UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 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 August 4, 2000, 32,391,164 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.
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 (Loss).............................................. 2
Comparative Condensed Consolidated Statements
of Cash Flows................................................. 3
Comparative Condensed Consolidated Balance Sheets.............. 4
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income........ 5
Comparative Condensed Consolidated Statements of
Cash Flows.................................................... 6
Comparative Condensed Consolidated Balance Sheets.............. 7
Notes to Condensed Consolidated Financial Statements
Note 1. Regulatory Accounting.................................. 8
Note 2. Business Segments...................................... 8
Note 3. Millennium Energy Businesses........................... 9
Note 4. Debt Retirement and Issuance...........................10
Note 5. Contingencies..........................................11
Note 6. Income Taxes...........................................11
Note 7. New Accounting Standards...............................12
Note 8. Review by Independent Public Accountants...............12
Note 9. Other Reclassifications................................13
Item 2. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview........................................................14
Factors Affecting Results of Operations
Competition
Retail......................................................15
TEP's Settlement Agreement and Retail Electric
Competition Rules..........................................15
Wholesale...................................................16
Transmission Access.........................................16
Regulatory Matters............................................17
Market Risks..................................................18
Results of Operations...........................................18
Contribution by Business Segment..............................18
Utility Sales and Revenues....................................19
Operating Expenses............................................20
Other Income (Deductions).....................................20
Interest Expense..............................................21
Results of Millennium Energy Businesses.........................21
AET and Global Solar..........................................21
MEH and NewEnergy.............................................21
Nations Energy................................................22
Dividends on Common Stock
UniSource Energy..............................................22
TEP...........................................................22
Millennium....................................................22
Liquidity and Capital Resources
Cash Flows
UniSource Energy............................................23
TEP.........................................................23
Investing and Financing Activities
TEP
Capital Expenditures.......................................24
TEP Credit Agreement.......................................24
Millennium -- Unregulated Energy Businesses
Sale of NewEnergy, Inc.....................................24
Capital Requirements.......................................24
Safe Harbor for Forward-Looking Statements......................25
Item 3. -- Quantitative and Qualitative
Disclosures About Market Risk..................................26
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments.................................................27
ACC Order on the Sierrita Contract..............................27
Item 4. -- Submission of Matters to a Vote of
Security Holders................................................27
Item 5. -- Other Information
Additional Financial Data.......................................28
Item 6. -- Exhibits and Reports on Form 8-K......................28
Signature Page...................................................29
Exhibit Index....................................................30
</PAGE>
DEFINITIONS
The abbreviations and acronyms used in the 2000 Second Quarter Form 10-Q
are defined below:
ACC................. Arizona Corporation Commission.
AET................. Advanced Energy Technologies, Inc., a wholly-owned
subsidiary of Millennium.
Affected Utilities.. Electric utilities regulated by the ACC, including
TEP, Arizona Public Service, Citizens Utilities
company, and several electric cooperatives.
Common Stock........ UniSource Energy's common stock, without par value.
Company............. UniSource Energy Corporation.
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 Discontinu-
ation of FASB Statement No. 71.
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.
Global Solar........ Global Solar Holdings, L.L.C., a corporation which is
67% owned by AET and 33% owned by ITN.
Heating Degree Days. Calculated by subtracting the average of the high and
low daily temperatures from 75.
ION................. ION International, Inc., a wholly-owned subsidiary of
Millennium.
IRS................. Internal Revenue Service.
ISO................. Independent System Operator.
ITC................. Investment tax credit.
ITN................. ITN Energy Systems, Inc., an unaffiliated company which
owns 33% of Global Solar.
kWh................. Kilowatt-hour(s).
MEH................. MEH Corporation, a wholly-owned subsidiary of Millennium.
Millennium.......... Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
Nations Energy...... Nations Energy Corporation, a wholly-owned subsidiary
of Millennium.
NewEnergy........... NewEnergy, Inc., formerly New Energy Ventures, Inc., a
company in which a 50% interest was owned by MEH.
NOL................. Net Operating Loss carryforward for income tax purposes.
Rate Settlement..... TEP's Rate Settlement agreement approved by the
ACC in August 1998, which provides retail base price
decreases over a two-year period.
Revolving Credit
Facility........... $100 million revolving credit facility entered into under
the Credit Agreement between a syndicate of banks
and TEP.
RTO................. Regional Transmission Organization.
Rules............... Retail Electric Competition Rules.
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.
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 June 30,
2000, and the related condensed consolidated statements of income (loss)
for each of the three-month and six-month periods ended June 30, 2000 and
1999 and the condensed consolidated statements of cash flows for the six-
month periods ended June 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 generally accepted accounting
principles.
We previously audited in accordance with generally accepted auditing
standards, the consolidated balance sheets and statements of capitalization
of the Company and of TEP as of December 31, 1999, and the related consoli-
dated 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
August 10, 2000
</PAGE>
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 (LOSS)
Three Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $172,891 $158,194
Sales for Resale 61,622 30,872
Other 2,563 4,506
--------- ---------
Total Operating Revenues 237,076 193,572
--------- ---------
Operating Expenses
Fuel and Purchased Power 98,258 60,868
Maintenance and Repairs 15,350 14,667
Other Operations 30,769 31,548
Depreciation and Amortization 27,761 21,005
Amortization of Transition Recovery Asset 4,679 -
Taxes Other Than Income Taxes 12,512 12,396
Capital Lease Expense - 25,918
Amortization of Springerville Unit 1 Allowance - (8,730)
Income Taxes (3,237) 3,392
--------- ---------
Total Operating Expenses 186,092 161,064
--------- ---------
Operating Income 50,984 32,508
--------- ---------
Other Income (Deductions)
Interest Income 3,252 1,801
Equity in Earnings (Losses) of Unconsolidated Entities (1,297) (2,656)
Other Income 1,482 613
Income Taxes (1,442) (332)
--------- ---------
Total Other Income (Deductions) 1,995 (574)
--------- ---------
Interest Expense
Long-Term Debt 17,155 16,797
Interest on Capital Leases 23,286 -
Interest Imputed on Losses Recorded at Present Value - 8,748
Other Interest Expense 1,879 2,681
--------- ---------
Total Interest Expense 42,320 28,226
--------- ---------
Net Income (Loss) $ 10,659 $ 3,708
========= =========
Average Shares of Common Stock Outstanding (000) 32,389 32,309
========= =========
Basic Earnings (Loss) per Share $ 0.33 $ 0.11
========= =========
Diluted Earnings (Loss) per Share $ 0.32 $ 0.11
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $304,181 $286,214
Sales for Resale 106,383 62,731
Other 4,114 6,763
--------- ---------
Total Operating Revenues 414,678 355,708
--------- ---------
Operating Expenses
Fuel and Purchased Power 158,798 115,787
Maintenance and Repairs 23,694 24,304
Other Operations 62,783 58,907
Depreciation and Amortization 55,218 44,118
Amortization of Transition Recovery Asset 5,582 -
Taxes Other Than Income Taxes 24,874 24,690
Capital Lease Expense - 51,379
Amortization of Springerville Unit 1 Allowance - (17,459)
Income Taxes (5,235) (78)
--------- ---------
Total Operating Expenses 325,714 301,648
--------- ---------
Operating Income 88,964 54,060
--------- ---------
Other Income (Deductions)
Interest Income 6,486 3,664
Equity in Earnings (Losses) of Unconsolidated Entities (1,868) (4,275)
Other Income 3,828 1,323
Income Taxes (1,728) (644)
--------- ---------
Total Other Income (Deductions) 6,718 68
--------- ---------
Interest Expense
Long-Term Debt 34,029 33,122
Interest on Capital Leases 46,552 -
Interest Imputed on Losses Recorded at Present Value - 17,496
Other Interest Expense 4,200 5,330
--------- ---------
Total Interest Expense 84,781 55,948
--------- ---------
Net Income (Loss) $ 10,901 $ (1,820)
========= =========
Average Shares of Common Stock Outstanding (000) 32,382 32,297
========= =========
Basic Earnings (Loss) per Share 0.34 $ (0.06)
========= =========
Diluted Earnings (Loss) per Share $ 0.33 $ (0.06)
========= =========
See Notes to Condensed Consolidated Financial Statements.
</PAGE>
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $315,796 $296,616
Cash Receipts from Sales for Resale 86,296 61,526
Fuel and Purchased Power Costs Paid (139,137) (113,721)
Wages Paid, Net of Amounts Capitalized (33,070) (36,969)
Payment of Other Operations and Maintenance Costs (49,863) (49,698)
Capital Lease Interest Paid (47,551) (46,693)
Taxes Paid, Net of Amounts Capitalized (48,329) (48,410)
Interest Paid, Net of Amounts Capitalized (36,541) (36,221)
Income Taxes Paid (3) (5,920)
Interest Received 6,676 3,253
Other 3,880 3,030
--------- ---------
Net Cash Flows - Operating Activities 58,154 26,793
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (53,139) (42,633)
Investments in and Loans to Millennium
Energy Businesses (5,443) (5,050)
Sale of Interest in Millennium Energy Businesses 19,950 4,050
Investment in Lease Debt (27,633) (15,728)
Other Investments - Net 381 306
--------- ---------
Net Cash Flows - Investing Activities (65,884) (59,055)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt - 1,977
Payments to Retire Long-Term Debt (48,103) (1,225)
Payments to Retire Capital Lease Obligations (22,817) (16,611)
Common Stock Dividends Paid (5,176) -
Other 1,479 1,629
--------- ---------
Net Cash Flows - Financing Activities (74,617) (14,230)
--------- ---------
Net Decrease in Cash and Cash Equivalents (82,347) (46,492)
Cash and Cash Equivalents, Beginning of Year 145,288 145,167
--------- ---------
Cash and Cash Equivalents, End of Period $ 62,941 $ 98,675
========= =========
UNISOURCE ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income (Loss) $ 10,901 $ (1,820)
Adjustments to Reconcile Net Income (Loss)
to Net Operating Cash Flows
Depreciation and Amortization Expense 55,218 44,043
Deferred Income Taxes and Investment Tax Credit 1,680 (842)
Lease Payments Deferred - 9,670
Amortization of Regulatory Assets & Liabilities,
Net of Interest Imputed on Losses Recorded at
Present Value 6,920 1,959
Unremitted Losses of Unconsolidated Subsidiaries 1,868 3,816
Other (368) 2,634
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable (35,015) (11,101)
Materials and Fuel 1,012 (7,640)
Accounts Payable 19,896 (2,505)
Taxes Accrued 948 (2,706)
Other Current Assets and Liabilities (8,681) (7,516)
Other Deferred Assets and Liabilities 3,775 (1,199)
--------- ---------
Net Cash Flows - Operating Activities $ 58,154 $ 26,793
========= =========
See Notes to Condensed Consolidated Financial Statements.
</PAGE>
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,339,690 $2,301,645
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 107,719 96,565
----------- -----------
Total Utility Plant 3,188,855 3,139,656
Less Accumulated Depreciation and Amortization (1,148,377) (1,105,371)
Less Accumulated Depreciation of Capital Lease
Assets (318,930) (304,429)
----------- -----------
Total Utility Plant - Net 1,721,548 1,729,856
----------- -----------
Investments and Other Property 128,991 114,483
----------- -----------
Current Assets
Cash and Cash Equivalents 62,941 145,288
Accounts Receivable 102,941 67,926
Materials and Fuel 41,107 42,119
Deferred Income Taxes - Current 16,771 17,148
Prepaid Pension Costs 16,066 15,818
Tax Settlement Deposit 4,487 13,471
Other 39,525 31,368
----------- -----------
Total Current Assets 283,838 333,138
----------- -----------
Deferred Debits - Regulatory Assets
Transition Recovery Asset 364,709 370,291
Income Taxes Recoverable Through Future Revenues 76,656 79,497
Other Regulatory Assets 7,301 8,639
Deferred Debits - Other 17,237 20,351
----------- -----------
Total Deferred Debits 465,903 478,778
----------- -----------
Total Assets $2,600,280 $2,656,255
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 642,226 $ 641,723
Accumulated Deficit (309,172) (317,475)
----------- -----------
Common Stock Equity 333,054 324,248
Capital Lease Obligations 864,698 880,427
Long-Term Debt 1,134,595 1,135,820
----------- -----------
Total Capitalization 2,332,347 2,340,495
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 29,416 36,335
Current Maturities of Long-Term Debt 1,725 48,603
Accounts Payable 51,787 34,068
Interest Accrued 62,850 66,311
Taxes Accrued 26,008 31,374
Other 15,993 18,038
----------- -----------
Total Current Liabilities 187,779 234,729
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 40,988 42,526
Other 39,166 38,505
----------- -----------
Total Deferred Credits and Other Liabilities 80,154 81,031
----------- -----------
Total Capitalization and Other Liabilities $2,600,280 $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
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $172,891 $158,194
Sales for Resale 61,622 30,872
Other 1,057 917
--------- ---------
Total Operating Revenues 235,570 189,983
--------- ---------
Operating Expenses
Fuel and Purchased Power 98,258 60,868
Maintenance and Repairs 15,350 14,667
Other Operations 26,472 26,772
Depreciation and Amortization 27,662 20,962
Amortization of Transition Recovery Asset 4,679 -
Taxes Other Than Income Taxes 12,360 12,192
Capital Lease Expense - 25,918
Amortization of Springerville Unit 1 Allowance - (8,730)
Income Taxes (2,057) 3,958
--------- ---------
Total Operating Expenses 182,724 156,607
--------- ---------
Operating Income 52,846 33,376
--------- ---------
Other Income (Deductions)
Interest Income 1,966 1,552
Interest Income-Note Receivable from UniSource Energy 2,311 2,554
Other Income 504 265
Income Taxes (1,933) (1,166)
--------- ---------
Total Other Income (Deductions) 2,848 3,205
--------- ---------
Interest Expense
Long-Term Debt 17,155 16,797
Interest on Capital Leases 23,273 -
Interest Imputed on Losses Recorded at Present Value - 8,748
Other Interest Expense 1,879 2,681
--------- ---------
Total Interest Expense 42,307 28,226
--------- ---------
Net Income $ 13,387 $ 8,355
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Retail Customers $304,181 $286,214
Sales for Resale 106,383 62,731
Other 1,629 1,674
--------- ---------
Total Operating Revenues 412,193 350,619
--------- ---------
Operating Expenses
Fuel and Purchased Power 158,798 115,787
Maintenance and Repairs 23,694 24,304
Other Operations 55,345 50,395
Depreciation and Amortization 55,049 44,043
Amortization of Transition Recovery Asset 5,582 -
Taxes Other Than Income Taxes 24,554 24,346
Capital Lease Expense - 51,379
Amortization of Springerville Unit 1 Allowance - (17,459)
Income Taxes (3,119) 1,399
--------- ---------
Total Operating Expenses 319,903 294,194
--------- ---------
Operating Income 92,290 56,425
--------- ---------
Other Income (Deductions)
Interest Income 4,002 3,017
Interest Income-Note Receivable from UniSource Energy 4,637 5,079
Other Income 1,017 797
Income Taxes (3,889) (2,335)
--------- ---------
Total Other Income (Deductions) 5,767 6,558
--------- ---------
Interest Expense
Long-Term Debt 34,029 33,122
Interest on Capital Leases 46,527 -
Interest Imputed on Losses Recorded at Present Value - 17,496
Other Interest Expense 4,200 5,330
--------- ---------
Total Interest Expense 84,756 55,948
--------- ---------
Net Income $ 13,301 $ 7,035
========= =========
See Notes to Condensed Consolidated Financial Statements.
</PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $315,796 $296,616
Cash Receipts from Sales for Resale 86,296 61,526
Fuel and Purchased Power Costs Paid (139,137) (113,721)
Wages Paid, Net of Amounts Capitalized (29,157) (33,499)
Payment of Other Operations and Maintenance Costs (43,664) (46,200)
Capital Lease Interest Paid (47,525) (46,693)
Taxes Paid, Net of Amounts Capitalized (48,082) (48,143)
Interest Paid, Net of Amounts Capitalized (36,541) (36,221)
Income Taxes Paid (3) (5,918)
Interest Received 4,300 2,787
Other 47 224
--------- ---------
Net Cash Flows - Operating Activities 62,330 30,758
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (50,091) (41,295)
Investment in Lease Debt 132 (15,728)
Other Investments - Net (473) (295)
--------- ---------
Net Cash Flows - Investing Activities (50,432) (57,318)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt - 1,977
Payments to Retire Long-Term Debt (48,103) (1,225)
Payments to Retire Capital Lease Obligations (22,737) (16,611)
Other 1,122 1,450
--------- ---------
Net Cash Flows - Financing Activities (69,718) (14,409)
--------- ---------
Net Decrease in Cash and Cash Equivalents (57,820) (40,969)
Cash and Cash Equivalents, Beginning of Year 88,402 118,236
--------- ---------
Cash and Cash Equivalents, End of Period $ 30,582 $ 77,267
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Six Months Ended
June 30,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 13,301 $ 7,035
Adjustments to Reconcile Net Income to Net
Operating Cash Flows
Depreciation and Amortization Expense 55,049 44,043
Deferred Income Taxes and
Investment Tax Credit 2,333 293
Lease Payments Deferred - 9,670
Amortization of Regulatory Assets & Liabilities, Net
of Interest Imputed on Losses Recorded at
Present Value 6,920 1,959
Interest Accrued on Note Receivable from UniSource
Energy (4,638) (5,079)
Other 4,658 2,379
Changes in Assets and Liabilities which Provided(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable (33,448) (10,811)
Materials and Fuel 1,014 (6,383)
Accounts Payable 19,946 (1,781)
Taxes Accrued 465 (2,758)
Other Current Assets and Liabilities (4,829) (6,633)
Other Deferred Assets and Liabilities 1,559 (1,176)
--------- ---------
Net Cash Flows - Operating Activities $ 62,330 $ 30,758
========= =========
See Notes to Condensed Consolidated Financial Statements.
</PAGE>
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,339,690 $2,301,645
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 107,719 96,565
----------- -----------
Total Utility Plant 3,188,855 3,139,656
Less Accumulated Depreciation and Amortization (1,148,377) (1,105,371)
Less Accumulated Depreciation of Capital Lease
Assets (318,930) (304,429)
----------- -----------
Total Utility Plant - Net 1,721,548 1,729,856
----------- -----------
Investments and Other Property 66,874 67,838
----------- -----------
Note Receivable from UniSource Energy 74,770 70,132
---------- -----------
Current Assets
Cash and Cash Equivalents 30,582 88,402
Accounts Receivable 104,187 70,739
Materials and Fuel 41,021 42,035
Deferred Income Taxes - Current 16,488 17,190
Prepaid Pension Costs 16,066 15,818
Tax Settlement Deposit 4,487 13,471
Other 9,155 6,249
----------- -----------
Total Current Assets 221,986 253,904
----------- -----------
Deferred Debits - Regulatory Assets
Transition Recovery Asset 364,709 370,291
Income Taxes Recoverable Through Future Revenues 76,656 79,497
Other Regulatory Assets 7,301 8,639
Deferred Debits - Other 17,237 20,351
----------- -----------
Total Deferred Debits 465,903 478,778
----------- -----------
Total Assets $2,551,081 $2,600,508
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2000 1999
(Unaudited)
---------------------------------------------------------------------------
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 647,738 $ 647,366
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (357,574) (370,875)
----------- -----------
Common Stock Equity 283,807 270,134
Capital Lease Obligations 864,334 880,111
Long-Term Debt 1,134,595 1,135,820
----------- -----------
Total Capitalization 2,282,736 2,286,065
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 29,303 36,263
Current Maturities of Long-Term Debt 1,725 48,603
Accounts Payable 60,633 42,864
Interest Accrued 62,850 66,311
Taxes Accrued 21,889 27,738
Other 15,139 15,289
----------- -----------
Total Current Liabilities 191,539 237,068
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 37,703 38,913
Other 39,103 38,462
----------- -----------
Total Deferred Credits and Other Liabilities 76,806 77,375
----------- -----------
Total Capitalization and Other Liabilities $2,551,081 $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 June 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 $270
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:
- Advanced Energy Technologies, Inc. (AET) which owns 67% of Global
Solar Holdings, L.L.C. (Global Solar), a developer and manufacturer of
photovoltaic materials. In June 2000, our share of Global Solar
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.
We disclose selected financial data for our business segments in the
following table:
Segments
----------------------
UniSource
Reconciling Energy
TEP Millennium Adjustments Consolidated
----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
----------------
Three months ended
June 30, 2000:
Operating Revenues $235,570 $ 1,609 $ (103) $237,076
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 13,263 (2,246) (2,153) 8,864
----------------------------------------------------------------------
Net Income (Loss) 13,387 (1,433) (1,295) 10,659
----------------------------------------------------------------------
Segments
----------------------
UniSource
Reconciling Energy
TEP Millennium Adjustments Consolidated
----------------------------------------------------------------------
- Thousands of Dollars -
Three months ended
June 30, 1999:
Operating Revenues 189,983 3,601 (12) 193,572
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 13,479 (3,607) (2,440) 7,432
----------------------------------------------------------------------
Net Income (Loss) 8,355 (3,180) (1,467) 3,708
----------------------------------------------------------------------
Six months ended
June 30, 2000:
Operating Revenues $412,193 $ 2,663 $ (178) $414,678
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 14,071 (2,627) (4,050) 7,394
----------------------------------------------------------------------
Net Income (Loss) 13,301 36 (2,436) 10,901
----------------------------------------------------------------------
Six months ended
June 30, 1999:
Operating Revenues 350,619 5,228 (139) 355,708
----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 10,769 (7,231) (4,792) (1,254)
----------------------------------------------------------------------
Net Income (Loss) 7,035 (5,973) (2,882) (1,820)
----------------------------------------------------------------------
Balance Sheet
-------------
Total Assets,
June 30, 2000 2,551,081 140,125 (90,926) 2,600,280
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 six months ended June 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 June 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 can not predict whether future market adjustments
will be necessary for this project.
Additional Interest Acquired in Global Solar
Effective June 1, 2000, AET increased its ownership percentage in
Global Solar from 50% to 67%. The remaining 33% of Global Solar is
owned by ITN Energy Systems, Inc. (ITN). Millennium and ITN finalized
the agreement in which ITN transferred its rights to certain assets and
proprietary and intellectual property, including thin-film battery
technology, to Global Solar. Millennium has agreed to contribute to
Global Solar up to $14 million in additional equity. As of June 30,
2000, Millennium funded $7.9 million under this agreement, including
$4.2 million in the second quarter of 2000.
Because we own 67% of Global Solar as of June 1, 2000, it is
consolidated with UniSource Energy for financial reporting purposes.
Previously, AET reported Global Solar'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 AET records 100% of Global Solar's losses for accounting purposes.
When Global Solar generates net income, AET will recognize 100% of net
income to the extent AET's recognized losses are greater than AET'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.
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 six-months ended June 30, 1999
have been reclassified to conform to the new presentation.
NOTE 4. DEBT RETIREMENT AND ISSUANCE
-------------------------------------
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.
Revolving Credit Facility
As of June 30, 2000, TEP had no borrowings under its Revolving
Credit Facility. However, TEP borrowed $25 million under its Revolving
Credit Facility in July 2000, which was repaid in August 2000.
Proceeds were used to fund on-going cash expenditures.
NOTE 5. 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.
See Note 6 regarding the $7 million reduction of the valuation
allowance.
Due to the financial restructuring, a change in TEP's ownership
occurred for tax purposes in December 1991. As a result, our use of
the NOL and ITC generated before 1992 is limited under the tax code.
At December 31, 1999, pre-1992 federal NOL and ITC carryforwards were
approximately $187 million and $20 million, respectively. In addition
to the pre-1992 NOL and ITC which are subject to the limitation, $175
million of federal NOL at December 31, 1999, is 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. TEP has not recorded revenue for these disputed energy
charges billed to Sierrita. In March 2000, the ACC ruled in favor of
TEP and ordered Sierrita to pay the disputed charges from May 14, 1999
forward. Sierrita has appealed the ACC's order, and we are unable to
predict the resolution of the appeal, but anticipate that the appeal
process will take between one and two years. If TEP ultimately
prevails, TEP would recognize pre-tax income equal to the disputed
amounts billed after May 14, 1999. At June 30, 2000, this amounted to
$2 million.
NOTE 6. INCOME TAXES
---------------------
The differences between the income tax expense (benefit) and the amount
obtained by multiplying income before income taxes by the U.S.
statutory federal income tax rate are as follows:
UniSource Energy
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Federal Income Tax (Benefit)
Expense at Statutory Rate $ 3,102 $ 2,601 $ 2,588 $ (439)
State Income Tax (Benefit)
Expense, Net of Federal
Deduction 435 361 363 (61)
Depreciation Differences
(Flow Through Basis) 1,574 356 2,135 682
Reduction in Valuation
Allowance - Benefit
(see Note 5) (7,000) - (7,000) -
Investment Tax Credit
Amortization - (700) - (1,400)
Foreign Operations of
Millennium Energy Businesses 62 1,065 (1,674) 1,678
Other 32 41 81 106
-------- --------- -------- ---------
Total (Benefit) Expense for
Federal and State Income
Taxes $(1,795) $ (3,724) $(3,507) $ 566
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 4,642 $ 4,718 $ 4,925 $ 3,769
State Income Tax Expense,
Net of Federal Deduction 650 654 689 523
Depreciation Differences
(Flow Through Basis) 1,574 356 2,135 682
Reduction in Valuation
Allowance - Benefit
(see Note 5) (7,000) - (7,000) -
Investment Tax Credit
Amortization - (700) - (1,400)
Other 10 96 21 160
-------- --------- ------- ---------
Total (Benefit) Expense for
Federal and State Income Taxes $ (124) $ 5,124 $ 770 $ 3,734
======== ========= ======== =========
Income taxes are included in the income statements as follows:
UniSource Energy
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Operating Expenses $(3,237) $ 3,392 $(5,235) $ (78)
Other Income (Deductions) 1,442 332 1,728 644
-------- -------- -------- --------
Total Income Tax (Benefit)
Expense $(1,795) $ 3,724 $(3,507) $ 566
======== ========= ======== =========
TEP
---------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
---------------------------------------
- Thousands of Dollars -
Operating Expenses $(2,057) $ 3,958 $(3,119) $ 1,399
Other Income (Deductions) 1,933 1,166 3,889 2,335
-------- --------- -------- ---------
Total Income Tax (Benefit)
Expense $ (124) $ 5,124 $ 770 $ 3,734
======== ========= ======== =========
NOTE 7. NEW ACCOUNTING STANDARDS
---------------------------------
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (FAS 133),
Accounting for Derivative Instruments and Hedging Activities. A
derivative financial instrument or other contract derives its value
from another investment or designated benchmark. This Statement
requires all derivative instruments to be recognized as either assets
or liabilities in the balance sheet. Some derivative instruments
offset, or hedge, exposure to a specific risk. If the derivative is
not a hedging instrument, measurement is at fair value and changes in
fair value (i.e., gains and losses) are recognized in earnings in the
period of change. If a derivative qualifies as a hedge, the accounting
for changes in fair value will depend on the specific exposure being
hedged. We are required to comply with FAS 133 effective January 1,
2001. We are still in the process of quantifying the effect, if any,
that compliance with FAS 133 will have on our financial statements.
NOTE 8. REVIEW BY INDEPENDENT PUBLIC ACCOUNTANTS
-------------------------------------------------
With respect to the unaudited condensed consolidated financial
information of UniSource Energy and TEP for the three-month and six-
month periods ended June 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 August 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 9. 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 owns all of the outstanding common stock
of four subsidiaries established for the purpose of operating or investing
in various unregulated energy-related businesses.
Management's Discussion and Analysis centers on the general financial
condition and the results of operations for UniSource Energy and its two
primary business segments, the electric utility business of TEP and the
unregulated energy businesses of Millennium, and includes the following:
* operating results during the second quarter and the first six months
of 2000 compared with the same periods in the prior year,
* changes in liquidity and capital resources during the second quarter
and first six 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
sixth month periods ended June 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 sixth month
periods ended June 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 $10.7 million for the second
quarter of 2000, and net income of $10.9 million for the first six months
of 2000. This compares with a net income of $3.7 million in the second
quarter of 1999 and a net loss of $1.8 million for the first six months of
1999. Second quarter net income for 2000 was higher than second quarter
net income for 1999 due primarily to stronger kWh sales by TEP and the
recognition of tax benefits from the resolution of various tax audit
issues. The net income for the first six months of 2000 increased over the
prior year period due primarily to stronger kWh sales by TEP, the
recognition of tax benefits mentioned above and a gain on the sale of a
minority interest in a power project of one of our unregulated energy
businesses in the first quarter 2000. See 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 with certainty 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, Retail 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 Competition, Retail;
Results of Operation 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 June 30, 2000, Millennium's unregulated energy-
related affiliates comprised approximately 5% of total assets, but at times
have had a significant impact on our consolidated net income and cash
flows. We continue to evaluate these affiliates for opportunities to
realize value from our investments. In the third quarter of 1999, we sold
our ownership interest in 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 some of these businesses. See Liquidity and Capital
Resources, Investing and Financing Activities, below.
FACTORS AFFECTING RESULTS OF OPERATIONS
---------------------------------------
COMPETITION
-----------
RETAIL
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electricity and
related services. Approximately 20% of TEP's retail customers are currently
eligible to choose an alternate energy supplier. However, no competitors
are currently providing electric service to customers in our retail service
area nor has TEP lost any significant customers to self-generation. It is
likely that, with open access in our retail service territory, some
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 that was
entered into 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, no ESPs have met all the necessary conditions to sell
electricity in TEP's service territory.
As required by the Rules consumer choice for energy supply beginning
in 2000 will be phased in 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 using FAS 71 in
November 1999. See Note 1 of Notes to Condensed Consolidated Financial
Statements, Regulatory Accounting.
Lawsuits have been filed 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 approving TEP's Settlement Agreement.
It has been contended that allowing marketplace competition to determine
rates violates 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 is still pending.
The Retail Electric Competition Rules are still in effect pending
submission of proposed forms of judgment for the court's consideration.
The parties to the consolidated case will submit forms of judgment which
will establish the specific impact of the court's ruling. We cannot
predict the outcome of these actions.
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
In December 1999, the FERC issued FERC Order No. 2000 which requires
all public utilities that are transmission owners to file a proposal for a
Regional Transmission Organization (RTO) by October 15, 2000. An RTO is an
organization or institution which is envisioned by the FERC to operate an
electric transmission system on a regional basis, 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 must 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.
TEP, along with other transmission owners and users located in the
southwestern United States, is continuing to investigate the feasibility of
forming an Independent System Operator (ISO) for the region. An ISO, which
could potentially satisfy the requirements of an RTO, would be responsible
for ensuring transmission reliability and nondiscriminatory access to the
regional transmission grid. The formation of an ISO would be subject to
approval by the FERC and state regulatory authorities in the region. The
financial aspects of forming an ISO, including the potential effects on
TEP's future results of operations, will be examined as part of the
developmental work.
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 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 (when complete) 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 that are in the process of being prepared for filing
with the FERC. 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. 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 June 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 $270 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.
MARKET RISKS
------------
We are potentially exposed to various forms of market risk. Changes
in interest rates, returns on marketable securities, changes in foreign
currency exchange rates, and changes in commodity prices may affect our
future financial results. TEP currently uses derivative commodity
instruments such as forward contracts to buy or sell energy, but does not
use derivative commodity or derivative financial instruments for either
trading or speculative purposes. In the future TEP will evaluate to what
extent, if any, it may use derivative financial and commodity instruments
in the normal course of its business. The market risks described above have
not changed materially from the market risks reported in the 1999 Form 10-K.
RESULTS OF OPERATIONS
---------------------
UniSource Energy recorded net income of $10.7 million or $0.33 per
average share of Common Stock in the second quarter of 2000, and net income
of $10.9 million or $0.34 per share in the first six months of 2000. This
compares with net income of $3.7 million or $0.11 per average share of
Common Stock in the second quarter of 1999, and a net loss of $1.8 million
or $0.06 per share in the first six months of 1999.
The primary factors affecting the results of operations in the second
quarter of 2000 relative to the same period in 1999 were increased kWh
sales by TEP and a benefit due to the successful resolution of various tax
issues and continued evaluation of reserves for future tax liabilities.
Energy sales increased due to an increase in retail customers and the
effects of warmer weather. Net tax benefits in the second quarter totaled
$6 million. The primary factors affecting the results of operations for
the first six months of 2000 relative to the same period in 1999 were
increased kWh sales by TEP, a $2.5 million pre-tax gain on the sale of a
minority interest in a power project by Nations Energy in the first quarter
of 2000 and the recognition of tax benefits described above.
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 second quarter and first six months
of 2000 and 1999, respectively:
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- --------------------------
(Millions) (Millions)
-------------------------------------------------------------------------------
Business Segment 2000 1999 2000 1999
-------------------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
Electric Utility $13.4 $ 8.4 $13.3 $ 7.0
Millennium Energy Businesses (1.4) (3.2) 0.0 (6.0)
Parent Company and Inter-
Company Eliminations (1.3) (1.5) (2.4) (2.8)
-------------------------------------------------------------------------------
Consolidated Net Income (Loss) $10.7 $(3.7) $10.9 $(1.8)
===============================================================================
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. Electric
utility results include interest income from this note.
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.
Results for the second quarter include the reclassification of some of
the results of our Millennium Energy Businesses in revenues and expenses.
Previously, these results were reported in Other Income (Deductions). See
Note 3 of Notes to Condensed Consolidated Financial Statements, Millennium
Energy Businesses.
During the fourth quarter of 1999, the ACC approved TEP's Settlement
Agreement which resulted in the discontinuation of regulatory accounting
for its generation operations under FAS 71. The effects of this change in
accounting for generation operations were recorded in accordance with FAS
101. The changes resulted in the reclassification and changes in
presentation of certain financial statement line items.
TEP will experience downward pressure on earnings due to the changes
in expense recognition as a result of ceasing to apply FAS 71 to 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
-------------------
Three Months Ended June 30, 2000 1999 Amount Percent
------------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 2,127,117 1,945,855 181,262 9.3%
Sales for Resale 1,226,142 997,556 228,586 22.9%
--------- --------- -------
Total 3,353,259 2,943,411 409,848 13.9%
========= ========= =======
Electric Revenues (000):
Retail Customers $172,891 $158,191 $14,700 9.3%
Sales for Resale 61,622 30,872 30,750 99.6%
-------- -------- ------
Total $234,513 $189,063 $45,450 24.0%
======== ======== =======
Increase
-------------------
Six Months Ended June 30, 2000 1999 Amount Percent
------------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 3,848,714 3,608,398 240,316 6.7%
Sales for Resale 2,717,803 2,176,842 540,961 24.9%
--------- --------- -------
Total 6,566,517 5,785,240 781,277 13.5%
========= ========= =======
Electric Revenues (000):
Retail Customers $304,181 $286,214 $17,967 6.3%
Sales for Resale 106,383 62,731 43,652 69.6%
-------- -------- -------
Total $410,564 $348,945 $61,619 17.7%
======== ======== =======
TEP's kWh sales to retail customers increased by 9.3% in the second
quarter of 2000 compared with the same period in 1999. The retail kWh
sales increase was due to a 2.9% increase in the number of retail customers
and warmer spring temperatures as measured by a 40% increase in Cooling
Degree Days compared with the second quarter of 1999. Retail revenues
increased by 9.3% in the second quarter of 2000 compared with the same
period in 1999, reflecting the higher kWh sales offset, in part, by the
impact of the 1.0% rate decrease effective July 1, 1999. For the first six
months of 2000, retail kWh sales increased 6.7% compared with the same
period in 1999 as a result of an increase in retail customers and an
increase in Heating and Cooling Degree Days for the first and second
quarters, respectively. Retail revenues increased 6.3% due to increased
retail kWh sales.
Kilowatt-hour sales for resale increased 22.9% and the related
revenues doubled in the second 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 June 30, 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,
reduced hydro supplies in the Northwestern United States and various
planned and unplanned plant outages in the region during periods of warmer
temperatures in May and June 2000 contributed to higher market prices.
For the first six months of 2000, wholesale sales increased 24.9% compared
with the same period in 1999 due primarily to an increase in buy/resale
activity. Revenues from wholesale sales increased 69.6% as a result of
increased sales volume and higher market prices as described above.
OPERATING EXPENSES
Fuel and Purchased Power expense increased by 61% in the second
quarter of 2000 compared with the same period the year before. Fuel
expense at TEP's generating plants increased primarily due to higher energy
requirements, including gas purchases, to meet increased kWh sales.
Purchased Power expense also increased primarily because of increased
purchases in response to the large increase in wholesale energy sales made
by TEP during the quarter. For the six months ended June 30, 2000, Fuel
and Purchased Power expense increased primarily for the same reasons
discussed above.
The discontinuation of regulatory accounting for TEP's generation
operations under FAS 71 and the resulting adoption of FAS 101 resulted in
reclassification and changes in presentation of certain financial statement
line items which has impacted several operating expense line items.
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 second
quarter and first six months of 2000 compared to the same periods the year
before is primarily due to this reclassification. Because we stopped
applying FAS 71, we discontinued Amortization of the Springerville Unit 1
Allowance contra-asset and the recognition of Interest Imputed on Losses
Recorded at Present Value.
The Transition Recovery Asset and its related amortization is a result
of the Settlement Agreement reached with the ACC in 1999 regarding the
recovery of costs stranded by the deregulation of power generation. The
amount of Amortization of Transition Recovery Asset totaled $4.7 million
and $5.6 million for the quarter and six months ended June 30, 2000,
respectively. Quarterly amortization amounts are a function of various
factors including kWh sales.
The change in Income Taxes for the second quarter of 2000 compared to
the same quarter the year before is primarily due to the recognition of
tax benefits from the resolution of various IRS audit issues. See Note 5 of
Notes to Condensed Consolidated Financial Statements, Contingencies.
For the first six months of 2000 compared with the same period in the
prior year, Depreciation and Amortization expense increased for the same
reasons discussed above. Other Operations expense increased to support
customer growth and higher kWh sales for the first six months of 2000
compared to the same prior year period.
OTHER INCOME (DEDUCTIONS)
INTEREST INCOME
TEP's income statements for the quarters ended June 30, 2000 and 1999
include $2.3 million and $2.6 million, respectively, of interest income on
the promissory note TEP received from UniSource Energy in exchange for the
transfer of its stock in Millennium. On UniSource Energy's consolidated
income statement, this income is eliminated as an inter-company
transaction. For the six months ended June 30, 2000 and 1999, the interest
income on the promissory note was $4.6 million and 5.0 million,
respectively.
Higher interest income for the quarter ended June 30, 2000 and the
first six months of 2000 was 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 Global Solar, 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 six
months ended June 30, 2000, compared to 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, there would have been no significant
change in Interest Expense for the second quarter and first six months of
2000 compared to the same periods of the prior year.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
---------------------------------------
The unregulated energy businesses of Millennium reported a net loss of
$1.4 million for the second quarter of 2000, and net income of $36,000 for
the first six months of 2000. This compares with a net loss of $3.2
million in the second quarter and a net loss of $6.0 million for the first
six 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 six months ended June 30, 2000 and 1999.
----------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
Subsidiary 2000 1999 2000 1999
----------------------------------------------------------------------
-Thousands of Dollars- -Thousands of Dollars-
AET $(1,270) $ (237) $ (1,808) $ (611)
MEH 363 (73) 677 (650)
Nations Energy (703) (3,028) 931 (4,970)
Other 177 158 236 258
----------------------------------------------------------------------
Total Millennium $(1,433) $(3,180) $ 36 $(5,973)
======================================================================
AET AND GLOBAL SOLAR
Advanced Energy Technologies, Inc. (AET) owns a 67% interest in Global
Solar Holdings, L.L.C. (Global Solar), which owns Global Solar Energy,
Inc., a manufacturer of thin-film photovoltaic cells. In November 1999,
Millennium and ITN, the other owner of Global Solar, entered into an
agreement in which Millennium's share of Global Solar would increase from
50% to 67%. This agreement became effective in June 2000. See Note 3 of
Notes to Condensed Consolidated Financial Statements, Millennium Energy
Businesses. AET's net losses in the second quarter and first six months of
1999 and 2000 were due to startup-related and small scale manufacturing
expenses. Commercial production of solar-powered photovoltaic electric
generating systems is scheduled in 2000.
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. 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 second quarter and first six months of 2000
was derived primarily from interest income from a note receivable as part
of the sale of NewEnergy to AES Corporation.
NATIONS ENERGY
Nations Energy Corporation (Nations Energy) develops independent power
projects worldwide. For the second quarter of 2000, Nations Energy
recorded a net loss of $0.7 million. In the second quarter of 1999,
Nations Energy recorded a net loss of $3.0 million resulting principally
from development costs and expenses related to the exercise of an option to
invest in a 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.
DIVIDENDS ON COMMON STOCK
-------------------------
UNISOURCE ENERGY
On May 12, 2000, UniSource Energy declared a cash dividend in the
amount of $0.08 per share on its Common Stock. This dividend was paid June
9, 2000 to shareholders of record at the close of business May 22, 2000.
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.
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 subsidiary
companies, 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 June 30,
2000, the required minimum net worth was $218 million. TEP's actual net
worth at June 30, 2000 was $284 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of June 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
June 30, 2000, TEP's equity ratio on that basis was 20%.
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 June 30,
1999 ending balance of $98.7 million to $62.9 million at June 30, 2000.
For the twelve-month period ended June 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 $31.4 million in
the first six months of 2000 compared with the same period in 1999. The
net increase primarily resulted from the following factors:
* $24.8 million increase in cash receipts from wholesale sales;
* $19.2 million increase in cash receipts from retail customers;
* $5.9 million reduction in income taxes paid; offset by
* $25.4 million increase in Fuel and Purchased Power Costs paid.
Net cash used for investing activities totaled $65.9 million during
the first six months of 2000 compared with $59.1 million during the same
period in 1999. Capital expenditures were $10.5 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 and (ii)
Nations Energy's $19.9 million in proceeds from the sale of its interest in
the Czech Republic power project. In 1999, $15.7 million of Springerville
Unit 1 Lease debt was purchased by TEP.
Net cash used for financing activities totaled $74.6 million in the
first six months of 2000 compared with $14.2 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 $22.8 million of scheduled payments that retired capital lease
obligations. In 1999, $16.6 million of capital lease obligations were
retired. In the first six months of 2000, UniSource Energy paid $5.2
million in dividends on Common Stock.
UniSource Energy's consolidated cash balance, including cash
equivalents, at August 4, 2000 was approximately $67 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 June 30, 1999 ending
balance of $77.3 million to $30.6 million at June 30, 2000. For the twelve-
month period ended June 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 $31.6 million in
the first six months of 2000 compared with the same period in 1999,
principally due to cash receipts from wholesale sales and from sales to
retail customers. 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 $50.4 million during
the first six months of 2000 compared with $57.3 million during the same
period of 1999. Capital expenditures were $8.8 million higher in 2000. In
1999, $15.7 million of Springerville Unit 1 Lease debt was purchased by
TEP.
Net cash used for financing activities totaled $69.7 million during
the first six months of 2000 compared with $14.4 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 August
4, 2000 was approximately $15 million. As of that date TEP had $10
million in borrowings outstanding under its Revolving Credit Facility.
This borrowing was repaid as of August 11, 2000. See TEP Credit Agreement,
below.
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 TEP Credit Agreement, below.
INVESTING AND FINANCING ACTIVITIES
----------------------------------
TEP
---
CAPITAL EXPENDITURES
TEP's capital expenditures for the three months and six months ended
June 30, 2000 were $23.7 million and $50.1 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 June 30, 2000, TEP had no borrowings under its $100 million
Revolving Credit Facility. However, TEP borrowed $25 million under its
Revolving Credit Facility in July. In early August this borrowing was
reduced to $10 million. Proceeds were used to fund on-going cash
expenditures. As of August 11, 2000, this borrowing has been repaid from
internally generated cash, resulting in no amounts outstanding under the
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%.
CAPITAL REQUIREMENTS
The unregulated energy businesses owned by Millennium have historically
required significant amounts of capital. During 1999 and in 2000, we have
taken the opportunity to realize the value from certain of these more
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 for a $2.5 million pre-tax gain.
Plans for 2000 and beyond include lower anticipated funding
requirements for Nations Energy and increased support of AET and Global
Solar. In particular, in November 1999 Millennium agreed to contribute to
Global Solar up to $14 million in additional equity. As of June 30, 2000,
Millennium had funded $7.9 million under this agreement, including $4.2
million in the second quarter of 2000.
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. The
remaining amount 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
affected 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 in-
cluding 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.
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
TAX ASSESSMENTS
See Note 5 of Notes to Condensed Consolidated Financial Statements,
Contingencies.
ACC ORDER ON THE SIERRITA CONTRACT
See Note 5 of Notes to Condensed Consolidated Financial Statements,
Contingencies.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
UniSource Energy conducted its annual meeting of shareholders on May
12, 2000. At that meeting, the shareholders of UniSource Energy elected
members of the Board of Directors.
The total votes were as follows:
Election of Directors
Against Broker
For or Withheld Abstain Non-Votes
--- ----------- ------- ---------
Ira R. Adler 29,991,585 447,294 15,243 --
Lawrence J. Aldrich 29,989,608 449,271 17,220 --
Larry W. Bickle 29,990,496 448,383 16,332 --
Elizabeth T. Bilby 29,984,981 453,898 21,847 --
Harold W. Burlingame 29,998,496 440,383 8,332 --
Jose L. Canchola 29,973,750 465,129 33,078 --
John L. Carter 29,991,926 446,953 14,902 --
Daniel W. L. Fessler 29,499,857 939,022 506,971 --
John A. Jeter 29,985,988 452,891 20,840 --
James S. Pignatelli 29,998,344 440,535 8,484 --
Martha R. Seger 29,976,396 462,483 30,432 --
H. Wilson Sundt 29,980,416 458,463 26,412 --
At UniSource Energy's annual meeting of shareholders on May 12, 2000
an amendment to UniSource Energy's 1994 Omnibus Stock and Incentive Plan
was voted on and approved.
The total votes were as follows:
1994 Omnibus Stock and Incentive
Plan Amendment
Against Broker
For or Withheld Abstain Non-Votes
--- ----------- ------- ---------
12,739,752 8,391,310 293,416 9,014,401
ITEM 5. - OTHER INFORMATION
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges for
TEP:
12 Months Ended
---------------
June 30, December 31,
2000 1999
---- ----
Ratio of Earnings to Fixed Charges 1.47 1.45
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 June 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: August 14, 2000 /s/ Ira R. Adler
----------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: August 14, 2000 /s/ Ira R. Adler
-----------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
</PAGE>
EXHIBIT INDEX
11 - Statement re computation of per share earnings - UniSource
Energy.
12 - Computation of Ratio of Earnings to Fixed Charges - TEP.
15 - Letter regarding unaudited interim financial information.
27a - Financial Data Schedule - TEP.
27b - Financial Data Schedule - UniSource Energy.
