To Our Shareholders

Customers, investors, employees – our futures are connected. Not just by the lines that deliver power, but also by Arizona’s growth potential and limitless possibilities.

This letter, like our company, is focused on our ongoing task of preparing for and connecting to Arizona’s energy future. In the short term, that means recovering our unexpectedly high natural gas costs. Full and timely recovery of our fuel costs is essential to our ability to finance future growth.

In the long term, ensuring Arizona’s energy future requires a diverse portfolio of new generating resources. Extending our transmission system into new coal and renewable markets, as well as encouraging conservation efforts through customer-driven demand-side management programs, requires aggressive action today.

As we make the transition from a competitive model to re-regulation, we’re working with our state regulators to forge a sustainable approach to Arizona’s energy growth. In 2005, we consolidated all of our generation, established a new resource acquisition process and we’re now implementing a new fuel cost recovery clause. These steps will improve our financial health, and only a healthy utility company can supply the energy demands of our dynamic state.

A healthy Arizona doesn’t just require a healthy utility, it demands one. Only a financially strong company can simultaneously manage growth, improve reliability and provide outstanding customer service – as we have for the last decade.

WE MET THE GROWTH CHALLENGE

Over the last 10 years, Arizona has experienced unprecedented economic and population growth. During the last decade, our gross state product increased by 74 percent (double the national level during that time) while job growth exceeded 40 percent. And the future looks just as promising.

In 2005, our core business was strong – net income from retail electric customers increased by nearly 10 percent. However, our earnings per share were lower than the previous year due primarily to regulatory write-offs and a loss on the sale of our Nevada generating unit. We replaced this generation with local Arizona generation at comparable terms and our consolidated APS generation will provide a solid platform as we complete our progress toward a vertically integrated, regulated company.

For APS, last year’s 4.3 percent customer growth – and 9.3 percent load growth – came after we added 300,000 customers from 1995 to 2004. Last year we also added our millionth customer.

While adding customers at a record pace, we also strengthened our infrastructure with a $5 billion investment over the last 10 years, including one of the few 500-kilovolt transmission lines built in the West in the last decade.

When the Arizona competitive rules kept APS from building new generation, we invested in new generation for APS customers under our competitive subsidiary, Pinnacle West Energy. Our 1,000-megawatt Redhawk combined-cycle plant and our 600-megawatt West Phoenix units were vital additions to support the Phoenix “load pocket.”

Supplying our customers with reliable power required that we recognize the physical reality of electricity, not just evolving regulatory structures. That meant we built new generation with our transmission capability and our customers firmly in mind. Some who built plants in Arizona were focused primarily on short-term profitability from potential new markets. Our company, on the other hand, focused on our duty to meet customers’ and shareholders’ needs for the long term.

Page 1 of 3
Next page