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
SECURITES EXCHANGE ACT OF 1934
For the period ended September 30, 1999
------------------
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number 1-6986
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PUBLIC SERVICE COMPANY OF NEW MEXICO
------------------------------------
(Exact name of registrant as specified in its charter)
New Mexico 85-00019030
---------- -----------
(State or other jurisdiction of (I.R.S. Employer
Incorporation of organization) Identification No.)
Alvarado Square, Albuquerque, New Mexico 87158
----------------------------------------------
(Address of principal executive offices)
(Zip Code)
(505) 241-2700
--------------
(Registrant's telephone number, including area code)
------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the 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
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common Stock-$5.00 par value 40,774,083 shares
---------------------------- -----------------
Class Outstanding at November 1, 1999
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
INDEX
Page No.
PART I. FINANCIAL INFORMATION:
Report of Independent Public Accountants............................... 3
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Earnings -
Three Months and Nine Months Ended September 30, 1999 and 1998......... 4
Consolidated Statements of Comprehensive Income -
Three Months and Nine Months Ended September 30, 1999 and 1998......... 5
Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998............................... 6
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1999 and 1998.......................... 7
Notes to Consolidated Financial Statements............................. 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS................... 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK..................................................... 24
PART II. OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS............................................... 25
ITEM 5. OTHER INFORMATION............................................... 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................ 31
Signature ................................................................ 33
2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Public Service Company of New Mexico:
We have reviewed the accompanying consolidated balance sheet of Public Service
Company of New Mexico (a New Mexico corporation) and subsidiaries as of
September 30, 1999 and the related consolidated statements of earnings and
comprehensive income for the three-month and nine-month periods ended September
30, 1999 and 1998, and the consolidated statements of cash flows for the
nine-month periods ended September 30, 1999 and 1998. These financial statements
are the responsibility of the company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Public Service Company of New
Mexico and subsidiaries as of December 31, 1998 (not presented herein), and, in
our report dated March 2, 1999, we expressed an unqualified opinion on that
statement. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 1998, is fairly stated,
in all material respects, in relation to the consolidated balance sheet from
which it has been derived.
ARTHUR ANDERSEN LLP
Albuquerque, New Mexico
November 5, 1999
3
ITEM 1. FINANCIAL STATEMENTS
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
1999 1998 1999 1998
-------- -------- -------- --------
(In thousands except per share amounts)
Operating revenues:
Electric 299,767 $280,662 $697,073 $636,817
Gas 38,249 39,321 171,432 195,826
Unregulated businesses 2,588 455 6,288 833
-------- -------- -------- --------
Total operating revenues 340,604 320,438 874,793 833,476
-------- -------- -------- --------
Operating expenses:
Cost of energy sold 180,730 139,628 399,093 347,754
Administrative and other costs 42,079 37,111 112,708 99,282
Energy production costs 32,980 33,208 104,018 104,260
Depreciation and amortization 23,313 20,516 69,739 62,532
Transmission and distribution costs 14,357 14,712 43,870 43,345
Taxes, other than income taxes 9,652 9,208 27,821 27,553
Income taxes 7,218 18,609 22,954 38,636
-------- -------- -------- --------
Total operating expenses 310,329 272,992 780,203 723,362
-------- -------- -------- --------
Operating income 30,275 47,446 94,590 110,114
-------- -------- -------- --------
Other income and deductions, net of taxes: 8,455 4,406 20,867 12,159
-------- -------- -------- --------
Income before interest charges 38,730 51,852 115,457 122,273
-------- -------- -------- --------
Interest charges:
Interest on long-term debt 16,208 13,659 49,610 34,215
Other interest charges 1,121 3,537 3,144 11,344
-------- -------- -------- --------
Net interest charges 17,329 17,196 52,754 45,559
-------- -------- -------- --------
Net earnings from continuing operations 21,401 34,656 62,703 76,714
Discontinued operations, net of tax:
Loss from operations of gas marketing - (1,320) - (7,386)
Estimated loss on disposal of gas marketing,
including provision for operating losses
during phase-out period - (1,347) - (1,347)
Cumulative effect of a change in accounting
principle, net of tax (Note 2) - - 3,541 -
-------- -------- -------- --------
Net earnings (Notes 2 and 5) 21,401 31,989 66,244 67,981
Preferred stock dividend requirements 147 147 440 440
-------- -------- -------- --------
Net earnings applicable to common stock $ 21,254 $ 31,842 $ 65,804 $ 67,541
======== ======== ======== ========
Net earnings (loss) per share of common stock (Note 3):
Earnings from continuing operations $ 0.52 $ 0.83 $ 1.51 $ 1.83
Loss from discontinued operations - (0.03) - (0.18)
Estimated loss on disposal of gas marketing - (0.04) - (0.03)
Cumulative effect of a change in accounting principle - - 0.09 -
-------- -------- -------- --------
Net earnings per common share (Basic) $ 0.52 $ 0.76 $ 1.60 $ 1.62
======== ======== ======== ========
Net earnings per common share (Diluted) $ 0.52 $ 0.76 $ 1.60 $ 1.60
======== ======== ======== ========
Dividends paid per share of common stock $ 0.20 $ 0.20 $ 0.60 $ 0.57
======== ======== ======== ========
The accompanying notes are an integral part of these financial statements.
4
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
1999 1998 1999 1998
--------- -------- -------- --------
(In thousands)
Net Earnings $ 21,401 $ 31,989 $ 66,244 $ 67,981
-------- -------- -------- --------
Other Comprehensive Income, net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses)
arising during the period, net of
reclassification adjustment 154 (393) 1,826 (80)
Minimum pension liability adjustment (1,065) (355) (3,226) (526)
-------- -------- -------- --------
Total other comprehensive losses (911) (748) (1,400) (606)
-------- -------- -------- --------
Total Comprehensive Income $ 20,490 $ 31,241 $ 64,844 $ 67,375
======== ======== ======== ========
Note: Tax expense (benefit) for Total Other Comprehensive Income for the
three months ended September 30, 1999 and 1998 was $(597) and $(490),
respectively. Tax expense (benefit) for Total Other Comprehensive
Income for the nine months ended September 30, 1999 and 1998 was
$(918) and $(397), respectively.
The accompanying notes are an integral part of these financial statements.
5
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
1999 1998
------------ -----------
(Unaudited)
ASSETS
Utility plant $2,640,879 $2,591,934
Accumulated depreciation and amortization (1,062,896) (998,175)
---------- ----------
Net utility plant 1,577,983 1,593,759
---------- ----------
Other property and investments 481,797 523,834
---------- ----------
Current assets:
Cash and temporary investments 88,620 61,280
Receivables 216,607 197,906
Income tax receivable - 8,266
Inventory 42,767 35,674
Other current assets 5,678 4,666
---------- ----------
Total current assets 353,672 307,792
---------- ----------
Deferred charges 145,645 151,403
---------- ----------
Total Assets $2,559,097 $2,576,788
========== ==========
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stock equity:
Common stock $ 203,870 $ 208,870
Additional paid-in capital 452,734 465,386
Accumulated other comprehensive income
(loss), net of tax (274) 1,127
Retained earnings 219,205 186,220
---------- ----------
Total common stock equity 875,535 861,603
Minority interest 12,771 13,405
Cumulative preferred stock without mandatory
redemption requirements 12,800 12,800
Long-term debt, less current maturities 977,115 1,008,614
---------- ----------
Total capitalization 1,878,221 1,896,422
---------- ----------
Current liabilities:
Short-term debt - 26,620
Accounts payable 116,347 113,975
Dividends payable 8,301 147
Accrued interest and taxes 39,640 34,289
Other current liabilities 34,259 28,308
---------- ----------
Total current liabilities 198,547 203,339
---------- ----------
Deferred credits 482,329 477,027
---------- ----------
Commitments and Contingencies (Note 7) - -
---------- ----------
Total Capitalization and Liabilities $2,559,097 $2,576,788
========== ==========
The accompanying notes are an integral part of these financial statements.
6
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30
------------------
1999 1998
-------- --------
(In thousands)
Cash Flows From Operating Activities:
Net earnings $ 66,244 $ 67,981
Adjustments to reconcile net earnings to net cash
flows from operating activities:
Depreciation and amortization 78,447 71,676
Gain on cumulative effect of a change in
accounting principle (Note 2) (5,862) -
Changes in certain assets and liabilities:
Receivables (10,670) 13,905
Inventory 1,114 10,591
Deferred charges 4,474 499
Accounts payable 2,310 (26,714)
Accrued interest and taxes 5,352 26,962
Deferred credits 7,899 (2,534)
Other 3,845 637
Other, net (3,751) (6,394)
-------- --------
Net cash flows from operating activities 149,402 156,609
-------- --------
Cash Flows From Investing Activities:
Utility plant additions (60,881) (89,828)
Purchase of PVNGS LOBs - (215,701)
(Increase) decrease in nuclear decommissioning trust 26,620 (2,675)
Other, net 13,584 5,637
-------- --------
Net cash flows from investing activities (20,677) (302,567)
-------- --------
Cash Flows From Financing Activities:
Dividends paid (24,895) (24,238)
Common stock repurchase (17,655) -
(Repayments) borrowings for nuclear decommissioning (26,620) 2,675
Debt repaid (31,580) (357,431)
Financing - 582,994
Other, net (635) (3,340)
-------- --------
Net cash flows from financing activities (101,385) 200,660
-------- --------
Increase in cash and temporary investments 27,340 54,702
Beginning of period 61,280 18,195
-------- --------
End of period $ 88,620 $ 72,897
======== ========
Supplemental Cash Flow Disclosures:
Interest paid $ 60,392 $ 35,239
Income taxes paid, net 27,525 35,118
Acquired DOE pipeline in exchange for
transportation services 3,100 -
The accompanying notes are an integral part of these financial statements.
7
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Accounting Policies and Responsibilities for Financial Statements
The significant accounting policies followed by Public Service Company of New
Mexico (the "Company") are set forth in note (1) of notes to the Company's
consolidated financial statements in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998 (the "1998 Form 10-K") filed with the
Securities and Exchange Commission ("SEC"). The consolidated financial
statements are unaudited and reflect all adjustments (consisting only of normal
and recurring adjustments) that are, in the opinion of management, necessary for
a fair presentation of the financial position and results of operations for the
interim periods presented. The consolidated financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
contained in the 1998 Form 10-K. The results of operations for the three and
nine months ended September 30, 1999 are not necessarily indicative of the
results for the entire year ending December 31, 1999. Certain 1998 amounts have
been reclassified to conform to the 1999 financial statement presentation.
(2) Accounting Changes
Effective January 1, 1999, the Company adopted Emerging Issues Task Force
("EITF") Issue No. 98-10, Accounting for Contracts Involved in Energy Trading
and Risk Management Activities. EITF Issue No. 98-10 requires gains or losses
resulting from the market value changes on energy trading contracts to be
recorded in earnings. The effect of the initial application of EITF Issue No.
98-10 is reported as a cumulative effect of a change in accounting principle
which increased the Company's consolidated net income by approximately $3.5
million (after related income tax expense of approximately $2.3 million), or
$.09 per common share.
(3) Earnings Per Share
The following table provides a reconciliation between basic and diluted earnings
per share for the periods ended:
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------- ------- ------- -------
(In thousands, except per
share amounts)
Net income applicable to common stock $21,254 $31,842 $65,804 $67,541
------- ------- ------- -------
Weighted-average shares of common stock
outstanding
Basic 40,774 41,774 41,127 41,774
Dilutive effect of common stock
equivalents (a) 159 231 127 327
------- ------- ------- -------
Diluted 40,933 42,005 41,254 42,101
------- ------- ------- -------
Earnings per share
Basic - net income $0.52 $0.76 $1.60 $1.62
Diluted - net income $0.52 $0.76 $1.60 $1.60
(a) Excludes the effect of anti-dilutive common stock equivalents related
to out-of-the-money options of 62,635 and 30,250 for the three months ended
September 30, 1999 and September 30, 1998, respectively, and 260,448 and
53,965 for the nine months ended September 30, 1999 and September 30, 1998,
respectively.
8
(4) Segments Information
The Company's principal business segments are electric ("Electric") and gas
("Gas") operations. Electric consists of three major business lines that include
the Electric Service Business Unit ("Distribution"), Transmission Service
Business Unit ("Transmission") and Bulk Power Business Unit ("Generation"). The
unregulated segments include the operation of Avistar, Inc. and corporate
administrative functions. Intersegment revenues are determined based on a
formula mutually agreed upon between affected segments and are not based on
market rates. Intersegment revenues are eliminated for consolidation purposes.
Summarized financial information by business segment for the three months and
nine months ended September 30, 1999 and 1998 is as follows:
Electric
--------------------------------------------
Distri. Trans. Gen. Total Gas Unregulated Consolidated
-------- ------- -------- --------- ------- ----------- ------------
(In thousands)
Three Months Ended:
- -------------------
1999:
Operating revenues:
External customers $143,442 $ 4,120 $152,205 $ 299,767 $38,249 $ 2,588 $ 340,604
Intersegment revenues - 7,450 88,752 96,202 - - 96,202
Operating income (loss) 13,954 2,014 15,740 31,708 (724) (709) 30,275
Segment net income (loss) 11,177 1,034 13,114 25,325 (2,789) (1,135) 21,401
1998 (a):
Operating revenues:
External customers $153,520 $ 4,228 $122,914 $ 280,662 $39,321 $ 455 $ 320,438
Intersegment revenues - 7,273 96,044 103,317 - - 103,317
Operating income (loss) 16,077 3,310 28,462 47,849 2,573 (2,976) 47,446
Segment net income (loss) 13,039 1,992 23,506 38,537 (15) (6,533) 31,989
Nine Months Ended:
- ------------------
1999:
Operating revenues:
External customers $405,816 $ 11,632 $279,625 $ 697,073 $171,432 $ 6,288 $ 874,793
Intersegment revenues - 22,351 245,919 268,270 - - 268,270
Operating income 40,605 6,561 37,797 84,963 9,134 493 94,590
Segment net income (loss) 32,121 3,513 33,602 69,236 1,859 (4,851) 66,244
1998 (a):
Operating revenues:
External customers $409,941 $ 11,953 $214,923 $ 636,817 $195,826 $ 833 $ 833,476
Intersegment revenues - 21,818 273,485 295,303 - - 295,303
Operating income (loss) 27,124 9,064 63,254 99,442 15,959 (5,287) 110,114
Segment net income (loss) 19,783 5,444 50,751 75,978 8,440 (16,437) 67,981
(a) On August 4, 1998, the Company adopted a plan to discontinue the natural
gas trading operations of its Energy Services Business Unit and completely
discontinued these operations on December 31, 1998. Included in the line
item Segment net income (loss) under Unregulated are losses of $2,667 and
$8,733 for the discontinued operations for the three months and nine months
ended September 30, 1998, respectively.
9
(5) Financial Instruments
The Company uses derivative financial instruments in limited instances to manage
risk as it relates to changes in natural gas and electric prices and adverse
market changes for investments held by the Company's various trusts. The Company
is exposed to credit losses in the event of non-performance or non-payment by
counterparties. The Company uses a credit management process to assess and
monitor the financial conditions of counterparties. The Company also uses, on a
limited basis, certain derivative instruments for bulk power electricity trading
purposes in order to take advantage of favorable price movements and market
timing activities in the wholesale power markets.
Natural Gas Contracts
Pursuant to an order issued by the New Mexico Public Utility Commission
("NMPUC"), predecessor to New Mexico Public Regulation Commission ("PRC"), the
Company has previously entered into swaps to hedge certain portions of natural
gas supply contracts in order to protect the Company's natural gas customers
from the risk of adverse price fluctuations in the natural gas market. The
financial impact of all hedge gains and losses from swaps flowed through the
Company's purchased gas adjustment clause. As a result, earnings were not
affected by gains or losses generated by these instruments. The Company hedged
40% of its natural gas deliveries during the 1998-1999 heating season. Less than
15.5% of the 1998-1999 heating season portfolio was hedged using financial
hedging contracts. The Company has hedged a portion of its 1999-2000 heating
season gas supply portfolio through the use of both physical and financial
hedging tools. Less than 9.1% of the Company's 1999-2000 heating season
portfolio is hedged using financial hedging contracts. As of September 30, 1999,
the Company had unrecognized mark-to-market gains of $0.5 million associated
with its gas-related financial hedging activities.
Electricity Trading Contracts
To take advantage of market opportunities associated with the purchase and sale
of electricity, the Company's wholesale power operation periodically enters into
derivative financial instrument contracts. The Company accounts for these
financial instruments as trading activities under the accounting guidelines set
forth under EITF Issue No. 98-10. As a result, all open contracts are marked to
market at the end of each period. These contracts may be in the form of futures
and are required to be reflected on the balance sheet at fair market value with
resulting gains and losses recognized in earnings. In addition, the Company
enters into forward physical contracts and physical options. Those contracts
that meet the criteria for trading activities under EITF Issue No. 98-10 are
marked to market and reflected on the balance sheet. The physical contracts are
subsequently recognized as revenues or purchased power when the actual physical
delivery occurs.
10
Through September 30, 1999, the Company's wholesale electric trading operations
settled trading contracts for the sale of electricity that generated $34 million
of electric revenues by delivering 820 million KWh. The Company purchased $36
million or 1,046 million KWh of electricity to support these contractual sale
and other open market sales opportunities. Energy purchases for trading purposes
are included in the cost of energy sold.
As of September 30, 1999, the Company had open trading contract positions to buy
$21.5 million and to sell $20.8 million of electricity. At September 30, 1999,
the Company had a gross mark-to-market gain (asset position) on these trading
contracts of $8.2 million and gross mark-to-market loss (liability position) of
$3.8 million, with net mark-to-market gain (asset position) of $4.4 million. The
mark-to-market valuation is recognized in earnings each period.
Corporate Hedge
The Company has about $62 million invested in domestic stocks in various trusts
for nuclear decommissioning, executive retirement and retiree medical benefits.
At the end of March 1999, the Company began using financial derivatives based on
the Standard & Poor's ("S&P") 500 Index to limit potential loss on these
investments due to adverse market fluctuations. The options are structured as a
collar, protecting the portfolio against losses beyond a certain amount and
balancing the cost of that downside protection by foregoing gains above a
certain level. If the S&P 500 Index is within the specified range when the
option contract expires, the Company will not be obligated to pay, nor will the
Company have the right to receive cash. The Company accounts for the market
value changes of these options under mark-to-market accounting on a quarterly
basis. At September 30, 1999, the Company recorded an unrealized year-to-date
gain of $0.7 million (pre-tax) on the market value of these options, although
the S&P 500 Index is still within the specified range of the collar.
(6) Accounting Pronouncements
EITF Issue No. 99-14, Recognition of Impairment Losses on Firmly Committed
Executory Contracts: The EITF has added an issue to its agenda to address
impairment of leased assets. A significant portion of the Company's nuclear
generating assets is held under operating leases. Based on the alternative
accounting methods being explored by the EITF, the related financial impact of
the future adoption of EITF No. 99-14 could potentially be significant. However,
a complete evaluation of the financial impact from the future adoption of EITF
Issue No. 99-14 will be undeterminable until EITF deliberations are completed
and stranded cost recovery issues are resolved.
11
Statement of Financial Accounting Standards ("SFAS") No. 137 -- Accounting for
Derivative Instruments and Hedging Activities-- Deferral of the Effective Date
of SFAS No. 133: SFAS No. 133 establishes accounting and reporting standards
requiring every derivative instrument to be recorded in the balance sheet as
either an asset or liability measured at its fair value. The Statement also
requires that changes in the derivatives' fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. The Company is in
the process of reviewing and identifying financial instruments currently
existing in the Company for compliance with the provisions SFAS No. 133. It is
likely that the adoption of SFAS No. 133 will add volatility to the Company's
operating results and/or asset and liability valuations. In June 1999, the
Financial Accounting Standards Board issued SFAS No. 137 to amend the effective
date for compliance with SFAS No. 133 to January 1, 2001.
(7) Commitments and Contingencies
There are various claims and lawsuits pending against the Company and certain of
its subsidiaries. The Company is also subject to Federal, state and local
environmental laws and regulations, and is currently participating in the
investigation and remediation of numerous sites. In addition, the Company
periodically entered into financial commitments in connection with business
operations. It is not possible at this time for the Company to determine fully
the effect of all litigation on its consolidated financial statements. However,
the Company has recorded a liability where such litigation can be estimated and
where an outcome is considered probable. The Company does not expect that any
known lawsuits, environmental costs and commitments will have a material adverse
effect on its financial condition or results of operations.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company's 1998 Form 10-K PART II, ITEM 7. -- "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" discussed
management's assessment of the Company's financial condition, results of
operations and other issues facing the Company. The following discussion and
analysis by management focuses on those factors that had a material effect on
the Company's financial condition and results of operations during the three
months and nine months ended September 30, 1999 and 1998. It should be read in
conjunction with the Company's consolidated financial statements and PART II,
ITEM 1 -- LEGAL PROCEEDINGS. Trends and contingencies of a material nature are
discussed to the extent known and considered relevant.
RESULTS OF OPERATIONS
For the Three Months Ended September 30, 1999
Consolidated Results - Net earnings of $21.4 million or $0.52 per common share
decreased $10.6 million ($0.24 per common share including the effect of the
stock purchase) for the quarter. The decline reflects the negative effects that
mild weather and the rate reduction that began in late July had on operations.
The following discussion highlights significant items that affected the results
of operations for the quarter ended September 30, 1999 versus 1998.
Operating revenues grew $20.2 million (6.3%) for the quarter to $340.6 million
reflecting strong wholesale electric sales. See the electric and gas operations
sections below for further discussions.
Total operating expenses grew $37.7 million (13.7%) to $310.3 million for the
quarter. The cost of energy sold (which includes coal, nuclear fuel, gas and
electricity purchased for resale) increased $41.1 million (29.4%) to $180.7
million, reflecting an 18.6% growth in wholesale electric volumes, a 5.1%
increase in gas sales volumes, higher prices for elecricity purchased for resale
and open market energy purchases used to supplement the Company's own energy
production capability due to scheduled and unscheduled electric generation plant
outages. Administrative costs increased $5.0 million (13.4%) to $42.1 million
due to costs associated with the implementation of a new customer billing system
and costs incurred to support the formation of a new holding company. In
addition, depreciation expense grew $2.8 million period-over-period caused by
continuing capital investments and a first quarter 1999 depreciation rate
change. These cost increases were partially offset by lower taxes due to lower
pre-tax income levels and lower energy production costs.
13
Operating income decreased $17.2 million (36.2%) to $30.3 million as margins for
both the gas and electric businesses were hurt by weak market pricing, the
electric rate reduction, mild weather conditions and excess electricity supply
in the Company's key markets.
Other income and deductions, net of taxes, increased $4.0 million for the
quarter to $8.5 million due to the recording of interest income from the Palo
Verde Nuclear Generating Station ("PVNGS") Capital Trust and a mark-to-market
gain on the corporate investment collar (see note 5 to Notes to Consolidated
Financial Statements).
Electric Operations - Net earnings from electric operations of $25.3 million
decreased $13.2 million (34.3%) for the quarter, reflecting weather conditions
and the rate reduction. The following discussion highlights significant items
that affected the results of operations of the electric business for the quarter
ended September 30, 1999 versus 1998.
Operating revenues grew $19.1 million (6.8%) for the quarter to $299.8 million
as a 18.6% improvement in wholesale electricity sales volume was only partially
offset by the implementation of a new rate order in late July 1999 (which will
lower rates by $37 million annually based on current customer base) and a 1.3%
decline in retail megawatt hour ("MWh") sales for the quarter due to mild local
weather conditions. The Company delivered wholesale (bulk) power of 3.61 million
MWh of electricity this year compared to 3.04 million MWh delivered last year.
Total electricity delivery was 5.51 million MWh compared to 4.97 MWh delivered
last year, a 10.9% improvement.
Total operating expenses grew $35.2 million (15.1%) caused primarily by an
increases in the cost of energy sold of $41.5 million as a result of
volume-related increases in power purchased for resale at higher prices and
higher administrative costs of $4.0 million due to Y2K compliance costs, holding
company formation costs and new customer billing system installation costs.
Depreciation and amortization expense increased $1.3 million for the quarter to
$18.3 million due to additions to the plant base and the 1999 rate change.
Operating income taxes decreased $9.0 million (41.1%) to $12.9 million
reflecting decreased electric gross margin (electric operating revenues less
fuel and purchased power expense) of $22.4 million for the quarter. The margin
decrease was attributable to increased purchased power expense (higher purchase
costs and volume growth) and decreased retail sales due to mild weather
conditions.
Gas Operations - Gas operations had a net loss of $2.8 million for the quarter
compared with a net loss of $0.02 million a year ago. The following discussion
highlights significant items that affected the results of operations of gas
operations for the quarter ended September 30, 1999 versus 1998.
14
Operating revenues declined $1.1 million (2.7%) for the quarter to $38.2
million. This decline was driven by a 15.7% decline in the average rate charges
per decatherm (due to weak gas prices). Price declines were partially offset by
a 5.1% volume improvement, as residential and commercial business posted double
digit growth and transportation volume growth of 21.1%.
Total operating expenses increased $2.2 million (6.1%) caused by increased gas
costs of $0.9 million, higher administrative costs of $1.6 million largely due
to the new customer billing system installation costs) and increased
depreciation and amortization expense of $1.6 million.
Operating income decreased $3.3 million to a loss of $0.7 million due to
depressed gas gross margin (gas operating revenues less gas purchased for
resale) of $2.0 million and increased operating expenses discussed above.
Discontinued Operations - In August 1998, the Company adopted a plan to
discontinue the natural gas trading operations of its Energy Services Business
Unit and completely discontinue these operations on December 31, 1998. Losses
from discontinued operations, net of taxes, for the three months ended September
30, 1998, were $2.7 million, or $0.07 per common share. These losses did not
recur in 1999.
For the Nine Months Ended September 30, 1999
Consolidated Results - Net earnings of $66.2 million or $1.60 per common share
decreased $1.7 million ($0.02 per common share including the effect of the
second quarter stock purchase) for the period. The decline was driven by mild
weather conditions that weakened market prices and the electric rate reduction
implemented in late July. The following discussion highlights significant items
that affected the results of operations for the nine months ended September 30,
1999 versus 1998.
Operating revenues grew $41.3 million (5.0%) for the nine months to $874.8
million. The growth in revenues was led by a 27.4% improvement in wholesale
electric power sales volumes (8.25 million MWh in 1999 versus 6.47 million MWh
in 1998) as the Company continued to expand its power trading operations. Retail
sales volumes also improved slightly year-over-year. These volume improvements
were partially offset by residential (down 1.4%) and commercial (down 0.9%)
price decreases due to the rate reduction implemented in late July.
Total operating expenses grew $56.8 million (7.9%) to $780.2 million for the
period. The cost of energy sold increased $51.3 million (14.8%) reflecting a
27.4% rise in wholesale electricity sales, a 1.5% increase in gas throughput and
higher unit costs associated with electricity purchased for resale.
Administrative expenses grew $13.4 million (13.5%) to $112.7 million due to the
non-recurring effect of Year 2000 ("Y2K") costs, new billing system
implementation costs and holding company formation costs. In addition,
depreciation expense grew $7.2 million as a result of continued capital
investment and higher 1999 depreciation rates. These increases were partially
offset by lower taxes reflecting lower pre-tax income.
15
Operating income for the current period decreased $15.5 million (14.25%) to
$94.6 million from a year ago, reflecting a 4.3% margin decline caused by weak
market prices in the Company's wholesale power market, weak first quarter gas
demand due to mild weather and higher administrative costs.
Other income and deductions, net of taxes, increased $8.7 million for the period
to $20.9 million due to the recording of interest income from the PVNGS Capital
Trust and a gain resulting from closing down of the coal mine reclamation
activities.
Net interest charges increased $7.2 million for the period to $52.8 million as a
result of the issuance of $435 million in senior unsecured notes in August 1998,
partially offset by a decrease in short-term debt interest charges.
Discontinued Operations - In August 1998, the Company adopted a plan to
discontinue the natural gas trading operations of its Energy Services Business
Unit and completely discontinue these operations on December 31, 1998. Losses
from discontinued operations, net of taxes, for the nine months ended September
30, 1998, were $8.7 million, or $0.21 per common share. These losses did not
recur in 1999.
Cumulative Effect of a Change in Accounting Principle - Effective January 1,
1999, the Company adopted EITF Issue No. 98-10. The effect of the initial
application of the new standard is reported as a cumulative effect of a change
in accounting principle. As a result, the Company recorded additional earnings,
net of taxes, of approximately $3.5 million, or $0.09 per common share, to
recognize the gain on net open physical electricity purchase and sales
commitments considered to be trading activities.
LIQUIDITY AND CAPITAL RESOURCES
Cash Activity - Cash generated from operating activities of $149.4 million
decreased $7.2 million (4.6%) from last year. The reduction in cash generation
reflects an $18.7 million increase in customer accounts receivable caused by
collection delays generated by implementation of a new customer billing system
and higher overall sales volumes. In addition, 1999 earnings include a $3.5
million non-cash gain from implementation of new accounting methods. These cash
uses were partially offset by cash generation from lower inventory levels and
higher non-cash depreciation charges.
16
Cash used for investing activities was $20.7 million in 1999 compared to $302.6
million in 1998. This decreased spending reflects the absence of the 1998
purchases of $215.7 million in PVNGS lease obligation bonds, lower construction
expenditures in 1999 of $28.9 million and the liquidation of insurance-based
investments in the nuclear decommissioning trust of $26.6 million (see financing
activities below for the payment of decommissioning debt of $26.6 million).
Cash used for financing activities was a use of $101.4 million in 1999 because
of the repurchase of $31.6 million of senior unsecured notes, $26.6 million of
loan repayments associated with nuclear decommissioning trust activities and
$17.7 million stock repurchase by the Company. Cash from financing activities in
1998 included proceeds from the issuance of senior unsecured notes of $429.4
million and repayment of short-term borrowings of $211.8 million.
Capital Requirements - The projection for total capital requirements for 1999 is
$176 million, which includes $145 million of utility construction expenditures.
During the nine month period, the Company spent approximately $98.3 million for
capital requirements and anticipates spending approximately $50.2 million over
the remainder of 1999. The Company expects that these cash requirements will be
met primarily through internally generated cash. However, to cover the
difference in the amounts and timing of cash generation and cash requirements,
the Company intends to utilize short-term borrowings under its liquidity
arrangements. These estimates are under continuing review and subject to
on-going adjustment based upon business needs and market conditions.
Stock Repurchase - In March 1999, the Company's board of directors approved a
plan to repurchase up to 1,587,000 shares of the Company's outstanding common
stock with maximum purchase price of $19.00 per share. The repurchase program
was created to facilitate the Company's stock option program. As of September
30, 1999, the Company repurchased one million shares of its previously
outstanding common stock at a cost of $17.7 million. The Company may from
time-to-time repurchase additional common stock for various corporate purposes.
Financing and Liquidity - In 1999, the Company retired $31.6 million of its 7.1%
senior unsecured notes through open market purchases, utilizing the funds from
operations and the funds from temporary investments. On October 28, 1999,
tax-exempt pollution control revenue bonds of $11.5 million with an interest
rate of 6.60% were issued to partially reimburse the Company for expenditures
associated with its share of a recently completed upgrade of the emission
control system at San Juan Generating Station ("SJGS").
The Company does not have any additional long-term financing plans for the
remainder of 1999.
17
As of September 30, 1999, the Company had $405.0 million of available liquidity
arrangements, consisting of $300.0 million from an unsecured revolving credit
facility, $80.0 million from an accounts receivable securitization and $25.0
million in local bank lines of credit. At September 30, 1999, the Company did
not have any short-term borrowings and had $90.4 million in cash and temporary
investments.
The Company's ability to finance its construction program at a reasonable cost
is dependent largely upon its earnings, credit ratings, regulatory approvals and
financial market conditions. In August 1999, two major credit rating agencies
upgraded the Company's securities to investment grade following the electric
rate order by the PRC, approving the rate case settlement. (See Item 5. Other
Events - "Upgrades of the Company's Securities Ratings to Investment Grade" in
the Current Report on Form 8-K dated September 2, 1999.)
OTHER ISSUES FACING THE COMPANY
Formation of Holding Company
The Electric Utility Industry Restructuring Act of 1999 (the "Restructuring
Act") opens the state's electric power market to customer choice in 2001. The
Restructuring Act requires that assets and activities subject to the PRC
jurisdiction, primarily electric and gas distribution, and transmission assets
and activities (collectively, the "regulated business"), be separated from other
competitive business, primarily electric generation and service and certain
other energy services (collectively, "the competitive businesses"). Such
separation is required to be accomplished through the creation of at least two
separate corporations. The Company has decided to accomplish the mandated
separation by the formation of a holding company and the transfer of the
regulated businesses to a newly-created, wholly owned subsidiary of such holding
company, subject to various regulatory approvals. Corporate separation of the
regulated business from the competitive businesses must be completed by January
1, 2001, although such date may be extended by up to one year by the PRC.
Completion of corporate separation will require a number of regulatory approvals
by, among others, the PRC and the Nuclear Regulatory Commission. Completion will
also require shareholder approval and a number of other consents from creditors
and lessors. Completion may also entail significant restructuring activities
with respect to the Company's existing liquidity arrangements and the Company's
publicly-held senior unsecured notes of which $403.4 million were outstanding as
of September 30, 1999. Holders of the Company's senior unsecured notes, $135
million at 7.5% and $268.4 million at 7.1%, may be offered the opportunity to
exchange their securities for similar senior unsecured notes of the newly
created regulated business.
18
On September 30, 1999, the Board of Directors of the Company authorized
management to commence the process of obtaining necessary regulatory and other
approvals so that corporate separation could occur in advance of the statutory
deadline of January 1, 2001 and in advance of approval of the balance of the
Company's transition plan under the Restructuring Act. The Company anticipates
filing its application with the PRC for necessary authorizations in the near
future.
Regulated Business
The regulated business comprised approximately 47% of the Company's total assets
and contributed approximately 41% of the Company's operating revenues and
approximately 49% of the Company's income before interest charges in 1998.
Stranded Costs
The Restructuring Act recognizes that electric utilities should be permitted a
reasonable opportunity to recover an appropriate amount of the costs incurred
previously in providing electric service ("stranded costs"). Stranded costs
include plant decommissioning costs, regulatory assets, lease and lease-related
costs recognized under cost-of-service regulation. Utilities will be allowed to
recover no less than 50% of such costs through a non-bypassable charge on all
customer bills for five years after implementation of customer choice. The PRC
could authorize a utility to recover up to 100% of its stranded costs if the PRC
finds that recovery of more than 50%: (i) is in the public interest; (ii) is
necessary to maintain the financial integrity of the public utility; (iii) is
necessary to continue adequate and reliable service; and (iv) will not cause an
increase in rates to residential or small business customers during the
transition period. Utilities will also be allowed to recover in full any costs
incurred in implementing full open access ("transition costs"). The transition
costs will be recovered through 2007 by means of a separate wire charge. While
recoverable stranded costs and transition costs will be collected as part of the
regulated business, it is anticipated that such collections would be paid to the
Company and be part of the revenues available to the competitive businesses
subsequent to restructuring.
Competitive Businesses
The competitive businesses which would be retained by the Company include the
Company's interests in generation facilities, including PVNGS, the Four Corners
Power Plant ("Four Corners"), and SJGS, together with the pollution control
facilities which have been financed with pollution control revenue bonds.
Approximately $586 million in pollution control revenue bonds would remain as
obligations of the generation subsidiary, as would certain other of the
Company's long-term obligations. The competitive businesses would not be subject
to regulation by the PRC. Under the Company's restructuring plan, the Company's
bondholders will continue to hold obligations of the Company following
restructuring. Since the Restructuring Act requires significant changes in the
assets and businesses of the Company, the bondholders will be accepting the
risks involved in those changes.
19
The Company will continue its competitive business following the restructuring,
which will be subject to market conditions. Following the separation as required
by the Restructuring Act, in support of its wholesale trading operations, the
Company is targeting to double its generating capacity and triple its sales
volume. Recently, the Company formed a non-regulated subsidiary, Avistar, Inc.
("Avistar") in August 1999, to achieve competitive business strategies. Avistar
provides services in the areas of utility management for municipalities and
other communities, remote metering and development of energy conservation and
supply projects for federal government facilities. The Company does not
anticipate an earnings contribution from Avistar over the next few years.
Financial Options
Funds generated from capitalizing the new regulated and competitive businesses
and/or from potential stranded cost recovery may be used by the Company to
retire or restructure currently outstanding debt obligations, to repurchase the
Company's outstanding equity securities or to fund business expansion. In this
regard, the Company announced a five-year strategy to invest up to $600 million
to expand its power generation portfolio to support its asset-backed wholesale
electricity sales operations and expand the geographic range of its generation
operations into new markets. A significant portion of the Company's recent
revenue and earnings growth has been generated from the Company's wholesale
electricity trading operations. The expansion strategy is focused on developing
opportunities to expand these operations.
Risk of Deregulation
Deregulation in the electric utility is likely to have a significant impact on
the price for electric generation and recovery of the investment in electric
generation assets. Such price pressures will likely put a strain on electric
generation margins. In response to competition and the need to gain economies of
scale, electricity producers will need to control costs to maintain margins,
profitability and cash flow that will be adequate to support investments in new
technology and infrastructure. As a result, the uncertainties surrounding
deregulation and the Company's ability to be competitive in a deregulated
environment could be significant business risks for the Company as deregulation
and possible industry consolidation continue to evolve.
20
New Customer Billing System
As previously reported, the Company installed a new customer billing system in
November 1998, for which the Company has had a significant number of
implementation issues. (See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- OTHER ISSUES FACING THE COMPANY -- NEW
CUSTOMER BILLING SYSTEM" in the quarterly report on Form 10-Q for the quarter
ended June 30, 1999.)
On October 1, 1999, the Company and the PRC Staff entered into a stipulation
that would allow the Company to bill an additional service charge to customers
who were not billed the appropriate electric service charges and/or gas access
fees. The one-time charge will be equal to or less than the amount that
customers would have otherwise been billed had their bills not been delayed. On
October 14, 1999, at the conclusion of a hearing, the hearing examiner announced
that he would certify the stipulation to the PRC for approval and on October 20,
1999, the hearing examiner issued a certification of the stipulation. On
November 2, 1999, the PRC approved the stipulation, concluding the investigation
without imposing any civil penalty on the Company. Under the stipulated
agreement, the Company is allowed to collect approximately $0.7 million in
unbilled electric service charges and gas access fees in the November and
December billing cycles.
Because of the implementation issues associated with the new billing system, the
Company was estimating retail gas and electric revenues through July 1999.
Beginning with the August financial reports, the Company was able to generate
reports produced by the new billing system that reflect the actual revenues
billed for all subsequent months. The Company now is in the process of fully
reconciling previously estimated revenues to those actually billed to customers.
The Company's financial, tax and regulatory reports have reflected these
estimates. Management does not believe that the estimation on the subsequent
reconciliation process will have a material adverse effect on the Company's
results of operations or financial condition.
The Year 2000 ("Y2K") Issues
As previously reported, the Y2K issue is a consequence of computer programs ("IT
Systems") written using two digits rather than four digits to define the
applicable year. The Company adopted a plan to address the Y2K issue for
internal systems and external dependencies. In June 1999, the Company reported,
as required, to the North American Electric Reliability Council ("NERC") that it
believes its mission critical systems used to produce and deliver electricity
are Y2K ready, without any exceptions. On July 2, 1999, the Company announced
that it believes its mission critical systems used to produce electricity and to
deliver gas and electricity are Y2K ready. The Company's remaining non-mission
critical systems had been scheduled to be Y2K ready by October 1, 1999, but not
21
all of those systems met that deadline. Several systems have been delayed due to
vendor delivery problems or remediation delays. The Company expects these
non-mission critical systems to be Y2K ready by December 31, 1999. None of these
systems have any direct impact on the production of electricity or the delivery
of gas or electricity to customers. (See ITEM 2. -- "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- OTHER ISSUES FACING
THE COMPANY -- THE YEAR 2000 ISSUE" in the Company's quarterly report on Form
10-Q for the quarter ended June 30, 1999.)
The estimated status of each phase as of October 31, 1999, is set out below:
Estimated Status of
Y2K Project Phases Completion*
------------------ -------------------
Awareness Phase 100%
Inventory Phase 100%
Assessment Phase 100%
Planning and Scheduling Phase 100%
Repair Phase 99%
Testing Phase 98%
Re-Integration/Deployment Phase 98%
Company-Wide Testing Phase 91%
* The stated percentages represent the status of completion as of
October 31, 1999, of all of the Company's IT Systems and
Embedded Systems, including mission critical systems. For
purposes of this presentation, "mission critical systems"
include systems whose failures could cause an interruption in
the supply of electricity or gas to the Company's customers,
could interfere with the Company's ability to communicate with
customers, or could interfere with the Company's cash flow.
The Company has a 10.2% undivided interest in PVNGS, with portions of its
interest held under leases. Arizona Public Service Company ("APS"), the
operating agent of PVNGS, notified the U. S. Nuclear Regulatory Commission
("NRC") on June 26, 1999 that PVNGS is Y2K ready.
Although the mission critical systems are Y2K ready, work will continue on the
development and testing of the Company's contingency plans. Contingency plans
for mission critical systems were completed on July 30, 1999. The Company
participated in the successful September drills organized by the NERC and the
Western Systems Coordinating Council, with valuable lessons being learned and
changes to be implemented for future drills. Testing of the Company's
contingency plans will continue into November and December 1999. The Company has
completed the remediation and testing of its prior energy management system
("EMS") and it is now Y2K ready. In addition, the Company has completed the
testing and installation of an upgraded EMS that is also Y2K ready. The Company
has also developed and is testing a process to switch from the upgraded system
to the prior system in case of a system failure.
22
The Company has spent approximately $12.2 million on non-PVNGS Y2K related
activities during the first nine months of 1999, and approximately $17.5 million
since project commencement. The Company's share of the PVNGS costs associated
with the Y2K project is deemed to be immaterial.
The statements in this section are Y2K readiness disclosures pursuant to the
Year 2000 Information and Readiness Disclosure Act.
Labor Union Negotiations
The Company and International Brotherhood of Electrical Workers ("IBEW") Local
Union 611 will enter into negotiations for a successor agreement during the
later part of the first quarter of 2000. The current collective bargaining
agreement, which covers the 654 bargaining unit employees in the Company's
regulated operations, expires on May 1, 2000. The Company's negotiating team is
currently preparing for the upcoming negotiations. The outcome of future
negotiations cannot be determined at this time.
Accounting Standards
EITF Issue 99-14, Recognition of Impairment Losses on Firmly Committed Executory
Contracts: The Emerging Issues Task Force ("EITF") has added an issue to its
agenda to address impairment of leased assets. A significant portion of the
Company's nuclear generating assets are held under operating leases. Based on
the alternative accounting methods being explored by the EITF, the related
financial impact of the future adoption of EITF Issue No. 99-14 could
potentially be significant. However, a complete evaluation of the financial
impact from the future adoption of EITF Issue No. 99-14 will be undeterminable
until EITF deliberations are completed and stranded cost recovery issues are
resolved.
Statement of Financial Accounting Standards ("SFAS") No. 137 -- Accounting for
Derivative Instruments and Hedging Activities-- Deferral of the Effective Date
of SFAS No. 133: SFAS No. 133 establishes accounting and reporting standards
requiring every derivative instrument be recorded in the balance sheet as either
an asset or liability measured at its fair value. The Statement also requires
that changes in the derivatives' fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. The Company is in the process
of reviewing and identifying all financial instruments currently existing in the
Company in compliance with the provisions of SFAS No. 133. It is likely that the
adoption of SFAS No. 133 will add volatility to the Company's operating results
and/or asset and liability valuations. In June 1999, Financial Accounting
Standards Board issued SFAS No. 137 to amend the effective date for the
compliance of SFAS No. 133 to January 1, 2001.
23
Disclosure Regarding Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies without fear of litigation so long
as those statements are identified as forward-looking and are accompanied by
meaningful, cautionary statements identifying important factors that could cause
actual results to differ materially from those projected in the statement. Words
such as "estimates," "expects," "anticipates," "plans," "believes," "projects,"
and similar expressions identify forward-looking statements. Accordingly, the
Company hereby identifies the following important factors which could cause the
Company's actual financial results to differ materially from any such results
which might be projected, forecasted, estimated or budgeted by the Company in
forward-looking statements: (i) adverse actions of utility regulatory
commissions; (ii) utility industry restructuring; (iii) failure to recover
stranded costs; (iv) the inability of the Company to successfully compete
outside its traditional regulated market; (v) the success of the Company's
expansion strategies; (vi) regional economic conditions, which could affect
customer growth; (vii) adverse impacts resulting from environmental regulations;
(viii) loss of favorable fuel supply contracts; (ix) failure to obtain water
rights and rights-of-way; (x) operational and environmental problems at
generating stations; (xi) the cost of debt and equity capital; (xii) weather
conditions; and (xiii) technical developments in the utility industry.
The costs of the Company's Y2K Project and the dates on which the Company
believes it will complete the phases of the Project are based upon management's
best estimates, which were derived using numerous assumptions regarding future
events, including the continued availability of certain resources, third-party
remediation plans, and other factors. There can be no assurance that these
estimates will prove to be accurate and actual results could differ materially
from those currently anticipated. Specific factors that could cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in Y2K issues, the ability to identify, assess, remediate
and test all relevant computer codes and embedded technology, and similar
uncertainties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company uses derivative financial instruments in limited instances to manage
risk as it relates to changes in natural gas and electric prices and adverse
market changes for investments held by the Company's various trusts. The Company
is exposed to credit losses in the event of non-performance or non-payment by
counterparties. The Company uses a credit management process to assess and
24
monitor the financial conditions of counterparties. The Company also uses, on a
limited basis, certain derivative instruments for bulk power electricity trading
purposes in order to take advantage of favorable price movements and market
timing activities in the wholesale power markets. See Note 5 to Notes to
Consolidated Financial Statements for the Company's market risk information.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
San Diego Gas Electric Company ("SDG&E") Complaints
As previously reported, SDG&E has filed four separate and similar complaints
with the FERC, alleging that certain charges under the Company's 100 MW power
sales agreement with SDG&E were unjust, unreasonable and unduly discriminatory.
The Company filed responses to such complaints denying the allegations made by
SDG&E, requesting they be dismissed. (See PART II, ITEM 7. -- "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --
OTHER ISSUES FACING THE COMPANY -- NMPUC REGULATORY ISSUES -- SAN DIEGO GAS AND
ELECTRIC COMPANY ("SDG&E") COMPLAINTS" in the Company's 1998 annual report on
Form 10-K.)
On March 11, 1999, the FERC issued two separate orders regarding these
complaints. One order, among other things, dismissed the first two complaints
filed by SDG&E. In dismissing the first two complaints, the FERC stated that
SDG&E had not presented sufficient evidence to warrant a hearing regarding the
reasonableness of the contract rate. The order also ruled that an appropriate
time frame for evaluating the reasonableness of the contract rate is over the
life of the contract rather than a snapshot of the rate on a year-to-year basis
as SDG&E alleged in the first two complaints. The second order established the
refund period for the latest complaint, the fourth complaint, and consolidated
it with the other remaining complaint and set a hearing.
Commencing July 19, 1999, a hearing was held on Phase I of the SDG&E complaint
issues regarding whether SDG&E has the right to challenge the rates charged
under the power sales agreement under the Federal Power Act ("FPA") Section 206
"just and reasonable standard", or whether SDG&E has waived this right and is
limited to challenging the rates under the tougher Section 206 "public interest
standard". On September 14, 1999, the Administrative Law Judge issued his
initial decision (subject to review by FERC on exceptions or on its own motion),
holding that the standard of review to be applied in Phase II of the proceeding
is the "public interest" standard. The Phase II hearing regarding whether, and
to what extent, the Company's power sale agreement rates are unlawful, excessive
and/or contrary to the public interest is scheduled for June 2000.
25
The Company estimates that the potential refund amount, if the relief sought in
the third and fourth complaints is granted, could be up to as much as $20.3
million plus accrued interest through the refund date. However, the precise
nature of the claim has not yet been presented by SDG&E, and the final amount of
the claim, based on the evidence, could turn out different from the claims
presented in the complaints. The Company continues to firmly believe that the
remaining two complaints are without merit and intends to vigorously defend its
position. The Company cannot predict the ultimate outcome of this matter.
In addition, the Company currently estimates that the net revenue reduction
resulting from the loss of SDG&E contract that expires in April 2001 will be
approximately $20 million annually.
Kirtland Air Force Base ("KAFB") Contract
As previously reported, the Company was informed that the Department of Energy
("DOE") had entered into an intra-agency agreement with the Western Area Power
Administration ("Western") on behalf of KAFB, one of the Company's largest
retail electric customers, under the terms of which Western will competitively
procure power for KAFB. In May 1999, the Company received a request for network
transmission service from Western to facilitate the delivery of wholesale power
to KAFB over the Company's transmission system. (See PART I, ITEM 2. --
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- OTHER ISSUES FACING THE COMPANY -- Kirtland Air Force Base
("KAFB") Contract" in the quarterly report on Form 10-Q for the quarter ended
March 31, 1999.)
The Company denied Western's request, by letter dated June 30, 1999, citing the
fact that KAFB is and will continue to be a retail customer until the effective
date KAFB can elect customer choice service under the provisions of the
Restructuring Act of 1999 (the effective date for customer choice for KAFB is
January 1, 2002, unless extended by the PRC). The Company also cited several
provisions of Federal law that prohibit the provision of such service to
Western. On October 4, 1999, Western filed a petition at the Federal Energy
Regulatory Commission ("FERC") requesting the FERC to consider, on an expedited
basis, ordering the Company to provide network transmission service to Western
under the Company's Open Access Transmission Tariff on behalf of DOE and several
other entities located on KAFB. The Company responded to the Western petition on
October 25, 1999, and intends to litigate this matter vigorously. The net
revenue reduction to the Company if DOE replaces the Company as the power
supplier to KAFB is estimated to be approximately $7.0 million annually.
26
In a separate but related proceeding, the Company and the United States
Executive Agencies on behalf of KAFB are involved in a PRC case regarding a
dispute over the terms under which KAFB has taken retail service from the
Company. Among the disputed issues in this case are the interpretation of
language in a retail rate schedule pertaining to the continuation of service
after expiration of the Company's electric service agreement for service to KAFB
and an issue related to the proper scope of the case under the New Mexico Public
Utility Act.
The Company is currently unable to predict the ultimate outcome of these
matters.
New Royalty Claim
On September 23, 1999, a class action lawsuit, on behalf of natural gas
producers, royalty owners and others, was filed in state district court in
Stevens County, Kansas against the Company and its subsidiaries, Sunterra Gas
Gathering Company and Sunterra Gas Processing Company (collectively called
"Company"), as well as numerous other unrelated parties in the natural gas
industry, alleging that gas producers have been underpaid royalties due to
mismeasurement of gas on privately owned lands. The suit also purports to be
brought on behalf of state taxing authorities, although no representative of
that class is designated. The complaint alleges that the mismeasurement
practices alleged breached contracts between plaintiffs and defendants,
constituted negligent or intentional misrepresentation, conversion, negligence,
breach of fiduciary duty and violations of Kansas statutory laws. The complaint
also alleges a civil conspiracy among defendants to misrepresent and mislead
plaintiffs. The complaint also alleges that the defendants fraudulently
concealed the mismeasurement practices alleged in the complaint from plaintiffs
and seeks to suspend the applicable statute of limitations in order to recover
damages for the period from 1974 to the present.
The Company will vigorously defend against this lawsuit and, at this very
preliminary stage, is unable to predict the ultimate outcome or the potential
liability, if any.
City of Gallup ("Gallup") Complaint
As previously reported, in 1998, Gallup, Gallup Joint Utilities and the
Pittsburg & Midway Coal Mining Co. ("Pitt-Midway") filed a joint complaint and
petition ("Complaint") with the NMPUC (predecessor of the PRC). The Complaint
sought an interim declaratory order stating, among other things, that
Pitt-Midway is no longer an obligated customer of the Company, Gallup is
entitled to serve Pitt-Midway and the Company must wheel power purchased by
Gallup from other suppliers over the Company's transmission system. In September
1998, the NMPUC issued an order without conducting a hearing, granting the
requests sought in the Complaint. The Company strongly disagreed with the
NMPUC's decision and filed a motion with the New Mexico Supreme Court ("Supreme
Court") in September 1998, requesting an emergency stay of the NMPUC order
pending its appeal of the order. (See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- OTHER ISSUES FACING THE COMPANY
- -- NMPUC REGULATORY ISSUES -- City of Gallup ("Gallup") Complaint" in the 1998
Form 10-K.)
27
On August 16, 1999, oral arguments on the Company's appeal were heard, and on
October 13, 1999, the Supreme Court issued an order, annulling and vacating the
NMPUC final order on remand regarding the Gallup Complaint, stating that the
NMPUC lacked the statutory authority to issue that order, because the New Mexico
Public Utility Act did not authorize Gallup to seek a wheeling order from the
NMPUC. The Company has filed testimony regarding certain aspects of its petition
for declaratory order at the FERC, requesting a determination as to whether the
Company's agreement with Gallup requires (i) the Company to deliver energy to
Gallup at the Company's Yah-Ta-Hey station and (ii) the Company to wheel energy
for Gallup. Hearings are scheduled in February 2000.
Nuclear Decommissioning Trust
As previously reported, in 1998, the Company and the trustee of the Company's
master decommissioning trust filed a civil complaint and an amended complaint,
respectively, against several companies and individuals for the
under-performance of a corporate owned life insurance program. The program,
which was approved by the NMPUC and set up in a trust in 1987, was used to fund
a portion of the Company's nuclear decommissioning obligations for its 10.2%
interest in PVNGS. In January 1999, the life insurance program was terminated,
and the life insurance policies were surrendered by the trust in exchange for
the cash surrender value of the policies. In the lawsuit, the Company asserted
various tort, contract and equity theories against the defendants, seeking,
among other things, an amount sufficient to compensate for the harm to the
Company caused by the defendants' conduct. A defendant counterclaimed for
indemnity based on its engagement contract with the Company, claiming that if it
had injured the trustee, then the Company must pay the damages. The Company
denied liability under the counterclaim and set forth numerous defenses. The
case is proceeding in State District Court in Santa Fe County. The defendants'
motions to dismiss were denied and the Company's motions to further amend the
complaint to assert claims against two additional defendants, a law firm and an
accounting firm, were granted. (See PART II, ITEM 1. -- "LEGAL PROCEEDINGS --
Nuclear Decommissioning Trust" in the Company's quarterly report on Form 10-Q
for the quarter ended June 30, 1999.)
On August 13, 1999, the Company appealed one of the trial court's decisions
regarding pretrial discovery to the New Mexico Court of Appeals. While this
decision is on appeal, all pretrial discovery is being stayed. The Company is
currently unable to predict the ultimate outcome or amount of recovery, if any.
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ITEM 5. OTHER INFORMATION
Clean Air Act
As previously reported, the Clean Air Act Amendments of 1990 (the "Act") impose
stringent limits on emissions of sulfur dioxide and nitrogen from fossil-fueled
electric generating plants. The Act is intended to reduce air contamination from
every sizable source of air pollution in the nation. The Act established the
Grand Canyon Visibility Transport Commission ("Commission") and charged it with
assessing adverse impacts on visibility at the Grand Canyon. The Commission
broadened its scope to assess visibility impairment in mandatory Class I areas
(parks and wilderness areas) located in the Colorado Plateau. The Commission
submitted its findings and recommendations to the Environmental Protection
Agency ("EPA") in June 1996. See PART I, ITEM 1. -- "BUSINESS -- ENVIRONMENTAL
FACTORS" in the 1998 Form 10-K.
On July 1, 1999, the final regional haze regulations were published. The purpose
of the regional haze regulations is to address regional haze visibility
impairment in the 156 Class I areas in the nation. The final rule calls for all
states to establish goals and emission reduction strategies for improving
visibility in all of the Class I areas. The rule contains specific provisions to
allow the western states to implement the Commission's recommendations within
the framework of Section 309 of the rule.
Arizona Public Service Company ("APS"), as the operating agent of the Four
Corners Power Plant ("Four Corners"), previously filed a petition for review
alleging EPA improperly classified Four Corners Unit 4 with respect to nitrogen
oxides emission limitations. In October 1999, EPA issued a direct final rule,
which classified Four Corners Unit 4 as APS proposed. Depending on the comments
filed by other parties, if any, the rules may be become final as soon as
December 1999. APS does not currently expect this rule to have a material impact
on the Four Corners operations.
In a related matter, in September 1999, the EPA proposed a Federal
Implementation Plan ("FIP") to set air quality standards at certain power
plants, including Four Corners. The comment period on this proposal ends in
November 1999. The FIP is similar to current New Mexico regulation of Four
Corners with minor modifications. APS does not currently expect the FIP to have
a material impact on the Four Corners operations.
Certain Assets of Plains Electric Generation and Transmission Cooperative, Inc.
("Plains")
As previously reported, the Company and Tri-State Generation and Transmission
Association, Inc. ("Tri-State") submitted a binding joint offer in 1998 for the
acquisition of the assets of Plains, and Plains subsequently announced that it
would be entering into exclusive negotiations with the Company and Tri-State
regarding the joint proposal. Plains entered into a merger agreement with
Tri-State, with Tri-State being the surviving entity. Tri-State would then,
under the terms of an asset sale agreement with the Company, sell certain assets
to the Company consisting primarily of transmission assets and the Plains
29
headquarters building in Albuquerque. In addition, the Company agreed to become
the power supplier of approximately 50 MW to one of Plains' member cooperatives.
Plains, Tri-State and the Company have filed for regulatory approvals from the
PRC and the Federal Energy Regulatory Commission. (See ITEM 2. --"MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --
ASSETS ACQUISTIONS" in the Company's quarterly report on Form 10-Q for the
quarter ended June 30, 1999.)
In the pending PRC case, a settlement stipulation was entered into among the
Company, Tri-State, Plains and the PRC Staff to resolve the issues in the case,
to permit the merger to take place and to allow Tri-State to sell the
above-referenced assets to the Company. None of the other intervenors in the
case objected to the settlement stipulation. The principal disputed issue had
been the scope of the PRC's jurisdiction over Tri-State after the completion of
the merger; Tri-State argued that the PRC should have very limited jurisdiction
while the PRC Staff argued for substantially broader jurisdiction. The
settlement stipulation effected a compromise in which there would be limited PRC
rate regulation of Tri-State after the merger. A hearing on the stipulation was
held commencing on November 2, 1999 before a PRC hearing examiner. The Company
cannot predict the outcome of the case or when a decision will be issued by the
PRC.
The Company and Tri-State entered into an asset sale agreement, dated September
9, 1999, pursuant to which Tri-State has agreed to sell the above-referenced
assets to the Company. The purchase price to be paid by the Company is $13.2
million, subject to adjustment at the time of the closing of the purchase. The
asset sale agreement contains standard covenants and conditions for this type of
agreement.
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
3.1* Restated Articles of Incorporation of the Company, as amended
through May 10, 1985
3.2* By-laws of Public Service Company of New Mexico With All
Amendments to and including June 8, 1999
10.44.2** Second Restated and Amended Non-Union Severance Pay Plan of
Public Service Company of New Mexico dated August 1, 1999
10.77 San Juan Project Participation Agreement dated as of
October 27, 1999, among Public Service Company of New Mexico,
Tucson Electric Power Company, The City of Farmington, New
Mexico, M-S-R Public Power Agency, The Incorporated County of
Los Alamos, New Mexico, Southern California Public Power
Authority, City of Anaheim, Utah Associated Municipal Power
Systems and Tri-State Generation and Transmission
Association, Inc.
10.78 Stipulation in the matter of the Commission's
investigation of the rates for electric service of Public
Service Company of New Mexico, Rate Case No. 2761, dated May
21, 1999
10.78.1 Supplemental Stipulation in the matter of the Commission's
investigation of the rates for electric service of Public
Service Company of New Mexico, Rate Case No. 2761, dated May
27, 1999
10.79 Asset Sale Agreement between Tri-State Generation and
Transmission Association, Inc., a Colorado Cooperative
Association and Public Service Company of New Mexico, a New
Mexico Corporation, dated September 9, 1999
15.0 Letter Re: Unaudited Interim Financial Information
27 Financial Data Schedule
* The Company hereby incorporates the exhibits by reference pursuant to
Exchange Act Rule 12b-32 and Regulation S-K, Section 10, paragraph (d).
** Designates each management contract or compensation plan or arrangement
required to be identified pursuant to paragraph 3 of Item 14 (a) of Form
10-K.
31
b. Reports on Form 8-K:
Report dated September 2, 1999 and filed September 2, 1999 relating to
the electric rate case, upgrades of the Company's securities ratings to
investment grade and disclosure regarding forward looking statements.
Report dated September 16, 1999 and filed September 16, 1999 relating to
the Company's third quarter earnings projection.
Report dated October 7, 1999 and filed October 7, 1999 related to the
Company's board of directors approve filing holding company plan.
Report dated October 22, 1999 and filed October 22, 1999 relating to the
Company's third quarter earnings.
32
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PUBLIC SERVICE COMPANY OF NEW MEXICO
-------------------------------------
(Registrant)
Date: November 12, 1999 /s/ John R. Loyack
-------------------------------------
John R. Loyack
Vice President, Corporate Controller
and Chief Accounting Officer
(Officer duly authorized to
sign this report)
33