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Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 0-296
El Paso Electric Company
(Exact name of registrant as specified in its charter)
Texas 74-0607870
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Stanton Tower, 100 North Stanton, El Paso, Texas 79901
(Address of principal executive offices) (Zip Code)
(915) 543-5711
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES X NO
--- ---
As of November 2, 2001, there were 50,386,228 shares of the Company's no par
value common stock outstanding.
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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
INDEX TO FORM 10-Q
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 2001 and December 31, 2000... 1
Consolidated Statements of Operations - Three Months, Nine Months and
Twelve Months Ended September 30, 2001 and 2000.......................... 3
Consolidated Statements of Comprehensive Operations - Three Months, Nine
Months and Twelve Months Ended September 30, 2001 and 2000............... 5
Consolidated Statements of Cash Flows - Nine Months Ended September 30,
2001 and 2000............................................................ 6
Notes to Consolidated Financial Statements............................... 7
Independent Accountants' Review Report................................... 16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 27
Item 6. Exhibits and Reports on Form 8-K.................................. 27
i
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS September 30,
(In thousands) 2001 December 31,
(Unaudited) 2000
------------- ------------
Utility plant:
Electric plant in service............................................ $1,685,321 $1,659,539
Less accumulated depreciation and amortization....................... 452,349 391,675
---------- ----------
Net plant in service............................................... 1,232,972 1,267,864
Construction work in progress........................................ 89,759 72,580
Nuclear fuel; includes fuel in process of $3,257 and
$10,430, respectively.............................................. 75,673 75,880
Less accumulated amortization........................................ 39,574 36,289
---------- ----------
Net nuclear fuel................................................... 36,099 39,591
---------- ----------
Net utility plant................................................ 1,358,830 1,380,035
---------- ----------
Current assets:
Cash and temporary investments....................................... 26,036 11,344
Accounts receivable, principally trade, net of allowance for
doubtful accounts of $3,636 and $3,325, respectively............... 92,214 86,647
Inventories, at cost................................................. 25,063 24,845
Net undercollection of fuel revenues................................. 30,211 15,733
Prepayments and other................................................ 10,560 7,759
---------- ----------
Total current assets............................................. 184,084 146,328
---------- ----------
Long-term contract receivable.......................................... 4,908 10,709
---------- ----------
Deferred charges and other assets:
Decommissioning trust fund........................................... 57,398 60,176
Other................................................................ 16,345 17,890
---------- ----------
Total deferred charges and other assets.......................... 73,743 78,066
---------- ----------
Total assets..................................................... $1,621,565 $1,615,138
========== ==========
See accompanying notes to consolidated financial statements.
1
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Continued)
CAPITALIZATION AND LIABILITIES September 30,
(In thousands except for share data) 2001 December 31,
(Unaudited) 2000
------------- -------------
Capitalization:
Common stock, stated value $1 per share, 100,000,000 shares
authorized, 61,528,564 and 60,429,107 shares issued,
and 228,505 and 276,066 restricted shares, respectively................... $ 61,757 $ 60,705
Capital in excess of stated value........................................... 250,081 244,528
Unearned compensation - restricted stock awards............................. (1,792) (1,309)
Retained earnings........................................................... 257,783 202,116
Accumulated other comprehensive income (loss) (net unrealized
gains (losses) on marketable securities), net of tax...................... (1,274) 2,902
---------- ----------
566,555 508,942
Treasury stock, 11,323,037 and 9,230,786 shares, respectively; at cost...... (125,210) (96,908)
---------- ----------
Common stock equity....................................................... 441,345 412,034
Long-term debt.............................................................. 611,992 715,058
Financing obligations....................................................... - 25,165
---------- ----------
Total capitalization.................................................. 1,053,337 1,152,257
---------- ----------
Current liabilities:
Current maturities of long-term debt and financing obligations.............. 115,539 57,663
Accounts payable, principally trade......................................... 34,645 39,799
Taxes accrued other than federal income taxes............................... 18,272 17,054
Interest accrued............................................................ 16,168 16,528
Other....................................................................... 16,138 14,524
---------- ----------
Total current liabilities............................................. 200,762 145,568
---------- ----------
Deferred credits and other liabilities:
Decommissioning liability................................................... 133,896 128,129
Accrued postretirement benefit liability.................................... 84,192 81,784
Accumulated deferred income taxes, net...................................... 78,234 47,279
Accrued pension liability................................................... 30,871 31,134
Other....................................................................... 40,273 28,987
---------- ----------
Total deferred credits and other liabilities.......................... 367,466 317,313
---------- ----------
Commitments and contingencies
Total capitalization and liabilities.................................. $1,621,565 $1,615,138
========== ==========
See accompanying notes to consolidated financial statements.
2
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except for share data)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
Electric utility operating revenues................................. $ 209,466 $ 210,635 $ 603,983 $ 517,839
----------- ----------- ----------- -----------
Energy expenses:
Fuel.............................................................. 49,741 50,006 152,400 111,680
Purchased and interchanged power.................................. 23,809 27,008 74,957 46,561
----------- ----------- ----------- -----------
73,550 77,014 227,357 158,241
----------- ----------- ----------- -----------
Electric utility operating revenues net of energy expenses.......... 135,916 133,621 376,626 359,598
----------- ----------- ----------- -----------
Energy services operations:
Operating revenues................................................ 1,016 775 3,001 3,080
Operating expenses................................................ 1,351 1,628 4,464 4,407
----------- ----------- ----------- -----------
(335) (853) (1,463) (1,327)
----------- ----------- ----------- -----------
Other electric utility operating expenses:
Other operations.................................................. 34,449 32,647 99,141 96,881
Maintenance....................................................... 8,996 9,946 34,177 29,322
Depreciation and amortization..................................... 22,432 21,739 66,831 65,063
Taxes other than income taxes..................................... 11,608 10,692 33,147 32,683
----------- ----------- ----------- -----------
77,485 75,024 233,296 223,949
----------- ----------- ----------- -----------
Operating income.................................................... 58,096 57,744 141,867 134,322
----------- ----------- ----------- -----------
Other income (deductions):
Investment income, net............................................ 747 961 3,354 2,706
Litigation settlements............................................ - - - (1,000)
Other, net........................................................ (482) (494) (1,735) (2,127)
----------- ----------- ----------- -----------
265 467 1,619 (421)
----------- ----------- ----------- -----------
Income before interest charges...................................... 58,361 58,211 143,486 133,901
----------- ----------- ----------- -----------
Interest charges (credits):
Interest on long-term debt........................................ 15,419 16,890 48,113 50,453
Other interest.................................................... 1,987 1,909 5,972 5,739
Interest capitalized.............................................. (1,175) (931) (3,471) (2,763)
----------- ----------- ----------- -----------
16,231 17,868 50,614 53,429
----------- ----------- ----------- -----------
Income before income taxes and extraordinary item................... 42,130 40,343 92,872 80,472
Income tax expense.................................................. 16,336 14,901 36,214 31,306
----------- ----------- ----------- -----------
Income before extraordinary item.................................... 25,794 25,442 56,658 49,166
Extraordinary loss on extinguishments of debt, net of
income tax benefit................................................ 830 1,223 991 1,772
----------- ----------- ----------- -----------
Net income.......................................................... $ 24,964 $ 24,219 $ 55,667 $ 47,394
=========== =========== =========== ===========
Basic earnings per share:
Income before extraordinary item.................................. $ 0.51 $ 0.47 $ 1.11 $ 0.90
Extraordinary loss on extinguishments of debt, net of
income tax benefit............................................. 0.02 0.02 0.02 0.03
----------- ----------- ----------- -----------
Net income..................................................... $ 0.49 $ 0.45 $ 1.09 $ 0.87
=========== =========== =========== ===========
Diluted earnings per share:
Income before extraordinary item.................................. $ 0.50 $ 0.46 $ 1.09 $ 0.89
Extraordinary loss on extinguishments of debt, net of
income tax benefit............................................. 0.02 0.02 0.02 0.03
----------- ----------- ----------- -----------
Net income..................................................... $ 0.48 $ 0.44 $ 1.07 $ 0.86
=========== =========== =========== ===========
Weighted average number of common shares
outstanding....................................................... 50,940,426 54,400,463 51,096,435 54,691,003
=========== =========== =========== ===========
Weighted average number of common shares and
dilutive potential common shares outstanding...................... 51,798,263 55,345,544 52,033,643 55,460,129
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
3
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except for share data)
Twelve Months Ended
September 30,
-------------------------------
2001 2000
----------- -----------
Electric utility operating revenues............................................. $ 782,552 $ 654,633
----------- -----------
Energy expenses:
Fuel.......................................................................... 200,267 139,228
Coal mine reclamation adjustment.............................................. - (6,601)
Purchased and interchanged power.............................................. 89,613 47,906
----------- -----------
289,880 180,533
----------- -----------
Electric utility operating revenues net of energy expenses...................... 492,672 474,100
----------- -----------
Energy services operations:
Operating revenues............................................................ 5,162 3,696
Operating expenses............................................................ 6,727 5,357
----------- -----------
(1,565) (1,661)
----------- -----------
Other electric utility operating expenses:
Other operations.............................................................. 134,546 135,981
Maintenance................................................................... 46,655 37,022
Depreciation and amortization................................................. 88,769 88,156
Taxes other than income taxes................................................. 43,618 40,532
----------- -----------
313,588 301,691
----------- -----------
Operating income................................................................ 177,519 170,748
----------- -----------
Other income (deductions):
Investment income, net........................................................ 4,130 3,789
Litigation settlements........................................................ - (17,500)
Other, net.................................................................... (1,879) 918
----------- -----------
2,251 (12,793)
----------- -----------
Income before interest charges.................................................. 179,770 157,955
----------- -----------
Interest charges (credits):
Interest on long-term debt.................................................... 64,909 71,764
Other interest................................................................ 7,865 7,539
Interest capitalized.......................................................... (4,464) (1,577)
----------- -----------
68,310 77,726
----------- -----------
Income before income taxes and extraordinary item............................... 111,460 80,229
Income tax expense.............................................................. 43,804 29,988
----------- -----------
Income before extraordinary item................................................ 67,656 50,241
Extraordinary loss on extinguishments of debt, net of income tax benefit........ 991 1,857
----------- -----------
Net income...................................................................... $ 66,665 $ 48,384
=========== ===========
Basic earnings per share:
Income before extraordinary item.............................................. $ 1.31 $ 0.91
Extraordinary loss on extinguishments of debt, net of income tax benefit...... 0.02 0.04
----------- -----------
Net income................................................................. $ 1.29 $ 0.87
=========== ===========
Diluted earnings per share:
Income before extraordinary item.............................................. $ 1.29 $ 0.90
Extraordinary loss on extinguishments of debt, net of income tax benefit...... 0.02 0.04
----------- -----------
Net income................................................................. $ 1.27 $ 0.86
=========== ===========
Weighted average number of common shares outstanding............................ 51,493,984 55,412,512
=========== ===========
Weighted average number of common shares and dilutive
potential common shares outstanding........................................... 52,437,756 56,131,974
=========== ===========
See accompanying notes to consolidated financial statements.
4
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(Unaudited)
(In thousands)
Three Months Nine Months Twelve Months
Ended Ended Ended
September 30, September 30, September 30,
------------------ ------------------ ------------------
2001 2000 2001 2000 2001 2000
------- ------- ------- ------- ------- -------
Net income...................................... $24,964 $24,219 $55,667 $47,394 $66,665 $48,384
Other comprehensive income (loss):
Net unrealized gains (losses) on marketable
securities:
Unrealized holding gains (losses) arising
during period.............................. (4,631) (436) (7,565) (662) (9,786) 2,992
Reclassification adjustments for losses
included in net income..................... 589 176 1,169 559 1,528 778
Income tax benefit (expense) related to items
of other comprehensive income (loss)......... 1,396 91 2,220 36 2,872 (1,320)
------- ------- ------- ------- ------- -------
Other comprehensive income (loss),
net of tax..................................... (2,646) (169) (4,176) (67) (5,386) 2,450
------- ------- ------- ------- ------- -------
Comprehensive income............................ $22,318 $24,050 $51,491 $47,327 $61,279 $50,834
======= ======= ======= ======= ======= =======
See accompanying notes to consolidated financial statements.
5
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Nine Months Ended
September 30,
-------------------------------
2001 2000
---------- ----------
Cash flows from operating activities:
Net income.............................................................. $ 55,667 $ 47,394
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of electric plant in service............ 66,831 65,063
Amortization of nuclear fuel.......................................... 12,737 13,152
Deferred income taxes................................................. 33,776 29,679
Extraordinary loss on extinguishments of debt, net of
income tax benefit................................................. 991 1,772
Amortization and accretion of interest costs.......................... 7,098 7,105
Other operating activities............................................ 1,338 2,441
Change in:
Accounts receivable................................................... (5,567) (25,004)
Inventories........................................................... (218) 796
Net under/overcollection of fuel revenues............................. (4,635) (19,717)
Prepayments and other................................................. (2,801) 41
Long-term contract receivable......................................... 5,801 4,851
Accounts payable...................................................... (5,154) 7,814
Litigation settlements payable........................................ - (16,500)
Taxes accrued other than federal income taxes......................... 1,218 1,537
Interest accrued...................................................... (360) (1,362)
Other current liabilities............................................. 1,614 1,889
Deferred charges and credits.......................................... 3,533 (140)
---------- ----------
Net cash provided by operating activities........................... 171,869 120,811
---------- ----------
Cash flows from investing activities:
Cash additions to utility property, plant and equipment................. (46,777) (49,747)
Cash additions to nuclear fuel.......................................... (8,876) (9,685)
Interest capitalized:
Utility property, plant and equipment................................. (3,103) (2,296)
Nuclear fuel.......................................................... (368) (467)
Investment in decommissioning trust fund................................ (3,618) (4,034)
Other investing activities.............................................. 972 64
---------- ----------
Net cash used for investing activities.............................. (61,770) (66,165)
---------- ----------
Cash flows from financing activities:
Proceeds from exercise of stock options................................. 5,244 -
Purchases of treasury stock............................................. (28,302) (25,275)
Repurchases of and payments on long-term debt........................... (68,780) (40,628)
Nuclear fuel financing obligations:
Proceeds.............................................................. 10,868 12,229
Payments.............................................................. (13,986) (14,758)
Payments on capital lease obligations................................... - (1,688)
Other financing activities.............................................. (451) (1,579)
---------- ----------
Net cash used for financing activities.............................. (95,407) (71,699)
---------- ----------
Net increase (decrease) in cash and temporary investments................. 14,692 (17,053)
Cash and temporary investments at beginning of period..................... 11,344 37,234
---------- ----------
Cash and temporary investments at end of period........................... $ 26,036 $ 20,181
========== ==========
See accompanying notes to consolidated financial statements.
6
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. Principles of Preparation
The consolidated financial statements include the accounts of El Paso
Electric Company and its wholly-owned subsidiary, MiraSol Energy Services, Inc.
("MiraSol") (collectively, the "Company"). MiraSol, which began operations as a
separate subsidiary in March 2001, provides energy efficiency products and
services previously provided by the Company's Energy Services Business Group.
All intercompany transactions and balances have been eliminated in
consolidation. Additionally, the revenues and expenses of the former Energy
Services Business Group have been reclassified for all periods presented in the
accompanying consolidated statements of operations as energy services revenues
and expenses. Certain other prior period amounts have been reclassified to
conform with the current period presentation.
Pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC"), certain financial information has been condensed and
certain footnote disclosures have been omitted. Such information and disclosures
are normally included in financial statements prepared in accordance with
generally accepted accounting principles.
These condensed consolidated financial statements should be read in
conjunction with the financial statements and notes thereto in the Annual Report
of El Paso Electric Company on Form 10-K for the year ended December 31, 2000
(the "2000 Form 10-K"). Capitalized terms used in this report and not defined
herein have the meaning ascribed for such terms in the 2000 Form 10-K. In the
opinion of management of the Company, the accompanying consolidated financial
statements contain all adjustments necessary to present fairly the financial
position of the Company at September 30, 2001 and December 31, 2000; the results
of its operations for the three, nine and twelve months ended September 30, 2001
and 2000; and its cash flows for the nine months ended September 30, 2001 and
2000. The results of operations for the three, nine and twelve months ended
September 30, 2001 and the cash flows for the nine months ended September 30,
2001 are not necessarily indicative of the results to be expected for the full
calendar year.
At January 1, 2001, the Company adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"), as amended, including implementation guidance
discussed by the Financial Accounting Standards Board's (the "FASB") Derivatives
Implementation Group (the "DIG") and cleared by the FASB as of January 1, 2001.
This standard requires the recognition of derivatives as either assets or
liabilities in the balance sheet with measurement of those instruments at fair
value. Any changes in the fair value of these instruments are recorded in
earnings or other comprehensive income.
The Company uses commodity contracts to manage its exposure to price and
availability risks and these contracts generally have the characteristics of
derivatives. The Company does not trade or use these instruments with the
objective of earning financial gains on the commodity price fluctuations. The
Company determined, upon implementation of SFAS No. 133, that all such contracts
that had the characteristics of derivatives met the "normal purchases and normal
sales" exception provided in SFAS No. 133, and, as such, were not required to be
accounted for as derivatives pursuant to SFAS No. 133 and other guidance.
7
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At July 1, 2001, the Company implemented DIG Issue C10, "Scope Exceptions:
Can Option Contracts and Forward Contracts with Optionality Features Qualify for
the Normal Purchases and Normal Sales Exception," DIG Issue C15, "Scope
Exceptions: Normal Purchases and Normal Sales Exception for Option-Type
Contracts and Forward Contracts in Electricity" and DIG Issue C16, "Scope
Exceptions: Applying the Normal Purchases and Normal Sales Exception to
Contracts That Combine a Forward Contract and a Purchase Option Contract."
Based upon this implementation, the Company has determined that certain of its
natural gas commodity contracts with optionality features are not eligible for
the normal purchases exception and, therefore, are required to be accounted for
as derivative instruments pursuant to SFAS No. 133. However, as of September
30, 2001, the variable pricing provisions of existing gas contracts are such
that these derivative instruments have no significant fair value. As of
September 30, 2001, the Company determined that all such existing contracts
affected by DIG Issue C15 met the specific criteria listed in the Issue and,
therefore, continue to qualify for the normal purchases and normal sales
exception.
Additionally, the FASB has continued to issue additional guidance on SFAS No.
133 including providing revised guidance on DIG Issue C15, the ultimate effects
of which may impact the Company's application of SFAS No. 133.
Supplemental Cash Flow Disclosures (in thousands)
Nine Months Ended September 30,
-------------------------------
2001 2000
-------- --------
Cash paid for:
Interest on long-term debt (1)................... $ 47,315 $ 48,945
Other interest................................... 18 231
Income taxes..................................... 3,550 1,200
Non-cash investing and financing activities:
Grants of restricted shares of
common stock................................. 1,776 1,725
- ----------
(1) Includes interest on bonds, letter of credit fees related to bonds, and
interest on nuclear fuel financing not capitalized.
8
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Reconciliation of Basic and Diluted Earnings Per Share
The reconciliation of basic and diluted earnings per share before
extraordinary item is presented below:
Three Months Ended September 30,
-------------------------------------------------------------------------
2001 2000
----------------------------------- -----------------------------------
Per Per
Income Shares Share Income Shares Share
-------------- ---------- ----- -------------- ---------- -----
(In thousands) (In thousands)
Basic earnings per share:
Income before extraordinary
item............................... $ 25,794 50,940,426 $0.51 $ 25,442 54,400,463 $0.47
===== =====
Effect of dilutive securities:
Unvested restricted stock........... - 79,769 - 70,209
Stock options....................... - 778,068 - 874,872
-------------- ---------- -------------- ----------
Diluted earnings per share:
Income before extraordinary
item............................... $ 25,794 51,798,263 $0.50 $ 25,442 55,345,544 $0.46
============== ========== ===== ============== ========== =====
Nine Months Ended September 30,
-------------------------------------------------------------------------
2001 2000
----------------------------------- -----------------------------------
Per Per
Income Shares Share Income Shares Share
-------------- ---------- ----- -------------- ---------- -----
(In thousands) (In thousands)
Basic earnings per share:
Income before extraordinary
item............................... $ 56,658 51,096,435 $1.11 $ 49,166 54,691,003 $0.90
===== =====
Effect of dilutive securities:
Unvested restricted stock........... - 53,588 - 48,193
Stock options....................... - 883,620 - 720,933
-------------- ---------- -------------- ----------
Diluted earnings per share:
Income before extraordinary
item............................... $ 56,658 52,033,643 $1.09 $ 49,166 55,460,129 $0.89
============== ========== ===== ============== ========== =====
Twelve Months Ended September 30,
-------------------------------------------------------------------------
2001 2000
----------------------------------- -----------------------------------
Per Per
Income Shares Share Income Shares Share
-------------- ---------- ----- -------------- ---------- -----
(In thousands) (In thousands)
Basic earnings per share:
Income before extraordinary
item............................... $ 67,656 51,493,984 $1.31 $ 50,241 55,412,512 $0.91
===== =====
Effect of dilutive securities:
Unvested restricted stock........... - 60,536 - 50,210
Stock options....................... - 883,236 - 669,252
-------------- ---------- -------------- ----------
Diluted earnings per share:
Income before extraordinary
item............................... $ 67,656 52,437,756 $1.29 $ 50,241 56,131,974 $0.90
============== ========== ===== ============== ========== =====
9
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Options that were excluded from the computation of diluted earnings per share
because the exercise price was greater than the average market price of the
shares for the period are listed below:
1) 60,000 options granted May 29, 1998 at an exercise price of $9.50 were
excluded for the fourth quarter of 1999 and the first quarter of 2000.
2) 42,432 options granted January 1, 2000 at an exercise price of $9.81 were
excluded for the first quarter of 2000.
3) 50,000 options granted March 15, 2000 at an exercise price of $9.50 were
excluded for the first quarter of 2000.
4) 2,107 options granted October 1, 2000 at an exercise price of $13.77 were
excluded for the fourth quarter of 2000 and the first quarter of 2001.
5) 150,000 options granted December 15, 2000 at an exercise price of $12.60
were excluded for the first quarter of 2001.
6) 2,941 options granted January 1, 2001 at an exercise price of $13.20 were
excluded for the first quarter of 2001.
7) 150,000 options granted May 10, 2001 at an exercise price of $14.95 were
excluded for the second and third quarters of 2001.
8) 795 options granted April 1, 2001 at an exercise price of $14.60 were
excluded for the third quarter of 2001.
9) 1,424 options granted July 1, 2001 at an exercise price of $15.99 were
excluded for the third quarter of 2001.
B. Regulation
For a full discussion of the Company's regulatory matters, see Note B of
Notes to Financial Statements in the 2000 Form 10-K.
Texas Regulatory Matters
Deregulation. The Texas Restructuring Law requires most electric utilities
to separate their power generation activities from transmission and distribution
activities by January 1, 2002. However, the law specifically recognizes and
preserves the substantial benefits the Company bargained for in its Texas Rate
Stipulation and Texas Settlement Agreement, exempting the Company's Texas
service area from retail competition and preserving non-fuel base rates at their
current levels until the end of the Freeze Period in 2005. At the end of the
Freeze Period, the Company will be subject to the provisions of retail
competition under the law and may have no further claim for recovery of stranded
costs. The Company believes that its continued ability to provide bundled
electric service at current frozen base rates in its Texas service area will
allow the Company the opportunity to collect its Texas jurisdictional stranded
costs.
Fuel. Although the Company's base rates are frozen in Texas pursuant to the
Texas Rate Stipulation, the Company can request adjustments to its fuel factor
to more accurately reflect projected increases or decreases in energy costs
associated with the provision of electricity as well as seek recovery
10
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
of past undercollections of fuel revenues. In November 2000, the Texas
Commission approved a settlement which increased the fixed fuel factor from
$0.01435 to $0.02186 per kWh.
On January 8, 2001, the Company filed a new petition with the Texas
Commission for a fuel factor increase to $0.02915 per kWh and a 12-month
surcharge of previously undercollected fuel costs. On May 4, 2001, the Company
filed a unanimous settlement agreement (the "Texas Fuel Settlement") between the
Company and the parties which had intervened, including the City of El Paso.
After gas costs declined and off-system sales margins increased from previously
forecasted levels, the Texas Fuel Settlement included a proposed fuel factor
increase to $0.02494 per kWh. This factor was implemented on an interim basis
in April 2001. In combination, the two increases in fuel factors increased fuel
revenue collections by $36.5 million through September 30, 2001. The Texas Fuel
Settlement also provides for the surcharge of underrecovered fuel costs as of
December 31, 2000 of approximately $15 million plus interest over an 18-month
period. The surcharge was implemented on an interim basis beginning with the
first billing cycle in June 2001. The Texas Fuel Settlement provides for the
final agreement between the parties for the non-recovery of certain purchased
power contract costs as well as the favorable disposition of previously
unrecognized Palo Verde performance rewards, including interest. These
provisions taken together did not have a material effect on the Company's
results of operations and resulted in an $11.0 million increase in Net
Undercollection of Fuel Revenues and a $10.5 million increase in Deferred
Credits and Other Liabilities - Other, which were recorded in June 2001. The
Company also agreed to a prospective change in the Palo Verde performance
standards, which will materially reduce future rewards and penalties on a
symmetrical basis. The settlement agreement, while resolving all disputed
issues in the case, included some stipulations on fuel reconciliation issues
beyond the scope of the public notice initially filed. Therefore, the parties to
the proceeding agreed to provide a supplemental notice and intervention period.
After publication of the additional notice, a group of individuals intervened in
the case and were designated as the Low-Income Intervenors. No other person or
party sought or were granted party status. Subsequently, the Low-Income
Intervenors reached an agreement with the Company, which was memorialized by a
side agreement not requiring Commission approval, and in which they supported
the stipulation previously agreed to by all other parties. Based on the
unanimous settlement and stipulation, a hearing examiner remanded the case for
final approval to the Texas Commission which granted approval at the Open
Meeting of October 18, 2001.
The fuel surcharge granted to the Company, as well as the Company's other
energy expenses not otherwise finally resolved in the Texas Fuel Settlement,
will be subject to final review by the Texas Commission in the Company's next
fuel reconciliation proceeding, which is expected to be filed by the middle of
2002. The Texas Commission staff, local regulatory authorities such as the City
of El Paso, and customers are entitled to intervene in a fuel reconciliation
proceeding and to challenge the prudence of fuel and purchased power expenses
not otherwise finally resolved in the Texas Fuel Settlement.
New Mexico Regulatory Matters
Deregulation. In March 2001, the New Mexico Legislature amended the New
Mexico Restructuring Law to postpone deregulation in New Mexico until January 1,
2007, and to prohibit the separation of a utility's transmission and
distribution activities from its existing generation activities until September
1,
11
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2005. The amended New Mexico Restructuring Law permits utilities to form
holding companies and participate in unregulated power production, provided the
utility does not separate its transmission and distribution activities from its
existing generation activities.
The amended New Mexico law requires the New Mexico Commission to approve
previously filed applications to form holding companies to the extent that the
applications do not conflict with the provisions of the law as amended and are
otherwise in the public interest. Accordingly, in early April 2001, the Company
filed its suggested amendments to its previously filed proposed corporate
restructuring plan. The filing sought to conform the Company's proposal with
the requirements under the amended law which requires the regulated utility to
continue to own all regulated generation currently owned and operated by the
utility. On June 28, 2001, the New Mexico Commission issued its order approving
formation of a holding company for the Company. Although the order approved the
Company's formation of a holding company, it also placed thirty-eight conditions
upon its approval. The conditions include numerous reporting and compliance
requirements as well as strict prohibitions on certain intercompany activity.
The Company sought rehearing on the Final Order, which was denied without action
by the Commission. The Company filed an appeal with the New Mexico Supreme
Court on September 15, 2001. After reviewing the Company's options in light of
the Commission's holding company order, the Company determined it was in its
best interest to request that the Commission vacate the Final Order. The
Company negotiated with the Commission staff and the Attorney General to file a
Joint Motion asking the Court to dismiss the appeal so the Commission could
vacate the Final Order and allow the Company to withdraw its application. The
Court dismissed the appeal on October 10, 2001, and the Commission's action to
vacate the order is pending. If the Final Order is vacated, the Company will no
longer be subject to the holding company conditions. The Company can then
request a holding company at a later date, if and when needed, subject to
whatever legal requirements are in effect at that time.
While the Company is continuing to evaluate the possible benefits, if any, of
forming a holding company prior to 2005, it cannot separate its existing
generation activities from its transmission and distribution activities until
September 1, 2005. In either 2004 or 2005, the Company anticipates that it will
seek New Mexico Commission approval to separate the Company's generation
activities from its transmission and distribution activities to allow the
Company to comply with the Texas Restructuring Law requirements.
Fuel. The New Mexico Settlement Agreement entered into in October 1998
eliminated the then existing fuel factor of $0.01949 per kWh and incorporated it
into frozen base rates. Accordingly, the Company was required to absorb any
increases in fuel and purchased power ("energy") expenses related to its New
Mexico retail customers until new rates were implemented subsequent to the end
of the rate freeze on April 30, 2001. The average energy costs incurred for New
Mexico jurisdictional customers exceeded this fuel factor by a substantial
amount. Therefore, on April 23, 2001, the Company filed a petition with the New
Mexico Commission proposing a settlement that would implement a new fixed fuel
factor and reinstate for a two-year period a fuel adjustment clause in lieu of a
base rate increase (the "New Mexico Fuel Factor Agreement"). The proposed fixed
fuel factor of $0.01501 per kWh would increase revenues by approximately $19
million annually and would be in addition to the fuel factor that is currently
included in base rates. The proposed fixed fuel factor would keep overall
retail rates more
12
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
consistent with the retail rates charged to Texas jurisdictional customers. The
reinstatement of a fuel adjustment clause would also substantially mitigate the
financial risk to the Company of any further energy cost increases over the two-
year period of the agreement.
The New Mexico Commission has allowed the Company to implement its New Mexico
Fuel Factor Agreement, beginning with consumption on June 15, 2001, subject to
refund, and appointed a hearing examiner to preside over the hearing in the case
and submit a recommended decision. On October 23, 2001, the hearing examiner
issued a Certification of Stipulation in which he recommended Commission
approval of the New Mexico Fuel Factor Agreement with only one change relating
to the reconciliation of fuel recoveries following the two-year period of the
applicability of the New Mexico Fuel Factor Agreement and during the pendancy of
the rate case proceeding to be filed following the two-year period. Because the
proposed change differs from the New Mexico Fuel Factor Agreement signed by the
parties, the Company has filed an exception to the Certification of Stipulation.
Nonetheless, the Company does not believe the proposed change would have a
negative substantive impact on the Company. The Company began recording the
effects of the New Mexico Fuel Factor Agreement during the third quarter of 2001
and expects a final order by the end of 2001.
C. Common Stock Repurchase Program
The Company's Board of Directors previously approved two stock repurchase
programs allowing the Company to purchase up to twelve million of its
outstanding shares of common stock. As of September 30, 2001, the Company had
repurchased 11,252,729 shares of common stock under these programs for
approximately $124.7 million, including commissions. The Company expects to
continue to make purchases primarily in the open market at prevailing prices and
will also engage in private transactions, if appropriate. Any repurchased
shares will be available for issuance under employee benefit and stock option
plans, or may be retired.
D. Commitments and Contingencies
For a full discussion of commitments and contingencies, including
environmental matters related to the Company, see Note H of Notes to Financial
Statements in the 2000 Form 10-K. In addition, see Note C of Notes to Financial
Statements in the 2000 Form 10-K regarding matters related to Palo Verde,
including decommissioning, spent fuel storage, disposal of low-level radioactive
waste and liability and insurance matters.
13
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Power Contracts
In addition to the contracts entered into prior to December 31, 2000 and
discussed in the Company's 2000 Form 10-K, the Company has since entered into
the following agreements with various counterparties for forward firm purchases
and sales of electricity:
Type of Contract Quantity Term
---------------- -------- ----
Purchase on-peak 103 MW 2001
Purchase on-peak 50 MW October 2001
Sale off-peak 50 MW December 2001
Purchase on-peak 128 MW 2002
Sale off-peak 25 MW 2002
Purchase on-peak 25 MW April through October 2002
Purchase on-peak 60 MW June through September 2002
Purchase on-peak 103 MW 2003 through 2005
The Company also has an agreement with a counterparty for power exchanges
under which the Company will receive 80 MW of on-peak capacity and associated
energy during 2002 at the Eddy County tie and concurrently deliver the same
amount at Palo Verde and/or Four Corners. The on-peak exchange amount will
decrease to 30 MW for 2003 through 2005. The agreement also gives the
counterparty the option to deliver up to 133 MW of off-peak capacity and
associated energy to the Company at the Eddy County tie from 2002 through 2005
in exchange for the same amount of energy concurrently delivered by the Company
at Palo Verde and/or Four Corners. The Company will receive a guaranteed margin
on any energy exchanged under the off-peak agreement.
Tax Matters
The Company's federal income tax returns for the years 1996 through 1998 have
been examined by the Internal Revenue Service ("IRS"). On October 3, 2001, the
Company received the IRS notice of proposed deficiency. The primary audit
adjustments proposed by the IRS relate to whether the Company was entitled to
deduct payments made on emergence from Chapter 11 bankruptcy proceedings
relating to the Palo Verde Nuclear plant. The Company has protested the audit
adjustments through administrative appeals and believes that its treatment of
the payments is supported by substantial legal authority. In the event that the
IRS prevails, the resulting income tax and interest payments could be material
to the Company's financial position, results of operations and cash flows. The
Company believes that the audit adjustments can be resolved through
administrative appeals and that adequate provision has been made through
September 30, 2001 for any additional tax that may be due.
Environmental Matters
The Company is subject to regulation with respect to air, soil and water
quality, solid waste disposal and other environmental matters by federal, state
and local authorities. These authorities govern current facility operations and
exercise continuing jurisdiction over facility modifications. Environmental
regulations can change rapidly and are difficult to predict. Substantial
expenditures may be required to comply with these regulations. The Company
analyzes the costs of its obligations arising from environmental matters on an
ongoing basis, and management believes it has made adequate provision in its
consolidated financial statements to meet such obligations. However, unforeseen
14
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
expenses associated with compliance could have a material adverse effect on the
future operations and financial condition of the Company.
E. Litigation
The Company is a party to various claims, legal actions and complaints. In
many of these matters, the Company has excess casualty liability insurance that
covers the various claims, actions and complaints. Based upon a review of these
claims and applicable insurance coverage, the Company believes that none of
these claims will have a material adverse effect on the financial position,
results of operations and cash flows of the Company.
15
Independent Accountants' Review Report
--------------------------------------
The Shareholders and the Board of Directors
El Paso Electric Company:
We have reviewed the accompanying condensed consolidated balance sheet of El
Paso Electric Company and subsidiary (the Company) as of September 30, 2001, the
related condensed consolidated statements of operations and comprehensive
operations for the three months, nine months and twelve months ended September
30, 2001 and 2000, and the related condensed consolidated statements of cash
flows for the nine months ended September 30, 2001 and 2000. These condensed
consolidated financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the balance sheet of El Paso Electric
Company as of December 31, 2000, and the related statements of operations,
comprehensive operations, changes in common stock equity and cash flows for the
year then ended (not presented herein); and in our report dated March 8, 2001,
we expressed an unqualified opinion on those financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2000 is fairly stated, in all material
respects, in relation to the balance sheet from which it has been derived.
KPMG LLP
El Paso, Texas
October 26, 2001
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information contained in this Item 2 updates, and should be read in
conjunction with, the information set forth in Part II, Item 7 of the Company's
2000 Form 10-K.
Statements in this document, other than statements of historical information,
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements, as well as other oral and written forward-looking
statements made by or on behalf of the Company from time to time, including
statements contained in the Company's filings with the Securities and Exchange
Commission and its reports to shareholders, involve known and unknown risks and
other factors which may cause the Company's actual results in future periods to
differ materially from those expressed in any forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to: (i) increased prices for fuel and purchased power, (ii) the
possibility that regulators may not permit the Company to pass through all such
increased costs to customers, (iii) fluctuations in wholesale margins due to
uncertainty in the wholesale power market, (iv) unanticipated increased costs
associated with scheduled and unscheduled outages and (v) other factors
discussed below under the headings "Overview" and "Liquidity and Capital
Resources," as well as in the Company's filings with the Securities and Exchange
Commission. The Company's filings are available from the Securities and Exchange
Commission or may be obtained upon request from the Company. Any such forward-
looking statement is qualified by reference to these risks and factors. The
Company cautions that these risks and factors are not exclusive. The Company
does not undertake to update any forward-looking statement that may be made from
time to time by or on behalf of the Company except as required by law.
Overview
El Paso Electric Company is an electric utility that serves retail customers
in west Texas and southern New Mexico and wholesale customers in Texas, New
Mexico, California and Mexico. The Company owns or has substantial ownership
interests in five electrical generating facilities providing it with a total
capacity of approximately 1,500 MW. The Company's energy sources consist of
nuclear fuel, natural gas, coal, purchased power and wind. The Company owns or
has significant ownership interests in four 345 kV transmission lines and three
500 kV lines to provide power from Palo Verde and Four Corners, and owns the
distribution network within its retail service territory. The Company is
subject to extensive regulation by the Texas and New Mexico Commissions and,
with respect to wholesale power sales, transmission of electric power and the
issuance of securities, by the FERC.
The Company faces a number of risks and challenges that could negatively
impact its operations and financial results. The most significant of these
risks and challenges arise from the deregulation of the electric utility
industry, the possibility of increased costs, especially from Palo Verde, and
the Company's high level of debt.
The electric utility industry in general and the Company in particular are
facing significant challenges and increased competition as a result of changes
in federal provisions relating to third-party transmission services and
independent power production, as well as changes in state laws and regulatory
provisions relating to wholesale and retail service. In 1999, both Texas and
New Mexico passed industry deregulation legislation requiring the Company to
separate its transmission and distribution functions, which will remain
regulated, from its power generation and energy services businesses, which will
operate in a competitive market in the future. New Mexico subsequently amended
its deregulation law
17
to delay the implementation date. While the Company is not subject to
deregulation in its Texas and New Mexico jurisdictions until late 2005 and
January 2007, respectively, the potential effects of competition in the power
generation and energy services markets remain important to the Company. There
can be no assurance that the deregulation of the power generation market will
not adversely affect the future operations, cash flows and financial condition
of the Company.
The changing regulatory environment and the advent of unregulated power
production have created a substantial risk that the Company will lose important
customers. The Company's wholesale and large retail customers already have, in
varying degrees, additional alternate sources of economical power, including co-
generation of electric power. Historically, the Company has lost certain large
retail customers to self generation and/or co-generation and seen reductions in
wholesale sales due to new sources of generation. American National Power,
Inc., a wholly-owned subsidiary of International Power PLC, has announced it is
exploring the possibility of building a generation plant in El Paso, Texas.
Duke Energy has begun the initial phase of construction on a generation plant in
Deming, New Mexico and has announced it is exploring the possibility of building
a generation plant in Lordsburg, New Mexico. Public Service Company of New
Mexico has begun the initial phase of construction on a generation plant outside
Las Cruces, New Mexico. If the Company loses a significant portion of its
retail customer base or wholesale sales, the Company may not be able to replace
such revenues through either the addition of new customers or an increase in
rates to remaining customers.
Another risk to the Company is potential increased costs, including the risk
of additional or unanticipated costs at Palo Verde resulting from (i) increases
in operation and maintenance expenses; (ii) the replacement of steam generators;
(iii) an extended outage of any of the Palo Verde units; (iv) increases in
estimates of decommissioning costs; (v) the storage of radioactive waste,
including spent nuclear fuel; and (vi) compliance with the various requirements
and regulations governing commercial nuclear generating stations. At the same
time, the Company's Texas retail base rates are effectively capped through a
rate freeze ending in August 2005. Additionally, upon initiation of retail
competition, there will be competitive pressure on the Company's power
generation rates which could reduce its profitability. The Company also cannot
assure that its revenues will be sufficient to recover any increased costs,
including any increased costs in connection with Palo Verde or other operations,
whether as a result of inflation, changes in tax laws or regulatory
requirements, or other causes.
Under the Texas Commission rules and the Company's energy cost recovery
clauses ("fuel clauses") in certain wholesale rates, energy costs are passed
through to customers. However, energy costs were not passed through to the
Company's New Mexico customers prior to June 15, 2001. These energy costs were
included in base rates and were not subject to periodic reconciliation or
adjustment for fluctuations in such costs. From October 1, 2000 through June
15, 2001, the Company incurred increased energy expenses which cannot be
recovered from New Mexico and certain wholesale customers of approximately $6.9
million, net of tax, compared to the same period a year earlier. The New Mexico
Commission allowed the Company to implement its New Mexico Fuel Factor
Agreement, beginning with consumption on June 15, 2001, subject to refund, and
appointed a hearing examiner to preside over the hearing in the case and submit
a recommended decision. On October 23, 2001, the hearing examiner issued a
Certification of Stipulation in which he recommended Commission approval of the
New Mexico Fuel Factor Agreement with only one change relating to the
reconciliation of fuel recoveries following the two-year period of the
applicability of the New Mexico Fuel Factor Agreement and during the pendancy of
the rate case proceeding to be filed following the two-year period. Because the
proposed change differs from the New Mexico Fuel Factor Agreement signed by the
parties, the Company has filed an exception to the Certification of Stipulation.
Nonetheless, the Company does not believe the proposed change would have a
negative substantive impact on the Company. The
18
reinstatement of a fuel adjustment clause would also substantially mitigate the
financial risk to the Company of any further energy cost increases over the two-
year period of the agreement. The Company began recording the effects of the New
Mexico Fuel Factor Agreement during the third quarter of 2001 and expects a
final order by the end of 2001. See Item 1, Note B, "Regulation - New Mexico
Regulatory Matters - Fuel" and Item 3, "Quantitative and Qualitative Disclosures
About Market Risk - Commodity Price Risk."
Liquidity and Capital Resources
The Company's principal liquidity requirements in the near-term are expected
to consist of interest and principal payments on the Company's indebtedness and
capital expenditures related to the Company's generating facilities and
transmission and distribution systems. The Company expects that cash flows from
operations will be sufficient for such purposes.
Long-term capital requirements of the Company will consist primarily of
construction of electric utility plant and payment of interest on and retirement
of debt. The Company is analyzing its capacity needs but currently has no
definite plans to add any significant amount of new generating capacity to serve
retail load prior to 2004. Utility construction expenditures will consist
primarily of expanding and updating the transmission and distribution systems
and the cost of capital improvements and replacements at Palo Verde and other
generating facilities, including the replacement of the Palo Verde steam
generators.
As of September 30, 2001, cash and temporary investments totaled $26.0
million, an increase of $14.7 million from the December 31, 2000 balance of
$11.3 million. The Company redeemed the remaining $34.6 million of Series B
First Mortgage Bonds at their maturity on May 1, 2001 from cash on hand. The
Company has a $100 million revolving credit facility, which provides up to $70
million for nuclear fuel purchases and up to $50 million (depending on the
amount of borrowings outstanding for nuclear fuel purchases) for working capital
needs. The revolving credit facility's term ends on February 8, 2002, when it
is expected to be renewed or replaced on comparable terms. At September 30,
2001, approximately $45.0 million had been drawn for nuclear fuel purchases. No
amounts are currently outstanding on this facility for working capital needs.
The Company has a high debt to capitalization ratio and significant debt
service obligations. Due to the Texas Rate Stipulation, the Texas Settlement
Agreement, and competitive pressures, the Company does not expect to be able to
raise its base rates in Texas in the event of increases in non-fuel costs or
loss of revenues. Accordingly, as described below, debt reduction continues to
be a high priority for the Company in order to gain additional financial
flexibility to address the evolving competitive market.
As part of an aggressive deleveraging program, the Company has significantly
reduced its long-term debt since its emergence from bankruptcy in 1996. From
June 1, 1996 through November 2, 2001, the Company repurchased on the open
market approximately $395.3 million of first mortgage bonds, including
approximately $26.4 million of first mortgage bonds during the third quarter of
2001 and an additional $9.0 million in October 2001. As mentioned above, the
Company also redeemed the remaining $34.6 million of Series B First Mortgage
Bonds at their maturity on May 1, 2001 from cash on hand. Common stock equity
as a percentage of capitalization, including current maturities of long-term
debt and financing and capital lease obligations, has increased from 19% at June
30, 1996 to 38% at September 30, 2001.
19
The Company continues to believe that the orderly reduction of debt with a
goal of achieving a capital structure that is more typical in the electric
utility industry is a significant component of long-term shareholder value
creation. Accordingly, the Company will regularly evaluate market conditions
and, when appropriate, use a portion of its available cash to reduce its fixed
obligations through open market purchases of first mortgage bonds.
The degree to which the Company is leveraged could have important
consequences on the Company's liquidity, including (i) the Company's ability to
obtain additional financing for working capital, capital expenditures,
acquisitions, general corporate or other purposes could be limited in the future
and (ii) the Company's higher than average leverage may place the Company at a
competitive disadvantage by limiting its financial flexibility to respond to the
demands of the competitive market and make it more vulnerable to adverse
economic or business changes.
The Company's Board of Directors previously approved two stock repurchase
programs allowing the Company to purchase up to twelve million of its
outstanding shares of common stock. As of November 2, 2001, the Company had
repurchased 11,302,729 shares of common stock under these programs for
approximately $125.4 million, including commissions. The Company expects to
continue to make purchases primarily in the open market at prevailing prices and
will also engage in private transactions, as appropriate. Any repurchased
shares may be available for issuance under employee benefit and stock option
plans, or may be retired.
Historical Results of Operations
Three Months Nine Months Twelve Months
Ended September 30, Ended September 30, Ended September 30,
------------------- ------------------- -------------------
2001 2000 2001 2000 2001 2000
------- ------- ------- ------- ------- -------
Income before extraordinary
item (in thousands).................... $25,794 $25,442 $56,658 $49,166 $67,656 $50,241
Diluted earnings per share
before extraordinary item.............. 0.50 0.46 1.09 0.89 1.29 0.90
Results of operations for the twelve months ended September 30, 2000 were
affected by the following unusual or infrequent items: (i) an adjustment of
$4.0 million, net of tax, reducing fuel expense based on a reduction of the
Company's estimated coal mine reclamation liability; (ii) a charge to earnings
of $10.1 million, net of tax, as a result of the settlement agreement with Las
Cruces; and (iii) a one-time charge to earnings of $2.5 million, net of tax,
resulting from the write-off of interest capitalized prior to 1999 on postload
nuclear fuel.
20
Electric utility operating revenues net of energy expenses increased $2.3
million, $17.0 million and $18.6 million for the three, nine and twelve months
ended September 30, 2001, respectively, compared to the same periods last year,
primarily due to changes in the following (in thousands):
Three Nine Twelve
Months Months Months
Ended Ended Ended
------- ------- --------
Economy sales margins.............. $(2,024) $21,507 $ 31,897
kWh sales.......................... 1,970 8,507 11,486
Energy expenses not recovered
in New Mexico service area........ 3,739 (6,855) (10,567)
Coal mine reclamation
adjustment........................ - - (6,601)
Write-off of capitalized interest
related to postload nuclear fuel.. - - (2,614)
Margins on energy swaps............ (957) (1,280) (1,280)
Other.............................. (433) (4,851) (3,749)
------- ------- --------
Total........................... $ 2,295 $17,028 $ 18,572
======= ======= ========
Comparisons of kWh sales and electric utility operating revenues are shown
below (in thousands):
Increase (Decrease)
-------------------------
Three Months Ended September 30: 2001 2000 Amount Percent
- -------------------------------- ---------- ---------- --------- ----------
Electric kWh sales:
Retail.................................. 1,830,696 1,833,694 (2,998) (0.2)%
Sales for resale........................ 480,717 398,239 82,478 20.7 (1)
Economy sales........................... 173,762 399,415 (225,653) (56.5) (2)
---------- ---------- ---------
Total.................................. 2,485,175 2,631,348 (146,173) (5.6)
========== ========== =========
Electric utility operating revenues:
Retail.................................. $ 164,955 $ 162,739 $ 2,216 1.4%
Sales for resale........................ 27,431 23,185 4,246 18.3 (1)
Economy sales........................... 15,069 19,658 (4,589) (23.3) (3)
Other (5)............................... 2,011 5,053 (3,042) (60.2) (4)
---------- ---------- ---------
Total.................................. $ 209,466 $ 210,635 $ (1,169) (0.6)
========== ========== =========
21
Increase (Decrease)
-------------------------
Nine Months Ended September 30: 2001 2000 Amount Percent
- ------------------------------- ---------- ---------- --------- ----------
Electric kWh sales:
Retail.................................. 4,795,357 4,716,701 78,656 1.7%
Sales for resale........................ 1,186,639 965,678 220,961 22.9 (6)
Economy sales........................... 802,614 1,295,830 (493,216) (38.1) (2)
---------- ---------- ---------
Total.................................. 6,784,610 6,978,209 (193,599) (2.8)
========== ========== =========
Electric utility operating revenues:
Retail.................................. $ 435,717 $ 406,360 $ 29,357 7.2% (7)
Sales for resale........................ 71,147 52,936 18,211 34.4 (8)
Economy sales........................... 89,799 49,445 40,354 81.6 (9)
Other (5)............................... 7,320 9,098 (1,778) (19.5) (10)
---------- ---------- ---------
Total.................................. $ 603,983 $ 517,839 $ 86,144 16.6
========== ========== =========
Increase (Decrease)
-------------------------
Twelve Months Ended September 30: 2001 2000 Amount Percent
- --------------------------------- ---------- ---------- --------- ----------
Electric kWh sales:
Retail.................................. 6,193,398 6,068,012 125,386 2.1%
Sales for resale........................ 1,503,501 1,209,912 293,589 24.3 (6)
Economy sales........................... 1,221,072 1,705,864 (484,792) (28.4) (2)
---------- ---------- ---------
Total.................................. 8,917,971 8,983,788 (65,817) (0.7)
========== ========== =========
Electric utility operating revenues:
Retail.................................. $ 559,665 $ 519,294 $ 40,371 7.8% (7)
Sales for resale........................ 88,373 65,771 22,602 34.4 (8)
Economy sales........................... 125,272 59,161 66,111 111.7 (9)
Other (5)............................... 9,242 10,407 (1,165) (11.2) (10)
---------- ---------- ---------
Total.................................. $ 782,552 $ 654,633 $ 127,919 19.5
========== ========== =========
- ----------
(1) Primarily due to increased sales to CFE.
(2) Primarily due to a weaker power market in 2001 compared to last year.
(3) Primarily due to decreased kWh sales.
(4) Primarily due to margins on swaps entered into with a large power marketer
in 2000 in order to lock in a fixed price on certain power purchases with
no comparable amount in the current period.
(5) Represents revenues with no related kWh sales.
(6) Primarily due to increased kWh sales to CFE and IID.
(7) Primarily due to increased energy expenses that are passed through directly
to Texas jurisdictional customers.
(8) Primarily due to (i) increased energy expenses that are passed through
directly to certain wholesale customers and (ii) increased sales to CFE.
(9) Primarily due to increased margins on economy sales.
(10) Primarily due to margins on swaps entered into with a large power marketer
in 2000 in order to lock in a fixed price on certain power purchases with
no comparable amount in the current period. This decrease was partially
offset by increased transmission revenues.
22
Other electric utility operations and maintenance expense increased $0.9
million, $7.1 million and $8.2 million for the three, nine and twelve months
ended September 30, 2001, respectively, compared to the same periods last year,
as follows (in thousands):
Increase
Three Months Ended September 30: 2001 2000 (Decrease)
- -------------------------------- ---------- ---------- ----------
Pensions and benefits expense............. $ 7,526 $ 5,549 $ 1,977 (1)
Operations expense at generation plants... 8,578 7,708 870
Maintenance expense at
generation plants........................ 6,212 6,779 (567)
Other..................................... 21,129 22,557 (1,428) (2)
------- ------- -------
Total electric utility other operations
and maintenance expense.............. $43,445 $42,593 $ 852
======= ======= =======
Increase
Nine Months Ended September 30: 2001 2000 (Decrease)
- ------------------------------- ---------- ---------- ----------
Maintenance expense at
generation plants........................ $ 26,221 $ 21,540 $ 4,681 (3)
Pensions and benefits expense............. 19,366 16,206 3,160 (1)
Operations expense at generation plants... 25,765 24,115 1,650
Outside services expense.................. 4,159 6,679 (2,520) (4)
Other..................................... 57,807 57,663 144
-------- -------- -------
Total electric utility other operations
and maintenance expense.............. $133,318 $126,203 $ 7,115
======== ======== =======
Increase
Twelve Months Ended September 30: 2001 2000 (Decrease)
- --------------------------------- ---------- ---------- ----------
Maintenance expense at
generation plants........................ $ 36,057 $ 26,631 $ 9,426 (3)
Operations expense at generation plants... 35,640 33,691 1,949
Pensions and benefits expense............. 27,157 26,726 431
Outside services expense.................. 6,211 9,524 (3,313) (4)
Other..................................... 76,136 76,431 (295)
-------- -------- -------
Total electric utility other operations
and maintenance expense.............. $181,201 $173,003 $ 8,198
======== ======== =======
- ----------
(1) Primarily due to (i) an increase in OPEB costs resulting from a change in
discount rate and escalation assumptions for medical costs for 2001 and
(ii) an increase in employee bonus accrual in 2001.
(2) Primarily due to (i) decreased transmission maintenance expense and (ii)
decreased expense for union negotiations.
(3) Primarily due to scheduled maintenance outages in 2001 and the fourth
quarter of 2000.
(4) Primarily due to a decrease in consulting fees and corporate restructuring
expenses.
23
Depreciation and amortization expense did not change significantly for the
three, nine and twelve months ended September 30, 2001 compared to the same
period last year.
Taxes other than income taxes increased $0.9 million, $0.5 million and $3.1
million for the three, nine and twelve months ended September 30, 2001,
respectively, compared to the same periods last year. The increases for the
three, nine and twelve months ended September 30, 2001 were primarily due to (i)
an increase in Texas revenue related taxes due to higher operating income in
2001, (ii) a $0.4 million Texas Franchise Tax refund in September 2000, and
(iii) the establishment of Navajo Nation taxes related to the Company's
participation in Four Corners. These increases were partially offset by a
decrease in Arizona property taxes as a result of depreciation and Arizona House
Bill 2324. The increase for the twelve months ended September 30, 2001, also
included a $3.1 million reversal in December 1999 of sales tax reserves
established in prior years.
Other income (deductions) did not change significantly for the three months
ended September 30, 2001 compared to the same period last year. Other income
(deductions) increased $2.0 million and $15.0 million for the nine and twelve
months ended September 30, 2001, respectively, compared to the same periods last
year due to litigation settlements of $1.0 million for the nine and twelve
months ended September 30, 2000 with no comparable activity in the current
period. Other income (deductions) for the twelve months ended September 30,
2001 also increased due to the accrual of the $16.5 million settlement agreement
payment to Las Cruces in December 1999. The twelve month increase was partially
offset by (i) an adjustment of $1.7 million to increase the reported cash value
of Company-owned life insurance policies in December 1999 and (ii) a gain
realized on the disposition of non-utility property of $1.4 million during the
twelve months ended September 30, 2000 with no comparable activity in the
current period.
Interest charges decreased $1.6 million, $2.8 million, and $9.4 million for
the three, nine and twelve months ended September 30, 2001, respectively,
compared to the same period last year due to (i) a reduction in outstanding debt
as a result of open market purchases and maturities of the Company's first
mortgage bonds and (ii) increased capitalized interest related to construction
work in progress. The twelve month decrease was also due to adjustments to
postload nuclear fuel to write-off a portion of accumulated interest capitalized
prior to 1999 and discontinue capitalizing interest thereon in 1999. These
decreases were partially offset by an increase in interest charges related to
the remarketing of the pollution control bonds in August 2000.
Income tax expense, excluding the tax effect of the extraordinary item,
increased $1.4 million for the three months ended September 30, 2001 and
increased $4.9 million for the nine months ended September 30, 2001 primarily
due to changes in pretax income and certain permanent differences. The increase
of $13.8 million for the twelve months ended September 30, 2001 compared to the
same period last year was primarily due to changes in pretax income and certain
permanent differences including (i) a decrease in the adjustment to the cash
value of Company-owned life insurance policies and (ii) a decrease in tax-exempt
income partially offset by a decrease in nondeductible transition costs.
Extraordinary loss on extinguishments of debt, net of income tax benefit,
represents the payment of premiums on debt extinguishments and the recognition
of unamortized issuance expenses on that debt.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" and Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets." The Company does not believe that
its activities or assets as of September 30, 2001 will be impacted by these
standards.
24
Additionally, in July 2001, the FASB issued Statement of Financial Accounting
Standards No. 143 "Accounting for Asset Retirement Obligations" ("SFAS No.
143"). SFAS No. 143 provides accounting guidance for retirement obligations,
for which there is a legal obligation to settle, associated with tangible long-
lived assets. SFAS No. 143 requires that asset retirement costs be capitalized
as part of the cost of the related long-lived asset and such costs should be
allocated to expense by using a systematic and rational method. The statement
requires that the initial measurement of the asset retirement obligation
liability to be recorded at fair value and the use of an allocation approach for
subsequent changes in the measurement of the liability. Upon adoption of SFAS
No. 143, an entity will use a cumulative-effect approach to recognize transition
amounts for any existing asset retirement obligation liability, asset retirement
costs and accumulated depreciation. SFAS No. 143 is effective for fiscal years
beginning after June 15, 2002. Management has not yet quantified the impact of
adopting SFAS No. 143 on the Company's financial statements.
On October 3, 2001, the Financial Accounting Standards Board issued FASB
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", ("SFAS No. 144"). While SFAS No. 144 supersedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of", it retains many of the fundamental provisions of that
Statement. SFAS No. 144 is effective for fiscal years beginning after December
15, 2001. Management has not yet quantified the impact, if any, of adopting SFAS
No. 144 on the Company's financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following discussion regarding the Company's market-risk sensitive
instruments contains forward-looking information involving risks and
uncertainties. The statements regarding potential gains and losses are only
estimates of what could occur in the future. Actual future results may differ
materially from those estimates presented due to the characteristics of the
risks and uncertainties involved.
The Company is exposed to market risk due to changes in interest rates,
equity prices and commodity prices. See the Company's 2000 Form 10-K, Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk," for a complete
discussion of the market risks faced by the Company and the Company's market
risk sensitive assets and liabilities. As of September 30, 2001, there have
been no material changes in the interest rate and equity price risks faced by
the Company or the fair values of assets and liabilities disclosed in Item 7A,
"Quantitative and Qualitative Disclosures About Market Risk," in the Company's
2000 Form 10-K. Additionally, the commodity price risk that the Company had
been exposed to due to increased energy costs will be substantially mitigated by
the New Mexico Fuel Factor Agreement as discussed below.
Commodity Price Risk
The Company utilizes contracts of various durations for the purchase of
natural gas, uranium concentrates and coal to effectively manage its available
fuel portfolio. These agreements contain fixed and variable pricing provisions
and are settled by physical delivery. The fuel contracts with variable pricing
provisions, as well as substantially all of the Company's purchased power
requirements, are exposed to fluctuations in prices due to unpredictable
factors, including weather, which impact supply and demand.
25
Natural gas and purchased power prices increased significantly from May 2000
through May 2001. Since that time, price levels have decreased to nearly pre-
May 2000 levels; however, natural gas prices have recently begun to increase
again due to expected seasonal factors, but not significantly. The Company's
exposure to fuel and purchased power price risk was substantially mitigated
during this time period through the operation of the Texas Commission rules and
the Company's energy cost recovery clauses ("fuel clauses") in certain wholesale
rates. Under these rules and fuel clauses, energy costs are passed through to
customers. In the Company's New Mexico service area, pursuant to a rate freeze
that expired on April 30, 2001, energy costs were included in the Company's base
rates and were not subject to periodic reconciliation or adjustment for
fluctuations in such costs. Therefore, the Company was exposed to commodity
price risk on energy costs that were related to sales of electricity to its New
Mexico customers. However, in June 2001, the Company entered into the New
Mexico Fuel Factor Agreement which, among other things, would implement a new
fixed fuel factor and reinstate a fuel adjustment clause to reflect its
increased energy costs and provide a mechanism for passing through to New Mexico
customers increases and decreases in energy costs. See Item 1, Note B,
"Regulation - New Mexico Regulatory Matters - Fuel" for further discussion. The
implementation of the provisions of the New Mexico Fuel Factor Agreement, which
is contingent on final approval of the New Mexico Commission, has substantially
mitigated the remaining financial risk to the Company of any further energy cost
increases.
In the normal course of business, the Company utilizes contracts of various
durations for the forward sales and purchases of electricity to effectively
manage its available generating capacity and supply needs. Such contracts
include forward contracts for the sale of generating capacity and energy during
periods when the Company's available power resources are expected to exceed the
requirements of its native load and sales for resale. They also include forward
contracts for the purchase of wholesale capacity and energy during periods when
the market price of electricity is below the Company's expected incremental
power production costs or to supplement the Company's generating capacity when
demand is anticipated to exceed such capacity. As of September 30, 2001, the
Company had entered into forward sales and purchase contracts for energy as
discussed in Item 1, Note D, "Commitments and Contingencies - Power Contracts."
These agreements are generally fixed-priced contracts which qualify for the
normal purchases and normal sales exceptions to SFAS No. 133 and are not
recorded at their fair value in the Company's financial statements. Because of
the operation of the Company's fuel clauses, these contracts do not expose the
Company to significant commodity price risk.
26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company hereby incorporates by reference the information set forth in
Part I of this report under Note E of Notes to Consolidated Financial
Statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: See Index to Exhibits incorporated herein by reference.
(b) Reports on Form 8-K:
None
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EL PASO ELECTRIC COMPANY
By: /s/ Gary R. Hedrick
-------------------------------------
Gary R. Hedrick
President, Chief Executive
Officer and Director
(Duly Authorized Officer and
Principal Financial Officer)
Dated: November 13, 2001
28
EL PASO ELECTRIC COMPANY
INDEX TO EXHIBITS
Exhibit
Number Exhibit
- ------- -------
10.09 Stock Option Agreement, dated as of July 1, 2001, with Wilson K.
Cadman. (Identical in all material respects to Exhibit 99.17 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1997)
+10.10 Form of Directors' Restricted Stock Award Agreement between the
Company and certain directors of the Company. (Identical in all
material respects to Exhibit 10.07 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999)
15 Letter re Unaudited Interim Financial Information
+ Three agreements, dated as of July 1, 2001, substantially
identical in all material respects to Exhibit 10.10, were
entered into with Kenneth R. Heitz; Patricia Z. Holland-Branch;
and Charles A. Yamarone, directors of the Company.