting company  o	

 	 	Emerging growth company ☐	
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether each registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o   No  x
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of each registrant’s most recently completed second fiscal quarter: 

			
PINNACLE WEST CAPITAL CORPORATION	 	$9,020,511,769.84 as of June 30, 2018	
ARIZONA PUBLIC SERVICE COMPANY	 	$0 as of June 30, 2018	
 
The number of shares outstanding of each registrant’s common stock as of February 15, 2019

			
PINNACLE WEST CAPITAL CORPORATION	 	112,146,511 shares	
ARIZONA PUBLIC SERVICE COMPANY	 	Common Stock, $2.50 par value, 71,264,947 shares. Pinnacle West Capital Corporation is the sole holder of Arizona Public Service Company’s Common Stock.	
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Pinnacle West Capital Corporation’s definitive Proxy Statement relating to its Annual Meeting of Shareholders to be held on May 15, 2019 are incorporated by reference into Part III hereof.
 
Arizona Public Service Company meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced disclosure format allowed under that General Instruction.

Table of Contents

TABLE OF CONTENTS

	
			
 	 	Page	
 	 	 	
GLOSSARY OF NAMES AND TECHNICAL TERMS	ii	
 	 	
FORWARD-LOOKING STATEMENTS	1	
 	 	 	
PART I	 	2	
Item 1.	Business	2	
Item 1A.	Risk Factors	29	
Item 1B.	Unresolved Staff Comments	42	
Item 2.	Properties	43	
Item 3.	Legal Proceedings	46	
Item 4.	Mine Safety Disclosures	46	
Executive Officers of Pinnacle West	47	
 	 	 	
PART II	 	48	
Item 5.	Market for Registrants’ Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	48	
Item 6.	Selected Financial Data	49	
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	51	
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	85	
Item 8.	Financial Statements and Supplementary Data	86	
 	Pinnacle West Financial Statements	90	
 	APS Financial Statements	99	
 	Combined Notes to Consolidated Financial Statements	105	
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	187	
Item 9A.	Controls and Procedures	187	
Item 9B.	Other Information	188	
 	 	 	
PART III	 	188	
Item 10.	Directors, Executive Officers and Corporate Governance of Pinnacle West	188	
Item 11.	Executive Compensation	188	
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	189	
Item 13.	Certain Relationships and Related Transactions, and Director Independence	190	
Item 14.	Principal Accountant Fees and Services	191	
 	 	 	
PART IV	 	192	
Item 15.	Exhibits and Financial Statement Schedules	192	
 	 	 	
SIGNATURES	212	
 
This combined Form 10-K is separately filed by Pinnacle West and APS.  Each registrant is filing on its own behalf all of the information contained in this Form 10-K that relates to such registrant and, where required, its subsidiaries.  Except as stated in the preceding sentence, neither registrant is filing any information that does not relate to such registrant, and therefore makes no representation as to any such information.  The information required with respect to each company is set forth within the applicable items.  Item 8 of this report includes Consolidated Financial Statements of Pinnacle West and Consolidated Financial Statements of APS.  Item 8 also includes Combined Notes to Consolidated Financial Statements.

i

GLOSSARY OF NAMES AND TECHNICAL TERMS

		
4CA	4C Acquisition, LLC, a subsidiary of the Company	
AC	Alternating Current	
ACC	Arizona Corporation Commission	
ADEQ	Arizona Department of Environmental Quality	
AFUDC	Allowance for Funds Used During Construction	
ANPP	Arizona Nuclear Power Project, also known as Palo Verde	
APS	Arizona Public Service Company, a subsidiary of the Company	
ARO	Asset retirement obligations	
ASU	Accounting Standards Update	
BART	Best available retrofit technology	
Base Fuel Rate	The portion of APS’s retail base rates attributable to fuel and purchased power costs	
BCE	Bright Canyon Energy Corporation, a subsidiary of the Company	
BHP Billiton	BHP Billiton New Mexico Coal, Inc.	
BNCC	BHP Navajo Coal Company	
CAISO	California Independent System Operator	
CCR	Coal combustion residuals	
Cholla	Cholla Power Plant	
DC	Direct Current	
distributed energy systems	Small-scale renewable energy technologies that are located on customers’ properties, such as rooftop solar systems	
DOE	United States Department of Energy	
DOI	United States Department of the Interior	
DSM	Demand side management	
EES	Energy Efficiency Standard	
El Dorado	El Dorado Investment Company, a subsidiary of the Company	
El Paso	El Paso Electric Company	
EPA	United States Environmental Protection Agency	
FERC	United States Federal Energy Regulatory Commission	
Four Corners	Four Corners Power Plant	
GWh	Gigawatt-hour, one billion watts per hour	
kV	Kilovolt, one thousand volts	
kWh	Kilowatt-hour, one thousand watts per hour	
LFCR	Lost Fixed Cost Recovery Mechanism	
MMBtu	One million British Thermal Units	
MW	Megawatt, one million watts	
MWh	Megawatt-hour, one million watts per hour	
Native Load	Retail and wholesale sales supplied under traditional cost-based rate regulation	
Navajo Plant	Navajo Generating Station	
NERC	North American Electric Reliability Corporation	
NRC	United States Nuclear Regulatory Commission	
NTEC	Navajo Transitional Energy Company, LLC	
OCI	Other comprehensive income	
OSM	Office of Surface Mining Reclamation and Enforcement	
Palo Verde	Palo Verde Generating Station or PVGS	
Pinnacle West	Pinnacle West Capital Corporation (any use of the words “Company,” “we,” and “our” refer to Pinnacle West)	
PSA	Power supply adjustor approved by the ACC to provide for recovery or refund of variations in actual fuel and purchased power costs compared with the Base Fuel Rate	
RES	Arizona Renewable Energy Standard and Tariff	
Salt River Project or SRP	Salt River Project Agricultural Improvement and Power District	
SCE	Southern California Edison Company	
TCA	Transmission cost adjustor	
TEAM	Tax expense adjustor mechanism	
VIE	Variable interest entity	

ii

Table of Contents

FORWARD-LOOKING STATEMENTS
 
This document contains forward-looking statements based on current expectations.  These forward-looking statements are often identified by words such as “estimate,” “predict,” “may,” “believe,” “plan,” “expect,” “require,” “intend,” “assume,” “project” 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 outcomes currently expected or sought by Pinnacle West or APS.  In addition to the Risk Factors described in Item 1A and in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report, these factors include, but are not limited to:

•	our ability to manage capital expenditures and operations and maintenance costs while maintaining reliability and customer service levels;	
		
•	variations in demand for electricity, including those due to weather, seasonality, the general economy, customer and sales growth (or decline), and the effects of energy conservation measures and distributed generation;	
		
•	power plant and transmission system performance and outages;	
		
•	competition in retail and wholesale power markets;	
		
•	regulatory and judicial decisions, developments and proceedings;	
		
•	new legislation, ballot initiatives and regulation, including those relating to environmental requirements, regulatory policy, nuclear plant operations and potential deregulation of retail electric markets;	
		
•	fuel and water supply availability;	
		
•	our ability to achieve timely and adequate rate recovery of our costs, including returns on and of debt and equity capital investment;	
		
•	our ability to meet renewable energy and energy efficiency mandates and recover related costs;	
		
•	risks inherent in the operation of nuclear facilities, including spent fuel disposal uncertainty;	
		
•	current and future economic conditions in Arizona, including in real estate markets;	
		
•	the development of new technologies which may affect electric sales or delivery;	
		
•	the cost of debt and equity capital and the ability to access capital markets when required;	
		
•	environmental, economic and other concerns surrounding coal-fired generation, including regulation of greenhouse gas emissions;	
		
•	volatile fuel and purchased power costs;	
		
•	the investment performance of the assets of our nuclear decommissioning trust, pension, and other postretirement benefit plans and the resulting impact on future funding requirements;	
		
•	the liquidity of wholesale power markets and the use of derivative contracts in our business;	
		
•	potential shortfalls in insurance coverage;	
		
•	new accounting requirements or new interpretations of existing requirements;	
		
•	generation, transmission and distribution facility and system conditions and operating costs;	
		
•	the ability to meet the anticipated future need for additional generation and associated transmission facilities in our region;	
		
•	the willingness or ability of our counterparties, power plant participants and power plant land owners to meet contractual or other obligations or extend the rights for continued power plant operations; and	
		
•	restrictions on dividends or other provisions in our credit agreements and ACC orders. 	
 
These and other factors are discussed in the Risk Factors described in Item 1A of this report, and in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report, which readers should review carefully before placing any reliance on our financial statements or disclosures.  Neither Pinnacle West nor APS assumes any obligation to update these statements, even if our internal estimates change, except as required by law.

1

Table of Contents

PART I

ITEM 1.  BUSINESS
  Pinnacle West
 Pinnacle West is a holding company that conducts business through its subsidiaries.  We derive essentially all of our revenues and earnings from our wholly-owned subsidiary, APS.  APS is a vertically-integrated electric utility that provides either retail or 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.
 
Pinnacle West’s other subsidiaries are El Dorado, BCE and 4CA.  Additional information related to these subsidiaries is provided later in this report.
 
Our reportable business segment is 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.
 
BUSINESS OF ARIZONA PUBLIC SERVICE COMPANY
 
APS currently provides electric service to approximately 1.2 million customers.  We own or lease 6,015 MW of regulated generation capacity (which is expected to increase by 510 MW upon completion of the Ocotillo Modernization Project by the middle of 2019) and we hold a mix of both long-term and short-term purchased power agreements for additional capacity, including a variety of agreements for the purchase of renewable energy.  During 2018, no single purchaser or user of energy accounted for more than 2.7% of our electric revenues.

2

Table of Contents

The following map shows APS’s retail service territory, including the locations of its generating facilities and principal transmission lines.

3

Table of Contents

Energy Sources and Resource Planning
To serve its customers, APS obtains power through its various generation stations and through purchased power agreements.  Resource planning is an important function necessary to meet Arizona’s future energy needs.  APS’s sources of energy by type used to supply energy to Native Load customers during 2018 were as follows:

Generation Facilities
 
APS has ownership interests in or leases the coal, nuclear, gas, oil and solar generating facilities described below.  For additional information regarding these facilities, see Item 2.
 
Coal-Fueled Generating Facilities
 
Four Corners — Four Corners is located in the northwestern corner of New Mexico, and was originally a 5-unit coal-fired power plant.  APS owns 100% of Units 1, 2 and 3, which were retired as of December 30, 2013. APS operates the plant and owns 63% of Four Corners Units 4 and 5 following the acquisition of SCE’s interest in Units 4 and 5 described below.  APS has a total entitlement from Four Corners of 970 MW. Additionally, 4CA, a wholly-owned subsidiary of Pinnacle West, owned 7% of Units 4 and 5 from July 2016 through July 2018 following its acquisition of El Paso's interest in these units described below.
 
On December 30, 2013, APS purchased SCE’s 48% interest in each of Units 4 and 5 of Four Corners. Concurrently with the closing of the SCE transaction, BHP Billiton, the parent company of BNCC, the coal

4

Table of Contents

supplier and operator of the mine that served Four Corners, transferred its ownership of BNCC to NTEC, a company formed by the Navajo Nation to own the mine and develop other energy projects. Also occurring concurrently with the closing, the Four Corners’ co-owners executed a long-term agreement for the supply of coal to Four Corners from July 2016 through 2031 (the "2016 Coal Supply Agreement"). El Paso, a 7% owner of Units 4 and 5 of Four Corners, did not sign the 2016 Coal Supply Agreement. Under the 2016 Coal Supply Agreement, APS agreed to assume the 7% shortfall obligation. (See Note 10 for a discussion of certain matters related to the 2016 Coal Supply Agreement.) On February 17, 2015, APS and El Paso entered into an asset purchase agreement providing for the purchase by APS, or an affiliate of APS, of El Paso’s 7% interest in each of Units 4 and 5 of Four Corners. 4CA purchased the El Paso interest on July 6, 2016. The purchase price was immaterial in amount, and 4CA assumed El Paso's reclamation and decommissioning obligations associated with the 7% interest.

NTEC had the option to purchase the 7% interest within a certain timeframe pursuant to an option granted to NTEC. On December 29, 2015, NTEC provided notice of its intent to exercise the option. The purchase did not occur during the originally contemplated timeframe. Concurrent with the settlement of the 2016 Coal Supply Agreement matter described in Note 10, NTEC and 4CA agreed to allow for the purchase by NTEC of the 7% interest, consistent with the option. On June 29, 2018, 4CA and NTEC entered into an asset purchase agreement providing for the sale to NTEC of 4CA's 7% interest in Four Corners. Completion of the sale was subject to the receipt of approval by FERC, which was received on July 2, 2018, and the sale transaction closed on July 3, 2018. NTEC purchased the 7% interest at 4CA’s book value, approximately $70 million, and will pay 4CA the purchase price over a period of four years pursuant to a secured interest-bearing promissory note. In connection with the sale, Pinnacle West guaranteed certain obligations that NTEC will have to the other owners of Four Corners, such as NTEC's 7% share of capital expenditures and operating and maintenance expenses. Pinnacle West's guarantee is secured by a portion of APS's payments to be owed to NTEC under the 2016 Coal Supply Agreement.

The 2016 Coal Supply Agreement contained alternate pricing terms for the 7% interest in the event NTEC did not purchase the interest. Until the time that NTEC purchased the 7% interest, the alternate pricing provisions were applicable to 4CA as the holder of the 7% interest. These terms included a formula under which NTEC must make certain payments to 4CA for reimbursement of operations and maintenance costs and a specified rate of return, offset by revenue generated by 4CA’s power sales. Such payments are due to 4CA at the end of each calendar year. A $10 million payment was due to 4CA at December 31, 2017, which NTEC satisfied by directing to 4CA a prepayment from APS of a portion of a future mine reclamation obligation. The balance of the amount under this formula due December 31, 2018 for calendar year 2017 is approximately $20 million, which was paid to 4CA on December 14, 2018. The balance of the amount under this formula at December 31, 2018 for calendar year 2018 (up to the date that NTEC purchased the 7% interest) is approximately $10 million, which is due to 4CA at December 31, 2019.
  
APS, on behalf of the Four Corners participants, negotiated amendments to an existing facility lease with the Navajo Nation, which extends the Four Corners leasehold interest from 2016 to 2041.  The Navajo Nation approved these amendments in March 2011.  The effectiveness of the amendments also required the approval of the DOI, as did a related federal rights-of-way grant.  A federal environmental review was undertaken as part of the DOI review process, and culminated in the issuance by DOI of a record of decision on July 17, 2015 justifying the agency action extending the life of the plant and the adjacent mine.  

On April 20, 2016, several environmental groups filed a lawsuit against OSM and other federal agencies in the District of Arizona in connection with their issuance of the approvals that extended the life of Four Corners and the adjacent mine.  The lawsuit alleges that these federal agencies violated both the Endangered Species Act ("ESA") and the National Environmental Policy Act ("NEPA") in providing the

5

Table of Contents

federal approvals necessary to extend operations at Four Corners and the adjacent Navajo Mine past July 6, 2016.  APS filed a motion to intervene in the proceedings, which was granted on August 3, 2016.

On September 15, 2016, NTEC, the company that owns the adjacent mine, filed a motion to intervene for the purpose of dismissing the lawsuit based on NTEC's tribal sovereign immunity. On September 11, 2017, the Arizona District Court issued an order granting NTEC's motion, dismissing the litigation with prejudice, and terminating the proceedings. On November 9, 2017, the environmental group plaintiffs appealed the district court order dismissing their lawsuit. Oral argument for this appeal has been scheduled for March 2019. We cannot predict whether this appeal will be successful and, if it is successful, the outcome of further district court proceedings.
 
Cholla — Cholla was originally a 4-unit coal-fired power plant, which is located in northeastern Arizona.  APS operates the plant and owns 100% of Cholla Units 1, 2 and 3.  PacifiCorp owns Cholla Unit 4, and APS operates that unit for PacifiCorp.  On September 11, 2014, APS announced that it would close its 260 MW Unit 2 at Cholla and cease burning coal at Units 1 and 3 by the mid-2020s if EPA approves a compromise proposal offered by APS to meet required environmental and emissions standards and rules. On April 14, 2015, the ACC approved APS's plan to retire Unit 2, without expressing any view on the future recoverability of APS's remaining investment in the Unit, which was later addressed in the March 27, 2017 settlement agreement regarding APS's general retail case (the "2017 Settlement Agreement"). (See Note 3 for details related to the resulting regulatory asset and allowed recovery set forth in the 2017 Settlement Agreement.) APS believes that the environmental benefits of this proposal are greater in the long-term than the benefits that would have resulted from adding the emissions control equipment. APS closed Unit 2 on October 1, 2015. Following the closure of Unit 2, APS has a total entitlement from Cholla of 387 MW.  In early 2017, EPA approved a final rule incorporating APS's compromise proposal, which took effect for Cholla on April 26, 2017.

APS purchases all of Cholla’s coal requirements from a coal supplier that mines all of the coal under long-term leases of coal reserves with the federal and state governments and private landholders.  The Cholla coal contract runs through 2024. In addition, APS has a coal transportation contract that runs through 2019, with the ability to extend the contract annually through 2024.
 
Navajo Plant — The Navajo Plant is a 3-unit coal-fired power plant located in northern Arizona.  Salt River Project operates the plant and APS owns a 14% interest in Units 1, 2 and 3.  APS has a total entitlement from the Navajo Plant of 315 MW.  The Navajo Plant’s coal requirements are purchased from a supplier with long-term leases from the Navajo Nation and the Hopi Tribe.  The Navajo Plant is under contract with its coal supplier through 2019, with extension rights through 2026.  The Navajo Plant site is leased from the Navajo Nation and is also subject to an easement from the federal government. 

The co-owners of the Navajo Plant and the Navajo Nation agreed that the Navajo Plant will remain in operation until December 2019 under the existing plant lease. The co-owners and the Navajo Nation executed a lease extension on November 29, 2017 that will allow for decommissioning activities to begin after the plant ceases operations in December 2019. Various stakeholders, including regulators, tribal representatives, the plant's coal supplier and DOI have been meeting to determine if an alternate solution can be reached that would permit continued operation of the plant beyond 2019. Although we cannot predict whether any alternate plans will be found that would be acceptable to all of the stakeholders and feasible to implement, we believe it is probable that the current owners of the Navajo Plant will cease plant operations in 2019.

APS is currently recovering depreciation and a return on the net book value of its interest in the Navajo Plant over its previously estimated life through 2026. APS will seek continued recovery in rates for the book value of its remaining investment in the plant (see Note 3 for details related to the resulting regulatory asset)

6

Table of Contents

plus a return on the net book value as well as other costs related to retirement and closure, which are still being assessed and which may be material.
    
On February 14, 2017, the ACC opened a docket titled "ACC Investigation Concerning the Future of the Navajo Generating Station" with the stated goal of engaging stakeholders and negotiating a sustainable pathway for the Navajo Plant to continue operating in some form after December 2019. APS cannot predict the outcome of this proceeding.
 These coal-fueled plants face uncertainties, including those related to existing and potential legislation and regulation, that could significantly impact their economics and operations.  See “Environmental Matters” below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview and Capital Expenditures” in Item 7 for developments impacting these coal-fueled facilities.  See Note 10 for information regarding APS’s coal mine reclamation obligations.

Nuclear

Palo Verde Generating Station — Palo Verde is a 3-unit nuclear power plant located approximately 50 miles west of Phoenix, Arizona.  APS operates the plant and owns 29.1% of Palo Verde Units 1 and 3 and approximately 17% of Unit 2.  In addition, APS leases approximately 12.1% of Unit 2, resulting in a 29.1% combined ownership and leasehold interest in that unit.  APS has a total entitlement from Palo Verde of 1,146 MW.
 
Palo Verde Leases — In 1986, APS entered into agreements with three separate lessor trust entities in order to sell and lease back approximately 42% of its share of Palo Verde Unit 2 and certain common facilities.  The leaseback was originally scheduled to expire at the end of 2015 and contained options to renew the leases or to purchase the leased property for fair market value at the end of the lease terms.  On July 7, 2014, APS exercised the fixed rate lease renewal options.  The exercise of the renewal options resulted in APS retaining the assets through 2023 under one lease and 2033 under the other two leases. At the end of the lease renewal periods, APS will have the option to purchase the leased assets at their fair market value, extend the leases for up to two years, or return the assets to the lessors. See Note 18 for additional information regarding the Palo Verde Unit 2 sale leaseback transactions.
 
Palo Verde Operating Licenses — Operation of each of the three Palo Verde Units requires an operating license from the NRC.  The NRC issued full power operating licenses for Unit 1 in June 1985, Unit 2 in April 1986 and Unit 3 in November 1987, and issued renewed operating licenses for each of the three units in April 2011, which extended the licenses for Units 1, 2 and 3 to June 2045, April 2046 and November 2047, respectively.
 
Palo Verde Fuel Cycle — The participant owners of Palo Verde are continually identifying their future nuclear fuel resource needs and negotiating arrangements to fill those needs.  The fuel cycle for Palo Verde is comprised of the following stages:
• mining and milling of uranium ore to produce uranium concentrates;
• conversion of uranium concentrates to uranium hexafluoride;
• enrichment of uranium hexafluoride;
• fabrication of fuel assemblies;
• utilization of fuel assemblies in reactors; and
• storage and disposal of spent nuclear fuel.
    
The Palo Verde participants have contracted for 100% of Palo Verde’s requirements for uranium concentrates through 2025 and 15% through 2028. In 2018, Palo Verde executed five uranium contracts covering the time period from 2019 to 2025.

7

Table of Contents

The participants have contracted for 100% of Palo Verde’s requirements for conversion services through 2025, and 40% through 2030. A long-term contract for conversion services was executed in 2018 covering years 2019 to 2030.

The participants have contracted for 100% of Palo Verde’s requirements for enrichment services through 2021, 90% of enrichment services for 2022, and 80% for 2023 through 2026. In 2018, four enrichment contracts were executed to bring the requirements coverage to these levels.

The participants have contracted for 100% of Palo Verde’s requirements for fuel fabrication through 2027. In 2018, a fabrication contract was executed with a new fabrication supplier for Unit 2, and the existing fabrication contract was renegotiated for Units 1 and 3.

Spent Nuclear Fuel and Waste Disposal — The Nuclear Waste Policy Act of 1982 (“NWPA”) required the DOE to accept, transport, and dispose of spent nuclear fuel and high level waste generated by the nation’s nuclear power plants by 1998.  The DOE’s obligations are reflected in a contract for Disposal of Spent Nuclear Fuel and/or High-Level Radioactive Waste (the “Standard Contract”) with each nuclear power plant.  The DOE failed to begin accepting spent nuclear fuel by 1998.  APS is directly and indirectly involved in several legal proceedings related to the DOE’s failure to meet its statutory and contractual obligations regarding acceptance of spent nuclear fuel and high level waste.
 
APS Lawsuit for Breach of Standard Contract — In December 2003, APS, acting on behalf of itself and the Palo Verde participants, filed a lawsuit against the DOE in the United States Court of Federal Claims ("Court of Federal Claims") for damages incurred due to the DOE’s breach of the Standard Contract.  The Court of Federal Claims ruled in favor of APS and the Palo Verde participants in October 2010 and awarded $30.2 million in damages to APS and the Palo Verde participants for costs incurred through December 2006.
 
On December 19, 2012, APS, acting on behalf of itself and the participant owners of Palo Verde, filed a second breach of contract lawsuit against the DOE in the Court of Federal Claims. This lawsuit sought to recover damages incurred due to the DOE’s breach of the Standard Contract for failing to accept Palo Verde’s spent nuclear fuel and high level waste from January 1, 2007 through June 30, 2011, as it was required to do pursuant to the terms of the Standard Contract and the NWPA. On August 18, 2014, APS and the DOE entered into a settlement agreement, stipulating to a dismissal of the lawsuit and payment of $57.4 million by the DOE to the Palo Verde owners for certain specified costs incurred by Palo Verde during the period January 1, 2007 through June 30, 2011. APS’s share of this amount is $16.7 million. Amounts recovered in the lawsuit and settlement were recorded as adjustments to a regulatory liability and had no impact on the amount of reported net income. In addition, the settlement agreement provides APS with a method for submitting claims and getting recovery for costs incurred through December 31, 2016, which has been extended to December 31, 2019.

APS has submitted and received payment for four claims pursuant to the terms of the August 18, 2014 settlement agreement, for four separate time periods during July 1, 2011 through June 30, 2018. The DOE has paid $74.2 million for these claims (APS’s share is $21.6 million). The amounts recovered were primarily recorded as adjustments to a regulatory liability and had no impact on reported net income. APS's next claim pursuant to the terms of the August 18, 2014 settlement agreement was submitted to the DOE on October 31, 2018 in the amount of $10.2 million (APS's share is $3 million). This claim is pending DOE review.

The One-Mill Fee — In 2011, the National Association of Regulatory Utility Commissioners and the Nuclear Energy Institute challenged the DOE’s 2010 determination of the adequacy of the one tenth of a cent

8

Table of Contents

per kWh fee (the “one-mill fee”) paid by the nation’s commercial nuclear power plant owners pursuant to their individual obligations under the Standard Contract.  This fee is recovered by APS in its retail rates.  In June 2012, the U.S. Court of Appeals for the District of Columbia Circuit (the “D.C. Circuit”) held that the DOE failed to conduct a sufficient fee analysis in making the 2010 determination.  The D.C. Circuit remanded the 2010 determination to the Secretary of the DOE (“Secretary”) with instructions to conduct a new fee adequacy determination within six months.  In February 2013, upon completion of the DOE’s revised one-mill fee adequacy determination, the D.C. Circuit reopened the proceedings.  On November 19, 2013, the D.C. Circuit found that the DOE did not conduct a legally adequate fee assessment and ordered the Secretary to notify Congress of his intent to suspend collecting annual fees for nuclear waste disposal from nuclear power plant operators, as he is required to do pursuant to the NWPA and the D.C. Circuit’s order.  On January 3, 2014, the Secretary notified Congress of his intention to suspend collection of the one-mill fee, subject to Congress’ disapproval. On May 16, 2014, the DOE notified all commercial nuclear power plant operators who are party to a Standard Contract that it reduced the one-mill fee to zero, thus effectively terminating the one-mill fee.
 
DOE’s Construction Authorization Application for Yucca Mountain — The DOE had planned to meet its NWPA and Standard Contract disposal obligations by designing, licensing, constructing, and operating a permanent geologic repository at Yucca Mountain, Nevada.  In June 2008, the DOE submitted its Yucca Mountain construction authorization application to the NRC, but in March 2010, the DOE filed a motion to dismiss with prejudice the Yucca Mountain construction authorization application.  Several interested parties have also intervened in the NRC proceeding.  Additionally, a number of interested parties filed a variety of lawsuits in different jurisdictions around the country challenging the DOE’s authority to withdraw the Yucca Mountain construction authorization application and the NRC’s cessation of its review of the Yucca Mountain construction authorization application.  The cases have been consolidated into one matter at the D.C. Circuit.  In August 2013, the D.C. Circuit ordered the NRC to resume its review of the application with available appropriated funds.

On October 16, 2014, the NRC issued Volume 3 of the safety evaluation report developed as part of the Yucca Mountain construction authorization application. This volume addresses repository safety after permanent closure, and its issuance is a key milestone in the Yucca Mountain licensing process. Volume 3 contains the staff’s finding that the DOE’s repository design meets the requirements that apply after the repository is permanently closed, including but not limited to the post-closure performance objectives in NRC regulations.

On December 18, 2014, the NRC issued Volume 4 of the safety evaluation report developed as part of the Yucca Mountain construction authorization application. This volume covers administrative and programmatic requirements for the repository. It documents the staff’s evaluation of whether the DOE’s research and development and performance confirmation programs, as well as other administrative controls and systems, meet applicable NRC requirements. Volume 4 contains the staff’s finding that most administrative and programmatic requirements in NRC regulations are met, except for certain requirements relating to ownership of land and water rights.

Publication of Volumes 3 and 4 does not signal whether or when the NRC might authorize construction of the repository.
 
Waste Confidence and Continued Storage — On June 8, 2012, the D.C. Circuit issued its decision on a challenge by several states and environmental groups of the NRC’s rulemaking regarding temporary storage and permanent disposal of high level nuclear waste and spent nuclear fuel.  The petitioners had challenged the NRC’s 2010 update to the agency’s waste confidence decision and temporary storage rule (“Waste Confidence Decision”).

9

Table of Contents

The D.C. Circuit found that the agency’s Waste Confidence Decision update constituted a major federal action, which, consistent with NEPA, requires either an environmental impact statement or a finding of no significant impact from the agency’s actions.  The D.C. Circuit found that the NRC’s evaluation of the environmental risks from spent nuclear fuel was deficient, and therefore remanded the Waste Confidence Decision update for further action consistent with NEPA.
 
On September 6, 2012, the NRC Commissioners issued a directive to the NRC staff to proceed directly with development of a generic environmental impact statement to support an updated Waste Confidence Decision.  The NRC Commissioners also directed the staff to establish a schedule to publish a final rule and environmental impact study within 24 months of September 6, 2012. 

In September 2013, the NRC issued its draft Generic Environmental Impact Statement (“GEIS”) to support an updated Waste Confidence Decision. On August 26, 2014, the NRC approved a final rule on the environmental effects of continued storage of spent nuclear fuel. Renamed as the Continued Storage Rule, the NRC’s decision adopted the findings of the GEIS regarding the environmental impacts of storing spent fuel at any reactor site after the reactor’s licensed period of operations. As a result, those generic impacts do not need to be re-analyzed in the environmental reviews for individual licenses. Although Palo Verde had not been involved in any licensing actions affected by the D.C. Circuit’s June 8, 2012, decision, the NRC lifted its suspension on final licensing actions on all nuclear power plant licenses and renewals that went into effect when the D.C. Circuit issued its June 2012 decision. The final Continued Storage Rule was subject to continuing legal challenges before the NRC and the Court of Appeals. In June 2016, the D.C. Circuit issued its final decision, rejecting all remaining legal challenges to the Continued Storage Rule. On August 8, 2016, the D.C. Circuit denied a petition for rehearing.

Palo Verde has sufficient capacity at its on-site independent spent fuel storage installation (“ISFSI”) to store all of the nuclear fuel that will be irradiated during the initial operating license period, which ends in December 2027.  Additionally, Palo Verde has sufficient capacity at its on-site ISFSI to store a portion of the fuel that will be irradiated during the period of extended operation, which ends in November 2047.  If uncertainties regarding the United States government’s obligation to accept and store spent fuel are not favorably resolved, APS will evaluate alternative storage solutions that may obviate the need to expand the ISFSI to accommodate all of the fuel that will be irradiated during the period of extended operation.
 
Nuclear Decommissioning Costs — APS currently relies on an external sinking fund mechanism to meet the NRC financial assurance requirements for decommissioning its interests in Palo Verde Units 1, 2 and 3.  The decommissioning costs of Palo Verde Units 1, 2 and 3 are currently included in APS’s ACC jurisdictional rates.  Decommissioning costs are recoverable through a non-bypassable system benefits charge (paid by all retail customers taking service from the APS system).  Based on current nuclear decommissioning trust asset balances, site specific decommissioning cost studies, anticipated future contributions to the decommissioning trusts, and return projections on the asset portfolios over the expected remaining operating life of the facility, we are on track to meet the current site specific decommissioning costs for Palo Verde at the time the units are expected to be decommissioned. See Note 19 for additional information about APS’s nuclear decommissioning trusts.
 
Palo Verde Liability and Insurance Matters — See “Palo Verde Generating Station — Nuclear Insurance” in Note 10 for a discussion of the insurance maintained by the Palo Verde participants, including APS, for Palo Verde.

10

Table of Contents

Natural Gas and Oil Fueled Generating Facilities

APS has six natural gas power plants located throughout Arizona, consisting of Redhawk, located near Palo Verde; Ocotillo, located in Tempe (discussed below); Sundance, located in Coolidge; West Phoenix, located in southwest Phoenix; Saguaro, located north of Tucson; and Yucca, located near Yuma.  Several of the units at Yucca run on either gas or oil.  APS has two oil-only power plants: Fairview, located in the town of Douglas, Arizona and Yucca GT-4 in Yuma, AZ.  APS owns and operates each of these plants with the exception of one oil-only combustion turbine unit and one oil and gas steam unit at Yucca that are operated by APS and owned by the Imperial Irrigation District.  APS has a total entitlement from these plants of 3,179 MW.  Gas for these plants is financially hedged up to five years in advance of purchasing and the gas is generally purchased one month prior to delivery.  APS has long-term gas transportation agreements with three different companies, some of which are effective through 2024.  Fuel oil is acquired under short-term purchases delivered by truck directly to the power plants.

Ocotillo was originally a 330 MW 4-unit gas plant located in the metropolitan Phoenix area.  In early 2014, APS announced a project to modernize the plant, which involves retiring two older 110 MW steam units, adding five 102 MW combustion turbines and maintaining two existing 55 MW combustion turbines.  In total, this increases the capacity of the site by 290 MW to 620 MW.  (See Note 3 for rate recovery as part of the ACC final written Opinion and Order issued reflecting its decision in APS’s general retail rate case (the "2017 Rate Case Decision")). On September 9, 2016, Maricopa County issued a final permit decision that authorizes construction of the Ocotillo modernization project and construction began in early 2017 with completion targeted by the middle of 2019.

Solar Facilities
APS developed utility scale solar resources through the 170 MW ACC-approved AZ Sun Program, investing approximately $675 million in this program. These facilities are owned by APS and are located in multiple locations throughout Arizona. In addition to the AZ Sun Program, APS developed the 40 MW Red Rock Solar Plant, which it owns and operates. Two of our large customers purchase renewable energy credits from APS that are equivalent to the amount of renewable energy that Red Rock is projected to generate.
 
APS owns and operates more than forty small solar systems around the state.  Together they have the capacity to produce approximately 4 MW of renewable energy.  This fleet of solar systems includes a 3 MW facility located at the Prescott Airport and 1 MW of small solar systems in various locations across Arizona.  APS has also developed solar photovoltaic distributed energy systems installed as part of the Community Power Project in Flagstaff, Arizona.  The Community Power Project, approved by the ACC on April 1, 2010, was a pilot program through which APS owns, operates and receives energy from approximately 1 MW of solar photovoltaic distributed energy systems located within a certain test area in Flagstaff, Arizona.  The pilot program is now complete, and as part of the 2017 Rate Case Decision, the participants have been transferred to the Solar Partner Program described below. Additionally, APS owns 12 MW of solar photovoltaic systems installed across Arizona through the ACC-approved Schools and Government Program.

In December 2014, the ACC voted that it had no objection to APS implementing an APS-owned rooftop solar research and development program aimed at learning how to efficiently enable the integration of rooftop solar and battery storage with the grid.  The first stage of the program, called the "Solar Partner Program," placed 8 MW of residential rooftop solar on strategically selected distribution feeders in an effort to maximize potential system benefits, as well as made systems available to limited-income customers who could not easily install solar through transactions with third parties. The second stage of the program, which included an additional 2 MW of rooftop solar and energy storage, placed two energy storage systems sized at 2 MW on two different high solar penetration feeders to test various grid-related operation improvements and system

11

Table of Contents

interoperability, and was in operation by the end of 2016.  The costs for this program have been included in APS's rate base as part of the 2017 Rate Case Decision.
In the 2017 Rate Case Decision, the ACC also approved the "APS Solar Communities" program. APS Solar Communities is a three-year program authorizing APS to spend $10 million - $15 million in capital costs each year to install utility-owned distributed generation systems on low to moderate income residential homes, buildings of non-profit entities, Title I schools and rural government facilities. The 2017 Rate Case Decision provided that all operations and maintenance expenses, property taxes, marketing and advertising expenses, and the capital carrying costs for this program will be recovered through the RES.
Energy Storage

APS deploys a number of advanced technologies on its system, including energy storage. Storage can provide capacity, improve power quality, be utilized for system regulation, integrate renewable generation, and can be used to defer certain traditional infrastructure investments. Battery storage can also aid in integrating higher levels of renewables by storing excess energy when system demand is low and renewable production is high and then releasing the stored energy during peak demand hours later in the day and after sunset. APS is utilizing grid-scale battery storage projects to evaluate the potential benefits for customers and further our understanding of how storage works with other advanced technologies and the grid. We are preparing for additional battery storage in the future.

In early 2018, APS entered into a 15-year power purchase agreement for a 65 MW solar facility that charges a 50 MW solar-fueled battery. Service under this agreement is scheduled to begin in 2021. APS issued a request for proposal for approximately 106 MW of battery storage to be located at up to five of its AZ Sun sites. Based upon our evaluation of the RFP responses, APS has decided to expand the initial phase of battery deployment to 141 MW by adding a sixth AZ Sun site. In February 2019, we contracted for the 141 MW and anticipate such facilities could be in service by mid-2020. Additionally, in February 2019, APS signed two 20-year power purchase agreements for energy storage totaling 150 MW. Service under these agreements are scheduled to begin in 2021.  We plan to install at least an additional 660 MW of APS-owned solar plus battery storage and stand-alone battery storage systems by the summer of 2025, with the first 260 MW being procured in 2019 (60 MW on additional AZ Sun sites and 100 MW of solar plus 100 MW of battery storage). 

Purchased Power Contracts
In addition to its own available generating capacity, APS purchases electricity under various arrangements, including long-term contracts and purchases through short-term markets to supplement its owned or leased generation and hedge its energy requirements.  A portion of APS’s purchased power expense is netted against wholesale sales on the Consolidated Statements of Income.  (See Note 16.)  APS continually assesses its need for additional capacity resources to assure system reliability. In addition, APS has also entered into several power purchase agreements for energy storage. (See "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Energy Storage" above for details of our energy storage power purchase agreements.)

12

Table of Contents

Purchased Power Capacity — APS’s purchased power capacity under long-term contracts as of December 31, 2018 is summarized in the table below.  All capacity values are based on net capacity unless otherwise noted.

						
Type	 	Dates Available	 	Capacity (MW)	
Purchase Agreement (a)	 	Year-round through June 14, 2020	 	60		
Exchange Agreement (b)	 	May 15 to September 15 annually through February 2021	 	480		
Tolling Agreement	 	Summer seasons through October 2019	 	560		
Demand Response Agreement (c)	 	Summer seasons through 2024	 	25		
Tolling Agreement	 	Summer seasons from Summer 2020 through Summer 2025	 	565		
Tolling Agreement	 	June 1 through September 30, 2020-2026	 	570		
Renewable Energy (d)	 	Various	 	629		
		
(a)	Up to 60 MW of capacity is available; however, the amount of electricity available to APS under this agreement is based in large part on customer demand and is adjusted annually.	
		
(b)	This is a seasonal capacity exchange agreement under which APS receives electricity during the summer peak season (from May 15 to September 15) and APS returns a like amount of electricity during the winter season (from October 15 to February 15).	
		
(c)	The capacity under this agreement may be increased in 10 MW increments in years 2017 through 2024, up to a maximum of 50 MW.	
		
(d)	Renewable energy purchased power agreements are described in detail below under “Current and Future Resources — Renewable Energy Standard — Renewable Energy Portfolio.”	

In February 2019, APS entered into a power purchase agreement for 463 MW of summer seasonal capacity from May to October annually from 2021 through 2027.
Current and Future Resources
 
Current Demand and Reserve Margin
Electric power demand is generally seasonal.  In Arizona, demand for power peaks during the hot summer months.  APS’s 2018 peak one-hour demand on its electric system was recorded on July 24, 2018 at 7,320 MW, compared to the 2017 peak of 7,363 MW recorded on June 20, 2017.  APS’s reserve margin at the time of the 2018 peak demand, calculated using system load serving capacity, was 18%.  For 2019, due to expiring purchase contracts, APS is procuring market resources to maintain its minimum 15% planning reserve criteria.

Future Resources and Resource Plan
APS filed its preliminary 2017 Integrated Resource Plan ("IRP") on March 1, 2016 and an updated preliminary 2017 IRP on September 30, 2016. In March of 2018, the ACC reviewed the 2017 IRPs of its jurisdictional utilities and voted to not acknowledge any of the plans.  APS does not believe that this lack of acknowledgment will have a material impact on our financial position, results of operations or cash flows.  Based on an ACC decision, APS is required to file a Preliminary IRP by April 1, 2019 and its final IRP by April 1, 2020.

See "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities" above for information regarding future plans for the Cholla Plant, Four Corners Plant, Navajo Plant and Ocotillo Plant. See "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Purchased Power Contracts" above for information regarding future plans for purchased power contracts.

13

Table of Contents

Energy Imbalance Market

In 2015, APS and the CAISO, the operator for the majority of California's transmission grid, signed an agreement for APS to begin participation in the Energy Imbalance Market (“EIM”). APS's participation in the EIM began on October 1, 2016.  The EIM allows for rebalancing supply and demand in 15-minute blocks, with dispatching every five minutes before the energy is needed, instead of the traditional one hour blocks.  APS continues to expect that its participation in EIM will lower its fuel costs, improve visibility and situational awareness for system operations in the Western Interconnection power grid, and improve integration of APS’s renewable resources.

Renewable Energy Standard
In 2006, the ACC adopted the RES.  Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies.  The renewable energy requirement is 9% of retail electric sales in 2019 and increases annually until it reaches 15% in 2025.  In APS’s 2009 general retail rate case settlement agreement (the “2009 Settlement Agreement”), APS committed to use its best efforts to have 1,700 GWh of new renewable resources in service by year-end 2015 in addition to its RES renewable resource commitments. APS met its settlement commitment in 2015.
A component of the RES is focused on stimulating development of distributed energy systems.  Accordingly, under the RES, an increasing percentage of that requirement must be supplied from distributed energy resources.  This distributed energy requirement is 30% of the overall RES requirement of 9% in 2019. On June 29, 2018, APS filed its 2019 RES Implementation Plan and requested a permanent waiver of the residential distributed energy requirement for 2019. The following table summarizes the RES requirement standard (not including the additional commitment required by the 2009 Settlement Agreement) and its timing:

	
						
 	2019	 	2020	 	2025	
RES as a % of retail electric sales	9%	 	10%	 	15%	
Percent of RES to be supplied from distributed energy resources	30%	 	30%	 	30%	

On April 21, 2015, the RES rules were amended to require utilities to report on all eligible renewable resources in their service territory, irrespective of whether the utility owns renewable energy credits associated with such renewable energy. The rules allow the ACC to consider such information in determining whether APS has satisfied the requirements of the RES. See "Clean Resource Energy Standard and Tariff" in Note 3 for information regarding an additional renewable energy standards proposal.

14

Table of Contents

Renewable Energy Portfolio.  To date, APS has a diverse portfolio of existing and planned renewable resources totaling 1,806 MW, including solar, wind, geothermal, biomass and biogas.  Of this portfolio, 1,717 MW are currently in operation and 89 MW are under contract for development or are under construction.  Renewable resources in operation include 238 MW of facilities owned by APS, 629 MW of long-term purchased power agreements, and an estimated 817 MW of customer-sited, third-party owned distributed energy resources.
 
APS’s strategy to achieve its RES requirements includes executing purchased power contracts for new facilities, ongoing development of distributed energy resources and procurement of new facilities to be owned by APS.  See "Energy Sources and Resource Planning - Generation Facilities - Solar Facilities" above for information regarding APS-owned solar facilities.

The following table summarizes APS’s renewable energy sources currently in operation and under development as of December 31, 2018.  Agreements for the development and completion of future resources are subject to various conditions, including successful siting, permitting and interconnection of the projects to the electric grid.

15

Table of Contents

	
															
 	 	Location	 	Actual/
  Target
Commercial
Operation
Date	 	Term
(Years)	 	Net
  Capacity
  In Operation
(MW AC)	 	Net Capacity
  Planned/Under
Development
(MW AC)	 	
APS Owned	 	 	 	 	 	 		 	 		 	 		 	
Solar:	 	 	 	 	 	 		 	 		 	 		 	
AZ Sun Program:	 	 	 	 	 	 		 	 		 	 		 	
Paloma	 	Gila Bend, AZ	 	2011	 	 		 	17		 	 		 	
Cotton Center	 	Gila Bend, AZ	 	2011	 	 		 	17		 	 		 	
Hyder Phase 1	 	Hyder, AZ	 	2011	 	 		 	11		 	 		 	
Hyder Phase 2	 	Hyder, AZ	 	2012	 	 		 	5		 	 		 	
Chino Valley	 	Chino Valley, AZ	 	2012	 	 		 	19		 	 		 	
Hyder II	 	Hyder, AZ	 	2013	 	 		 	14		 	 		 	
Foothills	 	Yuma, AZ	 	2013	 	 		 	35		 	 		 	
Gila Bend	 	Gila Bend, AZ	 	2014	 	 		 	32		 	 	 	
Luke AFB	 	Glendale, AZ	 	2015	 	 	 	10		 	 	 	
Desert Star	 	Buckeye, AZ	 	2015	 	 	 	10		 	 	 	
Subtotal AZ Sun Program	 	 	 	 	 	 		 	170		 	—		 	
Multiple Facilities	 	AZ	 	Various	 	 		 	4		 	 		 	
Red Rock	 	Red Rock, AZ	 	2016	 	 	 	40		 	 	 	
Distributed Energy:	 	 	 	 	 	 		 	 		 	 		 	
APS Owned (a)	 	AZ	 	Various	 	 		 	24		 	 	 	
Total APS Owned	 	 	 	 	 	 		 	238		 	—		 	
Purchased Power Agreements	 	 	 	 	 	 		 	 		 	 		 	
Solar:	 	 	 	 	 	 		 	 		 	 		 	
Solana	 	Gila Bend, AZ	 	2013	 	30		 	250		 	 		 	
RE Ajo	 	Ajo, AZ	 	2011	 	25		 	5		 	 		 	
Sun E AZ 1	 	Prescott, AZ	 	2011	 	30		 	10		 	 		 	
Saddle Mountain	 	Tonopah, AZ	 	2012	 	30		 	15		 	 		 	
Badger	 	Tonopah, AZ	 	2013	 	30		 	15		 	 		 	
Gillespie	 	Maricopa County, AZ	 	2013	 	30		 	15		 	 		 	
Solar + Energy Storage:	 	 	 	 	 	 	 	 	 	 	 	
  Sun Streams	 	Arlington, AZ	 	2021	 	15		 	 	 	50		 	
Wind:	 	 	 	 	 	 		 	 		 	 		 	
Aragonne Mesa	 	Santa Rosa, NM	 	2006	 	20		 	90		 	 		 	
High Lonesome	 	Mountainair, NM	 	2009	 	30		 	100		 	 		 	
Perrin Ranch Wind	 	Williams, AZ	 	2012	 	25		 	99		 	 		 	
Geothermal:	 	 	 	 	 	 		 	 		 	 		 	
Salton Sea	 	Imperial County, CA	 	2006	 	23		 	10		 	 		 	
Biomass:	 	 	 	 	 	 		 	 		 	 		 	
Snowflake	 	Snowflake, AZ	 	2008	 	15		 	14		 	 		 	
Biogas:	 	 	 	 	 	 		 	 		 	 		 	
Glendale Landfill	 	Glendale, AZ	 	2010	 	20		 	3		 	 		 	
NW Regional Landfill	 	Surprise, AZ	 	2012	 	20		 	3		 	 		 	
Total Purchased Power Agreements	 	 	 	 	 	 		 	629		 	50		 	
Distributed Energy	 	 	 	 	 	 		 	 		 	 		 	
Solar  (b)	 	 	 	 	 	 		 	 		 	 		 	
Third-party Owned	 	AZ	 	Various	 	 		 	817		 	39		 	
Agreement 1	 	Bagdad, AZ	 	2011	 	25		 	15		 	 		 	
Agreement 2	 	AZ	 	2011-2012	 	20-21		 	18		 	 		 	
Total Distributed Energy	 	 	 	 	 	 		 	850		 	39		 	
Total Renewable Portfolio	 	 	 	 	 	 		 	1,717		 	89		 	

16

Table of Contents

(a)	Includes Flagstaff Community Power Project, APS School and Government Program and APS Solar Partner Program.	
		
(b)	Includes rooftop solar facilities owned by third parties. Distributed generation is produced in DC and is converted to AC for reporting purposes.	

Demand Side Management
 In December 2009, Arizona regulators placed an increased focus on energy efficiency and other demand side management programs to encourage customers to conserve energy, while incentivizing utilities to aid in these efforts that ultimately reduce the demand for energy.  The ACC initiated its Energy Efficiency rulemaking, with a proposed EES of 22% cumulative annual energy savings by 2020.  This standard was adopted and became effective on January 1, 2011.  This standard will likely impact Arizona’s future energy resource needs.  (See Note 3 for energy efficiency and other demand side management obligations).
 
Competitive Environment and Regulatory Oversight
 
Retail
 
The ACC regulates APS’s retail electric rates and its issuance of securities.  The ACC must also approve any significant transfer or encumbrance of APS’s property used to provide retail electric service and approve or receive prior notification of certain transactions between Pinnacle West, APS and their respective affiliates. (See Note 3 for information regarding ACC's regulation of APS's retail electric rates.)
 
APS is subject to varying degrees of competition from other investor-owned electric and gas utilities in Arizona (such as Southwest Gas Corporation), as well as cooperatives, municipalities, electrical districts and similar types of governmental or non-profit organizations.  In addition, some customers, particularly industrial and large commercial customers, may own and operate generation facilities to meet some or all of their own energy requirements.  This practice is becoming more popular with customers installing or having installed products such as rooftop solar panels to meet or supplement their energy needs.
 
On May 9, 2013, the ACC voted to re-examine the facilitation of a deregulated retail electric market in Arizona.  The ACC subsequently opened a docket for this matter and received comments from a number of interested parties on the considerations involved in establishing retail electric deregulation in the state.  One of these considerations was whether various aspects of a deregulated market, including setting utility rates on a “market” basis, would be consistent with the requirements of the Arizona Constitution.  On September 11, 2013, after receiving legal advice from the ACC staff, the ACC voted 4-1 to close the current docket and await full Arizona Constitutional authority before any further examination of this matter.  The motion approved by the ACC also included opening one or more new dockets in the future to explore options to offer more rate choices to customers and innovative changes within the existing cost-of-service regulatory model that could include elements of competition.  The ACC opened a docket on November 4, 2013 to explore technological advances and innovative changes within the electric utility industry.  A series of workshops in this docket were held in 2014 and another in February of 2015.

On November 17, 2018, the ACC voted 5-0 to again re-examine retail competition. A Special Open Meeting Workshop was held on December 3, 2018. No substantive action was taken, but interested parties were asked to submit written comments and respond to a list of questions from ACC Staff. Those comments and responses are still being submitted. The ACC is planning at least one more workshop on the issue in 2019. APS cannot predict whether these efforts will result in any changes.

17

Table of Contents

Wholesale
 
FERC regulates rates for wholesale power sales and transmission services.  (See Note 3 for information regarding APS’s transmission rates.)  During 2018, approximately 4.7% of APS’s electric operating revenues resulted from such sales and services.  APS’s wholesale activity primarily consists of managing fuel and purchased power supplies to serve retail customer energy requirements.  APS also sells, in the wholesale market, its generation output that is not needed for APS’s Native Load and, in doing so, competes with other utilities, power marketers and independent power producers.  Additionally, subject to specified parameters, APS hedges both electricity and fuels.  The majority of these activities are undertaken to mitigate risk in APS’s portfolio.

Subpoena from Arizona Corporation Commissioner Robert Burns   

On August 25, 2016, Commissioner Burns, individually and not by action of the ACC as a whole, served subpoenas in APS’s then current retail rate proceeding on APS and Pinnacle West for the production of records and information relating to a range of expenditures from 2011 through 2016. The subpoenas requested information concerning marketing and advertising expenditures, charitable donations, lobbying expenses, contributions to 501(c)(3) and (c)(4) nonprofits and political contributions. The return date for the production of information was set as September 15, 2016. The subpoenas also sought testimony from Company personnel having knowledge of the material, including the Chief Executive Officer.

On September 9, 2016, APS filed with the ACC a motion to quash the subpoenas or, alternatively, to stay APS's obligations to comply with the subpoenas and decline to decide APS's motion pending court proceedings. Contemporaneously with the filing of this motion, APS and Pinnacle West filed a complaint for special action and declaratory judgment in the Superior Court of Arizona for Maricopa County, seeking a declaratory judgment that Commissioner Burns’ subpoenas are contrary to law. On September 15, 2016, APS produced all non-confidential and responsive documents and offered to produce any remaining responsive documents that are confidential after an appropriate confidentiality agreement is signed.

On February 7, 2017, Commissioner Burns opened a new ACC docket and indicated that its purpose is to study and rectify problems with transparency and disclosure regarding financial contributions from regulated monopolies or other stakeholders who may appear before the ACC that may directly or indirectly benefit an ACC Commissioner, a candidate for ACC Commissioner, or key ACC Staff.  As part of this docket, Commissioner Burns set March 24, 2017 as a deadline for the production of all information previously requested through the subpoenas. Neither APS nor Pinnacle West produced the information requested and instead objected to the subpoena. On March 10, 2017, Commissioner Burns filed suit against APS and Pinnacle West in the Superior Court of Arizona for Maricopa County in an effort to enforce his subpoenas. On March 30, 2017, APS filed a motion to dismiss Commissioner Burns' suit against APS and Pinnacle West. In response to the motion to dismiss, the court stayed the suit and ordered Commissioner Burns to file a motion to compel the production of the information sought by the subpoenas with the ACC. On June 20, 2017, the ACC denied the motion to compel.

On August 4, 2017, Commissioner Burns amended his complaint to add all of the ACC Commissioners and the ACC itself as defendants. All defendants moved to dismiss the amended complaint. On February 15, 2018, the Superior Court dismissed Commissioner Burns’ amended complaint. On March 6, 2018, Commissioner Burns filed an objection to the proposed final order from the Superior Court and a motion to further amend his complaint. The Superior Court permitted Commissioner Burns to amend his complaint to add a claim regarding his attempted investigation into whether his fellow commissioners should have been disqualified from voting on APS’s 2017 rate case. Commissioner Burns filed his second amended complaint, and all defendants filed responses opposing the second amended complaint and requested that it be dismissed.

18

Table of Contents

Oral argument occurred in November 2018 regarding the motion to dismiss. On December 18, 2018, the trial court granted the defendants’ motions to dismiss and entered final judgment on January 18, 2019. On February 13, 2019, Commissioner Burns filed a notice of appeal. APS and Pinnacle West cannot predict the outcome of this matter.

Environmental Matters

Climate Change

Legislative Initiatives. There have been no recent successful attempts by Congress to pass legislation that would regulate greenhouse gas ("GHG") emissions, and it is unclear at this time whether the 116 th Congress will consider a climate change bill. In the event climate change legislation ultimately passes, the actual economic and operational impact of such legislation on APS depends on a variety of factors, none of which can be fully known until a law is written and enacted and the specifics of the resulting program are established. These factors include the terms of the legislation with regard to allowed GHG emissions; the cost to reduce emissions; in the event a cap-and-trade program is established, whether any permitted emissions allowances will be allocated to source operators free of cost or auctioned (and, if so, the cost of those allowances in the marketplace) and whether offsets and other measures to moderate the costs of compliance will be available; and, in the event of a carbon tax, the amount of the tax per pound of carbon dioxide (“CO 2 ”) equivalent emitted.

In addition to federal legislative initiatives, state-specific initiatives may also impact our business. While Arizona has no pending legislation and no proposed agency rule regulating GHGs in Arizona at this time, the California legislature enacted AB 32 and SB 1368 in 2006 to address GHG emissions. In October 2011, the California Air Resources Board approved final regulations that established a state-wide cap on GHG emissions beginning on January 1, 2013 and established a GHG allowance trading program under that cap. The first phase of the program, which applies to, among other entities, importers of electricity, commenced on January 1, 2013. Under the program, entities selling electricity into California, including APS, must hold carbon allowances to cover GHG emissions associated with electricity sales into California from outside the state. APS is authorized to recover the cost of these carbon allowances through the PSA.

Regulatory Initiatives. In 2009, EPA determined that GHG emissions endanger public health and welfare. As a result of this “endangerment finding,” EPA determined that the Clean Air Act required new regulatory requirements for new and modified major GHG emitting sources, including power plants. APS will generally be required to consider the impact of GHG emissions as part of its traditional New Source Review ("NSR") analysis for new major sources and major modifications to existing plants.

On June 2, 2014, EPA issued two proposed rules to regulate GHG emissions from modified and reconstructed electric generating units ("EGUs") pursuant to Section 111(b) of the Clean Air Act and existing fossil fuel-fired power plants pursuant to Clean Air Act Section 111(d). On August 3, 2015, EPA finalized carbon pollution standards for EGUs, the "Clean Power Plan". On October 10, 2017, EPA issued a proposal to repeal the Clean Power Plan and proposed replacement regulations on August 21, 2018. In addition, judicial challenges to the Clean Power Plan are pending before the D.C. Circuit, though that litigation is currently in abeyance while EPA develops regulatory action to potentially repeal and replace that regulation.

EPA's pending proposal to regulate carbon emissions from EGUs replaces the Clean Power Plan with standards that are based entirely upon measures that can be implemented to improve the heat rate of steam-electric power plants, specifically coal-fired EGUs. In contrast with the Clean Power Plan, EPA's proposed "Affordable Clean Energy Rule" would not involve utility-level generation dispatch shifting away from coal-fired generation and toward renewable energy resources and natural gas-fired combined cycle power plants. In

19

Table of Contents

addition, to address the NSR implications of power plant upgrades potentially necessary to achieve compliance with the proposed Affordable Clean Energy Rule standards, EPA also proposed to revise EPA's NSR regulations to more readily authorize the implementation of EGU efficiency upgrades.

We cannot predict the outcome of EPA's regulatory actions related to the August 2015 carbon pollution standards for EGU's, including any actions related to EPA's repeal proposal for the Clean Power Plan or additional rulemaking actions to approve the EPA's recently proposed Affordable Clean Energy Rule. In addition, we cannot predict whether the D.C. Circuit Court will continue to hold the litigation challenging the original Clean Power Plan in abeyance in light of EPA's repeal proposal, which is still pending.

Company Response to Climate Change Initiatives . We have undertaken a number of initiatives that address emission concerns, including renewable energy procurement and development, promotion of programs and rates that promote energy conservation, renewable energy use, and energy efficiency. (See “Energy Sources and Resource Planning - Current and Future Resources” above for details of these plans and initiatives.) APS currently has a diverse portfolio of renewable resources, including solar, wind, geothermal, biogas, and biomass.
APS prepares an annual inventory of GHG emissions from its operations. For APS's operations involving fossil-fuel electricity generation and electricity transmission and distribution, APS's annual GHG inventory is reported to EPA under the EPA GHG Reporting Program. APS also voluntarily tracks and reports the full-scope of the Company's GHG emissions arising from all APS operations. In addition to GHG emissions from generation and transmission and distribution operations, this data includes all other GHG emissions arising from ancillary Company operations, such as vehicle use, employee travel, portable generators and facility energy usage. This data is then voluntarily communicated to the public in Pinnacle West’s annual Corporate Responsibility Report, which is available on our website ( www.pinnaclewest.com ). The report provides information related to the Company and its approach to sustainability and its workplace and environmental performance. The information on Pinnacle West’s website, including the Corporate Responsibility Report, is not incorporated by reference into or otherwise a part of this report.
  
EPA Environmental Regulation

Regional Haze Rules . In 1999, EPA announced regional haze rules to reduce visibility impairment in national parks and wilderness areas. The rules require states (or, for sources located on tribal land, EPA) to determine what pollution control technologies constitute the BART for certain older major stationary sources, including fossil-fired power plants. EPA subsequently issued the Clean Air Visibility Rule, which provides guidelines on how to perform a BART analysis.

Cholla. APS believed that EPA’s original 2012 final rule establishing controls constituting BART for Cholla, which would require installation of selective catalytic reduction ("SCR") controls, was unsupported and that EPA had no basis for disapproving Arizona’s State Implementation Plan ("SIP") and promulgating a Federal Implementation Plan ("FIP") that was inconsistent with the state’s considered BART determinations under the regional haze program.  In September 2014, APS met with EPA to propose a compromise BART strategy, whereby APS would permanently close Cholla Unit 2 and cease burning coal at Units 1 and 3 by the mid-2020s. (See Note 3 for details related to the resulting regulatory asset.) APS made the proposal with the understanding that additional emission control equipment is unlikely to be required in the future because retiring and/or converting the units as contemplated in the proposal is more cost effective than, and will result in increased visibility improvement over, the BART requirements for oxides of nitrogen ("NOx") imposed through EPA's BART FIP. In early 2017, EPA approved a final rule incorporating APS's compromise proposal, which took effect for Cholla on April 26, 2017.

20

Table of Contents

Four Corners . Based on EPA’s final standards, APS's 63% share of the cost of required BART controls for Four Corners Units 4 and 5 is approximately $400 million, the majority of which has already been incurred.  (See Note 3 for information regarding the related rate recovery.) In addition, APS and El Paso entered into an asset purchase agreement providing for the purchase by APS, or an affiliate of APS, of El Paso's 7% interest in Four Corners Units 4 and 5. 4CA purchased the El Paso interest on July 6, 2016. NTEC purchased the interest from 4CA on July 3, 2018. (See "Four Corners Coal Supply Agreement - 4CA Matter" in Note 10 for a discussion of the NTEC purchase.) The cost of the pollution controls related to the 7% interest is approximately $45 million, which was assumed by NTEC through its purchase of the 7% interest.
 
Navajo Plant . APS estimates that its share of costs for upgrades at the Navajo Plant, based on EPA’s FIP, could be up to approximately $200 million; however, given the future plans for the Navajo Plant, we do not expect to incur these costs.  See "Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities - Navajo Generating Station" above and "Navajo Plant" in Note 3 for information regarding future plans for the Navajo Plant.

Coal Combustion Waste. On December 19, 2014, EPA issued its final regulations governing the handling and disposal of CCR, such as fly ash and bottom ash. The rule regulates CCR as a non-hazardous waste under Subtitle D of the Resource Conservation and Recovery Act ("RCRA") and establishes national minimum criteria for existing and new CCR landfills and surface impoundments and all lateral expansions consisting of location restrictions, design and operating criteria, groundwater monitoring and corrective action, closure requirements and post closure care, and recordkeeping, notification, and internet posting requirements. The rule generally requires any existing unlined CCR surface impoundment that is contaminating groundwater above a regulated constituent’s groundwater protection standard to stop receiving CCR and either retrofit or close, and further requires the closure of any CCR landfill or surface impoundment that cannot meet the applicable performance criteria for location restrictions or structural integrity. Such closure requirements are deemed "forced closure" or "closure for cause" of unlined surface impoundments, and are the subject of recent regulatory and judicial activities described below.

On December 16, 2016, President Obama signed the Water Infrastructure Improvements for the Nation ("WIIN") Act into law, which contains a number of provisions requiring EPA to modify the self-implementing provisions of the Agency's current CCR rules under Subtitle D. Such modifications include new EPA authority to directly enforce the CCR rules through the use of administrative orders and providing states, like Arizona, where the Cholla facility is located, the option of developing CCR disposal unit permitting programs, subject to EPA approval. For facilities in states that do not develop state-specific permitting programs, EPA is required to develop a federal permit program, pending the availability of congressional appropriations. By contrast, for facilities located within the boundaries of Native American tribal reservations, such as the Navajo Nation, where the Navajo Plant and Four Corners facilities are located, EPA is required to develop a federal permit program regardless of appropriated funds.

ADEQ has initiated a process to evaluate how to develop a state CCR permitting program that would cover EGUs, including Cholla. While APS has been working with ADEQ on the development of this program, we are unable to predict when Arizona will be able to finalize and secure EPA approval for a state-specific CCR permitting program. With respect to the Navajo Nation, APS has sought clarification as to when and how EPA would be initiating permit proceedings for facilities on the reservation, including Four Corners. We are unable to predict at this time when EPA will be issuing CCR management permits for the facilities on the Navajo Nation. At this time, it remains unclear how the CCR provisions of the WIIN Act will affect APS and its management of CCR.

Based upon utility industry petitions for EPA to reconsider the RCRA Subtitle D regulations for CCR, which were premised in part on the CCR provisions of the 2016 WIIN Act, on September 13, 2017, EPA

21

Table of Contents

agreed to evaluate whether to revise these federal CCR regulations. On July 17, 2018, EPA finalized a revision to its RCRA Subtitle D regulations for CCR, the "Phase I, Part I" revision to its CCR regulations, deferring for future action a number of other proposed changes contemplated in a March 1, 2018 proposal. For the final rule issued on July 17, 2018, EPA established nationwide health-based standards for certain constituents of CCR subject to groundwater corrective action, and delayed the closure deadlines for certain unlined CCR surface impoundments by 18 months (for example, those disposal units required to undergo forced closure). These changes to the federal regulations governing CCR disposal are unlikely to have a material impact on APS. As for those aspects of the March 2018 rulemaking proposal for which EPA has yet to take final action, it remains unclear which specific provisions of the federal CCR rules will ultimately be modified, how they will be modified, or when such modification will occur.

Pursuant to a June 24, 2016 order by the D.C. Circuit Court of Appeals in the litigation by industry- and environmental-groups challenging EPA’s CCR regulations, EPA is required to complete a rulemaking proceeding in the near future concerning whether or not boron must be included on the list of groundwater constituents that might trigger corrective action under EPA’s CCR rules.  Simultaneously with the issuance of EPA's proposed modifications to the federal CCR rules in response to industry petitions, on March 1, 2018, EPA issued a proposed rule seeking comment as to whether or not boron should be included on this list. EPA is not required to take final action approving the inclusion of boron.  Should EPA take final action adding boron to the list of groundwater constituents that might trigger corrective action, any resulting corrective action measures may increase APS's costs of compliance with the CCR rule at our coal-fired generating facilities.  At this time APS cannot predict the eventual results of this rulemaking proceeding concerning boron.

On August 21, 2018, the D.C. Circuit Court issued its decision on the merits in this litigation. The Court upheld the legality of EPA’s CCR regulations, though it vacated and remanded back to EPA a number of specific provisions, which are to be corrected in accordance with the Court’s order. Among the issues affecting APS’s management of CCR, the D.C. Circuit’s decision vacated and remanded those provisions of the EPA CCR regulations that allow for the operation of unlined CCR surface impoundments, even where those unlined impoundments have not otherwise violated a regulatory location restriction or groundwater protection standard (i.e., otherwise triggering forced closure). At this time, it remains unclear how this D.C. Circuit Court decision will affect APS’s operations or financial results, as EPA has yet to take regulatory action on remand to revise its 2015 CCR regulations consistent with the Court’s order.

Based on this decision, on December 17, 2018, certain environmental groups filed an emergency motion with the D.C. Circuit to either stay or summarily vacate EPA's July 17, 2018 final rule extending the closure-initiation deadline for certain unlined CCR surface impoundments until October 2020. In response, EPA filed a motion to remand but not vacate that deadline extension regulation. We cannot predict the outcome of the D.C. Circuit's consideration of these dueling motions, and whether or how such a ruling would affect APS's operations or financial results.

APS currently disposes of CCR in ash ponds and dry storage areas at Cholla and Four Corners. APS estimates that its share of incremental costs to comply with the CCR rule for Four Corners is approximately $22 million and its share of incremental costs to comply with the CCR rule for Cholla is approximately $20 million. The Navajo Plant currently disposes of CCR in a dry landfill storage area. APS estimates that its share of incremental costs to comply with the CCR rule for the Navajo Plant is approximately $1 million. Additionally, the CCR rule requires ongoing, phased groundwater monitoring. By October 17, 2017, electric utility companies that own or operate CCR disposal units, such as APS, must have collected sufficient groundwater sampling data to initiate a detection monitoring program.  To the extent that certain threshold constituents are identified through this initial detection monitoring at levels above the CCR rule’s standards, the rule required the initiation of an assessment monitoring program by April 15, 2018.

22

Table of Contents

APS recently completed the statistical analyses for its CCR disposal units that triggered assessment monitoring. APS determined that several of its CCR disposal units at Cholla and Four Corners will need to undergo corrective action. In addition, all such units must cease operating and initiate closure by October of 2020. APS currently estimates that the additional incremental costs to complete this corrective action and closure work, along with the costs to develop replacement CCR disposal capacity, could be approximately $5 million for both Cholla and Four Corners. APS initiated an assessment of corrective measures on January 14, 2019, and anticipates completing this assessment during the summer of 2019. During this assessment, APS will gather additional groundwater data, solicit input from the public, host public hearings, and select remedies. As such, this $5 million cost estimate may change based upon APS’s performance of the CCR rule’s corrective action assessment process. Given uncertainties that may exist until we have fully completed the corrective action assessment process, we cannot predict any ultimate impacts to the Company; however, at this time we do not believe any potential change to the cost estimate would have a material impact on our financial position, results of operations or cash flows.

Effluent Limitation Guidelines. On September 30, 2015, EPA finalized revised effluent limitation guidelines establishing technology-based wastewater discharge limitations for fossil-fired EGUs.  EPA’s final regulation targets metals and other pollutants in wastewater streams originating from fly ash and bottom ash handling activities, scrubber activities, and coal ash disposal leachate.  Based upon an earlier set of preferred alternatives, the final effluent limitations generally require chemical precipitation and biological treatment for flue gas desulfurization scrubber wastewater, “zero discharge” from fly ash and bottom ash handling, and impoundment for coal ash disposal leachate. 

On August 11, 2017, EPA announced that it would be initiating rulemaking proceedings to potentially revise the September 2015 effluent limitation guidelines. On September 18, 2017, EPA finalized a regulation postponing the earliest date on which compliance with the effluent limitation guidelines for these waste-streams would be required from November 1, 2018 until November 1, 2020. Until EPA issues a proposal describing how it intends to change the effluent limitation guidelines for bottom ash transport water and flue gas desulfurization wastewater, it is unclear how EPA’s reconsideration process will affect how the Four Corners plant manages these waste-streams. We expect that compliance with these limitations will be required in connection with National Pollution Discharge Elimination System ("NPDES") discharge permit renewals.  APS anticipates that, in connection with EPA's current reconsideration of the NPDES permit for Four Corners (see "Four Corners National Pollutant Discharge Elimination System Permit" below), EPA will propose a compliance deadline for the effluent limitation guidelines governing bottom ash transport water during March of 2019. Until EPA proposes a new NPDES permit reissuance for Four Corners, it is unclear what date EPA will assign as a compliance deadline for Four Corners. Cholla and the Navajo Plant do not require NPDES permitting.

Ozone National Ambient Air Quality Standards. On October 1, 2015, EPA finalized revisions to the primary ground-level ozone national ambient air quality standards (“NAAQS”) at a level of 70 parts per billion (“ppb”).  With ozone standards becoming more stringent, our fossil generation units will come under increasing pressure to reduce emissions of NOx and volatile organic compounds, and to generate emission offsets for new projects or facility expansions located in ozone nonattainment areas.  EPA was expected to designate attainment and nonattainment areas relative to the new 70 ppb standard by October 1, 2017.  While EPA took action designating attainment and unclassifiable areas on November 6, 2017, the Agency's final action designating non-attainment areas was not issued until April 30, 2018. At that time, EPA designated the geographic areas containing Yuma and Phoenix, Arizona as in non-attainment with the 2015 70 ppb ozone NAAQS. The vast majority of APS's natural gas-fired EGUs are located in these jurisdictions. Areas of Arizona and the Navajo Nation where the remainder of APS's fossil-fuel fired EGU fleet is located were designated as in attainment. We anticipate that revisions to the SIPs and FIPs implementing required controls to achieve the new 70 ppb standard will be in place between 2020 and 2021.  At this time, because proposed SIPs and FIPs

23

Table of Contents

implementing the revised ozone NAAQSs have yet to be released, APS is unable to predict what impact the adoption of these standards may have on the Company. APS will continue to monitor these standards as they are implemented within the jurisdictions affecting APS.

Superfund-Related Matters. The Comprehensive Environmental Response Compensation and Liability Act ("CERCLA" or "Superfund") establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air.  Those who released, generated, transported to, or disposed of hazardous substances at a contaminated site are among the parties who are potentially responsible ("PRPs").  PRPs may be strictly, and often are jointly and severally, liable for clean-up.  On September 3, 2003, EPA advised APS that EPA considers APS to be a PRP in the Motorola 52 nd  Street Superfund Site, Operable Unit 3 ("OU3") in Phoenix, Arizona.  APS has facilities that are within this Superfund site.  APS and Pinnacle West have agreed with EPA to perform certain investigative activities of the APS facilities within OU3.  In addition, on September 23, 2009, APS agreed with EPA and one other PRP to voluntarily assist with the funding and management of the site-wide groundwater remedial investigation and feasibility study ("RI/FS") for OU3.  Based upon discussions between the OU3 working group parties and EPA, along with the results of recent technical analyses prepared by the OU3 working group to supplement the RI/FS, APS anticipates finalizing the RI/FS in the summer or fall of 2019. We estimate that our costs related to this investigation and study will be approximately $2 million.  We anticipate incurring additional expenditures in the future, but because the overall investigation is not complete and ultimate remediation requirements are not yet finalized, at the present time expenditures related to this matter cannot be reasonably estimated.

On August 6, 2013, the Roosevelt Irrigation District ("RID") filed a lawsuit in Arizona District Court against APS and 24 other defendants, alleging that RID’s groundwater wells were contaminated by the release of hazardous substances from facilities owned or operated by the defendants.  The lawsuit also alleges that, under Superfund laws, the defendants are jointly and severally liable to RID.  The allegations against APS arise out of APS’s current and former ownership of facilities in and around OU3.  As part of a state governmental investigation into groundwater contamination in this area, on January 25, 2015, ADEQ sent a letter to APS seeking information concerning the degree to which, if any, APS’s current and former ownership of these facilities may have contributed to groundwater contamination in this area.  APS responded to ADEQ on May 4, 2015. On December 16, 2016, two RID environmental and engineering contractors filed an ancillary lawsuit for recovery of costs against APS and the other defendants in the RID litigation. That same day, another RID service provider filed an additional ancillary CERCLA lawsuit against certain of the defendants in the main RID litigation, but excluded APS and certain other parties as named defendants. Because the ancillary lawsuits concern past costs allegedly incurred by these RID vendors, which were ruled unrecoverable directly by RID in November of 2016, the additional lawsuits do not increase APS's exposure or risk related to these matters.

On April 5, 2018, RID and the defendants in that particular litigation executed a settlement agreement, fully resolving RID's CERCLA claims concerning both past and future cost recovery. APS's share of this settlement was immaterial. In addition, the two environmental and engineering vendors voluntarily dismissed their lawsuit against APS and the other named defendants without prejudice. An order to this effect was entered on April 17, 2018. With this disposition of the case, the vendors may file their lawsuit again in the future. In addition, APS and certain other parties not named in the remaining RID service provider lawsuit may be brought into the litigation via third-party complaints filed by the current direct defendants. We are unable to predict the outcome of these matters; however, we do not expect the outcome to have a material impact on our financial position, results of operations or cash flows.

Manufactured Gas Plant Sites. Certain properties which APS now owns or which were previously owned by it or its corporate predecessors were at one time sites of, or sites associated with, manufactured gas plants. APS is taking action to voluntarily remediate these sites. APS does not expect these matters to have a material adverse effect on its financial position, results of operations or cash flows.

24

Table of Contents

Federal Agency Environmental Lawsuit Related to Four Corners

On April 20, 2016, several environmental groups filed a lawsuit against OSM and other federal agencies in the District of Arizona in connection with their issuance of the approvals that extended the life of Four Corners and the adjacent mine.  The lawsuit alleges that these federal agencies violated both ESA and NEPA in providing the federal approvals necessary to extend operations at the Four Corners Power Plant and the adjacent Navajo Mine past July 6, 2016.  APS filed a motion to intervene in the proceedings, which was granted on August 3, 2016.

On September 15, 2016, NTEC, the company that owns the adjacent mine, filed a motion to intervene for the purpose of dismissing the lawsuit based on NTEC's tribal sovereign immunity. On September 11, 2017, the Arizona District Court issued an order granting NTEC's motion, dismissing the litigation with prejudice, and terminating the proceedings. On November 9, 2017, the environmental group plaintiffs appealed the district court order dismissing their lawsuit. Oral arguments in this appeal will be heard in March 2019. We cannot predict whether this appeal will be successful and, if it is successful, the outcome of further district court proceedings.

Four Corners National Pollutant Discharge Elimination System ("NPDES") Permit

On July 16, 2018, several environmental groups filed a petition for review before the EPA Environmental Appeals Board ("EAB") concerning the NPDES wastewater discharge permit for Four Corners, which was reissued on June 12, 2018.  The environmental groups allege that the permit was reissued in contravention of several requirements under the Clean Water Act and did not contain required provisions concerning EPA’s 2015 revised effluent limitation guidelines for steam-electric EGUs, 2014 existing-source regulations governing cooling-water intake structures, and effluent limits for surface seepage and subsurface discharges from coal-ash disposal facilities.  To address certain of these issues through a reconsidered permit, EPA took action on December 19, 2018 to withdraw the NPDES permit reissued in June 2018. Withdrawal of the permit moots the EAB appeal, and EPA filed a motion to dismiss on that basis. EPA indicated that it anticipates proposing a replacement NPDES permit by March 2019 and, depending on the extent of public comments concerning that proposal, taking final action on a new NPDES permit by June 2019. At this time, we cannot predict the outcome of EPA's reconsideration of the NPDES permit and whether reconsideration will have a material impact on our financial position, results of operations or cash flows.

Navajo Nation Environmental Issues

Four Corners and the Navajo Plant are located on the Navajo Reservation and are held under rights of way granted by the federal government, as well as leases from the Navajo Nation. See “Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities” above for additional information regarding these plants.

In July 1995, the Navajo Nation enacted the Navajo Nation Air Pollution Prevention and Control Act, the Navajo Nation Safe Drinking Water Act, and the Navajo Nation Pesticide Act (collectively, the “Navajo Acts”). The Navajo Acts purport to give the Navajo Nation Environmental Protection Agency authority to promulgate regulations covering air quality, drinking water, and pesticide activities, including those activities that occur at Four Corners and the Navajo Plant. On October 17, 1995, the Four Corners participants and the Navajo Plant participants each filed a lawsuit in the District Court of the Navajo Nation, Window Rock District, challenging the applicability of the Navajo Acts as to Four Corners and the Navajo Plant. The Court has stayed these proceedings pursuant to a request by the parties, and the parties are seeking to negotiate a settlement.

25

Table of Contents

In April 2000, the Navajo Nation Council approved operating permit regulations under the Navajo Nation Air Pollution Prevention and Control Act. APS believes the Navajo Nation exceeded its authority when it adopted the operating permit regulations. On July 12, 2000, the Four Corners participants and the Navajo Plant participants each filed a petition with the Navajo Supreme Court for review of these regulations. Those proceedings have been stayed, pending the settlement negotiations mentioned above. APS cannot currently predict the outcome of this matter.

On May 18, 2005, APS, SRP, as the operating agent for the Navajo Plant, and the Navajo Nation executed a Voluntary Compliance Agreement to resolve their disputes regarding the Navajo Nation Air Pollution Prevention and Control Act. As a result of this agreement, APS sought, and the courts granted, dismissal of the pending litigation in the Navajo Nation Supreme Court and the Navajo Nation District Court, to the extent the claims relate to the Clean Air Act. The agreement does not address or resolve any dispute relating to other Navajo Acts. APS cannot currently predict the outcome of this matter.

Water Supply

Assured supplies of water are important for APS’s generating plants. At the present time, APS has adequate water to meet its operating needs. The Four Corners region, in which Four Corners is located, has historically experienced drought conditions that may affect the water supply for the plants if adequate moisture is not received in the watershed that supplies the area. However, during the past 12 months the region has received snowfall and precipitation sufficient to recover the Navajo Reservoir to an optimum operating level, reducing the probability of shortage in future years. Although the watershed and reservoirs are in a good condition at this time, APS is continuing to work with area stakeholders to implement agreements to minimize the effect, if any, on future drought conditions that could have an impact on operations of its plants.

Conflicting claims to limited amounts of water in the southwestern United States have resulted in numerous court actions, which, in addition to future supply conditions, have the potential to impact APS’s operations.

San Juan River Adjudication. Both groundwater and surface water in areas important to APS’s operations have been the subject of inquiries, claims, and legal proceedings, which will require a number of years to resolve. APS is one of a number of parties in a proceeding, filed March 13, 1975, before the Eleventh Judicial District Court in New Mexico to adjudicate rights to a stream system from which water for Four Corners is derived. An agreement reached with the Navajo Nation in 1985, however, provides that if Four Corners loses a portion of its rights in the adjudication, the Navajo Nation will provide, for an agreed upon cost, sufficient water from its allocation to offset the loss. In addition, APS is a party to a water contract that allows the company to secure water for Four Corners in the event of a water shortage and is a party to a shortage sharing agreement, which provides for the apportionment of water supplies to Four Corners in the event of a water shortage in the San Juan River Basin.

Gila River Adjudication. A summons served on APS in early 1986 required all water claimants in the Lower Gila River Watershed in Arizona to assert any claims to water on or before January 20, 1987, in an action pending in Arizona Superior Court. Palo Verde is located within the geographic area subject to the summons. APS’s rights and the rights of the other Palo Verde participants to the use of groundwater and effluent at Palo Verde are potentially at issue in this adjudication. As operating agent of Palo Verde, APS filed claims that dispute the court’s jurisdiction over the Palo Verde participants’ groundwater rights and their contractual rights to effluent relating to Palo Verde. Alternatively, APS seeks confirmation of such rights. Several of APS’s other power plants are also located within the geographic area subject to the summons, including a number of gas-fired power plants located within Maricopa and Pinal Counties. In November 1999,

26

Table of Contents

the Arizona Supreme Court issued a decision confirming that certain groundwater rights may be available to the federal government and Indian tribes. In addition, in September 2000, the Arizona Supreme Court issued a decision affirming the lower court’s criteria for resolving groundwater claims. Litigation on both of these issues has continued in the trial court. In December 2005, APS and other parties filed a petition with the Arizona Supreme Court requesting interlocutory review of a September 2005 trial court order regarding procedures for determining whether groundwater pumping is affecting surface water rights. The Arizona Supreme Court denied the petition in May 2007, and the trial court is now proceeding with implementation of its 2005 order. No trial date concerning APS’s water rights claims has been set in this matter.

At this time, the lower court proceedings in the Gila River adjudication are in the process of determining the specific hydro-geologic testing protocols for determining which groundwater wells located outside of the subflow zone of the Gila River should be subject to the adjudication court’s jurisdiction. A hearing to determine this jurisdictional test question was held in March of 2018 in front of a special master, and a draft decision based on the evidence heard during that hearing was issued on May 17, 2018. The decision of the special master, which was finalized on November 14, 2018, but which is subject to further review by the trial court judge, accepts the proposed hydro-geologic testing protocols supported by APS and other industrial users of groundwater. Upon a final decision by the trial court judge in this matter, further proceedings thereafter will be dedicated to determining the specific hydro-geologic testing protocols for subflow depletion determinations. The determinations made in this final stage of the proceedings will ultimately govern the adjudication of rights for parties, such as APS, that rely on groundwater extraction to support their industrial operations. At this time, APS cannot predict the outcome of these proceedings.

Little Colorado River Adjudication. APS has filed claims to water in the Little Colorado River Watershed in Arizona in an action pending in the Apache County, Arizona, Superior Court, which was originally filed on September 5, 1985. APS’s groundwater resource utilized at Cholla is within the geographic area subject to the adjudication and, therefore, is potentially at issue in the case. APS’s claims dispute the court’s jurisdiction over its groundwater rights. Alternatively, APS seeks confirmation of such rights. Other claims have been identified as ready for litigation in motions filed with the court. On December 20, 2018, the court issued a case management order governing future proceedings in the adjudication, whereby discovery is currently scheduled to close in December 2019 and a trial will be held in June 2020.

Although the above matters remain subject to further evaluation, APS does not expect that the described litigation will have a material adverse impact on its financial position, results of operations or cash flows.

BUSINESS OF OTHER SUBSIDIARIES

Bright Canyon Energy

On July 31, 2014, Pinnacle West announced its creation of a wholly-owned subsidiary, BCE.  BCE's focus is on new growth opportunities that leverage the Company’s core expertise in the electric energy industry.  BCE’s first initiative is a 50/50 joint venture with BHE U.S. Transmission LLC, a subsidiary of Berkshire Hathaway Energy Company.  The joint venture, named TransCanyon, is pursuing independent transmission opportunities within the eleven states that comprise the Western Electricity Coordinating Council, excluding opportunities related to transmission service that would otherwise be provided under the tariffs of the retail service territories of the venture partners’ utility affiliates.  TransCanyon continues to pursue transmission development opportunities in the western United States consistent with its strategy.
    
On March 29, 2016, TransCanyon entered into a strategic alliance agreement with Pacific Gas and Electric Company ("PG&E") to jointly pursue competitive transmission opportunities solicited by the CAISO,

27

Table of Contents

the operator for the majority of California's transmission grid. TransCanyon and PG&E intend to jointly engage in the development of future transmission infrastructure and compete to develop, build, own and operate transmission projects approved by the CAISO.

El Dorado
 
El Dorado owns minority interests in several energy-related investments and Arizona community-based ventures.  El Dorado’s short-term goal is to prudently realize the value of its existing investments.  As of December 31, 2018, El Dorado had total assets of approximately $8 million. El Dorado is not expected to contribute in any material way to our future financial performance, nor will it require any material amounts of capital over the next three years. 

4CA
    
As of December 31, 2018, 4CA had total assets of approximately $72 million, primarily consisting of a note receivable from NTEC.  See "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generating Facilities - Coal-Fueled Generating Facilities - Four Corners" above for information regarding 4CA and the note receivable from NTEC.
OTHER INFORMATION
 
Subpoenas

Pinnacle West has received grand jury subpoenas issued in connection with an investigation by the office of the United States Attorney for the District of Arizona. The subpoenas seek information principally pertaining to the 2014 statewide election races in Arizona for Secretary of State and for positions on the ACC. The subpoenas request records involving certain Pinnacle West officers and employees, including the Company’s Chief Executive Officer, as well as communications between Pinnacle West personnel and a former ACC Commissioner. Pinnacle West is cooperating fully with the United States Attorney’s office in this matter.

Other Information

Pinnacle West, APS and El Dorado are all incorporated in the State of Arizona.  BCE and 4CA are incorporated in Delaware. Additional information for each of these companies is provided below:

								
 	 	Principal Executive Office
Address	 	Year of
Incorporation	 	Approximate
Number of
Employees at
December 31, 2018	
Pinnacle West	 	400 North Fifth Street
Phoenix, AZ 85004	 	1985	 	96		
APS	 	400 North Fifth Street
P.O. Box 53999
Phoenix, AZ 85072-3999	 	1920	 	6,158		
BCE	 	400 East Van Buren
Phoenix, AZ 85004	 	2014	 	5		
El Dorado	 	400 East Van Buren
Phoenix, AZ 85004	 	1983	 	—		
4CA	 	400 North Fifth Street
Phoenix, AZ 85004	 	2016	 	—		
Total	 	 	 	 	 	6,259		

28

Table of Contents

The APS number includes employees at jointly-owned generating facilities (approximately 2,526 employees) for which APS serves as the generating facility manager.  Approximately 1,330 APS employees are union employees, represented by the International Brotherhood of Electrical Workers ("IBEW"). In January 2018, the Company concluded negotiations with the IBEW and approved a two-year extension of the contract set to expire on April 1, 2018.  Under the extension, union members received wage increases for 2018 and 2019; there were no other changes. The current contract expires on April 1, 2020.

WHERE TO FIND MORE INFORMATION

We use our website ( www.pinnaclewest.com) as a channel of distribution for material Company information.  The following filings are available free of charge on our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”):  Annual Reports on Form 10-K, definitive proxy statements for our annual shareholder meetings, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports. The SEC maintains a website that contains reports, proxy and information statements and other information regarding issuers, such as the Company, that file electronically with the SEC. The address of that website is www.sec.gov. Our board and committee charters, Code of Ethics for Financial Executives, Code of Ethics and Business Practices and other corporate governance information is also available on the Pinnacle West website.  Pinnacle West will post any amendments to the Code of Ethics for Financial Executives and Code of Ethics and Business Practices, and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, on its website.  The information on Pinnacle West’s website is not incorporated by reference into this report.
 
You can request a copy of these documents, excluding exhibits, by contacting Pinnacle West at the following address:  Pinnacle West Capital Corporation, Office of the Corporate Secretary, Mail Station 8602, P.O. Box 53999, Phoenix, Arizona 85072-3999 (telephone 602-250-4400).

ITEM 1A.  RISK FACTORS
 
In addition to the factors affecting specific business operations identified in the description of these operations contained elsewhere in this report, set forth below are risks and uncertainties that could affect our financial results.  Unless otherwise indicated or the context otherwise requires, the following risks and uncertainties apply to Pinnacle West and its subsidiaries, including APS.

REGULATORY RISKS
 
Our financial condition depends upon APS’s ability to recover costs in a timely manner from customers through regulated rates and otherwise execute its business strategy.
 
APS is subject to comprehensive regulation by several federal, state and local regulatory agencies that significantly influence its business, liquidity and results of operations and its ability to fully recover costs from utility customers in a timely manner.  The ACC regulates APS’s retail electric rates and FERC regulates rates for wholesale power sales and transmission services.  The profitability of APS is affected by the rates it may charge and the timeliness of recovering costs incurred through its rates.  Consequently, our financial condition and results of operations are dependent upon the satisfactory resolution of any APS rate proceedings and ancillary matters which may come before the ACC and FERC, including in some cases how court challenges to these regulatory decisions are resolved. Arizona, like certain other states, has a statute that allows the ACC to reopen prior decisions and modify otherwise final orders under certain circumstances.

29

Table of Contents

The ACC must also approve APS’s issuance of securities and any significant transfer or encumbrance of APS property used to provide retail electric service, and must approve or receive prior notification of certain transactions between us, APS and our respective affiliates.  Decisions made by the ACC or FERC could have a material adverse impact on our financial condition, results of operations or cash flows.

APS’s ability to conduct its business operations and avoid fines and penalties depends upon compliance with federal, state and local statutes, regulations and ACC requirements, and obtaining and maintaining certain regulatory permits, approvals and certificates.
 
APS must comply in good faith with all applicable statutes, regulations, rules, tariffs, and orders of agencies that regulate APS’s business, including FERC, NRC, EPA, the ACC, and state and local governmental agencies.  These agencies regulate many aspects of APS’s utility operations, including safety and performance, emissions, siting and construction of facilities, customer service and the rates that APS can charge retail and wholesale customers.  Failure to comply can subject APS to, among other things, fines and penalties.  For example, under the Energy Policy Act of 2005, FERC can impose penalties (approximately $1.2 million dollars per day per violation) for failure to comply with mandatory electric reliability standards.  APS is also required to have numerous permits, approvals and certificates from these agencies.  APS believes the necessary permits, approvals and certificates have been obtained for its existing operations and that APS’s business is conducted in accordance with applicable laws in all material respects.  However, changes in regulations or the imposition of new or revised laws or 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 .

The operation of APS’s nuclear power plant exposes it to substantial regulatory oversight and potentially significant liabilities and capital expenditures.
 
The NRC has broad authority under federal law to impose safety-related, security-related and other licensing requirements for the operation of nuclear generating facilities.  Events at nuclear facilities of other operators or impacting the industry generally may lead the NRC to impose additional requirements and regulations on all nuclear generating facilities, including Palo Verde.  In the event of noncompliance with its requirements, the NRC has the authority to impose a progressively increased inspection regime that could ultimately result in the shut-down of a unit or civil penalties, or both, depending upon the NRC’s assessment of the severity of the situation, until compliance is achieved.  The increased costs resulting from penalties, a heightened level of scrutiny and implementation of plans to achieve compliance with NRC requirements may adversely affect APS’s financial condition, results of operations and cash flows.

APS is subject to numerous environmental laws and regulations, and changes in, or liabilities under, existing or new laws or regulations may increase APS’s cost of operations or impact its business plans.
 
APS is, or may become, subject to numerous environmental laws and regulations affecting many aspects of its present and future operations, including air emissions of conventional pollutants and greenhouse gases, water quality, discharges of wastewater and waste streams originating from fly ash and bottom ash handling facilities, solid waste, hazardous waste, and coal combustion products, which consist of bottom ash, fly ash, and air pollution control wastes.  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 APS to obtain and comply with a wide variety of environmental licenses, permits, and other approvals.  If there is a delay or failure to obtain any required environmental regulatory approval, or if APS fails to obtain, maintain, or comply with any such approval, operations at affected facilities could be suspended or subject to additional expenses.  In addition, failure to comply with applicable environmental laws and regulations could result in civil liability as a result of government

30

Table of Contents

enforcement actions or private claims or criminal penalties.  Both public officials and private individuals may seek to enforce applicable environmental laws and regulations.  APS cannot predict the outcome (financial or operational) of any related litigation that may arise.
 
Environmental Clean Up.  APS has been named as a PRP for a Superfund site in Phoenix, Arizona, and it could be named a PRP in the future for other environmental clean-up at sites identified by a regulatory body. APS 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 PRPs.

Coal Ash. In December 2014, EPA issued final regulations governing the handling and disposal of CCR, which are generated as a result of burning coal and consist of, among other things, fly ash and bottom ash. The rule regulates CCR as a non-hazardous waste. APS currently disposes of CCR in ash ponds and dry storage areas at Cholla and Four Corners and in a dry landfill storage area at the Navajo Plant. To the extent the rule requires the closure or modification of these CCR units or the construction of new CCR units beyond what we currently anticipate, APS would incur significant additional costs for CCR disposal. In addition, the rule may also require corrective action to address releases from CCR disposal units or the presence of CCR constituents within groundwater near CCR disposal units above certain regulatory thresholds.

Ozone National Ambient Air Quality Standards. In 2015, EPA finalized revisions to the national ambient air quality standards for nitrogen oxides, which set new, more stringent standards intended to protect human health and human welfare. Depending on the final attainment designations for the new standards and the state implementation requirements, APS may be required to invest in new pollution control technologies and to generate emission offsets for new projects or facility expansions located in ozone nonattainment areas.

APS cannot assure 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 it.  Revised or additional regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs incurred by APS are not fully recoverable from APS’s customers, could have a material adverse effect on its financial condition, results of operations or cash flows.  Due to current or potential future regulations or legislation coupled with trends in natural gas and coal prices, the economics of continuing to own certain resources, particularly coal facilities, may deteriorate, warranting early retirement of those plants, which may result in asset impairments.  APS would seek recovery in rates for the book value of any remaining investments in the plants as well as other costs related to early retirement, but cannot predict whether it would obtain such recovery.
 
APS faces potential financial risks resulting from climate change litigation and legislative and regulatory efforts to limit GHG emissions, as well as physical and operational risks related to climate effects.

Concern over climate change has led to significant legislative and regulatory efforts to limit CO 2 , which is a major byproduct of the combustion of fossil fuel, and other GHG emissions.
Potential Financial Risks - Greenhouse Gas Regulation, the Clean Power Plan and Potential Litigation. In 2015, EPA finalized a rule to limit carbon dioxide emissions from existing power plants. The implementation of this rule within the jurisdictions where APS operates could result in a shift in in-state generation from coal to natural gas and renewable generation. Such a substantial change in APS’s generation portfolio could require additional capital investments and increased operating costs, and thus have a significant financial impact on the Company. EPA took action in October 2017 to repeal these regulations and in August 2018 EPA proposed the Affordable Clean Energy Rule to replace the Clean Power Plan with a new set of regulations.

31

Table of Contents

Depending on the final outcome of a pending judicial review of the Clean Power Plan, along with related regulatory activity to repeal or replace these regulations, the utility industry may face alternative efforts from private parties seeking to establish alternative GHG emission limitations from power plants. Alternative GHG emission limitations may arise from litigation under either federal or state common laws or citizen suit provisions of federal environmental statutes that attempt to force federal agency rulemaking or imposing direct facility emission limitations. Such lawsuits may also seek damages from harm alleged to have resulted from power plant GHG emissions.
Physical and Operational Risks. Weather extremes such as drought and high temperature variations are common occurrences in the Southwest’s desert area, and these are risks that APS considers in the normal course of business in the engineering and construction of its electric system. Large increases in ambient temperatures could require evaluation of certain materials used within its system and represent a greater challenge.
Co-owners of our jointly owned generation facilities may have unaligned goals and positions due to the effects of legislation, regulations, economic conditions or changes in our industry, which could have a significant impact on our ability to continue operations of such facilities.

APS owns certain of our power plants jointly with other owners with varying ownership interests in such facilities. Changes in the nature of our industry and the economic viability of certain plants, including impacts resulting from types and availability of other resources, fuel costs, legislation and regulation, together with timing considerations related to expiration of leases or other agreements for such facilities, could result in unaligned positions among co-owners. Such differences in the co-owners’ willingness or ability to continue their participation could ultimately lead to disagreements among the parties as to how and whether to continue operation of such plants, which could lead to eventual shut down of units or facilities and uncertainty related to the resulting cost recovery of such assets. See Note 3 for a discussion of the co-owners' plans to cease operations of the Navajo Plant and the related risks associated with APS's continued recovery of its remaining investment in the plant.

Deregulation or restructuring of the electric industry may result in increased competition, which could have a significant adverse impact on APS’s business and its results of operations.
 
In 1999, the ACC approved rules for the introduction of retail electric competition in Arizona.  Retail competition could have a significant adverse financial impact on APS due to an impairment of assets, a loss of retail customers, lower profit margins or increased costs of capital.  Although some very limited retail competition existed in APS’s service area in 1999 and 2000, there are currently no active retail competitors offering unbundled energy or other utility services to APS’s customers.  This is in large part due to a 2004 Arizona Court of Appeals decision that found critical components of the ACC's rules to be violative of the Arizona Constitution. The ruling also voided the operating authority of all the competitive providers previously authorized by the ACC. On May 9, 2013, the ACC voted to re-examine the facilitation of a deregulated retail electric market in Arizona.  The ACC subsequently opened a docket for this matter and received comments from a number of interested parties on the considerations involved in establishing retail electric deregulation in the state.  One of these considerations is whether various aspects of a deregulated market, including setting utility rates on a “market” basis, would be consistent with the requirements of the Arizona Constitution.  On September 11, 2013, after receiving legal advice from the ACC staff, the ACC voted 4-1 to close the current docket and await full Arizona Constitutional authority before any further examination of this matter.  The motion approved by the ACC also included opening one or more new dockets in the future to explore options to offer more rate choices to customers and innovative changes within the existing cost-of-service regulatory model that could include elements of competition. 

One of these options would be a continuation or expansion of APS’s existing AG (Alternative Generation)-X program, which essentially allows up to 200 MW of cumulative load to be served via a buy-

32

Table of Contents

through arrangement with competitive suppliers of generation.  The AG-X program was approved by the ACC as part of the 2017 Settlement Agreement.
 
In November 2018, the ACC voted to again re-examine retail competition. Interested parties were asked to submit written comments, which are still being submitted. In addition, proposals to enable or support retail electric competition may be made from time to time through ballot initiatives, legislative action or other forums in Arizona. The ACC held one workshop on retail competition in December 2018 and is planning at least one more workshop on the issue in 2019. We cannot predict future regulatory or legislative action that might result in increased competition.

Proposals to change policy in Arizona or other states made through ballot initiatives or referenda may increase the Company’s cost of operations or impact its business plans.

In Arizona and other states, a person or organization may file a ballot initiative or referendum with the Arizona Secretary of State or other applicable state agency and, if a sufficient number of verifiable signatures are presented, the initiative or referendum may be placed on the ballot for the public to vote on the matter. Ballot initiatives and referenda may relate to any matter, including policy and regulation related to the electric industry, and may change statutes or the state constitution in ways that could impact Arizona utility customers, the Arizona economy and the Company. Some ballot initiatives and referenda are drafted in an unclear manner and their potential industry and economic impact can be subject to varied and conflicting interpretations. We may oppose certain initiatives or referenda (including those that could result in negative impacts to our customers, the state or the Company) via the electoral process, litigation, traditional legislative mechanisms, agency rulemaking or otherwise, which could result in significant costs to the Company. The passage of certain initiatives or referenda could result in laws and regulations that impact our business plans and have a material adverse impact on our financial condition, results of operations or cash flows.

OPERATIONAL RISKS
 
APS’s results of operations can be adversely affected by various factors impacting demand for electricity.
 
Weather Conditions.   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, APS’s overall operating results fluctuate substantially on a seasonal basis.  In addition, APS has historically sold less power, and consequently earned less income, when weather conditions are milder.  As a result, unusually mild weather could diminish APS’s financial condition, results of operations or cash flows.
 
Higher temperatures may decrease the snowpack, which might result in lowered soil moisture and an increased threat of forest fires.  Forest fires could threaten APS’s communities and electric transmission lines and facilities.  Any damage caused as a result of forest fires could negatively impact APS’s financial condition, results of operations or cash flows.
 
Effects of Energy Conservation Measures and Distributed Energy Resources.   The ACC has enacted rules regarding energy efficiency that mandate a 22% cumulative annual energy savings requirement by 2020.  This will likely increase participation by APS customers in energy efficiency and conservation programs and other demand-side management efforts, which in turn will impact the demand for electricity.  The rules also include a requirement for the ACC to review and address financial disincentives, recovery of fixed costs and the recovery of net lost income/revenue that would result from lower sales due to increased energy efficiency requirements.  To that end, the LFCR is designed to address these matters.

33

Table of Contents

APS must also meet certain distributed energy requirements.  A portion of APS’s total renewable energy requirement must be met with an increasing percentage of distributed energy resources (generally, small scale renewable technologies located on customers’ properties).  The distributed energy requirement was 25% of the overall RES requirement of 3% in 2011 and increased to 30% of the applicable RES requirement for 2012 and subsequent years.  Customer participation in distributed energy programs would result in lower demand, since customers would be meeting some of their own energy needs. 

In addition to these rules and requirements, energy efficiency technologies and distributed energy resources continue to evolve, which may have similar impacts on demand for electricity. Reduced demand due to these energy efficiency requirements, distributed energy requirements and other emerging technologies, unless substantially offset through ratemaking mechanisms, could have a material adverse impact on APS’s financial condition, results of operations and cash flows.
 
Actual and Projected Customer and Sales Growth.  Retail customers in APS's service territory increased 1.7% for the year ended December 31, 2018 compared with the prior year. For the three years 2016 through 2018, APS’s retail customer growth averaged 1.6% per year.  We currently project annual customer growth to be 1.5 - 2.5% for 2019 and to average in the range of 1.5 - 2.5% for 2019 through 2021 based on our assessment of improving economic conditions in Arizona. 

Retail electricity sales in kWh, adjusted to exclude the effects of weather variations, increased 0.1% for the year ended December 31, 2018 compared with the prior year. Improving economic conditions and customer growth were offset by energy savings driven by customer conservation, energy efficiency, and distributed renewable generation initiatives. For the three years 2016 through 2018, annual retail electricity sales were about flat, adjusted to exclude the effects of weather variations.  We currently project that annual retail electricity sales in kWh will increase in the range of 1.0 - 2.0% for 2019 and increase on average in the range of 1.5 - 2.5% during 2019 through 2021, including the effects of customer conservation and energy efficiency and distributed renewable generation initiatives, but excluding the effects of weather variations.  A slower recovery of the Arizona economy or acceleration of the expected effects of customer conservation, energy efficiency or distributed renewable generation initiatives could further impact these estimates.

Actual customer and sales growth may differ from our projections as a result of numerous factors, such as economic conditions, customer growth, usage patterns and energy conservation, impacts of energy efficiency programs and growth in distributed renewable generation, and responses to retail price changes. Additionally, recovery of a substantial portion of our fixed costs of providing service is based upon the volumetric amount of our sales.  If our customer growth rate does not continue to improve as projected, or if we experience acceleration of expected effects of customer conservation, energy efficiency or distributed renewable generation initiatives, we may be unable to reach our estimated sales projections, which could have a negative impact on our financial condition, results of operations and cash flows.

The operation of power generation facilities and transmission systems involves risks that could result in reduced output or unscheduled outages, which could materially affect APS’s results of operations .
 
The operation of power generation, transmission and distribution facilities involves certain risks, including the risk of breakdown or failure of equipment, fuel interruption, and performance below expected levels of output or efficiency.  Unscheduled outages, including extensions of scheduled outages due to mechanical failures or other complications, occur from time to time and are an inherent risk of APS’s business.  Because our transmission facilities are interconnected with those of third parties, the operation of our facilities could be adversely affected by unexpected or uncontrollable events occurring on the larger transmission power grid, and the operation or failure of our facilities could adversely affect the operations of others.  Concerns over physical security of these assets could include damage to certain of our facilities due to vandalism or other

34

Table of Contents

deliberate acts that could lead to outages or other adverse effects. If APS’s facilities operate below expectations, especially during its peak seasons, it may lose revenue or incur additional expenses, including increased purchased power expenses. 
 
The impact of wildfires could negatively affect APS's results of operations.

Wildfires have the potential to affect the communities that APS serves and APS's vast network of electric transmission lines and facilities. The potential likelihood of wildfires has increased due to many of the same weather impacts existing in Arizona as those that led to the recent wildfires in Northern California. While we proactively take steps to mitigate wildfire risk in the areas of our electrical assets, given APS's expansive service territory, wildfire risk is always present. APS could be held liable for damages incurred as a result of wildfires that were caused by or enhanced due to APS's negligence. The Arizona liability standard is different from that of California, which generally imposes liability for resulting damages without regard to fault. Any damage caused to our assets, loss of service to our customers or liability imposed as a result of wildfires could negatively impact APS's financial condition, results of operations or cash flows.

The inability to successfully develop or acquire generation resources to meet reliability requirements and other new or evolving standards or regulations could adversely impact our business.
 
Potential changes in regulatory standards, impacts of new and existing laws and regulations, including environmental laws and regulations, and the need to obtain various regulatory approvals create uncertainty surrounding our generation portfolio.  The current abundance of low, stably priced natural gas, together with environmental and other concerns surrounding coal-fired generation resources, create strategic challenges as to the appropriate generation portfolio and fuel diversification mix.  In addition, APS is required by the ACC to meet certain energy resource portfolio requirements, including those related to renewables development and energy efficiency measures.  The development of any generation facility is subject to many risks, including those related to financing, siting, permitting, new and evolving technology, and the construction of sufficient transmission capacity to support these facilities.  APS’s inability to adequately develop or acquire the necessary generation resources could have a material adverse impact on our business and results of operations.

In expressing concerns about the environmental and climate-related impacts from continued extraction, transportation, delivery and combustion of fossil fuels, environmental advocacy groups and other third parties have in recent years undertaken greater efforts to oppose the permitting and construction of fossil fuel infrastructure projects. These efforts may increase in scope and frequency depending on a number of variables, including the future course of Federal environmental regulation and the increasing financial resources devoted to these opposition activities. APS cannot predict the effect that any such opposition may have on our ability to develop and construct fossil fuel infrastructure projects in the future.
 
The lack of access to sufficient supplies of water could have a material adverse impact on APS’s business and results of operations.
 
Assured supplies of water are important for APS’s generating plants.  Water in the southwestern United States is limited, and various parties have made conflicting claims regarding the right to access and use such limited supply of water.  Both groundwater and surface water in areas important to APS’s generating plants have been and are the subject of inquiries, claims and legal proceedings.  In addition, the region in which APS’s power plants are located is prone to drought conditions, which could potentially affect the plants’ water supplies.  APS’s inability to access sufficient supplies of water could have a material adverse impact on our business and results of operations.

35

Table of Contents

We are subject to cybersecurity risks and risks of unauthorized access to our systems.

We operate in a highly regulated industry that requires the continued operation of sophisticated information technology systems and network infrastructure. In the regular course of our business, we handle a range of sensitive security, customer and business systems information. There appears to be an increasing level of activity, sophistication and maturity of threat actors, in particular nation state actors, that seek to exploit potential vulnerabilities in the electric utility industry and wish to disrupt the U.S. bulk power, transmission and distribution system. Our information technology systems, generation (including our Palo Verde nuclear facility), transmission and distribution facilities, and other infrastructure facilities and systems and physical assets could be targets of unauthorized access and are critical areas of cyber protection for us.

Despite implementation of security measures, our technology systems are vulnerable to disability, failures or unauthorized access. If a significant cybersecurity event or breach were to occur, we may not be able to fulfill critical business functions and we could (i) experience property damage, disruptions to our business, theft of or unauthorized access to customer, employee, financial or system operation information or other information; (ii) experience loss of revenue or incur significant costs for repair, remediation and breach notification, and increased capital and operating costs to implement increased security measures; and (iii) be subject to increased regulation, litigation and reputational damage. These types of events could also require significant management attention and resources, and could have a material adverse impact on our financial condition, results of operations or cash flows.

We are subject to laws and rules issued by multiple government agencies concerning safeguarding and maintaining the confidentiality of our security, customer and business information. One of these agencies, NERC, has issued comprehensive regulations and standards surrounding the security of bulk power systems, and is continually in the process of developing updated and additional requirements with which the utility industry must comply. The NRC also has issued regulations and standards related to the protection of critical digital assets at commercial nuclear power plants. The increasing promulgation of NERC and NRC rules and standards will increase our compliance costs and our exposure to the potential risk of violations of the standards. Experiencing a cybersecurity incident could cause us to be non-compliant with applicable laws and regulations, such as those promulgated by NERC and the NRC, or contracts that require us to securely maintain confidential data, causing us to incur costs related to legal claims or proceedings and regulatory fines or penalties.

The risk of these system-related events and security breaches occurring continues to intensify. We have experienced, and expect to continue to experience, threats and attempted intrusions to our information technology systems and we could experience such threats and attempted intrusions to our operational control systems. To date we have not experienced a material breach or disruption to our network or information systems or our service operations. However, as such attacks continue to increase in sophistication and frequency, we may be unable to prevent all such attacks from being successful in the future.

We have obtained cyber insurance to provide coverage for a portion of the losses and damages that may result from a security breach of our information technology systems, but such insurance is subject to a number of exclusions and may not cover the total loss or damage caused by a breach. The market for cybersecurity insurance is relatively new and coverage available for cybersecurity events may evolve as the industry matures. In the future, adequate insurance may not be available at rates that we believe are reasonable, and the costs of responding to and recovering from a cyber incident may not be covered by insurance or recoverable in rates.

36

Table of Contents

The ownership and operation of power generation and transmission facilities on Indian lands could result in uncertainty related to continued leases, easements and rights-of-way, which could have a significant impact on our business.
 
Certain APS power plants and portions of certain APS transmission lines are located on Indian lands pursuant to leases, easements or other rights-of-way that are effective for specified periods.  APS is unable to predict the final outcomes of pending and future approvals by the applicable sovereign governing bodies with respect to renewals of these leases, easements and rights-of-way.
 
There are inherent risks in the ownership and operation of nuclear facilities, such as environmental, health, fuel supply, spent fuel disposal, regulatory and financial risks and the risk of terrorist attack.
 
APS has an ownership interest in and operates, on behalf of a group of participants, Palo Verde, which is the largest nuclear electric generating facility in the United States.  Palo Verde constitutes approximately 18% of our owned and leased generation capacity.  Palo Verde is subject to environmental, health and financial risks, such as the ability to obtain adequate supplies of nuclear fuel; 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; the costs of securing the facilities against possible terrorist attacks; and unscheduled outages due to equipment and other problems.  APS maintains nuclear decommissioning trust funds and external insurance coverage to minimize its financial exposure to some of these risks; however, it is possible that damages could exceed the amount of insurance coverage.  In addition, APS may be required under federal law to pay up to $120.1 million (but not more than $17.9 million per year) of liabilities arising out of a nuclear incident occurring not only at Palo Verde, but at any other nuclear power reactor in the United States. 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 and 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 and to promulgate new regulations that could require significant capital expenditures and/or increase operating costs.
 
The use of derivative contracts in the normal course of our business could result in financial losses that negatively impact our results of operations.
 
APS’s operations include managing market risks related to commodity prices.  APS is exposed to the impact of market fluctuations in the price and transportation costs of electricity, natural gas and coal to the extent that unhedged positions exist.  We have established procedures to manage risks associated with these market fluctuations by utilizing various commodity derivatives, including exchange traded futures 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 and fuels.  The changes in market value of such contracts have a high correlation to price changes in the hedged commodity.  To the extent that commodity markets are illiquid, we may not be able to execute our risk management strategies, which could result in greater unhedged positions than we would prefer at a given time and financial losses that negatively impact our results of operations.
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) contains measures aimed at increasing the transparency and stability of the over-the counter, or OTC, derivative markets and preventing excessive speculation. The Dodd-Frank Act could restrict, among other things, trading positions in the energy futures markets, require different collateral or settlement positions, or increase regulatory reporting over derivative positions. Based on the provisions included in the Dodd-Frank Act and the implementation of regulations, these changes could, among other things, impact our ability to hedge commodity price and interest rate risk or increase the costs associated with our hedging programs.

37

Table of Contents

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 APS’s 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, which could result in a material adverse impact on our earnings for a given period.
 
Changes in technology could create challenges for APS’s existing business.
 
Alternative energy technologies that produce power or reduce power consumption or emissions are being developed and commercialized, including renewable technologies such as photovoltaic (solar) cells, customer-sited generation, energy storage (batteries), and efficiency technologies.  Advances in technology and equipment/appliance efficiency could reduce the demand for supply from conventional generation and increase the complexity of managing APS's information technology and power system operations, which could adversely affect APS’s business.
 
APS continues to pursue and implement advanced grid technologies, including transmission and distribution system technologies and digital meters enabling two-way communications between the utility and its customers.  Many of the products and processes resulting from these and other alternative technologies have not yet been widely used or tested on a long-term basis, and their use on large-scale systems is not as established or mature as APS’s existing technologies and equipment.  The implementation of new and additional technologies adds complexity to our information technology and operational technology systems, which could require additional infrastructure and resources. Widespread installation and acceptance of new technologies could also enable the entry of new market participants, such as technology companies, into the interface between APS and its customers and could have other unpredictable effects on APS’s traditional business model.

Deployment of renewable energy technologies is expected to continue across the western states and result in a larger portion of the overall energy production coming from these sources. These trends, which have benefited from historical and continuing government support for certain technologies, have the potential to put downward pressure on wholesale power prices throughout the western states which could make APS's existing generating facilities less economical and impact their operational patterns and long-term viability.
 
We are subject to employee workforce factors that could adversely affect our business and financial condition.
 
Like many companies in the electric utility industry, our workforce is maturing, with approximately 30% of employees eligible to retire by the end of 2020.  Although we have undertaken efforts to recruit, train and develop new employees, we face increased competition for talent.  We are subject to other employee workforce factors, such as the availability and retention of qualified personnel and the need to negotiate collective bargaining agreements with union employees.  These or other employee workforce factors could negatively impact our business, financial condition or results of operations.

38

Table of Contents

FINANCIAL RISKS
 
Financial market disruptions or new rules or regulations may increase our financing costs or limit our access to various financial markets, which may adversely affect our liquidity and our ability to implement our financial strategy.
 
Pinnacle West and APS rely on access to credit markets as a significant source of liquidity and the capital markets for capital requirements not satisfied by cash flow from our operations.  We believe that we will maintain sufficient access to these financial markets.  However, certain market disruptions or rules or regulations may cause our cost of borrowing to increase generally, and/or otherwise adversely affect our ability to access these financial markets.
 
In addition, the credit commitments of our lenders under our bank facilities may not be satisfied or continued beyond current commitment periods for a variety of reasons, including new rules and regulations, periods of financial distress or liquidity issues affecting our lenders or financial markets, which could materially adversely affect the adequacy of our liquidity sources and the cost of maintaining these sources.
 
Changes in economic conditions, monetary policy, financial regulation or other factors could result in higher interest rates, which would increase interest expense on our existing variable rate debt and new debt we expect to issue in the future, and thus reduce funds available to us for our current plans.

Additionally, an increase in our leverage, whether as a result of these factors or otherwise, could adversely affect us by:

•	causing a downgrade of our credit ratings;	
		
•	increasing the cost of future debt financing and refinancing;	
		
•	increasing our vulnerability to adverse economic and industry conditions; and	
		
•	requiring us to dedicate an increased portion of our cash flow from operations to payments on our debt, which would reduce funds available to us for operations, future investment in our business or other purposes.	

A downgrade of our credit ratings could materially and adversely affect our business, financial condition and results of operations.
 
Our current ratings are set forth in “Liquidity and Capital Resources — Credit Ratings” in Item 7.  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 or withdrawal could adversely affect the market price of Pinnacle West’s and APS’s securities, limit our access to capital and increase our borrowing costs, which would diminish our financial results.  We would be required to pay a higher interest rate for future financings, and our potential pool of investors and funding sources could decrease.  In addition, borrowing costs under 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 severely limit 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.

39

Table of Contents

Investment performance, changing interest rates and other economic, social and political factors could decrease the value of our benefit plan assets and nuclear decommissioning trust funds or increase the valuation of our related obligations, resulting in significant additional funding requirements.  We are also subject to risks related to the provision of employee healthcare benefits and healthcare reform legislation.  Any inability to fully recover these costs in our utility rates would negatively impact our financial condition.
 
We have significant pension plan and other postretirement benefits plan obligations to our employees and retirees, and legal obligations to fund our pension trust and nuclear decommissioning trusts for Palo Verde.  We hold and invest substantial assets in these trusts that are designed to provide funds to pay for certain of these obligations as they arise.  Declines in market values of the fixed income and equity securities held in these trusts may increase our funding requirements into the related trusts.  Additionally, the valuation of liabilities related to our pension plan and other postretirement benefit plans are impacted by a discount rate, which is the interest rate used to discount future pension and other postretirement benefit obligations.  Declining interest rates decrease the discount rate, increase the valuation of the plan liabilities and may result in increases in pension and other postretirement benefit costs, cash contributions, regulatory assets, and charges to OCI.  Changes in demographics, including increased number of retirements or changes in life expectancy and changes in other actuarial assumptions, may also result in similar impacts.  The minimum contributions required under these plans are impacted by federal legislation and related regulations.  Increasing liabilities or otherwise increasing funding requirements under these plans, resulting from adverse changes in legislation or otherwise, could result in significant cash funding obligations that could have a material impact on our financial position, results of operations or cash flows.
 
We recover most of the pension costs and other postretirement benefit costs and all of the currently estimated nuclear decommissioning costs in our regulated rates.  Any inability to fully recover these costs in a timely manner would have a material negative impact on our financial condition, results of operations or cash flows.
 
Employee healthcare costs in recent years have continued to rise.  While most of the Patient Protection and Affordable Care Act provisions have been implemented, changes to or repeal of that Act and pending or future federal or state legislative or regulatory activity or court proceedings could increase costs of providing medical insurance for our employees and retirees. Any potential changes and resulting cost impacts cannot be determined with certainty at this time.
 
Our cash flow depends on the performance of APS.
 
We derive essentially all of our revenues and earnings from our wholly-owned subsidiary, APS.  Accordingly, our cash flow and our ability to pay dividends on our common stock is dependent upon the earnings and cash flows of APS and its distributions to us.  APS is a separate and distinct legal entity and has no obligation to make distributions to us.
 
APS’s financing agreements may restrict its ability to pay dividends, make distributions or otherwise transfer funds to us.  In addition, an ACC financing 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.  The common equity ratio, as defined in the ACC order, is total shareholder equity divided by the sum of total shareholder equity and long-term debt, including current maturities of long-term debt.

40

Table of Contents

Pinnacle West’s ability to meet its debt service obligations could be adversely affected because its debt securities are structurally subordinated to the debt securities and other obligations of its subsidiaries.
 
Because Pinnacle West is 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.  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 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.
 
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;	
		
•	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 or legislative developments;	
		
•	our dividend policy;	
		
•	future sales by the Company of 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.
 
Certain provisions of our articles of incorporation and bylaws and of Arizona law make it difficult for shareholders to change the composition of our board and may discourage takeover attempts.
 
These provisions, which could preclude our shareholders from receiving a change of control premium, include the following:
		
•	restrictions on 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;	
		
•	the ability of the Board of Directors to increase the size of the Board of Directors and fill vacancies on the Board of Directors, whether resulting from such increase, or from death, resignation, disqualification or otherwise; and	

41

Table of Contents

•	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.	
 
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 of Directors 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.

ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
Neither Pinnacle West nor APS has received written comments regarding its periodic or current reports from the SEC staff that were issued 180 days or more preceding the end of its 2018 fiscal year and that remain unresolved.

42

Table of Contents

ITEM 2.  PROPERTIES
 
Generation Facilities
 
APS

APS’s portfolio of owned and leased generating facilities is provided in the table below:

													
Name	 	No. of
Units	 	%
Owned (a)	 	Principal
Fuels
Used	 	Primary
Dispatch
Type	 	Owned
Capacity
(MW)	
Nuclear:	 	 	 	 		 	 	 	 	 	 		
Palo Verde (b)	 	3	 	29.1	%	 	Uranium	 	Base Load	 	1,146		
Total Nuclear	 	 	 	 		 	 	 	 	 	1,146		
Steam:	 	 	 	 		 	 	 	 	 	 		
Four Corners 4, 5 (c)	 	2	 	63	%	 	Coal	 	Base Load	 	970		
Cholla 1,3	 	2	 	 		 	Coal	 	Base Load	 	387		
Navajo (d)	 	3	 	14	%	 	Coal	 	Base Load	 	315		
Ocotillo (e)	 	—	 	 		 	Gas	 	Peaking	 	—		
Total Steam	 	 	 	 		 	 	 	 	 	1,672		
Combined Cycle:	 	 	 	 		 	 	 	 	 	 		
Redhawk	 	2	 	 		 	Gas	 	Load Following	 	984		
West Phoenix	 	5	 	 		 	Gas	 	Load Following	 	887		
Total Combined Cycle	 	 	 	 		 	 	 	 	 	1,871		
Combustion Turbine:	 	 	 	 		 	 	 	 	 	 		
Ocotillo (e)	 	2	 	 		 	Gas	 	Peaking	 	110		
Saguaro	 	3	 	 		 	Gas	 	Peaking	 	189		
Douglas/Fairview	 	1	 	 		 	Oil	 	Peaking	 	16		
Sundance	 	10	 	 		 	Gas	 	Peaking	 	420		
West Phoenix	 	2	 	 		 	Gas	 	Peaking	 	110		
Yucca 1, 2, 3	 	3	 	 		 	Gas	 	Peaking	 	93		
Yucca 4	 	1	 	 		 	Oil	 	Peaking	 	54		
Yucca 5, 6	 	2	 	 		 	Gas	 	Peaking	 	96		
Total Combustion Turbine	 	 	 	 		 	 	 	 	 	1,088		
Solar:	 	 	 	 		 	 	 	 	 	 		
Cotton Center (f)	 	1	 	 		 	Solar	 	As Available	 	17		
Hyder I (f)	 	1	 	 		 	Solar	 	As Available	 	16		
Paloma (f)	 	1	 	 		 	Solar	 	As Available	 	17		
Chino Valley	 	1	 	 		 	Solar	 	As Available	 	19		
Gila Bend (f)	 	1	 	 	 	Solar	 	As Available	 	32		
Hyder II (f)	 	1	 	 		 	Solar	 	As Available	 	14		
Foothills (f)	 	1	 	 		 	Solar	 	As Available	 	35		
Luke AFB	 	1	 	 	 	Solar	 	As Available	 	10		
Desert Star (f)	 	1	 	 	 	Solar	 	As Available	 	10		
Red Rock	 	1	 	 	 	Solar	 	As Available	 	40		
APS Owned Distributed Energy	 	 	 	 		 	Solar	 	As Available	 	24		
Multiple facilities	 	 	 	 		 	Solar	 	As Available	 	4		
Total Solar	 	 	 	 		 	 	 	 	 	238		
Total Capacity	 	 	 	 		 	 	 	 	 	6,015		

43

Table of Contents

(a)	100% unless otherwise noted.	
		
(b)	See “Business of Arizona Public Service Company — Energy Sources and Resource Planning — Generation Facilities — Nuclear” in Item 1 for details regarding leased interests in Palo Verde.  The other participants are Salt River Project (17.49%), SCE (15.8%), El Paso (15.8%), Public Service Company of New Mexico (10.2%), Southern California Public Power Authority (5.91%), and Los Angeles Department of Water & Power (5.7%).  The plant is operated by APS.	
		
(c)	The other participants are Salt River Project (10%), Public Service Company of New Mexico (13%), Tucson Electric Power Company (7%) and NTEC (7%).  The plant is operated by APS. 	
		
(d)	The other participants are Salt River Project (42.9%), Nevada Power Company (11.3%), the United States Government (24.3%) and Tucson Electric Power Company (7.5%).  The plant is operated by Salt River Project. In July 2016, Salt River Project purchased Los Angeles Department of Water & Power's share in this plant (21.2%).	
		
(e)	Ocotillo Steam Units 1 and 2 were retired on January 10, 2019. Units 3 through 7 are expected to go into service by the middle of 2019 and will increase generation capacity by 510 MW.	
		
(f)	APS is under contract to add battery storage at these AZ Sun sites and anticipates such storage facilities could be in service by mid-2020. (See "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Energy Storage" above for details related to these and other energy storage agreements.)	

See “Business of Arizona Public Service Company — Environmental Matters” in Item 1 with respect to matters having a possible impact on the operation of certain of APS’s generating facilities.
 
See “Business of Arizona Public Service Company” in Item 1 for a map detailing the location of APS’s major power plants and principal transmission lines.

4CA

4CA, a wholly-owned subsidiary of Pinnacle West, purchased El Paso's 7% interest in Units 4 and 5 of Four Corners on July 6, 2016 and subsequently sold the interest to NTEC on July 3, 2018. See "Areas of Business Focus - Operational Performance, Reliability and Recent Developments - Four Corners - Asset Purchase Agreement and Coal Supply Matters" in Item 7 for additional information about 4CA's interest in Four Corners.
 
Transmission and Distribution Facilities
 
Current Facilities .   APS’s transmission facilities consist of approximately 6,192 pole miles of overhead lines and approximately 49 miles of underground lines, 5,969 miles of which are located in Arizona.  APS’s distribution facilities consist of approximately 11,194 miles of overhead lines and approximately 21,854 miles of underground primary cable, all of which are located in Arizona. APS distribution facilities reflect an actual net gain of 357 miles in 2018.  APS shares ownership of some of its transmission facilities with other companies. 

44

Table of Contents

The following table shows APS’s jointly-owned interests in those transmission facilities recorded on the Consolidated Balance Sheets at December 31, 2018:

			
 	Percent Owned
(Weighted-Average)	
Morgan — Pinnacle Peak System	64.6	%	
Palo Verde — Rudd 500kV System	50.0	%	
Round Valley System	50.0	%	
ANPP 500kV System	33.5	%	
Navajo Southern System	26.7	%	
Four Corners Switchyards	63.1	%	
Palo Verde — Yuma 500kV System	19.0	%	
Phoenix — Mead System	17.1	%	
Palo Verde — Morgan System	87.9	%	
Hassayampa — North Gila System	80.0	%	
Cholla 500kV Switchyard	85.7	%	
Saguaro 500kV Switchyard	60.0	%	
Kyrene - Knox System	50.0	%	
 
Expansion.   Each year APS prepares and files with the ACC a ten-year transmission plan.  In APS’s 2019 plan, APS projects it will develop 15 miles of new transmission lines over the next ten years. One significant project, the Palo Verde to Morgan project recently completed all phases and is a new 500kV path that spans from the Palo Verde hub around the western and northern edges of the Phoenix metropolitan area and terminates at a bulk substation in the northeast part of Phoenix. The Palo Verde to Morgan project includes Palo Verde-Delaney-Sun Valley-Morgan-Pinnacle Peak. The project consisted of four phases and the fourth phase, Morgan to Sun Valley 500kV, was energized in April of 2018. In total, the project consisted of over 100 miles of new 500kV lines, with many of those miles constructed with the capability to string a 230kV line as a second circuit.

APS continues to work with regulators to identify transmission projects necessary to support renewable energy facilities. Two such projects, which have been completed and were included in previous APS transmission plans, are the Delaney to Palo Verde line and the North Gila to Hassayampa line, both of which support the transmission of renewable energy to Phoenix and California. The North Gila to Hassayampa line went into service in May 2015 and the Delaney to Palo Verde line went into service in May 2016.

Physical Security Standards. On July 14, 2015, FERC approved version 2 of the proposed Physical Security Reliability Standard CIP-014.  APS completed its initial implementation in 2018.  No additional significant financial or operational impacts on APS are anticipated.

NERC Critical Infrastructu re Protection Reliability Standards .  Since 2014, APS has been implementing a comprehensive project to ensure compliance with NERC's Critical Infrastructure Protection Reliability Standards ("CIP").  As a result of recent revisions to the CIP standards, the final compliance date is now January 1, 2020.  APS is 95% complete in its compliance implementation activities with total expenditures of $60.4 million incurred by APS as of December 31, 2018.  APS anticipates an additional expenditure of approximately $0.2 million with a final completion date in September 2019.

Plant and Transmission Line Leases and Rights-of-Way on Indian Lands
 
The Navajo Plant and Four Corners are located on land held under leases from the Navajo Nation and also under rights-of-way from the federal government.   The co-owners of the Navajo Plant and the Navajo

45

Table of Contents

Nation agreed that the Navajo Plant will remain in operation until December 2019 under the existing plant lease. The co-owners and the Navajo Nation executed a lease extension on November 29, 2017 that will allow for decommissioning activities to begin after the plant ceases operations in December 2019. Various stakeholders, including regulators, tribal representatives, the plant's coal supplier and the DOI have been meeting to determine if an alternate solution can be reached that would permit continued operation of the plant beyond 2019. Although we cannot predict whether any alternate plans will be found that would be acceptable to all of the stakeholders and feasible to implement, we believe it is probable that the current owners of the Navajo Plant will cease plant operations in December 2019.

APS, on behalf of the Four Corners participants, negotiated amendments to the Four Corners facility lease with the Navajo Nation, which extends the Four Corners leasehold interest from 2016 to 2041.  See "Areas of Business Focus - Operational Performance, Reliability and Recent Developments - Four Corners - Lease Extension" in Item 7 for additional information about the Four Corners right-of-way and lease matters.

Certain portions of our transmission lines are located on Indian lands pursuant to rights-of-way that are effective for specified periods.  Some of these rights-of-way have expired and our renewal applications have not yet been acted upon by the appropriate Indian tribes or federal agencies.  Other rights expire at various times in the future and renewal action by the applicable tribe or federal agencies will be required at that time.  In recent negotiations, certain of the affected Indian tribes have required payments substantially in excess of amounts that we have paid in the past for such rights-of-way.  The ultimate cost of renewal of certain of the rights-of-way for our transmission lines is therefore uncertain.

ITEM 3.  LEGAL PROCEEDINGS
 
See “Business of Arizona Public Service Company — Environmental Matters” in Item 1 with regard to pending or threatened litigation and other disputes.
See Note 3 for ACC and FERC-related matters.
See Note 10 for information regarding environmental matters and Superfund–related matters. 

ITEM 4.  MINE SAFETY DISCLOSURES
 
Not applicable.

46

Table of Contents

EXECUTIVE OFFICERS OF PINNACLE WEST
 
Pinnacle West’s executive officers are elected no less often than annually and may be removed by the Board of Directors at any time.  The executive officers, their ages at February 22, 2019, current positions and principal occupations for the past five years are as follows:

	
							
Name	 	Age	 	Position	 	Period	
Donald E. Brandt	 	64	 	Chairman of the Board and Chief Executive Officer of Pinnacle West; Chairman of the Board of APS	 	2009-Present	
 	 	 	 	President of APS	 	2013-2018	
 	 	 	 	President of Pinnacle West	 	2008-Present	
 	 	 	 	Chief Executive Officer of APS	 	2008-Present	
Robert S. Bement	 	63	 	Executive Vice President and Chief Nuclear Officer, PVGS, of APS	 	2016-Present	
 	 	 	 	Senior Vice President, Site Operations, PVGS, of APS	 	2011-2016	
Denise R. Danner	 	63	 	Vice President, Controller and Chief Accounting Officer of Pinnacle West; Chief Accounting Officer of APS	 	2010-Present	
 	 	 	 	Vice President and Controller of APS	 	2009-Present	
Donna M. Easterly	 	54	 	Vice President, Human Resources and Ethics of APS	 	2017-Present	
 	 	 	 	Vice President, Chief Procurement Officer of APS	 	2014-2017	
 	 	 	 	Director, Transmission and Distribution Construction of APS	 	2013-2014	
 	 	 	 	Director, Statewide Energy Delivery of APS	 	2010-2013	
Daniel T. Froetscher	 	57	 	Executive Vice President, Operations of APS	 	2018-Present	
 	 	 	 	Senior Vice President, Transmission, Distribution & Customers of APS	 	2014-2018	
 	 	 	 	Vice President, Energy Delivery of APS	 	2008-2014	
Jeffrey B. Guldner	 	53	 	President of APS	 	2018-Present	
 	 	 	 	Executive Vice President, Public Policy of Pinnacle West	 	2017-Present	
 	 	 	 	Executive Vice President, Public Policy of APS	 	2017-2018	
 	 	 	 	General Counsel of Pinnacle West and APS	 	2017-2018	
 	 	 	 	Senior Vice President, Public Policy of APS	 	2014-2017	
 	 	 	 	Senior Vice President, Customers and Regulation of APS	 	2012-2014	
James R. Hatfield	 	61	 	Executive Vice President of Pinnacle West and APS	 	2012-Present	
 	 	 	 	Chief Financial Officer of Pinnacle West and APS	 	2008-Present	
John S. Hatfield	 	53	 	Vice President, Communications of APS	 	2010-Present	
Barbara D. Lockwood	 	52	 	Vice President, Regulation of APS	 	2015-Present	
 	 	 	 	General Manager, Regulatory Policy and Compliance of APS	 	2014-2015	
 	 	 	 	General Manager, Innovation of APS	 	2012-2014	
Lee R. Nickloy	 	52	 	Vice President and Treasurer of Pinnacle West and APS	 	2010-Present	
Robert E. Smith	 	49	 	Senior Vice President and General Counsel of Pinnacle West and APS	 	2018-Present	

47

Table of Contents

PART II

  ITEM 5.  MARKET FOR REGISTRANTS’ COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Pinnacle West’s common stock is publicly held and is traded on the New York Stock Exchange under stock symbol PNW.  At the close of business on February 15, 2019, Pinnacle West’s common stock was held of record by approximately 17,769 shareholders.
 
APS’s common stock is wholly-owned by Pinnacle West and is not listed for trading on any stock exchange.  The sole holder of APS’s common stock, Pinnacle West, is entitled to dividends when and as declared out of legally available funds.  At December 31, 2018, APS did not have any outstanding preferred stock.

48

Table of Contents

ITEM 6.  SELECTED FINANCIAL DATA
PINNACLE WEST CAPITAL CORPORATION – CONSOLIDATED

The selected data presented below as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014 are derived from the Consolidated Financial Statements. The data should be read in connection with the Consolidated Financial Statements including the related notes included in Item 8 of this Form 10-K.

																					
 	 	2018	 	2017	 	2016	 	2015	 	2014	
 	 	(dollars in thousands, except per share amounts)	
OPERATING RESULTS	 	 		 	 		 	 		 	 		 	 		
Operating revenues	 	$	3,691,247		 	$	3,565,296		 	$	3,498,682		 	$	3,495,443		 	$	3,491,632		
Net income	 	530,540		 	507,949		 	461,527		 	456,190		 	423,696		
Less: Net income attributable to noncontrolling interests	 	19,493		 	19,493		 	19,493		 	18,933		 	26,101		
Net income attributable to common shareholders	 	$	511,047		 	$	488,456		 	$	442,034		 	$	437,257		 	$	397,595		
COMMON STOCK DATA	 	 		 	 		 	 		 	 		 	 		
Book value per share – year-end	 	$	46.59		 	$	44.80		 	$	43.14		 	$	41.30		 	$	39.50		
Earnings per weighted-average common share outstanding:	 	 		 	 		 	 		 	 		 	 		
Net income attributable to common shareholders – basic	 	$	4.56		 	$	4.37		 	$	3.97		 	$	3.94		 	$	3.59		
Net income attributable to common shareholders – diluted	 	$	4.54		 	$	4.35		 	$	3.95		 	$	3.92		 	$	3.58		
Dividends declared per share	 	$	2.87		 	$	2.70		 	$	2.56		 	$	2.44		 	$	2.33		
Weighted-average common shares outstanding – basic	 	112,129,017		 	111,838,922		 	111,408,729		 	111,025,944		 	110,626,101		
Weighted-average common shares outstanding – diluted	 	112,549,722		 	112,366,675		 	112,046,043		 	111,552,130		 	111,178,141		
BALANCE SHEET DATA	 	 		 	 		 	 		 	 		 	 		
Total assets	 	$	17,664,202		 	$	17,019,082		 	$	16,004,253		 	$	15,028,258		 	$	14,288,890		
Liabilities and equity:	 	 		 	 		 	 		 	 		 	 		
Current liabilities	 	$	1,648,964		 	$	1,197,852		 	$	1,292,946		 	$	1,442,317		 	$	1,559,143		
Long-term debt less current maturities	 	4,638,232		 	4,789,713		 	4,021,785		 	3,462,391		 	3,006,573		
Deferred credits and other	 	6,028,301		 	5,895,787		 	5,753,610		 	5,404,093		 	5,204,072		
Total liabilities	 	12,315,497		 	11,883,352		 	11,068,341		 	10,308,801		 	9,769,788		
Total equity	 	5,348,705		 	5,135,730		 	4,935,912		 	4,719,457		 	4,519,102		
Total liabilities and equity	 	$	17,664,202		 	$	17,019,082		 	$	16,004,253		 	$	15,028,258		 	$	14,288,890		

49

Table of Contents

SELECTED FINANCIAL DATA
ARIZONA PUBLIC SERVICE COMPANY – CONSOLIDATED

																					
 	 	2018	 	2017	 	2016	 	2015	 	2014	
 	 	(dollars in thousands)	
OPERATING RESULTS	 	 		 	 		 	 		 	 		 	 		
Operating revenues	 	$	3,688,342		 	$	3,557,652		 	$	3,498,090		 	$	3,494,900		 	$	3,490,998		
Fuel and purchased power costs	 	1,094,020		 	992,744		 	1,082,625		 	1,101,298		 	1,179,829		
Other operating expenses	 	1,764,554		 	1,640,369		 	1,556,980		 	1,556,670		 	1,505,644		
Operating income	 	829,768		 	924,539		 	858,485		 	836,932		 	805,525		
Other income	 	111,015		 	60,482		 	52,081		 	54,225		 	60,985		
Interest expense — net of allowance for borrowed funds	 	206,211		 	192,051		 	183,090		 	176,109		 	181,830		
Net income before income taxes	 	734,572		 	792,970		 	727,476		 	715,048		 	684,680		
Income taxes	 	144,814		 	269,168		 	245,842		 	245,841		 	237,360		
Net income	 	589,758		 	523,802		 	481,634		 	469,207		 	447,320		
Less: Net income attributable to noncontrolling interests	 	19,493		 	19,493		 	19,493		 	18,933		 	26,101		
Net income attributable to common shareholder	 	$	570,265		 	$	504,309		 	$	462,141		 	$	450,274		 	$	421,219		
BALANCE SHEET DATA	 	 		 	 		 	 		 	 		 	 		
Total assets	 	$	17,565,323		 	$	16,893,751		 	$	15,931,175		 	$	14,982,182		 	$	14,190,362		
Liabilities and equity:	 	 		 	 		 	 		 	 		 	 		
Total equity	 	$	5,786,797		 	$	5,385,869		 	$	5,037,970		 	$	4,814,794		 	$	4,629,852		
Long-term debt less current maturities	 	4,189,436		 	4,491,292		 	4,021,785		 	3,337,391		 	2,881,573		
Total capitalization	 	9,976,233		 	9,877,161		 	9,059,755		 	8,152,185		 	7,511,425		
Current liabilities	 	1,576,097		 	1,098,274		 	1,094,037		 	1,424,708		 	1,532,464		
Deferred credits and other	 	6,012,993		 	5,918,316		 	5,777,383		 	5,405,289		 	5,146,473		
Total liabilities and equity	 	$	17,565,323		 	$	16,893,751		 	$	15,931,175		 	$	14,982,182		 	$	14,190,362		

50

Table of Contents

ITEM 7.  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 Consolidated Financial Statements and APS’s Consolidated Financial Statements and the related Notes that appear in Item 8 of this report.  For information on factors that may cause our actual future results to differ from those we currently seek or anticipate, see “Forward-Looking Statements” at the front of this report and “Risk Factors” in Item 1A.

OVERVIEW
 
Pinnacle West owns 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, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona.  APS currently accounts for essentially all of our revenues and earnings.
 
Areas of Business Focus
 
Operational Performance, Reliability and Recent Developments.
 
Nuclear. APS operates and is a joint owner of Palo Verde. Palo Verde experienced strong performance during 2018, with its three units achieving a combined year-end capacity factor of 90.2% and an all-time best collective radiation exposure dose performance in the history of Palo Verde’s operation. For additional information, see "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generation Facilities - Nuclear."

Coal and Related Environmental Matters and Transactions.   APS is a joint owner of three coal-fired power plants and acts as operating agent for two of the plants.  APS is focused on the impacts on its coal fleet that may result from increased regulation and potential legislation concerning GHG emissions.  On August 3, 2015, EPA finalized a rule to limit carbon dioxide emissions from existing power plants (the "Clean Power Plan"), which the EPA later proposed repealing. EPA is considering a proposed replacement to the Clean Power Plan, which was published on August 21, 2018. This new proposal, the "Affordable Clean Energy Rule," is more narrow than its predecessor regulation, and is based entirely upon heat-rate improvements at steam-electric power plants. See "Business - Environmental Matters - Climate Change - Regulatory Initiatives" for additional information on the current status of EPA's carbon pollution standards for EGUs. APS continually analyzes its long-range capital management plans to assess the potential effects of such proposals, understanding that any resulting regulation and legislation could impact the economic viability of certain plants, as well as the willingness or ability of power plant participants to continue participation in such plants.

51

Table of Contents

Cholla

On September 11, 2014, APS announced that it would close its 260 MW Unit 2 at Cholla and cease burning coal at the other APS-owned units (Units 1 and 3) at the plant by the mid-2020s, if EPA approves a compromise proposal offered by APS to meet required environmental and emissions standards and rules. On April 14, 2015, the ACC approved APS's plan to retire Unit 2, without expressing any view on the future recoverability of APS's remaining investment in the Unit, which was later addressed in the 2017 Settlement Agreement. (See Note 3 for details related to the resulting cost recovery.) APS believes that the environmental benefits of this proposal are greater in the long-term than the benefits that would have resulted from adding emissions control equipment. APS closed Unit 2 on October 1, 2015. In early 2017, EPA approved a final rule incorporating APS's compromise proposal, which took effect for Cholla on April 26, 2017. For additional information, see "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Coal-Fueled Generating Facilities - Cholla."

Four Corners
 
Asset Purchase Agreement and Coal Supply Matters.   On December 30, 2013, APS purchased SCE’s 48% interest in each of Units 4 and 5 of Four Corners. The final purchase price for the interest was approximately $182 million. In connection with APS’s prior general retail rate case with the ACC, the ACC reserved the right to review the prudence of the Four Corners transaction for cost recovery purposes upon the closing of the transaction. On December 23, 2014, the ACC approved rate adjustments related to APS’s acquisition of SCE’s interest in Four Corners resulting in a revenue increase of $57.1 million on an annual basis. This decision was appealed and, on September 26, 2017, the Arizona Court of Appeals affirmed the ACC's decision on the Four Corners rate adjustment.

Concurrently with the closing of the SCE transaction described above, BHP Billiton, the parent company of BNCC, the coal supplier and operator of the mine that served Four Corners, transferred its ownership of BNCC to NTEC, a company formed by the Navajo Nation to own the mine and develop other energy projects. Also occurring concurrently with the closing, the Four Corners’ co-owners executed the 2016 Coal Supply Agreement for the supply of coal to Four Corners from July 2016 through 2031. El Paso, a 7% owner in Units 4 and 5 of Four Corners, did not sign the 2016 Coal Supply Agreement. Under the 2016 Coal Supply Agreement, APS agreed to assume the 7% shortfall obligation. (See Note 10 for a discussion of a settlement related to the 2016 Coal Supply Agreement and an advance purchase of coal inventory made under the agreement.) On February 17, 2015, APS and El Paso entered into an asset purchase agreement providing for the purchase by APS, or an affiliate of APS, of El Paso’s 7% interest in each of Units 4 and 5 of Four Corners. 4CA purchased the El Paso interest on July 6, 2016. The purchase price was immaterial in amount, and 4CA assumed El Paso's reclamation and decommissioning obligations associated with the 7% interest.
NTEC had the option to purchase the 7% interest within a certain timeframe pursuant to an option granted to NTEC. On December 29, 2015, NTEC provided notice of its intent to exercise the option. The purchase did not occur during the originally contemplated timeframe. Concurrent with the settlement of the 2016 Coal Supply Agreement matter described in Note 10, NTEC and 4CA agreed to allow for the purchase by NTEC of the 7% interest, consistent with the option. On June 29, 2018, 4CA and NTEC entered into an asset purchase agreement providing for the sale to NTEC of 4CA's 7% interest in Four Corners. Completion of the sale was subject to the receipt of approval by FERC, which was received on July 2, 2018, and the sale transaction closed on July 3, 2018. NTEC purchased the 7% interest at 4CA’s book value, approximately $70 million, and will pay 4CA the purchase price over a period of four years pursuant to a secured interest-bearing promissory note. In connection with the sale, Pinnacle West guaranteed certain obligations that NTEC will have to the other owners of Four Corners, such as NTEC's 7% share of capital expenditures and operating and maintenance expenses. Pinnacle West's guarantee is secured by a portion of APS's payments to be owed to NTEC under the 2016 Coal Supply Agreement.

52

Table of Contents

    The 2016 Coal Supply Agreement contained alternate pricing terms for the 7% interest in the event NTEC did not purchase the interest. Until the time that NTEC purchased the 7% interest, the alternate pricing provisions were applicable to 4CA, as the holder of the 7% interest. These terms included a formula under which NTEC must make certain payments to 4CA for reimbursement of operations and maintenance costs and a specified rate of return, offset by revenue generated by 4CA’s power sales. Such payments are due to 4CA at the end of each calendar year. A $10 million payment was due to 4CA at December 31, 2017, which NTEC satisfied by directing to 4CA a prepayment from APS of a portion of a future mine reclamation obligation. The balance of the amount due under this formula at December 31, 2018 for calendar year 2017 was approximately $20 million, which was paid to 4CA on December 14, 2018. The balance of the amount under this formula for calendar year 2018 (up to the date that NTEC purchased the 7% interest) is approximately $10 million, which is due to 4CA at December 31, 2019.

Lease Extension.   APS, on behalf of the Four Corners participants, negotiated amendments to an existing facility lease with the Navajo Nation, which extends the Four Corners leasehold interest from 2016 to 2041.  The Navajo Nation approved these amendments in March 2011.  The effectiveness of the amendments also required the approval of the DOI, as did a related federal rights-of-way grant.  A federal environmental review was undertaken as part of the DOI review process, and culminated in the issuance by DOI of a record of decision on July 17, 2015 justifying the agency action extending the life of the plant and the adjacent mine.  

On April 20, 2016, several environmental groups filed a lawsuit against OSM and other federal agencies in the District of Arizona in connection with their issuance of the approvals that extended the life of Four Corners and the adjacent mine.  The lawsuit alleges that these federal agencies violated both the ESA and NEPA in providing the federal approvals necessary to extend operations at the Four Corners Power Plant and the adjacent Navajo Mine past July 6, 2016.  APS filed a motion to intervene in the proceedings, which was granted on August 3, 2016.

On September 15, 2016, NTEC, the company that owns the adjacent mine, filed a motion to intervene for the purpose of dismissing the lawsuit based on NTEC's tribal sovereign immunity. On September 11, 2017, the Arizona District Court issued an order granting NTEC's motion, dismissing the litigation with prejudice, and terminating the proceedings. On November 9, 2017, the environmental group plaintiffs appealed the district court order dismissing their lawsuit. Oral argument for this appeal has been scheduled for March 2019. We cannot predict whether this appeal will be successful and, if it is successful, the outcome of further district court proceedings.
    
Wastewater Permit. On July 16, 2018, several environmental groups filed a petition for review before the EPA EAB concerning the NPDES wastewater discharge permit for Four Corners, which was reissued on June 12, 2018.  The environmental groups allege that the permit was reissued in contravention of several requirements under the Clean Water Act and did not contain required provisions concerning EPA’s 2015 revised effluent limitation guidelines for steam-electric EGUs, 2014 existing-source regulations governing cooling-water intake structures, and effluent limits for surface seepage and subsurface discharges from coal-ash disposal facilities.  To address certain of these issues through a reconsidered permit, EPA took action on December 19, 2018 to withdraw the NPDES permit reissued in June 2018. Withdrawal of the permit moots the EAB appeal, and EPA filed a motion to dismiss on that basis. EPA indicated that it anticipates proposing a replacement NPDES permit by March 2019 and, depending on the extent of public comments concerning that proposal, taking final action on a new NPDES permit by June 2019. At this time, we cannot predict the outcome of EPA's reconsideration of the NPDES permit and whether reconsideration will have a material impact on our financial position, results of operations or cash flows.

53

Table of Contents

For additional information, see "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities - Four Corners." 
    
Navajo Plant

The co-owners of the Navajo Plant and the Navajo Nation agreed that the Navajo Plant will remain in operation until December 2019 under the existing plant lease. The co-owners and the Navajo Nation executed a lease extension on November 29, 2017 that will allow for decommissioning activities to begin after the plant ceases operations in December 2019. Various stakeholders including regulators, tribal representatives, the plant's coal supplier and DOI have been meeting to determine if an alternate solution can be reached that would permit continued operation of the plant beyond 2019. Although we cannot predict whether any alternate plans will be found that would be acceptable to all of the stakeholders and feasible to implement, we believe it is probable that the current owners of the Navajo Plant will cease plant operations in December 2019.

APS is currently recovering depreciation and a return on the net book value of its interest in the Navajo Plant over its previously estimated life through 2026. APS will seek continued recovery in rates for the book value of its remaining investment in the plant (see Note 3 for details related to the resulting regulatory asset) plus a return on the net book value as well as other costs related to retirement and closure, which are still being assessed and may be material.
    
On February 14, 2017, the ACC opened a docket titled "ACC Investigation Concerning the Future of the Navajo Generating Station" with the stated goal of engaging stakeholders and negotiating a sustainable pathway for the Navajo Plant to continue operating in some form after December 2019. APS cannot predict the outcome of this proceeding.

For additional information, see "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities - Navajo Plant."

Natural Gas.   APS has six natural gas power plants located throughout Arizona, including Ocotillo. Ocotillo was originally a 330 MW 4-unit gas plant located in the metropolitan Phoenix area.  In early 2014, APS announced a project to modernize the plant, which involves retiring two older 110 MW steam units, adding five 102 MW combustion turbines and maintaining two existing 55 MW combustion turbines.  In total, this increases the capacity of the site by 290 MW to 620 MW, with completion targeted by the middle of 2019.  (See Note 3 for details of the rate recovery in our 2017 Rate Case Decision.) For additional information, see "Business of Arizona Public Service Company - Energy Sources and Resource Planning - Generation Facilities - Coal-Fueled Generating Facilities - Natural Gas and Oil-Fueled Generating Facilities."

Transmission and Delivery.   APS continues to work closely with customers, stakeholders, and regulators to identify and plan for transmission needs that support new customers, system reliability, access to markets and renewable energy development.  The capital expenditures table presented in the "Liquidity and Capital Resources" section below includes new APS transmission projects, along with other transmission costs for upgrades and replacements.  APS is also working to establish and expand advanced grid technologies throughout its service territory to provide long-term benefits both to APS and its customers.  APS is strategically deploying a variety of technologies that are intended to allow customers to better manage their energy usage, minimize system outage durations and frequency, enable customer choice for new customer sited technologies, and facilitate greater cost savings to APS through improved reliability and the automation of certain distribution functions.
 
Energy Imbalance Market. In 2015, APS and the CAISO, the operator for the majority of California's transmission grid, signed an agreement for APS to begin participation in EIM. APS's participation

54

Table of Contents

in the EIM began on October 1, 2016.  The EIM allows for rebalancing supply and demand in 15-minute blocks with dispatching every five minutes before the energy is needed, instead of the traditional one hour blocks.  APS continues to expect that its participation in EIM will lower its fuel costs, improve visibility and situational awareness for system operations in the Western Interconnection power grid, and improve integration of APS’s renewable resources.

Energy Storage. APS deploys a number of advanced technologies on its system, including energy storage. Storage can provide capacity, improve power quality, be utilized for system regulation, integrate renewable generation, and can be used to defer certain traditional infrastructure investments. Battery storage can also aid in integrating higher levels of renewables by storing excess energy when system demand is low and renewable production is high and then releasing the stored energy during peak demand hours later in the day and after sunset. APS is utilizing grid-scale battery storage projects to evaluate the potential benefits for customers and further our understanding of how storage works with other advanced technologies and the grid. We are preparing for additional battery storage in the future.

In early 2018, APS entered into a 15-year power purchase agreement for a 65 MW solar facility that charges a 50 MW solar-fueled battery. Service under this agreement is scheduled to begin in 2021. APS issued a request for proposal for approximately 106 MW of battery storage to be located at up to five of its AZ Sun sites. Based upon our evaluation of the RFP responses, APS has decided to expand the initial phase of battery deployment to 141 MW by adding a sixth AZ Sun site. In February 2019, we contracted for the 141 MW and anticipate such facilities could be in service by mid-2020. Additionally, in February 2019, APS signed two 20-year power purchase agreements for energy storage totaling 150 MW. Service under these agreements are scheduled to begin in 2021.  We plan to install at least an additional 660 MW of APS-owned solar plus battery storage and stand-alone battery storage systems by the summer of 2025, with the first 260 MW being procured in 2019 (60 MW on additional AZ Sun sites and 100 MW of solar plus 100 MW of battery storage). 

Regulatory Matters

Rate Matters.  APS needs timely recovery through rates of its capital and operating expenditures to maintain its financial health.  APS’s retail rates are regulated by the ACC and its wholesale electric rates (primarily for transmission) are regulated by FERC.  See Note 3 for information on APS’s FERC rates.

On June 1, 2016, APS filed an application with the ACC for an annual increase in retail base rates of $165.9 million. This amount excluded amounts that were then collected on customer bills through adjustor mechanisms. The application requested that some of the balances in these adjustor accounts (aggregating to approximately $267.6 million as of December 31, 2015) be transferred into base rates through the ratemaking process. This transfer would not have had an incremental effect on average customer bills. The average annual customer bill impact of APS’s request was an increase of 5.74% (the average annual bill impact for a typical APS residential customer was 7.96% ) . See Note 3 for details regarding the principal provisions of APS's application.

On March 27, 2017, a majority of the stakeholders in the general retail rate case, including the ACC Staff, the Residential Utility Consumer Office, limited income advocates and private rooftop solar organizations signed the 2017 Settlement Agreement and filed it with the ACC. The average annual customer bill impact under the 2017 Settlement Agreement was calculated as an increase of 3.28% (the average annual bill impact for a typical APS residential customer was calculated as 4.54%). (See Note 3 for details of the 2017 Settlement Agreement.)

55

Table of Contents

On August 15, 2017, the ACC approved (by a vote of 4-1), the 2017 Settlement Agreement without material modifications.  On August 18, 2017, the ACC issued the 2017 Rate Case Decision, which is subject to requests for rehearing and potential appeal. The new rates went into effect on August 19, 2017.

On October 17, 2017, Warren Woodward (an intervener in APS's general retail rate case) filed a Notice of Appeal in the Arizona Court of Appeals, Division One. The notice raises a single issue related to the application of certain rate schedules to new APS residential customers after May 1, 2018. Mr. Woodward filed a second notice of appeal on November 13, 2017 challenging APS’s $5 per month automated metering infrastructure opt-out program. Mr. Woodward’s two appeals have been consolidated and APS requested and was granted intervention. Mr. Woodward filed his opening brief on March 28, 2018.  The ACC and APS filed responsive briefs on June 21, 2018. The Arizona Court of Appeals issued a Memorandum Decision on December 11, 2018 affirming the ACC decisions challenged by Mr. Woodward.  Mr. Woodward filed a petition for review with the Arizona Supreme Court on January 9, 2019. Review by the Arizona Supreme Court is discretionary. APS cannot predict the outcome of this consolidated appeal but does not believe it will have a material impact on our financial position, results of operations or cash flows.

On January 3, 2018, an APS customer filed a petition with the ACC that was determined by the Administrative Law Judge to be a complaint filed pursuant to Arizona Revised Statute §40-246 and not a request for rehearing. Arizona Revised Statute §40-246 requires the ACC to hold a hearing regarding any complaint alleging that a public service corporation is in violation of any commission order or that the rates being charged are not just and reasonable if the complaint is signed by at least twenty-five customers of the public service corporation. The Complaint alleged that APS is “in violation of commission order” [sic]. On February 13, 2018, the complainant filed an amended Complaint alleging that the rates and charges in the 2017 Rate Case Decision are not just and reasonable.  The complainant requested that the ACC hold a hearing on the amended Complaint to determine if the average bill impact on residential customers of the rates and charges approved in the 2017 Rate Case Decision is greater than 4.54% (the average annual bill impact for a typical APS residential customer estimated by APS) and, if so, what effect the alleged greater bill impact has on APS's revenues and the overall reasonableness and justness of APS's rates and charges, in order to determine if there is sufficient evidence to warrant a full-scale rate hearing.  The ACC held a hearing on this matter beginning in September 2018 and the hearing was concluded on October 1, 2018. Post-hearing briefing was concluded on December 14, 2018. APS expects a recommended opinion and order from the judge within the first quarter of 2019. APS cannot predict the outcome of this matter.

On December 24, 2018, certain ACC Commissioners filed a letter stating that because the ACC had received a substantial number of complaints that the rate increase authorized by the 2017 Rate Case Decision was much more than anticipated, they believe there is a possibility that APS is earning more than was authorized by the 2017 Rate Case Decision.  Accordingly, the ACC Commissioners requested the ACC Staff to perform a rate review of APS using calendar year 2018 as a test year and file a report by May 3, 2019.  The ACC Commissioners also asked the ACC Staff to evaluate APS’s efforts to educate its customers regarding the new rates approved in the 2017 Rate Case Decision.  On January 9, 2019, the ACC Commissioners voted to open a docket for this matter.  APS does not believe that the rate review will have a material impact on our financial position, results of operations or cash flows.  However, depending upon the results of the rate review, the ACC may take further actions, including potentially attempting to reopen the 2017 Rate Case Decision.  APS cannot predict the outcome of this matter.

APS has several recovery mechanisms in place that provide more timely recovery to APS of its fuel and transmission costs, and costs associated with the promotion and implementation of its demand side management and renewable energy efforts and customer programs.  These mechanisms are described more fully below and in Note 3.

56

Table of Contents

SCR Cost Recovery . On December 29, 2017, in accordance with the 2017 Rate Case Decision, APS filed a Notice of Intent to file its SCR Adjustment to permit recovery of costs associated with the installation of SCR equipment at Four Corners Units 4 and 5.  APS filed the SCR Adjustment request in April 2018. Consistent with the 2017 Rate Case Decision, the request was narrow in scope and addressed only costs associated with this specific environmental compliance equipment. The SCR Adjustment request provided that there would be a $67.5 million annual revenue impact that would be applied as a percentage of base rates for all applicable customers. Also, as provided for in the 2017 Rate Case Decision, APS requested that the rate adjustment become effective no later than January 1, 2019. The hearing for this matter occurred in September 2018. At the hearing, APS accepted ACC Staff's recommendation of a lower annual revenue impact of approximately $58.5 million. The Administrative Law Judge issued a Recommended Opinion and Order finding that the costs for the SCR project were prudently incurred and recommending authorization of the $58.5 million dollar annual revenue requirement related to the installation and operation of the SCRs. Exceptions to the Recommended Opinion and Order were filed by the parties and intervenors on December 7, 2018.  The ACC has not issued a decision on this matter.  APS anticipates a decision later in 2019.

Renewable Energy .   The ACC approved the RES in 2006.  The renewable energy requirement is 9% of retail electric sales in 2019 and increases annually until it reaches 15% in 2025.  In APS’s 2009 general retail rate case settlement agreement, APS agreed to exceed the RES standards, committing to use APS’s best efforts to have 1,700 GWh of new renewable resources in service by year-end 2015, in addition to its RES renewable resource commitments.  APS met its settlement commitment in 2015. A component of the RES targets development of distributed energy systems. For additional information, see “Business of Arizona Public Service Company-Energy Sources and Resource Planning - Current and Future Resources-Renewable Energy Standard.”

On July 1, 2016, APS filed its 2017 RES Implementation Plan and proposed a budget of approximately $150 million. APS’s budget request included additional funding to process the high volume of residential rooftop solar interconnection requests and also requested a permanent waiver of the residential distributed energy requirement for 2017 contained in the RES rules. On April 7, 2017, APS filed an amended 2017 RES Implementation Plan and updated budget request which included the revenue neutral transfer of specific revenue requirements into base rates in accordance with the 2017 Settlement Agreement.  On August 15, 2017, the ACC approved the 2017 RES Implementation Plan.

On June 30, 2017, APS filed its 2018 RES Implementation Plan and proposed a budget of approximately $90 million.  APS’s budget request supports existing approved projects and commitments and includes the anticipated transfer of specific revenue requirements into base rates in accordance with the 2017 Settlement Agreement and also requests a permanent waiver of the residential distributed energy requirement for 2018 contained in the RES rules. APS's 2018 RES budget request is lower than the 2017 RES budget due in part to a certain portion of the RES being collected by APS in base rates rather than through the RES adjustor.

On November 20, 2017, APS filed an updated 2018 RES budget to include budget adjustments for APS Solar Communities (formerly known as AZ Sun II), which was approved as part of the 2017 Rate Case Decision. APS Solar Communities is a three-year program authorizing APS to spend $10 million - $15 million in capital costs each year to install utility-owned distributed generation ("DG") systems for low to moderate income residential homes, buildings of non-profit entities, Title I schools and rural government facilities. The 2017 Rate Case Decision provided that all operations and maintenance expenses, property taxes, marketing and advertising expenses, and the capital carrying costs for this program will be recovered through the RES. On June 12, 2018, the ACC approved the 2018 RES Implementation Plan.

57

Table of Contents

On June 29, 2018, APS filed its 2019 RES Implementation Plan and proposed a budget of approximately $89.9 million.  APS’s budget request supports existing approved projects and commitments and requests a permanent waiver of the residential distributed energy requirement for 2019 contained in the RES rules. The ACC has not yet ruled on the 2019 RES Implementation Plan.

In September 2016, the ACC initiated a proceeding which will examine the possible modernization and expansion of the RES.  On January 30, 2018, ACC Commissioner Tobin proposed a plan in this proceeding which would broaden the RES to include a series of energy policies tied to clean energy sources (the "Energy Modernization Plan"). The Energy Modernization Plan includes replacing the current RES standard with a new standard called the Clean Resource Energy Standard and Tariff ("CREST"), which incorporates the proposals in the Energy Modernization Plan. A set of CREST rules for the ACC's consideration was issued by Commissioner Tobin's office on July 5, 2018. See Note 3 for more information on the RES and the Energy Modernization Plan.

Demand Side Management.  In December 2009, Arizona regulators placed an increased focus on energy efficiency and other demand side management programs to encourage customers to conserve energy, while incentivizing utilities to aid in these efforts that ultimately reduce the demand for energy.  The ACC initiated an Energy Efficiency rulemaking, with a proposed EES of 22% cumulative annual energy savings by 2020.  The 22% figure represents the cumulative reduction in future energy usage through 2020 attributable to energy efficiency initiatives.  This standard became effective on January 1, 2011.
 
On June 1, 2016, APS filed its 2017 Demand Side Management Implementation Plan ("DSM Plan"), in which APS proposed programs and measures that specifically focus on reducing peak demand, shifting load to off-peak periods and educating customers about strategies to manage their energy and demand.  The requested budget in the 2017 DSM Plan was $62.6 million.  On January 27, 2017, APS filed an updated and modified 2017 DSM Plan that incorporated the proposed $4 million Residential Demand Response, Energy Storage and Load Management Program that was filed with the ACC on December 5, 2016 and requested that the budget for the 2017 DSM Plan be increased to $66.6 million. On August 15, 2017, the ACC approved the amended 2017 DSM Plan.

On September 1, 2017, APS filed its 2018 DSM Plan, which proposes modifications to the demand side management portfolio to better meet system and customer needs by focusing on peak demand reductions, storage, load shifting and demand response programs in addition to traditional energy savings measures. The 2018 DSM Plan seeks a reduced requested budget of $52.6 million and requests a waiver of the EES for 2018. On November 14, 2017, APS filed an amended 2018 DSM Plan, which revised the allocations between budget items to address customer participation levels, but kept the overall budget at $52.6 million. The ACC has not yet ruled on the APS 2018 amended DSM Plan.

On December 31, 2018, APS filed its 2019 DSM Plan, which requests a budget of $34.1 million and continues APS's focus on DSM strategies such as peak demand reduction, load shifting, storage and electrification strategies. The ACC has not yet ruled on the APS 2019 DSM Plan. See Note 3 for more information on demand side management.    

Tax Expense Adjustor Mechanism and FERC Tax Filing. As part of the 2017 Settlement Agreement, the parties agreed to a rate adjustment mechanism to address potential federal income tax reform and enable the pass-through of certain income tax effects to customers. On December 22, 2017 the Tax Cuts and Jobs Act (“Tax Act”) was enacted.  This legislation made significant changes to the federal income tax laws including a reduction in the corporate tax rate from 35% to 21% effective January 1, 2018.

58

Table of Contents

On January 8, 2018, APS filed an application with the ACC requesting that the TEAM be implemented in two steps. The first addresses the change in the marginal federal tax rate from 35% to 21% resulting from the Tax Act and, if approved, would reduce rates by $119.1 million annually through an equal cents per kWh credit. APS asked that this decrease become effective February 1, 2018. On February 22, 2018, the ACC approved the reduction of rates by $119.1 million for the remainder of 2018 through an equal cents per kWh credit applied to all but a small subset of customers who are taking service under specially-approved tariffs. The rate reduction was effective the first billing cycle in March 2018.

The impact of the TEAM, over time, is expected to be earnings neutral. However, on a quarterly basis, there is a difference between the timing and amount of the income tax benefit and the reduction in revenues refunded through the TEAM related to the lower federal income tax rate. The amount of the benefit of the lower federal income tax rate is based on quarterly pre-tax results, while the reduction in revenues from the prior year due to lower customer rates through the TEAM is based on a per kWh sales credit which follows our seasonal kWh sales pattern and is not impacted by earnings of the Company.

On August 13, 2018, APS filed a second request with the ACC to return an additional $86.5 million in tax savings to customers. This second request addresses amortization of non-depreciation related excess deferred taxes previously collected from customers. The ACC has not yet approved this request.
Additionally, as part of this second request, APS informed the ACC of its intent to file a third future request to address the amortization of depreciation related excess deferred taxes, as the Company is currently in the process of seeking IRS guidance regarding the amortization method and period applicable to these depreciation related excess deferred taxes.
The TEAM expressly applies to APS's retail rates with the exception of a small subset of customers taking service under specially-approved tariffs noted above. As discussed in Note 3, FERC issued an order on May 22, 2018 authorizing APS to provide for the cost reductions resulting from the income tax changes in its wholesale transmission rates.

See Note 3 for additional details.

Net Metering.       In 2015, the ACC voted to conduct a generic evidentiary hearing on the value and cost of DG to gather information that will inform the ACC on net metering issues and cost of service studies in upcoming utility rate cases.  A hearing was held in April 2016. On October 7, 2016, an Administrative Law Judge issued a recommendation in the docket concerning the value and cost of DG solar installations. On December 20, 2016, the ACC completed its open meeting to consider the recommended opinion and order by the Administrative Law Judge. After making several amendments, the ACC approved the recommended opinion and order by a 4-1 vote. As a result of the ACC’s action, effective with APS’s 2017 Rate Case Decision, the net metering tariff that governs payments for energy exported to the grid from residential rooftop solar systems was replaced by a more formula-driven approach that utilizes inputs from historical wholesale solar power until an avoided cost methodology is developed by the ACC.

As amended, the decision provides that payments by utilities for energy exported to the grid from DG solar facilities will be determined using a resource comparison proxy methodology, a method that is based on the most recent five-year rolling average price that APS pays for utility-scale solar projects, while a forecasted avoided cost methodology is being developed.  The price established by this resource comparison proxy method will be updated annually (between general retail rate cases) but will not be decreased by more than 10% per year. Once the avoided cost methodology is developed, the ACC will determine in APS's subsequent general retail rate cases which method (or a combination of methods) is appropriate to determine the actual price to be paid by APS for exported distributed energy.

59

Table of Contents

In addition, the ACC made the following determinations:

•	Customers who have interconnected a DG system or submitted an application for interconnection for DG systems prior to September 1, 2017, the date new rates were effective based on APS's 2017 Rate Case Decision, will be grandfathered for a period of 20 years from the date the customer’s interconnection application was accepted by the utility;	
		
•	Customers with DG solar systems are to be considered a separate class of customers for ratemaking purposes; and	
		
•	Once an export price is set for APS, no netting or banking of retail credits will be available for new DG customers, and the then-applicable export price will be guaranteed for new customers for a period of 10 years.	

This decision of the ACC addresses policy determinations only. The decision states that its principles will be applied in future general retail rate cases, and the policy determinations themselves may be subject to future change, as are all ACC policies. A first-year export energy price of 12.9 cents per kWh is included in the 2017 Settlement Agreement and became effective on September 1, 2017.

In accordance with the 2017 Rate Case Decision, APS filed its request for a second-year export energy price of 11.6 cents per kWh on May 1, 2018.  This price reflects the 10% annual reduction discussed above. The new tariff became effective on October 1, 2018.

On January 23, 2017, The Alliance for Solar Choice ("TASC") sought rehearing of the ACC's decision regarding the value and cost of DG. TASC asserted that the ACC improperly ignored the Administrative Procedure Act, failed to give adequate notice regarding the scope of the proceedings, and relied on information that was not submitted as evidence, among other alleged defects. TASC filed a Notice of Appeal in the Arizona Court of Appeals and filed a Complaint and Statutory Appeal in the Maricopa County Superior Court on March 10, 2017. As part of the 2017 Settlement Agreement described above, TASC agreed to withdraw these appeals when the ACC decision implementing the 2017 Settlement Agreement is no longer subject to appellate review.

Subpoena from Arizona Corporation Commissioner Robert Burns. On August 25, 2016, Commissioner Burns, individually and not by action of the ACC as a whole, served subpoenas in APS’s then current retail rate proceeding on APS and Pinnacle West for the production of records and information relating to a range of expenditures from 2011 through 2016. The subpoenas requested information concerning marketing and advertising expenditures, charitable donations, lobbying expenses, contributions to 501(c)(3) and (c)(4) nonprofits and political contributions. The return date for the production of information was set as September 15, 2016. The subpoenas also sought testimony from Company personnel having knowledge of the material, including the Chief Executive Officer.

On September 9, 2016, APS filed with the ACC a motion to quash the subpoenas or, alternatively, to stay APS's obligations to comply with the subpoenas and decline to decide APS's motion pending court proceedings. Contemporaneously with the filing of this motion, APS and Pinnacle West filed a complaint for special action and declaratory judgment in the Superior Court of Arizona for Maricopa County, seeking a declaratory judgment that Commissioner Burns’ subpoenas are contrary to law. On September 15, 2016, APS produced all non-confidential and responsive documents and offered to produce any remaining responsive documents that are confidential after an appropriate confidentiality agreement is signed.

On February 7, 2017, Commissioner Burns opened a new ACC docket and indicated that its purpose is to study and rectify problems with transparency and disclosure regarding financial contributions from regulated monopolies or other stakeholders who may appear before the ACC that may directly or indirectly

60

Table of Contents

benefit an ACC Commissioner, a candidate for ACC Commissioner, or key ACC Staff.  As part of this docket, Commissioner Burns set March 24, 2017 as a deadline for the production of all information previously requested through the subpoenas. Neither APS nor Pinnacle West produced the information requested and instead objected to the subpoena. On March 10, 2017, Commissioner Burns filed suit against APS and Pinnacle West in the Superior Court of Arizona for Maricopa County in an effort to enforce his subpoenas. On March 30, 2017, APS filed a motion to dismiss Commissioner Burns' suit against APS and Pinnacle West. In response to the motion to dismiss, the court stayed the suit and ordered Commissioner Burns to file a motion to compel the production of the information sought by the subpoenas with the ACC. On June 20, 2017, the ACC denied the motion to compel.

On August 4, 2017, Commissioner Burns amended his complaint to add all of the ACC Commissioners and the ACC itself as defendants. All defendants moved to dismiss the amended complaint. On February 15, 2018, the Superior Court dismissed Commissioner Burns’ amended complaint. On March 6, 2018, Commissioner Burns filed an objection to the proposed final order from the Superior Court and a motion to further amend his complaint. The Superior Court permitted Commissioner Burns to amend his complaint to add a claim regarding his attempted investigation into whether his fellow commissioners should have been disqualified from voting on APS’s 2017 rate case. Commissioner Burns filed his second amended complaint, and all defendants filed responses opposing the second amended complaint and requested that it be dismissed. Oral argument occurred in November 2018 regarding the motion to dismiss. On December 18, 2018, the trial court granted the defendants’ motions to dismiss and entered final judgment on January 18, 2019. On February 13, 2019, Commissioner Burns filed a notice of appeal. APS and Pinnacle West cannot predict the outcome of this matter.

Renewable Energy Ballot Initiative. On February 20, 2018, a renewable energy advocacy organization filed with the Arizona Secretary of State a ballot initiative for an Arizona constitutional amendment requiring Arizona public service corporations to provide at least 50% of their annual retail sales of electricity from renewable sources by 2030. For purposes of the proposed amendment, eligible renewable sources would not include nuclear generating facilities. The initiative was placed on the November 2018 Arizona elections ballot. On November 6, 2018, the initiative failed to receive adequate voter support and was defeated.
Energy Modernization Plan . On January 30, 2018, ACC Commissioner Tobin proposed the Energy Modernization Plan, which consists of a series of energy policies tied to clean energy sources such as energy storage, biomass, energy efficiency, electric vehicles, and expanded energy planning through the IRP process. The Energy Modernization Plan includes replacing the current RES standard with a new standard called the CREST, which incorporates the proposals in the Energy Modernization Plan. On February 22, 2018, the ACC Staff filed a Notice of Inquiry to further examine the matter. As a part of this proposal, the ACC voted in March 2018 to direct utilities to develop a comprehensive biomass generation plan to be included in each utility’s RES Implementation Plan. On July 5, 2018, Commissioner Tobin’s office issued a set of draft CREST rules for the ACC’s consideration.
In August 2018, the ACC directed ACC Staff to open a new rulemaking docket which will address a wide range of energy issues, including the Energy Modernization Plan proposals.  The rulemaking will consider possible modifications to existing ACC rules, such as the Renewable Energy Standard, Electric and Gas Energy Efficiency Standards, Net Metering, Resource Planning, and the Biennial Transmission Assessment, as well as the development of new rules regarding forest bioenergy, electric vehicles, interconnection of distributed generation, baseload security, blockchain technology and other technological developments, retail competition, and other energy-related topics.  Workshops on these energy issues are scheduled to be held throughout 2019. APS cannot predict the outcome of this matter.

61

Table of Contents

Integrated Resource Planning . ACC rules require utilities to develop fifteen-year IRPs which describe how the utility plans to serve customer load in the plan timeframe.  The ACC reviews each utility’s IRP to determine if it meets the necessary requirements and whether it should be acknowledged.  In March of 2018, the ACC reviewed the 2017 IRPs of its jurisdictional utilities and voted to not acknowledge any of the plans.  APS does not believe that this lack of acknowledgment will have a material impact on our financial position, results of operations or cash flows.  Based on an ACC decision, APS is required to file a Preliminary Resource Plan by April 1, 2019 and its final IRP by April 1, 2020.

FERC Matter. As part of APS’s acquisition of SCE’s interest in Four Corners Units 4 and 5, APS and SCE agreed, via a "Transmission Termination Agreement" that, upon closing of the acquisition, the companies would terminate an existing transmission agreement ("Transmission Agreement") between the parties that provides transmission capacity on a system (the "Arizona Transmission System") for SCE to transmit its portion of the output from Four Corners to California.  APS previously submitted a request to FERC related to this termination, which resulted in a FERC order denying rate recovery of $40 million that APS agreed to pay SCE associated with the termination.  On December 22, 2015, APS and SCE agreed to terminate the Transmission Termination Agreement and allow for the Transmission Agreement to expire according to its terms, which includes settling obligations in accordance with the terms of the Transmission Agreement.  APS established a regulatory asset of $12 million in 2015 in connection with the payment required under the terms of the Transmission Agreement. On July 1, 2016, FERC issued an order denying APS’s request to recover the regulatory asset through its FERC-jurisdictional rates.  APS and SCE completed the termination of the Transmission Agreement on July 6, 2016. APS made the required payment to SCE and wrote-off the $12 million regulatory asset and charged operating revenues to reflect the effects of this order in the second quarter of 2016.  On July 29, 2016, APS filed for a rehearing with FERC. In its order denying recovery, FERC also referred to its enforcement division a question of whether the agreement between APS and SCE relating to the settlement of obligations under the Transmission Agreement was a jurisdictional contract that should have been filed with FERC. On October 5, 2017, FERC issued an order denying APS's request for rehearing. FERC also upheld its prior determination that the agreement relating to the settlement was a jurisdictional contract and should have been filed with FERC. APS cannot predict whether or if the enforcement division will take any action. APS filed an appeal of FERC's July 1, 2016 and October 5, 2017 orders with the United States Court of Appeals for the Ninth Circuit on December 4, 2017. That proceeding is pending and APS cannot predict the outcome of the proceeding.

Financial Strength and Flexibility

Pinnacle West and APS currently have ample borrowing capacity under their respective credit facilities, and may readily access these facilities ensuring adequate liquidity for each company.  Capital expenditures will be funded with internally generated cash and external financings, which may include issuances of long-term debt and Pinnacle West common stock.
 
Other Subsidiaries

Bright Canyon Energy. On July 31, 2014, Pinnacle West announced its creation of a wholly-owned subsidiary, BCE.  BCE's focus is on new growth opportunities that leverage the Company’s core expertise in the electric energy industry.  BCE’s first initiative is a 50/50 joint venture with BHE U.S. Transmission LLC, a subsidiary of Berkshire Hathaway Energy Company.  The joint venture, named TransCanyon, is pursuing independent transmission opportunities within the eleven states that comprise the Western Electricity Coordinating Council, excluding opportunities related to transmission service that would otherwise be provided under the tariffs of the retail service territories of the venture partners’ utility affiliates.  TransCanyon continues to pursue transmission development opportunities in the western United States consistent with its strategy.

62

Table of Contents

On March 29, 2016, TransCanyon entered into a strategic alliance agreement with PG&E to jointly pursue competitive transmission opportunities solicited by the CAISO, the operator for the majority of California's transmission grid. TransCanyon and PG&E intend to jointly engage in the development of future transmission infrastructure and compete to develop, build, own and operate transmission projects approved by the CAISO.

El Dorado. The operations of El Dorado 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.

4CA. See "Four Corners - Asset Purchase Agreement and Coal Supply Matters" above for information regarding 4CA.

Key Financial Drivers
 
In addition to the continuing impact of the matters described above, many factors influence our financial results and our future financial outlook, including those listed below.  We closely monitor these factors to plan for the Company’s current needs, and to adjust our expectations, financial budgets and forecasts appropriately.
 
Operating Revenues.   For the years 2016 through 2018, retail electric revenues comprised approximately 95% of our total operating revenues.  Our electric operating revenues are affected by customer growth or decline, variations in weather from period to period, customer mix, average usage per customer and the impacts of energy efficiency programs, distributed energy additions, electricity rates and tariffs, the recovery of PSA deferrals and the operation of other recovery mechanisms.  These revenue transactions are affected by the availability of excess generation or other energy resources and wholesale market conditions, including competition, demand and prices.
 
Actual and Projected Customer and Sales Growth.  Retail customers in APS’s service territory increased 1.7% for the year ended December 31, 2018 compared with the prior year.  For the three years 2016 through 2018, APS’s customer growth averaged 1.6% per year. We currently project annual customer growth to be 1.5 - 2.5% for 2019 and to average in the range of 1.5 - 2.5% for 2019 through 2021 based on our assessment of improving economic conditions in Arizona.

Retail electricity sales in kWh, adjusted to exclude the effects of weather variations, increased 0.1% for the year ended December 31, 2018 compared with the prior year. Improving economic conditions and customer growth were offset by energy savings driven by customer conservation, energy efficiency, and distributed renewable generation initiatives.  For the three years 2016 through 2018, annual retail electricity sales were about flat, adjusted to exclude the effects of weather variations.  We currently project that annual retail electricity sales in kWh will increase in the range of 1.0 - 2.0% for 2019 and increase on average in the range of 1.5 - 2.5% during 2019 through 2021, including the effects of customer conservation and energy efficiency and distributed renewable generation initiatives, but excluding the effects of weather variations.  A slower recovery of the Arizona economy or acceleration of the expected effects of customer conservation, energy efficiency or distributed renewable generation initiatives could further impact these estimates.

Actual sales growth, excluding weather-related variations, may differ from our projections as a result of numerous factors, such as economic conditions, customer growth, usage patterns and energy conservation, impacts of energy efficiency programs and growth in DG, and responses to retail price changes.  Based on past experience, a reasonable range of variation in our kWh sales projections attributable to such economic factors

63

Table of Contents

under normal business conditions can result in increases or decreases in annual net income of up to approximately $15 million.
 
Weather.   In forecasting the retail sales growth numbers provided above, we assume normal weather patterns based on historical data.  Historically, extreme weather variations have resulted in annual variations in net income in excess of $20 million.  However, our experience indicates that the more typical variations from normal weather can result in increases or decreases in annual net income of up to $10 million.
 
Fuel and Purchased Power Costs.   Fuel and purchased power costs included on our Consolidated Statements of Income are impacted by our electricity sales volumes, existing contracts for purchased power and generation fuel, our power plant performance, transmission availability or constraints, prevailing market prices, new generating plants being placed in service in our market areas, changes in our generation resource allocation, our hedging program for managing such costs and PSA deferrals and the related amortization.

Operations and Maintenance Expenses .  Operations and maintenance expenses are impacted by customer and sales growth, power plant operations, maintenance of utility plant (including generation, transmission, and distribution facilities), inflation, unplanned outages, planned outages (typically scheduled in the spring and fall), renewable energy and demand side management related expenses (which are offset by the same amount of operating revenues) and other factors. See Note 2 for discussion of new accounting guidance related to the presentation of net periodic pension and postretirement benefit costs.

Depreciation and Amortization Expenses.   Depreciation and amortization expenses are impacted by net additions to utility plant and other property (such as new generation, transmission, and distribution facilities), and changes in depreciation and amortization rates.  See "Liquidity and Capital Resources" below for information regarding the planned additions to our facilities and income tax impacts related to bonus depreciation. 
 
Pension and Other Postretirement Non-Service Credits - Net .   Pension and other postretirement non-service credits can be impacted by changes in our actuarial assumptions. The most relevant actuarial assumptions are the discount rate used to measure our net periodic costs/credit, the expected long-term rate of return on plan assets used to estimate earnings on invested funds over the long-term, the mortality assumptions and the assumed healthcare cost trend rates. We review these assumptions on an annual basis and adjust them as necessary. See Note 2 for discussion of new accounting guidance related to the presentation of net periodic pension and postretirement benefit costs.

Property Taxes.   Taxes other than income taxes consist primarily of property taxes, which are affected by the value of property in-service and under construction, assessment ratios, and tax rates.  The average property tax rate in Arizona for APS, which owns essentially all of our property, was 11.0% of the assessed value for 2018, 11.2% for 2017 and 2016. We expect property taxes to increase as we add new generating units and continue with improvements and expansions to our existing generating units and transmission and distribution facilities. 
 
Income Taxes .   Income taxes are affected by the amount of pretax book income, income tax rates, certain deductions and non-taxable items, such as AFUDC.  In addition, income taxes may also be affected by the settlement of issues with taxing authorities. On December 22, 2017, the Tax Act was enacted and was generally effective on January 1, 2018. Changes which will impact the Company include a reduction in the corporate tax rate to 21%, revisions to the rules related to tax bonus depreciation, limitations on interest deductibility and an associated exception for certain public utilities, and requirements that certain excess deferred tax amounts of regulated utilities be normalized. (See Note 4 for details of the impacts on the Company as of December 31, 2018.) In APS's recent general retail rate case, the ACC approved a Tax Expense

64

Table of Contents

Adjustor Mechanism which will be used to pass through the income tax effects to retail customers of the Tax Act. (See Note 3 for details of the TEAM.)
 
Interest Expense.   Interest expense is affected by the amount of debt outstanding and the interest rates on that debt (see Note 6).  The primary factors affecting borrowing levels are expected to be our capital expenditures, long-term debt maturities, equity issuances and internally generated cash flow.  An allowance for borrowed funds used during construction offsets a portion of interest expense while capital projects are under construction.  We stop accruing AFUDC on a project when it is placed in commercial operation.

RESULTS OF OPERATIONS
 
Pinnacle West’s only reportable business segment is 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.
 
Operating Results – 2018 compared with 2017.

Our consolidated net income attributable to common shareholders for the year ended December 31, 2018 was $511 million , compared with $488 million for the prior year.  The results reflect an increase of approximately $19 million for the regulated electricity segment primarily due to higher revenue resulting from the retail regulatory settlement effective August 19, 2017, higher transmission revenues, higher retail revenues due to customer growth and higher average effective prices due to customer usage patterns and changes relating to customer program eligibility, partially offset by higher operations and maintenance expense and higher depreciation and amortization.

The following table presents net income attributable to common shareholders by business segment compared with the prior year:

												
 	Year Ended
December 31,	 	 	
 	2018	 	2017	 	Net change	
 	(dollars in millions)	
Regulated Electricity Segment:	 		 	 		 	 		
Operating revenues less fuel and purchased power expenses	$	2,590		 	$	2,561		 	$	29		
Operations and maintenance	(1,025	)	 	(936	)	 	(89	)	
Depreciation and amortization	(581	)	 	(532	)	 	(49	)	
Taxes other than income taxes	(212	)	 	(183	)	 	(29	)	
Pension and other postretirement non-service credits - net	50		 	25		 	25		
All other income and expenses, net	59		 	29		 	30		
Interest charges, net of allowance for borrowed funds used during construction	(218	)	 	(198	)	 	(20	)	
Income taxes (Note 4)	(134	)	 	(256	)	 	122		
Less income related to noncontrolling interests (Note 18)	(19	)	 	(19	)	 	—		
Regulated electricity segment income	510		 	491		 	19		
All other	1		 	(3	)	 	4		
Net Income Attributable to Common Shareholders	$	511		 	$	488		 	$	23		

65

Table of Contents

Operating revenues less fuel and purchased power expenses .  Regulated electricity segment operating revenues less fuel and purchased power expenses were $29 million higher for the year ended December 31, 2018 compared with the prior year.  The following table summarizes the major components of this change:

	
												
 	Increase (Decrease)	
 	Operating
revenues	 	Fuel and
purchased
power expenses	 	Net change	
 	(dollars in millions)	
Impacts of retail regulatory settlement effective
August 19, 2017 (Note 3)	 	 	 	 	 	
    Increase in net retail base rates	$	104		 	$	—		 	$	104		
    Change in residential rate design and seasonal rates (a)	7		 	—		 	7		
Higher transmission revenues (Note 3)	27		 	—		 	27		
Higher retail revenues due to higher customer growth and changes in customer usage patterns, partially offset by the impacts of energy efficiency and distributed generation	26		 	2		 	24		
Higher demand side management regulatory surcharges and renewable energy regulatory surcharges and purchased power, partially offset in operations and maintenance costs	1		 	(9	)	 	10		
Refunds due to lower federal corporate income tax rate (Note 3)	(143	)	 	—		 	(143	)	
Effects of weather	(15	)	 	(6	)	 	(9	)	
Changes in net fuel and purchased power costs, including off-system sales margins and related deferrals	120		 	121		 	(1	)	
Miscellaneous items, net	3		 	(7	)	 	10		
Total	$	130		 	$	101		 	$	29		
(a) As part of the 2017 Settlement Agreement, rate design changes were implemented that moved some revenue responsibility from summer to non-summer months. The change was made to better align revenue collections with costs of service.

Operations and maintenance .  Operations and maintenance expenses increased $89 million for the year ended December 31, 2018 compared with the prior-year period primarily because of:

•	An increase of $37 million related to public outreach costs at the parent company primarily associated with the ballot initiative (see Note 3);	

•	An increase of $21 million in fossil generation costs primarily due to higher planned outage and operating costs;	

•	An increase of $12 million related to costs for renewable energy and similar regulatory programs, which was partially offset in operating revenues and purchased power;	

•	An increase of $11 million for costs related to information technology;	

•	An increase of $9 million in transmission, distribution, and customer service costs primarily due to maintenance costs and customer bad debt expense;	

•	An increase of $6 million to inform customers about APS's clean energy focus;	

66

Table of Contents

		
•	A decrease of $6 million related to employee benefit cost;	

•	A decrease of $5 million related to the absence of the Navajo Plant capital projects canceled in 2017 due to the expected plant retirement, which were deferred for regulatory recovery in depreciation; and	

•	An increase of $4 million related to miscellaneous other factors.	

Depreciation and amortization.   Depreciation and amortization expenses were $49 million higher for the year ended December 31, 2018 compared with the prior-year period primarily due to increased depreciation and amortization rates of $36 million, increased plant in service of $8 million and the absence of the regulatory deferral of the canceled capital projects in 2017 associated with the expected Navajo Plant retirement of $5 million.

Taxes other than income taxes.   Taxes other than income taxes were $29 million higher for the year ended December 31, 2018 compared with the prior-year period primarily due to higher property values and the amortization of our property tax deferral regulatory asset.

Pension and other postretirement non-service credits, net. Pension and other postretirement non-service credits, net were $25 million higher for the year ended December 31, 2018 compared to the prior-year period primarily due to higher market returns and the adoption of new pension and other postretirement accounting guidance in 2018 (see Notes 2 and 7).
    
All other income and expenses, net.   All other income and expenses, net were $30 million higher for the year ended December 31, 2018 compared with the prior-year period primarily due to the debt return on the Four Corners SCR deferrals (Note 3) and increased allowance for equity funds used during construction.

Interest charges, net of allowance for borrowed funds used during construction. Interest charges, net of allowance for borrowed funds used during construction, were $20 million higher for the year ended December 31, 2018 compared with the prior-year period primarily due to higher debt balances in the current period.

Income taxes.   Income taxes were $122 million lower for the year ended December 31, 2018 compared with the prior-year period primarily due to the effects of the federal tax reform and lower pretax income in the current year period, partially offset by certain non-deductible costs (See Note 4).

67

Table of Contents

Operating Results – 2017 compared with 2016.

Our consolidated net income attributable to common shareholders for the year ended December 31, 2017 was $488 million, compared with $442 million for the prior year.  The results reflect an increase of approximately $48 million for the regulated electricity segment primarily due to higher revenue resulting from the retail regulatory settlement effective August 19, 2017, higher transmission revenues, higher retail revenues due to customer growth and higher average effective prices due to customer usage patterns and changes relating to customer program eligibility, partially offset by higher depreciation and amortization primarily due to increased plant in service and higher depreciation and amortization rates.

The following table presents net income attributable to common shareholders by business segment compared with the prior year:

												
 	Year Ended
December 31,	 	 	
 	2017	 	2016	 	Net change	
 	(dollars in millions)	
Regulated Electricity Segment:	 		 	 		 	 		
Operating revenues less fuel and purchased power expenses	$	2,561		 	$	2,407		 	$	154		
Operations and maintenance	(936	)	 	(926	)	 	(10	)	
Depreciation and amortization	(532	)	 	(485	)	 	(47	)	
Taxes other than income taxes	(183	)	 	(166	)	 	(17	)	
Pension and other postretirement non-service credits - net	25		 	20		 	5		
All other income and expenses, net	29		 	35		 	(6	)	
Interest charges, net of allowance for borrowed funds used during construction	(198	)	 	(186	)	 	(12	)	
Income taxes	(256	)	 	(237	)	 	(19	)	
Less income related to noncontrolling interests (Note 18)	(19	)	 	(19	)	 	—		
Regulated electricity segment income	491		 	443		 	48		
All other	(3	)	 	(1	)	 	(2	)	
Net Income Attributable to Common Shareholders	$	488		 	$	442		 	$	46		

68

Table of Contents

Operating revenues less fuel and purchased power expenses .  Regulated electricity segment operating revenues less fuel and purchased power expenses were $154 million higher for the year ended December 31, 2017 compared with the prior year.  The following table summarizes the major components of this change:

												
 	Increase (Decrease)	
 	Operating
revenues	 	Fuel and
purchased
power expenses	 	Net change	
 	(dollars in millions)	
Impacts of retail regulatory settlement effective August 19, 2017 (Note 4)	$	55		 	$	—		 	$	55		
Transmission revenues (Note 4):	 	 	 	 			
Higher transmission revenues	30		 	—		 	30		
Absence of 2016 FERC disallowance	12		 	—		 	12		
Higher retail revenues due to customer growth and higher average effective prices due to customer usage patterns and changes relating to customer program participation (a)	21		 	(3	)	 	24		
Lost fixed cost recovery	14		 	—		 	14		
Effects of weather	9		 	3		 	6		
Changes in net fuel and purchased power costs, including off-system sales margins and related deferrals	(83	)	 	(92	)	 	9		
Higher demand side management regulatory surcharges and renewable energy regulatory surcharges and purchased power partially offset in operations and maintenance costs	9		 	2		 	7		
Miscellaneous items, net	(3	)	 	—		 	(3	)	
Total	$	64		 	$	(90	)	 	$	154		

(a) Partially offset by the impacts of efficiency programs and distributed generation.

Operations and maintenance .   Operations and maintenance expenses increased $10 million for the year ended December 31, 2017 compared with the prior year primarily because of:

•	An increase of $15 million for employee benefit costs;	

•	An increase of $9 million for costs primarily related to information technology and other corporate support;	

•	An increase of $8 million related to costs for demand-side management, renewable energy and similar regulatory programs, which is partially offset in operating revenues and purchased power;	

•	An increase of $5 million related to the Navajo Plant capital projects canceled due to the expected plant retirement, which were deferred for regulatory recovery in depreciation;	

•	A decrease of $12 million for lower Palo Verde operating costs;	

•	A decrease of $11 million in fossil generation costs primarily due to less planned outage activity in the current year and lower Navajo Plant costs;	

69

Table of Contents

•	A decrease of $5 million primarily due to the absence of 2016 costs to support the Company's positions on a solar net metering ballot initiative in Arizona; and	

•	An increase of $1 million related to miscellaneous other factors.	

Depreciation and amortization.   Depreciation and amortization expenses were $47 million higher for the year ended December 31, 2017 compared with the prior year primarily related to increased plant in service of $32 million and increased depreciation and amortization rates of $19 million, partially offset by the regulatory deferral of the canceled capital projects associated with the expected Navajo Plant retirement of $5 million.

Taxes other than income taxes.   Taxes other than income taxes were $17 million higher for the year ended December 31, 2017 compared with the prior year primarily due to higher property values and the amortization of our property tax deferral regulatory asset.

Pension and other postretirement non-service credits, net. Pension and other postretirement non-service credits, net were $5 million higher for the year ended December 31, 2017 compared to the prior-year period primarily due to higher market returns.

All other income and expenses, net.   All other income and expenses, net, were $6 million lower for the year ended December 31, 2017 compared with the prior year primarily due to the absence of a gain on sale of a transmission line, which occurred in 2016.

Interest charges, net of allowance for borrowed funds used during construction .   Interest charges, net of allowance for borrowed funds used during construction, increased $12 million for the year ended December 31, 2017 compared with the prior year, primarily because of higher debt balances in the current year.

Income taxes. Income taxes were $19 million higher for the year ended December 31, 2017 compared with the prior year primarily due to the effects of higher pretax income in the current year and the effects of the federal tax reform, partially offset by a lower effective tax rate primarily due to stock compensation. The stock compensation guidance requires all excess income tax benefits and deficiencies arising from share-based payments to be recognized in earnings in the period they occur, which causes effective tax rate fluctuations when stock compensation payouts occur.

LIQUIDITY AND CAPITAL RESOURCES
 
Overview
 
Pinnacle West’s primary cash needs are for dividends to our shareholders and principal and interest payments on our indebtedness.  The level of our common stock dividends and future dividend growth will be dependent on declaration by our Board of Directors and based on a number of factors, including our financial condition, payout ratio, free cash flow and other factors.
 
Our primary sources of cash are dividends from APS and external debt and equity issuances.  An ACC order requires APS to maintain a common equity ratio of at least 40% .  As defined in the related ACC order, the common equity ratio is defined as total shareholder equity divided by the sum of total shareholder equity and long-term debt, including current maturities of long-term debt.  At December 31, 2018, APS’s common equity ratio, as defined, was 54% .  Its total shareholder equity was approximately $5.7 billion , and total capitalization was approximately $10.5 billion .  Under this order, APS would be prohibited from paying dividends if such payment would reduce its total shareholder equity below approximately $4.2 billion ,

70

Table of Contents

assuming APS’s total capitalization remains the same.  This restriction does not materially affect Pinnacle West’s ability to meet its ongoing cash needs or ability to pay dividends to shareholders.
 
APS’s capital requirements consist primarily of capital expenditures and maturities of long-term debt.  APS funds its capital requirements with cash from operations and, to the extent necessary, external debt financing and equity infusions from Pinnacle West.

On December 20, 2018, the Joint Committee on Taxation (“JCT”) released the general explanation of the Tax Act. The document - commonly referred to as the "Blue Book" - provides a comprehensive technical description of the Tax Act and includes the legislative intent of Congress with respect to the changes made by provisions of the Tax Act. The “Blue Book” provides clarification that the intent of the Tax Act was to exclude from the definition of bonus depreciation qualified property any property placed in service by a regulated public utility after December 31, 2017. As a result, the Company currently does not anticipate recognizing any cash tax benefits related to bonus depreciation for property placed in service on or after January 1, 2018 (See Note 4).

Summary of Cash Flows
 
The following tables present net cash provided by (used for) operating, investing and financing activities for the years ended December 31, 2018, 2017 and 2016 (dollars in millions):

Pinnacle West Consolidated

												
 	2018	 	2017	 	2016	
Net cash flow provided by operating activities	$	1,277		 	$	1,118		 	$	1,023		
Net cash flow used for investing activities	(1,193	)	 	(1,429	)	 	(1,252	)	
Net cash flow provided by (used for) financing activities	(92	)	 	316		 	198		
Net increase (decrease) in cash and cash equivalents	$	(8	)	 	$	5		 	$	(31	)	
 
Arizona Public Service Company

												
 	2018	 	2017	 	2016	
Net cash flow provided by operating activities	$	1,255		 	$	1,162		 	$	1,010		
Net cash flow used for investing activities	(1,187	)	 	(1,401	)	 	(1,219	)	
Net cash flow provided by (used for) financing activities	(76	)	 	244		 	196		
Net increase (decrease) in cash and cash equivalents	$	(8	)	 	$	5		 	$	(13	)	

  Operating Cash Flows
 
2018 Compared with 2017. Pinnacle West’s consolidated net cash provided by operating activities was $1,277 million in 2018 compared to $1,118 million in 2017. The increase of $159 million in net cash provided is primarily due to higher cash receipts from operating activities as a result of the retail regulatory settlement effective August 19, 2017, higher transmission receipts and higher receipts due to customer growth and higher average effective prices. These items are partially offset by higher payments for operations and maintenance, income taxes, other taxes and interest. The difference between APS and Pinnacle West's net cash provided by operating activities primarily relates to Pinnacle West's cash payments for 4CA's operating costs and differences in other operating cash payments.

2017 Compared with 2016. Pinnacle West’s consolidated net cash provided by operating activities was $1,118 million in 2017 compared to $1,023 million in 2016. The increase of $95 million in net cash provided

71

Table of Contents

is primarily due to lower payments of operations and maintenance, fuel and purchased power costs and higher cash receipts, partially offset by no collateral posted in 2017 compared to $17 million returned in 2016. The difference between APS and Pinnacle West's net cash provided by operating activities primarily relates to Pinnacle West's cash payments for 4CA's operating costs and differences in other operating cash payments.

Retirement plans and other postretirement benefits. Pinnacle West sponsors a qualified defined benefit pension plan and a non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and our subsidiaries.  The requirements of the Employee Retirement Income Security Act of 1974 ("ERISA") require us to contribute a minimum amount to the qualified plan.  We contribute at least the minimum amount required under ERISA regulations, but no more than the maximum tax-deductible amount.  The minimum required funding takes into consideration the value of plan assets and our pension benefit obligations.  Under ERISA, the qualified pension plan was 110% funded as of January 1, 2019 and 117% as of January 1, 2018.  Under GAAP, the qualified pension plan was 90% funded as of January 1, 2019 and 95% funded as of January 1, 2018. See Note 7 for additional details. 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 made contributions to our pension plan totaling $50 million in 2018 , $100 million in 2017 , and $100 million in 2016 .  The minimum required contributions for the pension plan are zero for the next three years.  We expect to make voluntary contributions up to a total of $350 million during the 2019-2021 period.  With regard to contributions to our other postretirement benefit plan, we did not make a contribution in 2018 . We made a contribution of approximately $1 million in each of 2017 and 2016 .  We do not expect to make any contributions over the next three years to our other postretirement benefit plans. In 2018, the Company was reimbursed $72 million for prior years retiree medical claims from the other postretirement benefit plan trust assets.

Because of plan changes in 2014, the Company sought IRS approval to move approximately $186 million of other postretirement benefit trust assets into a new trust account to pay for active union employee medical costs. In December 2016, FERC approved a methodology for determining the amount of other postretirement benefit trust assets to transfer into a new trust account to pay for active union employee medical costs. On January 2, 2018, these funds were moved to the new trust account, which is included in the other special use funds on the Consolidated Balance Sheets. The Company and the IRS executed a final Closing Agreement on March 2, 2018. The Company made an informational filing with FERC during February 2018. It is the Company’s understanding that completion of these regulatory requirements permits access to approximately $186 million for the sole purpose of paying active union employee medical benefits.

Investing Cash Flows

2018 Compared with 2017. Pinnacle West’s consolidated net cash used for investing activities was $1,193 million in 2018, compared to $1,429 million in 2017. The decrease of $236 million in net cash used primarily related to decreased capital expenditures. The difference between APS and Pinnacle West's net cash used for investing activities primarily relates to Pinnacle West's investing cash activity related to 4CA.

2017 Compared with 2016. Pinnacle West’s consolidated net cash used for investing activities was $1,429 million in 2017, compared to $1,252 million in 2016. The increase of $177 million in net cash used primarily related to increased capital expenditures.

72

Table of Contents

Capital Expenditures.   The following table summarizes the estimated capital expenditures for the next three years:
 
Capital Expenditures
(dollars in millions)

												
 	Estimated for the Year Ended
December 31,	
 	2019	 	2020	 	2021	
APS	 		 	 		 	 		
Generation:	 		 	 		 	 		
Clean:	 	 	 	 	 	
Nuclear Fuel	$	72		 	$	64		 	$	64		
Nuclear Generation	70		 	68		 	67		
Renewables (a)	16		 	18		 	3		
New Resources (b)	77		 	119		 	305		
Environmental	30		 	40		 	71		
New Gas Generation	16		 	—		 	—		
Other Generation	109		 	116		 	108		
Distribution	508		 	462		 	559		
Transmission	202		 	169		 	199		
Other (c)	126		 	147		 	108		
Total APS	$	1,226		 	$	1,203		 	$	1,484		

(a)	Primarily APS Solar Communities program	
		
(b)	Projected future generation resources, which may include energy storage, renewable projects, and other clean energy projects	
		
(c)	Primarily information systems and facilities projects	
 
Generation capital expenditures are comprised of various additions and improvements to APS’s clean resources, including nuclear plants, renewables and projected future new resources. Generation capital expenditures also include improvements to existing fossil plants. Examples of the types of projects included in the forecast of generation capital expenditures are additions of roof top solar systems, new clean resources, and upgrades and capital replacements of various nuclear and fossil power plant equipment, such as turbines, boilers and environmental equipment.  We are monitoring the status of environmental matters, which, depending on their final outcome, could require modification to our planned environmental expenditures.

Distribution and transmission capital expenditures are comprised of infrastructure additions and upgrades, capital replacements, and new customer construction.  Examples of the types of projects included in the forecast include power lines, substations, and line extensions to new residential and commercial developments.

Capital expenditures will be funded with internally generated cash and external financings, which may include issuances of long-term debt and Pinnacle West common stock.
 
Financing Cash Flows and Liquidity
 
2018 Compared with 2017. Pinnacle West’s consolidated net cash used for financing activities was $92 million in 2018, compared to $316 million of net cash provided in 2017, an increase of $408 million in net

73

Table of Contents

cash used.  The increase in net cash used by financing activities includes $403 million in lower issuances of long-term debt, higher long-term debt repayments of $57 million and higher dividend payments of $19 million through December 31, 2018, which are partially offset by $63 million in lower net short-term debt.

APS’s consolidated net cash used by financing activities was $76 million in 2018, compared to $244 million of net cash provided in 2017, an increase of $320 million in net cash used.  The increase in net cash used by financing activities includes $254 million in lower issuances of long-term debt, higher long-term debt repayments of $182 million and higher dividend payments of $19 million through December 31, 2018, which are partially offset by $136 million in lower net short-term debt.

2017 Compared with 2016. Pinnacle West’s consolidated net cash provided by financing activities was $316 million in 2017, compared to $198 million in 2016, an increase of $118 million in net cash provided.  The net cash provided by financing activities includes $245 million in lower long-term debt repayments and $155 million higher issuances of long-term debt through December 31, 2017, partially offset by a $259 million net decrease in short-term borrowings and $16 million of higher dividend payments.

APS’s consolidated net cash provided by financing activities was $244 million in 2017, compared to $196 million in 2016, an increase of $48 million in net cash provided.  The net cash provided by financing activities includes $370 million in lower long-term debt repayments and $108 million in higher equity infusions from Pinnacle West, partially offset by $143 million lower issuances of long-term debt through December 31, 2017, $271 million net decrease in short-term borrowings and $16 million of higher dividend payments.

Significant Financing Activities.   On December 19, 2018, the Pinnacle West Board of Directors declared a dividend of $0.7375 per share of common stock, payable on March 1, 2019 to shareholders of record on February 1, 2019. During 2018, Pinnacle West increased its indicated annual dividend from $2.78 per share to $2.95 per share. For the year ended December 31, 2018, Pinnacle West's total dividends paid per share of common stock were $2.82 per share, which resulted in dividend payments of $309 million.

On May 30, 2018, APS purchased all $32 million of Maricopa County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds, 2009 Series C, due 2029. These bonds were classified as current maturities of long-term debt on our Consolidated Balance Sheets at December 31, 2017.

On June 26, 2018, APS repaid at maturity APS's $50 million term loan facility.

On August 9, 2018, APS issued $300 million of 4.20% unsecured senior notes that mature on August 15, 2048.  The net proceeds from the sale of the notes were used to repay commercial paper borrowings.

On November 30, 2018, APS repaid its $100 million term loan facility that would have matured April 22, 2019.

On December 21, 2018, Pinnacle West entered into a $150 million term loan facility that matures December 2020. The proceeds were used for general corporate purposes.

On December 21, 2018, Pinnacle West contributed $150 million into APS in the form of an equity infusion. APS used this contribution to repay short-term indebtedness.

Available Credit Facilities .  Pinnacle West and APS maintain committed revolving credit facilities in order to enhance liquidity and provide credit support for their commercial paper programs.

74

Table of Contents

On June 28, 2018, Pinnacle West refinanced its 364 -day $125 million unsecured revolving credit facility that would have matured on July 30, 2018 with a new 364 -day $150 million credit facility that matures June 27, 2019. Borrowings under the facility bear interest at LIBOR plus 0.70% per annum. At December 31, 2018 , Pinnacle West had $54 million outstanding under the facility.

On July 12, 2018, Pinnacle West replaced its $200 million revolving credit facility that would have matured in May 2021, with a new $200 million facility that matures in July 2023. Pinnacle West has the option to increase the amount of the facility up to a maximum of $300 million upon the satisfaction of certain conditions and with the consent of the lenders.  At December 31, 2018 , Pinnacle West had no outstanding borrowings under its credit facility, no letters of credit outstanding and $22 million of commercial paper borrowings.

On July 12, 2018, APS replaced its $500 million revolving credit facility that would have matured in May 2021, with a new $500 million facility that matures in July 2023.

At December 31, 2018 , APS had two revolving credit facilities totaling $1 billion , including a $500 million credit facility that matures in June 2022 and the above-mentioned $500 million facility. APS may increase the amount of each facility up to a maximum of $700 million , for a total of $1.4 billion , upon the satisfaction of certain conditions and with the consent of the lenders. Interest rates are based on APS’s senior unsecured debt credit ratings. These facilities are available to support APS’s $500 million commercial paper program, for bank borrowings or for issuances of letters of credit. At December 31, 2018 , APS had no commercial paper outstanding and no outstanding borrowings or letters of credit under its revolving credit facilities. See "Financial Assurances" in Note 10 for a discussion of APS's other outstanding letters of credit.

Other Financing Matters.   See Note 16 for information related to the change in our margin and collateral accounts.
 
Debt Provisions
 
Pinnacle West’s and APS’s debt covenants related to their respective bank financing arrangements include maximum debt to capitalization ratios.  Pinnacle West and APS comply with this covenant.  For both Pinnacle West and APS, this covenant requires that the ratio of consolidated debt to total consolidated capitalization not exceed 65%.  At December 31, 2018 , the ratio was approximately 50% for Pinnacle West and 46% for APS.  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 and could "cross-default" other debt.  See further discussion of "cross-default" provisions below.
 
Neither Pinnacle West’s nor APS’s financing agreements contain "rating triggers" that would result in an acceleration of the required interest and principal payments in the event of a rating downgrade.  However, our bank credit agreements contain a pricing grid in which the interest rates we pay for borrowings thereunder are determined by our current credit ratings.
 
All of Pinnacle West’s loan 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 certain other material agreements.  All of APS’s 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 certain other material agreements.  Pinnacle West and APS do not have a material adverse change restriction for credit facility borrowings.

See Note 6 for further discussions of liquidity matters. 

75

Table of Contents

Credit Ratings

The ratings of securities of Pinnacle West and APS as of February 15, 2019 are shown below.  We are disclosing these credit ratings to enhance understanding of our cost of short-term and long-term capital and our ability to access the markets for liquidity and long-term debt.  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’s securities and/or result in an increase in the cost of, or limit access to, capital.  Such revisions may also result in substantial additional cash or other collateral requirements related to certain derivative instruments, insurance policies, natural gas transportation, fuel supply, and other energy-related contracts.  At this time, we believe we have sufficient available liquidity resources to respond to a downward revision to our credit ratings.

						
 	Moody’s	 	Standard & Poor’s	 	Fitch	
Pinnacle West	 	 	 	 	 	
Corporate credit rating	A3	 	A-	 	A-	
Senior unsecured	A3	 	BBB+	 	A-	
Commercial paper	P-2	 	A-2	 	F2	
Outlook	Stable	 	Stable	 	Stable	

APS	 	 	 	 	 	
Corporate credit rating	A2	 	A-	 	A-	
Senior unsecured	A2	 	A-	 	A	
Commercial paper	P-1	 	A-2	 	F2	
Outlook	Stable	 	Stable	 	Stable	

Off-Balance Sheet Arrangements
 
See Note 18 for a discussion of the impacts on our financial statements of consolidating certain VIEs.

76

Table of Contents

Contractual Obligations
 
The following table summarizes Pinnacle West’s consolidated contractual requirements as of December 31, 2018 (dollars in millions):

																				
 	2019	 	2020-
2021	 	2022-
2023	 	Thereafter	 	Total	
Long-term debt payments, including interest: (a)	 	 	 		 	 		 	 		 	 		
APS	$	695		 	$	589		 	$	336		 	$	6,419		 	$	8,039		
Pinnacle West	12		 	461		 	—		 	—		 	473		
Total long-term debt payments, including interest	707		 	1,050		 	336		 	6,419		 	8,512		
Short-term debt payments, including interest (b)	76		 	—		 	—		 	—		 	76		
Fuel and purchased power commitments (c)	574		 	1,093		 	1,103		 	5,701		 	8,471		
Renewable energy credits (d)	37		 	70		 	61		 	155		 	323		
Purchase obligations (e)	48		 	20		 	20		 	206		 	294		
Coal reclamation	32		 	42		 	46		 	167		 	287		
Nuclear decommissioning funding requirements	2		 	4		 	4		 	52		 	62		
Noncontrolling interests (f)	23		 	46		 	46		 	159		 	274		
Operating lease payments (g)	14		 	22		 	12		 	42		 	90		
Total contractual commitments	$	1,513		 	$	2,347		 	$	1,628		 	$	12,901		 	$	18,389		
		
(a)	The long-term debt matures at various dates through 2048 and bears interest principally at fixed rates.  Interest on variable-rate long-term debt is determined by using average rates at December 31, 2018 (see Note 6).	
		
(b)	See Note 5 - Lines of credit and short-term borrowings for further details.	
		
(c)	Our fuel and purchased power commitments include purchases of coal, electricity, natural gas, renewable energy, nuclear fuel, and natural gas transportation (see Notes 3 and 10).	
		
(d)	Contracts to purchase renewable energy credits in compliance with the RES (see Note 3).	
		
(e)	These contractual obligations include commitments for capital expenditures and other obligations.	
		
(f)	Payments to the noncontrolling interests relate to the Palo Verde Sale Leaseback (see Note 18).	
		
(g)	Commitments relating to purchased power lease contracts are included within the fuel and purchased power commitments line above.	
 
This table excludes $41 million in unrecognized tax benefits because the timing of the future cash outflows is uncertain.  Estimated minimum required pension contributions are zero for 2019, 2020 and 2021 (see Note 7).

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.  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.

77

Table of Contents

Regulatory Accounting
 
Regulatory accounting allows for the actions of regulators, such as the ACC and FERC, to be reflected in our 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.  Regulatory assets represent incurred costs that have been deferred because they are probable of future recovery in customer rates.  Regulatory liabilities generally represent amounts collected in rates to recover costs expected to be incurred in the future or amounts collected in excess of costs incurred and are refundable to customers. Management continually assesses whether our regulatory assets are probable of future recovery by considering factors such as applicable regulatory environment changes and recent rate orders to other regulated entities in the same jurisdiction.  This determination reflects the current political and regulatory climate in Arizona and is subject to change in the future.  If future recovery of costs ceases to be probable, the assets would be written off as a charge in current period earnings, except for pension benefits which would be charged to OCI and result in lower future earnings.  We had $1,510 million of regulatory assets and $2,492 million of regulatory liabilities on the Consolidated Balance Sheets at December 31, 2018.
 
See Notes 1 and 3 for more information.

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 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, the mortality assumptions, and the assumed healthcare cost trend rates.  We review these assumptions on an annual basis and adjust them as necessary.

On January 1, 2018, we adopted new accounting standard ASU 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This new standard changed our income statement presentation of net periodic benefit cost and allows only the service cost component of periodic net benefit cost to be eligible for capitalization. See Note 2 for additional information.

78

Table of Contents

The following chart reflects the sensitivities that a change in certain actuarial assumptions would have had on the December 31, 2018 reported pension liability on the Consolidated Balance Sheets and our 2018 reported pension expense, after consideration of amounts capitalized or billed to electric plant participants, on Pinnacle West’s Consolidated Statements of Income (dollars in millions): 

									
 	 	Increase (Decrease)	
Actuarial Assumption (a)	 	Impact on
Pension
Liability	 	Impact on
Pension
Expense	
Discount rate:	 	 		 	 		
Increase 1%	 	$	(328	)	 	$	(12	)	
Decrease 1%	 	397		 	15		
Expected long-term rate of return on plan assets:	 	 	 	 	
Increase 1%	 	—		 	(21	)	
Decrease 1%	 	—		 	21		
		
(a)	Each fluctuation assumes that the other assumptions of the calculation are held constant while the rates are changed by one percentage point.	
 
The following chart reflects the sensitivities that a change in certain actuarial assumptions would have had on the December 31, 2018 other postretirement benefit obligation and our 2018 reported other postretirement benefit expense, after consideration of amounts capitalized or billed to electric plant participants, on Pinnacle West’s Consolidated Statements of Income (dollars in millions): 

									
 	 	Increase (Decrease)	
Actuarial Assumption (a)	 	Impact on Other
Postretirement 
Benefit
Obligation	 	Impact on Other
Postretirement
Benefit Expense	
Discount rate:	 	 		 	 		
Increase 1%	 	$	(85	)	 	$	(1	)	
Decrease 1%	 	108		 	6		
Healthcare cost trend rate (b):	 	 	 	 	
Increase 1%	 	101		 	10		
Decrease 1%	 	(81	)	 	(4	)	
Expected long-term rate of return on plan assets – pretax:	 	 		 	 	
Increase 1%	 	—		 	(5	)	
Decrease 1%	 	—		 	5		
		
(a)	Each fluctuation assumes that the other assumptions of the calculation are held constant while the rates are changed by one percentage point.	
		
(b)	This assumes a 1% change in the initial and ultimate healthcare cost trend rate.	
 
See Notes 2 and 7 for further details about our pension and other postretirement benefit plans.

79

Table of Contents

Fair Value Measurements
 
We account for derivative instruments, investments held in our nuclear decommissioning trust fund, investments held in our other special use funds, certain cash equivalents, and plan assets held in our retirement and other benefit plans at fair value on a recurring basis.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  We use inputs, or assumptions that market participants would use, to determine fair market value. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.  The significance of a particular input determines how the instrument is classified in a fair value hierarchy.  The determination of fair value sometimes requires subjective and complex judgment.  Our assessment of the inputs and the significance of a particular input to fair value measurement may affect the valuation of the instruments and their placement within a fair value hierarchy.  Actual results could differ from our estimates of fair value.  See Note 1 for a discussion of accounting policies and Note 13 for fair value measurement disclosures.

Asset Retirement Obligations

We recognize an ARO for the future decommissioning or retirement of our tangible long-lived assets for which a legal obligation exists. The ARO liability represents an estimate of the fair value of the current obligation related to decommissioning and the retirement of those assets. ARO measurements inherently involve uncertainty in the amount and timing of settlement of the liability. We use an expected cash flow approach to measure the amount we recognize as an ARO. This approach applies probability weighting to discounted future cash flow scenarios that reflect a range of possible outcomes. The scenarios consider settlement of the ARO at the expiration of the asset’s current license or lease term and expected decommissioning dates. The fair value of an ARO is recognized in the period in which it is incurred. The associated asset retirement costs are capitalized as part of the carrying value of the long-lived asset and are depreciated over the life of the related assets. In addition, we accrete the ARO liability to reflect the passage of time. Changes in these estimates and assumptions could materially affect the amount of the recorded ARO for these assets. In accordance with GAAP accounting, APS accrues removal costs for its regulated utility assets, even if there is no legal obligation for removal.

AROs as of December 31, 2018 are described further in Note 11.

Income Taxes

Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best estimate of current and future taxes to be paid.
On December 22, 2017, the Tax Act was enacted, and is generally effective January 1, 2018. This legislation made significant changes to the federal income tax laws. Changes which impact the Company include, but are not limited to, a reduction in the corporate tax rate to 21%, revisions to the rules related to tax bonus depreciation, limitations on interest deductibility and an associated exception for certain public utility property, and requirements that certain excess deferred tax amounts of regulated utilities be normalized.
Deferred tax assets or liabilities are recognized for the estimated future tax effects attributable to temporary differences between the financial statement basis and the tax basis of assets and liabilities as well as tax credit carryforwards and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period the change is enacted. Given the regulatory nature of the Company’s business, substantially all of the effect on deferred tax assets and liabilities for the reduction in the federal corporate tax

80

Table of Contents

rate to 21% was recorded as a regulatory liability recoverable by ratepayers as of December 31, 2017. See Note 3 for further discussion of the accounting for the regulatory liability.
The calculation of our tax liabilities involves dealing with the application of complex laws and regulations which are voluminous and often ambiguous. Interpretations and guidance surrounding income tax laws and regulations change over time. Tax positions taken by Pinnacle West on its income tax returns that are recognized in the financial statements must satisfy a "more likely than not" recognition threshold, assuming that the position will be sustained upon examination by taxing authorities with full knowledge of all relevant information, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. Additional guidance may be issued through legislation, Treasury regulations, or other technical guidance, which may materially affect amounts the Company has recognized in its financial statements.
We record unrecognized tax benefits for tax positions that may not satisfy this "more likely than not" recognition threshold as liabilities in accordance with generally accepted accounting principles. These liabilities are adjusted when management judgment changes as a result of the evaluation of new information not previously available. These changes will be reflected as an increase or decrease to income tax expense in the period in which new information is available.

OTHER ACCOUNTING MATTERS
We adopted the following new accounting standards on January 1, 2018:

•	ASU 2014-09: Revenue from Contracts with Customers, and related amendments	

•	ASU 2016-01: Financial Instruments, Recognition and Measurement	

•	ASU 2016-15: Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments	

•	ASU 2016-18: Statement of Cash Flows, Restricted Cash	

•	ASU 2017-01: Business Combinations, Clarifying the Definition of a Business	

•	ASU 2017-05: Other Income, Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets	

•	ASU 2017-07: Compensation-Retirement Benefits, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost	

•	ASU 2018-02: Income Statement-Reporting Comprehensive Income, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income	

We adopted the following new accounting standards on January 1, 2019:

•	ASU 2016-02: Leases, and related amendments	

•	ASU 2017-12: Derivatives and Hedging, Targeted Improvements to Accounting for Hedging Activities	

We are currently evaluating the impacts of the pending adoption of the following new accounting standards effective for us on January 1, 2020:

81

Table of Contents

		
•	ASU 2016-13: Financial Instruments, Measurement of Credit Losses	

•	ASU 2018-15: Internal-Use Software: Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract	

See Note 2 for additional information related to new accounting standards.

MARKET AND CREDIT RISKS
 
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 and benefit plan assets.
 
Interest Rate and Equity Risk
 
We have exposure to changing interest rates.  Changing interest rates will affect interest paid on variable-rate debt and the market value of fixed income securities held by our nuclear decommissioning trust, other special use funds (see Note 13 and Note 19), and benefit plan assets.  The nuclear decommissioning trust, other special use funds and benefit plan assets also have risks associated with the changing market value of their equity and other non-fixed income investments.  Nuclear decommissioning and benefit plan costs are recovered in regulated electricity prices.

The tables below present contractual balances of our consolidated long-term and short-term debt at the expected maturity dates, as well as the fair value of those instruments on December 31, 2018 and 2017.  The interest rates presented in the tables below represent the weighted-average interest rates as of December 31, 2018 and 2017 (dollars in millions):
 
Pinnacle West – Consolidated

																						
 	 	Short-Term
Debt	 	Variable-Rate
Long-Term Debt	 	Fixed-Rate
Long-Term Debt	
 	 	Interest	 	 	 	Interest	 	 	 	Interest	 	 	
2018	 	Rates	 	Amount	 	Rates	 	Amount	 	Rates	 	Amount	
2019	 	2.99	%	 	$	76		 	—		 	—		 	8.75	%	 	$	500		
2020	 	—		 	—		 	3.02	%	 	150		 	2.23	%	 	550		
2021	 	—		 	—		 	—		 	—		 	—		 	—		
2022	 	—		 	—		 	—		 	—		 	—		 	—		
2023	 	—		 	—		 	—		 	—		 	—		 	—		
Years thereafter	 	—		 	—		 	1.76	%	 	36		 	4.25	%	 	3,940		
Total	 	 		 	$	76		 	 	 	$	186		 	 		 	$	4,990		
Fair value	 	 		 	$	76		 	 		 	$	186		 	 		 	$	5,048		

82

Table of Contents

	
																					
 	 	Short-Term
Debt	Variable-Rate
Long-Term Debt	 	Fixed-Rate
Long-Term Debt	
 	 	Interest	 	 	Interest	 	 	 	Interest	 	 	
2017	 	Rates	 	Amount	Rates	 	Amount	 	Rates	 	Amount	
2018	 	2.14	%	 	$	95		2.17	%	 	$	50		 	1.75	%	 	$	32		
2019	 	—		 	—		2.27	%	 	100		 	8.75	%	 	500		
2020	 	—		 	—		—		 	—		 	2.23	%	 	550		
2021	 	—		 	—		—		 	—		 	—		 	—		
2022	 	—		 	—		—		 	—		 	—		 	—		
Years thereafter	 	—		 	—		1.77	%	 	36		 	4.25	%	 	3,640		
Total	 	 		 	$	95		 	 	$	186		 	 		 	$	4,722		
Fair value	 	 		 	$	95		 		 	$	186		 	 		 	$	5,119		

The tables below present contractual balances of APS’s long-term and short-term debt at the expected maturity dates, as well as the fair value of those instruments on December 31, 2018 and 2017.  The interest rates presented in the tables below represent the weighted-average interest rates as of December 31, 2018 and 2017 (dollars in millions):
 
APS — Consolidated

															
 	 	Variable-Rate
Long-Term Debt	 	Fixed-Rate
Long-Term Debt	
 	 	Interest	 	 	 	Interest	 	 	
2018	 	Rates	 	Amount	 	Rates	 	Amount	
2019	 	—		 	—		 	8.75	%	 	$	500		
2020	 	—		 	—		 	2.20	%	 	250		
2021	 	—		 	—		 	—		 	—		
2022	 	—		 	—		 	—		 	—		
2023	 	—		 	—		 	—		 	—		
Years thereafter	 	1.76	%	 	36		 	4.25	%	 	3,940		
Total	 	 	 	$	36		 	 		 	$	4,690		
Fair value	 	 		 	$	36		 	 		 	$	4,754		

	
															
 	 	Variable-Rate
Long-Term Debt	 	Fixed-Rate
Long-Term Debt	
 	 	Interest	 	 	 	Interest	 	 	
2017	 	Rates	 	Amount	 	Rates	 	Amount	
2018	 	2.17	%	 	$	50		 	1.75	%	 	$	32		
2019	 	2.27	%	 	100		 	8.75	%	 	500		
2020	 	—		 	—		 	2.20	%	 	250		
2021	 	—		 	—		 	—		 	—		
2022	 	—		 	—		 	—		 	—		
Years thereafter	 	1.77	%	 	36		 	4.25	%	 	3,640		
Total	 	 	 	$	186		 	 	 	$	4,422		
Fair value	 	 		 	$	186		 	 		 	$	4,820		

83

Table of Contents

Commodity Price Risk
 
We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity and natural gas.  Our risk management committee, consisting of officers and key management personnel, oversees company-wide energy risk management activities to ensure compliance with our stated energy risk management policies.  We manage risks associated with these market fluctuations by utilizing various commodity instruments that may qualify as derivatives, including futures, forwards, options and swaps.  As part of our risk management program, we use such instruments to hedge purchases and sales of electricity and fuels.  The changes in market value of such contracts have a high correlation to price changes in the hedged commodities.

The following table shows the net pretax changes in mark-to-market of our derivative positions in 2018 and 2017 (dollars in millions):

								
 	2018	 	2017	
Mark-to-market of net positions at beginning of year	$	(91	)	 	$	(49	)	
Decrease (Increase) in regulatory asset	31		 	(46	)	
Recognized in OCI:	 	 	 	
Mark-to-market losses realized during the period	2		 	4		
Change in valuation techniques	—		 	—		
Mark-to-market of net positions at end of year	$	(58	)	 	$	(91	)	

The table below shows the fair value of maturities of our derivative contracts (dollars in millions) at December 31, 2018 by maturities and by the type of valuation that is performed to calculate the fair values, classified in their entirety based on the lowest level of input that is significant to the fair value measurement.  See Note 1, “Derivative Accounting” and “Fair Value Measurements,” for more discussion of our valuation methods.

																									
Source of Fair Value	 	2019	 	2020	 	2021	 	2022	 	2023	 	Total 
fair 
value	
Observable prices provided by other external sources	 	$	(29	)	 	$	(10	)	 	$	(7	)	 	$	(4	)	 	$	—		 	$	(50	)	
Prices based on unobservable inputs	 	(4	)	 	(4	)	 	—		 	—		 	—		 	(8	)	
Total by maturity	 	$	(33	)	 	$	(14	)	 	$	(7	)	 	$	(4	)	 	$	—		 	$	(58	)	

84

Table of Contents

The table below shows the impact that hypothetical price movements of 10% would have on the market value of our risk management assets and liabilities included on Pinnacle West’s Consolidated Balance Sheets at December 31, 2018 and 2017 (dollars in millions):

																
 	December 31, 2018
Gain (Loss)	 	December 31, 2017
Gain (Loss)	
 	Price Up  10%	 	Price Down 10%	 	Price Up  10%	 	Price Down 10%	
Mark-to-market changes reported in:	 		 	 		 	 		 	 		
Regulatory asset (liability) (a)	 		 	 		 	 		 	 		
Electricity	$	1		 	$	(1	)	 	$	1		 	$	(1	)	
Natural gas	44		 	(44	)	 	45		 	(45	)	
Total	$	45		 	$	(45	)	 	$	46		 	$	(46	)	

(a)	These contracts are economic 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.  To the extent the amounts are eligible for inclusion in the PSA, the amounts are recorded as either a regulatory asset or liability.	
 
Credit Risk
 
We are exposed to losses in the event of non-performance or non-payment by counterparties.  See Note 16 for a discussion of our credit valuation adjustment policy.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
 
See “Market and Credit Risks” in Item 7 above for a discussion of quantitative and qualitative disclosures about market risks.

85

Table of Contents

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
INDEX TO FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES

	
		
 	Page	
 	 	
Management’s Report on Internal Control over Financial Reporting (Pinnacle West Capital Corporation)	87	
Report of Independent Registered Public Accounting Firm	88	
Pinnacle West Consolidated Statements of Income for 2018, 2017 and 2016	90	
Pinnacle West Consolidated Statements of Comprehensive Income for 2018, 2017 and 201 6	91	
Pinnacle West Consolidated Balance Sheets as of December 31, 2018 and 201 7	92	
Pinnacle West Consolidated Statements of Cash Flows for 2018, 2017 and 201 6	94	
Pinnacle West Consolidated Statements of Changes in Equity for 2018, 2017 and 201 6	95	
 	 	
Management’s Report on Internal Control over Financial Reporting (Arizona Public Service Company)	96	
Report of Independent Registered Public Accounting Firm	97	
APS Consolidated Statements of Income for 2018, 2017 and 201 6	99	
APS Consolidated Statements of Comprehensive Income for 2018, 2017 and 201 6	100	
APS Consolidated Balance Sheets as of December 31, 2018 and 201 7	101	
APS Consolidated Statements of Cash Flows for 2018, 2017 and 201 6	103	
APS Consolidated Statements of Changes in Equity for 2018, 2017 and 201 6	104	
 	 	
Combined Notes to Consolidated Financial Statements	105	
Note 1. Summary of Significant Accounting Policies	105	
Note 2. New Accounting Standards	112	
Note 3. Regulatory Matters	116	
Note 4. Income Taxes	130	
Note 5. Lines of Credit and Short-Term Borrowings	134	
Note 6. Long-Term Debt and Liquidity Matters	136	
Note 7. Retirement Plans and Other Postretirement Benefits	138	
Note 8. Leases	147	
Note 9. Jointly-Owned Facilities	149	
Note 10. Commitments and Contingencies	150	
Note 11. Asset Retirement Obligations	159	
Note 12. Selected Quarterly Financial Data (Unaudited)	160	
Note 13. Fair Value Measurements	161	
Note 14. Earnings Per Share	168	
Note 15. Stock-Based Compensation	168	
Note 16. Derivative Accounting	171	
Note 17. Other Income and Other Expense	175	
Note 18. Palo Verde Sale Leaseback Variable Interest Entities	176	
Note 19. Investments	177	
Note 20. Revenue	179	
Note 21. Changes in Accumulated Other Comprehensive Loss	181	

See Note 12 for the selected quarterly financial data (unaudited) required to be presented in this Item.

86

Table of Contents

MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
(PINNACLE WEST CAPITAL CORPORATION)

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f), for Pinnacle West.  Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our evaluation under the framework in Internal Control — Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2018.  The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein and also relates to the Company’s consolidated financial statements.
 
February 22, 2019

87

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Shareholders and the Board of Directors of
Pinnacle West Capital Corporation
Phoenix, Arizona

Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Pinnacle West Capital Corporation and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows, for each of the three years in the period ended December 31, 2018, the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
    
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

88

Table of Contents

Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
    
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Deloitte & Touche LLP

Phoenix, Arizona
February 22, 2019

We have served as the Company's auditor since 1932.

89

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(dollars and shares in thousands, except per share amounts)

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
 	 	 	 	 	 	
OPERATING REVENUES (NOTE 20)	$	3,691,247		 	$	3,565,296		 	$	3,498,682		
OPERATING EXPENSES	 		 	 		 	 		
Fuel and purchased power	1,076,116		 	981,301		 	1,075,510		
Operations and maintenance	1,036,744		 	949,107		 	931,692		
Depreciation and amortization	582,354		 	534,118		 	485,829		
Taxes other than income taxes	212,849		 	184,347		 	166,499		
Other expenses	9,497		 	6,660		 	3,541		
Total	2,917,560		 	2,655,533		 	2,663,071		
OPERATING INCOME	773,687		 	909,763		 	835,611		
OTHER INCOME (DEDUCTIONS)	 		 	 		 	 		
Allowance for equity funds used during construction (Note 1)	52,319		 	47,011		 	42,140		
Pension and other postretirement non-service credits - net (Note 7)	49,791		 	24,664		 	20,373		
Other income (Note 17)	24,896		 	4,006		 	901		
Other expense (Note 17)	(17,966	)	 	(21,539	)	 	(15,337	)	
Total	109,040		 	54,142		 	48,077		
INTEREST EXPENSE	 		 	 		 	 		
Interest charges	243,465		 	219,796		 	205,720		
Allowance for borrowed funds used during construction (Note 1)	(25,180	)	 	(22,112	)	 	(19,970	)	
Total	218,285		 	197,684		 	185,750		
INCOME BEFORE INCOME TAXES	664,442		 	766,221		 	697,938		
INCOME TAXES (Note 4)	133,902		 	258,272		 	236,411		
NET INCOME	530,540		 	507,949		 	461,527		
Less: Net income attributable to noncontrolling interests (Note 18)	19,493		 	19,493		 	19,493		
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS	$	511,047		 	$	488,456		 	$	442,034		
 	 	 	 	 	 	
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — BASIC	112,129		 	111,839		 	111,409		
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING — DILUTED	112,550		 	112,367		 	112,046		
 	 	 	 	 	 	
EARNINGS PER WEIGHTED-AVERAGE COMMON SHARE OUTSTANDING	 		 	 		 	 		
Net income attributable to common shareholders — basic	$	4.56		 	$	4.37		 	$	3.97		
Net income attributable to common shareholders — diluted	$	4.54		 	$	4.35		 	$	3.95		

  The accompanying notes are an integral part of the financial statements.

90

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
 	 	 	 	 	 	
NET INCOME	$	530,540		 	$	507,949		 	$	461,527		
 	 	 	 	 	 	
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX	 		 	 		 	 		
Derivative instruments:	 		 	 		 	 		
Net unrealized loss, net of tax benefit (expense) of ($78), $24, and ($585) (Note 16)	(78	)	 	(35	)	 	(538	)	
Reclassification of net realized loss, net of tax benefit of $473, $1,294, and $985 (Note 16)	1,527		 	2,225		 	2,941		
Pension and other postretirement benefits activity, net of tax benefit (expense) of ($1,585), $693, and $633 (Note 7)	4,397		 	(3,370	)	 	(1,477	)	
Total other comprehensive income (loss)	5,846		 	(1,180	)	 	926		
 	 	 	 	 	 	
COMPREHENSIVE INCOME	536,386		 	506,769		 	462,453		
Less: Comprehensive income attributable to noncontrolling interests	19,493		 	19,493		 	19,493		
 	 	 	 	 	 	
COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS	$	516,893		 	$	487,276		 	$	442,960		
 
The accompanying notes are an integral part of the financial statements.

91

Table of Contents

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

	
								
 	December 31,	
 	2018	 	2017	
ASSETS	 		 	 		
 	 	 	 	
CURRENT ASSETS	 		 	 		
Cash and cash equivalents	$	5,766		 	$	13,892		
Customer and other receivables	267,887		 	305,147		
Accrued unbilled revenues	137,170		 	112,434		
Allowance for doubtful accounts	(4,069	)	 	(2,513	)	
Materials and supplies (at average cost)	269,065		 	264,012		
Fossil fuel (at average cost)	25,029		 	25,258		
Assets from risk management activities (Note 16)	1,113		 	1,931		
Deferred fuel and purchased power regulatory asset (Note 3)	37,164		 	75,637		
Other regulatory assets (Note 3)	129,738		 	172,451		
Other current assets	56,128		 	48,039		
Total current assets	924,991		 	1,016,288		
INVESTMENTS AND OTHER ASSETS	 		 	 		
Nuclear decommissioning trust (Notes 13 and 19)	851,134		 	871,000		
Other special use funds (Notes 13 and 19)	236,101		 	32,542		
Other assets	103,247		 	52,040		
Total investments and other assets	1,190,482		 	955,582		
PROPERTY, PLANT AND EQUIPMENT (Notes 1, 6 and 9)	 		 	 		
Plant in service and held for future use	18,736,628		 	17,798,061		
Accumulated depreciation and amortization	(6,366,014	)	 	(6,128,535	)	
Net	12,370,614		 	11,669,526		
Construction work in progress	1,170,062		 	1,291,498		
Palo Verde sale leaseback, net of accumulated depreciation of $245,275 and $241,405 (Note 18)	105,775		 	109,645		
Intangible assets, net of accumulated amortization of $591,202 and $582,272	262,902		 	257,189		
Nuclear fuel, net of accumulated amortization of $137,850 and $144,070	120,217		 	117,408		
Total property, plant and equipment	14,029,570		 	13,445,266		
DEFERRED DEBITS	 		 	 		
Regulatory assets (Notes 1, 3 and 4)	1,342,941		 	1,202,302		
Assets for other postretirement benefits (Note 7)	46,906		 	268,978		
Other	129,312		 	130,666		
Total deferred debits	1,519,159		 	1,601,946		
TOTAL ASSETS	$	17,664,202		 	$	17,019,082		
 
The accompanying notes are an integral part of the financial statements.

92

Table of Contents

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

								
 	December 31,	
 	2018	 	2017	
LIABILITIES AND EQUITY	 		 	 		
CURRENT LIABILITIES	 		 	 		
Accounts payable	$	277,336		 	$	256,442		
Accrued taxes	154,819		 	148,946		
Accrued interest	61,107		 	56,397		
Common dividends payable	82,675		 	77,667		
Short-term borrowings (Note 5)	76,400		 	95,400		
Current maturities of long-term debt (Note 6)	500,000		 	82,000		
Customer deposits	91,174		 	70,388		
Liabilities from risk management activities (Note 16)	35,506		 	59,252		
Liabilities for asset retirements (Note 11)	19,842		 	4,745		
Regulatory liabilities (Note 3)	165,876		 	100,086		
Other current liabilities	184,229		 	246,529		
Total current liabilities	1,648,964		 	1,197,852		
LONG-TERM DEBT LESS CURRENT MATURITIES (Note 6)	4,638,232		 	4,789,713		
DEFERRED CREDITS AND OTHER	 		 	 		
Deferred income taxes (Note 4)	1,807,421		 	1,690,805		
Regulatory liabilities (Notes 1, 3, 4 and 7)	2,325,976		 	2,452,536		
Liabilities for asset retirements (Note 11)	706,703		 	674,784		
Liabilities for pension benefits (Note 7)	443,170		 	327,300		
Liabilities from risk management activities (Note 16)	24,531		 	37,170		
Customer advances	137,153		 	113,996		
Coal mine reclamation	212,785		 	231,597		
Deferred investment tax credit	200,405		 	205,575		
Unrecognized tax benefits (Note 4)	22,517		 	13,115		
Other	147,640		 	148,909		
Total deferred credits and other	6,028,301		 	5,895,787		
COMMITMENTS AND CONTINGENCIES (SEE NOTES)			 			
EQUITY	 		 	 		
Common stock, no par value; authorized 150,000,000 shares, 112,159,896 and 111,816,170 issued at respective dates	2,634,265		 	2,614,805		
Treasury stock at cost; 58,135 shares at end of 2018 and 64,463 shares at end of 2017	(4,825	)	 	(5,624	)	
Total common stock	2,629,440		 	2,609,181		
Retained earnings	2,641,183		 	2,442,511		
Accumulated other comprehensive loss (Note 21)	(47,708	)	 	(45,002	)	
Total shareholders’ equity	5,222,915		 	5,006,690		
Noncontrolling interests (Note 18)	125,790		 	129,040		
Total equity	5,348,705		 	5,135,730		
TOTAL LIABILITIES AND EQUITY	$	17,664,202		 	$	17,019,082		
  The accompanying notes are an integral part of the financial statements.

93

Table of Contents

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

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
CASH FLOWS FROM OPERATING ACTIVITIES	 		 	 		 	 		
Net Income	$	530,540		 	$	507,949		 	$	461,527		
Adjustments to reconcile net income to net cash provided by operating activities:	 		 	 		 	 		
Depreciation and amortization including nuclear fuel	650,955		 	610,629		 	565,011		
Deferred fuel and purchased power	(78,277	)	 	(48,405	)	 	(60,303	)	
Deferred fuel and purchased power amortization	116,750		 	(14,767	)	 	38,152		
Allowance for equity funds used during construction	(52,319	)	 	(47,011	)	 	(42,140	)	
Deferred income taxes	117,355		 	248,164		 	206,870		
Deferred investment tax credit	(5,170	)	 	(4,587	)	 	23,082		
Change in derivative instruments fair value	—		 	(373	)	 	(403	)	
Stock compensation	19,547		 	20,502		 	18,883		
Changes in current assets and liabilities:	 		 	 		 	 		
Customer and other receivables	37,530		 	(93,797	)	 	(2,489	)	
Accrued unbilled revenues	(24,736	)	 	(4,485	)	 	(11,709	)	
Materials, supplies and fossil fuel	(6,103	)	 	(6,683	)	 	(1,491	)	
Income tax receivable	—		 	3,751		 	(3,162	)	
Other current assets	33,844		 	(10,580	)	 	(23,324	)	
Accounts payable	(14,602	)	 	(23,769	)	 	(66,917	)	
Accrued taxes	6,597		 	9,982		 	447		
Other current liabilities	28,174		 	19,154		 	29,594		
Change in margin and collateral accounts — assets	143		 	(300	)	 	673		
Change in margin and collateral accounts — liabilities	(2,211	)	 	(533	)	 	17,735		
Change in unrecognized tax benefits	(1,235	)	 	5,891		 	1,628		
Change in long-term regulatory liabilities	(109,284	)	 	45,764		 	14,682		
Change in other long-term assets	78,604		 	(68,480	)	 	(60,163	)	
Change in other long-term liabilities	(48,958	)	 	(29,980	)	 	(82,793	)	
Net cash flow provided by operating activities	1,277,144		 	1,118,036		 	1,023,390		
CASH FLOWS FROM INVESTING ACTIVITIES	 		 	 		 	 		
Capital expenditures	(1,178,169	)	 	(1,408,774	)	 	(1,275,472	)	
Contributions in aid of construction	27,716		 	23,708		 	64,296		
Allowance for borrowed funds used during construction	(25,180	)	 	(22,112	)	 	(19,970	)	
Proceeds from nuclear decommissioning trust sales and other special use funds	653,033		 	542,246		 	633,410		
Investment in nuclear decommissioning trust and other special use funds	(672,165	)	 	(544,527	)	 	(635,691	)	
Other	1,941		 	(19,078	)	 	(18,651	)	
Net cash flow used for investing activities	(1,192,824	)	 	(1,428,537	)	 	(1,252,078	)	
CASH FLOWS FROM FINANCING ACTIVITIES	 		 	 		 	 		
Issuance of long-term debt	445,245		 	848,239		 	693,151		
Repayment of long-term debt	(182,000	)	 	(125,000	)	 	(370,430	)	
Short-term borrowings and (repayments) — net	(7,000	)	 	(107,800	)	 	137,200		
Short-term debt borrowings under revolving credit facility	45,000		 	58,000		 	40,000		
Short-term debt repayments under revolving credit facility	(57,000	)	 	(32,000	)	 	—		
Dividends paid on common stock	(308,892	)	 	(289,793	)	 	(274,229	)	
Common stock equity issuance and purchases - net	(5,055	)	 	(13,390	)	 	(4,867	)	
Distributions to noncontrolling interests	(22,744	)	 	(22,744	)	 	(22,744	)	
Net cash flow (used for) provided by financing activities	(92,446	)	 	315,512		 	198,081		
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	(8,126	)	 	5,011		 	(30,607	)	
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR	13,892		 	8,881		 	39,488		
CASH AND CASH EQUIVALENTS AT END OF YEAR	$	5,766		 	$	13,892		 	$	8,881		

 The accompanying notes are an integral part of the financial statements.

94

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(dollars in thousands, except per share amounts)

																														
 	Common Stock	 	Treasury Stock	 	Retained Earnings	 	Accumulated Other Comprehensive Income (Loss)	 	Noncontrolling Interests	 	Total	
 	Shares	 	Amount	 	Shares	 	Amount	 	 	 	 	 	 	 	 	
Balance, December 31, 2015	111,095,402		 	$	2,541,668		 	(115,030	)	 	$	(5,806	)	 	$	2,092,803		 	$	(44,748	)	 	$	135,540		 	$	4,719,457		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	 	—		 	 	 	—		 	442,034		 	—		 	19,493		 	461,527		
Other comprehensive income	 	 	—		 	 	 	—		 	—		 	926		 	—		 	926		
Dividends on common stock ($2.56 per share)	 	 	—		 	 	 	—		 	(284,765	)	 	—		 	—		 	(284,765	)	
Issuance of common stock	296,651		 	13,982		 	 	 	—		 	—		 	—		 	—		 	13,982		
Purchase of treasury stock (a)	 	 	—		 	(128,105	)	 	(9,087	)	 	—		 	—		 	—		 	(9,087	)	
Reissuance of treasury stock for stock-based compensation and other	 	 	—		 	187,818		 	10,760		 	—		 	—		 	—		 	10,760		
Stock compensation cumulative effect adjustments (b)	 	 	40,380		 	 	 	—		 	5,475		 	—		 	—		 	45,855		
Net capital activities by noncontrolling interests	 	 	—		 	 	 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Balance, December 31, 2016	111,392,053		 	2,596,030		 	(55,317	)	 	(4,133	)	 	2,255,547		 	(43,822	)	 	132,290		 	4,935,912		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	 	—		 	 	 	—		 	488,456		 	—		 	19,493		 	507,949		
Other comprehensive loss	 	 	—		 	 	 	—		 	—		 	(1,180	)	 	—		 	(1,180	)	
Dividends on common stock ($2.70 per share)	 	 	—		 	 	 	—		 	(301,492	)	 	—		 	—		 	(301,492	)	
Issuance of common stock	424,117		 	18,775		 	 	 	—		 	—		 	—		 	—		 	18,775		
Purchase of treasury stock (a)	 	 	—		 	(216,911	)	 	(17,755	)	 	—		 	—		 	—		 	(17,755	)	
Reissuance of treasury stock for stock-based compensation and other	 	 	—		 	207,765		 	16,264		 	—		 	—		 	—		 	16,264		
Net capital activities by noncontrolling interests	 	 	—		 	 	 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Balance, December 31, 2017	111,816,170		 	2,614,805		 	(64,463	)	 	(5,624	)	 	2,442,511		 	(45,002	)	 	129,040		 	5,135,730		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	 	—		 	 	 	—		 	511,047		 	—		 	19,493		 	530,540		
Other comprehensive income	 	 	—		 	 	 	—		 	—		 	5,846		 	—		 	5,846		
Dividends on common stock ($2.87 per share)	 	 	—		 	 	 	—		 	(320,927	)	 	—		 	—		 	(320,927	)	
Issuance of common stock	343,726		 	19,460		 	 	 	—		 	—		 	—		 	—		 	19,460		
Purchase of treasury stock (a)	 	 	—		 	(129,903	)	 	(10,338	)	 	—		 	—		 	—		 	(10,338	)	
Reissuance of treasury stock for stock-based compensation and other	 	 	—		 	136,231		 	11,137		 	—		 	—		 	—		 	11,137		
Net capital activities by noncontrolling interests	 	 	—		 	 	 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Reclassification of income tax effects related to new tax reform (See Note 2)	 	 	—		 	 	 	—		 	8,552		 	(8,552	)	 	—		 	—		
Balance, December 31, 2018	112,159,896		 	$	2,634,265		 	(58,135	)	 	$	(4,825	)	 	$	2,641,183		 	$	(47,708	)	 	$	125,790		 	$	5,348,705		
(a)    Primarily represents shares of common stock withheld from certain stock awards for tax purposes.
(b)     During 2016, we adopted new stock-based compensation accounting guidance.

The accompanying notes are an integral part of the financial statements.

95

Table of Contents

MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
(ARIZONA PUBLIC SERVICE COMPANY)

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f), for APS.  Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our evaluation under the framework in Internal Control — Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2018.  The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein and also relates to the Company’s financial statements.
 
February 22, 2019

96

Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Shareholders and the Board of Directors of
Arizona Public Service Company
Phoenix, Arizona

Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Arizona Public Service Company and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows, for each of the three years in the period ended December 31, 2018, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
    
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

97

Table of Contents

Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
    
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Deloitte & Touche LLP

Phoenix, Arizona
February 22, 2019

We have served as the Company's auditor since 1932.

98

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands)

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
 	 	 	 	 	 	
OPERATING REVENUES	$	3,688,342		 	$	3,557,652		 	$	3,498,090		
 	 	 	 	 	 	
OPERATING EXPENSES	 		 	 		 	 		
Fuel and purchased power	1,094,020		 	992,744		 	1,082,625		
Operations and maintenance	969,227		 	917,983		 	902,467		
Depreciation and amortization	580,694		 	532,423		 	484,909		
Taxes other than income taxes	212,136		 	183,254		 	166,064		
Other expense	2,497		 	6,709		 	3,540		
Total	2,858,574		 	2,633,113		 	2,639,605		
OPERATING INCOME	829,768		 	924,539		 	858,485		
OTHER INCOME (DEDUCTIONS)	 		 	 		 	 		
Allowance for equity funds used during construction (Note 1)	52,319		 	47,011		 	42,140		
Pension and other postretirement non-service credits - net (Note 7)	51,242		 	24,371		 	20,224		
Other income (Note 17)	22,746		 	3,013		 	271		
Other expense (Note 17)	(15,292	)	 	(13,913	)	 	(10,554	)	
Total	111,015		 	60,482		 	52,081		
INTEREST EXPENSE	 		 	 		 	 		
Interest charges	231,391		 	214,163		 	202,571		
Allowance for borrowed funds used during construction (Note 1)	(25,180	)	 	(22,112	)	 	(19,481	)	
Total	206,211		 	192,051		 	183,090		
INCOME BEFORE INCOME TAXES	734,572		 	792,970		 	727,476		
INCOME TAXES (Note 4)	144,814		 	269,168		 	245,842		
NET INCOME	589,758		 	523,802		 	481,634		
Less: Net income attributable to noncontrolling interests (Note 18)	19,493		 	19,493		 	19,493		
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER	$	570,265		 	$	504,309		 	$	462,141		
 
The accompanying notes are an integral part of the financial statements.

99

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
 	 	 	 	 	 	
NET INCOME	$	589,758		 	$	523,802		 	$	481,634		
 	 	 	 	 	 	
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX	 		 	 		 	 		
Derivative instruments:	 		 	 		 	 		
Net unrealized loss, net of tax benefit (expense) of ($78), $24, and ($585) (Note 16)	(78	)	 	(35	)	 	(538	)	
Reclassification of net realized loss, net of tax benefit of $473, $1,294, and $985 (Note 16)	1,527		 	2,225		 	2,941		
Pension and other postretirement benefits activity, net of tax benefit (expense) of ($1,159), $977, and $293 (Note 7)	3,465		 	(3,750	)	 	(729	)	
Total other comprehensive income (loss)	4,914		 	(1,560	)	 	1,674		
 	 	 	 	 	 	
COMPREHENSIVE INCOME	594,672		 	522,242		 	483,308		
Less: Comprehensive income attributable to noncontrolling interests	19,493		 	19,493		 	19,493		
 	 	 	 	 	 	
COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON SHAREHOLDER	$	575,179		 	$	502,749		 	$	463,815		
 
The accompanying notes are an integral part of the financial statements.

100

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

	
								
 	December 31,	
 	2018	 	2017	
ASSETS	 		 	 		
PROPERTY, PLANT AND EQUIPMENT (Notes 1, 6 and 9)	 		 	 		
Plant in service and held for future use	$	18,733,142		 	$	17,654,078		
Accumulated depreciation and amortization	(6,362,771	)	 	(6,041,965	)	
Net	12,370,371		 	11,612,113		
Construction work in progress	1,170,062		 	1,266,636		
Palo Verde sale leaseback, net of accumulated depreciation of $245,275 and $241,405 (Note 18)	105,775		 	109,645		
Intangible assets, net of accumulated amortization of $590,069 and $581,135	262,746		 	257,028		
Nuclear fuel, net of accumulated amortization of $137,850 and $144,070	120,217		 	117,408		
Total property, plant and equipment	14,029,171		 	13,362,830		
INVESTMENTS AND OTHER ASSETS	 		 	 		
Nuclear decommissioning trust (Notes 13 and 19)	851,134		 	871,000		
Other special use funds (Notes 13 and 19)	236,101		 	30,358		
Other assets	40,817		 	36,796		
Total investments and other assets	1,128,052		 	938,154		
CURRENT ASSETS	 		 	 		
Cash and cash equivalents	5,707		 	13,851		
Customer and other receivables	257,654		 	292,791		
Accrued unbilled revenues	137,170		 	112,434		
Allowance for doubtful accounts	(4,069	)	 	(2,513	)	
Materials and supplies (at average cost)	269,065		 	262,630		
Fossil fuel (at average cost)	25,029		 	25,258		
Assets from risk management activities (Note 16)	1,113		 	1,931		
Deferred fuel and purchased power regulatory asset (Note 3)	37,164		 	75,637		
Other regulatory assets (Note 3)	129,738		 	172,451		
Other current assets	35,111		 	41,055		
Total current assets	893,682		 	995,525		
DEFERRED DEBITS	 		 	 		
Regulatory assets (Notes 1, 3, and 4)	1,342,941		 	1,202,302		
Assets for other postretirement benefits (Note 7)	43,212		 	265,139		
Other	128,265		 	129,801		
Total deferred debits	1,514,418		 	1,597,242		
TOTAL ASSETS	$	17,565,323		 	$	16,893,751		
 
The accompanying notes are an integral part of the financial statements.

101

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

	
								
 	December 31,	
 	2018	 	2017	
LIABILITIES AND EQUITY	 		 	 		
CAPITALIZATION	 		 	 		
Common stock	$	178,162		 	$	178,162		
Additional paid-in capital	2,721,696		 	2,571,696		
Retained earnings	2,788,256		 	2,533,954		
Accumulated other comprehensive loss (Note 21)	(27,107	)	 	(26,983	)	
Total shareholder equity	5,661,007		 	5,256,829		
Noncontrolling interests (Note 18)	125,790		 	129,040		
Total equity	5,786,797		 	5,385,869		
Long-term debt less current maturities (Note 6)	4,189,436		 	4,491,292		
Total capitalization	9,976,233		 	9,877,161		
CURRENT LIABILITIES	 		 	 		
Current maturities of long-term debt (Note 6)	500,000		 	82,000		
Accounts payable	266,277		 	247,852		
Accrued taxes	176,357		 	157,349		
Accrued interest	60,228		 	55,533		
Common dividends payable	82,700		 	77,700		
Customer deposits	91,174		 	70,388		
Liabilities from risk management activities (Note 16)	35,506		 	59,252		
Liabilities for asset retirements (Note 11)	19,842		 	4,192		
Regulatory liabilities (Note 3)	165,876		 	100,086		
Other current liabilities	178,137		 	243,922		
Total current liabilities	1,576,097		 	1,098,274		
DEFERRED CREDITS AND OTHER	 		 	 		
Deferred income taxes (Note 4)	1,812,664		 	1,742,485		
Regulatory liabilities (Notes 1, 3, and 4)	2,325,976		 	2,452,536		
Liabilities for asset retirements (Note 11)	706,703		 	666,527		
Liabilities for pension benefits (Note 7)	425,404		 	306,542		
Liabilities from risk management activities (Note 16)	24,531		 	37,170		
Customer advances	137,153		 	113,996		
Coal mine reclamation	212,785		 	215,830		
Deferred investment tax credit	200,405		 	205,575		
Unrecognized tax benefits (Note 4)	41,861		 	43,876		
Other	125,511		 	133,779		
Total deferred credits and other	6,012,993		 	5,918,316		
COMMITMENTS AND CONTINGENCIES (SEE NOTES)			 			
TOTAL LIABILITIES AND EQUITY	$	17,565,323		 	$	16,893,751		
  The accompanying notes are an integral part of the financial statements.

102

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)

												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
CASH FLOWS FROM OPERATING ACTIVITIES	 		 	 		 	 		
Net income	$	589,758		 	$	523,802		 	$	481,634		
Adjustments to reconcile net income to net cash provided by operating activities:	 		 	 		 	 		
Depreciation and amortization including nuclear fuel	649,295		 	608,935		 	564,091		
Deferred fuel and purchased power	(78,277	)	 	(48,405	)	 	(60,303	)	
Deferred fuel and purchased power amortization	116,750		 	(14,767	)	 	38,152		
Allowance for equity funds used during construction	(52,319	)	 	(47,011	)	 	(42,140	)	
Deferred income taxes	59,927		 	249,465		 	221,167		
Deferred investment tax credit	(5,170	)	 	(4,587	)	 	23,082		
Change in derivative instruments fair value	—		 	(373	)	 	(403	)	
Changes in current assets and liabilities:	 		 	 		 	 		
Customer and other receivables	35,406		 	(68,040	)	 	(1,601	)	
Accrued unbilled revenues	(24,736	)	 	(4,485	)	 	(11,709	)	
Materials, supplies and fossil fuel	(6,206	)	 	(6,503	)	 	(1,454	)	
Income tax receivable	—		 	11,174		 	(14,567	)	
Other current assets	31,707		 	(6,775	)	 	(21,640	)	
Accounts payable	(15,608	)	 	(26,561	)	 	(67,543	)	
Accrued taxes	19,008		 	26,773		 	(13,912	)	
Other current liabilities	25,070		 	27,912		 	5,097		
Change in margin and collateral accounts — assets	143		 	(300	)	 	673		
Change in margin and collateral accounts — liabilities	(2,211	)	 	(533	)	 	17,735		
Change in unrecognized tax benefits	(1,235	)	 	5,891		 	1,628		
Change in long-term regulatory liabilities	(109,284	)	 	45,764		 	14,682		
Change in other long-term assets	77,952		 	(78,540	)	 	(45,866	)	
Change in other long-term liabilities	(55,169	)	 	(31,106	)	 	(76,855	)	
Net cash flow provided by operating activities	1,254,801		 	1,161,730		 	1,009,948		
CASH FLOWS FROM INVESTING ACTIVITIES	 		 	 		 	 		
Capital expenditures	(1,169,061	)	 	(1,381,930	)	 	(1,248,010	)	
Contributions in aid of construction	27,716		 	23,708		 	64,296		
Allowance for borrowed funds used during construction	(25,180	)	 	(22,112	)	 	(19,481	)	
Proceeds from nuclear decommissioning trust sales and other special use funds	653,033		 	542,246		 	633,410		
Investment in nuclear decommissioning trust and other special use funds	(672,165	)	 	(544,527	)	 	(635,691	)	
Other	(1,789	)	 	(18,538	)	 	(13,865	)	
Net cash flow used for investing activities	(1,187,446	)	 	(1,401,153	)	 	(1,219,341	)	
CASH FLOWS FROM FINANCING ACTIVITIES	 		 	 		 	 		
Issuance of long-term debt	295,245		 	549,478		 	693,151		
Repayment of long-term debt	(182,000	)	 	—		 	(370,430	)	
Short-term borrowings and (repayments) — net	—		 	(135,500	)	 	135,500		
Short-term debt borrowings under revolving credit facility	25,000		 	—		 	—		
Short-term debt repayments under revolving credit facility	(25,000	)	 	—		 	—		
Dividends paid on common stock	(316,000	)	 	(296,800	)	 	(281,300	)	
Equity infusion from Pinnacle West	150,000		 	150,000		 	42,000		
Noncontrolling interests	(22,744	)	 	(22,744	)	 	(22,744	)	
Net cash flow provided by (used for) financing activities	(75,499	)	 	244,434		 	196,177		
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	(8,144	)	 	5,011		 	(13,216	)	
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR	13,851		 	8,840		 	22,056		
CASH AND CASH EQUIVALENTS AT END OF YEAR	$	5,707		 	$	13,851		 	$	8,840		
Supplemental disclosure of cash flow information:	 		 	 		 	 		
Cash paid (received) during the year for:	 		 	 		 	 		
Income taxes, net of refunds	$	77,942		 	$	(14,098	)	 	$	26,864		
Interest, net of amounts capitalized	196,419		 	184,210		 	181,809		
Significant non-cash investing and financing activities:	 		 	 		 	 		
Accrued capital expenditures	$	132,620		 	$	130,057		 	$	114,874		
Dividends declared but not paid	82,700		 	77,700		 	72,900		
 
The accompanying notes are an integral part of the financial statements.

103

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(dollars in thousands)

																											
 	Common Stock	 	Additional Paid-In Capital	 	Retained Earnings	 	Accumulated Other Comprehensive Income (Loss)	 	Noncontrolling Interests	 	Total	
 	Shares	 	Amount	 	 	 	 	 	 	 	 	 	 	
Balance, December 31, 2015	71,264,947		 	$	178,162		 	$	2,379,696		 	$	2,148,493		 	$	(27,097	)	 	$	135,540		 	$	4,814,794		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Equity infusion from Pinnacle West	 	 	—		 	42,000		 	—		 	—		 	—		 	42,000		
Net income	 	 	—		 	—		 	462,141		 	—		 	19,493		 	481,634		
Other comprehensive income	 	 	—		 	—		 	—		 	1,674		 	—		 	1,674		
Dividends on common stock	 	 	—		 	—		 	(284,800	)	 	—		 	—		 	(284,800	)	
Stock compensation cumulative effect adjustments (a)	 	 	—		 	—		 	5,411		 	—		 	—		 	5,411		
Net capital activities by noncontrolling interests	 	 	—		 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Balance, December 31, 2016	71,264,947		 	178,162		 	2,421,696		 	2,331,245		 	(25,423	)	 	132,290		 	5,037,970		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Equity infusion from Pinnacle West	 	 	—		 	150,000		 	—		 	—		 	—		 	150,000		
Net income	 	 	—		 	—		 	504,309		 	—		 	19,493		 	523,802		
Other comprehensive loss	 	 	—		 	—		 	—		 	(1,560	)	 	—		 	(1,560	)	
Dividends on common stock	 	 	—		 	—		 	(301,600	)	 	—		 	—		 	(301,600	)	
Net capital activities by noncontrolling interests	 	 	—		 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Balance, December 31, 2017	71,264,947		 	178,162		 	2,571,696		 	2,533,954		 	(26,983	)	 	129,040		 	5,385,869		
 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Equity infusion from Pinnacle West	 	 	—		 	150,000		 	—		 	—		 	—		 	150,000		
Net income	 	 	—		 	—		 	570,265		 	—		 	19,493		 	589,758		
Other comprehensive income	 	 	—		 	—		 	—		 	4,914		 	—		 	4,914		
Dividends on common stock	 	 	—		 	—		 	(321,001	)	 	—		 	—		 	(321,001	)	
Reclassifications of income tax effects related to new tax reform (See Note 2)	 	 	—		 	—		 	5,038		 	(5,038	)	 	—		 	—		
Net capital activities by noncontrolling interests	 	 	—		 	—		 	—		 	—		 	(22,743	)	 	(22,743	)	
Balance, December 31, 2018	71,264,947		 	$	178,162		 	$	2,721,696		 	$	2,788,256		 	$	(27,107	)	 	$	125,790		 	$	5,786,797		
(a)     During 2016, we adopted new stock-based compensation accounting guidance.

The accompanying notes are an integral part of the financial statements.

104

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1 .     Summary of Significant Accounting Policies

Description of Business and Basis of Presentation
 
Pinnacle West is a holding company that conducts business through its subsidiaries, APS, El Dorado, BCE and 4CA. APS, our wholly-owned subsidiary, is a vertically-integrated electric utility that provides either retail or wholesale electric service to substantially all of the state of Arizona, with the major exceptions of about one-half of the Phoenix metropolitan area, the Tucson metropolitan area and Mohave County in northwestern Arizona.  APS accounts for essentially all of our revenues and earnings, and is expected to continue to do so.  El Dorado is an investment firm. BCE is a subsidiary that was formed in 2014 that focuses on growth opportunities that leverage the Company's core expertise in the electric energy industry. BCE is currently pursuing transmission opportunities through a joint venture arrangement. 4CA is a subsidiary that was formed in 2016 as a result of the purchase of El Paso's 7% interest in Four Corners. See Note 10 for more information on 4CA matters.
 
Pinnacle West’s Consolidated Financial Statements include the accounts of Pinnacle West and our subsidiaries:  APS, El Dorado, BCE and 4CA. APS’s consolidated financial statements include the accounts of APS and certain VIEs relating to the Palo Verde sale leaseback.  Intercompany accounts and transactions between the consolidated companies have been eliminated.
 
We consolidate VIEs for which we are the primary beneficiary.  We determine whether we are the primary beneficiary of a VIE through a qualitative analysis that identifies which variable interest holder has the controlling financial interest in the VIE.  In performing our primary beneficiary analysis, we consider all relevant facts and circumstances, including the design and activities of the VIE, the terms of the contracts the VIE has entered into, and which parties participated significantly in the design or redesign of the entity.  We continually evaluate our primary beneficiary conclusions to determine if changes have occurred which would impact our primary beneficiary assessments.  We have determined that APS is the primary beneficiary of certain VIE lessor trusts relating to the Palo Verde sale leaseback, and therefore APS consolidates these entities (see Note 18 ).
 
Our consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments, except as otherwise disclosed in the notes) that we believe are necessary for the fair presentation of our financial position, results of operations and cash flows for the periods presented.
    
These consolidated financial statements and notes have been prepared consistently, with the exception of the reclassification of certain prior year amounts on our Consolidated Statements of Income and APS's Consolidated Statements of Income. Beginning in the quarter ended March 31, 2018, APS changed the format of presentation of its Consolidated Statements of Income from a utility ratemaking format to a commercial format. Minor changes were made in the description of certain income statement line items and the amounts presented in the comparable prior period also changed by immaterial amounts due to the change from a utility to a non-utility format and also from the adoption of the new accounting guidance for net periodic pension cost and net periodic postretirement benefit cost. In addition, the prior year amounts were reclassified to conform to the current year presentation for the other special use funds in the investment and other assets section on the Consolidated Balance Sheets.

105

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Accounting Records and Use of Estimates
 
Our accounting records are maintained in accordance with accounting principles generally accepted in the United States of America ("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.

Regulatory Accounting
 
APS is regulated by the ACC and FERC.  The accompanying financial statements reflect the rate-making policies of these commissions.  As a result, we capitalize certain costs that would be included as expense in the current period by unregulated companies.  Regulatory assets represent incurred costs that have been deferred because they are probable of future recovery in customer rates. Regulatory liabilities generally represent amounts collected in rates to recover costs expected to be incurred in the future or amounts collected in excess of costs incurred and are refundable to customers.
 
Management continually assesses whether our regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory environment and recent rate orders applicable to APS or other regulated entities in the same jurisdiction.  This determination reflects the current political and regulatory climate in Arizona and is subject to change in the future.  If future recovery of costs ceases to be probable, the assets would be written off as a charge in current period earnings.
 
See Note 3 for additional information.
 
Electric Revenues
 
We derive electric revenues primarily from sales of electricity to our regulated Native Load customers. Revenues related to the sale of electricity are generally recognized when service is rendered or electricity is delivered to customers. The billing of electricity sales to individual Native Load customers is based on the reading of their meters. We obtain customers' meter data on a systematic basis throughout the month, and generally bill customers within a month from when service was provided. Customers are generally required to pay for services within 15 days of when the services are billed. Unbilled revenues are estimated by applying an average revenue/kWh by customer class to the number of estimated kWhs delivered but not billed. Differences historically between the actual and estimated unbilled revenues are immaterial. We exclude sales taxes and franchise fees on electric revenues from both revenue and taxes other than income taxes.
 
On January 1, 2018, we adopted new revenue guidance ASU 2014-09, Revenue from contracts with customers, accordingly our 2018 electric revenues primarily consist of activities that now are classified as revenues from contracts with customers. Our electric revenues generally represent a single performance obligation delivered over time. We have elected to apply the invoice practical expedient and, as such, we recognize revenue based on the amount to which we have a right to invoice for services performed. See Note 2.

Revenues from our Native Load customers and non-derivative instruments are reported on a gross basis on Pinnacle West’s Consolidated Statements of Income.  In the electricity business, some contracts to purchase electricity are netted against other contracts to sell electricity. This is called a "book-out" and usually occurs for contracts that have the same terms (quantities, delivery points and delivery periods) and for which

106

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

power does not flow. We net these book-outs, which reduces both wholesale revenues and fuel and purchased power costs.

Some of our cost recovery mechanisms are alternative revenue programs.  For alternative revenue programs that meet specified accounting criteria, we recognize revenues when the specific events permitting billing of the additional revenues have been completed.

See Notes 2 and 20 for additional information.

Allowance for Doubtful Accounts
 
The allowance for doubtful accounts represents our best estimate of existing accounts receivable that will ultimately be uncollectible.  The allowance is calculated by applying estimated write-off factors to various classes of outstanding receivables, including accrued utility revenues.  The write-off factors used to estimate uncollectible accounts are based upon consideration of both historical collections experience and management’s best estimate of future collections success given the existing collections environment.
 
Property, Plant and Equipment
 
Utility plant is the term we use to describe the business property and equipment that supports electric service, consisting primarily of generation, transmission and distribution facilities.  We report utility plant at its original cost, which includes:

•	material and labor;	
		
•	contractor costs;	
		
•	capitalized leases;	
		
•	construction overhead costs (where applicable); and	
		
•	allowance for funds used during construction.	

Pinnacle West’s property, plant and equipment included in the December 31, 2018 and 2017 Consolidated Balance Sheets is composed of the following (dollars in thousands):

	
								
Property, Plant and Equipment:	2018	 	2017	
Generation	$	8,285,514		 	$	7,963,998		
Transmission	3,033,579		 	2,836,578		
Distribution	6,378,345		 	6,025,856		
General plant	1,039,190		 	971,629		
Plant in service and held for future use	18,736,628		 	17,798,061		
Accumulated depreciation and amortization	(6,366,014	)	 	(6,128,535	)	
Net	12,370,614		 	11,669,526		
Construction work in progress	1,170,062		 	1,291,498		
Palo Verde sale leaseback, net of accumulated depreciation	105,775		 	109,645		
Intangible assets, net of accumulated amortization	262,902		 	257,189		
Nuclear fuel, net of accumulated amortization	120,217		 	117,408		
Total property, plant and equipment	$	14,029,570		 	$	13,445,266		

Property, plant and equipment balances and classes for APS are not materially different than Pinnacle West.

107

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

We expense the costs of plant outages, major maintenance and routine maintenance as incurred.  We charge retired utility plant to accumulated depreciation.  Liabilities associated with the retirement of tangible long-lived assets are recognized at fair value as incurred and capitalized as part of the related tangible long-lived assets.  Accretion of the liability due to the passage of time is an operating expense, and the capitalized cost is depreciated over the useful life of the long-lived asset.  See Note  11 .
 
APS records a regulatory liability for the excess of the amount that has been recovered in regulated rates over the amount calculated in accordance with guidance on accounting for asset retirement obligations.  APS believes it is probable it will recover in regulated rates, the costs calculated in accordance with this accounting guidance.
 
We record depreciation and amortization on utility plant on a straight-line basis over the remaining useful life of the related assets.  The approximate remaining average useful lives of our utility property at December 31, 2018 were as follows:
 
• Fossil plant — 17 years ;
• Nuclear plant — 23 years ;
• Other generation — 19 years ;
• Transmission — 39 years ;
• Distribution — 34 years ; and
• General plant — 6 years .
 
Depreciation of utility property, plant and equipment is computed on a straight-line, remaining-life basis. Depreciation expense was $486 million in 2018 , $453 million in 2017 , and $422 million in 2016 . For the years 2016 through 2018 , the depreciation rates ranged from a low of 0.18% to a high of 19.67% .  The weighted-average depreciation rate was 2.81% in 2018 , 2.80% in 2017 , and 2.66% in 2016 .

Asset Retirement Obligations

APS has asset retirement obligations for its Palo Verde nuclear facilities and certain other generation assets.  The Palo Verde asset retirement obligation primarily relates to final plant decommissioning.  This obligation is based on the NRC’s requirements for disposal of radiated property or plant and agreements APS reached with the ACC for final decommissioning of the plant.  The non-nuclear generation asset retirement obligations primarily relate to requirements for removing portions of those plants at the end of the plant life or lease term and coal ash pond closures. Some of APS’s transmission and distribution assets have asset retirement obligations because they are subject to right of way and easement agreements that require final removal.  These agreements have a history of uninterrupted renewal that APS expects to continue.  As a result, APS cannot reasonably estimate the fair value of the asset retirement obligation related to such transmission and distribution assets. Additionally, APS has aquifer protection permits for some of its generation sites that require the closure of certain facilities at those sites.

See Note 11 for further information on Asset Retirement Obligations.

Allowance for Funds Used During Construction
 
AFUDC represents the approximate net composite interest cost of borrowed funds and an allowed return on the equity funds used for construction of regulated utility plant.  Both the debt and equity components of AFUDC are non-cash amounts within the Consolidated Statements of Income.  Plant

108

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation.
 
AFUDC was calculated by using a composite rate of 7.03% for 2018 , 6.68% for 2017 , and 7.17% for 2016 .  APS compounds AFUDC semi-annually and ceases to accrue AFUDC when construction work is completed and the property is placed in service.
 
Materials and Supplies
 
APS values materials, supplies and fossil fuel inventory using a weighted-average cost method.  APS materials, supplies and fossil fuel inventories are carried at the lower of weighted-average cost or market, unless evidence indicates that the weighted-average cost (even if in excess of market) will be recovered.
 
Fair Value Measurements
 
We apply recurring fair value measurements to cash equivalents, derivative instruments, investments held in the nuclear decommissioning trust and other special use funds. On an annual basis, we apply fair value measurements to plan assets held in our retirement and other benefits plans. Due to the short-term nature of short-term borrowings, the carrying values of these instruments approximate fair value.  Fair value measurements may also be applied on a nonrecurring basis to other assets and liabilities in certain circumstances such as impairments.  We also disclose fair value information for our long-term debt, which is carried at amortized cost (see Note 6).
 
Fair value is the price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market which we can access for the asset or liability in an orderly transaction between willing market participants on the measurement date.  Inputs to fair value may include observable and unobservable data.  We maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
 
We determine fair market value using observable inputs such as actively-quoted prices for identical instruments when available.  When actively-quoted prices are not available for the identical instruments, we use other observable inputs, such as prices for similar instruments, other corroborative market information, or prices provided by other external sources.  For options, long-term contracts and other contracts for which observable price data are not available, we use models and other valuation methods, which may incorporate unobservable inputs to determine fair market value.
 
The use of models and other valuation methods to determine fair market value often requires subjective and complex judgment.  Actual results could differ from the results estimated through application of these methods.
 
See Note 13 for additional information about fair value measurements.

109

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Derivative Accounting
 
We are exposed to the impact of market fluctuations in the commodity price and transportation costs of electricity, natural gas, coal and in interest rates.  We manage risks associated with market volatility by utilizing various physical and financial instruments including futures, forwards, options and swaps.  As part of our overall risk management program, we may use derivative instruments to hedge purchases and sales of electricity and fuels.  The changes in market value of such contracts have a high correlation to price changes in the hedged transactions.  We also enter into derivative instruments for economic hedging purposes.  Contracts that have the same terms (quantities, delivery points and delivery periods) and for which power does not flow are netted, which reduces both revenues and fuel and purchased power expenses in our Consolidated Statements of Income, but does not impact our financial condition, net income or cash flows.
 
We account for our derivative contracts in accordance with derivatives and hedging guidance, which requires all derivatives not qualifying for a scope exception to be measured at fair value on the balance sheet as either assets or liabilities.  Transactions with counterparties that have master netting arrangements are reported net on the balance sheet.  See Notes 2 and 16 for additional information about our derivative instruments.
 
Loss Contingencies and Environmental Liabilities
 
Pinnacle West and APS are involved in certain legal and environmental matters that arise in the normal course of business.  Contingent losses and environmental liabilities are recorded when it is determined that it is probable that a loss has occurred and the amount of the loss can be reasonably estimated.  When a range of the probable loss exists and no amount within the range is a better estimate than any other amount, Pinnacle West and APS record a loss contingency at the minimum amount in the range.  Unless otherwise required by GAAP, legal fees are expensed as incurred.
 
Retirement Plans and Other Postretirement Benefits
 
Pinnacle West sponsors a qualified defined benefit and account balance pension plan for the employees of Pinnacle West and its subsidiaries.  We also sponsor another postretirement benefit plan for the employees of Pinnacle West and its subsidiaries that provides medical and life insurance benefits to retired employees.  Pension and other postretirement benefit expense are determined by actuarial valuations, based on assumptions that are evaluated annually.  See Note 7 for additional information on pension and other postretirement benefits. On January 1, 2018, we adopted new accounting guidance ASU 2017-07, Compensation-Retirement Benefits: Improving the presentation of net periodic pension cost and net periodic postretirement benefit cost. See Note 2 for additional discussion.
 
Nuclear Fuel
 
APS amortizes nuclear fuel by using the unit-of-production method.  The unit-of-production method is based on actual physical usage.  APS divides the cost of the fuel by the estimated number of thermal units it expects to produce with that fuel.  APS then multiplies that rate by the number of thermal units produced within the current period.  This calculation determines the current period nuclear fuel expense.
 
APS also charges nuclear fuel expense for the interim storage and permanent disposal of spent nuclear fuel.  The DOE is responsible for the permanent disposal of spent nuclear fuel and charged APS $0.001 per kWh of nuclear generation through May 2014, at which point the DOE reduced the fee to zero.  In accordance with a settlement agreement with the DOE in August 2014, we will now accrue a receivable for incurred

110

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

claims and an offsetting regulatory liability through the settlement period ending December of 2019. See Note 10 for information on spent nuclear fuel disposal costs.
 
Income Taxes
 
Income taxes are provided using the asset and liability approach prescribed by guidance relating to accounting for income taxes and are based on currently enacted tax rates.  We file our federal income tax return on a consolidated basis, and we file our state income tax returns on a consolidated or unitary basis.  In accordance with our intercompany tax sharing agreement, federal and state income taxes are allocated to each first-tier subsidiary as though each first-tier subsidiary filed a separate income tax return.  Any difference between that method and the consolidated (and unitary) income tax liability is attributed to the parent company.  The income tax accounts reflect the tax and interest associated with management’s estimate of the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement for all known and measurable tax exposures. On January 1, 2018, we adopted new guidance ASU 2018-02, Income Statement-Reporting Comprehensive Income: Reclassification of certain tax effects from accumulated other comprehensive income. See Note  4 for additional discussion.
 
Cash and Cash Equivalents
 
We consider cash equivalents to be highly liquid investments with a remaining maturity of three months or less at acquisition.

The following table summarizes supplemental Pinnacle West cash flow information for each of the last three years (dollars in thousands):

	
												
 	Year ended December 31,	
 	2018	 	2017	 	2016	
Cash paid during the period for:	 		 	 		 	 		
Income taxes, net of refunds	$	21,173		 	$	2,186		 	$	9,956		
Interest, net of amounts capitalized	208,479		 	189,288		 	184,462		
Significant non-cash investing and financing activities:	 		 	 		 	 		
Accrued capital expenditures	$	132,620		 	$	130,404		 	$	114,855		
Dividends declared but not paid	82,675		 	77,667		 	72,926		
Sale of 4CA 7% interest in Four Corners	68,907		 	—		 	—		

Intangible Assets
 
We have no goodwill recorded and have separately disclosed other intangible assets, primarily APS's software, on Pinnacle West’s Consolidated Balance Sheets. The intangible assets are amortized over their finite useful lives.  Amortization expense was $68 million in 2018 , $72 million in 2017 , and $58 million in 2016 .  Estimated amortization expense on existing intangible assets over the next five years is $58 million in 2019, $47 million in 2020, $34 million in 2021, $25 million in 2022, and $22 million in 2023.  At December 31, 2018 , the weighted-average remaining amortization period for intangible assets was 8 years.
 
Investments
 
El Dorado holds investments in both debt and equity securities.  Investments in debt securities are generally accounted for as held-to-maturity and investments in equity securities are accounted for using either

111

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the equity method (if significant influence) or the measurement alternative for investments without readily determinable fair values (if less than 20% ownership and no significant influence).
 
Our investments in the nuclear decommissioning trust fund, coal reclamation escrow and active union employee medical account, are accounted for in accordance with guidance on accounting for investments in debt and equity securities. See Notes 13 and 19 for more information on these investments.

On January 1, 2018, we adopted new accounting guidance ASU 2016-01, Financial Instruments: Recognition and measurement. See Note 2 .

Business Segments
 
Pinnacle West’s reportable business segment is our regulated electricity segment, which consists of traditional regulated retail and wholesale electricity businesses (primarily electricity service to Native Load customers) and related activities and includes electricity generation, transmission and distribution. All other segment activities are insignificant.

Preferred Stock

At December 31, 2018 , Pinnacle West had 10 million shares of serial preferred stock authorized with no par value, none of which was outstanding, and APS had 15,535,000 shares of various types of preferred stock authorized with $25 , $50 and $100 par values, none of which was outstanding.
 
2 .     New Accounting Standards
 
Standards Adopted in 2018

  ASU 2014-09, Revenue from Contracts with Customers

In May 2014, a new revenue recognition accounting standard was issued. This standard provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. Since the issuance of the new revenue standard, additional guidance was issued to clarify certain aspects of the new revenue standard, including principal versus agent considerations, identifying performance obligations, and other narrow scope improvements. The new revenue standard, and related amendments, became effective for us on January 1, 2018. The standard may be adopted using a full retrospective application or a simplified transition method that allows entities to record a cumulative effect adjustment in retained earnings at the date of initial application.

We adopted this standard and related amendments on January 1, 2018 using the modified retrospective transition approach. The adoption of the new revenue guidance resulted in expanded disclosures, but otherwise did not have a material impact on our financial statements. See Note 20.

ASU 2016-01, Financial Instruments: Recognition and Measurement

In January 2016, a new accounting standard was issued relating to the recognition and measurement of financial instruments. The new guidance requires certain investments in equity securities to be measured at fair value with changes in fair value recognized in net income, and modifies the impairment assessment of certain equity securities. The new standard was effective for us on January 1, 2018. The standard required modified retrospective application, with the exception of certain aspects of the standard that required prospective

112

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

application. We adopted this standard on January 1, 2018, using primarily a retrospective approach. Due to regulatory accounting treatment, the adoption of this standard did not have a material impact on our financial statements. See Notes 13 and 19 for disclosures relating to our investments in debt and equity securities.

ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments

In August 2016, a new accounting standard was issued that clarifies how entities should present certain specific cash flow activities on the statement of cash flows. The guidance is intended to eliminate diversity in practice in how entities classify these specific activities between cash flows from operating activities, investing activities and financing activities. The specific activities addressed include debt prepayments and extinguishment costs, proceeds from the settlement of insurance claims, proceeds from corporate-owned life insurance policies, and other activities. The standard also addresses how entities should apply the predominance principle when a transaction includes separately identifiable cash flows. The new standard was effective for us, and was adopted on January 1, 2018, using a retrospective transition method. The adoption of this guidance did not have a significant impact on our financial statements, as either our statement of cash flow presentation is consistent with the new prescribed guidance or we do not have significant activities relating to the specific transactions that are addressed by the new standard.

ASU 2016-18, Statement of Cash Flows: Restricted Cash

In November 2016, a new accounting standard was issued that clarifies how restricted cash and restricted cash equivalents should be presented on the statement of cash flows. The new guidance requires entities to include restricted cash and restricted cash equivalents as a component of the beginning and ending cash and cash equivalent balances on the statement of cash flows. The new standard is effective for us, and was adopted on January 1, 2018, using a retrospective transition method. The adoption of this guidance did not impact our financial statements, as our holdings and activities designated as restricted cash and restricted cash equivalents at transition and in prior periods are insignificant.

ASU 2017-01, Business Combinations: Clarifying the Definition of a Business

In January 2017, a new accounting standard was issued that clarifies the definition of a business. This standard is intended to assist entities with evaluating whether a transaction should be accounted for as an acquisition (or disposal) of assets or a business.  The definition of a business affects many areas of accounting, including acquisitions, disposals, goodwill, and consolidation. The new standard was effective for us and was adopted on January 1, 2018 using a prospective transition approach. This standard did not have an impact on our financial statements on the date of adoption.

ASU 2017-05, Other Income: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets

In February 2017, a new accounting standard was issued that intended to clarify the scope of accounting guidance pertaining to gains and losses from the derecognition of nonfinancial assets, and to add guidance for partial sales of nonfinancial assets. The new standard was effective for us, and was adopted on January 1, 2018, using a modified retrospective transition approach. This standard did not have a significant impact on our financial statements on the date of adoption. On July 3, 2018, 4CA sold its 7% interest in Four Corners. The sale transaction was accounted for in accordance with the guidance in ASU 2017-05, see Note 10.

113

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

ASU 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost

In March 2017, a new accounting standard was issued that modifies how plan sponsors present net periodic pension cost and net periodic postretirement benefit cost (net benefit costs). The presentation changes require net benefit costs to be disaggregated on the income statement by the various components that comprise these costs. Specifically, only the service cost component is eligible for presentation as an operating income item, and all other cost components are now presented as non-operating items. This presentation change was applied retrospectively. Furthermore, the new standard allows only the service cost component to be eligible for capitalization. The change in capitalization requirements was applied prospectively. The new guidance was effective for us on January 1, 2018.

We adopted this new accounting standard on January 1, 2018. As a result of adopting this standard we have presented the non-service cost components of net benefits costs in other income instead of operating income. Prior year non-service cost components have also been reclassified to conform to this new presentation. We elected to apply the practical expedient guidance. As such, prior period costs have been estimated based on amounts previously disclosed in our pension and other postretirement benefit plan notes. The changes impacting capitalization have been adopted prospectively. As such, upon adoption, we are no longer capitalizing a portion of the non-service cost components of net benefit costs.

In 2018 the non-service credit components are a reduction to total benefit costs. Excluding non-service credits from eligible capitalization costs resulted in the capitalization of an additional $15 million of net benefit costs, with a corresponding increase to pretax income for the year. See Note 7 for additional information related to our pension plans and other postretirement benefits.

ASU 2018-02, Income Statement-Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

In February 2018, new accounting guidance was issued that allows entities an optional election to reclassify the income tax effects of the Tax Act on items within accumulated other comprehensive income to retained earnings. Amounts eligible for reclassification must relate to the effects from the Tax Act remaining in accumulated other comprehensive income. The new guidance also requires expanded disclosures. This guidance is effective for us on January 1, 2019 with early application permitted. The guidance should be applied either in the period of adoption or retrospectively to each period in which the effect of the Tax Act was recognized.

We early adopted this guidance in the quarter ended March 31, 2018, and we have elected to reclassify the income tax effects of the Tax Act related to other comprehensive income to retained earnings. As of December 31, 2018, on a consolidated basis our accumulated other comprehensive income decreased $9 million , and APS's accumulated other comprehensive income decreased $5 million , as a result of adopting this guidance. Amounts were reclassified from accumulated other comprehensive income to retained earnings, and related to tax rate changes. The adoption of this guidance did not impact our income from continuing operations. See Note 4 for additional discussion of the Tax Act.

114

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Standards Adopted in 2019

ASU 2016-02, Leases

In February 2016, a new lease accounting standard was issued. This new standard supersedes the existing lease accounting model, and modifies both lessee and lessor accounting. The new standard requires a lessee to reflect most operating lease arrangements on the balance sheet by recording a right-of-use asset and a lease liability that is initially measured at the present value of lease payments. Among other changes, the new standard also modifies the definition of a lease, and requires expanded lease disclosures. Since the issuance of the new lease standard, additional lease related guidance has been issued relating to land easements and how entities may elect to account for these arrangements at transition, among other items. The new lease standard and related amendments were effective for us on January 1, 2019, with early application permitted. The standard must be adopted using a modified retrospective approach with a cumulative-effect adjustment to the opening balance of retained earnings determined at either the date of adoption, or the earliest period presented in the financial statements. The standard includes various optional practical expedients provided to facilitate transition.

We adopted this standard, and related amendments, on January 1, 2019. We elected the transition method that allows us to apply the guidance on the date of adoption, January 1, 2019, and will not retrospectively adjust prior periods. We also elected certain transition practical expedients that allow us to not reassess (a) whether any expired or existing contracts are or contain leases, (b) the lease classification for any expired or existing leases and (c) initial direct costs for any existing leases. These practical expedients apply to leases that commenced prior to January 1, 2019. Furthermore, we elected the practical expedient transition provisions relating to the treatment of existing land easements.

On January 1, 2019 the adoption of this new accounting standard resulted in the recognition on our Consolidated Balance Sheets of approximately $194 million of right-of-use lease assets and $119 million of lease liabilities relating to our operating lease arrangements. The right-of-use lease assets include $85 million of prepaid lease costs that have been reclassified from other deferred debits, and $10 million of deferred lease costs that have been reclassified from other current liabilities. In addition to these balance sheet impacts the adoption of the guidance will also result in expanded lease related disclosures in our 2019 financial statements.

ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities

In August 2017, a new accounting standard was issued that modifies hedge accounting guidance with the intent of simplifying the application of hedge accounting. The new standard became effective for us on January 1, 2019, with early application permitted. At transition, the guidance requires the changes to be applied to hedging relationships existing on the date of adoption, with the effect of adoption reflected as of the beginning of the fiscal year of adoption using a cumulative effect adjustment approach. The presentation and disclosure changes may be applied prospectively. We adopted this standard on January 1, 2019 and because we are not currently applying hedge accounting, the adoption of the standard did not impact our financial statements.

Standards Pending Adoption

ASU 2016-13, Financial Instruments: Measurement of Credit Losses

In June 2016, a new accounting standard was issued that amends the measurement of credit losses on certain financial instruments. The new standard will require entities to use a current expected credit loss model

115

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to measure impairment of certain investments in debt securities, trade accounts receivables, and other financial instruments. The new standard is effective for us on January 1, 2020 and must be adopted using a modified retrospective approach for certain aspects of the standard, and a prospective approach for other aspects of the standard. We are currently evaluating this new accounting standard and the impacts it may have on our financial statements.

ASU 2018-15, Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract

In August 2018, a new accounting standard was issued that clarifies how customers in a cloud computing service arrangement should account for implementation costs associated with the arrangement. To determine which implementation costs should be capitalized, the new guidance aligns the accounting with existing guidance pertaining to internal-use software. As a result of this new standard, certain cloud computing service arrangement implementation costs will now be subject to capitalization and amortized on a straight-line basis over the cloud computing service arrangement term. The new standard is effective for us on January 1, 2020, with early application permitted, and may be applied using either a retrospective or prospective transition approach. We are currently evaluating this new accounting standard and the impacts it may have on our financial statements.

3 .     Regulatory Matters
 
Retail Rate Case Filing with the Arizona Corporation Commission
 
On June 1, 2016, APS filed an application with the ACC for an annual increase in retail base rates of $165.9 million . This amount excluded amounts that were then collected on customer bills through adjustor mechanisms. The application requested that some of the balances in these adjustor accounts (aggregating to approximately $267.6 million as of December 31, 2015) be transferred into base rates through the ratemaking process. This transfer would not have had an incremental effect on average customer bills. The average annual customer bill impact of APS’s request was an increase of 5.74% (the average annual bill impact for a typical APS residential customer was 7.96% ).

On March 27, 2017, a majority of the stakeholders in the general retail rate case, including the ACC Staff, the Residential Utility Consumer Office, limited income advocates and private rooftop solar organizations signed a settlement agreement (the "2017 Settlement Agreement") and filed it with the ACC. The 2017 Settlement Agreement provides for a net retail base rate increase of $94.6 million , excluding the transfer of adjustor balances, consisting of: (1) a non-fuel, non-depreciation, base rate increase of $87.2 million per year; (2) a base rate decrease of $53.6 million attributable to reduced fuel and purchased power costs; and (3) a base rate increase of $61.0 million due to changes in depreciation schedules. The average annual customer bill impact under the 2017 Settlement Agreement was calculated as an increase of 3.28% (the average annual bill impact for a typical APS residential customer was calculated as 4.54% ).

Other key provisions of the agreement include the following:

•	an agreement by APS not to file another general retail rate case application before June 1, 2019;	
		
•	an authorized return on common equity of 10.0% ;	
		
•	a capital structure comprised of 44.2% debt and 55.8% common equity;	
		
•	a cost deferral order for potential future recovery in APS’s next general retail rate case for the construction and operating costs APS incurs for its Ocotillo modernization project;	

116

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

		
•	a cost deferral and procedure to allow APS to request rate adjustments prior to its next general retail rate case related to its share of the construction costs associated with installing selective catalytic reduction ("SCR") equipment at Four Corners;	
		
•	a deferral for future recovery (or credit to customers) of the Arizona property tax expense above or below a specified test year level caused by changes to the applicable Arizona property tax rate;	
		
•	an expansion of the PSA to include certain environmental chemical costs and third-party battery storage costs;	
		
•	a new AZ Sun II program (now known as APS Solar Communities) for utility-owned solar DG with the purpose of expanding access to rooftop solar for low and moderate income Arizonans, recoverable through the RES, to be no less than $10 million per year, and not more than $15 million per year;	
		
•	an increase to the per kWh cap for the environmental improvement surcharge from $0.00016 to $0.00050 and the addition of a balancing account;	
		
•	rate design changes, including:	
		
▪	a change in the on-peak time of use period from noon - 7 p.m. to 3 p.m. - 8 p.m. Monday through Friday, excluding holidays;	
		
▪	non-grandfathered DG customers would be required to select a rate option that has time of use rates and either a new grid access charge or demand component;	
		
▪	a Resource Comparison Proxy (“RCP”) for exported energy of 12.9 cents per kWh in year one; and	
		
•	an agreement by APS not to pursue any new self-build generation (with certain exceptions) having an in-service date prior to January 1, 2022 (extended to December 31, 2027 for combined-cycle generating units), unless expressly authorized by the ACC.	

Through a separate agreement, APS, industry representatives, and solar advocates committed to stand by the 2017 Settlement Agreement and refrain from seeking to undermine it through ballot initiatives, legislation or advocacy at the ACC.

On August 15, 2017, the ACC approved (by a vote of 4-1), the 2017 Settlement Agreement without material modifications.  On August 18, 2017, the ACC issued a final written Opinion and Order reflecting its decision in APS’s general retail rate case (the "2017 Rate Case Decision"), which is subject to requests for rehearing and potential appeal. The new rates went into effect on August 19, 2017.

On October 17, 2017, Warren Woodward (an intervener in APS's general retail rate case) filed a Notice of Appeal in the Arizona Court of Appeals, Division One. The notice raises a single issue related to the application of certain rate schedules to new APS residential customers after May 1, 2018. Mr. Woodward filed a second notice of appeal on November 13, 2017 challenging APS’s $5 per month automated metering infrastructure opt-out program. Mr. Woodward’s two appeals have been consolidated, and APS requested and was granted intervention. Mr. Woodward filed his opening brief on March 28, 2018.  The ACC and APS filed responsive briefs on June 21, 2018. The Arizona Court of Appeals issued a Memorandum Decision on December 11, 2018 affirming the ACC decisions challenged by Mr. Woodward.  Mr. Woodward filed a petition for review with the Arizona Supreme Court on January 9, 2019. Review by the Arizona Supreme Court is discretionary. APS cannot predict the outcome of this consolidated appeal but does not believe it will have a material impact on our financial position, results of operations or cash flows.

On January 3, 2018, an APS customer filed a petition with the ACC that was determined by the ACC Staff to be a complaint filed pursuant to Arizona Revised Statute §40-246 (the “Complaint”) and not a request for rehearing. Arizona Revised Statute §40-246 requires the ACC to hold a hearing regarding any complaint alleging that a public service corporation is in violation of any commission order or that the rates being charged are not just and reasonable if the complaint is signed by at least twenty-five customers of the public

117

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

service corporation. The Complaint alleged that APS is “in violation of commission order” [sic]. On February 13, 2018, the complainant filed an amended Complaint alleging that the rates and charges in the 2017 Rate Case Decision are not just and reasonable.  The complainant requested that the ACC hold a hearing on the amended Complaint to determine if the average bill impact on residential customers of the rates and charges approved in the 2017 Rate Case Decision is greater than 4.54% (the average annual bill impact for a typical APS residential customer estimated by APS,) and, if so, what effect the alleged greater bill impact has on APS's revenues and the overall reasonableness and justness of APS's rates and charges, in order to determine if there is sufficient evidence to warrant a full-scale rate hearing.  The ACC held a hearing on this matter beginning in September 2018 and the hearing was concluded on October 1, 2018. Post-hearing briefing was concluded on December 14, 2018. APS expects a recommended opinion and order from the judge within the first quarter of 2019. APS cannot predict the outcome of this matter.

On December 24, 2018, certain ACC Commissioners filed a letter stating that because the ACC had received a substantial number of complaints that the rate increase authorized by the 2017 Rate Case Decision was much more than anticipated, they believe there is a possibility that APS is earning more than was authorized by the 2017 Rate Case Decision.  Accordingly, the ACC Commissioners requested the ACC Staff to perform a rate review of APS using calendar year 2018 as a test year and file a report by May 3, 2019.  The ACC Commissioners also asked the ACC Staff to evaluate APS’s efforts to educate its customers regarding the new rates approved in the 2017 Rate Case Decision.  On January 9, 2019, the ACC Commissioners voted to open a docket for this matter.  APS does not believe that the rate review will have a material impact on our financial position, results of operations or cash flows.  However, depending upon the results of the rate review, the ACC may take further actions, including potentially attempting to reopen the 2017 Rate Case Decision.  APS cannot predict the outcome of this matter.

Prior Rate Case Filing with the Arizona Corporation Commission
 
On June 1, 2011, APS filed an application with the ACC for a net retail base rate increase of $95.5 million .  On January 6, 2012, APS and other parties to the general retail rate case entered into an agreement (the "2012 Settlement Agreement") detailing the terms upon which the parties agreed to settle the rate case.  On May 15, 2012, the ACC approved the 2012 Settlement Agreement without material modifications.
 
Cost Recovery Mechanisms
 
APS has received regulatory decisions that allow for more timely recovery of certain costs outside of a general retail rate case through the following recovery mechanisms.
 
Renewable Energy Standard .   In 2006, the ACC approved the RES.  Under the RES, electric utilities that are regulated by the ACC must supply an increasing percentage of their retail electric energy sales from eligible renewable resources, including solar, wind, biomass, biogas and geothermal technologies.  In order to achieve these requirements, the ACC allows APS to include a RES surcharge as part of customer bills to recover the approved amounts for use on renewable energy projects.  Each year APS is required to file a five-year implementation plan with the ACC and seek approval for funding the upcoming year’s RES budget.
  
In 2013, the ACC conducted a hearing to consider APS’s proposal to establish compliance with distributed energy requirements by tracking and recording distributed energy, rather than acquiring and retiring renewable energy credits. On February 6, 2014, the ACC established a proceeding to modify the renewable energy rules to establish a process for compliance with the renewable energy requirement that is not based solely on the use of renewable energy credits. On September 9, 2014, the ACC authorized a rulemaking process to modify the RES rules. The proposed changes would permit the ACC to find that utilities have

118

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

complied with the distributed energy requirement in light of all available information. The ACC adopted these changes on December 18, 2014.  The revised rules went into effect on April 21, 2015.    

In December 2014, the ACC voted that it had no objection to APS implementing an APS-owned rooftop solar research and development program aimed at learning how to efficiently enable the integration of rooftop solar and battery storage with the grid.  The first stage of the program, called the "Solar Partner Program," placed 8 MW of residential rooftop solar on strategically selected distribution feeders in an effort to maximize potential system benefits, as well as made systems available to limited-income customers who could not easily install solar through transactions with third parties. The second stage of the program, which included an additional 2 MW of rooftop solar and energy storage, placed two energy storage systems sized at 2 MW on two different high solar penetration feeders to test various grid-related operation improvements and system interoperability, and was in operation by the end of 2016.  The costs for this program have been included in APS's rate base as part of the 2017 Rate Case Decision.

On July 1, 2016, APS filed its 2017 RES Implementation Plan and proposed a budget of approximately $150 million . APS’s budget request included additional funding to process the high volume of residential rooftop solar interconnection requests and also requested a permanent waiver of the residential distributed energy requirement for 2017 contained in the RES rules. On April 7, 2017, APS filed an amended 2017 RES Implementation Plan and updated budget request which included the revenue neutral transfer of specific revenue requirements into base rates in accordance with the 2017 Settlement Agreement.  On August 15, 2017, the ACC approved the 2017 RES Implementation Plan.

On June 30, 2017, APS filed its 2018 RES Implementation Plan and proposed a budget of approximately $90 million .  APS’s budget request supports existing approved projects and commitments and includes the anticipated transfer of specific revenue requirements into base rates in accordance with the 2017 Settlement Agreement and also requests a permanent waiver of the residential distributed energy requirement for 2018 contained in the RES rules. APS's 2018 RES budget request is lower than the 2017 RES budget due in part to a certain portion of the RES being collected by APS in base rates rather than through the RES adjustor.

On November 20, 2017, APS filed an updated 2018 RES budget to include budget adjustments for APS Solar Communities (formerly known as AZ Sun II), which was approved as part of the 2017 Rate Case Decision. APS Solar Communities is a 3 -year program authorizing APS to spend $10 million to $15 million in capital costs each year to install utility-owned DG systems for low to moderate income residential homes, buildings of non-profit entities, Title I schools and rural government facilities. The 2017 Rate Case Decision provided that all operations and maintenance expenses, property taxes, marketing and advertising expenses, and the capital carrying costs for this program will be recovered through the RES. On June 12, 2018, the ACC approved the 2018 RES Implementation Plan.

On June 29, 2018, APS filed its 2019 RES Implementation Plan and proposed a budget of approximately $89.9 million .  APS’s budget request supports existing approved projects and commitments and requests a permanent waiver of the residential distributed energy requirement for 2019 contained in the RES rules. The ACC has not yet ruled on the 2019 RES Implementation Plan.

In September 2016, the ACC initiated a proceeding which will examine the possible modernization and expansion of the RES. On January 30, 2018, ACC Commissioner Tobin proposed a plan in this proceeding which would broaden the RES to include a series of energy policies tied to clean energy sources (the "Energy Modernization Plan"). The Energy Modernization Plan includes replacing the current RES standard with a new standard called the Clean Resource Energy Standard and Tariff ("CREST"), which incorporates the

119

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

proposals in the Energy Modernization Plan.  A set of draft CREST rules for the ACC’s consideration was issued by Commissioner Tobin’s office on July 5, 2018. See "Energy Modernization Plan" below for more information on CREST.

Demand Side Management Adjustor Charge . The ACC EES requires APS to submit a Demand Side Management Implementation Plan ("DSM Plan") annually for review by and approval of the ACC. On March 20, 2015, APS filed an application with the ACC requesting a budget of $68.9 million for 2015 and minor modifications to its DSM portfolio going forward, including for the first time three resource savings projects which reflect energy savings on APS's system. The ACC approved APS’s 2015 DSM budget on November 25, 2015. In its decision, the ACC also ruled that verified energy savings from APS's resource savings projects could be counted toward compliance with the EES; however, the ACC ruled that APS was not allowed to count savings from systems savings projects toward determination of the achievement of performance incentives, nor may APS include savings from conservation voltage reduction in the calculation of its LFCR mechanism.

On June 1, 2016, APS filed its 2017 DSM Plan, in which APS proposed programs and measures that specifically focus on reducing peak demand, shifting load to off-peak periods and educating customers about strategies to manage their energy and demand.  The requested budget in the 2017 DSM Plan was $62.6 million . On January 27, 2017, APS filed an updated and modified 2017 DSM Plan that incorporated the proposed Residential Demand Response, Energy Storage and Load Management Program and requested that the budget be increased to $66.6 million . On August 15, 2017, the ACC approved the amended 2017 DSM Plan.

On September 1, 2017, APS filed its 2018 DSM Plan, which proposes modifications to the demand side management portfolio to better meet system and customer needs by focusing on peak demand reductions, storage, load shifting and demand response programs in addition to traditional energy savings measures. The 2018 DSM Plan seeks a reduced requested budget of $52.6 million and requests a waiver of the EES for 2018.   On November 14, 2017, APS filed an amended 2018 DSM Plan, which revised the allocations between budget items to address customer participation levels, but kept the overall budget at $52.6 million . The ACC has not yet ruled on the APS 2018 amended DSM Plan.

On December 31, 2018, APS filed its 2019 DSM Plan, which requests a budget of $34.1 million and continues APS's focus on DSM strategies such as peak demand reduction, load shifting, storage and electrification strategies. The ACC has not yet ruled on the APS 2019 DSM Plan.    
     
Power Supply Adjustor Mechanism and Balance.  The PSA provides for the adjustment of retail rates to reflect variations in retail fuel and purchased power costs. The PSA is subject to specified parameters and procedures, including the following:

•	APS records deferrals for recovery or refund to the extent actual retail fuel and purchased power costs vary from the Base Fuel Rate;	

•	An adjustment to the PSA rate is made annually each February 1 (unless otherwise approved by the ACC) and goes into effect automatically unless suspended by the ACC;	

•	The PSA uses a forward-looking estimate of fuel and purchased power costs to set the annual PSA rate, which is reconciled to actual costs experienced for each PSA Year (February 1 through January 31) (see the following bullet point);	

•	The PSA rate includes (a) a “Forward Component,” under which APS recovers or refunds differences between expected fuel and purchased power costs for the upcoming calendar year	

120

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

and those embedded in the Base Fuel Rate; (b) a “Historical Component,” under which differences between actual fuel and purchased power costs and those recovered or refunded through the combination of the Base Fuel Rate and the Forward Component are recovered during the next PSA Year; and (c) a “Transition Component,” under which APS may seek mid-year PSA changes due to large variances between actual fuel and purchased power costs and the combination of the Base Fuel Rate and the Forward Component; and

•	The PSA rate may not be increased or decreased more than $ 0.004 per kWh in a year without permission of the ACC.	

The following table shows the changes in the deferred fuel and purchased power regulatory asset (liability) for 2018 and 2017 (dollars in thousands):

								
 	Twelve Months Ended
December 31,	
 	2018	 	2017	
Beginning balance	$	75,637		 	$	12,465		
Deferred fuel and purchased power costs — current period	78,277		 	48,405		
Amounts refunded/(charged) to customers	(116,750	)	 	14,767		
Ending balance	$	37,164		 	$	75,637		

The PSA rate for the PSA year beginning February 1, 2017 was $(0.001348) per kWh, as compared to $0.001678 per kWh for the prior year.  This rate was comprised of a forward component of $(0.001027) per kWh and a historical component of $(0.000321) per kWh. On August 19, 2017, the PSA rate was revised to $0.000555 per kWh a s part of the 2017 Rate Case Decision. This new rate was comprised of a forward component of $0.000876 per kWh and a historical component of $(0.000321) per kWh.

The PSA rate for the PSA year beginning February 1, 2018 is $0.004555 per kWh, consisting of a forward component of $0.002009 per kWh and a historical component of $0.002546 per kWh. This represented a $0.004 per kWh increase over the August 19, 2017 PSA, the maximum permitted under the Plan of Administration for the PSA. This left $16.4 million of 2017 fuel and purchased power costs above this annual cap. These costs rolled over until the following year and were reflected in the 2019 reset of the PSA.

On November 30, 2018, APS filed its PSA rate for the PSA year beginning February 1, 2019. That rate was $0.001658 per kWh and consisted of a forward component of $0.000536 per kWh and a historical component of $0.001122 per kWh. The 2019 PSA rate is a $0.002897 per kWh decrease compared to 2018. These rates went into effect as filed on February 1, 2019.
 
Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters .  In July 2008, FERC approved an Open Access Transmission Tariff for APS to move from fixed rates to a formula rate-setting methodology in order to more accurately reflect and recover the costs that APS incurs in providing transmission services.  A large portion of the rate represents charges for transmission services to serve APS's retail customers ("Retail Transmission Charges").  In order to recover the Retail Transmission Charges, APS was previously required to file an application with, and obtain approval from, the ACC to reflect changes in Retail Transmission Charges through the TCA.  Under the terms of the 2012 Settlement Agreement, however, an adjustment to rates to recover the Retail Transmission Charges will be made annually each June 1 and will go into effect automatically unless suspended by the ACC.

121

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The formula rate is updated each year effective June 1 on the basis of APS's actual cost of service, as disclosed in APS's FERC Form 1 report for the previous fiscal year.  Items to be updated include actual capital expenditures made as compared with previous projections, transmission revenue credits and other items.  The resolution of proposed adjustments can result in significant volatility in the revenues to be collected.  APS reviews the proposed formula rate filing amounts with the ACC Staff.  Any items or adjustments which are not agreed to by APS and the ACC Staff can remain in dispute until settled or litigated at FERC.  Settlement or litigated resolution of disputed issues could require an extended period of time and could have a significant effect on the Retail Transmission Charges because any adjustment, though applied prospectively, may be calculated to account for previously over- or under-collected amounts.

Effective June 1, 2017, APS's annual wholesale transmission rates for all users of its transmission system increased by approximately $35.1 million for the twelve-month period beginning June 1, 2017 in accordance with the FERC-approved formula.  An adjustment to APS’s retail rates to recover FERC approved transmission charges went into effect automatically on June 1, 2017. Effective June 1, 2018, APS's annual wholesale transmission rates for all users of its transmission system decreased by approximately $22.7 million for the twelve-month period beginning June 1, 2018 in accordance with the FERC-approved formula.  An adjustment to APS’s retail rates to recover FERC approved transmission charges went into effect automatically on June 1, 2018.

On January 31, 2017, APS made a filing with FERC to reduce the Post-Employment Benefits Other than Pension expense reflected in its FERC transmission formula rate calculation to recognize certain savings resulting from plan design changes to the other postretirement benefit plans.  A transmission customer intervened and protested certain aspects of APS’s filing.  FERC initiated a proceeding under Section 206 of the Federal Power Act to evaluate the justness and reasonableness of the revised formula rate filing APS proposed.  APS entered into a settlement agreement with the intervening transmission customer, which was filed with FERC for approval on September 26, 2017. FERC approved the settlement agreement without modification or condition on December 21, 2017.

On March 7, 2018, APS made a filing to make modifications to its annual transmission formula to provide transmission customers the benefit of the reduced federal corporate income tax rate resulting from the Tax Act beginning in its 2018 annual transmission formula rate update filing. These modifications were approved by FERC on May 22, 2018 and reduced APS’s transmission rates compared to the rate that would have gone into effect absent these changes.
 
Lost Fixed Cost Recovery Mechanism . The LFCR mechanism permits APS to recover on an after-the-fact basis a portion of its fixed costs that would otherwise have been collected by APS in the kWh sales lost due to APS energy efficiency programs and to DG such as rooftop solar arrays.  The fixed costs recoverable by the LFCR mechanism were first established in the 2012 Settlement Agreement and amount to approximately 3.1 cent s per residential kWh lost and 2.3 cents per non-residential kWh lost.  These amounts were revised in the 2017 Settlement Agreement to 2.5 cents for both lost residential and non-residential kWh. The LFCR adjustment has a year-over-year cap of 1% of retail revenues.  Any amounts left unrecovered in a particular year because of this cap can be carried over for recovery in a future year.  The kWh’s lost from energy efficiency are based on a third-party evaluation of APS’s energy efficiency programs.  DG sales losses are determined from the metered output from the DG units.
 
APS filed its 2016 annual LFCR adjustment on January 15, 2016, requesting an LFCR adjustment of $46.4 million (a $7.9 million annual increase). The ACC approved the 2016 annual LFCR effective beginning in May 2016. APS filed its 2017 LFCR adjustment on January 13, 2017 requesting an LFCR adjustment of

122

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

$63.7 million (a $17.3 million per year increase over 2016 levels). On April 5, 2017, the ACC approved the 2017 annual LFCR adjustment as filed, effective with the first billing cycle of April 2017. On February 15, 2018, APS filed its 2018 annual LFCR Adjustment, requesting that effective May 1, 2018, the LFCR be adjusted to $60.7 million (a $3 million per year decrease from 2017 levels). On February 6, 2019, the ACC approved the 2018 annual LFCR adjustment to become effective March 1, 2019. On February 15, 2019, APS filed its 2019 annual LFCR adjustment, requesting that effective May 1, 2019, the annual LFCR recovery amount be reduced to $36.2 million (a $24.5 million decrease from previous levels). Because the LFCR mechanism has a balancing account that trues up any under or over recoveries, the delay in implementation does not have an adverse effect on APS.
    
Tax Expense Adjustor Mechanism and FERC Tax Filing.  As part of the 2017 Settlement Agreement, the parties agreed to a rate adjustment mechanism to address potential federal income tax reform and enable the pass-through of certain income tax effects to customers. On December 22, 2017, the Tax Act was enacted.  This legislation made significant changes to the federal income tax laws including a reduction in the corporate tax rate from 35% to 21% effective January 1, 2018.

On January 8, 2018, APS filed an application with the ACC requesting that the TEAM be implemented in two steps.  The first addresses the change in the marginal federal tax rate from 35% to 21% resulting from the Tax Act and, if approved, would reduce rates by $119.1 million annually through an equal cents per kWh credit.  APS asked that this decrease become effective February 1, 2018. On February 22, 2018, the ACC approved the reduction of rates by $119.1 million for the remainder of 2018 through an equal cents per kWh credit applied to all but a small subset of customers who are taking service under specially-approved tariffs. The rate reduction was effective for the first billing cycle in March 2018.

The impact of the TEAM, over time, is expected to be earnings neutral. However, on a quarterly basis, there is a difference between the timing and amount of the income tax benefit and the reduction in revenues refunded through the TEAM related to the lower federal income tax rate. The amount of the benefit of the lower federal income tax rate is based on quarterly pre-tax results, while the reduction in revenues from the prior year due to lower customer rates through the TEAM is based on a per kWh sales credit which follows our seasonal kWh sales pattern and is not impacted by earnings of the Company.

On August 13, 2018, APS filed a second request with the ACC to return an additional $86.5 million in tax savings to customers. This second request addresses amortization of non-depreciation related excess deferred taxes previously collected from customers. The ACC has not yet approved this request.

Additionally, as part of this second request, APS informed the ACC of its intent to file a third future request to address the amortization of depreciation related excess deferred taxes, as the Company is currently in the process of seeking IRS guidance regarding the amortization method and period applicable to these depreciation related excess deferred taxes.

The TEAM expressly applies to APS's retail rates with the exception of a small subset of customers taking service under specially-approved tariffs noted above. As discussed under "Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters" above, FERC issued an order on May 22, 2018 authorizing APS to provide for the cost reductions resulting from the income tax changes in its wholesale transmission rates.

123

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Net Metering

In 2015, the ACC voted to conduct a generic evidentiary hearing on the value and cost of DG to gather information that will inform the ACC on net metering issues and cost of service studies in upcoming utility rate cases.  A hearing was held in April 2016. On October 7, 2016, the Administrative Law Judge issued a recommendation in the docket concerning the value and cost of DG solar installations. On December 20, 2016, the ACC completed its open meeting to consider the recommended opinion and order by the Administrative Law Judge. After making several amendments, the ACC approved the recommended decision by a 4-1 vote. As a result of the ACC’s action, effective with APS’s 2017 Rate Case Decision, the net metering tariff that governs payments for energy exported to the grid from residential rooftop solar systems was replaced by a more formula-driven approach that utilizes inputs from historical wholesale solar power until an avoided cost methodology is developed by the ACC .

As amended, the decision provides that payments by utilities for energy exported to the grid from DG solar facilities will be determined using a RCP methodology, a method that is based on the most recent five-year rolling average price that APS pays for utility-scale solar projects, while a forecasted avoided cost methodology is being developed.  The price established by this RCP method will be updated annually (between general retail rate cases) but will not be decreased by more than 10% per year. Once the avoided cost methodology is developed, the ACC will determine in APS's subsequent rate cases which method (or a combination of methods) is appropriate to determine the actual price to be paid by APS for exported distributed energy.

In addition, the ACC made the following determinations:

•	Customers who have interconnected a DG system or submitted an application for interconnection for DG systems prior to September 1, 2017, the date new rates were effective based on APS's 2017 Rate Case Decision, will be grandfathered for a period of 20 years from the date the customer’s interconnection application was accepted by the utility;	

•	Customers with DG solar systems are to be considered a separate class of customers for ratemaking purposes; and	

•	Once an export price is set for APS, no netting or banking of retail credits will be available for new DG customers, and the then-applicable export price will be guaranteed for new customers for a period of 10 years.	

This decision of the ACC addresses policy determinations only. The decision states that its principles will be applied in future general retail rate cases, and the policy determinations themselves may be subject to future change, as are all ACC policies. A first-year export energy price of 12.9 cents per kWh is included in the 2017 Settlement Agreement and became effective on September 1, 2017.
    
In accordance with the 2017 Rate Case Decision, APS filed its request for a second-year export energy price of 11.6 cents per kWh on May 1, 2018.  This price reflects the 10% annual reduction discussed above. The new tariff became effective on October 1, 2018.

On January 23, 2017, TASC sought rehearing of the ACC's decision regarding the value and cost of DG. TASC asserted that the ACC improperly ignored the Administrative Procedure Act, failed to give adequate notice regarding the scope of the proceedings, and relied on information that was not submitted as evidence, among other alleged defects. TASC filed a Notice of Appeal in the Arizona Court of Appeals and filed a Complaint and Statutory Appeal in the Maricopa County Superior Court on March 10, 2017. As part of the

124

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2017 Settlement Agreement described above, TASC agreed to withdraw these appeals when the ACC decision implementing the 2017 Settlement Agreement is no longer subject to appellate review.

Subpoena from Arizona Corporation Commissioner Robert Burns

On August 25, 2016, Commissioner Burns, individually and not by action of the ACC as a whole, served subpoenas in APS’s then current retail rate proceeding on APS and Pinnacle West for the production of records and information relating to a range of expenditures from 2011 through 2016. The subpoenas requested information concerning marketing and advertising expenditures, charitable donations, lobbying expenses, contributions to 501(c)(3) and (c)(4) nonprofits and political contributions. The return date for the production of information was set as September 15, 2016. The subpoenas also sought testimony from Company personnel having knowledge of the material, including the Chief Executive Officer.

On September 9, 2016, APS filed with the ACC a motion to quash the subpoenas or, alternatively to stay APS's obligations to comply with the subpoenas and decline to decide APS's motion pending court proceedings. Contemporaneously with the filing of this motion, APS and Pinnacle West filed a complaint for special action and declaratory judgment in the Superior Court of Arizona for Maricopa County, seeking a declaratory judgment that Commissioner Burns’ subpoenas are contrary to law. On September 15, 2016, APS produced all non-confidential and responsive documents and offered to produce any remaining responsive documents that are confidential after an appropriate confidentiality agreement is signed.

On February 7, 2017, Commissioner Burns opened a new ACC docket and indicated that its purpose is to study and rectify problems with transparency and disclosure regarding financial contributions from regulated monopolies or other stakeholders who may appear before the ACC that may directly or indirectly benefit an ACC Commissioner, a candidate for ACC Commissioner, or key ACC Staff.  As part of this docket, Commissioner Burns set March 24, 2017 as a deadline for the production of all information previously requested through the subpoenas. Neither APS nor Pinnacle West produced the information requested and instead objected to the subpoena. On March 10, 2017, Commissioner Burns filed suit against APS and Pinnacle West in the Superior Court of Arizona for Maricopa County in an effort to enforce his subpoenas. On March 30, 2017, APS filed a motion to dismiss Commissioner Burns' suit against APS and Pinnacle West. In response to the motion to dismiss, the court stayed the suit and ordered Commissioner Burns to file a motion to compel the production of the information sought by the subpoenas with the ACC. On June 20, 2017, the ACC denied the motion to compel.

On August 4, 2017, Commissioner Burns amended his complaint to add all of the ACC Commissioners and the ACC itself as defendants. All defendants moved to dismiss the amended complaint. On February 15, 2018, the Superior Court dismissed Commissioner Burns’ amended complaint. On March 6, 2018, Commissioner Burns filed an objection to the proposed final order from the Superior Court and a motion to further amend his complaint. The Superior Court permitted Commissioner Burns to amend his complaint to add a claim regarding his attempted investigation into whether his fellow commissioners should have been disqualified from voting on APS’s 2017 rate case. Commissioner Burns filed his second amended complaint, and all defendants filed responses opposing the second amended complaint and requested that it be dismissed. Oral argument occurred in November 2018 regarding the motion to dismiss. On December 18, 2018, the trial court granted the defendants’ motions to dismiss and entered final judgment on January 18, 2019. On February 13, 2019, Commissioner Burns filed a notice of appeal. APS and Pinnacle West cannot predict the outcome of this matter.

125

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Renewable Energy Ballot Initiative
On February 20, 2018, a renewable energy advocacy organization filed with the Arizona Secretary of State a ballot initiative for an Arizona constitutional amendment requiring Arizona public service corporations to provide at least 50% of their annual retail sales of electricity from renewable sources by 2030. For purposes of the proposed amendment, eligible renewable sources would not include nuclear generating facilities. The initiative was placed on the November 2018 Arizona elections ballot. On November 6, 2018, the initiative failed to receive adequate voter support and was defeated.
Energy Modernization Plan

On January 30, 2018, ACC Commissioner Tobin proposed the Energy Modernization Plan, which consists of a series of energy policies tied to clean energy sources such as energy storage, biomass, energy efficiency, electric vehicles, and expanded energy planning through the IRP process. The Energy Modernization Plan includes replacing the current RES standard with a new standard called the CREST, which incorporates the proposals in the Energy Modernization Plan. On February 22, 2018, the ACC Staff filed a Notice of Inquiry to further examine the matter. As a part of this proposal, the ACC voted in March 2018 to direct utilities to develop a comprehensive biomass generation plan to be included in each utility’s RES Implementation Plan. On July 5, 2018, Commissioner Tobin’s office issued a set of draft CREST rules for the ACC’s consideration.
    
In August 2018, the ACC directed ACC Staff to open a new rulemaking docket which will address a wide range of energy issues, including the Energy Modernization Plan proposals.  The rulemaking will consider possible modifications to existing ACC rules, such as the Renewable Energy Standard, Electric and Gas Energy Efficiency Standards, Net Metering, Resource Planning, and the Biennial Transmission Assessment, as well as the development of new rules regarding forest bioenergy, electric vehicles, interconnection of distributed generation, baseload security, blockchain technology and other technological developments, retail competition, and other energy-related topics.  Workshops on these energy issues are scheduled to be held throughout 2019. APS cannot predict the outcome of this matter.

Integrated Resource Planning

ACC rules require utilities to develop fifteen-year IRPs which describe how the utility plans to serve customer load in the plan timeframe.  The ACC reviews each utility’s IRP to determine if it meets the necessary requirements and whether it should be acknowledged.  In March of 2018, the ACC reviewed the 2017 IRPs of its jurisdictional utilities and voted to not acknowledge any of the plans.  APS does not believe that this lack of acknowledgment will have a material impact on our financial position, results of operations or cash flows.  Based on an ACC decision, APS is required to file a Preliminary Resource Plan by April 1, 2019 and its final IRP by April 1, 2020.

Four Corners
 
SCE-Related Matters . On December 30, 2013, APS purchased SCE’s 48% ownership interest in each of Units 4 and 5 of Four Corners.  The 2012 Settlement Agreement includes a procedure to allow APS to request rate adjustments prior to its next general retail rate case related to APS’s acquisition of the additional interests in Units 4 and 5 and the related closure of Units 1-3 of Four Corners.  APS made its filing under this provision on December 30, 2013. On December 23, 2014, the ACC approved rate adjustments resulting in a revenue increase of $57.1 million on an annual basis.  This included the deferral for future recovery of all non-fuel operating costs for the acquired SCE interest in Four Corners, net of the non-fuel operating costs savings

126

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

resulting from the closure of Units 1-3 from the date of closing of the purchase through its inclusion in rates.  The 2012 Settlement Agreement also provided for deferral for future recovery of all unrecovered costs incurred in connection with the closure of Units 1-3.  The deferral balance related to the acquisition of SCE’s interest in Units 4 and 5 and the closure of Units 1-3 was $48 million as of December 31, 2018 and is being amortized in rates over a total of 10 years. The ACC's rate adjustment decision was appealed and on September 26, 2017, the Court of Appeals affirmed the ACC's decision on the Four Corners rate adjustment.
 
As part of APS’s acquisition of SCE’s interest in Units 4 and 5, APS and SCE agreed, via a "Transmission Termination Agreement" that, upon closing of the acquisition, the companies would terminate an existing transmission agreement ("Transmission Agreement") between the parties that provides transmission capacity on a system (the "Arizona Transmission System") for SCE to transmit its portion of the output from Four Corners to California.  APS previously submitted a request to FERC related to this termination, which resulted in a FERC order denying rate recovery of $40 million that APS agreed to pay SCE associated with the termination. On December 22, 2015, APS and SCE agreed to terminate the Transmission Termination Agreement and allow for the Transmission Agreement to expire according to its terms, which includes settling obligations in accordance with the terms of the Transmission Agreement. APS established a regulatory asset of $12 million in 2015 in connection with the payment required under the terms of the Transmission Agreement. On July 1, 2016, FERC issued an order denying APS’s request to recover the regulatory asset through its FERC-jurisdictional rates.  APS and SCE completed the termination of the Transmission Agreement on July 6, 2016. APS made the required payment to SCE and wrote-off the $12 million regulatory asset and charged operating revenues to reflect the effects of this order in the second quarter of 2016.  On July 29, 2016, APS filed a request for rehearing with FERC. In its order denying recovery, FERC also referred to its enforcement division a question of whether the agreement between APS and SCE relating to the settlement of obligations under the Transmission Agreement was a jurisdictional contract that should have been filed with FERC. On October 5, 2017, FERC issued an order denying APS's request for rehearing. FERC also upheld its prior determination that the agreement relating to the settlement was a jurisdictional contract and should have been filed with FERC. APS cannot predict whether or if the enforcement division will take any action. APS filed an appeal of FERC's July 1, 2016 and October 5, 2017 orders with the United States Court of Appeals for the Ninth Circuit on December 4, 2017. That proceeding is pending, and APS cannot predict the outcome of the proceeding.

SCR Cost Recovery . On December 29, 2017, in accordance with the 2017 Rate Case Decision, APS filed a Notice of Intent to file its SCR Adjustment to permit recovery of costs associated with the installation of SCR equipment at Four Corners Units 4 and 5.  APS filed the SCR Adjustment request in April 2018.  Consistent with the 2017 Rate Case Decision, the request was narrow in scope and addressed only costs associated with this specific environmental compliance equipment.  The SCR Adjustment request provided that there would be a $67.5 million annual revenue impact that would be applied as a percentage of base rates for all applicable customers.  Also, as provided for in the 2017 Rate Case Decision, APS requested that the adjustment become effective no later than January 1, 2019.  The hearing for this matter occurred in September 2018.  At the hearing, APS accepted ACC Staff's recommendation of a lower annual revenue impact of approximately $58.5 million . The Administrative Law Judge issued a Recommended Opinion and Order finding that the costs for the SCR project were prudently incurred and recommending authorization of the $58.5 million annual revenue requirement related to the installation and operation of the SCRs. Exceptions to the Recommended Opinion and Order were filed by the parties and intervenors on December 7, 2018.  The ACC has not issued a decision on this matter.  APS anticipates a decision later in 2019.

127

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Cholla

On September 11, 2014, APS announced that it would close Unit 2 of Cholla and cease burning coal at the other APS-owned units (Units 1 and 3) at the plant by the mid-2020s, if EPA approves a compromise proposal offered by APS to meet required environmental and emissions standards and rules. On April 14, 2015, the ACC approved APS's plan to retire Unit 2, without expressing any view on the future recoverability of APS's remaining investment in the Unit. APS closed Unit 2 on October 1, 2015. In early 2017, EPA approved a final rule incorporating APS's compromise proposal, which took effect on April 26, 2017.

Previously, APS estimated Cholla Unit 2’s end of life to be 2033. APS has been recovering a return on and of the net book value of the unit in base rates. Pursuant to the 2017 Settlement Agreement described above, APS will be allowed continued recovery of the net book value of the unit and the unit’s decommissioning and other retirement-related costs ( $89 million as of December 31, 2018 ), in addition to a return on its investment. In accordance with GAAP, in the third quarter of 2014, Unit 2’s remaining net book value was reclassified from property, plant and equipment to a regulatory asset. The 2017 Settlement Agreement also shortened the depreciation lives of Cholla Units 1 and 3 to 2026.
Navajo Plant
The co-owners of the Navajo Plant and the Navajo Nation agreed that the Navajo Plant will remain in operation until December 2019 under the existing plant lease. The co-owners and the Navajo Nation executed a lease extension on November 29, 2017 that will allow for decommissioning activities to begin after the plant ceases operations in December 2019. Various stakeholders including regulators, tribal representatives, the plant's coal supplier and the U.S. Department of the Interior have been meeting to determine if an alternate solution can be reached that would permit continued operation of the plant beyond 2019. Although we cannot predict whether any alternate plans will be found that would be acceptable to all of the stakeholders and feasible to implement, we believe it is probable that the current owners of the Navajo Plant will cease operations in December 2019.
  
On February 14, 2017, the ACC opened a docket titled "ACC Investigation Concerning the Future of the Navajo Generating Station" with the stated goal of engaging stakeholders and negotiating a sustainable pathway for the Navajo Plant to continue operating in some form after December 2019. APS cannot predict the outcome of this proceeding.

APS is currently recovering depreciation and a return on the net book value of its interest in the Navajo Plant over its previously estimated life through 2026. APS will seek continued recovery in rates for the book value of its remaining investment in the plant ( $88 million as of December 31, 2018 ) plus a return on the net book value as well as other costs related to retirement and closure, which are still being assessed and may be material. APS believes it will be allowed recovery of the net book value, in addition to a return on its investment. In accordance with GAAP, in the second quarter of 2017, APS's remaining net book value of its interest in the Navajo Plant was reclassified from property, plant and equipment to a regulatory asset. If the ACC does not allow full recovery of the remaining net book value of this interest, all or a portion of the regulatory asset will be written off and APS's net income, cash flows, and financial position will be negatively impacted.

128

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Regulatory Assets and Liabilities
 
The detail of regulatory assets is as follows (dollars in thousands):

																		
S	 	 	December 31, 2018	 	December 31, 2017	
 	Amortization Through	 	Current	 	Non-Current	 	Current	 	Non-Current	
Pension	(a)	 	$	—		 	$	733,351		 	$	—		 	$	576,188		
Retired power plant costs	2033	 	28,182		 	167,164		 	27,402		 	188,843		
Income taxes - AFUDC equity	2048	 	6,457		 	151,467		 	3,828		 	142,852		
Deferred fuel and purchased power — mark-to-market (Note 16)	2023	 	31,728		 	23,768		 	52,100		 	34,845		
Deferred fuel and purchased power (b) (c)	2019	 	37,164		 	—		 	75,637		 	—		
Four Corners cost deferral	2024	 	8,077		 	40,228		 	8,077		 	48,305		
Income taxes — investment tax credit basis adjustment	2047	 	1,079		 	25,522		 	1,066		 	26,218		
Lost fixed cost recovery (b)	2019	 	32,435		 	—		 	59,844		 	—		
Palo Verde VIEs (Note 18)	2046	 	—		 	20,015		 	—		 	19,395		
Deferred compensation	2036	 	—		 	36,523		 	—		 	36,413		
Deferred property taxes	2027	 	8,569		 	66,356		 	8,569		 	74,926		
Loss on reacquired debt	2038	 	1,637		 	13,668		 	1,637		 	15,305		
Tax expense of Medicare subsidy	2024	 	1,235		 	6,176		 	1,236		 	7,415		
TCA balancing account (b)	2020	 	3,860		 	772		 	1,220		 	—		
AG-1 deferral	2022	 	2,654		 	5,819		 	2,654		 	8,472		
Mead-Phoenix transmission line CIAC	2050	 	332		 	10,044		 	332		 	10,376		
Coal reclamation	2026	 	1,546		 	15,607		 	1,068		 	12,396		
SCR deferral	N/A	 	—		 	23,276		 	—		 	353		
Other	Various	 	1,947		 	3,185		 	3,418		 	—		
Total regulatory assets (d)	 	 	$	166,902		 	$	1,342,941		 	$	248,088		 	$	1,202,302		
		
(a)	This asset represents the future recovery of pension benefit obligations through retail rates.  If these costs are disallowed by the ACC, this regulatory asset would be charged to OCI and result in lower future revenues.  See Note 7 for further discussion.	
		
(b)	See “Cost Recovery Mechanisms” discussion above.	
		
(c)	Subject to a carrying charge.	
		
(d)	There are no regulatory assets for which the ACC has allowed recovery of costs, but not allowed a return by exclusion from rate base.  FERC rates are set using a formula rate as described in “Transmission Rates, Transmission Cost Adjustor and Other Transmission Matters.”	

129

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The detail of regulatory liabilities is as follows (dollars in thousands):

																		
 	 	 	December 31, 2018	 	December 31, 2017	
 	Amortization Through	 	Current	 	Non-Current	 	Current	 	Non-Current	
Excess deferred income taxes - ACC - Tax Cuts and Jobs Act	(a)	 	$	—		 	$	1,272,709		 	$	—		 	$	1,266,104		
Excess deferred income taxes - FERC - Tax Cuts and Jobs Act	2058	 	6,302		 	243,691		 	—		 	254,170		
Asset retirement obligations	2057	 	—		 	278,585		 	—		 	332,171		
Removal costs	(b)	 	39,866		 	177,533		 	18,238		 	209,191		
Other post retirement benefits	(c)	 	37,864		 	125,903		 	37,642		 	151,985		
Income taxes - deferred investment tax credit	2047	 	2,164		 	51,120		 	2,164		 	52,497		
Income taxes - change in rates	2048	 	2,769		 	70,069		 	2,573		 	70,537		
Spent nuclear fuel	2027	 	6,503		 	57,002		 	6,924		 	62,132		
Renewable energy standard (d)	2020	 	44,966		 	20		 	23,155		 	—		
Demand side management (d)	2020	 	14,604		 	4,123		 	3,066		 	4,921		
Sundance maintenance	2030	 	1,278		 	17,228		 	—		 	16,897		
Deferred gains on utility property	2022	 	4,423		 	6,581		 	4,423		 	10,988		
Four Corners coal reclamation	2038	 	1,858		 	17,871		 	1,858		 	18,921		
Tax expense adjustor mechanism (d)	2019	 	3,237		 	—		 	—		 	—		
Other	Various	 	42		 	3,541		 	43		 	2,022		
Total regulatory liabilities	 	 	$	165,876		 	$	2,325,976		 	$	100,086		 	$	2,452,536		

(a)	While the majority of the excess deferred tax balance shown is subject to special amortization rules under federal income tax laws, which require amortization of the balance over the remaining regulatory life of the related property, treatment of a portion of the liability, and the month in which pass-through of the excess deferred tax balance will begin is subject to regulatory approval. This approval will be sought through the Company's TEAM adjustor mechanism. As a result, the Company cannot estimate the amount of this regulatory liability which is expected to reverse within the next 12 months. See Note 4.	
		
(b)	In accordance with regulatory accounting guidance, APS accrues for removal costs for its regulated assets, even if there is no legal obligation for removal.	
		
(c)	See Note 7.	
		
(d)	See “Cost Recovery Mechanisms” discussion above.	

4 .     Income Taxes
 
Certain assets and liabilities are reported differently for income tax purposes than they are for financial statement purposes.  The tax effect of these differences is recorded as deferred taxes.  We calculate deferred taxes using currently enacted income tax rates.    

APS has recorded regulatory assets and regulatory liabilities related to income taxes on its Balance Sheets in accordance with accounting guidance for regulated operations.  The regulatory assets are for certain temporary differences, primarily the allowance for equity funds used during construction, investment tax credit (“ITC”) basis adjustment and tax expense of Medicare subsidy.  The regulatory liabilities primarily relate to the change in income tax rates and deferred taxes resulting from ITCs.

130

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On December 22, 2017, the Tax Act was enacted. This legislation made significant changes to the federal income tax laws, including a reduction in the corporate tax rate to 21% effective January 1, 2018. As a result of this rate reduction, the Company recognized a $1.14 billion reduction in its net deferred income tax liabilities as of December 31, 2017.

In accordance with accounting for regulated companies, the effect of this rate reduction is substantially offset by a net regulatory liability. As of December 31, 2017, to reflect the $1.14 billion reduction in its net deferred income tax liabilities caused by the rate reduction, APS has recorded a net regulatory liability of $1.52 billion and a new $377 million net deferred tax asset. The Company will amortize the net regulatory liability in accordance with applicable federal income tax laws, which require the amortization of a majority of the balance over the remaining regulatory life of the related property. As a result of the modifications made to the annual transmission formula rate during the second quarter, the Company has recorded amortization of FERC jurisdictional net excess deferred tax liabilities, retroactive to January 1, 2018. The Company continues to work with the ACC on a plan to amortize the remaining net excess deferred tax liabilities subject to its jurisdiction. See Note 3 for more details.

In August 2018, Treasury proposed regulations that clarify bonus depreciation transition rules under the Tax Act for regulated public utility property placed in service after September 27, 2017 and before January 1, 2018. During the third quarter the Company recorded deferred tax liabilities of approximately $11 million and an increase in its net regulatory liability for excess deferred taxes of approximately $9 million , primarily related to bonus depreciation benefits claimed on the Company’s 2017 tax return as a result of this clarifying guidance. However, the proposed regulations are ambiguous with respect to regulated public utility property placed in service on or after January 1, 2018. On December 20, 2018, the Joint Committee on Taxation (“JCT”) released the general explanation of the Tax Act. The document - commonly referred to as the "Blue Book" - provides a comprehensive technical description of the Tax Act and includes the legislative intent of Congress with respect to the changes made by provisions of the Tax Act. The “Blue Book” provides clarification that the intent of the Tax Act was to exclude from the definition of bonus depreciation qualified property any property placed in service by a regulated public utility after December 31, 2017. In a footnote, the JCT indicated that a technical correction bill may be necessary to reflect this intent.

Management recognizes tax positions which it believes are "more likely than not" to be sustained upon examination. In applying this "more likely than not" assessment, the Company is required to consider the technical merits of a position, including legislative intent. As a result, while no legislation has been passed which clarifies the ambiguities related to bonus depreciation for property placed in service on or after January 1, 2018, the Company currently believes the continued availability of bonus depreciation is not "more likely than not" to be sustained upon examination. As a result, the Company has not recognized any current or deferred tax benefits related to bonus depreciation for property placed in service on or after January 1, 2018.

For the quarter ending March 31, 2018, the Company early adopted  ASU 2018-02, Income Statement-Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income and elected to reclassify the income tax effects of the Tax Act on items within accumulated other comprehensive income to retained earnings. See Note 2 for additional information.

In accordance with regulatory requirements, APS ITCs are deferred and are amortized over the life of the related property with such amortization applied as a credit to reduce current income tax expense in the statement of income.
 
Net income associated with the Palo Verde sale leaseback VIEs is not subject to tax (see Note 18).  As a result, there is no income tax expense associated with the VIEs recorded on the Pinnacle West Consolidated and APS Consolidated Statements of Income.

131

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  The following is a tabular reconciliation of the total amounts of unrecognized tax benefits, excluding interest and penalties, at the beginning and end of the year that are included in accrued taxes and unrecognized tax benefits (dollars in thousands):

	
																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Total unrecognized tax benefits, January 1	$	41,966		 	$	36,075		 	$	34,447		 	$	41,966		 	$	36,075		 	$	34,447		
Additions for tax positions of the current year	3,436		 	2,937		 	2,695		 	3,436		 	2,937		 	2,695		
Additions for tax positions of prior years	2,696		 	4,783		 	886		 	2,696		 	4,783		 	886		
Reductions for tax positions of prior years for:	 		 	 		 	 		 	 		 	 		 	 		
Changes in judgment	(1,764	)	 	(1,829	)	 	(1,953	)	 	(1,764	)	 	(1,829	)	 	(1,953	)	
Settlements with taxing authorities	—		 	—		 	—		 	—		 	—		 	—		
Lapses of applicable statute of limitations	(5,603	)	 	—		 	—		 	(5,603	)	 	—		 	—		
Total unrecognized tax benefits, December 31	$	40,731		 	$	41,966		 	$	36,075		 	$	40,731		 	$	41,966		 	$	36,075		

Included in the balances of unrecognized tax benefits are the following tax positions that, if recognized, would decrease our effective tax rate (dollars in thousands):

	
																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Tax positions, that if recognized, would decrease our effective tax rate	$	19,504		 	$	16,373		 	$	11,313		 	$	19,504		 	$	16,373		 	$	11,313		

As of the balance sheet date, the tax year ended December 31, 2015 and all subsequent tax years remain subject to examination by the IRS.  With a few exceptions, we are no longer subject to state income tax examinations by tax authorities for years before 2014.

We reflect interest and penalties, if any, on unrecognized tax benefits in the Pinnacle West Consolidated and APS Consolidated Statements of Income as income tax expense.  The amount of interest expense or benefit recognized related to unrecognized tax benefits are as follows (dollars in thousands):

	
																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Unrecognized tax benefit interest expense/(benefit) recognized	$	(780	)	 	$	577		 	$	529		 	$	(780	)	 	$	577		 	$	529		

Following are the total amount of accrued liabilities for interest recognized related to unrecognized benefits that could reverse and decrease our effective tax rate to the extent matters are settled favorably (dollars in thousands):

	
																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Unrecognized tax benefit interest accrued	$	1,130		 	$	1,910		 	$	1,333		 	$	1,130		 	$	1,910		 	$	1,333		

Additionally, as of December 31, 2018 , we have recognized less than $1 million of interest expense to be paid on the underpayment of income taxes for certain adjustments that we have filed, or will file, with the IRS.

132

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The components of income tax expense are as follows (dollars in thousands):

																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	Year Ended December 31,	 	Year Ended December 31,	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Current:	 		 	 		 	 		 	 	 	 	 	 	
Federal	$	18,375		 	$	11,624		 	$	8,630		 	$	88,180		 	$	21,512		 	$	711		
State	3,342		 	3,052		 	1,259		 	1,877		 	2,778		 	4,276		
Total current	21,717		 	14,676		 	9,889		 	90,057		 	24,290		 	4,987		
Deferred:	 		 	 		 	 		 	 		 	 		 	 		
Federal	94,721		 	223,729		 	201,743		 	32,436		 	221,078		 	215,178		
State	17,464		 	19,867		 	24,779		 	22,321		 	23,800		 	25,677		
Total deferred	112,185		 	243,596		 	226,522		 	54,757		 	244,878		 	240,855		
Income tax expense	$	133,902		 	$	258,272		 	$	236,411		 	$	144,814		 	$	269,168		 	$	245,842		

The following chart compares pretax income at the statutory federal income tax rate of 21% in 2018 and 35% in 2017 and 2016 to income tax expense (dollars in thousands):

	
																								
 	Pinnacle West Consolidated	 	APS Consolidated	
 	Year Ended December 31,	 	Year Ended December 31,	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Federal income tax expense at statutory rate	$	139,533		 	$	268,177		 	$	244,278		 	$	154,260		 	$	277,540		 	$	254,617		
Increases (reductions) in tax expense resulting from:	 		 	 		 	 		 	 		 	 		 	 		
State income tax net of federal income tax benefit	16,411		 	14,897		 	16,311		 	19,091		 	17,276		 	18,750		
Nondeductible expenditures associated with ballot initiative	7,879		 	—		 	—		 	—		 	—		 	—		
Stock compensation	(1,804	)	 	(6,659	)	 	(2,951	)	 	(780	)	 	(3,489	)	 	(1,937	)	
Excess deferred income taxes - Tax Cuts and Jobs Act	(6,725	)	 	9,348		 	—		 	(4,715	)	 	9,431		 	—		
Allowance for equity funds used during construction (see Note 1)	(7,231	)	 	(12,937	)	 	(11,724	)	 	(7,231	)	 	(12,937	)	 	(11,724	)	
Palo Verde VIE noncontrolling interest (see Note 18)	(4,094	)	 	(6,823	)	 	(6,823	)	 	(4,094	)	 	(6,823	)	 	(6,823	)	
Investment tax credit amortization	(6,742	)	 	(6,715	)	 	(5,887	)	 	(6,742	)	 	(6,715	)	 	(5,887	)	
Other	(3,325	)	 	(1,016	)	 	3,207		 	(4,975	)	 	(5,115	)	 	(1,154	)	
Income tax expense	$	133,902		 	$	258,272		 	$	236,411		 	$	144,814		 	$	269,168		 	$	245,842		

133

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The components of the net deferred income tax liability were as follows (dollars in thousands):

																
 	Pinnacle West Consolidated	 	APS Consolidated	
 	December 31,	 	December 31,	
 	2018	 	2017	 	2018	 	2017	
DEFERRED TAX ASSETS	 		 	 		 	 	 	 	
Risk management activities	$	15,785		 	$	25,103		 	$	15,785		 	$	25,103		
Regulatory liabilities:	 		 	 		 	 		 	 	
Excess deferred income taxes - Tax Cuts and Jobs Act	376,869		 	376,906		 	376,869		 	376,906		
Asset retirement obligation and removal costs	117,201		 	135,847		 	117,201		 	135,847		
Unamortized investment tax credits	53,284		 	54,661		 	53,284		 	54,661		
Other postretirement benefits	40,532		 	47,021		 	40,532		 	47,021		
Other	40,380		 	37,489		 	40,380		 	37,489		
Pension liabilities	112,019		 	83,126		 	107,009		 	77,280		
Coal reclamation liabilities	47,508		 	45,802		 	47,508		 	45,802		
Renewable energy incentives	30,779		 	33,546		 	30,779		 	33,546		
Credit and loss carryforwards	1,755		 	53,946		 	—		 	1,920		
Other	58,820		 	56,630		 	59,919		 	62,421		
Total deferred tax assets	894,932		 	950,077		 	889,266		 	897,996		
DEFERRED TAX LIABILITIES	 		 	 		 	 		 	 	
Plant-related	(2,277,724	)	 	(2,220,886	)	 	(2,277,724	)	 	(2,220,886	)	
Risk management activities	(237	)	 	(491	)	 	(237	)	 	(491	)	
Other postretirement assets and other special use funds	(57,697	)	 	(66,134	)	 	(57,274	)	 	(65,733	)	
Regulatory assets:	 		 	 		 	 	 	 		
Allowance for equity funds used during construction	(39,086	)	 	(36,365	)	 	(39,086	)	 	(36,365	)	
Deferred fuel and purchased power	(23,086	)	 	(40,778	)	 	(23,086	)	 	(40,778	)	
Pension benefits	(181,504	)	 	(142,848	)	 	(181,504	)	 	(142,848	)	
Retired power plant costs (see Note 3)	(48,348	)	 	(53,611	)	 	(48,348	)	 	(53,611	)	
Other	(72,096	)	 	(74,423	)	 	(72,096	)	 	(74,423	)	
Other	(2,575	)	 	(5,346	)	 	(2,575	)	 	(5,346	)	
Total deferred tax liabilities	(2,702,353	)	 	(2,640,882	)	 	(2,701,930	)	 	(2,640,481	)	
Deferred income taxes — net	$	(1,807,421	)	 	$	(1,690,805	)	 	$	(1,812,664	)	 	$	(1,742,485	)	

As of December 31, 2018 , the deferred tax assets for credit and loss carryforwards relate primarily to federal general business credits of approximately $14 million , which first begin to expire in 2036, and state credit carryforwards net of federal benefit of $7 million , which first begin to expire in 2023. The credit and loss carryforwards amount above has been reduced by $19 million of unrecognized tax benefits.

5 .        Lines of Credit and Short-Term Borrowings
 
Pinnacle West and APS maintain committed revolving credit facilities in order to enhance liquidity and provide credit support for their commercial paper programs, to refinance indebtedness, and for other general corporate purposes .

134

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The table below presents the consolidated credit facilities and the amounts available and outstanding as of December 31, 2018 and 2017 (dollars in thousands):

	
																				
 	December 31, 2018	 	December 31, 2017	
 	Pinnacle West	APS	Total	 	Pinnacle West	APS	Total	
Commitments under Credit Facilities	$	350,000		$	1,000,000		$	1,350,000		 	$	325,000		$	1,000,000		$	1,325,000		
Outstanding Commercial Paper and Revolving Credit Facility Borrowings	(76,400	)	—		(76,400	)	 	(95,400	)	—		(95,400	)	
Amount of Credit Facilities Available	$	273,600		$	1,000,000		$	1,273,600		 	$	229,600		$	1,000,000		$	1,229,600		
 	 	 	 	 	 	 	 	
Weighted-Average Commitment Fees	0.125%	0.100%	 	 	0.125%	0.100%	 	

Pinnacle West
 
On June 28, 2018, Pinnacle West refinanced its 364 -day $125 million unsecured revolving credit facility that would have matured on July 30, 2018 with a new 364 -day $150 million credit facility that matures June 27, 2019. Borrowings under the facility bear interest at LIBOR plus 0.70% per annum. At December 31, 2018 , Pinnacle West had $54 million outstanding under the facility.

On July 12, 2018, Pinnacle West replaced its $200 million revolving credit facility that would have matured in May 2021, with a new $200 million facility that matures in July 2023. Pinnacle West has the option to increase the amount of the facility up to a maximum of $300 million upon the satisfaction of certain conditions and with the consent of the lenders.  At December 31, 2018 , Pinnacle West had no outstanding borrowings under its credit facility, no letters of credit outstanding and $22 million of commercial paper borrowings.
 
APS
 
On July 12, 2018, APS replaced its $500 million revolving credit facility that would have matured in May 2021, with a new $500 million facility that matures in July 2023.

At December 31, 2018 , APS had two revolving credit facilities totaling $1 billion , including a $500 million credit facility that matures in June 2022 and the above-mentioned $500 million facility. APS may increase the amount of each facility up to a maximum of $700 million , for a total of $1.4 billion , upon the satisfaction of certain conditions and with the consent of the lenders. Interest rates are based on APS’s senior unsecured debt credit ratings. These facilities are available to support APS’s $500 million commercial paper program, for bank borrowings or for issuances of letters of credit. At December 31, 2018 , APS had no commercial paper outstanding and no outstanding borrowings or letters of credit under its revolving credit facilities. See "Financial Assurances" in Note 10 for a discussion of APS's other outstanding letters of credit.

Debt Provisions
 
On November 27, 2018, the ACC issued a financing order in which, subject to specified parameters and procedures, it approved APS’s short-term debt authorization equal to a sum of (i) 7% of APS’s capitalization, and (ii) $500 million (which is required to be used for costs relating to purchases of natural gas and power). See Note 6 for additional long-term debt provisions.

135

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6 .     Long-Term Debt and Liquidity Matters
 
All of Pinnacle West’s and APS’s debt is unsecured.  The following table presents the components of long-term debt on the Consolidated Balance Sheets outstanding at December 31, 2018 and 2017 (dollars in thousands):

												
 	Maturity	 	Interest	 	December 31,	
 	Dates (a)	 	Rates	 	2018	 	2017	
APS	 	 	 	 	 		 	 		
Pollution control bonds:	 	 	 	 	 		 	 		
Variable	2029	 	(b)	 	$	35,975		 	$	35,975		
Fixed	2024	 	4.70%	 	115,150		 	147,150		
Total pollution control bonds	 	 	 	 	151,125		 	183,125		
Senior unsecured notes	2019-2048	 	2.20%-8.75%	 	4,575,000		 	4,275,000		
Term loans		 	(c)	 	—		 	150,000		
Unamortized discount	 	 	 	 	(12,638	)	 	(11,288	)	
Unamortized premium	 	 	 	 	7,736		 	8,049		
Unamortized debt issuance cost	 	 	 	 	(31,787	)	 	(31,594	)	
Total APS long-term debt	 	 	 	 	4,689,436		 	4,573,292		
Less current maturities		 	 	 	500,000		 	82,000		
Total APS long-term debt less current maturities	 	 	 	 	4,189,436		 	4,491,292		
Pinnacle West	 	 	 	 	 		 	 		
Senior unsecured notes	2020	 	2.25%	 	300,000		 	300,000		
Term loan	2020	 	(d)	 	150,000		 	—		
Unamortized discount	 	 	 	 	(121	)	 	(184	)	
Unamortized debt issuance cost	 	 	 	 	(1,083	)	 	(1,395	)	
Total Pinnacle West long-term debt	 	 	 	 	448,796		 	298,421		
Less current maturities	 	 	 	 	—		 	—		
Total Pinnacle West long-term debt less current maturities	 	 	 	 	448,796		 	298,421		
TOTAL LONG-TERM DEBT   LESS CURRENT MATURITIES	 	 	 	 	$	4,638,232		 	$	4,789,713		
		
(a)	This schedule does not reflect the timing of redemptions that may occur prior to maturities.	
		
(b)	The weighted-average rate for the variable rate pollution control bonds was 1.76% at December 31, 2018 and 1.77% at December 31, 2017 .	
		
(c)	The weighted-average interest rate was 2.24% at December 31, 2017 .	
		
(d)	The weighted-average interest rate was 3.02% at December 31, 2018 .	

The following table shows principal payments due on Pinnacle West’s and APS’s total long-term debt (dollars in thousands):

									
Year	 	Consolidated
Pinnacle West	 	Consolidated
APS	
2019	 	$	500,000		 	$	500,000		
2020	 	700,000		 	250,000		
2021	 	—		 	—		
2022	 	—		 	—		
2023	 	—		 	—		
Thereafter	 	3,976,125		 	3,976,125		
Total	 	$	5,176,125		 	$	4,726,125		

136

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

  Debt Fair Value
 
Our long-term debt fair value estimates are classified within Level 2 of the fair value hierarchy. The following table represents the estimated fair value of our long-term debt, including current maturities (dollars in thousands):

	
																
 	As of
December 31, 2018	 	As of
December 31, 2017	
 	Carrying
Amount	 	Fair Value	 	Carrying
Amount	 	Fair Value	
Pinnacle West	$	448,796		 	$	443,955		 	$	298,421		 	$	298,608		
APS	4,689,436		 	4,789,608		 	4,573,292		 	5,006,348		
Total	$	5,138,232		 	$	5,233,563		 	$	4,871,713		 	$	5,304,956		

Credit Facilities and Debt Issuances
 
Pinnacle West

On December 21, 2018, Pinnacle West entered into a $150 million term loan facility that matures December 2020. The proceeds were used for general corporate purposes.
 
APS
 
On May 30, 2018, APS purchased all $32 million of Maricopa County, Arizona Pollution Control Corporation Pollution Control Revenue Refunding Bonds, 2009 Series C, due 2029. These bonds were classified as current maturities of long-term debt on our Consolidated Balance Sheets at December 31, 2017.

On June 26, 2018, APS repaid at maturity APS's $50 million term loan facility.

On August 9, 2018, APS issued $300 million of 4.20% unsecured senior notes that mature on August 15, 2048.  The net proceeds from the sale of the notes were used to repay commercial paper borrowings.

On November 30, 2018, APS repaid its $100 million term loan facility that would have matured April 22, 2019.

On December 21, 2018, Pinnacle West contributed $150 million into APS in the form of an equity infusion. APS used this contribution to repay short-term indebtedness.

See “Lines of Credit and Short-Term Borrowings” in Note 5 and “Financial Assurances” in Note  10 for discussion of APS’s separate outstanding letters of credit.
 
Debt Provisions
 
Pinnacle West’s and APS’s debt covenants related to their respective bank financing arrangements include maximum debt to capitalization ratios. Pinnacle West and APS comply with this covenant.  For both Pinnacle West and APS, this covenant requires that the ratio of consolidated debt to total consolidated capitalization not exceed 65% .  At December 31, 2018 , the ratio was approximately 50% for Pinnacle West and 46% for APS.  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 and could cross-default other debt.  See further discussion of “cross-default” provisions below.

137

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
Neither Pinnacle West’s nor APS’s financing agreements contain “rating triggers” that would result in an acceleration of the required interest and principal payments in the event of a rating downgrade.  However, our bank credit agreements contain a pricing grid in which the interest rates we pay for borrowings thereunder are determined by our current credit ratings.
 
All of Pinnacle West’s loan 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 certain other material agreements.  All of APS’s 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 certain other material agreements.  Pinnacle West and APS do not have a material adverse change restriction for credit facility borrowings.

Although provisions in APS’s 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. On November 27, 2018, the ACC issued a financing order in which, subject to specified parameters and procedures, it approved an increase in APS’s long-term debt authorization from $5.1 billion to $5.9 billion in light of the projected growth of APS and its customer base and the resulting projected financing needs.  See Note 5 for additional short-term debt provisions.
 
7 .     Retirement Plans and Other Postretirement Benefits
 
Pinnacle West sponsors a qualified defined benefit and account balance pension plan (The Pinnacle West Capital Corporation Retirement Plan) and a non-qualified supplemental excess benefit retirement plan for the employees of Pinnacle West and its subsidiaries.  All new employees participate in the account balance plan.  Defined benefit plans specify the amount of benefits a plan participant is to receive using information about the participant.  The pension plan covers nearly all employees.  The supplemental excess benefit retirement plan covers officers of the Company and highly compensated employees designated for participation by the Board of Directors.  Our employees do not contribute to the plans.  We calculate the benefits based on age, years of service and pay.

Pinnacle West also sponsors other postretirement benefit plans (Pinnacle West Capital Corporation Group Life and Medical Plan and Pinnacle West Capital Corporation Post-65 Retiree Health Reimbursement Arrangement) for the employees of Pinnacle West and its subsidiaries.  These plans provide medical and life insurance benefits to retired employees.  Employees must retire to become eligible for these retirement benefits, which are based on years of service and age.  For the medical insurance plan, retirees make contributions to cover a portion of the plan costs.  For the life insurance plan, retirees do not make contributions.  We retain the right to change or eliminate these benefits.

Because of plan changes in 2014, the Company sought IRS approval to move approximately $186 million of other postretirement benefit trust assets into a new trust account to pay for active union employee medical costs. In December 2016, FERC approved a methodology for determining the amount of other postretirement benefit trust assets to transfer into a new trust account to pay for active union employee medical costs. On January 2, 2018, these funds were moved to the new trust account, which is included in the other special use funds on the Consolidated Balance Sheets. The Company and the IRS executed a final Closing Agreement on March 2, 2018. The Company made an informational filing with FERC during February 2018. It is the Company’s understanding that completion of these regulatory requirements permits access to approximately $186 million for the sole purpose of paying active union employee medical benefits.

138

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pinnacle West uses a December 31 measurement date each year for its pension and other postretirement benefit plans.  The market-related value of our plan assets is their fair value at the measurement date.  See Note 13 for further discussion of how fair values are determined.  Due to subjective and complex judgments, which may be required in determining fair values, actual results could differ from the results estimated through the application of these methods.
 
A significant portion of the changes in the actuarial gains and losses of our pension and postretirement plans is attributable to APS and therefore is recoverable in rates.  Accordingly, these changes are recorded as a regulatory asset or regulatory liability.
 
The following table provides details of the plans’ net periodic benefit costs and the portion of these costs charged to expense (including administrative costs and excluding amounts capitalized as overhead construction or billed to electric plant participants) (dollars in thousands):

																								
 	Pension	 	Other Benefits	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Service cost-benefits earned during the period	$	56,669		 	$	54,858		 	$	53,792		 	$	21,100		 	$	17,119		 	$	14,993		
Interest cost on benefit obligation	124,689		 	129,756		 	131,647		 	28,147		 	29,959		 	29,721		
Expected return on plan assets	(182,853	)	 	(174,271	)	 	(173,906	)	 	(42,082	)	 	(53,401	)	 	(36,495	)	
Amortization of:	 		 	 		 	 		 	 		 	 		 	 		
Prior service cost (credit)	—		 	81		 	527		 	(37,842	)	 	(37,842	)	 	(37,883	)	
Net actuarial loss	32,082		 	47,900		 	40,717		 	—		 	5,118		 	4,589		
Net periodic benefit cost (benefit)	$	30,587		 	$	58,324		 	$	52,777		 	$	(30,677	)	 	$	(39,047	)	 	$	(25,075	)	
Portion of cost charged to expense	$	10,120		 	$	27,295		 	$	26,172		 	$	(21,426	)	 	$	(18,274	)	 	$	(12,435	)	

On January 1, 2018, we adopted new accounting standard ASU 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This new standard changed our income statement presentation of net periodic benefit cost/(credits) and allows only the service cost component of net periodic benefit cost to be eligible for capitalization. See Note 2 for additional information.    

139

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table shows the plans’ changes in the benefit obligations and funded status for the years 2018 and 2017 (dollars in thousands):

																
 	Pension	 	Other Benefits	
 	2018	 	2017	 	2018	 	2017	
Change in Benefit Obligation	 		 	 		 	 		 	 		
Benefit obligation at January 1	$	3,394,186		 	$	3,204,462		 	$	753,393		 	$	716,445		
Service cost	56,669		 	54,858		 	21,100		 	17,119		
Interest cost	124,689		 	129,756		 	28,147		 	29,959		
Benefit payments	(184,161	)	 	(166,342	)	 	(31,540	)	 	(30,144	)	
Actuarial (gain) loss	(200,757	)	 	171,452		 	(94,329	)	 	20,014		
Benefit obligation at December 31	3,190,626		 	3,394,186		 	676,771		 	753,393		
Change in Plan Assets	 		 	 		 	 		 	 		
Fair value of plan assets at January 1	3,057,027		 	2,675,357		 	1,022,371		 	882,651		
Actual return on plan assets	(201,078	)	 	428,374		 	(40,354	)	 	139,367		
Employer contributions	50,000		 	100,000		 	—		 	353		
Benefit payments	(172,473	)	 	(146,704	)	 	(72,453	)	 	—		
Transfer to active union medical account	—		 	—		 	(185,887	)	 	—		
Fair value of plan assets at December 31	2,733,476		 	3,057,027		 	723,677		 	1,022,371		
Funded Status at December 31	$	(457,150	)	 	$	(337,159	)	 	$	46,906		 	$	268,978		

The following table shows the projected benefit obligation and the accumulated benefit obligation for pension plans with an accumulated obligation in excess of plan assets as of December 31, 2018 and 2017 (dollars in thousands):

								
 	2018	 	2017	
Projected benefit obligation	$	3,190,626		 	$	3,394,186		
Accumulated benefit obligation	3,038,774		 	3,227,233		
Fair value of plan assets	2,733,476		 	3,057,027		

The following table shows the amounts recognized on the Consolidated Balance Sheets as of December 31, 2018 and 2017 (dollars in thousands):

																
 	Pension	 	Other Benefits	
 	2018	 	2017	 	2018	 	2017	
Noncurrent asset	$	—		 	$	—		 	$	46,906		 	$	268,978		
Current liability	(13,980	)	 	(9,859	)	 	—		 	—		
Noncurrent liability	(443,170	)	 	(327,300	)	 	—		 	—		
Net amount recognized	$	(457,150	)	 	$	(337,159	)	 	$	46,906		 	$	268,978		

140

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table shows the details related to accumulated other comprehensive loss as of December 31, 2018 and 2017 (dollars in thousands): 

																
 	Pension	 	Other Benefits	
 	2018	 	2017	 	2018	 	2017	
Net actuarial loss	$	794,292		 	$	643,199		 	$	63,544		 	$	75,439		
Prior service credit	—		 	—		 	(227,733	)	 	(265,575	)	
APS’s portion recorded as a regulatory (asset) liability	(733,351	)	 	(576,188	)	 	163,767		 	189,627		
Income tax expense (benefit)	(15,083	)	 	(24,915	)	 	561		 	853		
Accumulated other comprehensive loss	$	45,858		 	$	42,096		 	$	139		 	$	344		

The following table shows the estimated amounts that will be amortized from accumulated other comprehensive loss and regulatory assets and liabilities into net periodic benefit cost in 2019 (dollars in thousands):

								
 	Pension	 	Other
Benefits	
Net actuarial loss	$	43,248		 	$	—		
Prior service credit	—		 	(37,821	)	
Total amounts estimated to be amortized from accumulated other comprehensive loss (gain) and regulatory assets (liabilities) in 2019	$	43,248		 	$	(37,821	)	

The following table shows the weighted-average assumptions used for both the pension and other benefits to determine benefit obligations and net periodic benefit costs:

															
 	Benefit Obligations
As of December 31,	 	Benefit Costs
For the Years Ended December 31,	
 	2018	 	2017	 	2018	 	2017	 	2016	
Discount rate – pension	4.34	%	 	3.65	%	 	3.65	%	 	4.08	%	 	4.37	%	
Discount rate – other benefits	4.39	%	 	3.71	%	 	3.71	%	 	4.17	%	 	4.52	%	
Rate of compensation increase	4.00	%	 	4.00	%	 	4.00	%	 	4.00	%	 	4.00	%	
Expected long-term return on plan assets - pension	N/A		 	N/A		 	6.05	%	 	6.55	%	 	6.90	%	
Expected long-term return on plan assets - other benefits	N/A		 	N/A		 	5.40	%	 	6.05	%	 	4.45	%	
Initial healthcare cost trend rate (pre-65 participants)	7.00	%	 	7.00	%	 	7.00	%	 	7.00	%	 	7.00	%	
Initial healthcare cost trend rate (post-65 participants)	4.75	%	 	4.75	%	 	4.75	%	 	5.00	%	 	5.00	%	
Ultimate healthcare cost trend rate	4.75	%	 	4.75	%	 	4.75	%	 	5.00	%	 	5.00	%	
Number of years to ultimate trend rate (pre-65 participants)	7		 	8		 	8		 	4		 	4		

In selecting the pretax expected long-term rate of return on plan assets, we consider past performance and economic forecasts for the types of investments held by the plan.  For 2019, we are assuming a 6.25% long-term rate of return for pension assets and 5.55% (before tax) for other benefit assets, which we believe is reasonable given our asset allocation in relation to historical and expected performance.

141

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In selecting our healthcare trend rates, we consider past performance and forecasts of healthcare costs.  A one percentage point change in the assumed initial and ultimate healthcare cost trend rates would have the following effects on our December 31, 2018 amounts (dollars in thousands): 

								
 	1% Increase	 	1% Decrease	
Effect on other postretirement benefits expense, after consideration of amounts capitalized or billed to electric plant participants	$	10,235		 	$	(4,322	)	
Effect on service and interest cost components of net periodic other postretirement benefit costs	11,223		 	(8,479	)	
Effect on the accumulated other postretirement benefit obligation	101,224		 	(81,144	)	

Plan Assets
 
The Board of Directors has delegated oversight of the pension and other postretirement benefit plans’ assets to an Investment Management Committee (“Committee”).  The Committee has adopted investment policy statements (“IPS”) for the pension and the other postretirement benefit plans’ assets. The investment strategies for these plans include external management of plan assets, and prohibition of investments in Pinnacle West securities.
 
The overall strategy of the pension plan’s IPS is to achieve an adequate level of trust assets relative to the benefit obligations.  To achieve this objective, the plan’s investment policy provides for mixes of investments including long-term fixed income assets and return-generating assets.  The target allocation between return-generating and long-term fixed income assets is defined in the IPS and is a function of the plan’s funded status.  The plan’s funded status is reviewed on at least a monthly basis.
 
Changes in the value of long-term fixed income assets, also known as liability-hedging assets, are intended to offset changes in the benefit obligations due to changes in interest rates.  Long-term fixed income assets consist primarily of fixed income debt securities issued by the U.S. Treasury and other government agencies, U.S. Treasury Futures Contracts, and fixed income debt securities issued by corporations.  Long-term fixed income assets may also include interest rate swaps, and other instruments.
 
Return-generating assets are intended to provide a reasonable long-term rate of investment return with a prudent level of volatility.  Return-generating assets are composed of U.S. equities, international equities, and alternative investments.  International equities include investments in both developed and emerging markets.  Alternative investments include investments in real estate, private equity and various other strategies.  The plan may also hold investments in return-generating assets by holding securities in partnerships, common and collective trusts and mutual funds.

Based on the IPS, and given the pension plan's funded status at year-end 2018, the target and actual allocation for the pension plan at December 31, 2018 are as follows:

						
 	Pension	
 	Target Allocation	 	Actual Allocation	
Long-term fixed income assets	62	%	 	64	%	
Return-generating assets	38	%	 	36	%	
Total	100	%	 	100	%	

The permissible range is within +/- 3% of the target allocation shown in the above table, and also considers the Plan's funded status.

142

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the additional target allocations, as a percent of total pension plan assets, for the return-generating assets:

			
Asset Class	Target Allocation	
Equities in US and other developed markets	18	%	
Equities in emerging markets	6	%	
Alternative investments	14	%	
Total	38	%	

The pension plan IPS does not provide for a specific mix of long-term fixed income assets, but does expect the average credit quality of such assets to be investment grade. 

As of December 31, 2018 , the asset allocation for other postretirement benefit plan assets is governed by the IPS for those plans, which provides for different asset allocation target mixes depending on the characteristics of the liability.  Some of these asset allocation target mixes vary with the plan’s funded status. The following table presents the actual allocations of the investment for the other postretirement benefit plan at December 31, 2018 :

			
 	Other Benefits	
 	Actual Allocation	
Long-term fixed income assets	69	%	
Return-generating assets	31	%	
Total	100	%	

See Note 13 for a discussion on the fair value hierarchy and how fair value methodologies are applied.  The plans invest directly in fixed income, U.S. Treasury Futures Contracts, and equity securities, in addition to investing indirectly in fixed income securities, equity securities and real estate through the use of mutual funds, partnerships and common and collective trusts.  Equity securities held directly by the plans are valued using quoted active market prices from the published exchange on which the equity security trades, and are classified as Level 1.  U.S. Treasury Futures Contracts are valued using the quoted active market prices from the exchange on which they trade, and are classified as Level 1. Fixed income securities issued by the U.S. Treasury held directly by the plans are valued using quoted active market prices, and are classified as Level 1.  Fixed income securities issued by corporations, municipalities, and other agencies are primarily valued using quoted inactive market prices, or quoted active market prices for similar securities, or by utilizing calculations which incorporate observable inputs such as yield, maturity and credit quality.  These instruments are classified as Level 2.
 
Mutual funds, partnerships, and common and collective trusts are valued utilizing a net asset value (NAV) concept or its equivalent. Mutual funds, which includes exchange traded funds (ETFs), are classified as Level 1 and valued using a NAV that is observable and based on the active market in which the fund trades.

Common and collective trusts are maintained by banks or investment companies and hold certain investments in accordance with a stated set of objectives (such as tracking the performance of the S&P 500 Index).  The trust's shares are offered to a limited group of investors, and are not traded in an active market. Investments in common and collective trusts are valued using NAV as a practical expedient and, accordingly, are not classified in the fair value hierarchy. The NAV for trusts investing in exchange traded equities, and fixed income securities is derived from the market prices of the underlying securities held by the trusts. The

143

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NAV for trusts investing in real estate is derived from the appraised values of the trust's underlying real estate assets.  As of December 31, 2018 , the plans were able to transact in the common and collective trusts at NAV.

Investments in partnerships are also valued using the concept of NAV as a practical expedient and, accordingly, are not classified in the fair value hierarchy. The NAV for these investments is derived from the value of the partnerships' underlying assets. The plan's partnerships holdings relate to investments in high-yield fixed income instruments and assets of privately held portfolio companies. Certain partnerships also include funding commitments that may require the plan to contribute up to $75 million to these partnerships; as of December 31, 2018 , approximately $62 million of these commitments have been funded.
 
The plans’ trustee provides valuation of our plan assets by using pricing services that utilize methodologies described to determine fair market value.  We have internal control procedures to ensure this information is consistent with fair value accounting guidance.  These procedures include assessing valuations using an independent pricing source, verifying that pricing can be supported by actual recent market transactions, assessing hierarchy classifications, comparing investment returns with benchmarks, and obtaining and reviewing independent audit reports on the trustee’s internal operating controls and valuation processes.

144

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2018 , by asset category, are as follows (dollars in thousands):

	
																
 	Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)	 	Significant
Other
Observable
Inputs
(Level 2)	 	Other (a)	 	Balance at December 31, 2018	
Pension Plan:	 		 	 		 	 	 	 		
Cash and cash equivalents	$	451		 	$	—		 	$	—		 	$	451		
Fixed income securities:	 		 	 		 	 	 	 		
Corporate	—		 	1,237,744		 	—		 	1,237,744		
U.S. Treasury	372,649		 	—		 	—		 	372,649		
Other (b)	—		 	78,902		 	—		 	78,902		
Common stock equities (c)	196,661		 	—		 	—		 	196,661		
Mutual funds (d)	120,976		 	—		 	—		 	120,976		
Common and collective trusts:	 	 	 	 	 	 	 	
   Equities	—		 	—		 	272,926		 	272,926		
   Real estate	—		 	—		 	165,123		 	165,123		
   Fixed Income	—		 	—		 	86,483		 	86,483		
Partnerships	—		 	—		 	125,217		 	125,217		
Short-term investments and other (e)	—		 	—		 	76,344		 	76,344		
Total	$	690,737		 	$	1,316,646		 	$	726,093		 	$	2,733,476		
Other Benefits:	 		 	 		 	 		 	 		
Cash and cash equivalents	$	93		 	$	—		 	$	—		 	$	93		
Fixed income securities:	 		 	 		 	 	 	 		
Corporate	—		 	163,286		 	—		 	163,286		
U.S. Treasury	318,017		 	—		 	—		 	318,017		
Other (b)	—		 	7,531		 	—		 	7,531		
Common stock equities (c)	129,199		 	—		 	—		 	129,199		
Mutual funds (d)	10,963		 	—		 	—		 	10,963		
Common and collective trusts:	 		 	 		 	 	 	 		
   Equities	—		 	—		 	65,720		 	65,720		
   Real estate	—		 	—		 	19,054		 	19,054		
Short-term investments and other (e)	3,633		 	—		 	6,181		 	9,814		
Total	$	461,905		 	$	170,817		 	$	90,955		 	$	723,677		
		
(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.	
		
(b)	This category consists primarily of debt securities issued by municipalities.	
		
(c)	This category primarily consists of U.S. common stock equities.	
		
(d)	These funds invest in international common stock equities.	
		
(e)	This category includes plan receivables and payables.	

 

145

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The fair value of Pinnacle West’s pension plan and other postretirement benefit plan assets at December 31, 2017 , by asset category, are as follows (dollars in thousands):

																
 	Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)	 	Significant
Other
Observable
Inputs
(Level 2)	 	Other (a)	 	Balance at December 31, 2017	
Pension Plan:	 		 	 		 	 	 	 		
Cash and cash equivalents	$	3,830		 	$	—		 	$	—		 	$	3,830		
Fixed income securities:	 		 	 		 	 	 	 		
Corporate	—		 	1,365,194		 	—		 	1,365,194		
U.S. Treasury	221,291		 	—		 	—		 	221,291		
Other (b)	—		 	100,599		 	—		 	100,599		
Common stock equities (c)	228,088		 	—		 	—		 	228,088		
Mutual funds (d)	233,732		 	—		 	—		 	233,732		
Common and collective trusts:	 	 	 	 	 	 	 	
   Equities	—		 	—		 	408,763		 	408,763		
   Real estate	—		 	—		 	171,569		 	171,569		
   Fixed Income	—		 	—		 	90,869		 	90,869		
Partnerships	—		 	—		 	133,379		 	133,379		
Short-term investments and other (e)	—		 	1,208		 	98,505		 	99,713		
Total	$	686,941		 	$	1,467,001		 	$	903,085		 	$	3,057,027		
Other Benefits:	 		 	 		 	 		 	 		
Cash and cash equivalents	$	143		 	$	—		 	$	—		 	$	143		
Fixed income securities:	 		 	 		 	 	 	 		
Corporate	—		 	306,008		 	—		 	306,008		
U.S. Treasury	336,963		 	—		 	—		 	336,963		
Other (b)	—		 	32,508		 	—		 	32,508		
Common stock equities (c)	196,153		 	—		 	—		 	196,153		
Mutual funds (d)	39,269		 	—		 	—		 	39,269		
Common and collective trusts:	 	 	 	 	 	 	 	
   Equities	—		 	—		 	75,310		 	75,310		
   Real estate	—		 	—		 	15,422		 	15,422		
Short-term investments and other (e)	11,268		 	149		 	9,178		 	20,595		
Total	$	583,796		 	$	338,665		 	$	99,910		 	$	1,022,371		

		
(a)	These investments primarily represent assets valued using net asset value as a practical expedient, and have not been classified in the fair value hierarchy.	
		
(b)	This category consists primarily of debt securities issued by municipalities.	
		
(c)	This category primarily consists of U.S. common stock equities.	
		
(d)	These funds invest in U.S. and international common stock equities.	
		
(e)	This category includes plan receivables and payables.	

Contributions
 
Future year contribution amounts are dependent on plan asset performance and plan actuarial assumptions.  We made contributions to our pension plan totaling $50 million in 2018 , $100 million in 2017 , and $100 million in 2016 .  The minimum required contributions for the pension plan are zero for the next three years.  We expect to make voluntary contributions up to a total of $350 million during the 2019-2021 period. 

146

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

With regard to contributions to our other postretirement benefit plan, we did not make a contribution in 2018 . We made a contribution of approximately $1 million in each of 2017 and 2016 .  We do not expect to make any contributions over the next three years to our other postretirement benefit plans. In 2018, the Company was reimbursed $72 million for prior years retiree medical claims from the other postretirement benefit plan trust assets.
 
Estimated Future Benefit Payments
 
Benefit payments, which reflect estimated future employee service, for the next five years and the succeeding five years thereafter, are estimated to be as follows (dollars in thousands):

									
Year	 	Pension	 	Other Benefits	
2019	 	$	188,492		 	$	32,622		
2020	 	193,087		 	34,199		
2021	 	198,471		 	35,551		
2022	 	204,399		 	36,673		
2023	 	211,346		 	37,405		
Years 2024-2028	 	1,093,319		 	187,023		

Electric plant participants contribute to the above amounts in accordance with their respective participation agreements.

Employee Savings Plan Benefits
 
Pinnacle West sponsors a defined contribution savings plan for eligible employees of Pinnacle West and its subsidiaries.  In 2018, costs related to APS’s employees represented 99% of the total cost of this plan.  In a defined contribution savings plan, the benefits a participant receives result from regular contributions participants make to their own individual account, the Company’s matching contributions and earnings or losses on their investments.  Under this plan, the Company matches a percentage of the participants’ contributions in cash which is then invested in the same investment mix as participants elect to invest their own future contributions.  Pinnacle West recorded expenses for this plan of approximately $11 million for 2018 , $10 million for 2017 , and $10 million for 2016 .

8 .     Leases
 
We lease certain vehicles, land, buildings, equipment and miscellaneous other items through operating rental agreements with varying terms, provisions and expiration dates.
 
Lease expense recognized in the Consolidated Statements of Income was $18 million in 2018 , $18 million in 2017 , and $16 million in 2016 .  APS’s lease expense was $17 million in 2018 , $17 million in 2017 , and $15 million in 2016 . These amounts do not include purchased power lease contracts, discussed below.

147

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Estimated future minimum lease payments for Pinnacle West’s and APS’s operating leases, excluding purchased power agreements, are approximately as follows (dollars in thousands):

									
Year	 	Pinnacle West
Consolidated	 	APS	
2019	 	$	13,747		 	$	13,411		
2020	 	12,428		 	12,143		
2021	 	9,478		 	9,282		
2022	 	6,513		 	6,321		
2023	 	5,359		 	5,171		
Thereafter	 	42,236		 	40,656		
Total future lease commitments	 	$	89,761		 	$	86,984		

In 1986, APS entered into agreements with three separate lessor trust entities in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities.  These lessor trust entities have been deemed VIEs for which APS is the primary beneficiary.  As the primary beneficiary, APS consolidated these lessor trust entities.  The impacts of these sale leaseback transactions are excluded from our lease disclosures as lease accounting is eliminated upon consolidation.  See Note 18 for a discussion of VIEs.

Purchased Power Lease Contracts
A purchased power contract may contain a lease for accounting purposes. This generally occurs when a purchased power contract designates a specific power plant from which the buyer purchases substantially all of the output and also meets other required lease accounting criteria. APS has certain purchased power contracts that contain lease arrangements. The future minimum lease payments due under these contracts are $54 million , all of which relate to 2019. Due to the inherent uncertainty associated with the reliability of the fuel source, payments under most renewable purchased power lease contracts are considered contingent rents and are excluded from future minimum lease payments. See Note 10 for additional information on our purchased power contract estimated commitments.
Operating lease cost for purchased power lease contracts was $47 million in 2018, $60 million in 2017 and $82 million in 2016. In addition, contingent rents for purchased power lease contracts was $109 million in 2018, $100 million in 2017, and $88 million in 2016. These costs are recorded in fuel and purchased power on the Consolidated Statements of Income, and are subject to recovery under the PSA or RES. See Note 3.
See Note 2 for a discussion of the new lease accounting standard we adopted on January 1, 2019.

 

148

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9 .     Jointly-Owned Facilities
 
APS shares ownership of some of its generating and transmission facilities with other companies.  We are responsible for our share of operating costs which are included in the corresponding operating expenses on our Consolidated Statements of Income. We are also responsible for providing our own financing.  Our share of operating expenses and utility plant costs related to these facilities is accounted for using proportional consolidation.  The following table shows APS’s interests in those jointly-owned facilities recorded on the Consolidated Balance Sheets at December 31, 2018 (dollars in thousands):

	
																			
 	 	Percent
Owned	 	 	 	Plant in
Service	 	Accumulated
Depreciation	 	Construction
Work in
Progress	 	
Generating facilities:	 	 		 	 	 	 		 	 		 	 		 	
Palo Verde Units 1 and 3	 	29.1	%	 		 	$	1,887,729		 	$	1,095,878		 	$	25,185		 	
Palo Verde Unit 2 (a)	 	16.8	%	 		 	638,419		 	369,372		 	20,852		 	
Palo Verde Common	 	28.0	%	 	(b)	 	752,300		 	277,414		 	39,995		 	
Palo Verde Sale Leaseback	 	 		 	(a)	 	351,050		 	245,275		 	—		 	
Four Corners Generating Station	 	63.0	%	 		 	1,466,579		 	544,308		 	23,430		 	
Cholla common facilities (c)	 	50.5	%	 		 	183,390		 	82,434		 	893		 	
Transmission facilities:	 	 		 	 	 	 		 	 		 	 		 	
ANPP 500kV System	 	33.5	%	 	 (b)	 	129,587		 	49,340		 	2,705		 	
Navajo Southern System	 	26.7	%	 	(b)	 	82,046		 	30,464		 	284		 	
Palo Verde — Yuma 500kV System	 	19.0	%	 	(b)	 	15,304		 	6,729		 	530		 	
Four Corners Switchyards	 	63.1	%	 	 (b)	 	68,707		 	15,436		 	1,334		 	
Phoenix — Mead System	 	17.1	%	 	(b)	 	39,329		 	18,527		 	44		 	
Palo Verde — Rudd 500kV System	 	50.0	%	 		 	93,887		 	25,573		 	302		 	
Morgan — Pinnacle Peak System	 	64.6	%	 	 (b)	 	117,722		 	16,744		 	—		 	
Round Valley System	 	50.0	%	 		 	515		 	153		 	—		 	
Palo Verde — Morgan System	 	87.9	%	 	(b)	 	219,292		 	6,660		 	—		 	
Hassayampa — North Gila System	 	80.0	%	 		 	142,541		 	9,805		 	—		 	
Cholla 500kV Switchyard	 	85.7	%	 		 	5,078		 	1,414		 	38		 	
Saguaro 500kV Switchyard	 	60.0	%	 		 	20,414		 	12,790		 	—		 	
Kyrene — Knox System	 	50.0	%	 		 	578		 	307		 	—		 	
		
(a)	See Note 18.	
		
(b)	Weighted-average of interests.	
		
(c)	PacifiCorp owns Cholla Unit 4 and APS operates the unit for PacifiCorp.  The common facilities at Cholla are jointly-owned.	

APS also has a 14% ownership in the Navajo Plant.  In the second quarter of 2017, APS’s remaining net book value of its interest was reclassified from property, plant and equipment to a regulatory asset.  See “Navajo Plant” in Note 3 for more details.

149

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10 .     Commitments and Contingencies
 
Palo Verde Generating Station
 
Spent Nuclear Fuel and Waste Disposal
 
On December 19, 2012, APS, acting on behalf of itself and the participant owners of Palo Verde, filed a second breach of contract lawsuit against the DOE in the United States Court of Federal Claims ("Court of Federal Claims").  The lawsuit sought to recover damages incurred due to the DOE’s breach of the Contract for Disposal of Spent Nuclear Fuel and/or High Level Radioactive Waste ("Standard Contract") for failing to accept Palo Verde's spent nuclear fuel and high level waste from January 1, 2007 through June 30, 2011, as it was required to do pursuant to the terms of the Standard Contract and the Nuclear Waste Policy Act.  On August 18, 2014, APS and the DOE entered into a settlement agreement, stipulating to a dismissal of the lawsuit and payment of $57.4 million by the DOE to the Palo Verde owners for certain specified costs incurred by Palo Verde during the period January 1, 2007 through June 30, 2011. APS’s share of this amount is $16.7 million . Amounts recovered in the lawsuit and settlement were recorded as adjustments to a regulatory liability and had no impact on the amount of reported net income. In addition, the settlement agreement, as amended, provides APS with a method for submitting claims and getting recovery for costs incurred through December 31, 2019.

APS has submitted four claims pursuant to the terms of the August 18, 2014 settlement agreement, for four separate time periods during July 1, 2011 through June 30, 2018. The DOE has approved and paid $74.2 million for these claims (APS’s share is $21.6 million ). The amounts recovered were primarily recorded as adjustments to a regulatory liability and had no impact on reported net income. In accordance with the 2017 Rate Case Decision, this regulatory liability is being refunded to customers (see Note 3). APS's next claim pursuant to the terms of the August 18, 2014 settlement agreement was submitted to the DOE on October 31, 2018 in the amount of $10.2 million (APS's share is $3.0 million ). This claim is pending DOE review.

Nuclear Insurance
 
Public liability for incidents at nuclear power plants is governed by the Price-Anderson Nuclear Industries Indemnity Act ("Price-Anderson Act"), which limits the liability of nuclear reactor owners to the amount of insurance available from both commercial sources and an industry-wide retrospective payment plan.  In accordance with the Price-Anderson Act, the Palo Verde participants are insured against public liability for a nuclear incident of up to approximately $14.1 billion per occurrence.  Palo Verde maintains the maximum available nuclear liability insurance in the amount of $450 million , which is provided by American Nuclear Insurers ("ANI").  The remaining balance of approximately $13.6 billion of liability coverage is provided through a mandatory industry-wide retrospective premium program.  If losses at any nuclear power plant covered by the program exceed the accumulated funds, APS could be responsible for retrospective premiums.  The maximum retrospective premium per reactor under the program for each nuclear liability incident is approximately $137.6 million , subject to a maximum annual premium of approximately $20.5 million per incident.  Based on APS’s ownership interest in the three Palo Verde units, APS’s maximum retrospective premium per incident for all three units is approximately $120.1 million , with a maximum annual retrospective premium of approximately $17.9 million .

The Palo Verde participants maintain insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.8 billion .  APS has also secured accidental outage insurance for a sudden and unforeseen accidental outage of any of the three units. The property damage, decontamination, and accidental outage insurance are provided by Nuclear Electric Insurance Limited

150

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

("NEIL").  APS is subject to retrospective premium adjustments under all NEIL policies if NEIL’s losses in any policy year exceed accumulated funds.  The maximum amount APS could incur under the current NEIL policies totals approximately $24.8 million for each retrospective premium assessment declared by NEIL’s Board of Directors due to losses.  In addition, NEIL policies contain rating triggers that would result in APS providing approximately $71.2 million of collateral assurance within 20 business days of a rating downgrade to non-investment grade.  The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions, sublimits and exclusions.
 
Fuel and Purchased Power Commitments and Purchase Obligations
 
APS is party to various fuel and purchased power contracts and purchase obligations with terms expiring between 2019 and 2043 that include required purchase provisions.  APS estimates the contract requirements to be approximately $622 million in 2019 ; $555 million in 2020 ; $558 million in 2021 ; $563 million in 2022 ; $560 million in 2023 ; and $5.9 billion thereafter.  However, these amounts may vary significantly pursuant to certain provisions in such contracts that permit us to decrease required purchases under certain circumstances. These amounts include estimated commitments relating to purchased power lease contracts, see Note 8.
 
Of the various fuel and purchased power contracts mentioned above, some of those contracts for coal supply include take-or-pay provisions.  The current coal contracts with take-or-pay provisions have terms expiring through 2031.
 
The following table summarizes our estimated coal take-or-pay commitments (dollars in thousands):

	
																								
 	 Years Ended December 31,	
 	2019	 	2020	 	2021	 	2022	 	2023	 	Thereafter	
Coal take-or-pay commitments (a)	$	179,879		 	$	181,059		 	$	184,944		 	$	186,244		 	$	187,518		 	$	1,422,253		

(a)	Total take-or-pay commitments are approximately $2.3 billion .  The total net present value of these commitments is approximately $1.7 billion .	
 
APS may spend more to meet its actual fuel requirements than the minimum purchase obligations in our coal take-or-pay contracts. The following table summarizes actual amounts purchased under the coal contracts which include take-or-pay provisions for each of the last three years (dollars in thousands):

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
Total purchases	$	206,093		 	$	165,220		 	$	160,066		

Renewable Energy Credits
 
APS has entered into contracts to purchase renewable energy credits to comply with the RES.  APS estimates the contract requirements to be approximately $37 million in 2019 ; $36 million in 2020 ; $34 million in 2021 ; $31 million in 2022 ; $30 million in 2023 ; and $155 million thereafter.  These amounts do not include purchases of renewable energy credits that are bundled with energy.

151

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Coal Mine Reclamation Obligations
 
APS must reimburse certain coal providers for amounts incurred for final and contemporaneous coal mine reclamation.  We account for contemporaneous reclamation costs as part of the cost of the delivered coal.  We utilize site-specific studies of costs expected to be incurred in the future to estimate our final reclamation obligation.  These studies utilize various assumptions to estimate the future costs.  Based on the most recent reclamation studies, APS recorded an obligation for the coal mine final reclamation of approximately $213 million at December 31, 2018 and $216 million at December 31, 2017 . Under our current coal supply agreements, APS expects to make payments for the final mine reclamation as follows:  $32 million in 2019 ; $21 million in 2020 ; $21 million in 2021 ; $22 million in 2022 ; $24 million in 2023 ; and $167 million thereafter.  Any amendments to current coal supply agreements may change the timing of the contribution. Portions of these funds will be held in an escrow account and distributed to certain coal providers under the terms of the applicable coal supply agreements.

Superfund-Related Matters
 
The Comprehensive Environmental Response Compensation and Liability Act ("CERCLA" or "Superfund") establishes liability for the cleanup of hazardous substances found contaminating the soil, water or air.  Those who released, generated, transported to, or disposed of hazardous substances at a contaminated site are among the parties who are potentially responsible ("PRPs").  PRPs may be strictly, and often are jointly and severally, liable for clean-up. On September 3, 2003, EPA advised APS that EPA considers APS to be a PRP in the Motorola 52 nd  Street Superfund Site, Operable Unit 3 ("OU3") in Phoenix, Arizona.  APS has facilities that are within this Superfund site.  APS and Pinnacle West have agreed with EPA to perform certain investigative activities of the APS facilities within OU3.  In addition, on September 23, 2009, APS agreed with EPA and one other PRP to voluntarily assist with the funding and management of the site-wide groundwater remedial investigation and feasibility study ("RI/FS").  Based upon discussions between the OU3 working group parties and EPA, along with the results of recent technical analyses prepared by the OU3 working group to supplement the RI/FS for OU3, APS anticipates finalizing the RI/FS in the fall or winter of 2019. We estimate that our costs related to this investigation and study will be approximately $2 million .  We anticipate incurring additional expenditures in the future, but because the overall investigation is not complete and ultimate remediation requirements are not yet finalized, at the present time expenditures related to this matter cannot be reasonably estimated.
 
On August 6, 2013, Roosevelt Irrigation District ("RID") filed a lawsuit in Arizona District Court against APS and 24 other defendants, alleging that RID’s groundwater wells were contaminated by the release of hazardous substances from facilities owned or operated by the defendants.  The lawsuit also alleges that, under Superfund laws, the defendants are jointly and severally liable to RID.  The allegations against APS arise out of APS’s current and former ownership of facilities in and around OU3.  As part of a state governmental investigation into groundwater contamination in this area, on January 25, 2015, ADEQ sent a letter to APS seeking information concerning the degree to which, if any, APS’s current and former ownership of these facilities may have contributed to groundwater contamination in this area.  APS responded to ADEQ on May 4, 2015. On December 16, 2016, two RID environmental and engineering contractors filed an ancillary lawsuit for recovery of costs against APS and the other defendants in the RID litigation. That same day, another RID service provider filed an additional ancillary CERCLA lawsuit against certain of the defendants in the main RID litigation, but excluded APS and certain other parties as named defendants. Because the ancillary lawsuits concern past costs allegedly incurred by these RID vendors, which were ruled unrecoverable directly by RID in November of 2016, the additional lawsuits do not increase APS's exposure or risk related to these matters.

152

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On April 5, 2018, RID and the defendants in that particular litigation executed a settlement agreement, fully resolving RID's CERCLA claims concerning both past and future cost recovery. APS's share of this settlement was immaterial. In addition, the two environmental and engineering vendors voluntarily dismissed their lawsuit against APS and the other named defendants without prejudice. An order to this effect was entered on April 17, 2018. With this disposition of the case, the vendors may file their lawsuit again in the future. In addition, APS and certain other parties not named in the remaining RID service provider lawsuit may be brought into the litigation via third-party complaints filed by the current direct defendants. We are unable to predict the outcome of these matters; however, we do not expect the outcome to have a material impact on our financial position, results of operations or cash flows.
 
Environmental Matters
 
APS is subject to numerous environmental laws and regulations affecting many aspects of its present and future operations, including air emissions of both conventional pollutants and greenhouse gases, water quality, wastewater discharges, solid waste, hazardous waste, and CCRs.  These laws and regulations can change from time to time, imposing new obligations on APS resulting in increased capital, operating, and other costs.  Associated capital expenditures or operating costs could be material.  APS intends to seek recovery of any such environmental compliance costs through our rates, but cannot predict whether it will obtain such recovery.  The following proposed and final rules involve material compliance costs to APS.
 
Regional Haze Rules.   APS has received the final rulemaking imposing new pollution control requirements on Four Corners and the Navajo Plant. EPA will require these plants to install pollution control equipment that constitutes BART to lessen the impacts of emissions on visibility surrounding the plants. In addition, EPA issued a final rule for Regional Haze compliance at Cholla that does not involve the installation of new pollution controls and that will replace an earlier BART determination for this facility. See below for details of the Cholla BART approval.

Four Corners. Based on EPA’s final standards, APS's 63% share of the cost of required controls for Four Corners Units 4 and 5 is approximately $400 million , the majority of which has already been incurred.  In addition, APS and El Paso entered into an asset purchase agreement providing for the purchase by APS, or an affiliate of APS, of El Paso's 7% interest in Four Corners Units 4 and 5. 4CA purchased the El Paso interest on July 6, 2016. NTEC purchased the interest from 4CA on July 3, 2018. See "Four Corners Coal Supply Agreement - 4CA Matter" below for a discussion of the NTEC purchase. The cost of the pollution controls related to the 7% interest is approximately $45 million , which was assumed by NTEC through its purchase of the 7% interest.

Navajo Plant. APS estimates that its share of costs for upgrades at the Navajo Plant, based on EPA’s Federal Implementation Plan ("FIP"), could be up to approximately $200 million ; however, given the future plans for the Navajo Plant, we do not expect to incur these costs.  See "Navajo Plant" in Note 3 for information regarding future plans for the Navajo Plant.

Cholla . APS believed that EPA’s original 2012 final rule establishing controls constituting BART for Cholla, which would require installation of SCR controls, was unsupported and that EPA had no basis for disapproving Arizona’s State Implementation Plan ("SIP") and promulgating a FIP that was inconsistent with the state’s considered BART determinations under the regional haze program.  In September 2014, APS met with EPA to propose a compromise BART strategy, whereby APS would permanently close Cholla Unit 2 and cease burning coal at Units 1 and 3 by the mid-2020s. (See Note 3 for details related to the resulting regulatory asset.) APS made the proposal with the understanding that additional emission control equipment is unlikely to be required in the future because retiring and/or converting the units as contemplated in the proposal is more

153

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

cost effective than, and will result in increased visibility improvement over, the BART requirements for oxides of nitrogen ("NOx") imposed through EPA's BART FIP. In early 2017, EPA approved a final rule incorporating APS's compromise proposal, which took effect for Cholla on April 26, 2017.
 
Coal Combustion Waste . On December 19, 2014, EPA issued its final regulations governing the handling and disposal of CCR, such as fly ash and bottom ash. The rule regulates CCR as a non-hazardous waste under Subtitle D of the Resource Conservation and Recovery Act ("RCRA") and establishes national minimum criteria for existing and new CCR landfills and surface impoundments and all lateral expansions consisting of location restrictions, design and operating criteria, groundwater monitoring and corrective action, closure requirements and post closure care, and recordkeeping, notification, and internet posting requirements. The rule generally requires any existing unlined CCR surface impoundment that is contaminating groundwater above a regulated constituent’s groundwater protection standard to stop receiving CCR and either retrofit or close, and further requires the closure of any CCR landfill or surface impoundment that cannot meet the applicable performance criteria for location restrictions or structural integrity. Such closure requirements are deemed "forced closure" or "closure for cause" of unlined surface impoundments, and are the subject of recent regulatory and judicial activities described below.

On December 16, 2016, President Obama signed the Water Infrastructure Improvements for the Nation ("WIIN") Act into law, which contains a number of provisions requiring EPA to modify the self-implementing provisions of the Agency's current CCR rules under Subtitle D. Such modifications include new EPA authority to directly enforce the CCR rules through the use of administrative orders and providing states, like Arizona, where the Cholla facility is located, the option of developing CCR disposal unit permitting programs, subject to EPA approval. For facilities in states that do not develop state-specific permitting programs, EPA is required to develop a federal permit program, pending the availability of congressional appropriations. By contrast, for facilities located within the boundaries of Native American tribal reservations, such as the Navajo Nation, where the Navajo Plant and Four Corners facilities are located, EPA is required to develop a federal permit program regardless of appropriated funds.

ADEQ has initiated a process to evaluate how to develop a state CCR permitting program that would cover electric generating units ("EGUs"), including Cholla. While APS has been working with ADEQ on the development of this program, we are unable to predict when Arizona will be able to finalize and secure EPA approval for a state-specific CCR permitting program. With respect to the Navajo Nation, APS has sought clarification as to when and how EPA would be initiating permit proceedings for facilities on the reservation, including Four Corners. We are unable to predict at this time when EPA will be issuing CCR management permits for the facilities on the Navajo Nation. At this time, it remains unclear how the CCR provisions of the WIIN Act will affect APS and its management of CCR.

Based upon utility industry petitions for EPA to reconsider the RCRA Subtitle D regulations for CCR, which were premised in part on the CCR provisions of the 2016 WIIN Act, on September 13, 2017 EPA agreed to evaluate whether to revise these federal CCR regulations. On July 17, 2018, EPA finalized a revision to its RCRA Subtitle D regulations for CCR, the "Phase I, Part I" revision to its CCR regulations, deferring for future action a number of other proposed changes contemplated in a March 1, 2018 proposal. For the final rule issued on July 17, 2018, EPA established nationwide health-based standards for certain constituents of CCR subject to groundwater corrective action and delayed the closure deadlines for certain unlined CCR surface impoundments by 18 months (for example, those disposal units required to undergo forced closure). These changes to the federal regulations governing CCR disposal are unlikely to have a material impact on APS. As for those aspects of the March 2018 rulemaking proposal for which EPA has yet to take final action, it remains unclear which specific provisions of the federal CCR rules will ultimately be modified, how they will be modified, or when such modification will occur.

154

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pursuant to a June 24, 2016 order by the D.C. Circuit Court of Appeals in the litigation by industry- and environmental-groups challenging EPA’s CCR regulations, EPA is required to complete a rulemaking proceeding in the near future concerning whether or not boron must be included on the list of groundwater constituents that might trigger corrective action under EPA’s CCR rules.  Simultaneously with the issuance of EPA's proposed modifications to the federal CCR rules in response to industry petitions, on March 1, 2018, EPA issued a proposed rule seeking comment as to whether or not boron should be included on this list. EPA is not required to take final action approving the inclusion of boron.  Should EPA take final action adding boron to the list of groundwater constituents that might trigger corrective action, any resulting corrective action measures may increase APS's costs of compliance with the CCR rule at our coal-fired generating facilities.  At this time APS cannot predict the eventual results of this rulemaking proceeding concerning boron.

On August 21, 2018, the D.C. Circuit Court issued its decision on the merits in this litigation. The Court upheld the legality of EPA’s CCR regulations, though it vacated and remanded back to EPA a number of specific provisions, which are to be corrected in accordance with the Court’s order. Among the issues affecting APS’s management of CCR, the D.C. Circuit’s decision vacated and remanded those provisions of the EPA CCR regulations that allow for the operation of unlined CCR surface impoundments, even where those unlined impoundments have not otherwise violated a regulatory location restriction or groundwater protection standard (i.e., otherwise triggering forced closure). At this time, it remains unclear how this D.C. Circuit Court decision will affect APS’s operations or any financial impacts, as EPA has yet to take regulatory action on remand to revise its 2015 CCR regulations consistent with the Court’s order.

Based on this decision, on December 17, 2018, certain environmental groups filed an emergency motion with the D.C. Circuit to either stay or summarily vacate EPA's July 17, 2018 final rule extending the closure-initiation deadline for certain unlined CCR surface impoundments until October 2020. In response, EPA filed a motion to remand but not vacate that deadline extension regulation. We cannot predict the outcome of the D.C. Circuit's consideration of these dueling motions, and whether or how such a ruling would affect APS's operations.

APS currently disposes of CCR in ash ponds and dry storage areas at Cholla and Four Corners. APS estimates that its share of incremental costs to comply with the CCR rule for Four Corners is approximately $22 million and its share of incremental costs to comply with the CCR rule for Cholla is approximately $20 million . The Navajo Plant currently disposes of CCR in a dry landfill storage area. APS estimates that its share of incremental costs to comply with the CCR rule for the Navajo Plant is approximately $1 million . Additionally, the CCR rule requires ongoing, phased groundwater monitoring. By October 17, 2017, electric utility companies that own or operate CCR disposal units, such as APS, must have collected sufficient groundwater sampling data to initiate a detection monitoring program.  To the extent that certain threshold constituents are identified through this initial detection monitoring at levels above the CCR rule’s standards, the rule required the initiation of an assessment monitoring program by April 15, 2018.

APS recently completed the statistical analyses for its CCR disposal units that triggered assessment monitoring. APS determined that several of its CCR disposal units at Cholla and Four Corners will need to undergo corrective action. In addition, all such units must cease operating and initiate closure by October of 2020. APS currently estimates that the additional incremental costs to complete this corrective action and closure work, along with the costs to develop replacement CCR disposal capacity, could be approximately $5 million for both Cholla and Four Corners. APS initiated an assessment of corrective measures on January 14, 2019, and anticipates completing this assessment during the summer of 2019. During this assessment, APS will gather additional groundwater data, solicit input from the public, host public hearings, and select remedies. As such, this $5 million cost estimate may change based upon APS’s performance of the CCR rule’s corrective action assessment process. Given uncertainties that may exist until we have fully completed the corrective

155

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

action assessment process, we cannot predict any ultimate impacts to the Company; however, at this time we do not believe any potential change to the cost estimate would have a material impact on our financial position, results of operations or cash flows.

Clean Power Plan. On June 2, 2014, EPA issued two proposed rules to regulate greenhouse gas ("GHG") emissions from modified and reconstructed EGUs pursuant to Section 111(b) of the Clean Air Act and existing fossil fuel-fired power plants pursuant to Clean Air Act Section 111(d). On August 3, 2015, EPA finalized carbon pollution standards for EGUs, the "Clean Power Plan". On October 10, 2017, EPA issued a proposal to repeal the Clean Power Plan and proposed replacement regulations on August 21, 2018. In addition, judicial challenges to the Clean Power Plan are pending before the D.C. Circuit, though that litigation is currently in abeyance while EPA develops regulatory action to potentially repeal and replace that regulation.

EPA's pending proposal to regulate carbon emissions from EGUs replaces the Clean Power Plan with standards that are based entirely upon measures that can be implemented to improve the heat rate of steam-electric power plants, specifically coal-fired EGUs. In contrast with the Clean Power Plan, EPA's proposed "Affordable Clean Energy Rule" would not involve utility-level generation dispatch shifting away from coal-fired generation and toward renewable energy resources and natural gas-fired combined cycle power plants. In addition, to address the New Source Review ("NSR") implications of power plant upgrades potentially necessary to achieve compliance with the proposed Affordable Clean Energy Rule standards, EPA also proposed to revise EPA's NSR regulations to more readily authorize the implementation of EGU efficiency upgrades.

We cannot predict the outcome of EPA's regulatory actions related to the August 2015 carbon pollution standards for EGU's, including any actions related to EPA's repeal proposal for the Clean Power Plan or additional rulemaking actions to approve the EPA's recently proposed Affordable Clean Energy Rule. In addition, we cannot predict whether the D.C. Circuit Court will continue to hold the litigation challenging the original Clean Power Plan in abeyance in light of EPA's repeal proposal, which is still pending.

Other environmental rules that could involve material compliance costs include those related to effluent limitations, the ozone national ambient air quality standard and other rules or matters involving the Clean Air Act, Clean Water Act, Endangered Species Act, RCRA, Superfund, the Navajo Nation, and water supplies for our power plants.  The financial impact of complying with current and future environmental rules could jeopardize the economic viability of our coal plants or the willingness or ability of power plant participants to fund any required equipment upgrades or continue their participation in these plants.  The economics of continuing to own certain resources, particularly our coal plants, may deteriorate, warranting early retirement of those plants, which may result in asset impairments.  APS would seek recovery in rates for the book value of any remaining investments in the plants as well as other costs related to early retirement, but cannot predict whether it would obtain such recovery.
 
Federal Agency Environmental Lawsuit Related to Four Corners

On April 20, 2016, several environmental groups filed a lawsuit against OSM and other federal agencies in the District of Arizona in connection with their issuance of the approvals that extended the life of Four Corners and the adjacent mine.  The lawsuit alleges that these federal agencies violated both the Endangered Species Act ("ESA") and the National Environmental Policy Act ("NEPA") in providing the federal approvals necessary to extend operations at the Four Corners Power Plant and the adjacent Navajo Mine past July 6, 2016.  APS filed a motion to intervene in the proceedings, which was granted on August 3, 2016.

156

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On September 15, 2016, NTEC, the company that owns the adjacent mine, filed a motion to intervene for the purpose of dismissing the lawsuit based on NTEC's tribal sovereign immunity. On September 11, 2017, the Arizona District Court issued an order granting NTEC's motion, dismissing the litigation with prejudice, and terminating the proceedings. On November 9, 2017, the environmental group plaintiffs appealed the district court order dismissing their lawsuit. Oral argument for this appeal has been scheduled for March 2019. We cannot predict whether this appeal will be successful and, if it is successful, the outcome of further district court proceedings.

Four Corners National Pollutant Discharge Elimination System ("NPDES") Permit

On July 16, 2018, several environmental groups filed a petition for review before the EPA Environmental Appeals Board ("EAB") concerning the NPDES wastewater discharge permit for Four Corners, which was reissued on June 12, 2018.  The environmental groups allege that the permit was reissued in contravention of several requirements under the Clean Water Act and did not contain required provisions concerning EPA’s 2015 revised effluent limitation guidelines for steam-electric EGUs, 2014 existing-source regulations governing cooling-water intake structures, and effluent limits for surface seepage and subsurface discharges from coal-ash disposal facilities.  To address certain of these issues through a reconsidered permit, EPA took action on December 19, 2018 to withdraw the NPDES permit reissued in June 2018. Withdrawal of the permit moots the EAB appeal, and EPA filed a motion to dismiss on that basis. EPA indicated that it anticipates proposing a replacement NPDES permit by March 2019 and, depending on the extent of public comments concerning that proposal, taking final action on a new NPDES permit by June 2019. At this time, we cannot predict the outcome of EPA's reconsideration of the NPDES permit and whether reconsideration will have a material impact on our financial position, results of operations or cash flows.

Four Corners Coal Supply Agreement

Arbitration

On June 13, 2017, APS received a Demand for Arbitration from NTEC in connection with the Coal Supply Agreement, dated December 30, 2013, under which NTEC supplies coal to APS and the other Four Corners owners (collectively, the “Buyer”) for use at the Four Corners Power Plant (the "2016 Coal Supply Agreement"). NTEC was originally seeking a declaratory judgment to support its interpretation of a provision regarding uncontrollable forces in the agreement that relates to annual minimum quantities of coal to be purchased by the Buyer. NTEC also alleged a shortfall in the Buyer’s purchases for the initial contract year of approximately $30 million . APS’s share of this amount is approximately $17 million . On September 20, 2017, NTEC amended its Demand for Arbitration, removing its request for a declaratory judgment and at such time was only seeking relief for the alleged shortfall in the Buyer's purchases for the initial contract year.

On June 29, 2018, the parties settled the dispute for $45 million , which includes settlement for the initial contract year and the current contract year. APS’s share of this amount is approximately $34 million . In connection with the settlement, the parties amended the 2016 Coal Supply Agreement, including modifying the provisions that gave rise to this dispute. (See “4CA Matter” below for additional matters agreed to between 4CA and NTEC in the settlement arrangement.) The arbitration was dismissed on July 9, 2018.

Coal Advance Purchase

On March 12, 2018, APS paid to NTEC approximately $24 million as an advance payment for APS’s share of coal under the 2016 Coal Supply Agreement. The coal inventory purchased represents an amount that APS expects to use for its plant operations within the next year.

157

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4CA Matter

On July 6, 2016, 4CA purchased El Paso’s 7% interest in Four Corners. NTEC had the option to purchase the 7% interest within a certain timeframe pursuant to an option granted to NTEC. On December 29, 2015, NTEC provided notice of its intent to exercise the option. The purchase did not occur during the originally contemplated timeframe. Concurrent with the settlement of the 2016 Coal Supply Agreement matter described above, NTEC and 4CA agreed to allow for the purchase by NTEC of the 7% interest, consistent with the option. On June 29, 2018, 4CA and NTEC entered into an asset purchase agreement providing for the sale to NTEC of 4CA's 7% interest in Four Corners. Completion of the sale was subject to the receipt of approval by FERC, which was received on July 2, 2018, and the sale transaction closed on July 3, 2018. NTEC purchased the 7% interest at 4CA’s book value, approximately $70 million , and will pay 4CA the purchase price over a period of four years pursuant to a secured interest-bearing promissory note. In connection with the sale, Pinnacle West guaranteed certain obligations that NTEC will have to the other owners of Four Corners, such as NTEC's 7% share of capital expenditures and operating and maintenance expenses. Pinnacle West's guarantee is secured by a portion of APS's payments to be owed to NTEC under the 2016 Coal Supply Agreement.
The 2016 Coal Supply Agreement contained alternate pricing terms for the 7% interest in the event NTEC did not purchase the interest. Until the time that NTEC purchased the 7% interest, the alternate pricing provisions were applicable to 4CA as the holder of the 7% interest. These terms included a formula under which NTEC must make certain payments to 4CA for reimbursement of operations and maintenance costs and a specified rate of return, offset by revenue generated by 4CA’s power sales. Such payments are due to 4CA at the end of each calendar year. A $10 million payment was due to 4CA at December 31, 2017, which NTEC satisfied by directing to 4CA a prepayment from APS of a portion of a future mine reclamation obligation. The balance of the amount under this formula due December 31, 2018 for calendar year 2017 is approximately $20 million , which was paid to 4CA on December 14, 2018. The balance of the amount under this formula at December 31, 2018 for calendar year 2018 (up to the date that NTEC purchased the 7% interest) is approximately $10 million , which is due to 4CA at December 31, 2019.
Financial Assurances
 
In the normal course of business, we obtain standby letters of credit and surety bonds from financial institutions and other third parties. These instruments guarantee our own future performance and provide third parties with financial and performance assurance in the event we do not perform. These instruments support certain commodity contract collateral obligations and other transactions. As of December 31, 2018 , standby letters of credit totaled $0.2 million and will expire in 2019. As of December 31, 2018 , surety bonds expiring through 2019 totaled $17 million . The underlying liabilities insured by these instruments are reflected on our balance sheets, where applicable. Therefore, no additional liability is reflected for the letters of credit and surety bonds themselves.
 
We enter into agreements that include indemnification provisions relating to liabilities arising from or related to certain of our agreements.  Most significantly, APS has agreed to indemnify the equity participants and other parties in the Palo Verde sale leaseback transactions with respect to certain tax matters.  Generally, a maximum obligation is not explicitly stated in the indemnification provisions and, therefore, the overall maximum amount of the obligation under such indemnification provisions cannot be reasonably estimated.  Based on historical experience and evaluation of the specific indemnities, we do not believe that any material loss related to such indemnification provisions is likely.

158

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Pinnacle West has issued parental guarantees and has provided indemnification under certain surety bonds for APS which were not material at December 31, 2018 . Since July 6, 2016, Pinnacle West has issued five parental guarantees for 4CA relating to payment obligations arising from 4CA’s acquisition of El Paso’s 7% interest in Four Corners, and pursuant to the Four Corners participation agreement payment obligations arising from 4CA’s ownership interest in Four Corners, four of which terminated following the sale of 4CA's 7% interest to NTEC. (See "Four Corners Coal Supply Agreement - 4CA Matter" above for information related to this sale.)

In connection with the sale of 4CA's 7% interest to NTEC, Pinnacle West is guaranteeing certain obligations that NTEC will have to the other owners of Four Corners. (See "Four Corners Coal Supply Agreement - 4CA Matter" above for information related to this guarantee.) A maximum obligation is not
explicitly stated in the guarantee and, therefore, the overall maximum amount of the obligation under such guarantee cannot be reasonably estimated; however, we consider the fair value of this guarantee to be immaterial.
 
11 .      Asset Retirement Obligations
 
In 2018, APS recognized an ARO for the removal of hazardous waste containing solar panels at all of our utility scale solar plants, which resulted in an increase to the ARO in the amount of $14 million . In addition, due to the sale of 4CA assets to NTEC in 2018 (see Note 10 for more information on 4CA matters) there was a decrease to the ARO of $9 million . APS recognized an ARO of $7 million for rooftop solar removals in accordance with the obligations included in the customer contracts, which requires APS to remove the panels at the end of the contract life and includes the costs for the disposal of hazardous materials in accordance with environmental regulations. Finally, APS has other ARO adjustments resulting in a net decrease of $1 million .

In 2017, APS received a new decommissioning study for the Navajo Plant. This resulted in an increase to the ARO in the amount of $22 million , an increase in regulatory asset of $2 million and a reduction of the regulatory liability of $20 million .

The following table shows the change in our asset retirement obligations for 2018 and 2017 (dollars in thousands):

	
								
 	2018	 	2017	
Asset retirement obligations at the beginning of year	$	679,529		 	$	624,475		
Changes attributable to:	 		 	 		
Accretion expense	36,876		 	33,104		
Settlements	(9,726	)	 	—		
Estimated cash flow revisions	2,002		 	21,950		
Newly incurred or acquired obligations	17,864		 	—		
Asset retirement obligations at the end of year	$	726,545		 	$	679,529		

In accordance with regulatory accounting, APS accrues removal costs for its regulated utility assets, even if there is no legal obligation for removal.  See detail of regulatory liabilities in Note 3.

159

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12 .     Selected Quarterly Financial Data (Unaudited)

Consolidated quarterly financial information for 2018 and 2017 is provided in the tables below (dollars in thousands, except per share amounts).  Weather conditions cause significant seasonal fluctuations in our revenues; therefore, results for interim periods do not necessarily represent results expected for the year.

	
																				
 	2018 Quarter Ended	 	2018	
 	March 31,	 	June 30,	 	September 30,	 	December 31,	 	Total	
Operating revenues	$	692,714		 	$	974,123		 	$	1,268,034		 	$	756,376		 	$	3,691,247		
Operations and maintenance	265,682		 	268,397		 	246,545		 	256,120		 	1,036,744		
Operating income	31,334		 	242,162		 	433,307		 	66,884		 	773,687		
Income taxes	(1,265	)	 	44,039		 	84,333		 	6,795		 	133,902		
Net income	8,094		 	171,612		 	319,885		 	30,949		 	530,540		
Net income attributable to common shareholders	3,221		 	166,738		 	315,012		 	26,076		 	511,047		
 	 	 	 	 	 	 	 	 	 	
Earnings Per Share:	 		 	 		 	 		 	 		 	 		
Net income attributable to common shareholders — Basic	$	0.03		 	$	1.49		 	$	2.81		 	$	0.23		 	$	4.56		
Net income attributable to common shareholders — Diluted	0.03		 	1.48		 	2.80		 	0.23		 	4.54		

	
																				
 	2017 Quarter Ended	 	2017	
 	March 31,	 	June 30,	 	September 30,	 	December 31,	 	Total	
Operating revenues	$	677,728		 	$	944,587		 	$	1,183,322		 	$	759,659		 	$	3,565,296		
Operations and maintenance	226,071		 	220,985		 	230,839		 	271,212		 	949,107		
Operating income	67,411		 	297,257		 	459,548		 	85,547		 	909,763		
Income taxes	4,211		 	88,967		 	144,319		 	20,775		 	258,272		
Net income	28,185		 	172,317		 	280,945		 	26,502		 	507,949		
Net income attributable to common shareholders	23,312		 	167,443		 	276,072		 	21,629		 	488,456		
 	 	 	 	 	 	 	 	 	 	
Earnings Per Share:	 		 	 		 	 		 	 		 	 		
Net income attributable to common shareholders — Basic	$	0.21		 	$	1.50		 	$	2.47		 	$	0.19		 	$	4.37		
Net income attributable to common shareholders — Diluted	0.21		 	1.49		 	2.46		 	0.19		 	4.35		

160

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Selected Quarterly Financial Data (Unaudited) - APS
 
APS's quarterly financial information for 2018 and 2017 is as follows (dollars in thousands):

	
																				
 	2018 Quarter Ended	 	2018	
 	March 31,	 	June 30,	 	September 30,	 	December 31,	 	Total	
Operating revenues	$	692,006		 	$	971,963		 	$	1,267,997		 	$	756,376		 	$	3,688,342		
Operations and maintenance	254,601		 	251,999		 	226,346		 	236,281		 	969,227		
Operating income	37,878		 	251,590		 	453,547		 	86,753		 	829,768		
Net income attributable to common shareholder	9,599		 	177,825		 	338,366		 	44,475		 	570,265		

	
																				
 	2017 Quarter Ended	 	2017	
 	March 31,	 	June 30,	 	September 30,	 	December 31,	 	Total	
Operating revenues	$	677,589		 	$	943,406		 	$	1,178,846		 	$	757,811		 	$	3,557,652		
Operations and maintenance	219,008		 	215,775		 	222,374		 	260,826		 	917,983		
Operating income	70,269		 	296,700		 	465,658		 	91,912		 	924,539		
Net income attributable to common shareholder	23,162		 	169,108		 	284,256		 	27,783		 	504,309		

13 .     Fair Value Measurements
 
We classify our assets and liabilities that are carried at fair value within the fair value hierarchy.  This hierarchy ranks the quality and reliability of the inputs used to determine fair values, which are then classified and disclosed in one of three categories.  The three levels of the fair value hierarchy are:
 
Level 1 — Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 — Other significant observable inputs, including quoted prices in active markets for similar assets or liabilities; quoted prices in markets that are not active, and model-derived valuations whose inputs are observable (such as yield curves). 
 
Level 3 — Valuation models with significant unobservable inputs that are supported by little or no market activity.  Instruments in this category include long-dated derivative transactions where valuations are unobservable due to the length of the transaction, options, and transactions in locations where observable market data does not exist.  The valuation models we employ utilize spot prices, forward prices, historical market data and other factors to forecast future prices.
 
Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.  Thus, a valuation may be classified in Level 3 even though the valuation may include significant inputs that are readily observable.  We maximize the use of observable inputs and minimize the use of unobservable inputs.  We rely primarily on the market approach of using prices and other market information for identical and/or comparable assets and liabilities.  If market data is not readily available, inputs may reflect our own assumptions about the inputs market participants would use.  Our assessment of the inputs and the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities as well as their placement within the fair value hierarchy levels.  We assess whether a market is active by obtaining observable broker quotes, reviewing actual market activity, and assessing the volume of transactions.  We consider broker quotes observable inputs when the quote is

161

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

binding on the broker, we can validate the quote with market activity, or we can determine that the inputs the broker used to arrive at the quoted price are observable.

Certain instruments have been valued using the concept of Net Asset Value ("NAV"), as a practical expedient. These instruments are typically structured as investment companies offering shares or units to multiple investors for the purpose of providing a return. These instruments are similar to mutual funds; however, their NAV is generally not published and publicly available, nor are these instruments traded on an exchange. Instruments valued using NAV, as a practical expedient are included in our fair value disclosures however, in accordance with GAAP are not classified within the fair value hierarchy levels.

Recurring Fair Value Measurements
 
We apply recurring fair value measurements to cash equivalents, derivative instruments, and investments held in the nuclear decommissioning trust and other special use funds. On an annual basis we apply fair value measurements to plan assets held in our retirement and other benefit plans.  See Note 7 for fair value discussion of plan assets held in our retirement and other benefit plans.
 
Cash Equivalents
 
Cash equivalents represent certain investments in money market funds that are valued using quoted prices in active markets.

Risk Management Activities — Derivative Instruments
 
Exchange traded commodity contracts are valued using unadjusted quoted prices.  For non-exchange traded commodity contracts, we calculate fair value based on the average of the bid and offer price, discounted to reflect net present value.  We maintain certain valuation adjustments for a number of risks associated with the valuation of future commitments.  These include valuation adjustments for liquidity and credit risks.  The liquidity valuation adjustment represents the cost that would be incurred if all unmatched positions were closed out or hedged.  The credit valuation adjustment represents estimated credit losses on our net exposure to counterparties, taking into account netting agreements, expected default experience for the credit rating of the counterparties and the overall diversification of the portfolio.  We maintain credit policies that management believes minimize overall credit risk.
 
Certain non-exchange traded commodity contracts are valued based on unobservable inputs due to the long-term nature of contracts, characteristics of the product, or the unique location of the transactions.  Our long-dated energy transactions consist of observable valuations for the near-term portion and unobservable valuations for the long-term portions of the transaction.  We rely primarily on broker quotes to value these instruments.  When our valuations utilize broker quotes, we perform various control procedures to ensure the quote has been developed consistent with fair value accounting guidance.  These controls include assessing the quote for reasonableness by comparison against other broker quotes, reviewing historical price relationships, and assessing market activity.  When broker quotes are not available, the primary valuation technique used to calculate the fair value is the extrapolation of forward pricing curves using observable market data for more liquid delivery points in the same region and actual transactions at more illiquid delivery points.
 
When the unobservable portion is significant to the overall valuation of the transaction, the entire transaction is classified as Level 3.  Our classification of instruments as Level 3 is primarily reflective of the long-term nature of our energy transactions.

162

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Our energy risk management committee, consisting of officers and key management personnel, oversees our energy risk management activities to ensure compliance with our stated energy risk management policies.  We have a risk control function that is responsible for valuing our derivative commodity instruments in accordance with established policies and procedures.  The risk control function reports to the chief financial officer’s organization.
 
Investments Held in Nuclear Decommissioning Trust and Other Special Use Funds
 
The nuclear decommissioning trust and other special use funds invest in fixed income and equity securities. Other special use funds include the coal reclamation escrow account and the active union medical trust. See Note 19 for additional discussion about our investment accounts.

We value investments in fixed income and equity securities using information provided by our trustees and escrow agent. Our trustees and escrow agent use pricing services that utilize the valuation methodologies described below to determine fair market value. We have internal control procedures designed to ensure this information is consistent with fair value accounting guidance. These procedures include assessing valuations using an independent pricing source, verifying that pricing can be supported by actual recent market transactions, assessing hierarchy classifications, comparing investment returns with benchmarks, and obtaining and reviewing independent audit reports on the trustees’ and escrow agent's internal operating controls and valuation processes.

Fixed Income Securities

Fixed income securities issued by the U.S. Treasury are valued using quoted active market prices and are typically classified as Level 1.  Fixed income securities issued by corporations, municipalities, and other agencies, including mortgage-backed instruments, are valued using quoted inactive market prices, quoted active market prices for similar securities, or by utilizing calculations which incorporate observable inputs such as yield curves and spreads relative to such yield curves.  These fixed income instruments are classified as Level 2.  Whenever possible, multiple market quotes are obtained which enables a cross-check validation.  A primary price source is identified based on asset type, class, or issue of securities.

Fixed income securities may also include short-term investments in certificates of deposit, variable rate notes, time deposit accounts, U.S. Treasury and Agency obligations, U.S. Treasury repurchase agreements, commercial paper, and other short term instruments. These instruments are valued using active market prices or utilizing observable inputs described above.

Equity Securities

The nuclear decommissioning trust's equity security investments are held indirectly through commingled funds.  The commingled funds are valued using the funds' NAV as a practical expedient. The funds' NAV is primarily derived from the quoted active market prices of the underlying equity securities held by the funds. We may transact in these commingled funds on a semi-monthly basis at the NAV.  The commingled funds are maintained by a bank and hold investments in accordance with the stated objective of tracking the performance of the S&P 500 Index.  Because the commingled funds' shares are offered to a limited group of investors, they are not considered to be traded in an active market. As these instruments are valued using NAV, as a practical expedient, they have not been classified within the fair value hierarchy.

163

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The nuclear decommissioning trust and other special use funds may also hold equity securities that include exchange traded mutual funds and money market accounts for short-term liquidity purposes. These short-term, highly-liquid, investments are valued using active market prices.

  Fair Value Tables
 
The following table presents the fair value at December 31, 2018 of our assets and liabilities that are measured at fair value on a recurring basis (dollars in thousands):

	
																						
 	Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)	 	Significant
Other
Observable
Inputs
(Level 2)	 	Significant
Unobservable
Inputs 
(Level 3)	 	Other	 	 	 	Balance at December 31, 2018	
Assets	 		 	 		 	 		 	 		 	 	 	 		
Cash equivalents	$	1,200		 	$	—		 	$	—		 	$	—		 	 	 	$	1,200		
Risk management activities — derivative instruments:	 		 	 		 	 		 	 		 	 	 	 		
Commodity contracts	—		 	3,140		 	2		 	(2,029	)	 	(a)	 	1,113		
Nuclear decommissioning trust:	 		 	 		 	 		 	 	 	 	 	 		
Equity securities	5,203		 	—		 	—		 	2,148		 	(b)	 	7,351		
U.S. commingled equity funds	—		 	—		 	—		 	396,805		 	(c)	 	396,805		
U.S. Treasury debt	148,173		 	—		 	—		 	—		 	 	 	148,173		
Corporate debt	—		 	96,656		 	—		 	—		 	 	 	96,656		
Mortgage-backed debt securities	—		 	113,115		 	—		 	—		 	 	 	113,115		
Municipal bonds	—		 	79,073		 	—		 	—		 	 	 	79,073		
Other fixed income	—		 	9,961		 	—		 	—		 	 	 	9,961		
Subtotal nuclear decommissioning trust	153,376		 	298,805		 	—		 	398,953		 		 	851,134		
 	 	 	 	 	 	 	 	 	 	 	 	
Other special use funds:	 	 	 	 	 	 	 	 	 	 	 	
Equity securities	45,130		 	—		 	—		 	593		 	(b)	 	45,723		
U.S. Treasury debt	173,310		 	—		 	—		 	—		 	 	 	173,310		
Municipal bonds	—		 	17,068		 	—		 	—		 	 	 	17,068		
Subtotal other special use funds	218,440		 	17,068		 	—		 	593		 	 	 	236,101		
 	 	 	 	 	 	 	 	 	 	 	 	
Total Assets	$	373,016		 	$	319,013		 	$	2		 	$	397,517		 	 	 	$	1,089,548		
Liabilities	 		 	 		 	 		 	 		 	 	 	 		
Risk management activities — derivative instruments:	 		 	 		 	 		 	 		 	 	 	 		
Commodity contracts	$	—		 	$	(52,696	)	 	$	(8,216	)	 	$	875		 	(a)	 	$	(60,037	)	

(a)	Represents counterparty netting, margin, and collateral. See Note 16.	
		
(b)	Represents net pending securities sales and purchases.	
		
(c)	Valued using NAV as a practical expedient and, therefore, are not classified in the fair value hierarchy.	

164

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 The following table presents the fair value at December 31, 2017 of our assets and liabilities that are measured at fair value on a recurring basis (dollars in thousands):

	
																						
 	Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)	 	Significant
Other
Observable
Inputs
(Level 2)	 	Significant
Unobservable
Inputs (a)
(Level 3)	 	Other	 	 	 	Balance at December 31, 2017	
Assets	 		 	 		 	 		 	 		 	 	 	 		
Cash equivalents	$	10,630		 	$	—		 	$	—		 	$	—		 	 	 	$	10,630		
Risk management activities — derivative instruments:	 		 	 		 	 		 	 		 	 	 	 		
Commodity contracts	—		 	5,683		 	1,036		 	(4,737	)	 	(b)	 	1,982		
Nuclear decommissioning trust:	 		 	 		 	 		 	 		 	 	 	 		
Cash and cash equivalents	7,224		 	—		 	—		 	109		 	(d)	 	7,333		
U.S. commingled equity funds	—		 	—		 	—		 	417,390		 	(e)	 	417,390		
U.S. Treasury debt	127,662		 	—		 	—		 	—		 	 	 	127,662		
Corporate debt	—		 	114,007		 	—		 	—		 	 	 	114,007		
Mortgage-backed debt securities	—		 	111,874		 	—		 	—		 	 	 	111,874		
Municipal bonds	—		 	79,049		 	—		 	—		 	 	 	79,049		
Other fixed income	—		 	13,685		 	—		 	—		 	 	 	13,685		
Subtotal nuclear decommissioning trust	134,886		 	318,615		 	—		 	417,499		 		 	871,000		
 	 	 	 	 	 	 	 	 	 	 	 	
Other special use funds (c):	455		 	31,562		 	—		 	525		 	 	 	32,542		
 	 	 	 	 	 	 	 	 	 	 	 	
Total Assets	$	145,971		 	$	355,860		 	$	1,036		 	$	413,287		 		 	$	916,154		
Liabilities	 		 	 		 	 		 	 		 	 	 	 		
Risk management activities — derivative instruments:	 		 	 		 	 		 	 		 	 	 	 		
Commodity contracts	$	—		 	$	(78,646	)	 	$	(19,292	)	 	$	1,516		 	(b)	 	$	(96,422	)	
		
(a)	Primarily consists of long-dated electricity contracts.	
		
(b)	Represents counterparty netting, margin, and collateral. See Note 16.	
		
(c)	Primarily consists of fixed income municipal bonds. Presented as coal reclamation escrow in 2017.	
		
(d)	Represents nuclear decommissioning trust net pending securities sales and purchases.	
		
(e)	Valued using NAV as a practical expedient and, therefore, are not classified in the fair value hierarchy.	
 
Fair Value Measurements Classified as Level 3
 
The significant unobservable inputs used in the fair value measurement of our energy derivative contracts include broker quotes that cannot be validated as an observable input primarily due to the long-term nature of the quote.  Significant changes in these inputs in isolation would result in significantly higher or lower fair value measurements.  Changes in our derivative contract fair values, including changes relating to unobservable inputs, typically will not impact net income due to regulatory accounting treatment (see Note 3).
 
Because our forward commodity contracts classified as Level 3 are currently in a net purchase position, we would expect price increases of the underlying commodity to result in increases in the net fair value of the

165

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

related contracts.  Conversely, if the price of the underlying commodity decreases, the net fair value of the related contracts would likely decrease.

Other unobservable valuation inputs include credit and liquidity reserves which do not have a material impact on our valuations; however, significant changes in these inputs could also result in higher or lower fair value measurements.
 
The following tables provide information regarding our significant unobservable inputs used to value our risk management derivative Level 3 instruments at December 31, 2018 and December 31, 2017 :

	
																		
 	December 31, 2018
Fair Value (thousands)	 	Valuation Technique	 	Significant Unobservable Input	 	Range	 	Weighted-Average	
Commodity Contracts	Assets	 	Liabilities	 								
Electricity:	 		 	 		 	 	 	 	 	 	 	 		
Forward Contracts (a)	$	—		 	$	2,456		 	Discounted cash flows	 	Electricity forward price (per MWh)	 	$17.88 - $37.03	 	$	26.10		
Natural Gas:	 		 	 		 	 	 	 	 	 	 	 		
Forward Contracts (a)	2		 	5,760		 	Discounted cash flows	 	Natural gas forward price (per MMBtu)	 	$1.79 - $2.92	 	$	2.48		
Total	$	2		 	$	8,216		 	 	 	 	 	 	 	 		
		
(a)	Includes swaps and physical and financial contracts.	

	
																		
 	December 31, 2017
Fair Value (thousands)	 	Valuation Technique	 	Significant Unobservable Input	 	Range	 	Weighted-Average	
Commodity Contracts	Assets	 	Liabilities	 								
Electricity:	 		 	 		 	 	 	 	 	 	 	 		
Forward Contracts (a)	$	21		 	$	15,485		 	Discounted cash flows	 	Electricity forward price (per MWh)	 	$18.51 - $38.75	 	$	27.89		
Natural Gas:	 		 	 		 	 	 	 	 	 	 	 		
Forward Contracts (a)	1,015		 	3,807		 	Discounted cash flows	 	Natural gas forward price (per MMBtu)	 	$2.33 - $3.11	 	$	2.71		
Total	$	1,036		 	$	19,292		 	 	 	 	 	 	 	 		
		
(a)	Includes swaps and physical and financial contracts.	

166

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table shows the changes in fair value for our risk management activities' assets and liabilities that are measured at fair value on a recurring basis using Level 3 inputs for the years ended December 31, 2018 and 2017 (dollars in thousands):

	
									
 	 	Year Ended
December 31,	
Commodity Contracts	 	2018	 	2017	
Net derivative balance at beginning of period	 	$	(18,256	)	 	$	(47,406	)	
Total net gains (losses) realized/unrealized:	 	 		 	 		
Included in earnings	 	—		 	—		
Included in OCI	 	—		 	3		
Deferred as a regulatory asset or liability	 	(1,130	)	 	(13,643	)	
Settlements	 	(787	)	 	5,834		
Transfers into Level 3 from Level 2	 	(12,830	)	 	(10,026	)	
Transfers from Level 3 into Level 2	 	24,789		 	46,982		
Net derivative balance at end of period	 	$	(8,214	)	 	$	(18,256	)	
Net unrealized gains included in earnings related to instruments still held at end of period	 	$	—		 	$	—		

Transfers between levels in the fair value hierarchy shown in the table above reflect the fair market value at the beginning of the period and are triggered by a change in the lowest significant input as of the end of the period.  We had no significant Level 1 transfers to or from any other hierarchy level.  Transfers in or out of Level 3 are typically related to our long-dated energy transactions that extend beyond available quoted periods.
 
Financial Instruments Not Carried at Fair Value
 
The carrying value of our short-term borrowings approximate fair value and are classified within Level 2 of the fair value hierarchy. See Note 6 for our long-term debt fair values. The NTEC note receivable related to the sale of 4CA’s interest in Four Corners bears interest at 3.9% per annum and has a book value of $61 million as of December 31, 2018 , as presented on the Consolidated Balance Sheets.  The carrying amount is not materially different from the fair value of the note receivable and is classified within Level 3 of the fair value hierarchy.  See Note 10 for more information on 4CA matters.

 

167

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14 .     Earnings Per Share
 
The following table presents the calculation of Pinnacle West’s basic and diluted earnings per share for continuing operations attributable to common shareholders for the years ended December 31, 2018 , 2017 and 2016 (in thousands, except per share amounts):

												
 	2018	 	2017	 	2016	
Net income attributable to common shareholders	$	511,047		 	$	488,456		 	$	442,034		
Weighted average common shares outstanding — basic	112,129		 	111,839		 	111,409		
Net effect of dilutive securities:	 		 	 		 	 		
Contingently issuable performance shares and restricted stock units	421		 	528		 	637		
Weighted average common shares outstanding — diluted	112,550		 	112,367		 	112,046		
Earnings per weighted-average common share outstanding	 	 	 	 	 	
Net income attributable to common shareholders - basic	$	4.56		 	$	4.37		 	$	3.97		
Net Income attributable to common shareholders - diluted	$	4.54		 	$	4.35		 	$	3.95		

15 .     Stock-Based Compensation
 
Pinnacle West has incentive compensation plans under which stock-based compensation is granted to officers, key-employees, and non-officer members of the Board of Directors. Awards granted under the 2012 Long-Term Incentive Plan (“2012 Plan”) may be in the form of stock grants, restricted stock units, stock units, performance shares, restricted stock, dividend equivalents, performance share units, performance cash, incentive and non-qualified stock options, and stock appreciation rights.  The 2012 Plan authorizes up to 4.6 million common shares to be available for grant.  As of December 31, 2018 , 1.9 million common shares were available for issuance under the 2012 Plan. During 2018, 2017, and 2016, the Company granted awards in the form of restricted stock units, stock units, stock grants, and performance shares. Awards granted from 2007 to 2011 were issued under the 2007 Long-Term Incentive Plan (“2007 Plan”), and no new awards may be granted under the 2007 Plan.

Stock-Based Compensation Expense and Activity
 
Compensation cost included in net income for stock-based compensation plans was $20 million in 2018 , $21 million in 2017 , and $19 million in 2016 .  The compensation cost capitalized is immaterial for all years. Income tax benefits related to stock-based compensation arrangements were $7 million in 2018 , $15 million in 2017 , and $10 million in 2016 .

As of December 31, 2018 , there were approximately $9 million of unrecognized compensation costs related to nonvested stock-based compensation arrangements. We expect to recognize these costs over a weighted-average period of 2 years. 

The total fair value of shares vested was $24 million in 2018 , $22 million in 2017 and $22 million in 2016 .

168

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table is a summary of awards granted and the weighted-average grant date fair value for the three years ended 2018 , 2017 and 2016 :

	
																								
 	Restricted Stock Units, Stock Grants, and Stock Units (a)	 	Performance Shares (b)	
 	2018	 	2017	 	2016	 	2018	 	2017	 	2016	
Units granted	132,997		 	161,963		 	141,811		 	171,708		 	147,706		 	166,666		
Weighted-average grant date fair value	$	77.51		 	$	72.60		 	$	67.34		 	$	76.56		 	$	78.99		 	$	66.60		

(a)	Units granted includes awards that will be cash settled of 66,252 in 2018, 67,599 in 2017, and 43,952 in 2016.	
		
(b)	Reflects the target payout level.	
 
The following table is a summary of the status of non-vested awards as of December 31, 2018 and changes during the year:

	
														
 	Restricted Stock Units, Stock Grants, and Stock Units	 	Performance Shares	
 	Shares	 	Weighted-Average
Grant Date
Fair Value	 	Shares (b)	 	Weighted-Average
Grant Date
Fair Value	
Nonvested at January 1, 2018	291,288		 	$	69.78		 	309,502		 	$	72.46		
Granted	132,997		 	77.51		 	171,708		 	76.56		
Vested	(147,938	)	 	67.12		 	(159,284	)	 	66.61		
Forfeited (c)	(5,356	)	 	73.42		 	(9,542	)	 	73.34		
Nonvested at December 31, 2018	270,991		(a)	74.39		 	312,384		 	77.67		
Vested Awards Outstanding at December 31, 2018	73,144		 			 	159,284		 			

(a)	Includes 148,131 of awards that will be cash settled.	
		
(b)	The nonvested performance shares are reflected at target payout level. 	
		
(c)	We account for forfeitures as they occur.	

Share-based liabilities paid relating to restricted stock units were $4 million , $4 million and $3 million in 2018, 2017 and 2016, respectively. This includes cash used to settle restricted stock units of $5 million , $4 million and $3 million in 2018, 2017 and 2016, respectively. Restricted stock units that are cash settled are classified as liability awards. All performance shares are classified as equity awards.
 
Restricted Stock Units, Stock Grants, and Stock Units
 
Restricted stock units are granted to officers and key employees.  Restricted stock units typically vest and settle in equal annual installments over a 4 -year period after the grant date.  Vesting is typically dependent upon continuous service during the vesting period; however, awards granted to retirement-eligible employees will vest upon the employee's retirement. Awardees elect to receive payment in either 100% stock, 100% cash, or 50% in cash and 50% in stock. Restricted stock unit awards typically include a dividend equivalent feature. This feature allows each award to accrue dividend rights equal to the dividends they would have received had they directly owned the stock. Interest on dividend rights compounds quarterly. If the award is forfeited the employee is not entitled to the dividends on those shares.

169

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
In December 2012, the Company granted a retention award of 50,617 performance-linked restricted stock units to the Chairman of the Board and Chief Executive Officer of Pinnacle West.  This award vested on December 31, 2016, because he remained employed with the Company through that date.  The Board did increase the number of awards that vested by 33,745 restricted stock units, payable in stock because certain performance requirements were met. In February 2017, 84,362 restricted stock units were released.

Compensation cost for restricted stock unit awards is based on the fair value of the award, with the fair value being the market price of our stock on the measurement date. Restricted stock unit awards that will be settled in cash are accounted for as liability awards, with compensation cost initially calculated on the date of grant using the Company’s closing stock price, and remeasured at each balance sheet date. Restricted stock unit awards that will be settled in shares are accounted for as equity awards, with compensation cost calculated using the Company's closing stock price on the date of grant. Compensation cost is recognized over the requisite service period based on the fair value of the award.
 
Stock grants are issued to non-officer members of the Board of Directors. They may elect to receive the stock grant, or to defer receipt until a later date and receive stock units in lieu of the stock grant.  The members of the Board of Directors who elect to defer may elect to receive payment in either 100% stock, 100% cash, or 50% in cash and 50% in stock.  Each stock unit is convertible to one share of stock. The stock units accrue dividend rights, equal to the amount of dividends the Directors would have received had they directly owned stock equal to the number of vested restricted stock units or stock units from the date of grant to the date of payment, plus interest compounded quarterly.  The dividends and interest are paid, based on the Director’s election, in either stock, cash, or 50% in cash and 50% in stock.
 
Performance Share Awards
 
Performance share awards are granted to officers and key employees.  The awards contain two separate performance criteria that affect the number of shares that may be received if after the end of a 3 -year performance period the performance criteria are met. For the first criteria, the number of shares that will vest is based on non-financial performance metrics (i.e., the metric component). The other criteria is based upon Pinnacle West's total shareholder return ("TSR") in relation to the TSR of other companies in a specified utility index (i.e., the TSR component). The exact number of shares issued will vary from 0% to 200% of the target award.  Shares received include dividend rights paid in stock equal to the amount of dividends that recipients would have received had they directly owned stock, equal to the number of vested performance shares from the date of grant to the date of payment plus interest compounded quarterly. If the award is forfeited or if the performance criteria are not achieved, the employee is not entitled to the dividends on those shares.
 
Performance share awards are accounted for as equity awards, with compensation cost based on the fair value of the award on the grant date. Compensation cost relating to the metric component of the award is based on the Company’s closing stock price on the date of grant, with compensation cost recognized over the requisite service period based on the number of shares expected to vest. Management evaluates the probability of meeting the metric component at each balance sheet date. If the metric component criteria are not ultimately achieved, no compensation cost is recognized relating to the metric component, and any previously recognized compensation cost is reversed. Compensation cost relating to the TSR component of the award is determined using a Monte Carlo simulation valuation model, with compensation cost recognized ratably over the requisite service period, regardless of the number of shares that actually vest.

170

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

16 .     Derivative Accounting
 
Derivative financial instruments are used to manage exposure to commodity price and transportation costs of electricity, natural gas, coal, emissions allowances and interest rates.  Risks associated with market volatility are managed by utilizing various physical and financial derivative instruments, including futures, forwards, options and swaps.  As part of our overall risk management program, we may use derivative instruments to hedge purchases and sales of electricity and fuels.  Derivative instruments that meet certain hedge accounting criteria may be designated as cash flow hedges and are used to limit our exposure to cash flow variability on forecasted transactions.  The changes in market value of such instruments have a high correlation to price changes in the hedged transactions.  Derivative instruments are also entered into for economic hedging purposes.  While economic hedges may mitigate exposure to fluctuations in commodity prices, these instruments have not been designated as accounting hedges.  Contracts that have the same terms (quantities, delivery points and delivery periods) and for which power does not flow are netted, which reduces both revenues and fuel and purchased power costs in our Consolidated Statements of Income, but does not impact our financial condition, net income or cash flows.
  
Our derivative instruments, excluding those qualifying for a scope exception, are recorded on the balance sheet as an asset or liability and are measured at fair value.  See Note 13 for a discussion of fair value measurements.  Derivative instruments may qualify for the normal purchases and normal sales scope exception if they require physical delivery and the quantities represent those transacted in the normal course of business.  Derivative instruments qualifying for the normal purchases and sales scope exception are accounted for under the accrual method of accounting and excluded from our derivative instrument discussion and disclosures below.

For its regulated operations, APS defers for future rate treatment 100% of the unrealized gains and losses on derivatives pursuant to the PSA mechanism that would otherwise be recognized in income.  Realized gains and losses on derivatives are deferred in accordance with the PSA to the extent the amounts are above or below the Base Fuel Rate (see Note 3).  Gains and losses from derivatives in the following tables represent the amounts reflected in income before the effect of PSA deferrals.

As of December 31, 2018 and 2017, we had the following outstanding gross notional volume of derivatives, which represent both purchases and sales (does not reflect net position):

	
								
 	 	 	Quantity	
Commodity	 	Unit of Measure	December 31, 2018	 	December 31, 2017	
Power	 	GWh	250		 	583		
Gas	 	Billion cubic feet	218		 	240		

171

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Gains and Losses from Derivative Instruments
 
The following table provides information about gains and losses from derivative instruments in designated cash flow accounting hedging relationships during the years ended December 31, 2018 , 2017 and 2016 (dollars in thousands):

	
															
 	 	Financial Statement 	 	Year Ended
December 31,	
Commodity Contracts	 	Location	 	2018	 	2017	 	2016	
Gain (Loss) Recognized in OCI on Derivative Instruments (Effective Portion)	 	OCI — derivative instruments	 	$	—		 	$	(59	)	 	$	47		
Loss Reclassified from Accumulated OCI into Income (Effective Portion Realized) (a)	 	Fuel and purchased power (b)	 	(2,000	)	 	(3,519	)	 	(3,926	)	
		
(a)	During the years ended December 31, 2018 , 2017 , and 2016 , we had no losses reclassified from accumulated OCI to earnings related to discontinued cash flow hedges.	
		
(b)	Amounts are before the effect of PSA deferrals.	
 
During the next twelve months, we estimate that a net loss of $1.5 million before income taxes will be reclassified from accumulated OCI as an offset to the effect of market price changes for the related hedged transactions.  In accordance with the PSA, most of these amounts will be recorded as either a regulatory asset or liability and have no immediate effect on earnings.
 
The following table provides information about gains and losses from derivative instruments not designated as accounting hedging instruments during the years ended December 31, 2018 , 2017 and 2016 (dollars in thousands):

	
															
 	 	Financial Statement 	 	Year Ended
December 31,	
Commodity Contracts	 	Location	 	2018	 	2017	 	2016	
Net Gain (Loss) Recognized in Income	 	Operating revenues	 	$	(2,557	)	 	$	(1,192	)	 	$	771		
Net Gain (Loss) Recognized in Income	 	Fuel and purchased power (a)	 	(12,951	)	 	(87,991	)	 	25,711		
Total	 	 	 	$	(15,508	)	 	$	(89,183	)	 	$	26,482		
		
(a)	Amounts are before the effect of PSA deferrals.	
 
Derivative Instruments in the Consolidated Balance Sheets
 
Our derivative transactions are typically executed under standardized or customized agreements, which include collateral requirements and, in the event of a default, would allow for the netting of positive and negative exposures associated with a single counterparty.  Agreements that allow for the offsetting of positive and negative exposures associated with a single counterparty are considered master netting arrangements.  Transactions with counterparties that have master netting arrangements are offset and reported net on the Consolidated Balance Sheets.  Transactions that do not allow for offsetting of positive and negative positions are reported gross on the Consolidated Balance Sheets.
 
We do not offset a counterparty's current derivative contracts with the counterparty’s non-current derivative contracts, although our master netting arrangements would allow current and non-current positions

172

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

to be offset in the event of a default.  Additionally, in the event of a default, our master netting arrangements would allow for the offsetting of all transactions executed under the master netting arrangement.  These types of transactions may include non-derivative instruments, derivatives qualifying for scope exceptions, trade receivables and trade payables arising from settled positions, and other forms of non-cash collateral (such as letters of credit).  These types of transactions are excluded from the offsetting tables presented below.
 
As of December 31, 2017, we no longer have derivative instruments that are designated as cash flow hedging instruments.

The following tables provide information about the fair value of our risk management activities reported on a gross basis, and the impacts of offsetting as of December 31, 2018 and 2017 .  These amounts relate to commodity contracts and are located in the assets and liabilities from risk management activities lines of our Consolidated Balance Sheets.

	
																					
As of December 31, 2018:
(dollars in thousands)	 	Gross 
Recognized 
Derivatives
  (a)	 	Amounts 
Offset
(b)	 	Net
  Recognized
  Derivatives	 	Other
  (c)	 	Amount 
Reported on 
Balance Sheet	
Current assets	 	$	3,106		 	$	(2,149	)	 	$	957		 	$	156		 	$	1,113		
Investments and other assets	 	36		 	(36	)	 	—		 	—		 	—		
Total assets	 	3,142		 	(2,185	)	 	957		 	156		 	1,113		
 	 	 	 	 	 	 	 	 	 	 	
Current liabilities	 	(36,345	)	 	2,149		 	(34,196	)	 	(1,310	)	 	(35,506	)	
Deferred credits and other	 	(24,567	)	 	36		 	(24,531	)	 	—		 	(24,531	)	
Total liabilities	 	(60,912	)	 	2,185		 	(58,727	)	 	(1,310	)	 	(60,037	)	
Total	 	$	(57,770	)	 	$	—		 	$	(57,770	)	 	$	(1,154	)	 	$	(58,924	)	
		
(a)	All of our gross recognized derivative instruments were subject to master netting arrangements.	
		
(b)	No cash collateral has been provided to counterparties, or received from counterparties, that is subject to offsetting.	
		
(c)	Represents cash collateral and cash margin that is not subject to offsetting. Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument.  Includes cash collateral received from counterparties of $ 1,310 and cash margin provided to counterparties of $156 .	

173

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	
																					
As of December 31, 2017:
(dollars in thousands)	 	Gross
  Recognized
  Derivatives
  (a)	 	Amounts
Offset 
(b)	 	Net
  Recognized
  Derivatives	 	Other
  (c)	 	Amount
  Reported on
  Balance Sheet	
Current assets	 	$	5,427		 	$	(3,796	)	 	$	1,631		 	$	300		 	$	1,931		
Investments and other assets	 	1,292		 	(1,241	)	 	51		 	—		 	51		
Total assets	 	6,719		 	(5,037	)	 	1,682		 	300		 	1,982		
 	 	 	 	 	 	 	 	 	 	 	
Current liabilities	 	(59,527	)	 	3,796		 	(55,731	)	 	(3,521	)	 	(59,252	)	
Deferred credits and other	 	(38,411	)	 	1,241		 	(37,170	)	 	—		 	(37,170	)	
Total liabilities	 	(97,938	)	 	5,037		 	(92,901	)	 	(3,521	)	 	(96,422	)	
Total	 	$	(91,219	)	 	$	—		 	$	(91,219	)	 	$	(3,221	)	 	$	(94,440	)	
		
(a)	All of our gross recognized derivative instruments were subject to master netting arrangements.	
		
(b)	No cash collateral has been provided to counterparties, or received from counterparties, that is subject to offsetting.	
		
(c)	Represents cash collateral and cash margin that is not subject to offsetting.  Amounts relate to non-derivative instruments, derivatives qualifying for scope exceptions, or collateral and margin posted in excess of the recognized derivative instrument.  Includes cash collateral received from counterparties of $3,521 and cash margin provided to counterparties of $300 .	

Credit Risk and Credit Related Contingent Features
 
We are exposed to losses in the event of nonperformance or nonpayment by counterparties and have risk management contracts with many counterparties. As of December 31, 2018 , Pinnacle West has no counterparties with positive exposures of greater than 10% of risk management assets. Our risk management process assesses and monitors the financial exposure of all counterparties.  Despite the fact that the great majority of trading counterparties' debt is rated as investment grade by the credit rating agencies, there is still a possibility that one or more of these counterparties could default, resulting in a material impact on consolidated earnings for a given period. Counterparties in the portfolio consist principally of financial institutions, major energy companies, municipalities and local distribution companies.  We maintain credit policies that we believe minimize overall credit risk to within acceptable limits.  Determination of the credit quality of our counterparties is based upon a number of factors, including credit ratings and our evaluation of their financial condition.  To manage credit risk, we employ collateral requirements 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.
 
Certain of our derivative instrument contracts contain credit-risk-related contingent features including, among other things, investment grade credit rating provisions, credit-related cross-default provisions, and adequate assurance provisions.  Adequate assurance provisions allow a counterparty with reasonable grounds for uncertainty to demand additional collateral based on subjective events and/or conditions.  For those derivative instruments in a net liability position, with investment grade credit contingencies, the counterparties could demand additional collateral if our debt credit rating were to fall below investment grade (below BBB- for Standard & Poor’s or Fitch or Baa3 for Moody’s).

174

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table provides information about our derivative instruments that have credit-risk-related contingent features at December 31, 2018 (dollars in thousands):

	
				
 	December 31, 2018	
Aggregate fair value of derivative instruments in a net liability position	$	60,912		
Cash collateral posted	—		
Additional cash collateral in the event credit-risk related contingent features were fully triggered (a)	56,876		
		
(a)	This amount is after counterparty netting and includes those contracts which qualify for scope exceptions, which are excluded from the derivative details above.	
 
We also have energy related non-derivative instrument contracts with investment grade credit-related contingent features, which could also require us to post additional collateral of approximately $94 million if our debt credit ratings were to fall below investment grade.

17 .     Other Income and Other Expense
 
The following table provides detail of Pinnacle West's Consolidated other income and other expense for 2018 , 2017 and 2016 (dollars in thousands):

	
												
 	2018	 	2017	 	2016	
Other income:	 		 	 		 	 		
Interest income	$	8,647		 	$	3,497		 	$	884		
Debt return on Four Corners SCR deferral (Note 3)	16,153		 	354		 	—		
Miscellaneous	96		 	155		 	17		
Total other income	$	24,896		 	$	4,006		 	$	901		
Other expense:	 		 	 		 	 		
Non-operating costs	$	(10,076	)	 	$	(11,749	)	 	$	(9,235	)	
Investment losses — net	(417	)	 	(4,113	)	 	(1,747	)	
Miscellaneous	(7,473	)	 	(5,677	)	 	(4,355	)	
Total other expense	$	(17,966	)	 	$	(21,539	)	 	$	(15,337	)	

175

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Other Income and Other Expense - APS
 
The following table provides detail of APS’s other income and other expense for 2018 , 2017 and 2016 (dollars in thousands):

	
												
 	2018	 	2017	 	2016	
Other income:	 		 	 		 	 		
Interest income	$	6,496		 	$	2,504		 	$	261		
Debt return on Four Corners SCR deferral (Note 3)	16,153		 	354		 	—		
Miscellaneous	97		 	155		 	10		
Total other income	$	22,746		 	$	3,013		 	$	271		
Other expense:	 		 	 		 	 		
Non-operating costs	$	(9,462	)	 	$	(10,825	)	 	$	(8,455	)	
Miscellaneous	(5,830	)	 	(3,088	)	 	(2,099	)	
Total other expense	$	(15,292	)	 	$	(13,913	)	 	$	(10,554	)	

18 .     Palo Verde Sale Leaseback Variable Interest Entities
 
In 1986, APS entered into agreements with three separate VIE lessor trust entities in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities.  APS will retain the assets through 2023 under one lease and 2033 under the other two leases. APS will be required to make payments relating to these leases of approximately $23 million annually for the period 2019 through 2023, and about $16 million annually for the period 2024 through 2033. At the end of the lease period, APS will have the option to purchase the leased assets at their fair market value, extend the leases for up to two years , or return the assets to the lessors.
 
The leases' terms give APS the ability to utilize the assets for a significant portion of the assets' economic life, and therefore provide APS with the power to direct activities of the VIEs that most significantly impact the VIEs' economic performance. Predominantly due to the lease terms, APS has been deemed the primary beneficiary of these VIEs and therefore consolidates the VIEs.

As a result of consolidation, we eliminate lease accounting and instead recognize depreciation expense, resulting in an increase in net income of $19 million for 2018 , 2017 and 2016 . The increase in net income is entirely attributable to the noncontrolling interests.  Income attributable to Pinnacle West shareholders is not impacted by the consolidation.
    
Our Consolidated Balance Sheets at December 31, 2018 and December 31, 2017 include the following amounts relating to the VIEs (dollars in thousands):

	
								
 	December 31, 2018	 	December 31, 2017	
Palo Verde sale leaseback property, plant and equipment, net of accumulated depreciation	$	105,775		 	$	109,645		
Equity-Noncontrolling interests	125,790		 	129,040		

Assets of the VIEs are restricted and may only be used for payment to the noncontrolling interest holders.  These assets are reported on our consolidated financial statements.

176

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

APS is exposed to losses relating to these VIEs upon the occurrence of certain events that APS does not consider 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 make specified payments to the VIEs’ noncontrolling 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 were to occur during the lease periods, APS may be required to pay the noncontrolling equity participants approximately $297 million beginning in 2019, and up to $456 million over the lease extension term.
 
For regulatory ratemaking purposes, the agreements continue to be treated as operating leases and, as a result, we have recorded a regulatory asset relating to the arrangements.
 
19 .     Investments in Nuclear Decommissioning Trusts and Other Special Use Funds
 
We have investments in debt and equity securities held in Nuclear Decommissioning Trusts, Coal Reclamation Escrow Accounts, and an Active Union Employee Medical Account. Investments in debt securities are classified as available-for-sale securities. We record both debt and equity security investments at their fair value on our Consolidated Balance Sheets. See Note 13 for a discussion of how fair value is determined and the classification of the investments within the fair value hierarchy. The investments in each trust or account are restricted for use and are intended to fund specified costs and activities as further described for each fund below.

Nuclear Decommissioning Trusts - To fund the future costs APS expects to incur to decommission Palo Verde, APS established external decommissioning trusts in accordance with NRC regulations.  Third-party investment managers are authorized to buy and sell securities per stated investment guidelines.  The trust funds are invested in fixed income securities and equity securities. Earnings and proceeds from sales and maturities of securities are reinvested in the trusts. Because of the ability of APS to recover decommissioning costs in rates, and in accordance with the regulatory treatment, APS has deferred realized and unrealized gains and losses (including other-than-temporary impairments) in other regulatory liabilities.
 
Coal Reclamation Escrow Accounts - APS has investments restricted for the future coal mine reclamation funding related to Four Corners. This escrow account is primarily invested in fixed income securities. Earnings and proceeds from sales of securities are reinvested in the escrow account. Because of the ability of APS to recover coal reclamation costs in rates, and in accordance with the regulatory treatment, APS has deferred realized and unrealized gains and losses (including other-than-temporary impairments) in other regulatory liabilities. Activities relating to APS coal reclamation escrow account investments are included within the other special use funds in the table below.

Active Union Employee Medical Account - APS has investments restricted for paying active union employee medical costs. These investments were transferred from APS other postretirement benefit trust assets into the active union employee medical trust in January 2018 (see Note 7). These investments may be used to pay active union employee medical costs incurred in the current period and in future periods. The account is invested primarily in fixed income securities. In accordance with the ratemaking treatment, APS has deferred the unrealized gains and losses (including other-than-temporary impairments) in other regulatory assets. Activities relating to active union employee medical account investments are included within the other special use funds in the table below.

177

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

APS

The following tables present the unrealized gains and losses based on the original cost of the investment and summarizes the fair value of APS's nuclear decommissioning trust and other special use fund assets at December 31, 2018 and December 31, 2017 (dollars in thousands): 

																				
	December 31, 2018	
 	Fair Value		Total
Unrealized
Gains		Total
Unrealized
Losses	
Investment Type:	Nuclear Decommissioning Trusts		Other Special Use Funds		Total					
Equity Securities	$	402,008			$	45,130			$	447,138			$	222,147			$	(459	)	
Available for Sale-Fixed Income Securities	446,978			190,378			637,356		(a)	8,634			(6,778	)	
Other	2,148			593			2,741		(b)	—			—		
Total	$	851,134			$	236,101			$	1,087,235			$	230,781			$	(7,237	)	
		
(a)	As of December 31, 2018, the amortized cost basis of these available-for-sale investments is $635 million	
		
(b)	Represents net pending securities sales and purchases.	

	
																				
	December 31, 2017	
 	Fair Value		Total
Unrealized
Gains		Total
Unrealized
Losses	
Investment Type:	Nuclear Decommissioning Trusts		Other Special Use Funds		Total					
Equity Securities	$	424,614			$	430			$	425,044			$	248,623			$	—		
Available for Sale-Fixed Income Securities	446,277			29,439			475,716		(a)	11,537			(2,996	)	
Other	109			489			598		(b)	—			—		
Total	$	871,000			$	30,358			$	901,358			$	260,160			$	(2,996	)	
		
(a)	As of December 31, 2017, the amortized cost basis of these available-for-sale investments is $467 million .	
		
(b)	Represents net pending securities sales and purchases.	

178

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table sets forth APS's realized gains and losses relating to the sale and maturity of available-for-sale debt securities and equity securities, and the proceeds from the sale and maturity of these investment securities for the years ended December 31, 2018, 2017 and 2016 (dollars in thousands):

	
												
 	Year Ended December 31,	
 	Nuclear Decommissioning Trusts		Other Special Use Funds		Total	
2018									
Realized gains	$	6,679			$	1			$	6,680		
Realized losses	(13,552	)		—			(13,552	)	
Proceeds from the sale of securities (a)	554,385			98,648			653,033		
2017									
Realized gains	21,813			17			21,830		
Realized losses	(13,146	)		(9	)		(13,155	)	
Proceeds from the sale of securities (a)	542,246			4,093			546,339		
2016									
Realized gains	11,213			—			11,213		
Realized losses	(10,106	)		—			(10,106	)	
Proceeds from the sale of securities (a)	633,410			—			633,410		
		
(a)	Proceeds are reinvested in the nuclear decommissioning trusts or other special use funds.	
    
Fixed Income Securities Contractual Maturities

The fair value of fixed income securities, summarized by contractual maturities, at December 31, 2018 is as follows (dollars in thousands):

	
																
 	Nuclear Decommissioning		Coal Reclamation Escrow Accounts		Active Union Medical Trust		Total	
Less than one year	$	26,819			$	21,237			$	39,966			$	88,022		
1 year – 5 years	97,566			15,658			104,128			217,352		
5 years – 10 years	128,379			2,511			—			130,890		
Greater than 10 years	194,214			6,878			—			201,092		
Total	$	446,978			$	46,284			$	144,094			$	637,356		

20 .     Revenue

On January 1, 2018, we adopted new revenue guidance in ASU 2014-09 and related amendments. The new revenue guidance requires entities to recognize revenue when control of the promised good or service is transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We applied the new guidance using the modified retrospective method applied to contracts which were not completed as of January 1, 2018. The adoption of the new revenue guidance resulted in expanded disclosures but otherwise did not have a material impact on our financial statements. New revenue disclosures required by the standard are included below, and in Note 1. See Note 2 for additional information regarding the new accounting standard.

179

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Sources of Revenue

The following table provides detail of Pinnacle West's consolidated revenue disaggregated by revenue sources (dollars in thousands):

					
 	 	Year Ended December 31,	
 	 	2018	
Retail residential electric service	 	$	1,867,370		
Retail non-residential electric service	 	1,628,891		
Wholesale energy sales	 	109,198		
Transmission services for others	 	60,261		
Other sources	 	25,527		
Total operating revenues	 	$	3,691,247		

We derive our revenues from contracts with customers primarily from sales of electricity to our regulated retail customers. Our retail electric services and tariff rates are regulated by the ACC. Revenues from wholesale energy sales and transmission services for others represent energy and transmission sales to wholesale customers. Our wholesale activities and tariff rates are regulated by the FERC.

Revenue Activities

Our revenues are primarily derived from activities that are classified as revenues from contracts with customers. This includes sales of electricity to our regulated retail customers and wholesale and transmission activities. Our revenues from contracts with customers for the year ended December 31, 2018 were $3,644 million .

We have certain revenues that do not meet the specific accounting criteria to be classified as revenues from contracts with customers. For the year ended December 31, 2018 , our revenues that do not qualify as revenue from contracts with customers were $47 million . This relates primarily to certain regulatory cost recovery mechanisms that are considered alternative revenue programs. We recognize revenue associated with alternative revenue programs when specific events permitting recognition are completed. Certain amounts associated with alternative revenue programs will subsequently be billed to customers; however, we do not reclassify billed amounts into revenue from contracts with customers. See Note 3 for a discussion of our regulatory cost recovery mechanisms.

Contract Assets and Liabilities from Contracts with Customers

There were no material contract assets, contract liabilities, or deferred contract costs recorded on the Consolidated Balance Sheets as of December 31, 2018 .

180

Table of Contents

COMBINED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

21 .     Changes in Accumulated Other Comprehensive Loss
 
The following table shows the changes in Pinnacle West's consolidated accumulated other comprehensive loss, including reclassification adjustments, net of tax, by component for the years ended December 31, 2018 and 2017 (dollars in thousands): 

																
 	 Pension and Other Postretirement Benefits	 	 	 	 Derivative Instruments	 	 	 	Total	
Balance December 31, 2016	$	(39,070	)	 		 	$	(4,752	)	 		 	$	(43,822	)	
OCI (loss) before reclassifications	(6,438	)	 		 	(35	)	 		 	(6,473	)	
Amounts reclassified from accumulated other comprehensive loss	3,068		 	(a)	 	2,225		 	(b)	 	5,293		
Balance December 31, 2017	(42,440	)	 		 	(2,562	)	 		 	(45,002	)	
OCI (loss) before reclassifications	102		 		 	(78	)	 		 	24		
Amounts reclassified from accumulated other comprehensive loss	4,295		 	(a)	 	1,527		 	(b)	 	5,822		
Reclassification of income tax effect related to
tax reform	(7,954	)	 	 	 	(598	)	 	 	 	(8,552	)	
Balance December 31, 2018	$	(45,997	)	 		 	$	(1,711	)	 		 	$	(47,708	)	
		
(a)	These amounts primarily represent amortization of actuarial loss, and are included in the computation of net periodic pension cost.  See Note 7.	
		
(b)	These amounts represent realized gains and losses and are included in the computation of fuel and purchased power costs and are subject to the PSA.  See Note 16.	

Changes in Accumulated Other Comprehensive Loss - APS
 
The following table shows the changes in APS's consolidated accumulated other comprehensive loss, including reclassification adjustments, net of tax, by component for the years ended December 31, 2018 and 2017 (dollars in thousands): 

																
 	 Pension and Other Postretirement Benefits	 	 	 	 Derivative Instruments	 	 	 	Total	
Balance December 31, 2016	$	(20,671	)	 		 	$	(4,752	)	 		 	$	(25,423	)	
OCI (loss) before reclassifications	(6,884	)	 		 	(35	)	 		 	(6,919	)	
Amounts reclassified from accumulated other comprehensive loss	3,134		 	(a)	 	2,225		 	(b)	 	5,359		
Balance December 31, 2017	(24,421	)	 		 	(2,562	)	 		 	(26,983	)	
OCI (loss) before reclassifications	(326	)	 		 	(78	)	 		 	(404	)	
Amounts reclassified from accumulated other comprehensive loss	3,791		 	(a)	 	1,527		 	(b)	 	5,318		
Reclassification of income tax effect related to
tax reform	(4,440	)	 	 	 	(598	)	 	 	 	(5,038	)	
Balance December 31, 2018	$	(25,396	)	 		 	$	(1,711	)	 		 	$	(27,107	)	
		
(a)	These amounts primarily represent amortization of actuarial loss, and are included in the computation of net periodic pension cost.  See Note 7.	
		
(b)	These amounts represent realized gains and losses and are included in the computation of fuel and purchased power costs and are subject to the PSA.  See Note 16.	

181

Table of Contents

PINNACLE WEST CAPITAL CORPORATION HOLDING COMPANY
SCHEDULE I — CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)

	
												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
Operating revenues	$	—		 	$	119		 	$	370		
Operating expenses	53,844		 	24,591		 	26,573		
Operating loss	(53,844	)	 	(24,472	)	 	(26,203	)	
Other	 		 	 		 	 		
Equity in earnings of subsidiaries	569,249		 	507,495		 	462,027		
Other expense	(3,202	)	 	(2,422	)	 	(1,622	)	
Total	566,047		 	505,073		 	460,405		
Interest expense	12,074		 	5,633		 	3,151		
Income before income taxes	500,129		 	474,968		 	431,051		
Income tax benefit	(10,918	)	 	(13,488	)	 	(10,983	)	
Net income attributable to common shareholders	511,047		 	488,456		 	442,034		
Other comprehensive income (loss) — attributable to common shareholders	5,846		 	(1,180	)	 	926		
Total comprehensive income — attributable to common shareholders	$	516,893		 	$	487,276		 	$	442,960		

See Combined Notes to Consolidated Financial Statements.

182

Table of Contents

PINNACLE WEST CAPITAL CORPORATION HOLDING COMPANY
SCHEDULE I — CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
(dollars in thousands)

	
								
 	December 31,	
 	2018	 	2017	
ASSETS	 		 	 		
Current assets	 		 	 		
Cash and cash equivalents	$	41		 	$	41		
Accounts receivable	99,989		 	93,554		
Income tax receivable	32,737		 	19,124		
Other current assets	1,502		 	267		
Total current assets	134,269		 	112,986		
Investments and other assets	 		 	 		
Investments in subsidiaries	5,859,834		 	5,465,137		
Deferred income taxes	5,243		 	54,352		
Other assets	34,910		 	44,613		
Total investments and other assets	5,899,987		 	5,564,102		
Total Assets	$	6,034,256		 	$	5,677,088		
LIABILITIES AND EQUITY	 		 	 		
Current liabilities	 		 	 		
Accounts payable	9,565		 	7,638		
Accrued taxes	9,006		 	8,927		
Common dividends payable	82,675		 	77,667		
Short-term borrowings	76,400		 	95,400		
Other current liabilities	19,215		 	17,417		
Total current liabilities	196,861		 	207,049		
 	 	 	 	
Long-term debt less current maturities (Note 6)	448,796		 	298,421		
 	 	 	 	
Pension liabilities	17,766		 	20,758		
Other	22,128		 	15,130		
Total deferred credits and other	39,894		 	35,888		
COMMITMENTS AND CONTINGENCIES (SEE NOTES)			 			
Common stock equity	 	 	 	
Common stock	2,629,440		 	2,609,181		
Accumulated other comprehensive loss	(47,708	)	 	(45,002	)	
Retained earnings	2,641,183		 	2,442,511		
Total Pinnacle West Shareholders’ equity	5,222,915		 	5,006,690		
Noncontrolling interests	125,790		 	129,040		
Total Equity	5,348,705		 	5,135,730		
Total Liabilities and Equity	$	6,034,256		 	$	5,677,088		

See Combined Notes to Consolidated Financial Statements.

183

Table of Contents

PINNACLE WEST CAPITAL CORPORATION HOLDING COMPANY
SCHEDULE I — CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
(dollars in thousands)

												
 	Year Ended December 31,	
 	2018	 	2017	 	2016	
Cash flows from operating activities	 		 	 		 	 		
Net income	$	511,047		 	$	488,456		 	$	442,034		
Adjustments to reconcile net income to net cash provided by operating activities:	 	 	 	 	 		
Equity in earnings of subsidiaries — net	(569,249	)	 	(507,495	)	 	(462,027	)	
Depreciation and amortization	76		 	76		 	85		
Deferred income taxes	49,535		 	(264	)	 	(12,402	)	
Accounts receivable	(7,881	)	 	(2,106	)	 	15,823		
Accounts payable	1,967		 	(11,162	)	 	10,402		
Accrued taxes and income tax receivables — net	(13,535	)	 	(22,247	)	 	20,041		
Dividends received from subsidiaries	316,000		 	296,800		 	239,300		
Other	31,807		 	15,092		 	5,514		
Net cash flow provided by operating activities	319,767		 	257,150		 	258,770		
Cash flows from investing activities	 		 	 		 	 		
Construction work in progress	—		 	—		 	(18,457	)	
Investments in subsidiaries	(142,796	)	 	(178,027	)	 	(19,242	)	
Repayments of loans from subsidiaries	6,477		 	2,987		 	1,026		
Advances of loans to subsidiaries	(500	)	 	(6,388	)	 	(2,092	)	
Net cash flow used for investing activities	(136,819	)	 	(181,428	)	 	(38,765	)	
Cash flows from financing activities	 		 	 		 	 		
Issuance of long-term debt	150,000		 	298,761		 	—		
Short-term debt borrowings under revolving credit facility	20,000		 	58,000		 	40,000		
Short-term debt repayments under revolving credit facility	(32,000	)	 	(32,000	)	 	—		
Commercial paper - net	(7,000	)	 	27,700		 	1,700		
Dividends paid on common stock	(308,892	)	 	(289,793	)	 	(274,229	)	
Repayment of long-term debt	—		 	(125,000	)	 	—		
Common stock equity issuance - net of purchases	(5,055	)	 	(13,390	)	 	(4,867	)	
Other	(1	)	 	—		 	—		
Net cash flow used for financing activities	(182,948	)	 	(75,722	)	 	(237,396	)	
Net decrease in cash and cash equivalents	—		 	—		 	(17,391	)	
Cash and cash equivalents at beginning of year	41		 	41		 	17,432		
Cash and cash equivalents at end of year	$	41		 	$	41		 	$	41		

     See Combined Notes to Consolidated Financial Statements.

PINNACLE WEST CAPITAL CORPORATION HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS OF HOLDING COMPANY

The Combined Notes to Consolidated Financial Statements in Part II, Item 8 should be read in conjunction with the Pinnacle West Capital Corporation Holding Company Financial Statements.

The Pinnacle West Capital Corporation Holding Company Financial Statements have been prepared to present the financial position, results of operations and cash flows of Pinnacle West Capital Corporation on a stand-alone basis as a holding company. Investments in subsidiaries are accounted for using the equity method.

184

Table of Contents

PINNACLE WEST CAPITAL CORPORATION
SCHEDULE II — RESERVE FOR UNCOLLECTIBLES
(dollars in thousands)

	
																					
Column A	 	Column B	 	Column C	 	Column D	 	Column E	
 	 	 	 	Additions	 	 	 	 	
Description	 	Balance at
beginning
of period	 	Charged to
cost and
expenses	 	Charged
to other
accounts	 	Deductions	 	Balance
at end of
period	
Reserve for uncollectibles:	 	 		 	 		 	 		 	 		 	 		
2018	 	$	2,513		 	$	10,870		 	$	—		 	$	9,314		 	$	4,069		
2017	 	3,037		 	6,836		 	—		 	7,360		 	2,513		
2016	 	3,125		 	4,025		 	—		 	4,113		 	3,037		

185

Table of Contents

ARIZONA PUBLIC SERVICE COMPANY
SCHEDULE II — RESERVE FOR UNCOLLECTIBLES
(dollars in thousands)

	
																					
Column A	 	Column B	 	Column C	 	Column D	 	Column E	
 	 	 	 	Additions	 	 	 	 	
Description	 	Balance at
beginning
of period	 	Charged to
cost and
expenses	 	Charged
to other
accounts	 	Deductions	 	Balance
at end of
period	
Reserve for uncollectibles:	 	 		 	 		 	 		 	 		 	 		
2018	 	$	2,513		 	$	10,870		 	$	—		 	$	9,314		 	$	4,069		
2017	 	3,037		 	6,836		 	—		 	7,360		 	2,513		
2016	 	3,125		 	4,025		 	—		 	4,113		 	3,037		

186

Table of Contents

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None. 
ITEM 9A.  CONTROLS AND PROCEDURES
 
(a) Disclosure Controls and Procedures
 
The term “disclosure controls and procedures” means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) (15 U.S.C. 78a et seq .) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to a company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
 
Pinnacle West’s management, with the participation of Pinnacle West’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of Pinnacle West’s disclosure controls and procedures as of December 31, 2018.  Based on that evaluation, Pinnacle West’s Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, Pinnacle West’s disclosure controls and procedures were effective.
 
APS’s management, with the participation of APS’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of APS’s disclosure controls and procedures as of December 31, 2018.  Based on that evaluation, APS’s Chief Executive Officer and Chief Financial Officer have concluded that, as of that date, APS’s disclosure controls and procedures were effective.
 
(b) Management’s Annual Reports on Internal Control Over Financial Reporting
 
Reference is made to “Management’s Report on Internal Control over Financial Reporting (Pinnacle West Capital Corporation)” in Item 8 of this report and “Management’s Report on Internal Control over Financial Reporting (Arizona Public Service Company)” in Item 8 of this report.
 
(c) Attestation Reports of the Registered Public Accounting Firm
 
Reference is made to “Report of Independent Registered Public Accounting Firm” in Item 8 of this report and “Report of Independent Registered Public Accounting Firm” in Item 8 of this report on the internal control over financial reporting of Pinnacle West and APS, respectively.
 
(d) Changes In Internal Control Over Financial Reporting
 
No change in Pinnacle West’s or APS’s internal control over financial reporting occurred during the fiscal quarter ended December 31, 2018 that materially affected, or is reasonably likely to materially affect, Pinnacle West’s or APS’s internal control over financial reporting.

187

Table of Contents

ITEM 9B.  OTHER INFORMATION

None.

PART III
 
ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS
AND CORPORATE GOVERNANCE OF PINNACLE WEST
 
Reference is hereby made to “Information About Our Board and Corporate Governance,” “Proposal 1 — Election of Directors” and to “Section 16(a) Beneficial Ownership Reporting Compliance” in the Pinnacle West Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 15, 2019 (the “2019 Proxy Statement”) and to the “Executive Officers of Pinnacle West” section in Part I of this report.
 
Pinnacle West has adopted a Code of Ethics for Financial Executives that applies to financial executives including Pinnacle West’s Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer, Controller, Treasurer, and General Counsel, the President and Chief Operating Officer of APS and other persons designated as financial executives by the Chair of the Audit Committee.  The Code of Ethics for Financial Executives is posted on Pinnacle West’s website ( www.pinnaclewest.com) .  Pinnacle West intends to satisfy the requirements under Item 5.05 of Form 8-K regarding disclosure of amendments to, or waivers from, provisions of the Code of Ethics for Financial Executives by posting such information on Pinnacle West’s website.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
Reference is hereby made to “Directors’ Compensation,” “Executive Compensation,” and “Human Resources Committee Interlocks and Insider Participation” in the 2019 Proxy Statement.

188

Table of Contents

ITEM 12.  SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
 
Reference is hereby made to “Ownership of Pinnacle West Stock” in the 2019 Proxy Statement.

Securities Authorized for Issuance Under Equity Compensation Plans
 
The following table sets forth information as of December 31, 2018 with respect to the 2012 Plan and the 2007 Plan, under which our equity securities are outstanding or currently authorized for issuance.

Equity Compensation Plan Information 

									
Plan Category	Number of
securities to be
issued upon
exercise of
outstanding
options, warrants
and rights
  (a)	 	Weighted-
average exercise price
of outstanding
options,
warrants and
rights
  (b)	 	Number of
securities remaining
available for future
issuance under
equity
compensation plans
(excluding
securities reflected
in column (a))
  (c)	
Equity compensation plans approved by security holders	1,350,003		 	—		 	1,862,883		
Equity compensation plans not approved by security holders	 	 	—		 	 	
Total	1,350,003		 	—		 	1,862,883		

(a)	This amount includes shares subject to outstanding performance share awards and restricted stock unit awards at the maximum amount of shares issuable under such awards.  However, payout of the performance share awards is contingent on the Company reaching certain levels of performance during a three-year performance period.  If the performance criteria for these awards are not fully satisfied, the award recipient will receive less than the maximum number of shares available under these grants and may receive nothing from these grants.	
		
(b)	The weighted-average exercise price in this column does not take performance share awards or restricted stock unit awards into account, as those awards have no exercise price.	
		
(c)	Awards under the 2012 Plan can take the form of options, stock appreciation rights, restricted stock, performance shares, performance share units, performance cash, stock grants, stock units, dividend equivalents, and restricted stock units.  Additional shares cannot be awarded under the 2007 Plan.  However, if an award under the 2012 Plan is forfeited, terminated or canceled or expires, the shares subject to such award, to the extent of the forfeiture, termination, cancellation or expiration, may be added back to the shares available for issuance under the 2012 Plan.	

Equity Compensation Plans Approved By Security Holders
 
Amounts in column (a) in the table above include shares subject to awards outstanding under two equity compensation plans that were previously approved by our shareholders:  (a) the 2007 Plan, which was approved by our shareholders at our 2007 annual meeting of shareholders and under which no new stock awards may be granted; and (b) the 2012 Plan, as amended, which was approved by our shareholders at our 2012 annual meeting of shareholders and the first amendment to the 2012 Plan was approved by our shareholders at our 2017 annual meeting of shareholders.  See Note 15 of the Notes to Consolidated Financial Statements for additional information regarding these plans.

189

Table of Contents

      Equity Compensation Plans Not Approved by Security Holders
 
The Company does not have any equity compensation plans under which shares can be issued that have not been approved by the shareholders.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
Reference is hereby made to “Information About Our Board and Corporate Governance” and “Related Party Transactions” in the 2019 Proxy Statement.

190

Table of Contents

ITEM 14.  PRINCIPAL ACCOUNTANT
FEES AND SERVICES
 
Pinnacle West
 
Reference is hereby made to “Accounting and Auditing Matters — Audit Fees and — Pre-Approval Policies” in the 2019 Proxy Statement.
 
APS
 
The following fees were paid to APS’s independent registered public accountants, Deloitte & Touche LLP, for the last two fiscal years:

	
									
Type of Service	 	2018	 	2017	
Audit Fees (1)	 	$	2,342,455		 	$	2,212,137		
Audit-Related Fees (2)	 	300,334		 	292,467		
 
(1)       The aggregate fees billed for services rendered for the audit of annual financial statements and for review of financial statements included in Reports on Form 10-Q.
(2)       The aggregate fees billed for assurance and related services that are reasonably related to the performance of the audit or review of the financial statements and are not included in Audit Fees reported above, which primarily consist of fees for employee benefit plan audits performed in 2018 and 2017.
 
Pinnacle West’s Audit Committee pre-approves each audit service and non-audit service to be provided by APS’s registered public accounting firm.  The Audit Committee has delegated to the Chair of the Audit Committee the authority to pre-approve audit and non-audit services to be performed by the independent public accountants if the services are not expected to cost more than $50,000.  The Chair must report any pre-approval decisions to the Audit Committee at its next scheduled meeting.  All of the services performed by Deloitte & Touche LLP for APS in 2018 were pre-approved by the Audit Committee or the Chair consistent with the pre-approval policy.

191

Table of Contents

PART IV

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
Financial Statements and Financial Statement Schedules
 
See the Index to Financial Statements and Financial Statement Schedule in Part II, Item 8.
 
Exhibits Filed
 
The documents listed below are being filed or have previously been filed on behalf of Pinnacle West or APS and are incorporated herein by reference from the documents indicated and made a part hereof.  Exhibits not identified as previously filed are filed herewith.

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
 	 	 	 	 	 	 	 	 	
3.1	 	Pinnacle West	 	Articles of Incorporation, restated as of May 21, 2008	 	3.1 to Pinnacle West/APS June 30, 2008 Form 10-Q Report, File No. 1-8962	 	8/7/2008	
 	 	 	 	 	 	 	 	 	
3.2	 	Pinnacle West	 	Pinnacle West Capital Corporation Bylaws, amended as of February 22, 2017	 	3.1 to Pinnacle West/APS February 28, 2017 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	2/28/2017	
 	 	 	 	 	 	 	 	 	
3.3	 	APS	 	Articles of Incorporation, restated as of May 25, 1988	 	4.2 to APS’s Form 18 Registration Nos. 33-33910 and 33-55248 by means of September 24, 1993 Form 8-K Report, File No. 1-4473	 	9/29/1993	
 	 	 	 	 	 	 	 	 	
3.3.1	 	APS	 	Amendment to the Articles of Incorporation of Arizona Public Service Company, amended May 16, 2012	 	3.1 to Pinnacle West/APS May 22, 2012 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	5/22/2012	
 	 	 	 	 	 	 	 	 	
3.4	 	APS	 	Arizona Public Service Company Bylaws, amended as of December 16, 2008	 	3.4 to Pinnacle West/APS December 31, 2008 Form 10-K, File No. 1-4473	 	2/20/2009	
 	 	 	 	 	 	 	 	 	
4.1	 	Pinnacle West	 	Specimen Certificate of Pinnacle West Capital Corporation Common Stock, no par value	 	4.1 to Pinnacle West June 20, 2017 Form 8-K Report, File No. 1-8962
	 	6/20/2017

4.2	 	Pinnacle West
APS	 	Indenture dated as of January 1, 1995 among APS and The Bank of New York Mellon, as Trustee	 	4.6 to APS’s Registration Statement Nos. 33-61228 and 33-55473 by means of January 1, 1995 Form 8-K Report, File No. 1-4473	 	1/11/1995	
 	 	 	 	 	 	 	 	 	
4.2a	 	Pinnacle West
APS	 	First Supplemental Indenture dated as of January 1, 1995	 	4.4 to APS’s Registration Statement Nos. 33-61228 and 33-55473 by means of January 1, 1995 Form 8-K Report, File No. 1-4473	 	1/11/1995	
 	 	 	 	 	 	 	 	 	
4.3	 	Pinnacle West
APS	 	Indenture dated as of November 15, 1996 between APS and The Bank of New York, as Trustee	 	4.5 to APS’s Registration Statements Nos. 33-61228, 33-55473, 33-64455 and 333- 15379 by means of November 19, 1996 Form 8-K Report, File No. 1-4473	 	11/22/1996	

192

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
4.3a	 	Pinnacle West
APS	 	First Supplemental Indenture dated as of November 15, 1996	 	4.6 to APS’s Registration Statements Nos. 33-61228, 33-55473, 33-64455 and 333-15379 by means of November 19, 1996 Form 8-K Report, File No. 1-4473	 	11/22/1996	
 	 	 	 	 	 	 	 	 	
4.3b	 	Pinnacle West
APS	 	Second Supplemental Indenture dated as of April 1, 1997	 	4.10 to APS’s Registration Statement Nos. 33-55473, 33-64455 and 333-15379 by means of April 7, 1997 Form 8-K Report, File No. 1-4473	 	4/9/1997	
 	 	 	 	 	 	 	 	 	
4.3c	 	Pinnacle West
APS	 	Third Supplemental Indenture dated as of November 1, 2002	 	10.2 to Pinnacle West’s March 31, 2003 Form 10-Q Report, File No. 1-8962	 	5/15/2003	
 	 	 	 	 	 	 	 	 	
4.4	 	Pinnacle West	 	Indenture dated as of December 1, 2000 between the Company and The Bank of New York, as Trustee, relating to Senior Unsecured Debt Securities	 	4.1 to Pinnacle West’s Registration Statement No. 333-52476	 	12/21/2000	
 	 	 	 	 	 	 	 	 	
4.4a	 	Pinnacle West	 	Third Supplemental Indenture dated as of November 30, 2017	 	4.1 to Pinnacle West November 30, 2017 Form 8-K Report, File No. 1-8962	 	11/30/2017	
 	 	 	 	 	 	 	 	 	
4.5	 	Pinnacle West	 	Indenture dated as of December 1, 2000 between the Company and The Bank of New York, as Trustee, relating to Subordinated Unsecured Debt Securities	 	4.2 to Pinnacle West’s Registration Statement No. 333-52476	 	12/21/2000	
 	 	 	 	 	 	 	 	 	
4.6	 	Pinnacle West
APS	 	Indenture dated as of January 15, 1998 between APS and The Bank of New York Mellon Trust Company N.A. (successor to JPMorgan Chase Bank, N.A., formerly known as The Chase Manhattan Bank), as Trustee	 	4.10 to APS’s Registration Statement Nos. 333-15379 and 333-27551 by means of January 13, 1998 Form 8-K Report, File No. 1-4473	 	1/16/1998	
 	 	 	 	 	 	 	 	 	
4.6a	 	Pinnacle West
APS	 	Seventh Supplemental Indenture dated as of May 1, 2003	 	4.1 to APS’s Registration Statement No. 333-90824 by means of May 7, 2003 Form 8-K Report, File No. 1-4473	 	5/9/2003	
 	 	 	 	 	 	 	 	 	
4.6b	 	Pinnacle West
APS	 	Eighth Supplemental Indenture dated as of June 15, 2004	 	4.1 to APS’s Registration Statement No. 333-106772 by means of June 24, 2004 Form 8-K Report, File No. 1-4473	 	6/28/2004	
 	 	 	 	 	 	 	 	 	
4.6c	 	Pinnacle West
APS	 	Ninth Supplemental Indenture dated as of August 15, 2005	 	4.1 to APS’s Registration Statements Nos. 333-106772 and 333-121512 by means of August 17, 2005 Form 8-K Report, File No. 1-4473	 	8/22/2005	
 	 	 	 	 	 	 	 	 	
4.6d	 	APS	 	Tenth Supplemental Indenture dated as of August 1, 2006	 	4.1 to APS’s July 31, 2006 Form 8-K Report, File No. 1-4473	 	8/3/2006	
 	 	 	 	 	 	 	 	 	
4.6e	 	Pinnacle West
APS	 	Eleventh Supplemental Indenture dated as of February 26, 2009	 	4.6e to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	
 	 	 	 	 	 	 	 	 	
4.6f	 	Pinnacle West
APS	 	Twelfth Supplemental Indenture dated as of August 25, 2011	 	4.6f to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	
 	 	 	 	 	 	 	 	 	
4.6g	 	Pinnacle West
APS	 	Thirteenth Supplemental Indenture dated as of January 13, 2012	 	4.6g to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	

193

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
 	 	 	 	 	 	 	 	 	
4.6h	 	Pinnacle West
APS	 	Fourteenth Supplemental Indenture dated as of January 10, 2014	 	4.6h to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	
 	 	 	 	 	 	 	 	 	
4.6i	 	Pinnacle West
APS	 	Fifteenth Supplemental Indenture dated as of June 18, 2014	 	4.6i to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	
 	 	 	 	 	 	 	 	 	
4.6j	 	Pinnacle West
APS	 	Sixteenth Supplemental Indenture dated as of January 12, 2015	 	4.6j to Pinnacle West/APS 2014 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/20/2015	
 	 	 	 	 	 	 	 	 	
4.6k	 	Pinnacle West
APS	 	Seventeenth Supplemental Indenture dated as of May 19, 2015	 	4.1 to Pinnacle West/APS May 14, 2015 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	5/19/2015	
 	 	 	 	 	 	 	 	 	
4.6l	 	Pinnacle West
APS	 	Eighteenth Supplemental Indenture dated as of November 6, 2015	 	4.1 to Pinnacle West/APS November 3, 2015 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	11/6/2015	
 	 	 	 	 	 	 	 	 	
4.6m	 	Pinnacle West
APS	 	Nineteenth Supplemental Indenture dated as of May 6, 2016	 	4.1 to Pinnacle West/APS May 3, 2016 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	5/6/2016	
 	 	 	 	 	 	 	 	 	
4.6n	 	Pinnacle West
APS	 	Twentieth Supplemental Indenture dated as of September 20, 2016	 	4.1 to Pinnacle West/APS September 15, 2016 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	9/20/2016	
 	 	 	 	 	 	 	 	 	
4.6o	 	Pinnacle West
APS	 	Twenty-First Supplemental Indenture dated as of September 11, 2017	 	4.1 to Pinnacle West/APS September 11, 2017 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	9/11/2017	
 	 	 	 	 	 	 	 	 	
4.6p	 	Pinnacle West
APS	 	Twenty-Second Supplemental Indenture dated as of August 9, 2018	 	4.1 to Pinnacle West/APS August 9, 2018 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	8/9/2018	
 	 	 	 	 	 	 	 	 	
4.7	 	Pinnacle West	 	Second Amended and Restated Pinnacle West Capital Corporation Investors Advantage Plan dated as of June 23, 2004	 	4.4 to Pinnacle West’s June 23, 2004 Form 8-K Report, File No. 1-8962	 	8/9/2004	
 	 	 	 	 	 	 	 	 	
4.7a	 	Pinnacle West	 	Third Amended and Restated Pinnacle West Capital Corporation Investors Advantage Plan dated as of November 25, 2008	 	4.1 to Pinnacle West’s Form S-3 Registration Statement No. 333-155641, File No. 1-8962	 	11/25/2008	
 	 	 	 	 	 	 	 	 	
4.8	 	Pinnacle West	 	Agreement, dated March 29, 1988, relating to the filing of instruments defining the rights of holders of long-term debt not in excess of 10% of the Company’s total assets	 	4.1 to Pinnacle West’s 1987 Form 10-K Report, File No. 1-8962	 	3/30/1988	
 	 	 	 	 	 	 	 	 	
4.8a	 	Pinnacle West
APS	 	Agreement, dated March 21, 1994, relating to the filing of instruments defining the rights of holders of APS long-term debt not in excess of 10% of APS’s total assets	 	4.1 to APS’s 1993 Form 10-K Report, File No. 1-4473	 	3/30/1994	
 	 	 	 	 	 	 	 	 	
10.1.1	 	Pinnacle West
APS	 	Two separate Decommissioning Trust Agreements (relating to PVGS Units 1 and 3, respectively), each dated July 1, 1991, between APS and Mellon Bank, N.A., as Decommissioning Trustee	 	10.2 to APS’s September 30, 1991 Form 10-Q Report, File No. 1-4473	 	11/14/1991	

194

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.1.1a	 	Pinnacle West
APS	 	Amendment No. 1 to Decommissioning Trust Agreement (PVGS Unit 1), dated as of December 1, 1994	 	10.1 to APS’s 1994 Form 10-K Report, File No. 1-4473	 	3/30/1995	
 	 	 	 	 	 	 	 	 	
10.1.1b	 	Pinnacle West
APS	 	Amendment No. 1 to Decommissioning Trust Agreement (PVGS Unit 3), dated as of December 1, 1994	 	10.2 to APS’s 1994 Form 10-K Report, File No. 1-4473	 	3/30/1995	
 	 	 	 	 	 	 	 	 	
10.1.1c	 	Pinnacle West
APS	 	Amendment No. 2 to APS Decommissioning Trust Agreement (PVGS Unit 1) dated as of July 1, 1991	 	10.4 to APS’s 1996 Form 10-K Report , File No. 1-4473	 	3/28/1997	
 	 	 	 	 	 	 	 	 	
10.1.1d	 	Pinnacle West
APS	 	Amendment No. 2 to APS Decommissioning Trust Agreement (PVGS Unit 3) dated as of July 1, 1991	 	10.6 to APS’s 1996 Form 10-K Report, File No. 1-4473	 	3/28/1997	
 	 	 	 	 	 	 	 	 	
10.1.1e	 	Pinnacle West
APS	 	Amendment No. 3 to the Decommissioning Trust Agreement (PVGS Unit 1), dated as of March 18, 2002	 	10.2 to Pinnacle West’s March 31, 2002 Form 10-Q Report, File No. 1-8962	 	5/15/2002	
 	 	 	 	 	 	 	 	 	
10.1.1f	 	Pinnacle West
APS	 	Amendment No. 3 to the Decommissioning Trust Agreement (PVGS Unit 3), dated as of March 18, 2002	 	10.4 to Pinnacle West’s March 2002 Form 10-Q Report, File No. 1-8962	 	5/15/2002	
 	 	 	 	 	 	 	 	 	
10.1.1g	 	Pinnacle West
APS	 	Amendment No. 4 to the Decommissioning Trust Agreement (PVGS Unit 1), dated as of December 19, 2003	 	10.3 to Pinnacle West’s 2003 Form 10-K Report, File No. 1-8962	 	3/15/2004	
 	 	 	 	 	 	 	 	 	
10.1.1h	 	Pinnacle West
APS	 	Amendment No. 4 to the Decommissioning Trust Agreement (PVGS Unit 3), dated as of December 19, 2003	 	10.5 to Pinnacle West’s 2003 Form 10-K Report, File No. 1-8962	 	3/15/2004	
 	 	 	 	 	 	 	 	 	
10.1.1i	 	Pinnacle West
APS	 	Amendment No. 5 to the Decommissioning Trust Agreement (PVGS Unit 1), dated as of May 1, 2007	 	10.1 to Pinnacle West/APS March 31, 2007 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/9/2007	
 	 	 	 	 	 	 	 	 	
10.1.1j	 	Pinnacle West
APS	 	Amendment No. 5 to the Decommissioning Trust Agreement (PVGS Unit 3), dated as of May 1, 2007	 	10.2 to Pinnacle West/APS March 31, 2007 Form 10-Q Report, File Nos. 1-8962 and 104473	 	5/9/2007	
 	 	 	 	 	 	 	 	 	
10.1.2	 	Pinnacle West
APS	 	Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2) dated as of January 31, 1992, among APS, Mellon Bank, N.A., as Decommissioning Trustee, and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee under two separate Trust Agreements, each with a separate Equity Participant, and as Lessor under two separate Facility Leases, each relating to an undivided interest in PVGS Unit 2	 	10.1 to Pinnacle West’s 1991 Form 10-K Report, File No. 1-8962	 	3/26/1992	

195

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.1.2a	 	Pinnacle West
APS	 	First Amendment to Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of November 1, 1992	 	10.2 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
10.1.2b	 	Pinnacle West
APS	 	Amendment No. 2 to Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of November 1, 1994	 	10.3 to APS’s 1994 Form 10-K Report, File No. 1-4473	 	3/30/1995	
 	 	 	 	 	 	 	 	 	
10.1.2c	 	Pinnacle West
APS	 	Amendment No. 3 to Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of June 20, 1996	 	10.1 to APS’s June 30, 1996 Form 10-Q Report, File No. 1-4473	 	8/9/1996	
 	 	 	 	 	 	 	 	 	
10.1.2d	 	Pinnacle West
APS	 	Amendment No. 4 to Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2) dated as of December 16, 1996	 	APS 10.5 to APS’s 1996 Form 10-K Report, File No. 1-4473	 	3/28/1997	
 	 	 	 	 	 	 	 	 	
10.1.2e	 	Pinnacle West
APS	 	Amendment No. 5 to the Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of June 30, 2000	 	10.1 to Pinnacle West’s March 31, 2002 Form 10-Q Report, File No. 1-8962	 	5/15/2002	
 	 	 	 	 	 	 	 	 	
10.1.2f	 	Pinnacle West
APS	 	Amendment No. 6 to the Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of March 18, 2002	 	10.3 to Pinnacle West’s March 31, 2002 Form 10-Q Report, File No. 1-8962	 	5/15/2002	
 	 	 	 	 	 	 	 	 	
10.1.2g	 	Pinnacle West
APS	 	Amendment No. 7 to the Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of December 19, 2003	 	10.4 to Pinnacle West’s 2003 Form 10-K Report, File No. 1-8962	 	3/15/2004	
 	 	 	 	 	 	 	 	 	
10.1.2h	 	Pinnacle West
APS	 	Amendment No. 8 to the Amended and Restated Decommissioning Trust Agreement (PVGS Unit 2), dated as of April 1, 2007	 	10.1.2h to Pinnacle West’s 2007 Form 10-K Report, File No. 1-8962	 	2/27/2008	
 	 	 	 	 	 	 	 	 	
10.2.1 b	 	Pinnacle West
APS	 	Arizona Public Service Company Deferred Compensation Plan, as restated, effective January 1, 1984, and the second and third amendments thereto, dated December 22, 1986, and December 23, 1987, respectively	 	10.4 to APS’s 1988 Form 10-K Report, File No. 1-4473	 	3/8/1989	
 	 	 	 	 	 	 	 	 	
10.2.1a b	 	Pinnacle West
APS	 	Third Amendment to the Arizona Public Service Company Deferred Compensation Plan, effective as of January 1, 1993	 	10.3A to APS’s 1993 Form 10-K Report, File No. 1-4473	 	3/30/1994	
 	 	 	 	 	 	 	 	 	
10.2.1b b	 	Pinnacle West
APS	 	Fourth Amendment to the Arizona Public Service Company Deferred Compensation Plan effective as of May 1, 1993	 	10.2 to APS’s September 30, 1994 Form 10-Q Report, File No. 1-4473	 	11/10/1994	
 	 	 	 	 	 	 	 	 	
10.2.1c b	 	Pinnacle West
APS	 	Fifth Amendment to the Arizona Public Service Company Deferred Compensation Plan effective January 1, 1997	 	10.3A to APS’s 1996 Form 10-K Report, File No. 1-4473	 	3/28/1997	
 	 	 	 	 	 	 	 	 	
10.2.1d b	 	Pinnacle West
APS	 	Sixth Amendment to the Arizona Public Service Company Deferred Compensation Plan effective January 1, 2001	 	10.8A to Pinnacle West’s 2000 Form 10-K Report, File No. 1-8962	 	3/14/2001	

196

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.2.2 b	 	Pinnacle West
APS	 	Arizona Public Service Company Directors’ Deferred Compensation Plan, as restated, effective January 1, 1986	 	10.1 to APS’s June 30, 1986 Form 10-Q Report, File No. 1-4473	 	8/13/1986	
 	 	 	 	 	 	 	 	 	
10.2.2a b	 	Pinnacle West
APS	 	Second Amendment to the Arizona Public Service Company Directors’ Deferred Compensation Plan, effective as of January 1, 1993	 	10.2A to APS’s 1993 Form 10-K Report, File No. 1-4473	 	3/30/1994	
 	 	 	 	 	 	 	 	 	
10.2.2b b	 	Pinnacle West
APS	 	Third Amendment to the Arizona Public Service Company Directors’ Deferred Compensation Plan, effective as of May 1, 1993	 	10.1 to APS’s September 30, 1994 Form 10-Q Report, File No. 1-4473	 	11/10/1994	
 	 	 	 	 	 	 	 	 	
10.2.2c b	 	Pinnacle West
APS	 	Fourth Amendment to the Arizona Public Service Company Directors Deferred Compensation Plan, effective as of January 1, 1999	 	10.8A to Pinnacle West’s 1999 Form 10-K Report, File No. 1-8962	 	3/30/2000	
 	 	 	 	 	 	 	 	 	
10.2.3 b	 	Pinnacle West
APS	 	Trust for the Pinnacle West Capital Corporation, Arizona Public Service Company and SunCor Development Company Deferred Compensation Plans dated August 1, 1996	 	10.14A to Pinnacle West’s 1999 Form 10-K Report, File No. 1-8962	 	3/30/2000	
 	 	 	 	 	 	 	 	 	
10.2.3a b	 	Pinnacle West
APS	 	First Amendment dated December 7, 1999 to the Trust for the Pinnacle West Capital Corporation, Arizona Public Service Company and SunCor Development Company Deferred Compensation Plans	 	10.15A to Pinnacle West’s 1999 Form 10-K Report, File No. 1-8962	 	3/30/2000	
 	 	 	 	 	 	 	 	 	
10.2.4 b	 	Pinnacle West
APS	 	Pinnacle West Capital Corporation, Arizona Public Service Company, SunCor Development Company and El Dorado Investment Company Deferred Compensation Plan as amended and restated effective January 1, 1996	 	10.10A to APS’s 1995 Form  10-K Report, File No. 1-4473	 	3/29/1996	
 	 	 	 	 	 	 	 	 	
10.2.4a b	 	Pinnacle West
APS	 	First Amendment effective as of January 1, 1999, to the Pinnacle West Capital Corporation, Arizona Public Service Company, SunCor Development Company and El Dorado Investment Company Deferred Compensation Plan	 	10.7A to Pinnacle West’s 1999 Form 10-K Report, File No. 1-8962	 	3/30/2000	
 	 	 	 	 	 	 	 	 	
10.2.4b b	 	Pinnacle West
APS	 	Second Amendment effective January 1, 2000 to the Pinnacle West Capital Corporation, Arizona Public Service Company, SunCor Development Company and El Dorado Investment Company Deferred Compensation Plan	 	10.10A to Pinnacle West’s 1999 Form 10-K Report, File No. 1-8962	 	3/30/2000	
 	 	 	 	 	 	 	 	 	
10.2.4c b	 	Pinnacle West
APS	 	Third Amendment to the Pinnacle West Capital Corporation, Arizona Public Service Company, SunCor Development Company and El Dorado Investment Company Deferred Compensation Plan, effective as of January 1, 2002	 	10.3 to Pinnacle West’s March 31, 2003 Form 10-Q Report, File No. 1-8962	 	5/15/2003	

197

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.2.4d b	 	Pinnacle West
APS	 	Fourth Amendment to the Pinnacle West Capital Corporation, Arizona Public Service Company, SunCor Development Company and El Dorado Investment Company Deferred Compensation Plan, effective January 1, 2003	 	10.64b to Pinnacle West/APS 2005 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/13/2006	
 	 	 	 	 	 	 	 	 	
10.2.5 b	 	Pinnacle West
APS	 	Deferred Compensation Plan of 2005 for Employees of Pinnacle West Capital Corporation and Affiliates (as amended and restated effective January 1, 2016)	 	10.2.5 to Pinnacle West/APS 2015 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/19/2016	
 	 	 	 	 	 	 	 	 	
10.3.1 b	 	Pinnacle West
APS	 	Pinnacle West Capital Corporation Supplemental Excess Benefit Retirement Plan, amended and restated as of January 1, 2003	 	10.7A to Pinnacle West’s 2003 Form 10-K Report, File No. 1-8962	 	3/15/2004	
 	 	 	 	 	 	 	 	 	
10.3.1a b	 	Pinnacle West
APS	 	Pinnacle West Capital Corporation Supplemental Excess Benefit Retirement Plan, as amended and restated, dated December 18, 2003	 	10.48b to Pinnacle West/APS 2005 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/13/2006	
 	 	 	 	 	 	 	 	 	
10.3.2 b	 	Pinnacle West
APS	 	Pinnacle West Capital Corporation Supplemental Excess Benefit Retirement Plan of 2005 (as amended and restated effective January 1, 2016)	 	10.3.2 to Pinnacle West/APS 2015 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/19/2016	
 	 	 	 	 	 	 	 	 	
10.3.2a b	 	Pinnacle West
APS	 	First Amendment to the Pinnacle West Capital Corporation Supplemental Excess Benefit Retirement Plan of 2005 (as amended and restated effective January 1, 2016)	 	10.3.2a to Pinnacle West/APS 2016 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/24/2017	
 	 	 	 	 	 	 	 	 	
10.3.2b b	 	Pinnacle West
APS	 	Second Amendment to the Pinnacle West Capital Corporation Supplemental Excess Benefit Retirement Plan of 2005 (as amended and restated effective January 1, 2016)	 	10.3.2b to Pinnacle West/APS 2017 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/23/2018	
 	 	 	 	 	 	 	 	 	
10.4.1 b	 	Pinnacle West
APS	 	Letter Agreement dated June 17, 2008 between Pinnacle West/APS and James R. Hatfield	 	10.1 to Pinnacle West/APS June 30, 2008 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/7/2008	
 	 	 	 	 	 	 	 	 	
10.4.2 b	 	APS	 	Retention Agreement dated December 19, 2008 between APS and Robert Bement	 	 	 	 	
 	 	 	 	 	 	 	 	 	
10.4.3 b	 	APS	 	Discretionary Credit Award Agreement dated October 20, 2014 between APS and Robert Bement	 	 	 	 	
 	 	 	 	 	 	 	 	 	
10.5.1 bd	 	Pinnacle West
APS	 	Key Executive Employment and Severance Agreement between Pinnacle West and certain executive officers of Pinnacle West and its subsidiaries	 	10.77bd to Pinnacle West/APS 2005 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/13/2006	
 	 	 	 	 	 	 	 	 	
10.5.1a bd	 	Pinnacle West
APS	 	Form of Amended and Restated Key Executive Employment and Severance Agreement between Pinnacle West and certain officers of Pinnacle West and its subsidiaries	 	10.4 to Pinnacle West/APS September 30, 2007 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	11/6/2007	

198

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.5.2 bd	 	Pinnacle West
APS	 	Form of Key Executive Employment and Severance Agreement between Pinnacle West and certain officers of Pinnacle West and its subsidiaries	 	10.3 to Pinnacle West/APS September 30, 2007 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	11/6/2007	
 	 	 	 	 	 	 	 	 	
10.5.3 bd	 	Pinnacle West
APS	 	Form of Key Executive Employment and Severance Agreement between Pinnacle West and certain officers of Pinnacle West and its subsidiaries	 	10.5.3 to Pinnacle West/APS 2009 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/19/2010	
 	 	 	 	 	 	 	 	 	
10.5.4 bd	 	Pinnacle West
APS	 	Form of Key Executive Employment and Severance Agreement between Pinnacle West and certain officers of Pinnacle West and its subsidiaries	 	10.5.4 to Pinnacle West/APS 2012 Form 10-K, File Nos. 1-8962 and 1-4473	 	2/22/2013	
 	 	 	 	 	 	 	 	 	
10.6.1 b	 	Pinnacle West	 	Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	Appendix B to the Proxy Statement for Pinnacle West’s 2007 Annual Meeting of Shareholders, File No. 1-8962	 	4/20/2007	
 	 	 	 	 	 	 	 	 	
10.6.1a b	 	Pinnacle West	 	First Amendment to the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.2 to Pinnacle West/APS April 18, 2007 Form 8-K Report, File No. 1-8962	 	4/20/2007	
 	 	 	 	 	 	 	 	 	
10.6.1b bd	 	Pinnacle West
APS	 	Performance Share Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.3 to Pinnacle West/APS March 31, 2009 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/5/2009	
 	 	 	 	 	 	 	 	 	
10.6.1c bd	 	Pinnacle West	 	Form of Performance Share Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.1 to Pinnacle West/APS June 30, 2010 Form 10-Q Report, File No. 1-8962	 	8/3/2010	
 	 	 	 	 	 	 	 	 	
10.6.1d bd	 	Pinnacle West	 	Form of Restricted Stock Unit Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.2 to Pinnacle West/APS June 30, 2010 Form 10-Q Report, File No. 1-8962	 	8/3/2010	
 	 	 	 	 	 	 	 	 	
10.6.1e bd	 	Pinnacle West	 	Form of Performance Share Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.4 to Pinnacle West/APS March 31, 2011 Form 10-Q Report, File No. 1-8962	 	4/29/2011	
 	 	 	 	 	 	 	 	 	
10.6.1f bd	 	Pinnacle West	 	Form of Restricted Stock Unit Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan	 	10.5 to Pinnacle West/APS March 31, 2011 Form 10-Q Report, File No. 1-8962	 	4/29/2011	
 	 	 	 	 	 	 	 	 	
10.6.1g bd	 	Pinnacle West	 	Form of Restricted Stock Unit Agreement under the Pinnacle West Capital Corporation 2007 Long-Term Incentive Plan (Supplemental 2010 Award)	 	10.6 to Pinnacle West/APS March 31, 2011 Form 10-Q Report, File No. 1-8962	 	4/29/2011	
 	 	 	 	 	 	 	 	 	
10.6.2 b	 	Pinnacle West	 	Description of Annual Stock Grants to Non-Employee Directors	 	10.1 to Pinnacle West/APS September 30, 2007 Form 10-Q Report, File No. 1-8962	 	11/6/2007	
 	 	 	 	 	 	 	 	 	
10.6.3 b	 	Pinnacle West	 	Description of Annual Stock Grants to Non-Employee Directors	 	10.2 to Pinnacle West/APS June 30, 2008 Form 10-Q Report, File No. 1-8962	 	8/7/2008	
 	 	 	 	 	 	 	 	 	
10.6.4 bd	 	Pinnacle West
APS	 	Summary of 2019 Variable Incentive Plan and Officer Variable Incentive Plan	 	 	 	 	

199

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.6.5	 	Pinnacle West	 	Description of Restricted Stock Unit Grant to Donald E. Brandt	 	Pinnacle West/APS December 24, 2012 Form 8-K Report, File No. 1-8962	 	12/26/2012	
 	 	 	 	 	 	 	 	 	
10.6.6 b	 	Pinnacle West
APS	 	Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	Appendix A to the Proxy Statement for Pinnacle West’s 2012 Annual Meeting of Shareholders, File No. 1-8962	 	3/29/2012	
 	 	 	 	 	 	 	 	 	
10.6.6a bd	 	Pinnacle West	 	Form of Performance Share Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.1 to Pinnacle West/APS March 31, 2012 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/3/2012	
 	 	 	 	 	 	 	 	 	
10.6.6b bd	 	Pinnacle West	 	Form of Restricted Stock Unit Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.2 to Pinnacle West/APS March 31, 2012 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/3/2012	
 	 	 	 	 	 	 	 	 	
10.6.6c bd	 	Pinnacle West	 	Form of Performance Share Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.6.8c to Pinnacle West/APS 2013 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/21/2014	
 	 	 	 	 	 	 	 	 	
10.6.6d bd	 	Pinnacle West	 	Form of Restricted Stock Unit Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.6.8d to Pinnacle West/APS 2013 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/21/2014	
 	 	 	 	 	 	 	 	 	
10.6.6e bd	 	Pinnacle West	 	Form of Performance Share Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.6.6e to Pinnacle West/APS 2015 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/19/2016	
 	 	 	 	 	 	 	 	 	
10.6.6f bd	 	Pinnacle West	 	Form of Restricted Stock Unit Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.6.6f to Pinnacle West/APS 2016 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/24/2017	
 	 	 	 	 	 	 	 	 	
10.6.6g bd	 	Pinnacle West	 	Form of Performance Share Award Agreement under the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	10.6.6g to Pinnacle West/APS 2016 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/24/2017	
 	 	 	 	 	 	 	 	 	
10.6.6h bd	 	Pinnacle West	 	Master Amendment to Performance Share Agreements	 	10.3 to Pinnacle West/APS March 31, 2012 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/3/2012	
 	 	 	 	 	 	 	 	 	
10.6.6i bd	 	Pinnacle West	 	Master Amendment to Restricted Stock Unit Agreements	 	10.4 to Pinnacle West/APS March 31, 2012 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/3/2012	
 	 	 	 	 	 	 	 	 	
10.6.6j bd	 	Pinnacle West	 	Performance Cash Award Agreement, dated May 10, 2017, between Pinnacle West and Donald E. Brandt	 	10.1 to Pinnacle West/APS June 30, 2017 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/2/2017	
 	 	 	 	 	 	 	 	 	
10.6.6k bd	 	Pinnacle West	 	First Amendment to the Pinnacle West Capital Corporation 2012 Long-Term Incentive Plan	 	Appendix A to the Proxy Statement for Pinnacle West’s 2017 Annual Meeting of Shareholders, File No. 1-8962	 	3/31/2017	
 	 	 	 	 	 	 	 	 	
10.7.1	 	Pinnacle West
APS	 	Indenture of Lease with Navajo Tribe of Indians, Four Corners Plant	 	5.01 to APS's Form S-7 Registration Statement, File No. 2-59644	 	9/1/1977	

200

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.7.1a	 	Pinnacle West
APS	 	Supplemental and Additional Indenture of Lease, including amendments and supplements to original lease with Navajo Tribe of Indians, Four Corners Plant	 	5.02 to APS’s Form S-7 Registration Statement, File No. 2-59644	 	9/1/1977	
 	 	 	 	 	 	 	 	 	
10.7.1b	 	Pinnacle West
APS	 	Amendment and Supplement No. 1 to Supplemental and Additional Indenture of Lease Four Corners, dated April 25, 1985	 	10.36 to Pinnacle West’s Registration Statement on Form  8-B Report, File No. 1-89	 	7/25/1985	
 	 	 	 	 	 	 	 	 	
10.7.1c	 	Pinnacle West
APS	 	Amendment and Supplement No. 2 to Supplemental and Additional Indenture of Lease with the Navajo Nation dated March 7, 2011	 	10.1 to Pinnacle West/APS March 31, 2011 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	4/29/2011	
 	 	 	 	 	 	 	 	 	
10.7.1d	 	Pinnacle West
APS	 	Amendment and Supplement No. 3 to Supplemental and Additional Indenture of Lease with the Navajo Nation dated March 7, 2011	 	10.2 to Pinnacle West/APS March 31, 2011 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	4/29/2011	
 	 	 	 	 	 	 	 	 	
10.7.2	 	Pinnacle West
APS	 	Application and Grant of multi-party rights-of-way and easements, Four Corners Plant Site	 	5.04 to APS’s Form S-7 Registration Statement, File No. 2-59644	 	9/1/1977	
 	 	 	 	 	 	 	 	 	
10.7.2a	 	Pinnacle West
APS	 	Application and Amendment No. 1 to Grant of multi-party rights-of-way and easements, Four Corners Site dated April 25, 1985	 	10.37 to Pinnacle West’s Registration Statement on Form 8-B, File No. 1-8962	 	7/25/1985	
 	 	 	 	 	 	 	 	 	
10.7.3	 	Pinnacle West
APS	 	Application and Grant of APS rights- of-way and easements, Four Corners Site	 	5.05 to APS’s Form S-7 Registration Statement, File No. 2-59644	 	9/1/1977	
 	 	 	 	 	 	 	 	 	
10.7.3a	 	Pinnacle West
APS	 	Application and Amendment No. 1 to Grant of APS rights-of-way and easements, Four Corners Site dated April 25, 1985	 	10.38 to Pinnacle West’s Registration Statement on Form 8-B, File No. 1-8962	 	7/25/1985	
 	 	 	 	 	 	 	 	 	
10.7.4	 	Pinnacle West
APS	 	Four Corners Project Co-Tenancy Agreement, conformed copy up through and including Amendment No. 11, dated June 30, 2018, among APS, Public Service Company of New Mexico, SRP, Tucson Electric Power Company and Navajo Transitional Energy Company, LLC	 	10.7.4c to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	
 	 	 	 	 	 	 	 	 	
10.8.1	 	Pinnacle West
APS	 	Indenture of Lease, Navajo Units 1, 2, and 3	 	5(g) to APS’s Form S-7 Registration Statement, File No. 2-36505	 	3/23/1970	
 	 	 	 	 	 	 	 	 	
10.8.2	 	Pinnacle West
APS	 	Application of Grant of rights-of-way and easements, Navajo Plant	 	5(h) to APS Form S-7 Registration Statement, File No. 2-36505	 	3/23/1970	
 	 	 	 	 	 	 	 	 	
10.8.3	 	Pinnacle West
APS	 	Water Service Contract Assignment with the United States Department of Interior, Bureau of Reclamation, Navajo Plant	 	5(l) to APS’s Form S-7 Registration Statement, File No. 2-394442	 	3/16/1971	

201

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.8.4	 	Pinnacle West
APS	 	Navajo Project Co-Tenancy Agreement dated as of March 23, 1976, and Supplement No. 1 thereto dated as of October 18, 1976, Amendment No. 1 dated as of July 5, 1988, and Amendment No. 2 dated as of June 14, 1996; Amendment No. 3 dated as of February 11, 1997; Amendment No. 4 dated as of January 21, 1997; Amendment No. 5 dated as of January 23, 1998; Amendment No. 6 dated as of July 31, 1998	 	10.107 to Pinnacle West/APS 2005 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/13/2006	
 	 	 	 	 	 	 	 	 	
10.8.5	 	Pinnacle West
APS	 	Navajo Project Participation Agreement dated as of September 30, 1969, and Amendment and Supplement No. 1 dated as of January 16, 1970, and Coordinating Committee Agreement No. 1 dated as of September 30, 1971	 	10.108 to Pinnacle West/APS 2005 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/13/2006	
 	 	 	 	 	 	 	 	 	
10.9.1	 	Pinnacle West
APS	 	ANPP Participation Agreement, dated August 23, 1973, among APS, SRP, SCE, Public Service Company of New Mexico, El Paso, Southern California Public Power Authority, and Department of Water and Power of the City of Los Angeles, and amendments 1-12 thereto	 	10. 1 to APS’s 1988 Form 10-K Report, File No. 1-4473	 	3/8/1989	
 	 	 	 	 	 	 	 	 	
10.9.1a	 	Pinnacle West
APS	 	Amendment No. 13, dated as of April 22, 1991, to ANPP Participation Agreement, dated August 23, 1973, among APS, SRP, SCE, Public Service Company of New Mexico, El Paso, Southern California Public Power Authority, and Department of Water and Power of the City of Los Angeles	 	10.1 to APS’s March 31, 1991 Form 10-Q Report, File No. 1-4473	 	5/15/1991	
 	 	 	 	 	 	 	 	 	
10.9.1b	 	Pinnacle West
APS	 	Amendment No. 14 to ANPP Participation Agreement, dated August 23, 1973, among APS, SRP, SCE, Public Service Company of New Mexico, El Paso, Southern California Public Power Authority, and Department of Water and Power of the City of Los Angeles	 	99.1 to Pinnacle West’s June 30, 2000 Form 10-Q Report, File No. 1-8962	 	8/14/2000	
 	 	 	 	 	 	 	 	 	
10.9.1c	 	Pinnacle West
APS	 	Amendment No. 15, dated November 29, 2010, to ANPP Participation Agreement, dated August 23, 1973, among APS, SRP, SCE, Public Service Company of New Mexico, El Paso, Southern California Public Power Authority, and Department of Water and Power of the City of Los Angeles	 	10.9.1c to Pinnacle West/APS 2010 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/18/2011	

202

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.9.1d	 	Pinnacle West
APS	 	Amendment No. 16, dated April 28, 2014, to ANPP Participation Agreement, dated August 23, 1973, among APS, SRP, SCE, Public Service Company of New Mexico, El Paso, Southern California Public Power Authority, and Department of Water and Power of the City of Los Angeles	 	10.2 to Pinnacle West/APS March 31, 2014 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/2/2014	
 	 	 	 	 	 	 	 	 	
10.10.1	 	Pinnacle West
APS	 	Asset Purchase and Power Exchange Agreement dated September 21, 1990 between APS and PacifiCorp, as amended as of October 11, 1990 and as of July 18, 1991	 	10.1 to APS’s June 30, 1991 Form 10-Q Report, File No. 1-4473	 	8/8/1991	
 	 	 	 	 	 	 	 	 	
10.10.2	 	Pinnacle West
APS	 	Long-Term Power Transaction Agreement dated September 21, 1990 between APS and PacifiCorp, as amended as of October 11, 1990, and as of July 8, 1991	 	10.2 to APS’s June 30, 1991 Form 10-Q Report, File No. 1-4473	 	8/8/1991	
 	 	 	 	 	 	 	 	 	
10.10.2a	 	Pinnacle West
APS	 	Amendment No. 1 dated April 5, 1995 to the Long-Term Power Transaction Agreement and Asset Purchase and Power Exchange Agreement between PacifiCorp and APS	 	10.3 to APS’s 1995 Form 10-K Report, File No. 1-4473	 	3/29/1996	
 	 	 	 	 	 	 	 	 	
10.10.3	 	Pinnacle West
APS	 	Restated Transmission Agreement between PacifiCorp and APS dated April 5, 1995	 	10.4 to APS’s 1995 Form 10-K Report, File No. 1-4473	 	3/29/1996	
 	 	 	 	 	 	 	 	 	
10.10.4	 	Pinnacle West
APS	 	Contract among PacifiCorp, APS and DOE Western Area Power Administration, Salt Lake Area Integrated Projects for Firm Transmission Service dated May 5, 1995	 	10.5 to APS’s 1995 Form 10-K Report, File No. 1-4473	 	3/29/1996	
 	 	 	 	 	 	 	 	 	
10.10.5	 	Pinnacle West
APS	 	Reciprocal Transmission Service Agreement between APS and PacifiCorp dated as of March 2, 1994	 	10.6 to APS’s 1995 Form 10-K Report, File No. 1-4473	 	3/29/1996	
 	 	 	 	 	 	 	 	 	
10.11.1	 	Pinnacle West	 	Term Loan Agreement dated as of December 21, 2018 among Pinnacle West, as Borrower, KeyBank National Association, as Agent, PNC Bank, National Association and Wells Fargo Bank, National Association, as Co-Syndication Agents and such institutions compromising the lenders party thereto	 	 	 	 	
 	 	 	 	 	 	 	 	 	
10.11.2	 	Pinnacle West	 	Five-Year Credit Agreement dated as of July 12, 2018, among Pinnacle West, as Borrower, Barclays Bank PLC, as Agent and Issuing Bank, and the lenders and other parties thereto	 	10.3 to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	

203

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.11.3	 	Pinnacle West	 	364-day Credit Agreement dated as of June 28, 2018, among Pinnacle West, as Borrower, MUFG Bank, Ltd., as Agent and Issuing Bank, JPMorgan Chase Bank, N.A. and Bank of America, N.A., as Co-Syndication Agent	 	10.1 to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	
 	 	 	 	 	 	 	 	 	
10.11.4	 	Pinnacle West
APS	 	Five-Year Credit Agreement dated as of June 29, 2017 among APS, as Borrower, Barclays Bank PLC, as Agent and Issuing Bank, and the lenders and other parties thereto	 	10.2 to Pinnacle West/APS June 30, 2017 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2017	
 	 	 	 	 	 	 	 	 	
10.11.4a	 	Pinnacle West
APS	 	Amendment No. 1, dated July 13, 2018, to Five-Year Credit Agreement dated as of June 29, 2017, among APS, as Borrower, Barclays Bank PLC, as Agent and Issuing Bank, and the lenders and other parties thereto	 	10.11.4a to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	
 	 	 	 	 	 	 	 	 	
10.11.5	 	Pinnacle West
APS	 	Five-Year Credit Agreement dated as of July 12, 2018 among APS, as Borrower, Barclays Bank PLC, as Agent and Issuing Bank, and the lenders and other parties thereto
	 	10.4 to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	
 	 	 	 	 	 	 	 	 	
10.12.1 c	 	Pinnacle West
APS	 	Facility Lease, dated as of August 1, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its capacity as Owner Trustee, as Lessor, and APS, as Lessee	 	4.3 to APS’s Form 18 Registration Statement, File No. 33-9480	 	10/24/1986	
 	 	 	 	 	 	 	 	 	
10.12.1a c	 	Pinnacle West
APS	 	Amendment No. 1, dated as of November 1, 1986, to Facility Lease, dated as of August 1, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its capacity as Owner Trustee, as Lessor, and APS, as Lessee	 	10.5 to APS’s September 30, 1986 Form 10-Q Report by means of Amendment No. 1 on December 3, 1986 Form 8, File No. 1-4473	 	12/4/1986	
 	 	 	 	 	 	 	 	 	
10.12.1b c	 	Pinnacle West
APS	 	Amendment No. 2 dated as of June 1, 1987 to Facility Lease dated as of August 1, 1986 between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Lessor, and APS, as Lessee	 	10.3 to APS’s 1988 Form 10-K Report, File No. 1-4473	 	3/8/1989	
 	 	 	 	 	 	 	 	 	
10.12.1c c	 	Pinnacle West
APS	 	Amendment No. 3, dated as of March 17, 1993, to Facility Lease, dated as of August 1, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Lessor, and APS, as Lessee	 	10.3 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	

204

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.12.1d c	 	Pinnacle West
APS	 	Amendment No. 4, dated as of September 30, 2015, to Facility Lease, dated as of August 1, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee under a Trust Agreement with Emerson Finance LLC, as Lessor, and APS, as Lessee	 	10.2 to Pinnacle West/APS September 30, 2015 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	10/30/2015	
 	 	 	 	 	 	 	 	 	
10.12.1e c	 	Pinnacle West
APS	 	Amendment No. 3, dated as of September 30, 2015, to Facility Lease, dated as of August 1, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee under a Trust Agreement with Security Pacific Capital Leasing Corporation, as Lessor, and APS, as Lessee	 	10.3 to Pinnacle West/APS September 30, 2015 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	10/30/2015	
 	 	 	 	 	 	 	 	 	
10.12.2	 	Pinnacle West
APS	 	Facility Lease, dated as of December 15, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its capacity as Owner Trustee, as Lessor, and APS, as Lessee	 	10.1 to APS’s November 18, 1986 Form 8-K Report, File No. 1-4473	 	1/20/1987	
 	 	 	 	 	 	 	 	 	
10.12.2a	 	Pinnacle West
APS	 	Amendment No. 1, dated as of August 1, 1987, to Facility Lease, dated as of December 15, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Lessor, and APS, as Lessee	 	4.13 to APS’s Form 18 Registration Statement No.  33-9480 by means of August 1, 1987 Form 8-K Report, File No. 1-4473	 	8/24/1987	
 	 	 	 	 	 	 	 	 	
10.12.2b	 	Pinnacle West
APS	 	Amendment No. 2, dated as of March 17, 1993, to Facility Lease, dated as of December 15, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Lessor, and APS, as Lessee	 	10.4 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
10.12.2c	 	Pinnacle West
APS	 	Amendment No. 3, dated July 10, 2014, to Facility Lease, dated as of December 15, 1986, between U.S. Bank National Association, successor to State Street Bank and Trust Company, as successor to the First National Bank of Boston, as Lessor, and APS, as Lessee	 	10.2 to Pinnacle West/APS June 30, 2014 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	7/31/2014	

205

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.13.1	 	Pinnacle West
APS	 	Agreement between Pinnacle West Energy Corporation and APS for Transportation and Treatment of Effluent by and between Pinnacle West Energy Corporation and APS dated as of the 10th day of April, 2001	 	10.102 to Pinnacle West/APS 2004 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/16/2005	
 	 	 	 	 	 	 	 	 	
10.13.2	 	Pinnacle West
APS	 	Agreement for the Transfer and Use of Wastewater and Effluent by and between APS, SRP and PWE dated June 1, 2001	 	10.103 to Pinnacle West/APS 2004 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/16/2005	
 	 	 	 	 	 	 	 	 	
10.13.3	 	Pinnacle West
APS	 	Agreement for the Sale and Purchase of Wastewater Effluent dated November 13, 2000, by and between the City of Tolleson, Arizona, APS and SRP	 	10.104 to Pinnacle West/APS 2004 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/16/2005	
 	 	 	 	 	 	 	 	 	
10.13.4	 	Pinnacle West
APS	 	Operating Agreement for the Co-Ownership of Wastewater Effluent dated November 16, 2000 by and between APS and SRP	 	10.105 to Pinnacle West/APS 2004 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	3/16/2005	
 	 	 	 	 	 	 	 	 	
10.13.5	 	Pinnacle West
APS	 	Municipal Effluent Purchase and Sale Agreement dated April 29, 2010, by and between City of Phoenix, City of Mesa, City of Tempe, City of Scottsdale, City of Glendale, APS and SRP	 	10.1 to Pinnacle West/APS March 31, 2010 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/6/2010	
 	 	 	 	 	 	 	 	 	
10.14.1	 	Pinnacle West
APS	 	Contract, dated July 21, 1984, with DOE providing for the disposal of nuclear fuel and/or high-level radioactive waste, ANPP	 	10.31 to Pinnacle West’s Form S-14 Registration Statement, File No. 2-96386	 	3/13/1985	
 	 	 	 	 	 	 	 	 	
10.15.1	 	Pinnacle West
APS	 	Territorial Agreement between APS and SRP	 	10.1 to APS’s March 31, 1998 Form 10-Q Report, File No. 1-4473	 	5/15/1998	
 	 	 	 	 	 	 	 	 	
10.15.2	 	Pinnacle West
APS	 	Power Coordination Agreement between APS and SRP	 	10.2 to APS’s March 31, 1998 Form 10-Q Report, File No. 1-4473	 	5/15/1998	
 	 	 	 	 	 	 	 	 	
10.15.3	 	Pinnacle West
APS	 	Memorandum of Agreement between APS and SRP	 	10.3 to APS’s March 31, 1998 Form 10-Q Report, File No. 1-4473	 	5/15/1998	
 	 	 	 	 	 	 	 	 	
10.15.3a	 	Pinnacle West
APS	 	Addendum to Memorandum of Agreement between APS and SRP dated as of May 19, 1998	 	10.2 to APS’s May 19, 1998 Form 8-K Report, File No. 1-4473	 	6/26/1998	
 	 	 	 	 	 	 	 	 	
10.16	 	Pinnacle West
APS	 	Purchase and Sale Agreement dated November 8, 2010 by and between SCE and APS	 	10.1 to Pinnacle West/APS November 8, 2010 Form 8-K Report, File Nos. 1-8962 and 1-4473	 	11/8/2010	
 	 	 	 	 	 	 	 	 	
10.17	 	Pinnacle West
APS	 	Proposed Settlement Agreement dated January 6, 2012 by and among APS and certain parties to its retail rate case (approved by ACC Order No. 73183)	 	10.17 to Pinnacle West/APS 2011 Form 10-K Report, File Nos. 1-8962 and 1-4473	 	2/24/2012	
 	 	 	 	 	 	 	 	 	
10.18	 	Pinnacle West
APS	 	Proposed Settlement Agreement dated March 27, 2017 by and among APS and certain parties to its retail rate case (approved by ACC Order No. 76295)	 	10.1 to Pinnacle West/APS March 31, 2017 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	5/2/2017	

206

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
10.19	 	Pinnacle West	 	Purchase and Sale Agreement, dated June 29, 2018, by and between Navajo Transitional Energy Company, LLC and 4CA	 	10.2 to Pinnacle West/APS June 30, 2018 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/3/2018	
 	 	 	 	 	 	 	 	 	
21.1	 	Pinnacle West	 	Subsidiaries of Pinnacle West	 	 	 	 	
 	 	 	 	 	 	 	 	 	
23.1	 	Pinnacle West	 	Consent of Deloitte & Touche LLP	 	 	 	 	
 	 	 	 	 	 	 	 	 	
23.2	 	APS	 	Consent of Deloitte & Touche LLP	 	 	 	 	
 	 	 	 	 	 	 	 	 	
31.1	 	Pinnacle West	 	Certificate of Donald E. Brandt, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	 	 	 	 	
 	 	 	 	 	 	 	 	 	
31.2	 	Pinnacle West	 	Certificate of James R. Hatfield, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	 	 	 	 	
 	 	 	 	 	 	 	 	 	
31.3	 	APS	 	Certificate of Donald E. Brandt, Chief Executive Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	 	 	 	 	
 	 	 	 	 	 	 	 	 	
31.4	 	APS	 	Certificate of James R. Hatfield, Chief Financial Officer, pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended	 	 	 	 	
 	 	 	 	 	 	 	 	 	
32.1 e	 	Pinnacle West	 	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	 	 	 	 	
 	 	 	 	 	 	 	 	 	
32.2 e	 	APS	 	Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	 	 	 	 	
 	 	 	 	 	 	 	 	 	
99.1	 	Pinnacle West
APS	 	Collateral Trust Indenture among PVGS II Funding Corp., Inc., APS and Chemical Bank, as Trustee	 	4.2 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.1a	 	Pinnacle West
APS	 	Supplemental Indenture to Collateral Trust Indenture among PVGS II Funding Corp., Inc., APS and Chemical Bank, as Trustee	 	4.3 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.2 c	 	Pinnacle West
APS	 	Participation Agreement, dated as of August 1, 1986, among PVGS Funding Corp., Inc., Bank of America National Trust and Savings Association, State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its individual capacity and as Owner Trustee, Chemical Bank, in its individual capacity and as Indenture Trustee, APS, and the Equity Participant named therein	 	28.1 to APS’s September 30, 1992 Form 10-Q Report, File No. 1-4473	 	11/9/1992	

207

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
 	 	 	 	 	 	 	 	 	
99.2a c	 	Pinnacle West
APS	 	Amendment No. 1 dated as of November 1, 1986, to Participation Agreement, dated as of August 1, 1986, among PVGS Funding Corp., Inc., Bank of America National Trust and Savings Association, State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its individual capacity and as Owner Trustee, Chemical Bank, in its individual capacity and as Indenture Trustee, APS, and the Equity Participant named therein	 	10.8 to APS’s September 30, 1986 Form 10-Q Report by means of Amendment No. 1, on December 3, 1986 Form 8, File No. 1-4473	 	12/4/1986	
 	 	 	 	 	 	 	 	 	
99.2b c	 	Pinnacle West
APS	 	Amendment No. 2, dated as of March 17, 1993, to Participation Agreement, dated as of August 1, 1986, among PVGS Funding Corp., Inc., PVGS II Funding Corp., Inc., State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its individual capacity and as Owner Trustee, Chemical Bank, in its individual capacity and as Indenture Trustee, APS, and the Equity Participant named therein	 	28.4 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.3 c	 	Pinnacle West
APS	 	Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease, dated as of August 1, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Indenture Trustee	 	4.5 to APS’s Form 18 Registration Statement, File No. 33-9480	 	10/24/1986	
 	 	 	 	 	 	 	 	 	
99.3a c	 	Pinnacle West
APS	 	Supplemental Indenture No. 1, dated as of November 1, 1986 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease, dated as of August 1, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Indenture Trustee	 	10.6 to APS’s September 30, 1986 Form 10-Q Report by means of Amendment No. 1 on December  3, 1986 Form 8, File No. 1-4473	 	12/4/1986	
 	 	 	 	 	 	 	 	 	
99.3b c	 	Pinnacle West
APS	 	Supplemental Indenture No. 2 to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease, dated as of August 1, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Lease Indenture Trustee	 	4.4 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.4 c	 	Pinnacle West
APS	 	Assignment, Assumption and Further Agreement, dated as of August 1, 1986, between APS and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee	 	28.3 to APS’s Form 18 Registration Statement, File No. 33-9480	 	10/24/1986	

208

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
99.4a c	 	Pinnacle West
APS	 	Amendment No. 1, dated as of November 1, 1986, to Assignment, Assumption and Further Agreement, dated as of August 1, 1986, between APS and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee	 	10.10 to APS’s September 30, 1986 Form 10-Q Report by means of Amendment No. l on December  3, 1986 Form 8, File No. 1-4473	 	12/4/1986	
 	 	 	 	 	 	 	 	 	
99.4b c	 	Pinnacle West
APS	 	Amendment No. 2, dated as of March 17, 1993, to Assignment, Assumption and Further Agreement, dated as of August 1, 1986, between APS and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee	 	28.6 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.5	 	Pinnacle West
APS	 	Participation Agreement, dated as of December 15, 1986, among PVGS Funding Report Corp., Inc., State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its individual capacity and as Owner Trustee, Chemical Bank, in its individual capacity and as Indenture Trustee under a Trust Indenture, APS, and the Owner Participant named therein	 	28.2 to APS’s September 30, 1992 Form 10-Q Report, File No. 1-4473	 	11/9/1992	
 	 	 	 	 	 	 	 	 	
99.5a	 	Pinnacle West
APS	 	Amendment No. 1, dated as of August 1, 1987, to Participation Agreement, dated as of December 15, 1986, among PVGS Funding Corp., Inc. as Funding Corporation, State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, Chemical Bank, as Indenture Trustee, APS, and the Owner Participant named therein	 	28.20 to APS’s Form 18 Registration Statement No. 33-9480 by means of a November 6, 1986 Form 8-K Report, File No. 1-4473	 	8/10/1987	
 	 	 	 	 	 	 	 	 	
99.5b	 	Pinnacle West
APS	 	Amendment No. 2, dated as of March 17, 1993, to Participation Agreement, dated as of December 15, 1986, among PVGS Funding Corp., Inc., PVGS II Funding Corp., Inc., State Street Bank and Trust Company, as successor to The First National Bank of Boston, in its individual capacity and as Owner Trustee, Chemical Bank, in its individual capacity and as Indenture Trustee, APS, and the Owner Participant named therein	 	28.5 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.6	 	Pinnacle West
APS	 	Trust Indenture, Mortgage Security Agreement and Assignment of Facility Lease, dated as of December 15, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Indenture Trustee	 	10.2 to APS’s November 18, 1986 Form 10-K Report, File No. 1-4473	 	1/20/1987	

209

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
99.6a	 	Pinnacle West
APS	 	Supplemental Indenture No. 1, dated as of August 1, 1987, to Trust Indenture, Mortgage, Security Agreement and Assignment of Facility Lease, dated as of December 15, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Indenture Trustee	 	4.13 to APS’s Form 18 Registration Statement No. 33-9480 by means of August 1, 1987 Form 8-K Report, File No. 1-4473	 	8/24/1987	
 	 	 	 	 	 	 	 	 	
99.6b	 	Pinnacle West
APS	 	Supplemental Indenture No. 2 to Trust Indenture Mortgage, Security Agreement and Assignment of Facility Lease, dated as of December 15, 1986, between State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee, and Chemical Bank, as Lease Indenture Trustee	 	4.5 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.7	 	Pinnacle West
APS	 	Assignment, Assumption and Further Agreement, dated as of December 15, 1986, between APS and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee	 	10.5 to APS’s November 18, 1986 Form 8-K Report, File No. 1-4473	 	1/20/1987	
 	 	 	 	 	 	 	 	 	
99.7a	 	Pinnacle West
APS	 	Amendment No. 1, dated as of March 17, 1993, to Assignment, Assumption and Further Agreement, dated as of December 15, 1986, between APS and State Street Bank and Trust Company, as successor to The First National Bank of Boston, as Owner Trustee	 	28.7 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.8 c	 	Pinnacle West
APS	 	Indemnity Agreement dated as of March 17, 1993 by APS	 	28.3 to APS’s 1992 Form 10-K Report, File No. 1-4473	 	3/30/1993	
 	 	 	 	 	 	 	 	 	
99.9	 	Pinnacle West
APS	 	Extension Letter, dated as of August 13, 1987, from the signatories of the Participation Agreement to Chemical Bank	 	28.20 to APS’s Form 18 Registration Statement No. 33-9480 by means of a November 6, 1986 Form 8-K Report, File No. 1-4473	 	8/10/1987	
 	 	 	 	 	 	 	 	 	
99.10	 	Pinnacle West
APS	 	ACC Order, Decision No. 61969, dated September 29, 1999, including the Retail Electric Competition Rules	 	10.2 to APS’s September 30, 1999 Form 10-Q Report, File No. 1-4473	 	11/15/1999	
 	 	 	 	 	 	 	 	 	
99.11	 	Pinnacle West	 	Purchase Agreement by and among Pinnacle West Energy Corporation and GenWest, L.L.C. and Nevada Power Company, dated June 21, 2005	 	99.5 to Pinnacle West/APS June 30, 2005 Form 10-Q Report, File Nos. 1-8962 and 1-4473	 	8/9/2005	
 	 	 	 	 	 	 	 	 	
101.SCH	 	Pinnacle West
APS	 	XBRL Taxonomy Extension Schema Document	 	 	 	 	
 	 	 	 	 	 	 	 	 	
101.CAL	 	Pinnacle West
APS	 	XBRL Taxonomy Extension Calculation Linkbase Document	 	 	 	 	
 	 	 	 	 	 	 	 	 	
101.LAB	 	Pinnacle West
APS	 	XBRL Taxonomy Extension Label Linkbase Document	 	 	 	 	

210

Table of Contents

	
									
Exhibit
No.	 	Registrant(s)	 	Description	 	Previously Filed as Exhibit:  a	 	Date Filed	
101.PRE	 	Pinnacle West
APS	 	XBRL Taxonomy Extension Presentation Linkbase Document	 	 	 	 	
 	 	 	 	 	 	 	 	 	
101.DEF	 	Pinnacle West
APS	 	XBRL Taxonomy Definition Linkbase Document	 	 	 	 	

	
 	
a Reports filed under File No. 1-4473 and 1-8962 were filed in the office of the Securities and Exchange Commission located in Washington, D.C.
 
b Management contract or compensatory plan or arrangement to be filed as an exhibit pursuant to Item 15(b) of Form 10-K.
 
c An additional document, substantially identical in all material respects to this Exhibit, has been entered into, relating to an additional Equity Participant.  Although such additional document may differ in other respects (such as dollar amounts, percentages, tax indemnity matters, and dates of execution), there are no material details in which such document differs from this Exhibit.
 
d Additional agreements, substantially identical in all material respects to this Exhibit have been entered into with additional persons.  Although such additional documents may differ in other respects (such as dollar amounts and dates of execution), there are no material details in which such agreements differ from this Exhibit.
 
e Furnished herewith as an Exhibit.

211

Table of Contents

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	
		
 	PINNACLE WEST CAPITAL CORPORATION	
 	(Registrant)	

Date: February 22, 2019	/s/ Donald E. Brandt	
 	(Donald E. Brandt, Chairman of
the Board of Directors, President and
Chief Executive Officer)	
 
Power of Attorney
 
We, the undersigned directors and executive officers of Pinnacle West Capital Corporation, hereby severally appoint James R. Hatfield and Robert E. Smith, and each of them, our true and lawful attorneys with full power to them and each of them to sign for us, and in our names in the capacities indicated below, any and all amendments to this Annual Report on Form 10-K filed with the Securities and Exchange Commission.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

	
					
Signature	 	Title	 	Date	

/s/ Donald E. Brandt	 	Principal Executive Officer	 	February 22, 2019	
(Donald E. Brandt, Chairman	 	and Director	 	 	
of the Board of Directors, President	 	 	 	 	
and Chief Executive Officer)	 	 	 	 	

/s/ James R. Hatfield	 	Principal Financial Officer	 	February 22, 2019	
(James R. Hatfield,	 	 	 	 	
Executive Vice President and	 	 	 	 	
Chief Financial Officer)	 	 	 	 	

/s/ Denise R. Danner	 	Principal Accounting Officer	 	February 22, 2019	
(Denise R. Danner,	 	 	 	 	
Vice President, Controller and	 	 	 	 	
Chief Accounting Officer)	 	 	 	 	

212

Table of Contents

	
					
/s/ Denis A. Cortese, M.D.	 	Director	 	February 22, 2019	
(Denis A. Cortese, M.D.)	 	 	 	 	

/s/ Richard P. Fox	 	Director	 	February 22, 2019	
(Richard P. Fox)	 	 	 	 	

/s/ Michael L. Gallagher	 	Director	 	February 22, 2019	
(Michael L. Gallagher)	 	 	 	 	

/s/ Dale E. Klein, Ph.D.	 	Director	 	February 22, 2019	
(Dale E. Klein, Ph.D.)	 	 	 	 	

/s/ Humberto S. Lopez	 	Director	 	February 22, 2019	
(Humberto S. Lopez)	 	 	 	 	

/s/ Kathryn L. Munro	 	Director	 	February 22, 2019	
(Kathryn L. Munro)	 	 	 	 	

/s/ Bruce J. Nordstrom	 	Director	 	February 22, 2019	
(Bruce J. Nordstrom)	 	 	 	 	

/s/ Paula J. Sims	 	Director	 	February 22, 2019	
(Paula J. Sims)	 	 	 	 	

/s/ James E. Trevathan	 	Director	 	February 22, 2019	
(James E. Trevathan)	 	 	 	 	

/s/ David P. Wagener	 	Director	 	February 22, 2019	
(David P. Wagener)	 	 	 	 	

213

Table of Contents

SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	
		
 	ARIZONA PUBLIC SERVICE COMPANY	
 	(Registrant)	

  Date: February 22, 2019	/s/ Donald E. Brandt	
 	(Donald E. Brandt, Chairman of
the Board of Directors and Chief
Executive Officer)	
 
Power of Attorney
 
We, the undersigned directors and executive officers of Arizona Public Service Company, hereby severally appoint James R. Hatfield and Robert E. Smith, and each of them, our true and lawful attorneys with full power to them and each of them to sign for us, and in our names in the capacities indicated below, any and all amendments to this Annual Report on Form 10-K filed with the Securities and Exchange Commission.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

	
					
Signature	 	Title	 	Date	

/s/ Donald E. Brandt	 	Principal Executive Officer	 	February 22, 2019	
(Donald E. Brandt, Chairman	 	and Director	 	 	
of the Board of Directors and	 	 	 	 	
Chief Executive Officer)	 	 	 	 	

/s/ James R. Hatfield	 	Principal Financial Officer	 	February 22, 2019	
(James R. Hatfield,	 	 	 	 	
Executive Vice President and	 	 	 	 	
Chief Financial Officer)	 	 	 	 	

/s/ Denise R. Danner	 	Principal Accounting Officer	 	February 22, 2019	
(Denise R. Danner,	 	 	 	 	
Vice President, Controller and	 	 	 	 	
Chief Accounting Officer)	 	 	 	 	

214

Table of Contents

	
					
/s/ Denis A. Cortese, M.D.	 	Director	 	February 22, 2019	
(Denis A. Cortese, M.D.)	 	 	 	 	

/s/ Richard P. Fox	 	Director	 	February 22, 2019	
(Richard P. Fox)	 	 	 	 	

/s/ Michael L. Gallagher	 	Director	 	February 22, 2019	
(Michael L. Gallagher)	 	 	 	 	

/s/ Dale E. Klein	 	Director	 	February 22, 2019	
(Dale E. Klein, Ph.D.)	 	 	 	 	

/s/ Humberto S. Lopez	 	Director	 	February 22, 2019	
(Humberto S. Lopez)	 	 	 	 	

/s/ Kathryn L. Munro	 	Director	 	February 22, 2019	
(Kathryn L. Munro)	 	 	 	 	

/s/ Bruce J. Nordstrom	 	Director	 	February 22, 2019	
(Bruce J. Nordstrom)	 	 	 	 	

/s/ Paula J. Sims	 	Director	 	February 22, 2019	
(Paula J. Sims)	 	 	 	 	

/s/ James E. Trevathan	 	Director	 	February 22, 2019	
(James E. Trevathan)	 	 	 	 	

/s/ David P. Wagener	 	Director	 	February 22, 2019	
(David P. Wagener)	 	 	 	 	

215

RETENTION AGREEMENT

This RETENTION AGREEMENT (“Agreement”) is entered into by and between Arizona Public Service Company (“APS”) and Robert Bement (“Employee”) (collectively the “Parties”). APS highly values and desires to continue to employ Employee, and Employee desires to continue to be employed by APS.

In consideration of the mutual agreements contained in this Agreement, the Parties agree effective December 19, 2008 (“Effective Date”) as follows:

1.     Deferred Compensation Arrangement.

1.1 Plan.  Beginning on or about December 17, 2008, APS shall establish a deferred compensation arrangement pursuant to the terms of this Section on behalf of the Employee (“Deferred Compensation Arrangement”). A bookkeeping entry (“Account”) shall be utilized as a means for the measurement and determination of amounts, if any, to be paid to the Employee in accordance with the Deferred Compensation Arrangement.

1.2 Credits.  APS shall credit an amount equal to Three Hundred Thousand Dollars ($300,000.00) to the Account effective on or about December 17, 2008, and an amount equal to Seventy Thousand Dollars ($70,000.00) to the Account effective January 1, 2010 and each of the next four 1 anuary 1 thereafter (each, a “Company Credit”), provided that the Employee remains employed with APS on each such crediting date and demonstrates sustained competent performance of his assigned job responsibilities.

1.3 Distribution . Subject to the applicable terms and conditions of this Agreement and provided the Employee remains actively employed with APS through December 31, 2014, the Employee shall be entitled to a payment of benefits under the Deferred Compensation Arrangement in an amount equal to the Company Credits credited to his Account as of the date of his termination. By no later than December 31, 2008, the Employee must submit an election form as required by APS, to receive such distribution in the form of either a lump sum or an annuity. If Employee is entitled to payment, it will begin, or in the case of a lump sum will be made, upon the Employee's termination of employment. If no timely election is made, payment shall be made in a lump sum. Any election made as to time and form of payment shall be irrevocable. Any payment made shall be subject to applicable withholdings including federal, state and local taxes.

1.4      Termination, Death or Disability .

(a) If Employee is terminated for cause, or Employee voluntarily terminates before December 31, 2014, Employee shall forfeit all amounts credited to his Account and no benefits shall be payable under the Deferred Compensation Arrangement. If Employee’s employment with APS is involuntarily terminated without cause by APS before December 31, 2014, the Employee will be entitled to a lump sum payment in an amount equal to the Company Credits credited to his Account

at the time of termination. Payment will be made at the time of the termination, or if applicable, at the time specified in Section 8 of this Agreement.
(b) In the event that the Employee is determined to be disabled under the Pinnacle West Capital Corporation Long-Term Disability Plan before the Employee terminates employment and such disability meets the definition of “disabled” for purposes of Section 409A of the Internal Revenue Code (“Code Section 409A”), and (i) if such disability occurs on or before December 31, 2014, the Account will not be credited with Company Credits, beginning as of the date of such disability, and the Employee shall be entitled to a lump sum payment on December 31, 2014 in an amount equal to the Company Credits credited to his Account at the time of distribution or (ii) if such disability occurs after December 31, 2014, the Employee shall be entitled to a lump sum payment in an amount equal to the Company Credits credited to his Account at the time of distribution, payable within 30 days after the date of disability.

(c) In the event that the Employee dies before he terminates employment or after the commencement of payments to him under the Deferred Compensation Arrangement, but before all such benefits have been paid in full, any balance credited to the Account that has not been paid under the Account as determined on the date of death shall be paid to the Employee's beneficiary in a lump sum within sixty (60) days after the date of death. The Employee's beneficiary for purposes of the Deferred Compensation Arrangement shall mean the person(s) or trust(s) specified by the Employee as the Employee's beneficiary, in the form and manner required by APS and on file with APS. In the event no beneficiary is named at the time of death, any benefits shall be paid to the Employee's estate.

3.     Confidentiality.

Employee shall hold the existence and terms of this Agreement in confidence. Employee shall not publicly or privately discuss or disclose the nature or content of this Agreement. However, Employee may disclose the terms of this Agreement if required by federal or state law, and Employee may disclose the terms of this Agreement to Employee's accountant, attorney, consultant and spouse. In addition, the Parties may disclose this Agreement as necessary to enforce its provisions.

4.     Reporting to Federal and State Agencies.

Nothing in this Agreement shall be construed to prohibit the Employee from reporting or disclosing any suspected instance of illegal activity of any nature, any nuclear safety concerns, any workplace safety concerns, or any public safety concerns to the NRC, the United States Department of Labor (“DOL”), or any other federal, state, or local government agency or court. This Agreement shall not be construed to prohibit the Employee from providing information to the NRC, DOL, EEOC, United States Securities and Exchange Commission, OSHA, or Arizona Division of Occupational Safety and Health, or testifying in any civil or criminal proceedings, even if such information or testimony being provided relates to the claims or matters covered by this Agreement. This Agreement shall not be construed as a waiver or

withdrawal of any safety concerns which the Employee has or may have reported to the NRC or DOL, or withdrawal of any participation by the Employee in any NRC proceedings. In this regard, the Parties to this Agreement understand that this Agreement shall be interpreted in a manner consistent with 10 CPR § 50.7(f). Notwithstanding anything to the contrary in this paragraph, the Employee hereby waives and releases any right to receive any relief as a result of the Employee's participation in any investigation or proceeding of the NRC, DOL, or any federal, state, or local government agency or court.

5 .     Law . The provisions of this Agreement shall be construed and interpreted according to the laws of the State of Arizona to the extent not preempted by Federal law.

6.      Severability . The invalidity or unenforceability of any particular provision of this Agreement shall not affect any other provision hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were omitted.

7.     Agreement . This Agreement constitutes the entire Agreement between the Parties and supersedes all other negotiations and agreements with respect to the subject matter of this Agreement.

8.     Time of Payment . For the period during which the Employee is a specified employee, as determined in accordance with Code Section 409A, any payments made under the Deferred Compensation Arrangement on account of the Employee's termination of employment that would otherwise be paid during a six month period beginning on the Employee's termination of employment shall not be paid at such time and shall instead be paid, in the case of a lump sum payment, or begin, in the case of an annuity, on the first day of the seventh month following the Employee's termination of employment. Any annuity installments that would have been paid during such six month period, but for this Section 8, shall be paid in a lump-sum on the first day of the seventh month following the Employee's termination of employment.

	
		
ARIZONA PUBLIC SERVICE COMPANY	EMPLOYEE	
 	 	
By: /s/ Randall K. Edington	By: /s/ Robert Bement	
   Executive Vice President Nuclear &	   Robert Bement	
   Chief Nuclear Officer	   	
 	 	
Date: 12/22/08	Date: 12/19/2008	

                

    

DISCRETIONARY CREDIT AWARD AGREEMENT
This Discretionary Credit Award Agreement (the “Agreement”) is entered into by and between Arizona Public Service Company (“APS”) and Robert Bement (“Employee”).
1. Background.  The Company and Employee previously entered into a Retention Agreement dated December 19, 2008 (the “2008 Agreement”), which continues to remain in effect.
2.      Purpose . Section 3.9 of the Deferred Compensation Plan of 2005 for Employees of Pinnacle West Capital Corporation and Affiliates (the “Deferred Compensation Plan”) allows APS to award Discretionary Credits in such amounts and subject to such terms and conditions as APS deems appropriate. The purpose of this Agreement is to award Discretionary Credits to Employee subject to the terms and conditions set forth below.
3.      Definitions . A number of key terms, with specialized meanings, are used throughout this Agreement. These key terms are identified by the capitalization of the initial letter of each word or phrase even when the word or phrase does not begin a sentence. Each of these key terms will be given the meaning ascribed to it in the Deferred Compensation Plan unless the term is defined in this Agreement. Whenever these key terms are used, they will be given the defined meaning unless a clearly different meaning is required by the context.
4.      Discretionary Credits . Four Discretionary Credits in the aggregate amount of $300,000 will be allocated to a Discretionary Credit Account established for the benefit of Employee pursuant to Section 3.9 of the Deferred Compensation Plan. The Discretionary Credit Account shall be credited with: (i) $75,000 on January 1, 2015; (ii) $75,000 on January 1, 2016; (iii) $75,000 on January 1, 2017; and (iv) $75,000 on January 1, 2018 provided that the Employee remains employed with APS on each such crediting date and demonstrates sustained competent performance of his assigned job responsibilities.
5.      Interest . The Discretionary Credit Account shall be credited with interest in accordance with Section 3.5 of the Deferred Compensation Plan.
6.      Modification of 2008 Agreement . Effective retroactive to January 1, 2014, the “Company Credits” credited to Employee pursuant to the 2008 Agreement shall be credited with interest calculated in accordance with Section 3.5 of the Deferred Compensation Plan. All other terms and conditions of the 2008 Agreement shall continue in full force and effect.
7.      Vesting . The Discretionary Credit Account vests on December 31, 2018. If Employee Separates from Service prior to December 31, 2018, the amounts allocated to the Discretionary Credit Account will be forfeited; provided, however, that if Employee’s employment with APS is involuntarily terminated by APS without Cause, Employee dies or Employee becomes Disabled prior to December 31, 2018, all amounts previously credited to the Discretionary Credit Account will be fully vested as of the date of the termination by APS without Cause, death or Disability as applicable. For purposes of this document, “Disability” shall have the meaning ascribed to it in the Pinnacle West Capital Corporation Long-Term Disability Plan. For purposes of this document, “Cause” means any act or omission that could result in disciplinary action pursuant to

1    

applicable laws or APS policies and procedures, as determined in the sole discretion of APS. The determination of whether “Cause” exists shall be made by APS, in its sole and absolute discretion, in accordance with its personnel policies and procedures.
8.      Payment of Discretionary Credits .
(a)      General Rule . Except as otherwise provided below in this Section 8, Employee’s vested interest in his Discretionary Credit Account will be paid to Employee in substantially equal installments over a period of approximately five years following Employee’s Separation from Service with the first installment payment to made within 30 days following Employee’s Separation from Service and each subsequent installment payment shall be made on the next four anniversaries of the first payment date, unless Employee is a Specified Employee on the date of his Separation from Service. If Employee is a Specified Employee on the date of his Separation from Service, the first installment payment shall be paid within 30 days following the first day of the seventh month following Employee’s Separation from Service and each subsequent installment payment shall be made on the next four anniversaries of the first payment date. The Discretionary Credit Account may not be distributed as a Short‑Term Payout or due to an Unforeseeable Financial Emergency.
(b)      Disability . If Employee becomes Disabled prior to his Separation from Service and if such Disability occurs prior to December 31, 2018, Employee shall receive a single lump sum payment of Employee’s vested interest in his Discretionary Credit Account on the first business day following December 31, 2018 as long as the Disability constitutes a “disability” as defined in Section 409A of the Code. If the Disability does not constitute a “disability” as defined in Section 409A of the Code, the general rule set forth in Section 8(a) will apply, unless Employee incurs a Separation from Service before December 31, 2018, in which case Employee shall receive a single lump sum payment of Employee’s vested interest in his Discretionary Credit Account within 30 days following Employee’s Separation from Service, unless Employee is a Specified Employee on the date of his Separation from Service. If Employee is a Specified Employee on the date of his Separation from Service, Employee’s vested interest in his Discretionary Credit Account shall be paid within 30 days following the first day of the seventh month following Employee’s Separation from Service.
(c)      Death . If Employee dies while employed by the Company, or after the commencement of installment payments as described in Section 8(a) but before all such payments have been made in full, the Beneficiary designated by Employee pursuant to the Deferred Compensation Plan shall receive a single lump sum payment of Employee’s vested interest in his Discretionary Credit Account within sixty days of Employee’s death.
(d)      Termination without Cause . If Employee’s employment is terminated by the Company without cause and if, as a result of such termination, Employee incurs a Separation from Service before December 31, 2018, Employee shall receive a single lump sum payment of Employee’s vested interest in his Discretionary Credit Account within 30 days following Employee’s Separation from Service, unless Employee is a Specified Employee on the date of his Separation from Service. If Employee is a Specified Employee on the date of his Separation from Service,

2    

Employee’s vested interest in his Discretionary Credit Account shall be paid within 30 days following the first day of the seventh month following Employee’s Separation from Service.
9.      Employee’s Plan Status . Regardless of whether Employee makes an Annual Deferral pursuant to the terms of the Deferred Compensation Plan for the relevant Plan Year, Employee shall be deemed to be a Participant in the Deferred Compensation Plan and to have elected to participate in the Deferred Compensation Plan for the limited purpose of receiving the Discretionary Credits described in this Agreement. This Agreement shall be deemed to be Employee’s Election Form for purposes of Section 2.2 and Section 3.3 of the Deferred Compensation Plan.
10.      Relationship to Other Benefits . The Discretionary Credits allocated to Employee pursuant to this Agreement shall not be taken into account as compensation or for purposes of determining any benefits due to Employee pursuant to the terms of any pension, retirement, savings, profit sharing, incentive, group insurance or other tax qualified or nonqualified benefit plan sponsored by APS, Pinnacle West Capital Corporation or any affiliate of either. In addition, the amounts payable to Employee attributable to the Discretionary Credit Account established for Employee pursuant to the Deferred Compensation Plan shall be disregarded for purposes of the benefit plans referred to in the preceding sentence.
11.      Plan Document . As provided above, this Agreement is entered into pursuant to the provisions of Section 3.9 of the Deferred Compensation Plan. Accordingly, except as otherwise set forth in this Agreement, the provisions of the Deferred Compensation Plan shall apply in determining the rights of Employee as well as the administration of Employee’s Discretionary Credit Account. In cases of conflict, this Agreement controls over any conflicting provisions of the Deferred Compensation Plan, except as may be required by Section 409A of the Internal Revenue Code or the provisions of any other applicable law or regulation.
12.      Amendments . This Agreement may not be modified, altered or changed except by a written agreement signed by APS and Employee.
13.      Confidentiality . Employee shall hold the existence and terms of this Agreement in confidence. Employee shall not publicly or privately discuss or disclose the nature or content of this Agreement. However, Employee may disclose the terms of this Agreement if required by federal or state law, and Employee may disclose the terms of this Agreement to Employee’s accountant, attorney, consultant and spouse. In addition, APS and Employee may disclose this Agreement as necessary to enforce its provisions.
14.      Reporting to Federal and State Agencies . Nothing in this Agreement shall be construed to prohibit Employee from reporting or disclosing any suspected instance of illegal activity of any nature, any nuclear safety concerns, any workplace safety concerns, or any public safety concerns to the Nuclear Regulatory Commission (“NRC”), the United States Department of Labor (“DOL”), or any other federal, state, or local government agency or court. This Agreement shall not be construed to prohibit Employee from providing information to the NRC, DOL, Equal Employment Opportunity Commission, United States Securities and Exchange Commission, Occupational Safety and Health Administration, or Arizona Division of Occupational Safety and

3    

Health, or testifying in any civil or criminal proceedings, even if such information or testimony being provided relates to the claims or matters covered by this Agreement. This Agreement shall not be construed as a waiver or withdrawal of any safety concerns which Employee has or may have reported to the NRC or DOL, or withdrawal of any participation by Employee in any NRC proceedings. In this regard, the parties to this Agreement understand that this Agreement shall be interpreted in a manner consistent with 10 CFR § 50.7(f). Notwithstanding anything to the contrary in this paragraph, Employee hereby waives and releases any right to receive any relief as a result of the Employee's participation in any investigation or proceeding of the NRC, DOL, or any federal, state, or local government agency or court.
15.      Entire Agreement . APS and Employee acknowledge and agree that this Agreement and the Deferred Compensation Plan constitute the entire agreement between APS and Employee with respect to the subject matter hereof.
16.      Severability . If any provision of this Agreement is held to be invalid, the remaining provisions shall remain in full force and effect.
IN WITNESS WHEREOF, APS and Employee have executed this Agreement on the dates set forth below.

		
ARIZONA PUBLIC SERVICE COMPANY	EMPLOYEE	
 	 	
By:   /s/   Donald E. Brandt	By: /s/ Robert Bement	
        Donald E. Brandt	        Robert Bement	
        Chairman and Chief Executive Officer	   	
 	 	
Date:   9/15/2014	Date: 10/20/2014	

4    

Exhibit 10.6.4

Summary of 2019 Incentive Plans

On December 18, 2018, the Human Resources Committee (the “Committee”) of the Pinnacle West Board of Directors (the “Board”) approved the Pinnacle West 2019 CEO Annual Incentive Award Plan (the “PNW Plan”), which provides an incentive award opportunity for Donald E. Brandt, the Chairman of the Board, President, and Chief Executive Officer of Pinnacle West and the Chairman of the Board and Chief Executive Officer of APS.  On December 19, 2018, the Board, acting on the recommendation of the Committee, approved the APS 2019 Annual Incentive Award Plan (the “APS Plan”), which includes an incentive award opportunity for James R. Hatfield, Executive Vice President and Chief Financial Officer of Pinnacle West and APS and the APS 2019 Annual Incentive Award Plan for Palo Verde Employees (the “Palo Verde Plan”), which includes an incentive award opportunity for Robert S. Bement, Executive Vice President and Chief Nuclear Officer of APS.

No incentive payments will be awarded under the PNW Plan or the APS Plan unless Pinnacle West, with respect to Mr. Brandt, or APS, with respect to Mr. Hatfield, each achieves a specified threshold earnings level.  The Committee will evaluate the impacts of unusual or nonrecurring adjustments to earnings in determining whether any earnings level has been met for purposes of the PNW Plan and may make adjustments to reflect such impacts. Earnings impacts of actions of the Arizona Corporation Commission ("ACC") in the PNW Plan year are excluded.

Mr. Brandt’s incentive award opportunity is based 62.5% on Pinnacle West’s 2019 earnings, and 37.5% on the achievement of performance goals established for all business units of APS. Mr. Brandt has an award opportunity of 50% of his base salary if the threshold earnings level is met. If Pinnacle West’s 2019 earnings exceed the threshold level, Mr. Brandt’s award opportunity increases proportionately by up to an additional 75% of his base salary. To the extent certain business unit performance goals are met, Mr. Brandt has a further award opportunity of up to 75% of base salary. The business unit performance indicators for Mr. Brandt are in the functional areas of customer service, transmission and distribution, fossil generation, corporate resources and performance of the Palo Verde Generating Station. In no event may Mr. Brandt’s award exceed 200% of his base salary.

The award opportunities for Mr. Hatfield under the APS Plan are based on the achievement of specified 2019 APS earnings levels and specified business unit performance goals.  Mr. Hatfield has a target award opportunity of up to 75% of his base salary.  Mr. Hatfield may earn less or more than the target amount, up to a maximum award opportunity of 150% of base salary, depending on the achievement of the earnings and business unit performance goals separately or in combination, and before adjustment for individual performance.  The business unit performance indicators that will be considered for Mr. Hatfield are derived from the APS critical areas of focus, as provided in its “Core” strategic framework, in the functional areas of employees, operational excellence, and shareholder value.  The Committee may adjust targets under the APS Plan to reflect unanticipated events or unusual or nonrecurring adjustments to earnings that arise in the APS Plan year, including ACC rate-related impacts on earnings.

The award opportunity for Mr. Bement under the Palo Verde Plan is based on the achievement of specified 2019 APS earnings levels and specified business unit performance goals. No incentive payment will be awarded to Mr. Bement under the APS earnings portion of the Palo Verde Plan unless Palo Verde achieves specified business unit performance goals and APS achieves a target threshold earnings level.  The business unit performance indicators for Mr. Bement under the Palo Verde Plan are in the functional areas of employees, operational excellence, performance improvement and shareholder value.  Mr. Bement has a threshold award opportunity of 18.8% of his base salary, a target of 75% of his base salary, and up to a maximum of 150% of his base salary, depending on the achievement of the earnings and business unit performance goals, separately or in combination, and before adjustment for individual performance.

Exhibit 10.6.4

Any awards for Messrs. Brandt, Hatfield and Bement are subject to potential forfeiture or recovery to the extent required by the Company’s clawback policy.

U.S. $150,000,000
TERM LOAN AGREEMENT
Dated as of December 21, 2018
among
PINNACLE WEST CAPITAL CORPORATION,
as Borrower ,

THE LENDERS PARTY HERETO,

KEYBANK NATIONAL ASSOCIATION,
as Agent ,

PNC BANK, NATIONAL ASSOCIATION,
and
WELLS FARGO BANK, NATIONAL ASSOCIATION
as Co-Syndication Agents ,

_______________________________________________________________________

KEYBANC CAPITAL MARKETS INC.,
PNC CAPITAL MARKETS LLC,
and
WELLS FARGO SECURITIES, LLC

as Joint Lead Arrangers and as Joint Bookrunners

1

TABLE OF CONTENTS

ARTICLE I DEFINITIONS AND ACCOUNTING TERMS

Section 1.01	Certain Defined Terms     1	
		
Section 1.02	Other Interpretive Provisions     15	
		
Section 1.03	Accounting Terms     16	
		
Section 1.04	Rounding     16	
		
Section 1.05	Times of Day     16	
ARTICLE II AMOUNTS AND TERMS OF THE LOANS

Section 2.01	The Loans     17	
		
Section 2.02	Making the Loans     17	
		
Section 2.03	Agent’s Fees     18	
		
Section 2.04	Repayment of Loans     18	
		
Section 2.05	Interest on Loans     18	
		
Section 2.06	Interest Rate Determination .    20	
		
Section 2.07	Optional Conversion of Loans     21	
		
Section 2.08	Prepayments of Loans     21	
		
Section 2.09	Increased Costs .    22	
		
Section 2.10	Illegality     23	
		
Section 2.11	Payments and Computations     24	
		
Section 2.12	Taxes     25	
		
Section 2.13	Sharing of Payments, Etc.     29	
		
Section 2.14	Evidence of Debt     29	
		
Section 2.15	Use of Proceeds     30	
		
Section 2.16	Affected Lenders     30	
		
Section 2.17	Replacement of Lenders     31	
ARTICLE III CONDITIONS PRECEDENT

Section 3.01	Conditions Precedent to Effectiveness     31	
		
Section 3.02	Determinations Under Section 3.01     33	
ARTICLE IV REPRESENTATIONS AND WARRANTIES

Section 4.01	Representations and Warranties of the Borrower     33	
ARTICLE V COVENANTS OF THE BORROWER

Section 5.01	Affirmative Covenants     38	
		
Section 5.02	Negative Covenants     41	
		
Section 5.03	Financial Covenant     42	
ARTICLE VI EVENTS OF DEFAULT

i

		
Section 6.01	Events of Default     43	
ARTICLE VII THE AGENT

Section 7.01	Appointment and Authority     45	
		
Section 7.02	Rights as a Lender     45	
		
Section 7.03	Exculpatory Provisions     45	
		
Section 7.04	Reliance by Agent     46	
		
Section 7.05	Delegation of Duties     46	
		
Section 7.06	Resignation of Agent     47	
		
Section 7.07	Non-Reliance on Agent and Other Lenders     47	
		
Section 7.08	No Other Duties, Etc .    47	
		
Section 7.09	Certain ERISA Matters     47	
ARTICLE VIII MISCELLANEOUS

Section 8.01	Amendments, Etc.     49	
		
Section 8.02	Notices, Etc .    51	
		
Section 8.03	No Waiver; Cumulative Remedies; Enforcement     52	
		
Section 8.04	Costs and Expenses; Indemnity; Damage Waiver     53	
		
Section 8.05	Right of Set-off     55	
		
Section 8.06	Effectiveness; Binding Effect     55	
		
Section 8.07	Successors and Assigns     55	
		
Section 8.08	Confidentiality     59	
		
Section 8.09	Governing Law     59	
		
Section 8.10	Counterparts; Integration     59	
		
Section 8.11	Jurisdiction, Etc .    60	
		
Section 8.12	Payments Set Aside     60	
		
Section 8.13	Patriot Act and Beneficial Ownership Regulation     60	
		
Section 8.14	Waiver of Jury Trial     61	
		
Section 8.15	No Advisory or Fiduciary Responsibility     61	
		
Section 8.16	Survival of Representations and Warranties     61	
		
Section 8.17	Severability     62	
		
Section 8.18	Acknowledgement and Consent to Bail-In of EEA Financial Institutions     62	

Schedules
Schedule 1.01         Commitments and Ratable Shares
Schedule 4.01(j)     Subsidiaries
Schedule 4.01(k)     Existing Indebtedness
Schedule 8.02         Certain Addresses for Notices
Exhibits
Exhibit A         Form of Note
Exhibit B         Form of Notice of Initial Borrowing

ii

Exhibit C         Form of Assignment and Assumption
Exhibit D        Form of Interest Election Request

iii

TERM LOAN AGREEMENT 
 
Dated as of December 21, 2018
PINNACLE WEST CAPITAL CORPORATION, an Arizona corporation (the “ Borrower ”), the banks, financial institutions and other institutional lenders (the “ Initial Lenders ”) listed on the signature pages hereof, the other Lenders (as hereinafter defined), PNC BANK, NATIONAL ASSOCIATION and WELLS FARGO BANK, NATIONAL ASSOCIATION, as Co-Syndication Agents, and KEYBANK NATIONAL ASSOCIATION, as Agent for the Lenders, agree as follows:
The Borrower has requested that the Lenders provide a $150,000,000 term loan facility for the purposes set forth herein, and the Lenders are willing to do so on the terms and conditions set forth herein.
In consideration of the mutual covenants and agreements herein contained, the parties hereto covenant and agree as follows:
Article I 

 DEFINITIONS AND ACCOUNTING TERMS
Section 1.01      Certain Defined Terms . As used in this Agreement, the following terms shall have the following meanings:
“ Administrative Questionnaire ” means an Administrative Questionnaire in a form supplied by the Agent.
“ Affected Lender ” means any Lender, as reasonably determined by the Agent or, if the Agent is the Affected Lender, by the Required Lenders, that (a) has failed to (i) fund all or any portion of its Loans unless such Lender notifies the Agent and the Borrower in writing that such failure is the result of such Lender’s determination that one or more conditions precedent to funding (each of which conditions precedent, together with any applicable default, shall be specifically identified in writing) has not been satisfied or (ii) pay to the Agent or any other Lender any other amount required to be paid by it under this Agreement, (b) has notified the Borrower, the Agent or any Lender in writing of its intention not to fund a Loan or any of its other funding obligations under this Agreement, (c) has failed, within three Business Days after written request by the Agent, or, if the Agent is the Affected Lender, by the Required Lenders, to confirm that it will comply with the terms of this Agreement relating to its obligations to fund a Loan, (d) shall (or whose parent company shall) generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make a general assignment for the benefit of creditors; or shall have had any proceeding instituted by or against such Lender (or its parent company) seeking to adjudicate it as bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, administrator, assignee for the benefit of creditors or similar Person charged with reorganization or liquidation of its business or custodian for it or for any

substantial part of its property and, in the case of any such proceeding instituted against it (but not instituted by it), either such proceeding shall remain undismissed or unstayed for a period of 30 days, or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee, administrator, assignee for the benefit of creditors or similar Person charged with reorganization or liquidation of its business or custodian for, it or for any substantial part of its property) shall occur, or shall take (or whose parent company shall take) any corporate action to authorize any of the actions set forth above in this subsection (d) or (e) has become the subject of a Bail-In Action, provided that a Lender shall not be deemed to be an Affected Lender solely by virtue of the ownership or acquisition of any equity interest in any Lender or any Person that directly or indirectly controls such Lender by a Governmental Authority or an instrumentality thereof.
“ Affiliate ” means, as to any Person, any other Person that, directly or indirectly, controls, is controlled by or is under common control with such Person or is a director or officer of such Person. For purposes of this definition, the term “control” (including the terms “controlling”, “controlled by” and “under common control with”) of a Person means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of Voting Stock, by contract or otherwise.
“ Agent ” means KeyBank National Association (including its branches and Affiliates as may be required to administer its duties) in its capacity as administrative agent under any of the Loan Documents, or any successor administrative agent.
“ Agent’s Account ” means the account of the Agent designated as such by the Agent to the Lenders and the Borrower from time to time.
“ Agent’s Office ” means the Agent’s address specified in Section 8.02(a) and, as appropriate, the Agent’s Account, or such other address or account as the Agent may from time to time notify the Borrower and the Lenders.
“ Agreement ” means this Term Loan Agreement, dated as of December 21, 2018, among the Borrower, the Lenders named herein and from time to time party hereto, the Co-Syndication Agents and the Agent, together with all schedules and exhibits hereto.
“ Anti-Corruption Laws ” means all laws, rules, and regulations of any jurisdiction applicable to the Borrower or its Subsidiaries from time to time concerning or relating to bribery, corruption or money laundering.
“ Applicable Lending Office ” means, with respect to each Lender, such Lender’s Domestic Lending Office in the case of a Base Rate Loan and such Lender’s Eurodollar Lending Office in the case of a Eurodollar Rate Loan.
“ Applicable Rate ” means (i) if a Base Rate Loan, 0.000% per annum and (ii) if a Eurodollar Rate Loan, 0.600% per annum.

2

“ Approved Fund ” means any Fund that is administered or managed by (a) a Lender, (b) an Affiliate of a Lender or (c) an entity or an Affiliate of any entity that administers or manages a Lender.
“ APS ” means Arizona Public Service Company, an Arizona corporation.
“ Arrangers ” means each of KeyBanc Capital Markets Inc., PNC Capital Markets LLC and Wells Fargo Securities, LLC, together with their successors and assigns.
“ Assignment and Assumption ” means an assignment and assumption entered into by a Lender and an Eligible Assignee, and accepted by the Agent, in substantially the form of Exhibit C hereto.
“ Authorized Officer ” means the chairman of the board, chief executive officer, chief operating officer, chief financial officer, chief accounting officer, president, any vice president, treasurer, controller or any assistant treasurer of the Borrower.
“ Bail-In Action ” means the exercise of any Write-Down and Conversion Powers by the applicable EEA Resolution Authority in respect of any liability of an EEA Financial Institution.
“ Bail-In Legislation ” means, with respect to any EEA Member Country implementing Article 55 of Directive 2014/59/EU of the European Parliament and of the Council of the European Union, the implementing law for such EEA Member Country from time to time which is described in the EU Bail-In Legislation Schedule.
“ Base Rate ” means for any day a fluctuating rate per annum equal to the highest of:
(a)    the Prime Rate;
(b)    the Federal Funds Rate plus 0.50%; and
(c)    an amount equal to (i) the Eurodollar Rate for a one month Interest Period on such day (or if such day is not a Business Day, the immediately preceding Business Day) plus (ii) 1%; provided that, if the Base Rate shall be less than zero, such rate shall be deemed to be zero for purposes of this Agreement.
“ Base Rate Loan ” means a Loan that bears interest as provided in Section 2.05(a)(i).
“ Beneficial Ownership Certification ” means a certification regarding beneficial ownership as required by the Beneficial Ownership Regulation in form and substance acceptable to the Agent in its discretion.
“ Beneficial Ownership Regulation ” means 31 C.F.R. § 1010.230.
“ Benefit Plan ” means any of (a) an “employee benefit plan” (as defined in ERISA) that is subject to Title I of ERISA, (b) a “plan” as defined in Section 4975 of the Internal Revenue Code or (c) any Person whose assets include (for purposes of ERISA Section 3(42) or otherwise for

3

purposes of Title I of ERISA or Section 4975 of the Internal Revenue Code) the assets of any such “employee benefit plan” or “plan”.
“ Borrower ” has the meaning given to such term in the introductory paragraph hereof.
“ Borrower Information ” has the meaning specified in Section 8.08.
“ Borrowing ” means Loans of the same Type that are made, Converted or continued on the same date and, in the case of Eurodollar Rate Loans, as to which a single Interest Period is in effect.
“ Business Day ” means a day of the year on which banks are not required or authorized by Law to close in New York, New York or Phoenix, Arizona and, if the applicable Business Day relates to any Loan in which interest is calculated by reference to the Eurodollar Rate, on which dealings are carried on in the London interbank market.
“ Capital Lease Obligations ” means, subject to Section 1.03, 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 or a finance lease on the balance sheet of such Person under GAAP and, for the purposes of this Agreement, the amount of such obligations shall be the capitalized amount thereof, determined in accordance with GAAP.
“ Change in Law ” means the occurrence, after the date of this Agreement, of any of the following: (a) the adoption of any Law, (b) any change in any Law or in the administration, interpretation or application thereof by any Governmental Authority or (c) the making or issuance of any request, rules, guideline, requirement or directive (whether or not having the force of law) by any Governmental Authority; provided, however, that notwithstanding anything herein to the contrary, (i) the Dodd-Frank Wall Street Reform and Consumer Protection Act and all requests, rules, guidelines, requirements and directives thereunder, issued in connection therewith or in implementation thereof, and (ii) all requests, rules, guidelines, requirements and directives promulgated by the Bank for International Settlements, the Basel Committee on Banking Supervision (or any successor or similar authority) or the United States or foreign regulatory authorities, in each case pursuant to Basel III, shall in each case be deemed a “Change in Law” regardless of the date enacted, adopted, issued or implemented.
“ Commitment ” means, as to any Lender, its obligation to make a Loan to the Borrower pursuant to Section 2.01, in an aggregate principal amount not to exceed the amount set forth opposite such Lender’s name on Schedule 1.01 under the column “Commitment”. “ Commitments ” means the total of the Lenders’ Commitments hereunder. The Commitments shall in no event exceed $150,000,000.
“ Consolidated ” refers to the consolidation of accounts in accordance with GAAP.
“ Consolidated Indebtedness ” means, at any date, the Indebtedness of the Borrower and its Consolidated Subsidiaries determined on a Consolidated basis as of such date; provided , however , that so long as the creditors of the VIE Lessor Trusts have no recourse to the assets of APS,

4

“Consolidated Indebtedness” shall not include any Indebtedness or other obligations of the VIE Lessor Trusts.
“ Consolidated Net Worth ” means, at any date, the sum as of such date of (a) 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) (b) the amount of the Consolidated surplus, whether capital or earned, of the Borrower, determined in accordance with GAAP as of the end of the most recent calendar month (excluding the effect on the Borrower’s accumulated other comprehensive income/loss of the ongoing application of Accounting Standards Codification Topic 815).
“ Consolidated Subsidiary ” means, at any date, any Subsidiary or other entity the accounts of which would be Consolidated with those of the Borrower on its Consolidated financial statements if such financial statements were prepared as of such date; provided that in no event will Consolidated Subsidiaries include the VIE Lessor Trusts.
“ Controlled Affiliate ” has the meaning specified in Section 4.01(n).
“ Convert ”, “ Conversion ”, “ Converted ” and “ Converting ” each refers to a conversion of Loans of one Type into Loans of the other Type pursuant to Section 2.06, Section 2.07 or Section 2.10.
“ Co-Syndication Agent ” means each of PNC Bank, National Association and Wells Fargo Bank, National Association, in its capacity as a co-syndication agent for the Lenders.
“ Debtor Relief Laws ” means the Bankruptcy Code of the United States of America, and all other liquidation, conservatorship, bankruptcy, assignment for the benefit of creditors, moratorium, rearrangement, receivership, insolvency, reorganization, or similar debtor relief Laws of the United States of America or other applicable jurisdictions from time to time in effect and affecting the rights of creditors generally.
“ Default ” means any Event of Default or any event that would constitute an Event of Default but for the requirement that notice be given or time elapse or both.
“ Dollars ” or “ $ ” means dollars of the United States of America.
“ Domestic Lending Office ” means, with respect to any Lender, the office of such Lender described as such in such Lender’s Administrative Questionnaire, or such other office or offices as a Lender may from time to time notify the Borrower and the Agent.
“ EEA Financial Institution ” means (a) any credit institution or investment firm established in any EEA Member Country which is subject to the supervision of an EEA Resolution Authority, (b) any entity established in an EEA Member Country which is a parent of an institution described in clause (a) of this definition, or (c) any financial institution established in an EEA Member Country

5

which is a subsidiary of an institution described in clauses (a) or (b) of this definition and is subject to consolidated supervision with its parent;
“ EEA Member Country ” means any of the member states of the European Union, Iceland, Liechtenstein, and Norway.
“ EEA Resolution Authority ” means any public administrative authority or any person entrusted with public administrative authority of any EEA Member Country (including any delegee) having responsibility for the resolution of any EEA Financial Institution.
“ Effective Date ” has the meaning specified in Section 3.01.
“ Eligible Assignee ” means any Person that meets the requirements to be an assignee under Section 8.07(b)(iii) and Section 8.07(b)(v), (subject to such consents, if any, as may be required under Section 8.07(b)(iii)).
“ Environmental Action ” means any action, suit, demand, demand letter, claim, notice of non-compliance or violation, notice of liability or potential liability, investigation, proceeding, consent order or consent agreement relating in any way to any Environmental Law, Environmental Permit or Hazardous Materials or arising from alleged injury or threat of injury to health, safety or the environment and relating to any Environmental Law, including, without limitation, (a) by any Governmental Authority for enforcement, cleanup, removal, response, remedial or other actions or damages and (b) by any Governmental Authority or any third party for damages, contribution, indemnification, cost recovery, compensation or injunctive relief.
“ Environmental Law ” means any federal, state, local or foreign statute, law, ordinance, rule, regulation, code, order, judgment, decree or judicial or agency interpretation, policy or guidance relating to pollution or protection of the environment, natural resources or, to the extent relating to exposure to Hazardous Materials, human health or safety, including, without limitation, those relating to the use, handling, transportation, treatment, storage, disposal, release or discharge of Hazardous Materials.
“ Environmental Permit ” means any permit, approval, identification number, license or other authorization required under any Environmental Law.
“ ERISA ” means the Employee Retirement Income Security Act of 1974.
“ ERISA Affiliate ” means any trade or business (whether or not incorporated) under common control with the Borrower within the meaning of Section 414(b) or (c) of the Internal Revenue Code (and Sections 414(m) and (o) of the Internal Revenue Code for purposes of provisions relating to Section 412 of the Internal Revenue Code).
“ ERISA Event ” means (a) a Reportable Event with respect to a Pension Plan; (b) a withdrawal by the Borrower or any ERISA Affiliate from a Pension Plan subject to Section 4063 of ERISA during a plan year in which it was a substantial employer (as defined in Section 4001(a)(2) of ERISA) or a cessation of operations that is treated as such a withdrawal under Section 4062(e) of

6

ERISA; (c) a complete or partial withdrawal by the Borrower or any ERISA Affiliate from a Multiemployer Plan or notification that a Multiemployer Plan is in reorganization; (d) the filing of a notice of intent to terminate, the treatment of a Plan amendment as a termination under Section 4041 or 4041A of ERISA, or the commencement of proceedings by the PBGC to terminate a Pension Plan or Multiemployer Plan; (e) an event or condition which constitutes grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Pension Plan or Multiemployer Plan; or (f) the imposition of any liability under Title IV of ERISA, other than for PBGC premiums due but not delinquent under Section 4007 of ERISA, upon the Borrower or any ERISA Affiliate.
“ EU Bail-In Legislation Schedule ” means the EU Bail-In Legislation Schedule published by the Loan Market Association (or any successor person), as in effect from time to time.
“ Eurodollar Lending Office ” means, with respect to any Lender, the office of such Lender described as such in such Lender’s Administrative Questionnaire, or such other office or offices as a Lender may from time to time notify the Borrower and the Agent.
“ Eurodollar Rate ” means for any Interest Period as to any Eurodollar Rate Loan, (i) the rate per annum determined by the Agent to be the offered rate which appears on the page of the Reuters Screen which displays the London interbank offered rate administered by ICE Benchmark Administration Limited (such page currently being the LIBOR01 page) (the “ LIBO Rate ”) for deposits (for delivery on the first day of such Interest Period) with a term equivalent to such Interest Period in Dollars, determined as of approximately 11:00 a.m. (London, England time), two Business Days prior to the commencement of such Interest Period, or (ii) in the event the rate referenced in the preceding clause (i) does not appear on such page or service or if such page or service shall cease to be available, the rate determined by the Agent to be the offered rate on such other page or other service which displays the LIBO Rate for deposits (for delivery on the first day of such Interest Period) with a term equivalent to such Interest Period in Dollars, determined as of approximately 11:00 a.m. (London, England time) two Business Days prior to the commencement of such Interest Period; provided that if LIBO Rates are quoted under either of the preceding clauses (i) or (ii), but there is no such quotation for the Interest Period elected, the LIBO Rate shall be equal to the Interpolated Rate; and provided , further , that if any such rate determined pursuant to this definition is below zero, the Eurodollar Rate will be deemed to be zero.
“ Eurodollar Rate Loan ” means a Loan that bears interest at a rate based on the Eurodollar Rate (other than a Base Rate Loan bearing interest at a rate based on the Eurodollar Rate).
“ Events of Default ” has the meaning specified in Section 6.01.
“ Excluded Taxes ” means, with respect to the Agent, any Lender or any other recipient of any payment to be made by or on account of any obligation of the Borrower hereunder, (a) Taxes imposed on or measured by its overall net income (however denominated), and franchise Taxes imposed on it (in lieu of net income Taxes), by the United States of America or the jurisdiction (or any political subdivision thereof) under the Laws of which such recipient is organized or does business or in which its principal office is located or, in the case of any Lender, in which its Applicable Lending Office is located, (b) any branch profits Taxes imposed by the United States of America

7

or any similar Tax imposed by any other jurisdiction in which the Borrower is located, (c) any backup withholding Tax that is required by the Internal Revenue Code to be withheld from amounts payable to a Lender that has failed to comply with clause (A) of Section 2.12(e)(ii), (d) in the case of a Foreign Lender (other than as agreed to between any assignee and the Borrower pursuant to a request by the Borrower under Section 2.17), any United States of America withholding Tax that (i) is required to be imposed on amounts payable to such Foreign Lender pursuant to the Laws in force at the time such Foreign Lender becomes a party hereto (or designates a new Applicable Lending Office) or (ii) is attributable to such Foreign Lender’s failure or inability (other than as a result of a Change in Law) to comply with clause (B) of Section 2.12(e)(ii), except to the extent that such Foreign Lender (or its assignor, if any) was entitled, at the time of designation of a new Applicable Lending Office (or assignment), to receive additional amounts from the Borrower with respect to such withholding Tax pursuant to Section 2.12(a)(i) or (ii); and (e) any United States withholding Tax imposed by FATCA.
“ Executive Order ” has the meaning specified in Section 4.01 (p).
“ FATCA ” means Sections 1471 through 1474 of the Internal Revenue Code, as of the date of this Agreement (or any amended or successor version that is substantively comparable and not materially more onerous to comply with), any current or future regulations or official interpretations thereof and any agreement entered into pursuant to Section 1471(b)(1) of the Internal Revenue Code.
“ Federal Funds Rate ” means, for any day, the rate per annum equal to the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System on such day, as published by the Federal Reserve Bank of New York on the Business Day next succeeding such day; provided that (a) if such day is not a Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Business Day as so published on the next succeeding Business Day, and (b) if no such rate is so published on such next succeeding Business Day, the Federal Funds Rate for such day shall be the average rate (rounded upward, if necessary, to a whole multiple of 1/100 of 1%) charged to the Agent on such day on such transactions as determined by the Agent; provided further , that if the Federal Funds Rate shall be less than zero, such rate shall be deemed to be zero for purposes of this Agreement.
“ Fee Letter ” means that certain Administrative Agent Fee Letter dated as of December 21, 2018, between the Agent and the Borrower, as amended, modified, restated or supplemented from time to time.
“ Foreign Lender ” means any Lender that is organized under the Laws of a jurisdiction other than that in which the Borrower is resident for tax purposes. For purposes of this definition, the United States of America, each State thereof and the District of Columbia shall be deemed to constitute a single jurisdiction.
“ Four Corners Acquisition ” means the acquisition by APS from Southern California Edison Company (“ SCE ”) of SCE’s interests in Units 4 and 5 of the Four Corners Power Plant near Farmington, New Mexico, pursuant to the Purchase and Sale Agreement, dated as of November 8, 2010, by and between SCE and APS.

8

“ 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.
“ GAAP ” has the meaning specified in Section 1.03.
“ Governmental Authority ” means the government of the United States of America or any other nation, or of any political subdivision thereof, whether state or local, and any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative powers or functions of or pertaining to government (including any supra-national bodies such as the European Union or the European Central Bank) and any group or body charged with setting financial accounting or regulatory capital rules or standards (including, without limitation, the Financial Accounting Standards Board, the Bank for International Settlements or the Basel Committee on Banking Supervision or any successor or similar authority to any of the foregoing).
“ Government Official ” shall mean (a) an executive, official, employee or agent of a governmental department, agency or instrumentality, (b) a director, officer, employee or agent of a wholly or partially government owned or controlled company or business, (c) a political party or official thereof, or candidate for political office or (d) an executive, official, employee or agent of a public international organization (e.g., the International Monetary Fund or the World Bank).
“ Guarantee ” means as to any Person, any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Indebtedness of any other Person or in any manner providing for the payment of any Indebtedness of any other Person or otherwise protecting the holder of such Indebtedness 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 Materials ” means (a) petroleum and petroleum products, byproducts or breakdown products, radioactive materials, asbestos-containing materials, polychlorinated biphenyls and radon gas and (b) any other chemicals, materials or substances designated, classified or regulated as hazardous or toxic or as a pollutant or contaminant under any Environmental Law.
“ Hedge Agreement ” means any interest rate swap, cap or collar agreement, interest rate future or option contract, currency swap agreement, currency future or option contract, commodity future or option contract, commodity forward contract or other similar agreement.
“ Indebtedness ” means as to any Person at any date (without duplication): (a) indebtedness created, issued, incurred or assumed by such Person for borrowed money or evidenced by bonds, debentures, notes or similar instruments; (b) 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 (unless subject to a good faith dispute); (c) all Indebtedness secured by a Lien on any asset of such

9

Person, to the extent such Indebtedness has been assumed by, or is a recourse obligation of, such Person; (d) all Guarantees by such Person; (e) all Capital Lease Obligations of such Person; and (f) 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 Indebtedness; provided that Indebtedness, in accordance with Section 1.03, shall exclude any obligation or liability arising from the application or interpretation of ASC Topic 840 or 842 or any related, similar or successor pronouncement, guideline, publication or rule, or which is otherwise excluded in accordance with Section 1.03.

“ Indemnified Taxes ” means Taxes other than Excluded Taxes.
“ Ineligible Institution ” means (a) a natural person, (b) an Affected Lender or any of its Subsidiaries, (c) the Borrower, any of its Subsidiaries or any of its Affiliates, (d) a company, investment vehicle or trust for, or owned and operated for the primary benefit of, a natural person or relative(s) thereof, or (e) any Person who, upon becoming a Lender hereunder, would constitute an Affected Lender or a Subsidiary thereof.
“ Initial Borrowing ” means the Loans made by the Initial Lenders on the Effective Date pursuant to Section 2.01 hereof.
“ Initial Lenders ” has the meaning given to such term in the introductory paragraph hereof.
“ Interest Election Request ” means a written request by the Borrower to Convert or continue a Borrowing in accordance with the definition of “ Interest Period ” contained in this Section 1.01 and/or Section 2.07, as applicable, in each case in substantially the form of Exhibit D hereto.
“ Interest Period ” means, for each Eurodollar Rate Loan comprising part of the same Borrowing, the period commencing on (i) the date such Eurodollar Rate Loan is disbursed, (ii) the date of the Conversion of any Base Rate Loan into such Eurodollar Rate Loan or (iii) the effective date of the most recent continuation of such Eurodollar Rate Loan, as the case may be, and ending on the last day of the period selected by the Borrower pursuant to the provisions below and, thereafter, each subsequent period commencing on the last day of the immediately preceding Interest Period and ending on the last day of the period selected by the Borrower pursuant to the provisions below. The duration of each such Interest Period shall be one week or one, two, three or six months, as the Borrower may, upon notice (in the form of an Interest Election Request duly completed and executed by the Borrower) received by the Agent not later than 12:00 noon on the third Business Day prior to the first day of such Interest Period, select; provided , however , that:
(a)    the Borrower may not select any Interest Period that ends after the Maturity Date;
(b)    Interest Periods commencing on the same date for Eurodollar Rate Loans comprising part of the same Borrowing shall be of the same duration;
(c)    whenever the last day of any Interest Period would otherwise occur on a day other than a Business Day, the last day of such Interest Period shall be extended to occur

10

on the next succeeding Business Day, provided , however , that, if such extension would cause the last day of such Interest Period (other than a one week Interest Period) to occur in the next following calendar month, the last day of such Interest Period shall occur on the next preceding Business Day; and
(d)    other than with respect to a one week Interest Period, whenever the first day of any Interest Period occurs on a day of an initial calendar month for which there is no numerically corresponding day in the calendar month that succeeds such initial calendar month by the number of months equal to the number of months in such Interest Period, such Interest Period shall end on the last Business Day of such succeeding calendar month.
“ Internal Revenue Code ” means the Internal Revenue Code of 1986, as amended from time to time, and the regulations promulgated and rulings issued thereunder.
“ Interpolated Rate ” means, in relation to the LIBO Rate, the rate which results from interpolating on a linear basis between:
(a)    the applicable LIBO Rate for the longest period (for which that LIBO Rate is available) which is less than the Interest Period of that Loan; and
(b)    the applicable LIBO Rate for the shortest period (for which that LIBO Rate is available) which exceeds the Interest Period of that Loan,
each as of approximately 11:00 a.m. (London, England time) two Business Days prior to the commencement of such Interest Period of that Loan.
“ Laws ” means, collectively, all international, foreign, Federal, state and local statutes, treaties, rules, guidelines, regulations, ordinances, codes and administrative or judicial precedents or authorities, including the interpretation or administration thereof by any Governmental Authority charged with the enforcement, interpretation or administration thereof, and all applicable administrative orders, directed duties, licenses, authorizations and permits of, and agreements with, any Governmental Authority.
“ Lenders ” means the Initial Lenders and each Person that shall become a party hereto pursuant to Section 8.07.
“ LIBO Rate ” has the meaning specified in the definition of “ Eurodollar Rate .”
“ Lien ” means any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or otherwise), charge or other security interest or preferential arrangement that has the practical effect of creating a security interest, including, without limitation, the lien or retained security title of a conditional vendor and any easement, right of way or other encumbrance on title to real property, and any capital lease having substantially the same economic effect as any of the foregoing.
“ Loans ” has the meaning specified in Section 2.01.

11

“ Loan Documents ” mean this Agreement, each Note and the Fee Letter.
“ Material Adverse Effect ” means a material adverse effect on (a) the financial condition, operations, business or property of the Borrower and its Subsidiaries taken as a whole, (b) the rights and remedies of the Agent or any Lender under this Agreement or any Note or (c) the ability of the Borrower to perform its obligations under this Agreement or any Note.
“ Material Subsidiary ” means APS and, at any time, each other Subsidiary of the Borrower which as of such time meets the definition of a “significant subsidiary” included as of the date hereof in Regulation S-X of the Securities and Exchange Commission or whose assets at such time exceed 10% of the assets of the Borrower and the Subsidiaries (on a Consolidated basis).
“ Maturity Date ” means December 21, 2020.
“ Multiemployer Plan ” means any employee benefit plan of the type described in Section 4001(a)(3) of ERISA, to which the Borrower or any ERISA Affiliate makes or is obligated to make contributions, or during the preceding five plan years, has made or been obligated to make contributions.
“ Note ” means a promissory note of the Borrower payable to the order of any Lender, delivered pursuant to a request made under Section 2.14, in substantially the form of Exhibit A hereto.
“ Notice of Initial Borrowing ” has the meaning specified in Section 2.02(a).
“ Obligations ” means all loans to, and debts, liabilities, obligations, covenants and duties of, the Borrower arising under any Loan Document or otherwise with respect to any Loan, whether direct or indirect (including those acquired by assumption), absolute or contingent, due or to become due, now existing or hereafter arising and including interest and fees that accrue under any Loan Document after the commencement by or against the Borrower of any proceeding under any Debtor Relief Laws naming such Person as the debtor in such proceeding, regardless of whether such interest and fees are allowed claims in such proceeding.
“ OFAC ” means Office of Foreign Assets Control of the United States Department of the Treasury.
“ Other Taxes ” means all present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies arising from any payment made hereunder or under any other Loan Document or from the execution, delivery or enforcement of, or otherwise with respect to, this Agreement or any other Loan Document.

“ Participant ” has the meaning specified in Section 8.07(d).
“ Participant Register ” has the meaning specified in Section 8.07(d).
“ PATRIOT Act ” means the USA PATRIOT Act (Title III of Pub. L. 107-56 (signed into law October 26, 2001)), as amended.

12

“ PBGC ” means the Pension Benefit Guaranty Corporation.
“ Pension Plan ” means any “employee pension benefit plan” (as such term is defined in Section 3(2) of ERISA), other than a Multiemployer Plan, that is subject to Title IV of ERISA and is sponsored or maintained by the Borrower or any ERISA Affiliate or to which the Borrower or any ERISA Affiliate contributes or has an obligation to contribute, or in the case of a multiple employer or other plan described in Section 4064(a) of ERISA, has made contributions at any time during the immediately preceding five plan years.
“ Percentage ” means, with respect to any Lender at any time, a fraction the numerator of which is the outstanding principal amount of such Lender’s Loans at such time and the denominator of which is the aggregate outstanding principal amount of all Loans at such time; provided , that (i) the initial Percentage of each Lender shall be the percentage set forth opposite such Lender’s name on Schedule 1.01 under the column “Ratable Share” and (ii) if the outstanding principal amount of all Loans has been repaid in full, the Percentage of each Lender shall be such Lender’s Percentage as in effect immediately prior to such repayment.
“ Person ” means an individual, partnership, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture, limited liability company or other entity, or a government or any political subdivision or agency thereof.
“ Plan ” means any “employee benefit plan” (as such term is defined in Section 3(3) of ERISA) established by the Borrower or, with respect to any such plan that is subject to Section 412 of the Internal Revenue Code or Title IV of ERISA, any ERISA Affiliate.
“ Prime Rate ” means the rate of interest per annum publicly announced from time to time by KeyBank National Association as its prime rate in effect at its principal office in Cleveland, Ohio; each change in the Prime Rate shall be effective from and including the date such change is publicly announced as being effective.
“ Prohibited Person ” means any Person (a) listed in the Annex to the Executive Order or identified pursuant to Section 1 of the Executive Order; (b) that is owned or controlled by, or acting for or on behalf of, any Person listed in the Annex to the Executive Order or identified pursuant to the provisions of Section 1 of the Executive Order; (c) with whom a Lender is prohibited from dealing or otherwise engaging in any transaction by any terrorism or anti-laundering law, including the Executive Order; (d) who commits, threatens, conspires to commit, or support “terrorism” as defined in the Executive Order; (e) who is named as a “Specially designated national or blocked person” on the most current list published by the OFAC at its official website, at http://www.treas.gov/offices/enforcement/ofac/sdn/t11sdn.pdf or any replacement website or other replacement official publication of such list; or (f) who is owned or controlled by a Person listed above in clause (c) or (e).
“ PTE ” means a prohibited transaction class exemption issued by the U.S. Department of Labor, as any such exemption may be amended from time to time.
“ PVNGS ” means the Palo Verde Nuclear Generating Station.

13

“ Ratable Share ” of any amount means, with respect to any Lender at any time but subject to Section 2.16, the product of such amount times such Lender’s Percentage.
“ Register ” has the meaning specified in Section 8.07(c).
“ Related Parties ” means, with respect to any Person, such Person’s Affiliates and the partners, directors, officers, employees, agents, trustees and advisors of such Person and of such Person’s Affiliates.
“ Reportable Event ” means any of the events set forth in Section 4043(c) of ERISA, other than events for which the 30-day notice period has been waived under the final regulations issued under Section 4043, as in effect as of the date of this Agreement (the “Section 4043 Regulations”). Any changes made to the Section 4043 Regulations that become effective after the Effective Date shall have no impact on the definition of Reportable Event as used herein unless otherwise amended by the Borrower and the Required Lenders.
“ Required Lenders ” means, as of any date of determination, but subject to Section 2.16, Lenders holding in the aggregate more than 50% of the aggregate outstanding principal amount of all Loans (or, if all Loans have been repaid in full, more than 50% of the aggregate amount of all outstanding Obligations).
“ Sanctions ” means economic or financial sanctions or trade embargoes imposed, administered or enforced from time to time by OFAC and any similar economic or financial sanctions or trade embargoes of the type described in Sections 4.01(n) through (q) and imposed, administered or enforced from time to time by the U.S. government, including the U.S. Department of State, or any other applicable Governmental Authority.
“ SEC Reports ” means the Borrower’s (i) Form 10-K Report for the year ended December 31, 2017, (ii) Form 10-Q Reports for the quarters ended March 31, 2018, June 30, 2018 and September 30, 2018 and (iii) Form 8-K Reports filed on January 9, 2018, February 20, 2018, February 22, 2018, May 22, 2018, June 28, 2018, July 2, 2018, August 9, 2018 and December 20, 2018.
“ Subsidiary ” of any Person means any corporation, partnership, joint venture, limited liability company, trust or estate of which (or in which) more than 50% of (a) the issued and outstanding Voting Stock, (b) the interest in the capital or profits of such limited liability company, partnership or joint venture or (c) the beneficial interest in such trust or estate, is at the time directly or indirectly owned or controlled by such Person, by such Person and one or more of its other Subsidiaries or by one or more of such Person’s other Subsidiaries; provided that in no event will Subsidiaries include the VIE Lessor Trusts.
“ Taxes ” means all present or future taxes, levies, imposts, duties, deductions, withholdings (including backup withholding), assessments, fees or other charges imposed by any Governmental Authority, including any interest, additions to tax or penalties applicable thereto.

14

“ Type ”, when used in reference to any Loan or Borrowing, refers to whether the rate of interest on such Loan, or on the Loans comprising such Borrowing, is determined by reference to the Eurodollar Rate or the Base Rate.
“ VIE Lessor Trusts ” means the three (3) separate variable-interest entity lessor trusts that purchased from, and leased back to, APS certain interests in the PVNGS Unit 2 and related common facilities, as described in Note 6 of Combined Notes to Condensed Consolidated Financial Statements in Borrower’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2018.
“ Voting Stock ” means capital stock issued by a corporation, or equivalent interests in any other Person, the holders of which are ordinarily, in the absence of contingencies, entitled to vote for the election of directors (or persons performing similar functions) of such Person, even if the right so to vote has been suspended by the happening of such a contingency.
“ Write-Down and Conversion Powers ” means, with respect to any EEA Resolution Authority, the write-down and conversion powers of such EEA Resolution Authority from time to time under the Bail-In Legislation for the applicable EEA Member Country, which write-down and conversion powers are described in the EU Bail-In Legislation Schedule.
Section 1.02      Other Interpretive Provisions . With reference to this Agreement and each other Loan Document, unless otherwise specified herein or in such other Loan Document:
(a)      The definitions of terms herein shall apply equally to the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words “include,” “includes” and “including” shall be deemed to be followed by the phrase “without limitation.” The word “will” shall be construed to have the same meaning and effect as the word “shall.” Unless the context requires otherwise, (i) any definition of or reference to any agreement, instrument or other document shall be construed as referring to such agreement, instrument or other document as from time to time amended, restated, supplemented or otherwise modified (subject to any restrictions on such amendments, restatements, supplements or modifications set forth herein or in any other Loan Document), (ii) any reference herein to any Person shall be construed to include such Person’s permitted successors and permitted assigns, (iii) the words “herein,” “hereof” and “hereunder,” and words of similar import when used in any Loan Document, shall be construed to refer to such Loan Document in its entirety and not to any particular provision thereof, (iv) all references in a Loan Document to Articles, Sections, Exhibits and Schedules shall be construed to refer to Articles and Sections of, and Exhibits and Schedules to, the Loan Document in which such references appear, (v) any reference to any law shall include all statutory and regulatory provisions consolidating, amending, replacing or interpreting such law and any reference to any law or regulation shall, unless otherwise specified, refer to such law or regulation as amended, modified or supplemented from time to time, and (vi) the words “asset” and “property” shall be construed to have the same meaning and effect and to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights.

15

(b)      In the computation of periods of time from a specified date to a later specified date, the word “from” means “from and including;” the words “to” and “until” each mean “to but excluding;” and the word “through” means “to and including.”
(c)      Section headings herein and in the other Loan Documents are included for convenience of reference only and shall not affect the interpretation of this Agreement or any other Loan Document.
Section 1.03      Accounting Terms . Unless otherwise specified herein, and subject to the provision below, 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 (“ GAAP ”). If at any time any change in GAAP or in the interpretation thereof would affect the computation of any financial ratio or requirement set forth in any Loan Document, and either the Borrower or the Required Lenders shall so request, the Agent, the Lenders and the Borrower shall negotiate in good faith to amend such ratio or requirement to preserve the original intent thereof in light of such change in GAAP or in the interpretation thereof (subject to the approval of the Required Lenders); provided that , unless and until so amended, such ratio or requirement shall continue to be computed in accordance with GAAP prior to such change therein. Notwithstanding the foregoing, (a) for purposes of all financial or covenant calculations made under this Agreement and for purposes of defining and calculating Capital Lease Obligations, Indebtedness and Consolidated Indebtedness hereunder for such purposes, all leases or other agreements of any Person deemed to be a lease or other obligation under GAAP (as in effect from time to time) (whether such lease or other agreement is existing as of the date hereof or hereafter entered into) that would not be characterized as (i) a Capital Lease Obligation, (ii) Indebtedness or (iii) Consolidated Indebtedness, in each case, under this Agreement based on GAAP as in effect as of December 31, 2015, will not be deemed to be (i) a Capital Lease Obligation, (ii) Indebtedness or (iii) Consolidated Indebtedness, respectively, as a result of any change in GAAP, or the interpretation or application thereof required or approved by such Person’s independent certified public accountants, occurring or coming into or taking effect after December 31, 2015, including ASC Topic 840 or 842 or any related, similar or successor pronouncement, guidance, publication or rule and (b) all terms of an accounting or financial nature used herein shall be construed, and all computations of amounts and ratios referred to herein shall be made (i) without giving effect to any election under Accounting Standards Codification 825-10-25 (or any other Accounting Standards Codification or Financial Accounting Standard having a similar result or effect) to value any Indebtedness or other liabilities of any Person at “fair value”, as defined therein and (ii) without giving effect to any treatment of Indebtedness in respect of convertible debt instruments under Accounting Standards Codification 470-20 (or any other Accounting Standards Codification or Financial Accounting Standard having a similar result or effect) to value any such Indebtedness in a reduced or bifurcated manner as described therein, and such Indebtedness shall at all times be valued at the full stated principal amount thereof.

16

Section 1.04      Rounding . Any financial ratios required to be maintained by the Borrower pursuant to this Agreement shall be calculated by dividing the appropriate component by the other component, carrying the result to one place more than the number of places by which such ratio is expressed herein and rounding the result up or down to the nearest number (with a rounding-up if there is no nearest number).
Section 1.05      Times of Day . Unless otherwise specified, all references herein to times of day shall be references to Eastern time (daylight or standard, as applicable).
ARTICLE II     

 AMOUNTS AND TERMS OF THE LOANS
Section 2.01      The Loans .
Subject to the terms and conditions hereof (including, without limitation, Section 3.01), each Lender, by its acceptance hereof, severally agrees to make a one-time loan (individually, a “ Loan ” and, collectively, the “ Loans ”) to the Borrower on the Effective Date in Dollars in an aggregate principal amount equal to such Lender’s Commitment.  As provided in Section 2.05, the Borrower may elect that each Borrowing of Loans be either Base Rate Loans or Eurodollar Rate Loans. Amounts borrowed by the Borrower hereunder and prepaid or otherwise repaid may not be reborrowed. Unless an earlier maturity is provided for hereunder, all Loans shall mature and be due and payable on the Maturity Date. The Commitments shall immediately and automatically terminate upon the earlier of (i) 5:00 p.m. on the Effective Date and (ii) the making of the Loans pursuant to this Section 2.01.
Section 2.02      Making the Loans .
(a)      The Initial Borrowing shall be made on notice, given not later than (x) 12:00 noon on the third Business Day prior to the Effective Date in the case of an Initial Borrowing consisting of Eurodollar Rate Loans or (y) 12:00 noon on the Business Day prior to the Effective Date in the case of an Initial Borrowing consisting of Base Rate Loans, by the Borrower to the Agent, which shall give to each Lender prompt notice thereof by facsimile. Such notice of the Initial Borrowing (the “ Notice of Initial Borrowing ”) shall be in writing or by facsimile in substantially the form of Exhibit B hereto, specifying therein the requested (i) date of the Initial Borrowing (which shall be the Effective Date and a Business Day), (ii) Type of Loans comprising the Initial Borrowing, (iii) aggregate amount of the Initial Borrowing, and (iv) in the case of an Initial Borrowing consisting of Eurodollar Rate Loans, initial Interest Period for each such Loan. Each Lender shall, before 2:00 p.m. on the date of the Initial Borrowing, make available for the account of its Applicable Lending Office to the Agent at the Agent’s Account, in same day funds, such Lender’s Ratable Share of the Initial Borrowing. After the Agent’s receipt of such funds and upon fulfillment of the applicable conditions set forth in Article III, the Agent will make such funds available to the Borrower at the Agent’s address referred to in Section 8.02 or as requested by the Borrower in the Notice of Initial Borrowing.

17

(b)      Anything in subsection (a) above to the contrary notwithstanding, (i) the Borrower may not select Eurodollar Rate Loans for any Borrowing if the aggregate amount of such Borrowing is less than $5,000,000 or less than an integral multiple of $1,000,000 in excess thereof or if the obligation of the Lenders to make Eurodollar Rate Loans shall then be suspended pursuant to Section 2.06 or 2.10, and (ii) at no time shall there be more than three (3) different Interest Periods outstanding for Eurodollar Rate Loans.
(c)      The Notice of Initial Borrowing shall be irrevocable and binding on the Borrower. If the Notice of Initial Borrowing specifies that the Initial Borrowing is to be comprised of Eurodollar Rate Loans, the Borrower shall indemnify each Lender against any loss, cost or expense reasonably incurred by such Lender as a result of any failure (i) to fulfill on or before the date specified in the Notice of Initial Borrowing the applicable conditions set forth in Article III or (ii) to otherwise borrow the Eurodollar Rate Loans requested by the Borrower in the Notice of Initial Borrowing on such date (and shall set forth such indemnification obligation in the Notice of Initial Borrowing), including, without limitation, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Loan to be made by such Lender as part of the Initial Borrowing when such Loan, as a result of any such failure, is not made on such date.
(d)      Unless the Agent shall have received notice from a Lender prior to the time of the Initial Borrowing that such Lender will not make available to the Agent such Lender’s Ratable Share of the Initial Borrowing, the Agent may assume that such Lender has made such portion available to the Agent on the date of the Initial Borrowing in accordance with subsection (a) of this Section 2.02 and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Lender shall not have so made such Ratable Share available to the Agent, such Lender and the Borrower severally agree to repay to the Agent within one Business Day after demand for such Lender and within three Business Days after demand for the Borrower such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent, at (i) in the case of the Borrower, the interest rate applicable at the time to Loans comprising the Initial Borrowing and (ii) in the case of such Lender, the Federal Funds Rate. If the Borrower and such Lender shall pay such interest to the Agent for the same or an overlapping period, the Agent shall promptly remit to the Borrower the amount of such interest paid by the Borrower for such period. If such Lender shall repay to the Agent such corresponding amount, such amount so repaid shall constitute such Lender’s Loan as part of the Initial Borrowing for purposes of this Agreement.
(e)      The failure of any Lender to make the Loan to be made by it as part of the Initial Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Loan on the date of the Initial Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Loan to be made by such other Lender on the date of the Initial Borrowing.
Section 2.03      Agent’s Fees . The Borrower shall pay to the Agent for its own account such fees as are agreed between the Borrower and the Agent pursuant to the Fee Letter between the Borrower and the Agent.

18

Section 2.04      Repayment of Loans . The Borrower hereby unconditionally agrees to pay to the Agent on the Maturity Date, for the account of the Lenders, the then unpaid principal amount of the Loans, together with all accrued and unpaid interest thereon, and all other outstanding Obligations.
Section 2.05      Interest on Loans .
(a)      Scheduled Interest . The Borrower shall pay interest on the unpaid principal amount of each Loan owing to each Lender from the date of such Loan until such principal amount shall be paid in full, at the following rates per annum :
(i)      Base Rate Loans . During such periods as such Loan is a Base Rate Loan, a rate per annum equal at all times to the sum of (x) the Base Rate in effect from time to time plus (y) the Applicable Rate for Base Rate Loans in effect from time to time, payable in arrears quarterly on the last Business Day of each March, June, September and December during such periods and on the date such Base Rate Loan shall be Converted or paid in full.
(ii)      Eurodollar Rate Loans . During such periods as such Loan is a Eurodollar Rate Loan, a rate per annum equal at all times during each Interest Period for such Loan to the sum of (x) the Eurodollar Rate for such Interest Period for such Loan plus (y) the Applicable Rate for Eurodollar Rate Loans in effect from time to time, payable in arrears on the last day of such Interest Period and, if such Interest Period has a duration of more than three months, on each day that occurs during such Interest Period every three months from the first day of such Interest Period and on the date such Eurodollar Rate Loan shall be Converted or paid in full.
(b)      Default Interest . Upon the occurrence and during the continuance of an Event of Default under Section 6.01(a), the Agent may, and upon the request of the Required Lenders shall, require the Borrower to pay interest (“ Default Interest ”) on (i) the unpaid principal amount of each Loan owing to each Lender, payable in arrears on the dates referred to in clause (a)(i) or (a)(ii) above, at a rate per annum equal at all times to 2% per annum above the rate per annum required to be paid on such Loan pursuant to clause (a)(i) or (a)(ii) above and (ii) to the fullest extent permitted by Law, the amount of any interest, fee or other amount payable hereunder that is not paid when due, from the date such amount shall be due until such amount shall be paid in full, payable in arrears on the date such amount shall be paid in full and on demand, at a rate per annum equal at all times to 2% per annum above the rate per annum required to be paid on Base Rate Loans pursuant to clause (a)(i) above, provided , however , that following acceleration of the Loans pursuant to Section 6.01, Default Interest shall accrue and be payable hereunder whether or not previously required by the Agent.
(c)      Interest Rate Limitation . Nothing contained in this Agreement or in any other Loan Document shall be deemed to establish or require the payment of interest to any Lender at a rate in excess of the maximum rate permitted by applicable Law. If the amount of interest payable for the account of any Lender on any interest payment date would exceed the maximum amount permitted by applicable Law to be charged by such Lender, the amount of interest payable for its account on such interest payment date shall be automatically reduced to such maximum permissible amount.

19

In the event of any such reduction affecting any Lender, if from time to time thereafter the amount of interest payable for the account of such Lender on any interest payment date would be less than the maximum amount permitted by applicable Law to be charged by such Lender, then the amount of interest payable for its account on such subsequent interest payment date shall be automatically increased to such maximum permissible amount, provided that at no time shall the aggregate amount by which interest paid for the account of any Lender has been increased pursuant to this sentence exceed the aggregate amount by which interest paid for its account has theretofore been reduced pursuant to the previous sentence.
Section 2.06      Interest Rate Determination .
(a)      The Agent shall give prompt notice to the Borrower and the Lenders of the applicable interest rate determined by the Agent for purposes of Section 2.05(a).
(b)      (i)    If the Required Lenders determine that for any reason in connection with any request for a Eurodollar Rate Loan or a Conversion to or continuation thereof that (a) Dollar deposits are not being offered to banks in the London interbank eurodollar market for the applicable amount and Interest Period of such Eurodollar Rate Loan, (b) adequate and reasonable means do not exist for determining the Eurodollar Rate for any requested Interest Period with respect to a proposed Eurodollar Rate Loan, or (c) the Eurodollar Rate for any requested Interest Period with respect to a proposed Eurodollar Rate Loan does not adequately and fairly reflect the cost to such Lenders of funding such Loan, the Agent will promptly so notify the Borrower and each Lender, whereupon each Eurodollar Rate Loan will automatically on the last day of the then existing Interest Period therefor Convert into a Base Rate Loan. Thereafter, the obligation of the Lenders to make or maintain Eurodollar Rate Loans shall be suspended until the Agent (upon the instruction of the Required Lenders) revokes such notice. Upon receipt of such notice, the Borrower may revoke any pending request for a Borrowing of, Conversion to or continuation of Eurodollar Rate Loans or, failing that, will be deemed to have Converted such request into a request for a Base Rate Loan in the amount specified therein.
(i)      Notwithstanding anything to the contrary herein, if at any time the Agent or the Required Lenders determine (which determination shall be conclusive absent manifest error) that (i) the circumstances set forth in Section 2.06(b)(i) have arisen and such circumstances are unlikely to be temporary or (ii) the circumstances set forth in Section 2.06(b)(i) have not arisen but the supervisor for the administrator of the Eurodollar Rate or a Governmental Authority having jurisdiction over the Agent has made a public statement identifying a specific date after which the Eurodollar Rate shall no longer be used for determining interest rates for loans, then the Agent and the Borrower shall endeavor to establish an alternate rate of interest to the Eurodollar Rate that gives due consideration to the then prevailing market convention for determining a rate of interest for syndicated loans in the United States at such time, and shall enter into an amendment to this Agreement to reflect such alternate rate of interest and such other related changes to this Agreement as may be applicable. Notwithstanding anything to the contrary in Section 8.01 , such amendment shall become effective without any further action or consent of any other party

20

to this Agreement so long as the Agent shall not have received, within five (5) Business Days of the date notice of such alternate rate of interest, together with a copy of such amendment, is provided to the Lenders, a written notice from the Required Lenders stating that such Required Lenders object to such amendment. Provided that , if such alternate rate of interest shall be less than zero, such rate shall be deemed to be zero for the purposes of this Agreement.
(c)      If the Borrower shall fail to select the duration of any Interest Period for any Eurodollar Rate Loans in accordance with the provisions contained in the definition of “Interest Period” in Section 1.01, the Agent will forthwith so notify the Borrower and the Lenders and such Loans will automatically, on the last day of the then existing Interest Period therefor, Convert into Base Rate Loans.
(d)      On the date on which the aggregate unpaid principal amount of Eurodollar Rate Loans comprising any Borrowing shall be reduced, by payment or prepayment or otherwise, to less than $5,000,000, such Loans shall automatically Convert into Base Rate Loans.
(e)      Upon the occurrence and during the continuance of any Event of Default,
(i)      with respect to Eurodollar Rate Loans, each such Loan will automatically, on the last day of the then existing Interest Period therefor, Convert into a Base Rate Loan (or if such Loan is then a Base Rate Loan, will continue as a Base Rate Loan); and
(ii)      the obligation of the Lenders to Convert Loans into Eurodollar Rate Loans shall be suspended until the Agent shall notify the Borrower and the Lenders that the circumstances causing such suspension no longer exist.
Section 2.07      Optional Conversion of Loans . The Borrower may on any Business Day, upon notice given to the Agent (in the form of an Interest Election Request duly completed and executed by the Borrower) not later than 12:00 noon on the third Business Day prior to the date of the proposed Conversion and subject to the provisions of Sections 2.06 and 2.10, Convert all or any portion of the Loans of one Type comprising the same Borrowing into Loans of the other Type; provided , however , that (a) any Conversion of Eurodollar Rate Loans into Base Rate Loans shall be made only on the last day of an Interest Period for such Eurodollar Rate Loans, (b) any Conversion of Base Rate Loans into Eurodollar Rate Loans shall be in an amount not less than the minimum amount specified in Section 2.02(b) and (c) no Conversion of any Loans shall result in more separate Borrowings than permitted under Section 2.02(b). Each such notice of a Conversion shall, within the restrictions specified above, specify (i) the date of such Conversion, (ii) the Loans to be Converted and (iii) if such Conversion is into Eurodollar Rate Loans, the duration of the initial Interest Period for each such Loan. Each Interest Election Request shall be irrevocable and binding on the Borrower.
Section 2.08      Prepayments of Loans .
(a)      Optional . At any time and from time to time, the Borrower shall have the right to prepay the Loans, in whole or in part, without premium or penalty (except as provided in clause (z) below), upon notice at least two Business Days’ prior to the date of such prepayment, in the case

21

of Eurodollar Rate Loans, and not later than 11:00 a.m. on the date of such prepayment, in the case of Base Rate Loans, to the Agent specifying the proposed date of such prepayment and the aggregate principal amount and Type of the Loans to be prepaid (and, in the case of Eurodollar Rate Loans, the Interest Period of the Borrowing pursuant to which made); provided , however , that (x) each partial prepayment shall be in a minimum aggregate principal amount of $1,000,000 and, if in excess thereof, in an integral multiple of $1,000,000, (y) accrued interest to the date of prepayment on the principal amount prepaid shall be payable by the Borrower on the date of such prepayment, and (z) in the event of any such prepayment of a Eurodollar Rate Loan, the Borrower shall be obligated to reimburse the Lenders in respect thereof pursuant to Section 8.04(e). Each prepayment of Loans shall be applied ratably to the outstanding principal amount of each Lender’s Loan in accordance with such Lender’s Ratable Share.
(b)      Mandatory . The Borrower shall prepay the aggregate principal amount of the Loans, together with accrued interest to the date of prepayment on the principal amount prepaid, without requirement of demand therefor, or shall pay or prepay any other Indebtedness then outstanding at any time, when and to the extent required to comply with applicable Laws of any Governmental Authority or applicable resolutions of the Board of Directors of the Borrower.
Section 2.09      Increased Costs .
(a)      Increased Costs Generally . If any Change in Law shall:
(i)      impose, modify or deem applicable any reserve, special deposit, compulsory loan, insurance charge or similar requirement against assets of, deposits with or for the account of, or credit extended or participated in by, any Lender (except any reserve requirement contemplated by Section 2.09(e));
(ii)      impose on any Lender or the London interbank market any other condition, cost or expense affecting this Agreement or Eurodollar Rate Loans made by such Lender; or
(iii)      subject the Agent or any Lender to any Taxes (other than (A) Indemnified Taxes, (B) Excluded Taxes and (C) Other Taxes) on its loans, loan principal, letters of credit, commitments, or other obligations, or its deposits, reserves, other liabilities or capital attributable thereto;
and the result of any of the foregoing shall be to increase the cost to the Agent or such Lender of making, maintaining or Converting any Loan (or of maintaining its obligation to make any such Loan), or to reduce the amount of any sum received or receivable by the Agent or such Lender hereunder (whether of principal, interest or any other amount) then, upon request of the Agent or such Lender, the Borrower will pay to the Agent or such Lender such additional amount or amounts as will compensate the Agent or such Lender for such additional costs incurred or reduction suffered.
(b)      Capital Requirements . If any Lender determines that any Change in Law affecting such Lender or any Applicable Lending Office of such Lender or such Lender’s holding company, if any, regarding capital or liquidity requirements has or would have the effect of reducing the rate

22

of return on such Lender’s capital or on the capital of such Lender’s holding company, if any, as a consequence of this Agreement, the Commitments of such Lender or the Loans made by such Lender, to a level below that which such Lender or such Lender’s holding company could have achieved but for such Change in Law (taking into consideration such Lender’s policies and the policies of such Lender’s holding company with respect to capital adequacy and liquidity), then from time to time the Borrower will pay to such Lender such additional amount or amounts as will compensate such Lender or such Lender’s holding company for any such reduction suffered.
(c)      Certificates for Reimbursement . A certificate of a Lender setting forth the amount or amounts necessary to compensate such Lender or its holding company, as the case may be, as specified in subsection (a) or (b) of this Section and delivered to the Borrower shall be conclusive and binding upon all parties absent manifest error. The Borrower shall pay such Lender the amount shown as due on any such certificate within 30 days after receipt thereof.
(d)      Delay in Requests . Failure or delay on the part of any Lender to demand compensation pursuant to the foregoing provisions of this Section shall not constitute a waiver of such Lender’s right to demand such compensation, provided that the Borrower shall not be required to compensate a Lender pursuant to the foregoing provisions of this Section for any increased costs incurred or reductions suffered more than three months prior to the date that such Lender notifies the Borrower of the Change in Law giving rise to such increased costs or reductions and of such Lender’s intention to claim compensation therefor (except that, if the Change in Law giving rise to such increased costs or reductions is retroactive, then the three-month period referred to above shall be extended to include the period of retroactive effect thereof).
(e)      Reserves on Eurodollar Rate Loans . The Borrower shall pay to each Lender, as long as such Lender shall be required to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency funds or deposits (currently known as “Eurocurrency liabilities”), additional interest on the unpaid principal amount of each Eurodollar Rate Loan equal to the actual costs of such reserves allocated to such Loan by such Lender (as determined by such Lender in good faith, which determination shall be conclusive absent manifest error), which shall be due and payable on each date on which interest is payable on such Loan, provided the Borrower shall have received at least 30 days’ prior notice (with a copy to the Agent) of such additional interest from such Lender. If a Lender fails to give notice 30 days prior to the relevant interest payment date, such additional interest shall be due and payable 30 days from receipt of such notice.
Section 2.10      Illegality . If any Lender shall have determined in good faith that the introduction of or any change in any applicable Law or in the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof, or compliance with any guideline or request from any such Governmental Authority (whether or not having the force of law), makes it unlawful for any Lender or its Applicable Lending Office to make, maintain or fund Eurodollar Rate Loans, or to determine or charge interest rates based upon the Eurodollar Rate, or any Governmental Authority has imposed material restrictions on the authority of such Lender to purchase or sell, or to take deposits of, Dollars in the London interbank market, then, on notice thereof by such Lender to the Borrower through the Agent, any obligation of such Lender to make or continue Eurodollar Rate Loans or to Convert Base Rate Loans to

23

Eurodollar Rate Loans shall be suspended until such Lender notifies the Agent and the Borrower that the circumstances giving rise to such determination no longer exist. Upon receipt of such notice, the Borrower shall, upon demand from such Lender (with a copy to the Agent), prepay or, if applicable, Convert all Eurodollar Rate Loans of such Lender to Base Rate Loans, either on the last day of the Interest Period therefor, if such Lender may lawfully continue to maintain such Eurodollar Rate Loans to such day, or immediately, if such Lender may not lawfully continue to maintain such Eurodollar Rate Loans. Upon any such prepayment or Conversion, the Borrower shall also pay accrued interest on the amount so prepaid or Converted.
Section 2.11      Payments and Computations .
(a)      All payments to be made by the Borrower shall be made without condition or deduction for any counterclaim, defense, recoupment or setoff. The Borrower shall make each payment hereunder not later than 1:00 p.m. on the day when due in Dollars to the Agent at the Agent’s Account in same day funds. The Agent will promptly thereafter cause to be distributed like funds relating to the payment of principal, interest or fees ratably (other than amounts payable pursuant to Section 2.09, 2.10, 2.12, 2.17 or 8.04(e)) to the Lenders for the account of their respective Applicable Lending Offices, and like funds relating to the payment of any other amount payable to any Lender to such Lender for the account of its Applicable Lending Office, in each case to be applied in accordance with the terms of this Agreement. Upon its acceptance of an Assignment and Assumption and recording of the information contained therein in the Register pursuant to Section 8.07(c), from and after the effective date specified in such Assignment and Assumption, the Agent shall make all payments hereunder and under the Notes in respect of the interest assigned thereby to the Lender assignee thereunder, and the parties to such Assignment and Assumption shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves.
(b)      All computations of interest based on the Base Rate (when the Base Rate is based on the Prime Rate) shall be made by the Agent on the basis of a year of 365 or 366 days, as the case may be, and all other computations of interest and fees hereunder (including computations of interest based on the Eurodollar Rate and the Federal Funds Rate and of fees) shall be made by the Agent on the basis of a year of 360 days, in each case for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest or fees are payable. Each determination by the Agent of an interest rate hereunder shall be conclusive and binding for all purposes, absent manifest error.
(c)      Whenever any payment hereunder or under the Notes shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest or fees, as the case may be; provided , however , that, if such extension would cause payment of interest on or principal of Eurodollar Rate Loans to be made in the next following calendar month, such payment shall be made on the next preceding Business Day.
(d)      Unless the Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Lenders hereunder that the Borrower will not make such payment in full, the Agent may assume that the Borrower has made such payment in full to the Agent on

24

such date and the Agent may, in reliance upon such assumption, cause to be distributed to each Lender on such due date an amount equal to the amount then due to such Lender. If and to the extent the Borrower shall not have so made such payment in full to the Agent, each Lender shall repay to the Agent forthwith on demand such amount distributed to such Lender together with interest thereon, for each day from the date such amount is distributed to such Lender until the date such Lender repays such amount to the Agent, at the Federal Funds Rate.
Section 2.12      Taxes .
(a)      Payments Free of Taxes; Obligation to Withhold; Payments on Account of Taxes .
(i)      Any and all payments by or on account of any obligation of the Borrower hereunder or under any other Loan Document shall to the extent permitted by applicable Laws be made free and clear of and without reduction or withholding for any Taxes. If, however, applicable Laws require the Borrower or the Agent to withhold or deduct any Tax, such Tax shall be withheld or deducted in accordance with such Laws as determined by the Borrower or the Agent, as the case may be, upon the basis of the information and documentation to be delivered pursuant to subsection (e) below.
(ii)      If the Borrower or the Agent shall be required by the Internal Revenue Code to withhold or deduct any Taxes, including both United States of America Federal backup withholding and withholding Taxes, from any payment, then (A) the Agent shall withhold or make such deductions as are determined by the Agent to be required based upon the information and documentation it has received pursuant to subsection (e) below, (B) the Agent shall timely pay the full amount withheld or deducted to the relevant Governmental Authority in accordance with the Internal Revenue Code, and (C) to the extent that the withholding or deduction is made on account of Indemnified Taxes or Other Taxes, the sum payable by the Borrower shall be increased as necessary so that after any required withholding or the making of all required deductions (including deductions applicable to additional sums payable under this Section) the Agent or each Lender, as the case may be, receives an amount equal to the sum it would have received had no such withholding or deduction been made.
(b)      Payment of Other Taxes by the Borrower . Without limiting the provisions of subsection (a) above, the Borrower shall timely pay any Other Taxes to the relevant Governmental Authority in accordance with applicable Laws.
(c)      Tax Indemnifications .
(i)      Without limiting the provisions of subsection (a) or (b) above, the Borrower shall, and does hereby, indemnify the Agent and each Lender, and shall make payment in respect thereof within 30 days after written demand therefor, for the full amount of any Indemnified Taxes or Other Taxes (including Indemnified Taxes or Other Taxes imposed or asserted on or attributable to amounts payable under this Section) withheld or deducted by the Borrower or the Agent or paid by the Agent or such Lender, as the case may be, and any penalties, interest and reasonable expenses arising therefrom or with respect thereto, whether

25

or not such Indemnified Taxes or Other Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. The Borrower shall also, and does hereby, indemnify the Agent, and shall make payment in respect thereof within 10 days after demand therefor, for any amount which a Lender for any reason fails to pay indefeasibly to the Agent as required by clause (ii) of this subsection. A certificate as to the amount of any such payment or liability delivered to the Borrower by a Lender (with a copy to the Agent), or by the Agent on its own behalf or on behalf of a Lender, shall be conclusive absent manifest error.
(ii)      Each Lender shall, within 30 days after demand therefor, severally indemnify (A) the Agent for (i) any Indemnified Taxes and Other Taxes attributable to such Lender (but only to the extent that the Borrower has not already indemnified the Agent for such Indemnified Taxes and Other Taxes and without limiting the obligation of the Borrower to do so), (ii) any Taxes attributable to such Lender’s failure to comply with the provisions of Section 8.07(d) relating to the maintenance of a Participant Register and (iii) any Excluded Taxes attributable to such Lender, in each case, that are payable or paid by the Agent in connection with any Loan Document, and any reasonable expenses arising therefrom or with respect thereto, whether or not such Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority and (B) the Borrower and the Agent against any and all Taxes and any and all related losses, claims, liabilities, penalties, interest and expenses (including the fees, charges and disbursements of any counsel for the Borrower or the Agent) incurred by or asserted against the Borrower or the Agent by any Governmental Authority as a result of the failure by such Lender to deliver, or as a result of the inaccuracy, inadequacy or deficiency of, any documentation required to be delivered by such Lender to the Borrower or the Agent pursuant to subsection (e). A certificate as to the amount of such payment or liability delivered to any Lender by the Agent shall be conclusive absent manifest error. Each Lender hereby authorizes the Agent to set off and apply any and all amounts at any time owing to such Lender under this Agreement or any other Loan Document or otherwise payable by the Agent to the Lender from any other source against any amount due to the Agent under this clause (ii). The agreements in this clause (ii) shall survive the resignation and/or replacement of the Agent, any assignment of rights by, or the replacement of, a Lender, the termination of the Commitments and the repayment, satisfaction or discharge of all other Obligations.
(d)      Evidence of Payments . Upon request by the Borrower or the Agent, as the case may be, after any payment of Taxes by the Borrower or by the Agent to a Governmental Authority as provided in this Section 2.12, the Borrower shall deliver to the Agent or the Agent shall deliver to the Borrower, as the case may be, the original or a certified copy of a receipt issued by such Governmental Authority evidencing such payment, a copy of any return required by Laws to report such payment or other evidence of such payment reasonably satisfactory to the Borrower or the Agent, as the case may be.

26

(e)      Status of Lenders; Tax Documentation .
(i)      Each Lender shall deliver to the Borrower and to the Agent, at the time or times prescribed by applicable Laws or when reasonably requested by the Borrower or the Agent, such properly completed and executed documentation prescribed by applicable Laws or by the taxing authorities of any jurisdiction and such other reasonably requested information as will permit the Borrower or the Agent, as the case may be, to determine (A) whether or not payments made hereunder or under any other Loan Document are subject to Taxes, (B) if applicable, the required rate of withholding or deduction, and (C) such Lender’s entitlement to any available exemption from, or reduction of, applicable Taxes in respect of all payments to be made to such Lender by the Borrower pursuant to this Agreement or otherwise to establish such Lender’s status for withholding tax purposes in the applicable jurisdiction.
(ii)      Without limiting the generality of the foregoing, if the Borrower is resident for tax purposes in the United States of America,
(A)      any Lender that is a “United States person” within the meaning of Section 7701(a)(30) of the Internal Revenue Code shall deliver to the Borrower and the Agent executed originals of Internal Revenue Service Form W-9 or such other documentation or information prescribed by applicable Laws or reasonably requested by the Borrower or the Agent as will enable the Borrower or the Agent, as the case may be, to determine whether or not such Lender is subject to backup withholding or information reporting requirements; and
(B)      each Foreign Lender that is entitled under the Internal Revenue Code or any applicable treaty to an exemption from or reduction of withholding tax with respect to payments hereunder or under any other Loan Document shall deliver to the Borrower and the Agent (in such number of copies as shall be requested by the recipient) on or prior to the date on which such Foreign Lender becomes a Lender under this Agreement (and from time to time thereafter upon the request of the Borrower or the Agent, but only if such Foreign Lender is legally entitled to do so), whichever of the following is applicable:
(1)      executed originals of Internal Revenue Service Form W-8BEN or Form W-8BEN-E claiming eligibility for benefits of an income tax treaty to which the United States of America is a party,
(2)      executed originals of Internal Revenue Service Form W-8ECI,
(3)      executed originals of Internal Revenue Service Form W-8IMY and all required supporting documentation,
(4)      in the case of a Foreign Lender claiming the benefits of the exemption for portfolio interest under section 881(c) of the Internal Revenue

27

Code, (x) a certificate to the effect that such Foreign Lender is not (A) a “bank” within the meaning of section 881(c)(3)(A) of the Internal Revenue Code, (B) a “10 percent shareholder” of the Borrower within the meaning of section 881(c)(3)(B) of the Internal Revenue Code, or (C) a “controlled foreign corporation” described in section 881(c)(3)(C) of the Internal Revenue Code and (y) executed originals of Internal Revenue Service Form W-8BEN or Form W-8BEN-E, or
(5)      executed originals of any other form prescribed by applicable Laws as a basis for claiming exemption from or a reduction in United States of America Federal withholding tax together with such supplementary documentation as may be prescribed by applicable Laws to permit the Borrower or the Agent to determine the withholding or deduction required to be made.
(iii)      Each Lender shall promptly (A) notify the Borrower and the Agent of any change in circumstances which would modify or render invalid any claimed exemption or reduction, and (B) take such steps as shall not be materially disadvantageous to it, in the reasonable judgment of such Lender, and as may be reasonably necessary (including the re-designation of its Applicable Lending Office) to avoid any requirement of applicable Laws of any jurisdiction that the Borrower or the Agent make any withholding or deduction for taxes from amounts payable to such Lender.
(iv)      If a payment made to a Lender under any Loan Document would be subject to U.S. federal withholding Tax imposed by FATCA if such Lender were to fail to comply with the applicable reporting requirements of FATCA (including those contained in Section 1471(b) or 1472(b) of the Internal Revenue Code, as applicable), such Lender shall deliver to each of the Borrower and the Agent at the time or times prescribed by law and at such time or times reasonably requested by the Borrower or the Agent such documentation prescribed by applicable law (including as prescribed by Section 1471(b)(3)(C)(i) of the Internal Revenue Code) and such additional documentation reasonably requested by the Borrower or the Agent as may be necessary for the Borrower and the Agent to comply with their obligations under FATCA and to determine that such Lender has complied with such Lender’s obligations under FATCA or to determine the amount to deduct and withhold from such payment. Solely for purposes of this clause (iv), “FATCA” shall include any amendments made to FATCA after the date of this Agreement.
(f)      Treatment of Certain Refunds . Unless required by applicable Laws, at no time shall the Agent have any obligation to file for or otherwise pursue on behalf of a Lender, or have any obligation to pay to any Lender, any refund of Taxes withheld or deducted from funds paid for the account of such Lender. If the Agent or any Lender determines, in its sole discretion, that it has received a refund of any Taxes or Other Taxes as to which it has been indemnified by the Borrower or with respect to which the Borrower has paid additional amounts pursuant to this Section, it shall pay to the Borrower an amount equal to such refund (but only to the extent of indemnity payments made, or additional amounts paid, by the Borrower under this Section with respect to the Taxes or

28

Other Taxes giving rise to such refund), net of all reasonable out-of-pocket expenses incurred by the Agent or such Lender, as the case may be, and without interest (other than any interest paid by the relevant Governmental Authority with respect to such refund), provided that the Borrower, upon the request of the Agent or such Lender, agrees to repay the amount paid over to the Borrower (plus any penalties, interest or other charges imposed by the relevant Governmental Authority) to the Agent or such Lender in the event the Agent or such Lender is required to repay such refund to such Governmental Authority. This subsection shall not be construed to require the Agent or any Lender to make available its tax returns (or any other information relating to its taxes that it deems confidential) to the Borrower or any other Person.
(g)      Payments . Failure or delay on the part of the Agent or any Lender to demand compensation pursuant to the foregoing provisions of this Section 2.12 shall not constitute a waiver of the Agent’s or such Lender’s right to demand such compensation, provided that the Borrower shall not be required to compensate the Agent or a Lender pursuant to the foregoing provisions of this Section 2.12 for any Indemnified Taxes or Other Taxes imposed or asserted by the relevant Governmental Authority more than three months prior to the date that the Agent or such Lender, as the case may be, claims compensation with respect thereto (except that, if a Change in Law giving rise to such Indemnified Taxes or Other Taxes is retroactive, then the three-month period referred to above shall be extended to include the period of retroactive effect thereof).
(h)      The Agent and each Lender agrees to cooperate with any reasonable request made by the Borrower in respect of a claim of a refund in respect of Indemnified Taxes as to which it has been indemnified by the Borrower or with respect to which the Borrower has paid additional amounts pursuant to this Section 2.12 if (i) the Borrower has agreed in writing to pay all of the Agent’s or such Lender’s reasonable out-of-pocket costs and expenses relating to such claim, (ii) the Agent or such Lender determines, in its good faith judgment, that it would not be disadvantaged, unduly burdened or prejudiced as a result of such claim and (iii) the Borrower furnishes, upon request of the Agent or such Lender, an opinion of tax counsel (such opinion, which can be reasoned, and such counsel to be reasonably acceptable to such Lender or the Agent) that the Borrower is likely to receive a refund or credit.
Section 2.13      Sharing of Payments, Etc . If any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) on account of the Loans owing to it (other than pursuant to Section 2.09, 2.10, 2.12, 2.17 or 8.04(e) or any payment obtained by a Lender as consideration for the assignment of or sale of a participation in any of its Loans to any assignee or participant, other than to the Borrower or any Subsidiary thereof if permitted hereby (as to which the provisions of this Section 2.13 shall apply) in excess of its Ratable Share of payments on account of the Loans obtained by all the Lenders, such Lender shall forthwith purchase from the other Lenders (for cash at face value) such participations in the Loans owing to them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them; provided , however , that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each Lender shall be rescinded and such Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such Lender’s Ratable Share (according to the proportion of (i) the amount of such Lender’s required repayment to (ii) the total amount so recovered from the

29

purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered. The Borrower agrees that any Lender so purchasing a participation from another Lender pursuant to this Section 2.13 may, to the fullest extent permitted by Law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were the direct creditor of the Borrower in the amount of such participation.
Section 2.14      Evidence of Debt .
(a)      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 Loan owing to such Lender from time to time, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder in respect of Loans. The Borrower agrees that upon notice by any Lender to the Borrower (with a copy of such notice to the Agent) to the effect that a Note is required or appropriate in order for such Lender to evidence (whether for purposes of pledge, enforcement or otherwise) the Loans owing to, or to be made by, such Lender, the Borrower shall promptly execute and deliver to such Lender a Note payable to the order of such Lender in a principal amount equal to the Loans owing to, or to be made by, such Lender.
(b)      The Register maintained by the Agent pursuant to Section 8.07(c) shall include a control account, and a subsidiary account for each Lender, in which accounts (taken together) shall be recorded (i) the date and amount of each Borrowing made hereunder, the Type of Loans comprising such Borrowing and, if appropriate, the Interest Period applicable thereto, (ii) the terms of each Assignment and Assumption delivered to and accepted by it, (iii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iv) the amount of any sum received by the Agent from the Borrower hereunder and each Lender’s share thereof.
(c)      Entries made in good faith by the Agent in the Register pursuant to subsection (b) above, and by each Lender in its account or accounts pursuant to subsection (a) above, shall be prima facie evidence of the amount of principal and interest due and payable or to become due and payable from the Borrower to, in the case of the Register, each Lender and, in the case of such account or accounts, such Lender, under this Agreement, absent manifest error; provided , however , that the failure of the Agent or such Lender to make an entry, or any finding that an entry is incorrect, in the Register or such account or accounts shall not limit or otherwise affect the obligations of the Borrower under this Agreement.
Section 2.15      Use of Proceeds . The proceeds of the Loans shall be available (and the Borrower agrees that it shall use such proceeds) solely for general corporate purposes of the Borrower and in accordance with Section 4.01(p).
Section 2.16      Affected Lenders . Notwithstanding any provision of this Agreement to the contrary, if any Lender becomes an Affected Lender, then the following provisions shall apply for so long as such Lender is an Affected Lender:

30

(a)      the outstanding principal amount of the Loans of such Affected Lender shall not be included in determining whether the Required Lenders have taken or may take any action hereunder (including any consent to any amendment or waiver pursuant to Section 8.01), other than any waiver, amendment or modification requiring the consent of all Lenders or of each Lender affected;
(b)      to the extent the Agent receives any payments or other amounts for the account of an Affected Lender under this Agreement, such Affected Lender shall be deemed to have requested that the Agent use such payment or other amount to fulfill such Affected Lender’s previously unsatisfied obligations to fund a Loan under Section 2.01 or any other unfunded payment obligation of such Affected Lender under this Agreement; and
(c)      subject to Section 8.18, for the avoidance of doubt, the Borrower, the Agent and each other Lender shall retain and reserve its other rights and remedies respecting each Affected Lender.
In the event that (a) the Agent and the Borrower each agrees that an Affected Lender has adequately remedied all matters that caused such Lender to be an Affected Lender or (b) an Affected Lender is replaced by another Lender pursuant to Section 2.17, then, in either case, this Section 2.16 will no longer apply to such Lender.
Section 2.17      Replacement of Lenders . If any Lender requests compensation under Section 2.09, or if the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 2.12, or if any Lender is an Affected Lender, then the Borrower may, at its sole expense and effort, upon notice to such Lender and the Agent, require such Lender to assign and delegate, without recourse (in accordance with and subject to the restrictions contained in, and consents required by, Section 8.07), all of its interests, rights and obligations under this Agreement and the related Loan Documents to one or more assignees that shall assume such obligations (which any such assignee may be another Lender (other than an Affected Lender), if such Lender accepts such assignment), provided that:
(a)      the Borrower shall have paid to the Agent the assignment fee specified in Section 8.07(b);
(b)      such Lender shall have received payment of an amount equal to the outstanding principal amount of its Loans, accrued interest thereon, accrued fees and all other amounts payable to it hereunder and under the other Loan Documents (including any amounts under Section 8.04(e)) from the assignee (to the extent of such outstanding principal and accrued interest and fees) or the Borrower (in the case of all other amounts);
(c)      in the case of any such assignment resulting from a claim for compensation under Section 2.09 or payments required to be made pursuant to Section 2.12, such assignment will result in a reduction in such compensation or payments thereafter; and
(d)      such assignment does not conflict with applicable Laws.

31

A Lender shall not be required to make any such assignment or delegation if, prior thereto, as a result of a waiver by such Lender or otherwise, the circumstances entitling the Borrower to require such assignment and delegation cease to apply.
ARTICLE III     

 CONDITIONS PRECEDENT
Section 3.01      Conditions Precedent to Effectiveness . This Agreement shall become effective on and as of the first date (the “ Effective Date ”) on which the following conditions precedent have been satisfied:
(a)      The Lenders shall have been given such access to the management, records, books of account, contracts and properties of the Borrower and its Subsidiaries as they shall have requested.
(b)      The Borrower shall have paid all accrued and agreed fees and expenses of the Agent, the Arrangers and the Lenders, including but not limited to all fees then due and payable pursuant to the Fee Letter, and the reasonable accrued fees and expenses of one law firm acting as counsel to the Agent that have been invoiced at least one Business Day prior to the Effective Date.
(c)      On the Effective Date, the following statements shall be true and the Agent shall have received a certificate signed by a duly authorized officer of the Borrower, dated the Effective Date, stating that:
(i)      The representations and warranties contained in Section 4.01 are true and correct on and as of the Effective Date, both before and after giving effect to the Initial Borrowing and the application of the proceeds thereof, as though made on and as of such date (excluding that the Initial Borrowing is not listed on Schedule 4.01(k) hereto); and
(ii)      No event has occurred and is continuing, or would result from the Initial Borrowing or the application of the proceeds thereof, that constitutes a Default.
(d)      The Agent shall have received the Notice of Initial Borrowing pursuant to Section 2.02.
(e)      The Agent shall have received on or before the Effective Date the following, each dated such day, in form and substance satisfactory to the Agent and the Lenders:
(i)      Receipt by the Agent of executed counterparts of this Agreement properly executed by a duly authorized officer of the Borrower and by each Lender.
(ii)      The Notes, payable to the order of the Lenders to the extent requested by any Lender pursuant to Section 2.14(a).
(iii)      The articles of incorporation of the Borrower certified to be true and complete as of a recent date by the appropriate governmental authority of the state or other jurisdiction

32

of its incorporation and certified by a secretary, assistant secretary or associate secretary of the Borrower to be true and correct as of the Effective Date.
(iv)      The bylaws of the Borrower certified by a secretary, assistant secretary or associate secretary of the Borrower to be true and correct as of the Effective Date.
(v)      Certified copies of the resolutions of the Board of Directors of the Borrower approving this Agreement and the Notes, and of all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Agreement and the Notes.
(vi)      A certificate of the secretary, assistant secretary or associate secretary of the Borrower certifying the names and true signatures of the officers of the Borrower authorized to sign this Agreement and the Notes and the other documents to be delivered hereunder.
(vii)      A certificate as of a recent date from the Borrower’s state of incorporation evidencing that the Borrower is in good standing in its state of organization or formation.
(viii)      A favorable opinion of counsel for the Borrower, in form and substance reasonably acceptable to the Lenders.
(ix)      A written opinion of Sidley Austin LLP, special New York counsel for the Agent, addressed to the Agent and the Lenders, with respect to the enforceability of this Agreement and the Notes, if any, issued on the Effective Date, in form and substance reasonably acceptable to the Agent.
(f)      PATRIOT Act . At least five days prior to the Effective Date, the Borrower shall have provided to the Agent and the Lenders the documentation and other information reasonably requested by the Agent, and reasonably available to the Borrower, in order to comply with requirements of the PATRIOT Act.
(g)      In the event that the Borrower qualifies as a “legal entity customer” under the Beneficial Ownership Regulation, the Borrower shall deliver, at least five days prior to the Effective Date, a Beneficial Ownership Certification in relation to the Borrower.
Section 3.02      Determinations Under Section 3.01 . For purposes of determining compliance with the conditions specified in Section 3.01 and the satisfaction of each Lender with respect to letters delivered to it from the Borrower as set forth in Sections 4.01(a), 4.01(e) and 4.01(f), each Lender that has signed this Agreement 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 the Lenders unless an officer of the Agent responsible for the transactions contemplated by this Agreement shall have received notice from such Lender prior to the date that the Borrower designates as the proposed Effective Date, specifying its objection thereto. The Agent shall promptly notify the Lenders and the Borrower of the occurrence of the Effective Date.

33

ARTICLE IV     

 REPRESENTATIONS AND WARRANTIES
Section 4.01      Representations and Warranties of the Borrower . The Borrower represents and warrants as follows:
(a)      Each of the Borrower and each Material Subsidiary: (i) is a corporation or other entity duly organized and validly existing under the Laws of the jurisdiction of its incorporation or organization; (ii) has all requisite corporate or if the Material Subsidiary is not a corporation, other comparable power necessary to own its assets and carry on its business as presently conducted; (iii) has all governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as presently conducted, if the failure to have any such license, authorization, consent or approval is reasonably likely to have a Material Adverse Effect and except as disclosed to the Agent in the SEC Reports or by means of a letter from the Borrower to the Lenders (such letter, if any, to be delivered to the Agent for prompt distribution to the Lenders) delivered prior to the execution and delivery of this Agreement (which, in each case, shall be satisfactory to each Lender in its sole discretion) and except that (A) 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, (B) from time to time communities served by APS may become incorporated and considerable time may elapse before such a franchise is procured, (C) certain such franchises may have expired prior to the renegotiation thereof, (D) certain minor defects and exceptions may exist which, individually and in the aggregate, are not material and (E) certain franchises, certificates, licenses and permits may not be specific as to their geographical scope); and (iv) is qualified to do business in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary and where failure so to qualify is reasonably likely to have a Material Adverse Effect.
(b)      The execution, delivery and performance by the Borrower of this Agreement and the other Loan Documents, and the consummation of the transactions contemplated hereby and thereby, are within the Borrower’s corporate powers, have been duly authorized by all necessary corporate action, and do not or did not (i) contravene the Borrower’s articles of incorporation or by-laws, (ii) contravene any Law, decree, writ, injunction or determination of any Governmental Authority, in each case applicable to or binding upon the Borrower or any of its properties, (iii) contravene any contractual restriction binding on or affecting the Borrower or (iv) cause the creation or imposition of any Lien upon the assets of the Borrower or any Material Subsidiary, except for Liens created under this Agreement and except where such contravention or creation or imposition of such Lien is not reasonably likely to have a Material Adverse Effect.
(c)      No authorization or approval or other action by, and no notice to or filing with, any Governmental Authority is required for the due execution, delivery and performance by the Borrower of this Agreement or the Notes to be delivered by it.
(d)      This Agreement has been, and each of the other Loan Documents upon execution and delivery will have been, duly executed and delivered by the Borrower. This Agreement is, and each of the other Loan Documents upon execution and delivery will be, the legal, valid and binding

34

obligation of the Borrower enforceable against the Borrower in accordance with their respective 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.
(e)      (i) The Consolidated balance sheet of the Borrower as of December 31, 2017, and the related Consolidated statements of income and cash flows of the Borrower for the fiscal year then ended, accompanied by an opinion thereon of Deloitte & Touche LLP, independent registered public accountants, and the Consolidated balance sheet of the Borrower as of September 30, 2018, and the related Consolidated statements of income and cash flows of the Borrower for the nine months then ended, duly certified by the chief financial officer of the Borrower, copies of which have been furnished to the Agent, fairly present in all material respects, subject, in the case of said balance sheet as of September 30, 2018, and said statements of income and cash flows for the nine months then ended, to year-end audit adjustments, the Consolidated financial condition of the Borrower as at such dates and the Consolidated results of the operations of the Borrower for the periods ended on such dates, all in accordance with GAAP (except as disclosed therein); and (ii) except as disclosed to the Agent in the SEC Reports or by means of a letter from the Borrower to the Lenders (such letter, if any, to be delivered to the Agent for prompt distribution to the Lenders) delivered prior to the execution and delivery of this Agreement (which, in each case, shall be satisfactory to each Lender in its sole discretion), since December 31, 2017, there has been no Material Adverse Effect.
(f)      There is no pending or, to the knowledge of an Authorized Officer of the Borrower, threatened action, suit, investigation, litigation or proceeding, including, without limitation, any Environmental Action, affecting the Borrower or any of its Subsidiaries before any court, governmental agency or arbitrator that (i) purports to affect the legality, validity or enforceability of this Agreement or any other Loan Document or the consummation of the transactions contemplated hereby or (ii) would be reasonably likely to have a Material Adverse Effect (except as disclosed to the Agent in the SEC Reports or by means of a letter from the Borrower to the Lenders (such letter, if any, to be delivered to the Agent for prompt distribution to the Lenders) delivered prior to the execution and delivery of this Agreement (which, in each case, shall be satisfactory to each Lender in its sole discretion)), and there has been no adverse change in the status, or financial effect on the Borrower or any of its Subsidiaries, of such disclosed litigation that would be reasonably likely to have a Material Adverse Effect.
(g)      No proceeds of any Loan will be used to acquire any equity security not issued by the Borrower of a class that is registered pursuant to Section 12 of the Securities Exchange Act of 1934.
(h)      The Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U issued by the Board of Governors of the Federal Reserve System), and no proceeds of any Loan will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock, in any case in violation of Regulation U. After application of the proceeds of any Loan, not more than 25% of the value of the assets subject to any restriction under this Agreement

35

on the right to sell, pledge, transfer, or otherwise dispose of such assets is represented by margin stock.
(i)      The Borrower and its Subsidiaries have filed all United States of America 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 the Borrower or any of its Subsidiaries, except to the extent that (i) 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 and its Subsidiaries in accordance with GAAP or (ii) the failure to make such filings or such payments is not reasonably likely to have a Material Adverse Effect. The charges, accruals and reserves on the books of the Borrower and its Material Subsidiaries as set forth in the most recent financial statements of the Borrower delivered to the Agent pursuant to Section 4.01(e) or Section 5.01(h)(i) or 5.01(h)(ii) hereof in respect of Taxes and other governmental charges are, in the opinion of the Borrower, adequate.
(j)      Set forth on Schedule 4.01(j) hereto (as such schedule may be modified from time to time by the Borrower by written notice to the Agent) is a complete and accurate list of all the Material Subsidiaries of the Borrower.
(k)      Set forth on Schedule 4.01(k) hereto is a complete and accurate list identifying any Indebtedness of the Borrower outstanding in a principal amount equal to or exceeding $5,000,000 and which is not described in the financial statements referred to in Section 4.01(e).
(l)      The Borrower is not an “investment company”, or a company “controlled” by an “investment company”, within the meaning of the Investment Company Act of 1940, as amended.
(m)      No report, certificate or other written information furnished by the Borrower or any of its Subsidiaries to the Agent, any Arranger or any Lender in connection with the transactions contemplated hereby and the negotiation of this Agreement or delivered hereunder or any other Loan Document (as modified or supplemented by other information so furnished) at the time so furnished, when taken together as a whole with all such written information so furnished, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading, except as would not reasonably be expected to result in a Material Adverse Effect; provided that with respect to any projected financial information, forecasts, estimates or forward-looking information, the Borrower represents only that such information and materials have been prepared in good faith on the basis of assumptions believed to be reasonable at the time of preparation of such forecasts, and no representation or warranty is made as to the actual attainability of any such projections, forecasts, estimates or forward-looking information.
(n)      Neither the Borrower nor any of its Subsidiaries or, to the knowledge of the Borrower, any of their respective Affiliates over which any of the foregoing exercises management control (each, a “ Controlled Affiliate ”) or any director or officer of the Borrower, any of its Subsidiaries or any of their respective Controlled Affiliates (each, a “ Manager ”) is a Prohibited Person, and the Borrower, its Subsidiaries and, to the knowledge of the Borrower, such Controlled Affiliates are in compliance with all applicable orders, rules and regulations of OFAC.

36

(o)      Neither the Borrower nor any of its Subsidiaries or, to the knowledge of the Borrower, any of their respective Controlled Affiliates or Managers: (i) is the target of Sanctions; (ii) is owned or controlled by, or acts on behalf of, any Person that is targeted by United States or multilateral economic or trade sanctions currently in force; (iii) is, or is owned or controlled by, a Person who is located, organized or resident in a country, region or territory that is, or whose government is, the subject of Sanctions, including, without limitation, Crimea, Cuba, Iran, North Korea, Sudan and Syria, or (iv) is named, identified or described on any list of Persons with whom United States Persons may not conduct business, including any such blocked persons list, designated nationals list, denied persons list, entity list, debarred party list, unverified list, sanctions list or other such lists published or maintained by the United States, including OFAC, the United States Department of Commerce or the United States Department of State, or any other applicable Governmental Authority.
(p)      None of the Borrower’s or its Subsidiaries’ assets constitute property of, or are beneficially owned, directly or indirectly, by any Person that is the target of Sanctions, including but not limited to, the International Emergency Economic Powers Act, 50 U.S.C. §§ 1701 et seq., The Trading with the Enemy Act, 50 U.S.C. App. 1 et seq. (the “ Trading With the Enemy Act ”), any of the foreign assets control regulations of the Treasury (31 C.F.R., Subtitle B, Chapter V, as amended) (the “ Foreign Assets Control Regulations ”) or any enabling legislation or regulations promulgated thereunder or executive order relating thereto (which includes, without limitation, (i) Executive Order No. 13224, effective as of September 24, 2001, and relating to Blocking Property and Prohibiting Transactions With Persons Who Commit, Threaten to Commit, or Support Terrorism (66 Fed. Reg. 49079 (2001)) (the “ Executive Order ”) and (ii) the PATRIOT Act), if the result of such ownership would be that any Borrowing made by any Lender would be in violation of law (“ Embargoed Person ”); (a) no Embargoed Person has any interest of any nature whatsoever in the Borrower if the result of such interest would be that any Borrowing would be in violation of law; (b) the Borrower has not engaged in business with Embargoed Persons if the result of such business would be that any Borrowing made by any Lender would be in violation of law; (c) the Borrower will not, directly or indirectly, use the proceeds of the Borrowing, or lend, contribute or otherwise make available such proceeds to any subsidiary, joint venture partner or other Person, (i) to fund any activities or business of or with any Person, or in any country or territory, that, at the time of such funding, is, or whose government is, the subject of Sanctions, or (ii) in any other manner that would result in a violation of Sanctions or Anti-Corruption Laws by any Person (including any Person participating in the Borrowing, whether as a Lender or otherwise), and (d) neither the Borrower nor any Controlled Affiliate (i) is or will become a “blocked person” as described in the Executive Order, the Trading With the Enemy Act or the Foreign Assets Control Regulations or (ii) to the knowledge of the Borrower, engages in any dealings or transactions, or be otherwise associated, with any such “blocked person”. For purposes of determining whether or not a representation is true under this Section 4.01(p), with respect to the securities of the Borrower, the Borrower shall not be required to make any investigation into (x) the ownership of publicly traded stock or other publicly traded securities or (y) the beneficial ownership of any collective investment fund.
(q)      Neither the Borrower nor any of its Subsidiaries or, to the knowledge of the Borrower and its Subsidiaries, any of their respective Managers, has failed to comply with the U.S. Foreign

37

Corrupt Practices Act, as amended from time to time (the “ FCPA ”), or any other applicable Anti-Corruption Laws, and it and they have not made, offered, promised or authorized, and will not make, offer, promise or authorize, whether directly or indirectly, any payment, of anything of value to a Government Official while knowing or having a reasonable belief that all or some portion will be used for the purpose of: (a) influencing any act, decision or failure to act by a Government Official in his or her official capacity, (b) inducing a Government Official to use his or her influence with a government or instrumentality to affect any act or decision of such  government or entity or (c) securing an improper advantage, in each case in order to obtain, retain or direct business.
(r)      If Borrower is required to deliver a Beneficial Ownership Certificate, as of the Effective Date, the information included in the Beneficial Ownership Certification is true and correct in all respects.
(s)      The Borrower is not an EEA Financial Institution.
ARTICLE V     

 COVENANTS OF THE BORROWER
Section 5.01      Affirmative Covenants . So long as any Loan shall remain unpaid, the Borrower shall:
(a)      Compliance with Laws, Etc . (i) Comply, and cause each of its Material Subsidiaries to comply, in all material respects, with all applicable Laws of Governmental Authorities, such compliance to include, without limitation, compliance with ERISA and Environmental Laws, unless the failure to so comply is not reasonably likely to have a Material Adverse Effect and (ii) comply at all times with all Laws, orders, decrees, writs, injunctions or determinations of any Governmental Authority relating to the incurrence or maintenance of Indebtedness by the Borrower, such compliance to include, without limitation, compliance with the PATRIOT Act, all applicable orders, rules and regulations of OFAC, the FCPA, the Racketeer Influenced and Corrupt Organizations Chapter of the Organized Crime Control Act of 1970 and other Anti-Corruption Laws, except (other than in the case of the PATRIOT Act, the applicable orders, rules and regulations of OFAC, or the FCPA, or any similar applicable laws) to the extent that the failure to do so could not reasonably be expected to have a Material Adverse Effect.
(b)      Payment of Taxes, Etc . Pay and discharge, and cause each of its Subsidiaries to pay and discharge, before the same shall become delinquent, all Taxes imposed upon it or upon its property; provided , however , that neither the Borrower nor any of its Subsidiaries shall be required to pay or discharge any such Tax (i) that is being contested in good faith and by proper proceedings and as to which appropriate reserves are being maintained in accordance with GAAP or (ii) if the failure to pay such Tax is not reasonably likely to have a Material Adverse Effect.
(c)      Maintenance of Insurance . Maintain, and cause each of its Material Subsidiaries 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 Subsidiary

38

operates; provided , however , that the Borrower and its Subsidiaries 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 Subsidiary operates and to the extent consistent with prudent business practice.
(d)      Preservation of Corporate Existence, Etc . Preserve and maintain, and cause each of its Material Subsidiaries to preserve and maintain, its corporate existence, rights (charter and statutory) and franchises (other than “franchises” as described in Arizona Revised Statutes, Section 40-283 or any successor provision ) reasonably necessary in the normal conduct of its business, if the failure to maintain such rights or privileges is reasonably likely to have a Material Adverse Effect, and, in the case of APS, will cause APS to use its commercially reasonable efforts to preserve and maintain such franchises reasonably necessary in the normal conduct of its business, 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; provided , however , that the Borrower and its Subsidiaries may consummate any merger or consolidation permitted under Section 5.02(b).
(e)      Visitation Rights . At any reasonable time and from time to time, permit and cause each of its Subsidiaries to permit the Agent or any of the Lenders or any agents or representatives thereof, to examine and make copies of and abstracts from the records and books of account of, and visit the properties of, the Borrower and any of its Subsidiaries, and to discuss the affairs, finances and accounts of the Borrower and any of its Subsidiaries with any of their officers or directors; provided , however , that the Borrower and its Subsidiaries reserve the right to restrict access to any of its properties in accordance with reasonably adopted procedures relating to safety and security; and provided further that the costs and expenses incurred by such Lender or its agents or representatives in connection with any such examinations, copies, abstracts, visits or discussions shall be, upon the occurrence and during the continuation of a Default, for the account of the Borrower and, in all other circumstances, for the account of such Lender.
(f)      Keeping of Books . Keep, and cause each of its Material Subsidiaries to keep, proper books of record and account, in which full and correct entries shall be made of all financial transactions and the assets and business of the Borrower and each such Subsidiary in a manner that permits the preparation of financial statements in accordance with GAAP.
(g)      Maintenance of Properties, Etc . Keep, and 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), if the failure to do so is reasonably likely to have a Material Adverse Effect, it being understood that this covenant relates only to the working order and condition of such properties and shall not be construed as a covenant not to dispose of properties.

39

(h)      Reporting Requirements . Furnish to the Agent:
(i)      as soon as available and in any event within 50 days after the end of each of the first three fiscal quarters of each fiscal year of the Borrower, commencing with the fiscal quarter ending March 31, 2019, (A) for each such fiscal quarter of the Borrower, Consolidated statements of income and cash flows of the Borrower for such fiscal quarter and the related Consolidated balance sheet of the Borrower as of the end of such fiscal quarter, setting forth in each case in comparative form the corresponding figures for the corresponding fiscal quarter in (or, in the case of the balance sheet, as of the end of) the preceding fiscal year and (B) for the period commencing at the end of the previous fiscal year and ending with the end of such fiscal quarter, Consolidated statements of income and cash flows of the Borrower for such period setting forth in each case in comparative form the corresponding figures for the corresponding period in the preceding fiscal year; provided that so long as the Borrower remains subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Borrower may provide, in satisfaction of the requirements of this first sentence of this Section 5.01(h)(i), its report on Form 10-Q for such fiscal quarter. Each set of financial statements provided under this Section 5.01(h)(i) shall be accompanied by a certificate of an Authorized Officer, which certificate shall state that said Consolidated financial statements fairly present in all material respects the Consolidated financial condition and results of operations and cash flows of the Borrower in accordance with GAAP (except as disclosed therein), as at the end of, and for, such period (subject to normal year-end audit adjustments) and shall set forth reasonably detailed calculations demonstrating compliance with Section 5.03;
(ii)      as soon as available and in any event within 90 days after the end of each fiscal year of the Borrower, commencing with the fiscal year ending December 31, 2018, audited Consolidated statements of income and cash flows of the Borrower for such year and the related Consolidated balance sheet of the Borrower as at the end of such year, setting forth in each case in comparative form the corresponding figures for the preceding fiscal year; provided that, so long as the Borrower remains subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Borrower may provide, in satisfaction of the requirements of this first sentence of this Section 5.01(h)(ii), its report on Form 10-K for such fiscal year. Each set of financial statements provided pursuant to this Section 5.01(h)(ii) shall be accompanied by (A) an opinion thereon of independent certified public accountants of recognized national standing, which opinion shall state that said Consolidated financial statements fairly present in all material respects the Consolidated financial condition and results of operations of the Borrower as at the end of, and for, such fiscal year, in accordance with GAAP (except as disclosed therein) and (B) a certificate of an Authorized Officer, which certificate shall set forth reasonably detailed calculations demonstrating compliance with Section 5.03;
(iii)      as soon as possible and in any event within five days after any Authorized Officer of the Borrower knows of the occurrence of each Default continuing on the date of such statement, a statement of an Authorized Officer of the Borrower setting forth details

40

of such Default and the action that the Borrower has taken and proposes to take with respect thereto;
(iv)      promptly after the sending or filing thereof, copies of all reports and registration statements (other than exhibits thereto and registration statements on Form S-8 or its equivalent) that the Borrower or any Subsidiary files with the Securities and Exchange Commission;
(v)      promptly after an Authorized Officer becomes aware of the commencement thereof, notice of all actions and proceedings before any court, governmental agency or arbitrator affecting the Borrower or any of its Subsidiaries of the type described in Section 4.01(f), except, with respect to any matter referred to in Section 4.01(f)(ii), to the extent disclosed in a report on Form 8-K, Form 10-Q or Form 10-K of the Borrower;
(vi)      [intentionally omitted];
(vii)      promptly after the occurrence thereof, notice of the occurrence of any ERISA Event, together with (x) a written statement of an Authorized Officer of the Borrower specifying the details of such ERISA Event and the action that the Borrower has taken and proposes to take with respect thereto, (y) a copy of any notice with respect to such ERISA Event that may be required to be filed with the PBGC and (z) a copy of any notice delivered by the PBGC to the Borrower or an ERISA Affiliate with respect to such ERISA Event;
(viii)      as soon as possible and in any event within five days after any Authorized Officer of the Borrower knows of the occurrence thereof, notice of any change in the information provided in the Beneficial Ownership Certification that would result in a change to the list of beneficial owners identified in parts (c) or (d) of such certification; and
(ix)      promptly following request therefor, (a) such information and documentation reasonably requested by the Agent or any Lender for purposes of compliance with applicable “know your customer” requirements under the PATRIOT Act or other applicable anti-money laundering laws; or (b) such other information respecting the Borrower or any of its Subsidiaries as any Lender through the Agent may from time to time reasonably request.
Information required to be delivered pursuant to Section 5.01(h)(i) , Section 5.01(h)(ii) and Section 5.01(h)(iv) above shall be deemed to have been delivered on the date on which the Borrower provides notice to the Agent that such information has been posted on the Borrower’s website on the Internet at www.pinnaclewest.com, 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 5.01(h)(i) or Section 5.01(h)(ii) and (ii) the Borrower shall deliver paper copies of the information referred to in Section 5.01(h)(i) , Section 5.01(h)(ii) , and Section 5.01(h)(iv) to any Lender which requests such delivery.
(i)      Change in Nature of Business . Conduct directly or through its Subsidiaries the same general type of business conducted by the Borrower and its Material Subsidiaries on the date hereof.

41

Section 5.02      Negative Covenants . So long as any Loan shall remain unpaid, the Borrower shall not:
(a)      Liens, Etc . Directly or indirectly create, incur, assume or permit to exist any Lien securing Indebtedness for borrowed money on or with respect to any property or asset (including, without limitation, the capital stock of APS) of the Borrower, whether now owned or held or hereafter acquired (unless it makes, or causes to be made, effective provision whereby the Obligations will be equally and ratably secured with any and all other obligations thereby secured so long as such other Indebtedness shall be so secured, such security to be pursuant to an agreement reasonably satisfactory to the Required Lenders); provided , however , that this Section 5.02(a) shall not apply to Liens securing Indebtedness for borrowed money (other than Indebtedness for borrowed money secured by the capital stock of APS) which do not in the aggregate exceed at any time outstanding the principal amount of $50,000,000.
(b)      Mergers, Etc . Merge or consolidate with or into any Person, or permit any of its Material Subsidiaries to do so, except that (i) any Material Subsidiary of the Borrower may merge or consolidate with or into any other Material Subsidiary of the Borrower, (ii) any Subsidiary of the Borrower may merge into the Borrower or any Material Subsidiary of the Borrower and (iii) the Borrower or any Material Subsidiary may merge with any other Person so long as the Borrower or such Material Subsidiary is the surviving corporation, provided , in each case, that no Default shall have occurred and be continuing at the time of such proposed transaction or would result therefrom.
(c)      Sales, Etc. of Assets . Sell, lease, transfer or otherwise dispose of, or permit any of its Material Subsidiaries to sell, lease, transfer or otherwise dispose of, any assets, or grant any option or other right to purchase, lease or otherwise acquire any assets to any Person other than the Borrower or any Subsidiary of the Borrower, except (i) dispositions in the ordinary course of business, including, without limitation, sales or other dispositions of electricity and related and ancillary services, other commodities, emissions credits and similar mechanisms for reducing pollution, and damaged, obsolete, worn out or surplus property no longer required or useful in the business or operations of the Borrower or any of its Subsidiaries, (ii) sale or other disposition of patents, copyrights, trademarks or other intellectual property that are, in the Borrower’s reasonable judgment, no longer economically practicable to maintain or necessary in the conduct of the business of the Borrower or its Subsidiaries and any license or sublicense of intellectual property that does not interfere with the business of the Borrower or any Material Subsidiary, (iii) in a transaction authorized by subsection (b) of this Section, (iv) individual dispositions occurring in the ordinary course of business which involve assets with a book value not exceeding $5,000,000, (v) sales, leases, transfers or dispositions of assets during the term of this Agreement having an aggregate book value not to exceed 30% of the total of all assets properly appearing on the most recent balance sheet of the Borrower provided pursuant to Section 4.01(e)(i) or Section 5.01(h)(ii) hereof, (vi) at any time following the consummation of the Four Corners Acquisition, which occurred on December 30, 2013, and the closure by APS of Units 1, 2 and 3 of the Four Corners Power Plant near Farmington, New Mexico, as described in the SEC Reports, (A) disposition of all or any portion of APS’ interests in such Units 1, 2 and 3, or (B) disposition of all or any portion of any Subsidiary’s (other than

42

APS) interests in Units 4 and 5 of the Four Corners Power Plant near Farmington, New Mexico, and (vii) any Lien permitted under Section 5.02(a).
(d)      Ownership of APS . Except to the extent permitted under Section 5.02(b), cease at any time to own directly or indirectly at least 80% of the outstanding capital stock of APS.
Section 5.03      Financial Covenant . So long as any Loan shall remain unpaid, the Borrower will maintain a ratio of (a) Consolidated Indebtedness to (b) the sum of Consolidated Indebtedness plus Consolidated Net Worth of not greater than 0.65 to 1.0.
ARTICLE VI     

 EVENTS OF DEFAULT
Section 6.01      Events of Default . If any of the following events (“ Events of Default ”) shall occur and be continuing:
(a)      The Borrower shall fail to pay when due (i) any principal of any Loan or (ii) any interest on any Loan or any fees or other amounts payable under this Agreement or any other Loan Documents, and (in the case of this clause (ii) only) such failure shall continue for a period of three Business Days; or
(b)      Any representation or warranty made by the Borrower herein or by the Borrower (or any of its officers) in any certificate or other document delivered in connection with this Agreement or any other Loan Document shall prove to have been incorrect in any material respect when made or deemed made or furnished; or
(c)      (i) The Borrower shall fail to perform or observe any term, covenant or agreement contained in Section 2.15, Section 5.01(d) (as to the corporate existence of the Borrower), Section 5.01(h)(iii), Section 5.01(h)(vi), Section 5.02 or Section 5.03; or (ii) the Borrower shall fail to perform or observe any term, covenant or agreement contained in Section 5.01(e) if such failure shall remain unremedied for 15 days after written notice thereof shall have been given to the Borrower by the Agent or any Lender; or (iii) the Borrower shall fail to perform or observe any other term, covenant or agreement contained in this Agreement or any other Loan Document on its part to be performed or observed if such failure shall remain unremedied for 30 days after written notice thereof shall have been given to the Borrower by the Agent or any Lender; or
(d)      (i) The Borrower or any of its Material Subsidiaries shall fail to pay (A) any principal of or premium or interest on any Indebtedness that is outstanding in a principal amount of at least $35,000,000 in the aggregate (but excluding Indebtedness outstanding hereunder), or (B) an amount, or post collateral as contractually required in an amount, of at least $35,000,000 in respect of any Hedge Agreement, of the Borrower or such Material Subsidiary (as the case may be), in each case, when the same 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 Indebtedness or Hedge Agreement; or (ii) any event of default shall exist under any agreement or instrument relating to any such

43

Indebtedness and shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such event is to accelerate, or to permit the acceleration of, the maturity of such Indebtedness; or
(e)      The Borrower or any of its Material Subsidiaries shall fail to pay any principal of or premium or interest in respect of any operating lease in respect of which the payment obligations of the Borrower have a present value of at least $35,000,000, when the same 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 such operating lease, if the effect of such failure is to terminate, or to permit the termination of, such operating lease; or
(f)      The Borrower or any of its Material Subsidiaries shall generally not pay its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted by or against the Borrower or any of its Material Subsidiaries seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any Debtor Relief Law, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for it or for any substantial part of its property and, in the case of any such proceeding instituted against it (but not instituted by it), either such proceeding shall remain undismissed or unstayed for a period of 60 days, or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee, custodian or other similar official for, it or for any substantial part of its property) shall occur; or the Borrower or any of its Material Subsidiaries shall take any corporate action to authorize any of the actions set forth above in this subsection (f); or
(g)      Judgments or orders for the payment of money that exceed any applicable insurance coverage (the insurer of which shall be rated at least “A” by A.M. Best Company) by more than $35,000,000 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; or
(h)      (i) Any “person” or “group” (as such terms are used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, but excluding any employee benefit plan of such person or its subsidiaries, and any person or entity acting in its capacity as trustee, agent or other fiduciary or administrator of any such plan) becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Securities Exchange Act of 1934), directly or indirectly, of 30% or more of the equity securities of the Borrower entitled to vote for members of the board of directors of the Borrower; or (ii) during any period of 24 consecutive months, a majority of the members of the board of directors of the Borrower cease (other than due to death or disability) to be composed of individuals (A) who were members of that board on the first day of such period, (B) whose election or nomination to that board was approved by individuals referred to in clause (A) above constituting at the time of such election or nomination at least a majority of that board or (C) whose election or nomination to that board was approved by individuals referred to in clauses (A) and (B) above constituting at the time of such election or nomination at least a majority of that board; or

44

(i)      (i) An ERISA Event occurs with respect to a Pension Plan or Multiemployer Plan which has resulted or could reasonably be expected to result in liability of the Borrower under Title IV of ERISA to the Pension Plan, Multiemployer Plan or the PBGC in an aggregate amount in excess of $35,000,000; or (ii) the Borrower or any ERISA Affiliate fails to pay when due, after the expiration of any applicable grace period, any installment payment with respect to its withdrawal liability under Section 4201 of ERISA under a Multiemployer Plan in an aggregate amount in excess of $35,000,000;
then, and in any such event, the Agent shall at the request, or may with the consent, of the Required Lenders, by notice to the Borrower, (i) declare the Loans, all interest thereon and all other amounts payable under this Agreement to be forthwith due and payable, whereupon the Loans, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrower; provided , however , that in the event of an actual or deemed entry of an order for relief with respect to the Borrower under the Bankruptcy Code of the United States of America, the Loans, all such interest and all such amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by the Borrower, and (ii) exercise all rights and remedies available to it under this Agreement, the other Loan Documents and applicable Law.
ARTICLE VII     

 THE AGENT
Section 7.01      Appointment and Authority . Each of the Lenders hereby irrevocably appoints KeyBank National Association to act on its behalf as the Agent hereunder and under the other Loan Documents and authorizes the Agent to take such actions on its behalf and to exercise such powers as are delegated to the Agent by the terms hereof or thereof, together with such actions and powers as are reasonably incidental thereto. Except as set forth in Section 7.06, the provisions of this Article are solely for the benefit of the Agent and the Lenders, and neither the Borrower nor any of its Affiliates shall have rights as a third party beneficiary of any of such provisions.
Section 7.02      Rights as a Lender . The Person serving as the Agent hereunder shall have the same rights and powers in its capacity as a Lender as any other Lender and may exercise the same as though it were not the Agent and the term “Lender” or “Lenders” shall, unless otherwise expressly indicated or unless the context otherwise requires, include the Person serving as the Agent hereunder in its individual capacity. Such Person and its Affiliates may accept deposits from, lend money to, act as the financial advisor or in any other advisory capacity for and generally engage in any kind of business with the Borrower or any Subsidiary or other Affiliate thereof as if such Person were not the Agent hereunder and without any duty to account therefor to the Lenders.
Section 7.03      Exculpatory Provisions . The Agent shall not have any duties or obligations except those expressly set forth herein and in the other Loan Documents. Without limiting the generality of the foregoing, the Agent:

45

(a)      shall not be subject to any fiduciary or other implied duties, regardless of whether a Default has occurred and is continuing;
(b)      shall not have any duty to take any discretionary action or exercise any discretionary powers, except discretionary rights and powers expressly contemplated hereby or by the other Loan Documents that the Agent is required to exercise as directed in writing by the Required Lenders (or such other number or percentage of the Lenders as shall be expressly provided for herein), provided that the Agent shall not be required to take any action that, in its opinion or the opinion of its counsel, may expose the Agent to liability or that is contrary to any Loan Document or applicable Law; and
(c)      shall not, except as expressly set forth herein and in the other Loan Documents, have any duty to disclose, and shall not be liable for the failure to disclose, any information relating to the Borrower or any of its Affiliates that is communicated to or obtained by the Person serving as the Agent or any of its Affiliates in any capacity.
The Agent shall not be liable for any action taken or not taken by it (i) with the consent or at the request of the Required Lenders (or such other number or percentage of the Lenders as shall be necessary, or as the Agent shall believe in good faith shall be necessary, under the circumstances as provided in Section 6.01 and Section 8.01) or (ii) in the absence of its own gross negligence or willful misconduct as determined by a final, non-appealable judgment by a court of competent jurisdiction. The Agent shall be deemed not to have knowledge of any Default unless and until notice describing such Default is given to the Agent by the Borrower or a Lender.
The Agent shall not be responsible for or have any duty to ascertain or inquire into (i) any statement, warranty or representation made in or in connection with this Agreement or any other Loan Document, (ii) the contents of any certificate, report or other document delivered hereunder or thereunder or in connection herewith or therewith, (iii) the performance or observance of any of the covenants, agreements or other terms or conditions set forth herein or therein or the occurrence of any Default, (iv) the validity, enforceability, effectiveness or genuineness of this Agreement, any other Loan Document or any other agreement, instrument or document or (v) the satisfaction of any condition set forth in Article III or elsewhere herein, other than to confirm receipt of items expressly required to be delivered to the Agent.
Section 7.04      Reliance by Agent . The Agent shall be entitled to rely upon, and shall not incur any liability for relying upon, any notice, request, certificate, consent, statement, instrument, document or other writing (including any electronic message, internet or intranet website posting or other distribution) believed by it to be genuine and to have been signed, sent or otherwise authenticated by the proper Person. The Agent also may rely upon any statement made to it orally or by telephone and believed by it to have been made by the proper Person, and shall not incur any liability for relying thereon. In determining compliance with any condition hereunder to the making of any Loan that by its terms must be fulfilled to the satisfaction of a Lender, the Agent may presume that such condition is satisfactory to such Lender unless the Agent shall have received notice to the contrary from such Lender prior to the making of such Loan. The Agent may consult with legal counsel (who may be counsel for the Borrower), independent accountants and other experts selected by it, and shall not be liable for any action taken or not taken by it in good faith in accordance with the advice of any such counsel, accountants or experts.

46

Section 7.05      Delegation of Duties . The Agent may perform any and all of its duties and exercise its rights and powers hereunder or under any other Loan Document by or through any one or more sub-agents appointed by the Agent. The Agent and any such sub-agent may perform any and all of its duties and exercise its rights and powers by or through their respective Related Parties. The exculpatory provisions of this Article shall apply to any such sub-agent and to the Related Parties of the Agent and any such sub-agent, and shall apply to their respective activities in connection with the syndication of the credit facilities provided for herein as well as activities as Agent.
Section 7.06      Resignation of Agent . The Agent may at any time give notice of its resignation to the Lenders and the Borrower. Upon receipt of any such notice of resignation, the Required Lenders shall have the right, with the consent of the Borrower so long as no Event of Default has occurred and is continuing, to appoint a successor, which shall be a bank with an office in the United States of America, or an Affiliate of any such bank with an office in the United States of America. If no such successor shall have been so appointed by the Required Lenders and shall have accepted such appointment within 45 days after the retiring Agent gives notice of its resignation, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent meeting the qualifications set forth above; provided that if the Agent shall notify the Borrower and the Lenders that no qualifying Person has accepted such appointment, then such resignation shall nonetheless become effective in accordance with such notice and (1) the retiring Agent shall be discharged from its duties and obligations hereunder and under the other Loan Documents (except that in the case of any collateral security held by the Agent on behalf of the Lenders under any of the Loan Documents, the retiring Agent shall continue to hold such collateral security until such time as a successor Agent is appointed) and (2) all payments, communications and determinations provided to be made by, to or through the Agent shall instead be made by or to each Lender directly, until such time as the Required Lenders appoint a successor Agent as provided for above in this Section. Upon the acceptance of a successor’s appointment as Agent hereunder, such successor shall succeed to and become vested with all of the rights, powers, privileges and duties of the retiring (or retired) Agent, and the retiring Agent shall be discharged from all of its duties and obligations hereunder or under the other Loan Documents (if not already discharged therefrom as provided above in this Section). The fees payable by the Borrower to a successor Agent shall be as agreed between the Borrower and such successor. After the retiring Agent’s resignation hereunder and under the other Loan Documents, the provisions of this Article and Section 8.04 shall continue in effect for the benefit of such retiring Agent, its sub-agents and their respective Related Parties in respect of any actions taken or omitted to be taken by any of them while the retiring Agent was acting as Agent.
Section 7.07      Non-Reliance on Agent and Other Lenders . Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender or any of their Related Parties and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender or any of their Related Parties and based on such documents and information as it shall from time to time deem appropriate, continue to make its own decisions in taking or not taking action under or based upon this Agreement, any other Loan Document or any related agreement or any document furnished hereunder or thereunder.

47

Section 7.08      No Other Duties, Etc . Anything herein to the contrary notwithstanding, none of the Arrangers, the Co-Syndication Agents or any other agents listed on the cover page hereof shall have any powers, duties or responsibilities under this Agreement or any of the other Loan Documents, except in its capacity, as applicable, as the Agent or a Lender hereunder.
Section 7.09      Certain ERISA Matters .
(a)      Each Lender (x) represents and warrants, as of the date such Person became a Lender party hereto, to, and (y) covenants, from the date such Person became a Lender party hereto to the date such Person ceases being a Lender party hereto, for the benefit of, the Agent and the Arrangers and their respective Affiliates, and not, for the avoidance of doubt, to or for the benefit of the Borrower, that at least one of the following is and will be true:
(i)      such Lender is not using “plan assets” (within the meaning of 29 CFR § 2510.3-101, as modified by Section 3(42) of ERISA) of one or more Benefit Plans in connection with the Loans or the Commitments,
(ii)      the transaction exemption set forth in one or more PTEs, such as PTE 84-14 (a class exemption for certain transactions determined by independent qualified professional asset managers), PTE 95-60 (a class exemption for certain transactions involving insurance company general accounts), PTE 90-1 (a class exemption for certain transactions involving insurance company pooled separate accounts), PTE 91-38 (a class exemption for certain transactions involving bank collective investment funds) or PTE 96-23 (a class exemption for certain transactions determined by in-house asset managers), is applicable with respect to such Lender’s entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement,
(iii)      (A) such Lender is an investment fund managed by a “Qualified Professional Asset Manager” (within the meaning of Part VI of PTE 84-14), (B) such Qualified Professional Asset Manager made the investment decision on behalf of such Lender to enter into, participate in, administer and perform the Loans, the Commitments and this Agreement, (C) the entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement satisfies the requirements of sub-sections (b) through (g) of Part I of PTE 84-14 and (D) to the best knowledge of such Lender, the requirements of subsection (a) of Part I of PTE 84-14 are satisfied with respect to such Lender’s entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement, or
(iv)      such other representation, warranty and covenant as may be agreed in writing between the Agent, in its sole discretion, and such Lender.
(b)      In addition, unless sub-clause (i) in the immediately preceding clause (a) is true with respect to a Lender or such Lender has not provided another representation, warranty and covenant as provided in sub-clause (iv) in the immediately preceding clause (a), such Lender further (x) represents and warrants, as of the date such Person became a Lender party hereto, to, and (y) covenants, from the date such Person became a Lender party hereto to the date such Person ceases

48

being a Lender party hereto, for the benefit of, the Agent and the Arrangers and their respective Affiliates, and not, for the avoidance of doubt, to or for the benefit of the Borrower, that:
(i)      none of the Agent or the Arrangers, or any of their respective Affiliates is a fiduciary with respect to the assets of such Lender (including in connection with the reservation or exercise of any rights by the Agent under this Agreement, any Loan Document or any documents related to hereto or thereto),
(ii)      the Person making the investment decision on behalf of such Lender with respect to the entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement is independent (within the meaning of 29 CFR § 2510.3-21) and is a bank, an insurance carrier, an investment adviser, a broker-dealer or other person that holds, or has under management or control, total assets of at least $50 million, in each case as described in 29 CFR § 2510.3-21(c)(1)(i)(A)-(E),
(iii)      the Person making the investment decision on behalf of such Lender with respect to the entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies (including in respect of the Obligations),
(iv)      the Person making the investment decision on behalf of such Lender with respect to the entrance into, participation in, administration of and performance of the Loans, the Commitments and this Agreement is a fiduciary under ERISA or the Internal Revenue Code, or both, with respect to the Loans, the Commitments and this Agreement and is responsible for exercising independent judgment in evaluating the transactions hereunder, and
(v)      no fee or other compensation is being paid directly to the Agent or the Arrangers or any their respective Affiliates for investment advice (as opposed to other services) in connection with the Loans, the Commitments or this Agreement.
(c)      The Agent and the Arrangers hereby informs the Lenders that each such Person is not undertaking to provide impartial investment advice, or to give advice in a fiduciary capacity, in connection with the transactions contemplated hereby, and that such Person has a financial interest in the transactions contemplated hereby in that such Person or an Affiliate thereof (i) may receive interest or other payments with respect to the Loans, the Commitments and this Agreement, (ii) may recognize a gain if it extended the Loans or the Commitments for an amount less than the amount being paid for an interest in the Loans or the Commitments by such Lender or (iii) may receive fees or other payments in connection with the transactions contemplated hereby, the Loan Documents or otherwise, including structuring fees, commitment fees, arrangement fees, facility fees, upfront fees, underwriting fees, ticking fees, agency fees, administrative agent or collateral agent fees, utilization fees, minimum usage fees, letter of credit fees, fronting fees, deal-away or alternate transaction fees, amendment fees, processing fees, term out premiums, banker’s acceptance fees, breakage or other early termination fees or fees similar to the foregoing.

49

ARTICLE VIII     

 MISCELLANEOUS
Section 8.01      Amendments, Etc . No amendment or waiver of any provision of this Agreement or any other Loan Document, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided , however , that no amendment, waiver or consent shall
(a)      unless agreed to by each Lender directly affected thereby, (i) reduce or forgive the principal amount of any Loan, reduce the rate of or forgive any interest thereon ( provided that only the consent of the Required Lenders shall be required to waive the applicability of any post-default increase in interest rates), or reduce or forgive any fees hereunder (other than fees payable to the Agent or the Arrangers for their own respective accounts), (ii) extend the final scheduled maturity date or any other scheduled date for the payment of any principal of or interest on any Loan, or extend the time of payment of any fees hereunder (other than fees payable to the Agent or the Arrangers for their own respective accounts), or (iii) increase any Commitment of any such Lender over the amount thereof in effect or extend the maturity thereof (it being understood that a waiver of any Default, if agreed to by the Required Lenders or all Lenders (as may be required hereunder with respect to such waiver), shall not constitute such an increase);
(b)      unless agreed to by all of the Lenders, (i) reduce the percentage of the aggregate Commitments or of the aggregate unpaid principal amount of the Loans, or the number or percentage of Lenders, that shall be required for the Lenders or any of them to take or approve, or direct the Agent to take, any action hereunder or under any other Loan Document (including as set forth in the definition of “Required Lenders”), (ii) change any other provision of this Agreement or any of the other Loan Documents requiring, by its terms, the consent or approval of all the Lenders for any amendment, modification, waiver, discharge or termination thereof or any consent to any departure by the Borrower therefrom, or (iii) change or waive any provision of Section 2.13, any other provision of this Agreement or any other Loan Document requiring pro rata treatment of any Lenders, or this Section 8.01 or Section 2.17(b); and
(c)      unless agreed to by the Agent in addition to the Lenders required as provided hereinabove to take such action, affect the respective rights or obligations of the Agent hereunder or under any of the other Loan Documents.
(d)      If, in connection with any proposed amendment, waiver or consent requiring the consent of “each Lender” or “each Lender directly affected thereby,” the consent of the Required Lenders is obtained, but the consent of other necessary Lenders is not obtained (any such Lender whose consent is necessary but not obtained being referred to herein as a “Non-Consenting Lender”), then the Borrower may elect to replace a Non-Consenting Lender as a Lender party to this Agreement, provided that, concurrently with such replacement, (i) 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 Loans and other Obligations due to the Non-Consenting Lender pursuant to an Assignment and Assumption and to become a Lender for all purposes under this Agreement and to assume all

50

obligations of the Non-Consenting Lender to be terminated as of such date and to comply with the requirements of clause (b) of Section 8.07, and (ii) the Borrower shall pay to such Non-Consenting Lender in same day funds on the day of such replacement (1) all interest, fees and other amounts then accrued but unpaid to such Non-Consenting Lender by the Borrower hereunder to and including the date of termination, including without limitation payments due to such Non-Consenting Lender under Sections 2.09 and 2.12, and (2) an amount, if any, equal to the payment which would have been due to such Lender on the day of such replacement under Section 8.04(e) had the Loans of such Non-Consenting Lender been prepaid on such date rather than sold to the replacement Lender.
Section 8.02      Notices, Etc .
(a)      All notices and other communications provided for hereunder shall be either (x) in writing (including facsimile communication) and mailed, faxed or delivered or (y) delivered, furnished, distributed or made available as and to the extent set forth in Sections 8.02(b) and (c), if to the Borrower, at the address specified on Schedule 8.02 ; if to any Lender, at its Domestic Lending Office; and if to the Agent, at the address specified on Schedule 8.02 ; or, as to the Borrower or the Agent, at such other address as shall be designated by such party in a written notice to the other parties and, as to each other party, at such other address as shall be designated by such party in a written notice to the Borrower and the Agent. All such notices and communications shall, when mailed or faxed, be effective when deposited in the mails or faxed, respectively, except that notices and communications to the Agent pursuant to Article II, Article III or Article VII shall not be effective until received by the Agent. Delivery by facsimile of an executed counterpart of any amendment or waiver of any provision of this Agreement or the Notes or of any Exhibit hereto to be executed and delivered hereunder shall be effective as delivery of a manually executed counterpart thereof. Notices delivered through electronic communications to the extent provided in subsection (b) below, shall be effective as provided in such subsection (b). Upon request of the Borrower, the Agent will provide to the Borrower (i) copies of each Administrative Questionnaire or (ii) the address of each Lender.
(b)      Notices and other communications to the Lenders and the Agent hereunder may be delivered or furnished by electronic communication (including e-mail and Internet or intranet websites) pursuant to procedures approved by the Agent and agreed to by 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 and the Borrower that it is incapable of receiving notices under such Article by electronic communication. The Agent or the Borrower may, in its discretion, agree to accept notices and other communications to it hereunder by electronic communications pursuant to procedures approved by it, provided that approval of such procedures may be limited to particular notices or communications. Unless the Agent and the Borrower otherwise agree, (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 sent during the normal business hours of the recipient, such notice or communication shall be deemed to have been sent 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 deemed received upon the deemed receipt by the intended recipient at its e-mail address

51

as described in the foregoing clause (i) of notification that such notice or communication is available and identifying the website address therefor.
(c)      The Borrower agrees that the Agent may make materials delivered to the Agent pursuant to Section 5.01(h)(i), Section 5.01(h)(ii) and Section 5.01(h)(iv), as well as any other written information, documents, instruments and other material relating to the Borrower or any of its Subsidiaries and relating to this Agreement, the Notes or the transactions contemplated hereby, or any other materials or matters relating to this Agreement, the Notes or any of the transactions contemplated hereby (collectively, the “ Communications ”) available to the Lenders by posting such notices on Intralinks or a substantially similar electronic system (the “ Platform ”). The Borrower acknowledges that (i) the distribution of material through an electronic medium is not necessarily secure and that there are confidentiality and other risks associated with such distribution, (ii) the Platform is provided “as is” and “as available” and (iii) neither the Agent nor any of its Affiliates warrants the accuracy, adequacy or completeness of the Communications or the Platform and each expressly disclaims liability for errors or omissions in the Communications or the Platform. No warranty of any kind, express, implied or statutory, including, without limitation, any warranty of merchantability, fitness for a particular purpose, non-infringement of third party rights or freedom from viruses or other code defects, is made by the Agent or any of its Affiliates in connection with the Platform.
(d)      Each Lender agrees that notice to it (as provided in the next sentence) (a “ Notice ”) specifying that any Communications have been posted to the Platform shall constitute effective delivery of such information, documents or other materials to such Lender for purposes of this Agreement; provided that if requested by any Lender the Agent shall deliver a copy of the Communications to such Lender by e-mail, facsimile or mail. Each Lender agrees (i) to notify the Agent in writing of such Lender’s e-mail address to which a Notice may be sent by electronic transmission (including by electronic communication) on or before the date such Lender becomes a party to this Agreement (and from time to time thereafter to ensure that the Agent has on record an effective e-mail address for such Lender) and (ii) that any Notice may be sent to such e-mail address.
(e)      The Borrower hereby acknowledges that certain of the Lenders may be “public-side” Lenders ( i.e., Lenders that do not wish to receive material non-public information with respect to the Borrower or its securities) (each, a “ Public Lender ”). The Borrower hereby agrees that (w) all Communications that are to be made available to Public Lenders shall be clearly and conspicuously marked “PUBLIC” which shall mean that the word “PUBLIC” shall appear prominently on the first page thereof; (x) by marking Communications “PUBLIC,” the Borrower shall be deemed to have authorized the Agent, the Arrangers and the Lenders to treat such Communications as not containing any material non-public information with respect to the Borrower or its securities for purposes of United States of America federal and state securities laws; (y) all Communications marked “PUBLIC” are permitted to be made available through a portion of the Platform designated as “Public Investor;” and (z) the Agent and the Arrangers shall be entitled to treat any Communications that are not marked “PUBLIC” as being suitable only for posting on a portion of the Platform not marked as “Public Investor.” Notwithstanding the foregoing, the Borrower shall be under no obligation to mark any Communications “PUBLIC.” Notwithstanding anything to the contrary

52

herein, the Borrower and the Agent need not provide to any Public Lender any information, notice, or other document hereunder that is not public information, including without limitation, the Notice of Initial Borrowing and any notice of Default.
Section 8.03      No Waiver; Cumulative Remedies; Enforcement . No failure by any Lender or the Agent to exercise, and no delay by any such Person in exercising, any right, remedy, power or privilege hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges herein provided are cumulative and not exclusive of any rights, remedies, powers and privileges provided by Law.
Notwithstanding anything to the contrary contained herein or in any other Loan Document, the authority to enforce rights and remedies hereunder and under the other Loan Documents against the Borrower shall be vested exclusively in, and all actions and proceedings at Law in connection with such enforcement shall be instituted and maintained exclusively by, the Agent in accordance with Article VI for the benefit of all the Lenders; provided , however , that the foregoing shall not prohibit (a) the Agent from exercising on its own behalf the rights and remedies that inure to its benefit (solely in its capacity as Agent) hereunder and under the other Loan Documents, (b) any Lender from exercising setoff rights in accordance with Section 8.05 (subject to the terms of Section 2.13), or (c) any Lender from filing proofs of claim or appearing and filing pleadings on its own behalf during the pendency of a proceeding relative to the Borrower under any Debtor Relief Law; and provided , further , that if at any time there is no Person acting as Agent hereunder and under the other Loan Documents, then (i) the Required Lenders shall have the rights otherwise ascribed to the Agent pursuant to Article VI and (ii) in addition to the matters set forth in clauses (b) and (c) of the preceding proviso and subject to Section 2.13, any Lender may, with the consent of the Required Lenders, enforce any rights and remedies available to it and as authorized by the Required Lenders.
Section 8.04      Costs and Expenses; Indemnity; Damage Waiver .
(a)      The Borrower agrees to pay on demand all costs and expenses of the Agent in connection with the administration, modification and amendment of this Agreement, the Notes and the other Loan Documents to be delivered hereunder, including, without limitation, the reasonable fees and expenses of one law firm acting as counsel for the Agent with respect thereto and with respect to advising the Agent as to its rights and responsibilities under this Agreement. The Borrower further agrees to pay on demand all costs and expenses of the Agent and the Lenders, if any (including, without limitation, reasonable counsel fees and expenses), in connection with the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement, the Notes and the other Loan Documents to be delivered hereunder, including, without limitation, reasonable fees and expenses of counsel for the Agent and each Lender in connection with the enforcement of rights under this Section 8.04(a).
(b)      The Borrower agrees to indemnify and hold harmless the Agent (and any sub-agent thereof), each Lender, each Arranger, each Co-Syndication Agent and each Related Party of any of the foregoing (each, an “ Indemnified Party ”) from and against any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and expenses of counsel)

53

incurred by or asserted or awarded against any Indemnified Party, in each case arising out of or in connection with or by reason of (including, without limitation, in connection with any investigation, litigation or proceeding or preparation of a defense in connection therewith, whether based on contract, tort or any other theory) (i) the Notes, this Agreement, any other Loan Document, any of the transactions contemplated herein or the actual or proposed use of the proceeds of any Loan, or (ii) the actual or alleged presence of Hazardous Materials on any property of the Borrower or any of its Subsidiaries or any Environmental Action relating in any way to the Borrower or any of its Subsidiaries, provided that such indemnity shall not, as to any Indemnified Party, be available to the extent (a) such fees and expenses are expressly stated in this Agreement to be payable by the Indemnified Party, included expenses payable under Section 2.12, Section 5.01(e) and Section 8.07(b) or (b) such claim, damage, loss, liability or expense is found in a final, non-appealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party’s gross negligence, willful misconduct or material breach of its obligations under this Agreement, 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 8.04(b) 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 otherwise a party thereto, and whether or not the transactions contemplated hereby are consummated, provided that if the Borrower and such Indemnified Party are adverse parties in any such litigation or proceeding, and the Borrower prevails in a final, non-appealable judgment by a court of competent jurisdiction, any amounts under this Section 8.04(b) previously paid or advanced by the Borrower to such Indemnified Party pursuant to this Section 8.04(b) will be returned by such Indemnified Party.
(c)      To the extent that the Borrower for any reason fails to indefeasibly pay any amount required under subsection (a) or (b) of this Section to be paid by it to the Agent (or any sub-agent thereof) or any Related Party of any of the foregoing (and without limiting its obligation to do so), each Lender severally agrees to pay to the Agent (or any such sub-agent) or such Related Party, as the case may be, such Lender’s Ratable Share (determined as of the time that the applicable unreimbursed expense or indemnity payment is sought) of such unpaid amount, provided that the unreimbursed expense or indemnified loss, claim, damage, liability or related expense, as the case may be, was incurred by or asserted against the Agent (or any such sub-agent) in its capacity as such, or against any Related Party of any of the foregoing acting for the Agent (or any such sub-agent) in connection with such capacity.
(d)      Without limiting the rights of indemnification of the Indemnified Parties set forth in this Agreement with respect to liabilities asserted by third parties, each party hereto also agrees not to assert any claim for special, indirect, consequential or punitive damages against the other parties hereto, or any Related Party of any party hereto, on any theory of liability, arising out of or otherwise relating to the Notes, this Agreement, any other Loan Document, any of the transactions contemplated herein or the actual or proposed use of the proceeds of the Loans. No Indemnified Party shall be liable for any damages arising from the use by unintended recipients of any information or other materials distributed by it through telecommunications, electronic or other information transmission systems (including Intralinks, SyndTrak or similar systems) in connection with this

54

Agreement or the other Loan Documents, provided that such indemnity shall not, as to any Indemnified Party, be available to the extent such damages are found in a final, non-appealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party’s gross negligence or willful misconduct.
(e)      If any payment of principal of, or Conversion of, any Eurodollar Rate Loan is made by the Borrower to or for the account of a Lender other than on the last day of the Interest Period for such Loan, as a result of a payment or Conversion pursuant to Section 2.06(d) or (e), 2.08 or 2.10, acceleration of the maturity of the Loans pursuant to Section 6.01 or for any other reason, or by an Eligible Assignee to a Lender other than on the last day of the Interest Period for such Loan upon an assignment of rights and obligations under this Agreement pursuant to Section 8.07 as a result of a demand by the Borrower pursuant to Section 2.17, the Borrower shall, upon demand by such Lender (with a copy of such demand to the Agent), pay to the Agent for the account of such Lender any amounts required to compensate such Lender for any additional losses, costs or expenses that it may reasonably incur as a result of such payment or Conversion, including, without limitation, any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by any Lender to fund or maintain such Loan.
(f)      Without prejudice to the survival of any other agreement of the Borrower hereunder, the agreements and obligations of the Borrower contained in Sections 2.02(c), 2.09, 2.12 and 8.04 shall survive the payment in full of principal, interest and all other amounts payable hereunder and under the Notes.
Section 8.05      Right of Set-off . Upon (i) the occurrence and during the continuance of any Event of Default and (ii) the making of the request or the granting of the consent specified by Section 6.01 to authorize the Agent to declare the Loans due and payable pursuant to the provisions of Section 6.01, each Lender and each of its Affiliates is hereby authorized at any time and from time to time, to the fullest extent permitted by Law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender or any such Affiliate to or for the credit or the account of the Borrower against any and all of the obligations of the Borrower now or hereafter existing under this Agreement or any other Loan Document to such Lender, whether or not such Lender shall have made any demand under this Agreement or such Note and although such obligations may be contingent or unmatured or are owed to a branch or office of such Lender different from the branch or office holding such deposit or obligated on such indebtedness. Each Lender agrees promptly to notify the Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender under this Section are in addition to other rights and remedies (including, without limitation, other rights of set-off) that such Lender may have.
Section 8.06      Effectiveness; Binding Effect . Except as provided in Section 3.01, this Agreement shall become effective when it shall have been executed by the Borrower and the Agent and when the Agent shall have received counterparts hereof that, when taken together, bear the signatures of each of the other parties hereto and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agent and each Lender and their respective successors and assigns,

55

except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lenders (and any purported assignment without such consent shall be null and void).
Section 8.07      Successors and Assigns .
(a)      The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns permitted hereby, except that the Borrower may not assign or otherwise transfer any of its rights or obligations hereunder without the prior written consent of the Agent and each Lender (and any purported assignment or transfer without such consent shall be null and void) and no Lender may assign or otherwise transfer any of its rights or obligations hereunder except (i) to an assignee in accordance with the provisions of subsection (b) of this Section, (ii) by way of participation in accordance with the provisions of subsection (d) of this Section, or (iii) by way of pledge or assignment of a security interest subject to the restrictions of subsection (f) of this Section. Nothing in this Agreement, expressed or implied, shall be construed to confer upon any Person (other than the parties hereto, their respective successors and assigns permitted hereby, Participants to the extent provided in subsection (d) of this Section and, to the extent expressly contemplated hereby, the Related Parties of each of the Agent and the Lenders) any legal or equitable right, remedy or claim under or by reason of this Agreement.
(b)      Any Lender may at any time assign to one or more assignees (other than to an Ineligible Institution) all or a portion of its rights and obligations under this Agreement (including all or a portion of the Loans owing to it at such time); provided that any such assignment shall be subject to the following conditions:
(i)      Minimum Amounts .
(A)      in the case of an assignment of the entire principal amount of the assigning Lender’s Loans at the time owing to it or in the case of an assignment to a Lender, no minimum amount need be assigned; and
(B)      in any case not described in subsection (b)(i)(A) of this Section, the aggregate outstanding principal amount of the Loans of the assigning Lender subject to each such assignment, determined as of the date the Assignment and Assumption with respect to which such assignment is delivered to the Agent or, if “Trade Date” is specified in the Assignment and Assumption, as of the Trade Date, shall not be less than $5,000,000 unless each of the Agent and, so long as no Event of Default has occurred and is continuing, the Borrower otherwise consents (each such consent not to be unreasonably withheld or delayed).
(ii)      Proportionate Amounts . Each partial assignment shall be made as an assignment of a proportionate part of all the assigning Lender’s rights and obligations under this Agreement with respect to the Loans assigned, and each such assignment shall be of a constant, and not a varying, percentage of all rights and obligations under this Agreement;

56

(iii)      Required Consents . No consent shall be required for any assignment except to the extent required by subsection (b)(i)(B) of this Section and, in addition:
(A)      the consent of the Borrower (such consent not to be unreasonably withheld or delayed; provided that the Borrower shall be deemed to have consented to any such assignment unless it shall object thereto by written notice to the Agent within ten (10) Business Days after having received notice thereof) shall be required unless (1) an Event of Default has occurred and is continuing at the time of such assignment or (2) such assignment is to a Lender, an Affiliate of a Lender or an Approved Fund; and
(B)      the consent of the Agent (such consent not to be unreasonably withheld or delayed) shall be required if such assignment is to a Person that is not a Lender, an Affiliate of a Lender or an Approved Fund with respect to such Lender.
(iv)      Assignment and Assumption . The parties to each assignment shall execute and deliver to the Agent an Assignment and Assumption, together with a processing and recordation fee in the amount of $3,500; provided , however , that no such fee shall be payable in the case of an assignment made at the request of the Borrower to an existing Lender. The assignee, if it is not a Lender, shall deliver to the Agent an Administrative Questionnaire.
(v)      No Assignment to Ineligible Institutions . No such assignment shall be made to any Ineligible Institution.
Subject to acceptance and recording thereof by the Agent pursuant to subsection (c) of this Section and notice thereof to the Borrower, from and after the effective date specified in each Assignment and Assumption, the assignee thereunder shall be a party to this Agreement and, to the extent of the interest assigned by such Assignment and Assumption, have the rights and obligations of a Lender under this Agreement, and the assigning Lender thereunder shall, to the extent of the interest assigned by such Assignment and Assumption, be released from its obligations under this Agreement (and, in the case of an Assignment and Assumption covering all of the assigning Lender’s rights and obligations under this Agreement, such Lender shall cease to be a party hereto) but shall continue to be entitled to the benefits of Sections 2.09, 2.12 and 8.04 with respect to facts and circumstances occurring prior to the effective date of such assignment. Upon request, the Borrower (at its expense) shall execute and deliver a Note to the assignee Lender. Any assignment or transfer by a Lender of rights or obligations under this Agreement that does not comply with this subsection 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 subsection (d) of this Section.
(c)      Register . The Agent shall maintain at the Agent’s Office 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, 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

57

available for inspection by the Borrower and any Lender, at any reasonable time and from time to time upon reasonable prior notice.
(d)      Participations . Any Lender may at any time, without the consent of, or notice to, the Borrower or the Agent, sell participations to any Person (other than an Ineligible Institution) (each, a “ Participant ”) in all or a portion of such Lender’s rights and/or obligations under this Agreement (including all or a portion of the Loans owing to it); provided that (i) such Lender’s obligations under this Agreement shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) the Borrower, the Agent and the Lenders shall continue to deal solely and directly with such Lender in connection with such Lender’s rights and obligations under this Agreement and (iv) no participant under any such participation shall have any right to approve any amendment or waiver of any provision of this Agreement or any Note, or any consent to any departure by the Borrower therefrom, except to the extent that such amendment, waiver or consent would reduce the principal of, or interest on, any Obligations or any fees or other amounts payable hereunder, in each case to the extent subject to such participation, or postpone any date fixed for any payment of principal of, or interest on, any Obligations or any fees or other amounts payable hereunder, in each case to the extent subject to such participation.
Any agreement or instrument pursuant to which a Lender sells such a participation shall provide that such Lender shall retain the sole right to enforce this Agreement and to approve any amendment, modification or waiver of any provision of this Agreement; provided that such agreement or instrument may provide that such Lender will not, without the consent of the Participant, agree to any amendment, waiver or other modification addressing the matters set forth in clause (iv) above to the extent subject to such participation. Subject to subsection (e) of this Section, the Borrower agrees that each Participant shall be entitled to the benefits of Sections 2.09, 2.12 and 8.04(e) to the same extent as if it were a Lender and had acquired its interest by assignment pursuant to subsection (b) of this Section. To the extent permitted by Law, each Participant also shall be entitled to the benefits of Section 8.05 as though it were a Lender, provided such Participant agrees to be subject to Section 2.13 as though it were a Lender. Each Lender that sells a participation shall, acting solely for this purpose as a non-fiduciary agent of the Borrower, maintain a register on which it enters the name and address of each Participant and the principal amounts (and stated interest) of each Participant’s interest in the Loans or other obligations under the Loan Documents (the “ Participant Register ”); provided that no Lender shall have any obligation to disclose all or any portion of the Participant Register (including the identity of any Participant or any information relating to a Participant’s interest in any Loans or its other obligations under any Loan Document) to any Person except to the extent that such disclosure is necessary to establish that such Loan or other obligation is in registered form under Section 5f.103-1(c) of the United States Treasury Regulations. The entries in the Participant Register shall be conclusive absent manifest error, and such Lender shall treat each Person whose name is recorded in the Participant Register as the owner of such participation for all purposes of this Agreement notwithstanding any notice to the contrary. For the avoidance of doubt, the Agent (in its capacity as Agent) shall have no responsibility for maintaining a Participant Register.

58

(e)      Limitations upon Participant Rights . A Participant shall not be entitled to receive any greater payment under Section 2.09 or 2.12 than the applicable Lender would have been entitled to receive with respect to the participation sold to such Participant, unless the sale of the participation to such Participant is made with the Borrower’s prior written consent. A Participant that would be a Foreign Lender if it were a Lender shall not be entitled to the benefits of Section 2.12 unless the Borrower is notified of the participation sold to such Participant and such Participant agrees, for the benefit of the Borrower, to comply with Section 2.12(e) as though it were a Lender.
(f)      Certain Pledges . Any Lender may at any time pledge or assign a security interest in all or any portion of its rights under this Agreement (including under its Note, if any) to secure obligations of such Lender, including any pledge or assignment to secure obligations to a Federal Reserve Bank or other central banking authority; provided that no such pledge or assignment shall release such Lender from any of its obligations hereunder or substitute any such pledgee or assignee for such Lender as a party hereto.
(g)      The words “execution,” “signed,” “signature,” and words of like import in any Assignment and Assumption 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, the New York State Electronic Signatures and Records Act, or any other similar state Laws based on the Uniform Electronic Transactions Act.
Section 8.08      Confidentiality . Neither the Agent nor any Lender may disclose to any Person any confidential, proprietary or non-public information of the Borrower furnished to the Agent or the Lenders by the Borrower (such information being referred to collectively herein as the “ Borrower Information ”), except that each of the Agent and each of the Lenders may disclose Borrower Information (i) to its and its Affiliates’ employees, officers, directors, agents and advisors having a need to know in connection with this Agreement (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Borrower Information and instructed to keep such Borrower Information confidential on substantially the same terms as provided herein), (ii) to the extent requested by any regulatory authority or self-regulatory body, (iii) to the extent required by applicable Laws or regulations or by any subpoena or similar legal process, (iv) to any other party to this Agreement, (v) in connection with the exercise of any remedies hereunder or any suit, action or proceeding relating to this Agreement or the enforcement of rights hereunder, (vi) subject to an agreement containing provisions substantially the same as those of this Section 8.08, (A) to any assignee or participant or prospective assignee or participant, (B) to any direct, indirect, actual or prospective counterparty (and its advisor) to any swap, derivative or securitization transaction related to the obligations under this Agreement and (C) to any credit insurance provider relating to the Borrower and its Obligations, (vii) to the extent such Borrower Information (A) is or becomes generally available to the public on a non-confidential basis other than as a result of a breach of this Section 8.08 by the Agent or such Lender or their Related Parties, or (B) is or becomes available to the Agent or such Lender on a nonconfidential basis from a source other than the Borrower (provided that the source of such information was not known by the recipient after inquiry to be bound by a confidentiality agreement with or other contractual, legal or fiduciary

59

obligation of confidentiality to the Borrower or any other Person with respect to such information) and (viii) with the consent of the Borrower. The obligations under this Section 8.08 shall survive for two calendar years after the date of the termination of this Agreement.
Section 8.09      Governing Law . This Agreement and the Notes shall be governed by, and construed in accordance with, the Laws of the State of New York.
Section 8.10      Counterparts; Integration . 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. Delivery of an executed counterpart of a signature page of this Agreement by telecopy or other electronic imaging means shall be effective as delivery of an original executed counterpart of this Agreement. This Agreement and the other Loan Documents constitute the entire contract among the parties relating to the subject matter hereof and supersede any and all previous agreements and understandings, oral or written, relating to the subject matter hereof.
Section 8.11      Jurisdiction, Etc .
(a)      Each of the parties hereto hereby submits to the exclusive jurisdiction of any New York State court or federal court of the United States of America sitting in the Borough of Manhattan in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or the other Loan Documents, or for recognition or enforcement of any judgment, and each of the parties hereto hereby agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State court or, to the extent permitted by Law, in such federal court.
(b)      Each of the parties hereto irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection that 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 or the Notes in any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof. 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.
Section 8.12      Payments Set Aside . To the extent that any payment by or on behalf of the Borrower is made to the Agent or any Lender, or the Agent or any Lender exercises its right of setoff, and such payment or the proceeds of such setoff or any part thereof is subsequently invalidated, declared to be fraudulent or preferential, set aside or required (including pursuant to any settlement entered into by the Agent or such Lender in its discretion) to be repaid to a trustee, receiver or any other party, in connection with any proceeding under any Debtor Relief Law or otherwise, then (a) to the extent of such recovery, the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such setoff had not occurred, and (b) each Lender severally agrees to pay to the Agent upon demand its applicable share (without duplication) of any amount so recovered from or repaid by the Agent, plus interest thereon from the date of such demand to the date such payment is made at a rate per annum equal to the Federal Funds Rate from time to time in effect. The obligations of

60

the Lenders under clause (b) of the preceding sentence shall survive the payment in full of the Obligations and the termination of this Agreement.
Section 8.13      Patriot Act and Beneficial Ownership Regulation . The Agent and each Lender hereby notifies the Borrower that pursuant to the requirements of the PATRIOT Act and the Beneficial Ownership Regulation, it is required to obtain, verify and record information that identifies each borrower (including the Borrower), guarantor or grantor (the “ Loan Parties ”), which information includes the name and address of each Loan Party and other information that will allow such Lender to identify such Loan Party in accordance with the PATRIOT Act and the Beneficial Ownership Regulation. The Borrower shall provide, to the extent commercially reasonable, such information and take such actions as are reasonably requested by the Agent or any Lender in order to assist the Agent and such Lender in maintaining compliance with the PATRIOT Act and the Beneficial Ownership Regulation.
Section 8.14      Waiver of Jury Trial . EACH OF THE BORROWER, THE AGENT AND THE LENDERS HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT, THE NOTES OR ANY OTHER LOAN DOCUMENT OR THE ACTIONS OF THE BORROWER, THE AGENT OR ANY LENDER IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE OR ENFORCEMENT THEREOF.
Section 8.15      No Advisory or Fiduciary Responsibility . In connection with all aspects of each transaction contemplated hereby, the Borrower acknowledges and agrees that: (i) the credit facilities provided for hereunder and any related arranging or other services in connection therewith (including in connection with any amendment, waiver or other modification hereof or of any other Loan Document) are an arm’s-length commercial transaction between the Borrower, on the one hand, and the Agent, each of the Lenders and each of the Arrangers, on the other hand, and the Borrower is capable of evaluating and understanding and understands and accepts the terms, risks and conditions of the transactions contemplated hereby and by the other Loan Documents (including any amendment, waiver or other modification hereof or thereof); (ii) in connection with the process leading to such transaction, each of the Agent, the Lenders and the Arrangers is and has been acting solely as a principal and is not the financial advisor, agent or fiduciary, for the Borrower or any of its Affiliates, stockholders, creditors or employees or any other Person; (iii) neither the Agent nor any Lender or any Arranger has assumed or will assume an advisory, agency or fiduciary responsibility in favor of the Borrower with respect to any of the transactions contemplated hereby or the process leading thereto, including with respect to any amendment, waiver or other modification hereof or of any other Loan Document (irrespective of whether the Agent or any Lender or any Arranger has advised or is currently advising the Borrower or any of its Affiliates on other matters) and neither the Agent nor any Lender or any Arranger has any obligation to the Borrower with respect to the transactions contemplated hereby except those obligations expressly set forth herein and in the other Loan Documents; (iv) the Agent, each of the Lenders and Arrangers and their respective Affiliates may be engaged in a broad range of transactions that involve interests that differ from those of the Borrower and its Affiliates, and neither the Agent nor any Lender or any Arranger has any obligation to disclose any of such interests by virtue of any advisory, agency

61

or fiduciary relationship; and (v) the Agent and each Lender and each Arranger have not provided and will not provide any legal, accounting, regulatory or tax advice with respect to any of the transactions contemplated hereby (including any amendment, waiver or other modification hereof or of any other Loan Document) and the Borrower has consulted its own legal, accounting, regulatory and tax advisors to the extent it has deemed appropriate. The Borrower hereby waives and releases, to the fullest extent permitted by Law, any claims that it may have against the Agent and each Lender and each Arranger with respect to any breach or alleged breach of agency or fiduciary duty in connection with the Loan Documents.
Section 8.16      Survival of Representations and Warranties . All representations and warranties made hereunder and in any other Loan Document or other document delivered pursuant hereto or thereto or in connection herewith or therewith shall survive the execution and delivery hereof and thereof. Such representations and warranties have been or will be relied upon by the Agent and each Lender, regardless of any investigation made by the Agent or any Lender or on their behalf, and shall continue in full force and effect as long as any Loan or any other Obligation hereunder shall remain unpaid or unsatisfied.
Section 8.17      Severability . If any provision of this Agreement or the other Loan Documents is held to be illegal, invalid or unenforceable, (a) the legality, validity and enforceability of the remaining provisions of this Agreement and the other Loan Documents shall not be affected or impaired thereby and (b) the parties shall endeavor in good faith negotiations to replace the illegal, invalid or unenforceable provisions with valid provisions the economic effect of which comes as close as possible to that of the illegal, invalid or unenforceable provisions. The invalidity of a provision in a particular jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction.
Section 8.18      Acknowledgement and Consent to Bail-In of EEA Financial Institutions . Notwithstanding anything to the contrary in any Loan Document or in any other agreement, arrangement or understanding among any such parties, each party hereto acknowledges that any liability of any EEA Financial Institution arising under any Loan Document, to the extent such liability is unsecured, may be subject to the Write-Down and Conversion Powers of an EEA Resolution Authority and agrees and consents to, and acknowledges and agrees to be bound by:
(a)      the application of any Write-Down and Conversion Powers by an EEA Resolution Authority to any such liabilities arising hereunder which may be payable to it by any party hereto that is an EEA Financial Institution; and
(b)      the effects of any Bail-In Action on any such liability, including, if applicable:
(i)      a reduction in full or in part or cancellation of any such liability;
(ii)      a conversion of all, or a portion of, such liability into shares or other instruments of ownership in such EEA Financial Institution, its parent undertaking, or a bridge institution that may be issued to it or otherwise conferred on it, and that such shares or other instruments of ownership will be accepted by it in lieu of any rights with respect to any such liability under this Agreement or any other Loan Document; or

62

(iii)      the variation of the terms of such liability in connection with the exercise of the Write-Down and Conversion Powers of any EEA Resolution Authority.
[ REMAINDER OF PAGE INTENTIONALLY LEFT BLANK; SIGNATURE PAGES FOLLOW ]

63

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.
PINNACLE WEST CAPITAL CORPORATION

By:     /s/ Lee R. Nickloy
Name:    Lee R. Nickloy
Title:    Vice President and Treasurer

Signature Page to Pinnacle West Term Loan Agreement

		
ADMINISTRATIVE AGENT:	KEYBANK NATIONAL ASSOCIATION, as Agent and Lender	

By:     /s/ Keven Smith
Name:    Keven Smith
Title:    Senior Vice President

Signature Page to Pinnacle West Term Loan Agreement

		
LENDERS:	PNC BANK, NATIONAL ASSOCIATION, as a Lender	

By:     /s/ Brittany M. Lehr
Name:    Brittany M. Lehr
Title:    Assistant Vice President

Signature Page to Pinnacle West Term Loan Agreement

WELLS FARGO BANK, NATIONAL ASSOCIATION, as a Lender

By:     /s/ Sheila M. Shaffer
Name:    Sheila M. Shaffer
Title:    Director

SCHEDULE 1.01

COMMITMENTS AND RATABLE SHARES

	
					
Lender	Commitment	Ratable Share	
KeyBank National Association		$75,000,000		50.00%	
PNC Bank, National Association		$37,500,000		25.00%	
Wells Fargo Bank, National Association		$37,500,000		25.00%	
TOTAL		$150,000,000		100%	

Signature Page to Pinnacle West Term Loan Agreement

SCHEDULE 4.01(j)

SUBSIDIARIES

Arizona Public Service Company

SCHEDULE 4.01(k)

EXISTING INDEBTEDNESS

None.

SCHEDULE 8.02

CERTAIN ADDRESSES FOR NOTICES

BORROWER:
Pinnacle West Capital Corporation
400 North Fifth Street
Mail Station 9040
Phoenix, AZ 85004
Attention:     Treasurer
Telephone:    (602) 250-3300
Telecopier:    (602) 250-3902
Electronic     Lee.Nickloy@PinnacleWest.com

AGENT :
KeyBank National Association
127 Public Square
Cleveland, OH 44114
Facsimile No.: 216-689-4981
Telephone No.: 206-343-6966
Attention: Keven Smith
Email: keven.smith@key.com

A-1

EXHIBIT A — FORM OF
PROMISSORY NOTE

	
		
$________	December 21, 2018	

FOR VALUE RECEIVED, the undersigned, PINNACLE WEST CAPITAL CORPORATION, an Arizona corporation (the “ Borrower ”), hereby promises to pay to the order of ________ or its registered assigns (the “ Lender ”), in accordance with the provisions of the Term Loan Agreement (as hereinafter defined), the principal amount of ________ DOLLARS ($________), or, if less, the aggregate outstanding principal amount of the Loans (as defined in the Term Loan Agreement) made by the Lender to the Borrower pursuant to the Term Loan Agreement dated as of December 21, 2018 among the Borrower, the Lender and certain other lenders party thereto, KeyBank National Association, as Agent for the Lender and such other lenders, and the other agents party thereto (as amended or modified from time to time, the “ Term Loan Agreement ”; the terms defined therein being used herein as therein defined).
The Borrower promises to pay interest on the unpaid principal amount of the Loans from the date of the Loans until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Term Loan Agreement.
Both principal and interest are payable in lawful money of the United States of America to the Agent for the account of the Lender in same day funds at the Agent’s Account. The Loans owing to the Lender by the Borrower pursuant to the Term Loan Agreement, and all payments made on account of principal thereof, shall be recorded by the Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Promissory Note, provided that the failure to so record any such Loan or any payment on account thereof shall not affect the payment obligations of the Borrower hereunder or under the Term Loan Agreement.
This Promissory Note is one of the Notes referred to in, and is entitled to the benefits of, the Term Loan Agreement. The Term Loan Agreement, among other things, (i) provides for the making of Loans by the Lender to the Borrower, the indebtedness of the Borrower resulting from such Loans being evidenced by this Promissory Note and (ii) contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified.
THIS PROMISSORY NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.

A-3

	
	
PINNACLE WEST CAPITAL CORPORATION
	
By:_________________________________
Name:
Title:	

A-4

LOANS AND PAYMENTS OF PRINCIPAL

	
					
Date	Amount of Loan	Amount of Principal Paid or Prepaid	Unpaid Principal Balance	Notation
Made By	

A-3

EXHIBIT B — FORM OF NOTICE OF INITIAL
BORROWING

KeyBank National Association, as Agent
for the Lenders party
to the Term Loan Agreement
referred to below

Attention: Keven Smith

December [21], 2018

Ladies and Gentlemen:

The undersigned, Pinnacle West Capital Corporation, an Arizona corporation (the “ Borrower ”), refers to the execution version of the Term Loan Agreement (document ID number: ACTIVE 237440555 v.9) (as amended or modified from time to time, the “ Term Loan Agreement ”, the terms defined therein being used herein as therein defined), among the undersigned, certain Lenders party thereto, KeyBank National Association, as Agent for said Lenders and the other agents party thereto, and hereby gives you notice, irrevocably, pursuant to Section 2.02 of the Term Loan Agreement that the undersigned hereby requests the Initial Borrowing under the Term Loan Agreement, and in that connection sets forth below the information relating to the Initial Borrowing as required by Section 2.02(a) of the Term Loan Agreement:

(i)	The Business Day of the Initial Borrowing is December 21, 2018.	
		
(ii)	The Type of Loans comprising the Initial Borrowing is [Base Rate Loans] [Eurodollar Rate Loans].	
		
(iii)	The aggregate amount of the Initial Borrowing is $150,000,000.	
		
[(iv)	The initial Interest Period for each Eurodollar Rate Loan made as part of the Initial Borrowing is [one week][[__] month[s]].]	
The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the Initial Borrowing:
(A)    the representations and warranties contained in Section 4.01 of the Term Loan Agreement are true and correct, both before and after giving effect to the Initial Borrowing and to the application of the proceeds thereof, as though made on and as of such date (excluding that the Initial Borrowing is not listed on Schedule 4.01(k) thereto);
(B)    no event has occurred and is continuing, or would result from the Initial Borrowing or from the application of the proceeds therefrom, that constitutes a Default; and

B-1

(C)    before and after giving effect to the Initial Borrowing and to the application of the proceeds therefrom, as though made on and as of such date, the Indebtedness of the Borrower does not exceed that permitted by (i) applicable resolutions of the Board of Directors of the Borrower or (ii) applicable Laws of any Governmental Authority.
[The Borrower hereby acknowledges and agrees as follows:

1.	This Notice of Initial Borrowing is irrevocable.	

2.	The Borrower shall indemnify each Lender against any loss (excluding loss of anticipated profits), cost or expense incurred by such Lender as a result of any failure by the Borrower (a) to execute and deliver the Term Loan Agreement on or before December 21, 2018, (b) to fulfill the applicable conditions set forth in Article III of the Term Loan Agreement on December 21, 2018 or (c) to otherwise borrow the Eurodollar Rate Loans requested by the Borrower in this Notice of Initial Borrowing on December 21, 2018, in each case in accordance with Section 8.04(e) of the Term Loan Agreement (the terms of which Section are hereby incorporated by reference into this Notice of Initial Borrowing to the same extent and with the same force as if fully set forth herein).	

3.	The terms of paragraphs 1 and 2 above are not conditioned upon the execution and delivery by the Borrower, the Agent or the Lenders of the Term Loan Agreement.]	
This Notice of Initial Borrowing shall be governed by, and construed in accordance with, the laws of the State of New York.
Very truly yours,
PINNACLE WEST CAPITAL CORPORATION

By:    ______________________________
Name:
Title:

B-2

EXHIBIT C — FORM OF
ASSIGNMENT AND ASSUMPTION

This Assignment and Assumption (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 Term Loan Agreement identified below (as amended, restated, supplemented or otherwise modified from time to time, the “ Term Loan Agreement ”), receipt of a copy of which is hereby acknowledged by the Assignee. Annex 1 attached hereto (the “ Standard Terms and Conditions ”) is 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 Standard Terms and Conditions and the Term Loan Agreement, as of the Effective Date referred to below, (i) all of the Assignor’s rights and obligations in its capacity as a Lender under the Term Loan Agreement and any other documents or instruments delivered pursuant thereto to the extent related to the amount and percentage interest identified below of all of such outstanding rights and obligations of the Assignor under the Term Loan Agreement (including, without limitation, all Loans owing to the Assignor) and (ii) to the extent permitted to be assigned under applicable Law, all claims, suits, causes of action and any other right of the Assignor (in its capacity as a Lender) against any Person, whether known or unknown, arising under or in connection with the Term Loan Agreement, any other documents or instruments delivered pursuant thereto or the loan transactions governed thereby or in any way based on or related to any of the foregoing, including, but not limited to, contract claims, tort claims, malpractice claims, statutory claims and all other claims at Law or in equity related to the rights and obligations sold and assigned pursuant to clause (i) above (the rights and obligations sold and assigned pursuant to clauses (i) and (ii) above being referred to herein collectively as, 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. Assignee shall deliver (if it is not already a Lender) to the Agent an Administrative Questionnaire.

C-1

		
1.	Assignor: ________________________________	

2.	Assignee: ________________________________	
[and is an Affiliate of [identify Lender]]

3.	Borrower: Pinnacle West Capital Corporation	

4.	Agent: KeyBank National Association, as the agent under the Term Loan Agreement	

5.	Term Loan Agreement: Term Loan Agreement dated as of December 21, 2018, by and among the Borrower, the Lenders party thereto, the Agent and the other agents party thereto.	

6.	Assigned Interest:	

				
Aggregate Principal Amount
of Loans of all Lenders	Principal Amount of Loans Assigned	Percentage Assigned of Aggregate Principal Amount of Loans Outstanding	CUSIP Number	
 	 	 	 	
$____________	$____________	___________%	 	

[7. Trade Date:]

Effective Date: ________, 20___ [TO BE INSERTED BY AGENT AND WHICH SHALL BE THE EFFECTIVE DATE OF RECORDATION OF TRANSFER IN THE REGISTER THEREFOR.]

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

ASSIGNOR

[NAME OF ASSIGNOR]

By: ______________________
Name:
Title:

ASSIGNEE

[NAME OF ASSIGNEE]

By: _____________________
Name:
Title:

C-2

[Consented to and] Accepted:

KEYBANK NATIONAL ASSOCIATION, as Agent

By: ______________________
Name:
Title:

C-3

[Consented to:]

PINNACLE WEST CAPITAL CORPORATION

By: _______________________
Name:
Title:

C-4

ANNEX 1 TO ASSIGNMENT AND ASSUMPTION
STANDARD TERMS AND CONDITIONS FOR
ASSIGNMENT AND ASSUMPTION

1.     Representations and Warranties .
1.1     Assignor . The Assignor (a) 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; and (b) assumes no responsibility with respect to (i) any statements, warranties or representations made in or in connection with the Term Loan Agreement or any other Loan Document, (ii) the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Loan Documents, (iii) the financial condition of the Borrower, any of its Subsidiaries or Affiliates or any other Person obligated in respect of any Loan Document or (iv) the performance or observance by the Borrower of any of its obligations under any Loan Document.
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 Term Loan Agreement, (ii) it meets all the requirements to be an Eligible Assignee under Section 8.07 of the Term Loan Agreement (subject to such consents, if any, as may be required under Section 8.07 of the Term Loan Agreement), (iii) from and after the Effective Date, it shall be bound by the provisions of the Term Loan Agreement as a Lender thereunder and, to the extent of the Assigned Interest, shall have the obligations of a Lender thereunder, (iv) it is sophisticated with respect to decisions to acquire assets of the type represented by the Assigned Interest and either it, or the Person exercising discretion in making its decision to acquire the Assigned Interest, is experienced in acquiring assets of such type, (v) it has received a copy of the Term Loan Agreement, and has received or has been accorded the opportunity to receive copies of the most recent financial statements referred to in Section 4.01(e) or delivered pursuant to Section 5.01(h), as applicable, thereof, and such other documents and information as it deems appropriate to make its own credit analysis and decision to enter into this Assignment and Assumption and to purchase the Assigned Interest, (vi) it has, independently and without reliance upon the Agent, the Assignor or any other Lender and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Assignment and Assumption and to purchase the Assigned Interest, and (vii) if it is a Foreign Lender, attached to the Assignment and Assumption is any documentation required to be delivered by it pursuant to the terms of the Term Loan 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.

C-5

2.     Payments . 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 facsimile or other electronic transmission 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.

C-6

EXHIBIT D – FORM OF
INTEREST ELECTION REQUEST

[Date]

KeyBank National Association, as Agent for the Lenders party to the
Term Loan Agreement referred to below
127 Public Square
Cleveland, OH 44114
Facsimile No.: 216-689-4981
Email: keven.smith@key.com
Attention: Keven Smith

Ladies and Gentlemen:

The undersigned, Pinnacle West Capital Corporation, an Arizona corporation (the “Borrower ”), refers to the Term Loan Agreement, dated as of December 21, 2018 (as amended, restated, supplemented, or otherwise modified from time to time, the “Term Loan Agreement” , the terms defined therein and not otherwise defined herein being used herein as therein defined), among the Borrower, the Lenders named therein and from time to time party thereto, KeyBank National Association, as Agent for said Lenders and the other agents party thereto, and hereby gives you notice, irrevocably, that the undersigned requests a [Conversion] [continuation] of a Borrowing (the “Existing Borrowing” ) under the Term Loan Agreement, and in that connection has set forth below the information relating to such [Conversion] [continuation] (the “Proposed [Conversion] [Continuation]” ) as required by the definition of “Interest Period” contained in Section 1.01 of the Term Loan Agreement and/or Section 2.07 of the Term Loan Agreement, as applicable:
(i)    The Business Day of the Proposed [Conversion] [Continuation] is _______ ___, 20__.
(ii)    The Type of Loans comprising the Existing Borrowing is [Base Rate Loans] [Eurodollar Rate Loans having an Interest Period of [one week][____ month(s)].
(iii)    The aggregate amount of the Proposed [Conversion] [Continuation] is $______________.
(iv)    The Type of Loans to which such Existing Borrowing is proposed to be [Converted] [continued] is [Base Rate Loans] [Eurodollar Rate Loans].
[(v)    The initial Interest Period for the Eurodollar Rate Loans made as part of the Proposed [Conversion] [Continuation] is [one week][____ month(s).]

The undersigned hereby certifies that the Borrower’s request for the Proposed [Conversion] [Continuation] is made in compliance with the definition of “Interest Period” contained in Section 1.01 of the Term Loan Agreement and with Sections 2.06 and 2.07 of the Term Loan Agreement. [The undersigned hereby acknowledges that the delivery of this Interest Election Request shall constitute a representation and warranty by the Borrower that, on the date of the Proposed [Conversion] [Continuation], no Event of Default has occurred and is continuing (unless the Borrower informs the Agent otherwise prior to the date of the Proposed [Conversion] [Continuation], in which case the Proposed [Conversion] [Continuation] shall not be made.]
Very truly yours,
PINNACLE WEST CAPITAL CORPORATION

By:    __________________________________
Name:
Title:

Exhibit 21.1

SUBSIDIARIES LIST

Arizona Public Service Company

	

	 	
*All other subsidiaries of Pinnacle West Capital Corporation and all subsidiaries of Arizona Public Service Company have been omitted as they do not constitute significant subsidiaries within the meaning of Rule 1-02(w) of Regulation S-X.

Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement Nos. 333-224366 and 333-218886 on Form S-3 and in Registration Statement Nos. 333-143432, 333-182427, and 333-157151 on Form S-8 of our report dated February 22, 2019, relating to the consolidated financial statements and financial statement schedules of Pinnacle West Capital Corporation and subsidiaries, and the effectiveness of Pinnacle West Capital Corporation and subsidiaries' internal control over financial reporting, appearing in this Annual Report on Form 10-K of Pinnacle West Capital Corporation for the year ended December 31, 2018.

/s/ Deloitte & Touche LLP
Phoenix, Arizona
February 22, 2019

Exhibit 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement No. 333-224366-01 on Form S-3 and in Registration Statement Nos. 333-46161 and 333-158774 on Form S-8 of our report dated February 22, 2019, relating to the consolidated financial statements and financial statement schedule of Arizona Public Service Company and subsidiaries, and the effectiveness of Arizona Public Service Company and subsidiaries' internal control over financial reporting, appearing in this Annual Report on Form 10-K of Arizona Public Service Company for the year ended December 31, 2018.

/s/ Deloitte & Touche LLP

Phoenix, Arizona
February 22, 2019

Exhibit 31.1
CERTIFICATION
I, Donald E. Brandt, certify that:

1.	I have reviewed this Annual Report on Form 10-K 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
		
c)	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	
		
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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	

1

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: February 22, 2019

				
	 	 	 	
 	 	/s/ Donald E. Brandt	 	
 	 	Donald E. Brandt	 	
 	 	Chairman, President and Chief Executive Officer	 	

 	 	 	 	

 	 	 	 	

                                                

2

CERTIFICATION
I, James R. Hatfield, certify that:

1.	I have reviewed this Annual Report on Form 10-K 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
		
c)	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	
		
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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	

1

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:    February 22, 2019

	

 	 	/s/ James R. Hatfield	 	
 	 	James R. Hatfield	 	
 	 	Executive Vice President and Chief Financial Officer	 	

 	 	 	 	

 	 	 	 	

                        

2

CERTIFICATION
I, Donald E. Brandt, certify that:

1.	I have reviewed this Annual Report on Form 10-K of Arizona Public Service Company;	
		
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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
		
c)	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	
		
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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	

2

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:    February 22, 2019

	

 	 	/s/ Donald E. Brandt	 	
 	 	Donald E. Brandt	 	
 	 	Chairman and Chief Executive Officer	 	

 	 	 	 	

 	 	 	 	

                    

2

CERTIFICATION
I, James R. Hatfield, certify that:

1.	I have reviewed this Annual Report on Form 10-K of Arizona Public Service Company;	
		
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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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)	designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;	
		
c)	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	
		
d)	disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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	

2

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:    February 22, 2019

	

 	 	/s/ James R. Hatfield	 	
 	 	James R. Hatfield	 	
 	 	Executive Vice President and Chief Financial Officer	 	

 	 	 	 	

 	 	 	 	

2

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, 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 Annual Report on Form 10-K of Pinnacle West Capital Corporation for the year ended December 31, 2018 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 Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.
Date:    February 22, 2019

	

 	 	/s/ Donald E. Brandt	 	
 	 	Donald E. Brandt	 	
 	 	Chairman, President and Chief Executive Officer	 	
 	 	 	 	
I, James R. Hatfield, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report on Form 10-K of Pinnacle West Capital Corporation for the year ended December 31, 2018 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 Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Pinnacle West Capital Corporation.
Date:    February 22, 2019

	

 	 	/s/ James R. Hatfield	 	
 	 	James R. Hatfield	 	
 	 	Executive Vice President and Chief Financial Officer	 	

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, 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 Annual Report on Form 10-K of Arizona Public Service Company for the year ended December 31, 2018 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 Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Arizona Public Service Company.
Date:    February 22, 2019

	

 	 	/s/ Donald E. Brandt	 	
 	 	Donald E. Brandt	 	
 	 	Chairman and Chief Executive Officer	 	
 	 	 	 	
I, James R. Hatfield, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report on Form 10-K of Arizona Public Service Company for the year ended December 31, 2018 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 Annual Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Arizona Public Service Company.
Date:    February 22, 2019

	

 	 	/s/ James R. Hatfield	 	
 	 	James R. Hatfield	 	
 	 	Executive Vice President and Chief Financial Officer