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, 2000
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; Address IRS Employer
File Number 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 6, 2000, 32,419,314 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 32,139,434
shares of the outstanding Common Stock of Tucson Electric Power Company.
<PAGE>
This combined Form 10-Q is separately filed by UniSource Energy Corporation
and Tucson Electric Power Company. Information contained in this document
relating to Tucson Electric Power Company is filed by UniSource Energy
Corporation and separately by Tucson Electric Power Company on its own
behalf. Tucson Electric Power Company makes no representation as to
information relating to UniSource Energy Corporation or its subsidiaries,
except as it may relate to Tucson Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions..............................................................iv
Review Report of Independent Accountants..................................1
PART I - FINANCIAL INFORMATION
Item 1. -- Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements 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. Regulatory Accounting..........................................8
Note 2. Business Segments..............................................8
Note 3. Millennium Energy Businesses...................................9
Note 4. Debt Retirements and Revolving Credit Facility................11
Note 5. San Juan Coal Contract Amendment..............................11
Note 6 Contingencies.................................................11
Note 7. Income Taxes..................................................12
Note 8. New Accounting Standard.......................................13
Note 9. Review by Independent Accountants.............................14
Note 10. Other Reclassifications.......................................14
Item 2. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview...............................................................15
Factors Affecting Results of Operations
Competition
Retail.............................................................16
Wholesale..........................................................18
Regulatory Matters...................................................18
San Juan Coal Contract Amendment.....................................19
Market Risks.........................................................19
Results of Operations..................................................21
Contribution by Business Segment.....................................21
Impact of Regulatory Accounting Changes..............................22
Utility Sales and Revenues...........................................22
Operating Expenses...................................................23
Other Income (Deductions)............................................24
Interest Expense.....................................................24
Results of Millennium Energy Businesses................................24
AET and Global Solar.................................................25
MEH and NewEnergy....................................................25
Nations Energy.......................................................25
Dividends on Common Stock
UniSource Energy.....................................................25
TEP..................................................................26
Millennium...........................................................26
Liquidity and Capital Resources
Cash Flows
UniSource Energy...................................................26
TEP................................................................27
Investing and Financing Activities
TEP
Capital Expenditures.............................................27
TEP Credit Agreement.............................................28
Millennium -- Unregulated Energy Businesses
Sale of NewEnergy, Inc...........................................28
Additional Investments in Energy Technologies....................28
Other Capital Requirements.......................................28
Safe Harbor for Forward-Looking Statements.............................29
Item 3. -- Quantitative and Qualitative Disclosures About Market Risk....30
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments........................................................31
ACC Order on the Sierrita Contract.....................................31
Item 5. -- Other Information
Directors and Executive Officers of the Registrants....................31
Regulation.............................................................31
Additional Financial Data..............................................32
Item 6. -- Exhibits and Reports on Form 8-K..............................32
Signature Page...........................................................33
Exhibit Index............................................................34
<PAGE>
DEFINITIONS
The abbreviations and acronyms used in the 2000 Third Quarter Form 10-Q
are defined below:
-------------------------------------------------------------------------------
ACC................. Arizona Corporation Commission.
ACC Holding Company
Order............. The order approved by the ACC in November 1997 allowing
TEP to form a holding company.
AET................. Advanced Energy Technologies, Inc., a wholly-owned
subsidiary of Millennium and the holder of Millennium's
interest in GES.
Affected Utilities.. Electric utilities regulated by the ACC, including
TEP, Arizona Public Service, Citizens Utilities
Company, and several electric cooperatives.
AISA................ The Arizona Independent Scheduling Administrator
Association, a temporary organization required by the
ACC Retail Electric Competition Rules.
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 a syndicate of banks,
dated as of December 30, 1997.
ESP................. Energy Service Provider.
FAS 71.............. Statement of Financial Accounting Standards No. 71:
Accounting for the Effects of Certain Types of
Regulation.
FAS 101............. Statement of Financial Accounting Standards No. 101:
Regulated Enterprises-Accounting for the Discontinuation
of FASB Statement No. 71.
FAS 133............. Statement of Financial Accounting Standards No. 133:
Accounting for Derivative Instruments and Hedging
Activities.
FERC................ Federal Energy Regulatory Commission.
First Mortgage
Bonds............. First mortgage bonds issued under the General First
Mortgage.
GAAP................ Generally Accepted Accounting Principles.
General First
Mortgage.......... The Indenture, dated as of April 1, 1941, of Tucson Gas,
Electric Light and Power Company to The Chase National
Bank of the City of New York, as trustee, as
supplemented and amended.
GES................. Global Energy Solutions, Inc., which is 67% owned by AET
and 33% owned by ITN, a privately-held company. GES is
the parent company of Global Solar and TFB.
Global Solar........ Global Solar Energy, Inc., a wholly owned-subsidiary of
GES, and manufacturer of thin-film solar products.
Heating Degree
Days.............. Calculated by subtracting the average of the high and
low daily temperatures from 75.
IRS................. Internal Revenue Service.
ISO................. Independent System Operator.
ITC................. Investment tax credit.
kWh................. Kilowatt-hour(s).
MEH................. MEH Corporation, a wholly-owned subsidiary of Millennium
which formerly held a 50% interest in NewEnergy.
Millennium.......... Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
Nations Energy...... Nations Energy Corporation, an independent power developer
and 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 carryback or carryforward for income
tax purposes.
Rate Settlement..... TEP's Rate Settlement agreement approved by the ACC in
August 1998, which provided 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.
RTO................. Regional Transmission Organization.
Rules............... Retail Electric Competition Rules.
San Juan............ San Juan Generating Station.
Settlement
Agreement......... TEP's Settlement Agreement approved by the ACC in
November 1999 provided for electric retail competition
and transition asset recovery.
Springerville....... Springerville Generating Station.
Springerville Common
Facilities........ Facilities at Springerville used in common with
Springerville Unit 1 and Springerville Unit 2
Generating Station.
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.
TFB................. TFB, Inc., a wholly-owned subsidiary of GES, and
manufacturer of thin film batteries.
UniSource Energy.... UniSource Energy Corporation.
<PAGE>
Report of Independent Accountants
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, 2000 and the related condensed consolidated statements of income for
each of the three-month and nine-month periods ended September 30, 2000 and
1999 and the condensed consolidated statements of cash flows for the nine-
month periods ended September 30, 2000 and 1999. 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 accounting principles.
generally accepted in the United States of America.
We previously audited in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheets
and statements of capitalization of the Company and of TEP as of December
31, 1999, 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 2, 2000 we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed
consolidated balance sheets as of December 31, 1999, is fairly stated in
all material respects in relation to the consolidated balance sheets from
which it has been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
November 10, 2000
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
-----------------------------------------------------------------------------
The weather causes seasonal fluctuations in UniSource Energy's sales. As a
result, quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with UniSource Energy's 1999 Form 10-K.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $214,513 $198,022
Sales for Resale 125,131 66,083
Other 3,132 3,519
--------- ---------
Total Operating Revenues 342,776 267,624
--------- ---------
Operating Expenses
Fuel and Purchased Power 169,265 103,604
Coal Contract Amendment Fee 13,231 -
Maintenance and Repairs 8,398 5,940
Other Operations 34,956 31,649
Depreciation and Amortization 31,003 20,772
Amortization of Transition Recovery Asset 8,795 -
Taxes Other Than Income Taxes 12,362 12,255
Capital Lease Expense - 25,455
Amortization of Springerville Unit 1 Allowance - (8,729)
Income Taxes 9,473 21,368
--------- ---------
Total Operating Expenses 287,483 212,314
--------- ---------
Operating Income 55,293 55,310
--------- ---------
Other Income (Deductions)
Interest Income 2,884 2,449
Equity in Earnings (Losses) of Unconsolidated Entities 319 610
Gain on Sale of NewEnergy - 34,651
Other Income 972 1,632
Income Taxes (1,717) (14,962)
--------- ---------
Total Other Income (Deductions) 2,458 24,380
--------- ---------
Interest Expense
Long-Term Debt 16,200 16,662
Interest on Capital Leases 22,901 -
Interest Imputed on Losses Recorded at Present Value - 8,747
Other Interest Expense 1,411 2,612
--------- ---------
Total Interest Expense 40,512 28,021
--------- ---------
Net Income $ 17,239 $ 51,669
========= =========
Average Shares of Common Stock Outstanding (000) 32,423 32,332
========= =========
Basic Earnings per Share $ 0.53 $ 1.60
========= =========
Diluted Earnings per Share $ 0.52 $ 1.58
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $518,694 $484,236
Sales for Resale 231,514 128,814
Other 7,246 10,282
--------- ---------
Total Operating Revenues 757,454 623,332
--------- ---------
Operating Expenses
Fuel and Purchased Power 328,063 219,391
Coal Contract Amendment Fee 13,231 -
Maintenance and Repairs 32,092 30,244
Other Operations 97,509 90,556
Depreciation and Amortization 86,221 64,890
Amortization of Transition Recovery Asset 14,377 -
Taxes Other Than Income Taxes 37,288 36,945
Capital Lease Expense - 76,834
Amortization of Springerville Unit 1 Allowance - (26,188)
Income Taxes 4,238 21,290
--------- ---------
Total Operating Expenses 613,019 513,962
--------- ---------
Operating Income 144,435 109,370
--------- ---------
Other Income (Deductions)
Interest Income 9,370 6,113
Equity in Earnings (Losses) of Unconsolidated Entities (1,549) (3,665)
Gain on Sale of NewEnergy - 34,651
Other Income 4,622 2,955
Income Taxes (3,445) (15,606)
--------- ---------
Total Other Income (Deductions) 8,998 24,448
--------- ---------
Interest Expense
Long-Term Debt 50,229 49,784
Interest on Capital Leases 69,453 -
Interest Imputed on Losses Recorded at Present Value - 26,243
Other Interest Expense 5,611 7,942
--------- ---------
Total Interest Expense 125,293 83,969
--------- ---------
Net Income $ 28,140 $ 49,849
========= =========
Average Shares of Common Stock Outstanding (000) 32,397 32,309
========= =========
Basic Earnings per Share $ 0.87 $ 1.54
========= =========
Diluted Earnings per Share $ 0.86 $ 1.53
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $539,243 $507,319
Cash Receipts from Sales for Resale 200,590 118,845
Fuel and Purchased Power Costs Paid (284,917) (201,317)
Wages Paid, Net of Amounts Capitalized (47,426) (53,356)
Payment of Other Operations and Maintenance Costs (76,365) (78,711)
Capital Lease Interest Paid (90,351) (81,066)
Taxes Paid, Net of Amounts Capitalized (63,168) (61,804)
Interest Paid, Net of Amounts Capitalized (61,377) (60,638)
Income Taxes Paid (3) (6,170)
Interest Received 11,969 6,527
Transfer of Tax Settlement to Escrow Account - (22,403)
Other 5,974 5,095
--------- ---------
Net Cash Flows - Operating Activities 134,169 72,321
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (78,677) (65,743)
Investments in and Loans to Equity Investees (7,091) (5,705)
Sale of Interest in Millennium Energy Businesses 31,506 4,041
Sale of Securities - 27,516
Investment in Lease Debt (27,633) (26,768)
Other Investments - Net 240 595
--------- ---------
Net Cash Flows - Investing Activities (81,655) (66,064)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Borrowings under Revolving Credit
Facility 25,000 -
Payments on Revolving Credit Facility (25,000) -
Proceeds from Issuance of Long-Term Debt - 1,977
Payments to Retire Long-Term Debt (50,116) (1,725)
Payments to Retire Capital Lease Obligations (38,907) (22,338)
Common Stock Dividends Paid (7,752) -
Other 2,273 2,320
--------- ---------
Net Cash Flows - Financing Activities (94,502) (19,766)
--------- ---------
Net Decrease in Cash and Cash Equivalents (41,988) (13,509)
Cash and Cash Equivalents, Beginning of Year 145,288 145,167
--------- ---------
Cash and Cash Equivalents, End of Period $103,300 $131,658
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 28,140 $ 49,849
Adjustments to Reconcile Net Income to Net Operating
Cash Flows
Depreciation and Amortization Expense 86,221 64,777
Coal Contract Amendment Fee 13,231 -
Deferred Income Taxes and Investment Tax Credit 15,783 32,924
Lease Payments Deferred - 3,707
Amortization of Regulatory Assets & Liabilities,
Net of Interest Imputed on Losses Recorded at
Present Value 15,634 2,940
Unremitted Losses of Unconsolidated Subsidiaries 1,549 3,209
Gain on Sale of NewEnergy - (34,651)
Other 1,132 1,135
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable (47,770) (24,688)
Tax Settlement Deposit - (22,450)
Materials and Fuel 3,583 (5,949)
Accounts Payable 35,549 7,031
Taxes Accrued 14,875 14,427
Other Current Assets and Liabilities (38,771) (12,590)
Other Deferred Assets and Liabilities 5,013 (7,350)
--------- ---------
Net Cash Flows - Operating Activities $134,169 $ 72,321
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,392,693 $2,301,645
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 69,362 96,565
----------- -----------
Total Utility Plant 3,203,501 3,139,656
Less Accumulated Depreciation and Amortization (1,164,651) (1,105,371)
Less Accumulated Depreciation of Capital Lease
Assets (326,213) (304,429)
----------- -----------
Total Utility Plant - Net 1,712,637 1,729,856
----------- -----------
Investments and Other Property 120,500 114,483
----------- -----------
Current Assets
Cash and Cash Equivalents 103,300 145,288
Accounts Receivable 115,696 67,926
Materials and Fuel 38,536 42,119
Deferred Income Taxes - Current 9,252 17,148
Prepaid Pension Costs 17,387 15,818
Tax Settlement Deposit - 13,471
Other 40,681 31,368
----------- -----------
Total Current Assets 324,852 333,138
----------- -----------
Deferred Debits - Regulatory Assets
Transition Recovery Asset 355,914 370,291
Income Taxes Recoverable Through Future Revenues 66,562 79,497
Other Regulatory Assets 7,382 8,639
Deferred Debits - Other 16,663 20,351
----------- -----------
Total Deferred Debits 446,521 478,778
----------- -----------
Total Assets $2,604,510 $2,656,255
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 642,703 $ 641,723
Accumulated Deficit (294,528) (317,475)
----------- -----------
Common Stock Equity 348,175 324,248
Capital Lease Obligations 852,665 880,427
Long-Term Debt 1,132,395 1,135,820
----------- -----------
Total Capitalization 2,333,235 2,340,495
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 25,914 36,335
Current Maturities of Long-Term Debt 1,725 48,603
Accounts Payable 66,741 34,068
Interest Accrued 33,748 66,311
Taxes Accrued 36,778 31,374
Other 15,643 18,038
----------- -----------
Total Current Liabilities 180,549 234,729
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 37,478 42,526
Other 53,248 38,505
----------- -----------
Total Deferred Credits and Other Liabilities 90,726 81,031
----------- -----------
Total Capitalization and Other Liabilities $2,604,510 $2,656,255
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
The weather causes seasonal fluctuations in TEP's sales. As a result,
quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with TEP's 1999 Form 10-K.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $214,513 $198,022
Sales for Resale 125,131 66,083
Other 857 651
--------- ---------
Total Operating Revenues 340,501 264,756
--------- ---------
Operating Expenses
Fuel and Purchased Power 169,265 103,604
Coal Contract Amendment Fee 13,231 -
Maintenance and Repairs 8,398 5,940
Other Operations 29,192 27,621
Depreciation and Amortization 30,826 20,734
Amortization of Transition Recovery Asset 8,795 -
Taxes Other Than Income Taxes 12,219 12,054
Capital Lease Expense - 25,455
Amortization of Springerville Unit 1 Allowance - (8,729)
Income Taxes 11,063 22,002
--------- ---------
Total Operating Expenses 282,989 208,681
--------- ---------
Operating Income 57,512 56,075
--------- ---------
Other Income (Deductions)
Interest Income 1,665 1,974
Interest Income-Note Receivable from UniSource Energy 2,345 2,506
Other Income 709 878
Income Taxes (1,901) (1,494)
--------- ---------
Total Other Income (Deductions) 2,818 3,864
--------- ---------
Interest Expense
Long-Term Debt 16,200 16,662
Interest on Capital Leases 22,890 -
Interest Imputed on Losses Recorded at Present Value - 8,747
Other Interest Expense 1,405 2,597
--------- ---------
Total Interest Expense 40,495 28,006
--------- ---------
Net Income $ 19,835 $ 31,933
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $518,694 $484,236
Sales for Resale 231,514 128,814
Other 2,486 2,325
--------- ---------
Total Operating Revenues 752,694 615,375
--------- ---------
Operating Expenses
Fuel and Purchased Power 328,063 219,391
Coal Contract Amendment Fee 13,231 -
Maintenance and Repairs 32,092 30,244
Other Operations 84,537 78,016
Depreciation and Amortization 85,875 64,777
Amortization of Transition Recovery Asset 14,377 -
Taxes Other Than Income Taxes 36,773 36,400
Capital Lease Expense - 76,834
Amortization of Springerville Unit 1 Allowance - (26,188)
Income Taxes 7,944 23,401
--------- ---------
Total Operating Expenses 602,892 502,875
--------- ---------
Operating Income 149,802 112,500
--------- ---------
Other Income (Deductions)
Interest Income 5,667 4,991
Interest Income-Note Receivable from UniSource Energy 6,982 7,585
Other Income 1,726 1,675
Income Taxes (5,790) (3,829)
--------- ---------
Total Other Income (Deductions) 8,585 10,422
--------- ---------
Interest Expense
Long-Term Debt 50,229 49,784
Interest on Capital Leases 69,417 -
Interest Imputed on Losses Recorded at Present Value - 26,243
Other Interest Expense 5,605 7,927
--------- ---------
Total Interest Expense 125,251 83,954
--------- ---------
Net Income $ 33,136 $ 38,968
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $539,243 $507,319
Cash Receipts from Sales for Resale 200,590 118,845
Fuel and Purchased Power Costs Paid (284,917) (201,317)
Wages Paid, Net of Amounts Capitalized (41,932) (47,929)
Payment of Other Operations and Maintenance Costs (67,135) (72,814)
Capital Lease Interest Paid (90,315) (81,066)
Taxes Paid, Net of Amounts Capitalized (62,696) (61,440)
Interest Paid, Net of Amounts Capitalized (61,377) (60,638)
Income Taxes Paid (3) (6,168)
Interest Received 7,182 14,799
Transfer of Tax Settlement of Escrow Account - (22,403)
Other 63 257
--------- ---------
Net Cash Flows - Operating Activities 138,703 87,445
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (73,679) (64,245)
Investment in and Loans to Equity Investees (2,000) -
Investment in Lease Debt 132 (26,768)
Other Investments - Net (543) 1,448
--------- ---------
Net Cash Flows - Investing Activities (76,090) (89,565)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Borrowing under Revolving Credit
Facility 25,000 -
Payments on Revolving Credit Facility (25,000) -
Proceeds from Issuance of Long-Term Debt - 1,977
Payments to Retire Long-Term Debt (50,116) (1,725)
Payments to Retire Capital Lease Obligations (38,789) (22,316)
Other 1,704 2,126
--------- ---------
Net Cash Flows - Financing Activities (87,201) (19,938)
--------- ---------
Net Decrease in Cash and Cash Equivalents (24,588) (22,058)
Cash and Cash Equivalents, Beginning of Year 88,402 118,236
--------- ---------
Cash and Cash Equivalents, End of Period $ 63,814 $ 96,178
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Nine Months Ended
September 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 33,136 $ 38,968
Adjustments to Reconcile Net Income to Net
Operating Cash Flows
Depreciation and Amortization Expense 85,875 64,777
Coal Contract Amendment Fee 13,231 -
Deferred Income Taxes and Investment Tax Credit 17,152 20,324
Lease Payments Deferred - 3,707
Amortization of Regulatory Assets & Liabilities, Net
of Interest Imputed on Losses Recorded at
Present Value 15,634 2,940
Interest Accrued on Note Receivable from UniSource
Energy (6,983) 1,744
Other 5,605 4,064
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable (45,526) (22,820)
Tax Settlement Deposit - (22,450)
Materials and Fuel 3,631 (5,898)
Accounts Payable 35,084 7,433
Taxes Accrued 14,002 14,118
Other Current Assets and Liabilities (34,132) (12,117)
Other Deferred Assets and Liabilities 1,994 (7,345)
--------- ---------
Net Cash Flows - Operating Activities $138,703 $ 87,445
========= =========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,392,693 $2,301,645
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 69,362 96,565
----------- -----------
Total Utility Plant 3,203,501 3,139,656
Less Accumulated Depreciation and Amortization (1,164,651) (1,105,371)
Less Accumulated Depreciation of Capital Lease
Assets (326,213) (304,429)
----------- -----------
Total Utility Plant - Net 1,712,637 1,729,856
----------- -----------
Investments and Other Property 68,705 67,838
----------- -----------
Note Receivable from UniSource Energy 77,115 70,132
---------- -----------
Current Assets
Cash and Cash Equivalents 63,814 88,402
Accounts Receivable 117,424 70,739
Materials and Fuel 38,404 42,035
Deferred Income Taxes - Current 8,425 17,190
Prepaid Pension Costs 17,387 15,818
Tax Settlement Deposit - 13,471
Other 8,904 6,249
----------- -----------
Total Current Assets 254,358 253,904
----------- -----------
Deferred Debits - Regulatory Assets
Transition Recovery Asset 355,914 370,291
Income Taxes Recoverable Through Future Revenues 66,562 79,497
Other Regulatory Assets 7,382 8,639
Deferred Debits - Other 16,663 20,351
----------- -----------
Total Deferred Debits 446,521 478,778
----------- -----------
Total Assets $2,559,336 $2,600,508
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 647,878 $ 647,366
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (337,739) (370,875)
----------- -----------
Common Stock Equity 303,782 270,134
Capital Lease Obligations 852,303 880,111
Long-Term Debt 1,132,395 1,135,820
----------- -----------
Total Capitalization 2,288,480 2,286,065
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 25,797 36,263
Current Maturities of Long-Term Debt 1,725 48,603
Accounts Payable 75,089 42,864
Interest Accrued 33,748 66,311
Taxes Accrued 32,269 27,738
Other 14,678 15,289
----------- -----------
Total Current Liabilities 183,306 237,068
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 34,365 38,913
Other 53,185 38,462
----------- -----------
Total Deferred Credits and Other Liabilities 87,550 77,375
----------- -----------
Total Capitalization and Other Liabilities $2,559,336 $2,600,508
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
NOTE 1. REGULATORY ACCOUNTING
------------------------------
TEP generally uses the same accounting policies and practices used
by unregulated companies for financial reporting under GAAP. 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 currently charge its customers to recover certain expenses, but
instead requires that these expenses be charged to customers in the
future. In this situation, FAS 71 requires that TEP defer these items
and show them as regulatory assets on the balance sheet until TEP is
allowed to charge its customers. TEP then amortizes these items as
expense to the income statement as those charges are recovered from
customers. Similarly, certain revenue items may be deferred as
regulatory liabilities, which are also eventually amortized to the
income statement.
In November 1999, upon approval by the ACC of a Settlement
Agreement relating to recovery of TEP's transition costs and standard
retail rates, we discontinued application of FAS 71 to our generation
operations. As a result, many costs in the UniSource Energy and TEP
income statements are reflected in different line items in 2000 than
they were in 1999. The primary differences are:
- In 2000, amortization of our capital lease assets and interest
related to Capital Leases are reflected in Depreciation and
Amortization and Interest on Capital Leases, respectively. Through
October 1999, these expenses were included as Capital Lease Expense.
- Amortization of Springerville Unit 1 Allowance and Interest Imputed
on Losses Recorded at Present Value are no longer presented in 2000.
In November 1999, the unamortized balance of the Springerville Unit 1
Allowance reduced the Springerville Unit 1 capital lease amount.
- Amortization of Transition Recovery Asset appears as an expense
beginning in November 1999.
- Amortization of Investment Tax Credit no longer contributes to
Income Taxes included in Other Income (Deductions) in 2000. All ITC
was recognized in November 1999.
We continue to apply FAS 71 to our regulated operations, the
distribution and transmission portions of TEP's business. To apply the
accounting policies and practices of FAS 71, the following conditions
must exist:
- 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 can continue to apply FAS 71
to these operations. If we stopped applying FAS 71 to TEP's remaining
regulated operations, we would write off the related balances of TEP's
regulatory assets as a charge in our income statement. Based on the
balances of TEP's regulatory assets at September 30, 2000, if we had
stopped applying FAS 71 to TEP's remaining regulated operations, we
would have recorded a net after-tax extraordinary loss of approximately
$258 million. While regulatory orders and market conditions may affect
our cash flows, our cash flows would not be affected if we stopped
applying FAS 71.
NOTE 2. BUSINESS SEGMENTS
--------------------------
We determine our business segments based on the way we organize
our operations and evaluate performance. We currently have two
reportable business segments that are managed separately based on
fundamental differences in their operations. UniSource Energy's
principal business segment is TEP, an electric utility business.
The other reportable business segment is comprised of the
unregulated energy businesses of Millennium:
- Ownership of 67% of Global Energy Solutions, Inc. (GES) the parent
company of Global Solar Energy, Inc. (Global Solar), a developer and
manufacturer of photovoltaic materials and other energy technology
businesses. In June 2000, our share of GES increased from 50% to 67%.
See Note 3;
- Nations Energy Corporation (Nations Energy) which is an independent
power developer. See Note 3 regarding the sale of Nations Energy
Holland Holding;
- Southwest Energy Solutions, Inc. which provides energy support
services to electric consumers; and
- ION International, Inc. which provides technology applications for
efficient use of energy.
Segments
----------------------
UniSource
Reconciling Energy
TEP Millennium Adjustments Consolidated
----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
----------------
Three months ended
September 30, 2000:
Operating Revenues $340,501 $ 2,381 $ (106) $342,776
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 32,799 (2,138) (2,232) 28,429
----------------------------------------------------------------------
Net Income (Loss) 19,835 (1,254) (1,342) 17,239
----------------------------------------------------------------------
Three months ended
September 30, 1999:
Operating Revenues 264,756 2,933 (65) 267,624
----------------------------------------------------------------------
Net Income Before
Income Taxes 55,429 34,743 (2,173) 87,999
----------------------------------------------------------------------
Net Income 31,933 21,000 (1,264) 51,669
----------------------------------------------------------------------
Segments
----------------------
UniSource
Reconciling Energy
TEP Millennium Adjustments Consolidated
----------------------------------------------------------------------
- Thousands of Dollars -
Nine months ended
September 30, 2000:
Operating Revenues $752,694 $ 5,044 $ (284) $757,454
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 46,870 (4,765) (6,282) 35,823
----------------------------------------------------------------------
Net Income (Loss) 33,136 (1,218) (3,778) 28,140
----------------------------------------------------------------------
Nine months ended
September 30, 1999:
Operating Revenues 615,375 8,161 (204) 623,332
----------------------------------------------------------------------
Net Income Before
Income Taxes 66,198 27,512 (6,965) 86,745
----------------------------------------------------------------------
Net Income 38,968 15,027 (4,146) 49,849
----------------------------------------------------------------------
Balance Sheet
-------------
Total Assets,
September 30, 2000 $2,559,336 $145,936 $(100,762) $2,604,510
Total Assets,
December 31, 1999 2,600,508 100,289 (44,542) 2,656,255
----------------------------------------------------------------------
Intersegment revenues are not material. The reconciling adjustments
include the following:
- Elimination of TEP's Note Receivable from UniSource Energy and
related interest; and
- Elimination of intercompany activity and balances.
NOTE 3. MILLENNIUM ENERGY BUSINESSES
--------------------------------------
Sale of Interest in Nations Holland and COPESA Market Adjustment
In January 2000, Nations Energy sold Nations Energy Holland
Holding, including its minority interest in a power project located in
the Czech Republic. Nations Energy recorded a pre-tax gain of $2.5
million on the sale. Nations Energy received $20 million in cash
proceeds from the sale which is reflected in the Cash Flows from
Investing Activities in the UniSource Energy cash flow statement for
the nine months ended September 30, 2000.
In March 2000, Nations International, a wholly owned subsidiary of
Nations Energy, recorded a $1.4 million decrease in the market value of
its minority interest investment in a project in Panama. At September
30, 2000, Nations International's investment in this project was $3.2
million. Nations International intends to sell its 40% equity interest
in this project. We cannot predict whether future market adjustments
will be necessary for this project.
Additional Investments in Energy Technologies
Effective June 1, 2000, Millennium increased its ownership
percentage in GES from 50% to 67%. The remaining 33% of GES is owned
by ITN Energy Systems, Inc. (ITN), a privately held company. Under the
agreement, ITN transferred its rights to certain assets and proprietary
and intellectual property, including thin-film battery technology, to
GES. Millennium agreed to contribute to GES up to $14 million in
additional equity. As of September 30, 2000, Millennium funded $11.4
million under this agreement, including $3.5 million in the third
quarter of 2000. As of October 31, 2000, Millennium had funded the
full $14 million under this agreement.
In September 2000, Millennium and ITN agreed to form a jointly-
owned space systems company for the purpose of developing and
commercializing small-scale satellites. Millennium agreed to provide
$10 million in equity and $10 million in credit to the venture. ITN
will contribute development contracts and proprietary technologies.
Separately, ITN and Millennium agreed to form a jointly-owned
product development company, which will provide research and
development services to AET affiliates and third parties. Millennium
committed to provide $4 million in credit to the company, and ITN will
provide additional technologies, including direct energy conversion,
fuel cells and thermal desalinization.
Millennium also agreed to provide an additional $20 million in
credit to Global Solar over a 4-year period to fund production and
expansion, and $6 million in credit to TFB, Inc. to fund the start-up
of a thin-film battery pilot line.
Because we own 67% of GES as of June 1, 2000, it is consolidated
with UniSource Energy for financial reporting purposes. Previously,
Millennium reported GES's earnings (losses) using the equity method. By
the end of 1999, all of ITN's equity contributions had been written
down to zero for financial reporting purposes. As a result, minority
interest is not reflected in the financial statements and Millennium
records 100% of GES's losses for accounting purposes. When GES
generates net income, Millennium will recognize 100% of net income to
the extent Millennium's recognized losses are greater than Millennium's
ownership percentage of such losses.
NewEnergy Note Receivable and Expiration of Guarantees
In consideration for the July 1999 sale of Millennium's 50%
interest in NewEnergy to The AES Corporation (AES), Millennium received
shares of AES common stock, which were sold in the third quarter of
1999, and two $11.4 million promissory notes issued by NewEnergy. The
maturity dates of the promissory notes are July 23, 2000 and July 23,
2001. In July 2000, Millennium collected $11.4 million from NewEnergy
as scheduled.
Subsequent to the sale of NewEnergy in July 1999, all guarantees
of performance bonds and contractual obligations that UniSource Energy
made on behalf of NewEnergy have been terminated.
Other Energy Related Investments
In July 2000, Millennium made a $15 million capital commitment to
a limited partnership which will fund energy related investments. As of
November 6, 2000 Millennium has funded approximately $1 million under
this commitment. The remaining $14 million is expected to be invested
within three to five years. A member of the UniSource Energy Board of
Directors will also have a minor investment in the project. An
affiliate of such board member will serve as the general partner.
Reclassification of Millennium Energy Businesses Results
The operating revenues and expenses from the Millennium Energy
businesses are currently included as part of UniSource Energy's
Operating Revenues and Operating Expenses. Previously, these revenues
and expenses were included in the Millennium Energy Businesses line
item in the Other Income and Deduction section of the income statement.
The income statements for the three- and nine-months ended September
30, 1999 have been reclassified to conform to the new presentation.
NOTE 4. DEBT RETIREMENTS AND REVOLVING CREDIT FACILITY
--------------------------------------------------------
Retirement of 12.22% First Mortgage Bonds
In June 2000, TEP retired its remaining $46.9 million principal
amount of 12.22% First Mortgage Bonds as scheduled.
Purchase of 7.50% First Collateral Trust Bonds
In August 2000, TEP purchased at a discount and retired $1.7
million principal amount of 7.50% First Collateral Trust Bonds due in
2008.
Revolving Credit Facility
As of September 30, 2000, TEP had no borrowings under its
Revolving Credit Facility. However, in July 2000, TEP borrowed $25
million under its Revolving Credit Facility and repaid it in August
2000. Proceeds were used to fund on-going cash expenditures.
NOTE 5. SAN JUAN COAL CONTRACT AMENDMENT
-----------------------------------------
In September 2000, to reduce fuel costs over the next 17 years,
TEP entered into an agreement to amend the San Juan Generating
Station's coal supply contract, replacing two surface mining operations
with one underground operation. To amend the contract, TEP is required
to make a $15 million payment in 2003. In September 2000, as a result
of this scheduled payment, TEP recorded a pre-tax $13 million Coal
Contract Amendment Fee expense which equals the present-value of the
$15 million payment. TEP expects the contract amendment to reduce its
future coal costs by $275 million over the term of the new contract
which expires in 2017. On a net present value basis, TEP expects the
savings to be at least $50 million.
NOTE 6. CONTINGENCIES
----------------------
Income Tax Assessments
In February 1998, the IRS issued an income tax assessment for the
1992 and 1993 tax years. The IRS challenged 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. In the second quarter of 2000, we
resolved the 1992 and 1993 audits. In the second quarter we also
received an IRS assessment related to tax years 1994, 1995, and 1996.
After reviewing the impact of these items on our accrued tax
liabilities and the potential for assessments related to later tax
years, we reversed $7 million of the deferred tax valuation allowance
in the second quarter of 2000. The $7 million reversal is included in
the $8.2 million reduction in the valuation allowance discussed in Note
7.
Due to the financial restructuring, a change in TEP's ownership
occurred for tax purposes in December 1991. This change limits our use
of the NOL and ITC generated before 1992 under the tax code. At
December 31, 1999, we had approximately $199 million of NOL and $21
million of ITC subject to the pre-1992 limitation and $175 million of
NOL not subject to the limitation. Because of the valuation allowance
amounts recorded, we do not expect these annual limitations to have a
material adverse impact on the financial statements.
ACC Order on the Sierrita Contract
On May 14, 1999, TEP filed a complaint with the ACC against Cyprus
Sierrita Corporation (now known as Phelps Dodge Sierrita, Inc.)
(Sierrita) over energy costs that TEP charged to Sierrita under an ACC-
approved contract. Sierrita has disputed these charges. The dispute
concerns the proper method of calculating energy charges under the
contract. In March 2000, the ACC ruled in favor of TEP and ordered
Sierrita to pay a significant portion of the disputed charges from May
14, 1999 forward. Sierrita has appealed the ACC's order. We believe
that the appeal process will take between one and two years. We do not
expect resolution of this matter to have a material adverse impact on
the financial statements. We reversed a $2.5 million reserve in
September 2000 resulting in $2.5 million of revenue, because we now
believe it is probable that TEP will prevail in the matters before the
Court of Appeals. The $2.5 million reserve related to disputed charges
for the period of May 17, 1999 through September 30, 2000. We do not
expect to record a reserve for the disputed charges billed after
September 2000.
NOTE 7. INCOME TAXES
---------------------
The differences between 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,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense at
Statutory Rate $ 9,950 $ 30,800 $ 12,538 $30,361
State Income Tax Expense,
Net of Federal Deduction 1,393 4,270 1,756 4,209
Depreciation Differences
(Flow Through Basis) 1,066 1,829 3,201 2,511
Reduction in Valuation
Allowance - Benefit
(see Note 6) (1,200) - (8,200) -
Investment Tax Credit
Amortization - (700) - (2,100)
Foreign Operations of
Millennium Energy Businesses 18 (115) (1,655) 1,563
Other (37) 246 43 352
-------- --------- -------- ---------
Total Expense for Federal and
State Income Taxes $11,190 $ 36,330 $ 7,683 $36,896
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $11,480 $ 19,400 $ 16,405 $ 23,169
State Income Tax Expense,
Net of Federal Deduction 1,607 2,689 2,296 3,212
Depreciation Differences
(Flow Through Basis) 1,066 1,829 3,201 2,511
Reduction in Valuation
Allowance - Benefit
(see Note 6) (1,200) - (8,200) -
Investment Tax Credit
Amortization - (700) - (2,100)
Other 11 278 32 438
------- -------- ------- --------
Total Expense for Federal
and State Income Taxes $12,964 $ 23,496 $13,734 $ 27,230
======= ======== ======= ========
Income taxes are included in the income statements as follows:
UniSource Energy
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Operating Expenses $ 9,473 $ 21,368 $ 4,238 $ 21,290
Other Income (Deductions) 1,717 14,962 3,445 15,606
------- -------- ------- -------
Total Income Tax Expense $11,190 $ 36,330 $ 7,683 $ 36,896
======= ========= ======= ========
TEP
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Operating Expenses $11,063 $22,002 $ 7,944 $23,401
Other Income (Deductions) 1,901 1,494 5,790 3,829
------- ------- ------- -------
Total Income Tax Expense $12,964 $23,496 $13,734 $27,230
======= ======= ======= =======
NOTE 8. NEW ACCOUNTING STANDARD
--------------------------------
In June 1998, the Financial Accounting Standards Board (FASB)
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 on the balance sheet. Some derivative instruments
offset, or hedge, exposure to a specific risk. If a derivative
qualifies as a hedge, the accounting for the changes in fair value will
depend on the specific exposure being hedged. If the derivative is not
a hedging instrument, measurement is at fair value and changes in fair
value (i.e., unrealized gains and losses) are recognized in earnings in
the period of change. We are required to comply with FAS 133 effective
January 1, 2001.
Based on our analysis to date, we expect that the most significant
impact of complying with FAS 133 will be the ongoing market adjustments
to the income statement from some of our wholesale trading activity.
We buy and sell wholesale power using forward contracts. Based on our
current interpretation of FAS 133 and other guidance, we believe our
wholesale forward contracts will be classified as follows:
- Normal Purchases and Sales: These forward contracts are excluded
from the requirements of FAS 133. The realized gains and losses on
these contracts are reflected on the income statement at the contract
settlement date. The wholesale contracts that generally qualify as
normal purchases and sales are our off-peak forward purchases and
sales.
- Cash Flow Hedge: The unrealized gains and losses related to these
forward contracts will be included in Other Comprehensive Income, a
component of stockholders' equity. On-peak forward purchase contracts
to meet our retail and firm commitments as well as on-peak forward
sales contracts of our excess system capacity are generally classified
as cash flow hedges. We define our on-peak purchases and sales as
occurring daily from 6 a.m. until 10 p.m., Monday through Saturday.
- Trading Activity: The unrealized gains and losses related to these
forward contracts will be reflected in the income statement. Our
trading activity generally consists of forward on-peak sales and
purchases that do not qualify for cash flow hedge treatment.
Unrealized gains and losses of our forward contracts represent the
differences between the forward contract prices and the market prices
at any given date until the final settlement of the contract. The
realized gain or loss on the forward contract recorded at the contract
settlement represents the difference between the contract price and our
actual cost of the commodity that was purchased or sold. Based on our
current analysis and interpretation of FAS 133, if we had adopted FAS
133 at September 30, 2000, we would have recorded a $1 million
unrealized loss on the income statement and a $12 million unrealized
loss as part of Other Comprehensive Income. If we had adopted FAS 133
at September 30, 1999 we would have recorded a $1 million unrealized
loss on the income statement and a $1 million unrealized loss as part
of Other Comprehensive Income. Because the forward contract volume in
2000 is roughly the same as 1999, the difference between adoption of
FAS 133 at September 30, 1999 and 2000 reflects the substantial
increase in energy market prices in 2000. Because of the volatility of
the wholesale power market and continual changes in the types of
forward contracts that we have, we do not know if these amounts are
representative of the amounts that we will recognize in the future
after we adopt FAS 133. There are also certain issues that still need
to be addressed by the FASB Derivatives Implementation Group that may
also impact the amounts we will recognize under FAS 133.
NOTE 9. REVIEW BY INDEPENDENT ACCOUNTANTS
------------------------------------------
With respect to the unaudited condensed consolidated financial
information of UniSource Energy and TEP for the three-month and nine-
month periods ended September 30, 2000 and 1999, 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, 2000 appearing herein states
that they did not audit and they do not express an opinion on that
unaudited condensed 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 condensed 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 10. OTHER RECLASSIFICATIONS
---------------------------------
In addition to the reclassifications discussed in Note 3, we have
made reclassifications to the prior year financial statements for
comparative purposes. These reclassifications had no effect on net
income.
<PAGE>
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
---------------------------------------------------------------------------
UniSource Energy is a holding company that owns all of the outstanding
common stock of TEP and Millennium. TEP is an operating public utility
engaged in the generation, purchase, transmission, distribution and sale of
electricity for customers in the greater Tucson, Arizona area and to
wholesale customers. Millennium is a holding company that owns
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 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 2000 compared with the same periods in the prior year,
* changes in liquidity and capital resources during the third quarter
and first nine months of 2000, 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. The seasonal nature of the electric
utility business causes operating results to vary significantly from
quarter to quarter. The results from the energy related businesses of
Millennium and certain of its subsidiaries and interests have also had an
impact on earnings reported by UniSource Energy for the quarters and the
nine-month periods ended September 30, 2000 and 1999.
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 nine months
ended September 30, 2000 and 1999. Management's Discussion and Analysis
explains the differences between periods for specific line items of the
Condensed Consolidated Financial Statements.
OVERVIEW
--------
UniSource Energy recorded net income of $17.2 million for the third
quarter of 2000, and net income of $28.1 million for the first nine months
of 2000. This compares with net income of $51.7 million in the third
quarter of 1999 and net income of $49.8 million for the first nine months
of 1999.
Growth in retail electricity sales, wholesale marketing activities and
efficient performance of generating units at TEP contributed to the
earnings recorded in the third quarter of 2000. Despite this strong
underlying performance at the utility, several factors contributed to the
lower net income reported for the third quarter of 2000 compared with the
third quarter of 1999:
* a one-time $8 million after-tax expense related to the amendment of
a coal supply contract in the third quarter of 2000;
* the $20.8 million after-tax gain on the sale of one of our unregulated
energy businesses in the third quarter of 1999; and
* the impact of accounting changes related to the discontinuation of FAS
71 regulatory accounting for TEP's generation operations in November
1999.
The same factors outlined above account for the lower net income
reported for the first nine months of 2000 compared with the same period of
1999. See Factors Affecting Results of Operations and Results of
Operations, below for further detail.
Our financial prospects are subject to significant competitive,
regulatory, economic and other uncertainties. The approval of TEP's
Settlement Agreement in November 1999 resolved a significant amount of
regulatory uncertainty and provides TEP with a reasonable opportunity to
recover 100 percent of its transition recovery assets. However, we cannot
predict the full impact of retail competition on TEP's future operating
results or financial condition. Some of the factors which may affect our
future financial results include weather variations which may affect
customer usage, load growth and demand levels in the current TEP service
territory, and market prices for wholesale and retail energy. See
Competition below.
Other uncertainties include the extent to which, in response to
industry changes or unanticipated economic downturns, TEP can alter
operations and reduce costs, which may be limited due to high financial and
operating leverage. Future results 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.
We are addressing the uncertainties discussed above by positioning our
subsidiaries to benefit from the changing regulatory and energy market
environment. In November 1998, TEP organized its utility business
activities into two separate business units: (1) generation and (2)
transmission and distribution, and in January 1999, TEP formed a third
business unit which provides administrative services to the utility
business units. We are improving cost measurement and management
techniques at TEP. We have also extended contracts, where appropriate, for
large wholesale and retail customers. We are investing in our unregulated
affiliates to provide energy products and services to markets both within
and beyond TEP's retail service territory. See Factors Affecting Results
of Operations, Competition, Retail; Results of Operations and Results of
Millennium Energy Businesses below.
Our financial prospects are also subject to uncertainties relating to
the start-up and developmental activities of the Millennium Energy
Businesses segment. At September 30, 2000, Millennium's unregulated energy-
related affiliates comprised approximately 6% of total assets, but at times
have had a significant impact on our consolidated net income and cash
flows. In the third quarter 2000, Millennium agreed to provide additional
funding to expand its existing solar energy and thin-film battery
businesses and to make new investments in research and development
and small-scale satellite technologies. Millennium also made a
commitment to contribute $15 million in capital to a limited partnership
that will invest in energy-related investments. We continue to evaluate
our affiliates for opportunities to realize value from our investments. In
the third quarter of 1999, we sold our ownership interest in affiliate
NewEnergy and recorded a pre-tax gain of $35 million on the transaction.
In January 2000, we sold our interest in a power project in which Nations
Energy had invested, recording a pre-tax gain of $2.5 million on the
transaction. See Results of Millennium Energy Businesses below.
Our consolidated capital structure remains highly leveraged. Since
April 1997, however, we have made significant progress in our financial
strategy to reduce TEP refinancing risk by extending maturities of long-
term debt and letters of credit and by reducing exposure to variable
interest rates by refinancing over $475 million in variable rate debt with
fixed interest rate securities. With a more stabilized regulatory outlook
and with ongoing improvements in our capital structure, UniSource Energy
paid its first dividend to common shareholders in March 2000. We had not
paid a common dividend to public shareholders since 1989. See Dividends on
Common Stock and Investing and Financing Activities, below.
TEP's capital requirements include construction expenditures and
scheduled maturities of debt 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, when necessary, borrowings under the Revolving Credit Facility.
Millennium's unregulated energy businesses will continue to require
additional funding to meet their capital and credit needs. We expect to
use existing cash balances to fulfill these needs, or if necessary, we may
seek investments by unaffiliated parties to meet the ongoing capital
requirements of Millennium's 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. Approximately 20% of TEP's retail customers are currently
eligible to choose an alternate energy supplier. Currently, no competitors
are providing electric service to customers in our retail service area nor
has TEP lost any significant customers to self-generation. However,
beginning in January 2001, the University of Arizona intends to buy 6 MW or
approximately 20% of its load from an alternate energy supplier. It is
likely that, with open access in our retail service territory, additional
customers will elect to purchase their energy requirements from other energy
suppliers when available. TEP also competes against gas service suppliers
and others who provide energy services.
TEP'S SETTLEMENT AGREEMENT AND RETAIL ELECTRIC COMPETITION RULES
In November 1999, the ACC approved the Settlement Agreement between
TEP and certain customer groups relating to recovery of TEP's transition
recovery assets and unbundling of tariffs. For TEP, the Retail Electric
Competition Rules (Rules) provide a framework for the introduction of
retail electric competition in Arizona. Direct access to competitive
electricity by customers became effective in January 2000, 60 days after
the effective date of the Settlement Agreement. However, certain
conditions must be met before competitive electricity will be sold in TEP's
service territory, such as certification of Energy Service Providers (ESPs)
by the ACC and execution of and compliance with direct access service
agreements by ESPs and other service providers with TEP. Currently, one
ESP has met all the necessary conditions but has not yet begun selling
electricity in TEP's service territory.
As required by the Rules, consumer choice for energy supply will be
phased in beginning in 2000 until January 1, 2001, when consumer choice
will 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 1.1% on July 1, 1998,
1% on July 1, 1999 and 1% on July 1, 2000. These reductions apply to all
retail customers except for certain customers that have negotiated non-
standard rates. In accordance with the Settlement Agreement approved in
November 1999, now that these three rate reductions have occurred, TEP's
retail rates will be frozen until December 31, 2008, except under certain
circumstances. TEP will recover the costs of transmission and distribution
under regulated unbundled rates. TEP's frozen rates will include two
Competition Transition Charge (CTC) components, a Fixed CTC and a Floating
CTC, which are designated for the recovery of its transition recovery
assets.
Other major provisions of the Settlement Agreement were reported in
the 1999 Form 10-K. See TEP's Settlement Agreement and Retail Electric
Competition Rules in the 1999 Form 10-K.
Approval of the Settlement Agreement caused TEP to discontinue
regulatory accounting for its generation operations under FAS 71, in
November 1999. See Note 1 of Notes to Condensed Consolidated Financial
Statements, Regulatory Accounting.
Several parties filed lawsuits in Maricopa County Superior Court
challenging the ACC's Retail Electric Competition Rules order and in the
Arizona Court of Appeals challenging the ACC's order which approved TEP's
Settlement Agreement. It had been contended that allowing marketplace
competition to determine rates violated the ACC's constitutional duty to set
rates.
On July 12, 2000 a Maricopa County Superior Court judge issued a
preliminary ruling on the consolidated cases that generally upheld the
Retail Electric Competition Rules but concluded that some of the Rules were
invalid. Specifically, the court held that several non-ratemaking Rules
were required to be submitted to the Arizona Attorney General for
certification. Additionally, the judge determined that, in determining
rates, the Arizona Constitution requires the ACC to consider the fair value
of the property of an ESP upon its certification. Based on the judge's
decision, the ACC can decide to permit marketplace competition to determine
rates, as it has already done in the Rules. However, since the Rules do
not require a fair value determination, the judge ruled them
unconstitutional regarding this matter. The action in the Arizona Court of
Appeals was dismissed as a result of stipulation by the parties involved.
On November 1, 2000 the Maricopa County Superior Court judge entered a
minute entry affirming the July 12, 2000 preliminary ruling that some of the
ACC's rules violated provisions of the Arizona Constitution. The minute entry
held that "the Commission's consistent and repeated failure to comply with
Article 15, section 14 of the Arizona Constitution, affects the entire
electrical deregulation process." The minute entry then specified that
plaintiff's counsel submit an amended form of judgment to be rendered by the
court. The amended form of judgment was requested, among other things, to
state that the "decisions are vacated for being 'unconstitutional and
unlawful.'" On November 8, 2000, plaintiff's counsel filed an amended form
of judgment for the court's consideration.
We believe that the Retail Electric Competition Rules are still in
effect pending the acceptance or revision of the proposed form of judgment
by the court. We cannot predict when the court will render a judgment or
the outcome of these actions. We cannot predict whether the decision will
be appealed or the effect of such appeal.
WHOLESALE
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy at market-based
rates in the wholesale market. We expect competition to sell capacity and
energy 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;
* restructuring of the electric utility industry in Arizona, California
and other western states;
* the availability and prices of natural gas, oil and coal;
* spot energy prices;
* effect of precipitation on temperature; and
* transmission access.
TRANSMISSION ACCESS
TEP, along with several neighboring transmission owners located in the
southwestern United States, filed a report with the FERC on October 16,
2000 which detailed the progress in establishing a Regional Transmission
Organization (RTO) that would be responsible for ensuring transmission
reliability and nondiscriminatory access to the regional transmission grid.
We expect that Desert STAR, the non-profit corporation named in the filing,
will make additional filings with the FERC in the near future to establish
itself as an RTO for the region.
The October 16, 2000 filing complied with FERC Order No. 2000, which
required all public utilities that are transmission owners to file a
proposal for an RTO by October 2000. An RTO is an organization or
institution which is envisioned by the FERC to operate an electric
transmission system on a regional basis and enhance operational
transmission efficiencies and reliability. The FERC has not dictated
specific RTO structures but has instead adopted a flexible approach to
considering proposed organizational structures, including the possibility
of a transmission company which would own and operate all of the
transmission assets in a particular region. As an alternative to an RTO
proposal, transmission-owning public utilities were required to file a
description of any efforts made by the utility to participate in an RTO,
the reasons for not participating and any obstacles to participation, and
any plans for further work toward participation. This order is a
culmination of the FERC's efforts to promote the regional development of
transmission system operation and contemplates that RTOs will be
operational by December 15, 2001. While FERC Order 2000 takes a voluntary
approach to participation in RTOs, the FERC has indicated that it will take
any action it considers necessary, including requiring RTO formation, to
address any undue market power that may exist on the part of transmission
owners.
The ACC Retail Electric Competition Rules require the formation and
implementation of an Arizona Independent Scheduling Administrator
Association (AISA). The AISA is anticipated to be a temporary organization
until the formation and implementation of an ISO or RTO. TEP, as an
Affected Utility, participated in the creation of the AISA. This includes
its incorporation as a not-for-profit entity, the filing at the FERC for
approval of its proposed structure, rates and procedures, and drafting of
its protocols for operation. Recently, the board of AISA approved a set of
operating protocols which have been tendered for filing with the FERC and
are currently under review. TEP continues to participate with the other
Affected Utilities in developing the AISA's structure and protocols in
response to retail competition.
REGULATORY MATTERS
------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. 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
currently charge its customers to recover certain expenses, but instead
requires that these expenses be charged to customers in the future. In this
situation, FAS 71 requires that TEP defer these items and show them as
regulatory assets on the balance sheet until TEP is allowed to charge its
customers. TEP then amortizes these items as expense to the income
statement as those charges are recovered from customers. Similarly, certain
revenue items may be deferred as regulatory liabilities, which are also
eventually amortized to the income statement.
The conditions a regulated company must satisfy to apply the
accounting policies and practices of FAS 71 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.
Under GAAP, FAS 71 must be discontinued once sufficiently detailed
deregulation guidance is issued for a separable portion of a business.
However, a company may continue to recognize regulatory assets formerly
associated with the deregulated portion of the business, to the extent the
transition plan provides for their recovery through the regulated
transmission and distribution portion of the business.
Effective November 1, 1999, TEP stopped applying FAS 71 to its
generation operations because the Settlement Agreement provided sufficient
details regarding the deregulation of TEP's generation operations. As a
result, we changed certain accounts in our financial statements. See
Regulatory Matters in the 1999 Form 10-K for a discussion of these
accounting changes.
We continue to apply FAS 71 in accounting for the distribution and
transmission portions of TEP's business, our regulated operations. We
periodically assess whether we can continue to apply FAS 71 to these
operations. If we stopped applying FAS 71 to TEP's remaining regulated
operations, we would write off the related balances of TEP's regulatory
assets as a charge in our income statement. Based on the balances of TEP's
regulatory assets at September 30, 2000, if we had stopped applying FAS 71
to TEP's remaining regulated operations, we would have recorded a net after-
tax extraordinary loss of approximately $258 million. While regulatory
orders and market conditions may affect our cash flows, our cash flows
would not be affected if we stopped applying FAS 71.
See Note 1 of Notes to Condensed Consolidated Financial Statements,
Regulatory Accounting.
SAN JUAN COAL CONTRACT AMENDMENT
--------------------------------
In the third quarter 2000, TEP entered into an agreement to amend the
San Juan Generating Station's coal supply contract. Under the terms of the
amended contract among TEP, San Juan Coal Company (SJCC) and Public Service
Company of New Mexico (a co-owner of the San Juan generating station), SJCC
will phase out the current surface mining operation and replace it with an
underground mining operation to be in full production by November 2002.
The underground mine will provide higher quality coal to San Juan and
reduce production costs.
TEP owns 50 percent of Units 1 and 2 of San Juan, which represent 322
MW of installed capacity. TEP expects the contract amendment to reduce its
future coal costs by $275 million over the life of the contract, which
expires in 2017. On a net present value basis, TEP expects the savings to
be at least $50 million. To amend the contract, TEP and the other owners
will make a one-time payment to SJCC in 2003. TEP's share of that payment
will be approximately $15 million. TEP recorded a $13.2 million pre-tax
($8.0 million after-tax) expense in the third quarter of 2000 to recognize
the present value of that payment.
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. The market risks resulting from changes in
interest rates, returns on marketable securities and changes in foreign
currency exchange rates have not changed materially from the market risks
reported in the 1999 Form 10-K.
COMMODITY PRICE RISKS
TEP is exposed to commodity price risk primarily relating to changes
in the market price of electricity, as well as changes in fuel costs
incurred to generate electricity. TEP enters into forward contracts to buy
or sell energy at a specified price at a future date. These contracts are
considered to be derivative commodity instruments. Generally, TEP commits
to future sales based on expected excess generating capability. However,
rather than producing additional power, TEP may enter into a forward
purchase contract to satisfy the forward sales contract if the market
prices are favorable. The forward sales contracts that are satisfied with
forward purchase contracts do not require any physical delivery of energy
by TEP. However, to take advantage of anticipated market opportunities,
TEP is at various times in a net open position. A net open position means
it has either committed to sell more electricity than it has purchase
contracts to cover or it has committed to purchase more power than it needs
for its selling commitments. To limit exposure to price risk, TEP has
trading policies with limits as to total open positions. TEP continually
reviews its trading policies and limits to respond to the constantly
changing market conditions.
TEP measures its market risk related to its commodity exposure by
using a sensitivity analysis. The market prices used to determine fair
value are estimated based on various factors including broker quotes,
exchange, over the counter prices and time value. As of September 30,
2000, the estimated potential unfavorable impact on pre-tax earnings of a
hypothetical 10% adverse shift in quoted market prices was $8 million.
However, because TEP's derivative commodity instruments are primarily
hedges of forward long generation positions which could generally be
settled with TEP generation and are not used for trading purposes, we do
not believe that this commodity price risk is material to our financial
position.
For accounting purposes, TEP recognizes gains and losses of energy
sales and purchases in the income statement upon settlement of the
contracts. In June 1998, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 133 (FAS 133),
Accounting for Derivative Instruments and Hedging Activities. This
Statement requires all derivative instruments to be recognized as either
assets or liabilities on 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 comply with FAS 133 effective January 1, 2001.
Based on our analysis to date, we expect that the most significant
impact of complying with FAS 133 will be the ongoing market adjustments to
the income statement from some of our wholesale trading activity. We buy
and sell wholesale power using forward contracts. Based on our current
interpretation of FAS 133 and other guidance, we believe our wholesale
forward contracts will be classified as follows:
* Normal Purchases and Sales: These forward contracts are excluded from
the requirements of FAS 133. The realized gains and losses on these
contracts are reflected in the income statement at the contract
settlement date. The wholesale contracts that generally qualify as
normal purchases and sales are our off-peak forward purchases and
sales.
* Cash Flow Hedge: The unrealized gains and losses related to these
forward contracts will be included in Other Comprehensive Income, a
component of stockholders' equity. On-peak forward purchase contracts
to meet our retail and firm commitments as well as on-peak forward
sales contracts of our excess system capacity are generally classified
as cash flow hedges. We define our on-peak purchases and sales as
occurring daily from 6 a.m. until 10 p.m., Monday through Saturday.
* Trading Activity: The unrealized gains and losses related to these
forward contracts will be reflected in the income statements. Our
trading activity generally consists of forward on-peak sales and
purchases that do not qualify for cash flow hedge treatment.
Unrealized gains and losses of our forward contracts represent
the differences between the forward contract prices and the market
prices at any given date until the final settlement of the contract. The
realized gain or loss on the forward contract recorded at the contract
settlement represents the difference between the contract price and our
actual cost of the commodity that was purchased or sold. Based on our
current analysis and interpretation of FAS 133, if we had adopted FAS 133
at September 30, 2000, we would have recorded a $1 million unrealized loss
on the income statement and a $12 million unrealized loss as part of Other
Comprehensive Income. If we had adopted FAS 133 at September 30, 1999 we
would have recorded a $1 million unrealized loss on the income statement
and a $1 million unrealized loss as part of Other Comprehensive Income.
Because the forward contract volume in 2000 is roughly the same as 1999,
the difference between adoption of FAS 133 at September 30, 1999 and 2000
reflects the substantial increase in energy market prices in 2000. Because
of the volatility of the wholesale power market and continual changes in
the types of forward contracts that we have, we do not know if these
amounts are representative of the amounts that we will recognize in the
future after we adopt FAS 133. There are also certain issues that still
need to be addressed by the FASB Derivatives Implementation Group that may
also impact the amounts we will recognize under FAS 133.
TEP is exposed to credit risk in its energy trading activities related
to potential nonperformance by counterparties. TEP manages the risk of
counterparty default by performing financial credit reviews and setting
limits, requiring collateral when needed, and using a standardized
agreement which allows for the netting of current period exposures to and
from a single counterparty. TEP does not anticipate any nonperformance by
any of its counterparties and did not experience any material counterparty
default during the nine months ended September 30, 2000.
TEP also purchases coal and natural gas in the normal course of
business for fuel for its generating plants. Purchases of gas historically
provided fuel for only 3-4% of total generation. During the nine months
ended September 30, 2000, however, approximately 7% of TEP's generation was
fueled by natural gas. Market prices of natural gas also increased
significantly in 2000, which, combined with increased usage, caused gas
costs to comprise 22% of total fuel expense for the nine months ended
September 30, 2000, compared with 9% in 1999. Despite the significant
increases in market prices for natural gas in the second and third quarters
of 2000, it was cost-effective for TEP to run its gas-fired generating
units to sell into the wholesale market or to supply generation for its
retail load during peak periods. TEP has historically purchased fixed
price natural gas prior to the summer for a portion of its expected use.
TEP plans to purchase forward gas contracts as a means of mitigating price
risk of this increasingly volatile commodity in the future. TEP acquires
its coal under long-term coal supply contracts. See Fuel Supply in the
1999 Form 10-K for additional information on TEP's coal contracts and gas
purchases.
RESULTS OF OPERATIONS
---------------------
UniSource Energy recorded net income of $17.2 million or $0.53 per
average share of Common Stock in the third quarter of 2000, and net income
of $28.1 million or $0.87 per share in the first nine months of 2000. This
compares with net income of $51.7 million or $1.60 per average share of
Common Stock in the third quarter of 1999, and net income of $49.8 million
or $1.54 per share in the first nine months of 1999.
Growth in retail electricity sales, wholesale marketing activities and
efficient performance of generating units at TEP contributed to the
earnings recorded in the third quarter of 2000. Despite this strong
underlying performance at the utility, several factors contributed to the
lower net income reported for the third quarter of 2000 compared with the
third quarter of 1999:
* a one-time $8 million after-tax expense related to the amendment of
a coal supply contract in the third quarter of 2000;
* the $20.8 million after-tax gain on the sale of one of our unregulated
energy businesses in the third quarter of 1999; and
* the impact of accounting changes related to the discontinuation of
regulatory accounting for TEP's generation operations under FAS 71
in November 1999.
The same factors outlined above account for the lower net income
reported for the first nine months of 2000 compared with the same period of
1999. See Factors Affecting Results of Operations and Results of
Operations, below for further detail.
CONTRIBUTION BY BUSINESS SEGMENT
--------------------------------
The table below shows the contributions to our consolidated after-tax
earnings by our two business segments, as well as parent company expenses
and inter-company eliminations, for the third quarter and first nine months
of 2000 and 1999, respectively:
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
-------------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $19.8 $31.9 $33.1 $39.0
Millennium (1.3) 21.0 (1.2) 15.0
Parent Company and Inter-
Company Eliminations (1.3) (1.2) (3.8) (4.2)
-------------------------------------------------------------------------
Consolidated Net Income $17.2 $51.7 $28.1 $49.8
=========================================================================
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. TEP results
include interest income from this note.
The operating revenues and expenses from the Millennium Energy
Businesses are currently included as part of UniSource Energy's Operating
Revenues and Operating Expenses. Previously, these revenues and expenses
were included in the Millennium Energy Businesses line item in the Other
Income and Deduction section of the income statement. The income
statements for the three and nine-months ended September 30, 1999 have
been reclassified to conform to the new presentation. See Note 3 of Notes
to Condensed Consolidated Financial Statements, Millennium Energy
Businesses.
TEP's 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 Millennium's
unregulated energy businesses are discussed in Results of Millennium Energy
Businesses below.
IMPACT OF REGULATORY ACCOUNTING CHANGES
---------------------------------------
TEP stopped applying regulatory accounting (FAS 71) to its generation
operations during the fourth quarter of 1999 in response to its Settlement
Agreement with the ACC. As a result, the operating results for 1999 and
2000 are not directly comparable because the presentation and calculation
of certain financial statement line items changed. Reported earnings are
lower in 2000 than in 1999 due primarily to:
* the change in accounting for capital leases. Previously, we recorded
lease expense consistent with our rate-making treatment and recorded
equal annual expense amounts over the lease term. Under current
accounting treatment, capital lease expense is higher in the earlier
years of the lease term because the interest expense component is
calculated on a mortgage basis.
* the reclassification of our generation-related regulatory assets to
the Transition Recovery Asset, which shortened the amortization
period for these assets to nine years and thereby increased the
annual amortization amounts.
TEP will continue to experience downward pressure on earnings due to
the changes in expense recognition from the discontinuation of FAS 71 for
our generation operations. However, TEP expects that the changes in
expense recognition may be offset, and earnings provided by, the following
factors:
* customer growth in TEP's service territory is expected to continue
at approximately 2% annually over the next five years;
* margins on wholesale sales are expected to increase as market prices
in the region increase over time; and
* a portion of free cash flow may be used to reduce TEP's debt,
thereby lowering interest expense.
UTILITY SALES AND REVENUES
--------------------------
Comparisons of TEP's kilowatt-hour sales and electric revenues are
shown below:
Increase
---------------
2000 1999 Amount Percent
Three Months Ended September 30, ---- ---- ------ -------
-------------------------------- - Thousands-
Electric kWh Sales:
Retail Customers 2,515,101 2,343,480 171,621 7.3%
Sales for Resale 1,729,286 1,657,115 72,171 4.4%
--------- --------- -------
Total 4,244,387 4,000,595 243,792 6.1%
========= ========= =======
Electric Revenues:
Retail Customers $214,513 $198,022 $16,491 8.3%
Sales for Resale 125,131 66,083 59,048 89.4%
-------- -------- -------
Total $339,644 $264,105 $75,539 28.6%
======== ======== =======
Nine Months Ended September. 30,
--------------------------------
Electric kWh Sales:
Retail Customers 6,363,815 5,951,879 411,936 6.9%
Sales for Resale 4,447,089 3,833,957 613,132 16.0%
---------- --------- ---------
Total 10,810,904 9,785,836 1,025,068 10.5%
========== ========= =========
Electric Revenues:
Retail Customers $518,694 $484,236 $ 34,458 7.1%
Sales for Resale 231,514 128,814 102,700 79.7%
-------- -------- --------
Total $750,208 $613,050 $137,158 22.3%
======== ======== ========
TEP's kWh sales to retail customers increased by 7.3% in the third
quarter of 2000 compared with the same period in 1999. The retail kWh
sales increase was due to a 2.8% increase in the number of retail customers
and warmer summer temperatures as measured by a 26% increase in Cooling
Degree Days compared with the third quarter of 1999. Retail revenues
increased by 8.3% in the third quarter of 2000 compared with the same
period in 1999, reflecting the higher kWh sales and $2.5 million in
revenues from the reversal of a reserve for disputed charges. These
increases were offset, in part, by a 1.0% rate decrease effective July 1,
2000. For the first nine months of 2000, retail kWh sales increased 6.9%
compared with the same period in 1999 as a result of an increase in retail
customers and weather changes. Retail revenues increased 7.1% due to
increased retail kWh sales. TEP established a new annual energy use record
on August 4, 2000. The maximum momentary peak on that day was 1,871
megawatts and the net hourly peak was 1,862 megawatts, compared with the
maximum momentary peak of 1,767 megawatts and the net hourly peak of 1,754
megawatts in the third quarter 1999.
Kilowatt-hour sales for resale increased 4.4% and the related revenues
increased by 89.4% in the third quarter of 2000 compared with the same
period in 1999. Wholesale sales volume increased primarily from an
increase in short-term buy/resale activity. Market prices were
significantly higher in the three months ended September, 2000 than in the
same prior year quarterly period, causing the revenue increase to exceed
the volume increase on a percentage basis. Higher natural gas prices and
warmer regional temperatures contributed to higher market prices. For the
first nine months of 2000, wholesale sales increased 16.0% compared with
the same period in 1999 due primarily to an increase in buy/resale
activity. Revenues from wholesale sales increased 79.7% as a result of
increased sales volume and higher market prices as described above.
OPERATING EXPENSES
------------------
Fuel and Purchased Power expense increased by $66 million in the third
quarter of 2000 compared with the same period the year before. Fuel
expense at TEP's generating plants increased $17 million primarily due to
higher natural gas prices and increased usage of gas generation to meet
increased kWh sales. Purchased Power expense also increased by $49 million
primarily because of increased purchases in response to the large increase
in wholesale energy sales made by TEP during the quarter. For the nine
months ended September 30, 2000, Fuel and Purchased Power expense increased
by $109 million primarily for the same reasons discussed above. Fuel
expense increased $22 million while Purchased Power expense was up $87
million.
Despite the large increases in Fuel and Purchased Power expense, TEP's
gross margin (Operating Revenues less Fuel and Purchased Power expense)
improved by 6% in the third quarter and 7% in the first nine months of 2000
compared with the prior year periods. This improvement was primarily due
to higher prices in the wholesale energy markets.
TEP recorded a $13.2 million pre-tax ($8 million after-tax) one-time
charge in the third quarter of 2000 as a result of a coal supply contract
amendment. See San Juan Coal Contract Amendment above.
The presentation and calculation of certain financial statement line
items changed in November 1999 as a result of the discontinuation of
regulatory accounting (FAS 71) for TEP's generation operations.
Accordingly, beginning in November 1999, Capital Lease expense is now being
reflected in Depreciation and Amortization and in Interest on Capital
Leases. The increase in Depreciation and Amortization for the third
quarter and first nine months of 2000 compared to the same periods the year
before is primarily due to this new presentation. Also, additional
property and equipment were placed in service during 2000. Because we
stopped applying FAS 71, we discontinued amortization of the Springerville
Unit 1 Allowance contra-asset and the corresponding recognition of Interest
Imputed on Losses Recorded at Present Value.
Other Operations and Maintenance and Repair expenses increased to
support customer growth and higher kWh sales for both the third quarter and
the first nine months of 2000 compared to the prior year periods.
The Transition Recovery Asset and its related amortization is a result
of the Settlement Agreement reached with the ACC in 1999. The amount of
Amortization of Transition Recovery Asset totaled $8.8 million and $14.4
million for the quarter and nine months ended September 30, 2000,
respectively. Quarterly amortization amounts are a function of various
factors including kWh sales.
Income Taxes were lower in both the third quarter and first nine
months of 2000 compared to the prior year periods due to lower pre-tax
income. We also recognized tax benefits from the resolution of various IRS
audit issues in the second quarter of 2000. See Note 6 of Notes to
Condensed Consolidated Financial Statements, Contingencies.
OTHER INCOME (DEDUCTIONS)
-------------------------
INTEREST INCOME
TEP's income statements for the quarters ended September 30, 2000 and
1999 include $2.3 million and $2.5 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 inter-company income is
eliminated. For the nine months ended September 30, 2000 and 1999, the
interest income on the promissory note was $7.0 million and $7.6 million,
respectively.
UniSource Energy recorded higher interest income for the quarter ended
September 30, 2000 and the first nine months of 2000, due primarily to
interest earned on lease debt investments. See Liquidity and Capital
Resources below.
EQUITY IN EARNINGS (LOSSES) OF UNCONSOLIDATED ENTITIES
Results from unconsolidated entities include various operations of the
unregulated energy businesses of Millennium. Because of the change in
ownership of GES, the results of operations from the consolidated
unregulated energy subsidiaries of Millennium are now included in Operating
Revenues and Operating Expenses. Previously, these revenues and expenses
were included in Other Income (Deductions). See Note 3 of Notes to
Condensed Consolidated Financial Statements, Millennium Energy Businesses.
The decrease in Equity in Losses of Unconsolidated Entities for the nine
months ended September 30, 2000, compared with the same prior year period,
is primarily due to the $2.5 million pre-tax gain on the sale of a minority
interest in a power project in the Czech Republic in the first quarter
2000.
INTEREST EXPENSE
----------------
Because we stopped applying FAS 71 to generation operations, we had
the following changes which had the net effect of increasing interest
expense:
* We reclassified Capital Lease Interest Expense from Operating
Expenses to Interest Expense; and
* We no longer record the Interest Imputed on Losses Recorded at Present
Value due to the elimination of the Springerville Unit 1 Allowance.
Absent these accounting changes, Interest Expense for the third quarter and
first nine months of 2000 would have been lower compared to the same
periods of the prior year due primarily to lower amortization of losses on
reacquired debt and lower letter of credit fees.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
---------------------------------------
The unregulated energy businesses of Millennium reported a net loss of
$1.3 million for the third quarter of 2000, and net loss of $1.2 for the
first nine months of 2000. This compares with a net income of $21.0
million in the third quarter and a net income of $15.0 million for the
first nine months of 1999. The table below provides a breakdown by
Millennium-owned subsidiaries of the after tax net income/(losses) recorded
for the three months and nine months ended September 30, 2000 and 1999.
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
----------------------------------------------------------------------
-Thousands of Dollars-
Subsidiary
AET $(1,466) $ (80) $(3,274) $ (691)
MEH 200 21,200 877 20,550
Nations Energy (339) (181) 592 (5,151)
Other 351 61 587 319
----------------------------------------------------------------------
Total Millennium $(1,254) $21,000 $(1,218) $ 15,027
======================================================================
AET AND GLOBAL SOLAR
Millennium owns 100% of AET, which owns 67% of GES, the parent
company of Global Solar Energy, Inc., a manufacturer of thin-film
photovoltaic cells. Effective June 1, 2000, Millennium increased its
ownership percentage in GES from 50% to 67%. See Note 3 of Notes to
Condensed Consolidated Financial Statements, Millennium Energy Businesses.
AET's net losses in the third quarter and first nine months of 2000 were
primarily due to research and development-related costs and delays at the
manufacturing facility.
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 in the third quarter of
1999, resulting in an after-tax gain of $20.8 million. See discussion of
NewEnergy and the terms of the sale below at Investing and Financing
Activities, Millennium - Unregulated Energy Businesses.
MEH's net income for the third quarter and first nine months of 2000
was derived primarily from interest income from a note receivable received
as part of the sale of NewEnergy to AES Corporation.
NATIONS ENERGY
Nations Energy develops independent power projects worldwide. For the
third quarter of 2000, Nations Energy recorded a net loss of $0.3 million
due to operating expenses at existing projects. The results for the nine
months ended September 30, 2000 and 1999 reflect transactions related to
Nations Energy's investment in a power project in the Czech Republic. The
loss reported in 1999 was principally from development costs and expenses
related to the exercise of an option to invest in this power project. The
minority investment interest in this plant was sold in the first quarter
2000. Management is considering the sale of Nation's remaining assets.
Currently the book value of these assets is approximately $20.3 million.
DIVIDENDS ON COMMON STOCK
-------------------------
UNISOURCE ENERGY
On August 4, 2000, UniSource Energy declared a cash dividend in the
amount of $0.08 per share on its Common Stock, payable September 8, 2000 to
shareholders of record at the close of business August 15, 2000. On
November 3, 2000, UniSource Energy declared a cash dividend in the amount
of $.08 per share on its Common Stock, payable December 8, 2000 to
shareholders of record at the close of business November 15, 2000.
UniSource Energy's Board of Directors will review our dividend policy
on a continuing basis, taking into consideration a number of factors
including our results of operations and financial condition, general
economic and competitive conditions and the cash flow from our
subsidiaries, TEP and Millennium.
TEP
In December 1999, TEP declared and paid a dividend of $34 million to
UniSource Energy, its sole shareholder.
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,
2000, the required minimum net worth was $226 million. TEP's actual net
worth at September 30, 2000 was $304 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of September 30, 2000, 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, 2000, TEP's equity ratio on that basis was 21%.
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. Therefore, TEP declared its December 1999 dividend from 1999
earnings since TEP had an accumulated deficit, rather than positive
retained earnings.
MILLENNIUM
In the third quarter of 1999, Millennium paid a $10 million cash
dividend to UniSource Energy. We cannot predict the amount or timing of
future dividends from Millennium.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
CASH FLOWS
----------
UNISOURCE ENERGY
Consolidated cash and cash equivalents decreased from the September
30, 1999 ending balance of $131.7 million to $103.3 million at September
30, 2000. For the twelve-month period ended September 30, 2000,
consolidated net cash outflows for investing and financing activities
exceeded the cash generated from operating activities.
Net cash flows from operating activities increased by $61.8 million in
the first nine months of 2000 compared with the same period in 1999. The
net increase primarily resulted from the following factors:
* $113.6 million increase in cash receipts from sales to wholesale
and retail customers;
* $83.6 million increase in Fuel and Purchased Power Costs paid to
support the higher sales;
* no cash outflows for tax settlements, compared with $22.4 million
paid in 1999; and
* $9.3 million increase in capital lease interest paid.
Net cash used for investing activities totaled $81.7 million during
the first nine months of 2000 compared with $66.1 million during the same
period in 1999. Capital expenditures were $12.9 million higher in 2000.
Other significant investing activities in 2000 included: (i) the $27.6
million purchase of Springerville Unit 1 Lease debt by Millennium, (ii)
Nations Energy's $19.9 million in proceeds from the sale of its interest in
the Czech Republic power project, and (iii) $11.4 million in proceeds from
the payment of the promissory note from NewEnergy to MEH. In 1999,
investing activities included : (i) the $26.8 million purchase of
Springerville Unit 1 Lease debt by TEP and (ii) Millennium's sale of the
AES Corporation stock received as consideration from the sale of NewEnergy
for $27.5 million.
Net cash used for financing activities totaled $94.5 million in the
first nine months of 2000 compared with $19.8 million during the same
period in 1999. In 2000, the major use of cash for financing activities
was $46.9 million to retire TEP's maturing 12.22% Series First Mortgage
Bonds on June 1, 2000 and $38.9 million of scheduled payments that retired
capital lease obligations. In 1999, $22.3 million of capital lease
obligations were retired. In the first nine months of 2000, UniSource
Energy paid $7.8 million in dividends on Common Stock.
UniSource Energy's consolidated cash balance, including cash
equivalents, at November 6, 2000 was approximately $132 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 expects to use cash to
fund investments in Millennium's unregulated energy businesses 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 available cash falls short of
expectations, we would reevaluate the investment requirements of
Millennium's unregulated energy businesses and/or seek additional financing
for, or investments in, those businesses by unrelated parties.
TEP
Cash and cash equivalents decreased from the September 30, 1999 ending
balance of $96.2 million to $63.8 million at September 30, 2000. For the
twelve-month period ended September 30, 2000, net cash outflows from
investing and financing activities exceeded net cash inflows for operating
activities.
Net cash flows from operating activities increased by $51.3 million in
the first nine months of 2000 compared with the same period in 1999,
principally due to cash receipts from wholesale sales and from sales to
retail customers, net of related fuel purchases. See Cash Flows,
UniSource Energy, above for a discussion of other factors affecting net
cash flows from operating activities.
Net cash used for investing activities totaled $76.1 million during
the first nine months of 2000 compared with $89.6 million during the same
period of 1999. Capital expenditures were $9.4 million higher in 2000. In
1999, $26.8 million of Springerville Unit 1 Lease debt was purchased by
TEP.
Net cash used for financing activities totaled $87.2 million during
the first nine months of 2000 compared with $19.9 million during the same
period in 1999. The retirement of maturing First Mortgage Bonds and
scheduled Payments to Retire Capital Lease Obligations were the principal
reasons for the increase in financing activities. On June 1, 2000 TEP's
maturing $46.9 million 12.22% Series First Mortgage Bonds were retired.
TEP's consolidated cash balance, including cash equivalents, at
November 6, 2000 was approximately $92 million.
TEP expects to generate enough cash flow during the next 12 months to
fund continuing operating activities, capital expenditures, required debt
maturities, and to pay dividends to UniSource Energy. However, TEP's cash
flows may vary due to changes in wholesale market conditions, changes in
short-term interest rates and other factors. If cash flows were to fall
short of our expectations, or if monthly cash requirements temporarily
exceed available cash balances, TEP would borrow from the Revolving Credit
Facility. See Investing and Financing Activities, TEP Credit Agreement,
below.
INVESTING AND FINANCING ACTIVITIES
----------------------------------
TEP
---
CAPITAL EXPENDITURES
TEP's capital expenditures for the three months and nine months ended
September 30, 2000 were $23.6 million and $73.7 million, respectively.
TEP's capital budget for the year ending December 31, 2000 is approximately
$95 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 differ 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, 2000 and as of November 6, 2000, TEP had no
borrowings 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 2000 and gradually increasing to 1.55 in 2002, and (c) a maximum
Leverage Ratio ranging from 6.60 in 2000 and gradually decreasing to 6.20
in 2002. TEP is in compliance with each of these covenants.
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. As part
of the transaction, two promissory notes were issued by NewEnergy totaling
$22.8 million. One of the promissory notes in the principal amount of
$11.4 million was paid on July 24, 2000 and the remaining promissory note
for an additional $11.4 million is due on July 23, 2001. This note is
secured by AES stock and bears interest at 9.5%.
ADDITIONAL INVESTMENTS IN ENERGY TECHNOLOGIES
Effective June 1, 2000, Millennium increased its ownership percentage
in GES from 50% to 67%. The remaining 33% of GES is owned by ITN Energy
Systems, Inc. (ITN), a privately-held company. Under the agreement, ITN
transferred its rights to certain assets and proprietary and intellectual
property, including thin-film battery technology, to GES. Millennium
agreed to contribute to GES up to $14 million in additional equity. As of
September 30, 2000, Millennium funded $11.4 million under this agreement,
including $3.5 million in the third quarter of 2000. As of October 31, 2000,
Millennium had funded the full $14 million under this agreement.
In September 2000, Millennium and ITN agreed to form a jointly-owned
space systems company for the purpose of developing and commercializing
small-scale satellites. Millennium agreed to provide $10 million in equity
and $10 million in credit to the venture. ITN will contribute development
contracts and proprietary technologies.
Separately, ITN and Millennium agreed to form a jointly-owned product
development company, which will provide research and development services
to AET affiliates and third parties. Millennium committed to provide $4
million in credit to the company, and ITN will provide additional
technologies, including direct energy conversion, fuel cells and thermal
desalinization.
Millennium also agreed to provide an additional $20 million in credit
to Global Solar over a 4-year period to fund production and expansion, and
$6 million in credit to TFB, Inc. to fund the start-up of a thin-film
battery pilot line.
OTHER CAPITAL REQUIREMENTS
During 1999 and in 2000, we have taken the opportunity to realize the
value from certain of Millennium's capital-intensive investments and focus
on emerging energy production and storage technologies.
In January 2000, Nations Energy sold its interest in the project
located in the Czech Republic resulting in a $2.5 million pre-tax gain.
In July 2000, Millennium made a $15 million capital commitment to a
limited partnership which will fund energy related investments. Initially,
$3 million is expected to be invested during the next six months. As of
November 6, 2000 Millennium has funded approximately $1 million under this
commitment. The remaining $12 million is expected to be invested within
three to five years. A member of the UniSource Energy Board of Directors
will also have a minor investment in the project. An affiliate of such
board member will serve as the general partner.
Our ability to fund additional future capital requirements of our
unregulated business segment will depend to a great extent on the amount
and availability of dividends UniSource Energy receives 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 Reform 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. Effects of competition in retail and wholesale energy markets.
3. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
4. Supply and demand conditions in wholesale energy markets, including
volatility in market prices and illiquidity in markets, which are
effected by a variety of factors including availability of generating
capacity, weather, natural gas prices and the impact of utility
restructuring and generation divestitures in various states.
5. 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.
6. Changes in governmental policies and regulatory actions with respect
to financings and rate structures.
7. Changes affecting the cost of competing energy alternatives,
including changes in available generating technologies and changes
in the cost of natural gas.
8. Changes in accounting principles or the application of such
principles to UniSource Energy or TEP.
9. Marketing conditions and technological changes affecting UniSource
Energy's unregulated businesses.
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 UniSource
Energy's and TEP's Annual Report on Form 10-K for the year ended December
31, 1999, 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 Risks.
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
---------------------------------------------------------------------------
TAX ASSESSMENTS
See Note 6 of Notes to Condensed Consolidated Financial Statements,
Contingencies.
ACC ORDER on the SIERRITA CONTRACT
See Note 6 of Notes to Condensed Consolidated Financial Statements,
Contingencies.
ITEM 5. - OTHER INFORMATION
---------------------------------------------------------------------------
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS
The following changes were effective October 1, 2000:
UniSource Energy
----------------
Ira R. Adler was named President and Chief Executive Officer of Global
Energy Solutions, the parent company of Global Solar Energy. Mr. Adler was
also elected to serve on the Millennium Board of Directors and continues to
serve on the UniSource Energy Board of Directors, to which he was elected
in 1998. He had been Executive Vice President and Chief Financial Officer
at UniSource Energy and TEP, and had served on the TEP Board of Directors
since 1998. He had been an officer of TEP since 1988.
Kevin P. Larson was named Vice President and Chief Financial Officer
of both UniSource Energy and TEP. Mr. Larson had been Vice President and
Treasurer at TEP.
Vincent Nitido, Jr. was named Vice President and General Counsel of
both UniSource Energy and TEP. Mr. Nitido had been Vice President and
Assistant General Counsel of TEP.
Michael J. DeConcini was named Senior Vice President for Strategic
Planning and Investments. Mr. DeConcini had been Vice President of
UniSource Energy.
Tucson Electric Power Company
-----------------------------
Dennis R. Nelson was named Senior Vice President and Chief Operating
Officer of the Energy Resources Business Unit. Mr. Nelson had been Senior
Vice President and General Counsel.
Steven J. Glaser was named Senior Vice President and Chief Operating
Officer of the Utility Distribution Business Unit. Mr. Glaser had been
Vice President of the Utility Distribution Business Unit.
REGULATION
Franchise
---------
In the general election of November 2000, the voters of the City of
Tucson approved a new 25-year franchise for TEP to provide electric service
to customers in the City of Tucson. The previous franchise was to expire
in 2001. Under the new franchise, TEP will pay to the city a fee based on
the amount of energy delivered (on a kWh basis) within the city limits.
This payment will be assessed to TEP's customers.
Arizona Corporation Commission
------------------------------
In the 2000 general election, the voters of Arizona approved an
amendment to the Arizona Constitution, expanding the membership of the ACC
from three to five members. The amendment also changed the term of office
from a single six-year term to up to two terms of four years. The first
election for the two new seats will take place in 2002 and their first
term will be a two-year term beginning in January 2003. Thereafter,
members will serve four-year terms.
The 2000 general election filled two open seats on the ACC. Incumbent
Commissioner William Mundell (Republican) was elected to complete the
remaining four years of the six-year term to which he was appointed in
1999. Mr. Mundell's term will end in 2004.
Marc Spitzer (Republican), was elected to a six-year term replacing
Carl Kunasek (Republican), who was ineligible to run due to term limits.
Mr. Spitzer's term will end in 2006.
The third member of the ACC, Jim Irvin, (Republican) will complete his
six-year term in 2002.
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges for
TEP:
9 Months Ended 12 Months Ended
September 30, September 30,
2000 2000
-------------- ---------------
Ratio of Earnings to 1.32 1.32
Fixed Charges
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
---------------------------------------------------------------------------
(a) Exhibits.
-- See Exhibit Index.
(b) Reports on Form 8-K.
UniSource Energy and TEP filed the following current reports on Form
8-K during the quarter ended September 30, 2000:
* None.
<PAGE>
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
each registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized. The signature for each
undersigned company shall be deemed to relate only to matters having
reference to such company or its subsidiary.
UNISOURCE ENERGY CORPORATION
----------------------------
(Registrant)
Date: November 14, 2000 /s/ Kevin Larson
----------------------------
Kevin Larson
Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: November 14, 2000 /s/ Kevin Larson
-----------------------------
Kevin Larson
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.
