SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 1996
OR
[X] 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 1-5924
TUCSON ELECTRIC POWER COMPANY
(Exact Name of Registrant as Specified in its Charter)
ARIZONA 86-0062700
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
220 WEST SIXTH STREET, TUCSON, ARIZONA P.O. BOX 711
85701 85702
(Address of Principal Executive Offices) (Zip Code)
(520) 571-4000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 _____
At October 22, 1996, 32,133,586 shares of the registrant's Common Stock,
no par value (the only class of Common Stock), were outstanding.
2
TABLE OF CONTENTS
Page
Definitions..............................................................ii
Independent Accountants' Report...........................................1
PART I - FINANCIAL INFORMATION
Item 1. -- Financial Statements
Comparative Condensed Consolidated Statements of Income..............2
Comparative Condensed Consolidated Statements of Cash Flows..........3
Comparative Condensed Consolidated Balance Sheets....................4
Notes to Condensed Consolidated Financial Statements
Note 1. Rate Matters................................................5
Note 2. Tax Assessments.............................................5
Note 3. Consolidated Subsidiaries...................................6
Note 4. Voluntary Severance Plan....................................7
Note 5. Common Stock Reverse Split..................................7
Note 6. Income Taxes................................................7
Note 7. Reclassification............................................8
Item 2. -- Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview.............................................................9
Competition
Wholesale.......................................................10
Retail..........................................................11
Accounting for the Effects of Regulation............................12
Investments in Energy-Related Ventures..............................13
Dividends on Common Stock...........................................13
Earnings............................................................14
Results of Operations
i
Results of Utility Operations
Sales and Revenues..............................................15
Operating Expenses..............................................16
Other Income....................................................16
Interest Expense................................................16
Income Taxes....................................................16
Liquidity and Capital Resources..........................................17
Cash Flows.........................................................17
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments..................................................19
Item 6. -- Exhibits and Reports on Form 8-K............................19
Signature Page...........................................................20
Exhibit Index............................................................21
DEFINITIONS
The abbreviations and acronyms used in the 1996 Third Quarter Form 10-Q are
defined below:
ACC............... Arizona Corporation Commission.
ADOR.............. Arizona Department of Revenue
Banks............. Various banks with which the Company has credit
relationships.
Common Stock...... The Company's common stock, without par value.
Company........... Tucson Electric Power Company.
ii
Energy Act........ The Energy Policy Act of 1992.
FAS 71............ Statement of Financial Accounting Standards #71:
Accounting for the Effects of Certain Types of
Regulation.
FAS 92............ Statement of Financial Accounting Standards #92:
Regulated Enterprises - Accounting for Phase-In Plans.
FAS 101........... Statement of Financial Accounting Standards #101:
Regulated Enterprises - Accounting for the
Discontinuation of Application of FAS 71.
FAS 121........... Statement of Financial Accounting Standards #121:
Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of.
FERC.............. Federal Energy Regulatory Commission.
First Mortgage Bonds First mortgage bonds issued under the General First
Mortgage.
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 Energy, LLC, a corporation in which a 50%
interest is owned by TEP Solar.
Irvington......... Irvington Generating Station.
Irvington Lease... The leveraged lease arrangement relating to Irvington Unit
4.
ITC............... Investment Tax Credit for income tax purposes.
kWh............... Kilowatt-hour(s).
MRA............... Master restructuring agreement between the Company and the
Banks which includes the Renewable Term Loan, Revolving
Credit and certain replacement reimbursement agreement.
MSR............... Modesto, Santa Clara and Redding Public Power Agency.
MW................ Megawatt(s).
Nations Energy.... Nations Energy Corporation, a wholly-owned subsidiary of
iii
the Company.
NEV............... New Energy Ventures, Inc.
1994 Rate Order... ACC Rate Order concerning an increase in the Company's
retail base rates and certain regulatory write-offs,
issued January 11, 1994.
1996 Rate Order..................... ACC Rate Order concerning an increase in
the Company's retail base rates and the recovery of
Springerville Unit 2 costs, issued March 29, 1996.
NOL............... Net Operating Loss carryforward for income tax purposes.
PURPA............. Public Utility Regulatory Policies Act of 1978, as
amended.
Renewable Term Loan Credit facility that replaced the Term Loan pursuant to
the MRA Sixth Amendment, dated as of November 1, 1994,
and effective March 7, 1995.
Revolving Credit.. $50 million revolving credit facility entered into between
a syndicate of banks and the Company.
Shareholders...... Holders of Common Stock.
Springerville..... Springerville Generating Station.
Springerville Coal Handling
Facilities Leases Leveraged lease arrangements relating to the coal
handling facilities serving Springerville.
Springerville Common Facilities
Leases.......... Leveraged lease arrangements relating to one-half interest
in certain facilities at Springerville used in common
with Springerville Unit 1 and Springerville Unit 2.
Springerville Unit 1 Leases Leveraged lease arrangements relating to
Springerville Unit 1, and one half interest in certain
facilities at Springerville used in common with
Springerville Unit 1 and Springerville Unit 2.
SWPP.............. SWPP Investment Company, a wholly-owned subsidiary of the
Company.
iv
TEP Solar......... TEP Solar Energy Corporation, a wholly-owned subsidiary of
the Company.
Valencia.......... Valencia Energy Company, previously a wholly-owned
subsidiary of the Company, merged into the Company on May
31, 1996.
VSP............... Voluntary Severance Plan offered to Company employees and
implemented in May 1996.
v
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Tucson Electric Power Company
220 West Sixth Street
Tucson, Arizona 85701
We have reviewed the accompanying condensed consolidated balance sheet of Tucson
Electric Power Company and subsidiaries (the Company) as of September 30, 1996
and the related condensed consolidated statements of income (loss) for the
three-month and nine-month periods ended September 30, 1996 and 1995, and cash
flows for the nine-month periods ended September 30, 1996 and 1995. 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 of 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 such condensed consolidated financial statements 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 and statement of capitalization of the
Company as of December 31, 1995 and the related consolidated statements of
income (loss), cash flows, and changes in stockholders' equity (deficit) for the
year then ended (not presented herein); and in our report dated January 29, 1996
(which includes an explanatory paragraph relating to the timing of the recovery
of 37.5% of Springerville Unit 2; see Note 1 to the September 30, 1996 condensed
consolidated financial statements for the current status of this matter), we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying consolidated balance
sheet as of December 31, 1995 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Tucson, Arizona
October 24, 1996
15
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
The September 30 condensed consolidated financial statements are
unaudited but reflect all normal recurring accruals and other adjustments
which are, in the opinion of management, necessary for a fair statement of
the results for the interim periods covered. Due to seasonal fluctuations in
sales, the quarterly results are not indicative of annual operating results.
Also see Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations.
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
1996 1995
-Thousands of Dollars-
Operating Revenues
Retail Customers $195,261 $192,929
Amortization of MSR Option Gain Regulatory Liability 5,014 5,014
Sales for Resale 22,803 19,844
--------- ---------
Total Operating Revenues 223,078 217,787
--------- ---------
Operating Expenses
Fuel and Purchased Power 60,198 42,182
Capital Lease Expense 25,824 26,661
Amortization of Springerville Unit 1 Allowance (7,273) (7,108)
Other Operations 23,535 24,710
Maintenance and Repairs 7,991 8,432
Depreciation and Amortization 24,735 23,291
Taxes Other Than Income Taxes 21,573 15,170
Voluntary Severance Plan Expense (Gain) (3,443) -
Income Taxes 17,322 (23)
--------- ---------
Total Operating Expenses 170,462 133,315
--------- ---------
Operating Income 52,616 84,472
--------- ---------
Other Income
Income Taxes 66,510 1,212
Reversal of Loss Provision 8,472 -
Interest Income 1,264 2,027
Gains on Sales of Securities - 28
Other 637 (152)
--------- ---------
Total Other Income 76,883 3,115
--------- ---------
Interest Expense
Long-Term Debt - Net 14,843 17,039
Interest Imputed on Losses Recorded at Present Value 8,006 8,098
Other 4,489 2,009
Allowance for Borrowed Funds Used During Construction (337) (288)
--------- ---------
Total Interest Expense 27,001 26,858
--------- ---------
Net Income $102,498 $ 60,729
========= =========
Average Shares of Common Stock Outstanding (000) 32,133 32,136
========= =========
Net Income per Average Share $ 3.19 $ 1.89
========= =========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
1996 1995
-Thousands of Dollars-
Operating Revenues
Retail Customers $482,511 $451,124
Amortization of MSR Option Gain Regulatory Liability 15,040 15,040
Sales for Resale 58,088 56,673
--------- ---------
Total Operating Revenues 555,639 522,837
--------- ---------
Operating Expenses
Fuel and Purchased Power 156,128 126,567
Capital Lease Expense 78,073 78,882
Amortization of Springerville Unit 1 Allowance (21,818) (21,324)
Other Operations 71,983 74,238
Maintenance and Repairs 26,345 30,888
Depreciation and Amortization 73,285 69,629
Taxes Other Than Income Taxes 51,310 45,511
Voluntary Severance Plan Expense (Gain) 10,555 -
Income Taxes 12,934 (68)
--------- ---------
Total Operating Expenses 458,795 404,323
--------- ---------
Operating Income 96,844 118,514
--------- ---------
Other Income
Income Taxes 80,371 3,471
Reversal of Loss Provision 8,472 -
Interest Income 4,166 6,806
Gains on Sales of Securities - 2,986
Other 706 297
--------- ---------
Total Other Income 93,715 13,560
--------- ---------
Interest Expense
Long-Term Debt - Net 44,600 53,049
Interest Imputed on Losses Recorded at Present Value 24,592 24,666
Other 9,197 6,425
Allowance for Borrowed Funds Used During Construction (1,036) (849)
--------- ---------
Total Interest Expense 77,353 83,291
--------- ---------
Net Income $113,206 $ 48,783
========= =========
Average Shares of Common Stock Outstanding (000) 32,133 32,139
========= =========
Net Income per Average Share $ 3.52 $ 1.52
========= =========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
1996 1995
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $491,791 $459,054
Cash Receipts from Sales for Resale 56,096 59,478
Fuel and Purchased Power Costs Paid (137,145) (124,748)
Wages Paid, Net of Amounts Capitalized (61,657) (50,700)
Payment of Other Operations and Maintenance Costs (56,420) (54,925)
Capital Lease Interest Paid (83,200) (82,742)
Interest Paid, Net of Amounts Capitalized (49,153) (57,006)
Taxes Paid, Net of Amounts Capitalized (65,612) (79,329)
Emission Allowance Inventory Sale 4,120 -
Interest Received 4,716 6,708
Income Taxes Paid (1,066) (1,760)
Other (3,101) -
--------- ---------
Net Cash Flows - Operating Activities 99,369 74,030
--------- ---------
Cash Flows from Investing Activities
Construction Expenditures (51,092) (42,049)
Purchase of Debt Securities - (17,697)
Investments in Joint Ventures (6,116) (11,529)
Other 250 3,327
--------- ---------
Net Cash Flows - Investing Activities (56,958) (67,948)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 31,400 -
Proceeds from Borrowings on the Renewable Term Loan 14,000 -
Payments to Retire Long-Term Debt (25,575) (36,507)
Payments on Renewable Term Loan (14,000) (143,060)
Payments to Retire Capital Lease Obligations (35,629) (16,657)
Other 297 273
--------- ---------
Net Cash Flows - Financing Activities (29,507) (195,951)
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents 12,904 (189,869)
Cash and Cash Equivalents, Beginning of Year 85,094 248,152
--------- ---------
Cash and Cash Equivalents, End of Period $ 97,998 $ 58,283
========= =========
See Notes to Condensed Consolidated Financial Statements.
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Nine Months Ended
September 30,
1996 1995
-Thousands of Dollars-
Net Income $113,206 $ 48,783
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 73,285 69,629
Deferred Income Taxes and
Investment Tax Credits - Net (68,504) (4,016)
Deferred Fuel and Purchased Power - 5,287
Lease Payments Deferred 3,386 4,408
Regulatory Amortizations, Net of Interest Imputed
on Losses Recorded at Present Value (12,266) (11,698)
Reversal of Loss Provision (8,472) -
Other (2,673) (2,250)
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable (25,611) (20,715)
Materials and Fuel 1,291 (3,630)
Accounts Payable 582 (10,320)
Taxes Accrued 25,313 4,643
Other Current Assets and Liabilities (7,717) (6,982)
Other Deferred Assets and Liabilities 7,549 891
--------- ---------
Net Cash Flows - Operating Activities $ 99,369 $ 74,030
========= =========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
1996 1995
- Thousands of Dollars -
Utility Plant
Plant in Service $2,122,234 $2,095,679
Utility Plant Under Capital Leases 893,064 893,064
Construction Work in Progress 65,544 50,898
----------- -----------
Total Utility Plant 3,080,842 3,039,641
Less Accumulated Depreciation and Amortization (905,702) (859,227)
Less Accumulated Amortization of Capital Leases (52,152) (40,113)
Less Springerville Unit 1 Allowance (163,084) (162,175)
----------- -----------
Total Utility Plant - Net 1,959,904 1,978,126
----------- -----------
Investments and Other Property 60,965 52,116
----------- -----------
Current Assets
Cash and Cash Equivalents 97,998 85,094
Accounts Receivable 87,328 61,717
Materials and Fuel 40,877 42,168
Deferred Income Taxes - Current 1,937 18,250
Other 14,342 7,565
----------- -----------
Total Current Assets 242,482 214,794
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Rates 135,957 135,957
Deferred Common Facility Costs 61,397 63,303
Deferred Springerville Unit 2 Costs 27,100 42,039
Deferred Lease Expense 16,341 19,808
Other Deferred Regulatory Assets 8,195 8,576
Deferred Debits - Other 15,830 16,211
----------- -----------
Total Deferred Debits 264,820 285,894
----------- -----------
Total Assets $2,528,171 $2,530,930
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
CAPITALIZATION AND OTHER LIABILITIES
September 30, December 31,
1996 1995
- Thousands of Dollars -
Capitalization
Common Stock $ 645,211 $ 645,295
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (513,244) (626,450)
----------- -----------
Common Stock Equity 125,610 12,488
Capital Lease Obligations 894,106 897,958
Long-Term Debt 1,224,160 1,207,460
----------- -----------
Total Capitalization 2,243,876 2,117,906
----------- -----------
Current Liabilities
Short-Term Debt 3,567 12,039
Current Obligations Under Capital Leases 10,289 33,389
Current Maturities of Long-Term Debt 1,200 12,075
Accounts Payable 25,760 25,178
Interest Accrued 41,214 57,389
Taxes Accrued 41,009 15,696
Accrued Employee Expenses 9,786 14,297
Other 6,409 7,372
----------- -----------
Total Current Liabilities 139,234 177,435
----------- -----------
Deferred Credits and Other Liabilities
MSR Option Gain Regulatory Liability 12,436 25,610
Accumulated Deferred Investment Tax Credits
Regulatory Liability 16,168 19,603
Other Regulatory Liabilities 13,945 10,343
Deferred Income Taxes - Noncurrent 64,600 145,982
Other 37,912 34,051
----------- -----------
Total Deferred Credits and Other Liabilities 145,061 235,589
----------- -----------
Total Capitalization and Other Liabilities $2,528,171 $2,530,930
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. RATE MATTERS
- ---------------------
On March 29, 1996, the ACC authorized a 1.1%, or $6.4 million, increase
in base rates effective March 31, 1996. Pursuant to the 1996 Rate Order, the
Company agreed to not seek an increase in base rates before January 1, 2000,
subject to conditions specified in such order.
The 1996 Rate Order recognizes all of Springerville Unit 2 as used and
useful for regulatory purposes, so the Company will be able to recover
operating and capital costs associated with the portion of such generating
unit not previously included in rate base. Prior to the 1996 Rate Order, the
Company was not recovering through retail rates the depreciation, property
taxes, operating and maintenance expenses other than fuel, or interest costs
associated with the 37.5% of Springerville Unit 2 capacity not deemed by the
ACC to be used and useful for the retail jurisdiction and therefore not
included in rate base (hereinafter referred to as "retail excess capacity
deferrals"). The 1994 Rate Order permitted such costs to be deferred for
future recovery over the remaining useful life of Springerville Unit 2.
However, this phase-in plan did not qualify under FAS 92 and, therefore, such
retail excess capacity deferrals, while deferred for regulatory purposes,
were not deferred for financial reporting purposes and were expensed as
incurred. Such retail excess capacity deferrals totaled $3 million during
the three months ended March 31, 1996, bringing the total to $81 million at
March 30, 1996. Beginning March 31, 1996, the total retail excess capacity
deferrals are amortized for regulatory purposes over 20 years.
In addition, prior to the 1996 Rate Order, the Company was not
recovering through retail rates 37.5% of the deferred Springerville Unit 2
rate synchronization costs ($28 million at March 30, 1996), which were non-
fuel costs of Springerville Unit 2 incurred from January 1, 1991 through
October 14, 1991. Beginning March 31, 1996, these costs are being amortized
over a three-year period on the Consolidated Statements of Income,
in accordance with the 1996 Rate Order. These costs ($23 million at September
30, 1996), together with the balance of such costs that the Company has been
recovering through rates, pursuant to the 1994 Rate Order, ($4 million at
September 30, 1996), are reported in the Company's Condensed Consolidated
Balance Sheet as Deferred Springerville Unit 2 Costs. The amortization of
such costs is included in Depreciation and Amortization on the Company's
Condensed Consolidated Statements of Income and amounted to $6 million and $4
million for the three months ended September 30, 1996 and 1995, respectively,
and $15 million and $11 million for the nine months ended September 30, 1996
and 1995, respectively.
NOTE 2. TAX ASSESSMENTS
- ------------------------
Ruling on Arizona Sales Tax Assessments - Coal Sales
The Arizona Department of Revenue (ADOR) issued transaction privilege
(sales) tax assessments to the Company alleging that Valencia was liable for
sales tax on gross income received from coal sales, transportation and coal-
handling services to the Company for the period November 1985 through May
1993. The Company protested these assessments. On March 11, 1994, the
Arizona Tax Court issued a Minute Entry granting Summary Judgment to the ADOR
and upholding the validity of the assessment issued for the period November
1985 through March 1990. The Company appealed this decision to the Court of
Appeals. On September 12, 1996, the Arizona Court of Appeals upheld the
validity of the assessment issued for the period November 1985 through March
1990. The Company filed with the Court of Appeals a motion for
reconsideration of their September 12, 1996 decision. Additionally, the
Company is protesting the assessments for the period April 1990 through May
1993.
Previously, the Company had recorded an expense through the Consolidated
Statements of Income (Loss) in current and prior years and related liability
for the amount of sales taxes and interest thereon which the Company then
believed was probable of incurrence. As a result of the Court of Appeals
decision, the Company recorded an additional expense of approximately $9.2
million in September 1996. Such expense is included in Taxes Other Than
Income Taxes ($7.3 million) and Other Interest Expense ($1.9 million) in the
Condensed Consolidated Statement of Income. The amounts recorded by the
Company included estimates for the period June 1993 through September 1996,
the period for which the Company has not yet been assessed.
Generally, Arizona law requires payment of an assessment due prior to
pursuing the appellate process. The Company has previously paid, under
protest, a total of $23 million of the disputed sales tax assessments,
subject to refund in the event the Company would prevail. The Court's
decision does not require additional cash payments by the Company at this
time.
On May 31, 1996, Valencia was merged into the Company (see Note 3).
Effective with the merger, Valencia no longer supplies coal to the Company.
Instead the Company acquires coal directly from the supplier. As a result,
the Company believes it is not liable for transaction privilege tax computed
on a basis similar to the assessments described above subsequent to May 31,
1996.
Ruling on New Mexico Sales Tax Liability
The New Mexico Taxation and Revenue Department issued a gross receipts
tax assessment to a seller from whom Valencia purchased coal, alleging sales
tax liability of approximately $12 million on payments made to the seller for
coal Valencia purchased for resale and which Valencia resold. The terms of
the coal supply agreement provide that the buyer shall bear and pay all such
gross receipt taxes. The assessment covered the period June 1993 to April
1996. On September 18, 1996, the New Mexico Taxation and Revenue Department
issued an amended assessment showing that no such taxes were owed. No
adjustment was required as a result of this amended assessment.
Arizona Sales Tax Assessments - Leases
The ADOR has issued transaction privilege (sales) tax assessments to the
lessors from whom the Company leases certain property. The assessments
allege sales tax liability on a component of rents paid by the Company on the
Springerville Unit 1 Leases, Springerville Common Facilities Leases,
Irvington Lease and Springerville Coal Handling Facilities Leases.
Assessments cover the period August 1, 1988 to September 30, 1993. Under the
terms of the lease agreements, if the ADOR prevails the Company must
reimburse the lessors for taxes paid by them pursuant to indemnification
provisions.
In the opinion of management, the Company has recorded, through the
Consolidated Statements of Income (Loss) in current and prior years,
a liability for the amount of state taxes and interest thereon for which the
Company feels incurrence is probable as of September 30, 1996. In the event
that the assessments by the ADOR are sustained, an additional liability would
result. Although it is reasonably possible that the ultimate resolution of
such matter could result in an additional sales tax expense of up to
approximately $19 million in excess of amounts recorded, management and
outside tax counsel believe that the Company has meritorious defenses to
mitigate or eliminate the assessed amounts.
Based on the current status of the legal proceedings, the Company
believes that the ultimate resolution of such dispute will occur over a
period of two to four years. Based on consultations with counsel, the Company
believes that the resolution of this tax matter should not have a material
adverse effect on the Company's Consolidated Financial Statements.
NOTE 3. CONSOLIDATED SUBSIDIARIES
- ----------------------------------
On May 31, 1996, Valencia Energy Company, a wholly-owned subsidiary of
the Company, was merged into the Company. Effective with the merger, the
Company assumed all of the assets and liabilities of Valencia; the
responsibilities for the coal procurement, coal transportation and coal
handling services at Springerville Generating Station; and the
responsibilities as the lessee of the Springerville Coal Handling Facilities
Leases. Certain amounts previously included in Fuel and Purchased Power have
been reclassified to Capital Lease Expense, Other Operations, Maintenance and
Repairs, Depreciation and Amortization and Taxes Other Than Income Taxes on
the Company's Condensed Consolidated Statements of Income to conform to the
current year's presentation.
In May 1996, TEP Solar Energy Corporation, a wholly-owned subsidiary of
the Company, and ITN Energy Systems formed Global Solar Energy, LLC for the
purpose of development and manufacturing of photovoltaic materials. TEP
Solar has a 50% interest in Global Solar. The investment in Global Solar is
included in the Company's Condensed Consolidated Balance Sheet at September
30, 1996 under Investments and Other Property and in the Company's Condensed
Consolidated Statement of Cash Flows for the nine months ended September 30,
1996 as Investments in Joint Ventures.
In July 1996, the Company's investment subsidiaries satisfied
approximately $8.5 million of short-term debt obligations with the assignment
of certain finance receivables held by such investment subsidiaries. Upon
settlement, a provision for loss recorded against such receivables in prior
years was reversed, resulting in income of approximately $8.5 million.
NOTE 4. VOLUNTARY SEVERANCE PLAN
- ---------------------------------
In May 1996, the Company implemented a Voluntary Severance Plan (VSP).
The VSP resulted in an expense in June 1996 for termination benefits of
approximately $14 million included in Voluntary Severance Plan Expense (Gain)
on the Company's Condensed Consolidated Statement of Income. Approximately
$10 million of the termination benefits were paid in July 1996 with the
remaining benefits to be paid over the next three years. In addition, the
reduction in the workforce resulted in partial settlements and curtailments
of the Company's two pension plans in July 1996. As a result of such
settlements and curtailments, in the third quarter of 1996 the Company
recognized a gain of approximately $3.7 million due to the reduction of the
projected benefit obligation associated with severed employees' pension
benefits. This gain is included in Voluntary Severance Plan Expense (Gain)
on the Company's Condensed Consolidated Statement of Income.
NOTE 5. COMMON STOCK REVERSE SPLIT
- -----------------------------------
In May 1996, Shareholders approved a one-for-five reverse split of the
Company's common stock. All references in the financial statements to
average number of shares and per share amounts of the Common Stock have been
retroactively restated to reflect the reverse split. In addition,
Shareholders also approved the reduction in the number of authorized shares
of Common Stock from 200 million to 75 million.
NOTE 6. INCOME TAXES
- ---------------------
The benefit for income taxes included in the Comparative Condensed
Consolidated Statements of Income consists of the following:
Three Months Ended
September 30,
1996 1995
---------- ----------
- Thousands of Dollars -
Operating Expenses:
Deferred Tax Benefit (Expense)
Federal $ (13,785)
State (3,552)
---------- ----------
Total (17,337)
Investment Tax Credit Amortization 15 $ 23
---------- ----------
Total Benefit (Expense) Included in
Operating Expenses (17,322) 23
---------- ----------
Other Income:
Deferred Tax Benefit (Expense)
Federal (3,760) -
State (978) -
---------- ----------
Total (4,738) -
Reduction in Valuation Allowance 70,283 -
Investment Tax Credit Amortization 965 1,212
---------- ----------
Total Benefit Included in
Other Income 66,510 1,212
---------- ----------
Total Benefit for Federal and State
Income Taxes $ 49,188 $ 1,235
========== ==========
Nine Months Ended
September 30,
1996 1995
---------- ----------
- Thousands of Dollars -
Operating Expenses:
Deferred Tax Benefit (Expense)
Federal $ (10,320)
State (2,659)
---------- ----------
Total (12,979)
Investment Tax Credit Amortization 45 $ 68
---------- ----------
Total Benefit (Expense) Included in
Operating Expenses (12,934) 68
---------- ----------
Other Income:
Deferred Tax Benefit (Expense)
Federal (3,377) -
State (937) -
---------- ----------
Total (4,314) -
Reduction in Valuation Allowance 81,296 -
Investment Tax Credit Amortization 3,389 3,471
---------- ----------
Total Benefit Included in
Other Income 80,371 3,471
---------- ----------
Total Benefit for Federal and State
Income Taxes $ 67,437 $ 3,539
========== ==========
The recognition of $70.3 million of income tax benefit in the third
quarter of 1996 and $81.3 million of income tax benefit for the nine months
ended September 30, 1996 results from a revision in the estimated amount of
NOLs that the Company believes are likely to reduce future taxable income.
The Company recognizes benefits related to prior period NOLs based on changes
in the estimated amount of NOLs that, in the Company's judgment, are more
likely than not to be realized in the future.
The differences between income tax benefit and the amount obtained by
multiplying income before income taxes by the U.S. statutory federal income
tax rate are as follows:
Three Months Ended
September 30,
1996 1995
---------- ----------
- Thousands of Dollars -
Federal Income Tax Expense at
Statutory Rate $ (18,659) $ (20,823)
State Income Tax Expense, Net of
Federal Deduction (2,868) -
Investment Tax Credit Amortization 980 1,235
Reduction in Valuation Allowance 70,283 -
Net Operating Loss Carryforwards - 20,823
Other (548) -
---------- ----------
Total Benefit for Federal and
State Income Taxes $ 49,188 $ 1,235
========== ==========
Nine Months Ended
September 30,
1996 1995
---------- ----------
- Thousands of Dollars -
Federal Income Tax Expense at
Statutory Rate $ (16,019) $ (15,835)
State Income Tax Expense, Net of
Federal Deduction (2,462) -
Investment Tax Credit Amortization 3,434 3,539
Reduction in Valuation Allowance 81,296 -
Net Operating Loss Carryforwards - 15,835
Use of Capital Loss Carryforwards 1,663 -
Other (475) -
---------- ----------
Total Benefit for Federal and
State Income Taxes $ 67,437 $ 3,539
========== ==========
NOTE 7. RECLASSIFICATION
- -------------------------
Minor reclassifications, other than those described in Note 3, have been
made to the prior year financial statements to conform to the current year's
presentation.
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following contains information regarding the results of the Company's
operations during the third quarter and first nine months of 1996 compared with
the third quarter and first nine months of 1995, the outlook for dividends on
Common Stock, and changes in liquidity and capital resources of the Company
during the third quarter and first nine months of 1996. Also management's
expectations of identifiable material trends are discussed.
OVERVIEW
Earnings for the Company improved significantly during the third quarter
and first nine months of 1996 relative to the same periods in 1995. Net income
for the third quarter improved to $102.5 million, a 69% increase over the $60.7
million in net income recorded for the third quarter of 1995. Net income during
the first nine months of 1996 also increased to $113.2 million from $48.8
million for the same period in 1995. As described below, several items
recorded during 1995 and 1996 had a one-time effect on earnings. In addition,
net income for the third quarter and first nine months of 1996 was affected by
the recognition of substantial non-cash tax benefits. Due to continuing
improvement in the Company's profitability, the Company recognized non-cash tax
benefits associated with the expected future utilization of federal and state
net operating loss carryforwards generated in prior periods. Such recognized
benefits totaled $70.3 million for the third quarter of 1996 and $81.3 million
for the first nine months of 1996. See Results of Utility Operations,
Income Taxes below. Based on the net income recorded for the first nine
months of 1996, the Company ended the third quarter of 1996 with common
stock equity of $125.6 million, compared to a balance of $12.5 million as of
December 31, 1995.
Items having a one-time effect on earnings during the third quarter of 1996
include a $9.2 million charge related to a court ruling on contested sales tax
assessments, a $3.7 million reduction in pension expense related to
implementation of the Company's Voluntary Severance Plan (VSP), and income of
$9.5 million attributable to the settlement of claims and property tax refunds
involving the Company's investment subsidiaries. See Notes 2, 3, and 4 of
Notes to Condensed Consolidated Financial Statements for information
pertaining to these items. In addition to these items, net income for the
first nine months of 1996 was affected by a one-time second quarter charge
of $14.0 million related to the VSP. The Company also recorded a one-time
$12.2 million reduction to fuel and purchased power expense in the third
quarter of 1995 due to the satisfaction of certain fuel contract provisions.
Net income for the first nine months of 1995 was also affected by a one-time
gain of $3.0 million related to sales of securities by the investment
subsidiaries. Excluding each of these one-time items from the periods in which
they were recorded, the Company's income before income taxes increased to $49.5
million during the third quarter of 1996 from $47.2 million during the same
period in 1995. Excluding the effects of these same one-time items, the
Company's income before income taxes increased to $56.0 million during the first
nine months of 1996 from $30.0 million during the same period in 1995. This
improvement in adjusted pre-tax income is attributable, among other things, to
growth in the number of customers in the Company's retail service area,
increased revenues from a 1.1% retail rate increase implemented in March 1996,
and reductions in both operating and capital costs.
Despite such improvements, the Company's financial prospects continue to be
subject to significant economic, regulatory and other uncertainties, some of
which are beyond the Company's control. These uncertainties include the degree
of utilization of generation capacity through either retail electric service or
wholesale sales and the extent to which the Company, due to continued high
financial and operating leverage, can alter operations and reduce costs in
response to unanticipated economic downturns or industry changes. The Company's
success will depend, in part, on the Company's ability to contain the costs of
serving retail customers and the level of sales to such customers. Although the
Company anticipates continued growth in sales over the next five years primarily
as a result of anticipated population and economic growth in the Tucson area, a
number of factors such as changes in the economic and regulatory environment and
the increasingly competitive electric markets could affect the Company's levels
of sales.
The Company is developing strategies to address the uncertainties discussed
above as well as to position itself to benefit from the changing regulatory
environment. Such strategies include the implementation of enhanced cost
measurement and management techniques, organizational realignment and staffing
reductions, and the development of new entities to provide energy services to
markets beyond the Company's retail service territory. See Note 4 of Notes
to Condensed Consolidated Financial Statements, Voluntary Severance Plan,
and Investments in Energy-Related Ventures below.
If the Company is unable to make sales at prices adequate to recover its
costs or if for other reasons the Company fails to maintain or improve its cash
flows, the Company's ability to meet its obligations may be jeopardized. During
the period 1999-2003, approximately $250 million of the Company's long-term debt
obligations will mature. Letters of credit supporting $805 million of the
Company's long-term variable rate debt obligations are also scheduled to expire
during the period 1999-2002. Should the credit ratings on the Company's senior
debt securities reach investment grade levels on certain dates or during certain
periods subsequent to January 1, 1997, the expiration dates for such letters of
credit would move forward to the period 1997-2000. In the event that expiring
letters of credit are not replaced or extended, the corresponding variable rate
debt obligations would be subject to mandatory redemption. In addition, the
Company's borrowings under the Renewable Term Loan, which totaled $31 million as
of October 22, 1996, are scheduled to be repaid during the period 1997-1999.
While the Company intends to pay or refinance maturing bonds and bank loans, and
to replace or extend expiring letters of credit, there can be no assurance that
the Company will be able to pay such debt or replace or extend such letters of
credit. The Company's future cash flows will also be affected by the level of
interest rates due to the significant amount of variable rate debt outstanding.
See Liquidity and Capital Resources below.
The Company's capital structure is highly leveraged and the Company's
ability to raise capital (through either public or private financings) is
limited. The Company's ability to obtain debt financing is limited due to the
restrictive covenants contained in existing obligations to creditors. To the
extent the Company refinances its debt obligations in order to repay them when
due, such refinancing may be made on terms which may be adverse to the Company.
Such terms could include, among other things, higher interest rates and various
restrictive covenants, such as dividend payment restrictions. Access to equity
capital may be limited because of the Company's present inability to pay
dividends. See Dividends on Common Stock below.
During the next twelve months, the Company expects to be able to fund
continuing operating activities and construction expenditures with internal cash
flows, existing cash balances, and, if necessary, drawdowns under the Renewable
Term Loan and/or borrowings under the Revolving Credit. As discussed in
Liquidity and Capital Resources below, there are a variety of factors that
could cause actual cash flows to differ materially from projected cash flows.
Cash balances are invested in investment grade, money-market securities with an
emphasis on preserving the principal amount invested.
COMPETITION
WHOLESALE
The Company competes with other utilities, marketers and independent power
producers in the sale of electric capacity and energy in the wholesale market.
The Company's rates for wholesale sales of capacity and energy, generally, are
not permitted to exceed rates determined on a cost of service basis. In the
current market, wholesale prices are substantially below costs determined on a
fully allocated cost of service basis, but, in all instances, wholesale sales
have been made at prices which exceed the level necessary to recover fuel and
other variable costs. It is expected that competition to sell capacity will
remain vigorous, and that prices will remain depressed for at least the next
several years, due to increased competition and surplus capacity in the
southwestern United States. Competition for the sale of capacity and energy is
influenced by many factors, including the availability of capacity in the
southwestern United States, the availability and prices of natural gas and oil,
spot energy prices and transmission access. In addition, the Energy Act has
promoted increased competition in the wholesale electric power markets by
encouraging the participation of utility affiliates, independent power producers
and other non-utility participants in the development of power generation. The
Energy Act also confers expanded authority upon FERC to issue orders requiring
electric utilities to transmit power and energy to or for wholesale purchasers
and sellers, and to require electric utilities to enlarge or construct
additional transmission capacity to provide these services.
The FERC issued two orders pertaining to transmission access on April 24,
1996. FERC Order No. 888, among other things, requires all public utilities
that own, control, or operate interstate transmission facilities to offer
transmission service to others under a single tariff that incorporates certain
minimum terms and conditions of transmission service established by the FERC.
This tariff must also be used by public utilities for their own wholesale market
transactions. Transmission and generation services for new wholesale service
are to be unbundled and priced separately. A Phase I open access tariff
containing the terms and conditions outlined in the Order was filed by the
Company on July 9, 1996. The FERC has scheduled a hearing on the Company's
Phase I open access tariff for May 1997. A settlement conference on this matter
has also been scheduled for November 6, 1996.
FERC Order Number 889 requires transmission service providers to establish
or participate in an open access same-time information system (OASIS) that
provides information on the availability of transmission capacity to wholesale
market participants. The order also establishes standards of conduct that are
designed to prevent employees of a public utility engaged in marketing functions
from obtaining preferential access to OASIS-related information or from engaging
in unduly discriminatory business practices. As such, public utilities will be
required to completely separate their wholesale power marketing and transmission
operation functions. Compliance with these rules is required by January 3,
1997.
Given the intense level of competition already present in the wholesale
market for electricity, the Company does not believe that Order Number 888 or
Order Number 889 will have a material effect on the Company's future results of
operations. However, these orders could assume greater significance if the
Company's retail service territory were to be opened to competing suppliers of
electricity.
RETAIL
Under current law, the Company is not in direct competition with any other
regulated electric utility for electric service in the Company's retail service
territory. However, the Company does compete against gas service suppliers and
others who may provide energy services which would be substitutes for, or bypass
of, the Company's services. In addition, the ACC is considering a proposed rule
that, if adopted, would phase-in retail electric competition in Arizona over a
four year period beginning January 1, 1999.
Electric energy for meeting retail customers' needs primarily competes with
natural gas, an alternative fuel source for certain retail energy uses. Such
uses may include heating, cooling and a limited number of other energy
applications. In most applications, electric energy is a cost effective source
of energy compared with natural gas. Also, customers, particularly industrial
and large commercial customers, may own and operate facilities to generate their
own electric energy requirements and, if such facilities are qualifying
facilities, to require the displaced electric utility to purchase the output of
such facilities at "avoided costs" pursuant to PURPA. Such facilities may be
operated by the customers themselves or by other entities engaged for such
purpose.
The Company actively markets energy and customized energy-related services
to meet customer needs. The Company has to date lost no customers to self-
generation in part because of such efforts. For example, the Company's two
mining customers, which provide approximately 10% of the Company's total annual
revenues from retail customers, each have considered self-generation. However,
following negotiations with the Company in 1993 and 1994, new contracts were
executed that included, among other things, rate reductions and term extensions.
These contracts expire after the year 2000, subject to various provisions
allowing the customers to terminate partially or entirely, under certain
circumstances upon at least one and up to two years prior notice. To date, no
such notice has been received. The ability to enter into or extend contracts,
to avoid early termination, and to retain customers will be dependent on, among
other things, the Company's ability to contain its costs, market conditions and
alternatives available to customers.
On October 9, 1996, the ACC voted to publish a Notice of Proposed
Rulemaking (NOPR) and to establish a procedural schedule for the consideration
of a proposed rule on retail electric competition. The proposed rule, if
ultimately adopted by the ACC, would open up the service territory of each
"Affected Utility" to competing electric service providers on a phased-in basis
over the period 1999 to 2003. Beginning no later than January 1, 1999, retail
customers representing at least 20% of each Affected Utility's 1995 peak demand
would be eligible to choose their electric service provider from companies
certificated by the ACC. Beginning no later than January 1, 2001, retail
customers representing at least 50% of each Affected Utility's 1995 peak demand
would be eligible to choose their service provider. All remaining retail
customers would then be eligible to choose from certificated service providers
by January 1, 2003. Under the proposed rule, Affected Utilities would be
required to provide distribution wheeling services (i.e., retail wheeling) at
rates approved by the ACC in order to facilitate sales by competing service
providers.
The Affected Utilities whose service territories would be open to competing
service providers under the proposed rule include Tucson Electric Power Company,
Arizona Public Service Company, Citizens Utilities Company, and several electric
cooperatives. However, electric cooperatives would be permitted to request a
modification to the proposed phase-in schedule in order to preserve their tax
exempt status or to modify power supply arrangements and related loan
agreements. Each of the Affected Utilities would be eligible to offer electric
service to customers of other certificated entities within Arizona.
Participation in competitive retail markets by other electric utilities which
are not regulated by the ACC, such as the Salt River Project and certain
municipal utilities, would be permitted under the proposed rule on a similar
reciprocal basis (i.e., their service territories would be similarly open to
competing service providers). However, such participation would likely require
action by the Arizona legislature.
The proposed rule specifies that the ACC shall allow the recovery of
unmitigated stranded costs by Affected Utilities. Stranded cost is defined in
the proposed rule as the net difference between the value of prudent
jurisdictional assets and obligations under traditional regulation and the
market value of those assets and obligations in a competitive retail market. In
order to recover stranded costs, utilities would have to demonstrate to the ACC
that they have taken every feasible, cost effective measure to mitigate or
offset stranded costs, and utilities would have to file estimates of unmitigated
stranded costs with the ACC which are fully supported by analyses and records of
market transactions undertaken by willing buyers and sellers. Furthermore,
Affected Utilities would have to seek ACC approval of distribution charges or
other means of recovering unmitigated stranded costs from customers who reduce
or terminate service as a direct result of retail competition. The proposed
rule specifies that other issues related to the analysis and recovery of
stranded costs would be examined by a working group following adoption of the
proposed rule. Until such time as the ACC adopts specific guidelines for
quantifying unmitigated stranded costs, including the methods used to identify
and value jurisdictional assets and obligations, the Company believes that any
estimate of unmitigated stranded costs would be highly speculative.
Should the rule become effective in its present form, each Affected Utility
would be required to file unbundled service tariffs with the ACC by December 31,
1997, for the following services: distribution wheeling service, metering and
meter reading services, billing and collection services, open access
transmission service (as approved by the Federal Energy Regulatory Commission,
if applicable), ancillary services (as defined by the Federal Regulatory Energy
Commission in Order No. 888), information services such as the provision of
customer information to other service providers, and other ancillary services
necessary for safe and reliable system operation. Until such time as the ACC
determines that retail competition has been substantially implemented, each
Affected Utility would also have to provide standard offer bundled service
equivalent to the services currently being provided at regulated rates to all
consumers located in their current retail service areas.
The proposed rule envisions that new market entrants would be required to
obtain a certificate of convenience and necessity from the ACC prior to offering
retail electric service. New market entrants would be required to demonstrate
adequate technical and financial capabilities to the ACC prior to certification.
In addition, all competitive market participants, including Affected Utilities,
would be required to obtain at least one-half of one percent of the energy sold
competitively in the Arizona retail market from new solar generating resources
by January 1, 1999. This required percentage would increase to one percent on
January 1, 2002. New solar resources are defined under the proposed rule as
photovoltaic or solar thermal resources that are installed on or after January
1, 1997.
Under the proposed rule, certain issues pertaining to retail electric
competition would be addressed by the ACC in workshops or proceedings to be held
after adoption of the rule. Such issues include the guidelines to be used for
stranded cost quantification and recovery, the possible formation of an
independent system operator for electrical transmission facilities, issues
related to system reliability and safety, and the methods to be used in
determining consumer participation during the early phase-in periods.
The proposed rule is subject to public comment and approval by the ACC
prior to becoming effective. In comments filed with the ACC on an earlier draft
version of the proposed rule, the Company stated its belief that major
financial, legal, operational, pricing, and reliability issues were not
adequately addressed by the draft rule. The Company plans to file written
comments with the ACC on the proposed rule after publication of the NOPR. The
Company also plans to participate in the oral proceedings scheduled for December
2, 3, and 4, 1996. At the present time the Company is unable to predict the
effect such a proposed rule would have, if adopted, on the Company's future
results of operations.
The Arizona legislature is also investigating the potential merits of
retail electric competition. Legislation has been passed which calls for the
establishment of a joint legislative study committee on electric industry
competition. This committee is charged with studying and making recommendations
on a wide variety of issues related to electric industry competition. The
committee is to complete a report to the legislature no later than December 31,
1997. Such report is to contain a proposal for electric utility competition for
implementation by December 31, 1999. An advisory committee on electric industry
competition was also created, consisting of members representing electric
consumers, electric utilities, various State offices and agencies, and other
interested parties. The Company has a representative on such advisory committee
and intends to actively participate as a committee member.
The Company continues to assess the likely impact of the ACC's proposed
rule on retail competition, FERC Order Nos. 888 and 889, the Energy Act, and
other possible legislation on the Company. The Company is unable to predict the
ultimate impact of increased wholesale and retail competition on the Company's
future results of operations.
ACCOUNTING FOR THE EFFECTS OF REGULATION
The Company prepares its financial statements in accordance with the
provisions of FAS 71. This statement requires a cost-based rate-regulated
utility to reflect the effect of regulatory decisions in its financial
statements. In certain circumstances, FAS 71 requires that certain costs and/or
obligations be reflected in a deferral account in the balance sheet and not be
reflected in the statement of income or loss until matching revenues are
recognized. Therefore, the Company's Condensed Consolidated Balance Sheets at
September 30, 1996, and at December 31, 1995, contain certain line items (for
example, Deferred Debits - Regulatory Assets and MSR Option Gain Regulatory
Liability, Accumulated Deferred Investment Tax Credits Regulatory Liability, and
Other Regulatory Liabilities) solely as a result of the application of FAS 71.
In addition, a number of line items in the Company's Condensed Consolidated
Statements of Income for the quarters ended September 30, 1996 and 1995, and the
nine months ended September 30, 1996 and 1995, also reflect the application of
FAS 71.
If at some point in the future the Company determines that all or a portion
of the Company's regulated operations no longer meet the criteria for continued
application of FAS 71, the Company would be required to adopt the provisions of
FAS 101 for that portion of the operations for which FAS 71 no longer applied.
Adoption of FAS 101 would require the Company to write off its regulatory assets
and liabilities as of the date of adoption of FAS 101 and would preclude the
future deferral in the balance sheet of costs not recovered through rates at the
time such costs were incurred, even if such costs were expected to be recovered
in the future. Based on the balances of the Company's regulatory assets and
liabilities as of September 30, 1996, the Company estimates that future adoption
of FAS 101 for all of the Company's regulated operations would result in an
extraordinary loss of $139 million, which includes a reduction for the related
deferred income taxes of $68 million. The Company's cash flows would not be
affected by the adoption of FAS 101.
At the present time, the Company recovers the costs of its plant assets
through its regulated revenues. If in the future the Company discontinues
accounting according to the provisions of FAS 71, the Company would also need to
consider whether the markets in which the Company is then selling power will
allow the Company to recover the costs of its plant assets. If at that time
market prices are not expected to allow the Company to recover the costs of its
plant assets, additional write-downs may be required in accordance with the
provisions of FAS 121. The Company is presently unable to predict the amounts,
if any, of any potential future write-downs attributable to the provisions of
FAS 121 under such circumstances.
INVESTMENTS IN ENERGY-RELATED VENTURES
The Company continues to evaluate and pursue energy-related investment
opportunities through its wholly-owned subsidiaries Nations Energy Corporation
(Nations Energy), TEP Solar Energy Corporation (TEP Solar) and SWPP Investment
Company (SWPP). In addition, the Company has a currently exercisable option to
purchase for a nominal amount a 50% interest in New Energy Ventures, Inc. (NEV),
a buyer's agent providing load aggregation and advisory services to energy
consumers primarily in the State of California.
On August 27, 1996, NEV announced that it had reached an agreement with the
Bonneville Power Administration (BPA) to purchase 200 MW of surplus firm
capacity for a five year period beginning January 1, 1998. In addition, NEV
also obtained an option to purchase an additional 200 MW of firm capacity from
BPA for a five year period beginning from the time such option is exercised.
Through a companion agreement, NEV also agreed to purchase seasonal economy
power from BPA. These agreements were reached by NEV in anticipation of making
future sales of electric capacity and energy to clients. Retail electric
competition is presently scheduled to be introduced in California on a phased-in
basis beginning on or before January 1, 1998.
DIVIDENDS ON COMMON STOCK
The Company is precluded by restrictive covenants in certain debt
agreements from declaring or paying dividends. No dividend on Common Stock has
been declared or paid since 1989.
Under the applicable provisions of amendments to the Arizona General
Corporation Law, in effect starting in 1996, a company is permitted to make
distributions to shareholders unless, after giving effect to such distribution,
either (i) the company would not be able to pay its debts as they come due in
the usual course of business, or (ii) the company's total assets would be less
than the sum of its total liabilities plus the amount necessary to satisfy any
liquidation preferences of shareholders with preferential rights. Under such
provisions, the Company is currently able to declare and pay a dividend.
The Company's ability to pay a dividend is restricted, however, by certain
covenants of the General First Mortgage applicable so long as certain series of
First Mortgage Bonds (aggregating $184 million in principal amount) are
outstanding. These covenants restrict the payment of dividends on Common Stock
if certain cash flow coverage and retained earnings tests are not met. The cash
flow coverage test would prevent the Company from paying dividends on its Common
Stock until such time as the Company's cash flow coverage ratio, as defined
therein, is greater or equal to a ratio of 2 to 1, and the retained earnings
test would permit dividend payments if the Company has positive retained
earnings rather than an accumulated deficit. As of September 30, 1996, the
Company had a cash flow coverage ratio in excess of 2 to 1 and the Company's
accumulated deficit was $513 million. Such covenants will remain in effect
until the First Mortgage Bonds of such series have been paid or redeemed. The
latest maturity of such First Mortgage Bonds is in 2003.
The MRA contains a similar dividend restriction based on the amount of
retained earnings. Such restriction will no longer apply if (i) the Renewable
Term Loan and the Revolving Credit have been paid in full and the commitments
relating thereto have been terminated and (ii) the Company's senior long-term
debt is rated investment grade. At October 22, 1996, the Company's total
outstanding amount under the Renewable Term Loan was $31 million, and to date no
amounts have been borrowed under the Revolving Credit. Commitments relating to
such facilities permit the Company to borrow an additional $133 million under
the Renewable Term Loan and $50 million under the Revolving Credit. Also, the
Company's senior debt is currently rated below investment grade.
In order for the Company to pay a dividend when such covenants would
otherwise restrict such payment, the Company would have to (i) obtain a waiver
or an amendment to the MRA's retained earnings covenant and (ii) redeem all
outstanding First Mortgage Bonds of the series that contain dividend
restrictions or amend the General First Mortgage. Such General First Mortgage
amendment would require approval by holders of 75% of all First Mortgage Bonds.
In addition to such restrictive covenants, the Company may also be
restricted under the Federal Power Act from paying dividends from funds properly
included in capital account. The provisions of the Federal Power Act leave
unclear the scope of any such restriction and its potential applicability to the
Company.
EARNINGS
The Company recorded net income of $102.5 million in the third quarter of
1996 compared with net income of $60.7 million in the third quarter of 1995.
The net income per average share of Common Stock was $3.19 for the third quarter
of 1996 compared with net income per average share of Common Stock of $1.89 for
the third quarter of 1995.
For the first nine months of 1996, the Company recorded net income of
$113.2 million, compared with net income of $48.8 million recorded for the first
nine months of 1995. The net income per average share of Common Stock was $3.52
for the first nine months of 1996, compared with net income per average share of
Common Stock of $1.52 for the first nine months of 1995.
RESULTS OF OPERATIONS
RESULTS OF UTILITY OPERATIONS
SALES AND REVENUES
Comparisons of kilowatt-hour sales and electric revenues are shown below:
Increase/(Decrease)
Three Months Ended September 30 1996 1995 Amount Percent
Electric kWh Sales (000):
Retail Customers 2,240,499 2,232,633 7,866 0.4%
Sales for Resale 836,721 633,391 203,330 32.1
Total 3,077,220 2,866,024 211,196 7.4
Electric Revenues (000):
Retail Customers $195,261 $192,929 $ 2,332 1.2%
Amortization of MSR Option
Gain Regulatory Liability 5,014 5,014 - -
Sales for Resale 22,803 19,844 2,959 14.9
Total $223,078 $217,787 $ 5,291 2.4
Increase/(Decrease)
Nine Months Ended September 30 1996 1995 Amount Percent
Electric kWh Sales (000):
Retail Customers 5,718,042 5,401,473 316,569 5.9%
Sales for Resale 2,231,072 1,651,537 579,535 35.1
Total 7,949,114 7,053,010 896,104 12.7
Electric Revenues (000):
Retail Customers $482,511 $451,124 $ 31,387 7.0%
Amortization of MSR Option
Gain Regulatory Liability 15,040 15,040 - -
Sales for Resale 58,088 56,673 1,415 2.5
Total $555,639 $522,837 $ 32,802 6.3
KWh sales to retail customers increased by 0.4% in the third quarter of
1996 compared with the third quarter of 1995. Despite a 2.9% increase in the
average number of retail customers, retail kWh sales remained nearly unchanged
due to milder temperatures in the third quarter of 1996 compared to the same
period in 1995. KWh sales to retail customers increased by 5.9% in the first
nine months of 1996 compared with the same period in 1995. Sales were higher in
the first nine months of 1996 due to warmer weather conditions in the second
quarter, growth in the average number of retail customers, and a 6.6% increase
in sales to industrial customers. Based on cooling degree days, a commonly used
measure in the electric industry that is calculated by subtracting 75 from the
average of the high and low daily temperatures, the Tucson area registered a
decrease of approximately 17% in such cooling degree days for the third quarter
of 1996 compared with the same period in 1995, and a decrease of approximately
9% in such cooling degree days compared with the ten year average for the same
period from 1986 to 1995. Such cooling degree days were 862, 1,040, and 949 for
the third quarter of 1996, 1995, and the ten year average for the third quarter,
respectively.
Revenues from sales to retail customers increased in the third quarter and
first nine months of 1996 compared with the same periods in 1995 due to higher
kWh sales discussed above and a 1.1% retail rate increase implemented by the
Company on March 31, 1996. See Note 1 of Notes to Condensed Consolidated
Financial Statements, Rate Matters.
Sales for resale increased by 32.1% in the third quarter of 1996 relative
to the same period in 1995 due primarily to increased power sales to California
from the Southwestern United States. This increase in regional sales occurred
due to a reduction in power transfer capability between the Pacific Northwest
and California. A reduction in power transfer capability was imposed by the
Western Systems Coordinating Council due to transmission system disturbances
experienced in July and August of 1996. Since the system disturbances and
subsequent derating of transmission lines occurred during a period of heavy
electrical demand in California, power sales to California from the Southwestern
United States were higher than normal during the third quarter of 1996. Sales
for resale increased by 35.1% in the first nine months of 1996 compared with the
same period in 1995 due to higher third quarter sales, warmer weather conditions
during the second quarter of 1996, and the availability of generating capacity
which had been out of service in early 1995 for planned maintenance activities.
Higher natural gas prices during the third quarter and first nine months of 1996
also contributed to increased sales of surplus coal-fired energy in the
wholesale market.
Revenues from sales for resale were 14.9% higher in the third quarter and
2.5% higher in the first nine months of 1996 relative to the same periods in
1995. Such revenues did not increase proportionately with the increase in kWh
sales during these periods due to the expiration of a firm power sale agreement
with Nevada Power Company in December 1995. In addition, lower priced economy
energy sales represented a higher percentage of total wholesale kWh sales during
the first nine months of 1996 relative to the same period in 1995.
OPERATING EXPENSES
Total Fuel and Purchased Power expense increased in the third quarter and
first nine months of 1996 compared with the same periods in 1995 due to
increased kWh sales and a one-time $12.2 million reduction to fuel expense
recorded in the third quarter of 1995. This one-time non-cash reduction to fuel
expense was related to the satisfaction of certain fuel contract provisions.
Taxes Other Than Income Taxes increased in the third quarter and first nine
months of 1996 compared with the same periods in 1995 due to a charge of $7.3
million in the third quarter of 1996 related to a court ruling on contested
sales tax assessments. See Note 2 of Notes to Condensed Consolidated
Financial Statements, Tax Assessments.
Voluntary Severance Plan Expense (Gain) for the third quarter of 1996
reflected a net gain of $3.4 million. This net gain was comprised of a $3.7
million benefit reflecting curtailments and settlements of pension liabilities
related to the VSP, as well as additional charges of $0.3 million related to the
VSP. During the first nine months of 1996, a net expense of $10.6 million was
recorded to reflect the Company's implementation of the VSP. See Note 4 of
Notes to Condensed Consolidated Financial Statements, Voluntary Severance Plan.
Income Taxes expense included in Operating Expenses increased to $17.3
million in the third quarter of 1996, compared with a $23,000 benefit recorded
29
in the third quarter of 1995. For the first nine months of 1996, income tax
expense increased to $12.9 million relative to a $68,000 benefit recorded for
the same period in 1995. See Income Taxes below and Note 6 of Notes to
Condensed Consolidated Financial Statements, Income Taxes.
OTHER INCOME
Income Tax benefits included in Other Income increased in the third quarter
of 1996 to $66.5 million, compared with a $1.2 million benefit recorded in the
third quarter of 1995. For the first nine months of 1996, Income Tax benefits
included in Other Income increased to $80.4 million, compared with a benefit of
$3.5 million recorded for the same period in 1995. See Income Taxes below
and Note 6 of Notes to Condensed Consolidated Financial Statements, Income
Taxes.
A Reversal of Loss Provision in the amount of $8.5 million was recorded in
the third quarter of 1996. The reversal of loss provision relates to the
satisfaction by the Company's investment subsidiaries of approximately $8.5
million of short-term debt obligations through the assignment of certain finance
receivables held by such investment subsidiaries. See Note 3 of Notes to
Condensed Consolidated Financial Statements, Consolidated Subsidiaries.
INTEREST EXPENSE
Interest expense on long-term debt decreased in the third quarter and first
nine months of 1996 relative to the same periods in 1995 due to a reduction in
the aggregate amount of debt outstanding and due to lower interest rates on the
Company's variable rate debt obligations. The weighted average interest rate on
the Company's tax exempt variable rate debt obligations was 3.5% for the first
nine months of 1996 compared with 3.9 percent for the same period in 1995.
INCOME TAXES
Net income tax benefits increased $48 million in the third quarter of 1996
compared with the third quarter of 1995 due primarily to the recognition of
$70.3 million, or $2.19 per average share of Common Stock, of income tax
benefits related to the expected future utilization of federal and state NOLs
generated in prior periods. The Company believes it is more likely than not that
such NOLs will be used in the future to reduce income taxes payable. The $70.3
million benefit is partially offset by income tax expense related to the
operating results for the third quarter of 1996.
Net income tax benefits increased $63.9 million for the nine months ended
September 30, 1996 compared with the same period in 1995 due primarily to the
recognition of $81.3 million of income tax benefits related to the expected
future utilization of NOLs, partially offset by the recognition of income tax
expense related to the operating results for the nine months ended September 30,
1996.
The recognition of the $70.3 million benefit in the third quarter of 1996
and the $81.3 million benefit for the nine months ended September 30, 1996
results from a revision in the estimated amount of NOLs that the Company
believes are likely to reduce future taxable income. The Company recognizes
benefits related to prior period NOLs based on changes in the estimated amount
of NOLs that, in the Company's judgment, are more likely than not to be realized
in the future. A significant factor, among others, considered in estimating
such amount is the three year historical average book income before income
taxes.
If the Company's operating results continue to improve, the three year
historical average net book income would continue to increase. Correspondingly,
the Company would likely recognize NOL and ITC carryforward benefits totaling up
to approximately $70 million over the next two years relating to the remaining
unrecognized balance of prior period NOLs at September 30, 1996. The amount of
NOL and ITC benefits recognized in periods subsequent to the third quarter of
1996, if any, and the timeframe in which such benefits are recognized, may vary
significantly from the estimates described in this paragraph. In addition, in
future periods when such NOLs are utilized to offset taxable income, income tax
expense shown on the Company's Consolidated Statements of Income
(Loss) will not be reduced to reflect such utilization.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to generate sufficient cash flows during 1996 to fund
its continuing operating activities and construction expenditures. However, the
Company's projected cash flows are subject to variation due to changes in
wholesale revenues, changes in short-term interest rates, and other factors.
For example, an increase in short-term interest rates of 100 basis points (1%)
would result in an approximate $10 million increase in annual interest payments.
If cash flows were to fall short of expectations, the Company would rely on
existing cash balances, borrowings under the Renewable Term Loan and, if
necessary, borrowings under the Revolving Credit.
At October 22, 1996, the Company had a loan balance of $31 million
outstanding under the Renewable Term Loan, and to date, no amount has been
borrowed under the Revolving Credit. The Renewable Term Loan commitment and the
Revolving Credit commitment were $164 million and $50 million, respectively.
The Company's cash and cash equivalents balance at October 22, 1996 was
approximately $113 million. Cash balances are invested in investment grade
money-market securities with an emphasis on preserving the principal amounts
invested.
CASH FLOWS
The Company's cash and cash equivalents increased $39.7 million or 68%,
from the September 30, 1995 ending balance of $58.3 million to the September 30,
1996 ending balance of $98.0 million. This increase was due to the receipt of
net cash flows from continuing operating activities in excess of the net cash
flows required for investing and financing activities for the twelve month
period ended September 30, 1996.
Net cash flows from continuing operating activities increased in aggregate
by $25 million in the first nine months of 1996 compared with the same period in
1995. This increase was due primarily to an increase of $32.7 million in cash
receipts from retail customers and a $7.9 million reduction in interest paid
(net of amounts capitalized) during the first nine months of 1996 compared with
the same period in 1995, and a $14.6 million tax payment made in the first
quarter of 1995 related to an appeal of a transaction privilege tax assessment
(see Note 2 of Notes to Condensed Consolidated Financial Statements,
Tax Assessments). Also contributing to the increase in net cash flows in
the first nine months of 1996 was the receipt of $4.1 million in the first
quarter of 1996 related to the sale of emission allowances. These increases
to net cash flows were partially offset by a $3.4 million decrease in cash
receipts from wholesale customers, a $2.0 million reduction in interest
received, a $12.4 million increase in fuel and purchase power costs
paid, an $11.0 million increase in wages paid (due primarily to
implementation of the Company's Voluntary Severance Plan in the second
quarter of 1996), and the payment of $4.5 million in the second quarter
of 1996 to establish the Low Income Fund for Emergencies (LIFE), a low income
customer assistance fund required by the 1996 Rate Order.
Net cash outflows from investing activities decreased in aggregate by $11
million in the first nine months of 1996 compared with the same period in 1995.
Despite a $9.0 million increase in construction expenditures, related primarily
to the installation of sulfur dioxide emission reduction facilities at the
Navajo Generating Station, net cash outflows from investing activities decreased
due to a $5.4 million reduction in investments in energy-related ventures and
the May 1995 purchase of approximately $18 million of Springerville Unit 1 lease
debt securities.
Net cash outflows from financing activities decreased in aggregate by $166
million in the first nine months of 1996 compared with the same period in 1995
as a result of lower debt principal repayments and the receipt of loan proceeds
related to the May 1996 issuance of pollution control revenue bonds by the
Pollution Control Corporation of Coconino County, Arizona. Payments toward the
retirement of capital lease obligations increased by $19.0 million due primarily
to a scheduled $23.8 million lease payment on Irvington Unit 4 made in July
1996. Lease payments on Irvington Unit 4 totaled $28.0 million during the
first nine months of 1996, compared with $8.5 million during the same time
period in 1995. Future lease payments on Irvington Unit 4 are scheduled at $8.5
million in 1997 and approximately $13.4 million per year in 1998 and 1999.
* * *
Statements contained in Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations relating to anticipated
growth in sales (See Overview above), anticipated sources of funding for
continuing operating activities and construction expenditures (See Overview
and Liquidity and Capital Resources above), and the anticipated recognition
of NOL and ITC carryforward benefits (See Results of Utility Operations,
Income Taxes above) constitute "forward-looking statements" as defined in
the Securities Litigation Reform Act of 1995. Such forward-looking
statements involve risks and uncertainties which could cause actual
results or outcomes to differ materially from those expressed in
such forward-looking statements. The projections made herein are expressed in
good faith and believed by the Company to have a reasonable basis, but there can
be no assurance that actual outcomes or results will not differ materially from
the expected outcomes or results described herein. Important factors that could
cause actual results to differ materially from the forward-looking statements
identified in this paragraph are discussed in the above referenced sections and
accompany such forward-looking statements.
PART II - OTHER INFORMATION
ITEM 1. -- LEGAL PROCEEDINGS
TAX ASSESSMENTS
See Note 2 of Notes to Condensed Consolidated Financial Statements, Tax
Assessments.
ITEM 6. -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
15 - Letter regarding unaudited interim financial information.
35
27a - Financial Data Schedule.
27b - Financial Data Schedule.
(b) Reports on Form 8-K.
- Dated October 1, 1996, reporting on the recognition of income tax
benefits, a court ruling on contested sales tax assessments, a ruling
on New Mexico sales tax liability, and the reversal of prior period
losses.
- Dated October 11, 1996, reporting on a rule proposed by the ACC for
retail electric competition.
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.
TUCSON ELECTRIC POWER COMPANY
(Registrant)
Date: October 25, 1996 Ira R. Adler
Ira R. Adler
36
Senior Vice President and Principal
Financial Officer
EXHIBIT INDEX
15 - Letter regarding unaudited interim financial information.
27a - Financial Data Schedule.
27b - Financial Data Schedule.