UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 1999
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Registrant; State of
Incorporation; Address IRS Employer
Commission and Telephone Number Identification Number
---------- ---------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
Indicate by check mark whether each registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
YeYes X No _____
At May 7, 1999, 32,303,281 shares of UniSource Energy Corporation's
Common Stock, no par value (the only class of Common Stock) were
outstanding.
UniSource Energy Corporation is the sole holder of the 32,162,167
shares of the outstanding Common Stock of Tucson Electric Power Company.
In accordance with Rule 12b-25, the following disclosure items have been
omitted from the UniSource Energy Corporation Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1999: Note 3, Unregulated Energy
Businesses, of Item 1. -- Financial Statements excludes certain financial
information for New Energy Ventures, Inc., an affiliate owned 50% by
UniSource Energy Corporation.
This combined Form 10-Q is separately filed by UniSource Energy Corporation
and Tucson Electric Power Company. Information contained in this document
relating to Tucson Electric Power Company is filed by UniSource Energy
Corporation and separately by Tucson Electric Power Company on its own
behalf. Tucson Electric Power Company makes no representation as to
information relating to UniSource Energy Corporation or its subsidiaries,
except as it may relate to Tucson Electric Power Company.
TABLE OF CONTENTS
Page
Definitions......................................................iv
Review Report of Independent Accountants..........................1
PART I - FINANCIAL INFORMATION
Item 1. -- Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements of Loss...2
Comparative Condensed Consolidated Statements of
Cash Flows.............................................3
Comparative Condensed Consolidated Balance Sheets........4
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Loss...5
Comparative Condensed Consolidated Statements of
Cash Flows.............................................6
Comparative Condensed Consolidated Balance Sheets........7
Notes to Condensed Consolidated Financial Statements
Note 1. Accounting for the Effects of Regulation............8
Note 2. Segment and Related Information.....................9
Note 3. Unregulated Energy Businesses......................10
Note 4. Tax Assessments....................................11
Note 5. Springerville Common Facilities Lease..............12
Note 6. Income Taxes.......................................12
Note 7. New Accounting Standards...........................13
Note 8. Review by Independent Public Accoutants............14
Note 9. Reclassifications..................................14
Item 2. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview.....................................................15
Factors Affecting Results Of Operations
Competition
Retail................................................15
Wholesale.............................................16
Accounting For The Effects Of Regulation.....................18
Market Risks.................................................19
Future Generating Resources..................................20
Impact Of The Year 2000 On Computer Systems and Applications.21
Results Of Operations...........................................21
Contribution By Business Segment...........................23
Utility Sales and Revenues.................................23
Operating Expenses.........................................24
Other Income (Deductions)..................................24
Interest Expense...........................................25
Results Of Unregulated Energy Businesses........................25
AET and Global Solar.......................................25
MEH and NEV................................................25
Nations Energy.............................................25
Dividends On Common Stock
UniSource Energy...........................................26
TEP........................................................26
Liquidity And Capital Resources
Cash Flows
UniSource Energy...........................................26
TEP........................................................27
Investing And Financing Activities
UniSource Energy
Loans and Guarantees......................................28
Stock Warrants............................................28
TEP
Capital Expenditures......................................28
TEP Credit Agreement......................................28
Springerville Common Facilities Leases....................29
Millennium -- Unregulated Energy Businesses
Capital Requirements.......................................29
Safe Harbor For Forward-Looking Statements......................30
Item 3. -- Quantitative And Qualitative Disclosures
About Market Risk....................................30
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings
Tax Assessments.............................................31
Item 5. -- Other Information
Additional Financial Data...................................31
Item 6. -- Exhibits and Reports on Form 8-K.....................31
Signature Page...................................................32
Exhibit Index....................................................33
DEFINITIONS
The abbreviations and acronyms used in the 1999 First Quarter Form 10-Q are
defined below:
ACC................. Arizona Corporation Commission.
ADOR................ Arizona Department of Revenue.
AET................. Advanced Energy Technologies, Inc., a wholly-
owned subsidiary of Millennium.
Affected Utilities.. Electric utilities regulated by the ACC,
including TEP,Arizona Public Service,Citizens
Utilities company, and several electric cooperatives.
Common Stock........ UniSource Energy's common stock, without par value.
Company............. UniSource Energy Corporation.
Credit Agreement.... Credit Agreement between TEP and the banks,
dated as of December 30, 1997.
FAS 71.............. Statement of Financial Accounting Standards No.
71: Accounting for the Effects of Certain Types of
Regulation.
FERC................ Federal Energy Regulatory Commission.
First Mortgage Bonds First mortgage bonds issued under the General
First Mortgage.
GAAP................ Generally Accepted Accounting Principles.
Global Solar........ Global Solar Energy, L.L.C., a corporation in
which a 50% interest is owned by AET.
IRS................. Internal Revenue Service.
Irvington........... Irvington Generating Station.
ISO................. Independent System Operator.
ITC................. Investment tax credit.
kWh................. Kilowatt-hour(s).
MEH................. MEH Corporation, a wholly-owned subsidiary of
Millennium.
MW.................. Megawatt(s).
MWh................. Megawatt-hour(s).
Millennium.......... Millennium Energy Holdings, Inc., a wholly-
owned subsidiary of UniSource Energy.
Nations Energy...... Nations Energy Corporation, a wholly-owned subsidiary
of NEV
New Energy Ventures,
Inc................ a company in which a 50% interest is owned by MEH.
NEV Southwest....... New Energy Ventures Southwest, L.L.C., a wholly-
owned subsidiary of NEV.
NOL................. Net Operating Loss carryforward for income tax purposes.
OASIS............... Open Access Same-Time Information System is an
Internet-based information network that the electric
industry developed in response to the FERC policy on
open transmission access.
Rate Settlement..... TEP's Rate Settlement agreement approved by the
ACC in August 1998, which provides retail base price
decreases over a two-year period.
Revolving Credit
Facility........... $100 million revolving credit facility
entered into under the Credit Agreement between a
syndicate of banks and TEP.
Springerville....... Springerville Generating Station.
Springerville Common
Facilities........ Facilities at Springerville used in common with
Springerville Unit 1 and Springerville Unit 2.
Springerville Common
Facilities Leases. Leveraged lease arrangements relating to an
undivided one-half interest in certain Springerville
Common Facilities.
Springerville Unit 1 Unit 1 of the Springerville Generating Station.
Springerville Unit
1 Leases.......... Leveraged lease arrangement relating to
Springerville Unit 1 and an undivided one-half
interest in certain Springerville Common Facilities.
TEP................. Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
TEP Warrants........ Warrants for the purchase of TEP Common Stock
which were issued in 1992.
UniSource Energy.... UniSource Energy Corporation.
UniSource Energy
Warrants.......... Warrants for the purchase of UniSource
Energy Common Stock which were issued in exchange
for TEP Warrants, pursuant to an exchange offer
which expired October 23, 1998.
WSCC............... Western Systems Coordinating Council.
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated
balance sheets and the related condensed consolidated
statements of loss and of cash flows of Tucson Electric Power
Company and its subsidiaries (TEP) as of March 31, 1999 and for
the three-month periods ended March 31, 1999 and 1998. This
financial information is the responsibility of TEP's
management.
We conducted our review in accordance with standards
established by the American Institute of Certified Public
Accountants. A review of interim financial information consists
principally of applying analytical procedures to financial data
and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the accompanying financial
information for it to be in conformity with generally accepted
accounting principles.
We previously audited in accordance with generally accepted
auditing standards, the consolidated balance sheet and
statement of capitalization as of December 31, 1998, and the
related consolidated statements of income, of changes in
stockholder's equity, and of cash flows for the year then ended
(not presented herein); and in our report dated February 4,
1999 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, 1998, is fairly stated, in all material respects
in relation to the consolidated balance sheet from which it
has been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
May 17, 1999
>Page>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
The weather causes seasonal fluctuations in UniSource Energy's sales. As a
result, quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with the Company's 1998 Form 10-K.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF LOSS
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Operating Revenues
Retail Customers $128,651 $138,087
Sales for Resale 31,859 22,854
--------- ---------
Total Operating Revenues 160,510 160,941
--------- ---------
Operating Expenses
Fuel and Purchased Power 54,919 48,400
Capital Lease Expense 25,461 25,778
Amortization of Springerville Unit 1 Allowance (8,729) (7,631)
Other Operations 23,623 26,298
Maintenance and Repairs 9,637 10,724
Depreciation and Amortization 23,081 22,563
Taxes Other Than Income Taxes 12,154 12,926
Income Taxes (2,559) (1,937)
--------- ---------
Total Operating Expenses 137,587 137,121
--------- ---------
Operating Income 22,923 23,820
--------- ---------
Other Income (Deductions)
Income Taxes (232) (631)
Interest Income 1,638 1,716
Unregulated Energy Businesses - Net (2,793) (4,036)
Other 658 810
--------- ---------
Total Other Income (Deductions) (729) (2,141)
--------- ---------
Interest Expense
Long-Term Debt 16,325 17,111
Interest Imputed on Losses Recorded at Present Value 8,748 8,545
Other 2,649 3,058
--------- ---------
Total Interest Expense 27,722 28,714
--------- ---------
Net Loss $ (5,528) $ (7,035)
========= =========
Average Shares of Common Stock Outstanding (000) 32,287 32,139
========= =========
Basic and Diluted Loss per Share $ (0.17) $ (0.22)
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $147,388 $146,532
Cash Receipts from Sales for Resale 31,511 27,000
Fuel and Purchased Power Costs Paid (58,132) (42,978)
Wages Paid, Net of Amounts Capitalized (15,857) (21,925)
Payment of Other Operations and Maintenance Costs (25,501) (23,593)
Capital Lease Interest Paid (44,505) (41,319)
Taxes Paid, Net of Amounts Capitalized (11,110) (11,519)
Interest Paid, Net of Amounts Capitalized (24,004) (17,198)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (4,819) -
Emission Allowance Inventory Sales - 29
Interest Received 2,222 2,361
Other 1,294 1,907
--------- ---------
Net Cash Flows - Operating Activities (1,513) 9,297
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (16,729) (18,443)
Investments in and Loans to Unregulated
Energy Businesses (5,050) (6,000)
Distributions from Unregulated Energy Businesses 500 -
Other 85 193
--------- ---------
Net Cash Flows - Investing Activities (21,194) (24,250)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 255 1,105
Payments to Retire Long-Term Debt (1,225) -
Payments to Retire Capital Lease Obligations (16,552) (8,737)
Other 837 (1,876)
--------- ---------
Net Cash Flows - Financing Activities (16,685) (9,508)
--------- ---------
Net Decrease in Cash and Cash Equivalents (39,392) (24,461)
Cash and Cash Equivalents, Beginning of Year 145,167 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $105,775 $121,795
========= =========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Net Loss $ (5,528) $ (7,035)
Adjustments to Reconcile Net Loss
to Net Operating Cash Flows
Depreciation and Amortization Expense 23,081 22,563
Deferred Income Taxes and Investment Tax Credit (8,459) (4,117)
Lease Payments Deferred (16,404) (12,616)
Amortization of Regulatory Assets & Liabilities,
Net of Interest Imputed on Losses Recorded at
Present Value 18 914
Deferred Contract Termination Fee 962 (9,038)
Unremitted (Earnings) Losses of Unconsolidated
Subsidiaries 1,385 6,591
Other 3,083 (123)
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 6,379 987
Materials and Fuel (3,146) 251
Accounts Payable (7,805) 508
Taxes Accrued 8,311 11,961
Other Current Assets and Liabilities (2,578) (1,928)
Other Deferred Assets and Liabilities (812) 379
--------- ---------
Net Cash Flows - Operating Activities $ (1,513) $ 9,297
========= =========
Non-Cash Financing Activities (these activities do not affect the statements
of cash flows):
The proceeds from the issuance of $200 million of Pollution Control Revenue
Bonds in March 1998 were held in trust and used in May 1998 to redeem $200
million of previously issued bonds.
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1999 1998
(Unaudited)
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,250,056 $2,263,871
Utility Plant Under Capital Leases 886,902 886,902
Construction Work in Progress 82,007 74,050
----------- -----------
Total Utility Plant 3,218,965 3,224,823
Less Accumulated Depreciation and Amortization (1,048,456) (1,051,994)
Less Accumulated Amortization of Capital Leases (90,624) (85,826)
Less Springerville Unit 1 Allowance (171,431) (171,413)
----------- -----------
Total Utility Plant - Net 1,908,454 1,915,590
----------- -----------
Investments and Other Property 116,070 110,318
----------- -----------
Current Assets
Cash and Cash Equivalents 105,775 145,167
Accounts Receivable 66,388 72,767
Materials and Fuel 40,025 37,040
Deferred Income Taxes - Current 9,594 14,820
Other 21,587 24,950
----------- -----------
Total Current Assets 243,369 294,744
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 148,244 152,111
Deferred Springerville Generation Costs 98,316 102,211
Deferred Lease Expense 9,523 9,877
Other Regulatory Assets 18,210 18,886
Deferred Debits - Other 30,468 30,443
----------- -----------
Total Deferred Debits 304,761 313,528
----------- -----------
Total Assets $2,572,654 $2,634,180
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1999 1998
(Unaudited)
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 641,089 $ 640,640
Accumulated Deficit (399,522) (393,994)
----------- -----------
Common Stock Equity 241,567 246,646
Capital Lease Obligations 869,649 889,543
Long-Term Debt 1,183,198 1,184,423
----------- -----------
Total Capitalization 2,294,414 2,320,612
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 14,989 11,647
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 26,313 34,118
Interest Accrued 42,765 70,771
Taxes Accrued 35,478 27,167
Accrued Employee Expenses 17,388 15,207
Other 6,011 6,705
----------- -----------
Total Current Liabilities 144,669 167,340
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 49,992 62,028
Deferred Investment Tax Credits Regulatory Liability 9,736 10,436
Emission Allowance Gain Regulatory Liability 31,324 31,335
Other 42,519 42,429
----------- -----------
Total Deferred Credits and Other Liabilities 133,571 146,228
----------- -----------
Total Capitalization and Other Liabilities $2,572,654 $2,634,180
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF LOSS
The weather causes seasonal fluctuations in TEP's sales. As a result,
quarterly results are not indicative of annual operating results. The
quarterly financial statements that follow are unaudited but reflect all
normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. Also see Item 2. - Management's Discussion and Analysis of
Financial Condition and Results of Operations. This quarterly report should
be reviewed in conjunction with the TEP's 1998 Form 10-K.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF LOSS
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Operating Revenues
Retail Customers $128,777 $138,149
Sales for Resale 31,859 22,854
--------- ---------
Total Operating Revenues 160,636 161,003
--------- ---------
Operating Expenses
Fuel and Purchased Power 54,919 48,400
Capital Lease Expense 25,461 25,778
Amortization of Springerville Unit 1 Allowance (8,729) (7,631)
Other Operations 23,623 26,298
Maintenance and Repairs 9,637 10,724
Depreciation and Amortization 23,081 22,563
Taxes Other Than Income Taxes 12,154 12,926
Income Taxes (2,559) (1,937)
--------- ---------
Total Operating Expenses 137,587 137,121
--------- ---------
Operating Income 23,049 23,882
--------- ---------
Other Income (Deductions)
Income Taxes (1,169) (1,560)
Interest Income 1,465 1,716
Interest Income-Note Receivable from UniSource Energy 2,525 2,300
Other 532 769
--------- ---------
Total Other Income (Deductions) 3,353 3,225
--------- ---------
Interest Expense
Long-Term Debt 16,325 17,111
Interest Imputed on Losses Recorded at Present Value 8,748 8,545
Other 2,649 3,058
--------- ---------
Total Interest Expense 27,722 28,714
--------- ---------
Net Loss $ (1,320) $ (1,607)
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $147,388 $146,532
Cash Receipts from Sales for Resale 31,511 27,000
Fuel and Purchased Power Costs Paid (58,132) (42,978)
Wages Paid, Net of Amounts Capitalized (14,406) (20,971)
Payment of Other Operations and Maintenance Costs (23,516) (22,109)
Capital Lease Interest Paid (44,505) (41,319)
Taxes Paid, Net of Amounts Capitalized (11,000) (11,477)
Interest Paid, Net of Amounts Capitalized (24,004) (17,198)
Contract Termination Fee Paid - (10,000)
Income Taxes Paid (4,818) -
Emission Allowance Inventory Sales - 29
Interest Received 1,962 1,828
Other 86 862
--------- ---------
Net Cash Flows - Operating Activities 566 10,199
--------- ---------
Cash Flows from Investing Activities
Capital Expenditures (15,493) (18,414)
Transfer of Millennium Cash to UniSource Energy - (45,412)
Other Investments - Net (411) 18
--------- ---------
Net Cash Flows - Investing Activities (15,904) (63,808)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 255 1,105
Payments to Retire Long-Term Debt (1,225) -
Payments to Retire Capital Lease Obligations (16,552) (8,737)
Other 703 (1,859)
--------- ---------
Net Cash Flows - Financing Activities (16,819) (9,491)
--------- ---------
Net Decrease in Cash and Cash Equivalents (32,157) (63,100)
Cash and Cash Equivalents, Beginning of Year 118,236 146,256
--------- ---------
Cash and Cash Equivalents, End of Period $ 86,079 $ 83,156
========= =========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
Three Months Ended
March 31,
1999 1998
(Unaudited)
-Thousands of Dollars-
Net Loss $ (1,320) $ (1,607)
Adjustments to Reconcile Net Loss to Net
Operating Cash Flows
Depreciation and Amortization Expense 23,081 22,563
Deferred Income Taxes and
Investment Tax Credit (7,117) (377)
Lease Payments Deferred (16,404) (12,616)
Amortization of Regulatory Assets & Liabilities, Net
of Interest Imputed on Losses Recorded at
Present Value 18 914
Deferred Contract Termination Fee 962 (9,038)
Unremitted Earnings of Unconsolidated Subsidiaries (234) (213)
Interest Accrued on Note Receivable from
UniSource Energy (2,525) (2,300)
Other 1,451 340
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 10,306 (74)
Materials and Fuel (2,792) 250
Accounts Payable (7,346) 1,561
Taxes Accrued 8,390 11,962
Other Current Assets and Liabilities (5,097) (1,545)
Other Deferred Assets and Liabilities (807) 379
--------- ---------
Net Cash Flows - Operating Activities $ 566 $ 10,199
========= =========
Non-Cash Financing Activities (these activities do not affect the statements
of cash flows):
The proceeds from the issuance of $200 million of Pollution Control Revenue
Bonds in March 1998 were held in trust and used in May 1998 to redeem $200
million of previously issued bonds.
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1999 1998
(Unaudited)
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,250,056 $2,263,871
Utility Plant Under Capital Leases 886,902 886,902
Construction Work in Progress 82,007 74,050
----------- -----------
Total Utility Plant 3,218,965 3,224,823
Less Accumulated Depreciation and Amortization (1,048,456) (1,051,994)
Less Accumulated Amortization of Capital Leases (90,624) (85,826)
Less Springerville Unit 1 Allowance (171,431) (171,413)
----------- -----------
Total Utility Plant - Net 1,908,454 1,915,590
----------- -----------
Investments and Other Property 64,017 62,978
----------- -----------
Note Receivable from UniSource Energy 70,132 79,462
---------- -----------
Current Assets
Cash and Cash Equivalents 86,079 118,236
Interest on Note Receivable from UniSource Energy 11,855 -
Accounts Receivable 64,572 72,239
Materials and Fuel 39,948 36,995
Deferred Income Taxes - Current 9,594 14,820
Other 13,748 14,735
----------- -----------
Total Current Assets 225,796 257,025
----------- -----------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 148,244 152,111
Deferred Springerville Generation Costs 98,316 102,211
Deferred Lease Expense 9,523 9,877
Other Regulatory Assets 18,210 18,886
Deferred Debits - Other 30,468 30,443
----------- -----------
Total Deferred Debits 304,761 313,528
----------- -----------
Total Assets $2,573,160 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
1999 1998
(Unaudited)
- Thousands of Dollars -
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock $ 646,873 $ 646,568
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (411,670) (410,350)
----------- -----------
Common Stock Equity 228,846 229,861
Capital Lease Obligations 869,649 889,543
Long-Term Debt 1,183,198 1,184,423
----------- -----------
Total Capitalization 2,281,693 2,303,827
----------- -----------
Current Liabilities
Current Obligations Under Capital Leases 14,989 11,647
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 30,207 37,256
Interest Accrued 42,765 70,771
Taxes Accrued 35,472 27,082
Accrued Employee Expenses 16,935 14,897
Other 6,011 6,705
----------- -----------
Total Current Liabilities 148,104 170,083
----------- -----------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 59,810 70,504
Deferred Investment Tax Credits Regulatory Liability 9,736 10,436
Emission Allowance Gain Regulatory Liability 31,324 31,335
Other 42,493 42,398
----------- -----------
Total Deferred Credits and Other Liabilities 143,363 154,673
----------- -----------
Total Capitalization and Other Liabilities $2,573,160 $2,628,583
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------------------------------------------------------
NOTE 1. ACCOUNTING FOR THE EFFECTS OF REGULATION
Accounting Implications
The ACC regulates TEP's retail utility business. TEP generally
uses the same accounting policies and practices used by unregulated
companies for financial reporting under generally accepted accounting
principles. However, sometimes these principles, such as FAS 71,
require special accounting treatment for regulated companies to show
the effect of regulation. For example, in setting TEP's retail rates,
the ACC may not allow TEP to charge its customers currently to recover
certain expenses but; instead, require that these expenses be recovered
from customers in the future. In this situation, FAS 71 requires that
TEP capitalize and report these expenses as regulatory assets on the
balance sheet until TEP is allowed to charge its customers. TEP then
amortizes these items to the income statement as those amounts are
recovered from customers. Similarly, certain items of revenue may be
deferred as regulatory liabilities, which are also eventually amortized
to the income statement.
We have recorded regulatory assets and liabilities in our balance
sheets in accordance with FAS 71. A regulated company must satisfy
certain conditions to apply the accounting policies and practices of
FAS 71. These conditions include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
We periodically assess whether we continue to meet these
conditions. If we were required to stop applying FAS 71 to all or a
portion of TEP's regulated utility operations, we would write off the
related balances of TEP's regulatory assets and liabilities as a charge
in our income statement. In that event, our earnings would be reduced
by the net amount of regulatory assets and liabilities, after
applicable deferred income taxes. Based on the balances of TEP's
regulatory assets and liabilities at March 31, 1999, if we ceased
applying FAS 71 to all of TEP's regulated operations, we would record
an extraordinary loss of approximately $140 million, net of the related
deferred income tax benefit of $93 million. Approximately 60% of TEP's
net regulatory assets on the balance sheet relate to electric
generation. While our cash flows may be affected by regulatory orders
and market conditions, our cash flows would not be affected if we
ceased to apply FAS 71.
If we stop applying FAS 71, we would need to evaluate the
likelihood that we could recover the cost of TEP's electric plant in
the marketplace. If undiscounted cash flows are less than the carrying
value of those plant assets that we continue to own, then we would need
to write off as an expense a portion of those plant assets to reflect
their current market value. Plant assets to be disposed of would be
written down to fair value if it is less than carrying value. We
cannot predict if we would write off any plant assets as a result of
these evaluations.
Recent Events That May Impact TEP's Application of FAS 71
In December 1996, the ACC adopted retail electric competition
rules (Rules) that provided a framework for the phase-in of retail
electric competition in Arizona beginning in January 1999. The Rules
were amended and adopted on an emergency basis in August 1998. The
Rules, as originally adopted, assumed a competition start date of
January 1, 1999. On January 5, 1999, the ACC delayed implementation of
the Rules.
On April 14, 1999, the ACC approved a modified order that provides
affected utilities with five options for stranded cost recovery. The
following recovery options are provided by the ACC's written order:
1. Net Revenues Lost Methodology -- Stranded costs would be
determined by comparing generation revenues under competition to
revenues under regulation. Using growth as a mitigating factor, the
amount of recovery would be reduced over a five-year period.
2. Divestiture/Auction Methodology -- Stranded costs would be
determined by auctioning non-essential generation assets. The amount of
stranded costs would be the difference between the assets' market value
and their book value. Recovery of stranded costs would occur over a
maximum 10-year period.
3. Financial Integrity Methodology -- The ACC would provide
sufficient revenues necessary to maintain financial integrity, such as
avoiding default under currently existing financial instruments for a
period of ten years, at which time there would be no remaining stranded
costs.
4. Settlement Methodology -- This option provides for some
combination of the three preceding methods, submitted as a settlement
option.
5. Alternative Methodology -- This option approved by the ACC would
allow affected utilities to file an alternative plan. Under this
option, utilities would be required to demonstrate how an alternative
plan would be in the best interests of all stakeholders.
TEP and other affected utilities have until June 14, 1999 to amend
their previously filed stranded cost recovery plans. TEP's original
stranded cost plan filed on August 21, 1998, specified divestiture of
generation assets as the preferred method for recovery given the then-
available options. TEP expects to file an amended plan in accordance
with the April 14 order.
Also on April 14, 1999, the ACC approved amendments to the
electric competition rules that require a phase-in to a competitive
market, ensuring all customers will have access to competitive
generation by January 1, 2001. Retail electric competition in Arizona
had been scheduled to begin on January 1, 1999, but the ACC delayed the
opening of the market by staying the previous Competition Rules pending
further review.
Under the amendments, consumer choice will be available to all
customers by January 1, 2001. TEP, as the regulated local distribution
company, will continue to provide delivery of electricity over existing
power lines to homes and businesses and will continue to provide
operation and maintenance of the lines.
Under these rules, competitive electric service will be available
in each affected utility's service territory after the affected
utility's stranded cost plan is approved by the ACC. In addition, the
proposed rules replace certain affiliated interest rules with a code
of conduct to be filed by each utility.
The amended rules will be submitted to the Secretary of State's
Office for publication in the Arizona Administrative Register. It is
anticipated that public comment sessions will be held in June, and the
Rules will be resubmitted to the ACC for their final approval in July
or August 1999.
TEP will stop accounting for its generation operations using FAS
71 when the ACC approves a cost recovery plan specific to TEP which
includes the amount of stranded costs (including regulatory assets, net
of regulatory liabilities) that TEP can recover and a cost recovery
method. The amount and method of recovery that the ACC approves for
TEP will determine whether write-offs or other adjustments will occur
at that time. Until the ACC approves the amount and recovery method,
we are unable to predict the amount of write-offs or other adjustments,
if any, which would be recorded at that time.
We cannot predict the outcome of the ACC's retail competition
rules. Additionally, federal legislators introduced several retail
competition initiatives in Congress which, if passed, could modify or
override the actions taken by the ACC. We will continue to monitor the
progress of the legislation and assess it's impact on retail electric
competition in Arizona.
NOTE 2. SEGMENT AND RELATED INFORMATION
In 1998, we adopted Statement of Financial Accounting Standards
No.131 (FAS 131), Disclosures about Segments of an Enterprise and
Related Information, which requires that we report financial and
descriptive information about our operating segments. These segments
are determined based on the way we organize our operations and evaluate
performance. UniSource Energy's principal business segment is the
regulated electric utility business of TEP. The other reportable
business segment is the unregulated energy businesses of Millennium:
- Advanced Energy Technologies, Inc. (Advanced Energy) which owns 50
percent of Global Solar Energy, L.L.C., a developer and manufacturer of
photovoltaic materials;
- MEH Corporation (MEH) which holds a 50 percent interest in New
Energy Ventures, Inc. (NEV), an energy buyer representative; and
- Nations Energy Corporation (Nations) which is an independent power
developer.
See Note 3 for more information on our unregulated energy
businesses. Intersegment revenues are not material.
We disclose selected financial data for our business segments in the
following table:
- ----------------------------------------------------------------------
Segments
----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Reconciling Energy
Utility Businesses Adjustments Consolidated
- ----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Three months ended
March 31, 1999:
Operating Revenues $160,636 $ 1,627 $ (1,753) $ 160,510
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy (374)
MEH (577)
Nations (1,942)
Other Entities 100
--------
Total Net
Income (Loss) (1,320) (2,793) (1,415) (5,528)
- ----------------------------------------------------------------------
Three months ended
March 31, 1998:
Operating Revenues 161,003 341 (403) 160,941
- ----------------------------------------------------------------------
Net Income (Loss):
Advanced Energy 170
MEH (4,050)
Nations (204)
Other Entities 48
--------
Total Net
Income (Loss) (1,607) (4,036) (1,392) (7,035)
- ----------------------------------------------------------------------
The reconciling adjustments include the following:
- Elimination of the revenues of Millennium's unregulated energy
businesses to show this activity in Unregulated Energy Businesses - Net
in the Other Income (Deductions) section of UniSource Energy's income
statements, and
- Elimination of intercompany activity and balances.
NOTE 3. UNREGULATED ENERGY BUSINESSES
Purchase of Generating Assets by Nations Energy
In March 1999, Nations Energy funded $3.3 million of equity in a
Curacao refinery project. The investment was made through a special
purpose company, Curacao Energy Company, Ltd., which will own a
controlling interest in the project. The project is a 167MW
cogeneration facility that will supply power, steam, water and
compressed air to Refineria di Korsou. Construction is planned to
begin later this year.
Nations Energy Holland Holding increased its minority equity
interest in a power project located in the Czech Republic with an $0.8
million payment in the first quarter of 1999. The $400 million, 340 MW
project is scheduled for completion in late 1999. Once completed, the
generating facility will sell power to a regional distribution company
and to an adjacent industrial complex.
NOTE 4. TAX ASSESSMENTS
Ruling on Arizona Sales Tax Assessments - Coal Sales
We received from the ADOR and are protesting, sales tax
assessments which allege that a former TEP subsidiary is liable for
sales tax on gross income from coal sales, transportation and coal-
handling services provided to TEP from November 1985 through May 1996.
Arizona law generally requires payment of an assessment prior to
pursuing the appellate process. We have previously paid, under
protest, a total of $23 million of the disputed sales tax assessments.
In September 1996, the Arizona Court of Appeals upheld the validity of
the assessment issued for the period November 1985 through March 1990.
However, in May 1998, the Arizona Supreme Court remanded the case back
to the Arizona Tax Court to be reheard. The case is set for trial in
the first week of June 1999. The payments previously made will be
refunded if we are successful in the appeal.
TEP has recorded an expense and a related liability for the sales
taxes and interest for the period November 1985 through May 1996 that
we believe are probable of incurrence. On May 31, 1996, the former
subsidiary was merged into TEP. Because TEP now acquires coal directly
from unaffiliated companies, we do not believe we are liable for sales
tax computed on a basis similar to the assessments described above
after May 31, 1996. For periods prior to May 31, 1996, we continue to
record an estimated interest expense on the disputed assessments.
Arizona Sales Tax Assessments - Leases
The ADOR has issued sales tax assessments to some of the lessors
of TEP's generation-related facilities and equipment. The assessments
allege sales tax liability on a component of rents we paid on the
Springerville Unit 1 Leases, the Springerville Common Facilities
Leases, the Irvington Lease and the Springerville Coal Handling
Facilities Lease from August 1, 1988 to June 30, 1997. Under the
indemnification provisions in the lease agreements, if the ADOR
prevails, we would be required to reimburse the lessors for the sales
taxes that they pay. We filed an appeal of the assessments in the
Arizona Tax Court in February 1998. In July 1998, the Arizona Tax
Court upheld the assessment issued on the Irvington lease for the
period August 1988 through September 1990, and we have appealed the
decision. Oral argument on the appeal is scheduled to begin on May 25,
1999. Arizona law generally requires payment of an assessment prior to
pursuing the appellate process. Under protest, we paid a total of $2
million of the disputed assessments. These payments will be refunded
if we are successful in the appeals process.
We have recorded a liability for the probable amount of sales
taxes and interest due as of March 31, 1999. If the ADOR prevails, we
would need to record an additional expense and related liability. Even
though it is reasonably possible that the resolution of this issue
could result in approximately $23 million of additional sales tax
expense, we do not believe this outcome is likely. We do not expect
that the resolution of this assessment will have a material negative
impact on the financial statements. We believe that the ultimate
resolution of this issue could occur between two to four years from
now.
INCOME TAX ASSESSMENTS
In February 1998, the IRS issued an income tax assessment for the
1992 and 1993 tax years. The IRS is challenging our treatment of
various items relating to a 1992 financial restructuring, including the
amount of NOL and ITC generated before December 1991 that may be used
to reduce taxes in future periods.
Due to a financial restructuring, a change in TEP's ownership
occurred for tax purposes in December 1991. As a result, our use of
the NOL and ITC generated before 1992 may be limited under the tax
code. The IRS is challenging our calculation of this limitation. At
March 31, 1999, pre-1992 federal NOL and ITC carryforwards were
approximately $200 million and $23 million, respectively. In addition
to the pre-1992 NOL and ITC which are subject to the limitation, $203
million of federal NOL at March 31, 1999, is not subject to the
limitation.
We do not expect the resolution of these issues to have a material
adverse impact on the financial statements.
NOTE 5. SPRINGERVILLE COMMON FACILITIES LEASE
Under the terms of the Springerville Common Facilities lease
agreement, we must ensure that $70 million of secured notes underlying
this lease are refinanced by December 31, 1999 in order to avoid a
special event of loss under the lease. This special event of loss would
require us to repurchase the Springerville Common Facilities at the
higher of a specified price or the fair market value of the facilities.
TEP has intends, and believes it has the ability, to refinance the
underlying debt on these leases in 1999.
NOTE 6. INCOME TAXES
The differences between the income tax expense (benefit) and the
amount obtained by multiplying income before income taxes by the U.S.
statutory federal income tax rate are as follows:
UniSource
Energy TEP
------------------ ------------------
Three Months Ended Three Months Ended
March 31, March 31,
1999 1998 1999 1998
- --------------------------------------------------------------------
-Thousands of Dollars -
Federal Income Tax
Benefit at Statutory Rate $ (3,040) $ (3,903) $ (949) $ (694)
State Income Tax Benefit,
Net of Federal Benefit (422) (601) (132) (107)
Depreciation Differences
(Flow Through Basis) 326 1,040 326 1,040
Investment Tax Credit
Amortization (700) (573) (700) (573)
Adjustment for Unregulated
Energy Businesses - (276) - -
Foreign Operations of
Unregulated Energy Businesses 613 238 - -
Other 65 (42) 65 (43)
- --------------------------------------------------------------------
Total Benefit for Federal
and State Income Taxes $ (3,158) $ (4,117) $ (1,390) $ (377)
====================================================================
Income taxes are included in the income statements as follows:
UniSource
Energy TEP
------------------- -----------------
Three Months Ended Three Months Ended
March 31, March 31,
1999 1998 1999 1998
- --------------------------------------------------------------------
-Thousands of Dollars -
Operating (Benefits) $ (2,559) $ (1,937) $ (2,559) $ (1,937)
Other Deductions 232 631 1,169 1,560
Unregulated Energy
Businesses - Net (831) (2,811) - -
- --------------------------------------------------------------------
Total Income Tax Benefit $ (3,158) $ (4,117) $ (1,390) $ (377)
====================================================================
As of December 31, 1997 both UniSource Energy and TEP had recorded
the amount of prior period NOL benefit that we expect to use on future
income tax returns. At the present time, we are not able to estimate
future additional amounts of NOL benefit that we may recognize in the
income statements of either UniSource Energy or TEP. This is because
there are still open tax years for which there may be additional
assessments and because federal and state NOL carryforwards have
varying expiration dates. We do not expect to recognize additional
amounts of NOL benefit until such items are resolved.
NOTE 7. NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 (FAS 133),
Accounting for Derivative Instruments and Hedging Activities. A
derivative financial instrument or other contract derives its value
from another investment or designated benchmark. This Statement
requires all derivative instruments to be recognized as either assets
or liabilities in the balance sheet. Some derivative instruments
offset, or hedge, exposure to a specific risk. If the derivative is
not a hedging instrument, measurement is at fair value and changes in
fair value (i.e., gains and losses) are recognized in earnings in the
period of change. If a derivative qualifies as a hedge, the accounting
for changes in fair value will depend on the specific exposure being
hedged. We are required to adopt FAS 133 in the first quarter of 2000.
We are still in the process of quantifying the effect, if any, that the
adoption of FAS 133 will have on our financial statements.
In November 1998, the Emerging Issues Task Force issued guidance
on accounting for energy trading activities (EITF 98-10). Energy
trading activities are intended to generate profits from changes in the
market prices for energy-related commodities such as electricity,
natural gas and coal. These activities include certain purchase power
and transmission contracts. This guidance would require us to measure
the difference between cost and market value for our energy contracts
and include any resulting gains or losses in earnings. We adopted this
guidance in the first quarter of 1999. TEP does engage in some forms
of energy trading but does not engage in the type of energy purchases
and sales defined in EITF 98-10 as energy trading; therefore the
adoption of this guidance had no effect on our financial statements.
NOTE 8. REVIEW BY INDEPENDENT PUBLIC ACCOUNTANTS
With respect to the unaudited consolidated financial information
of TEP for the three-month periods ended March 31, 1999 and 1998,
PricewaterhouseCoopers LLP reported that they have applied limited
procedures in accordance with professional standards for a review of
such information. However, their separate report dated May 17 , 1999,
appearing herein, states that they did not audit and they do not
express an opinion on that unaudited consolidated financial
information. Accordingly, the degree of reliance on their report on
such information should be restricted in light of the limited nature of
the review procedures applied. PricewaterhouseCoopers LLP is not
subject to the liability provisions of section 11 of the Securities Act
of 1933 for their report on the unaudited consolidated financial
information because that report is not a "report" or a "part" of a
registration statement prepared or certified by PricewaterhouseCoopers
LLP within the meaning of sections 7 and 11 of the Act.
NOTE 9. RECLASSIFICATIONS
Minor reclassifications 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
- ---------------------------------------------------------------------------
UniSource Energy is a holding company that owns all of the outstanding
common stock of TEP and Millennium. TEP is an operating public utility
engaged in the generation, purchase, transmission, distribution and sale of
electricity for customers in the greater Tucson, Arizona area and to
wholesale customers. Millennium owns all of the outstanding common stock
of four subsidiaries established for the purpose of operating or investing
in various unregulated energy-related businesses.
Management's Discussion and Analysis centers on the general financial
condition and the results of operations for UniSource Energy and its two
primary business segments, the regulated electric utility business of TEP
and the unregulated energy businesses of Millennium, and includes the
following:
-- operating results during the first quarter compared with the same
period in the prior year,
-- the outlook for dividends on common stock,
-- changes in liquidity and capital resources during the first quarter of
1999, and
-- expectations of identifiable material trends which may affect our
business in the future.
TEP is the principal operating subsidiary of UniSource Energy and
accounts for substantially all of its assets, revenues and net income. The
financial condition and results of operations of TEP are currently the
principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis, although losses from
energy-related businesses of Millennium and certain of its subsidiaries and
interests have reduced the earnings reported by UniSource Energy for the
quarters ended March 31, 1999 and 1998.
Management's Discussion and Analysis should be read in conjunction
with the Company's Condensed Consolidated Financial Statements, beginning
on page 2, which present the results of operations for the quarters ended
March 31, 1999 and 1998. Management's Discussion and Analysis analyzes and
explains the differences between periods for specific line items of the
Condensed Consolidated Financial Statements.
OVERVIEW
- --------
UniSource Energy recorded a net loss of $5.5 million for the first
quarter of 1999, compared with a net loss of $7.0 million in the first
quarter of 1998. The improvement in first quarter results over the prior
year was due primarily to lower net losses recorded by Millennium's
unregulated energy businesses. This factor, along with other factors which
affected first quarter results, are discussed in more detail in Results of
Operations and Results of Unregulated Energy Businesses below.
Our financial prospects are subject to significant regulatory,
economic, and other uncertainties. Regulatory uncertainties include the
impact of the introduction of retail competition in Arizona and the
resolution of stranded cost recovery. Until the uncertainties surrounding
the introduction of retail competition in Arizona are resolved, predicting
the level of TEP's future energy sales and the composition of its future
revenues is difficult. See Competition, Retail below.
In a deregulated environment, revenues from sales of energy may
become less certain although revenues from transmission and distribution
services, which we expect to remain regulated, would likely continue to
grow. Even in a deregulated environment, TEP expects to continue to
benefit from the anticipated population and economic growth in the Tucson
area through increased revenues from its regulated services. Other
uncertainties include the extent to which TEP's ability to alter operations
and reduce costs in response to industry changes or unanticipated economic
downturns may be limited due to high financial and operating leverage.
Our future success will depend, in part, on our ability to contain and/or
reduce the costs of serving retail customers and the level of sales to such
customers.
We are addressing the uncertainties discussed above by positioning our
subsidiaries to benefit from the changing regulatory environment. We have
aligned our corporate structure to better meet the needs of the emerging
energy markets. In November 1998, TEP organized its regulated business
activities into three separate business units: generation, transmission and
distribution, and in January 1999, formed a business unit which provides
administrative services to the utility business units. Also, we are
improving cost measurement and management techniques at TEP. We have
extended contracts, where appropriate, for large wholesale and retail
customers, and are developing new affiliates to provide energy services to
markets beyond TEP's retail service territory. See Competition, Retail;
Results of Unregulated Energy Businesses; and Results of Operations below.
Our financial prospects are also subject to uncertainties relating to
the start-up and developmental activities of our unregulated energy
business segment. Although our investments in unregulated energy-related
affiliates comprise approximately 3% of total assets, start-up costs and
other subsidiary developmental activities have contributed to losses from
certain of these activities in 1999 and 1998.
Our consolidated capital structure remains highly leveraged. Since
April 1997, however, we have made significant progress in our financial
strategy to reduce refinancing risk by extending maturities of long-term
debt and letters of credit and by reducing exposure to variable interest
rates by refinancing with fixed interest rate securities.
Our businesses require large amounts of capital. TEP's capital
requirements include construction expenditures, scheduled debt maturities
and capital lease obligations. During the next twelve months, TEP expects
to be able to fund operating activities and construction expenditures with
internal cash flows, existing cash balances, and, if necessary, borrowings
under the Revolving Credit Facility. Some of our unregulated energy
businesses also require significant amounts of capital in the form of
investments, loans or guarantees. Our ability to invest additional amounts
of capital in our unregulated businesses will depend on dividends from TEP
and possible sales of equity securities. If necessary, we may seek
investments by unaffiliated parties to meet the ongoing capital
requirements of some of these businesses. See Liquidity and Capital
Resources; Investing and Financing Activities, below.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
-----------
RETAIL
Under current law, TEP does not compete with other companies for
electric service in TEP's retail service territory. However, TEP competes
against gas service suppliers and others who provide energy services. TEP
actively markets energy and customized energy-related services. We have
not lost any customers to self-generation partly because of these efforts.
For example, in recent years, TEP executed new contracts with two principal
customers that provide approximately 10% of TEP's total annual retail
revenues. Both customers are in the copper mining business. The new
contracts include price reductions, term extensions, and a provision for
interruptible service. These contracts expire in March 2001 and January
2003. These mining customers cannot terminate the contracts early without
at least one and up to two years notice. We have not received any such
notices.
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electric services.
In this section, we discuss the current status of regulatory actions of the
ACC regarding the introduction of retail electric competition in Arizona.
We also outline TEP's responses to these actions. There is considerable
uncertainty regarding the timing and the outcome of these matters. As a
result, we cannot predict the impact of retail competition on TEP's future
operating results or financial condition.
Retail Electric Competition Rules
---------------------------------
In December 1996, the ACC adopted retail electric competition rules
(Rules) that provided a framework for the phase-in of retail electric
competition in Arizona beginning in January 1999. The Rules were amended
and adopted on an emergency basis in August 1998. The Rules, as originally
adopted, assumed a competition start date of January 1, 1999. However, in
January 1999, the ACC delayed the implementation of the Rules pending
additional proceedings to resolve a number of important issues.
On April 14, 1999, the ACC approved amendments to the Rules. The
approved Rules include:
-- The date to open an Affected Utility's service territory to
competition would be set upon the resolution its of Stranded Costs and
Unbundled Tariffs by final ACC order.
-- If an Affected Utility's service territory is open prior to January 1,
2001, the existing phase-in schedule would be retained, calling for 20
percent of the market to initially have access to competitive generation
supply. As part of the 20 percent, each Affected Utility would reserve
an increasing percentage for residential customers according to a set
schedule.
-- Competitive Energy Service Provider affiliates of Affected Utilities
would not be permitted to enter another Affected Utility's service
territory until its own territory is open to competition. For example,
NEV Southwest may not sell energy to retail customers of other Affected
Utilities until TEP's territory is open to competition.
-- Requirements that a portion of energy sold competitively be generated
from solar sources would be eliminated.
The amended Rules adopt a similar phase-in to the competitive market
as the original rules, calling for three customer classes to be given the
initial opportunity for choice:
-- Large customers whose average usage/load is 1 megawatt (MW) or above,
such as mines, refineries, factories, and resorts. TEP currently serves
about 80 such customers in this category, representing 351 MW of load. Of
this load, approximately 60 percent is under contract through 2001;
-- Smaller commercial customers whose individual peak usage totals 40
kilowatts (kW) or greater, who can aggregate with similar entities to
reach a total load of 1 MW, also are eligible. Examples of these
customers are convenience stores, small fast-food restaurants and
large retail stores; and
-- A percentage of TEP's residential customers will be able to choose to
participate in the new market on a first-come, first-served basis. Every
three months, an additional one and one-quarter percent of residential
consumers will have the opportunity to choose.
By January 1, 2001, consumer choice will be available to all
customers. TEP, as the regulated local distribution company, will continue
to exclusively provide delivery of electricity over its power lines to
homes and businesses. TEP also will continue to be responsible for the
operation and maintenance of the lines. For those customers who do not, or
cannot, choose other energy providers, TEP remains obligated to provide
energy to those customers.
Under these Rules, competition will begin in each Affected Utility's
service territory after the Affected Utility's stranded cost plan is
approved by the ACC. We anticipate that public comment sessions will be
held in June 1999, and the Rules could be resubmitted to the ACC for their
final approval in July or August of 1999.
Rate Settlement Agreement
-------------------------
On August 25, 1998, the ACC approved a rate settlement agreement (Rate
Settlement) which gives TEP's retail customers the following base price
decreases:
-- an initial 1.1% decrease (about $7.0 million) which was effective
July 1, 1998;
-- a second decrease of 1.0% (about $5.5 million) on July 1, 1999; and
-- an additional 1.0% decrease (about $5.5 million) on July 1, 2000.
The latter two decreases will apply to all tariffed retail customers
prior to the start of competition and to all Standard Offer Electric
Service customers who do not have, or do not choose, access to competing
electric service providers during the proposed phase-in of the ACC's
electric competition rules. The Rate Settlement meets the requirement in
the ACC's electric competition rules for a 3-5% rate reduction.
Stranded Costs
--------------
In June 1998, the ACC adopted an order that outlined two options for
stranded cost recovery: 1) Divestiture/ Auction of all generation assets
to determine the amount of stranded costs for 100 percent recovery, or 2) a
Transition Revenues Methodology, where the Affected Utility would retain
generation assets in a separate affiliate with sufficient revenues
necessary to maintain financial integrity, such as avoiding default under
current existing financial instruments for a period of ten years.
In accordance with the June 1998 order, TEP filed with the ACC in
August 1998 a proposed plan for divestiture of generating assets and
stranded cost recovery. In this plan, TEP estimated that stranded costs
may range from $600 million to $1.1 billion, and proposed to recover
stranded costs and a return on any unamortized balance over a ten-year
period. In January 1999, the ACC stayed the effectiveness of the electric
competition rules and the June 1998 order.
On April 14, 1999, the ACC issued an order modifying the June 1998
order and providing the following options for stranded cost recovery:
1.Net Revenues Lost Methodology -- Stranded costs would be determined by
comparing generation revenues under competition to revenues under
regulation. Using growth as a mitigating factor, the amount of recovery
would be reduced over a five-year period.
2.Divestiture/Auction Methodology -- Stranded costs would be determined
by auctioning all non-essential generation assets. The amount of
stranded costs would be the difference between the assets' market value
and their book value. Recovery of stranded costs would occur over
10 years.
3.Financial Integrity Methodology -- The affected utility would recover
costs sufficient to maintain financial integrity, such as avoiding
default under currently existing financial instruments for a period of
ten years, at which time there would be no remaining stranded costs.
4.Settlement Methodology -- This option provides for some combination of
the three preceding methods, submitted as a settlement option.
5.Alternative Methodology -- This option would allow Affected Utilities
to file an alternative plan. Under this option, utilities would be
required to demonstrate how an alternative plan would be in the best
interests of all stakeholders.
Additional details for each method listed above is available in the
1998 Form 10-K.
TEP has until June 14, 1999 to amend its previously filed stranded
cost recovery plan. Although TEP's original stranded cost plan specified
divestiture of generation assets as the preferred method for recovery given
the options available at the time, TEP is currently evaluating each of the
five methodologies described above. In any case, TEP continues to seek 100%
recovery of its stranded costs.
WHOLESALE
---------
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy in the
wholesale market. FERC generally does not permit TEP's prices for
wholesale sales of capacity and energy to exceed rates determined on a cost
of service basis. However, in the fall of 1997, FERC granted TEP a tariff
to sell at market-based rates. In the current market, wholesale prices are
typically substantially below TEP's total cost of service, but in all
instances, we make wholesale sales at prices which exceed fuel and other
variable costs. We expect competition to sell capacity to remain vigorous.
Competition for the sale of capacity and energy is influenced by the
following factors:
-- availability of capacity in the southwestern United States,
-- the availability and prices of natural gas, oil and coal,
spot energy prices, and
-- transmission access.
TEP, along with other transmission owners and users located in the
southwestern United States, is investigating the feasibility of forming an
ISO for the region. An ISO would be responsible for ensuring transmission
reliability and nondiscriminatory access to the regional transmission grid.
Over 50 participants have signed a Development Agreement. The formation of
an ISO would be subject to approval by the FERC and state regulatory
authorities in the region. The financial aspects of forming an ISO,
including the potential effects on TEP's future results of operations, will
be examined as part of the developmental work.
The ACC electric competition rules, as discussed above, require the
formation and implementation of an Arizona Independent Scheduling
Administrator Association (AISA). The purpose of the AISA is to:
-- calculate available transmission capacity for Arizona transmission
facilities that belong to the Affected Utilities or other participants;
-- develop and operate an OASIS which covers all participants'
transmission systems;
-- implement and oversee the nondiscriminatory application of protocols
to ensure statewide consistency for transmission access; and
-- provide dispute resolution processes and receive all requests for
reservation and scheduling of Arizona transmission facilities.
TEP, as an Affected Utility, participated in the creation of the AISA.
This includes incorporation as a not-for-profit entity, the filing at the
FERC for approval of its proposed structure, rates and procedures, and the
drafting of its protocols for operation. At the AISA's request, FERC has
not ruled upon the filing pending the outcome of the electric competition
rules. TEP continues to participate, however, with the other Affected
Utilities in developing the AISA's corporate structure and protocols in
anticipation of the implementation of retail competition. See Competition,
Retail.
ACCOUNTING FOR THE EFFECTS OF REGULATION
- ----------------------------------------
The ACC regulates TEP's retail utility business. TEP generally uses
the same accounting policies and practices used by unregulated companies
for financial reporting under generally accepted accounting principles.
However, sometimes these principles, such as FAS 71, require special
accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the ACC may not
allow TEP to charge its customers currently to recover certain expenses
but; instead, require that these expenses be recovered from customers in
the future. In this situation, FAS 71 requires that TEP capitalize and
report these expenses as regulatory assets on the balance sheet until TEP
is allowed to charge its customers. TEP then amortizes these items to the
income statement as those amounts are recovered from customers. Similarly,
certain items of revenue may be deferred as regulatory liabilities, which
are also eventually amortized to the income statement.
We have recorded regulatory assets and liabilities in our balance
sheets in accordance with FAS 71. A regulated company must satisfy certain
conditions to apply the accounting policies and practices of FAS 71. These
conditions include:
-- an independent regulator sets rates;
-- the regulator sets the rates to cover specific costs of delivering
service; and
-- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
We periodically assess whether we continue to meet these conditions.
If we were required to stop applying FAS 71 to all or a portion of TEP's
regulated utility operations, we would write off the related balances of
TEP's regulatory assets and liabilities as a charge in our income
statement. In that event, our earnings would be reduced by the net amount
of regulatory assets and liabilities, after applicable deferred income
taxes. Based on the balances of TEP's regulatory assets and liabilities at
March 31, 1999, if we ceased applying FAS 71 to all of TEP's regulated
operations, we would record an extraordinary loss of approximately $140
million, net of the related deferred income tax benefit of $93 million.
Approximately 60% of TEP's net regulatory assets on the balance sheet
relate to electric generation. While our cash flows may be affected by
regulatory orders and market conditions, our cash flows would not be
affected if we ceased to apply FAS 71.
If we stop applying FAS 71, we would need to evaluate the likelihood
that we could recover the cost of TEP's electric plant in the marketplace.
If undiscounted cash flows are less than the carrying value of those plant
assets that we continue to own, then we would need to write off as an
expense a portion of those plant assets to reflect their current market
value. Plant assets to be disposed of would be written down to fair value
if it is less than carrying value. We cannot predict if we would write off
any plant assets as a result of these evaluations.
TEP will stop accounting for its generation operations using FAS 71
when the ACC approves a cost recovery plan specific to TEP which includes
the amount of stranded costs (including regulatory assets, net of
regulatory liabilities) that TEP can recover and a cost recovery method.
The amount and method of recovery that the ACC approves for TEP will
determine whether write-offs or other adjustments will occur at that time.
Until the ACC approves the amount and recovery method, we are unable to
predict the amount of write-offs or other adjustments, if any, which would
be recorded at that time.
MARKET RISKS
- ------------
We are potentially exposed to various forms of market risk. Changes
in interest rates, returns on marketable securities, changes in foreign
currency exchange rates, and changes in commodity prices may affect our
future financial results. TEP currently uses derivative commodity
instruments such as forward contracts to buy or sell energy but does not
use derivative financial instruments for hedging, trading or speculative
purposes. TEP continues to evaluate to what extent, if any, it may use
derivative financial and commodity instruments in the normal course of its
future business. Nations Energy uses derivative financial instruments to
manage certain interest rate risks, as described in Interest Rate Risk
below.
NEV, which is accounted for as a 50% owned equity investment of
Millennium, is also exposed to changes in the market price of electricity.
As an equity investment, our exposure to NEV is restricted to the amount of
our investment, advances and guarantees which are described in Note 3 of
Notes to Condensed Consolidated Financial Statements, Unregulated Energy
Businesses.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements below.
Interest Rate Risk
------------------
Exposure to interest rate changes relates primarily to TEP's long-term
debt obligations. The Company's market risks related to TEP's long-term
debt obligations have not changed materially from the market risks reported
in the 1998 Form 10-K.
Nations Energy has exposure to interest rate changes for certain of
its overseas projects and uses swap agreements to manage its interest rate
exposure. The agreements have the effect of converting certain variable
rate obligations to fixed rate obligations.
Marketable Securities Risk
--------------------------
Exposure to fluctuations in the return on marketable securities
relates to TEP's investment in debt securities. The Company's market risks
related to marketable securities have not changed materially from the
market risks reported in the 1998 Form 10-K.
Foreign Currency Exchange Risk
------------------------------
Exposure to changes in foreign currency exchange rates may arise from
transactions conducted by Nations Energy in foreign currencies. Nations
Energy's investment in a power project in the Czech Republic is highly
leveraged. Portions of the project's debt are denominated in U.S.
Dollars, German Deutschmarks, and Czech Korunas. The project bears the
risk that the value of the debt in each currency changes with fluctuations
in the applicable exchange rates, as well as the risk that the amount of
interest due each period changes with fluctuations in the applicable
exchange rates. The impact of recording the exchange rate fluctuations on
UniSource Energy's income statement for the period January through March
1999 was a loss of approximately $1.6 million.
Commodity Price Risk
--------------------
Exposure to changes in commodity prices at TEP relates to changes in
the market price of electricity, as well as to changes in fuel costs
incurred to generate electricity. The Company's market risks related to
changes in commodity prices have not changed materially from the market
risks reported in the 1998 Form 10-K.
FUTURE GENERATING RESOURCES
- ---------------------------
In the past, TEP assessed its need for future generating resources
based on the premise of a continued regulatory requirement to serve
customers in TEP's retail service area. However, the obligation to serve
all customers will likely be modified by the ACC's electric competition
rules. Further, the need for future resources will be affected by these
rules and TEP's ability to retain and attract customers. Under the
electric competition rules as adopted, some of TEP's retail customers will
be eligible to choose alternative energy providers when retail competition
is introduced. For those customers who do not or cannot choose other
energy providers, TEP remains obligated to provide energy. However, this
energy is not required to come from TEP-owned generating assets. See
Competition, Retail.
Regardless of who supplies electric power in TEP's retail service
area, TEP believes additional peaking resources are needed in Tucson by
2001 to improve system reliability locally. Therefore, in the first
quarter of 1999, TEP issued request for proposals for third parties to
provide 75 MW of peaking resources to be located in TEP's service
territory. The request for proposals contemplates TEP purchasing peaking
capacity on an as-needed basis through a "Must-Run Generation" contract.
Must-run generating units are those which are required to run in order to
maintain distribution system reliability and meet load requirements.
IMPACT OF THE YEAR 2000 ON COMPUTER SYSTEMS AND APPLICATIONS
- ------------------------------------------------------------
Our Year 2000 (Y2K) efforts began in 1996 and involve the inventory,
assessment, remediation and testing of our operational and business
systems. Our goal is to provide uninterrupted electric service and to
process business transactions at year 2000 and beyond. We believe that all
identified mission critical systems and applications within our control
will be Y2K ready by June 30, 1999. We believe that all identified
business critical systems and applications within our control will be Y2K
ready by September 30, 1999. "Y2K ready" means the systems have been
checked for date processing and are expected to operate properly for their
specific business requirements into year 2000.
State of Readiness
------------------
We have completed an inventory and assessment for each of TEP's
critical and non-critical information systems and embedded technologies.
The following areas are being addressed: control and embedded systems;
enterprise information systems; suppliers; and subsidiaries.
Control and Embedded Systems - We are reviewing the control and embedded
systems of TEP's utility plant including generation units partly owned but
not operated by TEP. Many of these systems are critical to the power
generation, transmission and distribution of electric service. The
inventory and assessment stages of this program were completed by September
30, 1998.
The testing and remediation efforts are over 90% complete for the critical
systems and are scheduled to be completed by June 30, 1999. A software
upgrade for the Energy Management (SCADA) System was placed in service on
April 1, 1999 and this system is now Y2K ready. Major upgrades for power
generation systems are scheduled for the second quarter of 1999 during
scheduled outages. All protective field devices are prepared for Y2K.
Enterprise Information Systems - We began the remediation, replacement, or
upgrade of these systems in 1996. We expect to complete this process by
the end of second quarter 1999. The following systems are included:
Department or Area Comments
------------------ --------
Customer Services, Billing, The vendor supplying the Customer
Receivables Information System has recently
identified some Y2K patches that will
be installed in the second quarter of
1999. Also, the current version of
the underlying software upon which the
system is built is not yet Y2K
compliant. We expect an updated
release of this software, which is Y2K
compliant, to be installed before the
end of the second quarter of 1999.
Human Resources, Payroll Y2K ready - System installed in 1993
and upgraded to be Y2K ready in 1998.
Work Management The vendor supplying the Work
Management System has recently
identified an upgraded release for
Year 2000. The upgrade is scheduled
for installation in the second quarter
of 1999. Also, the current version of
the underlying software upon which the
system is built is not Y2K compliant.
We expect an updated release of this
software, which is Y2K compliant, to
be installed before the end of the
second quarter of 1999.
General Ledger,Fixed Scheduled for replacement in second
Assets, Projects quarter 1999. Current systems are now
being remediated as a contingency with
a scheduled completion date in the
second quarter of 1999.
Accounts Payable, Y2K ready - Remediation completed in
Purchasing, Inventory 1998.
Testing of the current general ledger and fixed assets applications
continued in the first quarter of 1999 to cover additional month-end
closings. Upgrades to the operating system software are scheduled through
the second quarter of 1999. An integrated test is then scheduled for the
third quarter of 1999 for the enterprise hardware, operating software, and
major applications with year 2000 date processing.
Suppliers - We have identified the major vendors from whom we buy goods or
services for the generation, transmission and distribution of electrical
service. We are working with these vendors to determine their plans and to
investigate any potential impact on TEP. Major vendors of other TEP
business areas are also being reviewed for Y2K compliance.
Millennium Subsidiaries - We have contacted NEV, Nations Energy, and Global
Solar to determine their state of readiness. These companies will be
monitored to ensure plans are in place to avoid Y2K disruptions.
Costs
-----
From 1996 through March 31, 1999, we have expensed $1.0 million
addressing the Y2K issue. This amount does not include major system
replacement costs that, along with other functional changes, addressed Y2K
issues. A $1.4 million budget, which includes the $1.0 million already
expensed, has been established for Y2K project costs. All remediation
costs will be expensed as incurred.
Risks
-----
Currently we believe that all identified modifications to systems that
TEP operates will be made within the required time frames. Despite our
efforts, we cannot be certain that all Y2K problems with the systems we
operate will be identified and remediated in a timely manner. Although we
do not expect any of our potential Y2K problems to be major, it is possible
that such failure could disrupt the generation, transmission or
distribution of electric energy or the billing and collection process.
We cannot assure that systems or parties we do not control are
prepared for Y2K, or how this may affect TEP. As an example, the loss of
communications systems supplied by our vendors could affect our ability to
operate generation and transmission facilities. Also, interruptions of
generating capacity could result from instability of the electric grid.
TEP and other electric service providers in the WSCC are studying
possible Y2K risks resulting from interconnected electric and information
systems. The interconnected systems are critical to the reliability and
integrity of each electric service provider. As an example, the failure of
an interconnected provider to meet Y2K readiness could possibly disrupt the
provision of electric services by utilities. TEP and other electric
providers in the WSCC are working together in an effort to avoid such
disruptions.
Contingency Plans
-----------------
We are preparing contingency plans for the possibility that not all
remediation efforts, both internal and external, will succeed. We are
documenting the events or scenarios that might significantly impact the
delivery of electric service, including loss of generation, communications,
and other conditions that could result in electric power outages. We are
attempting to minimize the potential impact of these events with our draft
contingency plan that we completed in 1998. The plan includes developing
procedures, tests, and drills to coincide with the WSCC and NERC plans and
is scheduled to be finalized by June 30, 1999.
TEP performed compliance testing with the first North American
Electric Reliability Council (NERC) industry coordinated drill on April 9,
1999, and did not experience any significant events or difficulties. TEP
has scheduled to perform additional compliance testing to coincide with the
second drill on September 9, 1999.
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded a net loss of $5.5 million or $0.17 per
average share of Common Stock in the first quarter of 1999. This compares
with a net loss of $7.0 million or $0.22 per average share of Common Stock
in the first quarter of 1998. The primary reason for the smaller net loss
in the first quarter of 1999 was lower losses recorded by Millennium and
its unregulated energy businesses.
Contribution By Business Segment
--------------------------------
The table below shows the contributions to our consolidated earnings
and earnings per share by our two business segments, as well as parent
company expenses, for the three months ended March 31, 1999 and 1998:
Three Months Ended March 31
---------------------------
(Millions) Per Share
1999 1998 1999 1998
---- ---- ---- ----
Regulated Electric Utility $(1.3) $(1.6) $(0.04) $(0.05)
Unregulated Energy Businesses (2.8) (4.0) (0.09) (0.13)
Parent Company and Inter-Company
Eliminations (1.4) (1.4) (0.04) (0.04)
----- ----- ------ ------
Consolidated Net Income(Loss) $(5.5) $(7.0) $(0.17) $(0.22)
===== ===== ====== ======
TEP's regulated electric utility business accounts for substantially
all of UniSource Energy's assets, revenues, and net income on an annual
basis. The following discussion is related to TEP's utility operations,
unless otherwise noted. The results of our unregulated energy businesses
are discussed in Results of Unregulated Energy Businesses below. The
results of the parent company for the quarters ended March 31, 1999 and
1998 relate to the after-tax interest expense on the note we provided to
TEP in exchange for the stock of Millennium. See Interest Income below.
Utility Sales and Revenues
--------------------------
Comparisons of TEP's kilowatt-hour sales and electric revenues are
shown below:
Increase/(Decrease)
-------------------
Three Months Ended March 31 1999 1998 Amount Percent
--------------------------- ---- ---- ------ -------
Electric kWh Sales (000):
Retail Customers 1,662,544 1,790,309 (127,765) (7.1)%
Sales for Resale 1,179,286 850,132 329,154 38.7
--------- --------- -------
Total 2,841,830 2,640,441 201,389 7.6%
Electric Revenues (000):
Retail Customers $ 128,777 $ 138,149 $(9,372) (6.8)%
Sales for Resale 31,859 22,854 9,005 39.4
--------- --------- -------
Total $ 160,636 $ 161,003 $(367) (0.2)%
TEP's kWh sales to retail customers decreased by 7% in the first
quarter of 1999 compared with the same period in 1998. Despite a 2.6%
increase in the number of retail customers in the first quarter, total
retail kWh sales decreased due to a mild winter that reduced the demand for
electric heat in TEP's retail service territory. Revenues from sales to
retail customers were 7% lower in the first quarter of 1999 than in the
same period of 1998 because of the lower kWh sales.
TEP makes sales for resale on both a firm and interruptible basis to
the extent TEP's generating capacity is not needed for providing energy to
TEP's retail customers. TEP also enters into short-term energy sale
transactions (under one-year) that are offset by similar purchase
transactions. Rates for short-term energy sales are typically
substantially below rates determined on a fully allocated cost of service
basis, but, in all instances, rates exceed the level necessary to recover
fuel and other variable costs. KWh sales for resale and the revenues from
these sales increased by 39% in the first quarter of 1999 relative to the
same period in 1998. This increase in wholesale energy sales was due to 1)
increased power marketing activity, and 2) increased generation
availability from Irvington Unit 4, which was out of service in the first
quarter of 1998.
Operating Expenses
------------------
Total Operating Expenses remained stable in the first quarter of 1999
compared with the same period last year. Fuel and Purchased Power expense
increased 13.5% in the first quarter of 1999 compared with the same period
in 1998. This percentage increase exceeded the percentage increase in
kWh sales due to greater purchases of energy at higher prices relative to
the first quarter of 1998. Partially offsetting the higher fuel and
purchased power expenses was a 10.2% reduction in other operations and
maintenance expenses. This reduction was due to a shift in generation
maintenance activities from the first quarter to the second quarter of
1999.
Other Income (Deductions)
-------------------------
Interest Income
---------------
TEP's income statements for the quarters ended March 31, 1999 and 1998
include $2.5 million and $2.3 million, respectively of interest income on
the promissory note TEP received from UniSource Energy in exchange for the
transfer of its stock in Millennium. On UniSource Energy's consolidated
income statement, this income is eliminated as an inter-company
transaction.
Income (Losses) from Unregulated Energy Businesses
--------------------------------------------------
Our unregulated energy businesses contributed a net loss of $2.8
million for the first quarter ended March 31, 1999, compared with a net
loss of $4.0 million in the first quarter of 1998. See Note 3 of Notes To
Condensed Consolidated Financial Statements and Results of Unregulated
Energy Businesses, below for more information on the results of this
business segment.
Interest Expense
----------------
Interest expense decreased by approximately $1 million in the first
quarter of 1999 compared with the same period in 1998 due primarily to the
retirement of $30 million of long-term debt in December 1998.
Additionally, interest rates on variable rate debt were lower in the first
quarter of 1999 than in the first quarter of 1998 and contributed to the
interest expense decrease.
RESULTS OF UNREGULATED ENERGY BUSINESSES
- ----------------------------------------
The table below provides a breakdown by Millennium-owned subsidiary of
the after tax net income/(losses) recorded for the periods ended March 31,
1999 and 1998.
Three Months
Ended March 31
--------------
Subsidiary 1999 1998
---------------------------------------
- Thousands of Dollars -
AET $ (374) $ 170
MEH (577) (4,050)
Nations Energy (1,942) (204)
Other 100 48
------- -------
Total Millennium $(2,793) $(4,036)
======= =======
AET and Global Solar
--------------------
Advanced Energy Technologies, Inc. (AET) holds a 50% interest in
Global Solar Energy, L.L.C. (Global Solar), a manufacturer of thin-film
photovoltaic cells. AET's net loss in the first quarter of 1999 was due
to manufacturing startup-related expenses of the Tucson-based production
facility and the formation of an overseas affiliate to manufacture thin-
film photovoltaic cells in India. Small-scale manufacturing of thin
film photovoltaic cells would begin in the second quarter of 1999.
MEH and NEV
-----------
MEH holds a 50% interest in New Energy Ventures, Inc. (NEV). NEV was
formed to provide electricity, energy products and services, and technology-
based energy solutions to customers in deregulating energy markets. In the
first quarter of 1999, ownership of New Energy Ventures Southwest was
transferred from MEH to NEV. MEH recorded $0.9 million of losses for NEV
Southwest during the first three months of 1999. MEH has committed to fund
100% of the operating expenses of NEV Southwest until a competitive market
opens in Arizona.
MEH's net loss in the first quarter of 1998 consists of losses from
its equity investment in NEV. See Note 3 of Notes to Condensed
Consolidated Financial Statements, Unregulated Energy Businesses, for more
information regarding losses incurred by NEV.
Nations Energy
--------------
Nations Energy Corporation (Nations Energy) develops independent power
projects worldwide. The net loss of $1.9 million in first quarter of 1999
resulted principally from losses on foreign currency transactions related
to projects in the Czech Republic.
DIVIDENDS ON COMMON STOCK
- -------------------------
UniSource Energy
----------------
Our ability to pay cash dividends on common stock outstanding depends,
in part, on the cash flow from our subsidiary companies, TEP and
Millennium. TEP is our primary operating subsidiary and comprises
substantially all of UniSource Energy's assets. In December 1998, TEP
declared and paid a $30 million cash dividend to UniSource Energy.
Our Board of Directors may consider the declaration and payment of a
cash dividend to the common shareholders of UniSource Energy during 1999.
We will consider several factors in making this decision, including:
-- the capital needs of our affiliates;
-- our earnings;
-- our business prospects; and
-- the impact and status of deregulation in Arizona.
TEP
---
In December 1998, TEP declared and paid a dividend of $30 million to
UniSource Energy, its sole shareholder. TEP declared the dividend from
current year (1998) earnings since TEP has an accumulated deficit, rather
than positive retained earnings.
TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that
requires TEP to maintain a minimum level of net worth. As of March 31,
1999, the required minimum net worth was $183 million. TEP's actual net
worth at March 31, 1999 was $229 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of March 31, 1999, TEP was in
compliance with the terms of the Credit Agreement.
The ACC Holding Company Order states that TEP may not pay dividends to
UniSource Energy in excess of 75% of its earnings until TEP's equity ratio
equals 37.5% of total capital (excluding capital lease obligations). As of
March 31, 1999, TEP's equity ratio on that basis was 16%. TEP is in
compliance with this order.
In addition to these limitations, the Federal Power Act states that
dividends shall not be paid out of funds properly included in the capital
account. Although the terms of the Federal Power Act are unclear, we
believe that there is a reasonable basis to pay dividends from current year
earnings.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH FLOWS
----------
UniSource Energy
Consolidated cash and cash equivalents decreased by $16 million, or
13.2%, from the March 31, 1998 ending balance of $121.8 million to the
March 31, 1999 ending balance of $105.8 million. For the twelve-month
period ended March 31, 1999, consolidated net cash outflows for investing
and financing activities exceeded the cash generated from operating
activities.
Net cash flows from operating activities decreased by $10.8 million
in the first quarter of 1999 compared with the same period in 1998. The
decrease was due in part to higher cash outflows for the following:
-- $15.2 million in fuel and purchased power payments, due primarily to
sales increases;
-- $6.8 million in interest payments, due primarily to refinancing
activities in 1998 and related changes in interest payment dates;
-- $4.8 million for income taxes due primarily to the exhaustion of
certain tax benefits in 1998; and
-- $3.2 million in capital lease interest paid.
These cash outflows were partially offset by:
-- no cash outflows for contract termination fees in 1999, compared to
$10 million paid to a coal supplier in 1998;
-- wages paid were $6.1 million lower due primarily to a timing
difference in the payment of year-end incentive compensation to TEP
employees; and
-- higher cash receipts of $4.5 million from wholesale sales.
Total net cash outflows for investing activities decreased by $3.1
million during the first quarter of 1999 compared with the same period in
1998 due primarily to lower capital expenditures and investments in
unregulated energy businesses.
Total net cash outflows for financing activities increased by $7.2
million in the first quarter of 1999 compared with the same period in 1998
due primarily to an increase in payments applied to the principal balance
of the Springerville Unit 1 capital lease obligation.
Our consolidated cash balance, including cash equivalents, at May 7,
1999 was approximately $78 million. We invest cash balances in high-grade
money market securities with an emphasis on preserving the principal
amounts invested.
During 1999, UniSource Energy may require cash to fund investments in
our unregulated energy businesses and to pay dividends to shareholders. We
expect our sources of cash to be dividends from our subsidiaries, primarily
TEP. Although no specific offerings are currently contemplated, UniSource
Energy may also issue debt and/or equity securities from time to time. Our
cash flows may be subject to variation if TEP's actual results differ from
forecasts. If cash flows were to fall short of expectations, we would
reevaluate the investment requirements of our unregulated energy businesses
and/or seek additional financing for those businesses by unrelated parties.
TEP
---
Cash and cash equivalents increased by $2.9 million, or 3.5%, from the
March 31, 1998 ending balance of $83.2 million to the March 31, 1999 ending
balance of $86.1 million. For the twelve-month period ended March 31,
1999, net cash inflows for operating activities exceeded cash outflows from
investing and financing activities.
Net cash flows from operating activities decreased by $9.6 million in
the first quarter of 1999 compared with the same period in 1998. See
UniSource Energy, Cash Flows above for a discussion of factors affecting
net cash flows from operating activities.
Net cash outflows for investing activities decreased $47.9 million in
first quarter of 1999 from the first quarter of 1998. Prior to January 1,
1998, the Unregulated Energy Businesses were subsidiaries of TEP. The
transfer of Millennium and its $45 million of cash from TEP to UniSource
Energy on January 1, 1998 is reflected as a use of cash on TEP's statement
of cash flows. The subsidiaries holding that cash were subsidiaries of TEP
at year-end 1997, and became subsidiaries of UniSource Energy on January 1,
1998. Additionally, TEP's capital expenditures were $2.9 million lower in
the first quarter of 1999 than in the first quarter of 1998.
Net cash outflows for financing activities increased $7.3 million in
1999's first quarter over the same quarter in 1998. The increase was due
primarily to higher required payments on the Springerville Unit 1 capital
lease obligation.
TEP's consolidated cash balance, including cash equivalents, at May 7,
1999 was approximately $65 million.
TEP expects to generate enough cash flow during 1999 to fund
continuing operating activities, construction expenditures, required debt
maturities, and to pay dividends to UniSource Energy. Actual cash flows
may vary from projections if there are changes in wholesale revenues,
changes in short-term interest rates or other factors. If cash flows were
to fall short of our expectations, TEP would use existing cash balances
and, if necessary, borrow from the Revolving Credit Facility.
INVESTING AND FINANCING ACTIVITIES
- ----------------------------------
UniSource Energy
----------------
Loans and Guarantees
--------------------
Effective September 1, 1997, MEH exercised an option to acquire a 50%
ownership in NEV and made a $0.8 million capital contribution.
In December 1997, MEH committed to provide NEV with $20 million of
funding. At March 31, 1999, NEV had received $19 million in debt funding
under the commitment, resulting in a remaining commitment amount available
of $1 million at March 31, 1999. Additionally, in September 1998, NEV
issued a $4.8 million promissory note to MEH for a $3 million loan MEH
extended to NEV in September 1997, as well as preferred operating return
due MEH under the terms of NEV's original operating agreement.
In December 1998, UniSource Energy committed $30 million in credit to
NEV. NEV has drawn $15 million on the credit commitment at March 31, 1999.
NEV also had accrued interest and other accounts payable to MEH that
reduces the amount available to MEH under this credit commitment. Under
the terms of the commitment, NEV must provide collateral prior to any amounts
being drawn under this credit commitment.
Additionally, in August 1998, UniSource Energy guaranteed a $10
million loan that NEV obtained from an unrelated party. The note is callable
at any time after May 17, 1999. UniSource Energy is the guarantor of
performance bonds and other guarantees that secure amounts NEV may owe to
the utility distribution companies (UDCs) and energy suppliers in connection
with NEV's sales to retail electric customers. NEV bills its customers for
these charges. UniSource Energy's guarantees are secured by various NEV
accounts receivable and other assets.
Stock Warrants
--------------
In 1998, UniSource Energy offered to exchange UniSource Energy
warrants for TEP warrants. As of March 31, 1999:
-- 4.6 million TEP warrants,which expire December 15,2002, remained
outstanding;
-- 1.5 million UniSource Energy warrants expired; and
-- 1.5 million UniSource Energy warrants, which expire on December 15,
2000, remain outstanding.
TEP
---
Capital Expenditures
--------------------
TEP's capital expenditures for the quarter ended March 31, 1999 were
$15.5 million. TEP's capital budget for the year ending December 31, 1999
is approximately $90 million. These authorized expenditures include costs
for TEP to comply with current federal and state environmental regulations.
All of these estimates are subject to continuing review and adjustment.
Actual construction expenditures may be different from budgeted amounts due
to changes in business conditions, construction schedules, environmental
requirements, and changes to our business arising from retail competition.
TEP plans to fund these expenditures through internally generated cash
flow.
TEP Credit Agreement
--------------------
As of March 31, 1999 and as of May 7, 1999, TEP had no borrowings
outstanding under its $100 million Revolving Credit Facility.
TEP is required by its Credit Agreement to maintain certain financial
covenants including (a) a minimum Consolidated Tangible Net Worth equal to
the sum of $133 million plus 40% of cumulative Consolidated Net Income
since January 1, 1997, (b) a minimum Cash Coverage Ratio ranging from 1.40
in 1999 and gradually increasing to 1.55 in 2002, and (c) a maximum
Leverage Ratio ranging from 6.80 in 1999 and gradually decreasing to 6.20
in 2002. As of March 31, 1999, TEP was in compliance with each of these
covenants.
SPRINGERVILLE COMMON FACILITIES LEASES
--------------------------------------
Under the terms of the Springerville Common Facilities lease
agreement, the secured notes underlying this lease must be refinanced or
refunded by December 31, 1999 in order to avoid a special event of loss
under the lease. If a special event of loss were to occur, TEP would be
required to repurchase the facilities for an amount equal to the higher of
the stipulated loss value of $144 million or the fair market value of the
facilities. Upon such purchase, the lease would be terminated. Based on
the current amortization schedule for these notes, a principal amount of
approximately $70 million will be outstanding as of December 31, 1999.
Interest on the lease notes is currently paid at a variable rate of
interest equal to the Federal Funds rate plus 0.625%. TEP intends, and
believes it has the ability, to refinance the underlying debt on these
leases in 1999.
MILLENNIUM -- UNREGULATED ENERGY BUSINESSES
- -------------------------------------------
CAPITAL REQUIREMENTS
--------------------
Our Unregulated Energy Businesses owned by Millennium require
significant amounts of capital and we expect these needs to continue in the
near future. Actual capital expenditures, investments in and loans to
Unregulated Energy Businesses, net of distributions, for the quarters ended
March 31, 1999 and 1998 were as follows:
March 31
--------
Subsidiary 1999 1998
------------------------------------------
- Thousands of Dollars -
AET $ (2,870) $ 0
MEH (116) (6,000)
Nations Energy (2,802) (23)
Other (25) (5)
Total Millennium $ (5,813) $ (6,028)
Significant first quarter 1999 investments include:
-- $1.1 million in capital expenditures for Advanced Energy Technologies;
-- $1.75 million in capital contributions and loans to Advanced Energy
Technologies;
-- $3.3 million by Nations Energy for a controlling interest in a
refinery project located in Curacao.
Total forecasted investments for 1999 are $30 million. These
forecasts are subject to continuing review and revision, and contain
assumptions for each subsidiary regarding investment opportunities, growth
strategies, and potential investments by unaffiliated parties. Actual
expenditures may be higher or lower than these forecasts, or may be
allocated to our businesses in proportions different than planned. Our
ability to fund future capital requirements of our unregulated business
segment will depend to a great extent on the amount and predictability of
the dividends we receive from our primary operating subsidiary, TEP.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Quarterly Report on Form 10-Q contains forward-looking statements
as defined by the Private Securities Litigation Act of 1995. UniSource
Energy and TEP are including the following cautionary statements to make
applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statements
made by or for UniSource Energy or TEP in this Quarterly Report on Form 10-
Q. Forward-looking statements include statements concerning plans,
objectives, goals, strategies, future events or performance and underlying
assumptions and other statements that are not statements of historical
facts. Forward-looking statements may be identified by the use of words
such as "anticipates," "estimates," "expects," "intends," "plans,"
"predicts," "projects," and similar expressions. From time to time, we may
publish or otherwise make available forward-looking statements of this
nature. All such forward-looking statements, whether written or oral, and
whether made by or on behalf of UniSource Energy or TEP, are expressly
qualified by these cautionary statements and any other cautionary
statements which may accompany the forward-looking statements. In
addition, UniSource Energy and TEP disclaim any obligation to update any
forward-looking statements to reflect events or circumstances after the
date of this report.
Forward-looking statements involve risks and uncertainties that could
cause actual results or outcomes to differ materially from those expressed
in the forward-looking statements. We express our expectations, beliefs
and projections in good faith and believe them to have a reasonable basis.
However, we make no assurances that management's expectations, beliefs or
projections will be achieved or accomplished. We have identified the
following important factors that could cause actual results to differ
materially from those discussed in our forward-looking statements. These
may be in addition to other factors and matters discussed in other parts of
this report:
1. Effects of restructuring initiatives in the electric industry and
other energy-related industries.
2. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
3. Changes affecting TEP's cost of providing electrical service including
changes in fuel costs, generating unit operating performance, interest
rates, tax laws, environmental laws, and the general rate of inflation.
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 UniSource Energy or TEP.
7. Y2K disruptions resulting from unidentified or unremediated problems
for systems which we control, and Y2K disruptions resulting from
systems or parties which we do not control.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ---------------------------------------------------------------------
The information contained in this Item updates, and should be read in
conjunction with, information included in Part II, Item 7A in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998 in addition
to the interim condensed consolidated financial statements and
accompanying notes presented in Items 1 and 2 of this Form 10-Q.
See Item 2- Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of
Operations, Market Risk, Foreign Currency Exchange Risk.
PART II - OTHER INFORMATION
ITEM 1. -- LEGAL PROCEEDINGS
- ----------------------------
TAX ASSESSMENTS
- ---------------
See Note 4 of Notes to Condensed Consolidated Financial Statements,
Tax Assessments.
ITEM 5. - OTHER INFORMATION
- ---------------------------
ADDITIONAL FINANCIAL DATA
- -------------------------
The following table reflects the ratio of earnings to fixed charges for
TEP:
12 Months Ended
---------------
March 31, December 31,
1999 1998
---- ----
Ratio of Earnings to
Fixed Charges 1.36 1.41
ITEM 6. -- EXHIBITS AND REPORTS ON FORM 8-K
- -------------------------------------------
(a) Exhibits.
-- See Exhibit Index.
(b) Reports on Form 8-K.
The Company and TEP filed the following current reports on Form 8-K
during the quarter ended March 31, 1999:
UniSource Energy Corporation and Tucson Electric Power Company
-- Form 8-K dated January 4, 1999 (filed January 8, 1999), reporting on
the delay of retail electric competition in Arizona.
-- Form 8-K dated February 5, 1999 (filed February 16, 1999), reporting
on Proposed Orders by ACC Hearing Officer and 1998 Earnings.
UniSource Energy Corporation
-- Form 8-K dated March 5, 1999 (filed March 15, 1999), reporting on
adoption of a shareholder rights plan.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
each registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized. The signature for each
undersigned company shall be deemed to relate only to matters having
reference to such company or its subsidiary.
UNISOURCE ENERGY CORPORATION
(Registrant)
Date: May 17, 1999 Ira R. Adler
--------------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
TUCSON ELECTRIC POWER COMPANY
(Registrant)
Date: May 17, 1999 Ira R. Adler
--------------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
EXHIBIT INDEX
11 - Statement re computation of per share earnings - UniSource
Energy.
12 - Computation of Ratio of Earnings to Fixed Charges - TEP.
15 - Letter regarding unaudited interim financial information.
27a - Financial Data Schedule - UniSource Energy.
27b - Financial Data Schedule - TEP.