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, 2002
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 3, 2002, 33,564,058 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 (Loss)..........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. Basis of Accounting Presentation................................10
Note 2. Regulatory Accounting...........................................10
Note 3. Accounting for Derivative Instruments and Hedging Activities....10
Note 4. Millennium Energy Businesses....................................11
Note 5. Business Segments...............................................12
Note 6. Springerville Coal Handling Facilities Leases...................13
Note 7. Commitments and Contingencies...................................13
Note 8. Wholesale Accounts Receivable and Allowances....................13
Note 9. Income Taxes....................................................14
Note 10. UniSource Energy Earnings Per Share (EPS).......................14
Note 11. New Accounting Pronouncements...................................15
Note 12. Review by Independent Accountants...............................15
Item 2. - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview.................................................................16
Factors Affecting Results of Operations
Competition............................................................17
Industry Restructuring.................................................17
Western Energy Markets.................................................19
Market Risks...........................................................21
Future Generating Resources............................................23
Critical Accounting Policies.............................................24
Results of Operations....................................................26
Results of Millennium Energy Businesses..................................28
Results of UED...........................................................29
Dividends on Common Stock................................................29
TABLE OF CONTENTS
(concluded)
Liquidity and Capital Resources
Overall Liquidity......................................................29
Cash Flows
UniSource Energy.....................................................30
TEP..................................................................31
Investing and Financing Activities
UniSource Energy.....................................................31
TEP..................................................................31
Millennium...........................................................32
UED..................................................................33
Safe Harbor for Forward-Looking Statements...............................33
Item 3. - Quantitative and Qualitative Disclosures About Market Risk.......34
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings................................................35
Item 5. - Other Information
Additional Financial Data..............................................35
Item 6. - Exhibits and Reports on Form 8-K.................................35
Signature Page.............................................................36
Exhibit Index..............................................................37
DEFINITIONS
The abbreviations and acronyms used in the 2002 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,
a temporary organization required by the ACC
Retail Electric Competition Rules.
ALJ.......................... FERC Administrative Law Judge.
APS.......................... Arizona Public Service Company.
Capacity..................... The ability to produce power; the most power
a unit can produce or the maximum that can
be taken under a contract; measured in MWs.
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 a syndicate
of banks, dated as of December 30, 1997.
Desert STAR.................. The ISO formed in the southwestern U.S., in
which TEP is a participant.
Emission Allowance(s)........ An EPA-issued allowance which permits
emission of one ton of sulfur dioxide.
These allowances can be bought or sold.
Energy....................... The amount of power produced over a given
period of time; measured in MWh.
EPA.......................... The Environmental Protection Agency.
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.
GAAP......................... Generally Accepted Accounting Principles.
GES.......................... Global Energy Solutions, Inc., a subsidiary
owned 67% by Millennium, 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.
IPS.......................... Infinite Power Solutions, Inc., a wholly-owned
subsidiary of GES, which develops thin-film
batteries.
IRS.......................... Internal Revenue Service.
ISO.......................... Independent System Operator.
ITN.......................... ITN Energy Systems, Inc., a company owned 49%
by Millennium, which was formed to provide
research, development, and other services.
kWh.......................... Kilowatt-hour(s).
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which manages
and trades emission allowances, coal, and
related financial instruments.
MicroSat..................... MicroSat Systems, Inc., a company owned 49% by
Millennium, 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).
PG&E......................... Pacific Gas and Electric Company.
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.
DEFINITIONS
(concluded)
SCE.......................... Southern California Edison Company.
Second Mortgage Bonds........ TEP's second mortgage bonds issued under the
Indenture of Mortgage and Deed of Trust, dated
as of December 1, 1992, of TEP to the Bank of
New York, successor trustee, as supplemented.
Settlement Agreement......... TEP's Settlement Agreement approved by the ACC
in November 1999 that provided for electric
retail competition and transition recovery
asset recovery.
Springerville................ Springerville Generating Station.
Springerville Coal Handling
Facilities Leases.......... Leveraged lease arrangements relating to the
coal handling facilities serving
Springerville.
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 2......... Unit 2 of the Springerville Generating Station.
SRP.......................... Salt River Project Agricultural Improvement
and Power District.
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
UED.......................... UniSource Energy Development Company, a wholly-
owned subsidiary of UniSource Energy, which
owns a 20 MW gas turbine under lease to TEP
and engages in developing generation
resources and other project development
services and related activities.
UniSource Energy............. UniSource Energy Corporation.
WestConnect.................. The proposed for-profit RTO formed by the
reorganization of Desert STAR, in which TEP
is a participant.
WECC......................... Western Electricity Coordinating Council, the
organization formed upon the merger of the
Western Systems Coordinating Council,
Southwest Regional Transmission Association
and Western Regional Transmission Association.
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, 2002 and
the related condensed consolidated statements of income (loss) and of cash
flows for each of the three-month periods ended March 31, 2002 and 2001 and
the condensed consolidated statement of changes in stockholders' equity for
the three-month period ended March 31, 2002. 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 sheet
and statement of capitalization of the Company and TEP as of December 31,
2001, 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, 2002 we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed
consolidated balance sheet as of December 31, 2001 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 3, 2002
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
March 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Revenues $ 131,832 $ 134,677
Electric Wholesale Revenues 44,618 143,687
Net Unrealized Gain on Forward Sales and Purchases 1,021 2,692
Other Revenues 2,796 2,609
- -----------------------------------------------------------------------------
Total Operating Revenues 180,267 283,665
- -----------------------------------------------------------------------------
Operating Expenses
Fuel 48,319 70,951
Purchased Power 10,542 46,372
Other Operations and Maintenance 48,876 52,603
Depreciation and Amortization 33,450 28,698
Amortization of Transition Recovery Asset 2,882 2,346
Taxes Other Than Income Taxes 11,512 11,873
- -----------------------------------------------------------------------------
Total Operating Expenses 155,581 212,843
- -----------------------------------------------------------------------------
Operating Income 24,686 70,822
- -----------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 4,756 3,915
Other Income (Deductions) 195 (1,184)
- -----------------------------------------------------------------------------
Total Other Income (Deductions) 4,951 2,731
- -----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,133 15,772
Interest on Capital Leases 22,205 22,706
Other Interest Expense 2,109 1,464
- -----------------------------------------------------------------------------
Total Interest Expense 38,447 39,942
- -----------------------------------------------------------------------------
Income (Loss) Before Income Taxes and Cumulative
Effect of Accounting Change (8,810) 33,611
Income Tax Expense (Benefit) (2,496) 14,816
- -----------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of Accounting
Change (6,314) 18,795
Cumulative Effect of Accounting Change - Net of Tax - 470
- -----------------------------------------------------------------------------
Net Income (Loss) $ (6,314) $ 19,265
=============================================================================
Average Shares of Common Stock Outstanding (000) 33,613 33,266
=============================================================================
Basic Earnings per Share
Income (Loss) Before Cumulative Effect of Accounting
Change $(0.19) $0.57
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income (Loss) $(0.19) $0.58
=============================================================================
Diluted Earnings per Share
Income (Loss) Before Cumulative Effect of Accounting
Change $(0.19) $0.56
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income (Loss) $(0.19) $0.57
=============================================================================
Dividends Paid Per Share $0.125 $0.10
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 155,392 $ 157,671
Cash Receipts from Electric Wholesale Sales 87,281 152,969
Fuel Costs Paid (49,823) (80,603)
Purchased Power Costs Paid (56,299) (49,194)
Wages Paid, Net of Amounts Capitalized (21,696) (20,415)
Payment of Other Operations and Maintenance Costs (33,287) (33,337)
Capital Lease Interest Paid (34,914) (42,457)
Taxes Paid, Net of Amounts Capitalized (14,408) (12,971)
Interest Paid, Net of Amounts Capitalized (22,348) (23,792)
Income Taxes Paid (7,722) (10,450)
Interest Received 3,322 5,777
Other 3,674 4,680
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities 9,172 47,878
- -----------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (27,060) (39,561)
Investments in and Loans to
Equity Investees (5,423) (7,897)
Purchase of Springerville Lease Debt and Equity (101,135) -
Other 5,425 (1,376)
- -----------------------------------------------------------------------------
Net Cash Flows - Investing Activities (128,193) (48,834)
- -----------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (13,411) (14,500)
Common Stock Dividends Paid (4,198) (3,329)
Other 1,447 1,302
- -----------------------------------------------------------------------------
Net Cash Flows - Financing Activities (17,387) (17,752)
- -----------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (136,408) (18,708)
Cash and Cash Equivalents, Beginning of Year 228,154 163,004
- -----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 91,746 $ 144,296
=============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -----------------------------------------------------------------------------
Net Income (Loss) $ (6,314) $ 19,265
Adjustments to Reconcile Net Income (Loss) to
Net Cash Flows
Depreciation and Amortization Expense 33,450 28,698
Amortization of Transition Recovery Asset 2,882 2,346
Net Unrealized Gain on Forward Sales and Purchases (1,021) (3,474)
Amortization of Deferred Debt-Related Costs
included in Interest Expense 484 504
Deferred Income Taxes (8,723) 3,956
Unremitted Losses of Unconsolidated Subsidiaries 1,113 2,262
Other (6,103) (1,244)
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 56,316 28,052
Materials and Fuel (1,120) (1,537)
Accounts Payable (41,648) (12,550)
Interest Accrued (20,095) (29,971)
Taxes Accrued 7,963 10,446
Other Current Assets (2,444) (194)
Other Current Liabilities (7,658) (1,201)
Other Deferred Assets 142 (303)
Other Deferred Liabilities 1,948 2,823
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 9,172 $ 47,878
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $2,523,377 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 67,123 70,992
- -----------------------------------------------------------------------------
Total Utility Plant 3,337,595 3,310,484
Less Accumulated Depreciation and Amortization (1,295,810) (1,270,089)
Less Accumulated Depreciation of
Capital Lease Assets (370,019) (362,724)
- -----------------------------------------------------------------------------
Total Utility Plant - Net 1,671,766 1,677,671
- -----------------------------------------------------------------------------
Investments and Other Property 265,004 182,747
- -----------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 91,746 228,154
Accounts Receivable - Net 63,330 119,646
Materials and Fuel 47,164 45,052
Deferred Income Taxes - Current 14,838 11,165
Current Regulatory Assets 11,894 -
Other 33,335 30,891
- -----------------------------------------------------------------------------
Total Current Assets 262,307 434,908
- -----------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 328,792 331,674
Income Taxes Recoverable Through Future Revenues 62,328 64,239
Other Regulatory Assets 9,433 9,072
Other Assets 34,735 35,014
- -----------------------------------------------------------------------------
Total Regulatory and Other Assets 435,288 439,999
- -----------------------------------------------------------------------------
Total Assets $2,634,365 $2,735,325
=============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 414,947 $ 424,722
Capital Lease Obligations 800,093 853,793
Long-Term Debt 801,138 802,804
- -----------------------------------------------------------------------------
Total Capitalization 2,016,178 2,081,319
- -----------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 44,685 20,158
Current Maturities of Long-Term Debt 330,428 330,424
Accounts Payable 42,619 84,011
Interest Accrued 28,006 53,300
Taxes Accrued 45,087 25,904
Accrued Employee Expenses 11,139 13,577
Other 25,121 16,105
- -----------------------------------------------------------------------------
Total Current Liabilities 527,085 543,479
- -----------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 36,546 43,507
Other 54,556 67,020
- -----------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 91,102 110,527
- -----------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- -----------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,634,365 $2,735,325
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Common Accumulated Other Total
Shares Common Earnings Comprehensive Stockholders'
Outstanding* Stock (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
(Unaudited)
-In Thousands-
Balances at
December 31, 2001 33,502 $660,123 $(235,401) $ - $424,722
- -------------------------------------------------------------------------------
Comprehensive Income
(Loss):
2002 Year-to-Date Net
Loss - - (6,314) - (6,314)
-----------
Total Comprehensive
Income (Loss) (6,314)
-----------
Shares Issued under
Stock Compensation
Plans 7 66 - - 66
Shares Distributed by
Deferred Compensation
Trust 1 20 - - 20
Shares Issued for
Stock Options 47 651 - - 651
Dividend Declared - - (4,198) - (4,198)
- -------------------------------------------------------------------------------
Balances at
March 31, 2002 33,557 $660,860 $(245,913) $ - $414,947
===============================================================================
* UniSource Energy has 75 million authorized shares of common stock.
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
March 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Revenues $ 131,832 $ 134,677
Electric Wholesale Revenues 44,618 143,687
Net Unrealized Gain on Forward Electric
Sales and Purchases 817 2,692
Other Revenues 1,382 744
- -----------------------------------------------------------------------------
Total Operating Revenues 178,649 281,800
- -----------------------------------------------------------------------------
Operating Expenses
Fuel 48,319 70,951
Purchased Power 10,542 46,372
Other Operations and Maintenance 44,268 47,253
Depreciation and Amortization 32,356 28,480
Amortization of Transition Recovery Asset 2,882 2,346
Taxes Other Than Income Taxes 11,112 11,523
- -----------------------------------------------------------------------------
Total Operating Expenses 149,479 206,925
- -----------------------------------------------------------------------------
Operating Income 29,170 74,875
- -----------------------------------------------------------------------------
Other Income
Interest Income 4,483 2,773
Interest Income - Note Receivable from
UniSource Energy 2,301 2,300
Other Income 751 317
- -----------------------------------------------------------------------------
Total Other Income 7,535 5,390
- -----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,133 15,772
Interest on Capital Leases 22,191 22,692
Other Interest Expense 1,933 1,463
- -----------------------------------------------------------------------------
Total Interest Expense 38,257 39,927
- -----------------------------------------------------------------------------
Income (Loss) Before Income Taxes and
Cumulative Effect of Accounting Change (1,552) 40,338
Income Tax Expense 378 17,297
- -----------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of
Accounting Change (1,930) 23,041
Cumulative Effect of Accounting Change - Net
of Tax - 470
- -----------------------------------------------------------------------------
Net Income (Loss) $ (1,930) $ 23,511
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 155,392 $ 157,671
Cash Receipts from Electric Wholesale Sales 87,281 152,969
Fuel Costs Paid (49,823) (80,603)
Purchased Power Costs Paid (56,299) (49,194)
Wages Paid, Net of Amounts Capitalized (18,011) (18,361)
Payment of Other Operations and Maintenance Costs (25,262) (25,689)
Capital Lease Interest Paid (34,893) (42,450)
Taxes Paid, Net of Amounts Capitalized (13,201) (12,303)
Interest Paid, Net of Amounts Capitalized (22,342) (23,792)
Income Taxes Paid (7,667) (10,450)
Interest Received 3,050 4,536
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities 18,225 52,334
- -----------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (23,988) (29,210)
Purchase of Springerville Lease Debt and Equity (101,135) -
Other 2,152 (339)
- -----------------------------------------------------------------------------
Net Cash Flows - Investing Activities (122,971) (29,549)
- -----------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (13,338) (14,482)
Other 766 830
- -----------------------------------------------------------------------------
Net Cash Flows - Financing Activities (13,797) (14,877)
- -----------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (118,543) 7,908
Cash and Cash Equivalents, Beginning of Year 159,680 88,712
- -----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 41,137 $ 96,620
=============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -----------------------------------------------------------------------------
Net Income (Loss) $ (1,930) $ 23,511
Adjustments to Reconcile Net Income (Loss) to
Net Cash Flows
Depreciation and Amortization Expense 32,356 28,480
Amortization of Transition Recovery Asset 2,882 2,346
Net Unrealized Gain on Forward Electric Sales
and Purchases (817) (3,474)
Amortization of Deferred Debt-Related Costs
included in Interest Expense 484 504
Deferred Income Taxes (5,769) 6,429
Unremitted Losses of Unconsolidated Subsidiaries 91 409
Interest on Note Receivable from UniSource Energy (2,301) (2,300)
Other 1,660 1,774
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 53,001 27,545
Materials and Fuel 63 (834)
Accounts Payable (47,489) (14,112)
Interest Accrued (20,095) (29,971)
Taxes Accrued 7,852 10,353
Other Current Assets (1,857) 1,448
Other Current Liabilities (2,111) (1,428)
Other Deferred Assets 142 (1,263)
Other Deferred Liabilities 2,063 2,917
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 18,225 $ 52,334
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2002 2001
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $2,523,377 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 67,123 70,992
- -----------------------------------------------------------------------------
Total Utility Plant 3,337,595 3,310,484
Less Accumulated Depreciation and Amortization (1,295,810) (1,270,089)
Less Accumulated Depreciation of
Capital Lease Assets (370,019) (362,724)
- -----------------------------------------------------------------------------
Total Utility Plant - Net 1,671,766 1,677,671
- -----------------------------------------------------------------------------
Investments and Other Property 179,998 105,875
- -----------------------------------------------------------------------------
Note Receivable from UniSource Energy 72,433 70,132
- -----------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 41,137 159,680
Accounts Receivable - Net 69,334 124,487
Materials and Fuel 44,611 43,682
Deferred Income Taxes - Current 8,276 4,603
Current Regulatory Assets 11,894 -
Other 9,956 7,814
- -----------------------------------------------------------------------------
Total Current Assets 185,208 340,266
- -----------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 328,792 331,674
Income Taxes Recoverable Through Future Revenues 62,328 64,239
Other Regulatory Assets 9,433 9,072
Other Assets 34,735 35,014
- -----------------------------------------------------------------------------
Total Regulatory and Other Assets 435,288 439,999
- -----------------------------------------------------------------------------
Total Assets $2,544,693 $2,633,943
=============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 320,739 $ 322,471
Capital Lease Obligations 799,741 853,447
Long-Term Debt 800,699 801,924
- -----------------------------------------------------------------------------
Total Capitalization 1,921,179 1,977,842
- -----------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 44,440 19,971
Current Maturities of Long-Term Debt 330,325 330,325
Accounts Payable 41,704 89,193
Interest Accrued 28,006 53,300
Taxes Accrued 42,087 23,015
Accrued Employee Expenses 10,531 13,078
Other 22,089 6,531
- -----------------------------------------------------------------------------
Total Current Liabilities 519,182 535,413
- -----------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 52,899 56,906
Other 51,433 63,782
- -----------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 104,332 120,688
- -----------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- -----------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,544,693 $2,633,943
=============================================================================
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
- -----------------------------------------------------------------------------
(Unaudited)
-Thousands of Dollars-
Balances at
December 31, 2001 $ 653,250 $ (6,357) $(324,422) $ - $ 322,471
- -----------------------------------------------------------------------------
Comprehensive
Income (Loss):
2002 Year-to-Date
Net Loss - - (1,930) - (1,930)
------------
Total Comprehensive
Income (Loss) (1,930)
------------
Other 198 - - - 198
- -----------------------------------------------------------------------------
Balances at
March 31, 2002 $ 653,448 $ (6,357) $(326,352) $ - $ 320,739
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. BASIS OF ACCOUNTING PRESENTATION
- -----------------------------------------
The accompanying quarterly financial statements for UniSource Energy
Corporation (UniSource Energy) and Tucson Electric Power (TEP) 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. These financial statements are presented in accordance
with the SEC's interim reporting requirements which do not include all the
disclosures required by accounting principles generally accepted in the United
States of America (GAAP). The year-end condensed balance sheet data was
derived from audited financial statements, but does not include disclosures
required by GAAP. This quarterly report should be reviewed in conjunction
with UniSource Energy and TEP's 2001 Form 10-K.
Weather causes seasonal fluctuations in TEP's sales; therefore, quarterly
results are not indicative of annual operating results. We have made
reclassifications to the prior year financial statements for comparative
purposes. These reclassifications had no effect on net income.
NOTE 2. 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 Statement of Financial Accounting Standards No. 71
(FAS 71), Accounting for the Effects of Certain Types of Regulation, require
special accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the Arizona
Corporation Commission (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 an expense on our income statement.
Based on the balances of TEP's regulatory assets at March 31, 2002, if we had
stopped applying FAS 71 to TEP's remaining regulated operations, we would have
recorded an extraordinary loss, after-tax, of approximately $249 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 3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- ---------------------------------------------------------------------
On January 1, 2001, we recorded a $0.5 million after-tax gain in our
income statement for the cumulative effect of adopting Statement of Financial
Accounting Standards No. 133 (FAS 133), Accounting for Derivative Instruments
and Hedging Activities.
TEP enters into forward contracts 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, within established limits
to take advantage of favorable market opportunities. Millennium Environmental
Group, Inc. (MEG), a wholly-owned subsidiary of Millennium Energy Holdings,
Inc. (Millennium), enters into swap agreements, options and forward contracts
relating to emission allowances and coal. These activities are considered
trading activities.
Under FAS 133, we record unrealized gains and losses on our trading
activity and adjust the related asset or liability on a monthly basis to
reflect the market prices at the end of the month. The market prices used to
determine fair value for these contracts are estimated based on various
factors including broker quotes, exchange prices, over the counter prices and
time value. We report the unrealized gain/loss on forward sales net of the
unrealized gain/loss on forward purchases as a component of Operating
Revenues. The net pre-tax unrealized gain for the quarter ended March 31,
2002 was approximately $1 million. At March 31, 2002, we reported the fair
value of forward sale and purchase contracts and options sold as Other Current
Liabilities, and we reported the fair value of options purchased and MEG's
emission allowance inventory as Other Current Assets.
We treated certain forward sale and purchase contracts as cash flow
hedges when we adopted FAS 133. However, during 2001, new guidance was issued
which provided that certain forward power purchase or sale agreements,
including capacity contracts, could be excluded from the requirements of FAS
133. We implemented this new guidance in 2001 and determined that the items
designated as cash flow hedges upon adoption could be excluded from the FAS
133 requirements. Therefore, as these contracts settled in 2001, we reversed
the unrealized gain/loss included in Other Comprehensive Income and recorded
the realized gain/loss in the income statement. Additional guidance was
issued in late 2001 that had no impact on our accounting for derivatives. As
of March 31, 2002 and December 31, 2001, we had no cash flow hedges and,
therefore, our balance in Accumulated Other Comprehensive Income was zero.
NOTE 4. MILLENNIUM ENERGY BUSINESSES
- -------------------------------------
ENERGY TECHNOLOGY INVESTMENTS
During the first quarter of 2002, Millennium reallocated a $10 million
line of credit commitment from MicroSat Systems, Inc. (MicroSat) to Global
Solar Energy, Inc. (Global Solar) and Infinite Power Solutions, Inc. (IPS).
We refer to these companies and ITN Energy Systems, Inc. (ITN) as our Energy
Technology Investments. Millennium's first quarter advances to these Energy
Technology Investments totaled $3.6 million.
On April 3, 2002, Millennium signed a letter agreement that will
facilitate a change in the ownership structure of the Energy Technology
Investments to better align our ownership interest in these investments with
Millennium's business plans. Millennium will retain its preferred shareholder
and distribution status. We expect this change in ownership to occur in 2002.
Under the letter agreement Millennium will:
- increase its ownership of Global Solar from 67% to 81%;
- increase its ownership of IPS from 67% to 70%;
- decrease its ownership of MicroSat from 49% to 35%;
- decrease its ownership of ITN from 49% to 19%; and
- provide additional capital contributions of up to $2.7 million,
primarily to fund research and development activities at ITN.
Millennium expects to provide additional funding of between $11 million
and $21 million to its Energy Technology Investments in the last three
quarters of 2002. A significant portion of the funding under these agreements
will be utilized for research and development purposes and administrative
costs. As funds are expended for these purposes we will recognize expense.
Additional investment commitments may be made to these technology investments
depending on their funding requirements and business outlook. In addition,
Millennium is seeking external investors for the Energy Technology Investment
companies.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment to a limited partnership
which funds energy related investments. As of March 31, 2002, Millennium had
funded $6 million of this commitment. The remaining $9 million is expected to
be funded within the next three years. A member of the UniSource Energy Board
of Directors has a minor investment in the limited partnership.
Millennium has a $5 million capital commitment to a venture capital fund
that will focus on information technology, optics and biotechnology, primarily
within the retail service territory of TEP. A member of the UniSource Energy
Board of Directors owns the company that manages the fund. At March 31, 2002,
Millennium had funded approximately $1 million of this commitment. Millennium
expects to fund approximately $1 million in 2002.
Millennium owns a controlling 50.5% interest in Powertrusion
International, Inc., a manufacturer of lightweight composite utility poles.
Millennium is currently evaluating whether it will contribute an additional $2
million in contingent consideration , which is required by August 2002 in
order to maintain its controlling interest.
On April 1, 2002, Millennium invested $2 million in a start-up company
established to market energy related products, bringing Millennium's total
investment to $3.1 million.
NOTE 5. BUSINESS SEGMENTS
- --------------------------
Based on the way we organize our operations and evaluate performance, we
have three reportable business segments:
(1) TEP, an electric utility business, is UniSource Energy's principal
business segment.
(2) Millennium holds interests in unregulated energy businesses (see Note
4).
(3) UniSource Energy Development Company (UED), established in 2001,
engages in developing generating resources and other project
development activities. UED owns a 20 MW gas turbine under lease to
TEP. It is also responsible for developing Springerville Units 3 and
4 for the expansion of the Springerville Generating Station.
Significant reconciling adjustments consist of the elimination of
intercompany activity and balances, including:
- the elimination of intercompany sales between business segments;
- the elimination of an intercompany note between UniSource Energy and
TEP, as well as the related interest income and expense; and
- the elimination of UED's rental income and TEP's rental expense from
UED's turbine lease to TEP.
We disclose selected financial data for our business segments in the
following tables:
Segments UniSource
------------------------ Reconciling Energy
TEP Millennium UED Adjustments Consolidated
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Income Statement
- ----------------
Three months ended
March 31, 2002:
Operating Revenues -
External $ 178,464 $ 1,803 $ - $ - $ 180,267
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 185 2,539 840 (3,564) -
- -------------------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes (1,552) (5,462) 505 (2,301) (8,810)
- -------------------------------------------------------------------------------
Net Income (Loss) (1,930) (3,300) 305 (1,389) (6,314)
- -------------------------------------------------------------------------------
Three months ended
March 31, 2001:
Operating Revenues -
External $ 281,694 $ 1,971 $ - $ - $ 283,665
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 106 1,974 - (2,080) -
- -------------------------------------------------------------------------------
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
- -------------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
March 31, 2002 $2,544,693 $166,988 $ 29,862 $(107,178) $2,634,365
Total Assets,
December 31, 2001 2,633,943 176,097 26,895 (101,610) 2,735,325
- -------------------------------------------------------------------------------
NOTE 6. SPRINGERVILLE COAL HANDLING FACILITIES LEASES
- ------------------------------------------------------
In December 2001, TEP purchased a 13% ownership interest in the
Springerville Coal Handling Facilities Leases for $13 million. In January
2002, TEP purchased all $96 million of the capital lease debt related to these
leases. In a related transaction, in March 2002, TEP canceled that portion of
the leases related to its equity interest, as it held both the ownership
interest and the debt. The residual value in the leased asset is carried at
cost.
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
MILLENNIUM COMMITMENTS
See Note 4 for a description of Millennium's commitments.
UED COMMITMENTS
UED and Salt River Project Agricultural Improvement and Power District
(SRP) entered into a Joint Development Agreement in October 2001 to develop
two 400 MW coal-fired units at TEP's existing Springerville Station. UED and
SRP each committed project development funding for professional services and
other third party costs. At March 31, 2002, capitalized project development
costs on our balance sheet were approximately $12.6 million. If the project
does not proceed, the capitalized project development costs will be
immediately expensed. In addition, under certain limited circumstances
associated with withdrawal from the project, UED would be obligated to
reimburse SRP for zero, 50% or 100% of SRP's previously paid funding amounts,
depending on the circumstances of the withdrawal.
TEP CONTINGENCIES
Springerville Generating Station Complaint
On November 13, 2001, the Grand Canyon Trust, an environmental activist
group, filed a complaint in U.S. District Court against TEP for alleged
violations of the Clean Air Act at the Springerville Generating Station. The
complaint alleges that more stringent emission standards should apply to Units
1 and 2 and that new permits and the installation of additional facilities
meeting Best Available Control Technology standards are required for the
continued operation of Units 1 and 2 in accordance with applicable law. TEP
believes the claims are without merit and will vigorously contest these
claims.
NOTE 8. WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- -----------------------------------------------------
At March 31, 2002 and December 31, 2001, TEP's Accounts Receivable on the
balance sheet is net of an $8.4 million allowance for uncollectible
receivables related to 2000 and 2001 sales to the California Power Exchange
(CPX), the California Independent System Operator (CISO) and Enron Corp. and
certain of its affiliates (Enron). This allowance reflects a 50% reserve on
amounts unpaid from the CPX, the CISO and Enron, as we believe it is probable
that we will collect at least 50% of this aggregate outstanding net receivable
due to the recent (a) stabilization of the power markets, (b) rate increases
achieved by Pacific Gas and Electric Company (PG&E) and Southern California
Edison Company (SCE), (c) settlements made by California utilities with
various power providers, and (d) data in filings of FERC refund hearings. SCE
publicly disclosed that on March 1, 2002, it obtained financing and made
payments so that it has no material undisputed obligations that are past due
or in default. These payments included a payment to the CPX; however, TEP did
not receive a corresponding payment from the CPX.
There are several other outstanding legal issues, complaints and lawsuits
concerning the California energy crisis related to the FERC, wholesale power
suppliers, SCE, PG&E, the CPX and the CISO, and concerning Enron. We cannot
predict the outcome of these issues or lawsuits. We believe, however, that we
are adequately reserved for our transactions with the CPX, the CISO and Enron.
Accounts Receivable from Electric Wholesale Revenues, net of allowances,
totaled $27 million at March 31, 2002 and $70 million at December 31, 2001.
These amounts are included in Accounts Receivable on the balance sheet.
Excluding the receivables from the CPX, the CISO and Enron, as described
above, substantially all of the March 31, 2002 receivable balance has been
collected as of the date of this filing.
NOTE 9. INCOME TAXES
- ---------------------
UniSource Energy and TEP's Cumulative Effect of Accounting Change for the
three months ended March 31, 2001 is net of income tax expense of $312,000
(see Note 3). The differences between the Income Tax Expense (Benefit) lines
on our income statements and the amounts 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,
2002 2001 2002 2001
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Federal Income Tax Expense (Benefit)
at Statutory Rate $(3,084) $12,038 $ (543) $14,392
State Income Tax Expense (Benefit),
Net of Federal Deduction (406) 1,685 (71) 2,015
Depreciation Differences(Flow
Through Basis) 1,154 1,250 1,154 1,250
State Tax Credits (206) - (206) -
Other 46 155 44 (48)
Tax on Cumulative Effect of
Accounting Change - (312) - (312)
- -------------------------------------------------------------------------------
Total Federal and State Income Tax
Expense (Benefit) $(2,496) $14,816 $ 378 $17,297
===============================================================================
NOTE 10. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
- ---------------------------------------------------
Basic EPS is computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted EPS assumes
that proceeds from the hypothetical exercise of stock options and other stock-
based awards are used to repurchase outstanding shares of stock at the average
fair market price during the reporting period. The numerator in calculating
both basic and diluted earnings per share for each period is net income
(loss). The following table shows the effects of potential dilutive common
stock on the weighted average number of shares.
Three Months Ended March 31,
2002 2001
------------------------------------------------------------------------
In Thousands
Denominator:
Average Shares of Common Stock Outstanding 33,613 33,266
Effect of Dilutive Securities:
Warrants - 131
Options and Stock Issuable Under Employee
Benefit Plans - 646
------------------------------------------------------------------------
Total Shares 33,613 34,043
========================================================================
The dilutive share base for the quarter ended March 31, 2002 excludes
715,000 incremental common shares related to options, warrants and
contingently issuable shares. These shares are excluded due to their
antidilutive effect as a result of UniSource Energy's net loss during the
period. Options to purchase 22,000 shares of common stock at $18.74 to $18.84
per share were outstanding during the quarter ended March 31, 2001 but were
not included in the computation of diluted EPS, because the options' exercise
prices were greater than the average market price of the common stock.
At March 31, 2002, UniSource Energy had no outstanding warrants. There
were 4.6 million warrants outstanding that were exercisable into TEP common
stock at a ratio of five warrants to one common share. However, the dilutive
effect is the same as it would be if the warrants were exercisable into
UniSource Energy Common Stock.
NOTE 11. NEW ACCOUNTING PRONOUNCEMENTS
- ---------------------------------------
Statement of Financial Accounting Standards No. 143 (FAS 143), Accounting
for Asset Retirement Obligations, requires entities to record the fair value
of a liability for an asset retirement obligation in the period in which it is
incurred. When the liability is initially recorded, the entity should
capitalize the cost by increasing the carrying amount of the related long-
lived asset. Over time, the liability is accreted to its present value, and
the capitalized cost is depreciated over the useful life of the related asset.
Upon settlement of the liability, an entity either settles the obligation for
its recorded amount or incurs a gain or loss upon settlement. We are required
to comply with FAS 143 beginning January 1, 2003. We are currently in the
process of evaluating the impact of FAS 143 on our financial statements.
NOTE 12. 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, 2002 and 2001, 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 3, 2002
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.
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), Millennium Energy Holdings, Inc. (Millennium), and UniSource Energy
Development Company (UED). TEP is an electric utility that has provided
electric service to the community of Tucson, Arizona, for over 100 years.
TEP is the principal operating subsidiary of UniSource Energy and
represents most of its assets. Millennium invests in unregulated ventures
related primarily to the energy business, including a developer of thin-
film batteries, a developer of small-scale commercial satellites, and a
developer and manufacturer of thin-film photovoltaic cells. UED engages in
developing generating resources and other project development activities,
including facilitating the expansion of the Springerville Generating
Station through construction of Springerville Units 3 and 4. We conduct
our business in these three primary business segments-TEP's Electric
Utility Segment, the Millennium Energy Businesses Segment, and the
UniSource Energy Development Segment.
Management's Discussion and Analysis explains the general financial
condition and the results of operations for UniSource Energy and its three
primary business segments and includes the following:
- operating results during the first quarter of 2002 compared with the
same period in 2001,
- changes in liquidity and capital resources during the first quarter of
2002, and
- expectations of identifiable material trends which may affect our
business in the future.
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. However, the seasonal
nature of TEP's business causes operating results to vary significantly
from quarter to quarter. At March 31, 2002, Millennium's unregulated
energy-related affiliates comprised approximately 6% of total assets, but
at times have had a significant impact on our consolidated net income and
cash flows. At March 31, 2002, UED's unregulated business segment
comprised approximately 1% of total assets, but may have a significant
impact on our consolidated net income and cash flows in the future.
Management's Discussion and Analysis should be read in conjunction
with UniSource Energy and TEP's 2001 Form 10-K and with the Condensed
Consolidated Financial Statements, beginning on page 2, which present the
results of operations for the quarters ended March 31, 2002 and 2001.
Management's Discussion and Analysis explains the differences between
periods for specific line items of the Condensed Consolidated Financial
Statements.
OVERVIEW
- --------
UniSource Energy recorded a net loss of $6.3 million for the first
quarter of 2002, compared with net income of $19.3 million in the first
quarter of 2001. The decrease is primarily attributable to decreased
wholesale marketing activities and decreased retail sales to mining
customers at TEP. Wholesale revenues declined nearly 70% as a result of
reduced sales and significantly reduced market prices in the western U.S.
energy markets.
In the first quarter of 2002, TEP recorded a net loss of $1.9 million,
compared with net income of $23.5 million in the first quarter of 2001.
The reduced earnings resulted from: (1) significantly reduced electric
wholesale sales and revenues due to lower wholesale demand and lower
wholesale energy prices and (2) reduced retail sales and revenues due to
relatively mild winter weather and reduced consumption by mining customers.
See Results of Operations for further detail.
Outlook and Strategy
--------------------
In recent years, the electric utility industry has undergone
significant regulatory change designed to encourage competition in the sale
of electric generation services. However, given changing market conditions
including recent events in California related to deregulation and the Enron
Corp. (Enron) bankruptcy, the Arizona Corporation Commission (ACC) is in
the process of reviewing the Retail Electric Competition Rules (Rules).
Additionally, the Federal Energy Regulatory Commission (FERC) issued
various orders in response to the California energy crisis which have
impacted our businesses. We continually evaluate our position to develop
strategies to remain competitive and flexible in this changing environment.
Our plans and strategies include the following:
- Enhance the value of our transmission system while continuing to provide
reliable access to generation for our retail customers and market
access for all generating assets. This will include focusing on
completing a transmission line to an electric distribution company in
Nogales, Arizona. This line could eventually be connected to Mexico's
utility system.
- Facilitate the construction of Springerville Units 3 and 4, which will
allow us to spread the fixed costs of TEP's Springerville Units 1 and 2
over four units. This includes obtaining construction financing in 2002.
- Reduce TEP's debt as appropriate, using some of our excess cash flows.
- Proactively maintain our transmission and distribution system to
ensure reliable service to our retail customers.
- Efficiently manage our generating resources and look for ways to
reduce or control operating costs in order to improve profitability.
- Actively participate in the formulation of regulatory policies and
actions.
- Focus the efforts of Millennium's technology entities to begin larger
scale production of Global Solar Energy, Inc.'s (Global Solar) thin-film
photovoltaic cells and to develop thin-film battery technology. Seek
strategic partners and investors to achieve commercial operation of these
businesses.
To accomplish our goals, we estimate that during 2002, TEP will spend
$124 million on capital expenditures, Millennium will provide between $15
million and $25 million of funding to its technology investments, and we will
provide between $15 million and $100 million to UED. Our funding of UED will
depend upon the timing of financial close of the Springerville Unit 3 and 4
project and UED's ultimate ownership percentage.
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
The electric utility industry has undergone significant regulatory
change in the last few years designed to encourage competition in the sale
of electricity and related services. However, the recent experience in
California with deregulation has caused many states, including Arizona, to
reexamine the viability of retail electric deregulation.
As of January 1, 2001, all of TEP's retail customers are eligible to
choose an alternate energy supplier. Although there is one Energy Service
Provider (ESP) certified to provide service in TEP's retail service area,
currently none of TEP's retail customers have opted to receive service from
this ESP. TEP has met all conditions required by the ACC to facilitate
electric retail competition, including ACC approval of TEP's direct access
tariffs. However, ESPs must meet certain conditions before electricity can
be sold competitively in TEP's service territory. Examples of these
include ACC certification of ESPs, and execution of and compliance with
direct access service agreements with TEP.
TEP also competes against gas service suppliers and others that
provide energy services. Other forms of energy technologies, such as fuel
cells, may provide competition to TEP's services in the future, but to
date, are not financially viable alternatives. Self-generation by TEP's
large industrial customers could also provide competition for TEP's
services in the future, but has not had a significant impact to date.
In the wholesale market, TEP competes with other utilities, power
marketers and independent power producers in the sale of electric capacity
and energy.
INDUSTRY RESTRUCTURING
TEP'S Settlement Agreement and Retail Electric Competition Rules
----------------------------------------------------------------
In December 1996, the ACC adopted the 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.
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 major provisions of the
Settlement Agreement, as approved, were:
- Consumer choice for energy supply began in 2000, and by January 1,
2001 consumer choice was available to all retail customers.
- After certain rate reductions implemented in 1998 through 2000, TEP's
retail rates are frozen until December 31, 2008, except under certain
circumstances.
- TEP's frozen rates include two Competition Transition Charge (CTC)
components designated for the recovery of its transition recovery assets.
- A Fixed CTC component that equals a fixed charge per kilowatt-hour
sold; and
- A Floating CTC component that equals the amount of the frozen retail
rate less the price of retail electric service.
- By June 1, 2004, TEP will be required to file a general rate case for
its transmission and distribution business, including an updated cost-of-
service study.
- TEP is currently required to transfer its generation and other
competitive assets to a wholly-owned subsidiary by December 31, 2002. The
Settlement Agreement also requires that by December 31, 2002, TEP, as the
Utility Distribution Company, must acquire at least 50% of its requirements
through a competitive bidding process, while the remainder may be purchased
under contracts with TEP's generation subsidiary or other energy suppliers.
Approval of the Settlement Agreement caused TEP to discontinue
regulatory accounting under FAS 71 for its generation operations in
November 1999. See Note 2 of Notes to Condensed Consolidated Financial
Statements.
Recent Developments in the Arizona Regulatory Environment
---------------------------------------------------------
In January 2002, the ACC began a formal proceeding to reexamine the
circumstances that have changed since it adopted the Rules in 1996 and to
revisit the path to deregulation of the retail electric market. The ACC
opened a generic docket to consolidate this issue with several related
issues, including the future of the Arizona Independent Scheduling
Administrator (AISA) and TEP's subsequent application for variance of
certain provisions of the Settlement Agreement. In this application, TEP
requested an extension of the generation assets transfer requirement and
the 50% competitive bid requirement of its Settlement Agreement until the
latter of December 31, 2003 or six months after the ACC issues a final
order in the generic docket. Arizona Public Service Company (APS) also
submitted a request for variance from its transfer of assets requirement,
though the particulars of the APS request are much different from TEP's.
On March 22, 2002, the ACC's Utilities Division (Staff) submitted a
Staff Report to provide general guidance to the Commissioners on issues
contained in the generic docket. In its Report, the Staff recommended that
the ACC address issues affecting the smooth transition to competition,
including market power and market monitoring, competitive bidding, transfer
of generation assets, transmission constraints and reliability, adjustor
mechanisms, retail direct access and shopping credits, and other issues.
On May 2, 2002, the ACC issued a procedural order stating that
hearings will begin on June 17, 2002 to consider the transfer of assets
requirement and other issues for all affected utilities, including TEP. In
a separate procedural order, the ACC also stayed all proceedings scheduled
for TEP's variance application, except for a public comment meeting set for
June 10, 2002.
TEP cannot predict the outcome of these proceedings on its extension
application or of the ultimate resolution of issues contained in the
generic docket.
The status of the Rules and the ability of ESPs to continue to sell
competitive services may also be subject to change due to recent court
proceedings. Several parties, including certain rural electric cooperatives,
filed lawsuits in Maricopa County Superior Court challenging the Rules. In
November 2000, the Court found the Rules to be unconstitutional and unlawful.
The decision was appealed to the Court of Appeals, and implementation of the
judgment was stayed and the Rules remain in effect pending the outcome of the
appeals. TEP cannot predict the effect of the court decision or 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.
State and Federal Legislation
-----------------------------
In the 2002 session, Congress has focused on administrative controls
and oversight of the energy industry in light of the Enron and other high
profile bankruptcies. The Senate debated an energy bill and will likely
reconcile the Senate version with the House energy policy bill approved
earlier this session.
In this session, the Arizona State legislature is in the process of
considering freezing generation property tax values for tax year 2003. The
legislature also will likely create new study committees to modify State
law regulating electric competition and to review the development of
renewable resources. The legislature has shown concern about the State's
preparedness to meet growing electricity demand and has closely monitored
the siting and construction of new generation and transmission facilities.
Transmission Access
-------------------
In 1997, TEP and 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. As a result, they formed
a non-profit corporation named Desert STAR 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. In
October 2001, TEP and three other southwestern utilities filed agreements
and operating protocols with the FERC to form a new, for profit RTO to be
known as WestConnect to replace Desert STAR. The reorganization of Desert
STAR into WestConnect will be subject to approval by the FERC and certain
state regulatory authorities in the region. See Item 1 - Business -
Transmission Access in the 2001 Form 10-K.
The Rules also required the formation and implementation of an AISA.
In July 2001, the ACC Commissioners provided stakeholders the opportunity
to comment on a list of issues related to the AISA, including a proposal by
one of the Commissioners to end the obligation of Arizona utilities to fund
and participate in the AISA. The AISA docket is one of those that was
consolidated with the generic docket related to retail electric competition
issues. See Recent Developments in the Arizona Regulatory Environment,
above.
On April 18, 2002, the Western Systems Coordinating Council (WSCC),
Southwest Regional Transmission Association (SWRTA), and Western Regional
Transmission Association (WRTA) merged to form the Western Electricity
Coordinating Council (WECC). The new organization, WECC, will continue to
be responsible for coordinating and promoting electric system reliability
in the Western Interconnection as has been done by WSCC since its formation
nearly 35 years ago. In addition, WECC will support efficient competitive
power markets, assure open and non-discriminatory transmission access among
members, and provide a forum for resolving transmission access disputes
among members. WECC's interconnection-wide focus is intended to complement
current efforts to form RTO's in various parts of the West.
WESTERN ENERGY MARKETS
As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes affecting these markets and
market participants. During 2000 and 2001, these markets experienced
unprecedented price volatility, bankruptcies and payment defaults by
several of its largest participants, and increased attention and
intervention by regulatory agencies concerned with the outcomes of
deregulation of the electric power industry.
Rates and Market Prices
-----------------------
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. The average market price for around-the-
clock energy based on the Dow Jones Palo Verde Index decreased
significantly in 2002 compared with 2001, as shown below.
Average Market Price for Around-the-Clock Energy MWh
----------------------------------------------------------
Quarter ended March 31, 2002 $ 24
Quarter ended March 31, 2001 $ 178
Beginning in June 2000 and continuing through May 2001, the average
market price for around-the-clock energy in the western U.S. energy market
increased to unprecedented levels due to a number of factors, including
unusually high natural gas prices, decreased hydropower supply, increased
demand and insufficient generation to meet the increased demand. Prices
began a steady decline in June 2001, and now have reached levels that are
more consistent with historical prices. As of May 2002, the average
forward around-the-clock market price for the balance of the year 2002 was
approximately $31 per MWh, based on the Dow Jones Palo Verde Index. As a
result, we expect our wholesale revenues to be significantly lower in 2002
than in 2001. We cannot predict whether these lower prices will continue,
or whether changes in various factors that influence demand and capacity
will cause prices to rise again during the remainder of 2002.
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 and economic conditions in the western
U.S.;
- availability of capacity throughout the western U.S.;
- the extent of electric utility industry restructuring in Arizona,
California and other western states;
- the effect of FERC regulation of wholesale energy markets;
- the availability and price of natural gas;
- precipitation, which affects hydropower availability;
- transmission constraints; and
- environmental restrictions and the cost of compliance.
Payment Defaults and Allowances for Doubtful Accounts
-----------------------------------------------------
See Critical Accounting Policies - Payment Defaults and Allowances for
Doubtful Accounts, below and Note 8 of Notes to Condensed Consolidated
Financial Statements.
FERC Matters
------------
As described more fully in the 2001 Form 10-K, the FERC ordered
hearings and issued several orders during 2000 and 2001 to mitigate
volatile energy prices in the western U.S. and to address the energy
emergency in California. Certain soft price caps on power sold to the
California Independent System Operator (CISO) were enacted in 2000, and
were later replaced in 2001 with an order for price mitigation applicable
to certain wholesale power sales to California and throughout the entire
western U.S. which applies through September 30, 2002. Further, the FERC
issued several orders specifying the methodology to calculate
refunds/offsets applicable to wholesale sales into the CISO's spot markets
for the period from October 2, 2000 to June 20, 2001. The administrative
hearing before a FERC judge to determine the amount of refunds/offsets,
based on the FERC-specified methodology, is in progress.
On May 8, 2002, the FERC issued a data request regarding potential
manipulation of electric and natural gas prices in California energy markets.
The FERC has requested specific data and information with respect to certain
trading strategies in which companies may have engaged. This request has
been made to all sellers of wholesale electricity and/or ancillary services,
including TEP, to the CISO and/or the CPX during the period 2000 and 2001.
We are not able to predict the length and outcome of the FERC hearings
and the outcome of any subsequent lawsuits and appeals that might be filed.
As a participant in the June 2001 refund proceedings, TEP will be subject
to any final refund orders. TEP does not expect its refund liability, if
any, to have a significant impact on the financial statements. See
Critical Accounting Policies - Payment Defaults and Allowances for Doubtful
Accounts, below.
There are several other outstanding legal issues, complaints, and
lawsuits concerning the California energy crisis related to the FERC,
wholesale power suppliers, Southern California Edison Company (SCE),
Pacific Gas & Electric Company (PG&E), the California Power Exchange (CPX)
and CISO, and to Enron. We cannot predict the outcome of these issues or
lawsuits. We believe, however, that we are adequately reserved for our
transactions with the CPX, CISO and Enron. See Note 8 of Notes to
Condensed Consolidated Financial Statements.
SCE Power Exchange Agreement
----------------------------
A power exchange agreement between TEP and SCE requires SCE to provide
firm system capacity of 110 MW to TEP during summer months. TEP is then
obligated to return to SCE in the winter months the same amount of energy
that TEP received from SCE during the preceding summer. Since 1995, TEP
has relied upon this 110 MW from SCE. During 2000 and 2001, volatility in
the western energy markets and the deterioration in SCE's financial
condition created uncertainty for TEP regarding the availability of this
resource for TEP's summer peaking needs. Except for a few occasions in
2000 and 2001, SCE provided TEP with requested energy under the power
exchange agreement. Since June 2001, western power markets have stabilized
and SCE's financial condition appears to be improving. As such, we believe
that there is more certainty to the availability of this resource for TEP
in the summer of 2002. Nevertheless, TEP made forward purchases of
approximately 50 MW at an average price of $42 per MWh for the summer
peaking season to mitigate the risk of loss of this or other resources.
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 2001 Form 10-K.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements below.
Risk Management Committee
-------------------------
We have a Risk Management Committee responsible for the oversight of
commodity price risk and credit risk related to the wholesale energy
marketing activities of TEP and the emissions and coal trading activities
of Millennium Environmental Group, Inc. (MEG). Our Risk Management
Committee consists of officers with responsibility for finance, accounting,
legal, wholesale marketing, and the generation operations of UniSource
Energy. To limit our exposure to commodity price risk, the Risk Management
Committee sets trading policies and limits, which are reviewed frequently
to respond to constantly changing market conditions. To limit our exposure
to credit risk in these activities, the Risk Management Committee approves
credit policies and limits and reviews counterparty credit exposure on a
monthly basis.
Commodity Price Risk
--------------------
We are exposed to commodity price risk primarily relating to changes
in the market price of electricity, natural gas, coal and emissions
allowances. To manage its exposure to energy price risk, TEP enters into
forward contracts to buy or sell energy at a specified price and future
delivery period. Generally, TEP commits to future sales based on expected
excess generating capability, forward prices and generation costs, using a
diversified market approach to provide a balance between long-term, mid-
term and spot energy sales. Similarly, TEP enters into forward purchases
during its summer peaking period to ensure it can meet its load and reserve
requirements and account for other contract and resource contingencies.
These positions are managed on both a volumetric and dollar basis and are
closely monitored using risk management policies and procedures with
oversight by the Risk Management Committee. For example, the risk
management policies provide that TEP should not take a short position in
the third quarter and should have supply backing up all forward sales
positions.
TEP also enters into limited forward purchases and sales to take
advantage of market price changes with the intent to reverse the forward
positions at a profit. These types of transactions are considered to be
our trading positions. TEP marks its trading positions to market on a
daily basis using actively quoted prices obtained from brokers for power
traded over-the-counter at Palo Verde for forward periods of up to five
years. As of March 31, 2002, all of TEP's forward trading contracts were
for settlement within twelve months. TEP's trading policies restrict
forward trading positions to mature no longer than the end of the next
calendar year. Because of the short-term duration of these trading
positions, we believe that the market is liquid and that the various broker
quotations used to calculate the mark-to-market values represent accurate
measures of the fair values of these positions. An unrealized gain of $0.8
million was recorded on TEP's income statement in the first quarter of 2002
to adjust the value of its trading positions to fair value. TEP had a
cumulative unrealized loss of $0.5 million on its December 31, 2001 balance
sheet and a cumulative unrealized gain of $0.3 million on its March 31,
2002 balance sheet.
TEP uses a sensitivity analysis to measure the impact of an
unfavorable change in market prices on the fair value of its trading
positions. As of March 31, 2002, a 10% unfavorable change in the market
prices of electric power from year-end levels would have decreased the fair
value of these instruments by less than $1 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 Critical
Accounting Policies - Accounting for Derivative Instruments and Hedging
Activities, below and Note 3 of Notes to Condensed Consolidated Financial
Statements.
During the fourth quarter of 2001, we began managing and trading
emission allowances, coal and related financial instruments through MEG.
We manage the market risk of this new line of business by setting notional
limits by product, as well as limits to the potential change in fair market
value under a hypothetical 33% change in price or volatility. MEG's
trading activities, including swap agreements, options and forward
contracts, are closely monitored using risk management policies and
procedures with oversight by the Risk Management Committee. MEG marks its
trading positions to market on a daily basis using actively quoted prices
obtained from brokers. As of March 31, 2002, the fair value of MEG's
emission allowance inventory was $6 million and the net fair value of MEG's
options purchased, options sold and forward contracts was $2 million.
These amounts include a cumulative unrealized gain of $0.2 million to
adjust to fair market value as of March 31, 2002.
TEP is generally subject to increased commodity price risk during the
third quarter of each year, due to the seasonal nature of its business as a
summer-peaking utility. During the last two years, there has been some
uncertainty regarding availability of a power resource from the SCE Power
Exchange. (See Western Energy Markets - SCE Power Exchange Agreement,
above.) To mitigate the risk that this resource would be unavailable to
TEP, and/or the risk of other unexpected losses of generation resources due
to unplanned outages or natural disasters, TEP has purchased 50 MW of
energy on a forward basis to protect its retail customers from power
interruptions for the summer of 2002. TEP also plans to rely upon two new
peaking units which went in-service in June 2001, interruptible contracts,
and reserve sharing arrangements with other utilities as resources. Under
the terms of its Settlement Agreement, TEP's retail rates are frozen
through December 31, 2008, except under certain circumstances. As such,
TEP cannot recover increased purchased power costs without further ACC
action. See Factors Affecting Results of Competition - Industry
Restructuring, above.
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 of 2001, which, combined with increased usage, caused gas costs to
comprise 39% of total fuel expense for the quarter ended March 31, 2001.
With the significant reduction in wholesale energy prices in the first
quarter of 2002, only 5% of TEP's generation was fueled by natural gas in
that quarter. Natural gas prices were also lower in 2002, causing gas
costs to comprise only 11% of fuel expense in the first quarter of 2002.
TEP is assured of its gas supply as a retail customer of the local gas
supplier. TEP periodically negotiates its contract with its gas supplier
to establish terms relating to pricing and scheduling of gas delivery.
Credit Risk
-----------
UniSource Energy is exposed to credit risk in its energy trading
activities related to potential nonperformance by counterparties. We
manage 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 affected by payment defaults by SCE
and PG&E for amounts owed to the CPX and CISO. In the fourth quarter of
2001, Enron defaulted on amounts owed to TEP for energy sales.
We calculate counterparty credit exposure by adding any outstanding
receivable (net of amounts payable if a netting agreement exists) to the
mark-to-market value of any forward contracts. As of March 31, 2002, TEP's
total credit exposure related to its wholesale trading activities
(excluding defaulted amounts owed by CPX, CISO and Enron), was less than
$10 million, of which 95% was with 25 counterparties with investment grade
ratings. At March 31, 2002, MEG's total credit exposure was less than $1
million. Based on a review of our credit exposures at March 31, 2002, we
do not anticipate any nonperformance by any of our other counterparties.
See Critical Accounting Policies - Payment Defaults and Allowances for
Doubtful Accounts, below.
FUTURE GENERATING RESOURCES
Springerville Generating Station Expansion
------------------------------------------
As reported in the 2001 Annual Report on Form 10-K, UED and Salt River
Project Agricultural Improvement and Power District (SRP) signed a joint
development agreement, in October 2001, which set forth certain terms
associated with the ownership and development of two new coal-fired
electric generating units (Springerville Units 3 and 4). The arrangement
contemplates that SRP would effectively obtain 50% of the interest in the
total output of the project, or approximately 400 MW. The balance of the
electric output is expected to be sold to other regional power companies,
possibly including TEP. The parties are currently in the process of
further delineating the financial and ownership structure of the project
that would ultimately meet their respective objectives. UED anticipates
that at least some portion of the project will be financed with the
proceeds of project financing.
Springerville was originally designed for four units. Units 3 and 4
would consist of two 400 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 the two additional
generating units. The project scope and schedule are currently being
refined in connection with the terms of an engineering, procurement, and
construction contract. We are also continuing the permitting process,
evaluating financing alternatives, and negotiating with other potential
long-term power purchasers in addition to SRP.
The ACC approved construction of a third and fourth unit at the
Springerville Generating Station in 1977 and 1987, respectively, providing
that TEP, as plant operator, demonstrate that the fourth unit was needed to
provide an adequate, economical and reliable supply of electric power to
its customers. In July 2001, TEP filed an application requesting the ACC
to schedule a hearing addressing the need for the fourth electric
generating unit. Evidentiary hearings regarding the need for Unit 4 were
held in November 2001 in Springerville and Phoenix. The matter is pending
before the ACC.
TEP worked with the Environmental Protection Agency (EPA) and the
Arizona Department of Environmental Quality (ADEQ) to determine mutually
acceptable levels of emissions for all four units to accomplish significant
emission reductions from current levels. The ADEQ issued a final permit on
April 29, 2002. Springerville Units 3 and 4 will be equipped with modern
emissions control technology, and the emissions controls on Units 1 and 2
will be upgraded. Sulfur dioxide emissions from all four units will be up
to 55 percent less than those currently produced from the current two
units, while nitrogen oxide emissions will be up to 39 percent less. TEP
also volunteered to undertake some operational changes on the existing
units to reduce emissions as early as July 2003, rather than waiting until
the expansion project is scheduled for completion.
Environmental activist groups have expressed concerns regarding the
construction of Units 3 and 4. Such concerns have been expressed during
the permitting and ACC proceedings and may extend to other forums and to
issues apart from the proposed construction. On November 9, 2001, the
Grand Canyon Trust, an environmental activist group, filed a complaint in
U.S. District Court against TEP for alleged violations of the Clean Air Act
at the Springerville Generating Station. The complaint alleges that more
stringent emission standards should apply to Units 1 and 2 and that new
permits and the installation of additional facilities meeting Best
Available Control Technology standards are required for the continued
operation of Units 1 and 2 in accordance with applicable law. TEP believes
the claims are without merit and will vigorously contest these claims.
We presently anticipate that power purchase agreements with other
project off-takers, the engineering, procurement and construction contract,
and other required project agreements will be finalized during the second
and third quarters of 2002 and that the construction financing will be in
place by the end of the fourth quarter of 2002. We expect that
construction will begin by the first quarter of 2003, with commercial
operation of Unit 3 expected to occur in early
2006, followed six to twelve months later by Unit 4. We can make no
assurances, however, about the ultimate timing, or whether we will proceed
with this project.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
In preparing financial statements under GAAP, management exercises
judgment in the selection and application of accounting principles,
including making estimates and assumptions. We consider Critical
Accounting Policies to be those that could result in materially different
financial statement results if our assumptions regarding application of
accounting principles were different. We describe our Critical Accounting
Policies below. Other significant accounting policies are discussed in the
2001 Form 10-K, Note 1 - Nature of Operations and Summary of Significant
Accounting Policies. Recently issued accounting standards are discussed in
Note 11 of Notes to Condensed Consolidated Financial Statements - New
Accounting Pronouncements.
Accounting for Rate Regulation
------------------------------
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 TEP's Settlement
Agreement relating to recovery of TEP's transition costs and standard
retail rates, we stopped applying FAS 71 to our generation operations.
We continue to apply FAS 71 in accounting for 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 an expense on our income statement. Based on the balances of
TEP's regulatory assets at March 31, 2002, if we had stopped applying FAS
71 to TEP's remaining regulated operations, we would have recorded an
extraordinary loss, after-tax, of approximately $249 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.
Accounting for Derivative Instruments and Hedging Activities
------------------------------------------------------------
On January, 1, 2001, we adopted 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. Because
of the complexity of derivatives, the FASB established a Derivatives
Implementation Group (DIG). During 2001, the DIG issued new guidance,
which changed the contracts that qualified as derivatives under FAS 133.
When we adopted FAS 133, some of the forward contracts that we used to
buy and sell wholesale power were considered to be derivatives based on the
accounting guidance at that time. Some of the contracts qualified for
hedge accounting while some were considered to be trading activities.
Under FAS 133, we record unrealized gains and losses on our trading
activity and adjust the related asset or liability on a monthly basis to
reflect the market prices at the end of the month. The market prices used
to determine fair value for these contracts are estimated based on various
factors including broker quotes, exchange prices, over the counter prices
and time value. We report the unrealized gain/loss on forward sales net of
the unrealized gain/loss on forward purchases as a component of Operating
Revenues. The net pre-tax unrealized gain for the quarter ended March 31,
2002 was approximately $1 million. At March 31, 2002, we reported the fair
value of our forward sale and purchase contracts and options sold as Other
Current Liabilities and we reported the fair value of options purchased and
MEG's emission allowance inventory as Other Current Assets.
To date, the DIG has issued more than 100 interpretations to provide
guidance in applying FAS 133. As the DIG or the FASB 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.
See Note 3 of Notes to Condensed Consolidated Financial Statements -
Accounting for Derivative Instruments and Hedging Activities.
Payment Defaults and Allowances for Doubtful Accounts
-----------------------------------------------------
We record an allowance for doubtful accounts when we determine that an
account receivable will not be collected. At March 31, 2002 and December
31, 2001, TEP's Accounts Receivable on the balance sheet is net of an $8.4
million allowance for uncollectible receivables related to 2000 and 2001
sales to the CPX, the CISO and Enron. This allowance reflects a 50%
reserve on amounts unpaid from the CPX, the CISO and Enron, as TEP believes
it is probable that it will collect at least 50% of this aggregate
outstanding net receivable due to the recent (a) stabilization of the power
markets, (b) rate increases achieved by PG&E and SCE, (c) settlements made
by California utilities with various power providers, and (d) data in
filings of FERC refund hearings.
SCE publicly disclosed that on March 1, 2002, it obtained financing
and made payments so that it has no material undisputed obligations that
are past due or in default. These payments included a payment to the CPX;
however, TEP did not receive a corresponding payment from the CPX. In
addition, 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.
In addition to TEP's net receivable exposure of $0.8 million to Enron,
at December 31, 2001, TEP had forward electricity sales contracts for
periods through June 30, 2002 with an estimated mark-to-market value of
approximately $1 million. The unrealized gains associated with these
contracts were removed from TEP's revenues as of December 31, 2001. TEP
has filed a claim in Enron's bankruptcy proceedings for its receivable and
for the mark-to-market value of defaulted forward contracts.
The amount that we ultimately collect from the CPX, the CISO and Enron
would have an impact on our earnings if the amount is more or less than the
$8.4 million we have reserved. If we collect all of the $16.8 million, pre-
tax income will increase by $8.4 million. If we do not collect any of the
$16.8 million, pre-tax income will decrease by $8.4 million. We also
believe that we are due interest on the amounts we are owed.
Capitalization of UED Project Development Costs
-----------------------------------------------
UED capitalizes project development costs when it is probable that the
project will be completed and we expect to recover the costs of the
project. UED and SRP entered into a Joint Development Agreement in October
2001 to develop two 400 MW coal-fired units at TEP's existing Springerville
Station. UED and SRP each committed project development funding for
professional services and other third party costs. At March 31, 2002,
capitalized project development costs on UED's balance sheet were
approximately $12.6 million. If the project does not proceed, the
capitalized project development costs will be immediately expensed. In
addition, under certain limited circumstances associated with the withdrawal
from the project, UED would be obligated to reimburse SRP for zero, 50% or 100%
of SRP's previously paid funding amounts, depending on the circumstances of the
withdrawal. As of March 31, 2002, SRP has paid $11.1 million in project
development costs.
Unbilled Revenue
----------------
TEP's electric retail revenues include an estimate of MWhs delivered
but unbilled at the end of each period. The unbilled revenue is estimated
by comparing the actual MWhs consumed to the MWhs billed to our retail
customers. The excess of MWhs consumed over MWhs billed is then allocated
to the retail customer classes based on estimated usage by each customer
class. We then record revenue for each customer class based on the various
bill rates for each customer class. Due to the seasonal fluctuations of
our actual load, the unbilled revenue amount is greater in the summer
months than it is in the winter months.
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded a net loss of $6.3 million, or $0.19 per
average share of Common Stock in the first quarter of 2002. This compares
with net income of $19.3 million or $0.58 per average share of Common Stock
in the first quarter of 2001.
The primary factors affecting the results of operations in the first
quarter of 2002 include significantly reduced revenues from wholesale
marketing activities due to lower demand and a decline in market prices in
the western U.S. energy markets and reduced retail sales and revenues due
to relatively mild winter weather and reduced consumption by mining
customers.
Contribution By Business Segment
--------------------------------
The table below shows the contributions to our consolidated after-tax
net income and losses by our three business segments, as well as parent
company expenses and intercompany eliminations, for the first quarter of
2002 and 2001:
Three Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $ (1.9) $ 23.5
Millennium (3.3) (2.9)
UED 0.3 -
Intercompany Eliminations (1.4) (1.3)
- --------------------------------------------------------------------
Consolidated Net Income (Loss) $ (6.3) $ 19.3
====================================================================
Intercompany Eliminations include:
- elimination of intercompany sales between business segments;
- elimination of intercompany interest on the note payable from
UniSource Energy to TEP; and
- elimination of UED's rental income and TEP's rental expense from UED's
turbine lease to TEP.
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 relates to TEP's utility operations, unless otherwise noted. The
results of our unregulated energy businesses are discussed in Results of
Millennium Energy Businesses and Results of UED below.
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. Electric wholesale revenues are affected by market prices in the
wholesale energy market, availability of TEP generating resources, and the
level of wholesale trading activity.
TEP experienced a significant decline in wholesale energy sales and
revenues during the first quarter of 2002. Market demand in the western
region declined primarily as a result of mild winter temperatures, and
market prices fell as a
result of increased capacity in the region and declining natural gas
prices, as well as reduced demand. TEP's electric wholesale sales consist
primarily of four types of sales:
(1) Sales under long-term contracts for periods of more than one year.
TEP currently has long-term contracts with three entities to sell
firm capacity and energy: SRP, the Navajo Tribal Utility Authority
and the Tohono O'odham Utility Authority. TEP also has a long-term
interruptible contract with Phelps Dodge Energy Services, which
requires a fixed contract demand of 60 MW at all times except during
TEP's peak customer energy demand period, from July through September
of each year. Under the contract, TEP can interrupt delivery of
power if the utility experiences significant loss of any electric
generating resources.
(2) Forward contracts to sell energy for periods through the end of the
next calendar 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-month or one-year
periods.
(3) Short-term economy energy sales in the daily or hourly markets at
fluctuating spot market prices and other non-firm energy sales.
(4) Sales of transmission service.
Comparisons of TEP's kilowatt-hour sales delivered and the
corresponding electric revenues for the first quarter of 2002, compared
with the same period in 2001, are shown below:
Sales Operating Revenue
- ----------------------------------------------------------------------------------------------------
Percent Percent
Three Months Ended March 31, 2002 2001 Change 2002 2001 Change
- ----------------------------------------------------------------------------------------------------
- Millions of kWh - - Millions of Dollars -
Electric Retail Sales 1,681 1,769 (5.0%) $ 131.8 $ 134.7 (2.2%)
- ----------------------------------------------------------------------------------------------------
Electric Wholesale Sales Delivered:
Long-term Contracts 281 334 (15.9%) 14.6 16.6 (12.0%)
Forward Contracts 61 618 (90.1%) 2.4 49.1 (95.1%)
Short-term Sales and Other 679 583 16.5% 26.9 77.1 (65.1%)
Transmission - - - 0.7 0.9 (22.2%)
- ----------------------------------------------------------------------------------------------------
Total Electric Wholesale Sales 1,021 1,535 (33.5%) 44.6 143.7 (69.0%)
- ----------------------------------------------------------------------------------------------------
Total 2,702 3,304 (18.2%) $ 176.4 $ 278.4 (36.6%)
====================================================================================================
TEP's kWh sales to retail customers decreased 5% in the first quarter
of 2002 compared with the same period in 2001, despite a 2.4% increase in
retail customers. Sales to mining customers decreased by 38% because of
cutbacks in production by both of our large mining customers in response to
lower copper prices. Milder winter temperatures also reduced demand by
retail customers. Heating Degree Days for the quarter decreased by 15%,
from 1,000 days to 848 days. Revenues from sales to retail customers
decreased by 2% in the first quarter of 2002, reflecting the lower kWh
sales.
Kilowatt-hour electric wholesale sales decreased by 34%, while
revenues decreased by 69% in the first quarter of 2002 compared with 2001.
The decrease in revenues in the first quarter 2002 resulted from decreased
demand, decreased sales activity, and the sharp decline in market prices
from those in the first quarter of 2001. The largest decrease in sales and
revenues was in forward contracts, which represent purchase and resale
transactions. Short-term economy sales in the daily and hourly markets were
higher in the first quarter 2002 compared with the same period in 2001, but
the revenues from these sales were lower, due to lower average market prices
in 2002. Factors contributing to the lower market prices included more
generation online in the western U.S., lower natural gas prices, increased
hydropower supply, and weaker demand.
Fuel and Purchased Power Expenses
---------------------------------
Fuel expense at TEP's generating plants decreased by $23 million, or
32%, in the quarter ended March 31, 2002 compared with the same quarter in
2001. Lower wholesale demand and lower wholesale prices resulted in
decreased natural gas usage for generation. Natural gas prices were also
lower in the first quarter of 2002 compared with the same period in 2001.
The average cost of fuel per kWh generated for the first quarter of 2002
and 2001 was 1.84 cents and 2.40 cents, respectively. See Market Risks -
Commodity Price Risk, above.
Purchased Power expense decreased by $36 million, or 77%, in the first
quarter of 2002 compared with the same period in 2001 due principally to
decreased volume of trading activity and lower wholesale prices in the
forward and spot energy markets.
Other Operating Expenses
------------------------
Other Operations and Maintenance expense decreased by $3 million, or
6%, in the first quarter 2002, compared with the same period in 2001. The
primary reasons for this decrease include a $5 million reduction in bad
debt reserves, offset by a $2 million increase in maintenance expense. The
decrease in bad debt reserves in 2002 occurred because in January 2001, we
recorded $7 million in reserves, of which $5 million was recorded as
expense, to cover our credit exposure for risk of non-payment from electric
wholesale sales to California made in January 2001. See Note 8 of Notes to
Condensed Consolidated Financial Statements. We recorded no such reserves
in 2002. Maintenance expense increased due to a scheduled outage at
Springerville Unit 1.
Depreciation and amortization expense increased $4 million in the
first quarter 2002, compared with the same period in 2001, due to a $125
million increase in the depreciable asset base, which represents new line
extensions to support new business, the 75 MW gas turbine which went in-
service in June 2001, and routine improvements to our system.
Other Income
------------
TEP's income statements for the quarters ended March 31, 2002 and 2001
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 intercompany transaction.
Interest Income for the quarter ended March 31, 2002 was higher than
the same period in 2001, due to our January 2002 investment in $96 million
of Springerville Coal Handling Facilities Lease debt. See Liquidity and
Capital Resources, below, and Note 6 of Notes to Condensed Consolidated
Financial Statements.
Interest Expense
----------------
Interest Expense for the first quarter of 2002 decreased by $2 million
compared with the same period in 2001, primarily due to decreases in the
average interest rate on long-term variable rate tax-exempt debt in 2002.
Income Tax Expense
------------------
Income taxes decreased $17 million for the first quarter 2002,
compared with the same period in 2001, primarily due to lower pre-tax
income.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
- ---------------------------------------
The table below provides a breakdown of the after-tax net losses
recorded by Millennium Energy Businesses:
Three Months Ended
March 31,
2002 2001
- -----------------------------------------------------------
- Millions of Dollars -
Energy Technology Investments $ (3.3) $ (3.2)
Other - 0.3
- -----------------------------------------------------------
Total Millennium $ (3.3) $ (2.9)
===========================================================
Energy Technology Investments
-----------------------------
Millennium's Energy Technology Investments include Global Solar,
Infinite Power Solutions, Inc. (IPS), MicroSat Systems, Inc. (MicroSat) and
ITN Energy Systems, Inc. (ITN). The major factors contributing to the
losses in 2002 and 2001 are development efforts of solar modules by Global
Solar, expenditures to develop thin-film and solid-state rechargeable
batteries by IPS, research and development work performed by ITN and
contract work performed by MicroSat on satellite development. See Note 4
of Notes to Condensed Consolidated Financial Statements.
RESULTS OF UED
- --------------
UED was established in February 2001 and owns a 20 MW gas turbine,
which it leases to TEP under an operating lease arrangement. UED recorded
a net profit of $0.3 million for the quarter ended March 31, 2002. UED's
income represents rental income, less expenses, under the operating lease.
This rental income is eliminated from UniSource Energy's after-tax earnings
as an intercompany transaction.
UED and SRP are jointly developing Springerville Units 3 and 4 for the
expansion of the Springerville Generating Station. As of March 31, 2002,
the capitalized costs on UED's balance sheet were approximately $12.6
million. If the project does not proceed, the capitalized project
development costs will be immediately expensed. See Future Generating
Resources and Critical Accounting Policies - Capitalization of UED Project
Development Costs, above.
DIVIDENDS ON COMMON STOCK
- -------------------------
UniSource Energy
----------------
In February 2002, UniSource Energy declared a cash dividend of $.0125
per share on its Common Stock. This dividend, totaling approximately $4
million, was paid March 8, 2002 to shareholders of record at the close of
business February 21, 2002.
UniSource Energy's Board of Directors will review our dividend level
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, Millennium and UED.
TEP
---
In December 2001, TEP declared and paid a dividend of $50 million.
UniSource Energy is the primary holder of TEP's common stock.
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,
2002, the required minimum net worth was $263 million. TEP's actual net
worth at March 31, 2002 was $321 million. As of March 31, 2002, TEP was in
compliance with the terms of the Credit Agreement. See Investing and
Financing Activities - TEP Bank Credit Agreement, below.
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, 2002, TEP's equity ratio on that basis was 22%.
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 2001 dividend from 2001
earnings since TEP had an accumulated deficit, rather than positive
retained earnings.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
OVERALL LIQUIDITY
Our primary source of liquidity is our cash flow from operations,
which exceeded $200 million in each of the past two years. These cash
flows are derived primarily from retail and wholesale energy sales at TEP,
net of the related payments for fuel and purchased power. In the last two
years, our cash flows have benefited from higher margins on wholesale
energy sales in the western U.S. power markets. This enabled us to
increase our cash levels from $145 million at year-end 1999 to $228 million
at year-end 2001. We have been using our available cash to finance capital
expenditures, primarily at TEP, to make investments in our energy
technology affiliates, to pay dividends to shareholders, and to reduce
leverage at TEP by repaying high coupon debt and investing in lease debt.
For example, in January 2002, we purchased $96 million principal amount of
lease debt bearing an average coupon of 14.3%.
We do not expect the wholesale energy market conditions to be as
favorable in 2002, with market prices and margins lower than we saw in the
last two years. Another factor that could affect our cash flows from
operations is reduced energy demand by our large mining customers. As we
have reported elsewhere in this document, our two major mining customers
have reduced operations during the last few years due to lower copper
prices. This trend will continue in 2002 and we expect a 40 MW load
reduction to our system peak demand. We expect that these load reductions
will be offset, however, by lower purchased power costs to cover summer
peaking needs and by sales of excess capacity, when profitable, in the
second and fourth quarters. We do not, therefore, expect these reductions
to have a significant impact on cash flows.
In the event that we experience lower cash from operations due to
these, or other events, we will adjust our discretionary uses of cash
accordingly. We believe, however, that we will continue to have sufficient
cash flow to cover our capital needs, as well as required debt payments and
dividends to shareholders. Furthermore, we believe that even with lower
wholesale energy prices and lower demand from mining customers, we will
have sufficient excess cash flow to continue to make annual discretionary
debt reductions or lease debt investments at TEP in the range of $30
million. TEP's $100 million Revolving Credit Facility provides us with
another major source of liquidity. TEP has borrowed under this facility
only one time for a period of approximately one month during the past four
years. At March 31, 2002, there were no outstanding borrowings under this
facility. If TEP encountered temporary cash needs during the course of the
year, it would borrow from this Revolving Credit Facility.
The Revolving Credit Facility is part of TEP's Bank Credit Agreement,
which matures on December 30, 2002. The Credit Agreement also includes a
$341 million Letter of Credit Facility (LOC) which supports $329 million of
tax-exempt variable rate bonds. If TEP fails to extend or replace the LOCs
or to otherwise refinance the bonds prior to the expiration date, the bonds
would be subject to mandatory redemption. Therefore, the $329 million in
bonds have been classified as current liabilities on our balance sheet as
of March 31, 2002 and December 31, 2001. TEP has commenced negotiations
with its banks and believes that it will be able to negotiate a new credit
agreement prior to the maturity of its existing Credit Agreement. At that
time, the $329 million in tax-exempt variable rate bonds will be classified
as Long-Term Debt. See Investing and Financing Activities - TEP Bank
Credit Agreement, below.
There have been no significant changes in our contractual obligations
or other commercial commitments from those reported in our 2001 Annual
Report on Form 10-K.
CASH FLOWS
UniSource Energy
----------------
Consolidated cash and cash equivalents decreased from the March 31,
2001 balance of $144 million to $92 million at March 31, 2002. For the
twelve-month period ended March 31, 2002, net cash outflows for investing
and financing activities exceeded the cash generated from operating
activities.
Net cash flows from operating activities decreased by $39 million in
the first quarter 2002 compared with the same period in 2001. The net
decrease resulted primarily from the following factors:
- $44 million decrease in cash receipts from sales to wholesale and
retail customers, net of fuel and purchased power costs paid; and
- $2 million decrease in interest received due to lower interest rates
on temporary investments; offset by
- $8 million decrease in capital lease interest paid as a result of
scheduled changes in Springerville lease payments.
Net cash used for investing activities totaled $128 million in the
first quarter of 2002, compared with $49 million during the same period in
2001. TEP spent $101 million to purchase and hold outstanding
Springerville lease debt in January 2002. See Investment in Springerville
Lease Debt and Equity, below. Capital expenditures were $12 million higher
in the first quarter of 2001 than in 2002 primarily due to UED's purchase
of a 20 MW gas turbine, which was placed in-service in June 2001.
Net cash used for financing activities in the first quarter 2002
totaled $17 million, compared with $18 million in the first quarter 2001.
In 2002, UniSource Energy paid approximately $4 million in dividends, a 25%
increase from 2001.
UniSource Energy's consolidated cash balance, including cash
equivalents, at May 3, 2002 was approximately $66 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 decreased from the March 31, 2001 balance of
$97 million to $41 million at March 31, 2002. For the twelve-month period
ended March 31, 2002, net cash outflows for investing and financing
activities exceeded the cash generated from operating 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 3,
2002 was approximately $28 million.
INVESTING AND FINANCING ACTIVITIES
- ----------------------------------
UNISOURCE ENERGY
During the next 12 months, UniSource Energy expects to use cash to
fund investments in Millennium and UED'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 seek to
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
TEP's capital requirements consist primarily of capital expenditures
and optional and mandatory redemptions of long-term debt and capital lease
obligations.
Capital Expenditures
--------------------
TEP's capital expenditures for the three months ended March 31, 2002
were $24 million. TEP's forecast for capital expenditures for the year
ending December 31, 2002 is approximately $124 million. These expenditures
include costs for TEP to comply with current federal and state
environmental regulations. Actual construction expenditures may differ
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 entered into
a project development agreement for the joint construction of a 62-mile
transmission line from Tucson to Nogales, Arizona. In January 2002, the
ACC approved the location and construction of the proposed 345 kV line.
Pending federal studies and approvals for the portion of the line that will
pass through a national forest, construction could begin as early as the
first quarter of 2003, with an expected in-service date of December 31,
2003. Construction costs are expected to be approximately $70 million.
TEP has also applied to the U.S. Department of Energy for a Presidential
Permit that would allow building an extension of the line across the
international border with Mexico to interconnect with Mexico's utility
system, providing further reliability and market opportunities in the
region.
The estimated expenditures listed above do not include any amounts for
the potential expansion of the Springerville Generating Station.
Springerville generation expenditures are expected to be made by UED. See
Investing and Financing Activities - UED, below.
TEP Bank Credit Agreement
-------------------------
TEP has a $441 million Credit Agreement with a number of banks which
matures on December 30, 2002. The agreement consists of a $100 million
Revolving Credit Facility and a $341 million Letter of Credit Facility.
The Revolving Credit Facility is used to provide liquidity for general
corporate purposes. The Letter of Credit Facility supports $329 million
aggregate principal amount of tax-exempt variable rate debt. The
facilities are secured by $441 million in aggregate principal amount of
Second Mortgage Bonds. The Credit Agreement contains a number of
restrictive covenants including restrictions on additional indebtedness,
liens, sale of assets or mergers and sale-leasebacks. The Credit Agreement
also contains several 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 of 1.55 in 2002, and (c) a maximum Leverage Ratio of
6.20 in 2002. As of March 31, 2002, TEP was in compliance with these
financial covenants.
As of March 31, 2002 and as of May 3, 2002, TEP had no borrowings
outstanding under its $100 million Revolving Credit Facility.
TEP intends to enter into a new credit agreement prior to the maturity
of its existing Credit Agreement, in a structure substantially similar to
its existing facilities. TEP has filed an application with the ACC for
authority to refinance its Credit Agreement. We cannot, however, predict
the terms and the pricing that will be available at this time. The $329
million in aggregate principal amount of tax-exempt variable rate debt that
is supported by the Letter of Credit Facility has been classified as
Current Maturities of Long-Term Debt on TEP's Balance Sheet for the period
ended March 31, 2002 because the Letter of Credit Facility matures on
December 30, 2002. Once a longer term Letter of Credit Facility has been
completed, the bonds will be classified as Long-Term Debt.
Investment in Springerville Lease Debt and Equity
-------------------------------------------------
In December 2001, TEP purchased a 13% ownership interest in the
Springerville Coal Handling Facilities Leases for $13 million. In January
2002, TEP purchased all $96 million of the capital lease debt related to
these leases. In a related transaction, in March 2002, TEP canceled that
portion of the leases related to its equity interest, as it held both the
ownership interest and the debt. The residual value in the leased asset is
carried at cost.
MILLENNIUM
Millennium's significant investments, commitments and investment
proceeds for the quarter ended March 31, 2002 are discussed below.
Investments in Energy Technologies
----------------------------------
During the first quarter of 2002, Millennium reallocated a previous
$10 million line of credit commitment from MicroSat to Global Solar and
IPS. We refer to these companies and ITN as our Energy Technology
Investments. First quarter advances to our Energy Technology Investments
totaled $3.6 million.
On April 3, 2002, Millennium signed a letter agreement that will
facilitate a change in the ownership structure of the Energy Technology
Investments to better align our ownership interest in these investments
with Millennium's business plans. Millennium will retain its preferred
shareholder and distribution status. We expect this change in ownership to
occur in 2002. Under the letter agreement, Millennium will:
- increase its ownership of Global Solar from 67% to 81%;
- increase its ownership of IPS from 67% to 70%;
- decrease its ownership of MicroSat from 49% to 35%;
- decrease its ownership of ITN from 49% to 19%; and
- provide additional capital contributions under the agreement, of up to
$2.7 million, primarily to fund research and development activities at ITN.
Millennium expects to provide additional funding of between $11 million
and $21 million to its Energy Technology Investments in the last three quarters
of 2002. A significant portion of the funding under these agreements will be
utilized for research and development purposes and other administrative
costs. As these funds are expended for these purposes, we will recognize
expense. Additional investment commitments may be made to these technology
investments depending on their funding requirements and business outlook.
In addition, Millennium is seeking external investors for the Energy
Technology Investment companies.
As of March 31, 2002, Millennium had approximately $43 million
invested in these Energy Technology Investments. If management determines
that any of these entities are not viable, we would take the appropriate
write-offs.
Other Investments and Commitments
---------------------------------
Millennium has a $15 million capital commitment to a limited
partnership that funds energy-related investments. As of March 31, 2002,
Millennium had funded $6 million of this commitment. The remaining $9
million is expected to be funded within the next three years. A member of
the UniSource Energy Board of Directors has a minor investment in the
limited partnership.
Millennium has a $5 million capital commitment to a venture capital
fund that will focus on information technology, optics and biotechnology,
primarily within the retail service territory of TEP. A member of the
UniSource Energy Board of Directors owns the company that manages the fund.
At March 31, 2002, Millennium had funded approximately $1 million of this
commitment. Millennium expects to fund approximately $1 million in 2002.
Millennium owns a controlling 50.5% interest in Powertrusion
International, Inc., a manufacturer of lightweight composite utility poles.
Millennium is currently evaluating whether it will contribute an additional
$2 million in contingent consideration, which would be required by August
2002 for Millennium to maintain its controlling interest.
On April 1, 2002, Millennium invested $2 million in a start-up company
established to market energy-related products, bringing Millennium's total
investment to $3 million.
UED
UED is responsible as project developer for facilitating the expansion
of Springerville Units 3 and 4. See Future Generating Resources above. We
expect to provide between $15 million and $100 million in funding to UED
during 2002. Our funding to UED will depend upon the timing of the
financial close of the project and UED's ultimate ownership percentage of
the project. Total construction costs for this project are expected to
range from $900 million to $1 billion from 2002 to 2006, and total project
costs, which include construction costs, various development costs and
interest during construction, are expected to exceed $1.4 billion. We can
make no assurances, however, about the ultimate timing, or whether we will
proceed with this project.
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 western U.S., including
hydroelectric resources, weather, natural gas prices, the extent of
utility restructuring in various states, transmission constraints,
environmental restrictions and cost of compliance, and FERC regulation
of wholesale energy markets.
5. The creditworthiness of the entities to which TEP sells capacity and
energy.
6. 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.
7. Changes in governmental policies and regulatory actions with respect
to financing and rate structures.
8. Changes affecting the cost of competing energy alternatives, including
changes in available generating technologies and changes in the cost of
natural gas.
9. Changes in accounting principles or the application of such principles
to UniSource Energy or TEP.
10. 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 and TEP's Annual Report on Form 10-K for the year ended December 31,
2001, 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
- --------------------------------------------------------------------------------
LITIGATION RELATED TO ACC ORDERS AND RETAIL COMPETITION
See Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Developments in the Arizona
Regulatory Environment.
SPRINGERVILLE GENERATING STATION COMPLAINT
See Note 7 of Notes to Condensed Consolidated Financial Statements -
Commitments and Contingencies, TEP Contingencies.
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,
2002 2002
-------------- ---------------
Ratio of Earnings to Fixed Charges .96 * 1.57
* The Ratio of Earnings to Fixed Charges for the 3 months ended March 31,
2002 is less than one-to-one coverage as a result of the seasonal nature
of TEP's business. In the first quarter of 2002, TEP incurred a net loss
of $1.93 million, of which $1.46 million represents the amount of the
deficiency needed to attain a one-to-one coverage.
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
(a) Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K.
None.
SIGNATURES
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 9, 2002 /s/ Kevin Larson
------------------------------
Kevin Larson
Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
------------------------------
(Registrant)
Date: May 9, 2002 /s/ Kevin Larson
------------------------------
Kevin Larson
Vice President and Principal
Financial Officer
EXHIBIT INDEX
12 - Computation of Ratio of Earnings to Fixed Charges - TEP.
15 - Letter regarding unaudited interim financial information.