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 March 31, 1997
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 1-5924
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 May 8, 1997, 32,133,345 shares of the registrant's Common Stock,
no par value (the only class of Common Stock), were outstanding.
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. Tax Assessments 5
Note 2. Income Taxes 6
Note 3. Long-Term Debt 6
Note 4. Valencia Merger 7
Note 5. Common Stock Reverse Split 7
Note 6. New Accounting Standard 7
Note 7. Reclassification 7
Item 2. -- Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview 8
Competition
Wholesale 9
Retail 9
Holding Company Proposal 12
Accounting for the Effects of Regulation 12
Dividends on Common Stock 13
Earnings 13
Results of Operations
Results of Utility Operations
Sales and Revenues 14
Operating Expenses 14
Other Income 15
Liquidity and Capital Resources 15
Cash Flows 15
Financing Developments 16
Safe Harbor for Forward-Looking Statements 16
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments 18
Item 6. -- Exhibits and Reports on Form 8-K 18
Signature Page 19
Exhibit Index 20
DEFINITIONS
The abbreviations and acronyms used in the 1997 First 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 or TEP.... Tucson Electric Power Company.
FAS 71............ Statement of Financial Accounting Standards #71:
Accounting for the Effects of Certain Types of
Regulation.
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.
IDBs.............. Industrial development revenue or pollution control bonds.
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).
LOC............... Letter of Credit.
MRA............... Master restructuring agreement between the Company and the
Banks which includes the Renewable Term Loan, Revolving
Credit and certain replacement reimbursement agreements.
MSR............... Modesto, Santa Clara and Redding Public Power Agency.
MW................ Megawatt(s).
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.
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.
SEC............... Securities and Exchange Commission.
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.
Valencia.......... Valencia Energy Company, previously a wholly-owned
subsidiary of the Company, merged into the Company on May
31, 1996.
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Tucson Electric Power Company and its Stockholders
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 March 31, 1997 and
the related condensed consolidated statements of income and of cash flows for
the three-month periods ended March 31, 1997 and 1996. 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, 1996 and the related consolidated statements of
income, cash flows, and changes in stockholders' equity (deficit) for the year
then ended (not presented herein); and in our report dated January 27, 1997, we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of December 31, 1996 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
May 2, 1997
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
The March 31 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 presentation 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
March 31,
1997 1996
-Thousands of Dollars-
Operating Revenues
Retail Customers $129,937 $125,210
Amortization of MSR Option Gain Regulatory Liability 5,013 5,013
Sales for Resale 19,331 17,805
--------- ---------
Total Operating Revenues 154,281 148,028
--------- ---------
Operating Expenses
Fuel and Purchased Power 45,646 45,824
Capital Lease Expense 26,276 25,805
Amortization of Springerville Unit 1 Allowance (7,009) (7,273)
Other Operations 26,296 24,088
Maintenance and Repairs 10,231 9,534
Depreciation and Amortization 21,774 23,753
Taxes Other Than Income Taxes 12,625 15,051
Income Taxes (2,348) (5,872)
--------- ---------
Total Operating Expenses 133,491 130,910
--------- ---------
Operating Income 20,790 17,118
--------- ---------
Other Income (Deductions)
Income Taxes 14,558 7,357
Interest Income 1,756 1,473
Other Deductions (1,010) (562)
--------- ---------
Total Other Income (Deductions) 15,304 8,268
--------- ---------
Interest Expense
Long-Term Debt - Net 14,117 14,644
Interest Imputed on Losses Recorded at Present Value 8,279 8,363
Other 2,641 2,328
Allowance for Borrowed Funds Used During Construction (435) (368)
--------- ---------
Total Interest Expense 24,602 24,967
--------- ---------
Net Income $ 11,492 $ 419
========= =========
Average Shares of Common Stock Outstanding (000) 32,135 32,134
========= =========
Net Income per Average Share $ 0.36 $ 0.01
========= =========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
1997 1996
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $142,918 $140,519
Cash Receipts from Sales for Resale 22,402 17,037
Fuel and Purchased Power Costs Paid (39,847) (39,985)
Wages Paid, Net of Amounts Capitalized (20,259) (24,824)
Payment of Other Operations and Maintenance Costs (18,876) (20,806)
Capital Lease Interest Paid (37,512) (37,838)
Interest Paid, Net of Amounts Capitalized (13,400) (13,739)
Taxes Paid, Net of Amounts Capitalized (11,121) (12,013)
Emission Allowance Inventory Sale - 4,120
Interest Received 2,262 1,890
Other 410 884
--------- ---------
Net Cash Flows - Operating Activities 26,977 15,245
--------- ---------
Cash Flows from Investing Activities
Construction Expenditures (15,602) (17,835)
Investments in Joint Ventures (1,338) -
Other 988 311
--------- ---------
Net Cash Flows - Investing Activities (15,952) (17,524)
--------- ---------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt - (10,000)
Payments on Renewable Term Loan (31,000) -
Payments to Retire Capital Lease Obligations (4,061) (4,150)
Other 383 288
--------- ---------
Net Cash Flows - Financing Activities (34,678) (13,862)
--------- ---------
Net Decrease in Cash and Cash Equivalents (23,653) (16,141)
Cash and Cash Equivalents, Beginning of Year 130,291 85,094
--------- ---------
Cash and Cash Equivalents, End of Period $106,638 $ 68,953
========= =========
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Three Months Ended
March 31,
1997 1996
-Thousands of Dollars-
Net Income $ 11,492 $ 419
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 21,774 23,753
Deferred Income Taxes and
Investment Tax Credits - Net (16,907) (13,229)
Lease Payments Deferred (8,306) (9,308)
Regulatory Amortizations, Net of Interest Imputed
on Losses Recorded at Present Value (3,743) (3,923)
Other (1,954) (353)
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable 7,534 6,929
Materials and Fuel 153 1,290
Accounts Payable 2,369 (1,656)
Taxes Accrued 11,826 14,173
Other Current Assets and Liabilities (436) (7,456)
Other Deferred Assets and Liabilities 3,175 4,606
--------- ---------
Net Cash Flows - Operating Activities $ 26,977 $ 15,245
========= =========
See Notes to Condensed Consolidated Financial Statements.
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
March 31, December 31,
1997 1996
- Thousands of Dollars -
Utility Plant
Plant in Service $2,135,620 $2,129,205
Utility Plant Under Capital Leases 893,064 893,064
Construction Work in Progress 81,705 74,210
----------- -----------
Total Utility Plant 3,110,389 3,096,479
Less Accumulated Depreciation and Amortization (938,132) (922,947)
Less Accumulated Amortization of Capital Leases (60,524) (56,240)
Less Springerville Unit 1 Allowance (164,479) (163,388)
----------- -----------
Total Utility Plant - Net 1,947,254 1,953,904
----------- -----------
Investments and Other Property 70,443 69,289
----------- -----------
Current Assets
Cash and Cash Equivalents 106,638 130,291
Accounts Receivable 58,371 65,905
Materials and Fuel 30,203 30,356
Deferred Income Taxes - Current 4,842 10,223
Other 13,766 14,026
----------- -----------
Total Current Assets 213,820 250,801
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Rates 174,955 173,731
Deferred Common Facility Costs 60,127 60,762
Deferred Springerville Unit 2 Costs 18,558 21,260
Deferred Lease Expense 14,081 15,067
Other Deferred Regulatory Assets 7,806 8,004
Deferred Debits - Other 15,813 15,723
----------- -----------
Total Deferred Debits 291,340 294,547
----------- -----------
Total Assets $2,522,857 $2,568,541
=========== ===========
CAPITALIZATION AND OTHER LIABILITIES
March 31, December 31,
1997 1996
- Thousands of Dollars -
Capitalization
Common Stock $ 645,265 $ 645,243
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (494,106) (505,598)
----------- -----------
Common Stock Equity 144,802 133,288
Capital Lease Obligations 892,570 895,867
Long-Term Debt 1,192,025 1,223,025
----------- -----------
Total Capitalization 2,229,397 2,252,180
----------- -----------
Current Liabilities
Short-Term Debt 3,567 3,567
Current Obligations Under Capital Leases 15,833 10,383
Current Maturities of Long-Term Debt 1,635 1,635
Accounts Payable 32,241 28,806
Interest Accrued 41,314 57,404
Taxes Accrued 35,833 24,007
Other 11,855 15,614
----------- -----------
Total Current Liabilities 142,278 141,416
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 76,335 96,422
Accumulated Deferred Investment Tax Credits
Regulatory Liability 14,212 15,188
MSR Option Gain Regulatory Liability 3,017 7,853
Other Regulatory Liabilities 17,585 17,596
Other 40,033 37,886
----------- -----------
Total Deferred Credits and Other Liabilities 151,182 174,945
----------- -----------
Total Capitalization and Other Liabilities $2,522,857 $2,568,541
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. 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 which was denied. On
December 10, 1996, the Company filed with the Court of Appeals a Petition for
Review by the Arizona Supreme Court of the 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. The amounts recorded by the Company included
estimates for the period June 1993 through May 1996, the period for which the
Company has not yet been assessed.
On May 31, 1996, Valencia was merged into the Company. 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. For
periods subsequent to May 31, 1996 the Company continues to record an
estimated interest expense on the above assessments.
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.
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 March 31, 1997. 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 $20 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 and
considering the amounts already accrued, 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 2. INCOME TAXES
- ---------------------
The benefit for income taxes included in the Comparative Condensed
Consolidated Statements of Income consists of the following:
Three Months Ended
March 31,
1997 1996
---------- ----------
- Thousands of Dollars -
Operating Expenses:
Deferred Tax Benefit
Federal $ 1,859 $ 4,657
State 479 1,201
---------- ----------
Total 2,338 5,858
Investment Tax Credit Amortization 10 14
---------- ----------
Total Benefit Included in
Operating Expenses 2,348 5,872
---------- ----------
Other Income (Deductions):
Deferred Tax (Expense) Benefit
Federal (577) 1,030
State (149) 265
---------- ----------
Total (726) 1,295
Reduction in Valuation Allowance 14,318 4,849
Investment Tax Credit Amortization 966 1,213
---------- ----------
Total Benefit Included in
Other Income (Deductions) 14,558 7,357
---------- ----------
Total Benefit for Federal and State
Income Taxes $ 16,906 $ 13,229
========== ==========
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
March 31,
1997 1996
---------- ----------
- Thousands of Dollars -
Federal Income Tax Benefit at
Statutory Rate $ 1,895 $ 4,484
State Income Tax Benefit, Net of
Federal Deduction 291 690
Investment Tax Credit Amortization 976 1,227
Reduction in Valuation Allowance 14,318 4,849
Use of Capital Loss Carryforwards - 1,663
Other (574) 316
---------- ----------
Total Benefit for Federal and
State Income Taxes $ 16,906 $ 13,229
========== ==========
NOTE 3. LONG-TERM DEBT
- -----------------------
In February 1997, the Company repaid the outstanding Renewable Term Loan
balance of $31 million thereby reducing its Long-Term Debt. At April 30,
1997, the Company had $140 million available for borrowing under the
Renewable Term Loan.
In April 1997, the City of Farmington, New Mexico issued $80.4 million
of Pollution Control Revenue Bonds for the benefit of the Company. The
proceeds will be used in June 1997 to redeem $47.9 million principal amount
of previously issued 6.25% bonds that mature in 2003 and $32.5 million
principal amount of previously issued 6.10% bonds that mature in 2007. The
new bonds, which are unsecured, bear interest at 6.95% and mature in 2020.
In April 1997, the Coconino County, Arizona Pollution Control
Corporation issued $36.7 million of Pollution Control Revenue Bonds for the
benefit of the Company. The net proceeds loaned to the Company will be used
to fund $20 million of construction costs of additional pollution abatement
facilities at Navajo Generating Station and to redeem, in June 1997, $16.7
million principal amount of previously issued variable rate bonds that mature
in 2031. The new bonds, which are unsecured, bear interest at 7.125% and
mature in 2032.
In April 1997, the Coconino County, Arizona Pollution Control
Corporation issued $14.7 million of Pollution Control Revenue Bonds for the
benefit of the Company. The net proceeds loaned to the Company will be used
in June 1997 to redeem $14.7 million principal amount of previously issued
variable rate bonds that mature in 2031. The new bonds, which are unsecured,
bear interest at 7.00% and mature in 2032.
NOTE 4. VALENCIA MERGER
- ------------------------
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.
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 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. NEW ACCOUNTING STANDARD
- --------------------------------
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 (FAS 128), Earnings per
Share. This Statement simplifies the standards for computing earnings per
share (EPS) and replaces the presentation of primary EPS with a presentation
of basic EPS. It requires a dual presentation of basic and diluted EPS on
the face of the income statement. The Company is required to adopt FAS 128
in the fourth quarter of 1997. The Company does not expect the adoption of
FAS 128 to have a material impact on the Company's calculation of EPS.
NOTE 7. RECLASSIFICATION
- -------------------------
Minor reclassifications, other than those described in Note 4, 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 first quarter of 1997 compared with the first quarter of
1996, the outlook for dividends on Common Stock, and changes in liquidity and
capital resources of the Company during the first quarter of 1997. Also
management's expectations of identifiable material trends are discussed.
OVERVIEW
- --------
Earnings for the Company improved significantly during the first quarter of
1997 relative to the same period in 1996. Net income increased from $0.4
million in the first quarter of 1996 to $11.5 million in the first quarter of
1997. This improvement was due primarily to an increase in the amount of non-
cash income tax benefits recognized by the Company and to growth in the
Company's sales and revenues. 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
$14.3 million for the first quarter of 1997 compared with $4.8 million recorded
for the first quarter of 1996. See Results of Utility Operations, Other Income
below. Total kWh sales increased by 1.6% during the first quarter of 1997
relative to the same period in 1996. Due to the increase in sales, higher
wholesale energy prices, and a 1.1% retail rate increase implemented on March
31, 1996, total operating revenues increased by 4.2% in the first quarter of
1997 compared with the same period in 1996. Despite a 2.0% increase in the
Company's operating expenses, first quarter operating income increased by 21% in
1997 compared with the same period in 1996.
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 industry changes or unanticipated economic downturns. 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.
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, $192 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 also have scheduled expiration dates between
December 31, 1999 and December 31, 2002. See Financing Developments below.
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, 1998, the expiration dates for such letters of credit would move
forward to the period December 31, 1998 to December 31, 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. While
the Company intends to pay or refinance maturing bonds, 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
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. As of May 8,
1997, the Company's cash balance including cash equivalents was approximately
$88 million. 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 prices 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 may 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 Policy Act
of 1992 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 FERC issued two orders pertaining to transmission access in April 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 Company has since filed a Stipulation in Offer of
Settlement regarding the proposed tariff. Such settlement has been certified as
being uncontested by the Administrative Law Judge assigned to this matter and
has been referred to the FERC for approval.
FERC Order No. 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. The Company is in compliance with
these requirements.
The Company and several other electric utilities located in the
southwestern United States have recently begun to investigate the feasibility of
forming an independent system operator for the region. It is presently
contemplated that such an organization, if formed, would be responsible for
ensuring transmission reliability and nondiscriminatory access to the regional
transmission grid. Other utilities involved in the feasibility study include
Arizona Public Service Company, El Paso Electric Company, Nevada Power Company,
Public Service Company of New Mexico, Salt River Project, Texas-New Mexico Power
Company, and the Western Area Power Administration - Desert Southwest Region.
Several public meetings have been held in order to obtain public input to the
study. The feasibility study is expected to be completed by the end of 1997.
The formation of an independent system operator would be subject to approval by
the FERC and state regulatory authorities in the region. The financial aspects
of forming an independent system operator, including the potential effects on
the Company's future results of operations, are being examined as part of the
feasibility study.
Given the level of competition already present in the wholesale market for
electricity, the Company does not believe that FERC Order No. 888 or Order No.
889 will have a material effect on the Company's future results of operations.
However, such 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 recently adopted rules that
require a phase-in of 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 the Public Utilities Regulatory
Act of 1978, as amended. 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
principal 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, price reductions
and term extensions. In 1996, the Company negotiated contract amendments with
its largest mining customer. The contract amendments include, among other
things, price reductions, a market pricing mechanism covering a portion of the
customer's electrical load, and a change in service from a firm basis to an
interruptible basis. Such contract is scheduled to expire in January 2003,
while the contract with the Company's other principal mining customer is
scheduled to expire in March 2001. Early terminations of the contracts by
mining customers require 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. Changes in service
requirements (from a firm basis to an interruptible basis) may also permit the
Company to delay additions to peaking capacity.
On December 23, 1996, the ACC voted to adopt rules on retail electric
competition. The rules require each "Affected Utility" to open its retail
service area 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
will be eligible to choose their electric service provider from companies
certificated by the ACC. Such service providers would include Affected
Utilities as well as other entities that apply for and receive a certificate of
convenience and necessity from the ACC. Beginning no later than January 1,
2001, retail customers representing at least 50% of each Affected Utility's 1995
peak demand will 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 rules, Affected Utilities will be
required to provide distribution wheeling services (i.e., retail wheeling) at
rates approved by the ACC in order to facilitate sales by competing energy
providers. Such wheeling services would involve the transmission of energy
produced by other entities over the Company's transmission and distribution
system to consumers located in the Company's present retail service area.
While retail wheeling will expose the Company's service area to increased
competition, it will also open additional markets into which the Company may
sell its electric power.
The Affected Utilities whose service territories will be open to competing
service providers under the rules include the Company, Arizona Public Service
Company, Citizens Utilities Company, and several electric cooperatives.
However, electric cooperatives will be permitted to request a modification to
the 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 will 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, will be permitted under
the rules on a similar reciprocal basis (i.e., their service territories would
be similarly open to competing service providers).
The rules require new market entrants to obtain a certificate of
convenience and necessity from the ACC prior to offering retail electric
service. New market entrants will be required to demonstrate adequate technical
and financial capabilities to the ACC prior to certification. In addition, all
competitive market participants, including Affected Utilities, will 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 will increase to one percent on January 1, 2002.
New solar resources are defined under the rules as photovoltaic or solar thermal
resources that are installed on or after January 1, 1997. Electric service
providers not in compliance with these solar resource standards will be subject
to a penalty of up to 30 cents per kWh to be applied to the kWh deficiency in
solar energy provided.
The rules specify that the ACC shall allow the recovery of unmitigated
stranded costs by Affected Utilities. Stranded cost is defined in the rules 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 rules specify that other issues
related to the analysis and recovery of stranded costs would be examined by a
working group following adoption of the rules. 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.
Each Affected Utility will 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 FERC, if
applicable), ancillary services (as defined by FERC 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 will 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.
Pursuant to the rules, working groups have been formed to analyze various
issues related to retail competition. Each working group consists of members
representing a wide variety of interests including the ACC Staff, consumers,
Affected Utilities, and potential new service providers. Separate working
groups have been established to investigate issues related to the quantification
and recovery of stranded costs, the unbundling of utility services and rates,
the maintenance of system reliability and safety, the methods to be used in
determining consumer participation during the early phase-in periods, and
certain legal issues related to the rules. Reports describing the activities
and recommendations of working group members are scheduled to be provided to the
ACC by the fourth quarter of 1997. The Company is actively participating in
each of the working groups investigating retail competition issues.
On January 10, 1997, the Company filed with the ACC a motion for
reconsideration and request for stay of the rules. Concerns expressed by the
Company in its motion included the potential impact on system reliability,
mechanisms for stranded cost quantification and recovery, the ability to compete
fairly with public power entities and recipients of federal preference power,
and certain legal deficiencies which would likely result in legal appeals and
litigation. On January 30, 1997, the Company's motion for reconsideration was
deemed denied by the ACC by operation of law. On February 28, 1997, the Company
filed an appeal of the ACC order in both the Arizona Superior Court and the
Arizona Court of Appeals. At the present time, the Company is unable to
predict the outcome of the appeals or the effects such rules, in their present
form, would have on the Company's future results of operations.
The Arizona Legislature is also investigating the potential merits of
retail electric competition. Legislation was passed in 1996 requiring 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
who is actively participating as a committee member. Three subcommittees of
the advisory committee were recently formed for purposes of evaluating the
timing of retail competition, reviewing tax issues related to retail competition
and identifying specific legislative actions necessary to implement retail
competition.
The Company cannot predict whether or not there will be competing
initiatives on industry restructuring from both the ACC and the Arizona
Legislature. However, the Company believes that certain matters contained in
the ACC's rules on retail competition may require legislative changes, while
other matters may require constitutional amendments. Additionally, several
federal initiatives regarding retail electric competition have been introduced
in Congress which, if passed, could modify, augment or preempt the actions taken
by the ACC or the Arizona Legislature. The Company will continue to assess the
likely impact of the ACC's rules on retail competition, proposed legislation on
retail competition, and other potential market reforms on the Company. At the
present time the Company is unable to predict the ultimate impact of increased
retail competition on the Company's future results of operations. See Accounting
for the Effects of Regulation below for a discussion of the potential impact of
increased competition on the Company's accounting policies.
HOLDING COMPANY PROPOSAL
- ------------------------
On April 4, 1997, the Company filed with the ACC a notice of intent to
organize a public utility holding company. If approved by the ACC and the FERC,
the Company intends to establish through a one-for-one share exchange a new
corporate structure in which the Company will be a subsidiary of a new holding
company named UniSource Energy Corporation. The Company is seeking to establish
a holding company structure because the Company believes that it is in the best
interests of its Shareholders for the Company to participate in various segments
of the evolving and expanding electric energy business. The Company believes
that such participation would be facilitated and enhanced by the holding company
structure, a structure commonly used in the electric industry and other
industries to conduct different lines of business. In May 1995, Shareholders
approved the formation of a holding company and the related one-for-one share
exchange. If regulatory approvals are received, it is likely that no further
Shareholder approval would be required to effect the share exchange.
If the holding company structure is established, substantially all of the
assets of the holding company initially following the share exchange would
consist of the Company's Common Stock. The holding company would rely primarily
on funding sources other than TEP to fund its operations and to capitalize
affiliate companies because the Company is currently prohibited from paying
dividends (see Dividends on Common Stock below) and because the Company may be
prohibited from making investments in the holding company or affiliated
companies. Also, the ACC's affiliated interest rules would limit certain
transactions between the holding company and the Company unless approved by the
ACC. Accordingly, funds for the holding company would be limited until the
holding company obtains outside financing or until the affiliate companies are
able to pay cash dividends to the holding company. The Company is reviewing
various methods for the holding company to obtain outside financing, including
the issuance of new equity by the holding company.
In the unlikely event the holding company incurs liabilities in excess of
cash flow available from the Company, the affiliate companies or outside
financings, the holding company might not have sufficient cash available to meet
such liabilities. Under such circumstances the Company may be required to seek
waivers of the provisions of certain of its credit agreements and leases and the
affiliated interest rules in order to permit the Company to provide interim
financing to the holding company. There can be no assurance that a holding
company structure will be effected in the future, that the holding company will
be able to obtain outside financing, or that the Company would be able to obtain
necessary waivers if so required.
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 Consolidated Balance Sheets at March 31,
1997, and at December 31, 1996, 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 Consolidated Statements of
Income for the quarters ended March 31, 1997 and 1996 also reflect the
application of FAS 71.
As noted in Competition, Retail above, on December 23, 1996, the ACC voted
to adopt rules on retail electric competition. 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 is unable to predict whether it will recover the full
costs of its investments in utility plant assets and regulatory assets. If less
than full recovery is provided, write-offs of assets may occur and the Company
may be unable to continue to apply FAS 71.
Further, in response to the legislation adopted by the State of California
in 1996 establishing competitive markets for electricity in that state, the SEC
is reported to have questioned the continued applicability of FAS 71 by
California investor-owned utilities even though the recovery of stranded
costs is provided through a statutory funding mechanism. It is reasonably
possible that the SEC could question the continued applicability of FAS 71 to
investor-owned utilities subject to similar legislation or regulatory action in
other states. The Company understands that the Financial Accounting Standards
Board's Emerging Issues Task Force has agreed to commence consideration of this
issue during the second quarter of 1997. Depending upon the outcome of such
review, the SEC's response to this issue, and the applicability to the retail
electric competition rules adopted in Arizona, the Company may be unable to
continue to apply FAS 71, even if it believes it will recover the full
amount of its costs under the ACC competition phase-in plan. The Company is
unable to predict the outcome of these matters.
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 March 31, 1997, the Company estimates that if FAS 101 were
adopted and applied to all segments of the Company's operations, an
extraordinary loss of $158 million, which includes a reduction for the related
deferred income taxes of $82 million, would be required. 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. At that time, if
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.
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. The Company
is not currently prevented from declaring and paying a dividend under such
provisions.
The Company's ability to pay a dividend is restricted by certain covenants
of the General First Mortgage. 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 March 31, 1997, the Company had a cash flow
coverage ratio in excess of 2 to 1 and the Company's accumulated deficit was
$494 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 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 May 8, 1997, there was no outstanding balance due
under the Renewable Term Loan, and to date no amounts have been borrowed under
the Revolving Credit. Commitments relating to such facilities permit the
Company to borrow $140 million under the Renewable Term Loan and $50 million
under the Revolving Credit. The Company's senior long-term 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 Federal Power Act states
that dividends shall not be paid out of funds properly included in the capital
account. It is unclear whether such provisions of the Federal Power Act
restrict the Company from paying dividends.
EARNINGS
- --------
The Company recorded net income of $11.5 million in the first quarter of
1997 compared with net income of $0.4 million in the first quarter of 1996. The
net income per average share of Common Stock was $0.36 for the first quarter of
1997 compared with net income per average share of Common Stock of $0.01 for the
first quarter of 1996.
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 March 31 1997 1996 Amount Percent
- --------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 1,622,441 1,581,425 41,016 2.6%
Sales for Resale 715,187 719,064 (3,877) (0.5)
--------- --------- ------
Total 2,337,628 2,300,489 37,139 1.6
======== ========= ======
Electric Revenues (000):
Retail Customers $129,937 $125,210 $ 4,727 3.8%
Amortization of MSR Option
Gain Regulatory Liability 5,013 5,013 - -
Sales for Resale 19,331 17,805 1,526 8.6
------- -------- --------
Total $154,281 $148,028 $ 6,253 4.2
======== ======== ========
KWh sales to retail customers increased by 2.6% in the first quarter of
1997 compared with the first quarter of 1996, due primarily to a 2.6% increase
in the average number of retail customers. Revenues from sales to retail
customers increased by 3.8% in the first quarter of 1997 compared with the same
period in 1996 due to higher kWh sales and a 1.1% retail rate increase
implemented by the Company on March 31, 1996.
Sales for resale decreased by 0.5% in the first quarter of 1997 relative to
the same period in 1996. However, revenues from sales for resale increased by
8.6% due to higher market prices for wholesale economy energy in the first
quarter of 1997 compared with the first quarter of 1996. Factors contributing
to higher market prices included an increase in natural gas prices and a
reduction in regional generating capability due to planned and forced outages of
generating facilities in the southwestern United States.
OPERATING EXPENSES
Fuel and Purchased Power expense decreased slightly in the first quarter of
1997 compared with the same period in 1996. This expense did not increase
proportionately with the increase in kWh sales due to take-or-pay payments for
fuel accrued in the first quarter of 1996. No such payments were made or
accrued in the first quarter of 1997.
Other Operations expense increased by $2.2 million in the first quarter of
1997 relative to the same period in 1996. This increase was attributable to an
increase in payments for outside services as well as an adjustment related to
post-retirement benefits other than pensions.
Depreciation and Amortization expense decreased by $2.0 million in the
first quarter of 1997 compared with the first quarter of 1996. This decrease
was attributable to the completion in January 1997 of a three year amortization
period for Springerville Unit 2 Rate Synchronization Costs established in the
1994 Rate Order, as well as an extension of the depreciable life for pollution
control facilities as required by the Company's 1996 Rate Order.
Taxes Other Than Income Taxes decreased by $2.4 million in the first
quarter of 1997 compared with the same period in 1996. This decrease was due
primarily to a reduction in property tax rates and reduced property valuations
for tax purposes.
Income Tax benefit included in Operating Expenses decreased by $3.5 million
in the first quarter of 1997 compared with the first quarter of 1996 due to an
increase in pre-tax operating income net of interest expense.
OTHER INCOME
Income Tax benefits included in Other Income increased $7.2 million in the
first quarter of 1997 compared with the first quarter of 1996 due primarily to
increased NOL benefit recognition resulting from a revision in the expected
future utilization of NOLs generated in prior periods. 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 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 additional NOL benefits totaling up to
approximately $27 million over the next two years relating to prior period NOLs
unrecognized at March 31, 1997. The amount of NOL benefits recognized in
periods subsequent to March 31, 1997, if any, and the timeframe in which such
benefits are recognized, may vary significantly from the estimate described in
this paragraph. In addition, in future periods when such NOLs are utilized for
income tax purposes to offset taxable income, income tax expense shown on the
Company's Consolidated Statements of Income will not be reduced to reflect such
utilization.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company expects to generate sufficient cash flows during 1997 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 $9 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 May 8, 1997, there was no outstanding balance due under the Renewable
Term Loan, and to date, no amount has been borrowed under the Revolving Credit.
Pursuant to the terms of the MRA, the Renewable Term Loan commitment is
scheduled to decrease by 5% per quarter during 1997 and by 10% per quarter in
1998 and 1999, resulting in termination of the commitment by December 31, 1999.
As such, the Renewable Term Loan commitment decreased from $164 million to $156
million as of March 31, 1997. Due to MRA provisions regarding the optional
prepayment of debt obligations, and the April 1997 refinancing of $31.4 million
of floating rate IDBs (see Financing Developments below), the Renewable Term
Loan commitment was reduced by an additional $16 million as of April 29, 1997,
to $140 million. The Revolving Credit commitment remained at $50 million as of
May 8, 1997.
The Company's cash and cash equivalents balance at May 8, 1997 was
approximately $88 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 $37.7 million or 55%,
from the March 31, 1996 ending balance of $68.9 million to the March 31, 1997
ending balance of $106.6 million. This increase was due to the receipt of net
cash flows from operating activities in excess of the net cash flows required
for investing and financing activities for the twelve month period ended March
31, 1997.
Net cash flows from operating activities increased in aggregate by $11.7
million in the first quarter of 1997 compared with the same period in 1996.
This increase was due primarily to an increase in cash receipts from retail and
wholesale customers and a $4.6 million reduction in wages paid (net of amounts
capitalized) during the first quarter of 1997 compared with the same period in
1996. These increases to net cash flows were partially offset by the receipt of
$4.1 million in cash related to the sale of emission allowances in the first
quarter of 1996.
Net cash outflows from investing activities decreased in aggregate by $1.6
million in the first quarter of 1997 compared with the same period in 1996, due
primarily to a reduction in construction expenditures. This reduction was
partially offset by a $1.3 million increase in investments in joint ventures.
Net cash outflows from financing activities increased in aggregate by $20.8
million in the first quarter of 1997 compared with the same period in 1996 as a
result of the Company's repayment of the $31 million Renewable Term Loan balance
during the first quarter of 1997.
FINANCING DEVELOPMENTS
On April 29, 1997, the City of Farmington, New Mexico issued $80.41 million
aggregate principal amount of its 1997 Series A Pollution Control Revenue Bonds
(Tucson Electric Power Company San Juan Project) for the benefit of the Company.
The proceeds from this issuance have been made available to the Company under an
installment sale agreement and will be used on June 12, 1997 to redeem all of
the City of Farmington's Series 1973 Pollution Control Revenue bonds (Tucson Gas
& Electric Company San Juan Project), 6.25% due in 2003 ($47.91 million
aggregate principal amount) and all of the City of Farmington's 1977 Series A
Collateralized Pollution Control Revenue bonds (Tucson Gas & Electric Company
San Juan Project), 6.10% due 2007 ($32.5 million aggregate principal amount).
The Farmington 1977 Series A bonds were secured by an equal principal amount of
First Mortgage Bonds. The new bonds, which are unsecured, pay interest at a
fixed annual rate of 6.95% and will mature in October 2020.
On April 29, 1997, the Coconino County, Arizona Pollution Control
Corporation issued $36.7 million aggregate principal amount of its 1997 Series A
Pollution Control Revenue Bonds (Tucson Electric Power Company Navajo Project)
for the benefit of the Company. The proceeds from this issuance have been
loaned to the Company and will be used on June 4, 1997 to (i) redeem all of the
1996 Series A Pollution Control Revenue Bonds (Tucson Electric Power Company
Project), variable rate due 2031 ($16.7 million aggregate principal amount) and
(ii) fund the construction of additional pollution abatement facilities at the
Navajo Generating Station. The new bonds, which are unsecured, pay interest at
a fixed annual rate of 7.125% and will mature in October 2032.
On April 29, 1997, the Coconino County, Arizona Pollution Control
Corporation also issued $14.7 million aggregate principal amount of its 1997
Series B Pollution Control Revenue Bonds (Tucson Electric Power Company Navajo
Project) for the benefit of the Company. The proceeds from this issuance have
been loaned to the Company and will be used on June 4, 1997 to redeem all of the
1996 Series B Pollution Control Refunding Revenue Bonds (Tucson Electric Power
Company Project), variable rate due 2031 ($14.7 million aggregate principal
amount). The new bonds, which are unsecured, pay interest at a fixed annual
rate of 7.00% and will mature in October 2032.
The refunded Coconino bonds are backed by letters of credit. The issuers
of such letters of credit received First Mortgage Bonds in the aggregate
principal amount of $34.5 million to secure the Company's reimbursement
obligations. Upon the redemption of such Coconino bonds, the aggregate
principal amount of Company debt backed by letters of credit will be reduced
from $805 million to $774 million. The aggregate principal amount of First
Mortgage Bonds outstanding will also be reduced by $34.5 million.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Quarterly Report on Form 10-Q contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. The Company is
including the following cautionary statements to make applicable and take
advantage of the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 for any forward-looking statements made by, or on behalf, of
the Company in this Quarterly Report on Form 10-Q. Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance and underlying assumptions and other statements which are
other than statements of historical facts. Such forward-looking statements may
be identified, without limitation, by the use of the words "anticipates,"
"estimates," "expects," "intends," "plans," "predicts," "projects," and similar
expressions. From time to time, the Company may publish or otherwise make
available forward-looking statements of this nature. All such forward-looking
statements, whether written or oral, and whether made by or on behalf of the
Company, are expressly qualified by these cautionary statements and any other
cautionary statements which may accompany the forward-looking statements. In
addition, the Company disclaims any obligation to update any forward-looking
statements to reflect events or circumstances after the date hereof.
Forward-looking statements involve risks and uncertainties which could
cause actual results or outcomes to differ materially from those expressed in
the forward-looking statements. The Company's expectations, beliefs and
projections are expressed in good faith and are believed by the Company to have
a reasonable basis, including without limitation, management's examination of
historical operating trends, data contained in the Company's records and other
data available from third parties, but there can be no assurance that
management's expectations, beliefs or projections will result or be achieved or
accomplished. In addition to other factors and matters discussed elsewhere
herein, some of the important factors that, in the view of the Company, could
cause actual results to differ materially from those discussed in the forward-
looking statements include the following:
1. Effects of restructuring initiatives in the electric industry and other
energy-related industries.
2. Changes in economic conditions, demographic patterns and weather conditions
in the Company's retail service area.
3. Changes affecting the Company's cost of providing electrical service
including, but not limited to, changes in fuel costs, generating unit
operating performance, interest rates, tax laws, environmental laws, and the
general rate of inflation.
4. Changes in governmental policies and regulatory actions with respect to
allowed rates of return, financings, and rate structures.
5. Changes affecting the cost of competing energy alternatives, including
changes in available generating technologies and changes in the cost of
natural gas.
6. Changes in accounting principles or the application of such principles to the
Company.
PART II - OTHER INFORMATION
ITEM 1. -- LEGAL PROCEEDINGS
==============================================================================
TAX ASSESSMENTS
See Note 1 of Notes to Condensed Consolidated Financial Statements, Tax
Assessments.
ITEM 6. -- EXHIBITS AND REPORTS ON FORM 8-K
==============================================================================
(a) Exhibits.
- See Exhibit Index.
(b) Reports on Form 8-K.
- The Company has not filed any Current Reports on Form 8-K since
filing the Form 10-K for 1996.
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: May 14, 1997 Ira R. Adler
------------------------------------
Ira R. Adler
Senior Vice President and Principal
Financial Officer
EXHIBIT INDEX
4a - Amended and Restated Installment Sale Agreement, dated as of April 1,
1997, between the City of Farmington, New Mexico and the Registrant
relating to Pollution Control Revenue Bonds, 1997 Series A (Tucson
Electric Power Company San Juan Project).
4b - City of Farmington, New Mexico Ordinance No. 97-1055, adopted April
17, 1997, authorizing Pollution Control Revenue Bonds, 1997 Series A
(Tucson Electric Power Company San Juan Project).
4c - Loan Agreement, dated as of April 1, 1997, between Coconino County,
Arizona Pollution Control Corporation and the Registrant relating to
Pollution Control Revenue Bonds, 1997 Series A (Tucson Electric Power
Company Navajo Project).
4d - Indenture of Trust, dated as of April 1, 1997, between Coconino
County, Arizona Pollution Control Corporation and First Trust of New
York, National Association, authorizing Pollution Control Revenue
Bonds, 1997 Series A (Tucson Electric Power Company Navajo Project).
4e - Loan Agreement, dated as of April 1, 1997, between Coconino County,
Arizona Pollution Control Corporation and the Registrant relating to
Pollution Control Revenue Bonds, 1997 Series B (Tucson Electric Power
Company Navajo Project).
4f - Indenture of Trust, dated as of April 1, 1997, between Coconino
County, Arizona Pollution Control Corporation and First Trust of New
York, National Association, authorizing Pollution Control Revenue
Bonds, 1997 Series B (Tucson Electric Power Company Navajo Project).
15 - Letter regarding unaudited interim financial information.
27 - Financial Data Schedule.