UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 1999
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Registrant; State of
Commission Incorporation; IRS Employer
File Number Address; and Telephone Number Identification Number
- ----------- ----------------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
Indicate by check mark whether each registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No __
At August 10, 1999, 32,315,790 shares of UniSource Energy
Corporation's Common Stock, no par value (the only class of Common Stock)
were outstanding.
UniSource Energy Corporation is the sole holder of the 32,162,167
shares of the outstanding Common Stock of Tucson Electric Power Company.
<PAGE>
This combined Form 10-Q is separately filed by UniSource Energy Corporation
and Tucson Electric Power Company. Information contained in this document
relating to Tucson Electric Power Company is filed by UniSource Energy
Corporation and separately by Tucson Electric Power Company on its own
behalf. Tucson Electric Power Company makes no representation as to
information relating to UniSource Energy Corporation or its subsidiaries,
except as it may relate to Tucson Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions..................................................... iv
Review Report of Independent Accountants..........................1
PART I - FINANCIAL INFORMATION
Item 1. -- Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements
ofIncome (Loss)................................................2
Comparative Condensed Consolidated Statements
of Cash Flows.................................................3
Comparative Condensed Consolidated Balance Sheets...............4
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income.........5
Comparative Condensed Consolidated Statements
of Cash Flows.................................................6
Comparative Condensed Consolidated Balance Sheets...............7
Notes to Condensed Consolidated Financial Statements
Note 1. Accounting for the Effects of Regulation................8
Note 2. Segment and Related Information........................10
Note 3. Unregulated Energy Businesses..........................12
Note 4. Tax Assessments........................................12
Note 5. Springerville Common Facilities Lease..................13
Note 6. Income Taxes...........................................13
Note 7. New Accounting Standards...............................14
Note 8. Review by Independent Public Accountants...............15
Note 9. Reclassifications......................................15
Item 2. -- Management's Discussion and Analysis of
Financial Condition and Results of Operations
Overview........................................................16
Factors Affecting Results Of Operations
Competition
Retail......................................................17
Wholesale...................................................20
Accounting For The Effects Of Regulation......................20
Market Risks..................................................22
Future Generating Resources...................................22
Impact Of The Year 2000 On Computer
Systems and Applications....................................23
Results Of Operations...........................................25
Contribution By Business Segment..............................25
Utility Sales and Revenues....................................26
Operating Expenses............................................27
Other Income (Deductions).....................................27
Interest Expense..............................................27
Results Of Unregulated Energy Businesses........................28
AET and Global Solar..........................................28
MEH and NewEnergy.............................................28
Nations Energy................................................28
<PAGE>
Dividends On Common Stock
UniSource Energy..............................................28
TEP...........................................................29
Liquidity And Capital Resources
Cash Flows
UniSource Energy............................................29
TEP.........................................................30
Investing And Financing Activities
UniSource Energy
Loans and Guarantees.......................................30
TEP
Capital Expenditures.......................................30
TEP Credit Agreement.......................................31
Springerville Common Facilities Leases.....................31
Millennium -- Unregulated Energy Businesses
Sale of NewEnergy, Inc.....................................31
Capital Requirements.......................................31
Safe Harbor For Forward-Looking Statements......................32
Item 3. -- Quantitative And Qualitative
Disclosures About Market Risk.................................33
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments.................................................34
Item 4. -- Submission Of Matters To A Vote
Of Security Holders...........................................34
Item 5. -- Other Information
Additional Financial Data.......................................34
Item 6. -- Exhibits and Reports on Form 8-K.....................34
Signature Page...................................................36
Exhibit Index....................................................37
<PAGE>
DEFINITIONS
The abbreviations and acronyms used in the 1999 Second Quarter Form 10-Q
are defined below:
- ---------------------------------------------------------------------------
ACC................. Arizona Corporation Commission.
AET................. Advanced Energy Technologies, Inc., a wholly-
owned subsidiary of Millennium.
Affected Utilities.. Electric utilities regulated by the ACC,
including TEP, Arizona Public Service, Citizens
Utilities company, and several electric
cooperatives.
Common Stock........ UniSource Energy's common stock, without par value.
Company............. UniSource Energy Corporation.
Credit Agreement.... Credit Agreement between TEP and the banks,
dated as of December 30, 1997.
FAS 71.............. Statement of Financial Accounting Standards No.
71: Accounting for the Effects of Certain Types of
Regulation.
FERC................ Federal Energy Regulatory Commission.
First Mortgage Bonds First mortgage bonds issued under the General
First Mortgage.
GAAP................ Generally Accepted Accounting Principles.
Global Solar........ Global Solar Energy, L.L.C., a corporation in
which a 50% interest is owned by AET.
IRS................. Internal Revenue Service.
Irvington........... Irvington Generating Station.
ITC................. Investment tax credit.
kWh................. Kilowatt-hour(s).
MEH................. MEH Corporation, a wholly-owned subsidiary of
Millennium.
MW.................. Megawatt(s).
MWh................. Megawatt-hour(s).
Millennium.......... Millennium Energy Holdings, Inc., a wholly-
owned subsidiary of UniSource Energy.
Nations Energy..... Nations Energy Corporation, a wholly-owned subsidiary
of Millennium.
NewEnergy........... NewEnergy, Inc., formerly New Energy Ventures, Inc., a
company in which a 50% interest was owned by MEH.
NEV Southwest....... New Energy Ventures Southwest, L.L.C., a wholly-
owned subsidiary of NewEnergy.
NOL................. Net Operating Loss carryforward for income tax
purposes.
Rate Settlement..... TEP's Rate Settlement agreement approved by the
ACC in August 1998, which provides retail base price
decreases over a two-year period.
Revolving Credit
Facility........... $100 million revolving credit facility
entered into under the Credit Agreement between a
syndicate of banks and TEP.
Springerville....... Springerville Generating Station.
Springerville Common
Facilities........ Facilities at Springerville used in common with
Springerville Unit 1 and Springerville Unit 2.
Springerville Common
Facilities Lease.. Leveraged lease arrangements relating to an
undivided one-half interest in certain Springerville
Common Facilities.
Springerville Unit 1.Unit 1 of the Springerville Generating Station.
Springerville Unit
1 Lease............ Leveraged lease arrangement relating to
Springerville Unit 1 and an undivided one-half
interest in certain Springerville Common Facilities.
TEP................. Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
UniSource Energy.... UniSource Energy Corporation.
WSCC................ Western Systems Coordinating Council.
<PAGE>
To the Board of Directors and Stockholders of
UniSource Energy Corporation and
to the Board of Directors of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated balance
sheets of UniSource Energy Corporation and its subsidiaries (the Company)
and of Tucson Electric Power Company and its subsidiaries (TEP) as of June
30, 1999, and the related condensed consolidated statements of income
(loss) and of cash flows for each of the three-month and six-month periods
ended June 30, 1999 and 1998. These financial statements are the
responsibility of the Company's and TEP's management.
We conducted our reviews in accordance with standards established by
the American Institute of Certified Public Accountants. A review of
interim financial information consists principally of applying analytical
procedures to financial data and making inquiries of persons responsible
for financial and accounting matters. It is substantially less in scope
than an audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an opinion regarding
the financial statements taken as a whole. Accordingly, we do not express
such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the accompanying condensed consolidated interim
financial statements for them to be in conformity with generally accepted
accounting principles.
We previously audited in accordance with generally accepted auditing
standards, the consolidated balance sheets and statements of capitalization
as of December 31, 1998, and the related consolidated statements of income,
of changes in stockholders' equity, and of cash flows for the year then
ended (not presented herein); and in our report dated February 4, 1999 we
expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
consolidated balance sheet information as of December 31, 1998, is fairly
stated, in all material respects in relation to the consolidated balance
sheets from which it has been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
August 12, 1999
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
The weather causes seasonal fluctuations in UniSource Energy's sales. As a
result, quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with the UniSource Energy's 1998 Form 10-K.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $159,098 $150,652
Sales for Resale 30,872 28,951
--------- ---------
Total Operating Revenues 189,970 179,603
--------- ---------
Operating Expenses
Fuel and Purchased Power 60,868 56,693
Capital Lease Expense 25,918 26,558
Amortization of Springerville Unit 1 Allowance (8,730) (7,630)
Other Operations 26,772 27,130
Maintenance and Repairs 14,667 8,431
Depreciation and Amortization 20,962 22,883
Taxes Other Than Income Taxes 12,192 12,634
Income Taxes 3,958 3,038
--------- ---------
Total Operating Expenses 156,607 149,737
--------- ---------
Operating Income 33,363 29,866
--------- ---------
Other Income (Deductions)
Income Taxes (193) 3,016
Interest Income 1,666 3,524
Unregulated Energy Businesses - Net (3,180) (5,649)
Other 278 1,134
--------- ---------
Total Other Income (Deductions) (1,429) 2,025
--------- ---------
Interest Expense
Long-Term Debt 16,797 19,792
Interest Imputed on Losses Recorded at Present Value 8,748 8,545
Other 2,681 2,496
--------- ---------
Total Interest Expense 28,226 30,833
--------- ---------
Net Income (Loss) $ 3,708 $ 1,058
========= =========
Average Shares of Common Stock Outstanding (000) 32,316 32,138
========= =========
Basic and Diluted Earnings (Loss) per Share $ 0.11 $ 0.03
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $287,749 $288,739
Sales for Resale 62,731 51,805
--------- ---------
Total Operating Revenues 350,480 340,544
--------- ---------
Operating Expenses
Fuel and Purchased Power 115,787 105,093
Capital Lease Expense 51,379 52,336
Amortization of Springerville Unit 1 Allowance (17,459) (15,261)
Other Operations 50,395 53,428
Maintenance and Repairs 24,304 19,155
Depreciation and Amortization 44,043 45,446
Taxes Other Than Income Taxes 24,346 25,560
Income Taxes 1,399 1,101
--------- ---------
Total Operating Expenses 294,194 286,858
--------- ---------
Operating Income 56,286 53,686
--------- ---------
Other Income (Deductions)
Income Taxes (425) 2,385
Interest Income 3,304 5,240
Unregulated Energy Businesses - Net (5,973) (9,685)
Other 936 1,944
--------- ---------
Total Other Income (Deductions) (2,158) (116)
--------- ---------
Interest Expense
Long-Term Debt 33,122 36,903
Interest Imputed on Losses Recorded at Present Value 17,496 17,090
Other 5,330 5,554
--------- ---------
Total Interest Expense 55,948 59,547
--------- ---------
Net Income (Loss) $ (1,820) $ (5,977)
========= =========
Average Shares of Common Stock Outstanding (000) 32,301 32,138
========= =========
Basic and Diluted Earnings (Loss) per Share (0.06) $ (0.19)
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $296,616 $293,242
Cash Receipts from Sales for Resale 61,526 53,386
Fuel and Purchased Power Costs Paid (112,826) (94,642)
Wages Paid, Net of Amounts Capitalized (36,969) (34,932)
Payment of Other Operations and Maintenance Costs (50,055) (45,811)
Capital Lease Interest Paid (46,693) (44,789)
Taxes Paid, Net of Amounts Capitalized (48,410) (48,752)
Interest Paid, Net of Amounts Capitalized (36,221) (35,357)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (5,920) (3)
Emission Allowance Inventory Sales 39 11,368
Interest Received 3,253 3,966
Other 2,991 (786)
--------- ---------
Net Cash Flows - Operating Activities 27,331 46,890
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (42,633) (39,787)
Investments in and Loans to Unregulated
Energy Businesses (5,050) (11,066)
Sale of Interest in Unregulated Energy Businesses 4,050 -
Purchase of Debt Securities (15,728) -
Other Investments - Net (232) 2,130
--------- ---------
Net Cash Flows - Investing Activities (59,593) (48,723)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 1,977 2,321
Payments to Retire Long-Term Debt (1,225) (2,600)
Payments to Retire Capital Lease Obligations (16,611) (9,481)
Other 1,629 (2,565)
--------- ---------
Net Cash Flows - Financing Activities (14,230) (12,325)
--------- ---------
Net Decrease in Cash and Cash Equivalents (46,492) (14,158)
Cash and Cash Equivalents, Beginning of Year 145,167 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $ 98,675 $132,098
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Net Loss $ (1,820) $ (5,977)
Adjustments to Reconcile Net Loss
to Net Operating Cash Flows
Depreciation and Amortization Expense 44,043 45,446
Deferred Income Taxes and Investment Tax Credit (842) (7,816)
Lease Payments Deferred 9,670 12,350
Amortization of Regulatory Assets & Liabilities,
Net of Interest Imputed on Losses Recorded at
Present Value 36 1,828
Deferred Contract Termination Fee 1,923 (8,077)
Unremitted (Earnings) Losses of Unconsolidated
Subsidiaries 3,816 15,689
Emission Allowances 39 11,368
Other 2,595 (2,673)
Changes in Assets and Liabilities which Provided(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable (11,101) (16,850)
Materials and Fuel (7,640) (577)
Accounts Payable (1,967) 1,189
Taxes Accrued (2,706) (236)
Other Current Assets and Liabilities (7,516) (936)
Other Deferred Assets and Liabilities (1,199) 2,162
--------- ---------
Net Cash Flows - Operating Activities $ 27,331 $ 46,890
========= =========
Non-Cash Financing Activities (these activities do not affect the statements
of cash flows):
The proceeds from the issuance of $200 million of Pollution Control Revenue
Bonds in March 1998 were held in trust and used in May 1998 to redeem $200
million of previously issued bonds.
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,285,966 $2,263,871
Utility Plant Under Capital Leases 886,901 886,902
Construction Work in Progress 68,952 74,050
----------- -----------
Total Utility Plant 3,241,819 3,224,823
Less Accumulated Depreciation and Amortization (1,069,348) (1,051,994)
Less Accumulated Amortization of Capital Leases (95,450) (85,826)
Less Springerville Unit 1 Allowance (171,449) (171,413)
----------- -----------
Total Utility Plant - Net 1,905,572 1,915,590
----------- -----------
Investments and Other Property 128,268 110,318
----------- -----------
Current Assets
Cash and Cash Equivalents 98,675 145,167
Accounts Receivable 81,951 70,850
Materials and Fuel 44,077 37,040
Deferred Income Taxes - Current 18,390 14,820
Other 26,671 26,867
----------- -----------
Total Current Assets 269,764 294,744
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 146,848 152,111
Deferred Springerville Generation Costs 96,719 102,211
Deferred Lease Expense 9,197 9,877
Other Regulatory Assets 17,739 18,886
Deferred Debits - Other 30,214 30,443
----------- -----------
Total Deferred Debits 300,717 313,528
----------- -----------
Total Assets $2,604,321 $2,634,180
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
CAPITALIZATION AND OTHER LIABILITIES - Thousands of Dollars -
Capitalization
Common Stock $ 641,225 $ 640,640
Accumulated Deficit (395,814) (393,994)
----------- -----------
Common Stock Equity 245,411 246,646
Capital Lease Obligations 867,302 889,543
Long-Term Debt 1,136,320 1,184,423
----------- -----------
Total Capitalization 2,249,033 2,320,612
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 18,444 11,647
Current Maturities of Long-Term Debt 48,603 1,725
Accounts Payable 30,628 32,595
Interest Accrued 69,567 70,771
Taxes Accrued 24,461 27,167
Accrued Employee Expenses 12,160 16,730
Other 6,162 6,705
----------- -----------
Total Current Liabilities 210,025 167,340
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 60,893 62,028
Deferred Investment Tax Credits Regulatory Liability 9,036 10,436
Emission Allowance Gain Regulatory Liability 31,352 31,335
Other 43,982 42,429
----------- -----------
Total Deferred Credits and Other Liabilities 145,263 146,228
----------- -----------
Total Capitalization and Other Liabilities $2,604,321 $2,634,180
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
The weather causes seasonal fluctuations in TEP's sales. As a result,
quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with the TEP's 1998 Form 10-K.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $159,111 $150,735
Sales for Resale 30,872 28,951
--------- ---------
Total Operating Revenues 189,983 179,686
--------- ---------
Operating Expenses
Fuel and Purchased Power 60,868 56,693
Capital Lease Expense 25,918 26,558
Amortization of Springerville Unit 1 Allowance (8,730) (7,630)
Other Operations 26,772 27,130
Maintenance and Repairs 14,667 8,431
Depreciation and Amortization 20,962 22,883
Taxes Other Than Income Taxes 12,192 12,634
Income Taxes 3,958 3,038
--------- ---------
Total Operating Expenses 156,607 149,737
--------- ---------
Operating Income 33,376 29,949
--------- ---------
Other Income (Deductions)
Income Taxes (1,166) 2,076
Interest Income 1,552 3,524
Interest Income-Note Receivable from UniSource Energy 2,554 2,326
Other 265 1,031
--------- ---------
Total Other Income (Deductions) 3,205 8,957
--------- ---------
Interest Expense
Long-Term Debt 16,797 19,792
Interest Imputed on Losses Recorded at Present Value 8,748 8,545
Other 2,681 2,496
--------- ---------
Total Interest Expense 28,226 30,833
--------- ---------
Net Income $ 8,355 $ 8,073
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $287,888 $288,884
Sales for Resale 62,731 51,805
--------- ---------
Total Operating Revenues 350,619 340,689
--------- ---------
Operating Expenses
Fuel and Purchased Power 115,787 105,093
Capital Lease Expense 51,379 52,336
Amortization of Springerville Unit 1 Allowance (17,459) (15,261)
Other Operations 50,395 53,428
Maintenance and Repairs 24,304 19,155
Depreciation and Amortization 44,043 45,446
Taxes Other Than Income Taxes 24,346 25,560
Income Taxes 1,399 1,101
--------- ---------
Total Operating Expenses 294,194 286,858
--------- ---------
Operating Income 56,425 53,831
--------- ---------
Other Income (Deductions)
Income Taxes (2,335) 516
Interest Income 3,017 5,240
Interest Income-Note Receivable from UniSource Energy 5,079 4,626
Other 797 1,800
--------- ---------
Total Other Income (Deductions) 6,558 12,182
--------- ---------
Interest Expense
Long-Term Debt 33,122 36,903
Interest Imputed on Losses Recorded at Present Value 17,496 17,090
Other 5,330 5,554
--------- ---------
Total Interest Expense 55,948 59,547
--------- ---------
Net Income $ 7,035 $ 6,466
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $296,616 $293,242
Cash Receipts from Sales for Resale 61,526 53,386
Fuel and Purchased Power Costs Paid (112,826) (94,642)
Wages Paid, Net of Amounts Capitalized (33,499) (33,308)
Payment of Other Operations and Maintenance Costs (46,557) (42,655)
Capital Lease Interest Paid (46,693) (44,789)
Taxes Paid, Net of Amounts Capitalized (48,143) (48,690)
Interest Paid, Net of Amounts Capitalized (36,221) (35,357)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (5,918) (3)
Emission Allowance Inventory Sales 39 11,368
Interest Received 2,787 2,970
Other 185 872
--------- ---------
Net Cash Flows - Operating Activities 31,296 52,394
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (41,295) (39,677)
Transfer of Millennium Cash to UniSource Energy - (45,412)
Purchase of Debit Securities (15,728) -
Other Investments - Net (833) 1,792
--------- ---------
Net Cash Flows - Investing Activities (57,856) (83,297)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 1,977 2,321
Payments to Retire Long-Term Debt (1,225) (2,600)
Payments to Retire Capital Lease Obligations (16,611) (9,481)
Other 1,450 (2,391)
--------- ---------
Net Cash Flows - Financing Activities (14,409) (12,151)
--------- ---------
Net Decrease in Cash and Cash Equivalents (40,969) (43,054)
Cash and Cash Equivalents, Beginning of Year 118,236 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $ 77,267 $103,202
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Six Months Ended
June 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 7,035 $ 6,466
Adjustments to Reconcile Net Income to Net
Operating Cash Flows
Depreciation and Amortization Expense 44,043 45,446
Deferred Income Taxes and
Investment Tax Credit 293 745
Lease Payments Deferred 9,670 12,350
Amortization of Regulatory Assets & Liabilities, Net
of Interest Imputed on Losses Recorded at
Present Value 36 1,828
Deferred Contract Termination Fee 1,923 (8,077)
Unremitted Earnings of Unconsolidated Subsidiaries (460) (528)
Interest Accrued on Note Receivable from UniSource
Energy (5,079) (4,626)
Emission Allowances 39 11,368
Other 2,800 (838)
Changes in Assets and Liabilities which Provided(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable (10,811) (18,327)
Materials and Fuel (6,383) (577)
Accounts Payable (1,243) 3,680
Tax Accrued (2,758) (224)
Other Current Assets and Liabilities (6,633) 1,601
Other Deferred Assets and Liabilities (1,176) 2,107
--------- ---------
Net Cash Flows - Operating Activities $ 31,296 $ 52,394
========= =========
Non-Cash Financing Activities (these activities do not affect the statements
of cash flows):
The proceeds from the issuance of $200 million of Pollution Control Revenue
Bonds in March 1998 were held in trust and used in May 1998 to redeem $200
million of previously issued bonds.
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,285,966 $2,263,871
Utility Plant Under Capital Leases 886,901 886,902
Construction Work in Progress 68,952 74,050
----------- -----------
Total Utility Plant 3,241,819 3,224,823
Less Accumulated Depreciation and Amortization (1,069,348) (1,051,994)
Less Accumulated Amortization of Capital Leases (95,450) (85,826)
Less Springerville Unit 1 Allowance (171,449) (171,413)
----------- -----------
Total Utility Plant - Net 1,905,572 1,915,590
----------- -----------
Investments and Other Property 80,272 62,978
----------- -----------
Note Receivable from UniSource Energy 70,132 79,462
---------- -----------
Current Assets
Cash and Cash Equivalents 77,267 118,236
Interest on Note Receivable from UniSource Energy 14,408 -
Accounts Receivable 87,015 72,239
Materials and Fuel 43,981 36,995
Deferred Income Taxes - Current 18,537 14,820
Other 13,506 14,735
----------- -----------
Total Current Assets 254,714 257,025
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 146,848 152,111
Deferred Springerville Generation Costs 96,719 102,211
Deferred Lease Expense 9,197 9,877
Other Regulatory Assets 17,739 18,886
Deferred Debits - Other 30,214 30,443
----------- -----------
Total Deferred Debits 300,717 313,528
----------- -----------
Total Assets $2,611,407 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 647,001 $ 646,568
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (403,315) (410,350)
----------- -----------
Common Stock Equity 237,329 229,861
Capital Lease Obligations 867,302 889,543
Long-Term Debt 1,136,320 1,184,423
----------- -----------
Total Capitalization 2,240,951 2,303,827
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 18,444 11,647
Current Maturities of Long-Term Debt 48,603 1,725
Accounts Payable 36,645 35,735
Interest Accrued 69,567 70,771
Taxes Accrued 24,324 27,082
Accrued Employee Expenses 11,760 16,418
Other 6,100 6,705
----------- -----------
Total Current Liabilities 215,443 170,083
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 70,651 70,504
Deferred Investment Tax Credits Regulatory Liability 9,036 10,436
Emission Allowance Gain Regulatory Liability 31,352 31,335
Other 43,974 42,398
----------- -----------
Total Deferred Credits and Other Liabilities 155,013 154,673
----------- -----------
Total Capitalization and Other Liabilities $2,611,407 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------
NOTE 1. ACCOUNTING FOR THE EFFECTS OF REGULATION
- -------------------------------------------------
Accounting Implications
The ACC regulates TEP's retail utility business. TEP generally
uses the same accounting policies and practices used by unregulated
companies for financial reporting under generally accepted accounting
principles. However, sometimes these principles, such as FAS 71,
require special accounting treatment for regulated companies to show
the effect of regulation. For example, in setting TEP's retail rates,
the ACC may not allow TEP to charge its customers currently to recover
certain expenses but; instead, require that these expenses be recovered
from customers in the future. In this situation, FAS 71 requires that
TEP capitalize and report these expenses as regulatory assets on the
balance sheet until TEP is allowed to charge its customers. TEP then
amortizes these items to the income statement as those amounts are
recovered from customers. Similarly, certain items of revenue may be
deferred as regulatory liabilities, which are also eventually amortized
to the income statement.
We have recorded regulatory assets and liabilities in our balance
sheets in accordance with FAS 71. A regulated company must satisfy
certain conditions to apply the accounting policies and practices of
FAS 71. These conditions include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
We periodically assess whether we continue to meet these
conditions. If we were required to stop applying FAS 71 to all or a
portion of TEP's regulated utility operations, we would write off the
related balances of TEP's regulatory assets and liabilities as a charge
in our income statement. In that event, our earnings would be reduced
by the net amount of regulatory assets and liabilities, after
applicable deferred income taxes. Based on the balances of TEP's
regulatory assets and liabilities at June 30, 1999, if we ceased
applying FAS 71 to all of TEP's regulated operations, we would record
an extraordinary loss of approximately $138 million, net of the related
deferred income tax benefit of $92 million. In addition, TEP would
immediately recognize, as a reduction to the extraordinary loss, the
portion, or all of, the $23 million ITC carryforward balance that TEP
believes it would use on a future tax return. Approximately 60% of
TEP's net regulatory assets on the balance sheet relate to electric
generation. While our cash flows may be affected by regulatory orders
and market conditions, our cash flows would not be affected if we
ceased to apply FAS 71.
If we stop applying FAS 71, we would need to evaluate the
likelihood that we could recover the cost of TEP's electric plant in
the marketplace. If undiscounted cash flows related to these plant
assets are less than the carrying value of those assets that we
continue to own, then we would need to write off as an expense a
portion of those plant assets to reflect their current market value.
Plant assets to be disposed of would be written down to fair value if
it is less than carrying value. We cannot predict if we would write
off any plant assets as a result of these evaluations.
Recent Events That May Impact TEP's Application of FAS 71
In December 1996, the ACC adopted retail electric competition
rules (Rules) that provided a framework for the phase-in of retail
electric competition in Arizona beginning in January 1999. The Rules
were amended and adopted on an emergency basis in August 1998. The
Rules, as originally adopted, assumed a competition start date of
January 1, 1999. On January 5, 1999, the ACC delayed implementation of
the Rules.
On April 14, 1999, the ACC approved a modified order that provides
affected utilities with five options for stranded cost recovery. The
following recovery options are provided by the ACC's written order:
1. Net Revenues Lost Methodology -- Stranded costs would be determined
by comparing generation revenues under competition to revenues under
regulation. Using growth as a mitigating factor, the amount of recovery
would be reduced over a five-year period.
2. Divestiture/Auction Methodology -- Stranded costs would be
determined by auctioning non-essential generation assets. The amount of
stranded costs would be the difference between the assets' market value
and their book value. Recovery of stranded costs would occur over a
maximum 10-year period.
3. Financial Integrity Methodology -- The ACC would provide sufficient
revenues necessary to maintain financial integrity, such as avoiding
default under currently existing financial instruments for a period of
ten years, at which time there would be no remaining stranded costs.
4. Settlement Methodology -- This option provides for some combination
of the three preceding methods, submitted as a settlement option.
5. Alternative Methodology -- This option approved by the ACC would
allow affected utilities to file an alternative plan. Under this
option, utilities would be required to demonstrate how an alternative
plan would be in the best interests of all stakeholders.
Also on April 14, 1999, the ACC approved amendments to the
electric competition rules that require a phase-in to a competitive
market, ensuring all customers will have access to competitive
generation by January 1, 2001. Under these rules, competitive electric
service will be available in each affected utility's service territory
after the affected utility's stranded cost plan is approved by the ACC.
TEP, as the regulated local distribution company, will continue to
provide delivery of electricity over existing power lines to homes and
businesses and will continue to operate and maintain these lines.
It is expected that the Rules will be resubmitted to the ACC for
their final approval in the third quarter of 1999.
Settlement Agreement
On June 9, 1999, TEP entered into a Settlement Agreement
(Settlement) with certain customer groups related to the implementation
of retail electric competition. The Settlement will become effective
if and when the ACC approves the Settlement without modification.
Hearings to approve the Settlement commenced August 11. If the
Settlement is approved in the third quarter, competition could begin
early in the fourth quarter of 1999. Major provisions of the
Settlement include:
- Consumer choice for energy supply would begin sixty (60) days after
the ACC approves the Settlement and will be phased in as required by
the ACC's retail competition rules. By January 1, 2001, consumer
choice would be available to all customers.
- In accordance with the Rate Settlement Agreement approved by the ACC
in 1998, TEP decreased rates to retail customers by 1% on July 1, 1999
and will decrease rates an additional 1% on July 1, 2000. These
reductions will apply to all retail customers. The Settlement provides
that, after these reductions, TEP's rates would be frozen until
December 31, 2008, except under certain circumstances. TEP would
recover the costs of transmission and distribution under regulated
unbundled rates.
- TEP would recover its stranded costs, including regulatory assets,
through two Competition Transition Charges (CTC):
- A Fixed CTC component which would terminate when $450 million has
been recovered, but no later than December 31, 2008. When the Fixed
CTC terminates, TEP's retail rates would decrease by the amount of the
Fixed CTC.
- A Floating CTC component would be equal to the amount of the
frozen rates less the sum of unbundled transmission and distribution
charges and amounts based on the Palo Verde Futures Index for electric
energy. Because TEP's total retail rate would be frozen, the Floating
CTC would enable TEP to recoup the balance of stranded costs as
follows:
- when wholesale market prices for electric energy are strong,
stranded costs would be lower and the Floating CTC would be lower; and
- when wholesale market prices for electric energy are weak,
stranded costs would be greater and the Floating CTC would be higher.
The Floating CTC would terminate no later than December 31, 2008.
- By June 1, 2004, TEP would recommend to the ACC any required
modifications to the CTCs and other service charges. A rate change, to
take effect no later than January 1, 2005, would only be made if it
results in a net rate reduction.
- By December 31, 2002, TEP would transfer its generation and other
competitive assets to a subsidiary of TEP, at market value. At the
time that TEP makes this transfer, it would be required, under the
ACC's electric competition rules, to provide energy to any distribution
customer who does not choose another energy service provider. TEP's
generation subsidiary would sell energy into the wholesale market.
TEP, as a utility distribution company, would bid for energy in the
wholesale market for its standard offer energy requirements.
- On final approval of the Settlement by the ACC, TEP will dismiss all
pending litigation brought by TEP against the ACC.
There can be no assurance that the Settlement filed with the ACC
will be accepted as filed.
However, if and when the Settlement is approved, TEP will stop
accounting for its generation operations using FAS 71 and begin using
the same accounting policies and practices used by unregulated
companies for financial reporting. The regulatory assets of the
generation business, together with certain above-market generation
plant costs, totaling approximately $450 million, will be recovered
through the distribution business. No net gain or loss to TEP or
UniSource Energy is expected due to the recognition of stranded cost
regulatory assets on TEP's balance sheet. These regulatory assets will
amortize to expense over the period ending in 2008, as provided for in
the Settlement Agreement.
In addition, if the Settlement is approved we will immediately
recognize as income the following Investment Tax Credit (ITC) amounts:
- Deferred ITC: On our financial statements we have deferred the
benefit relating to ITC claimed on tax returns. This Deferred ITC was
then amortized to income over the tax lives of the related property.
The balance remaining when the Settlement is approved will be
recognized immediately. At June 30, 1999, the Deferred ITC balance was
$9 million.
- ITC Carryforward: This ITC is generated but not yet claimed on a
tax return, and will be recognized immediately as income to the extent
that we expect to use the ITC on future tax returns. At June 30, 1999,
the total ITC Carryforward was $23 million. The amounts expected to be
used on future returns have not presently been determined.
Certain other generation expenses, such as lease expense, will
amortize differently in the future, although total amounts of such
expenses will remain the same over the life of the leases.
We cannot predict the outcome of hearings on the Settlement or the
ACC's retail competition rules. Additionally, federal legislators
introduced several retail competition initiatives in Congress which, if
passed, could modify or override the actions taken by the ACC. We will
continue to monitor the progress of the legislation and assess its
impact on retail electric competition in Arizona.
NOTE 2. SEGMENT AND RELATED INFORMATION
- ----------------------------------------
In 1998, we adopted Statement of Financial Accounting Standards
No.131 (FAS 131), Disclosures about Segments of an Enterprise and
Related Information, which requires that we report financial and
descriptive information about our operating segments. These segments
are determined based on the way we organize our operations and evaluate
performance. UniSource Energy's principal business segment is the
regulated electric utility business of TEP. The other reportable
business segment is the unregulated energy businesses of Millennium:
- Advanced Energy Technologies, Inc. (Advanced Energy) which owns 50
percent of Global Solar Energy, L.L.C., a developer and manufacturer of
photovoltaic materials;
- Nations Energy Corporation (Nations) which is an independent power
developer; and
- MEH Corporation (MEH) which held a 50 percent interest in NewEnergy,
Inc. (NewEnergy), an energy buyer representative. See Note 3 regarding
the sale of our interest in NewEnergy.
See Note 3 for more information on our unregulated energy
businesses. Intersegment revenues are not material.
We disclose selected financial data for our business segments in
the following table:
Segments
----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Energy
Utility Businesses Eliminations Consolidated
- ----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Three months ended
June 30, 1999:
Operating Revenues $189,983 $ 3,601 $(3,614) $189,970
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy $ (237)
MEH (73)
Nations (3,028)
Other Entities 158
--------
Total Net
Income (Loss) $ 8,355 $(3,180) $(1,467) $ 3,708
- ----------------------------------------------------------------------
Three months ended
June 30, 1998:
Operating Revenues $179,686 $ 319 $ (402) $179,603
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy $ (187)
MEH (5,248)
Nations (200)
Other Entities (14)
--------
Total Net
Income (Loss) $ 8,073 $(5,649) $(1,366) $ 1,058
- ----------------------------------------------------------------------
Segments
----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Energy
Utility Businesses Eliminations Consolidated
- ----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Six months ended
June 30, 1999:
Operating Revenues $350,619 $ 5,228 $(5,367) $350,480
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy $ (611)
MEH (650)
Nations (4,970)
Other Entities 258
--------
Total Net
Income (Loss) $ 7,035 $(5,973) $(2,882) $ (1,820)
- ----------------------------------------------------------------------
Six months ended
June 30, 1998:
Operating Revenues $340,689 $ 660 $ (805) $340,544
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy $ (17)
MEH (9,298)
Nations (404)
Other Entities 34
--------
Total Net
Income (Loss) $ 6,466 $(9,685) $(2,758) $ (5,977)
- ----------------------------------------------------------------------
The eliminations include the following:
- Elimination of the revenues of Millennium's unregulated energy
businesses to show this activity in Unregulated Energy Businesses - Net
in the Other Income (Deductions) section of UniSource Energy's income
statements; and
- Elimination of intercompany activity and balances.
NOTE 3. UNREGULATED ENERGY BUSINESSES
- -------------------------------------
Sale of NewEnergy
On July 23, 1999, MEH sold its 50% ownership interest in NewEnergy
to The AES Corporation (AES) for approximately $50 million in
consideration, consisting of:
- Shares of AES common stock valued at $27 million as of July 23,
1999; and
- Two promissory notes issued by NewEnergy totaling $22.8 million.
The notes are secured, bear interest at 9.5%, and $11.4 million of the
principal amount is due July 23, 2000 and the remaining $11.4 million
is due July 23, 2001.
UniSource Energy expects to recognize a pre-tax gain of
approximately $34 million from the sale. As part of the agreement, AES
repaid a $10 million loan NewEnergy obtained from an unrelated party
that was guaranteed by UniSource Energy. UniSource Energy will
continue to guarantee up to $55.6 million of certain performance bonds
and contractual obligations relating to NewEnergy's purchases and sales
of electricity. AES will replace UniSource Energy as guarantor no
later than October 15, 1999. NewEnergy's repayment obligations to
UniSource Energy, including the guarantees and performance bonds
provided by UniSource Energy, are fully secured.
MEH (formerly Millennium) originally acquired its 50% ownership in
NewEnergy in September 1997. In the first quarter of 1999, MEH
transferred its ownership in New Energy Ventures Southwest (NEV SW) to
NewEnergy. MEH recorded after-tax income (loss) related to NewEnergy
and NEV SW of $0.2 million and ($5.5) million for the quarters ended
June 30, 1999 and 1998, respectively, and after-tax losses of ($0.3)
million and ($9.6) million for the six months ended June 30, 1999 and
1998, respectively. At June 30, 1999, the net investment in NewEnergy,
including NEV SW, included in Investments and Other Property on
UniSource Energy's balance sheet, was approximately $14 million.
Purchase and Sale of Generating Assets by Nations Energy
In March 1999, Nations Energy funded $3.3 million of equity in a
Curacao refinery project. In May 1999, Nations Energy sold this
interest for $3.3 million. No gain or loss was recorded on the
transaction.
NOTE 4. TAX ASSESSMENTS
- ------------------------
Ruling on Arizona Sales Tax Assessments - Coal Sales
We received from the ADOR and are protesting, sales tax
assessments which allege that a former TEP subsidiary is liable for
sales tax on gross income from coal sales, transportation and coal-
handling services provided to TEP from November 1985 through May 1996.
Arizona law generally requires payment of an assessment prior to
pursuing the appellate process. We have previously paid, under
protest, a total of $23 million of the disputed sales tax assessments.
In September 1996, the Arizona Court of Appeals upheld the validity of
the assessment issued for the period November 1985 through March 1990.
However, in May 1998, the Arizona Supreme Court remanded the case back
to the Arizona Tax Court. The payments previously made will be
refunded if we are successful in the appeal.
TEP has recorded an expense and a related liability for the sales
taxes and interest for the period November 1985 through May 1996 that
we believe are probable of incurrence. On May 31, 1996, the former
subsidiary was merged into TEP. Because TEP now acquires coal directly
from unaffiliated companies, we do not believe we are liable for sales
tax computed on a basis similar to the assessments described above
after May 31, 1996. For periods prior to May 31, 1996, we continue to
record an estimated interest expense on the disputed assessments.
Arizona Sales Tax Assessments - Leases
The ADOR has issued sales tax assessments to some of the lessors
of TEP's generation-related facilities and equipment. The assessments
allege sales tax liability on a component of rents we paid on the
Springerville Unit 1 Leases, the Springerville Common Facilities
Leases, the Irvington Lease and the Springerville Coal Handling
Facilities Lease from August 1, 1988 to June 30, 1997. Under the
indemnification provisions in the lease agreements, if the ADOR
prevails, we would be required to reimburse the lessors for the sales
taxes that they pay. We filed an appeal of the assessments in the
Arizona Tax Court in February 1998. In July 1998, the Arizona Tax
Court upheld the assessment issued on the Irvington lease for the
period August 1988 through September 1990, and we have appealed the
decision. Arizona law generally requires payment of an assessment
prior to pursuing the appellate process. Under protest, we paid a
total of $2 million of the disputed assessments. These payments will
be refunded if we are successful in the appeals process.
We have recorded a liability for the probable amount of sales
taxes and interest due as of June 30, 1999. If the ADOR prevails, we
would need to record an additional expense and related liability. Even
though it is reasonably possible that the resolution of this issue
could result in approximately $24 million of additional sales tax
expense, we do not believe this outcome is likely. We do not expect
that the resolution of this assessment will have a material negative
impact on the financial statements. We believe that the ultimate
resolution of this issue could occur between two to four years from
now.
Income Tax Assessments
In February 1998, the IRS issued an income tax assessment for the
1992 and 1993 tax years. The IRS is challenging our treatment of
various items relating to a 1992 financial restructuring, including the
amount of NOL and ITC generated before December 1991 that may be used
to reduce taxes in future periods.
Due to a financial restructuring, a change in TEP's ownership
occurred for tax purposes in December 1991. As a result, our use of
the NOL and ITC generated before 1992 may be limited under the tax
code. The IRS is challenging our calculation of this limitation. At
June 30, 1999, pre-1992 federal NOL and ITC carryforwards were
approximately $200 million and $23 million, respectively. In addition
to the pre-1992 NOL and ITC which are subject to the limitation, $175
million of federal NOL at June 30, 1999, is not subject to the
limitation.
We do not expect the resolution of these issues to have a material
adverse impact on the financial statements.
NOTE 5. SPRINGERVILLE COMMON FACILITIES LEASE
- ----------------------------------------------
Under the terms of the Springerville Common Facilities lease
agreement, we must ensure that $70 million of secured notes underlying
this lease are refinanced by December 31, 1999 in order to avoid a
special event of loss under the lease. This special event of loss would
require us to repurchase the Springerville Common Facilities at the
higher of a specified price or the fair market value of the facilities.
TEP intends, and believes it has the ability, to refinance the
underlying debt on these leases in 1999.
NOTE 6. INCOME TAXES
- ---------------------
The differences between the income tax expense (benefit) and the
amount obtained by multiplying income before income taxes by the U.S.
statutory federal income tax rate are as follows:
UniSource Energy
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Federal Income Tax (Benefit)
Expense at Statutory Rate $ 2,601 $ (923) $ (439) $ (4,826)
State Income Tax (Benefit)
Expense, Net of Federal
Deduction 361 (144) (61) (745)
Depreciation Differences
(Flow Through Basis) 356 2,419 682 3,459
Capital Loss Carryforwards - (4,463) - (4,463)
Investment Tax Credit
Amortization (700) (572) (1,400) (1,145)
Foreign Operations of
Unregulated Energy Businesses 1,065 93 1,678 331
Other 41 (105) 106 (423)
-------- --------- -------- ---------
Total (Benefit) Expense for
Federal and State Income
Taxes $ 3,724 $ (3,695) $ 566 $ (7,812)
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 4,718 $ 3,162 $ 3,769 $ 2,468
State Income Tax Expense,
Net of Federal Deduction 654 488 523 381
Depreciation Differences
(Flow Through Basis) 356 2,419 682 3,459
Capital Loss Carryforwards - (4,463) - (4,463)
Investment Tax Credit
Amortization (700) (572) (1,400) (1,145)
Other 96 (72) 160 (115)
-------- --------- ------- ---------
Total Expense for Federal
and State Income Taxes $ 5,124 $ 962 $ 3,734 $ 585
======== ========= ======== =========
Income taxes are included in the income statements as follows:
UniSource Energy
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Operating Expenses $ 3,958 $ 3,038 $ 1,399 $ 1,101
Other Income (Deductions) 193 (3,016) 425 (2,385)
Unregulated Energy
Businesses - Net (427) (3,717) (1,258) (6,528)
-------- --------- -------- ---------
Total Income Tax (Benefit)
Expense $ 3,724 $ (3,695) $ 566 $ (7,812)
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Operating Expenses $ 3,958 $ 3,038 $ 1,399 $ 1,101
Other Income (Deductions) 1,166 (2,076) 2,335 (516)
-------- --------- -------- ---------
Total Income Tax Expense $ 5,124 $ 962 $ 3,734 $ 585
======== ========= ======== =========
As of December 31, 1997 both UniSource Energy and TEP had recorded
the amount of prior period NOL benefit that we expect to use on future
income tax returns. At the present time, we are not able to estimate
future additional amounts of NOL benefit that we may recognize in the
income statements of either UniSource Energy or TEP. This is because
there are still open tax years for which there may be additional
assessments and because federal and state NOL carryforwards have
varying expiration dates. We do not expect to recognize additional
amounts of NOL benefit until such items are resolved.
NOTE 7. NEW ACCOUNTING STANDARDS
- ---------------------------------
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (FAS 133),
Accounting for Derivative Instruments and Hedging Activities. A
derivative financial instrument or other contract derives its value
from another investment or designated benchmark. This Statement
requires all derivative instruments to be recognized as either assets
or liabilities in the balance sheet. Some derivative instruments
offset, or hedge, exposure to a specific risk. If the derivative is
not a hedging instrument, measurement is at fair value and changes in
fair value (i.e., gains and losses) are recognized in earnings in the
period of change. If a derivative qualifies as a hedge, the accounting
for changes in fair value will depend on the specific exposure being
hedged. We are required to adopt FAS 133 effective January 1, 2001.
We are still in the process of quantifying the effect, if any, that the
adoption of FAS 133 will have on our financial statements.
In November 1998, the Emerging Issues Task Force issued guidance
on accounting for energy trading activities (EITF 98-10). Energy
trading activities are intended to generate profits from changes in the
market prices for energy-related commodities such as electricity,
natural gas and coal. These activities include certain purchase power
and transmission contracts. This guidance would require us to measure
the difference between cost and market value for our energy contracts
and include any resulting gains or losses in earnings. We adopted this
guidance in the first quarter of 1999. TEP does purchase and sell
electricity but does not engage in the type of activities defined in
EITF 98-10 as energy trading. Therefore the adoption of this guidance
had no effect on our financial statements.
NOTE 8. REVIEW BY INDEPENDENT PUBLIC ACCOUNTANTS
- -------------------------------------------------
With respect to the unaudited consolidated financial information
of UniSource Energy and Tucson Electric Power Company for the three-
month and six-month periods ended June 30, 1999 and 1998,
PricewaterhouseCoopers LLP reported that they have applied limited
procedures in accordance with professional standards for a review of
such information. However, their separate report dated August 12,
1999, appearing herein, states that they did not audit and they do not
express an opinion on that unaudited consolidated financial
information. Accordingly, the degree of reliance on their report on
such information should be restricted in light of the limited nature of
the review procedures applied. PricewaterhouseCoopers LLP is not
subject to the liability provisions of Section 11 of the Securities Act
of 1933 for their report on the unaudited consolidated financial
information because that report is not a "report" or a "part" of a
registration statement prepared or certified by PricewaterhouseCoopers
LLP within the meaning of Sections 7 and 11 of the Act.
NOTE 9. RECLASSIFICATIONS
- --------------------------
Minor reclassifications have been made to the prior year financial
statements to conform to the current year's presentation.
<PAGE>
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
UniSource Energy is a holding company that owns all of the outstanding
common stock of TEP and Millennium. TEP is an operating public utility
engaged in the generation, purchase, transmission, distribution and sale of
electricity for customers in the greater Tucson, Arizona area and to
wholesale customers. Millennium owns all of the outstanding common stock
of four subsidiaries established for the purpose of operating or investing
in various unregulated energy-related businesses.
Management's Discussion and Analysis centers on the general financial
condition and the results of operations for UniSource Energy and its two
primary business segments, the regulated electric utility business of TEP
and the unregulated energy businesses of Millennium, and includes the
following:
- operating results during the second quarter and the first six months
of 1999 compared with the same periods in the prior year,
- the outlook for dividends on common stock,
- changes in liquidity and capital resources during the second quarter
and first six months of 1999, and
- expectations of identifiable material trends which may affect our
business in the future.
TEP is the principal operating subsidiary of UniSource Energy and
accounts for substantially all of its assets, revenues and net income. The
financial condition and results of operations of TEP are currently the
principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis, although losses from
energy-related businesses of Millennium and certain of its subsidiaries and
interests have reduced the earnings reported by UniSource Energy for the
quarters and the six month periods ended June 30, 1999 and 1998.
Management's Discussion and Analysis should be read in conjunction
with the Condensed Consolidated Financial Statements, beginning on page 2,
which present the results of operations for the quarters and the six month
periods ended June 30, 1999 and 1998. Management's Discussion and Analysis
analyzes and explains the differences between periods for specific line
items of the Condensed Consolidated Financial Statements.
OVERVIEW
UniSource Energy recorded net income of $3.7 million for the second
quarter of 1999, and a net loss of $1.8 million for the first six months of
1999. This compares with net income of $1.1 million in the second quarter
and a net loss of $6.0 million for the first six months of 1998. Second
quarter net income for 1999 was higher than second quarter net income for
1998 due primarily to a 5.7% increase in recorded revenues from our TEP
subsidiary combined with $2.5 million in lower net losses recorded by
Millennium's unregulated energy businesses. The increase in TEP's revenues
contributed to improvement in UniSource Energy's net income since operating
expenses remained at approximately the same percentage of revenues.
Additionally, interest expense decreased by 8.5%. See Results of
Operations below for further detail. The net loss for the first six months
of 1999 was less than the net loss in the prior year period due primarily
to lower net losses at Millennium's unregulated energy businesses combined
with TEP's higher revenues of 2.9% and stable operating expenses as a
percentage of revenues over the same prior year period. See Results of
Operations below for further detail.
Our financial prospects are subject to significant regulatory,
economic and other uncertainties. Regulatory uncertainties include the
impact of the introduction of retail competition in Arizona and the
resolution of stranded cost recovery. Until the uncertainties surrounding
the introduction of retail competition in Arizona are resolved, predicting
the level of TEP's future energy sales and the composition of its future
revenues is difficult. See Competition, Retail below.
In a deregulated environment, revenues from sales of energy may become
less certain although revenues from transmission and distribution services,
which we expect to remain regulated, would likely continue to grow. Even
in a deregulated environment, TEP expects to continue to benefit from the
anticipated population and economic growth in the Tucson area through
increased revenues from its regulated services. Other uncertainties
include the extent to which TEP's ability to alter operations and reduce
costs in response to industry changes or unanticipated economic downturns
may be limited due to high financial and operating leverage. Our future
success will depend, in part, on our ability to contain and/or reduce the
costs of serving retail customers and the level of sales to such customers.
<PAGE>
We are addressing the uncertainties discussed above by positioning our
subsidiaries to benefit from the changing regulatory environment. We have
aligned our corporate structure to better meet the needs of the emerging
energy markets. In November 1998, TEP organized its regulated business
activities into three separate business units: generation, transmission and
distribution, and in January 1999, formed a business unit which provides
administrative services to the utility business units. Also, we are
improving cost measurement and management techniques at TEP. We have
extended contracts, where appropriate, for large wholesale and retail
customers, and are developing new affiliates to provide energy services to
markets beyond TEP's retail service territory. See Competition, Retail;
Results of Unregulated Energy Businesses; and Results of Operations below.
Our financial prospects are also subject to uncertainties relating to
the start-up and developmental activities of our unregulated energy
business segment. Although our investments in unregulated energy-related
affiliates comprise approximately 3% of total assets, start-up costs and
other subsidiary developmental activities have contributed to losses from
certain of these activities in 1999 and 1998. We continue to evaluate
these affiliates for opportunities to realize value from our investments.
In the third quarter of 1999, we sold our ownership interest in our
unregulated energy-related affiliate, NewEnergy, Inc., and will record a
gain on the transaction.
Our consolidated capital structure remains highly leveraged. Since
April 1997, however, we have made significant progress in our financial
strategy to reduce refinancing risk by extending maturities of long-term
debt and letters of credit and by reducing exposure to variable interest
rates by refinancing with fixed interest rate securities.
Our businesses require large amounts of capital. TEP's capital
requirements include construction expenditures, scheduled debt maturities
and capital lease obligations. During the next twelve months, TEP expects
to be able to fund operating activities and construction expenditures with
internal cash flows, existing cash balances, and, if necessary, borrowings
under the Revolving Credit Facility. Some of our unregulated energy
businesses also require significant amounts of capital in the form of
investments, loans or guarantees. We expect to reinvest proceeds from the
NewEnergy sale to help fulfill these needs. If necessary, we may seek
investments by unaffiliated parties to meet the ongoing capital
requirements of some of these businesses. See Liquidity and Capital
Resources; Investing and Financing Activities, below.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
-----------
RETAIL
Under current law and regulation, TEP does not compete with other
companies for electric service in TEP's retail service territory. However,
TEP competes against gas service suppliers and others who provide energy
services. TEP actively markets energy and customized energy-related
services and, partly because of these efforts, to date we have not lost any
customers to self-generation. It is likely however, that when open access
in our retail service territory begins, some customers will elect to
purchase their energy requirements from other energy suppliers.
In order to retain customers in preparation for open access, TEP has
renegotiated the contracts of some of its large retail customers. TEP
recently entered into a new contract with a major mining customer which
extends the term by over four years to 2006. The contract includes reduced
pricing that will lower TEP's annual revenues by approximately $2-$5
million depending on the price of copper.
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electric services.
In this section, we discuss the current status of regulatory actions of the
ACC regarding the introduction of retail electric competition in Arizona.
We also outline TEP's responses to these actions. There is considerable
uncertainty regarding the timing and the outcome of these matters. As a
result, we cannot predict the impact of retail competition on TEP's future
operating results or financial condition.
<PAGE>
Retail Electric Competition Rules
In December 1996, the ACC adopted retail electric competition rules
(Rules) that provided a framework for the phase-in of retail electric
competition for generation services in Arizona beginning in January 1999.
The Rules were amended and adopted on an emergency basis in August 1998.
The Rules, as originally adopted, assumed a competition start date of
January 1, 1999. However, in January 1999, the ACC delayed the
implementation of the Rules pending additional proceedings to resolve a
number of important issues.
On April 14, 1999, the ACC approved amendments to the Rules. The
approved Rules include:
- The date to open an Affected Utility's service territory to
competition would be set upon the resolution its of Stranded Costs and
Unbundled Tariffs by final ACC order.
- If an Affected Utility's service territory is open prior to January 1,
2001, the existing phase-in schedule would be retained, calling for 20
percent of the market to initially have access to competitive generation
supply. As part of the 20 percent, each Affected Utility would reserve
an increasing percentage for residential customers according to a set
schedule.
- Competitive Energy Service Provider affiliates of Affected Utilities
would not be permitted to enter another Affected Utility's service
territory until its own territory is open to competition.
- Requirements that a portion of energy sold competitively be generated
from solar sources would be eliminated.
The amended Rules adopt a similar phase-in to the competitive market
as the original rules, calling for three customer classes to be given the
initial opportunity for choice:
- Large customers whose average usage/load is 1 megawatt (MW) or above,
such as mines, refineries, factories, and resorts. TEP currently serves
about 80 such customers in this category, representing 351 MW of load.
Of this load, approximately 60 percent is under contract through 2001;
- Smaller commercial customers whose individual peak usage totals 40
kilowatts (kW) or greater, who can aggregate with similar entities to
reach a total load of 1 MW, also are eligible. Examples of these
customers are convenience stores, small fast-food restaurants and
large retail stores; and
- A percentage of TEP's residential customers will be able to choose to
participate in the new market on a first-come, first-served basis. Every
three months, an additional one and one-quarter percent of residential
consumers will have the opportunity to choose.
By January 1, 2001, consumer choice will be available to all
customers. TEP, as the regulated local distribution company, will continue
to exclusively deliver electricity over its power lines to homes and
businesses. TEP also will continue to be responsible for the operation and
maintenance of the lines. For those customers who do not, or cannot,
choose other energy providers, TEP remains obligated to provide energy to
those customers.
Under these Rules, competition will begin in each Affected Utility's
service territory after the Affected Utility's stranded cost plan is
approved by the ACC.
Stranded Costs
In June 1998, the ACC adopted an order that outlined two options for
stranded cost recovery: 1) Divestiture/ Auction of all generation assets to
determine the amount of stranded costs for 100 percent recovery, or 2) a
Transition Revenues Methodology, where the Affected Utility would retain
generation assets in a separate affiliate with sufficient revenues
necessary to maintain financial integrity, such as avoiding default under
current existing financial instruments for a period of ten years.
In accordance with the June 1998 order, TEP filed with the ACC in
August 1998 a proposed plan for divestiture of generating assets and
stranded cost recovery. In this plan, TEP estimated that stranded costs
resulting from the divestiture of all generating facilities could range
from $600 million to $1.1 billion, and proposed to recover stranded costs
<PAGE>
and a return on any unamortized balance over a ten-year period. In January
1999, the ACC stayed the effectiveness of the electric competition rules
and the June 1998 order.
On April 14, 1999, the ACC issued an order modifying its June 1998
order and providing additional options for stranded cost recovery. Details
on these methods are available in the 1998 Form 10-K at Item 1. -
Business, Rates And Regulation, ACC Orders On Stranded Cost Recovery, ACC
Hearing Officer Proposed Order on Stranded Costs.
Rate Settlement Agreement
On August 25, 1998, the ACC approved a rate settlement agreement (Rate
Settlement) which gives TEP's retail customers the following base price
decreases:
- an initial 1.1% decrease (about $7.0 million) which was effective July
1, 1998;
- a second decrease of 1.0% (about $5.5 million) which was effective on
July 1, 1999; and
- an additional 1.0% decrease (about $5.5 million) on July 1, 2000.
Settlement Agreement On Retail Competition
On June 9, 1999, TEP entered into a Settlement Agreement (Settlement)
with certain customer groups related to the implementation of retail
electric competition. The Settlement will become effective if and when the
ACC approves the Settlement without modification. Hearings to approve the
Settlement commenced August 11. If the Settlement is approved in the third
quarter, competition could begin early in the fourth quarter of 1999.
Major provisions of the Settlement include:
- Consumer choice for energy supply would begin sixty (60) days after
the ACC approves the Settlement and will be phased in as required by the
ACC's retail competition rules. By January 1, 2001, consumer choice
would be available to all customers.
- In accordance with the Rate Settlement Agreement approved by the ACC
in 1998, TEP decreased rates to retail customers by 1% on July 1, 1999
and will decrease rates an additional 1% on July 1, 2000. These
reductions will apply to all retail customers. The Settlement provides
that, after these reductions, TEP's rates would be frozen until
December 31, 2008, except under certain circumstances. TEP would
recover the costs of transmission and distribution under regulated
unbundled rates.
- TEP would recover its stranded costs, including regulatory assets,
through two Competition Transition Charges (CTC) components:
- A Fixed CTC component which would terminate when $450 million has been
recovered, but no later than December 31, 2008. When the Fixed CTC
terminates, TEP's retail rates would decrease by the amount of the
Fixed CTC.
- A Floating CTC component would be equal to the amount of the frozen
rates less the sum of unbundled transmission and distribution charges
and amounts based on the Palo Verde Futures Index for electric energy.
Because TEP's total retail rate would be frozen, the Floating CTC
would enable TEP to recoup the balance of stranded costs as follows:
- when wholesale market prices for electric energy are strong,
stranded costs would be lower and the Floating CTC would be
lower; and
- when wholesale market prices for electric energy are weak, stranded
costs would be greater and the Floating CTC would be higher.
The Floating CTC would terminate no later than December 31, 2008.
<PAGE>
- By June 1, 2004, TEP would recommend to the ACC any required
modifications to the CTCs and other service charges. A rate change, to
take effect no later than January 1, 2005, would only be made if it
results in a net rate reduction.
- By December 31, 2002, TEP would transfer its generation and other
competitive assets to a subsidiary of TEP, at market value. At the time
that TEP makes this transfer, it would be required, under the ACC's
electric competition rules, to provide energy to any distribution
customer who does not choose another energy service provider. TEP's
generation subsidiary would sell energy into the wholesale market.
TEP, as a utility distribution company (UDC), would bid for energy
in the wholesale market for its standard offer energy requirements.
- On final, and unappealable, approval of the Settlement by the ACC, TEP
will dismiss all pending litigation brought by TEP against the ACC.
The ACC may vote on approval of the Settlement during the third or
fourth quarter of 1999. If, and when, the Settlement is approved, TEP will
stop accounting for its generation operations using FAS 71. See Accounting
For The Effects Of Regulation, below. There can be no assurance, however,
that the Settlement will be accepted as filed or that key assumptions and
related events will be realized.
WHOLESALE
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy in the
wholesale market. FERC generally does not permit TEP's prices for
wholesale sales of capacity and energy to exceed rates determined on a cost
of service basis. However, in the Fall of 1997, FERC granted TEP a tariff
to sell at market-based rates. In the current market, wholesale prices are
typically substantially below TEP's total cost of service, but in all
instances, we make wholesale sales at prices which exceed fuel and other
variable costs. We expect competition to sell capacity to remain vigorous.
Competition for the sale of capacity and energy is influenced by the
following factors:
- availability of capacity in the southwestern United States,
- the availability and prices of natural gas, oil and coal,
- spot energy prices, and
- transmission access.
ACCOUNTING FOR THE EFFECTS OF REGULATION
- ----------------------------------------
The ACC regulates TEP's retail utility business. TEP generally uses
the same accounting policies and practices used by unregulated companies
for financial reporting under generally accepted accounting principles.
However, sometimes these principles, such as FAS 71, require special
accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the ACC may not
allow TEP to charge its customers currently to recover certain expenses
but; instead, require that these expenses be recovered from customers in
the future. In this situation, FAS 71 requires that TEP capitalize and
report these expenses as regulatory assets on the balance sheet until TEP
is allowed to charge its customers. TEP then amortizes these items to the
income statement as those amounts are recovered from customers. Similarly,
certain items of revenue may be deferred as regulatory liabilities, which
are also eventually amortized to the income statement.
We have recorded regulatory assets and liabilities in our balance
sheets in accordance with FAS 71. A regulated company must satisfy certain
conditions to apply the accounting policies and practices of FAS 71. These
conditions include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
We periodically assess whether we continue to meet these conditions.
If we were required to stop applying FAS 71 to all or a portion of TEP's
regulated utility operations, we would write off the related balances of
TEP's regulatory
<PAGE>
assets and liabilities as a charge in our income
statement. In that event, our earnings would be reduced by the net amount
of regulatory assets and liabilities, after applicable deferred income
taxes. Based on the balances of TEP's regulatory assets and liabilities at
June 30, 1999, if we ceased applying FAS 71 to all of TEP's regulated
operations, we would record an extraordinary loss of approximately $138
million, net of the related deferred income tax benefit of $92 million. In
addition, TEP would immediately recognize, as a reduction to the
extraordinary loss, the portion, or all of, the $23 million ITC
carryforward balance that TEP believes it would use on a future tax return.
Approximately 60% of TEP's net regulatory assets on the balance sheet
relate to electric generation. While our cash flows may be affected by
regulatory orders and market conditions, our cash flows would not be
affected if we ceased to apply FAS 71.
If we stop applying FAS 71, we would need to evaluate the likelihood
that we could recover the cost of TEP's electric plant in the marketplace.
If undiscounted cash flows related to these plant assets are less than the
carrying value of those assets that we continue to own, then we would need
to write off as an expense a portion of those plant assets to reflect their
current market value. Plant assets to be disposed of would be written down
to fair value if it is less than carrying value. We cannot predict if we
would write off any plant assets as a result of these evaluations.
However, if and when the Settlement is approved, TEP will stop
accounting for its generation operations using FAS 71 and begin using the
same accounting policies and practices used by unregulated companies for
financial reporting. The regulatory assets of the generation business,
together with certain above-market generation plant costs, totaling
approximately $450 million, will be recovered through the distribution
business. No net gain or loss to TEP or UniSource Energy is expected due
to the recognition of stranded cost regulatory assets on TEP's balance
sheet. These regulatory assets will amortize to expense over the period
ending in 2008, as provided for in the Settlement Agreement.
In addition, if the Settlement is approved we will immediately
recognize as income the following Investment Tax Credit (ITC) amounts:
- Deferred ITC: On our financial statements we have deferred the
benefit relating to ITC claimed on tax returns. This Deferred ITC was
then amortized to income over the tax lives of the related property.
The balance remaining when the Settlement is approved will be recognized
immediately. At June 30, 1999, the Deferred ITC balance was $9 million.
- ITC Carryforward: This ITC is generated but not yet claimed on a tax
return, and will be recognized immediately as income to the extent that
we expect to use the ITC on future tax returns. At June 30, 1999, the
total ITC Carryforward was $23 million. The amounts expected to be
used on future returns have not presently been determined.
Certain other generation expenses, such as lease expense, will
amortize differently in the future, although total amounts of such expenses
will remain the same over the life of the leases.
Overall, if the Settlement is approved in 1999, earnings will increase
in 1999, primarily as a result of the recognition of the ITC described
above, and earnings will be reduced in the next few subsequent years,
primarily as a result of the changes in ceasing to apply FAS 71 to
generation related assets. However, TEP expects that such earnings
reductions could be offset and its earnings power retained provided:
- customer growth in TEP's service territory continues at its current
pace, about 2% to 3% annually;
- margins on wholesale sales grow as market prices increase over time in
the region; and
- a portion of free cash flow is used to reduce TEP's debt.
We cannot predict the outcome of hearings on the Settlement or the
ACC's retail competition rules. Additionally, federal legislators
introduced several retail competition initiatives in Congress which, if
passed, could modify or override the actions taken by the ACC. We will
continue to monitor the progress of the legislation and assess its impact
on retail electric competition in Arizona.
<PAGE>
MARKET RISKS
- ------------
We are potentially exposed to various forms of market risk. Changes
in interest rates, returns on marketable securities, changes in foreign
currency exchange rates, and changes in commodity prices may affect our
future financial results. TEP currently uses derivative commodity
instruments such as forward contracts to buy or sell energy but does not
use derivative financial instruments for hedging, trading or speculative
purposes. TEP continues to evaluate to what extent, if any, it may use
derivative financial and commodity instruments in the normal course of its
future business. Nations Energy uses derivative financial instruments to
manage certain interest rate risks, as described in Interest Rate Risk
below.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements below.
Interest Rate Risk
Exposure to interest rate changes relates primarily to TEP's long-term
debt obligations. UniSource Energy's market risks related to TEP's long-
term debt obligations have not changed materially from the market risks
reported in the 1998 Form 10-K.
Nations Energy has exposure to interest rate changes for certain of
its overseas projects and uses swap agreements to manage its interest rate
exposure. The agreements have the effect of converting certain variable
rate obligations to fixed rate obligations.
Marketable Securities Risk
Exposure to fluctuations in the return on marketable securities
relates to TEP's investment in debt securities. UniSource Energy's market
risks related to marketable securities have not changed materially from the
market risks reported in the 1998 Form 10-K.
Foreign Currency Exchange Risk
Exposure to changes in foreign currency exchange rates may arise from
transactions conducted by Nations Energy in foreign currencies. Nations
Energy's investment in a power project in the Czech Republic is highly
leveraged. Portions of the project's debt are denominated in U.S. Dollars,
German Deutschmarks, and Czech Korunas. The project bears the risk that
the value of the debt in each currency changes with fluctuations in the
applicable exchange rates, as well as the risk that the amount of interest
due each period changes with fluctuations in the applicable exchange rates.
The impact of recording the exchange rate fluctuations on UniSource
Energy's income statement for the second quarter of 1999 was a gain of
approximately $1.3 million, and for the first six months of 1999 was a loss
of $275,000.
Commodity Price Risk
Exposure to changes in commodity prices at TEP relates to changes in
the market price of electricity, as well as to changes in fuel costs
incurred to generate electricity. UniSource Energy's market risks related
to changes in commodity prices have not changed materially from the market
risks reported in the 1998 Form 10-K.
FUTURE GENERATING RESOURCES
In the past, TEP assessed its need for future generating resources
based on the premise of a continued regulatory requirement to serve
customers in TEP's retail service area. However, the obligation to provide
generation services to all customers will likely be modified by the ACC's
electric competition rules. Further, the need for future resources will be
affected by these rules and TEP's ability to retain and attract customers.
Under the electric competition rules as adopted, some of TEP's retail
customers will be eligible to choose alternative energy providers when
retail competition is introduced. For those customers who do not or cannot
choose other energy providers, TEP remains obligated to provide energy.
However, this energy is not required to come from TEP-owned generating
assets. See Competition, Retail.
<PAGE>
Regardless of who supplies electric power in TEP's retail service
area, TEP believes additional peaking resources are needed in Tucson by
2001 to improve local system reliability. Therefore, in the first quarter
of 1999, TEP issued a request for proposals for third parties to provide 75
MW of peaking resources to be located in TEP's service territory. The
request for proposals contemplated designation of the peaking capacity as a
"must-run generation" facility. Must-run generating units are those which
are required to run in order to maintain distribution system reliability
and meet load requirements. Following a review of the initial responses,
TEP requested proposals for the design and construction of a 75 MW peaking
unit in TEP's service territory.
IMPACT OF THE YEAR 2000 ON COMPUTER SYSTEMS AND APPLICATIONS
- ------------------------------------------------------------
Our Year 2000 (Y2K) efforts began in 1996 and involve the inventory,
assessment, remediation and testing of our operational and business
systems. Our goal is to provide uninterrupted electric service and to
process business transactions at year 2000 and beyond. We successfully
completed our mission critical Year 2000 preparation process. This process
was to ensure that the systems necessary to provide safe reliable power to
our customers are ready for the new millennium. We believe that all
identified business critical systems and applications within our control
will be Y2K ready by September 30, 1999. "Y2K ready" means the systems
have been checked for date processing and are expected to operate properly
for their specific business requirements into year 2000.
State of Readiness
We have completed an inventory and assessment for each of our critical
and non-critical information systems and embedded technologies including
the following areas: control and embedded systems; enterprise information
systems; suppliers; and subsidiaries.
Control and Embedded Systems - We are reviewing the control and embedded
systems of TEP's utility plant, including generation units partly owned but
not operated by TEP. Many of these systems are critical to the power
generation, transmission and distribution of electric service. The
inventory and assessment stages of this program were completed by September
30, 1998.
We completed the testing and remediation efforts for our mission critical
systems by June 30, 1999. Our mission critical systems which were tested
and determined to be Y2K ready include the Springerville Generating
Station, the Irvington Generating Station, all transmission facilities, all
distribution facilities and our energy control centers.
Enterprise Information Systems - We began the remediation, replacement, or
upgrade of these systems in 1996, and expect to complete this process by
the end of the third quarter of 1999. The following systems are included:
Department or Area Comments
Customer Services, Billing, Vendor identified Y2K patches for the
Receivables Customer Information System have been
delivered and are being installed.
The upgraded release of the underlying
software is also being installed.
Testing was scheduled for July and
August, and the software upgrades are
expected to be in production during
August.
Human Resources, Payroll Y2K ready - System installed in 1993
and upgraded to be Y2K ready in 1998.
Work Management The upgraded release for the Work
Management System has been received
from the vendor and tested. The
upgrade for the underlying software
has also been received and
successfully tested. The production
installation of this software occurred
in July 1999.
<PAGE>
General Ledger, Fixed New vendor supplied Y2K compliant
Assets, Projects software for these functions was
implemented in the second quarter of
1999. Additional Y2K testing will be
conducted in August and September of
1999.
Accounts Payable, Y2K ready - Remediation completed in
Purchasing, Inventory 1998.
An integrated test is scheduled for all enterprise information systems for
the third quarter of 1999 to include the enterprise hardware, operating
software and all major applications with year 2000 date processing.
Suppliers - We have identified the major vendors from which we buy goods
and/or services for the generation, transmission and distribution of
electrical service. We are currently working with these vendors to
determine their plans and to investigate any potential impact on us. Major
vendors of our business areas are also being reviewed for Y2K compliance.
Millennium Subsidiaries - We have contacted Nations Energy and Global Solar
to determine their state of readiness. These companies will be monitored
to ensure plans are in place to avoid Y2K disruptions.
Costs
From 1996 through June 30, 1999, we have expensed $1.35 million
addressing the Y2K issue. This amount does not include major system
replacement costs that, along with other functional changes, addressed Y2K
issues. A $1.8 million estimate, which includes the $1.35 million already
expensed, has been established for Y2K project costs. All remediation
costs will be expensed as incurred.
Risks
We currently believe that all identified modifications to the systems
that TEP operates will be implemented within the required time frames.
Despite our efforts, we cannot be certain that all Y2K problems affecting
the systems we operate will be identified and remediated in a timely
manner. Although we do not expect any of our potential Y2K problems to be
significant, it is possible that such problems could disrupt the
generation, transmission or distribution of electric energy or the billing
and collection process.
We cannot assure that systems or parties outside of our control are
prepared for Y2K, or how their level of preparedness may affect us. As an
example, the loss of communications systems supplied by our vendors could
affect our ability to operate generation and transmission facilities.
Furthermore, any instability of the electric grid caused by parties outside
of our control may result in interruptions of generating capacity and
impact our ability to provide electric services.
TEP and other electric service providers in the Western System
Coordinating Counsel (WSCC) are studying possible Y2K risks resulting from
interconnected electric and information systems. The interconnected
systems are critical to the reliability and integrity of each electric
service provider. As an example, the failure of an interconnected provider
to meet Y2K readiness could possibly disrupt the provision of electric
services by utilities. TEP and other electric providers in the WSCC are
working together in an effort to avoid such disruptions.
Contingency Plans
We have prepared contingency plans for the possibility that not all
remediation efforts will succeed. We have documented the events or
scenarios that might significantly impact the delivery of electric service,
including loss of generation, communications, and other conditions that
could result in electric power outages. Our contingency plans are intended
to minimize the potential impact of any of these conditions. The plan,
which was finalized June 30, 1999, includes contingency procedures, tests,
and drills which coincide with the WSCC and North American Electric
Reliability Council (NERC) contingency plans.
TEP performed compliance testing with the first NERC industry
coordinated drill on April 9, 1999, and did not experience any significant
events or difficulties. TEP will perform additional compliance testing to
coincide with the second NERC drill on September 8 and 9, 1999.
<PAGE>
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded net income of $3.7 million or $0.11 per
average share of Common Stock in the second quarter, and a net loss of $1.8
million or $0.06 per share in the first six months of 1999. This compares
with net income of $1.1 million or $0.03 per average share of Common Stock
in the second quarter of 1998, and a net loss of $6.0 million or $0.19 per
share in the first six months of 1998.
The primary factors contributing to higher net income in the second
quarter of 1999 relative to the same period in 1998 were (i) a $2.4 million
reduction in net losses recorded by Millennium's unregulated energy
businesses, (ii) an $8.4 million increase in TEP's retail revenues, and
(iii) a $2.6 million reduction in interest expense recorded by TEP. The
increase in TEP's revenues was due to a 3% increase in average retail
customers and a 3.9% increase in average retail energy consumption during
the second quarter of 1999 relative to the same period in 1998. Lower
interest expense for the period is discussed in Interest Expense below.
The primary factors contributing to the smaller net loss for the first six
months of 1999 relative to the same period in 1998 were (i) a $3.7 million
reduction in net losses recorded by Millennium's unregulated energy
businesses, (ii) a $10.0 million increase in TEP's operating revenues, and
(iii) a $3.6 million reduction in interest expense recorded by TEP. A 21%
increase in wholesale sales contributed to the increase in revenues at TEP
during the first six months of 1999 compared with the same period in 1998.
Lower interest expense for the period is discussed in Interest Expense
below.
Contribution By Business Segment
The table below shows the contributions to our consolidated earnings
and earnings per share by our two business segments, as well as parent
company expenses and inter-company eliminations, for the three and six
months ended June 30, 1999 and 1998:
- --------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
1999 1998 1999 1998
- --------------------------------------------------------------------------
-Millions- -Millions-
Regulated Electric Utility $ 8.4 $ 8.1 $ 7.0 $ 6.5
Unregulated Energy Businesses (3.2) (5.6) (6.0) (9.7)
Parent Company and
Inter-Company Eliminations (1.5) (1.4) (2.8) (2.8)
- --------------------------------------------------------------------------
Consolidated Net Income (Loss) $(3.7) $(1.1) $(1.8) $(6.0)
==========================================================================
These segment results reflect the after-tax amount of interest accrued
on a note payable from UniSource Energy to TEP. This note was provided to
TEP in exchange for the stock of Millennium in January 1998. Regulated
Electric Utility income includes interest income on this note, while
interest expense on this note is shown as a parent company expense.
TEP's regulated electric utility business accounts for substantially
all of UniSource Energy's assets, revenues and net income on an annual
basis. The following discussion is related to TEP's utility operations,
unless otherwise noted. The results of our unregulated energy businesses
are discussed in Results of Unregulated Energy Businesses below.
<PAGE>
Utility Sales and Revenues
Comparisons of TEP's kilowatt-hour sales and electric revenues are
shown below:
Increase/(Decrease)
-------------------
Three Months Ended June 30 1999 1998 Amount Percent
- -------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 1,945,855 1,819,112 126,743 7.0%
Sales for Resale 997,556 1,036,756 (39,200) (3.8)
------- --------- ------ ---
Total 2,943,411 2,855,868 87,543 3.1%
========= =========
Electric Revenues (000):
Retail Customers $159,111 $150,735 $ 8,376 5.6%
Sales for Resale 30,872 28,951 1,921 6.6
------ ------ ----- ---
Total $189,983 $179,686 $10,297 5.7%
======== ========
Increase/(Decrease)
-------------------
Six Months Ended June 30 1999 1998 Amount Percent
- ------------------------ ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 3,608,399 3,609,421 (1,022) 0.0%
Sales for Resale 2,176,842 1,886,888 289,954 15.4
--------- --------- -------- ----
Total 5,785,241 5,496,309 288,932 5.3%
========= =========
Electric Revenues (000):
Retail Customers $287,888 $288,884 $ (996) (0.3)%
Sales for Resale 62,731 51,805 10,926 21.1
------ ------ ------ ----
Total $350,619 $340,689 $ 9,930 2.9%
======== ========
TEP's kWh sales to retail customers increased by 7% in the second
quarter of 1999 compared with the same period in 1998. The retail kWh
sales increase was due to a 3.0% increase in the number of retail customers
and a 3.9% increase in average retail energy consumption. A 35% increase
in cooling degree days contributed to the increase in customer demand for
power. Revenues from sales to retail customers increased $8.4 million, or
5.6%, in the second quarter of 1999 compared with the same period in 1998
despite a 1.1% rate decrease which was effective July 1, 1998. For the
first six months of 1999, kWh sales to retail customers remained flat
compared with the same period in 1998 due primarily to mild weather
conditions in the first quarter of 1999. Retail revenues decreased
slightly due to the 1.1% rate decrease noted above.
TEP makes sales for resale on both a firm and interruptible basis to
the extent TEP's generating capacity is not needed for providing energy to
TEP's retail customers. TEP also enters into short-term energy sale
transactions (under one-year) that are offset by similar purchase
transactions. Rates for short-term energy sales are typically
substantially below rates determined on a fully allocated cost of service
basis, but, in all instances, rates exceed the level necessary to recover
fuel and other variable costs.
Sales for Resale decreased 3.8% in the second quarter of 1999 from the
same period in 1998. The decrease reflected lower availability of energy
for resale because of scheduled maintenance during the 1999 quarter at the
Navajo, Four Corners, and Springerville generating stations. Despite lower
sales, higher regional wholesale energy prices resulted in a 6.6% increase
in revenues from Sales for Resale. The higher prices and limited available
capacity resulted from a number of coal and nuclear generators being down
for scheduled maintenance. Additionally, mild weather in the Northwest
during the second quarter delayed snowmelt and reduced typical
hydroelectric output. The 15.4% increase in kWh sales for the first six
months of 1999 from the same period in 1998 reflected increased wholesale
trading activity. Revenues from Sales for Resale were 21% higher during
the first six months of 1999 relative to the same period in 1998 due to
higher sales volume and higher wholesale prices as described above.
<PAGE>
Operating Expenses
Operating expenses remained constant as a percentage of revenues for
the quarter and six months ended June 30,1999. Total Operating
Expenses increased 4.6% in the second quarter of 1999 compared with the same
period last year. The increase was due primarily to a 7.4% increase in Fuel
and Purchased Power expense that resulted from higher sales and higher
prices for energy purchased. The increase was also due to significantly
higher Maintenance and Repair expense that resulted from generation
maintenance activities during the second quarter of 1999. These
increases were partially offset by a decrease in Depreciation and
Amortization expense resulting from the completion of amortization of
certain Springerville Unit 2 costs in the first quarter of 1999.
Total Operating Expenses increased 2.6% in the first six months of
1999 compared with the same period in the prior year. The increase was due
primarily to higher Fuel and Purchased Power expenses and higher
Maintenance and Repair expenses. The increase was partially offset by
higher amortization of the Springerville Unit 1 Allowance contra-asset.
Other Income (Deductions)
Interest Income
TEP's income statements for the quarters ended June 30, 1999 and 1998
include $2.6 million and $2.3 million, respectively, of interest income on
the promissory note TEP received from UniSource Energy in exchange for the
transfer of its stock in Millennium. On UniSource Energy's consolidated
income statement, this income is eliminated as an inter-company
transaction. For the six months ended June 30, 1999 and 1998, the interest
income on the promissory note was $5.1 million and $4.6 million,
respectively.
Lower interest income for the quarter ended June 30, 1999 and the
first six months of 1999 was due primarily to lower cash balances. See
Liquidity and Capital Resources below.
Income Taxes
For the second quarter and six months ended June 30, 1999, both
UniSource Energy and TEP recorded income tax expense rather than income tax
benefits in Other Income. Income tax benefits recorded in 1998 resulted
from the recognition of capital loss carryforwards. See Note 6. Income
Taxes in the Notes to Condensed Consolidated Financial Statements.
Income (Losses) from Unregulated Energy Businesses
Our unregulated energy businesses contributed a net loss of $3.2
million for the second quarter ended June 30, 1999, compared with a net
loss of $5.6 million in the second quarter of 1998. For the six months
ended June 30, 1999 and 1998, our unregulated energy businesses reported
losses of $6.0 million and $9.7 million respectively. See Note 3 of Notes
To Condensed Consolidated Financial Statements and Results of Unregulated
Energy Businesses, below for more information on the results of this
business segment.
Interest Expense
Interest expense decreased by approximately $2.6 million and $3.6 million
in the second quarter and the first six months of 1999 compared with the
same periods in 1998, respectively, due primarily to (i) reductions in long
term debt, and (ii) higher interest expense in 1998 due to interest
payments on two bond issues for up to 75 days before the redemption of old
bonds. Additionally, average interest rates on variable rate debt were 50
basis points lower for both the second quarter and first six months of 1999
relative to the prior year periods.
<PAGE>
RESULTS OF UNREGULATED ENERGY BUSINESSES
- ----------------------------------------
The table below provides a breakdown by Millennium-owned subsidiary of
the after tax net income/(losses) recorded for the three months and six
months ended June 30, 1999 and 1998.
- -----------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
Subsidiary 1999 1998 1999 1998
- -----------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
AET $ (237) $ (187) $ (611) $ (17)
MEH (73) (5,248) (650) (9,298)
Nations Energy (3,028) (200) (4,970) (404)
Other 158 (14) 258 34
- -----------------------------------------------------------------------
Total Millennium $(3,180) $(5,649) $(5,973) $(9,685)
=======================================================================
AET and Global Solar
Advanced Energy Technologies, Inc. (AET) holds a 50% interest in
Global Solar Energy, L.L.C. (Global Solar), a manufacturer of thin-film
photovoltaic cells. AET's net losses in the second quarter and first
six months of 1999 were due to manufacturing startup-related expenses of
the Tucson-based production facility and the formation of an overseas
affiliate to manufacture thin-film photovoltaic cells in India. Small-
scale manufacturing of thin film photovoltaic cells are expected to
begin in the third quarter of 1999.
MEH and NewEnergy
As of June 30, 1999, MEH held a 50% interest in NewEnergy. NewEnergy
was formed to provide electricity, energy products, services, and
technology-based energy solutions to customers in deregulating energy
markets. NewEnergy was sold to The AES Corporation on July 23, 1999. See
discussion of NewEnergy and the terms of the sale below at Investing and
Financing Activities, Millennium - Unregulated Energy Businesses.
Nations Energy
Nations Energy Corporation (Nations Energy) develops independent power
projects worldwide. The net loss of $3.0 million in the second quarter of
1999 resulted principally from development costs and expenses related to
the exercise of an option to invest in a power project in the Czech
Republic.
DIVIDENDS ON COMMON STOCK
- -------------------------
UniSource Energy
Our ability to pay cash dividends on common stock outstanding depends,
in part, on the cash flow from our subsidiary companies, TEP and
Millennium. TEP is our primary operating subsidiary and comprises
substantially all of UniSource Energy's assets. In December 1998, TEP
declared and paid a $30 million cash dividend to UniSource Energy.
Our Board of Directors may consider the declaration and payment of a
cash dividend to the common shareholders of UniSource Energy during 1999.
We will consider several factors in making this decision, including:
- the capital needs of our affiliates;
- our earnings;
- our business prospects; and
- the impact and status of deregulation in Arizona.
<PAGE>
TEP
In December 1998, TEP declared and paid a dividend of $30 million to
UniSource Energy, its sole shareholder. TEP declared the dividend from
current year (1998) earnings since TEP has an accumulated deficit, rather
than positive retained earnings.
TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that
requires TEP to maintain a minimum level of net worth. As of June 30,
1999, the required minimum net worth was $186 million. TEP's actual net
worth at June 30, 1999 was $237 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of June 30, 1999, TEP was in
compliance with the terms of the Credit Agreement.
The ACC Holding Company Order states that TEP may not pay dividends to
UniSource Energy in excess of 75% of its earnings until TEP's equity ratio
equals 37.5% of total capital (excluding capital lease obligations). As of
June 30, 1999, TEP's equity ratio on that basis was 16.7%. TEP is in
compliance with this order.
In addition to these limitations, the Federal Power Act states that
dividends shall not be paid out of funds properly included in the capital
account. Although the terms of the Federal Power Act are unclear, we
believe that there is a reasonable basis to pay dividends from current year
earnings.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH FLOWS
UniSource Energy
Consolidated cash and cash equivalents decreased by $33.4 million, or
25%, from June 30, 1998 to the June 30, 1999 ending balance of $98.7
million. For the twelve-month period ended June 30, 1999, consolidated net
cash outflows for investing and financing activities exceeded the cash
generated from operating activities.
Net cash flows from operating activities decreased by $19.6 million
in the first six months of 1999 compared with the same period in 1998. The
net decrease resulted from:
- $18.2 million increase in fuel and purchased power payments, due
primarily to sales increases;
- $8.1 million increase in cash receipts from wholesale sales;
- $5.9 million increase in income taxes paid;
- $4.3 million increase in other operations and maintenance costs;
- $11.3 million reduction of cash inflows from net emission allowance
sales which occurred in 1998; and
- no cash outflows for contract termination fees in 1999, compared with
$10 million paid to a coal supplier in 1998.
Total net cash outflows for investing activities increased by $10.9
million during the first six months of 1999 compared with the same period
in 1998 due primarily to the purchase of $14.9 million par value of
Springerville lease debt by TEP.
Total net cash outflows for financing activities increased by $1.9
million in the first six months of 1999 compared with the same period in
1998 due primarily to an increase in payments applied to the principal
balance of the Springerville Unit 1 capital lease obligation.
Our consolidated cash balance, including cash equivalents, at August
11, 1999 was approximately $92 million. We invest cash balances in high-
grade money market securities with an emphasis on preserving the principal
amounts invested.
During the next 12 months, UniSource Energy may require cash to fund
investments in our unregulated energy businesses, to pay interest on the
promissory note from UniSource Energy to TEP, and to pay dividends to
shareholders. We expect our sources of cash to be dividends from our
subsidiaries, primarily TEP. Although no specific offerings are currently
<PAGE>
contemplated, UniSource Energy may also issue debt and/or equity securities
from time to time. If cash flows were to fall short of expectations, we
would reevaluate the investment requirements of our unregulated energy
businesses and/or seek additional financing for those businesses by
unrelated parties.
TEP
Cash and cash equivalents decreased by $26 million, or 25%, from the
June 30, 1998 ending balance of $103.2 million to the March 31, 1999 ending
balance of $77.3 million. For the twelve-month period ended June 30, 1999,
net cash outflows from investing and financing activities exceeded net cash
inflows for operating activities.
Net cash flows from operating activities decreased by $21.1 million in
the first six months of 1999 compared with the same period in 1998. See
UniSource Energy, Cash Flows above for a discussion of factors affecting
net cash flows from operating activities.
Net cash outflows for investing activities decreased $25.4 million in
first six months of 1999 relative to the first six months of 1998.
Although TEP purchased $14.9 million of Springerville Unit 1 Lease debt in
1999, the transfer of Millennium and its $45 million of cash from TEP to
UniSource Energy on January 1, 1998 was reflected as a use of cash on TEP's
statement of cash flows in 1998. The subsidiaries holding that cash were
subsidiaries of TEP at year-end 1997, and became subsidiaries of UniSource
Energy on January 1, 1998. As a consequence, net cash outflows from
investing activities decreased during the first half of 1999 relative to
the same period in 1998.
Net cash outflows for financing activities increased $2.2 million in
1999's first six months over the same period in 1998. The increase was due
primarily to higher scheduled rent payments related to the Springerville
Unit 1 Lease.
TEP's consolidated cash balance, including cash equivalents, at August
11, 1999 was approximately $72.5 million.
TEP expects to generate enough cash flow during the next 12 months to
fund continuing operating activities, construction expenditures, required
debt maturities, and to pay dividends to UniSource Energy. Actual cash
flows may vary from projections if there are changes in wholesale revenues,
changes in short-term interest rates or other factors. If cash flows were
to fall short of our expectations, TEP would use existing cash balances
and, if necessary, borrow from the Revolving Credit Facility.
INVESTING AND FINANCING ACTIVITIES
- ----------------------------------
UniSource Energy
Loans and Guarantees
As described below, UniSource Energy sold its interest in NewEnergy on
July 23, 1999. Pursuant to the sale, UniSource Energy will continue to
provide guarantees on certain of NewEnergy's transactions. See Note 3.
Unregulated Energy Businesses in the Notes to Condensed Consolidated
Financial Statements and Sale of NewEnergy, Inc. below.
TEP
Capital Expenditures
TEP's capital expenditures for the three months and six months ended
June 30, 1999 were $25.8 and $41.3 million, respectively. TEP's capital
budget for the year ending December 31, 1999 is approximately $90 million.
These authorized expenditures include costs for TEP to comply with current
federal and state environmental regulations. All of these estimates are
subject to continuing review and adjustment. Actual construction
expenditures may be different from budgeted amounts due to changes in
business conditions, construction schedules, environmental requirements,
and changes to our business arising from retail competition. TEP plans to
fund these expenditures through internally generated cash flow.
<PAGE>
TEP Credit Agreement
As of June 30, 1999 and as of August 11, 1999, TEP had no borrowings
outstanding under its $100 million Revolving Credit Facility.
TEP is required by its Credit Agreement to maintain certain financial
covenants including (a) a minimum Consolidated Tangible Net Worth equal to
the sum of $133 million plus 40% of cumulative Consolidated Net Income
since January 1, 1997, (b) a minimum Cash Coverage Ratio ranging from 1.40
in 1999 and gradually increasing to 1.55 in 2002, and (c) a maximum
Leverage Ratio ranging from 6.80 in 1999 and gradually decreasing to 6.20
in 2002. TEP is in compliance with each of these covenants.
Springerville Common Facilities Lease
Under the terms of the Springerville Common Facilities lease
agreement, the secured notes underlying this lease must be refinanced or
refunded by December 31, 1999 in order to avoid a special event of loss
under the lease. If a special event of loss were to occur, TEP would be
required to repurchase the facilities for an amount equal to the higher of
the stipulated loss value of $144 million or the fair market value of the
facilities. Upon such purchase, the lease would be terminated. Based on
the current amortization schedule for these notes, a principal amount of
approximately $70 million will be outstanding as of December 31, 1999.
Interest on the lease notes is currently paid at a variable rate of
interest equal to the Federal Funds rate plus 0.625%. TEP intends, and
believes it has the ability, to refinance the underlying debt on these
leases in 1999.
Millennium -- Unregulated Energy Businesses
-------------------------------------------
Sale of NewEnergy, Inc.
On July 23, 1999, MEH sold its 50% ownership in NewEnergy to The AES
Corporation (AES) for approximately $50 million in consideration,
consisting of:
- Shares of AES common stock valued at $27.0 million as of July 23,
1999; and
- Two promissory notes issued by NewEnergy totaling $22.8 million. The
notes are secured, bear interest at 9.5%, and $11.4 million of the
principal amount is due July 23, 2000 and the remaining $11.4
million is July 23, 2001.
As part of the agreement, AES repaid a $10 million loan NewEnergy
obtained from an unrelated party that was guaranteed by UniSource Energy.
UniSource Energy will continue to guarantee up to $55.6 million of certain
performance bonds and contractual obligations relating to NewEnergy's
purchases and sales of electricity. AES will replace UniSource Energy as
guarantor no later than October 15, 1999. NewEnergy's repayment obligations
to UniSource Energy, including the guarantees and performance bonds provided
by UniSource Energy, are fully secured. See Note 3. Unregulated
Energy Businesses in the Notes To Condensed Consolidated Financial
Statements.
Prior to closing, AES agreed to extend up to $25 million in credit for
the benefit of NewEnergy. Amounts extended under that facility were
guaranteed by MEH and NEH until the closing, at which time the guarantee
terminated. AES also provided, prior to closing, additional guarantees as
needed to support NewEnergy's business activities.
UniSource Energy will recognize a pre-tax gain of approximately $34
million in the third quarter of 1999 on the transaction. Proceeds of the
NewEnergy sale will be available for reinvestment in other affiliates or
for payment as a dividend to UniSource Energy.
Capital Requirements
Our Unregulated Energy Businesses owned by Millennium require
significant amounts of capital and we expect these needs to continue in the
near future. The unregulated energy businesses had actual capital
<PAGE>
expenditures, and investments in and loans to their subsidiaries for the
three months and six months ended June 30, 1999 and 1998 were as follows:
- ----------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
Subsidiary 1999 1998 1999 1998
- ----------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
AET $ - $(1,095) $ (2,870) $ (1,091)
MEH (144) (3,998) (260) (9,982)
Nations Energy 3,547 (78) 745 (101)
Other (88) (81) (112) (136)
- ----------------------------------------------------------------------
Total Millennium $3,315 $(5,252) $ (2,497) $(11,310)
======================================================================
Our forecasted investments in our unregulated energy businesses are
subject to continuing review and revision, and contain assumptions for each
subsidiary regarding investment opportunities, growth strategies, and
potential investments by unaffiliated parties. Actual expenditures may be
higher or lower than these forecasts, or may be allocated to our businesses
in proportions different than planned. Our ability to fund the future
capital requirements of our unregulated business segment will depend to a
great extent on the amount and predictability of the dividends we receive
from our primary operating subsidiary, TEP. Proceeds from the sale of
NewEnergy will also be available for reinvestment in other affiliates
and/or to provide a dividend to UniSource Energy.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Quarterly Report on Form 10-Q contains forward-looking statements
as defined by the Private Securities Litigation Act of 1995. UniSource
Energy and TEP are including the following cautionary statements to make
applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statements
made by or for UniSource Energy or TEP in this Quarterly Report on Form 10-
Q. Forward-looking statements include statements concerning plans,
objectives, goals, strategies, future events or performance and underlying
assumptions and other statements that are not statements of historical
facts. Forward-looking statements may be identified by the use of words
such as "anticipates," "estimates," "expects," "intends," "plans,"
"predicts," "projects," and similar expressions. From time to time, we may
publish or otherwise make available forward-looking statements of this
nature. All such forward-looking statements, whether written or oral, and
whether made by or on behalf of UniSource Energy or TEP, are expressly
qualified by these cautionary statements and any other cautionary
statements which may accompany the forward-looking statements. In
addition, UniSource Energy and TEP disclaim any obligation to update any
forward-looking statements to reflect events or circumstances after the
date of this report.
Forward-looking statements involve risks and uncertainties that could
cause actual results or outcomes to differ materially from those expressed
in the forward-looking statements. We express our expectations, beliefs
and projections in good faith and believe them to have a reasonable basis.
However, we make no assurances that management's expectations, beliefs or
projections will be achieved or accomplished. We have identified the
following important factors that could cause actual results to differ
materially from those discussed in our forward-looking statements. These
may be in addition to other factors and matters discussed in other parts of
this report:
1. Effects of restructuring initiatives in the electric industry and
other energy-related industries.
2. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
3. Changes affecting TEP's cost of providing electrical service including
changes in fuel costs, generating unit operating performance, interest
rates, tax laws, environmental laws, and the general rate of inflation.
4. Changes in governmental policies and regulatory actions with respect
to allowed rates of return, financings, and rate structures.
5. Changes affecting the cost of competing energy alternatives, including
changes in available generating technologies and changes in the cost of
natural gas.
6. Changes in accounting principles or the application of such principles
to UniSource Energy or TEP.
<PAGE>
7. Y2K disruptions resulting from unidentified or unremediated problems
for systems which we control, and Y2K disruptions resulting from systems
or parties which we do not control.
- --------------------------------------------------------------------------------
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The information contained in this Item updates, and should be read in
conjunction with, information included in Part II, Item 7A in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998, in
addition to the interim condensed consolidated financial statements and
accompanying notes presented in Items 1 and 2 of this Form 10-Q.
See Item 2- Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of
Operations, Market Risk, Foreign Currency Exchange Risk.
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
- --------------------------------------------------------------------------
TAX ASSESSMENTS
See Note 4 of Notes to Condensed Consolidated Financial Statements,
Tax Assessments.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------
The Company conducted its annual meeting of shareholders on May 21,
1999. At that meeting, the shareholders of the Company elected members of
the Board of Directors.
The total votes were as follows:
Election of Directors Against Broker
For or Withheld Abstain Non-Votes
--- ----------- ------- ---------
Ira R. Adler 28,746,934 736,487 -- --
Larry W. Bickle 28,750,099 733,322 -- --
Elizabeth T. Bilby 28,727,812 755,609 -- --
Harold W. Burlingame 28,760,557 722,864 -- --
Jose L. Canchola 28,704,402 779,019 -- --
John L. Carter 28,761,175 722,246 -- --
Daniel W. L. Fessler 28,727,079 756,342 -- --
John A. Jeter 28,731,606 751,815 -- --
R. B. O'Rielly 28,715,840 767,581 -- --
James S. Pignatelli 28,743,173 740,248 -- --
Martha R. Seger 28,724,977 758,444 -- --
H. Wilson Sundt 28,734,509 748,912 -- --
ITEM 5. - OTHER INFORMATION
- -------------------------------------------------------------------------
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges for
TEP:
12 Months Ended
---------------
June 30, December 31,
1999 1998
---- ----
Ratio of Earnings to 1.38 1.35
Fixed Charges
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a) Exhibits.
-- See Exhibit Index.
(b) Reports on Form 8-K.
The Company and TEP filed the following current reports on Form 8-K
during the quarter ended June 30, 1999:
<PAGE>
UniSource Energy Corporation and Tucson Electric Power Company
- Form 8-K dated June 18,1999 (filed June 21, 1999), reporting on TEP's
Settlement Agreement filed with the ACC regarding the implementation of
retail electric competition and removal of an ACC Commissioner.
- Form 8-K dated June 25, 1999 (filed June 28, 1999), reporting on the
sale of NewEnergy, Inc., appointment of an ACC Commissioner, and the
procedural order schedule related to holding hearings and public
meetings necessary for the ACC to approve the Settlement Agreement.
<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
each registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized. The signature for each
undersigned company shall be deemed to relate only to matters having
reference to such company or its subsidiary.
UNISOURCE ENERGY CORPORATION
----------------------------
(Registrant)
Date: August 16, 1999 Ira R. Adler
--------------------------------------
Ira R. Adler
Executive Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: August 16, 1999 Ira R. Adler
--------------------------------------
Ira R. Adler
Executive Vice President and Principal
Financial Officer
<PAGE>
EXHIBIT INDEX
11 - Statement re computation of per share earnings - UniSource
Energy.
12 - Computation of Ratio of Earnings to Fixed Charges - TEP.
15 - Letter regarding unaudited interim financial information.
27a - Financial Data Schedule - TEP.
27b - Financial Data Schedule - UniSource Energy.
UNISOURCE ENERGY CORPORATION
EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE
Three Months Ended
June 30,
1999 1998
------ ------
- Thousands of Dollars -
(except per share data)
BASIC EARNINGS PER SHARE:
Net Income $3,708 $1,058
Average Shares of Common Stock Outstanding 32,316 32,138
--------- --------
Basic Earnings Per Share $ 0.11 $ 0.03
========= ========
DILUTED EARNINGS PER SHARE:
Net Income $3,708 $1,058
Average Shares of Common Stock Outstanding 32,316 32,138
Effect of Dilutive Securities:
Warrants - 127
Options and Stock Issuable under Employee Benefit
Plans 335 129
--------- --------
Total Shares 32,651 32,394
--------- --------
Diluted Earnings Per Share $ 0.11 $ 0.03
========= ========
4.6 million of the 7.6 million warrants outstanding are exercisable into
TEP common stock. However, the dilutive effect is the same as it would be if
the warrants were exercisable into UniSource Energy Common Stock.
UNISOURCE ENERGY CORPORATION
EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE
Six Months Ended
June 30,
1999 1998
------ ------
- Thousands of Dollars -
(except per share data)
BASIC EARNINGS PER SHARE:
Net Income (Loss) $(1,820) $(5,977)
Average Shares of Common Stock Outstanding 32,301 32,138
--------- --------
Basic Earnings Per Share $ (0.06) $ (0.19)
========= ========
DILUTED EARNINGS PER SHARE:
Net Income (Loss) $(1,820) $(5,977)
Average Shares of Common Stock Outstanding 32,301 32,138
Effect of Dilutive Securities:
Warrants - -
Options and Stock Issuable Under Employee Benefit
Plans - -
--------- --------
Total Shares 32,515 32,138
--------- --------
Diluted Earnings Per Share $ (0.06) $ (0.19)
========= ========
4.6 million of the 7.6 million warrants outstanding are exercisable into
TEP common stock. However, the dilutive effect is the same as it would be if
the warrants were exercisable into UniSource Energy Common Stock.
<TABLE>
Exhibit 12
TUCSON ELECTRIC POWER COMPANY
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(IN THOUSANDS)
12 Months Ended
----------------
Jun. 30, Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31,
1999 1998 1997 1996 1995 1994
------- -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
FIXED CHARGES:
Interest on Long-Term Debt (1) $68,891 $72,672 $66,247 $59,836 $69,174 $69,353
Other Interest (2) $13,009 $13,207 $9,640 $11,721 $9,113 $7,591
Interest on Capital Lease Obligations (3) $83,727 $81,823 $83,019 $84,383 $83,986 $82,511
------- ------- ------- ------- ------- -------
TOTAL FIXED CHARGES $165,627 $167,702 $158,906 $155,940 $162,273 $159,455
NET INCOME $42,246 $41,676 $83,572 $120,852 $54,905 $20,740
ADD (DEDUCT):
Income Taxes - Operating Expense $18,670 $18,372 $19,297 $9,795 $8,920 ($91)
Income Taxes - Other $2,057 ($794) ($41,401) ($91,950) ($29,356) ($4,820)
Total Fixed Charges $165,627 $167,702 $158,906 $155,940 $162,273 $159,455
------- -------- -------- -------- -------- ---------
TOTAL EARNINGS BEFORE TAXES
AND FIXED CHARGES $228,600 $226,956 $220,374 $194,637 $196,742 $175,284
RATIO OF EARNINGS TO FIXED CHARGES 1.380 1.353 1.387 1.248 1.212 1.099
(1) Amounts have been restated for years ended 1996 and 1997 to conform to current year's
presentation.
(2) Excludes recognition of Allowance for Borrowed Funds Used During Construction.
(3) Capital Lease Interest Paid from Statement of Cash Flows.
</TABLE>
<PAGE>
<PAGE>
Exhibit No. 15
August 12, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Commissioners:
We are aware that our report dated August 12, 1999 on our
review of interim financial information of UniSource
Energy Corporation (the Company) and Tucson Electric Power
Company (TEP) for the period ended June 30, 1999 and
included in the Company's and TEP's quarterly report on
Form 10-Q for the quarter then ended is incorporated by
reference in the Company's Registration Statements on Form
S-8 (Nos. 333-43765, 333-43767 and 333-43769, 333-53309,
333-53333 and 333-53337), on Form S-3 (No. 333-31043), and
on Form S-4 (No. 333-60809) and in Amendment No. 1 to
TEP's Registration Statement on Form S-4 (No. 333-64143).
Yours very truly,
PricewaterhouseCoopers LLP
<TABLE> <S> <C>
<ARTICLE> UT
<CIK> 0000100122
<NAME> TUCSON ELECTRIC POWER COMPANY
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,905,572
<OTHER-PROPERTY-AND-INVEST> 80,272
<TOTAL-CURRENT-ASSETS> 254,714
<TOTAL-DEFERRED-CHARGES> 300,717
<OTHER-ASSETS> 70,132
<TOTAL-ASSETS> 2,611,407
<COMMON> 640,644
<CAPITAL-SURPLUS-PAID-IN> 0
<RETAINED-EARNINGS> (403,315)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 237,329
0
0
<LONG-TERM-DEBT-NET> 1,136,320
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 48,603
0
<CAPITAL-LEASE-OBLIGATIONS> 867,302
<LEASES-CURRENT> 18,444
<OTHER-ITEMS-CAPITAL-AND-LIAB> 303,409
<TOT-CAPITALIZATION-AND-LIAB> 2,611,407
<GROSS-OPERATING-REVENUE> 350,619
<INCOME-TAX-EXPENSE> 1,399
<OTHER-OPERATING-EXPENSES> 292,795
<TOTAL-OPERATING-EXPENSES> 294,194
<OPERATING-INCOME-LOSS> 56,425
<OTHER-INCOME-NET> 6,558
<INCOME-BEFORE-INTEREST-EXPEN> 62,983
<TOTAL-INTEREST-EXPENSE> 55,948
<NET-INCOME> 7,035
0
<EARNINGS-AVAILABLE-FOR-COMM> 7,035
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> 31,296
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> UT
<CIK> 0000941138
<NAME> UNISOURCE ENERGY CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,905,572
<OTHER-PROPERTY-AND-INVEST> 128,268
<TOTAL-CURRENT-ASSETS> 269,764
<TOTAL-DEFERRED-CHARGES> 300,717
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 2,604,321
<COMMON> 641,225
<CAPITAL-SURPLUS-PAID-IN> 0
<RETAINED-EARNINGS> (395,814)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 245,411
0
0
<LONG-TERM-DEBT-NET> 1,136,320
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 48,603
0
<CAPITAL-LEASE-OBLIGATIONS> 867,302
<LEASES-CURRENT> 18,444
<OTHER-ITEMS-CAPITAL-AND-LIAB> 288,241
<TOT-CAPITALIZATION-AND-LIAB> 2,604,321
<GROSS-OPERATING-REVENUE> 350,480
<INCOME-TAX-EXPENSE> 1,399
<OTHER-OPERATING-EXPENSES> 292,795
<TOTAL-OPERATING-EXPENSES> 294,194
<OPERATING-INCOME-LOSS> 56,286
<OTHER-INCOME-NET> (2,158)
<INCOME-BEFORE-INTEREST-EXPEN> 54,128
<TOTAL-INTEREST-EXPENSE> 55,948
<NET-INCOME> (1,820)
0
<EARNINGS-AVAILABLE-FOR-COMM> (1,820)
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> 27,331
<EPS-BASIC> (.06)
<EPS-DILUTED> (.06)
</TABLE>
