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 September 30, 1999
OR
[ ] 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 November 8, 1999, 32,339,606 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.
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
of Income .....................................................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..................................................21
Future Generating Resources...................................22
Impact of the Year 2000 on Computer
Systems and Applications.....................................22
Results of Operations...........................................24
Contribution by Business Segment..............................24
Utility Sales and Revenues....................................25
Operating Expenses............................................26
Other Income (Deductions).....................................26
Interest Expense..............................................26
Results of Unregulated Energy Businesses........................27
AET and Global Solar..........................................27
MEH and NewEnergy.............................................27
Nations Energy................................................27
Dividends on Common Stock
UniSource Energy..............................................28
TEP...........................................................28
Liquidity and Capital Resources
Cash Flows
UniSource Energy............................................28
TEP.........................................................29
Investing and Financing Activities
UniSource Energy
Loans and Guarantees.......................................30
TEP
Capital Expenditures.......................................30
TEP Credit Agreement.......................................30
Springerville Common Facilities Leases.....................30
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.................................32
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments.................................................33
Item 5. -- Other Information
Additional Financial Data.......................................33
Item 6. -- Exhibits and Reports on Form 8-K.....................33
Signature Page...................................................34
Exhibit Index....................................................35
DEFINITIONS
The abbreviations and acronyms used in the 1999 Third 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.
Cooling Degree Days. Calculated by subtracting 75 from the average of the
high and low daily temperatures.
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 which is
50% owned by AET and 50% owned by ITN.
IRS................. Internal Revenue Service.
Irvington........... Irvington Generating Station.
ITC................. Investment tax credit.
ITN................. ITN Energy Systems, Inc., an unaffiliated company
which owns 50% of Global Solar.
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.
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.
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
September 30, 1999, and the related condensed consolidated statements of
income and of cash flows for each of the three-month and nine-month periods
ended September 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 reviews, 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
condensed consolidated balance sheet as of December 31, 1998, is fairly
stated in all material respects in relation to the consolidated balance
sheet from which it has been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
November 10, 1999
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 UniSource Energy's 1998 Form 10-K.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $198,608 $196,398
Sales for Resale 66,083 56,831
--------- ---------
Total Operating Revenues 264,691 253,229
--------- ---------
Operating Expenses
Fuel and Purchased Power 103,604 94,705
Capital Lease Expense 25,455 25,469
Amortization of Springerville Unit 1 Allowance (8,729) (7,631)
Other Operations 27,621 24,980
Maintenance and Repairs 5,940 8,172
Depreciation and Amortization 20,734 22,033
Taxes Other Than Income Taxes 12,054 12,594
Income Taxes 22,002 18,297
--------- ---------
Total Operating Expenses 208,681 198,619
--------- ---------
Operating Income 56,010 54,610
--------- ---------
Other Income (Deductions)
Income Taxes (14,328) (4,535)
Interest Income 2,222 3,075
Gain on the Sale of NewEnergy 34,651 -
Unregulated Energy Businesses 92 9,259
Other 1,028 536
--------- ---------
Total Other Income (Deductions) 23,665 8,335
--------- ---------
Interest Expense
Long-Term Debt 16,662 18,591
Interest Imputed on Losses Recorded at Present Value 8,747 8,544
Other 2,597 2,137
--------- ---------
Total Interest Expense 28,006 29,272
--------- ---------
Net Income $ 51,669 $ 33,673
========= =========
Average Shares of Common Stock Outstanding (000) 32,332 32,174
========= =========
Basic Earnings per Share $ 1.60 $ 1.05
========= =========
Diluted Earnings per Share $ 1.58 $ 1.05
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $486,357 $485,137
Sales for Resale 128,814 108,636
--------- ---------
Total Operating Revenues 615,171 593,773
--------- ---------
Operating Expenses
Fuel and Purchased Power 219,391 199,798
Capital Lease Expense 76,834 77,805
Amortization of Springerville Unit 1 Allowance (26,188) (22,892)
Other Operations 78,016 78,408
Maintenance and Repairs 30,244 27,327
Depreciation and Amortization 64,777 67,479
Taxes Other Than Income Taxes 36,400 38,154
Income Taxes 23,401 19,398
--------- ---------
Total Operating Expenses 502,875 485,477
--------- ---------
Operating Income 112,296 108,296
--------- ---------
Other Income (Deductions)
Income Taxes (13,495) 4,378
Interest Income 5,526 8,315
Gain on the Sale of NewEnegy 34,651 -
Unregulated Energy Businesses (7,139) (6,954)
Other 1,964 2,480
--------- ---------
Total Other Income (Deductions) 21,507 8,219
--------- ---------
Interest Expense
Long-Term Debt 49,784 55,494
Interest Imputed on Losses Recorded at Present Value 26,243 25,634
Other 7,927 7,691
--------- ---------
Total Interest Expense 83,954 88,819
--------- ---------
Net Income $ 49,849 $ 27,696
========= =========
Average Shares of Common Stock Outstanding (000) 32,309 32,150
========= =========
Basic Earnings per Share $ 1.54 $ 0.86
========= =========
Diluted Earnings per Share $ 1.53 $ 0.86
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $507,319 $494,694
Cash Receipts from Sales for Resale 118,845 101,679
Fuel and Purchased Power Costs Paid (201,317) (180,613)
Wages Paid, Net of Amounts Capitalized (53,356) (51,209)
Payment of Other Operations and Maintenance Costs (78,711) (68,435)
Capital Lease Interest Paid (81,066) (80,837)
Taxes Paid, Net of Amounts Capitalized (61,804) (61,732)
Interest Paid, Net of Amounts Capitalized (60,638) (57,193)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (6,170) (3)
Emission Allowance Inventory Sales 75 11,368
Interest Received 6,527 7,880
Transfer of Tax Settlement to Escrow Account (22,403) -
Other 5,020 (1,606)
--------- ---------
Net Cash Flows - Operating Activities 72,321 103,993
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (65,743) (56,367)
Investments in and Loans to Unregulated
Energy Businesses (5,505) (27,103)
Sale of Interest in Unregulated Energy Businesses 4,041 20,000
Sale of Securities 27,516 -
Purchase of Springerville Lease Debt (26,768) -
Other Investments - Net 403 1,788
--------- ---------
Net Cash Flows - Investing Activities (66,056) (61,682)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 1,977 99,014
Payments to Retire Long-Term Debt (1,725) (99,472)
Payments to Retire Capital Lease Obligations (22,338) (17,178)
Other 2,312 (6,401)
--------- ---------
Net Cash Flows - Financing Activities (19,774) (24,037)
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents (13,509) 18,274
Cash and Cash Equivalents, Beginning of Year 145,167 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $131,658 $164,530
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 49,849 $ 27,696
Adjustments to Reconcile Net Income
to Net Operating Cash Flows
Depreciation and Amortization Expense 64,777 67,479
Deferred Income Taxes and Investment Tax Credit 32,924 14,768
Lease Payments Deferred 3,707 4,127
Amortization of Regulatory Assets & Liabilities,
Net of Interest Imputed on Losses Recorded at
Present Value 55 2,742
Deferred Contract Termination Fee 2,885 (7,115)
Unremitted Losses of Unconsolidated
Subsidiaries 3,209 6,373
Gain on Sale of NewEnergy (34,651) -
Emission Allowances 75 11,368
Other 1,060 1,842
Changes in Assets and Liabilities which Provided(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable (24,688) (34,543)
Tax Settlement Deposit (22,450) -
Materials and Fuel (5,949) (3,405)
Accounts Payable 7,031 6,711
Taxes Accrued 14,427 14,610
Other Current Assets and Liabilities (12,590) (7,219)
Other Deferred Assets and Liabilities (7,350) (1,441)
--------- ---------
Net Cash Flows - Operating Activities $ 72,321 $103,993
========= =========
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
September 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,286,101 $2,263,871
Utility Plant Under Capital Leases 886,901 886,902
Construction Work in Progress 92,018 74,050
----------- -----------
Total Utility Plant 3,265,020 3,224,823
Less Accumulated Depreciation and Amortization (1,090,210) (1,051,994)
Less Accumulated Amortization of Capital Leases (100,442) (85,826)
Less Springerville Unit 1 Allowance (171,468) (171,413)
----------- -----------
Total Utility Plant - Net 1,902,900 1,915,590
----------- -----------
Investments and Other Property 139,366 110,318
----------- -----------
Current Assets
Cash and Cash Equivalents 131,658 145,167
Accounts Receivable 95,538 70,850
Materials and Fuel 43,433 37,040
Note Receivable 11,400 -
Deferred Income Taxes - Current 15,597 14,683
Tax Settlement Deposit 22,450 -
Other 26,533 26,867
----------- -----------
Total Current Assets 346,609 294,607
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 146,372 152,111
Deferred Springerville Generation Costs 95,237 102,211
Deferred Lease Expense 9,264 9,877
Other Regulatory Assets 16,210 18,886
Deferred Debits - Other 30,954 30,443
----------- -----------
Total Deferred Debits 298,037 313,528
----------- -----------
Total Assets $2,686,912 $2,634,043
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
CAPITALIZATION AND OTHER LIABILITIES - Thousands of Dollars -
Capitalization
Common Stock $ 641,366 $ 640,640
Accumulated Deficit (344,145) (393,994)
----------- -----------
Common Stock Equity 297,221 246,646
Capital Lease Obligations 852,529 889,543
Long-Term Debt 1,135,820 1,184,423
----------- -----------
Total Capitalization 2,285,570 2,320,612
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 37,045 11,647
Current Maturities of Long-Term Debt 48,603 1,725
Accounts Payable 39,626 32,595
Interest Accrued 43,561 70,771
Taxes Accrued 41,594 27,167
Accrued Employee Expenses 13,162 16,730
Other 5,880 6,705
----------- -----------
Total Current Liabilities 229,471 167,340
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 92,090 61,891
Deferred Investment Tax Credits Regulatory Liability 8,336 10,436
Emission Allowance Gain Regulatory Liability 31,376 31,335
Other 40,069 42,429
----------- -----------
Total Deferred Credits and Other Liabilities 171,871 146,091
----------- -----------
Total Capitalization and Other Liabilities $2,686,912 $2,634,043
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
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 TEP's 1998 Form 10-K.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $198,673 $196,449
Sales for Resale 66,083 56,831
--------- ---------
Total Operating Revenues 264,756 253,280
--------- ---------
Operating Expenses
Fuel and Purchased Power 103,604 94,705
Capital Lease Expense 25,455 25,469
Amortization of Springerville Unit 1 Allowance (8,729) (7,631)
Other Operations 27,621 24,980
Maintenance and Repairs 5,940 8,172
Depreciation and Amortization 20,734 22,033
Taxes Other Than Income Taxes 12,054 12,594
Income Taxes 22,002 18,297
--------- ---------
Total Operating Expenses 208,681 198,619
--------- ---------
Operating Income 56,075 54,661
--------- ---------
Other Income (Deductions)
Income Taxes (1,494) (1,924)
Interest Income 1,974 3,075
Interest Income-Note Receivable from UniSource Energy 2,506 2,352
Other 878 482
--------- ---------
Total Other Income (Deductions) 3,864 3,985
--------- ---------
Interest Expense
Long-Term Debt 16,662 18,591
Interest Imputed on Losses Recorded at Present Value 8,747 8,544
Other 2,597 2,137
--------- ---------
Total Interest Expense 28,006 29,272
--------- ---------
Net Income $ 31,933 $ 29,374
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $486,561 $485,333
Sales for Resale 128,814 108,636
--------- ---------
Total Operating Revenues 615,375 593,969
--------- ---------
Operating Expenses
Fuel and Purchased Power 219,391 199,798
Capital Lease Expense 76,834 77,805
Amortization of Springerville Unit 1 Allowance (26,188) (22,892)
Other Operations 78,016 78,408
Maintenance and Repairs 30,244 27,327
Depreciation and Amortization 64,777 67,479
Taxes Other Than Income Taxes 36,400 38,154
Income Taxes 23,401 19,398
--------- ---------
Total Operating Expenses 502,875 485,477
--------- ---------
Operating Income 112,500 108,492
--------- ---------
Other Income (Deductions)
Income Taxes (3,829) (1,408)
Interest Income 4,991 8,315
Interest Income-Note Receivable from UniSource Energy 7,585 6,978
Other 1,675 2,282
--------- ---------
Total Other Income (Deductions) 10,422 16,167
--------- ---------
Interest Expense
Long-Term Debt 49,784 55,494
Interest Imputed on Losses Recorded at Present Value 26,243 25,634
Other 7,927 7,691
--------- ---------
Total Interest Expense 83,954 88,819
--------- ---------
Net Income $ 38,968 $ 35,840
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $507,319 $494,694
Cash Receipts from Sales for Resale 118,845 101,679
Fuel and Purchased Power Costs Paid (201,317) (180,613)
Wages Paid, Net of Amounts Capitalized (47,929) (48,843)
Payment of Other Operations and Maintenance Costs (72,814) (63,650)
Capital Lease Interest Paid (81,066) (80,837)
Taxes Paid, Net of Amounts Capitalized (61,440) (61,644)
Interest Paid, Net of Amounts Capitalized (60,638) (57,193)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (6,168) (3)
Emission Allowance Inventory Sales 75 11,368
Interest Received 14,799 6,479
Transfer of Tax Settlement to Escrow Account (22,403) -
Other 182 (1,142)
--------- ---------
Net Cash Flows - Operating Activities 87,445 110,295
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (64,245) (56,245)
Transfer of Millennium Cash to UniSource Energy - (45,412)
Purchase of Springerville Lease Debt (26,768) -
Other Investments - Net 1,459 1,420
--------- ---------
Net Cash Flows - Investing Activities (89,554) (100,237)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 1,977 99,014
Payments to Retire Long-Term Debt (1,725) (99,472)
Payments to Retire Capital Lease Obligations (22,316) (17,178)
Other 2,115 (6,269)
--------- ---------
Net Cash Flows - Financing Activities (19,949) (23,905)
--------- ---------
Net Decrease in Cash and Cash Equivalents (22,058) (13,847)
Cash and Cash Equivalents, Beginning of Year 118,236 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $ 96,178 $132,409
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Nine Months Ended
September 30,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 38,968 $ 35,840
Adjustments to Reconcile Net Income to Net
Operating Cash Flows
Depreciation and Amortization Expense 64,777 67,479
Deferred Income Taxes and
Investment Tax Credit 20,324 20,877
Lease Payments Deferred 3,707 4,127
Amortization of Regulatory Assets & Liabilities, Net
of Interest Imputed on Losses Recorded at
Present Value 55 2,742
Deferred Contract Termination Fee 2,885 (7,115)
Unremitted Earnings of Unconsolidated Subsidiaries (456) (753)
Interest Accrued on Note Receivable from UniSource
Energy 1,744 (6,978)
Emission Allowances 75 11,368
Other 4,445 3,196
Changes in Assets and Liabilities which Provided(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable (22,820) (34,624)
Tax Settlement Deposit (22,450) -
Materials and Fuel (5,898) (3,406)
Accounts Payable 7,433 7,632
Taxes Accrued 14,118 14,626
Other Current Assets and Liabilities (12,117) (3,219)
Other Deferred Assets and Liabilities (7,345) (1,497)
--------- ---------
Net Cash Flows - Operating Activities $ 87,445 $110,295
========= =========
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
September 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,286,101 $2,263,871
Utility Plant Under Capital Leases 886,901 886,902
Construction Work in Progress 92,018 74,050
----------- -----------
Total Utility Plant 3,265,020 3,224,823
Less Accumulated Depreciation and Amortization (1,090,210) (1,051,994)
Less Accumulated Amortization of Capital Leases (100,442) (85,826)
Less Springerville Unit 1 Allowance (171,468) (171,413)
----------- -----------
Total Utility Plant - Net 1,902,900 1,915,590
----------- -----------
Investments and Other Property 91,368 62,978
----------- -----------
Note Receivable from UniSource Energy 70,132 79,462
---------- -----------
Current Assets
Cash and Cash Equivalents 96,178 118,236
Interest on Note Receivable from UniSource Energy 7,585 -
Accounts Receivable 97,000 72,239
Materials and Fuel 43,337 36,995
Deferred Income Taxes - Current 15,653 14,820
Tax Settlement Deposit 22,450 -
Other 13,849 14,735
----------- -----------
Total Current Assets 296,052 257,025
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 146,372 152,111
Deferred Springerville Generation Costs 95,237 102,211
Deferred Lease Expense 9,264 9,877
Other Regulatory Assets 16,210 18,886
Deferred Debits - Other 30,954 30,443
----------- -----------
Total Deferred Debits 298,037 313,528
----------- -----------
Total Assets $2,658,489 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1999 1998
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 647,124 $ 646,568
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (371,382) (410,350)
----------- -----------
Common Stock Equity 269,385 229,861
Capital Lease Obligations 852,194 889,543
Long-Term Debt 1,135,820 1,184,423
----------- -----------
Total Capitalization 2,257,399 2,303,827
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 36,975 11,647
Current Maturities of Long-Term Debt 48,603 1,725
Accounts Payable 44,323 35,735
Interest Accrued 43,561 70,771
Taxes Accrued 41,200 27,082
Accrued Employee Expenses 12,864 16,418
Other 5,787 6,705
----------- -----------
Total Current Liabilities 233,313 170,083
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 88,022 70,504
Deferred Investment Tax Credits Regulatory Liability 8,336 10,436
Emission Allowance Gain Regulatory Liability 31,376 31,335
Other 40,043 42,398
----------- -----------
Total Deferred Credits and Other Liabilities 167,777 154,673
----------- -----------
Total Capitalization and Other Liabilities $2,658,489 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
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, without regulatory
recovery, 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 September
30, 1999, if we ceased applying FAS 71 to all of TEP's regulated
operations, we would record an extraordinary loss of approximately $137
million, net of the related deferred income tax benefit of $91 million.
In addition, TEP would immediately recognize, as a reduction to the
extraordinary loss, 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 the present value of future
cash flows. 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.
On September 21, 1999, the ACC approved the final amendments to
the Rules governing retail electric competition in Arizona. The final
amendments did not have a significant impact on the electric
competition rules as previously drafted.
Settlement Agreement
On June 9, 1999, TEP and certain customer groups entered into a
Settlement Agreement (Settlement) related to the implementation of
retail electric competition. The ACC held hearings on TEP's Settlement
in August 1999. On October 26, 1999, the ACC Hearing Officer issued a
recommended opinion and order to approve TEP's Settlement with certain
modifications. The ACC has scheduled an Open Meeting to consider the
Settlement on November 22 and 23, 1999.
Major provisions of the Settlement as recommended by the Hearing
Officer include:
- - Consumer choice for energy supply would begin 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 equal a fixed charge per
kilowatt-hour. It 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 tariff 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 not otherwise recovered through the
fixed charge 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 be required to file a general rate case
including an updated cost-of-service study. Any rate change
resulting from this rate case would be effective no sooner than
June 1, 2005 and would only be made if the changes result 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.
As mentioned above, the ACC Hearing Officer recommended certain
modifications to the Settlement. TEP filed an exception to one of the
recommended modifications related to the proper allocation of stranded
costs between contract customers and non-contract customers. Contract
customers are certain large industrial and mining customers with which
TEP has negotiated non-standard rates approved by the ACC. The
proposed order requires that TEP file a report for approval by the
Director of the Utilities Division that demonstrates how stranded costs
will be collected from customer classes. TEP believes that the
recommendation is unclear as to the methodology to be utilized to
allocate stranded costs to customer classes. If the intent of the
modification in the proposed order is to make a determination that non-
contract customers are picking up an alleged stranded cost shortfall
from contract customers, then TEP strongly disagrees with this proposed
modification. TEP believes that no such subsidization exists.
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 net after-tax extraordinary income primarily as a result of
recognition of 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
is being amortized to income over the tax lives of the related
property. The balance remaining when the Settlement is approved
will be recognized immediately. At September 30, 1999, the Deferred
ITC balance was $8 million.
- - ITC Carryforward: This ITC is generated but not yet claimed on a
tax return, and will be recognized immediately as income based on
our expectation that this ITC will be claimed on future tax returns.
At September 30, 1999, the total ITC Carryforward was $23 million.
Certain other generation expenses such as lease expenses, will be
amortized 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.
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. (AET) which owns 50 percent of
Global Solar Energy, L.L.C. (Global Solar), a developer and
manufacturer of thin-film photovoltaic materials. In November 1999,
an agreement was entered into that changed the ownership structure of
both AET and Global Solar. See Note 3 regarding this agreement;
- - Nations Energy Corporation (Nations Energy) 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.
Selected financial data for our business segments is contained 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
September 30, 1999:
Operating Revenues $264,756 $ 2,933 $(2,998) $264,691
- ----------------------------------------------------------------------
Net Income (Loss):
AET $ (80)
MEH 21,200
Nations Energy (181)
Other Entities 61
--------
Total Net
Income (Loss) $ 31,933 $21,000 $(1,264) $ 51,669
- ----------------------------------------------------------------------
Three months ended
September 30, 1998:
Operating Revenues $253,280 $ 356 $ (407) $253,229
- ----------------------------------------------------------------------
Net Income (Loss):
AET $ (102)
MEH 101
Nations Energy 5,767
Other Entities (68)
--------
Total Net
Income (Loss) $ 29,374 $ 5,698 $(1,399) $ 33,673
- ----------------------------------------------------------------------
Nine months ended
September 30, 1999:
Operating Revenues $615,375 $ 8,161 $(8,365) $615,171
- ----------------------------------------------------------------------
Net Income (Loss):
AET $ (691)
MEH 20,550
Nations Energy (5,151)
Other Entities 319
--------
Total Net
Income (Loss) $ 38,968 $15,027 $(4,146) $ 49,849
- ----------------------------------------------------------------------
Segments
----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Energy
Utility Businesses Eliminations Consolidated
- ----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Nine months ended
September 30, 1998:
Operating Revenues $593,969 $ 1,016 $(1,212) $593,773
- ----------------------------------------------------------------------
Net Income (Loss):
AET $ (119)
MEH (9,197)
Nations Energy 5,363
Other Entities (34)
--------
Total Net
Income (Loss) $ 35,840 $(3,987) $(4,157) $ 27,696
- ----------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
September 30, 1999 $2,658,489 $100,670 $(72,247) $2,686,912
Total Assets,
December 31, 1998 $2,628,583 $ 74,007 $(68,547) $2,634,043
- ----------------------------------------------------------------------
The eliminations include the following:
- - Elimination of the revenues of Millennium's unregulated energy
businesses to show this activity in Unregulated Energy Businesses
in the Other Income (Deductions) section of UniSource Energy's
income statements;
- - Elimination of TEP's Note Receivable and related interest receivable
from UniSource Energy; 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 which were subsequently sold in the third quarter at a slight
gain; and
- - Two promissory notes issued by NewEnergy totaling $22.8 million.
The notes are secured by AES stock, bear interest at 9.5%, and $11.4
million of the principal amount is due July 23, 2000 and July 23,
2001, respectively.
UniSource Energy recognized a pre-tax gain of approximately $35
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. Previously, UniSource Energy provided
guarantees of up to $55.6 million of certain performance bonds and
contractual obligations relating to NewEnergy's purchases and sales of
electricity. On October 1, 1999, termination notices were sent on all
guarantees and the master surety agreement. The effective dates of
all terminations have passed, except for one guarantee up to the
amount of $6.5 million, which has a termination date of November 29,
1999. The termination of the guarantees means that UniSource Energy
will not incur any additional guarantee liability under these
agreements but does not extinguish any obligation existing prior to
the time of termination. The $6.5 million guarantee provided by
UniSource Energy is fully secured.
MEH 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 losses related to NewEnergy and NEV SW of $0.4
million and $9.6 million for the nine months ended September 30, 1999
and 1998, respectively.
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.
Agreement to Acquire Additional Interest in Global Solar
Millennium currently owns a 50% interest in Global Solar through
its subsidiary AET. The other 50% is owned by ITN Energy Systems, Inc.
(ITN). On November 1, 1999, Millennium and ITN entered into an
Agreement (Agreement) pursuant to which ITN will contribute its 50%
ownership interest in Global Solar to AET, in exchange for a 33.3%
ownership in AET. ITN has agreed to transfer its rights to certain
assets and proprietary and intellectual property, including thin-film
battery technology, to AET. Under the Agreement, Millennium retains a
66.7% interest in AET, and will contribute to AET up to $10 million in
additional equity and a $4 million working capital loan, upon the
occurrence of certain agreed-upon production and business milestones.
As of November 12, 1999, Millennium has funded $1.1 million of working
capital under this agreement.
NOTE 4. TAX ASSESSMENTS
- ------------------------
TEP has been contesting the Coal Sales Assessments and Lease
Assessments, described below, since 1990.
- - Coal Sales Assessments: The ADOR issued sales tax assessments which
alleged that a former TEP subsidiary was liable for sales tax on
gross income from coal sales, transportation and coal-handling
services provided to TEP from November 1985 through May 1996. On
May 31, 1996, the former subsidiary was merged into TEP. Because
TEP now acquires coal directly from unaffiliated companies, we are
not liable for sales tax computed on a basis similar to the
assessments described above after May 31, 1996.
- - Lease Assessments: The ADOR issued sales tax assessments to some
of the lessors of TEP's generation-related facilities and equipment.
Under the indemnification provisions in the lease agreements, we are
required to pay any sales tax assessments owed by the lessors. 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.
Because the applicable sales tax rate went to zero on July 1, 1997,
no additional assessments are expected.
In August 1999, a settlement was reached with the Arizona
Department of Revenue (ADOR) to settle these issues for $47.5 million.
The settlement agreement became effective upon execution by the lessors
of the generating facilities and their trustees subject to the lease
assessment in November 1999. TEP previously paid $25.1 million of the
settlement amount in order to file an appeal in the Arizona courts.
Under the terms of the agreement, the remaining $22.4 million was
deposited into an escrow account for the benefit of the ADOR and the
funds are to be released to the ADOR in 5 equal installments. As of
November 9, 1999, two of the installments had been released to the
ADOR, totaling $9 million. The remaining installments are scheduled to
be paid on January 15, April 15 and September 15, 2000. Interest
expense will be accrued on any payments made after their respective due
dates. This settlement does not result in additional sales tax expense
since we have previously recorded an expense for the amount of the
settlement.
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
September 30, 1999, pre-1992 federal NOL and ITC carryforwards were
approximately $151 million and $23 million, respectively. In addition
to the pre-1992 NOL and ITC which are subject to the limitation, $167
million of federal NOL at September 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, 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 has the ability, to refinance
the underlying debt on these leases in 1999. TEP filed a financing
application with the ACC requesting approval to refinance these leases
in the fourth quarter of 1999. TEP is in negotiations with the owner
participants of the common facilities and expects to complete this
refinancing transaction prior to year-end 1999.
NOTE 6. INCOME TAXES
- ---------------------
The differences between the income tax expense 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 Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Federal Income Tax
Expense at Statutory Rate $30,800 $19,777 $30,361 $14,951
State Income Tax
Expense, Net of Federal
Deduction 4,270 3,049 4,209 2,304
Depreciation Differences
(Flow Through Basis) 1,829 890 2,511 4,349
Capital Loss Carryforwards - - - (4,463)
Investment Tax Credit
Amortization (700) (661) (2,100) (1,806)
Foreign Operations of
Unregulated Energy Businesses (115) 247 1,563 578
Other 246 (470) 352 (893)
-------- --------- -------- ---------
Total Expense for
Federal and State Income
Taxes $36,330 $22,832 $36,896 $15,020
======= ======= ======= =======
TEP
---------------------------------------
Three Months Ended Six Months Ended
September 30, September 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $19,400 $17,358 $23,169 $19,826
State Income Tax Expense,
Net of Federal Deduction 2,689 2,673 3,212 3,054
Depreciation Differences
(Flow Through Basis) 1,829 890 2,511 4,349
Capital Loss Carryforwards - - - (4,463)
Investment Tax Credit
Amortization (700) (661) (2,100) (1,806)
Other 278 (39) 438 (154)
-------- --------- ------- ---------
Total Expense for Federal
and State Income Taxes $23,496 $20,221 $27,230 $20,806
======== ========= ======== =========
Income taxes are included in the income statements as follows:
UniSource Energy
---------------------------------------
Three Months Ended Six Months Ended
September 30, September 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Operating Expenses $22,002 $18,297 $23,401 $19,398
Other Income (Deductions) 585 974 1,010 (1,411)
Unregulated Energy
Businesses 13,743 3,561 12,485 (2,967)
-------- --------- -------- ---------
Total Income Tax Expense $36,330 $22,832 $36,896 $15,020
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---------------------------------------
- Thousands of Dollars -
Operating Expenses $22,002 $18,297 $23,401 $19,398
Other Income (Deductions) 1,494 1,924 3,829 1,408
------- ------- ------- -------
Total Income Tax Expense $23,496 $20,221 $27,230 $20,806
======= ======= ======= =======
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 nine-month periods ended September 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 November 10,
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.
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 third quarter and the first nine 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 third quarter
and first nine 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 and revenues. 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.
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 nine month
periods ended September 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 $51.7 million for the third
quarter of 1999, and net income of $49.8 million for the first nine months
of 1999. This compares with net income of $33.7 million in the third
quarter and net income of $27.7 million for the first nine months of 1998.
The increase in earnings for both the third quarter and the first nine
months of 1999 is due primarily to a gain on the sale of one of our
unregulated energy businesses and strong operating performance by TEP.
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.
In June 1999, TEP filed a Settlement Agreement with the ACC, which, if
approved, will resolve a significant amount of the regulatory uncertainties
and will provide TEP the opportunity to recover 100 percent of its stranded
costs. 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. We 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 an
unregulated energy-related affiliate, NewEnergy, Inc., and recorded 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
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electricity and
related services. 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.
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.
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.
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 and on September
21, 1999, voted to approve the final Rules. The approved Rules include the
following major provisions:
* 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 phase-in schedule requires that customers whose load equals 20
percent of the Affected Utility's total load 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. Three customer classes will have 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 that can aggregate with similar entities
to reach a total load of one 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.
* Competitive Energy Service Provider affiliates of Affected Utilities
would not be permitted to enter another Affected Utility's service
territory until their own territory is open to competition.
* By January 1, 2001, consumer choice will be available to all
customers. TEP, as the regulated local distribution company, will
continue to 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. TEP remains obligated to provide energy
to those customers who do not, or cannot, choose other energy providers.
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.
On April 14, 1999, the ACC authorized a modifcation of its June 1998
order permitting 100% stranded cost recovery without divestiture, 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.
TEP's original stranded cost recovery plan, filed with the ACC in
August 1998, specified divestiture of generation assets as the preferred
method for stranded cost recovery given the available options at that time.
In June 1999, TEP and certain customer groups entered into the Settlement
Agreement now pending before the ACC. See Settlement Agreement on Retail
Competition below.
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 and certain customer groups entered into a
Settlement Agreement (Settlement) related to the implementation of retail
electric competition. The ACC held hearings on TEP's Settlement in August
1999. On October 26, 1999, the ACC Hearing Officer issued a recommended
opinion and order to approve TEP's Settlement with certain modifications.
The ACC has scheduled an Open Meeting to consider the Settlement on November
22 and 23, 1999.
Major provisions of the Settlement as recommended by the Hearing
Officer include:
* Consumer choice for energy supply would begin 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 retail 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 Charge (CTC) components:
* A Fixed CTC component which would equal a fixed charge per kilowatt-
hour. It 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
tariff 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 not otherwise recovered through the fixed charge 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 will be required to file a general rate case
including an updated cost-of-service study. Any rate change
resulting from this rate case would be effective no sooner than
June 1, 2005 and would only be made if the changes result 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.
As mentioned above, the ACC Hearing Officer recommended certain
modifications to the Settlement. TEP filed an exception to one of the
recommended modifications related to the allocation of stranded costs
between contract customers and non-contract customers. Contract customers
are certain large industrial and mining customers with which TEP has
negotiated non-standard rates approved by the ACC. The proposed order
requires that TEP file a report for approval by the Director of the
Utilities Division that demonstrates how stranded costs will be collected
from customer classes. TEP believes that the recommendation is unclear as
to the methodology to be utilized to allocate stranded costs to customer
classes. If the intent of the modification in the proposed order is to
make a determination that non-contract customers are picking up an alleged
stranded cost shortfall from contract customers, then TEP strongly
disagrees with the proposed modification. TEP believes no such
subsidization exists.
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, without regulatory recovery, 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 September 30, 1999, if we ceased
applying FAS 71 to all of TEP's regulated operations, we would record an
extraordinary loss of approximately $137 million, net of the related
deferred income tax benefit of $91 million. In addition, TEP would
immediately recognize, as a reduction to the extraordinary loss, 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 the
present value of future cash flows. 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 net after-tax extraordinary income primarily as a result of
recognition of 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
is being amortized to income over the tax lives of the related
property. The balance remaining when the Settlement is approved
will be recognized immediately. At September 30, 1999, the Deferred
ITC balance was $8 million.
* ITC Carryforward: This ITC is generated but not yet claimed on a tax
return, and will be recognized immediately as income based on our
expectation that this ITC will be claimed on future tax returns. At
September 30, 1999, the total ITC Carryforward was $23 million.
Certain other generation expenses, such as lease expense, will be
amortized 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, reported 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 will be offset, 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 for energy 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.
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.
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 third quarter of 1999 was a gain of
approximately $1.0 million, and for the first nine months of 1999 was a
gain of $746,000.
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.
TEP believes additional peaking resources are needed in Tucson by 2001
to improve local system reliability. To address this need, in the third
quarter of 1999, TEP entered into an agreement to purchase a 75 MW gas
turbine. This peaking unit will be designated as a "must-run generation"
facility. Must-run generating units are those which are required to run in
certain circumstances in order to maintain distribution system reliability
and meet load requirements. TEP expects to spend approximately $28 million
from 1999 through 2001 on this project. We expect this unit to be in
operation by the second quarter of 2001.
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 readiness preparation process on
June 30, 1999. 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 as of November 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 have reviewed 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 completed this process in October
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 installed. The upgraded
release of the underlying software has
also been installed.
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.
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 was
conducted in September and October of
1999.
Accounts Payable, Y2K ready - Remediation completed in
Purchasing, Inventory 1998.
An integrated test was successfully performed for all enterprise
information systems in the third quarter of 1999. The test included 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 continue to work with these vendors to determine
their plans and to investigate any potential impact on us. Major vendors
of our business areas also continue to be reviewed for Y2K compliance.
Millennium Subsidiaries - We have contacted Nations Energy and Global Solar
to determine their state of readiness. These companies will continue to be
monitored to ensure plans are in place to avoid Y2K disruptions.
Costs
From 1996 through September 30, 1999, we have expensed $1.7 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 amount already
expensed, is anticipated 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. TEP has also prepared contingency
plans to mitigate the risk of business function interruptions in the
unlikely case of a date processing related failure in one of our business
computer or communications systems. 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
NERC industry coordinated drills on April 9, 1999, and on September 8-9,
1999, and did not experience any significant events or difficulties.
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded net income of $51.7 million or $1.60 per
average share of Common Stock in the third quarter, and net income of $49.8
million or $1.54 per share in the first nine months of 1999. This compares
with net income of $33.7 million or $1.05 per average share of Common Stock
in the third quarter of 1998, and net income of $27.7 million or $0.86 per
share in the first nine months of 1998.
Net income was $18.0 million higher in the third quarter of 1999 than
in the same period in 1998 due to (i) a gain on the sale of one of
Millennium's unregulated energy businesses and (ii) strong utility
operating performance by TEP. Millennium's net income was $15.3 million
higher in the third quarter of 1999 because of a $20.8 million after-tax
gain from the sale of NewEnergy. This compares with a $5.8 million after-
tax gain in the third quarter of 1998 on the sale of Nations Energy's
interest in a partnership which owned and operated the Coors Brewing
Company power plant. TEP's net income increased $2.5 million in the third
quarter of 1999 because of an improvement in operating income and from
lower interest expense.
Net income was $22.1 million higher for the first nine months of 1999
relative to the same period in 1998 due to the same factors described
above: (i) a gain of the sale of NewEnergy and (ii) strong utility
operating performance by TEP.
Contribution By Business Segment
The table below shows the contributions to our consolidated after-tax
earnings and earnings per share by our two business segments, as well as
parent company expenses and inter-company eliminations, for the three and
nine months ended September 30, 1999 and 1998:
- ---------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- ---------------------------------------------------------------------------
-Millions - -Millions-
Regulated Electric Utility $31.9 $29.4 $39.0 $35.8
Unregulated Energy Businesses 21.0 5.7 15.0 (4.0)
Parent Company and Inter-Company
Eliminations (1.2) (1.4) (4.2) (4.1)
- ---------------------------------------------------------------------------
Consolidated Net Income $51.7 $33.7 $49.8 $27.7
===========================================================================
Parent company results include the after-tax interest expense 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 results include interest income on this note.
TEP's regulated electric utility business accounts for substantially
all of UniSource Energy's assets and revenues. 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. 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.
Utility Sales and Revenues
Comparisons of TEP's kilowatt-hour sales and electric revenues are
shown below:
Increase/(Decrease)
-------------------
Three Months Ended September 30 1999 1998 Amount Percent
- ------------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 2,343,480 2,280,253 63,227 2.8%
Sales for Resale 1,657,115 1,417,787 239,328 16.9
--------- --------- -------
Total 4,000,595 3,698,040 302,555 8.2%
========= ========= =======
Electric Revenues (000):
Retail Customers $198,673 $196,449 $ 2,224 1.1%
Sales for Resale 66,083 56,831 9,252 16.3
------ ------ -----
Total $264,756 $253,280 $11,476 4.5%
======== ======== =======
Increase/(Decrease)
-------------------
Nine Months Ended September 30 1999 1998 Amount Percent
- ------------------------------ ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 5,951,879 5,889,674 62,205 1.1%
Sales for Resale 3,833,957 3,304,675 529,282 16.0
--------- --------- -------
Total 9,785,836 9,194,349 591,487 6.4%
========= ========= =======
Electric Revenues (000):
Retail Customers $486,561 $485,333 $ 1,228 0.3%
Sales for Resale 128,814 108,636 20,178 18.6
------ ------ -----
Total $615,375 $593,969 $21,406 3.6%
======== ======== =======
TEP's kWh sales to retail customers increased by 2.8% in the third
quarter of 1999 compared with the same period in 1998. The retail kWh
sales increase was due to a 2.6% increase in the number of retail
customers. Average retail energy consumption was also up slightly, despite
milder summer temperatures as measured by a 15% reduction in cooling degree
days compared with the third quarter of 1998. Retail revenues increased
only 1.1% in the third quarter of 1999 compared with the same period in
1998, reflecting the impact of the 1.0% rate decrease effective July 1,
1999.
For the first nine months of 1999, kWh sales to retail customers
increased 1.1% compared with the same period in 1998. Mild weather
conditions in both the winter (first quarter 1999) and the summer (third
quarter 1999) reduced customer demand for power and offset the 2.7%
increase in average retail customers for the nine-month period. Retail
revenues were up less than 1.0% for the nine-month period reflecting the
impact of the 1.1% rate decrease effective July 1, 1998 and the 1.0% rate
decrease effective July 1, 1999.
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.
Kilowatt-hour sales for resale increased 16.9% and the related
revenues grew by 16.3% in the third quarter of 1999 compared with the same
period in 1998. Wholesale sales volume increased due to both increased
buy/resale activity as well as an increase in generation available for
resale. In the first nine months of 1999, kWh sales for resale were up
16.0% and the related revenues were 18.6% higher than the same period in
1998. Market prices were slightly higher in the nine months ended
September 30, 1999 than in the prior year period, causing the year-to-date
revenue increase to exceed the volume increase.
Operating Expenses
Operating expenses remained constant as a percentage of revenues for
the third quarter of 1999 compared with the third quarter of 1998. Total
Operating Expenses increased 5.1% in the third quarter of 1999, due
primarily to a 9.4% increase in Fuel and Purchased Power expense that
resulted from higher wholesale energy sales.
Operating expenses were also stable as a percentage of revenues for
the nine months ended September 30, 1999 compared with the same period of
1998. Total Operating Expenses increased 3.6% in the first nine months of
1999. The increase was due primarily to higher Fuel and Purchased Power
expense as well as higher Maintenance and Repair expense for planned
generation maintenance activities in the second quarter of 1999. These
increases were 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 September 30, 1999 and
1998 include $2.5 million and $2.4 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 nine months ended September 30, 1999
and 1998, the interest income on the promissory note was $7.6 million and
$7.0 million, respectively.
Lower interest income for the quarter ended September 30, 1999 and the
first nine months of 1999 was due primarily to lower cash balances. See
Liquidity and Capital Resources below.
Income (Losses) from Unregulated Energy Businesses
Our unregulated energy businesses contributed net income of $21.0
million for the third quarter ended September 30, 1999, compared with net
income of $5.7 million in the third quarter of 1998. For the nine months
ended September 30, 1999 our unregulated businesses reported net income of
$15.0 million compared with a net loss of $4.0 million for the same period
in 1998. 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 $1.3 million and $4.9
million in the third quarter and the first nine 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 the
second quarter of 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 lower in both the third quarter
and first nine months of 1999 relative to the prior year periods.
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 nine
months ended September 30, 1999 and 1998.
- ---------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
Subsidiary 1999 1998 1999 1998
- ---------------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
AET $ (80) $ (102) $ (691) $ (119)
MEH 21,200 101 20,550 (9,197)
Nations Energy (181) 5,767 (5,151) 5,363
Other 61 (68) 319 (34)
- ---------------------------------------------------------------------------
Total Millennium $21,000 $5,698 $15,027 $(3,987)
===========================================================================
AET and Global Solar
Advanced Energy Technologies, Inc. (AET) currently owns a 50%
interest in Global Solar Energy, L.L.C. (Global Solar), a manufacturer
of thin-film photovoltaic cells. In November 1999, an agreement was
entered into that changed the ownership structure of both AET and Global
Solar. See Note 3. Unregulated Energy Businesses in the Notes to
Condensed Consolidated Financial Statements. AET's net losses in the
third quarter and first nine 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 began in the third quarter of 1999.
MEH and NewEnergy
Prior to the third quarter of 1999, MEH held a 50% interest in
NewEnergy, a provider of 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. MEH
recorded an after-tax gain of $20.8 million on the sale of NewEnergy in the
third quarter of 1999. See discussion of NewEnergy and the terms of the
sale below at Investing and Financing Activities, Millennium - Unregulated
Energy Businesses.
The net loss of $9.2 million for the first nine months of 1998
represents NewEnergy's start-up costs, development activities, and costs of
expansion into additional regions of the country.
Nations Energy
Nations Energy Corporation (Nations Energy) develops independent power
projects worldwide. Nations Energy recorded a small net loss in the third
quarter of 1999. This compares to net income of $5.8 million in the third
quarter of 1998, resulting from the sale of its interest in the partnership
which owned and operated the Coors Brewing Company power plant in Golden,
CO.
For the first nine months of 1999, Nations Energy recorded a net loss
of $5.2 million due primarily to development costs and expenses related to
the exercise of an option to invest in a power project in the Czech
Republic. This compares to net income of $5.4 million for the first nine
months of 1998, resulting from the sale of the partnership interest
described above.
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. In the
third quarter of 1999, Millennium paid a $10 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.
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 September 30,
1999, the required minimum net worth was $199 million. TEP's actual net
worth at September 30, 1999 was $269 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of September 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
September 30, 1999, TEP's equity ratio on that basis was 18.5%. 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 from the September
30, 1998 ending balance of $164.5 million to $131.7 million at September
30, 1999. For the twelve-month period ended September 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 $31.7 million in
the first nine months of 1999 compared with the same period in 1998. The
net decrease resulted from the following principal factors:
* $22.4 million transfer of cash to an escrow account related to a tax
settlement (see Note 4 of Notes to Condensed Consolidated Financial
Statements);
* $20.7 million increase in fuel and purchased power payments, due
primarily to sales increases;
* $17.2 million increase in cash receipts from wholesale sales;
* $12.6 million increase in cash receipts from retail customers;
* $10.3 million increase in other operations and maintenance costs,
primarily due to planned generation maintenance activities in the
second quarter of 1999;
* $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.
Net cash used for investing activities totaled $66.1 million during
the first nine months of 1999 compared with $61.7 million during the same
period in 1998. Capital expenditures were $9.4 million higher in 1999.
Other significant investing activities in 1999 included: (i) TEP purchased
$24.9 million par value of Springerville Unit 1 lease debt and (ii)
Millennium sold the AES Corporation stock received as consideration from
the sale of NewEnergy for $27.5 million. In 1998, Nations Energy received
$20 million in cash proceeds from the sale of its partnership interest in
the Coors Brewing Company power plant and $27.1 million was invested in or
loaned to other unregulated energy businesses.
Net cash used for financing activities totaled $19.8 million in the
first nine months of 1999 compared with $24.0 million during the same
period in 1998. In 1999, the major use of cash for financing activities
was $22.3 million to retire capital lease obligations. In 1998, $17.2
million of capital lease obligations were retired. Other significant
financing activities in 1998 included: (i) TEP issued long-term debt with
net cash proceeds of $99.0 million and (ii) TEP retired $99.5 million in
First Mortgage Bonds.
The Company's consolidated cash balance, including cash equivalents,
at November 8, 1999 was approximately $168 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
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 from the September 30, 1998 ending
balance of $132.4 million to $96.2 million at September 30, 1999. For the
twelve-month period ended September 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 $22.9 million in
the first nine months of 1999 compared with the same period in 1998,
principally due to the payment of $22.4 million into an escrow account
related to a tax settlement. See UniSource Energy, Cash Flows above for a
discussion of factors affecting net cash flows from operating activities.
Net cash used for investing activities totaled $89.6 million during
the first nine months of 1999 compared with $100.2 million during the same
period of 1998. Capital expenditures were $8.0 million higher in 1999.
Other investing activities for 1999 included the purchase of $24.9 million
par value of Springerville Unit 1 lease debt. In 1998, net cash outflows
from investing activities included the transfer of Millennium and its $45.4
million of cash from TEP to UniSource Energy on January 1, 1998. The
subsidiaries holding that cash were subsidiaries of TEP at year-end 1997,
and became subsidiaries of UniSource Energy on January 1, 1998.
Net cash used for financing activities totaled $19.9 million in the
first nine months of 1999 compared with $23.9 million during the same
period in 1998. See UniSource Energy, Cash Flows above for a discussion of
factors affecting net cash flows from financing activities.
TEP's consolidated cash balance, including cash equivalents, at
November 8, 1999 was approximately $133 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, or if monthly cash requirements
temporarily exceeded available cash balances, TEP would 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 continues 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 nine months ended
September 30, 1999 were $23.0 million and $64.2 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.
TEP Credit Agreement
As of September 30, 1999 and as of November 8, 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 has
the ability, to refinance the underlying debt on these leases in 1999. TEP
filed a financing application with the ACC requesting approval to refinance
these leases in the fourth quarter of 1999. TEP is in negotiations with
the owner participants of the common facilities and expects to complete
this refinancing transaction prior to year-end 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 by AES stock, bear interest at 9.5%, and
$11.4 million ofthe principal amount is due July 23, 2000 and
July 23, 2001, respectively.
As part of the agreement, AES repaid a $10 million loan NewEnergy
obtained from an unrelated party that was guaranteed by UniSource Energy.
Previously, UniSource Energy provided guarantees of up to $55.6 million
of certain performance bonds and contractual obligations relating
to NewEnergy's purchases and sales of electricity. On October 1, 1999,
termination notices were sent on all guarantees and the master surety
agreement. The effective dates of all terminations have passed,
except for one guarantee up to the amount of $6.5 million, which
has a termination date of November 29, 1999. The termination
of the guarantees means that UniSource Energy will not incur any
additional guarantee liability under these agreements but does
not extinguish any obligation existing prior to the time of termination.
The $6.5 million guarantee provided by UniSource Energy
is 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 New Energy Holdings until the closing, at which time
the guarantees terminated. AES also provided, prior to closing, additional
guarantees as needed to support NewEnergy's business activities.
UniSource Energy recognized an after-tax gain of $20.8 million in the
third quarter of 1999 on the transaction. MEH sold the AES Corporation
common stock received in consideration for the sale of NewEnergy in the
third quarter of 1999. Millennium used some of the proceeds from the sale
of AES stock to pay a $10 million cash dividend to UniSource Energy. The
remaining proceeds from the stock sale as well as other proceeds of the
NewEnergy sale will be available for reinvestment in other affiliates.
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 schedule below shows the amounts our unregulated energy
businesses recorded for capital expenditures, investments in and loans to
their subsidiaries and affiliates, as well as cash proceeds from sales of
investments for the three months and nine months ended September 30, 1999
and 1998:
- ---------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
Subsidiary 1999 1998 1999 1998
- ---------------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
AET $ (600) $ (606) $(3,470) $ (1,697)
MEH 27,489 (7,991) 27,229 (17,973)
Nations Energy (155) 12,507 590 12,406
Other (94) (8) (207) (33)
- ---------------------------------------------------------------------------
Total Millennium $26,640 $3,902 $24,142 $ (7,297)
===========================================================================
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.
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.
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.
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
- ----------------------------
TAX ASSESSMENTS
See Note 4 of Notes to Condensed Consolidated Financial Statements,
Tax Assessments.
ITEM 5. - OTHER INFORMATION
- ---------------------------
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges for
TEP:
12 Months Ended
---------------
September 30, December 31,
1999 1998
---- ----
Ratio of Earnings to 1.42 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 filed the following current reports on Form 8-K during
the quarter ended September 30, 1999:
* Form 8-K dated July 23, 1999 (filed August 9, 1999) reporting on the
closing of the sale of NewEnergy, Inc.
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: November 15, 1999 Ira R. Adler
-------------------------------------
Ira R. Adler
Executive Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: November 15, 1999 Ira R. Adler
-------------------------------------
Ira R. Adler
Executive Vice President and Principal
Financial Officer
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.
<TABLE> <S> <C>
<ARTICLE> UT
<CIK> 0000100122
<NAME> TUCSON ELECTRIC POWER COMPANY
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,902,900
<OTHER-PROPERTY-AND-INVEST> 91,368
<TOTAL-CURRENT-ASSETS> 296,052
<TOTAL-DEFERRED-CHARGES> 298,037
<OTHER-ASSETS> 70,132
<TOTAL-ASSETS> 2,658,489
<COMMON> 640,767
<CAPITAL-SURPLUS-PAID-IN> 0
<RETAINED-EARNINGS> (371,382)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 269,385
0
0
<LONG-TERM-DEBT-NET> 1,135,820
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 48,603
0
<CAPITAL-LEASE-OBLIGATIONS> 852,194
<LEASES-CURRENT> 36,975
<OTHER-ITEMS-CAPITAL-AND-LIAB> 315,512
<TOT-CAPITALIZATION-AND-LIAB> 2,658,489
<GROSS-OPERATING-REVENUE> 615,375
<INCOME-TAX-EXPENSE> 23,401
<OTHER-OPERATING-EXPENSES> 479,474
<TOTAL-OPERATING-EXPENSES> 502,875
<OPERATING-INCOME-LOSS> 112,500
<OTHER-INCOME-NET> 10,422
<INCOME-BEFORE-INTEREST-EXPEN> 122,922
<TOTAL-INTEREST-EXPENSE> 83,954
<NET-INCOME> 38,968
0
<EARNINGS-AVAILABLE-FOR-COMM> 38,968
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> 87,445
<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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,902,900
<OTHER-PROPERTY-AND-INVEST> 139,366
<TOTAL-CURRENT-ASSETS> 346,609
<TOTAL-DEFERRED-CHARGES> 298,037
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 2,686,912
<COMMON> 641,366
<CAPITAL-SURPLUS-PAID-IN> 0
<RETAINED-EARNINGS> (344,145)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 297,221
0
0
<LONG-TERM-DEBT-NET> 1,135,820
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 48,603
0
<CAPITAL-LEASE-OBLIGATIONS> 852,529
<LEASES-CURRENT> 37,045
<OTHER-ITEMS-CAPITAL-AND-LIAB> 315,694
<TOT-CAPITALIZATION-AND-LIAB> 2,686,912
<GROSS-OPERATING-REVENUE> 615,171
<INCOME-TAX-EXPENSE> 23,401
<OTHER-OPERATING-EXPENSES> 479,474
<TOTAL-OPERATING-EXPENSES> 502,875
<OPERATING-INCOME-LOSS> 112,296
<OTHER-INCOME-NET> 21,507
<INCOME-BEFORE-INTEREST-EXPEN> 133,803
<TOTAL-INTEREST-EXPENSE> 83,954
<NET-INCOME> 49,849
0
<EARNINGS-AVAILABLE-FOR-COMM> 49,849
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> 72,321
<EPS-BASIC> 1.54
<EPS-DILUTED> 1.53
</TABLE>
UNISOURCE ENERGY CORPORATION
EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE
Three Months Ended
September 30,
1999 1998
------ ------
- Thousands of Dollars -
(except per share data)
BASIC EARNINGS PER SHARE:
Net Income $51,669 $33,673
Average Shares of Common Stock Outstanding 32,332 32,174
--------- --------
Basic Earnings Per Share $ 1.60 $ 1.05
========= ========
DILUTED EARNINGS PER SHARE:
Net Income $51,669 $33,673
Average Shares of Common Stock Outstanding 32,332 32,174
Effect of Dilutive Securities:
Warrants - -
Options and Stock Issuable under Employee Benefit
Plans 341 40
--------- --------
Total Shares 32,673 32,214
--------- --------
Diluted Earnings Per Share $ 1.58 $ 1.05
========= ========
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
Nine Months Ended
September 30,
1999 1998
------ ------
- Thousands of Dollars -
(except per share data)
BASIC EARNINGS PER SHARE:
Net Income $49,849 $27,696
Average Shares of Common Stock Outstanding 32,309 32,150
--------- --------
Basic Earnings Per Share $ 1.54 $ 0.86
========= ========
DILUTED EARNINGS PER SHARE:
Net Income $49,849 $27,696
Average Shares of Common Stock Outstanding 32,309 32,150
Effect of Dilutive Securities:
Warrants - 42
Options and Stock Issuable under Employee Benefit
Plans 225 54
--------- --------
Total Shares 32,534 32,246
--------- --------
Diluted Earnings Per Share $ 1.53 $ 0.86
========= ========
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
----------------
Sep. 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) $66,962 $72,672 $66,247 $59,836 $69,174 $69,353
Other Interest (2) $13,269 $13,207 $9,640 $11,721 $9,113 $7,591
Interest on Capital Lease Obligations (3) $82,052 $81,823 $83,019 $84,383 $83,986 $82,511
------- ------- ------- ------- ------- -------
TOTAL FIXED CHARGES $162,283 $167,702 $158,906 $155,940 $162,273 $159,455
NET INCOME $44,805 $41,676 $83,572 $120,852 $54,905 $20,740
ADD (DEDUCT):
Income Taxes - Operating Expense $22,375 $18,372 $19,297 $9,795 $8,920 ($91)
Income Taxes - Other $1,627 ($794) ($41,401) ($91,950) ($29,356) ($4,820)
Total Fixed Charges $162,283 $167,702 $158,906 $155,940 $162,273 $159,455
------- -------- -------- -------- -------- -------
TOTAL EARNINGS BEFORE TAXES
AND FIXED CHARGES $231,090 $226,956 $220,374 $194,637 $196,742 $175,284
RATIO OF EARNINGS TO FIXED CHARGES 1.424 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>
Exhibit 15
November 10, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Commissioners:
We are aware that our report dated November 10, 1999 on
our review of interim financial information of UniSource
Energy Corporation (the Company) and Tucson Electric Power
Company (TEP) as of and for the period ended September 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, 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).
Very truly yours,
PricewaterhouseCoopers LLP
