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, 2001
OR
[ ] 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
Commission Incorporation; Address; IRS Employer
File Number and Telephone Number Identification Number
------------ ----------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
One South Church Avenue, Suite 100
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
One South Church Avenue, Suite 100
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.
Yes X No ___
At May 4, 2001, 33,310,398 shares of UniSource Energy Corporation's
Common Stock, no par value (the only class of Common Stock) were
outstanding.
UniSource Energy Corporation is the holder of 32,139,434 shares of the
outstanding Common Stock of Tucson Electric Power Company.
- ---------------------------------------------------------------------------
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
Report of Independent Accountants.........................................1
PART I - FINANCIAL INFORMATION
Item 1. -- Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements of Income...............2
Comparative Condensed Consolidated Statements of Cash Flows...........3
Comparative Condensed Consolidated Balance Sheets.....................4
Condensed Consolidated Statement of Changes in
Stockholders' Equity................................................5
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income (Loss)........6
Comparative Condensed Consolidated Statements of Cash Flows...........7
Comparative Condensed Consolidated Balance Sheets.....................8
Condensed Consolidated Statement of Changes in
Stockholders' Equity................................................9
Notes to Condensed Consolidated Financial Statements
Note 1. Regulatory Accounting..........................................10
Note 2. Accounting for Derivative Instruments and Hedging
Activities...................................................10
Note 3. Millennium Energy Businesses...................................11
Note 4. Business Segments..............................................14
Note 5. Commitments and Contingencies..................................14
Note 6. Wholesale Accounts Receivable and Allowances...................15
Note 7. Income Taxes...................................................16
Note 8. Review by Independent Accountants..............................17
Note 9. Reclassifications..............................................17
Item 2. -- Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview...............................................................18
Factors Affecting Results of Operations
Competition
Retail.............................................................19
Wholesale..........................................................20
Western Energy Markets...............................................21
Regulatory Matters...................................................23
Market Risks.........................................................23
Future Generating Resources..........................................25
Results of Operations..................................................26
Results of Millennium Energy Businesses................................29
Dividends on Common Stock..............................................29
Liquidity and Capital Resources
Cash Flows
UniSource Energy...................................................30
TEP................................................................30
TABLE OF CONTENTS
(concluded)
Investing and Financing Activities
UniSource Energy...................................................31
TEP................................................................31
Millennium -- Unregulated Energy Businesses........................31
Safe Harbor for Forward-Looking Statements.............................32
Item 3. -- Quantitative and Qualitative Disclosures About
Market Risk............................................................33
PART II - OTHER INFORMATION
Item 1. -- Legal Proceedings.............................................34
Item 5. -- Other Information
Additional Financial Data..............................................34
Item 6. -- Exhibits and Reports on Form 8-K..............................34
Signature Page...........................................................35
Exhibit Index............................................................36
DEFINITIONS
The abbreviations and acronyms used in the 2001 First Quarter Form 10-Q are
defined below:
- ----------------------------------------------------------------------------
ACC....................... Arizona Corporation Commission.
ACC Holding Company
Order................... The order approved by the ACC in November 1997
allowing TEP to form a holding company.
AISA...................... Arizona Independent Scheduling Administrator
Association, a temporary organization required
by the ACC Retail Electric Competition Rules.
AMT....................... Alternative Minimum Tax.
CDWR...................... California Department of Water Resources.
CISO...................... California Independent System Operator.
Common Stock.............. UniSource Energy's common stock, without
par value.
Company or UniSource
Energy.................. UniSource Energy Corporation.
CPX....................... California Power Exchange.
Credit Agreement.......... Credit Agreement between TEP and the banks,
dated as of December 30, 1997.
Desert STAR............... The ISO formed in the southwestern United
States, in which TEP is a participant.
ESP....................... Energy Service Provider.
FAS 71.................... Statement of Financial Accounting Standards
No. 71: Accounting for the Effects of Certain
Types of Regulation.
FAS 133................... Statement of Financial Accounting Standards
No. 133: Accounting for Derivative Instruments
and Hedging Activities.
FERC...................... Federal Energy Regulatory Commission.
First Mortgage Bonds...... First mortgage bonds issued under the First
Mortgage Indenture, dated as of April 1, 1941,
of Tucson Gas, Electric Light and Power
Company to the Chase National Bank of the City
of New York, as trustee, as supplemented
and amended.
GAAP...................... Generally Accepted Accounting Principles.
GES....................... Global Energy Solutions, Inc., which owns 100%
of Global Solar and Infinite Power Solutions.
Global Solar.............. Global Solar Energy, Inc., a wholly-owned
subsidiary of GES, which develops and
manufactures thin-film photovoltaic cells.
Heating Degree Days....... Calculated by subtracting the average of the
high and low daily temperatures from 65.
Infinite Power Solutions.. A developer of thin-film batteries which is
wholly-owned by GES.
IRS....................... Internal Revenue Service.
ISO....................... Independent System Operator.
ITC....................... Investment tax credit.
ITN....................... ITN Energy Systems, Inc., a Colorado Corporation.
kWh....................... Kilowatt-hour(s).
MEH....................... MEH Corporation, a wholly-owned subsidiary of
Millennium, which formerly held a 50% interest
in NewEnergy.
MicroSat.................. MicroSat Systems, Inc., a company owned 49% by
Millenium and 51% by ITN, which was formed to
develop and commercialize small-scale
satellites.
Millennium................ Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
MW........................ Megawatt(s).
MWh....................... Megawatt-hour(s).
Nations Energy............ Nations Energy Corporation, a wholly-owned
subsidiary of Millennium and holder of
interests in independent power projects in
Curacao and Panama.
NewEnergy................. NewEnergy, Inc., formerly New Energy Ventures,
Inc., a company in which a 50% interest was
owned by MEH.
NOL....................... Net Operating Loss carryback or carryforward for
income tax purposes.
NTUA...................... Navajo Tribal Utility Authority.
PDES...................... Phelps Dodge Energy Services.
PG&E...................... Pacific Gas and Electric Company.
DEFINITIONS
(concluded)
Revolving Credit
Facility............... $100 million revolving credit facility entered
into under the Credit Agreement between a
syndicate of banks and TEP.
RTO....................... Regional Transmission Organization.
Rules..................... Retail Electric Competition Rules.
SCE....................... Southern California Edison Company.
Settlement Agreement...... TEP's Settlement Agreement approved by the ACC
in November 1999 which provided for electric
retail competition and transition asset
recovery.
Springerville............. Springerville Generating Station.
Springerville Common
Facilities.............. Facilities at Springerville used in common with
Springerville Unit 1 and Springerville Unit 2.
Springerville Unit 1...... Unit 1 of the Springerville Generating Station.
Springerville Unit 1
Lease................... 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.
UniSource Energy.......... UniSource Energy Corporation.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
UniSource Energy Corporation and
to the Board of Directors of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated balance sheets of
UniSource Energy Corporation and its subsidiaries (the Company) and Tucson
Electric Power Company and its subsidiaries (TEP) as of March 31, 2001 and
the related condensed consolidated statements of income (loss) and of cash
flows for each of the three-month periods ended March 31, 2001 and 2000 and
the condensed consolidated statements of changes in stockholders' equity
for the three-month period ended March 31, 2001. These financial statements
are the responsibility of the Company's and TEP's management.
We conducted our reviews 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 reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated interim financial
statements for them to be in conformity with accounting principles
generally accepted in the United States of America.
We previously audited in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheets
and statements of capitalization of the Company and TEP as of December 31,
2000, and the related consolidated statements of income, of changes in
stockholders' equity, and of cash flows for the year then ended (not
presented herein), and in our report dated February 1, 2001 we expressed
an unqualified opinion on those consolidated financial statements.
In our opinion, the information set forth in the accompanying condensed
consolidated balance sheet information as of December 31, 2000 is fairly
stated in all material respects in relation to the consolidated balance
sheets from which it has been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
May 4, 2001
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 UniSource Energy's 2000 Form 10-K.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31,
2001 2000
(Unaudited)
- ----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 134,677 $ 131,290
Electric Sales for Resale:
Electric Sales for Resale Delivered 143,687 44,780
Unrealized Gain (Loss) on Forward Sales (39,767) -
- ----------------------------------------------------------------------------
Total Electric Sales for Resale 103,920 44,780
Other 2,609 1,409
- ----------------------------------------------------------------------------
Total Operating Revenues 241,206 177,479
- ----------------------------------------------------------------------------
Operating Expenses
Fuel 70,951 43,549
Purchased Power:
Purchased Power Received 46,372 16,991
Unrealized (Gain) Loss on Forward Purchases (42,459) -
- ----------------------------------------------------------------------------
Total Purchased Power 3,913 16,991
Other Operations 40,424 31,765
Maintenance and Repairs 12,179 8,344
Depreciation and Amortization 28,698 27,456
Amortization of Transition Recovery Asset 2,346 903
Taxes Other Than Income Taxes 11,873 12,414
Income Taxes 13,572 (1,998)
- ----------------------------------------------------------------------------
Total Operating Expenses 183,956 139,424
- ----------------------------------------------------------------------------
Operating Income 57,250 38,055
- ----------------------------------------------------------------------------
Other Income (Deductions)
Income Taxes (1,244) (286)
Interest Income 3,915 3,233
Other Income (Deductions) (1,184) 1,700
- ----------------------------------------------------------------------------
Total Other Income (Deductions) 1,487 4,647
- ----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 15,772 16,874
Interest on Capital Leases 22,706 23,265
Other Interest Expense 1,464 2,321
- ----------------------------------------------------------------------------
Total Interest Expense 39,942 42,460
- ----------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 18,795 242
Cumulative Effect of Accounting Change - Net of Tax 470 -
- ----------------------------------------------------------------------------
Net Income $ 19,265 $ 242
============================================================================
Average Shares of Common Stock Outstanding (000) 33,266 32,374
============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.57 $0.01
Cumulative Effect of Accounting Change - Net of Tax $0.01 -
Net Income $0.58 $0.01
============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.56 $0.01
Cumulative Effect of Accounting Change - Net of Tax $0.01 -
Net Income $0.57 $0.01
============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2001 2000
(Unaudited)
- ----------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 157,671 $ 153,005
Cash Receipts from Electric Sales for Resale 152,969 41,107
Fuel Costs Paid (80,603) (44,551)
Purchased Power Costs Paid (49,194) (17,284)
Wages Paid, Net of Amounts Capitalized (20,415) (18,500)
Payment of Other Operations and Maintenance Costs (33,337) (25,638)
Capital Lease Interest Paid (42,457) (43,733)
Taxes Paid, Net of Amounts Capitalized (12,971) (11,450)
Interest Paid, Net of Amounts Capitalized (23,792) (23,564)
Income Taxes Paid (10,450) (2)
Interest Received 5,777 4,618
Other 4,680 2,146
- ----------------------------------------------------------------------------
Net Cash Flows - Operating Activities 47,878 16,154
- ----------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (39,561) (26,307)
Investments in and Loans to
Millennium Energy Businesses (7,897) (2,118)
Proceeds from the Sale of
Millennium Energy Businesses - 19,950
Purchase of Springerville Lease Debt - (27,633)
Other (1,376) (96)
- ----------------------------------------------------------------------------
Net Cash Flows - Investing Activities (48,834) (36,204)
- ----------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (14,500) (20,725)
Common Stock Dividends Paid (3,329) (2,583)
Other 1,302 795
- ----------------------------------------------------------------------------
Net Cash Flows - Financing Activities (17,752) (23,738)
- ----------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (18,708) (43,788)
Cash and Cash Equivalents, Beginning of Year 163,004 145,288
- ----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 144,296 $ 101,500
============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- ----------------------------------------------------------------------------
Net Income $ 19,265 $ 242
Adjustments to Reconcile Net Income to Net Cash
Flows
Depreciation and Amortization Expense 28,698 27,456
Amortization of Transition Recovery Asset 2,346 903
Unrealized (Gains) Losses on
Forward Sales and Purchase Contracts (3,162) -
Amortization of Deferred Debt-Related Costs
Included in Interest Expense 504 1,192
Deferred Income Taxes 3,644 5,587
Unremitted Losses of Unconsolidated Subsidiaries 2,262 685
Gain on Sale of Nations Energy's
Czech Republic Interest - (2,527)
Market Value Adjustments Related to Nations Energy - 1,499
Other (1,244) 955
Changes in Assets and Liabilities which Provided
(Used)
Cash Exclusive of Changes Shown Separately
Accounts Receivable 28,052 6,264
Materials and Fuel (1,537) (998)
Accounts Payable (12,550) (2,985)
Interest Accrued (29,971) (25,862)
Taxes Accrued 10,446 10,671
Other Current Assets (194) (5,457)
Other Current Liabilities (1,201) (1,851)
Other Deferred Assets (303) 916
Other Deferred Liabilities 2,823 (536)
- ----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 47,878 $ 16,154
============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2001 2000
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,399,033 $2,389,587
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 112,929 94,789
- ---------------------------------------------------------------------------
Total Utility Plant 3,253,408 3,225,822
Less Accumulated Depreciation and Amortization (1,209,630) (1,186,035)
Less Accumulated Depreciation of
Capital Lease Assets (340,851) (333,497)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,702,927 1,706,290
- ---------------------------------------------------------------------------
Investments and Other Property 141,273 121,811
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 144,296 163,004
Accounts Receivable 87,690 115,742
Materials and Fuel 45,936 44,399
Deferred Income Taxes - Current 17,879 17,790
Other 19,467 19,273
- ---------------------------------------------------------------------------
Total Current Assets 315,268 360,208
- ---------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 350,937 353,283
Income Taxes Recoverable Through Future Revenues 71,381 73,459
Other Regulatory Assets 7,999 7,690
Other Assets 48,133 48,643
- ---------------------------------------------------------------------------
Total Regulatory and Other Assets 478,450 483,075
- ---------------------------------------------------------------------------
Total Assets $2,637,918 $2,671,384
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 374,915 $ 372,169
Capital Lease Obligations 848,571 857,829
Long-Term Debt 1,131,170 1,132,395
- ----------------------------------------------------------------------------
Total Capitalization 2,354,656 2,362,393
- ----------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 23,001 21,147
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 50,737 65,891
Interest Accrued 29,347 63,852
Taxes Accrued 37,257 26,811
Forward Sale and Purchase Contracts 19,946 -
Accrued Employee Expenses 11,496 14,405
Other 7,694 8,547
- ----------------------------------------------------------------------------
Total Current Liabilities 181,203 202,378
- ----------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 43,658 51,035
Other 58,401 55,578
- ----------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 102,059 106,613
- ----------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,637,918 $2,671,384
============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Accumulated Other Total
Common Earnings Comprehensive Stockholders'
Stock (Deficit) Income (Loss) Equity
- ----------------------------------------------------------------------------
- Thousands of Dollars -
Balances at
December 31, 2000 $ 655,539 $ (283,370) $ - $ 372,169
- ----------------------------------------------------------------------------
Comprehensive Income
(Loss):
2001 Year-to-Date Net
Income - 19,265 - 19,265
Cumulative Effect of
Accounting Change (net
of $9,179,000 income
tax benefit) - - (13,827) (13,827)
Unrealized Loss on Cash
Flow Hedges Not Yet
Settled (net of
$4,721,000 income tax
benefit) - - (7,111) (7,111)
Reversal of Previously
Recorded Unrealized
Losses for Contracts
which Settled During
the Period (net of
$4,556,000 income tax
expense) - - 6,863 6,863
-----------
Total Comprehensive Income 5,190
-----------
46,794 Shares Issued under
Stock Compensation
Plans 779 - - 779
5,264 Shares Distributed
by Deferred Compensation
Trust 106 - - 106
Dividend Declared - (3,329) - (3,329)
- ----------------------------------------------------------------------------
Balances at
March 31, 2001 $ 656,424 $ (267,434) $ (14,075) $ 374,915
============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (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 TEP's 2000 Form 10-K.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
March 31,
2001 2000
(Unaudited)
- ----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 134,677 $ 131,290
Electric Sales for Resale:
Electric Sales for Resale Delivered 143,687 44,780
Unrealized Gain (Loss) on Forward Sales (39,767) -
- ----------------------------------------------------------------------------
Total Electric Sales for Resale 103,920 44,780
Other 744 553
- ----------------------------------------------------------------------------
Total Operating Revenues 239,341 176,623
- ----------------------------------------------------------------------------
Operating Expenses
Fuel 70,951 43,549
Purchased Power:
Purchased Power Received 46,372 16,991
Unrealized (Gain) Loss on Forward Purchases (42,459) -
- ----------------------------------------------------------------------------
Total Purchased Power 3,913 16,991
Other Operations 35,074 28,873
Maintenance and Repairs 12,179 8,344
Depreciation and Amortization 28,480 27,387
Amortization of Transition Recovery Asset 2,346 903
Taxes Other Than Income Taxes 11,523 12,194
Income Taxes 15,195 (1,062)
- ----------------------------------------------------------------------------
Total Operating Expenses 179,661 137,179
- ----------------------------------------------------------------------------
Operating Income 59,680 39,444
- ----------------------------------------------------------------------------
Other Income (Deductions)
Income Taxes (2,102) (1,956)
Interest Income 2,773 2,036
Interest Income - Note Receivable from
UniSource Energy 2,300 2,326
Other Income 317 513
- ----------------------------------------------------------------------------
Total Other Income (Deductions) 3,288 2,919
- ----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 15,772 16,874
Interest on Capital Leases 22,692 23,254
Other Interest Expense 1,463 2,321
- ----------------------------------------------------------------------------
Total Interest Expense 39,927 42,449
- ----------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of
Accounting Change 23,041 (86)
Cumulative Effect of Accounting Change - Net of Tax 470 -
- ----------------------------------------------------------------------------
Net Income (Loss) $ 23,511 $ (86)
============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2001 2000
(Unaudited)
- ----------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 157,671 $ 153,005
Cash Receipts from Electric Sales for Resale 152,969 41,107
Fuel Costs Paid (80,603) (44,551)
Purchased Power Costs Paid (49,194) (17,284)
Wages Paid, Net of Amounts Capitalized (18,361) (16,489)
Payment of Other Operations and Maintenance Costs (25,689) (23,055)
Capital Lease Interest Paid (42,450) (43,721)
Taxes Paid, Net of Amounts Capitalized (12,303) (11,344)
Interest Paid, Net of Amounts Capitalized (23,792) (23,564)
Income Taxes Paid (10,450) (2)
Interest Received 4,536 3,333
- ----------------------------------------------------------------------------
Net Cash Flows - Operating Activities 52,334 17,435
- ----------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (29,210) (23,616)
Other Investments - Net (339) 159
- ----------------------------------------------------------------------------
Net Cash Flows - Investing Activities (29,549) (23,457)
- ----------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (14,482) (20,705)
Other 830 630
- ----------------------------------------------------------------------------
Net Cash Flows - Financing Activities (14,877) (21,300)
- ----------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 7,908 (27,322)
Cash and Cash Equivalents, Beginning of Year 88,712 88,402
- ----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 96,620 $ 61,080
============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- ----------------------------------------------------------------------------
Net Income (Loss) $ 23,511 $ (86)
Adjustments to Reconcile Net Income (Loss) to
Net Cash Flows
Depreciation and Amortization Expense 28,480 27,387
Amortization of Transition Recovery Asset 2,346 903
Unrealized (Gains) Losses on
Forward Sales and Purchase Contracts (3,162) -
Amortization of Deferred Debt-Related Costs
Included in Interest Expense 504 1,192
Deferred Income Taxes 6,117 5,767
Unremitted Losses of Unconsolidated Subsidiaries 409 114
Interest on Note Receivable from UniSource Energy (2,300) (2,326)
Other 1,774 830
Changes in Assets and Liabilities which Provided
Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 27,545 8,070
Materials and Fuel (834) (1,000)
Accounts Payable (14,112) (3,185)
Interest Accrued (29,971) (25,862)
Taxes Accrued 10,353 10,788
Other Current Assets 1,448 (3,502)
Other Current Liabilities (1,428) (2,029)
Other Deferred Assets (1,263) 916
Other Deferred Liabilities 2,917 (542)
- ----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 52,334 $ 17,435
============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2001 2000
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,399,033 $2,389,587
Utility Plant Under Capital Leases 741,446 741,446
Construction Work in Progress 112,929 94,789
- ---------------------------------------------------------------------------
Total Utility Plant 3,253,408 3,225,822
Less Accumulated Depreciation and Amortization (1,209,630) (1,186,035)
Less Accumulated Depreciation of
Capital Lease Assets (340,851) (333,497)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,702,927 1,706,290
- ---------------------------------------------------------------------------
Investments and Other Property 91,642 92,334
- ---------------------------------------------------------------------------
Note Receivable from UniSource Energy 70,132 70,132
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 96,620 88,712
Interest on Note Receivable from UniSource Energy 2,300 -
Accounts Receivable 89,373 116,580
Materials and Fuel 44,681 43,847
Deferred Income Taxes - Current 10,751 10,662
Other 5,137 6,585
- ---------------------------------------------------------------------------
Total Current Assets 248,862 266,386
- ---------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 350,937 353,283
Income Taxes Recoverable Through Future Revenues 71,381 73,459
Other Regulatory Assets 7,999 7,690
Other Assets 31,811 31,361
- ---------------------------------------------------------------------------
Total Regulatory and Other Assets 462,128 465,793
- ---------------------------------------------------------------------------
Total Assets $2,575,691 $2,600,935
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 305,413 $ 295,660
Capital Lease Obligations 848,260 857,519
Long-Term Debt 1,131,170 1,132,395
- ---------------------------------------------------------------------------
Total Capitalization 2,284,843 2,285,574
- ---------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 22,871 21,031
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 57,245 73,955
Interest Accrued 29,347 63,852
Taxes Accrued 35,838 25,485
Forward Sale and Purchase Contracts 19,946 -
Accrued Employee Expenses 11,168 14,152
Other 5,329 5,671
- ---------------------------------------------------------------------------
Total Current Liabilities 183,469 205,871
- ---------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 49,076 53,980
Other 58,303 55,510
- ---------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 107,379 109,490
- ---------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,575,691 $2,600,935
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Capital Accumulated Other Total
Common Stock Earnings Comprehensive Stockholders'
Stock Expense (Deficit) Income (Loss) Equity
- ----------------------------------------------------------------------------
- Thousands of Dollars -
Balances at
December 31, 2000 $ 651,723 $ (6,357) $(349,706) $ - $ 295,660
- ----------------------------------------------------------------------------
Comprehensive
Income (Loss):
2001 Year-to-Date
Net Income - - 23,511 - 23,511
Cumulative Effect of
Accounting Change
(net of $9,179,000
income tax benefit) - - - (13,827) (13,827)
Unrealized Loss on
Cash Flow Hedges
Not Yet Settled
(net of $4,721,000
income tax benefit) - - - (7,111) (7,111)
Reversal of Previously
Recorded Unrealized
Losses for Contracts
which Settled During
the Period (net of
$4,556,000 income
tax expense) - - - 6,863 6,863
-----------
Total Comprehensive Income 9,436
-----------
Other 317 - - - 317
- ----------------------------------------------------------------------------
Balances at
March 31, 2001 $ 652,040 $ (6,357) $(326,195) $(14,075) $ 305,413
============================================================================
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ---------------------------------------------------------------------
NOTE 1. REGULATORY ACCOUNTING
- ------------------------------
TEP generally uses the same accounting policies and practices used
by unregulated companies for financial reporting under GAAP. 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 currently charge its customers to recover certain expenses, but
instead requires that these expenses be charged to customers in the
future. In this situation, FAS 71 requires that TEP defer these items
and show them as regulatory assets on the balance sheet until TEP is
allowed to charge its customers. TEP then amortizes these items as
expense to the income statement as those charges are recovered from
customers. Similarly, certain revenue items may be deferred as
regulatory liabilities, which are also eventually amortized to the
income statement as rates to customers are reduced.
The conditions a regulated company must satisfy to apply the
accounting policies and practices of FAS 71 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.
In November 1999, upon approval by the ACC of a Settlement
Agreement relating to recovery of TEP's transition costs and standard
retail rates, we discontinued application of FAS 71 to our generation
operations.
We continue to apply FAS 71 to the distribution and transmission
portions of TEP's business, our regulated operations. We periodically
assess whether we can continue to apply FAS 71 to these operations. If
we stopped applying FAS 71 to TEP's remaining regulated operations, we
would write off the related balances of TEP's regulatory assets as a
charge in our income statement. Based on the balances of TEP's
regulatory assets at March 31, 2001, if we had stopped applying FAS 71
to TEP's remaining regulated operations, we would have recorded an
extraordinary loss, after-tax, of approximately $260 million. While
regulatory orders and market conditions may affect our cash flows, our
cash flows would not be affected if we stopped applying FAS 71.
NOTE 2. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- ---------------------------------------------------------------------
In 1998, the Financial Accounting Standards Board (FASB) 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. We buy and sell
wholesale power using forward contracts which are considered to be
derivatives. Under forward contracts, TEP commits to purchase or sell a
specified amount of capacity or energy at a specified price over a
given period of time, typically for one month, three months or one
year. Forward contracts may consist of sales of TEP's excess
generating capacity, purchases to meet our retail and firm energy
commitments, or trading activity, where forward sales and purchases may
be made within established limits to take advantage of favorable market
opportunities.
There are two types of gains and losses related to forward
contracts:
- An unrealized gain or loss is the difference between the contract
price and the market price at any interim date until the contract is
settled.
- A realized gain or loss is the difference between the contract price
and the actual cost of the commodity that was purchased or sold.
Realized gains or losses are recorded in the financial statements at
the settlement date. We base our decision to enter into forward
contracts based on an estimated realized gain.
On January 1, 2001, we adopted FAS 133. The financial statements
for 2000 do not reflect the requirements of FAS 133, as we recorded
realized gains and losses at the contract settlement date. FAS 133
requires us to recognize all derivative instruments on the balance
sheet as either assets or liabilities measured at fair value and to
record the related unrealized gains and losses throughout the contract
period until settlement. Based on our interpretation of FAS 133 and
other guidance, we have classified our wholesale forward contracts as
follows:
- Normal Purchases and Sales: Our off-peak forward purchases and sales
generally qualify as normal purchases and sales and are excluded from
the requirements of FAS 133. The realized gains and losses on these
contracts are reflected in the income statement at the contract
settlement date.
- Cash Flow Hedge: On-peak forward purchase contracts to meet our
retail and firm commitments, as well as on-peak forward sales contracts
of our excess system capacity are generally classified as cash flow
hedges. Our on-peak purchases and sales occur daily from 6 a.m. until
10 p.m., Monday through Saturday. The unrealized gains and losses
related to these forward contracts are included in Other Comprehensive
Income, a component of stockholders' equity. These unrealized gains
and losses are reversed from Other Comprehensive Income when the
contracts are settled.
- Trading Activity: Our trading activity generally consists of
forward on-peak sales and purchases that do not qualify for cash flow
hedge treatment. The unrealized gains and losses related to these
forward contracts are reflected in the income statement.
On January 1, 2001, we recorded the cumulative effects of adopting
FAS 133 in our financial statements by recognizing all derivatives at
fair value and recording the following amounts on our forward contracts
as of January 1, 2001:
Income Statement: after-tax unrealized gain of $470,000.
Balance Sheet:
- Other Comprehensive Income, a component of stockholders' equity:
after-tax unrealized loss of $14 million, and
- Forward Sale and Purchase Contract Liability of $22 million.
Under FAS 133, we record unrealized gains and losses on our
forward contracts and adjust the related liability on a monthly basis
to reflect the market prices at the end of the month. In the first
quarter of 2001, we recorded the following amounts on our forward
contracts:
Income Statement: after-tax unrealized loss on forward sales of $24
million and after-tax unrealized gain on forward
purchases of $26 million.
Balance Sheet:
- Other Comprehensive Income, a component of stockholders' equity: a
net after-tax unrealized loss of $248,000, consisting of:
- an unrealized loss of $7 million; and
- a $7 million reversal of previously recorded unrealized losses
on cash flow hedges which settled during the period.
- We adjusted the Forward Sale and Purchase Contract Liability to
$20 million.
All hedged contracts open at March 31, 2001 will be settled by
December 31, 2001, and as a result, the unrealized losses included in
Other Comprehensive Income as of March 31, 2001 will be reversed from
Other Comprehensive Income by year-end.
The market prices used to determine fair value for forward
contracts are estimated based on various factors including broker
quotes, exchange prices, over the counter prices and time value.
Because of the complexity of derivatives, the FASB established a
Derivatives Implementation Group (DIG). To date, the DIG has issued
more than 100 interpretations to provide guidance in applying FAS 133.
As the DIG continues to issue interpretations, we may change the
conclusions that we have reached and, as a result, the accounting
treatment and financial statement impact could change in the future.
NOTE 3. MILLENNIUM ENERGY BUSINESSES
- ------------------------------------
ENERGY TECHNOLOGY INVESTMENTS
At March 31, 2001, Millennium owned 67% of the following entities.
ITN Energy Systems, Inc., a privately held company (ITN) owned the
remaining 33%. The financial statements for these entities are
consolidated into the first quarter 2001 financial statements included
in this document.
- Global Solar Energy, Inc. (Global Solar) is a developer and
manufacturer of flexible thin-film photovoltaic cells. Global Solar
began limited production of photovoltaic cells in 1999. Target markets
for its products include military, space and commercial applications.
In 2000, Millennium agreed to provide $20 million in credit to
Global Solar over a maximum period of 4 years to fund its production
and expansion. As of March 31, 2001, Millennium has funded $9 million
under this credit commitment, $5 million of which was funded in the
first quarter of 2001.
Global Solar has certain federal government contracts that require
Global Solar to contribute to the research and development effort under
a cost share arrangement. Global Solar's share of costs is expensed as
incurred or capitalized in accordance with the terms of the contract.
Global Solar's remaining cost share commitment under these contracts at
March 31, 2001 was approximately $700,000.
- Infinite Power Solutions, Inc. is a developer of thin-film batteries
and was established in 2000. In 2000, Millennium committed to provide
$6 million of credit to this entity. As of March 31, 2001, Millennium
had not provided any funding under this agreement. ITN contributed
certain assets and proprietary and intellectual property relating to
thin-film battery technology.
During the first quarter of 2001, Millennium and ITN formed and
began to provide funding to the following entities, which are accounted
for under the equity method of accounting:
- MicroSat Systems Inc. is a space systems company formed for the
purpose of developing and commercializing small-scale satellites.
Millennium owns 49%, and the remaining 51% is owned by ITN. Millennium
has agreed to provide $10 million in equity and $10 million in credit
to the venture. ITN will contribute development contracts and
proprietary technologies.
MicroSat has certain federal government contracts that require MicroSat
to contribute to the research and development effort under a cost share
arrangement. MicroSat's share of costs is expensed as incurred or
capitalized in accordance with the terms of the contract. MicroSat's
remaining cost share commitment under these contracts at March 31, 2001
was approximately $9 million.
- A product development company, was formed to provide research and
development services to Global Energy Solutions, Inc.'s affiliates,
MicroSat and third parties. Millennium owns 49%, and the remaining 51%
is owned by ITN. Millennium committed to provide $3 million in equity
and $1 million in credit. ITN will contribute certain contracts,
technologies and intellectual property, including its thermal
desalinization technology.
Millennium provided $4 million in equity funding to these entities
in the first quarter of 2001.
Millennium expects to fund a total of $25 million to $35 million
to its various Energy Technology Investments in 2001. A significant
portion of the funding under these agreements will be used for research
and development purposes, establishment of the production line, and
other administrative costs. As funds are expended for these purposes,
it is expected that a major portion will be expensed.
NATIONS ENERGY COMMITMENTS
Nations Energy, a wholly-owned subsidiary of Millennium, develops
independent power projects in foreign energy markets. Through its
subsidiaries, Nations Energy has a 26% equity interest in a power
project located in Curacao, Netherland Antilles. The 160 MW project is
scheduled for completion in 2003. Once completed, the generating
facility will provide all electricity, steam, desalinated water and
compressed air for use in the oil refinery on the island of Curacao and
electricity for distribution to the community of Curacao. As of March
31, 2001, Nations Energy's total investment in this project was $4
million, of which $1 million was contributed in the first quarter of
2001. In addition, in December 2000, Nations Energy provided a $7
million deposit to fund scheduled equity contributions through April
2003, which is held by a financial institution. At March 31, 2001, $6
million of this deposit remained. Nations Energy holds a $10 million
deposit primarily for possible construction overruns and a guarantee of
$6 million of equity on behalf of another participant in the project.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
In July 2000, Millennium made a $15 million capital commitment to
a limited partnership which will fund energy related investments. As
of March 31, 2001, Millennium has funded $5 million under this
commitment, $4 million of which was funded in the first quarter of
2001. The remaining $10 million is expected to be invested within two
to three years. A member of the UniSource Energy Board of Directors has
a minor investment in the project. An affiliate of such board member
serves as the general partner.
In November 2000, Millennium made a $5 million capital commitment
to a venture capital fund that will focus on information technology,
optics and biotechnology in Tucson, Arizona. The company that manages
the fund is owned by a member of the UniSource Energy Board of
Directors. As of March 31, 2001, Millennium had funded $150,000 under
this commitment. Millennium expects to fund approximately $1 million
under this agreement in 2001.
In the first quarter of 2001, Millennium incurred expenditures of
$11 million in relation to the purchase of a 20 MW gas turbine, which
will be constructed at a site in Tucson. The unit is expected to be in
operation by mid-2001 to provide energy to help meet TEP's summer
peaking needs. These expenditures are included in capital expenditures
on UniSource Energy's cash flow statement for the three months ended
March 31, 2001.
RECLASSIFICATION OF MILLENNIUM ENERGY BUSINESSES RESULTS
The operating revenues and expenses from the Millennium Energy
businesses are currently included as part of UniSource Energy's
Operating Revenues and Operating Expenses. Previously, these revenues
and expenses were included in the Millennium Energy Businesses line
item in the Other Income and Deduction section of the income statement.
The income statement for the three months ended March 31, 2000 has been
reclassified to conform to the new presentation.
NOTE 4. BUSINESS SEGMENTS
- --------------------------
Based on the way we organize our operations and evaluate
performance, we have two reportable business segments. UniSource
Energy's principal business segment is TEP, an electric utility
business. The other reportable business segment consists of the
unregulated energy businesses of Millennium (see Note 3).
Intersegment revenues are not material. The only significant
reconciling adjustment is for the elimination of the intercompany note
between UniSource Energy and TEP as well as the related interest income
and expense. All other intercompany activity and balances have been
eliminated. We disclose selected financial data for our business
segments in the following tables:
- ----------------------------------------------------------------------
Segments
---------------------
UniSource
Reconciling Energy
TEP Millennium Adjustments Consolidated
- ----------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Three months ended
March 31, 2001:
Operating Revenues $ 239,341 $ 3,945 $ (2,080) $ 241,206
- -----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes
and Cumulative Effect
of Accounting Change 40,338 (4,427) (2,300) 33,611
- -----------------------------------------------------------------------
Cumulative Effect of
Accounting Change 470 - - 470
- -----------------------------------------------------------------------
Net Income (Loss) 23,511 (2,863) (1,383) 19,265
- -----------------------------------------------------------------------
Three months ended
March 31, 2000:
Operating Revenues $ 176,623 $ 1,054 $ (198) $ 177,479
- -----------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 808 (380) (1,898) (1,470)
- -----------------------------------------------------------------------
Net Income (Loss) (86) 1,469 (1,141) 242
- -----------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
March 31, 2001 $2,575,691 $ 139,646 $(77,419) $2,637,918
Total Assets,
December 31, 2000 2,600,935 167,331 (96,882) 2,671,384
- -----------------------------------------------------------------------
NOTE 5. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
TEP COMMITMENTS AND CONTINGENCIES
Four Corners Generating Station Commitment
TEP is a 7% owner of Four Corners Generating Station. The station
participation agreement requires that if one of the participants fails
to make its payments for operation of the station when due, the other
station participants must make such payments on behalf of the
defaulting party, in proportion to their ratable ownership interest in
the station, for a period of up to six months. During this time the
defaulting participant is entitled to its share of the power generated
by the station. After the grace period, the defaulting participant
must make its payments in arrears before it would be entitled to its
continuing share of power.
Southern California Edison Company (SCE) is a 48% owner of the
station. SCE has publicly disclosed that due to the high cost of
wholesale power in California which to date it has not been able to
recover from customers, it may no longer be able to continue to meet
its financial obligations. SCE has made all of its payments for the
station for periods through April 30, 2001. However, we are uncertain
whether SCE will be able to continue to make its payments for the
remainder of 2001. Based on the operating budget for the station for
the year 2001, in the event that SCE were to fail to pay, TEP may be
required to pay on SCE's behalf, for the power SCE receives, an average
amount of $1 million per month for up to six months.
TEP is unable to predict whether TEP will be required to make any
such payments in the future.
MILLENNIUM COMMITMENTS
See Note 3 for a description of Millennium's commitments.
NOTE 6. WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- -----------------------------------------------------
Market prices for wholesale power were significantly higher during
the first quarter of 2001 and the third and fourth quarters of 2000
than in the first two quarters of 2000 due to a shortage of generation
and the rising price of natural gas. During January and February 2001,
SCE and Pacific Gas & Electric Company (PG&E), two of the largest
utility market participants in California, defaulted on payments due to
the California Power Exchange (CPX) and California Independent System
Operator (CISO) for power consumed in the fourth quarter of 2000 and
the first quarter of 2001. On January 30, 2001, the CPX suspended its
day-ahead and day-of energy trading and subsequently ceased operations
and filed for bankruptcy. Beginning in January 2001, the California
Department of Water Resources (CDWR) was authorized to make energy
purchases on behalf of California customers. PG&E filed for
reorganization under Chapter 11 of the U.S. Bankruptcy Code on April 6,
2001. SCE signed a Memorandum of Understanding with the CDWR on April
9, 2001, which sets forth a comprehensive plan calling for legislation,
regulatory action and definitive agreements designed to resolve certain
aspects of the energy crisis and restore SCE's creditworthiness and
liquidity. Although TEP did not make sales directly to either SCE or
PG&E in 2000 or 2001, it did sell approximately $58 million of power to
the CPX and the CISO during 2000 and $7 million in January 2001. TEP
sold $9 million of power to the CDWR in the first quarter of 2001, all
of which has been paid according to terms.
The CPX has withheld some amounts due to parties, including TEP,
that sold power to the CPX in the fourth quarter of 2000 and the first
quarter of 2001. In addition, under default provisions contained in
the CPX tariff, the CPX has allocated the defaults of CPX participants
to remaining participants based upon the level of trading activity of
each participant during the preceding three-month period. Not only
have initial defaults of a CPX debtor been charged back to the other
participants, but defaults by other participants on charge-backs have
also been charged back. TEP has not collected the full amount due for
sales to the CPX and CISO in the fourth quarter of 2000 and the first
quarter of 2001 and TEP has been assessed amounts due as charge-backs.
A number of CPX participants filed suit against the CPX in February
2001, and a preliminary injunction was implemented that precluded the
CPX from issuing any more invoices for charge-backs, attempting to
collect on charge-backs or exercising against collateral. In April
2001, the FERC ordered the CPX to issue new invoices reflecting the
reversal of the charge-backs on the CPX accounting records.
Also during 2000, the FERC established certain soft caps on prices
for power sold at the CPX. The caps did not have a significant impact
on sales to the CPX during the first three quarters of 2000. However,
during the fourth quarter of 2000 and the first quarter of 2001, prices
for power in the day-ahead and real-time markets frequently exceeded
the caps established by FERC. During March 2001, the FERC issued two
orders requiring certain generators that sold power to California in
January and February 2001 to either refund amounts over specified
market prices or provide further data to defend their transactions. The
FERC has not yet addressed whether any refunds are due on sales made
from October 2, 2000 through December 31, 2000. TEP was not named in
these FERC orders and to date, no TEP sales have been rescinded due to
a price in excess of the cap. Other parties in California have
indicated an intent to seek return of revenues earned by wholesale
power suppliers which they determine to be "unlawful profits." The
determination of what would constitute "unlawful profits" is unclear at
the present time. In January 2001, the cities of San Francisco and San
Diego publicly disclosed that they had filed suit against several large
generators seeking return of what may be determined to be excessive
profits.
TEP has not been named as a defendant in any suits; TEP sales to
the CPX were insignificant as a percent of total sales to the CPX.
Substantially all of the sales TEP made to the CPX in 2000 and in 2001
were at prices at or below the soft caps imposed by FERC. TEP believes
that it has minimal, if any, exposure for any return of revenues earned
in excess of the caps.
On February 21, 2001, TEP filed a complaint at the FERC charging
that the State of California, California Governor Gray Davis, and the
CPX violated the Federal Power Act by letting the CDWR seize the
forward contracts of SCE and PG&E at the CPX without prior FERC
approval. TEP contends that this seizure violates the CPX tariff which
provides for the liquidation of favorable forward positions to mitigate
a market participant's default amount.
We considered the potential non-payment for certain amounts due to
TEP but not yet paid, the charge-back billings to TEP and the potential
implication of the soft caps if they were extended retroactively to the
CPX and CISO markets when we calculated our allowances for doubtful
accounts and potential refunds for wholesale transactions for 2000 and
2001. We have recorded allowances amounting to approximately $16
million, $7 million of which was recorded in the first quarter of 2001
and $9 million of which was recorded in the fourth quarter of 2000.
These allowances reserve in full the unpaid amounts which are past due
to TEP. We recorded no such allowances in periods prior to the fourth
quarter of 2000.
NOTE 7. INCOME TAXES
- ---------------------
The differences between the income tax expense (benefit) and the
amount obtained by multiplying pre-tax income by the U.S. statutory
federal income tax rate of 35% are as follows:
UniSource Energy TEP
------------------ ------------------
Three Months Ended Three Months Ended
March 31, March 31,
2001 2000 2001 2000
- ----------------------------------------------------------------------
-Thousands of Dollars -
Federal Income Tax Expense
(Benefit) at Statutory Rate $ 12,038 $ (515) $ 14,392 $ 283
State Income Tax Expense
(Benefit), Net of Federal
Deduction 1,685 (72) 2,015 40
Depreciation Differences
(Flow Through Basis) 1,250 561 1,250 561
Foreign Operations of
Millennium Energy
Businesses (8) (1,735) - -
Other 163 49 (48) 10
- ----------------------------------------------------------------------
Total Federal and State
Income Tax Expense (Benefit) $ 15,128 $ (1,712) $ 17,609 $ 894
======================================================================
Income tax expense (benefit) included in the income statements consists
of the following:
UniSource Energy TEP
------------------ ------------------
Three Months Ended Three Months Ended
March 31, March 31,
2001 2000 2001 2000
- ----------------------------------------------------------------------
-Thousands of Dollars -
Operating Expenses $ 13,572 $ (1,998) $ 15,195 $(1,062)
Other Income (Deductions) 1,244 286 2,102 1,956
Cumulative Effect of
Accounting Change 312 - 312 -
- ----------------------------------------------------------------------
Total Income Tax
Expense (Benefit) $ 15,128 $ (1,712) $ 17,609 $ 894
======================================================================
Due to the financial restructuring, a change in TEP's ownership
occurred for tax purposes in December 1991. This change limits our use
of the NOL and ITC generated before 1992 under the tax code. At
December 31, 2000, we had approximately $138 million of NOL and $20
million of ITC subject to the pre-1992 limitation and $164 million of
NOL not subject to the limitation. Because of the appropriate
valuation allowance amounts recorded, we do not expect these annual
limitations to have a material adverse impact on the financial
statements.
NOTE 8. REVIEW BY INDEPENDENT ACCOUNTANTS
- ------------------------------------------
With respect to the unaudited condensed consolidated financial
information of UniSource Energy and TEP for the three-month periods
ended March 31, 2001 and 2000, 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 4, 2001 appearing herein states that they did not
audit and they do not express an opinion on that unaudited condensed
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 (the "Act") for their
report on the unaudited condensed 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
- --------------------------
In addition to the reclassifications discussed in Note 3, we have
made reclassifications to the prior year financial statements for
comparative purposes. These reclassifications had no effect on net
income.
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- ---------------------------------------------------------------------------
UniSource Energy Corporation (UniSource Energy) is a holding company
that owns the outstanding common stock of Tucson Electric Power Company
(TEP) and Millennium Energy Holdings, Inc. (Millennium). TEP is an
electric utility which has provided electric service to the community of
Tucson, Arizona, for over 100 years and whose revenues reached $1 billion,
for the first time, in 2000. Millennium is a holding company that invests
in unregulated ventures related to the energy business. We conduct our
business in these two primary business segments--TEP's Electric Utility
Segment and the Millennium Energy Businesses Segment.
Management's Discussion and Analysis explains the general financial
condition and the results of operations for UniSource Energy and its two
primary business segments and includes the following:
* operating results during the first quarter of 2001 compared with
the same period in 2000,
* changes in liquidity and capital resources during the first
quarter of 2001, 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 and revenues. 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. The seasonal nature of the electric
utility business causes operating results to vary significantly from
quarter to quarter. At March 31, 2001, Millennium's unregulated energy-
related affiliates comprised approximately 5% of total assets, but at times
have had a significant impact on our consolidated net income and cash
flows.
Management's Discussion and Analysis should be read in conjunction
with the Condensed Consolidated Financial Statements, beginning on page 2,
which present the results of operations for the quarters ended March 31,
2001 and 2000. Management's Discussion and Analysis explains the
differences between periods for specific line items of the Condensed
Consolidated Financial Statements.
OVERVIEW
- --------
UniSource Energy recorded net income of $19.3 million for the first
quarter of 2001, compared with net income of $0.2 million in the first
quarter of 2000. The improvement in first quarter performance over the
prior year is primarily the result of increased wholesale marketing
activities and growth in retail electricity sales at TEP. Wholesale
revenues more than tripled due to sales of available generating capacity,
increased trading activities and significantly higher prices in the western
U.S. energy markets. See Results of Operations for further detail.
OUTLOOK AND STRATEGY
Our financial prospects and outlook for the next few years will be
affected by many competitive, regulatory and economic factors. Our plans
and strategies include the following:
* Continue to maintain our transmission and distribution system to
reliably serve our retail customers.
* Efficiently manage our generating resources and add capacity as
necessary to serve our retail customers. We are adding peaking
resources in the Tucson area to support expected growth in 2001.
* Evaluate the expansion of the Springerville Generating Station by
constructing Springerville Units 3 and 4. This additional generating
capacity would provide energy under long-term contracts to potential
wholesale power purchasers in Arizona and New Mexico and allow us to
spread the fixed costs of the existing common faciltities over two
additional generating units.
* Take advantage of opportunities to sell in the wholesale power
markets while carefully managing the risks associated with such
activities. We believe that over the near-term, average prices in
the wholesale power markets will remain at or above the average
pricing levels of 2000.
* Look for ways to reduce or control operating costs in order to
improve profitability. Because our Settlement Agreement provides
for a retail rate cap through 2008, we can benefit from cost
savings and from expected growth in our retail customer base.
* Continue to use some of our cash flows to de-leverage TEP. In
addition to our required debt retirements, in the last three years
we retired approximately $34 million in First Mortgage Bonds and
invested $54 million in Springerville Unit 1 lease debt. We will
continue to look for opportunities to retire or refinance higher
coupon debt and make additional investments in lease debt.
* Make ongoing investments in our technology affiliates. Although we
will record certain development expenses and experience some losses
in these investments, we believe that over time these ventures will
be profitable.
While we believe that our plans and strategies will continue to have
a positive impact on our financial prospects and position, we recognize
that we continue to be highly leveraged, and as a result, our access to the
capital markets may be limited or more expensive than for less leveraged
companies.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
-----------
RETAIL
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electricity and
related services. As of January 1, 2001, all of TEP's retail customers
became eligible to choose an alternate energy supplier. Currently, there
is one certified energy service provider (ESP) in TEP's retail service
area. During the first quarter of 2001, five commercial customers at 19
locations, totaling 10 MW of load, elected to purchase their energy
requirements from an alternate energy supplier. However, all of these
customers have since returned to TEP's customer base. It is possible,
however, that with open access in our retail service territory, these
customers may return to the ESP, and other customers may elect to purchase
their energy requirements from other energy suppliers. TEP also competes
against gas service suppliers and others who provide energy services.
TEP will continue to serve certain large retail customers under
contracts negotiated by TEP. TEP has contracts with two major mining
customers, one of which extends to 2006, with pricing tied to the price of
copper. TEP's other major mining customer publicly announced in March 2001
that because of certain economic conditions, it plans to curtail production
at its facilities in TEP's service area during August and September 2001.
TEP believes that it will be able to use this excess capacity to service
its retail load during this peak energy demand period, or sell into the
wholesale market.
TEP'S SETTLEMENT AGREEMENT AND RETAIL ELECTRIC COMPETITION RULES
In December 1996, the ACC adopted the Retail Electric Competition
Rules that provided a framework for the introduction of retail electric
competition in Arizona. These Rules, as amended and modified, were
approved by the ACC in September 1999. For TEP, the Rules became effective
in January 2000, and consumer choice was available to all customers by
January 1, 2001. However, certain conditions had to be met before
electricity could be sold competitively in TEP's service territory.
Examples of these include ACC approval of TEP's direct access tariffs, ACC
certification of ESPs, and execution of and compliance with direct access
service agreements by ESPs and TEP.
In November 1999, the ACC approved the Settlement Agreement between
TEP and certain customer groups relating to the implementation of retail
electric competition, including TEP's recovery of its transition recovery
assets and the unbundling of tariffs. The Settlement Agreement provides,
among other things, that TEP freeze its retail rates until December 31,
2008, except under certain circumstances. These include the impact of (a)
termination of the Fixed Competitive Transition Charge component of retail
rates as a result of the early collection of $450 million of transition
recovery assets; (b) changes in transmission charges due to regional
transmission organizations; and (c) a transmission and distribution rate
filing required in June 2004 which may result in lower rates. The
Settlement Agreement also requires TEP to transfer its generating and other
competitive assets to a subsidiary by December 31, 2002.
The status of the Rules and the ability of ESPs to continue to sell
competitive services may be subject to change due to recent court
proceedings. Several parties, including certain rural electric
cooperatives (Cooperatives), filed lawsuits in Maricopa County Superior
Court challenging the Rules, contending, among other things, that allowing
marketplace competition to determine rates violated the ACC's
constitutional duty to set rates. The Court found the Rules to be
unconstitutional and unlawful due to the failure of the Rules to establish
a fair value rate base for competitive electric service providers and
because certain of the Rules were not submitted for certification to the
Arizona Attorney General. The Court also invalidated all ACC orders
granting certificates of convenience and necessity to competitive electric
service providers in Arizona.
The ACC, RUCO (Residential Utility Consumer Office) and certain large
industrial customers have appealed the decision to the Court of Appeals.
In addition, the Cooperatives have filed a notice of cross appeal of
certain aspects of the decision. Implementation of the judgment is stayed
and the Rules remain in effect pending the outcome of the appeals.
TEP cannot predict the effect of the recent court decision on the
outcome of the appeals to which it is a party or the effect of the
judgment, if affirmed upon appeal, on the introduction of retail electric
competition in Arizona.
WHOLESALE
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy at market-based
rates in the wholesale market. We expect the market price and demand for
capacity and energy to continue to be influenced by the following factors
during the next few years:
* continued population growth in the western United States;
* limited availability of capacity throughout the western United
States;
* restructuring of the electric utility industry in Arizona,
California and other western states;
* the reduced availability and high prices of natural gas;
* precipitation, which affects hydropower availability;
* transmission constraints; and
* environmental restrictions and the cost of compliance.
The average market price for around-the-clock energy based on CPX Palo
Verde hub prices increased significantly in 2000 to $87 per MWh compared
with $26 per MWh in 1999. In the first quarter of 2001, the comparable
average market price based on the Dow Jones Palo Verde Index, was $188 per
MWh compared with $27 per MWh in the first quarter of 2000. As of May
2001, we estimate the average forward around-the-clock market price for the
balance of the year 2001 to be approximately $250 per MWh. Although we
cannot predict whether such prices are sustainable for the long-term, we
expect that average market prices during 2001 will remain at or above the
average pricing levels of 2000. See Western Energy Markets below.
NEW LONG-TERM WHOLESALE POWER CONTRACT
In the first quarter of 2001, TEP signed a five-year wholesale
contract to supply 60 MW of electricity to Phelps Dodge Energy Services
(PDES). The contract calls for TEP, beginning in March 2001, to supply the
power at all times except during TEP's peak customer energy demand period,
from July through September of each year. It also gives PDES the option of
receiving the power at several of its operations outside TEP's service
territory in Arizona and New Mexico. Under the contract, TEP can interrupt
delivery of power if the utility experiences significant loss of any
electric generating resources. TEP expects the contract to generate
revenues of about $30 million annually through 2006.
TRANSMISSION ACCESS
In 1997, TEP, along with other transmission owners and users located
in the southwestern U.S., began to investigate the feasibility of forming
an Independent System Operator (ISO) for the region. Over 50 parties
participated in a Development Agreement, and as a result, a non-profit
corporation named Desert STAR was formed in September 1999. In December
1999, the FERC issued FERC Order 2000, which established timelines for all
transmission owning entities to join a Regional Transmission Organization
(RTO) and defined the minimum characteristics and functions of an RTO. An
ISO would satisfy the requirements of an RTO and would be responsible for
ensuring transmission reliability and nondiscriminatory access to the
regional transmission grid. Over 140 entities have become members of
Desert STAR.
TEP, along with several neighboring transmission owners located in
the southwestern United States and Desert STAR, filed a report with the
FERC on October 16, 2000 that detailed their progress in establishing an RTO.
On December 27, 2000, Desert STAR, TEP, and other neighboring transmission
owners and other customers of the transmission system filed an additional
letter with FERC in which Desert STAR stated that it expected to file an
application by the end of March 2001 to become an RTO, and that it expected
to begin operation late in 2002. In February 2001, TEP, along with other
stakeholders, filed a request for extension to May 2001 for completing the
filing with the FERC. The formation of Desert STAR will be subject to
approval by the FERC and state regulatory authorities in the region.
The ACC Retail Electric Competition Rules also require the formation
and implementation of an Arizona Independent Scheduling Administrator
Association (AISA). The AISA is anticipated to be a temporary organization
until the formation and implementation of an ISO or RTO. TEP participated
in the creation of the AISA. This includes its 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. During 2000, the board of AISA approved a set of operating
protocols, which it submitted to the FERC for approval. The FERC approved
the protocols in part but rejected other parts, effectively requiring
modifications to the protocols. The Board of the AISA had been
unsuccessful in approving a compliance filing relative to the FERC Order
and asked FERC for an indefinite stay of implementation until such time as
the AISA Board could work out issues in the compliance filing. The FERC
approved a stay, subject to the filing of status updates by the AISA. On
May 1, 2001, the Board of the AISA approved the compliance filing and a
filing to make minor modifications to the wording of the operating
protocols for the AISA. The compliance filing will meet the requirements
of the FERC order relative to the AISA and will provide sunset language
should a future filing be needed to further modify the protocols. TEP
continues to participate with the other Affected Utilities in developing
the AISA's structure and protocols in response to retail competition.
WESTERN ENERGY MARKETS
----------------------
Due to the high market prices and the various factors influencing
supply and demand (as detailed above), the California energy markets, as
administered by the CPX and the CISO, became dysfunctional during 2000.
These high prices and extraordinary market conditions affect not only
California, but the entire Western Region of the United States and Canada.
During January and February 2001, SCE and PG&E, two of the California
utilities that are the largest market participants, defaulted on payments
due to the CPX and CISO for power consumed in the fourth quarter of 2000
and the first quarter of 2001. On January 30, 2001, the CPX suspended its
day-ahead and day-of energy trading and subsequently ceased operations and
filed for bankruptcy. Beginning in January 2001, the California Department
of Water Resources (CDWR) was authorized to make energy purchases on behalf
of California customers. PG&E filed for reorganization under Chapter 11 of
the U.S. Bankruptcy Code on April 6, 2001. SCE signed a Memorandum of
Understanding (MOU) with the CDWR on April 9, 2001, which sets forth a
comprehensive plan calling for legislation, regulatory action and
definitive agreements designed to resolve certain aspects of the energy
crisis and restore SCE's creditworthiness and liquidity.
Although TEP did not make sales directly to either of these utilities
in 2000 or 2001, it did make sales to the CPX and CISO and therefore is
affected by the defaults noted above. We cannot predict the outcome of
either the PG&E bankruptcy or the implementation of the SCE MOU and the
effect, if any, on the introduction of retail electric competition in
Arizona or TEP's ability to collect the full amounts it is owed by the CPX
and CISO.
PAYMENT DEFAULTS AND ALLOWANCES FOR DOUBTFUL ACCOUNTS
TEP sold approximately $58 million of power to the CPX and CISO
during 2000 and $7 million during January of 2001. As a result of payment
defaults by market participants, TEP's collection shortfall was
approximately $9 million for sales made in 2000 and $7 million for sales
made in 2001. We recorded an allowance for doubtful accounts and potential
refunds for wholesale transactions for the full amount of these uncollected
amounts in the fourth quarter of 2000 and the first quarter of 2001. Total
reserves for potential non-payment of amounts due to TEP for sales to the
CPX and CISO during 2000 and 2001 total $16 million. TEP sold $9 million
of power to the CDWR in the first quarter of 2001, all of which has been
paid according to terms.
Under default provisions contained in the CPX tariff, the CPX
allocated the defaults of CPX participants to remaining participants based
upon the level of trading activity of each participant during the preceding
three-month period. Not only were initial defaults of a CPX debtor charged
back to the other participants, but defaults by other participants on
charge-backs have also been charged back. A number of CPX participants
filed suit against the CPX in February 2001, and a preliminary injunction
was implemented that precluded the CPX from issuing any more invoices for
charge-backs, attempting to collect on charge-backs or exercising against
collateral. In April 2001, the FERC ordered the CPX to issue new invoices
reflecting the reversal of the charge-backs on the CPX accounting records.
As noted above, the CPX has ceased operations and filed for bankruptcy.
TEP has cash collateral of approximately $1 million on deposit in an escrow
account with the CPX which is currently unavailable to TEP due to the
bankruptcy stay.
On February 21, 2001, TEP filed a complaint at the FERC charging that
the State of California, California Governor Gray Davis, and the CPX
violated the Federal Power Act by letting the CDWR seize the forward
contracts of SCE and PG&E at the CPX without prior FERC approval. TEP
contends that this seizure violates the CPX tariff which provides for the
liquidation of favorable forward positions to mitigate a market
participant's default amount. TEP's complaint requests the FERC to: void
the seizure of these assets by Governor Davis; require the State of
California to pay fair market value for the contracts or assume the
wholesale power liabilities of PG&E and SCE to the PX; and declare that the
wholesale rates produced under the CPX tariffs are just and reasonable and
should be collected from the utilities' retail customers.
During March 2001, the FERC issued two orders requiring certain
generators that sold power to California in January and February 2001 to
either refund amounts over specified market prices or provide further data
to defend their transactions. TEP was not named in either of these orders.
The FERC has not yet addressed whether any refunds are due on sales made
from October 2, 2000 through December 31, 2000.
There are several other outstanding legal issues, complaints, and
lawsuits concerning the FERC, wholesale power suppliers, SCE, PG&E, the CPX
and CISO. New events and issues related to the California energy crisis
arise each day, and we cannot predict the outcome of these issues or
lawsuits. We believe, however, that we are adequately reserved for our
transactions with the CPX and CISO. See Note 6 of Notes to Financial
Statements.
DEPARTMENT OF ENERGY ORDERS
On December 14, 2000, the Secretary of Energy issued an order designed
to address the electric emergency in California. The order required
entities, including TEP, to "sell electricity to the California ISO that is
available in excess of electricity needed by each entity to render service
to its firm customers." This order was extended several times due to the
continuation of the emergency situation. The order was allowed to expire
on February 7, 2001. Another emergency order requiring four generators
(not including TEP) to continue to sell power was extended through March
16, 2001.
During January 2001, TEP sold approximately $7 million of energy to
the CPX and the CISO. Since January 12, however, planned generator
maintenance and increased firm customer demand resulted in a decrease of
excess energy available for sale from TEP to California. Furthermore, the
most critical energy shortages have been in Northern California. Due to
transmission constraints, energy cannot be moved from the South, where our
generation is located, to the North. Therefore, requests for power under
the Department of Energy order were minimal after January 12. During
February and March, sales to California amounting to $9 million were made
through the CDWR.
SCE POWER EXCHANGE AGREEMENT
As part of a 1992 litigation settlement, TEP and SCE agreed to a ten-
year power exchange agreement. The agreement began in May 1995 and
requires SCE to provide firm system capacity of 110 MW to TEP during summer
months. TEP is obligated to return to SCE in the winter months the same
amount of energy that it received during the preceding summer. For
example, in the summer of 2000 TEP received approximately 140,000 MWh from
SCE and returned the same amount during the winter months from November
2000 to February 2001. Since 1995, TEP has relied upon the 110 MW provided
under this agreement as a firm source of energy to supply its retail load
during the peak summer months. During the summer of 2000 there were two
days when power emergencies were called in California and SCE did not
deliver energy to TEP. This caused TEP to have to purchase power for
several peak hours of the day at high spot power prices. TEP believes the
agreement requires SCE to purchase power for TEP's benefit under those
circumstances, and during subsequent power alerts, SCE did purchase and
provide power to TEP under the agreement.
Since then, the continuing energy crisis in California and the
deteriorating financial condition of SCE has created uncertainty as to the
availability of this power for TEP. In the event that this resource is not
available to TEP in 2001 and 2002, TEP would need to seek alternative
sources of capacity and energy at prices that would likely be in excess of
the cost of this resource. To the extent possible, TEP would rely upon the
new peaking units it plans to have in place by mid-2001, interruptible
contracts, load-shifting by large industrial customers, and reserve sharing
arrangements with other utilities as resources before having to purchase
power on the spot markets. Using TEP's current summer load forecast, and
assuming all other resources are available, TEP estimates that the loss of
energy under this contract would cause TEP to need to purchase
approximately 4,000 MWh to meet its summer peaking needs. At an estimated
average cost of $500 per MWh, TEP's purchased power costs would increase by
$2 million.
To the extent that TEP takes less power during the summer than the
maximum allowed under the contract, TEP's obligation to return power in the
winter to SCE would be decreased by a similar amount. TEP could then sell
this power into the wholesale energy markets.
FOUR CORNERS GENERATING STATION COMMITMENT
TEP is a 7% owner of Four Corners Generating Station. The station
participation agreement requires that if one of the participants fails to
make its payments for operation of the station when due, the other station
participants must make such payments on behalf of the defaulting party, in
proportion to their ratable ownership interest in the station, for a period
of up to six months. During this time the defaulting participant is
entitled to its share of the power generated by the station. After the
grace period, the defaulting participant must make its payments in arrears
before it would be entitled to its continuing share of power.
SCE is a 48% owner of the station. SCE has publicly disclosed that
due to the high cost of wholesale power in California which to date it has
not been able to recover from customers, it may no longer be able to
continue to meet its financial obligations. SCE has made all of its
payments for the operation of the station through April 30, 2001. However,
we are uncertain whether SCE will be able to continue to make its payments
for the remainder of 2001. Based on the operating budget for the station
for the year 2001, in the event that SCE were to fail to pay, TEP may be
required to pay on SCE's behalf, for the power SCE receives, an average
amount of $1 million per month for up to six months. TEP is unable to
predict whether TEP will be required to make any such payments in the
future.
REGULATORY MATTERS
------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. 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
currently charge its customers to recover certain expenses, but instead
requires that these expenses be charged to customers in the future. In this
situation, FAS 71 requires that TEP defer these items and show them as
regulatory assets on the balance sheet until TEP is allowed to charge its
customers. TEP then amortizes these items as expense to the income
statement as those charges are recovered from customers. Similarly, certain
revenue items may be deferred as regulatory liabilities, which are also
eventually amortized to the income statement as rates to customers are
reduced.
The conditions a regulated company must satisfy to apply the
accounting policies and practices of FAS 71 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.
In November 1999, upon approval by the ACC of a Settlement Agreement
relating to recovery of TEP's transition costs and standard retail rates,
we discontinued application of FAS 71 to our generation operations.
We continue to apply FAS 71 to the distribution and transmission
portions of TEP's business, our regulated operations. We periodically
assess whether we can continue to apply FAS 71 to these operations. If we
stopped applying FAS 71 to TEP's remaining regulated operations, we would
write off the related balances of TEP's regulatory assets as a charge in
our income statement. Based on the balances of TEP's regulatory assets at
March 31, 2001, if we had stopped applying FAS 71 to TEP's remaining
regulated operations, we would have recorded an extraordinary loss, after
tax, of approximately $260 million. While regulatory orders and market
conditions may affect our cash flows, our cash flows would not be affected
if we stopped applying FAS 71.
MARKET RISKS
------------
We are exposed to various forms of market risk. Changes in interest
rates, returns on marketable securities, and changes in commodity prices
may affect our future financial results. The market risks resulting from
changes in interest rates and returns on marketable securities have not
changed materially from the market risks reported in the 2000 Form 10-K.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements below.
COMMODITY PRICE RISK
TEP is exposed to commodity price risk primarily relating to changes
in the market price of electricity, as well as changes in fuel costs
incurred to generate electricity. TEP enters into forward contracts to buy
or sell energy at a specified price at a future date. These contracts are
considered to be derivative commodity instruments. Generally, TEP commits
to future sales based on expected excess generating capability. However,
rather than producing additional power, TEP may enter into a forward
purchase contract to satisfy the forward sales contract if the market
prices are favorable. The forward sales contracts that are satisfied with
forward purchase contracts do not require any physical delivery of energy
by TEP. However, to take advantage of anticipated market opportunities,
TEP is at various times in a net open position. A net open position means
it has either committed to sell more electricity than it has purchase
contracts to cover or it has committed to purchase more power than it needs
for its selling commitments. To limit exposure to price risk, TEP has
trading policies with limits as to total open positions. TEP continually
reviews its trading policies and limits to respond to the constantly
changing market conditions.
TEP measures its market risk related to its commodity exposure by
using a sensitivity analysis. The market prices used to determine fair
value are estimated based on various factors including broker quotes,
exchange prices, over the counter prices and time value. As of March 31,
2001, TEP had no open trading positions; however, it had a number of
forward sales positions which are considered to be derivative commodity
instruments and hedges of forward long generation positions. As of March
31, 2001, an increase of 10% in the market prices of electric power from
quarter-end levels would have decreased the fair value of these instruments
by $3 million. Beginning in 2001, changes in the fair value of these
derivative instruments are measured in our financial statements in
accordance with FAS 133. See Note 2 of Notes to Financial Statements and
Accounting for Derivative Instruments and Hedging Activities, below.
TEP may have increased commodity price risk during 2001 and 2002, due
to a potential need to replace a power resource previously available to it
during the summer peak usage periods. See Western Energy Markets, SCE
Power Exchange Agreement, above. In the event that this resource were
unavailable to TEP, or if other unexpected losses of generation resources
were to occur due to unplanned outages or natural disasters, TEP would need
to seek alternative sources of capacity and energy at prices likely to be
significantly in excess of the cost of these resources. To the extent
possible, TEP would rely upon the new peaking units it plans to have in
place by mid-2001, interruptible contracts, load-shifting by large
industrial customers, and reserve sharing arrangements with other utilities
as resources before having to purchase power on the spot markets. Under
the terms of its Settlement Agreement, TEP's retail rates are frozen
through December 31, 2008, except under certain circumstances. See
Competition, Retail above. As such, TEP would not be able to recover any
such increased purchased power costs without further action by the ACC.
TEP also purchases coal and natural gas in the normal course of
business for fuel for its generating plants. TEP acquires its coal under
long-term coal supply contracts. Purchases of gas historically provided
fuel for only 3-4% of total generation. During the quarter ended March 31,
2001, approximately 10% of TEP's generation was fueled by natural gas.
Market prices of natural gas also increased significantly in the first
quarter 2001, which, combined with increased usage, caused gas costs to
comprise 39% of total fuel expense for the quarter ended March 31, 2001.
In contrast, TEP used almost no gas for generation fuel in the first
quarter of 2000. The sustained high levels of wholesale energy prices in
the first quarter of 2001 made it profitable for TEP to run its gas-fired
generating units to sell into the wholesale market. TEP is assured of its
gas supply as a retail customer of the local gas supplier in the region.
TEP periodically negotiates its contract with its gas supplier to establish
terms relating to pricing and scheduling of gas delivery. TEP has also
entered into a contract to hedge a portion of its gas requirements for the
summer of 2001.
CREDIT RISK
TEP is exposed to credit risk in its energy trading activities related
to potential nonperformance by counterparties. TEP manages the risk of
counterparty default by performing financial credit reviews and setting
limits and monitoring exposures, requiring collateral when needed, and
using a standardized agreement which allows for the netting of current
period exposures to and from a single counterparty. Despite such
mitigation efforts, there is a potential for defaults by counterparties to
occur from time to time. In the fourth quarter of 2000 and the first
quarter of 2001, TEP was impacted by payment defaults by SCE and PG&E for
amounts owed to the CPX and CISO.
TEP sold approximately $58 million of power to the CPX and CISO
during 2000 and $7 million during January of 2001. As a result of payment
defaults by SCE and PG&E, TEP's collection shortfall was approximately $9
million for sales made in 2000 and $7 million for sales made in 2001. We
recorded an allowance for doubtful accounts for the full amount of these
uncollected amounts in the fourth quarter of 2000 and the first quarter of
2001. We recorded no such allowances in years prior to 2000. See Western
Energy Markets, Payment Defaults and Allowances for Doubtful Accounts,
above. Based on a review of its credit exposures at March 31, 2001, TEP
does not anticipate any nonperformance by any of its other counterparties.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In 1998, the Financial Accounting Standards Board (FASB) 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. We buy and sell wholesale power using forward
contracts which are considered to be derivatives. See Note 2 of Notes to
Financial Statements.
On January 1, 2001, we recorded the cumulative effects of adopting
FAS 133 in our financial statements by recognizing all derivatives at fair
value and recording the following amounts on our forward contracts as of
January 1, 2001:
Income Statement: after-tax unrealized gain of $470,000.
Balance Sheet:
* Other Comprehensive Income, a component of stockholders' equity:
after-tax unrealized loss of $14 million, and
* Forward Sale and Purchase Contract Liability of $22 million.
Under FAS 133, we record unrealized gains and losses on our forward
contracts and adjust the related liability on a monthly basis to reflect
the market prices at the end of the month. In the first quarter of 2001,
we recorded the following amounts on our forward contracts:
Income Statement: after-tax unrealized loss on forward sales of $24
million and after-tax unrealized gain on forward purchases of $26
million.
Balance Sheet:
* Other Comprehensive Income, a component of stockholders' equity: a
net after-tax unrealized loss of $248,000, consisting of:
- an unrealized loss of $7 million; and
- a $7 million reversal of previously recorded unrealized losses
on cash flow hedges which settled during the period.
* Forward Sale and Purchase Contract Liability of $20 million.
All hedged contracts open at March 31, 2001 will be settled by
December 31, 2001, and as a result, the unrealized losses included in Other
Comprehensive Income as of March 31, 2001 will be reversed from Other
Comprehensive Income by year-end.
FUTURE GENERATING RESOURCES
---------------------------
TEP
To improve local system reliability, TEP determined that additional
peaking resources would be needed in Tucson beginning in 2001. To address
this need, TEP purchased a 75 MW gas turbine and Millennium purchased a 20
MW gas turbine. Construction is proceeding on both turbine sites and we
continue to expect these units to be in operation by mid-2001 to meet our
summer peaking needs. In the short and intermediate term, TEP's need will
be for additional peaking resources, not for base-load generating capacity.
TEP will continue to add peaking resources in the Tucson area as needed
based upon our forecasts of retail and firm wholesale load.
Millennium
In recognition of the strong retail growth in Arizona and New Mexico,
as well as existing and projected base-load generation capacity needs in
the western region, we are evaluating the expansion of the coal-fired
Springerville Generating Station by constructing Springerville Units 3 and
4. Springerville was originally designed for four units. Units 3 and 4
would consist of two 380 MW coal-fired base-load generating units at the
same site as Springerville Units 1 and 2, and would allow us to spread the
fixed costs of the existing common facilities over two additional
generating units. We have retained outside consultants to assist us in
developing the project scope and schedule, determining permitting
requirements, and defining the terms of an engineering, procurement, and
construction contract.
In addition, we are continuing to study various financing and
ownership structures and identifying equity participants and long-term
power purchasers. We also are continuing to evaluate permitting
requirements, potential fuel sources, and electric transmission
requirements to potential wholesale electric purchasers. Should we decide
to go forward with this project, we anticipate that Letters of Intent with
project participants will be signed in mid-year 2001. We expect that
construction would begin during the second half of 2001, with commercial
operation of Unit 3 expected to occur in 2004, followed by Unit 4 in 2005.
See also Future Generating Resources, Millennium in the 2000 Form 10-K.
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded net income of $19.3 million or $0.58 per
average share of Common Stock in the first quarter of 2001. This compares
with net income of $0.2 million or $0.01 per average share of Common Stock
in the first quarter of 2000. The primary factors affecting the results of
operations in the first quarter of 2001 were strong results from wholesale
marketing activities and growth in retail electricity sales at TEP.
Wholesale revenues more than tripled due to sales of available generating
capacity, increased trading activities and significantly higher prices in
the Western U.S. energy markets.
CONTRIBUTION BY BUSINESS SEGMENT
--------------------------------
The table below shows the contributions to our consolidated after-tax
earnings by our two business segments, as well as parent company expenses
and inter-company eliminations, for the first quarter of 2001 and 2000:
Three Months Ended
March 31,
2001 2000
- ---------------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $ 23.5 $ (0.1)
Millennium (2.9) 1.5
Parent Company and Inter-Company Eliminations (1.3) (1.2)
- ---------------------------------------------------------------------------
Consolidated Net Income $ 19.3 $ 0.2
===========================================================================
Parent company results include the after-tax interest expense accrued
on a note payable from UniSource Energy to TEP. This note was provided to
TEP in exchange for the stock of Millennium in January 1998. Electric
Utility results include interest income from this note.
TEP's electric utility business accounts for substantially all of
UniSource Energy's assets and revenues. 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. 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 Millennium Energy Businesses below.
NEW ACCOUNTING STANDARD
-----------------------
On January 1, 2001, we adopted FAS 133, Accounting for Derivative
Instruments and Hedging Activities. As a result, TEP began recognizing
unrealized gains and losses related to forward sale and purchase energy
contracts in its income statement in the first quarter of 2001. The
unrealized gain (loss) on forward sales is a component of Total Electric
Sales for Resale, and the unrealized (gain) loss on forward purchases is a
component of Total Purchased Power. Although the FASB requires that these
unrealized gains and losses be recorded separately for forward sales and
purchases, the net total of the two line items represents the net
unrealized gain or loss on TEP's forward trading activity at any given
point in time. See Note 2 of Notes to Financial Statements.
The analysis of sales for resale and purchased power costs below will
exclude the impact of these unrealized gains and losses required to be
recorded by FAS 133.
UTILITY KWH SALES AND REVENUES
------------------------------
Customer growth, weather and other consumption factors affect retail
sales of electricity. Price changes also contribute to changes in retail
revenues. Sales for resale are affected by market prices in the wholesale
energy market, competing sources of energy and capacity in the region.
During the first quarter 2001, TEP experienced significant growth in
wholesale energy sales and revenues, primarily due to significantly higher
regional market prices and opportunities to sell its excess generating
capacity to California and other western wholesale market participants.
These revenues more than tripled in the first quarter of 2001 compared with
the first quarter of 2000, and comprised 52% of total revenues. TEP's
sales for resale consist primarily of four types of sales:
(1) Sales of firm capacity under long-term contracts for periods of
more than one year. TEP currently has long-term contracts with
three entities to sell firm capacity: Salt River Project, the
NTUA, and effective March 2001, PDES.
(2) Forward contracts to sell energy for periods of up to one year.
Under forward contracts, TEP commits to sell a specified amount
of capacity or energy at a specified price over a given period of
time, typically for one month, three months or one year periods.
Forward contracts may consist of sales of TEP's excess generating
capacity, or may represent trading activity, where forward sales
and purchases may be made within established limits to take
advantage of favorable market opportunities.
(3) Short-term economy energy sales in the daily or hourly markets at
fluctuating spot market prices.
(4) Sales of transmission service.
Comparisons of TEP's kilowatt-hour sales delivered and the corresponding
electric revenues are shown below:
Three Months Ended
March 31, Increase
Sales: 2001 2000 Amount Percent
- ----------------------------------------------------------------------------
- Millions of kWh -
Electric Retail Customers 1,769 1,722 47 2.7%
- ----------------------------------------------------------------------------
Electric Sales for Resale Delivered:
Long-term Contracts 334 333 1 0.3%
Forward Contracts 618 474 144 30.4%
Short-term Sales 583 685 (102) (14.9%)
- ----------------------------------------------------------------------------
Total Electric Sales for Resale 1,535 1,492 43 2.9%
- ----------------------------------------------------------------------------
Total 3,304 3,214 90 2.8%
============================================================================
Three Months Ended
March 31, Increase
Operating Revenues: 2001 2000 Amount Percent
- ----------------------------------------------------------------------------
- Millions of Dollars -
Electric Retail Customers $ 134.7 $ 131.3 $ 3.4 2.6%
- ----------------------------------------------------------------------------
Electric Sales for Resale Delivered:
Long-term Contracts 16.6 13.2 3.4 25.8%
Forward Contracts 49.1 12.4 36.7 296.0%
Short-term Sales 77.1 18.4 58.7 319.0%
Transmission 0.9 0.8 0.1 12.5%
- ----------------------------------------------------------------------------
Total Electric Sales for Resale 143.7 44.8 98.9 220.8%
- ----------------------------------------------------------------------------
Total $ 278.4 $ 176.1 $ 102.3 58.1%
============================================================================
TEP's kWh sales to retail customers increased by 2.7% in the first
quarter of 2001 compared with the same period in 2000. The retail kWh
sales increase was due to a 2.6% increase in the number of retail customers
and cooler winter temperatures as measured by a 19% increase in Heating
Degree Days compared with the first quarter of 2000. Retail revenues
increased by 2.6% in the first quarter of 2001 compared with the same
period in 2000, reflecting the higher kWh sales. This increase was offset,
in part, by the effect of a 1.0% across-the-board rate reduction effective
July 1, 2000.
Kilowatt-hour sales for resale increased by 2.9% in the first quarter
of 2001 compared with 2000, while revenues from sales for resale more than
tripled in the same period. The largest increase in revenues was in short-
term economy sales in the daily and hourly markets. Sustained higher
market prices made it economical for TEP to run its gas generation units to
produce energy to sell to other regional utilities and marketers. Factors
contributing to the higher market prices include increased demand due to
population and economic growth in the region, higher natural gas prices,
dysfunction in the California marketplace, increased maintenance outages
due to higher than normal operating levels, lower availability of
hydropower resources, transmission constraints, and environmental
constraints.
FUEL AND PURCHASED POWER RECEIVED EXPENSES
------------------------------------------
Fuel and Purchased Power Received expenses increased by $57 million
or 94% in the first quarter of 2001 compared with the same period the year
before to support robust wholesale sales. Fuel expense at TEP's generating
plants increased by $27 million or 63% primarily because of higher natural
gas prices and increased usage of gas generation to meet increased kWh
sales. The average cost of fuel per kWh generated was 2.40 cents for first
quarter 2001 and 1.58 cents for first quarter 2000, reflecting the
increased usage of gas as fuel in 2001. Purchased Power Received expense
increased by $29 million or 173% because of higher wholesale energy prices
and increased purchases in the forward and spot energy markets for trading
purposes and under agreements to resell to wholesale customers.
OTHER OPERATING EXPENSES
------------------------
Other Operations expense increased $6 million, or 21% because of
additional reserves to cover our credit exposure for risk of non-payment
from wholesale sales to California made in January 2001. See Note 6 of
Notes to Financial Statements.
Maintenance Expense increased $4 million over the first quarter of
2000 because of scheduled maintenance at the Irvington and Springerville
Unit 2 generating plants.
Income Taxes increased $16 million in the first quarter of 2001 due
to higher pre-tax income than in the first quarter of 2000.
OTHER INCOME (DEDUCTIONS)
-------------------------
INTEREST INCOME
TEP's income statements for the quarters ended March 31, 2001 and
2000 each include $2 million 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.
Other interest income for the quarter ended March 31, 2001 was higher
than the same quarter in 2000 due to higher average cash balances. See
Liquidity and Capital Resources below.
INTEREST EXPENSE
Interest Expense for the first quarter decreased by $3 million or 6%
primarily due to lower amortization of losses on reacquired debt and a
decrease in the average interest rate on long-term variable rate tax-exempt
debt.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
- ---------------------------------------
The table below provides a breakdown by Millennium-owned subsidiaries
of the after-tax net income and losses recorded by the Millennium Energy
Businesses for the first quarter 2001 compared to the same period in 2000.
Three Months Ended
March 31,
2001 2000
- -------------------------------------------------------------
- Millions of Dollars -
Energy Technology Investments $ (2.2) $ (0.5)
Nations Energy (0.1) 1.6
Other (0.6) 0.4
- -------------------------------------------------------------
Total Millennium $ (2.9) $ 1.5
=============================================================
ENERGY TECHNOLOGY INVESTMENTS
Millennium recorded a net loss of $2 million related to its Energy
Technology Investments in the quarter ended March 31, 2001 resulting from
Global Solar's increased development efforts of its solar modules and
Infinite Power Solutions' expenditures to develop thin-film solid state
rechargeable batteries. See Note 3 of Notes to Financial Statements.
NATIONS ENERGY
Nations Energy recorded a small loss in the first quarter of 2001
compared with net income of nearly $2 million in the quarter ended March
31, 2000. Nations Energy's earnings in the first quarter 2000 included a
$2.5 million pre-tax gain on the sale of a minority interest in a power
project in the Czech Republic and a $1.5 million decrease in the market
value of its Panama investment.
OTHER MILLENNIUM INVESTMENTS
The net loss shown in the "Other" line item in the first quarter of
2001 relates primarily to a $1 million after-tax loss from Millennium's
investment in MicroSat, partially offset by approximately $0.5 million in
after-tax interest income on Millennium investments. The net gain in the
first quarter of 2000 reflects interest income on Millennium investments.
DIVIDENDS ON COMMON STOCK
- -------------------------
UNISOURCE ENERGY
On February 1, 2001 UniSource Energy declared a cash dividend in the
amount of $0.10 per share on its Common Stock, which was a 25% increase
from the prior quarter. This dividend, totaling approximately $3 million,
was paid March 9, 2001 to shareholders of record at the close of business
February 15, 2001.
UniSource Energy's Board of Directors will review our dividend policy
on a continuing basis, taking into consideration a number of factors
including our results of operations and financial condition, general
economic and competitive conditions and the cash flow from our subsidiary
companies, TEP and Millennium.
TEP
In December 2000, TEP declared and paid a dividend of $30 million to
UniSource Energy.
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,
2001, the required minimum net worth was $242 million. TEP's actual net
worth at March 31, 2001 was $305 million. See Investing and Financing
Activities, TEP Credit Agreement, below. As of March 31, 2001, 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, 2001, TEP's equity ratio on that basis was 21.3%.
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. Therefore, TEP declared its December 2000 dividend from 2000
earnings since TEP had an accumulated deficit, rather than positive
retained earnings.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH FLOWS
----------
UNISOURCE ENERGY
Consolidated cash and cash equivalents increased from the March 31,
2000 balance of $102 million to $144 million at March 31, 2001. For the
twelve-month period ended March 31, 2001, cash generated from operating
activities exceeded consolidated net cash outflows for investing and
financing.
Net cash flows from operating activities increased by $32 million in
the first quarter of 2001 compared with the same period in 2000. The net
increase resulted primarily from higher cash receipts from sales to
wholesale and retail customers, net of increased fuel and purchased power
costs.
Net cash used for investing activities totaled $49 million during the
first quarter of 2001 compared with $36 million during the same period in
2000. Capital expenditures were $13 million higher in 2001, and included
$11 million incurred by Millennium in relation to the purchase of a gas
turbine to be placed in service in mid-year 2001. Investments in and loans
to Millennium Energy Businesses also increased by $6 million in 2001.
Other significant investing activities in 2000 included: (i) the $28
million purchase of Springerville Unit 1 Lease debt by Millennium and (ii)
Nations Energy's $20 million in proceeds from the sale of its interest in
the Czech Republic power project.
Net cash used for financing activities totaled $18 million in the
first quarter of 2001 compared with $24 million during the same period in
2000. Scheduled payments that retired capital lease obligations were $6
million lower in first quarter 2001 than in first quarter 2000.
UniSource Energy's consolidated cash balance, including cash
equivalents, at May 4, 2001 was approximately $138 million. We invest cash
balances in high-grade money market securities with an emphasis on
preserving the principal amounts invested.
TEP
Cash and cash equivalents increased from the March 31, 2000 balance
of $61 million to $97 million at March 31, 2001. For the twelve-month period
ended March 31, 2001, net cash inflows from operating activities exceeded
net cash outflows from investing and financing activities.
The reasons for the changes in TEP's statement of cash flows are
incorporated above in the analysis of the changes in UniSource Energy's
consolidated cash flows.
TEP's consolidated cash balance, including cash equivalents, at
May 4, 2001 was approximately $96 million.
TEP expects to generate enough cash flow during the next 12 months to
fund continuing operating activities, capital expenditures, required debt
maturities, and to pay dividends to UniSource Energy. However, TEP's cash
flows may vary due to changes in wholesale market conditions, changes in
short-term interest rates and other factors. If cash flows were to fall
short of our expectations, or if monthly cash requirements temporarily
exceed available cash balances, TEP would borrow from the Revolving Credit
Facility.
INVESTING AND FINANCING ACTIVITIES
- ----------------------------------
UNISOURCE ENERGY
----------------
During the next 12 months, UniSource Energy expects to use cash to
fund investments in Millennium's 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. If available cash falls short of
expectations, we would reevaluate the investment requirements of
Millennium's unregulated energy businesses and/or seek additional financing
for, or investments in, those businesses by unrelated parties.
TEP
---
CAPTIAL EXPENDITURES
TEP's capital expenditures for the quarter ended March 31, 2001 were
$29 million. TEP's capital budget for the year ending December 31, 2001 is
approximately $99 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 these estimates 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.
In January 2001, TEP and Citizens Communications Company (Citizens)
entered into a project development agreement for the construction of a
transmission line from Tucson to Nogales, Arizona. The proposed line is
planned to be in service by December 31, 2003. Construction costs will
range from $20 million to $70 million, depending on the size of the line to
be built. This project could provide an opportunity for TEP to
interconnect with Mexico, providing further reliability and market
opportunities in the region.
The estimated expenditures of $99 million for the year 2001 do not
include any amounts for the new transmission line described above, or for
the potential expansion of the Springerville Generating Station.
Springerville generation expenditures are expected to be made by another
UniSource Energy subsidiary. See Investing and Financing Activities,
Millennium, below.
TEP BANK CREDIT AGREEMENT
As of March 31, 2001 and as of May 4, 2001, 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 1.50
in 2001 and increasing to 1.55 in 2002, and (c) a maximum Leverage Ratio
ranging from 6.40 in 2001 and decreasing to 6.20 in 2002. TEP is in
compliance with each of these covenants.
MILLENNIUM -- UNREGULATED ENERGY BUSINESSES
-------------------------------------------
During the past few years, some of the unregulated energy businesses
of Millennium have required significant amounts of capital. During 1999
and 2000, however, we took the opportunity to realize the value from
certain of these more capital intensive investments and focus on emerging
energy production and storage technologies. We expect this trend to
continue in 2001 as we look to sell our interests in our remaining Nations
Energy investments and continue to make investments in our technology
companies.
Below we provide an update on our significant investments,
commitments and investment proceeds in the first quarter of 2001.
INVESTMENTS IN ENERGY TECHNOLOGIES
Under an agreement reached with ITN in September 2000, Millennium
agreed to certain equity and credit commitments:
* a $20 million credit line to Global Solar,
* a $6 million credit line to Infinite Power Solutions,
* a $10 million equity commitment and a $10 million credit line to
MicroSat, and
* a $3 million equity commitment and a $1 million credit line to the
product development subsidiary.
As of March 31, 2001, Millennium had funded $9 million of its $20
million commitment to Global Solar, $5 million of which was funded in the
first quarter of 2001. As of March 31, 2001, Millennium had also funded $4
million in equity under its $10 million equity commitment to MicroSat.
Millennium expects to fund a total of $25 million to $35 million to its
various Energy Technology investments in 2001. A significant portion of
the funding under these agreements will be used for research and
development purposes, establishment of the production line, and other
administrative costs. As these funds are expended for these purposes, it
is expected that a major portion will be expensed.
OTHER INVESTMENTS AND COMMITMENTS
In July 2000, Millennium made a $15 million capital commitment to a
limited partnership which will fund energy related investments. As of
March 31, 2001, Millennium has funded $5 million under this commitment, $4
million of which was funded in the first quarter of 2001. The remaining
$10 million is expected to be invested within two to three years. A member
of the UniSource Energy Board of Directors will also have a minor
investment in the project. An affiliate of such board member will serve as
the general partner.
In November 2000, Millennium made a $5 million capital commitment to
a venture capital fund that will focus on information technology, optics
and biotechnology in Tucson, Arizona. The company that manages the fund is
owned by a member of the UniSource Energy Board of Directors. As of March
31, 2001 Millennium had funded $150,000 under this commitment. Millennium
expects to fund approximately $1 million under this agreement in 2001.
In the first quarter of 2001, Millennium incurred expenditures of $11
million in relation to the purchase of a 20 MW gas turbine, which is being
constructed at the North Loop site in Tucson. This unit is expected to be
in operation by mid-2001 to provide energy to meet TEP's summer peaking
needs.
We are evaluating the expansion of the coal-fired Springerville
Generating Station by constructing Springerville Units 3 and 4.
Springerville was originally designed for four units. Units 3 and 4 would
consist of two 380 MW coal-fired base-load generating units at the same
site as Springerville Units 1 and 2, and would allow us to spread the fixed
costs of the existing common facilities over two additional generating
units. We have retained outside consultants to assist us in developing the
project scope and schedule, determining permitting requirements, and
defining the terms of an engineering, procurement, and construction contract.
We are studying various financing and ownership structures, but expect
the project to be financed by a subsidiary of Millennium through the use of
limited or non-recourse project financing, secured in whole or in part, by
long-term power purchase agreements with unaffiliated wholesale electric
purchasers. Millennium is seeking to identify equity participants and long-
term power purchasers and expects to own at least 51% of the equity.
Permitting requirements and potential fuel sources are being evaluated, and
electric transmission requirements are being studied with potential
wholesale electric purchasers. Should we decide to go forward with this
project, we anticipate that Letters of Intent with project participants
will be signed in mid-year 2001. We expect construction would begin during
the second half of 2001, with commercial operation of Unit 3 expected to
occur in 2004, followed by Unit 4 in 2005. Total construction costs for
this project are expected to range from $800 million to $900 million from
2001 to 2005, and total project costs, which include construction costs,
various development costs and interest during construction, are expected to
exceed $1 billion.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Quarterly Report on Form 10-Q contains forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995.
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. Effects of competition in retail and wholesale energy markets.
3. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
4. Supply and demand conditions in wholesale energy markets,
including volatility in market prices and illiquidity in markets,
which are affected by a variety of factors. These factors
include the availability of generating capacity in the West,
including hydroelectric resources, weather, natural gas prices and
the impact of utility restructuring and generation divestitures
in various states.
5. Changes affecting TEP's cost of providing electrical service
including changes in fuel costs, generating unit operating
performance, scheduled and unscheduled plant outages, interest
rates, tax laws, environmental laws, and the general rate of
inflation.
6. Changes in governmental policies and regulatory actions with
respect to financings and rate structures.
7. Changes affecting the cost of competing energy alternatives,
including changes in available generating technologies and changes
in the cost of natural gas.
8. Changes in accounting principles or the application of such
principles to UniSource Energy or TEP.
9. Market conditions and technological changes affecting UniSource
Energy's unregulated businesses.
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 UniSource
Energy's and TEP's Annual Report on Form 10-K for the year ended December
31, 2000, 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 Risks.
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
- ---------------------------------------------------------------------------
None.
ITEM 5. - OTHER INFORMATION
- ---------------------------------------------------------------------------
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges for
TEP:
3 Months Ended 12 Months Ended
March 31, March 31,
2001 2001
-------------- ---------------
Ratio of Earnings to 1.68 1.72
Fixed Charges
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
- ---------------------------------------------------------------------------
(a) Exhibits.
-- See Exhibit Index.
(b) Reports on Form 8-K.
UniSource Energy and TEP filed the following current reports on Form
8-K during the quarter ended March 31, 2001:
* Dated January 11, 2001 regarding appeals to the Arizona Superior
Court rulings related to Retail Electric Competition Rules.
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 10, 2001 /s/ Kevin Larson
----------------------------
Kevin Larson
Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: May 10, 2001 /s/ Kevin Larson
-----------------------------
Kevin Larson
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.