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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification Number
----------- ------------------------------- --------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
220 West Sixth Street
Tucson, AZ 85701
(520) 571-4000
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Registrant Title of Each Class on Which Registered
---------- ------------------- -------------------
UniSource Energy Common Stock, no par New York Stock
Corporation value Exchange
Pacific Stock
Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of each registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of UniSource Energy Corporation voting Common
Stock held by non-affiliates of the registrant was $383,453,950.60 based on
the last reported sale price thereof on the consolidated tape on March 8,
1999.
At March 8, 1999, 32,290,859 shares of UniSource Energy Corporation
Common Stock, no par value (the only class of Common Stock), were
outstanding.
UniSource Energy Corporation is the sole holder of the 32,162,167 shares
of the outstanding Common Stock of Tucson Electric Power Company.
Documents incorporated by reference: Specified portions of UniSource
Energy Corporation's Proxy Statement relating to the 1999 Annual Meeting of
Shareholders are incorporated by reference into PART III.
- ----------------------------------------------------------------------------
This combined Form 10-K 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....................................................vi
- PART I -
Item 1. - Business
The Company ...................................................1
Regulated Electric Utility Operations
Peak Demand .................................................3
Customers ...................................................3
Sales for Resale ............................................4
Generating and Other Resources
TEP Generating Resources ..................................5
Springerville Station......................................5
Irvington Station..........................................6
Power Exchange Agreement ..................................7
Other Purchases and Interconnections ......................7
Future Generating Resources ...............................7
Rates and Regulation
General....................................................8
ACC Holding Company Order..................................8
1996 Rate Order............................................9
Rate Settlement Agreement..................................9
ACC Rules on Retail Competition............................9
ACC Orders on Stranded Cost Recovery......................11
State and Federal Legislation on Retail Competition.......13
Wholesale Transmission Access.............................13
Other Rate Matters........................................13
Fuel Supply
Coal......................................................14
Springerville Coal Handling Facilities....................15
Natural Gas...............................................15
Water Supply ...............................................15
Environmental Matters ......................................15
Clean Air.................................................15
Jointly-Owned Facilities..................................16
Unregulated Energy Businesses ................................16
Employees ....................................................18
TEP Utility Operating Statistics .............................19
Item 2. - Properties...........................................20
Item 3. - Legal Proceedings
Tax Assessments ..............................................21
Litigation Related to ACC Orders and Competition .............21
Item 4. - Submission of Matters to a Vote of Security Holders..21
TABLE OF CONTENTS
(continued)
Page
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- PART II -
Item 5. - Market for Registrant's Common Equity and Related
Stockholder Matters
UniSource Energy .............................................22
TEP ..........................................................22
Item 6. - Selected Consolidated Financial Data.................23
Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview....................................................24
Factors Affecting Results of Operations
Competition
Retail....................................................25
Wholesale.................................................27
Accounting for the Effects of Regulation ...................27
Market Risks ...............................................28
Impact of the Year 2000 on Computer Systems and Applications30
Results of Operations ........................................32
Contribution by Segment ....................................32
Utility Sales and Revenues .................................32
Fuel and Purchased Power Expense ...........................33
Other Operating Expenses ...................................33
Other Income (Deductions) ..................................34
Interest Expense ...........................................34
Results of Unregulated Energy Businesses ...................35
Dividends on Common Stock
UniSource Energy ...........................................36
TEP ........................................................36
Income Tax Position ..........................................37
Liquidity and Capital Resources
Cash Flows
Overview of Consolidated Cash Flows and Liquidity.........37
TEP Cash Flows and Liquidity..............................38
Investing and Financing Activities
TEP - Regulated Electric Utility
Capital Expenditures.................................38
Bond Issuance and Redemption.........................39
TEP Bank Credit Agreement............................40
Springerville Common Facilities Leases...............40
Tax-Exempt Local Furnishing Bonds....................41
Restrictive Covenants................................41
Millennium - Unregulated Energy Businesses
Capital Requirements.................................43
UniSource Energy - Parent Company Financing Activities
Promissory Note to TEP...............................43
Warrant Exchange Offer...............................43
Direct Stock Purchase Plan...........................44
Restrictions on Proceeds of Equity Issuance..........44
Loans and Guarantees.................................44
Safe Harbor for Forward-Looking Statements .................45
Item 7A. - Quantitative and Qualitative Disclosures about
Market Risk.................................................. 45
TABLE OF CONTENTS
(continued)
Page
----
Item 8. - Consolidated Financial Statements and
Supplementary Data............................................45
Independent Auditors' Report .................................46
Report of Independent Accountants ............................47
UniSource Energy Corporation
Consolidated Statements of Income ..........................48
Consolidated Statements of Cash Flows ......................49
Consolidated Balance Sheets ................................50
Consolidated Statements of Capitalization ..................51
Consolidated Statements of Changes in Stockholders' Equity .52
Tucson Electric Power Company
Consolidated Statements of Income ..........................53
Consolidated Statements of Cash Flows ......................54
Consolidated Balance Sheets ................................55
Consolidated Statements of Capitalization ..................56
Consolidated Statements of Changes in Stockholders' Equity .57
Notes to Consolidated Financial Statements
Note 1. Nature of Operations and Summary of Significant Accounting
Policies
Nature of Operations .......................................58
Basis of Presentation ......................................58
Use of Accounting Estimates ................................59
Regulation .................................................59
TEP Utility Plant ..........................................59
TEP Utility Plant Under Capital Leases .....................59
Springerville Unit 1 Allowance .............................60
Long-Term Debt .............................................60
Utility Operating Revenues .................................61
Fuel Costs .................................................61
Income Taxes ...............................................61
Emission Allowances ........................................61
New Accounting Standards ...................................61
Reclassifications ..........................................62
Note 2. TEP's Regulatory Assets and Liabilities
Accounting for the Effects of Regulation ...................62
Potential Discontinuation of Application of FAS 71 .........65
Note 3. Rate Matters
Rate Reduction .............................................67
1996 Rate Order ............................................68
Note 4. Segment and Related Information ......................68
Note 5. Unregulated Energy Businesses ........................71
International Power Projects - Nations Energy Corporation ..71
Energy Marketing - MEH Corporation .........................72
Photovoltaic Manufacturing - Advanced Energy
Technologies, Inc. ........................................73
Note 6. TEP's Utility Plant and Jointly-Owned Facilities
Utility Plant ..............................................73
Jointly-Owned Facilities ...................................74
Note 7. TEP's Long-Term Debt and Capital Lease Obligations
Long-Term Debt .............................................74
Sale and Redemption of Bonds - 1998.......................74
Sale and Redemption of Bonds - 1997.......................75
Other Long-Term Debt and Agreements
First and Second Mortgage.................................76
Bank Credit Agreement.....................................76
TABLE OF CONTENTS
(concluded)
Page
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Capital Lease Obligations ..................................76
Maturities and Sinking Fund Requirements ...................77
Note 8. Fair Value of TEP's Financial Instruments ............77
Note 9. Dividend Limitations .................................78
Note 10. Commitments and Contingencies
TEP Commitments - Fuel Purchase ............................78
Commitments-Environmental Regulation .......................79
UniSource Energy Commitments - Energy Related Affiliates ...79
Contingencies
Ruling on Arizona Sales Tax Assessments - Coal Sales......79
Arizona Sales Tax Assessments - Leases....................80
Income Tax Assessments....................................80
Note 11. Income Taxes ........................................81
Note 12. Employee Benefits Plans
Voluntary Severance Plan (VSP) .............................84
Pension and Other Postretirement Benefit Plans .............84
Defined Contribution Plans .................................86
Stock Option Plans .........................................87
Note 13. Warrants ............................................88
Note 14. Shareholder Rights Plan .............................88
Note 15. Supplemental Cash Flow Information ..................88
Note 16. Earnings Per Share (EPS) ............................90
Note 17. Quarterly Financial Data (Unaudited) ................92
Financial Statement Schedules
New Energy Ventures, Inc.
Report and Consolidated Financial Statements
December 31, 1998 and 1997..................................93
Item 9. - Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..........................113
- PART III -
Item 10. - Directors and Executive Officers of the Registrants
Directors ...................................................113
Executive Officers ..........................................113
Item 11. - Executive Compensation.............................115
Item 12. - Security Ownership of Certain Beneficial Owners and
Management
General .....................................................115
Security Ownership of Certain Beneficial Owners .............115
Security Ownership of Management ............................115
Item 13. - Certain Relationships and Related Transactions.....115
- PART IV -
Item 14. - Exhibits, Financial Statement Schedules, and
Reports on Form 8-K..........................................116
Signatures ..................................................117
Exhibit Index ...............................................121
DEFINITIONS
The abbreviations and acronyms used in the 1998 Form 10-K are
defined below:
- -------------------------------------------------------------------------------
ACC............... Arizona Corporation Commission.
AET............... Advanced Energy Technologies, Inc., a
wholly-owned subsidiary of Millennium.
Affected Utilities Electric utilities regulated by the ACC,
including TEP, Arizona Public Service,
Citizens Utilities company, and several
electric cooperatives.
APS............... Arizona Public Service Company.
BTU............... British Thermal Unit(s).
CAAA.............. Federal Clean Air Act Amendments.
Common Stock...... UniSource Energy's common stock, without
par value.
Company or UniSource Energy UniSource Energy Corporation.
Credit Agreement.. Credit Agreement between TEP and the
banks, dated as of December 30, 1997.
Emission Allowance(s) An EPA issued allowance which permits
emission of one ton of sulfur dioxide.
Such allowances can be sold.
EPA............... The Environmental Protection Agency.
FAS 71............ Statement of Financial Accounting
Standards No. 71: Accounting for the
Effects of Certain Types of Regulation.
FERC.............. Federal Energy Regulatory Commission.
First Collateral Trust Bonds Bonds issued under the First
Collateral Trust Indenture.
First Collateral Trust
Indenture The Indenture, dated as of August 1,
1998, of Tucson Electric Power Company
to Bank of Montreal Trust Company of
the City of New York, as trustee.
First Mortgage Bonds First mortgage bonds issued under the
General First Mortgage.
Four Corners...... Four Corners Generating Station.
GAAP.............. Generally Accepted Accounting
Principles.
General First Mortgage The Indenture, dated as of April 1,
1941, of Tucson Gas, Electric Light
and Power Company to The Chase National
Bank of the City of New York, as
trustee, as supplemented and amended.
General Second Mortgage The Indenture, dated as of December 1,
1992, of Tucson Electric Power Company
to Bank of Montreal Trust Company of
the City of New York, as trustee, as
supplemented.
Global Solar...... Global Solar Energy, L.L.C., a
corporation in which a 50% interest is
owned by AET.
Holding Company Act The Public Utility Holding Company Act
of 1935, as amended.
IDBs.............. Industrial development revenue or
pollution control revenue bonds.
IRS............... Internal Revenue Service.
Irvington......... Irvington Generating Station.
Irvington Lease... The leveraged lease arrangement relating
to Irvington Unit 4.
ISO............... Independent System Operator.
ITC............... Investment tax credit.
kW................ Kilowatt(s).
kWh............... Kilowatt-hour(s).
kV................ Kilovolt(s).
kVA............... Kilovoltampere(s).
LOC............... Letter of Credit.
MEH............... MEH Corporation, a wholly-owned
subsidiary of Millennium.
Millennium........ Millennium Energy Holdings, Inc., a
wholly-owned subsidiary of UniSource
Energy.
MSR............... Modesto, Santa Clara and Redding Public
Power Agency.
MW................ Megawatt(s).
MWh............... Megawatt-hour(s).
DEFINITIONS
(continued)
Nations Energy.... Nations Energy Corporation, a wholly-
owned subsidiary of Millennium.
Navajo............ Navajo Generating Station.
NEV............... New Energy Ventures, Inc., a company
in which a 50% interest is owned by
MEH.
NEV Southwest..... New Energy Ventures Southwest, L.L.C., a
wholly-owned subsidiary of NEV.
NEV Technologies.. NEV Technologies, a majority owned
subsidiary of NEV.
NOL............... Net Operating Loss carryforward for
income tax purposes.
NTUA.............. Navajo Tribal Utility Authority.
PNM............... Public Service Company of New Mexico.
Rate Settlement... TEP's Rate Settlement agreement approved
by the ACC in August 1998, which
provides retail base price decreases over
a two-year period.
Revolving Credit.. $100 million revolving credit facility
entered into under the Credit Agreement
between a syndicate of banks and TEP.
San Carlos........ San Carlos Resources Inc., a wholly-
owned subsidiary of TEP.
San Juan.......... San Juan Generating Station.
Second Mortgage Bonds TEP's second mortgage bonds issued under
the General Second Mortgage.
SES............... Southwest Energy Solutions, Inc., a
wholly-owned subsidiary of Millennium.
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 Common
Facilities Leases Leveraged lease arrangements relating
to an undivided one-half interest in
certain Springerville Common
Facilities.
Springerville Unit 1 Unit 1 of the Springerville Generating
Station.
Springerville Unit 1 Leases Leveraged lease arrangement
relating to Springerville Unit 1 and an
undivided one-half interest in certain
Springerville Common Facilities.
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.
TEP Warrants...... Warrants for the purchase of TEP Common
Stock which were issued in 1992.
UniSource Energy.. UniSource Energy Corporation.
UniSource Energy Warrants Warrants for the purchase of UniSource
Energy Common Stock which were issued
in exchange for TEP Warrants, pursuant
to an exchange offer which expired
October 23, 1998.
VSP............... Voluntary Severance Plan offered to TEP
employees and implemented in May 1996.
WSCC.............. Western Systems Coordinating Council.
PART I
This Annual Report on Form 10-K contains forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995. You
should read forward-looking statements with the cautionary statements and
important factors included in this Form 10-K. (See Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Safe Harbor for Forward-Looking Statements.) Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance and underlying assumptions. Forward-looking
statements 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, and projects. We express our
expectations, beliefs and projections in good faith and believe them to
have a reasonable basis. However, we cannot assure you that these
expectations, beliefs or projections will be achieved or realized.
ITEM 1. BUSINESS
- ----------------------------------------------------------------------------
THE COMPANY
- -----------
Overview of Consolidated Business
- ---------------------------------
UniSource Energy Corporation (UniSource Energy) is a holding company
which owns all of the outstanding common stock of Tucson Electric Power
Company (TEP) and Millennium Energy Holdings, Inc. (Millennium). UniSource
Energy was incorporated in the State of Arizona on March 8, 1995 and
obtained approval to form a holding company in November 1997. On January
1, 1998, TEP and UniSource Energy completed a transaction by which all
outstanding shares of TEP common stock were exchanged, on a share-for-share
basis, for shares of UniSource Energy common stock. Following the share
exchange, TEP transferred the stock of its subsidiary, MEH Corporation, to
UniSource Energy in exchange for a $95 million promissory note. (See Note
1 of Notes to Consolidated Financial Statements). MEH Corporation
subsequently changed its name to Millennium Energy Holdings, Inc. on
November 20, 1998.
We conduct our business in two primary business segments--the
Regulated Electric Utility Segment (TEP), and our Unregulated Energy
Businesses Segment comprised of the subsidiaries owned by Millennium.
Overview of Regulated Electric Utility
- --------------------------------------
TEP was incorporated in the State of Arizona on December 16,1963.
TEP is the successor by merger as of February 20, 1964, to a Colorado
corporation which was incorporated on January 25, 1902. It is an
operating public utility which generates, purchases, transmits,
distributes and sells electricity to over 320,000 retail customers and
to wholesale customers. TEP's retail service territory consists of a
1,155 square mile area of Southeastern Arizona with a population of
approximately 800,000 in the greater Tucson metropolitan area in Pima
County, as well as parts of Cochise County. TEP holds a franchise to
provide electric service to customers in the City of Tucson. This
franchise expires in 2001.
TEP owns all of the outstanding stock of San Carlos Resources Inc.
(San Carlos), which owns Springerville Unit 2.
We describe our regulated electric utility business further in the
Regulated Electric Utility Operations and Utility Operating Statistics
sections.
Overview of Unregulated Energy Businesses
- -----------------------------------------
Millennium owns 100% of the common stock of four subsidiaries.
We established these subsidiaries to pursue various unregulated
energy-related investment opportunities:
(i) Nations Energy Corporation (Nations Energy) develops
independent power projects.
(ii) MEH Corporation (MEH) holds a 50% interest in New
Energy Ventures, Inc. (NEV). NEV purchases
electricity on behalf of, and provides electric load
aggregation, energy management and advisory services
to, retail purchasers of electric energy.
(iii) Advanced Energy Technologies, Inc. (AET) holds a
50% interest in Global Solar Energy, L.L.C. (Global
Solar), a manufacturer of thin-film photovoltaic
cells.
(iv) Southwest Energy Solutions, Inc. (SES) provides
energy support services to electric consumers.
We describe our Unregulated Energy Businesses in more detail in
the Unregulated Energy Businesses section.
Competition and Response to Regulatory Change
- ---------------------------------------------
The electric utility industry is facing significant regulatory
change designed to encourage competition in the sale of certain electric
services. We continually evaluate our position to develop strategies to
remain competitive in this changing environment. In November 1998, TEP
realigned its regulated utility business into three separate business
units: generation, transmission and distribution, and in January 1999,
we formed a business unit which provides administrative services to the
utility business units. We may pursue other strategies in the future
which include one or more of the following:
-- creation of separate affiliates for our generation,
transmission and distribution businesses,
-- sale of generation assets,
-- acquisition of transmission assets,
-- growth of revenues from unregulated energy businesses, and
-- investments by unaffiliated parties in, or sales of portions
of, our unregulated energy businesses.
We cannot predict whether any transactions of the types described
above may actually occur, nor can we predict what their effect on our
financial condition or competitive position might be. We discuss
competition in our regulated electric utility business in more detail
in Rates and Regulatory Matters and in Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations, Competition.
REGULATED ELECTRIC UTILITY OPERATIONS
- -------------------------------------
PEAK DEMAND
Peak Demand 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
- MW -
Retail Customers-Net One Hour 1,786 1,659 1,619 1,617 1,585
Firm Sales to Other Utilities 179 177 177 223 226
----- ----- ----- ----- -----
Non-Coincident Peak Demand (A) 1,965 1,836 1,796 1,840 1,811
Total Generating Resources 1,896 1,992 1,952 1,952 1,952
Other Resources 235 235 133 133 23
----- ----- ----- ----- -----
Total TEP Resources (B) 2,131 2,227 2,085 2,085 1,975
Total Reserves (B) - (A) 166 391 289 245 164
Reserve Margin (% of Non-Coincident
Peak Demand) 8% 21% 16% 13% 9%
- ----------------------------------------------------------------------------
The peak demand for TEP's retail service area occurs during the summer
months due to the cooling requirements of our retail customers. TEP's peak
demand has grown at an average annual rate of about 3.3% during the past five
years. The peak demand for firm sales to other utilities generally does not
coincide with TEP's retail peak demand.
The chart above shows the relationship over a five-year period between
TEP's peak demand and its energy resources. In addition to TEP's generating
resources, total resources include firm capacity purchases and interruptible
retail load. TEP's reserves are the difference between energy resources and
peak demand, and the reserve margin is the ratio of reserves to peak demand.
TEP seeks to maintain a planning reserve margin in accordance with guidelines
set by the WSCC equal to its largest single hazard plus 5% of its non-
coincident peak demand. For 1998, this targeted reserve margin equaled 310
MW or 16% of non-coincident peak demand. TEP's actual reserve margin in 1998
was 8%, compared with 21% in 1997. The lower actual reserve margin in 1998
resulted from a combination of retail load growth and the expiration of a
lease on 96 MW of combustion turbines. TEP purchased additional firm energy
as needed to ensure it had adequate operating reserve margins throughout the
year in accordance with the operating requirements of the Southwest Reserve
Sharing Group.
TEP expects to meet near-term demand growth with existing resources,
purchases, and additional resources as discussed in Future Generating
Resources below. See TEP Generating Resources and Rates and Regulation, ACC
Rules on Retail Competition about the impact of retail competition on our
need for new resources.
CUSTOMERS
The average number of TEP's retail customers increased by 2.2% in 1998
to 320,744. TEP expects the number of its retail distribution customers, and
the amount of energy consumed by those customers, each to grow at an average
annual rate of approximately 2.0% through 2003. Retail peak demand in TEP's
service territory is expected to grow by about 2.5% annually over the same
period. TEP expects energy consumed by its residential, commercial, non-
mining industrial and mining customers to comprise 35%, 17%, 28% and 16%,
respectively, of total energy consumption during that period.
TEP uses population and demographic studies conducted by unrelated
parties to forecast the growth in the number of customers, peak demand, and
retail sales. TEP also uses assumptions about the weather, the economy, and
competitive conditions. The forecasts do not take into account the source or
price of energy.
Certain of TEP's retail customers will be eligible to choose alternative
energy providers when retail competition takes effect in Arizona. See ACC
Rules on Retail Competition for a discussion of these customers and the
proposed competition phase-in period. Even if a portion of TEP's retail
customers choose other energy suppliers, the forecasted growth rates in the
number of customers referred to above would continue to apply to TEP's
distribution business.
Sales to Large Industrial Customers
TEP provides electric utility service to a diversified group of
commercial, industrial, and public sector customers. Major industries served
include copper mining, defense, health care, education and governmental
entities. TEP's two largest retail customers are in the copper mining
industry. In 1998, sales to these customers totaled about 16% of TEP's total
retail energy sales, and their contract demands totaled approximately 11% of
the 1998 retail peak demand. Revenues from sales to mining customers
accounted for approximately 8% of TEP's retail revenues in 1998 and 9% in
1997 and 1996. Sales to mining customers are expected to grow at an annual
rate of about 0.7% over the next five years. Sales to mining customers
depend on a variety of factors including changes in supply and demand factors
in the world copper market and the economics of self-generation. During
1998, market prices for copper were at eleven-year lows, causing our mining
customers to reduce workforces and/or redesign work processes to reduce load.
Should copper prices continue at these levels, TEP may experience lower sales
to and lower revenues from mining customers.
TEP has contracts with its two principal mining customers to provide
them electric power at special rates. The special rates are designed to
induce the mines to continue to purchase electricity from TEP rather than
from other sources. These contracts expire between 2001 and 2003. However,
the contracts include provisions allowing the mines to cancel some or all of
their contract under certain circumstances, provided that they notify TEP at
least one, and up to two years, prior to such termination, and in some cases,
pay termination fees to TEP. To date, TEP has not received any termination
notices. Whether these contracts are extended or terminated will depend, in
part, on market conditions and available alternatives.
SALES FOR RESALE
TEP's electric utility operations include the wholesale marketing of
electricity to other utilities and power marketers. These transactions,
termed sales for resale, are made on both a firm basis and an interruptible
basis. A firm basis means that contractually, TEP must supply the power
(except under limited emergency circumstances), while an interruptible basis
means that TEP may stop supplying power under various circumstances. See
Other Purchases and Interconnections.
TEP's sales for resale consist primarily of three types of sales, which
are listed below, along with the percentage contribution to total sales for
resale in 1998:
-- sales of firm capacity under long-term contracts (31%);
-- forward contracts to sell energy for periods of up to one year (34%),
and
-- sales of excess generation in the hourly markets (31%).
KWh sales for resale increased by 31% in 1998 while revenues from these sales
grew by 47%. This increase in both sales and revenues was mainly due to
increased trading activity in the forward markets. See Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Market Risks, for a discussion of TEP's energy trading activities.
TEP currently has long-term contracts to sell firm capacity as follows:
Minimum
Contract
Company Demand MW Contract Term
- ------- --------- --------------
Salt River Project 100 June 1, 1991 - May 31, 2011
NTUA (Phase I) (1) 60 July 1, 1997 - May 31, 1999
NTUA (Phase II) (1) 40/50 June 1, 1999 - December 31, 2009
City of Farmington (2) 25 November 1, 1997- February 29, 2000
- --------------
(1) Phase I provides for a minimum demand of 60 MW during the contract
period. During Phase II, TEP will provide 40 MW of firm power in the
summer months (May - September) and 50 MW of firm power in the winter
months (October - April).
(2) The City of Farmington, New Mexico will purchase up to 25 MW of
firm power from November to February.
TEP cannot predict whether the contracts described above will be
replaced or extended in the future.
We expect strong competition to sell capacity and energy to continue
during the next few years due to:
-- surplus generating capacity in the Southwestern United
States;
-- restructuring of the electric utility industry in
California and other western states;
-- an active spot market in the Western United States.
See Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation, Competition, Wholesale.
GENERATING AND OTHER RESOURCES
------------------------------
TEP GENERATING RESOURCES
At December 31, 1998, TEP owned or leased 1,896 MW of net generating
capability as set forth in the following table:
Net Oper- TEP's Share
Unit Owned/ Capabil- ating ---------
Generating Source No. Location Fuel Type Leased ity MW Agent % MW
- ----------------- --- -------- --------- ------ -------- ------ -- --
Springerville Station 1 Springerville, AZ Coal Leased 380 TEP 100.0 380
Springerville Station 2 Springerville, AZ Coal Owned 380 TEP 100.0 380
San Juan Station 1 Farmington, NM Coal Owned 316 PNM 50.0 158
San Juan Station 2 Farmington, NM Coal Owned 312 PNM 50.0 156
Navajo Station 1 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 2 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 3 Page, AZ Coal Owned 750 SRP 7.5 56
Four Corners Station 4 Farmington, NM Coal Owned 784 APS 7.0 55
Four Corners Station 5 Farmington, NM Coal Owned 784 APS 7.0 55
Irvington Station 1 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
Irvington Station 2 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
Irvington Station 3 Tucson, AZ Gas/Oil Owned 104 TEP 100.0 104
Irvington Station 4 Tucson, AZ Coal/Gas Leased 156 TEP 100.0 156
Internal Combustion
Turbines Tucson, AZ Gas/Oil Owned 122 TEP 100.0 122
----
Total Company Capacity (1) 1,896
- ----------------------------------- =====
(1)Excludes 235 MW of additional resources, which consists of certain
capacity purchases and interruptible retail load. At December 31, 1998,
total owned capacity was 1,360 MW and leased capacity was 536 MW.
TEP is the operator of the Springerville and Irvington Generating
Stations, which are wholly-owned or leased by TEP. TEP has ownership
interests in the San Juan, Navajo and Four Corners Generating Stations,
which are operated by others. We provide additional information below on
those units operated by TEP, including details on the capital lease
obligations for Springerville Unit 1, Springerville Common Facilities,
and Irvington Unit 4.
Springerville Station
The Springerville Station, located in northeast Arizona, consists of
two coal-fired units. Springerville Unit 1 began commercial operation in
1985 and is leased and operated by TEP. Springerville Unit 2 started
commercial operation in June 1990 and is owned by San Carlos and operated
by TEP. These units may be operated for up to eight hours at a net
capacity of 400 MW each.
The initial terms of the Springerville Unit 1 Leases, which includes
a 50% interest in the Springerville Common Facilities, expire on January 1,
2015. At the end of the initial terms, TEP may exercise fair market value
purchase and renewal options. At December 31, 1998, the capitalized lease
asset related to Springerville Unit 1, net of allowance and accumulated
amortization, was $234 million, or $616 per kW based on the current 380 MW
capacity rating.
The annual cash cost of lease payments for the Springerville Unit 1
Leases will range from $33 million to $176 million, averaging approximately
$80 million. In 1998, the cash cost attributable to rent obligations and
other operations and maintenance expenses was $75 million, or an average of
$16 per kW per month based on a 380 MW capacity rating. The average cash
cost is estimated to be about $99 million per year or $22 per kW per month
for the period from January 1999 through December 2003. The average cash
cost will increase in periods after 2003. Due to timing differences between
cash and accrued expenses, TEP's cash cost of Springerville Unit 1 capacity
attributable to rent obligations and other operation and maintenance
expenses will differ from the amounts accrued in TEP's financial statements.
The expenses accrued in TEP's financial statements during 1998
were $92 million or an average of $20 per kW per month, before amortization
of the regulatory allowance and related interest expense. The estimated
expense is expected to average $98 million per year or $21 per kW per month
for the period from January 1999 through December 2003 and is expected to
increase slightly thereafter. See Springerville Unit 1 Allowance in Note 1
of Notes to Consolidated Financial Statements for additional information on
accounting for Springerville Unit 1.
In December 1985, TEP sold and leased back a 50% interest in the
Springerville Common Facilities. The initial lease term for the
Springerville Common Facilities Leases expires in 2017 for one owner
participant and 2021 for the other two owner participants, subject
to optional fair market value renewal and purchase options. The sales price
of these facilities was $132 million. At December 31, 1998, the capitalized
lease asset related to this interest in the Springerville Common Facilities,
net of accumulated amortization, was $117 million. Annual lease payments
under these leases vary with changes in the interest rate on the underlying
debt. These lease payments totaled about $12 million per year in 1998,
1997 and 1996. TEP plans to cause the underlying debt on these leases to be
refinanced in 1999 (see Investing and Financing Activities). Based on an
assumed interest rate of 8%, average annual lease payments would total
approximately $12 million.
Including one-half of the cost of the Springerville Common Facilities
(but excluding the cost of coal-handling facilities at Springerville which
were included in recoverable fuel costs), the total initial cost of
Springerville Unit 2 was $838 million, or $2,328 per kW based on the
previous 360 MW capacity rating. In a 1991 rate order, the ACC disallowed
recovery from retail customers of $175 million of the book value of
Springerville Unit 2. TEP recorded a loss for such disallowance in 1991.
The net recoverable cost, including the leased common facilities, is $663
million or $1,842 per kW based on the previous 360 MW capacity rating (or
$1,745 per kW based on the current 380 MW capacity rating).
See Fuel Supply, Springerville Coal Handling Facilities, for
information regarding the Springerville Coal Handling Facilities Leases.
Irvington Station
Irvington is a four-unit generating station located in Tucson,
AZ. Units 1, 2, and 3 are gas or oil burning units. In January 1988, TEP
began coal-fired commercial operation of Irvington Unit 4. The unit was
sold at its cost of $152 million and leased back under the Irvington Lease.
At December 31, 1998, the capitalized lease asset for Irvington Unit 4, net
of accumulated amortization, was $106 million. Annual lease payments range
from approximately $11 million to $14 million and average about $13 million.
The initial lease term expires in 2011, but the lease has optional fair
market value renewal and purchase option provisions.
Irvington Unit 4 (156 MW capability) has the flexibility to operate on
coal or gas. Coal has been the primary fuel and natural gas the secondary
fuel.
POWER EXCHANGE AGREEMENT
As part of a 1992 litigation settlement, TEP and Southern California
Edison (SCE) agreed to a ten-year power exchange agreement. The agreement
began in May 1995 and requires SCE to provide firm system capacity of
110 MW to TEP during summer months. TEP pays an annual charge of
approximately $1 million, increasing annually after the year 2000, to a
maximum of approximately $2 million annually for this agreement. TEP is
entitled to schedule firm energy deliveries from SCE during the summer (May
15 to September 15) of up to 36,300 MWh per month, and is obligated to
return to SCE on an interruptible basis the same amount of energy the
following winter season (November 1 to February 28). The energy provided
under the exchange is expensed based on the estimated cost of interruptible
energy to be provided to SCE. Under this exchange agreement, TEP received
100,735 MWh from SCE in 1998, and returned 39,082 MWh to SCE as of December
31, 1998.
OTHER PURCHASES AND INTERCONNECTIONS
TEP participates in a number of interchange agreements by which it can
purchase additional electric energy from other utilities. The amount of
energy purchased from other utilities and power marketers varies
substantially from time to time depending on demand for energy, cost of
purchased energy compared with TEP's cost of generating energy, and the
availability of such energy. TEP may also sell its surplus electric energy
through these agreements. See also Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations, Market Risks.
TEP has transmission access and power transaction arrangements
with over 180 electric systems or suppliers, including the California Power
Exchange. TEP is a member of the following organizations:
-- Southwest Reserve Sharing Group - A group of utilities serving
customers in portions of the southwestern United States. The group
provides emergency assistance and reserve sharing among members to
enhance system reliability in the Southwest region.
-- Western Systems Coordinating Council (WSCC) - A group of western
electric systems and suppliers working cooperatively to assure the
reliability of the region's interconnected generation and
transmission systems.
-- Western Systems Power Pool - A voluntary power pooling
arrangement designed to achieve more efficient use of electric
generation and transmission facilities among its members.
See Rates and Regulation, FERC Orders on Wholesale Transmission
Access for a discussion of possible changes in transmission issues.
FUTURE GENERATING RESOURCES
In the past, TEP assessed its need for future generating resources
based on the premise of a continued regulatory requirement to serve
customers in TEP's retail service area. However, the obligation to serve
all customers will likely be modified by the ACC's rules on retail
competition. Further, the need for future resources will be affected by
these rules and TEP's ability to retain and attract customers. Under the
Retail Competition Rules as adopted, some of TEP's retail customers will be
eligible to choose alternative energy providers when retail competition is
introduced. For those customers who do not or cannot choose other energy
providers, TEP remains obligated to provide energy. However, this energy
is not required to come from TEP-owned generating assets. See Rates and
Regulation, ACC Rules on Retail Competition below and Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Competition.
Regardless of who supplies electric power in TEP's retail service area,
TEP has identified the need for additional peaking resources in 2001, which
must be located in the Tucson service area to reliably serve the needs of
the area. Therefore, in the first quarter of 1999, TEP issued a request
for proposals to provide 75 MW of peaking resources to be located in TEP's
service territory. The request for proposals contemplates purchasing
peaking capacity on an as needed basis through a Must-Run Generation
contract. Must-run generating units are those which are required to run in
order to maintain distribution system reliability and meet load
requirements.
RATES AND REGULATION
- --------------------
GENERAL
TEP is regulated by the FERC and by the ACC. The FERC regulates the
terms and prices of TEP's sales to other utilities. The ACC has authority
over rates charged to retail customers, accounting classifications, and the
issuance of securities. The ACC also has authority to approve affiliate
transactions and establish holding companies and subsidiaries under its
Affiliated Interest Rules.
The ACC consists of three commissioners, each serving a six-year term.
One of the three is elected at each general election. Commissioners cannot
serve consecutive terms and can be elected to another term only after the
passing of six years after the end of their previous term as commissioners.
The present commissioners are:
-- Jim Irvin (Republican), Chairman, started his first term in
1997. His term expires in 2003.
-- Carl J. Kunasek (Republican), began his first term in 1995.
His term expires in 2001.
-- Tony West (Republican), started his first term in 1999. His
term expires in 2005.
The ACC determines TEP's rates for retail sales of electric energy on
a "cost of service" basis, which is designed to provide, after recovery of
allowable operating expenses, an opportunity to earn a reasonable rate of
return on "fair value rate base". Fair value rate base is generally
determined by reference to the original cost and the reproduction cost (in
each case, net of depreciation) of utility plant in service to the extent
deemed used and useful, and to various adjustments for deferred taxes and
other items, plus a working capital component. Over time, rate base is
increased by additions to utility plant in service and reduced by
depreciation and retirements of utility plant.
When retail electric competition takes effect, the ACC will require
unbundling of charges, with separate rates for all services, such as
generation, transmission, distribution, metering, meter reading, billing
and collection, and ancillary services. At that time, some of these charges
will be priced at market rates instead of cost of service levels. See
ACC Rules on Retail Competition below.
The FERC regulates TEP's rates for wholesale power sales and
transmission services. In general, these rates may not exceed rates
determined on a cost of service basis. In the fall of 1997, TEP was
granted a tariff to sell at market based rates. The FERC has historically
set rates in formal rate application proceedings. With respect to new
wholesale power sales, TEP's wholesale rates are generally substantially
below rates determined on a fully allocated cost of service basis, but, in
all instances, rates exceed the level necessary to recover fuel and other
variable costs.
ACC HOLDING COMPANY ORDER
In November 1997, the ACC allowed TEP to form a holding company. On
January 1, 1998, TEP and UniSource Energy completed a transaction by which
all outstanding shares of TEP common stock were exchanged, on a share-for-
share basis, for shares of UniSource Energy common stock. As a result of
the transaction, TEP became a wholly-owned subsidiary of UniSource Energy.
The ACC order approving the holding company contained a number
of conditions which impact the activities of UniSource Energy, TEP, and
TEP's sister companies (i.e., other companies owned by UniSource Energy or
its affiliates). These include:
-- UniSource Energy and its subsidiaries will only conduct
business activities that are part of the electric energy business
(as defined in the order).
-- During its first five years of operations, UniSource Energy
must provide to TEP: (i) 60% of the proceeds of any public equity
issuance by UniSource Energy; and (ii) 2% of the net after-tax
profits attributable to its equity interest in TEP's sister
companies. TEP will use the proceeds to reduce debt or add to
its equity accounts.
-- 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).
-- TEP will target a 37.5% equity ratio (excluding capital lease
obligations) in its capitalization structure for regulatory
purposes by December 31, 2000. If TEP does not attain that goal,
the ACC may set rates based on TEP's actual capital structure for
regulatory purposes rather than the hypothetical 37.5% equity
ratio currently reflected in rates.
-- The capitalization (debt and equity) of TEP's sister
companies may not exceed 30% of TEP's capitalization unless
otherwise approved by the ACC.
1996 RATE ORDER
In March 1996, the ACC approved a rate increase for TEP of 1.1%
(approximately $6.4 million annually). The 1996 Rate Order recognized all
of Springerville Unit 2 as used and useful for ratemaking purposes. This
allowed TEP to recover the operating and capital costs associated with that
portion of the generating unit not previously included in rates. See Notes
2 and 3 of the Notes to Consolidated Financial Statements, Deferred
Springerville Generation Costs, and Rate Matters. Under the 1996 Rate
Order, TEP cannot seek a base rate increase before January 1, 2000, except
under limited circumstances.
The rates approved in the 1996 Rate Order are based on a rate
of return of 6.59% on a fair value rate base of approximately $1.36 billion,
or 7.72% on an original cost rate base of approximately $1.16 billion. The
capital structure adopted by the ACC for ratemaking purposes assumes 62.5%
debt and 37.5% equity. Consistent with previous ACC rate orders, TEP's
leasehold interest in utility plant was reflected in rates through an
allowance for rental expense, and was therefore not included in rate base.
RATE SETTLEMENT AGREEMENT
On August 25, 1998, the ACC approved a rate settlement
agreement (Rate Settlement) which gives TEP's retail customers the
following base price decreases:
-- an initial 1.1% decrease (about $7.0 million) which was
effective July 1, 1998;
-- a second decrease of 1.0% (about $5.5 million) on July 1,
1999; and
-- an additional 1.0% decrease (about $5.5 million) on July 1,
2000.
The latter two decreases will apply to all tariffed retail customers
prior to the start of competition and to all Standard Offer Electric
Service customers who do not have, or do not choose, access to
competing electric service providers during the proposed two-year
phase-in of the ACC's Electric Competition Rules. The Rate
Settlement meets the requirement in the ACC's Electric Competition
Rules for a 3-5% rate reduction. TEP cannot predict when these
rules will take effect. See Competition, Retail.
The Rate Settlement resolved TEP's application for a price
decrease in its Shared Savings Proposal filed with the ACC on July 9, 1997.
This settlement also allows TEP to mitigate certain potentially stranded
costs by decreasing the recovery period for Retail Excess Capacity
Deferrals. See Note 3 of Notes to the Consolidated Financial Statements,
Rate Matters.
The Rate Settlement also affirmed an interim accounting order
issued by the ACC in July 1997. That order authorized TEP to record
a $50 million coal contract termination fee as a deferred regulatory
asset and to amortize that asset by $4 million per year over
approximately 13 years. At December 31, 1998, $44 million of this
regulatory asset remained unamortized. TEP incurred this fee when it
terminated a coal supply contract for the Springerville Generating Station
and negotiated a new coal contract which reduced TEP's annual fuel bill
initially by approximately $10 million.
ACC RULES ON RETAIL COMPETITION
In December 1996, the ACC adopted rules that provided a framework
for the phase-in of retail electric competition in Arizona beginning in
January 1999. The rules, as well as other ACC orders, contain references
to the Affected Utilities. These are the utilities, including TEP, which
are regulated by the ACC. These rules were amended and adopted on an
emergency basis in August 1998. In January 1999, the ACC delayed the
implementation of the rules pending additional proceedings to resolve a
number of important issues.
The rules, as adopted, assumed a competition start date of
January 1, 1999. We cannot predict the actual date that competition
will begin in Arizona, or the final form of the rules. The key
provisions of the rules, as amended, include the following:
-- Each Affected Utility shall make available at least 20% of its
1995 system retail peak demand for competitive generation supply
on a first-come, first-served basis, as follows:
-- All Affected Utility customers with non-coincident peak
demand load of 1 MW or greater will be eligible for
competitive electric services when competition starts.
-- Groups of Affected Utility customers with individual non-
coincident peak load demands of 40 kW or greater aggregated
into a combined load of 1 MW or greater will also be eligible
for competitive service when competition starts.
-- Each Affected Utility shall also offer a residential
phase-in program when competition starts. A minimum of 1 1/4%
of residential customers per quarter, calculated beginning
January 1, 1999, will be eligible to participate. All retail
customers shall be entitled to obtain competitive electric
services no later than January 1, 2001.
TEP currently serves about 80 customers who qualify under the 1 MW
or greater category described above, representing 351 MW of load.
Of this load, 60% is under contract through 2001.
-- Each Affected Utility shall make available to all customers in
its service territory Standard Offer bundled generation,
transmission, ancillary, distribution and other necessary services
at regulated rates. After January 1, 2001, Standard Offer service
shall be provided by the Affected Utilities, which will be known
as Utility Distribution Companies (UDCs), who shall also act as
energy providers of last resort.
-- Each Affected Utility shall file a report detailing possible
mechanisms to provide benefits, such as rate reductions of 3% -
5%, to all Standard Offer customers. TEP met this requirement in
August 1998 when it reached a Rate Settlement Agreement with the
ACC. See Rates and Regulation, Rate Settlement Agreement.
-- The Affected Utilities shall provide non-discriminatory open
access to transmission and distribution facilities to serve all
customers. The ACC supports the development of an Independent
System Operator (ISO) or, absent an ISO, an Independent Scheduling
Administrator (ISA).
-- All competitive generation assets and services shall be
separated from an Affected Utility prior to January 1, 2001. Such
separation shall either be to an unaffiliated party or to a
separate corporate affiliate or affiliates. If an Affected
Utility chooses to transfer its competitive generation assets or
competitive services to a competitive electric affiliate, such
transfer shall be at a value determined by the ACC to be fair and
reasonable.
-- The ACC shall allow the Affected Utilities a reasonable
opportunity for recovery of unmitigated stranded costs. See
ACC Orders on Stranded Cost Recovery below for a discussion of a
subsequent ACC order and TEP's filing on this topic.
On February 5, 1999, the ACC Hearing Officer issued a Proposed
Opinion and Order recommending changes to the Rules. These
recommendations include:
-- The date to open an Affected Utility's service territory to
competition would be set upon the resolution its of Stranded Costs
and Unbundled Tariffs by final ACC order.
-- If an Affected Utility's service territory is open prior to
January 1, 2001, the existing phase-in schedule is retained,
calling for 20 percent of the market to initially have access to
competitive generation supply. As part of the 20 percent, each
Affected Utility is to reserve an increasing percentage for
residential customers according to a set schedule.
-- Competitive Energy Service Provider affiliates of Affected
Utilities may not enter another Affected Utility's service
territory until its own territory is open to competition.
-- The requirement for energy generated from solar sources was
eliminated, citing it as prohibitively expensive and potentially
hindering competition in Arizona.
-- Affected Utilities will have an opportunity to amend their
tariffs for unbundled noncompetitive services with the ACC.
TEP filed exceptions to the Proposed Order on February 17, 1999.
No meeting date has yet been set to consider this Proposed Order. If the
Proposed Order amending the Rules is adopted, it will be forwarded to the
Secretary of State to start the amendment process. The Arizona
Administrative Procedures Act requires that the Rules be filed with the
Secretary of State before they can be amended. We anticipate that the
stay of the Rules would probably remain in effect until amendments are
adopted.
Appeal of ACC Order
In February 1997, TEP filed in the Arizona Superior Court an appeal of
the ACC order adopting the rules. TEP filed a motion for summary judgment,
claiming, among other things that the Competition Rules: (a) violated the
Regulatory Compact between TEP and the State of Arizona; (b) confiscated
TEP's property; and (c) violated due process. The Court did not grant
summary judgment but ruled that the ACC must hold hearings before it can
modify TEP's Certificate of Convenience and Necessity (CC&N). No trial
date has been set in the case and no final order has been issued. We
are unable to predict the outcome of the appeal.
ACC ORDERS ON STRANDED COST RECOVERY
June 1998 Order
On June 22, 1998, the ACC adopted an order outlining its policy
for stranded cost recovery by Arizona utilities in a competitive energy
market. The order required Affected Utilities to choose from one of two
methods for stranded cost recovery by August 21, 1998. Stranded costs
represent costs recoverable by a utility in a regulated market that would
not likely be recovered through the prices charged for electricity and
other services in a competitive market. The two options were:
(1) Divestiture/Auction Methodology
-- This method would require the sale of all electric
generation assets through auction by January 1, 2001.
-- Stranded costs would be calculated as the difference
between book value of generation assets (including related
regulatory assets) and the proceeds of the sale.
-- 100% of stranded costs, including a return on the
unamortized balance, would be recovered over a ten-year
period.
-- The ACC would work with the Affected Utility to provide
sufficient assurances in order to avoid triggering write-offs
related to the application of FAS 71.
-- All customers of Affected Utilities would pay for the
stranded costs.
(2) Transition Revenues Methodology
-- The ACC would determine the revenues necessary to maintain
financial integrity (such as avoiding default under currently
existing financial instruments).
-- Affected Utilities would recover the determined amount of
stranded costs for a period of ten years.
The order encouraged, but did not require, full divestiture of
generating assets through an auction to unaffiliated third parties.
The order stated that only those Affected Utilities choosing
divestiture through the Divestiture/Auction Methodology would have
the opportunity to recover 100% of unmitigated stranded costs. The
order also specified that some form of rate cap would be in place
for customers on Standard Offer electric service during the
transition period.
TEP's Stranded Cost Recovery Plan
Pursuant to the June 1998 Order, TEP filed a proposed plan for
divestiture of generating assets and stranded cost recovery with the
ACC on August 21, 1998. For a description of TEP's generation
properties, see TEP Generating Resources. The net book value of TEP's
generating plant assets (including assets held under capitalized leases)
was approximately $1.3 billion at December 31, 1998. TEP estimated its
stranded costs may range from $600 million to $1.1 billion. TEP proposed
to recover stranded costs and a return on any unamortized balance over
a ten-year period ending December 31, 2008.
Some of TEP's generating assets are held under lease. These
leases are terminable or assignable only under limited circumstances.
If TEP were to divest its generating assets, it would seek to negotiate
the termination of such leases. TEP expects that substantial cash payments
to lease participants would be required in connection with any such
terminations. To divest both owned and leased assets, TEP also believes
it would have to make cash payments to various creditors and other parties.
In addition, TEP has financed a substantial portion of the generating
assets through tax-exempt bonds. Some of these bonds may need to be
redeemed as a result of a divestiture. See Item 7. Management's
Discussion and Analysis of Financial Condition and Operating Results,
Investing and Financing Activities, Tax-Exempt Local Furnishing Bonds.
TEP expects that cash payments required to divest leased assets and
to redeem tax-exempt bonds would exceed the proceeds of the sale of owned
assets. Under its plan, as filed, TEP requested approval to finance the
cash requirements described above through a securitization of a competitive
transition charge (CTC).
ACC Staff Stranded Cost Recovery Agreement
On November 4, 1998, TEP reached a settlement agreement with
the ACC Staff related to TEP's plan to divest generation assets and
for 100% recovery of stranded costs. In addition to supporting
TEP's proposed plan, the agreement also supported an exchange of
TEP's interests in the Navajo and Four Corners Generating Stations
for certain high voltage transmission assets currently owned by APS.
However, because the ACC did not approve the settlement agreement by
November 25, 1998, the agreement is considered withdrawn by TEP and
the ACC Staff.
ACC Hearing Officer Proposed Order on Stranded Costs
On February 5, 1999, the ACC Hearing Officer issued a Proposed
Opinion and Order (Proposed Order) which, if adopted by the ACC,
would modify the June 1998 order so that, among other things,
divestiture is not required for 100% stranded cost recovery. The
recommended order, which was revised on March 12, 1999, allows each
Affected Utility to choose from the following options:
(1) Net Revenues Lost Methodology -- Stranded costs would be
determined by comparing generation revenues with competition
versus revenues without competition. Stranded costs would be
separated between regulatory and generation assets. Generation
related stranded costs would be recovered over a five-year period
as follows: (i) customers who continue to receive standard offer
bundled service would pay 100% of their proportionate share of
stranded costs, and (ii) customers electing to purchase energy
from competitors would pay a CTC on a declining percentage basis,
paying 100% of their proportionate share of stranded costs in year
one, 80% in year two, and decreasing 20% each year. Pre-existing
regulatory assets would be recovered 100% from all customers. Any
return on unamortized regulatory assets would be reduced by 20%
per year over five years following the initial five-year period.
(2) Divestiture/Auction Methodology -- Stranded costs would be
the difference between the market value from sale of non-essential
generation assets and their book value. Each generation asset
would include its portion of appropriate regulatory assets. The
Affected Utility would be permitted to recover 100% of stranded
costs over a ten-year period, with no return on the unamortized
balance. All customers would be charged either through the
standard offer rate or through a CTC.
(3) Financial Integrity Methodology -- The Affected Utility would
recover costs sufficient to maintain financial viability, that is,
have revenues sufficient to meet minimum financial ratios (similar
to the previous Transition Revenues Methodology). All customers
would pay their share over a ten-year period either through the
standard offer rate or through a CTC.
(4) Settlement Methodology -- Some combination of Options 1, 2,
and/or 3, submitted as a settlement option.
(5) Alternative Methodology -- A combination approach, found by the
ACC to be in the best interest of all stakeholders.
Under the Proposed Order, Affected Utilities will have an
opportunity to amend their previously filed stranded cost implementation
plans. TEP filed exceptions to the Proposed Order on February 17, 1999.
No meeting date has yet been set to consider this Proposed Order. If
the Proposed Order is approved, thereby amending the June 1998 stranded
cost order, TEP may amend its August 1998 stranded cost recovery proposal.
TEP intends to continue to seek 100% recovery of its stranded costs.
STATE AND FEDERAL LEGISLATION ON RETAIL COMPETITION
In May 1998 the Arizona State Legislature approved and the
Governor signed a bill regarding retail electric competition. The
legislation requires the introduction of customer choice to 20% of
each public power entity's retail load by December 31, 1998, with
100% customer choice by December 31, 2000. Although this legislation
relates directly only to public power entities such as SRP, the bill
encourages broader application of the legislation's principles by the
ACC to the state's investor-owned utilities, including TEP, and to
cooperatives.
Additionally, federal legislators introduced several retail
competition initiatives in Congress which, if passed, could modify
or override the actions taken by the ACC or the Arizona Legislature.
We are unable to predict when Congress will act or the ultimate
impact of such federal legislative initiatives.
WHOLESALE TRANSMISSION ACCESS
In April 1996, the FERC issued two orders pertaining to wholesale
transmission access. FERC Order No. 888 requires all public utilities
that own, control, or operate interstate transmission facilities to offer
transmission service to others under a single tariff. This tariff must
incorporate certain minimum terms and conditions of transmission service
established by the FERC and must also be used by public utilities for
their own wholesale market transactions. Transmission and generation
services for new wholesale service are to be unbundled and priced
separately. FERC Order No. 889 requires transmission service providers
to establish or participate in an Open Access Same-time Information System
(OASIS) that provides information on the availability of transmission
capacity to wholesale market participants. The order also establishes
standards of conduct to prevent employees of a public utility engaged in
marketing functions from obtaining preferential access to OASIS-related
information or from engaging in discriminatory business practices.
TEP is in compliance with the requirements of FERC Orders 888 and 889.
TEP, along with other transmission owners and users located in
the southwestern United States, is investigating the feasibility of
forming an ISO for the region. An ISO would be responsible for
ensuring transmission reliability and nondiscriminatory access to
the regional transmission grid. Over 50 participants have signed a
Development Agreement. The formation of an ISO would be subject to
approval by the FERC and state regulatory authorities in the region.
The financial aspects of forming an ISO, including the potential
effects on TEP's future results of operations, will be examined as
part of the developmental work.
The ACC Retail Electric Competition Rules require the formation
and implementation of an Arizona Independent Scheduling Administrator
Association (AISA). The purpose of the AISA is to:
-- calculate available transmission capacity for Arizona
transmission facilities that belong to the Affected
Utilities or other participants;
-- develop and operate an OASIS which covers all participants'
transmission systems;
-- implement and oversee the nondiscriminatory application of
protocols to ensure statewide consistency for transmission
access; and
-- provide dispute resolution processes and receive all requests
for reservation and scheduling of Arizona transmission
facilities.
TEP, as an Affected Utility, participated in the creation of the
AISA. This includes its incorporation as a not-for-profit entity,
the filing at the FERC for approval of its proposed structure, rates
and procedures, and drafting of its protocols for operation. At the
AISA's request, FERC has not ruled upon the filing pending the
outcome of the competition rules. TEP continues to participate,
however, with the other Affected Utilities in developing the AISA's
corporate structure and protocols in anticipation of the
implementation of retail competition. See ACC Rules on Retail
Electric Competition.
OTHER RATE MATTERS
See Regulated Electric Utility Operations, Customers and Item
7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations, Competition, Retail for a discussion of TEP's
contracts and negotiations with certain of its mining customers.
FUEL SUPPLY
- -----------
TEP's principal fuel for electric generation is low-sulfur coal.
Fuel cost information for the years 1998 -1994 is provided below:
Cost Per Million BTU Consumed Percentage of Total BTU Consumed
----------------------------- --------------------------------
1998 1997 1996 1995 1994 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Coal (A) $1.65 $1.66 $1.76 $1.71 $1.75 97% 97% 98% 99% 98%
Gas 2.67 2.74 2.24 1.69 1.86 3 3 2 1 2
All Fuels 1.69 1.68 1.77 1.71 1.75 100% 100% 100% 100% 100%
- ------------------------------------------
(A)The average cost per ton of coal for each of the last five years
(1998 - 1994) was $31.33, $31.33, $32.95, $32.11, and $33.12,
respectively.
COAL
Information concerning TEP's coal contracts is detailed below:
Year Average Cost Per Million
Contract Sulfur BTU (A) Coal Obtained
Station Coal Supplier Terminates Content 1998 1997 1996 From (B)
- ------- ------------- ---------- ------- ---- ---- ---- -------------
Four Corners BHP Minerals Inter- 2005 0.8% $1.03 $0.95 $1.34 Navajo Indian
national, Inc. Tribe
San Juan San Juan Coal Company 2017 0.8% $1.80 $1.74 $1.77 Federal and State
Agencies
Navajo Peabody Western Coal 2011 0.6% $1.21 $1.13 $1.18 Navajo and Hopi
Company Indian Tribes
Springerville Peabody Coalsales 2010 0.7% $1.69 $1.77 $1.84 Lee Ranch Coal
(C) Company Company
Irvington The Pittsburg & Midway 2015 0.4% $2.52 $1.99 $2.21 Navajo Indian Tribe
Coal Mining Company and Federal and
State Agencies
- -------------------------------
(A)Includes transportation and handling costs.
(B)Substantially all ofthe suppliers' leases extend atleast as long as coal
is being mined in economic quantities.
(C)Coal handling facilities costs included in Springerville fuel costs
above were $0.22 per million BTU in 1998, $0.23 per million BTU in 1997,
and $0.25 per million BTU in 1996.
TEP-Operated Generating Facilities
TEP operates the Springerville and Irvington Generating Stations.
The coal supplies for these plants are transported from northwestern New
Mexico by railroad.
In June 1997, TEP terminated its existing coal supply contract for
the Springerville Generating Station for a $50 million fee and entered
into a new contract with the same supplier. The new contract ends in 2010,
with an option to extend the term for another ten years. See Notes 2 and
10 of Notes to Consolidated Financial Statements, Deferred Springerville
Contract Termination Fee and Commitments and Contingencies, TEP Commitments
Fuel Purchase. The coal supply contract termination date for the Irvington
station is the earlier of 2015 or the remaining life of Unit 4.
The Springerville and Irvington contracts have various adjustment
clauses that will affect the future cost of coal delivered. We expect
coal reserves to be sufficient to supply the estimated requirements of
Springerville and Irvington for their presently estimated remaining lives.
The Springerville and Irvington contracts combined require TEP
to take 2.1 million tons of coal per year from 1999 to 2009. The
coal supply contracts require TEP to pay a take-or-pay charge if minimum
quantities of coal are not purchased. TEP's present fuel requirements
are in excess of the take-or-pay minimums. However, TEP also purchases
coal or natural gas in the spot market, or switches fuel burn from one
generating station to another in order to reduce overall fuel costs,
despite incurring take-or-pay minimum charges. In 1998 and 1996 TEP
incurred take-or-pay charges of $3.5 million and $4.4 million,
respectively. No take-or-pay charges occurred in 1997.
Generating Facilities Operated by Others
TEP also participates in jointly owned generating facilities
where coal supplies are under long-term contracts entered into by
the operating agents. Coal supplies are surface-mined in northern
Arizona and northwestern New Mexico. The coal supply for the San
Juan Station, a mine-mouth operation, is partially contracted through
the year 2017. The coal contract for Four Corners terminates in 2005.
The coal quantities under contract for the Navajo mine-mouth coal
fired generating station are expected to be sufficient for the
remaining life of the station.
SPRINGERVILLE COAL HANDLING FACILITIES
TEP is the lessee of the coal-handling facilities at Springerville
under a capital lease, referred to as the Springerville Coal Handling
Facilities Leases. This lease has a remaining initial lease term
through 2015 with fair market value renewal and purchase options. At
December 31, 1998, the capitalized lease asset related to the Springerville
coal-handling facilities, net of accumulated amortization, was $170
million. Annual rental payments range from approximately $10 million to
$28 million but average $21 million.
TEP allocates portions of the costs of its Springerville Coal
Handling Facilities Leases to deferred expense for future recovery
through rates. See Note 2 of Notes to Consolidated Financial Statements,
TEP's Regulatory Assets and Liabilities, for a description of the
accounting for the Springerville Coal Handling Facilities Leases.
Approximately half of the expenses of the coal handling facilities,
including lease costs and other operating and maintenance expenses,
are charged to fuel expense and amounted to $13 million, $13 million,
and $15 million in 1998, 1997 and 1996, respectively.
NATURAL GAS
In 1998, TEP purchased a small amount of natural gas for power
generation (approximately 3% of total TEP generation) on the spot market
from various suppliers. In June 1998, TEP entered into a one-year
agreement to purchase gas from Southwest Gas. During 1998, TEP received
natural gas sufficient to meet all of its needs.
WATER SUPPLY
- ------------
TEP believes there will be sufficient water to supply the
requirements of existing and planned electric generating stations in
which TEP has an interest for their estimated lives. A federal contract
for water at San Juan expires in 2005, and Public Service Company of
New Mexico is overseeing negotiations for extension of the contract.
ENVIRONMENTAL MATTERS
- ---------------------
TEP is subject to environmental regulation by federal, state
and local authorities. Air and water quality are under the most
stringent regulations. Resource extraction, waste disposal operations
and land use are also regulated. TEP spent $14 million in 1998 and $19
million in 1997 for construction costs to comply with environmental
requirements. TEP estimates that it will spend $6.0 million in 1999
and $0.5 million in 2000 for environmental compliance. These amounts
include TEP's estimated share of expenditures for improvements to shared
facilities, as discussed below. TEP believes that all existing
generating facilities are or will be in compliance with all existing
or expected environmental regulations, except as described below.
Clean Air
Arizona and New Mexico have adopted emission regulations
restricting the emissions from both existing and future coal, oil
and gas-fired plants. These regulations are in some instances more
stringent than those adopted by the EPA. The principal generating
units of TEP are located relatively close to national parks, monuments,
wilderness areas and Indian reservations. Since these areas have
relatively high air quality, TEP could be subject to control standards
of best available control technology and best available retrofit
technology. Such standards relate to the "prevention of significant
deterioration" of visibility and tall stack limitation rules.
The 1990 Federal Clean Air Act Amendments (CAAA) require
reductions of sulfur dioxide (SO2) and nitrogen oxide (NOx) emissions in
two phases, more complex facility permits and other requirements which
are currently in effect. TEP is subject only to Phase II of the SO2 and
NOx emission reductions which is effective January 1, 2000. All of TEP's
generating facilities (except internal combustion turbines) are affected.
TEP spent approximately $1 million in each of 1998, 1997 and 1996 and
expects to spend approximately $1 million annually in 1999 and 2000
complying with these requirements.
In 1993, TEP's generating units affected by Phase II were
allocated SO2 Emission Allowances based on past operational history.
Beginning in the year 2000, Phase II generating units must hold Emission
Allowances equal to the level of emissions in the compliance year or pay
penalties and offset excess emissions in future years. Due to the increase
in energy output at Springerville, TEP may not have sufficient Emission
Allowances to permit normal plant operation in compliance with the Phase
II SO2 regulations. TEP may have to purchase additional Emission
Allowances. Based on current estimates, TEP believes that it will
be able to acquire additional required allowances and that such
purchases will not have a material effect on TEP.
Title V of the CAAA requires that all of TEP's generating
facilities obtain more complex air quality permits. All TEP facilities
(including those jointly owned and operated by others) have applied for
these permits and TEP does not anticipate any material problems in
obtaining the required permits. TEP must pay an annual emission-based
fee for each generating facility subject to a Title V permit. These
emission-based fees are included in the CAAA compliance expenses discussed
above.
The CAAA also require multi-year studies of visibility impairment
in specified areas and studies of hazardous air pollutants. The results
of these studies will impact the development of future regulations of
electric utility generating units. Since these activities involve the
gathering of information not currently available, TEP cannot predict
the outcome of these studies.
TEP may incur additional costs to comply with recent and future
changes in federal and state environmental laws, regulations and
permit requirements at existing electric generating facilities.
Compliance with these changes may result in a reduction in operating
efficiency. TEP may need variances from certain environmental
standards and operating permit conditions until required equipment
and processes for control, handling and disposal of emissions are
operational and reliable. Failure to comply with any EPA or state
compliance requirements may result in substantial penalties or fines.
Jointly-Owned Facilities -- SO2 Emission Capital Improvements
-- Navajo -- In 1991, the EPA adopted a rule to reduce SO2
emissions at Navajo by 90% to improve visibility at Grand Canyon
National Park. TEP's share of the required capital expenditures
remaining as of December 31, 1998 is approximately $4.5 million.
-- San Juan -- To improve the efficiency of SO2 removal at San
Juan, the existing system is being replaced. TEP's estimated
share of the remaining costs as of December 31, 1998 is
approximately $2 million.
UNREGULATED ENERGY BUSINESSES
- ------------------------------
Our unregulated energy businesses are organized under Millennium
Energy Holdings, Inc. (Millennium), a wholly-owned subsidiary of
UniSource Energy. Millennium owns 100% of the common stock of four
subsidiaries (described below).
In addition to the activities currently underway or planned for
each of these subsidiaries, we continue to evaluate potential investment
opportunities in other energy-related markets. According to the ACC
Holding Company Order, the capitalization (debt and equity) of the
subsidiaries which are the sister companies to TEP may not exceed 30%
of TEP's capitalization unless otherwise approved by the ACC.
Millennium's total capitalization as of December 31, 1998 was $77
million or approximately 3% of TEP's total capitalization.
Our investments in the unregulated energy businesses owned by
Millennium comprise approximately 3% of the consolidated assets of
UniSource Energy. Millennium recorded a net loss of $8.1 million
for the year ended December 31,1998 related to these investments. These
results are included in the Other Income (Deductions) section on UniSource
Energy's income statement. We discuss the reasons for this loss in Item
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, Results of Operations, Results of Unregulated Energy
Businesses.
Nations Energy
Nations Energy Corporation was established in 1995 to develop
and invest in independent power projects worldwide. Nations Energy
is involved in the following projects:
-- In 1996, Nations Energy became actively involved in the
development of a power project in the Czech Republic. In the
third quarter of 1998, Nations Energy paid $8.1 million for a
minority interest in this project, which consists of the upgrade
and expansion of an existing cogeneration facility located in the
city of Kladno. This project is scheduled for completion in late-
1999. As of December 31, 1998, Nations Energy's total investment
in this project was $15.8 million.
-- In the third quarter 1998, Nations Energy purchased a minority
interest in Corporation Panamena de Energia, S.A. (COPESA) for
$7.5 million. COPESA is an independent power producer which owns
and operates a 43 MW power plant near Panama City. The energy is
sold under an agreement with an unrelated party.
In addition to these projects, Nations Energy is actively involved in the
development of other investment opportunities in both domestic and foreign
energy markets.
In September 1995, Nations Energy and Trigen Energy Corporation
formed a limited partnership called Trigen-Nations Energy, which
purchased the 40MW Coors Brewing Company power plant in Golden,Colorado.
Nations Energy had a 49% interest in that partnership. In the third
quarter of 1998, Nations Energy sold a 48% interest in that partnership
to Trigen Energy Corporation, retaining a 1% interest. Nations Energy
recorded a $5.8 million after-tax gain on the sale.
As a result of damages from Hurricane Mitch, in the fourth
quarter of 1998, Nations Energy wrote-off $1.6 million in capitalized
development costs and prepaid consulting expenses related to a project
in Honduras.
MEH and NEV
MEH Corporation holds a 50% interest in New Energy Ventures, Inc.
MEH exercised its option to acquire its 50% ownership interest in NEV
effective September 1, 1997. NEV was organized in 1995 for the purpose
of acting as a buyer's agent in procuring electric energy, performing
energy services, engaging in power marketing and trading and other
energy related activities.
NEV serves retail customers in California, New York and
Pennsylvania. As of December 31, 1998, NEV had contracts to purchase
energy for and sell energy to customers with a combined electrical demand
of more than 2,000 MW. Until time-of-use meters are installed for all
of those customers by the local utilities providing distribution services,
NEV is actually serving about 400 MW of load. NEV also participates in
East and West Coast wholesale energy markets. NEV obtains its energy
supply through purchase power contracts and spot market purchases. See
Note 5 of Notes to Consolidated Financial Statements, Unregulated Energy
Businesses, for additional information on NEV's operations.
NEV Technologies, a subsidiary of NEV, and its two joint
ventures hold exclusive distribution rights for the AlliedSignal
TurboGenerator TM in the western United States and certain international
markets. The TurboGenerator TM is a microturbine (for applications
requiring 40 kW-500 kW) which can be used for distributed generation,
off-grid power generation, portable power, and cogeneration, and provides
NEV with additional capabilities to provide energy options to its customer
base. In October 1998, Edison International made a $10 million minority
equity investment in NEV Technologies. NEV Technologies' two international
joint ventures are 50% owned by Dames & Moore Ventures.
New Energy Ventures Southwest, L.L.C. (NEV Southwest) was formed in
October 1998 and has offices in Tucson and Phoenix. NEV Southwest was
originally a wholly-owned subsidiary of MEH, and became a wholly-owned
subsidiary of NEV in February 1999. NEV Southwest will be responsible
for developing new customer service opportunities, including energy supply
and trading, in Arizona, Nevada, Utah, Colorado, and New Mexico, as these
states open their markets to retail electric competition.
AET and Global Solar
Advanced Energy Technologies, Inc. was established in May 1996.
This wholly-owned subsidiary of Millennium develops renewable energy
and distributed generation technologies. In 1996 AET acquired a 50%
ownership interest in Global Solar Energy, L.L.C., an Arizona corporation
which develops and manufactures flexible thin-film photovoltaic cells.
Commercial production of photovoltaic cells is scheduled to begin in 1999.
We expect Global Solar's manufacturing facility to produce up to 1 MW or
170,000 square feet of the product in the first twelve months of commercial
production.
SES
Southwest Energy Solutions, Inc., a wholly owned subsidiary of
Millennium, was established in January 1997. SES provides energy support
services to retail electric consumers including lighting equipment,
service restoration, and design, engineering and construction services.
EMPLOYEES
- ---------
As of December 31, 1998, TEP had 1,174 employees and wholly-owned
subsidiaries of Millennium had 33 employees. The International Brotherhood
of Electrical Workers (IBEW) 1116 represents about 60% of TEP's employees.
The collective bargaining agreement between the local union and TEP
terminated on November 30, 1998. The collective bargaining agreement has
been extended to November 30, 1999 for Springerville Generating Station
employees in exchange for a 2.5% wage increase. Labor and management
reached a tentative agreement on a new four-year labor contract for Tucson
employees in the first quarter of 1999.
TEP's UTILITY OPERATING STATISTICS
For Years Ended December 31,
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------
Generation and Purchased Power-kWh (000)
Remote Generation (Coal) 10,002,250 9,694,152 9,784,918 8,716,513 9,341,342
Local Generation (Oil, Gas & Coal) 720,515 806,819 723,232 500,958 825,385
Purchased Power 2,227,773 1,222,970 925,394 692,769 501,269
- ------------------------------------------------------------------------------------------------------
Total Generation and Purchased Power 12,950,538 11,723,941 11,433,544 9,910,240 10,667,996
Less Losses and Company Use 810,117 824,072 776,436 661,901 639,278
- ------------------------------------------------------------------------------------------------------
Total Energy Sold 12,140,421 10,899,869 10,657,108 9,248,339 10,028,718
======================================================================================================
Sales-kWh (000)
Residential 2,662,598 2,608,515 2,516,282 2,330,191 2,374,868
Commercial 1,355,319 1,316,360 1,306,826 1,280,752 1,281,050
Industrial 2,139,464 2,115,332 2,080,763 1,979,317 1,948,331
Mining 1,230,259 1,193,094 1,164,140 1,147,281 1,135,424
Public Authorities 242,845 237,113 228,800 204,746 183,525
- ------------------------------------------------------------------------------------------------------
Total - Retail Customers 7,630,485 7,470,414 7,296,811 6,942,287 6,923,198
Sales for Resale 4,509,936 3,429,455 3,360,297 2,306,052 3,105,520
- ------------------------------------------------------------------------------------------------------
Total Sales 12,140,421 10,899,869 10,657,108 9,248,339 10,028,718
======================================================================================================
Operating Revenues (000)
Residential $248,821 $246,251 $237,569 $218,208 $220,341
Commercial 146,269 146,377 143,623 138,294 137,508
Industrial 157,735 158,266 154,547 146,409 144,677
Mining 51,965 53,231 56,240 54,948 53,821
Public Authorities 17,950 17,531 16,949 14,952 13,435
Other 2,981 2,565 2,636 2,114 1,651
- ------------------------------------------------------------------------------------------------------
Total - Retail Customers 625,721 624,221 611,564 574,925 571,433
Amortization of MSR Option Gain
Regulatory Liability - 8,105 20,053 20,053 20,053
Sales for Resale 143,269 97,567 84,256 75,591 99,987
- ------------------------------------------------------------------------------------------------------
Total Operating Revenues $768,990 $729,893 $715,873 $670,569 $691,473
======================================================================================================
Customers (End of Period)
Residential 295,469 287,857 282,060 273,976 266,060
Commercial 28,648 28,309 28,199 27,858 27,360
Industrial 684 664 626 620 588
Mining 4 4 4 4 4
Public Authorities 61 61 61 59 59
- ------------------------------------------------------------------------------------------------------
Total Retail Customers 324,866 316,895 310,950 302,517 294,071
======================================================================================================
Average Revenue per kWh Sold (cents)
Residential 9.3 9.4 9.4 9.4 9.3
Commercial 10.8 11.1 11.0 10.8 10.7
Industrial and Mining 6.2 6.4 6.5 6.4 6.4
Average Retail Revenue per kWh Sold 8.2 8.4 8.4 8.3 8.3
Average Revenue per Residential Customer $855 $865 $854 $809 $841
Average kWh Sales per Residential Customer 9,144 9,159 9,050 8,641 9,066
ITEM 2. PROPERTIES
- -------------------------------------------------------------------------
TEP's transmission facilities, located in Arizona and New Mexico,
transmit electricity from TEP's remote electric generating stations at
Four Corners, Navajo, San Juan and Springerville to the Tucson area for
use by TEP's retail customers (see Item 1, Business, Generating and
Other Resources for the location of TEP's plants). The transmission
system is directly interconnected with systems operated by the following
utilities:
Utility Location
------- --------
Arizona Public Service Co. Arizona
Arizona Electric Power Cooperative Arizona
El Paso Electric Co. New Mexico, Texas
Public Service Co. of New Mexico New Mexico
Salt River Project Arizona
TEP has arrangements with approximately 180 companies, including
the five listed above, to interchange generation capacity and transmission
of energy.
As of December 31, 1998, TEP owned, or participated in, an overhead
electric transmission and distribution system consisting of:
-- 511 circuit-miles of 500 kV lines;
-- 1,122 circuit-miles of 345 kV lines;
-- 350 circuit-miles of 138 kV lines;
-- 440 circuit-miles of 46 kV lines; and
-- 9,643 circuit-miles of lower voltage primary lines.
The underground transmission and distribution system was comprised of
5,071 cable-miles. TEP owns approximately 76% of the poles on which the
lower voltage lines are located. Electric substation capacity consisted
of 173 substations with a total installed transformer capacity of
5,329,605 kVA.
The electric generating stations (except as noted below), TEP's
general office building, operating headquarters and warehouse and
service center are located on land owned by TEP. The electric
distribution and transmission facilities owned by TEP are located:
-- on property owned by TEP;
-- under or over streets, alleys, highways and other public
places, the public domain and national forests and state
lands under franchises, easements or other rights which are
generally subject to termination;
-- under or over private property as a result of easements
obtained primarily from the record holder of title; and
-- over Indian reservations under grant of easement by the
Secretary of Interior or lease by Indian tribes.
It is possible that some of the easements, and the property over which
the easements were granted, may have title defects or may be subject to
mortgages or liens existing at the time the easements were acquired.
Springerville is located on land parcels held by TEP under a
long-term surface ownership agreement with the State of Arizona.
Four Corners and Navajo are located on properties held under
easements from the United States and under leases from the Navajo
Indian Tribe. TEP, individually and in conjunction with PNM in
connection with San Juan, has acquired easements and leases for
transmission lines and a water diversion facility located on the
Navajo Indian Reservation. TEP has also acquired easements for
transmission facilities, related to San Juan and Navajo, across the
Zuni, Navajo and Tohono O'odham Indian Reservations.
TEP's rights under these various easements and leases may be
subject to defects such as:
-- possible conflicting grants or encumbrances due to the
absence of or inadequacies in the recording laws or record
systems of the Bureau of Indian Affairs and the Indian tribes;
-- possible inability of TEP to legally enforce its rights
against adverse claimants and the Indian tribes without
Congressional consent; and
-- failure or inability of the Indian tribes to protect TEP's
interests in the easements and leases from disruption by the
U.S Congress, Secretary of the Interior, or other adverse
claimants.
However, these possible defects have not and are not expected to
materially interfere with TEP's interest in and operation of its
facilities.
TEP, under separate sale and leaseback arrangements, leases the
following facilities (which do not include land):
-- coal handling facilities at Springerville;
-- a 50% undivided interest in the Springerville Common
Facilities;
-- Springerville Unit 1 and the remaining 50% undivided
interest in Springerville Common Facilities; and
-- Irvington Unit 4 and related common facilities.
See Note 7 of Notes to Consolidated Financial Statements, TEP's
Long-Term Debt and Capital Lease Obligations for additional information
on TEP's capital lease obligations.
Substantially all of the utility assets owned by TEP are subject
to the lien of the General First Mortgage and the General Second Mortgage.
Springerville Unit 2, which is owned by San Carlos, is not subject to
those liens.
ITEM 3. LEGAL PROCEEDINGS
- -----------------------------------------------------------------------
TAX ASSESSMENTS
---------------
See Contingencies in Note 10 of Notes to Consolidated Financial
Statements.
LITIGATION RELATED TO ACC ORDERS AND RETAIL COMPETITION
--------------------------------------------------------
See Rates and Regulatory Matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------------------
Not Applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- -----------------------------------------------------------------------
MATTERS
-------
On January 1, 1998, TEP and UniSource Energy completed a transaction
by which all outstanding shares of TEP common stock were exchanged, on a
share-for-share basis, for shares of UniSource Energy common stock. As
a result of this exchange, TEP became a wholly-owned subsidiary of
UniSource Energy. As such, TEP's common stock is no longer publicly
traded.
UniSource Energy
----------------
The common stock of UniSource Energy is listed on the New York
and Pacific Stock Exchanges, and began trading under the symbol of UNS on
January 2, 1998. The closing price of the common stock on March 8, 1999
was $11.875, with 25,219 shareholders of record. The table below lists
the high and low sale prices of UniSource Energy's common stock on the
consolidated tape as reported by Dow Jones. No dividends were paid on
UniSource Energy common stock during these periods.
Market Price per
Quarter Share of Common Stock
------- ---------------------
High Low
---- ---
1998
----
First $18.69 $16.56
Second 18.94 15.31
Third 16.06 12.25
Fourth 17.50 12.50
TEP
---
Prior to the share exchange described above, the common stock of TEP
was traded on the New York and Pacific Stock Exchanges. The table below
lists the high and low sale prices of TEP's common stock for 1997 on the
consolidated tape as reported by Dow Jones. No dividends were paid on
TEP common stock during 1997.
Market Price per
Quarter Share of Common Stock
------- ---------------------
High Low
---- ---
1997
---
First $16.75 $14.00
Second 15.38 13.88
Third 18.25 14.38
Fourth 18.19 16.19
TEP declared and paid a cash dividend of $30 million to its sole
shareholder, UniSource Energy, in the fourth quarter of 1998.
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Dividends on Common Stock.
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- -------------------------------------------------------------------------
UniSource
Energy TEP UniSource Energy and TEP
--------------------------------------------------------------------
1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ----
(In thousands - except per share data and ratios)
Summary of Operations
- ----------------------------------------------------------------------------------------------------------
Operating Revenues $768,676 $768,990 $729,893 $715,873 $670,569 $691,473
Income Tax Benefit Recognition
Related to Prior Period NOLs -
Part of Income Taxes - - $43,443 $88,638 $23,282 -
Net Income (Loss) of Unregulated
Energy Businesses $(8,109) - $(5,344) $(2,284) $(1,327) -
Net Income (Loss) $28,032 $41,676 $83,572 $120,852 $54,905 $20,740
Basic Earnings per Share $0.87 N/M $2.60 $3.76 $1.71 $0.65
Diluted Earnings per Share $0.87 N/M $2.59 $3.75 $1.70 $0.64
Shares of Common Stock Outstanding
Average 32,178 N/M 32,138 32,136 32,138 32,145
End of Year 32,258 N/M 32,139 32,139 32,138 32,145
Book Value per Share $7.65 N/M $6.75 $4.15 $0.39 $(1.31)
- -----------------------------------------------------------------------------------------------------------
Financial Position
- -----------------------------------------------------------------------------------------------------------
Total Utility Plant - Net $1,915,590 $1,915,590 $1,935,513 $1,953,904 $1,978,126 $2,007,422
Investments and Other Property 110,318 62,978 79,471 69,289 52,116 12,992
Total Assets 2,634,180 2,628,583 2,634,409 2,568,541 2,563,461 2,730,229
Long-Term Debt 1,184,423 1,184,423 1,215,120 1,223,025 1,207,460 1,381,935
Capital Lease Obligations 889,543 889,543 890,257 895,867 897,958 922,735
Common Stock Equity (Deficit) 246,646 229,861 216,878 133,288 12,488 (42,233)
------------------------------------------------------------------------
Total Capitalization $2,320,612 $2,303,827 $2,322,255 $2,252,180 $2,117,906 2,262,437
- -----------------------------------------------------------------------------------------------------------
Net Cash Flows from Operations (A) $162,745 $181,858 $126,283 $152,932 $119,390 $143,616
Capital Expenditures (B) 81,148 81,011 72,475 68,272 59,097 62,599
-----------------------------------------------------------------------
Free Cash Flow (A-B) $ 81,597 $100,847 $ 53,808 $ 84,660 $ 60,293 $ 81,017
- -----------------------------------------------------------------------------------------------------------
Ratio of Earnings to Fixed Charges N/R 1.35 1.39 1.25 1.21 1.10
N/M - Not Meaningful
N/R - Not Required
Note: See Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Management's Discussion and Analysis explains the general financial
condition and the results of operations for UniSource Energy and its
two primary business segments - the regulated electric utility business
of TEP and the unregulated energy businesses of Millennium, and includes
the following:
-- operating results during 1998 compared with 1997 and 1997
compared with 1996,
-- the outlook for dividends on common stock,
-- changes in liquidity and capital resources during 1998, and
-- expectations of identifiable material trends which may affect
our business in the future.
TEP is the principal operating subsidiary of UniSource Energy and
accounts for substantially all of its assets, revenues and net income.
The financial condition and results of operations of TEP are currently
the principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis, although losses from
energy-related ventures of Millennium and certain of its subsidiaries
and interests have reduced the earnings reported by UniSource Energy
for the years ended December 31, 1998, 1997 and 1996.
OVERVIEW
- --------
UniSource Energy recorded net income of $28.0 million in 1998,
compared with $83.6 million in 1997 and $120.9 million in 1996. Income tax
benefits related to prior period net operating losses were zero in 1998,
$43.4 million in 1997 and $88.6 million in 1996, accounting for the
majority of the fluctuation in reported net income for the last three
years. See Income Tax Benefits below. Common stock equity was $246.6
million at year-end, compared with $216.9 million as of December 31, 1997.
In addition to the reduction in income tax benefits described above,
the major reasons for the variance between the results for 1998 and the
results for 1997 were:
-- $10.7 million in higher interest costs in 1998 as a result
of refinancing debt on a fixed rate basis from a variable rate
basis,
-- $10.2 million in pre-tax other income from a reversal of
loss provision in 1997,
-- $8.1 million of non-cash regulatory revenues recorded in
1997,
-- a $4.4 million reduction in retail revenues in 1998 related
to a change in the method of estimating unbilled revenues,
-- a 1.1% retail rate decrease effective July 1, 1998, and
-- net losses from our unregulated energy businesses of $8.1
million in 1998 compared with $5.3 million in 1997.
Our financial prospects are subject to significant regulatory,
economic, and other uncertainties. Regulatory uncertainties include
the impact of the introduction of retail competition in Arizona and
the resolution of the Stranded Cost Recovery Plan filed by TEP with
the ACC in the third quarter of 1998. Until the uncertainties
surrounding the introduction of retail competition in Arizona are
resolved, predicting the level of TEP's future energy sales and the
composition of its future revenues is difficult. See Competition,
Retail below. In a deregulated environment, revenues from sales of
energy may become less certain although revenues from transmission
and distribution services, which we expect to remain regulated, would
likely continue to grow. Even in a deregulated environment, TEP expects
to continue to benefit from the anticipated population and economic
growth in the Tucson area through increased revenues from its regulated
services. Other uncertainties include the extent to which, in response
to industry changes or unanticipated economic downturns, TEP can alter
operations and reduce costs, which may be limited due to high financial
and operating leverage. Our future success will depend, in part, on our
ability to contain and/or reduce the costs of serving retail customers
and the level of sales to such customers.
We are addressing the uncertainties discussed above by
positioning our subsidiaries to benefit from the changing regulatory
environment. We have aligned our corporate structure to better meet
the needs of the emerging energy markets. In November 1998, TEP
organized its regulated business activities into three separate
business units: generation, transmission and distribution, and in
January 1999, formed a business unit which provides administrative
services to the utility business units. We are improving cost
measurement and management techniques at TEP. We have also extended
contracts, where appropriate, for large wholesale and retail customers,
and are developing new affiliates to provide energy services to markets
beyond TEP's retail service territory. See Competition, Retail;
Unregulated Energy Businesses; and Results of Operations below.
Our financial prospects are also subject to uncertainties
relating to the start-up and developmental activities of our unregulated
energy business segment. Although our investments in unregulated energy-
related affiliates comprise approximately 3% of total assets, start-up
costs and other subsidiary developmental activities have contributed to
losses from certain of these activities in 1998 and 1997. These losses
have reduced the earnings reported by UniSource Energy on a consolidated
basis for the years ended 1998 and 1997.
Our consolidated capital structure remains highly leveraged.
Since April 1997, however, we have made significant progress in our
financial strategy to reduce refinancing risk by extending maturities of
long-term debt and letters of credit and by reducing exposure to variable
interest rates by refinancing with fixed interest rate securities. TEP
refinanced variable rate debt obligations into fixed rate obligations and
entered into a new bank Credit Agreement. In the third quarter of 1998,
TEP refinanced all of the First Mortgage Bonds that contained provisions
prohibiting the payment of dividends, with bonds containing more flexible
financial covenants which allow TEP to pay dividends. In December 1998,
TEP paid a $30 million dividend to its sole shareholder, UniSource Energy.
This was the first dividend paid by TEP since 1989. See Investing and
Financing Activities, Bond Issuance and Redemption, and Dividends on Common
Stock, below.
Our businesses require a great deal of capital. TEP's capital
requirements include construction expenditures, scheduled debt maturities
and capital lease obligations. During the next twelve months, TEP expects
to be able to fund operating activities and construction expenditures with
internal cash flows, existing cash balances, and, if necessary, borrowings
under the Revolving Credit Facility. Some of our unregulated energy
businesses also require significant amounts of capital in the form of
investments, loans or guarantees. Our ability to invest additional
amounts of capital in our unregulated businesses will depend on dividends
from TEP and possible sales of equity securities. If necessary, we may
seek investments by unaffiliated parties to meet the ongoing capital
requirements of some of these businesses. See Liquidity and Capital
Resources, Investing and Financing Activities, below.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
-----------
RETAIL
Under current law, TEP does not compete with other companies for
electric service in TEP's retail service territory. However, TEP competes
against gas service suppliers and others who provide energy services. TEP
actively markets energy and customized energy-related services. We have
not lost any customers to self-generation partly because of these efforts.
For example, in recent years, TEP executed new contracts with two principal
customers that provide approximately 8% of TEP's total annual retail
revenues. Both customers are in the copper mining business. The new
contracts include price reductions, term extensions, and a provision for
interruptible service. These contracts expire in March 2001 and January
2003. These mining customers cannot terminate the contracts early without
at least one and up to two years prior notice. We have not received any
such notices.
The electric utility industry is undergoing significant regulatory
change designed to encourage competition in the sale of electric services.
In this section, we discuss the current status of regulatory actions of
the ACC regarding the introduction of retail electric competition in
Arizona. We also outline TEP's responses to these actions. There is
considerable uncertainty regarding the timing and the outcome of these
matters. As a result, we cannot predict the impact of retail competition
on TEP's future operating results or financial condition.
The future success of NEV is also dependent on the nature of
competitive retail energy markets throughout the United States.
Deregulation of the electricity industry is occurring on a state by
state basis. The ultimate size of each market, the timing of its
opening to competition, and the rules for participation by energy
service providers vary from state to state. To date, California is
the only state that has adopted statewide direct access competition,
while other states, such as New York and Pennsylvania, have begun to
phase-in direct access competition beginning in 1998. During 1998,
NEV continued to increase its sales to retail customers in California
and entered the New York and Pennsylvania markets through their pilot
programs. NEV opened offices in Illinois and Texas in 1998, and will
continue to pursue opportunities in states which open their markets to
competition.
Retail Electric Competition Rules
In December 1996, the ACC adopted retail electric competition rules
(Rules) that provided a framework for the phase-in of retail electric
competition in Arizona beginning in January 1999. The Rules were amended
and adopted on an emergency basis in August 1998. The Rules, as originally
adopted, assumed a competition start date of January 1, 1999. However,
in January 1999, the ACC delayed the implementation of the Rules pending
additional proceedings to resolve a number of important issues. See
Item 1. Business, Rates and Regulation, ACC Rules on Retail Competition,
for a description of the key provisions of the rules as drafted.
The ACC identified the following issues, among others, which the
ACC believed needed to be resolved before the Rules can go into effect:
-- establishing a competitive market structure between other
jurisdictions and the Affected Utilities;
-- determination of the methodologies for quantification and
recovery of stranded costs;
-- approval of unbundled tariffs, which provide separate rates
for generation, transmission, distribution, metering,
meter reading, billing and collection, and ancillary services;
-- questions of federal and state jurisdiction on transmission
issues critical to system reliability; and
-- pricing and cost recovery for must run generation.
On February 5, 1999, the ACC Hearing Officer issued a Proposed
Opinion and Order recommending changes to the Rules. These
recommendations include:
-- The date to open an Affected Utility's service territory to
competition would be set upon the resolution its of Stranded
Costs and Unbundled Tariffs by final ACC order.
-- If an Affected Utility's service territory is open prior to
January 1, 2001, the existing phase-in schedule would be
retained, calling for 20 percent of the market to initially
have access to competitive generation supply. As part of the
20 percent, each Affected Utility would reserve an increasing
percentage for residential customers according to a set
schedule.
-- Competitive Energy Service Provider affiliates of Affected
Utilities may not enter another Affected Utility's service
territory until its own territory is open to competition. For
example, NEV Southwest may not sell energy to retail customers
of other Affected Utilities until TEP's territory is open to
competition.
-- The requirement that a portion of energy sold competitively be
generated from solar sources was eliminated, citing it as
prohibitively expensive and potentially hindering competition
in Arizona.
-- Affected Utilities will have an opportunity to amend their
tariffs for unbundled noncompetitive services with the ACC.
TEP filed exceptions to the Proposed Order on February 17, 1999.
No meeting date has yet been set to consider this Proposed Order. If
the Proposed Order amending the Rules is adopted, it will be forwarded
to the Secretary of State to start the amendment process. The Arizona
Administrative Procedures Act requires that the Rules be filed with the
Secretary of State before they can be amended. We anticipate that the
stay of the Rules would probably remain in effect until amendments are
adopted.
We cannot predict the actual date that competition will begin
in Arizona, or the final form of the Rules.
Stranded Costs
On June 22, 1998, the ACC adopted an order which outlined two
options for stranded cost recovery: (i) Divestiture/Auction of all
generation assets to determine the amount of stranded costs for 100
percent recovery, or (ii) a Transition Revenues Methodology, where
the Affected Utility would retain generation assets in a separate
affiliate with sufficient revenues necessary to maintain financial
integrity, such as avoiding default under currently existing
financial instruments for a period of ten years.
On February 5, 1999, the ACC Hearing Officer issued a Proposed
Opinion and Order (Proposed Order) which recommends modification of
the June 1998 order so that divestiture is not required for 100%
stranded cost recovery. The recommended order, which was revised on
March 12, 1999, allows each Affected Utility to choose from the
following options:
(1) Net Revenues Lost Methodology
(2) Divestiture/Auction Methodology
(3) Financial Integrity Methodology
(4) Settlement Methodology
(5) Alternative Methodology
See Item 1. Business, Rates and Regulation, ACC Orders on Stranded
Cost Recovery, for a detailed description of the options.
Under the Proposed Order, Affected Utilities will have an
opportunity to amend their previously filed stranded cost implementation
plans. TEP's original stranded cost recovery plan, filed on August 21,
1998, specified divestiture of generation assets as the preferred method
for recovery given the then available options.
TEP filed exceptions to the Proposed Order on February 17, 1999.
No meeting date has yet been set to consider the Proposed Order. If the
Proposed Order is approved, thereby amending the June 1998 stranded cost
order, TEP may amend its August 1998 stranded cost recovery proposal.
TEP intends to continue to seek 100% recovery of its stranded costs
WHOLESALE
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy in the
wholesale market. FERC generally does not permit TEP's prices for
wholesale sales of capacity and energy to exceed rates determined on a
cost of service basis. However, in the fall of 1997, FERC granted TEP
a tariff to sell at market-based rates. In the current market, wholesale
prices are typically substantially below TEP's total cost of service,
but in all instances, we make wholesale sales at prices which exceed
fuel and other variable costs. We expect competition to sell capacity
to remain vigorous. Prices may remain depressed for at least the next
several years due to the surplus of capacity in the southwestern United
States. Competition for the sale of capacity and energy is influenced
by the following factors:
-- availability of capacity in the southwestern United States,
-- the availability and prices of natural gas, oil and coal,
-- spot energy prices, and
-- transmission access.
See also Item 1. Business, Regulated Electric Utility Operations
Sales for Resale.
ACCOUNTING FOR THE EFFECTS OF REGULATION
- ----------------------------------------
The ACC regulates TEP's utility business. TEP generally uses
the same accounting policies and practices used by unregulated companies
for financial reporting under generally accepted accounting principles.
However, sometimes these principles, such as FAS 71, require special
accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the ACC may
not allow TEP to currently charge its customers to recover certain
expenses but, instead, require that these expenses be charged to
customers in the future. In this situation, FAS 71 requires that TEP
not show these expenses on its current income statements but 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
expenses 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.
We have recorded regulatory assets and liabilities in our
balance sheets in accordance with FAS 71. A regulated company must
satisfy certain conditions to apply the accounting policies and
practices of FAS 71. These conditions include:
-- an independent regulator sets rates;
-- the regulator sets the rates to cover specific costs of
delivering service; and
-- the service territory lacks competitive pressures to reduce
rates below the rates set by the regulator.
We periodically assess whether we continue to meet these conditions.
If we were required to stop applying FAS 71 to all or a portion of TEP's
regulated utility operations, we would write off the related balances of
TEP's regulatory assets and liabilities as a charge in our income
statement. In that event, our earnings would be reduced by the amount of
regulatory assets, net of regulatory liabilities, after applicable deferred
income taxes. Based on the balances of TEP's regulatory assets and
liabilities at December 31, 1998, if we had ceased applying FAS 71 to all
of TEP's regulated operations, we would have recorded an extraordinary loss
of approximately $145 million, net of the related deferred income tax
benefit of $96 million. However, we would not write-off the regulatory
assets, net of regulatory liabilities, if we are authorized to recover
these amounts through the remaining regulated portion of our business.
Approximately 62% of TEP's net regulatory assets on the balance sheet
relate to electric generation. While regulatory orders and market
conditions may affect our cash flows, our cash flows would not be affected
if we stopped applying FAS 71.
If we stop applying FAS 71, we would need to evaluate the likelihood
that we could recover the cost of TEP's electric plant in the marketplace.
If undiscounted cash flows are less than the carrying value of plant assets
that we continue to own, then we would need to write off as an expense a
portion of plant assets to reflect their current market value. Plant
assets to be disposed of would be written down to fair value if it is
less than carrying value. We cannot predict if we would write off any
plant assets as a result of these evaluations.
In addition, if we stop applying FAS 71, we would change the way that
we account for our capital leases. If we had not used FAS 71 in 1998,
1997 and 1996, our lease expense included on our income statements would
have been higher by $21 million, $20 million, and $21 million,
respectively. Also, if TEP had not applied FAS 71, no amortization or
interest expense relating to the Springerville Unit 1 Allowance would have
been recorded. See Notes 1 and 2 of Notes to Consolidated Financial
Statements, Nature of Operations and Significant Accounting Policies,
Springerville Unit 1 Allowance, and TEP's Regulatory Assets and
Liabilities, Deferred Lease Expense.
We expect that TEP will stop accounting for its generation operations
using FAS 71 when the ACC approves a cost recovery plan specific to TEP
which includes the amount of stranded costs that TEP can recover and a
cost recovery method. See Competition, Retail for a discussion of the
ACC order regarding stranded cost recovery. Until the ACC approves the
amount and recovery method, we are unable to predict the amount of
write-offs, if any, or other changes in asset and liability values,
which would be recorded at that time.
MARKET RISKS
- ------------
We are potentially exposed to various forms of market risk. Changes
in interest rates, returns on marketable securities, changes in foreign
currency exchange rates, and changes in commodity prices may affect our
future financial results. TEP currently uses derivative commodity
instruments such as forward contracts to buy or sell energy for trading
purposes, but does not use derivative financial instruments for either
trading or speculative purposes. TEP continues to evaluate to what extent,
if any, it may use derivative financial and commodity instruments in the
normal course of its future business. NEV, which is accounted for as a
50% owned equity investment of Millennium, is also exposed to changes in
the market price of electricity. As an equity investment, our exposure
to NEV is restricted to the amount of our investment, advances and
guarantees which are described in Note 5 of Notes to Consolidated
Financial Statements, Unregulated Energy Businesses.
For additional information concerning risk factors, including
market risks, see Safe Harbor for Forward-Looking Statements below.
Interest Rate Risk
Exposure to interest rate changes relates to TEP's long-term debt
obligations. At December 31, 1998, the fair value of TEP's long-term debt
is estimated at $1.2 billion. We considered the principal amounts of
variable rate debt outstanding to be reasonable estimates of their fair
value. We calculated the present value of the cash flows of each fixed
rate obligation based on rates consistent with market yields for bonds
with similar characteristics with respect to: credit rating, time-to-
maturity, and the tax status of the bond coupon for Federal income tax
purposes. The fair value of TEP's long-term debt at December 31, 1998
exceeded the carrying value by $15 million. The change in the fair value
of our long-term debt resulting from a hypothetical one-half percent
change in interest rates is not a material exposure to TEP. However, TEP's
long-term debt includes $329 million of variable rate debt, and any
significant changes in interest rates could impact TEP's net income and
cash flows. The average interest rates on TEP's variable rate debt for
1998 and 1997 were 3.51% and 3.70%, respectively. See Note 8 of Notes
to Consolidated Financial Statements, Fair Value of TEP's Financial
Instruments.
Marketable Securities Risk
Exposure to fluctuations in the return on marketable securities
relates to TEP's investment in debt securities. At December 31, 1998,
TEP had marketable debt securities with an estimated fair value of
$22.1 million, which exceeded the carrying value by $4.3 million.
Foreign Currency Exchange Risk
Exposure to changes in foreign currency exchange rates may arise
from transactions conducted by Nations Energy in foreign currencies.
Nations Energy's investment in a power project in the Czech Republic is
heavily leveraged. Approximately one third of the project's debt is
denominated in US Dollars, one third in German Deutschmarks, and one
third in Czech Corunas. The project bears the risk that the value of
the debt in each currency changes with changes in the applicable exchange
rates as well as the risk that the amount of interest due each period
changes with changes in the applicable exchange rates. The impact on
UniSource Energy's equity in earnings of the project in the income
statement for October through December 1998, the period of Nations
Energy's ownership, was not material to the consolidated financial
statements for the year. However, as additional draws of debt are made,
management expects the amount of exchange risk and resulting fluctuations
in these earnings to increase in 1999. Earnings from the project could
vary significantly from month to month due to recording the impact of
this exchange rate risk.
Commodity Price Risk
Exposure to changes in commodity prices at TEP relates to changes in
the market price of electricity, as well as changes in fuel costs incurred
to generate electricity. TEP competes with other utilities, power
marketers and independent power producers in the sale of electric capacity
and energy in the wholesale market. The participants in this market trade
not only electricity and natural gas as commodities, but also derivative
commodity instruments such as futures, forwards, swaps, options and other
instruments. This market is largely unregulated and most transactions
are conducted on an over-the-counter basis, there being no central clearing
mechanism (except in the case of specific instruments traded on the
commodity exchanges). Power marketers, whether or not affiliated with
other entities, generally do not own production facilities and obtain
orders from FERC permitting sales at market based rates.
TEP enters into forward contracts to buy or sell energy at a
specified price at a future date. These contracts are considered to
be derivative commodity instruments. Generally, TEP commits to future
sales based on expected excess generating capability. However, rather
than producing additional power, TEP may enter into a forward purchase
contract to satisfy the forward sales contract if the market prices are
favorable. The forward sales contracts that are satisfied with forward
purchase contracts do not require any physical delivery of energy by TEP.
However, to take advantage of anticipated market opportunities,
TEP is at various times in a net open position. A net open position
means it has either committed to sell more electricity than it has
purchase contracts to cover or it has committed to purchase more
power than it needs for its selling commitments. To limit exposure
to price risk, TEP has trading policies with limits as to total open
positions. TEP continually reviews its trading policies and limits
to respond to the constantly changing market conditions. TEP
measures its market risk exposure by comparing its open positions to
the estimated market value of the positions. The market prices used
to determine fair value are estimated based on various factors
including broker quotes, exchange, over the counter prices and time
value. As of December 31, 1998, the fair value of these derivative
commodity instruments and the potential near term gains or losses in
future earnings, cash flows or fair values resulting from reasonably
possible near term changes in market prices are not material to the
results of operations, cash flows or financial position of TEP.
TEP is exposed to credit risk in its energy trading activities
related to potential nonperformance by counterparties under the terms of
their contractual agreements. TEP manages the risk of counterparty
default by performing financial credit reviews of its counterparties and
through the use of standardized agreements which allow for the netting
of positive and negative exposures associated with a single counterparty.
In addition, TEP may require collateral to support trading positions from
certain counterparties. TEP does not anticipate any nonperformance by
any of its counterparties and had no reserves related to nonperformance
at December 31, 1998. TEP did not experience any material counterparty
default during the year ended December 31, 1998.
TEP also purchases coal and small amounts of 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 comprise only 3% of total generation. Changes in gas prices
do not present a material risk to TEP. See Fuel Supply for additional
information on TEP's coal contracts and gas purchases.
IMPACT OF THE YEAR 2000 ON COMPUTER SYSTEMS AND APPLICATIONS
- ------------------------------------------------------------
Our Year 2000 (Y2K) efforts began in 1996 and involve the inventory,
assessment, remediation and testing of our operational and business
systems. Our goal is to provide uninterrupted electric service and to
process business transactions at year 2000 and beyond. We believe that
all identified mission critical systems and applications within our
control will be Y2K ready by June 30, 1999. We believe that all identified
business critical systems and applications within our control will be
Y2K ready by September 30, 1999. Y2K ready means the systems have been
checked for date processing and are expected to operate properly for
their specific business requirements into year 2000.
State of Readiness
We have completed an inventory and assessment for each of TEP's
critical and non-critical information systems and embedded technologies.
The following areas are being addressed: control and embedded systems;
enterprise information systems; suppliers; and subsidiaries.
Control and Embedded Systems - We are reviewing the control and embedded
systems of TEP's utility plant including generation units partly owned
but not operated by TEP. Many of these systems are critical to the power
generation, transmission and distribution of electric service. The
inventory and assessment stages of this program were completed by
September 30, 1998.
The testing and remediation efforts are 77% complete for the critical
systems and are scheduled to be completed by June 30, 1999. Major
upgrades are in process for the Energy Management (SCADA) System and
for power generation systems. All protective field devices are prepared
for Y2K.
Enterprise Information Systems - We began the remediation, replacement,
or upgrade of these systems in 1996. We expect to complete this process
by the end of second quarter 1999. The following systems are included:
Department or Area Comments
- ------------------ --------
Customer Services, Billing, The Customer Information System is Y2K
Receivables ready. However, the current version
of the underlying software upon which
the system is built is not yet Y2K
compliant. We expect an updated
release of the software, which is Y2K
compliant, to be installed before the
end of the second quarter of 1999.
Human Resources, Payroll Y2K ready - System installed in 1993
and upgraded to be Y2K ready in 1998.
Work Management The system is Y2K ready. However, the
current version of the underlying
software upon which the system is
built is not Y2K compliant. We expect
an updated release of the software,
which is Y2K compliant, to be
installed before the end of the second
quarter of 1999.
General Ledger, Fixed Scheduled for replacement in second
Assets, Projects quarter 1999. Current systems are now
being remediated as a contingency with
scheduled completion date in second
quarter 1999.
Accounts Payable, Y2K ready - Remediation completed in
Purchasing, Inventory 1998.
Testing of the current general ledger and fixed assets applications
continued in the first quarter of 1999 to cover additional month end
closings. Upgrades to the operating system software are scheduled
through the second quarter 1999. An integrated test is then scheduled
for the third quarter 1999 of the enterprise hardware, operating software,
and major applications with year 2000 date processing.
Suppliers - We have identified the major vendors from whom we buy
goods or services for the generation, transmission and distribution
of electrical service. We are working with these vendors to determine
their plans and to investigate any potential impact on TEP. Major vendors
of other TEP business areas are also being reviewed for Y2K compliance.
Millennium Subsidiaries - We have contacted NEV, Nations Energy, and
Global Solar to determine their state of readiness. These companies
will be monitored to ensure plans are in place to avoid Y2K disruptions.
Costs
From 1996 through December 31, 1998, we have expensed $800,000
addressing the Y2K issue. This amount does not include major system
replacement costs that, along with other functional changes, addressed
Y2K issues. A $1.35 million budget has been established for Y2K project
costs, and all remediation costs will be expensed as incurred.
Risks
Currently we believe that all identified modifications to systems
that TEP operates will be made within the required time frames. Despite
our efforts, we cannot be certain that all Y2K problems with the systems
we operate will be identified and remediated in a timely manner. Although
we do not expect any of our potential Y2K problems to be major, it is
possible that such failure could disrupt the generation, transmission
or distribution of electric energy or the billing and collection process.
We cannot assure that the systems or parties we do not control
are prepared for Y2K, or how this may effect TEP. As an example, the loss
of communications systems supplied by our vendors could affect our ability
to operate generation and transmission facilities. Also, interruptions
of generating capacity could result from instability of the electric grid.
TEP and other electric service providers in the WSCC are studying possible
Y2K risks resulting from interconnected electric and information systems.
The interconnected systems are critical to the reliability and integrity of
each electric service provider. As an example, the failure of an
interconnected provider to meet Y2K readiness could possibly disrupt the
provision of electric services by utilities. TEP and other electric
providers in the WSCC are working together in an effort to avoid such
disruptions. TEP has scheduled compliance testing to coincide with the
first North American Electric Reliability Council (NERC) industry
coordinated drill on April 9, 1999 and the second drill on September 9,
1999.
Contingency Plans
We are preparing contingency plans for the possibility that not
all remediation efforts, both internal and external, will succeed. We are
documenting the events or scenarios that might significantly impact the
delivery of electric service, including loss of generation, communications,
and other conditions that could result n electric power outages. We are
attempting to minimize the potential impact of these events with our
draft contingency plan which we completed in 1998. The plan includes
developing procedures, tests, and drills to coincide with the WSCC and
NERC plans and is scheduled to be finalized by June 30, 1999.
RESULTS OF OPERATIONS
- ---------------------
In 1998, UniSource Energy's consolidated net income was $28.0
million or $0.87 per average share of common stock compared with $83.6
million or $2.60 per average share of common stock in 1997, and $120.9
million or $3.76 per average share of common stock in 1996.
The decline in earnings in 1998 resulted primarily from the absence
of non-cash income tax benefits related to prior period net operating
losses, compared to amounts of tax benefits recognized in prior years.
Losses from our unregulated energy businesses also reduced our consolidated
net income in both 1998 and 1997.
Contribution by Business Segment
The table below shows the contributions to our consolidated earnings
and earnings per share by our two business segments, as well as parent
company expenses.
Amount in $ Millions Per Share
-------------------- ---------
1998 1997 1998 1997
---- ---- ---- ----
Regulated Electric Utility $41.7 $88.9 $1.30 $2.77
Unregulated Energy Businesses (8.1) (5.3) (0.25) (0.17)
Parent Company (5.6) -- (0.18) --
----- ----- ----- -----
Consolidated Net Income (Loss) $28.0 $83.6 $0.87 $2.60
===== ===== ===== =====
TEP's regulated electric utility business accounts for substantially
all of UniSource Energy's assets, revenues, and net income. The following
discussion is related to TEP's utility operations, unless otherwise noted.
The results of our unregulated energy businesses are discussed in Results
of Unregulated Energy Businesses below. The results of the parent company
in 1998 relate to the after-tax interest expense on the note we provided
to TEP in exchange for the stock of Millennium. See Interest Income,
below. Prior to 1998, the unregulated energy businesses now held by
Millennium were held by and consolidated with TEP.
Utility Sales and Revenues
Retail sales of electricity are affected primarily by customer
growth, weather and other consumption factors. In addition to these
factors, price changes contribute to changes in retail revenues.
In 1998, kWh sales to retail customers increased by 2.1% compared
with 1997. This sales increase resulted from an increase in the average
number of retail customers. The average number of retail customers grew
by 2.2% to 320,744 in 1998. KWh sales to retail customers grew by 2.4%
in 1997 compared with 1996. The average number of retail customers
increased by 2.3% in 1997. Usage by mining customers increased in 1997
with the addition of service to a reactivated mine.
Revenues from sales to retail customers increased by less than
1.0% in 1998 compared with 1997. The increase in kWh sales noted above
was offset by the effect of a 1.1% across-the-board rate reduction
retroactive to July 1, 1998. In addition, TEP recorded a $4.4 million
reduction in revenues resulting from a change in the method of estimating
unbilled revenues. In 1997, revenues from sales to retail customers were
2.1% greater than in 1996 as a result of the higher kWh sales discussed
above. Lower average prices to large mining customers from contract
renegotiations and extensions somewhat offset the effects of higher KWh
sales in 1997.
TEP makes sales for resale on both a firm and interruptible basis
to the extent generating capacity is not needed for providing energy to
TEP's retail customers. TEP also enters into short-term energy sale
transactions that are offset by similar purchase transactions. See
Regulated Electric Utility Operations, Sales for Resale. Rates for
short-term energy sales are typically substantially below rates determined
on a fully allocated cost of service basis, but, in all instances, rates
exceed the level necessary to recover fuel and other variable costs.
KWh sales for resale increased by 32% in 1998 compared with 1997, while
revenues from sales for resale increased by 47% for the same period, driven
by higher market prices in the wholesale energy market. Factors
contributing to the higher market prices include higher natural gas
prices and the tightening of excess capacity in the region. In 1997, kWh
sales for resale increased by 2% while the related revenues increased
by 16% over 1996.
TEP's non-cash revenue from the Amortization of the MSR Option
Gain Regulatory Liability was zero in 1998, $8.1 million in 1997 and
$20.1 million in 1996. This regulatory liability was fully amortized
as of May 1997. If we exclude the revenue from the MSR Option Gain
amortization, total operating revenues would have been 7% higher in
1998 than in 1997 and 4% higher in 1997 than in 1996.
Fuel and Purchased Power Expense
Fuel and Purchased Power expense increased by 18% in 1998
compared with 1997. Fuel expense at TEP's generating plants actually
declined slightly, while purchased power costs more than doubled. This
increase in purchased power expense is related to the large increase in
wholesale energy sales in 1998. Fuel and Purchased Power expense increased
in 1997 relative to 1996 because of increased energy requirements to meet
increased kWh sales. See Market Risks, Commodity Price Risk, above. The
average cost of fuel per kWh generated was 1.70 cents, 1.77 cents, and 1.83
cents for 1998, 1997, and 1996, respectively. In 1998 and 1997, fuel
expense included $3.8 million and $1.9 million related to the amortization
of the $50 million contract termination fee paid to TEP's major coal
supplier. See Note 2 of Notes to Consolidated Financial Statements,
TEP's Regulatory Assets and Liabilities, Deferred Springerville Coal
Termination Fee.
Other Operating Expenses
Excluding the increase in Fuel and Purchased Power expense, other
operating expenses were slightly lower in 1998 compared with 1997.
Significant changes in specific operating expense categories in 1998
compared with 1997 or in 1997 compared with 1996 are described below.
Expenses related to consulting fees caused Other Operations
expense to increase in 1997 compared with 1996. Such consulting fees
consisted of payments to NEV made prior to the exercise in September 1997
of the option to acquire a 50% interest in NEV.
Depreciation and Amortization expense increased in 1998 over 1997 due
to depreciation on additions to property in 1998. Depreciation and
Amortization expense was lower in 1997 relative to 1996. In January 1997,
TEP completed a three year amortization (at a rate of $14 million per year)
of Springerville Unit 2 rate synchronization costs established in the 1994
Rate Order. TEP also extended the depreciable life for its pollution
control facilities as required by the 1996 Rate Order.
Taxes Other Than Income Taxes decreased in 1997 versus 1996. A
charge of $7.3 million was recorded in the third quarter of 1996 related
to a court ruling on contested sales tax assessments. Lower property
taxes in 1997 also contributed to the variance. See Note 10 of Notes to
Consolidated Financial Statements, Contingencies.
Voluntary Severance Plan Expense of $2.9 million in 1997 represents
VSP expense related to post-retirement benefits other than pensions
recorded in the first quarter. The $10.6 million net expense in 1996
reflects implementation of TEP's Voluntary Severance Plan in the second
quarter of 1996 and related pension settlements. The VSP was accepted by
approximately 200 employees, or 15% of the total workforce.
Income tax expense included in Operating Expenses increased in 1997
compared with 1996 related to an increase in pre-tax operating income,
net of interest expense.
Other Income (Deductions)
Income Tax Benefits
UniSource Energy and TEP recognized zero, $43.4 million and $88.6
million of NOL benefit in 1998, 1997 and 1996, respectively. This
reduced NOL benefit recognition and changes in tax expense resulting from
changes in income before taxes, caused the 1998 income tax benefits
included in Other Income (Deductions) to decrease by $34.0 million and
$40.6 million for UniSource Energy and TEP, respectively, from 1997 levels.
For the same reasons, the 1997 income tax benefits included in Other Income
(Deductions) decreased by $53.5 million and $50.5 million for UniSource
Energy and TEP, respectively, from 1996 levels.
UniSource Energy and TEP recognize NOL benefits based on changes in
the estimated amount of prior period NOLs that are likely to be used on
future tax returns. A significant factor in estimating this amount is the
average annual book income before taxes for the prior three years. In
future periods when the NOLs are used on tax returns to reduce income
taxes paid, the income tax expense shown on the income statements will not
be reduced.
At December 31, 1997, both UniSource Energy and TEP had recorded the
amount of prior period NOL benefit that we expect to use on future income
tax returns. At the present time, we are not able to estimate additional
amounts of NOL benefit that we may recognize in the income statements of
either UniSource Energy or TEP. This is because there are still open tax
years for which additional assessments may be made and because federal and
state NOL carryforwards expire at various dates. We do not expect to
recognize additional amounts of NOL benefit until these items are resolved.
Reversal of Loss Provision
TEP recorded a $10.2 million Reversal of Loss Provision in the
second quarter of 1997 when it dissolved certain subsidiaries which were
part of TEP's former investment operations. TEP recorded an $8.5 million
Reversal of Loss Provision in 1996 when TEP's non-energy related
subsidiaries satisfied approximately $8.5 million of short-term debt
obligations by assigning finance receivables held by those subsidiaries.
Interest Income
TEP's income statement for 1998 includes $9.3 million of interest
income on the promissory note TEP received from UniSource Energy in
exchange for the transfer of its stock in Millennium. See Note 1 of
Notes to the Consolidated Financial Statements, Nature of Operations
and Summary of Significant Accounting Policies, Basis of Presentation.
On UniSource Energy's income statement, this income is eliminated as an
inter-company transaction.
Income (Losses) from Unregulated Energy Businesses
Our Unregulated Energy Business Investments contributed a netloss of
$8.1 million in 1998, compared with a net loss of $5.3 million in 1997 and
a net loss of $2.3 million in 1996. See Results of Unregulated Energy
Businesses, below for more information on the results of this business
segment.
Interest Expense
Interest expense increased in 1998 relative to 1997. Higher letter of
credit fees for TEP's new Credit Agreement, as well as higher interest
rates from the refinancing of certain variable rate debt obligations with
fixed rate debt obligations accounted for a substantial part of the
increase. TEP also incurred higher interest expense in 1998 when new bonds
were issued and interest expense was accrued for periods up to 75 days
before the redemption of old bonds. These refinancings benefit TEP by
extending debt maturities and reducing the risk of changes in variable
interest rates. In December 1998, TEP redeemed $30 million of its 8.50%
First Mortgage Bonds due in 2009. This redemption will reduce interest
expense in future periods.
Interest Expense on Long-Term Debt increased in 1997 over 1996 as a
result of the refinancing of certain variable and fixed rate debt
obligations with unsecured fixed rate debt obligations, having later
maturity dates, at higher interest rates, as well as higher average
interest rates on TEP's variable rate debt obligations. The weighted
average interest rate on TEP's tax-exempt variable rate debt obligations
was 3.7% in 1997 and 3.5% in 1996, excluding letter of credit fees.
See Investing and Financing Activities, Bond Issuance and
Redemption, and Note 7 of Notes to the Consolidated Financial Statements,
TEP's Long-Term Debt and Capital Lease Obligations.
Other Interest Expense was lower in 1997 than in 1996 due to
$1.9 million in interest expense incurred in the third quarter of1996
related to the 1996 contested sales tax assessment of $7.3 million.
RESULTS OF UNREGULATED ENERGY BUSINESSES
The table below provides a breakdown by subsidiary of the net
losses recorded by our Unregulated Energy Businesses for the three
years ended December 31, 1998.
Amounts in $ Millions
- --------------------------------------------------------------------
Subsidiary 1998 1997 1996
- --------------------------------------------------------------------
AET $(0.3) $(0.6) $(0.1)
MEH (9.2) (4.5) --
Nations Energy 1.4 0.2 (2.1)
Other 0.0 (0.4) (0.1)
- --------------------------------------------------------------------
Total Millennium $(8.1) $(5.3) $(2.3)
- --------------------------------------------------------------------
AET and Global Solar
AET's net losses in the period 1996 through 1998 represent ongoing
developmental costs at its 50% owned investment, Global Solar. Small-
scale manufacturing of thin film photovoltaic cells is scheduled to begin
in 1999.
MEH and NEV
Net losses from MEH's equity investment in NEV were the primary
contributors to net losses at Millennium in 1998 and 1997. NEV's losses
in 1998 resulted from:
-- narrow margins on energy sales;
-- gross margin that does not yet support administrative costs,
including start-up costs associated with expansion into
additional regions of the country; and
-- recognition of one-time losses from adverse sales commitments
resulting from contracts made prior to the start of operations.
NEV's losses in 1997 resulted primarily from start-up costs for
business development in anticipation of the opening of the California
electricity market to competition in 1998. In addition to amounts
recorded as losses from unregulated businesses in 1997, TEP recorded an
additional $6.3 million (pre-tax) in consulting expenses related to NEV.
These funds were paid to NEV during the first eight months of 1997,
prior to the exercise of the option to acquire a 50% interest in NEV.
NEV incurred a total loss of $47 million for the period September
1997 through December 1998. In 1998 and 1997, MEH recorded $16 million
and $7.8 million, respectively, of NEV's losses. These losses, totaling
$23.8 million, equal the total funds and unsecured commitments provided
by MEH and UniSource Energy to NEV. The amount of NEV's loss to be
recorded by MEH is limited to the total amount invested and committed by
MEH and UniSource Energy on an unsecured basis. Should MEH or UniSource
Energy provide additional unsecured funding to NEV, or should there be a
decline in the value of the collateral which secures the outstanding
secured loans from UniSource Energy to NEV, the unsecured amounts provided
would be immediately expensed up to the lesser of the amount of unsecured
funding provided or the amount of NEV's cumulative losses in excess of the
$23.8 million already recorded by MEH. While UniSource Energy does not
currently have plans to extend additional unsecured amounts, there can be
no assurance that additional funding will not be necessary.
See Investing and Financing Activities, UniSource Energy, Parent
Company Financing Activities, Loans and Guarantees, below.
Nations Energy
Nations Energy reported net income of $1.4 million in 1998. A
$5.8 million after-tax gain on the sale of a 48% investment in Trigen-
Nations Energy was largely offset by expenses for new project development.
In 1997, Nations Energy reported a small profit, primarily due to its
share of partnership income from its investment in Trigen-Nations Energy,
which exceeded expenses recorded for new project development. Nations
Energy is also exploring external financing options to support its growth
in new projects. There can be no assurance that any such financing will
be obtained.
DIVIDENDS ON COMMON STOCK
- -------------------------
UniSource Energy
Our ability to pay cash dividends on common stock outstanding
depends, in part, on the cash flow from our subsidiary companies, TEP and
Millennium. TEP is our primary operating subsidiary and comprises
substantially all of UniSource Energy's assets. In December 1998, TEP
declared and paid a $30 million cash dividend to UniSource Energy.
Our Board of Directors may consider the declaration and payment
of a cash dividend to the common shareholders of UniSource Energy during
1999. We will consider several factors in making this decision, including:
-- the capital needs of our affiliates;
-- our earnings;
-- our business prospects; and
-- the impact and status of deregulation in Arizona.
TEP
In December 1998, TEP declared and paid a dividend of $30 million
UniSource Energy, its sole shareholder. TEP declared the dividend from
current year earnings since TEP has an accumulated deficit, rather than
positive retained earnings.
TEP had not paid a dividend since 1989. TEP suspended its dividend
in 1989 due to financial difficulties which led to the Financial
Restructuring in 1992. After the Financial Restructuring, TEP did not pay
a dividend due, in part, to various restrictions in its debt agreements.
During 1998, TEP redeemed or exchanged those series of First Mortgage Bonds
that previously prevented TEP from paying dividends unless specific cash
flow coverage and retained earnings tests were met. See Investing and
Financing Activities, below.
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 December 31,
1998, the required minimum net worth was $183 million. TEP's actual net
worth at December 31, 1998 was $230 million. See Investing and Financing
Activities, TEP Bank Credit Agreement, below. As of December 31, 1998,
TEP was in compliance with the terms of the Credit Agreement.
The ACC Holding Company Order states that TEP may not pay dividends
to UniSource Energy in excess of 75% of its earnings until TEP's equity
ratio equals 37.5% of total capital (excluding capital lease obligations).
As of December 31, 1998, TEP's equity ratio on that basis was 16.3%. TEP
is in compliance with this order.
In addition to these limitations, the Federal Power Act states
that dividends shall not be paid out of funds properly included in the
capital account. Although the terms of the Federal Power Act are unclear,
we believe that there is a reasonable basis to pay dividends from current
year earnings.
INCOME TAX POSITION
- -------------------
At December 31, 1998, UniSource Energy and TEP had, for federal income
tax purposes:
-- $377 million of NOL carryforwards expiring in 2005 through
2009;
-- $23 million of unused ITC expiring in 2002 through 2005;
-- $18 million of AMT credit which will carry forward to
future years.
Due to the issuance of common stock to various creditors of TEP in
1992, a change in TEP ownership was deemed to have occurred for tax
purposes in December 1991. As a result, our use of the NOL and ITC
generated before 1992 may be limited under the tax code. The IRS is
challenging our calculation of this limitation. See Income Tax Assessments
in Note 10 of Notes to Consolidated Financial Statements. At December 31,
1998, pre-1992 federal NOL and ITC carryforwards which are subject to the
limitation were approximately $209 million and $23 million, respectively.
The $168 million of post-1992 federal NOL at December 31, 1998, is not
subject to the limitation.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CASH FLOWS
Overview of UniSource Energy Cash Flows and Liquidity
Net cash flows from operating activities increased in aggregate by
$36 million in 1998 compared with 1997. The increase was mainly due to
lower cash payments for contract termination fees to the Springerville
coal supplier. TEP paid $10 million to the coal supplier in 1998 compared
to a payment of $40 million in 1997. See Note 2 of Notes to Consolidated
Financial Statements, TEP Regulatory Assets and Liabilities, Deferred
Springerville Contract Termination Fee. Excluding contract termination
fee payments, net cash flows from operating activities increased by $7
million to $173 million from $166 million in 1997.
Net cash outflows for investing activities increased by $34 million
in 1998 compared with 1997. Construction expenditures at TEP increased by
$9 million, while investments and loans to Unregulated Energy Businesses
increased by $25 million. See Investing and Financing Activities, below
for a discussion of historical and forecasted construction expenditures
and investments in unregulated energy businesses.
Net cash outflows for financing activities increased in aggregate by
$19 million in 1998 compared with 1997. TEP completed several bond
issuance transactions in 1998 and used the proceeds to redeem First
Mortgage Bonds that prohibited the payment of dividends. In addition,
in December 1998, TEP redeemed $30 million of its 8.50% First Mortgage
Bonds due in 2009 to reduce interest expense in future periods. See
Investing and Financing Developments below.
As a result of activities described above, cash and cash equivalents
decreased by $1 million from the 1997 year-end balance of $146 million to
the 1998 year-end balance of $145 million. Our consolidated cash balance,
including cash equivalents, at March 8, 1999, was approximately $96
million. We invest cash balances in high-grade money market securities
with an emphasis on preserving the principal amounts invested.
During 1999, UniSource Energy will require cash to fund all or
some of the following activities: investments in our Unregulated Energy
Businesses, payment of interest on the promissory note to TEP, and
dividends to shareholders. We expect our sources of cash to be dividends
from our subsidiaries, primarily TEP. Although no specific offerings are
currently contemplated, UniSource Energy may also issue debt and/or equity
securities from time to time. Our cash flows may be subject to variation
if TEP's actual earnings differ from forecasts and the availability and
cost of new capital. If cash flows were to fall short of expectation, we
would reevaluate the investment requirements of our Unregulated Energy
Businesses and/or seek additional financing for those businesses by
unrelated parties.
TEP Cash Flows and Liquidity
TEP's net cash flows from operating activities increased in
aggregate by $56 million in 1998 compared with 1997. The increase was
mainly due to lower cash payments for contract termination fees to the
Springerville coal supplier. TEP paid $10 million to the coal supplier
in 1998 compared to a payment of $40 million in 1997. See Note 2 of
Notes to Consolidated Financial Statements, TEP's Regulatory Assets and
Liabilities, Deferred Springerville Contract Termination Fee. Excluding
contract termination fee payments, net cash flows from operating
activities increased by $26 million to $192 million from $166 million
in 1997.
Net cash outflows for investing activities increased by $50 million
in 1998 compared with 1997. Construction expenditures at TEP increased
by $9 million, while investments and loans to Unregulated Energy
Businesses decreased by $5 million. Prior to January 1, 1998, the
Unregulated Energy Businesses were subsidiaries of TEP. Additionally,
the transfer of Millennium and its $45 million of cash from TEP to
UniSource Energy on January 1, 1998 is reflected as a use of cash on
TEP's statement of cash flows. The subsidiaries holding that cash were
subsidiaries of TEP at year-end 1997, and became subsidiaries of UniSource
Energy on January 1, 1998. See Investing and Financing Activities, below
for a discussion of historical and forecasted construction expenditures.
Net cash outflows for financing activities increased in aggregate
by $50 million in 1998 compared with 1997. In addition to the bond
issuance and redemption activity described above, TEP paid a $30 million
cash dividend to UniSource Energy in the fourth quarter of 1998. See
Investing and Financing Activities below.
As a result of activities described above, TEP's cash and cash
equivalents decreased by $28 million from the 1997 year-end balance of
$146 million to the 1998 year-end balance of $118 million. TEP's
consolidated cash balance, including cash equivalents, at March 8, 1999,
was approximately $76 million.
After capital expenditures, scheduled debt maturities and payments
to retire capital lease obligations, TEP's net cash flows available for
other investing and financing activities were $83.0 million in 1998,
$40.1 million in 1997, and $36.8 million in 1996. During 1999, TEP
expects to generate sufficient internal cash flows to fund its operating
activities, construction expenditures, required debt maturities, and to
pay dividends to UniSource Energy. However, TEP's cash flows may vary
due to changes in wholesale revenues, changes in short-term interest
rates, and other factors. If cash flows were to fall short of expectations,
TEP would rely on existing cash balances and, if necessary, borrowings
under the Revolving Credit.
INVESTING AND FINANCING ACTIVITIES
TEP-REGULATED ELECTRIC UTILITY
------------------------------
Capital Expenditures
TEP's actual capital expenditures for the years 1996 through 1998,
along with estimated amounts for the years 1999 through 2003, are shown
below:
($ in millions)
-------------------------------------------
Actual Estimated
-------------------------------------------
1996 $ 68 1999 $ 88
1997 72 2000 72
1998 81 2001 75
2002 68
2003 64
-------------------
TOTAL $367
===================
The estimated capital expenditures for the five years 1999-2000 break
down in the following categories:
-- $237 million for transmission, and distribution and corporate
facilities in the Tucson area.
-- $124 million for existing production facilities.
-- $4 million to upgrade pollution control facilities at Navajo.
See Item 1., Business, Environmental Matters.
-- $2 million for pollution control facilities at San Juan. See
Item 1., Business, Environmental Matters.
These estimated expenditures include costs for TEP to comply with
current federal and state environmental regulations. All of these
estimates are subject to continuing review and adjustment. Actual
construction expenditures may be different from these estimates due to
changes in business conditions, construction schedules, environmental
requirements, and changes to our business arising from retail competition.
TEP plans to fund these expenditures through internally generated cash
flow.
Bond Issuance and Redemption
During 1998, TEP issued $386.9 million in new bonds and redeemed
$416.4 million of bonds. TEP achieved the following objectives with
this refinancing activity:
-- extended maturities,
-- replaced variable rate debt with fixed rate debt, and
-- eliminated restrictive covenants contained in existing
First Mortgage Bonds.
Bonds Issued in 1998
---------------------
Amount Rate Maturity Security
----------------------------------------------------------------------
($ millions)
1998 Apache A IDBs $ 83.7 5.85% 2028 Unsecured
1998 Apache B IDBs 99.8 5.875% 2033 Unsecured
1998 Apache C IDBs 16.5 5.85% 2026 Unsecured
12.22% Exchange Series
FMBs 46.9 12.22% 2000 First Mortgage
First Collateral Trust
Bonds,7.50% Series 140.0 7.50% 2008 First Mortgage Bonds
-----------------------------------------------------------------------
Total $386.9
=======================================================================
The 12.22% Exchange Series First Mortgage Bonds were issued in
exchange for the same amount of outstanding bonds having substantially
the same terms, except that the new bonds do not have a covenant
restricting the payment of dividends.
The First Collateral Trust Bonds are collateralized by an equal
principal amount of bonds issued under TEP's General First Mortgage
and held by the trustee. If the General First Mortgage is discharged,
these First Mortgage Bonds would be replaced with an equal amount of
bonds issued under the General Second Mortgage. If the General Second
Mortgage is discharged, these Second Mortgage Bonds would be surrendered
and the First Collateral Trust Bonds would become unsecured obligations
of TEP.
Bonds Redeemed in 1998
----------------------
Amount Rate Maturity Security
--------------------------------------------------------------------------
($ millions)
1981 Apache A IDBs $100.0 Variable 2020 Second Mortgage Bonds
1981 Apache B IDBs 100.0 Variable 2021 First Mortgage Bonds
First Mortgage Bonds 15.0 8.50% 1999 First Mortgage
First Mortgage Bonds 25.0 8.125% 2001 First Mortgage
First Mortgage Bonds 40.0 7.65% 2003 First Mortgage
First Mortgage Bonds 25.0 7.55% 2002 First Mortgage
First Mortgage Bonds 78.8(a) 12.22% 2000 First Mortgage
First Mortgage Bonds 32.1 8.50% 2009 First Mortgage
1976 Farmington
(sinking fund) 0.5 7.50% 2006 First Morgage Bonds
--------------------------------------------------------------------------
Total $416.4
==========================================================================
(a) $31.9 million were redeemed and $46.9 million were
surrendered in exchange for the newly issued 12.22%
Exchange Series Bonds.
When TEP redeemed all of its First Mortgage Bonds due in 1999, 2001,
2002, and 2003, as well as the $31.9 million of 12.22% First Mortgage Bonds
due 2000 not tendered for exchange as described above, it eliminated
covenants that prohibited the payment of common stock dividends. See
Dividends on Common Stock.
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 Second Mortgage Bonds ($441 million aggregate
principal amount). The Credit Agreement contains several financial
covenants, including interest coverage, leverage and net worth tests.
As of December 31, 1998, TEP was in compliance with these financial
covenants. See Restrictive Covenants below.
The original amount of the Credit Agreement was $544 million.
During 1998, TEP redeemed its $100 million 1981 Series A Apache County
Pollution Control Revenue Bonds. These bonds were supported by a $103
million letter of credit provided under the Credit Agreement. When the
bonds were redeemed, the letter of credit supporting the bonds was
cancelled and the Credit Agreement decreased by $103 million.
If TEP borrows under the Revolving Credit Facility, the borrowing
costs would be at a variable interest rate consisting of a spread over
LIBOR or an alternate base rate. The spread is based upon a pricing grid
tied to the credit rating on TEP's senior secured debt. Also, TEP pays a
commitment fee on the unused portion of the Revolving Credit Facility, and
a fee on the Letter of Credit Facility. These fees are also dependent on
TEP's credit ratings. At December 31, 1998, the commitment fee was 0.375%
per year, and the letter of credit fee (excluding letter of credit fronting
fees of 0.125%) was 1.375% per year. TEP had no borrowings outstanding
under the Revolving Credit Facility at December 31, 1998.
Springerville Common Facilities Leases
Under the terms of the Springerville Common Facilities lease
agreement, the secured notes underlying this lease must be refinanced or
refunded by December 31, 1999 in order to avoid a special event of loss
under the lease. If a special event of loss were to occur, TEP would be
required to repurchase the facilities for an amount equal to the higher
of the stipulated loss value ($144 million) or the fair market value of
the facilities. Upon such purchase, the lease would be terminated. Based
on the current amortization schedule for these notes, a principal amount
of approximately $70 million will be outstanding as of December 31, 1999.
Interest on the lease notes is currently paid at a variable rate of
interest equal to the Federal Funds rate plus 0.625%. TEP has the intent
and the ability to cause the underlying debt on these leases to be
refinanced in 1999.
Tax-Exempt Local Furnishing Bonds
TEP has financed a substantial portion of utility plant assets with
industrial development revenue bonds issued by the Industrial Development
Authorities of Pima County and Apache County. The interest on these bonds
is excluded from gross income of the bond holder for federal tax purposes.
This exclusion is allowed because the facilities qualify as facilities for
the local furnishing of electric energy as defined by the Internal Revenue
Code. These bonds are sometimes referred to as tax-exempt local furnishing
bonds. To qualify for this exclusion, the facilities must be part of a
system providing electric service to customers within not more than two
contiguous counties. TEP provides electric service to retail customers
in the City of Tucson and certain other portions of Pima County, Arizona
and to Fort Huachuca in contiguous Cochise County, Arizona.
As of December 31, 1998, TEP had approximately $580 million of
tax-exempt local furnishing bonds outstanding. In addition, approximately
$98 million of debt related to the Irvington Unit 4 lease obligation was
issued as tax-exempt local furnishing bonds. TEP has financed the
following facilities, in whole or in part, with the proceeds of tax-exempt
local furnishing bonds: Springerville Unit 2, Irvington Unit 4, a dedicated
345-kV transmission line from Springerville Unit 2 to TEP's retail service
area (the Express Line), and a portion of TEP's local transmission and
distribution system in the Tucson metropolitan area.
Any of the following events might cause TEP to have to redeem or
defease some or all of these bonds:
-- the introduction of retail competition in Arizona;
-- asset divestiture;
-- changes in tax laws; or
-- changes in system operations.
The introduction of retail competition and expanded wholesale competition
could affect TEP's system. However, TEP does not expect its system to
change in a manner that would cause a loss of tax exemption on its
tax-exempt local furnishing bonds. For example, TEP does not expect to
lose its qualification as a local furnishing system if an independent
system operator is established (see Item 1. Business, Rates and Regulation,
Wholesale Transmission Access) or due to future sales of electricity on a
competitive retail basis outside of the current two-county service area.
However, if TEP were to divest its generating assets or to change its use
of the Express Line, up to $325 million of tax-exempt local furnishing
bonds might have to be redeemed or defeased by TEP. TEP cannot provide
assurances as to the continued qualification of its local furnishing
facilities, in whole or in part, as a result of the possible events listed
above.
Restrictive Covenants
General First Mortgage Covenants
--------------------------------
TEP's General First Mortgage creates a first mortgage lien on and
security interest in most of TEP's utility plant assets. Springerville
Unit 2, which is owned by San Carlos, is not subject to this lien and
security interest. Under the General First Mortgage TEP may issue
additional First Mortgage Bonds on the basis of:
(1) up to 60% of net utility property additions; and
(2) the principal amount of retired First Mortgage Bonds.
In general, the amount of First Mortgage Bonds that TEP can issue is
also subject to a net earnings test. The test must show that TEP's
net earnings for 12 consecutive months within the preceding 15 months are
at least two (2.0) times the annual interest requirements on all
outstanding First Mortgage Bonds (including the new bonds).
At December 31, 1998, TEP had the ability to issue approximately
$26 million of new First Mortgage Bonds on the basis of property additions,
as described above. TEP also had the ability to issue about $475 million
of new First Mortgage Bonds on the basis of retired First Mortgage Bonds.
However, TEP's Credit Agreement allows no more than $411 million of
First Mortgage Bonds to be outstanding. There were $278 million of First
Mortgage Bonds outstanding at December 31, 1998. Additionally, the
Credit Agreement contains certain financial covenants that limit the amount
of new debt obligations TEP may issue. See Credit Agreement Covenants
below. Currently, TEP has no plans to issue additional First Mortgage
Bonds.
General Second Mortgage Covenants
---------------------------------
TEP's General Second Mortgage creates a second mortgage lien on and
security interest in most of TEP's utility plant assets. This lien does
not cover assets owned by San Carlos. Under the General Second Mortgage
TEP may issue additional Second Mortgage Bonds on the basis of:
(1) up to 70% of net utility property additions; and
(2) the principal amount of retired First and Second Mortgage
Bonds.
In general, the amount of Second Mortgage Bonds that TEP can issue
is also subject to a net earnings test. The test must show that TEP's net
earnings for 12 consecutive months within the preceding 16 months are at
least 1 3/4 times the annual interest requirements on all outstanding
First Mortgage Bonds and Second Mortgage Bonds (including the new bonds).
If TEP issued Second Mortgage Bonds based on retired First Mortgage
Bonds, the amount of retired First Mortgage Bonds available to issue new
First Mortgage Bonds would be reduced by the same amount.
At December 31, 1998, TEP had the ability to issue about $546
million of new Second Mortgage Bonds on the basis of net property additions
as described above. Also, TEP had the ability to issue approximately $628
million of new Second Mortgage Bonds on the basis of retired bonds. Using
an interest rate of 7.5%, the net earnings test would allow such new
issuances of Second Mortgage Bonds. These calculations assume that no
additional First Mortgage Bonds would be issued other than to refund First
Mortgage Bonds outstanding at December 31, 1998. However, issuance of
these amounts would be limited by financial covenants in TEP's bank Credit
Agreement. See Investing and Financing Activities, TEP Bank Credit
Agreement and Restrictive Covenants, Credit Agreement Covenants for
information regarding the Credit Agreement which is secured by $441
million in aggregate principal amount of Second Mortgage Bonds.
Credit Agreement Covenants
--------------------------
TEP's Credit Agreement contains a number of restrictive covenants
including restrictions on:
-- additional indebtedness,
-- liens,
-- sale of assets or mergers, and
-- sale-leasebacks.
TEP must also maintain several financial covenants. The table below
includes a brief description of each covenant, the requirement and TEP's
actual results for the period ended December 31, 1998.
December 31, 1998
---------------------------------
Covenant Requirement Actual
- -------------------------------------------------------------------
c>
Minimum Consolidated Tangible
Net Worth (equal to the sum of
$133 million plus 40% of
cumulative Consolidated Net
Income since January 1, 1997) $183 million $230 million
Minimum Cash Coverage Ratio 1.3 1.6
Maximum Leverage Ratio 7.0 6.4
See Dividends on Common Stock for a discussion of the effects
of such covenants on TEP's ability to declare or pay dividends.
See Investing and Financing Activities, TEP Bank Credit Agreement
for more information regarding the Credit Agreement.
MILLENNIUM--UNREGULATED ENERGY BUSINESSES
-----------------------------------------
Capital Requirements
Our Unregulated Energy Businesses owned by Millennium required
significant amounts of capital in 1998 and we expect these needs to
continue in the near future. Actual investments in and loans to
Unregulated Energy Business, net of distributions from joint
ventures, for the years 1996 through 1998, and forecasted amounts
for the years 1999 through 2001 are shown below:
($ millions)
---------------------------------------------
Actual Forecast
---------------------------------------------
1996 $ 9 1999 $ 30
1997 5 2000 35
1998 30 2001 20
The $30 million in capital for 1998 was invested in the
following subsidiaries:
-- $33 million of funding to NEV.
-- $2 million of investments in AET and Global Solar.
-- offset by $5 million in net cash inflows from Nations
Energy. Cash proceeds of $21 million from the sale of
Nations Energy's investment in the Coors project exceeded cash
requirements of $15 million for other investments by Nations
Energy in 1998.
Forecasted investments for the years 1999-2001 are subject to
continuing review and revision. These forecasts contain assumptions
for each subsidiary regarding investment opportunities, growth strategies,
and potential investments by unaffiliated parties. Actual expenditures
may be higher or lower than these forecasts, or may be allocated to our
businesses in proportions different than planned. Our ability to fund
future capital requirements of our unregulated business segment will
depend to a great extent on the amount and predictability of the
dividends we receive from our primary operating subsidiary, TEP.
UNISOURCE ENERGY-PARENT COMPANY FINANCING ACTIVITIES
----------------------------------------------------
Promissory Note to TEP
On January 1, 1998, TEP and UniSource Energy completed a transaction
by which all outstanding shares of TEP common stock were exchanged, on a
share-for-share basis, for shares of UniSource Energy common stock.
Following the share exchange, TEP transferred the stock of its subsidiary,
MEH Corporation (now Millennium) to UniSource Energy in exchange for a
$95 million ten-year promissory note from UniSource Energy. The
promissory note was issued in accordance with the ACC Order authorizing
the formation of the holding company. The interest rate on the note
issued to TEP is 9.78%. Interest is payable every two years beginning
January 1, 2000.
Warrant Exchange Offer
From August 18, 1998 through October 23, 1998, UniSource Energy
offered to exchange outstanding warrants previously issued by TEP.
At the time of the exchange offer, there were approximately 12.1 million
aggregate number of TEP Warrants outstanding. TEP Warrants entitle the
holder of five warrants to purchase one share of TEP common stock for
$16.00. Currently, UniSource Energy owns 100% of the common stock of TEP
and TEP common stock is not publicly traded. In order to provide TEP
Warrant holders with the opportunity to obtain warrants exercisable into
UniSource Energy common stock, which is listed and has an established
market, we offered to exchange UniSource Energy Warrants for TEP Warrants.
Each whole new UniSource Energy Warrant entitles the holder to purchase
one share of UniSource Energy common stock for $16.00. For each TEP
Warrant, the tendering holders received:
-- 0.20 UniSource Energy Warrant, expiring March 15, 1999; and
-- 0.20 UniSource Energy Warrant, expiring December 15, 2000.
The warrant exchange offer expired on October 23, 1998. Approximately
1.5 million UniSource Energy Warrants of each series were issued in
exchange for approximately 7.5 million tendered TEP Warrants.
Approximately 4.6 million TEP Warrants were not tendered for exchange and
retain the right to purchase, upon payment of the exercise price, TEP
common stock. The shares of TEP common stock issued as a result of any
exercise of TEP Warrants would not be exchangeable for UniSource Energy
common stock.
Direct Stock Purchase Plan
UniSource Energy established a direct stock purchase plan, called
the Investment Plus Plan, in the third quarter of 1998. The Investment
Plus Plan provides a method of investing directly in our common stock
without brokerage commissions or service charges.
Restrictions on Proceeds of Equity Issuance
Pursuant to the ACC Holding Company Order, 60% of the proceeds
of any public equity issuance undertaken by UniSource Energy in its
first five years of operations must be used to reduce TEP's debt or
add to TEP's equity account.
Loans and Guarantees
Effective September 1, 1997, MEH exercised an option to acquire a
50% ownership in NEV and made a $0.8 million capital contribution.
In December 1997, MEH committed to provide NEV with $20 million of
funding. At December 31, 1998, NEV had received $19 million in debt
funding under the commitment, resulting in a remaining commitment amount
available of $1 million at January 31, 1999. Additionally, in September
1998, NEV issued a $4.8 million promissory note to MEH for a $3 million
member loan MEH extended to NEV in September 1997, as well as preferred
operating return due MEH under the terms of NEV's original operating
agreement.
In December 1998, UniSource Energy committed $30 million in
credit to NEV. NEV has drawn $15 million on the credit commitment at
December 31, 1998. Under the terms of the commitment, NEV must provide
collateral prior to any amounts being drawn under this credit commitment.
Additionally, in August 1998, UniSource Energy guaranteed a $10
million loan that NEV obtained from an unrelated party. That loan is due
in 1999. UniSource Energy is the guarantor of $33.6 million of performance
bonds and other guarantees that secure amounts NEV may owe to the utility
distribution companies (UDCs) and energy suppliers in connection with
NEV's sales to retail electric customers. NEV bills its customers for
these charges. UniSource Energy's guarantees are secured by various NEV
accounts receivable and other assets.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
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 Annual Report on Form 10-K. Forward-looking statements
include statements concerning plans, objectives, goals, strategies,
future events or performance and underlying assumptions and other
statements which 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 which
could cause actual results or outcomes to differ materially from those
expressed in the forward-looking statements. We express our expectations,
beliefs and projections in good faith and believe them to have a
reasonable basis. However, we make no assurances that management's
expectations, beliefs or projections will be achieved or accomplished.
We have identified the following important factors that could cause
actual results to differ materially from those discussed in our forward-
looking statements. These may be in addition to other factors and matters
discussed in other parts of this report:
1. Effects of restructuring initiatives in the electric industry
and other energy-related industries.
2. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
3. Changes affecting TEP's cost of providing electrical service
including changes in fuel costs, generating unit operating
performance, interest rates, tax laws, environmental laws, and
the general rate of inflation.
4. Changes in governmental policies and regulatory actions with
respect to allowed rates of return, financings, and rate
structures.
5. Changes affecting the cost of competing energy alternatives,
including changes in available generating technologies and
changes in the cost of natural gas.
6. Changes in accounting principles or the application of such
principles to UniSource Energy or TEP.
7. Y2K disruptions resulting from unidentified or unremediated
problems for systems which we control, and Y2K disruptions
resulting from systems or parties which we do not control.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -----------------------------------------------------------------------
See Item 7. _ Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of
Operations, Market Risks.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- -----------------------------------------------------------------------
See Item 14, page 116, for a list of the Consolidated Financial
Statements which are included in the following pages. See Note 17
of Notes to Consolidated Financial Statements.
INDEPENDENT AUDITORS' REPORT
UniSource Energy Corporation and its Stockholders
Tucson Electric Power Company
We have audited the accompanying consolidated balance sheets and
statements of capitalization of UniSource Energy Corporation and its
subsidiaries (the Company) as of December 31, 1997, and the related
consolidated statements of income, changes in stockholders' equity
(deficit), and cash flows for each of the two years in the period
ended December 31, 1997. We have also audited the accompanying
consolidated balance sheets and statements of capitalization of
Tucson Electric Power Company and its subsidiaries (TEP) as of
December 31, 1997, and the related consolidated statements of income,
changes in stockholder's equity (deficit), and cash flows for each of
the two years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's and TEP's management.
Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of the Company and TEP
at December 31, 1997, and the results of their operations and their cash
flows for each of the two years in the period ended December 31, 1997
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Tucson, Arizona
February 23, 1998 (March 11, 1999 as to information with respect to
1997 and 1996 periods in Note 4 and in Note 12)
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
In our opinion, the accompanying consolidated balance sheets and
statements of capitalization and the related consolidated statements
of income, of changes in stockholders' equity, and of cash flows
present fairly, in all material respects, the financial position of
UniSource Energy Corporation and its subsidiaries (the Company) and
Tucson Electric Power Company and its subsidiaries (TEP) at December
31, 1998, and the results of their operations and their cash flows
for the year in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the
Company's and TEP's management; our responsibility is to express an
opinion on these financial statements based on our audit. We
conducted our audit of these statements in accordance with generally
accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe
that our audit provides a reasonable basis for the opinion expressed
above. The financial statements of the Company and of TEP at
December 31, 1997 and for the years ended December 31, 1997 and 1996
were audited by other independent accountants whose report dated
February 23, 1998, except as to Notes 4 and 12 which are as of March
11, 1999, expressed an unqualified opinion on those statements.
PricewaterhouseCoopers LLP
Los Angeles, California
February 4, 1999
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Retail Customers $ 625,407 $ 624,221 $ 611,564
Amortization of MSR Option Gain
Regulatory Liability - 8,105 20,053
Sales for Resale 143,269 97,567 84,256
- ---------------------------------------------------------------------------
Total Operating Revenues 768,676 729,893 715,873
- ---------------------------------------------------------------------------
Operating Expenses
Fuel and Purchased Power 255,527 216,163 208,808
Capital Lease Expense 104,045 103,914 104,087
Amortization of Springerville
Unit 1 Allowance (30,522) (28,037) (29,090)
Other Operations 109,170 107,199 97,555
Maintenance and Repairs 36,143 36,657 36,449
Depreciation and Amortization 90,358 86,405 98,246
Taxes Other Than Income Taxes 50,395 51,339 61,902
Voluntary Severance Plan Expense - Net - 2,933 10,555
Income Taxes 18,372 19,297 9,795
- ---------------------------------------------------------------------------
Total Operating Expenses 633,488 595,870 598,307
- ---------------------------------------------------------------------------
Operating Income 135,188 134,023 117,566
- ---------------------------------------------------------------------------
Other Income (Deductions)
Income Taxes 4,537 38,563 92,016
Reversal of Loss Provision - 10,154 8,472
Interest Income 10,866 11,239 6,460
Unregulated Energy Businesses - Net (8,109) (5,344) (2,284)
Other Income (Deductions) 3,150 1,812 1,484
- ---------------------------------------------------------------------------
Total Other Income (Deductions) 10,444 56,424 106,148
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 72,672 66,247 59,836
Interest Imputed on Losses Recorded at
Present Value 34,179 32,657 32,599
Other Interest Expense 10,749 7,971 10,427
- ---------------------------------------------------------------------------
Total Interest Expense 117,600 106,875 102,862
- ---------------------------------------------------------------------------
Net Income $ 28,032 $ 83,572 $ 120,852
===========================================================================
Average Shares of
Common Stock Outstanding (000) 32,178 32,138 32,136
===========================================================================
Basic Earnings Per Share $ 0.87 $ 2.60 $ 3.76
===========================================================================
Diluted Earnings Per Share $ 0.87 $ 2.59 $ 3.75
===========================================================================
See Notes to Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $ 670,793 $ 664,294 $ 653,933
Cash Receipts from Sales for Resale 141,210 96,569 80,123
Fuel and Purchased Power Costs Paid (238,722) (203,713) (180,134)
Wages Paid, Net of Amounts Capitalized (67,132) (60,398) (71,519)
Payment of Other Operations and
Maintenance Costs (88,713) (83,154) (76,531)
Capital Lease Interest Paid (81,823) (83,019) (84,383)
Interest Paid, Net of Amounts Capitalized (71,072) (66,625) (64,025)
Taxes Paid, Net of Amounts Capitalized (99,590) (99,126) (86,310)
Tax Assessment and Interest Deposit Paid (2,078) - (23,019)
Contract Termination Fee Paid (10,000) (40,000) -
Emission Allowance Inventory Purchases - (11,503) (12,340)
Emission Allowance Inventory Sales 11,368 39 14,712
Interest Received 10,149 9,152 6,342
Income Taxes Paid (5,113) (984) (1,566)
Other (6,532) 4,751 (2,351)
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities 162,745 126,283 152,932
- ---------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (81,148) (72,475) (68,272)
Investments in and Loans to Unregulated
Energy Business (50,682) (7,117) (9,173)
Distributions from Unregulated Energy
Businesses 20,750 2,119 -
Other Investments - Net 186 968 328
- ---------------------------------------------------------------------------
Net Cash Flows - Investing Activities (110,894) (76,505) (77,117)
- ---------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 99,511 16,928 16,725
Proceeds from Borrowings Under Renewable
Term Loan - - 14,000
Payments to Retire Long-Term Debt (129,472) (500) (11,600)
Payments on Renewable Term Loan - (31,000) (14,000)
Payments to Retire Capital Lease Obligations (17,232) (13,229) (36,292)
Payments for Credit Agreement and Debt
Issuance Costs (7,719) (7,470) (804)
Other 1,972 1,458 1,353
- ---------------------------------------------------------------------------
Net Cash Flows - Financing Activities (52,940) (33,813) (30,618)
- ---------------------------------------------------------------------------
Net Increase (Decrease) in
Cash and Cash Equivalents (1,089) 15,965 45,197
Cash and Cash Equivalents, Beginning of Year 146,256 130,291 85,094
- ---------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 145,167 $ 146,256 $ 130,291
===========================================================================
See Note 15 for supplemental cash flow information.
See Notes to Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
1998 1997
- ---------------------------------------------------------------------------
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,263,871 $2,194,150
Utility Plant Under Capital Leases 886,902 893,064
Construction Work in Progress 74,050 72,404
- ---------------------------------------------------------------------------
Total Utility Plant 3,224,823 3,159,618
Less Accumulated Depreciation and Amortization (1,051,994) (982,621)
Less Accumulated Amortization of Capital Leases (85,826) (73,728)
Less Springerville Unit 1 Allowance (171,413) (167,756)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,915,590 1,935,513
- ---------------------------------------------------------------------------
Investments and Other Property 110,318 79,471
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 145,167 146,256
Accounts Receivable 72,767 71,225
Materials and Fuel 37,040 34,005
Deferred Income Taxes - Current 14,820 14,910
Other 24,950 22,954
- ---------------------------------------------------------------------------
Total Current Assets 294,744 289,350
- ---------------------------------------------------------------------------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 152,111 170,034
Deferred Springerville Generation Costs 102,211 117,889
Deferred Lease Expense 9,877 11,571
Other Regulatory Assets 18,886 11,089
Deferred Debits - Other 30,443 19,492
- ---------------------------------------------------------------------------
Total Deferred Debits 313,528 330,075
- ---------------------------------------------------------------------------
Total Assets $2,634,180 $2,634,409
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 246,646 $ 216,878
Capital Lease Obligations 889,543 890,257
Long-Term Debt 1,184,423 1,215,120
- ---------------------------------------------------------------------------
Total Capitalization 2,320,612 2,322,255
- ---------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 11,647 14,552
Current Maturities of Long-Term Debt 1,725 500
Accounts Payable 34,118 33,141
Interest Accrued 70,771 64,812
Taxes Accrued 27,167 24,397
Accrued Employee Expenses 15,207 13,832
Contract Termination Fee Payable - 10,000
Other 6,705 6,987
- ---------------------------------------------------------------------------
Total Current Liabilities 167,340 168,221
- ---------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 62,028 77,606
Deferred Investment Tax Credits Regulatory
Liability 10,436 11,905
Emission Allowance Gain Regulatory Liability 31,335 17,591
Other 42,429 36,831
- ---------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 146,228 143,933
- ---------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
- ---------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,634,180 $2,634,409
===========================================================================
See Notes to Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CAPITALIZATION
December 31,
1998 1997
- ---------------------------------------------------------------------------
COMMON STOCK EQUITY - Thousands of Dollars -
Common Stock--No Par Value $ 640,640 $ 638,904
1998 1997
----------- -----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding 32,257,963 32,139,434
Warrants Outstanding 2,984,822 -
Accumulated Deficit (393,994) (422,026)
- ---------------------------------------------------------------------------
Total Common Stock Equity 246,646 216,878
- ---------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- ---------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 494,408 483,421
Springerville Coal Handling Facilities 166,288 168,959
Springerville Common Facilities 123,835 127,986
Irvington Unit 4 114,316 121,150
Other Leases 2,343 3,293
- ---------------------------------------------------------------------------
Total Capital Lease Obligations 901,190 904,809
Less Current Maturities (11,647) (14,552)
- ---------------------------------------------------------------------------
Total Long-Term Capital Lease Obligations 889,543 890,257
- ---------------------------------------------------------------------------
LONG-TERM DEBT
Interest
Issue Maturity Rate
- ---------------------------------------------------------------------------
First Mortgage Bonds
Corporate 2009 8.50% 27,900 165,000
2000 12.22% 46,878 78,750
Industrial Development 2006 - 2008 6.10% to 7.50% 63,500 64,000
Revenue Bonds (IDBs) 2021 Variable** - 100,000
First Collateral Trust
Bonds 2008 7.50% 140,000 -
Second Mortgage Bonds
(IDBs)* 2018 - 2022 Variable** 328,600 428,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 379,270
- ---------------------------------------------------------------------------
Total Stated Principal Amount 1,186,148 1,215,620
Less Current Maturities (1,725) (500)
- ---------------------------------------------------------------------------
Total Long-Term Debt 1,184,423 1,215,120
- ---------------------------------------------------------------------------
Total Capitalization $2,320,612 $2,322,255
===========================================================================
* These IDBs are backed by LOCs under TEP's Credit Agreement. TEP's
obligations under the Credit Agreement are secured with Second Mortgage
Bonds.
** Interest Rates on variable rate tax-exempt debt (IDBs) ranged from 2.83%
to 4.59% during 1998 and 1997, and averaged 3.51% in 1998 and 3.70% in 1997.
See Notes to Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Common Earnings
Stock (Deficit)
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Balances at December 31, 1995 $638,938 $(626,450)
1996 Net Income - 120,852
2,886 Shares Issued under Stock Compensation Plans 47 -
3,881 Shares Issued under Reverse Stock Split for
Shareholders with Fractional Shares - -
6,537 Net Shares Purchased by Deferred
Compensation Trust Less Distributions (99) -
- -----------------------------------------------------------------------------
Balances at December 31, 1996 638,886 (505,598)
1997 Net Income - 83,572
6,630 Shares Issued Under Stock Compensation Plans 108 -
5,687 Net Shares Purchased by Deferred
Compensation Trust Less Distributions (90) -
- -----------------------------------------------------------------------------
Balances at December 31, 1997 638,904 (422,026)
1998 Net Income - 28,032
116,696 Shares Issued Under Stock Compensation Plans 1,709 -
1,833 Net Shares Distributed by Deferred
Compensation Trust Less Purchases 27 -
- -----------------------------------------------------------------------------
Balances at December 31, 1998 $640,640 $(393,994)
=============================================================================
We describe limitations on our ability to pay dividends in Note 9.
See Notes to Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Retail Customers $ 625,721 $ 624,221 $ 611,564
Amortization of MSR Option Gain
Regulatory Liability - 8,105 20,053
Sales for Resale 143,269 97,567 84,256
- ---------------------------------------------------------------------------
Total Operating Revenues 768,990 729,893 715,873
- ---------------------------------------------------------------------------
Operating Expenses
Fuel and Purchased Power 255,527 216,163 208,808
Capital Lease Expense 104,045 103,914 104,087
Amortization of Springerville
Unit 1 Allowance (30,522) (28,037) (29,090)
Other Operations 109,170 107,199 97,555
Maintenance and Repairs 36,143 36,657 36,449
Depreciation and Amortization 90,358 86,405 98,246
Taxes Other Than Income Taxes 50,395 51,339 61,902
Voluntary Severance Plan Expense - Net - 2,933 10,555
Income Taxes 18,372 19,297 9,795
- ---------------------------------------------------------------------------
Total Operating Expenses 633,488 595,870 598,307
- ---------------------------------------------------------------------------
Operating Income 135,502 134,023 117,566
- ---------------------------------------------------------------------------
Other Income (Deductions)
Income Taxes 794 41,401 91,950
Reversal of Loss Provision - 10,154 8,472
Interest Income 10,800 11,239 6,460
Interest Income - Note Receivable from
UniSource Energy 9,329 - -
Other Income (Deductions) 2,851 (6,370) (734)
- ---------------------------------------------------------------------------
Total Other Income (Deductions) 23,774 56,424 106,148
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 72,672 66,247 59,836
Interest Imputed on Losses Recorded at
Present Value 34,179 32,657 32,599
Other Interest Expense 10,749 7,971 10,427
- ---------------------------------------------------------------------------
Total Interest Expense 117,600 106,875 102,862
- ---------------------------------------------------------------------------
Net Income $ 41,676 $ 83,572 $ 120,852
===========================================================================
See Notes to Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Retail Customers $ 670,793 $ 664,294 $ 653,933
Cash Receipts from Sales for Resale 141,210 96,569 80,123
Fuel and Purchased Power Costs Paid (238,722) (203,713) (180,134)
Wages Paid, Net of Amounts Capitalized (62,622) (60,398) (71,519)
Payment of Other Operations and
Maintenance Costs (81,676) (83,154) (76,531)
Capital Lease Interest Paid (81,823) (83,019) (84,383)
Interest Paid, Net of Amounts Capitalized (71,072) (66,625) (64,025)
Taxes Paid, Net of Amounts Capitalized (99,091) (99,126) (86,310)
Tax Assessment and Interest Deposit Paid (2,078) - (23,019)
Contract Termination Fee Paid (10,000) (40,000) -
Emission Allowance Inventory Purchases - (11,503) (12,340)
Emission Allowance Inventory Sales 11,368 39 14,712
Interest Received 8,517 9,152 6,342
Income Taxes Paid (3,883) (984) (1,566)
Other 937 4,751 (2,351)
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities 181,858 126,283 152,932
- ---------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (81,011) (72,475) (68,272)
Transfer of Millennium Cash to UniSource
Energy (45,412) - -
Investments in and Loans to Unregulated
Energy Businesses - (7,117) (9,173)
Distributions from Unregulated Energy
Businesses - 2,119 -
Other Investments - Net 104 968 328
- ---------------------------------------------------------------------------
Net Cash Flows - Investing Activities (126,319) (76,505) (77,117)
- ---------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from Issuance of Long-Term Debt 99,511 16,928 16,725
Proceeds from Borrowings Under
Renewable Term Loan - - 14,000
Payments to Retire Long-Term Debt (129,472) (500) (11,600)
Payments on Renewable Term Loan - (31,000) (14,000)
Dividend Paid to UniSource Energy (30,000) - -
Payments to Retire Capital Lease Obligations (17,232) (13,229) (36,292)
Payments for Credit Agreement and Debt
Issuance Costs (7,719) (7,470) (804)
Other 1,353 1,458 1,353
- ---------------------------------------------------------------------------
Net Cash Flows - Financing Activities (83,559) (33,813) (30,618)
- ---------------------------------------------------------------------------
Net Increase (Decrease) in
Cash and Cash Equivalents (28,020) 15,965 45,197
Cash and Cash Equivalents, Beginning of Year 146,256 130,291 85,094
- ---------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 118,236 $ 146,256 $ 130,291
===========================================================================
See Note 15 for supplemental cash flow information.
See Notes to Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED BALANCE SHEETS
December 31,
1998 1997
- ---------------------------------------------------------------------------
- Thousands of Dollars -
ASSETS
Utility Plant
Plant in Service $2,263,871 $2,194,150
Utility Plant Under Capital Leases 886,902 893,064
Construction Work in Progress 74,050 72,404
- ---------------------------------------------------------------------------
Total Utility Plant 3,224,823 3,159,618
Less Accumulated Depreciation and Amortization (1,051,994) (982,621)
Less Accumulated Amortization of Capital Leases (85,826) (73,728)
Less Springerville Unit 1 Allowance (171,413) (167,756)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,915,590 1,935,513
- ---------------------------------------------------------------------------
Investments and Other Property 62,978 79,471
- ---------------------------------------------------------------------------
Note Receivable from UniSource Energy 79,462 -
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 118,236 146,256
Accounts Receivable 72,239 71,225
Materials and Fuel 36,995 34,005
Deferred Income Taxes - Current 14,820 14,910
Other 14,735 22,954
- ---------------------------------------------------------------------------
Total Current Assets 257,025 289,350
- ---------------------------------------------------------------------------
Deferred Debits - Regulatory Assets
Income Taxes Recoverable Through Future Revenues 152,111 170,034
Deferred Springerville Generation Costs 102,211 117,889
Deferred Lease Expense 9,877 11,571
Other Regulatory Assets 18,886 11,089
Deferred Debits - Other 30,443 19,492
- ---------------------------------------------------------------------------
Total Deferred Debits 313,528 330,075
- ---------------------------------------------------------------------------
Total Assets $2,628,583 $2,634,409
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 229,861 $ 216,878
Capital Lease Obligations 889,543 890,257
Long-Term Debt 1,184,423 1,215,120
- ---------------------------------------------------------------------------
Total Capitalization 2,303,827 2,322,255
- ---------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 11,647 14,552
Current Maturities of Long-Term Debt 1,725 500
Accounts Payable 37,256 33,141
Interest Accrued 70,771 64,812
Taxes Accrued 27,082 24,397
Accrued Employee Expenses 14,897 13,832
Contract Termination Fee Payable - 10,000
Other 6,705 6,987
- ---------------------------------------------------------------------------
Total Current Liabilities 170,083 168,221
- ---------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 70,504 77,606
Deferred Investment Tax Credits Regulatory Liability 10,436 11,905
Emission Allowance Gain Regulatory Liability 31,335 17,591
Other 42,398 36,831
- ---------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 154,673 143,933
- ---------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
- ---------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,628,583 $2,634,409
===========================================================================
See Notes to Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CAPITALIZATION
December 31,
1998 1997
- ---------------------------------------------------------------------------
COMMON STOCK EQUITY - Thousands of Dollars -
Common Stock--No Par Value $ 646,568 $ 645,261
1998 1997
----------- -----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding - 32,139,434
Warrants Outstanding*** 918,445 2,410,856
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (410,350) (422,026)
- ---------------------------------------------------------------------------
Total Common Stock Equity 229,861 216,878
- ---------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- ---------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 494,408 483,421
Springerville Coal Handling Facilities 166,288 168,959
Springerville Common Facilities 123,835 127,986
Irvington Unit 4 114,316 121,150
Other Leases 2,343 3,293
- ---------------------------------------------------------------------------
Total Capital Lease Obligations 901,190 904,809
Less Current Maturities (11,647) (14,552)
- ---------------------------------------------------------------------------
Total Long-Term Capital Lease Obligations 889,543 890,257
- ---------------------------------------------------------------------------
LONG-TERM DEBT
Interest
Issue Maturity Rate
- ---------------------------------------------------------------------------
First Mortgage Bonds
Corporate 2009 8.50% 27,900 165,000
2000 12.22% 46,878 78,750
Industrial Development 2006 - 2008 6.10% to 7.50% 63,500 64,000
Revenue Bonds (IDBs) 2021 Variable** - 100,000
First Collateral Trust
Bonds 2008 7.50% 140,000 -
Second Mortgage Bonds
IDBs* 2018 - 2022 Variable** 328,600 428,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 379,270
- ---------------------------------------------------------------------------
Total Stated Principal Amount 1,186,148 1,215,620
Less Current Maturities (1,725) (500)
- ---------------------------------------------------------------------------
Total Long-Term Debt 1,184,423 1,215,120
- ---------------------------------------------------------------------------
Total Capitalization $2,303,827 $2,322,255
===========================================================================
* These IDBs are backed by LOCs under TEP's Credit Agreement. TEP's
obligations under the Credit Agreement are secured with Second Mortgage
Bonds.
** Interest rates on variable rate tax-exempt debt (IDBs) ranged from 2.83%
to 4.59% during 1998 and 1997, and the average interest rate on such debt was
3.51% in 1998 and 3.70% in 1997.
*** There are 4.6 million outstanding TEP warrants which entitle the holders
to purchase one share of TEP common stock for five warrants and $16.00. See
Note 13.
See Notes to Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
Capital Accumulated
Common Stock Earnings
Stock Expense (Deficit)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Balances at December 31, 1995 $645,295 $(6,357) $(626,450)
1996 Net Income - - 120,852
2,886 Shares Issued under Stock
Compensation Plans 47 - -
3,881 Shares Issued under Reverse
Stock Split for Shareholders with
Fractional Shares - - -
6,537 Net Shares Purchased by Deferred
Compensation Trust Less Distributions (99) - -
- ---------------------------------------------------------------------------
Balances at December 31, 1996 645,243 (6,357) (505,598)
1997 Net Income - - 83,572
6,630 Shares Issued Under Stock
Compensation Plans 108 - -
5,687 Net Shares Purchased by Deferred
Compensation Trust Less Distributions (90) - -
- ---------------------------------------------------------------------------
Balances at December 31, 1997 645,261 (6,357) (422,026)
1998 Net Income - - 41,676
Dividend Paid to UniSource Energy - - (30,000)
22,733 Shares Held by Deferred
Compensation Trust Transferred to
UniSource Energy 373 - -
Other 934 - -
- ---------------------------------------------------------------------------
Balances at December 31, 1998 $646,568 $(6,357) $(410,350)
===========================================================================
We describe limitations on our ability to pay dividends in Note 9.
See Notes to Consolidated Financial Statements.
UNISOURCE ENERGY, TEP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ----------------------------------------------------------------------------
NATURE OF OPERATIONS
UniSource Energy Corporation (UniSource Energy) is an exempt holding
company under the Public Utility Holding Company Act. UniSource Energy has
no significant operations of its own, but holds the stock of Tucson Electric
Power Company (TEP) and Millennium Energy Holdings, Inc. (Millennium). TEP,
a regulated public utility incorporated in Arizona since 1963, is UniSource
Energy's largest operating subsidiary and represents substantially all of
UniSource Energy's assets. Millennium holds the energy-related businesses
described in Note 5. In October 1998 Millennium, formerly a subsidiary of
MEH, and MEH Corporation (MEH), exchanged names.
TEP generates, transmits and distributes electricity. TEP serves retail
customers in an 1,155 square mile area in Southern Arizona. TEP also sells
electricity to other utilities and power marketing entities primarily located
in the Western United States. Approximately 60% of TEP's work force is
subject to a collective bargaining unit. The collective bargaining agreement
terminated on November 30, 1998. The collective bargaining agreement has
been extended to November 30, 1999 for Springerville Generating Station
employees in exchange for a 2.5% wage increase. Labor and management reached
a tentative agreement on a new four-year labor contract for Tucson employees
in the first quarter of 1999.
BASIS OF PRESENTATION
On January 1, 1998, TEP and UniSource Energy completed a transaction by
exchanging all the outstanding common stock of TEP on a share-for-share basis
for the common stock of UniSource Energy. In 1995, TEP's shareholders
approved the share exchange. In 1997, the FERC and ACC approved the
formation of the holding company.
Following the share exchange, in January 1998 TEP transferred the stock
of Millennium to UniSource Energy for a $95 million ten-year promissory note
from UniSource Energy. In accordance with the ACC order authorizing the
formation of the holding company, the note bears interest at 9.78% payable
every two years beginning January 1, 2000.
UniSource Energy's consolidated financial statements include the
financial results of operations of UniSource Energy and its wholly owned
subsidiaries as if UniSource Energy's current holding company structure had
existed in all periods shown. For periods prior to January 1998, UniSource
Energy's operations and those of TEP are the same.
UniSource Energy and TEP use the following three methods to report
investments in their subsidiaries or other companies:
- Consolidation: When we own a majority of the voting stock of a
subsidiary, we combine the accounts of the subsidiary with our accounts. We
eliminate intercompany balances and transactions when we combine these
accounts.
- The Equity Method: We use the equity method to report corporate joint
ventures, partnerships, and affiliated companies when we hold a 20% to 50%
voting interest. Under the equity method, we report:
- Our interest in the entity as an investment at cost on our balance
sheet; and
- Our percentage share of the net income (loss) from the entity in our
income.
- The Cost Method: We use the cost method when we hold less than a 20%
voting interest in an investment. Under the cost method, we report our
investment at cost on our balance sheet.
All non-utility operating transactions are included in the Other Income
(Deductions) section of the income statements.
USE OF ACCOUNTING ESTIMATES
Management makes estimates and assumptions when preparing financial
statements under Generally Accepted Accounting Principles (GAAP). These
estimates and assumptions affect:
- A portion of the reported amounts of assets and liabilities at the dates
of the financial statements;
- Our disclosures regarding contingent assets and liabilities at the dates
of the financial statements; and
- A portion of the reported revenues and expenses during the financial
statement reporting periods.
Because these estimates involve judgments, the actual amounts may differ from
the estimates.
REGULATION
The Arizona Corporation Commission (ACC) and, in some areas, the Federal
Energy Regulatory Commission (FERC) regulate TEP's utility accounting
practices and electricity rates. 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. These effects are described in Accounting for the Effects of
Regulation in Note 2.
TEP UTILITY PLANT
We report TEP's utility plant at its original cost. Utility plant
includes:
- Material and labor,
- Contractor costs,
- Construction overhead costs (where applicable), and
- An Allowance for Funds Used During Construction (AFUDC).
AFUDC reflects the cost of financing construction projects with borrowed
funds and equity funds. The component of AFUDC attributable to borrowed
funds is included as a reduction of Other Interest Expense. The equity
component is included in Other Income (Deductions). In 1998, 1997 and 1996,
we imputed the cost of capital on construction expenditures at 6.30%, 5.55%
and 4.24%, respectively, to reflect the cost of using borrowed and equity
funds to finance construction.
Depreciation
We compute depreciation on a straight-line basis at rates based on the
economic lives of the assets. These rates are authorized by the ACC and
averaged 3.53%, 3.44% and 3.56% in 1998, 1997 and 1996, respectively. The
economic lives for production plant are based on remaining lives. The
economic lives for transmission plant, distribution plant, general plant and
intangible plant are based on average lives. The rates also reflect
estimated removal costs, net of estimated salvage value. Minor replacements
and repairs are expensed as incurred. Retirements of utility plant, together
with removal costs less salvage, are charged to accumulated depreciation.
TEP UTILITY PLANT UNDER CAPITAL LEASES
TEP financed the following assets with leases:
- Springerville Common Facilities,
- Springerville Unit 1,
- Springerville Coal Handling Facilities, and
- Irvington Unit 4.
Under GAAP, these leases qualify as capital leases. However, for ACC rate-
making purposes, these leases are treated as operating leases with recovery
as if rent payments were made in equal amounts annually during the lease
term. We record lease expense (interest and depreciation) on a basis which
reflects the rate-making treatment. We describe the differences between GAAP
capital lease accounting used by unregulated companies and the ACC rate-
making method used by us in Deferred Lease Expense in Note 2. We describe
the lease terms in Capital Lease Obligations in Note 7.
The following table shows the amount of lease expense incurred for these
four leases and TEP's remaining leases.
Years Ended December 31,
1998 1997 1996
-----------------------------------------------------------------------
- Millions of Dollars -
Lease Expense:
Interest $ 96 $ 95 $ 95
Depreciation 18 17 15
-----------------------------------------------------------------------
Total Lease Expense $ 114 $ 112 $ 110
=======================================================================
Lease Expense Included In:
Operating Expenses - Fuel and
Purchased Power $ 10 $ 10 $ 9
Operating Expenses - Capital Lease
Expense 104 104 104
Balance Sheet - Deferred Lease Expense - (2) (3)
-----------------------------------------------------------------------
Total Lease Expense $ 114 $ 112 $ 110
=======================================================================
The Deferred Lease Expense of $10 million and $12 million at December
31, 1998 and 1997, respectively, includes:
- the cumulative difference in interest expense between the ACC's
operating lease method of amortizing the lease obligation for regulatory
purposes and GAAP capital lease amortization (see Deferred Lease Expense in
Note 2); and
- the balance of Pre-1993 Springerville Coal Handling Facilities Lease
Costs Deferred described in Deferred Lease Expense in Note 2.
SPRINGERVILLE UNIT 1 ALLOWANCE
In a 1989 Rate Order, the ACC limited TEP's recovery of non-fuel
expenses of Springerville Unit 1 through retail rates to a rate of $15 per kW
per month based on a 360 MW capacity rating. These costs averaged
approximately $22 per kW per month during the period 1996 through 1998. In
1990 and 1992, TEP recorded losses and a Springerville Unit 1 Allowance equal
to the present value of the excess of TEP's estimated costs through 2014 (the
end of the initial term of the lease) over $15 per kW per month using a
discount rate of 13%.
The balance sheet contra-asset Springerville Unit 1 Allowance (the
present value of the estimated excess costs) changes as follows:
- Increases each year by the amount of interest expense accrued at 13% on
the contra-asset. This interest expense is included as part of Interest
Imputed on Losses Recorded at Present Value in the Interest Expense section
in the income statements. In 1998, 1997 and 1996, the interest expense
accrual related to the Springerville Unit 1 Allowance was $34.2 million,
$32.4 million and $30.3 million, respectively.
- Decreases by the amount of Amortization of Springerville Unit 1
Allowance which is a contra-expense included in Operating Expenses. In 1998,
1997 and 1996, the amount amortized was $30.5 million, $28.0 million and
$29.1 million, respectively.
LONG-TERM DEBT
We defer all costs related to the issuance of long-term debt. These
costs include underwriters' commissions, discounts or premiums, and other
costs such as legal, accounting and regulatory fees and printing costs. We
amortize these costs over the life of the debt.
When we incur gains and losses on debt that we retire prior to maturity,
we amortize the gains or losses over the remaining original life of the debt.
UTILITY OPERATING REVENUES
We record utility operating revenues when we deliver electricity to
customers. Operating revenues include unbilled revenues which are earned
(service has been provided) but not billed by the end of an accounting
period. In the third quarter of 1998, TEP changed its method of estimating
unbilled revenues to more accurately reflect sales made but not yet billed.
If we had continued using the previous method of calculating unbilled
revenues, revenues for the three-months and twelve-months ended December 31,
1998 would have been $2.7 million less and $4.4 million greater,
respectively.
FUEL COSTS
Fuel inventory, primarily coal, is recorded at weighted average cost.
TEP uses full absorption costing. Under full absorption costing, all costs
incurred in the production process are included in the cost of the inventory.
Examples of these costs are direct material, direct labor and overhead costs.
As described in Deferred Lease Expense in Note 2, Pre-1993 Springerville
Coal Handling Facilities Lease Costs Deferred are being amortized to fuel
expense on a straight-line basis through the year 2030 at an average cost of
$1.4 million per year pursuant to the 1994 Rate Order.
INCOME TAXES
We are required by GAAP to report some of our assets and liabilities
differently for our financial statements than we do for income tax purposes.
The tax effects of differences in these items are reported as deferred income
tax assets or liabilities in our balance sheets. We measure these assets and
liabilities using income tax rates that are currently in effect.
See Note 2 for discussion of the following income tax items:
- Income Taxes Recoverable Through Future Revenues
- Deferred Investment Tax Credits Regulatory Liability
The income tax benefits included in Other Income (Deductions) in the
1997 and 1996 income statements are primarily a result of the recognition of
a portion of the net operating loss carryforwards. See Note 11.
We allocate income taxes to the subsidiaries based on their taxable
income and deductions used in the consolidated tax return.
EMISSION ALLOWANCES
Emission Allowances are issued by the EPA and each permits emission of
one ton of sulfur dioxide. These allowances can be sold. TEP records
Emission Allowance purchases in a noncurrent inventory account included in
Investments and Other Property on the balance sheets. Emission allowance
inventory is recorded at weighted average cost. Gains on sales of Emission
Allowances are deferred as Emission Allowance Gain Regulatory Liability in
the balance sheets. See Emission Allowance Gain Regulatory Liability in Note
2.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 (FAS 133), Accounting for
Derivative Instruments and Hedging Activities. A derivative financial
instrument or other contract derives its value from another investment or
designated benchmark. This Statement requires all derivative instruments to
be recognized as either assets or liabilities in the balance sheet. Some
derivative instruments offset, or hedge, exposure to a specific risk. If the
derivative is not a hedging instrument, measurement is at fair value and
changes in fair value (i.e., gains and losses) are recognized in earnings in
the period of change. If a derivative qualifies as a hedge, the accounting
for changes in fair value will depend on the specific exposure being hedged.
We are required to adopt FAS 133 in the first quarter of 2000. We are still
quantifying the effect, if any, that the adoption of FAS 133 will have on our
financial statements.
In November 1998, the Emerging Issues Task Force issued guidance on
accounting for energy trading activities. Energy trading activities are
intended to generate profits from changes in the market prices for energy-
related commodities such as electricity, natural gas and coal. These
activities include certain purchase power and transmission contracts. This
guidance requires us to measure the difference between cost and market value
for our energy contracts and include any resulting gains or losses in
earnings. We are required to adopt this guidance in the first quarter of
1999. We do not expect the adoption of this guidance to have a material
effect on our financial statements.
RECLASSIFICATIONS
We have made minor reclassifications to the prior year financial
statements to conform to the current year's presentation.
NOTE 2. TEP'S REGULATORY ASSETS AND LIABILITIES
- ------------------------------------------------
As discussed in Note 1, the ACC and, in some areas, the FERC regulate
TEP's utility accounting practices and electricity rates.
ACCOUNTING FOR THE EFFECTS OF 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, require that these
expenses be charged to customers in the future. In this situation, FAS 71
requires that TEP not show these expenses on its current income statements
but 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.
We have recorded regulatory assets and liabilities in our balance sheets
in accordance with FAS 71. TEP periodically assesses the recoverability of
costs recognized as regulatory assets and the ability to continue to account
for its activities in accordance with FAS 71 based on each rate action and
the criteria set forth in FAS 71.
The balance sheets contain certain amounts solely as a result of using
FAS 71:
December 31,
Assets (Liabilities) 1998 1997
--------------------------------------------------------------------
- Millions of Dollars -
Income Taxes Recoverable Through Future
Revenues $ 152 $ 170
Deferred Springerville Generation Costs 102 118
Deferred Lease Expense 10 12
Other Regulatory Assets 19 11
--------------------------------------------------------------------
Total Regulatory Assets $ 283 $ 311
====================================================================
Deferred Investment Tax Credits
Regulatory Liability $ (10) $ (12)
Emission Allowance Gain Regulatory
Liability (31) (18)
--------------------------------------------------------------------
Total Regulatory Liabilities $ (41) $ (30)
====================================================================
TEP records regulatory assets based on:
- ACC rate orders that provide a mechanism for recovery in regulated
rates; or
- historical rate treatment which provides evidence that the amounts will
probably be recovered through future rates.
Our regulated rates include a return on investment for the material
regulatory assets listed in the above table.
The income statements include the following amounts due to application
of FAS 71:
Years Ended December 31,
Income (Expense) 1998 1997 1996
----------------------------------------------------------------------
- Millions of Dollars -
Income Taxes Recoverable Through Future
Revenues - Tax Depreciation Differences
(Flow Through) $ (4) $ - $ -
Amortization of Deferred Springerville
Generation Costs (16) (15) (24)
Amortization of Other Regulatory Assets (2) (1) (1)
Investment Tax Credit Amortization 5 3 4
Amortization of MSR Option Gain Regulatory
Liability - 8 20
Interest Imputed on Losses (MSR Option Gain
Regulatory Liability) Recorded at Present
Value - - (2)
----------------------------------------------------------------------
If TEP had not applied FAS 71 in these years, the above amounts would
have been reflected in the income statements in prior periods, except for the
amortization and interest expense related to the MSR Option Gain Regulatory
Liability. These MSR amounts would not have been recorded. Capital lease
expense would be recognized at different annual amounts if TEP were to
discontinue the application of FAS 71 although the total would be the same
over the life of the leases. Lease expense included on our income statements
amounted to $114 million in 1998 and 1997 and $113 million in 1996. If we
had not applied FAS 71, lease expense would have been $135 million in 1998
and $134 million in 1997 and 1996. See Deferred Lease Expense below.
Additionally, if TEP had not applied FAS 71, no amortization or interest
expense relating to the Springerville Unit 1 Allowance (see Note 1) would
have been recorded. Instead, we would have reduced the Springerville Unit 1
Capital Lease Asset by the Springerville Unit 1 Allowance. This reduction to
the Springerville Unit 1 Capital Lease Asset would have reduced subsequent
capital lease depreciation expense.
See Potential Discontinuation of Application of FAS 71 below.
INCOME TAXES RECOVERABLE THROUGH FUTURE REVENUES
A portion of the total deferred income tax liability relates to our
utility business, but has not been reflected in the rates we charge our
customers. This portion of the liability is recorded as Income Taxes
Recoverable Through Future Revenues, a regulatory asset. These income taxes
represent the tax effect of temporary differences in depreciation and AFUDC.
We amortize these amounts to income tax expense as the temporary differences
reverse.
Deferred Springerville Generation Costs
Deferred Springerville Generation Costs consist of the following:
- Deferred Springerville Common Facility Costs: These are lease and
operating costs that TEP incurred for the leased portion of the Springerville
Common Facilities during the period after Springerville Unit 1 was placed in
service and before Springerville Unit 2 was placed in service. The ACC
ordered deferral of these costs and amortization, as depreciation, over the
initial term of the Springerville Common Facilities Leases. See Capital
Lease Obligations in Note 7. This depreciation amounts to approximately $3
million per year. The unamortized balance at December 31, 1998 and 1997 was
$55.7 million and $58.2 million, respectively.
- Deferred Springerville Contract Termination Fee: On June 27, 1997, TEP
signed an agreement with the coal supplier for the Springerville Generating
Station to terminate the then-existing coal supply contract and enter into a
new lower cost contract with the same supplier. See TEP Commitments - Fuel
Purchase in Note 10. TEP paid a $50 million termination fee in three
installments: $30 million in June 1997, $10 million in September 1997, and
$10 million in March 1998.
Based on an ACC order, TEP recorded a regulatory asset for the
termination fee and is amortizing approximately $4 million per year to Fuel
and Purchased Power expense over the 13-year term of the new agreement. The
unamortized balance at December 31, 1998 and 1997 was $44.2 million and $48.1
million, respectively.
- Deferred Springerville Unit 2 Costs: Prior to the ACC's 1996 Rate
Order, TEP was not recovering 37.5% of the deferred Springerville Unit 2 rate
synchronization costs (non-fuel costs of Springerville Unit 2 incurred from
January 1, 1991 through October 14, 1991) through retail rates. Beginning
March 31, 1996, these costs are being amortized over a three-year period in
accordance with the 1996 Rate Order. The amortization of these costs
included in Depreciation and Amortization on the 1998, 1997 and 1996 income
statements amounted to $9 million, $10 million and $21 million, respectively.
The unamortized balance at December 31, 1998 and 1997 was $2.3 million and
$11.6 million, respectively.
Deferred Lease Expense
Deferred Lease Expense relates to TEP's capital leases described in TEP
Utility Plant Under Capital Leases in Note 1 and is comprised of the
following:
- Pre-1993 Springerville Coal Handling Facilities Lease Costs Deferred:
TEP deferred certain lease and interest costs through 1992 based on ACC rate-
making treatment. The ACC's 1994 Rate Order allowed TEP to recover these
costs on a straight-line basis through 2030. These costs are being amortized
equally to Fuel and Purchased Power expense and Depreciation and Amortization
expense.
- Capital vs. Operating Lease Treatment: Under GAAP, these leases qualify
as capital leases. However, for ACC rate-making purposes, these leases are
treated as operating leases with recovery as if payments were made in equal
annual amounts. Because TEP follows FAS 71, Capital Lease Expense on the
income statement reflects the rate-making expense. However, the Capital
Lease Asset and Obligation on the balance sheet reflect capital lease
accounting used by unregulated companies. The differences between the ACC's
operating lease method and the GAAP capital lease method are recorded as a
deferred lease asset or liability and include the following:
- Interest Expense Differences: These are the differences between
interest expense under the ACC's operating lease method and interest expense
under GAAP capital lease accounting for unregulated companies.
- Lease Term Differences: Under GAAP, the initial term of the lease is
normally used for the cost recognition period. For rate-making purposes, the
ACC uses the initial term of the leases, except for the Springerville Coal
Handling Facilities Leases. The ACC mandated that the period of recovery for
the Springerville Coal Handling Facilities Leases be the initial term of the
leases plus the first optional renewal period of six years. As a result of
the ACC mandate and application of FAS 71, we amortize the Springerville Coal
Handling Facilities Lease costs based on the extended period. We describe
our lease terms in Capital Lease Obligations in Note 7.
Deferred Investment Tax Credits Regulatory Liability
ITC reduces federal income taxes. On our financial statements we have
deferred the benefit relating to ITC claimed on tax returns. This deferred
benefit is recorded as Deferred Investment Tax Credits Regulatory Liability
on the balance sheets. As authorized by the ACC, we amortize this regulatory
liability over the tax lives of the related property. This amortization is
an income tax benefit in the income statement. See Note 11.
Emission Allowance Gain Regulatory Liability
Gains on sales of Emission Allowances are deferred as an Emission
Allowance Gain Regulatory Liability in the balance sheets and will be
amortized as income in 2000 - 2024, the period TEP expects to use the
Emission Allowance inventory to meet EPA regulations. The deferral for
future amortization reflects the expected regulatory treatment of the gains.
We describe the environmental regulations that apply to TEP in Commitments -
Environmental Regulation in Note 10.
MSR Option Gain Regulatory Liability
In a 1989 Rate Order the ACC allocated to retail customers part of TEP's
1982 gain from the sale of an option to purchase a 28.8% interest in San Juan
Unit 4. The ACC ordered TEP to recognize the MSR Option Gain by amortizing
amounts to operating revenue through May 1997. Therefore, in 1990, TEP
recorded a loss and the MSR Option Gain Regulatory Liability, equal to the
present value of the amounts to be amortized through May 1997, calculated
using a 13% discount rate. In 1997 and 1996, the amounts amortized to
operating revenues were $8.1 million and $20.1 million, respectively.
Retail Excess Capacity Deferrals
SEE DISCUSSION OF THIS OFF-BALANCE SHEET REGULATORY ASSET IN RATE
REDUCTION IN NOTE 3.
POTENTIAL DISCONTINUATON OF APPLICATION OF FAS 71
A regulated company must satisfy certain conditions to apply the
accounting policies and practices of FAS 71. These conditions include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates below
the rates set by the regulator.
We periodically assess whether we continue to meet these conditions. If
we were required to stop applying FAS 71 to all or a portion of TEP's
regulated utility operations, we would write off the related balances of
TEP's regulatory assets and liabilities as a charge in our income statement.
In that event, our earnings would be reduced by the amount of regulatory
assets, net of regulatory liabilities, after applicable deferred income
taxes. Based on the balances of TEP's regulatory assets and liabilities at
December 31, 1998, if we had ceased applying FAS 71 to all of TEP's regulated
operations, we would have recorded an extraordinary loss of approximately
$145 million, net of the related income tax benefit of $97 million. However,
we would not write-off the regulatory assets, net of regulatory liabilities,
if we are authorized to recover these amounts through the remaining regulated
portion of our business. See Recovery of Stranded Costs below.
Approximately 62% of TEP's net regulatory assets on the balance sheet relate
to electric generation. While regulatory orders and market conditions may
affect our cash flows, our cash flows would not be affected if we stopped
applying FAS 71.
If we stop applying FAS 71, we would need to evaluate the likelihood
that we could recover the cost of TEP's electric plant in the marketplace.
If undiscounted cash flows are less than the carrying value of plant assets
that we continue to own, then we would need to write off as an expense a
portion of those plant assets to reflect their current market value. Plant
assets to be disposed of would be written down to fair value if it is less
than carrying value. We cannot predict if we would write off any plant
assets as a result of these evaluations.
Events That May Impact TEP's Application of FAS 71 - Retail Electric
Competition
In December 1996, the ACC adopted retail electric competition rules
(Rules) to introduce retail electric competition in Arizona. As initially
adopted, the rules required each "Affected Utility" (TEP, Arizona Public
Service Company, Citizens Utilities Company and several cooperatives) to open
its retail service area to competing electric service providers over the
period 1999 to 2003. On August 5, 1998, the ACC adopted amendments to these
Rules which, in part, provide a two-year phase-in schedule in which all
retail customers will have access to competitive generation by January 1,
2001. Subsequently, the ACC delayed implementation of the Rules - see below.
On June 22, 1998, the ACC adopted an order requiring Arizona utilities
to choose from one of two options for recovery of stranded costs resulting
from the implementation of retail electric competition by August 21, 1998.
Stranded costs represent costs recoverable by a utility in a regulated market
that would not likely be recovered through the prices charged for electricity
and other services in a competitive market. The two options were:
(1)Divestiture/Auction Methodology
- This method would require the sale of all electric generation assets
through auction by January 1, 2001;
- Stranded costs would be calculated as the difference between book
value of generation assets (including related regulatory assets) and the
proceeds of the sale;
- 100% of stranded costs, including a return on the unamortized balance,
would be recovered over a ten-year period; and
- All customers of Affected Utilities would pay for the stranded costs.
(2)Transition Revenues Methodology
- The ACC would determine the revenues necessary to maintain financial
integrity (such as avoiding default under currently existing financial
instruments); and
- Affected Utilities would recover the determined amount of stranded
costs over a period of ten years.
The June 1998 order encouraged, but did not require, full divestiture of
generating assets through an auction to unaffiliated third parties. The
order stated that only those Affected Utilities choosing divestiture through
the Divestiture/Auction Methodology would have the opportunity to recover
100% of unmitigated stranded costs. The order also specified that some form
of rate cap would be in place for Standard Offer Electric Service customers
during the transition period. Standard Offer Electric Service customers are
those who do not have, or do not choose, access to competing electric service
providers during the phase-in of retail electric competition.
On August 21, 1998, as required by the June 1998 order, TEP filed a
proposed plan for divestiture of generating assets and stranded cost recovery
with the ACC. Under the plan, TEP proposed to divest all of its generating
assets and associated property as a method of recovering stranded costs. In
its filing with the ACC, TEP estimated its stranded costs may range from $600
million to $1.1 billion.
ACC Staff Stranded Cost Recovery Agreement
On November 4, 1998, TEP reached a settlement agreement with the ACC
Staff related to TEP's plan to divest generation assets and for 100% recovery
of stranded costs. The agreement also supported an exchange of TEP's
interests in the Navajo and Four Corners Generating Stations for certain high
voltage transmission assets owned by APS. Because the ACC did not approve
the SCR Agreement by November 25, 1998, the agreement is considered withdrawn
by TEP and the ACC Staff.
ACC Delays Retail Electric Competition Rules
In December 1998, the ACC approved implementation of the Rules on
January 1, 1999. The Rules were substantially the same as those adopted in
December 1996 and amended on August 5, 1998. However, the ACC increased the
percentage of residential customers eligible to choose alternative energy
suppliers on January 1, 1999 from 1/2 of 1% to 1 1/2, with an additional 1 1/4%
eligible each quarter until January 1, 2001. This meant that 3,750 of TEP's
residential customers would have been eligible to choose a competing electric
service provider on January 1, 1999 and an additional 3,750 customers each
subsequent quarter.
On January 5, 1999, the ACC delayed implementation of the Rules. The
ACC did not set a date that the Rules will become effective. The ACC Hearing
Officer issued a Proposed Order on February 5, 1999 and amended it on March
12, 1999. If adopted by the ACC, the Proposed Order would modify the June
1998 order so that divestiture is not required for 100% stranded cost
recovery. The Proposed Order allows for alternative methodologies for
determining stranded costs so long as the plans are found to be in the best
interest of all stakeholders. Under the Proposed Order, Affected Utilities
will have an opportunity to amend their previously filed stranded cost
recovery plans. TEP's original stranded cost recovery plan, filed on August
21, 1998, specified divestiture of generation assets as the preferred method
for recovery given the then available options. TEP filed exceptions to the
Proposed Order on February 17, 1999. No meeting date has been set to
consider the Proposed Order. If the Proposed Order is approved, TEP may
amend its stranded cost recovery proposal. We cannot predict the outcome of
the numerous unresolved issues, including quantification and recovery of
stranded costs, whether the Rules will be changed, or the date the Rules will
become effective.
Recovery of Stranded Costs
We expect that TEP will stop accounting for its generation operations
using FAS 71 when the ACC approves a cost recovery plan specific to TEP which
includes the amount of stranded costs (including regulatory assets, net of
regulatory liabilities) that TEP can recover and a cost recovery method.
Until the ACC approves the amount and recovery method, we are unable to
predict the amount of write-offs, if any, or other changes in asset and
liability values which would be recorded at that time.
TEP intends to continue to seek 100% recovery of stranded costs. While
there can be no assurance as to the specific form of any stranded cost
recovery plan, the June 22, 1998 ACC order permitting recovery of 100% of
stranded costs upon divestiture of generating assets currently remains in
effect.
OTHER ACTIONS REGARDING COMPETITION
In May 1998 the Arizona State Legislature approved and the Governor
signed a bill regarding retail electric competition. The legislation
requires the introduction of customer choice to 20% of each public power
entity's retail load by December 31, 1998 with 100% customer choice by
December 31, 2000. This legislation only applies to public power entities
such as SRP. However, the bill encourages broader application of the
legislation's principles by the ACC to the state's investor-owned utilities,
including TEP, and cooperatives.
We cannot predict the outcome of the legislation or the ACC's Rules.
Additionally, federal legislators introduced several retail competition
initiatives in Congress which, if passed, could modify or override the
actions taken by the ACC or the Arizona Legislature.
NOTE 3. RATE MATTERS
- ---------------------
RATE REDUCTION
On August 25, 1998, the ACC approved a rate settlement agreement (Rate
Settlement) which provides TEP's retail customers with the following base
price decreases:
- an initial 1.1% decrease (approximately $7.0 million) effective July 1,
1998,
- a second decrease of 1.0% (approximately $5.5 million) on July 1, 1999,
and
- an additional 1.0% decrease (approximately $5.5 million) on July 1,
2000.
The latter two decreases will apply to all tariffed retail customers
prior to the start of competition and to all Standard Offer Electric Service
customers. See discussion regarding the delay in the ACC's retail electric
competition rules in Note 2.
The Rate Settlement also mitigates certain potentially stranded costs by
accelerating the recovery of the Retail Excess Capacity Deferrals. Beginning
December 31, 1996, the amortization period for the Retail Excess Capacity
Deferrals decreased from 20 years to 7.8 years. Retail Excess Capacity
Deferrals represent operating and capital costs associated with Springerville
Unit 2 capacity which the ACC did not allow us to recover in rates until 1994
and 1996. These Retail Excess Capacity Deferrals totaled $69.5 million and
$81.6 million at December 31, 1998 and 1997, respectively. These deferrals
are reflected only in our regulatory calculations. The accompanying balance
sheets do not include these deferrals as the costs were expensed when
incurred for financial reporting purposes. The $4.3 million (after-tax)
increase in annual amortization expense from the decreased amortization
period is reflected in TEP's regulatory accounting records, not presented
here, and does not have an impact on the expenses included in our financial
statements.
1996 RATE ORDER
On March 29, 1996, the ACC authorized a 1.1%, or $6.4 million, increase
in TEP's base rates effective March 31, 1996. Under the 1996 Rate Order, TEP
cannot seek a base rate increase before January 1, 2000, subject to specific
exceptions.
NOTE 4. SEGMENT AND RELATED INFORMATION
- ----------------------------------------
In 1998, we adopted Statement of Financial Accounting Standards No.131
(FAS 131), Disclosures about Segments of an Enterprise and Related
Information, which requires that we report financial and descriptive
information about our operating segments. These segments are determined
based on the way we organize our operations and evaluate performance.
UniSource Energy's principal business segment is TEP, a regulated electric
utility. The other reportable business segment is Millennium which holds the
following unregulated energy businesses:
- Advanced Energy Technologies, Inc. (Advanced Energy) which owns 50
percent of Global Solar Energy, L.L.C., a developer and manufacturer of
photovoltaic materials;
- MEH Corporation (MEH) which holds a 50 percent interest in New Energy
Ventures, Inc. (NEV), an energy buyer representative; and
- Nations Energy Corporation (Nations) which is an independent power
developer.
As discussed in Note 1, we record our percentage share of the earnings
of affiliated companies when we hold a 20% to 50% voting interest. Our
portion of the net income (loss) of the entities held by our unregulated
energy businesses is shown below in Net Income (Loss) from Equity Method
Entities.
See Note 5 for more information on our unregulated energy businesses.
Intersegment revenues are not material. The accounting policies of the
segments are described in Note 1. We disclose selected financial data for
our business segments in the following tables:
Segments
-----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Reconciling Energy
1998 Utility Businesses Adjustments Consolidated
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Operating Revenues $ 768,990 $ 1,927 $ (2,241) $ 768,676
- -----------------------------------------------------------------------------
Net Income (Loss) from
Equity Method Entities*:
Advanced Energy's
Joint Ventures (376) (376)
MEH's Joint Ventures (16,041) (16,041)
Nations' Joint Ventures 2,758 2,758
Other Entities'
Joint Ventures (44) (44)
-------- -------
Total - (13,703) - (13,703)
- -----------------------------------------------------------------------------
Interest Income 10,800 2,671 (2,605) 10,866
- -----------------------------------------------------------------------------
Interest Expense 117,600 14 (14) 117,600
- -----------------------------------------------------------------------------
Depreciation and
Amortization 90,358 89 (89) 90,358
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 17,578 (3,761) 18 13,835
- -----------------------------------------------------------------------------
Net Income (Loss):
Advanced Energy (261)
MEH (9,192)
Nations 1,396
Other Entities (52)
------
Total Net Income (Loss) 41,676 (8,109) (5,535) 28,032
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Net Cash Flows from
Operating Activities 181,858 (17,916) (1,197) 162,745
- -----------------------------------------------------------------------------
Capital Expenditures (81,011) (137) - (81,148)
- -----------------------------------------------------------------------------
Investments in and Loans
to Unregulated Energy
Businesses:
Advanced Energy (2,050) (2,050)
MEH (33,000) (33,000)
Nations (15,617) (15,617)
Other Entities (15) (15)
-------- -------
Total - (50,682) - (50,682)
- -----------------------------------------------------------------------------
Distributions from
Unregulated Energy
Businesses:
Nations - 20,750 - 20,750
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,628,583 74,144 (68,547) 2,634,180
- -----------------------------------------------------------------------------
Millennium's Equity
Method Investment in
Unregulated Energy
Businesses:
Advanced Energy 6,622 (6,622)
MEH 24,092 (24,092)
Nations 42,539 (42,539)
Other Entities 1,118 (1,118)
------- --------
Total - 74,371 (74,371) -
- -----------------------------------------------------------------------------
Segments
-----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Reconciling Energy
1997 Utility Businesses Adjustments Consolidated
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Operating Revenues $ 729,893 $ 682 $ (682) $ 729,893
- -----------------------------------------------------------------------------
Net Income (Loss) from
Equity Method Entities*:
Advanced Energy's
Joint Ventures (231) (231)
MEH's Joint Ventures (7,759) (7,759)
Nations' Joint Ventures 3,545 3,545
Other Entities'
Joint Ventures (11) (11)
-------- --------
Total - (4,456) - (4,456)
- -----------------------------------------------------------------------------
Interest Income 11,239 506 (506) 11,239
- -----------------------------------------------------------------------------
Interest Expense 106,875 47 (47) 106,875
- -----------------------------------------------------------------------------
Depreciation and
Amortization 86,405 43 (43) 86,405
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense (19,266) (2,838) 2,838 (19,266)
- -----------------------------------------------------------------------------
Net Income (Loss):
Advanced Energy (583)
MEH (4,567)
Nations 194
Other Entities (388)
------
Total 88,916 (5,344) - 83,572
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Net Cash Flows from
Operating Activities 128,488 (2,205) - 126,283
- -----------------------------------------------------------------------------
Capital Expenditures (72,391) (84) - (72,475)
- -----------------------------------------------------------------------------
Investments in and Loans to
Unregulated Energy Businesses:
MEH (4,800) (4,800)
Nations (2,117) (2,117)
Other Entities (200) (200)
-------- --------
Total - (7,117) - (7,117)
- -----------------------------------------------------------------------------
Distributions from
Unregulated Energy
Businesses:
Nations - 2,119 - 2,119
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,656,767 68,644 (91,002) 2,634,409
- -----------------------------------------------------------------------------
Millennium's Equity
Method Investment in
Unregulated Energy
Businesses:
Advanced Energy 4,783 (4,783)
MEH 4,284 (4,284)
Nations 41,155 (41,155)
Other Entities 1,388 (1,388)
------- --------
Total - 51,610 (51,610) -
- -----------------------------------------------------------------------------
Segments
-----------------------
TEP: Millennium:
Regulated Unregulated UniSource
Electric Energy Reconciling Energy
1996 Utility Businesses Adjustments Consolidated
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Operating Revenues $ 715,873 $ 280 $ (280) $ 715,873
- -----------------------------------------------------------------------------
Net Income (Loss) from
Equity Method Entities*:
Nations' Joint Ventures - 2,225 - 2,225
- -----------------------------------------------------------------------------
Interest Income 6,460 192 (192) 6,460
- -----------------------------------------------------------------------------
Interest Expense 102,862 14 (14) 102,862
- -----------------------------------------------------------------------------
Depreciation and
Amortization 98,246 - - 98,246
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense (82,221) 66 (66) (82,221)
- -----------------------------------------------------------------------------
Net Income (Loss):
Advanced Energy (89)
Nations (2,095)
Other Entities (100)
------
Total 123,136 (2,284) - 120,852
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Net Cash Flows from
Operating Activities 151,724 1,208 - 152,932
- -----------------------------------------------------------------------------
Capital Expenditures (68,184) (88) - (68,272)
- -----------------------------------------------------------------------------
Investments in and Loans to
Unregulated Energy Businesses:
Advanced Energy (5,000) (5,000)
Nations (4,173) (4,173)
-------- --------
Total - (9,173) - (9,173)
- -----------------------------------------------------------------------------
* The Net Income (Loss) from Equity Method Entities is included in
Unregulated Energy Businesses - Net in UniSource Energy's income statements.
Prior to 1998, the unregulated businesses now held by Millennium were
held by and consolidated with TEP.
The reconciling adjustments in 1998, 1997 and 1996 include the
following:
- Elimination of the revenues and expenses of Millennium's unregulated
energy businesses to show this activity in Unregulated Energy Businesses -
Net in the Other Income (Deductions) section of UniSource Energy's income
statements, and
- Elimination of intercompany activity and balances.
NOTE 5. UNREGULATED ENERGY BUSINESSES
- --------------------------------------
On January 1, 1998, TEP transferred the stock of its subsidiary,
Millennium Energy Holdings, Inc. (formerly MEH Corporation), to UniSource
Energy. See Basis of Presentation in Note 1. Millennium now owns 100% of
the stock of the entities described below which were established to pursue
various unregulated energy-related investment opportunities. See Note 4.
INTERNATIONAL POWER PROJECTS - NATIONS ENERGY CORPORATION
Nations and its subsidiaries develop independent power projects in
domestic and foreign energy markets. Nations owns 100% of the stock of the
following entities:
- Nations Energy Holland Holding (Nations Holland) - In October 1998,
Nations Holland paid $8.1 million for a minority equity interest in a power
project located in the Czech Republic. The 340 MW project is scheduled for
completion in late-1999. The existing assets and, once completed, the
generating facility produces power and steam which are sold to a regional
distribution company and an adjacent industrial complex. As of December 31,
1998, Nations Holland's total investment in this project was $15.8 million.
- Nations-Colorado Energy Corporation (Nations-Colorado) - In September
1998, Nations-Colorado sold a 48% interest in Trigen-Nations Energy, which
owns and operates the 40 MW Coors Brewing Company power plant in Golden,
Colorado. The $5.8 million after-tax gain on the sale is included in
Unregulated Energy Businesses - Net in UniSource Energy's income statements.
Following the sale, Nations Energy owns a 1% percent interest in Trigen-
Nations Energy.
- Nations International Ltd. (Nations International) - In September 1998,
Nations International purchased a minority interest in Corporation Panamena
de Energia, S.A. (COPESA) for $7.5 million. COPESA is an independent power
producer which owns and operates a 43 MW power plant near Panama City. The
energy is sold under an agreement with an unrelated party.
ENERGY MARKETING - MEH CORPORATION
Effective September 1, 1997, MEH (formerly Millennium) acquired a 50%
ownership in NEV and made a $0.8 million capital contribution.
Loans and Guarantees for NEV
In December 1997, MEH committed to provide NEV with $20 million of
funding. At December 31, 1998, NEV had received $19 million in debt funding
under the commitment, resulting in a remaining commitment amount available of
$1 million at January 31, 1999. Additionally, in September 1998, NEV issued
a $4.8 million promissory note to MEH for a $3 million loan MEH extended to
NEV in September 1997 as well as a preferred operating return due MEH under
the terms of NEV's original operating agreement.
In December 1998, UniSource Energy committed $30 million in credit to
NEV. NEV has drawn $15 million on the credit commitment at December 31,
1998. Under the terms of the commitment, NEV must provide collateral prior
to any amounts being drawn under this credit commitment.
Additionally, in August 1998 UniSource Energy guaranteed a $10 million
loan that NEV obtained from an unrelated party. That loan is due in 1999.
UniSource Energy is the guarantor of $33.1 million of performance bonds and
other guarantees that secure amounts NEV may owe to utility distribution
companies and energy suppliers in connection with NEV's sales to retail
electric customers. NEV bills its customers for these charges. UniSource
Energy's guarantees are secured by various NEV accounts receivable and other
assets.
NEV Losses
NEV incurred a total loss of $47 million for the period September 1997
through December 1998.
In 1998 and 1997, MEH recorded $16 million and $7.8 million,
respectively, of NEV's losses. These losses, totaling $23.8 million, equal
the total funds and unsecured commitments provided by MEH and UniSource
Energy to NEV. Our accounting policy limits the amount of NEV's loss to be
recorded by MEH to the total amount invested and committed by MEH and
UniSource Energy on an unsecured basis. Should MEH or UniSource Energy
provide additional unsecured funding to NEV or should the value of existing
collateral decline, the unsecured amounts provided would be immediately
expensed up to the lesser of the amount of unsecured funding provided or the
amount of NEV's cumulative losses in excess of the $23.8 million already
recorded by MEH. While we do not currently have plans to extend additional
unsecured amounts, there can be no assurance that additional funding will not
be necessary.
NEV Summarized Financial Information
December 31,
Balance Sheet 1998 1997
------------------------------------------------------------------
- Millions of Dollars -
Current Assets $ 115 $ 9
Noncurrent Assets 6 2
------------------------------------------------------------------
Total Assets $ 121 $ 11
==================================================================
Current Liabilities $ 90 $ 8
Noncurrent Liabilities 67 10
Minority Interest (of which $4 million
is Mandatorily Redeemable) 9 -
Shareholders' Deficit (45) (7)
------------------------------------------------------------------
Total Liabilities and Deficit $ 121 $ 11
==================================================================
Years Ended December 31,
Income Statement 1998 1997
------------------------------------------------------------------
- Millions of Dollars -
Retail Customer Revenue $ 206 $ 2
Utility Distribution Company Payments (102) -
Cost of Goods Sold (119) (2)
------ -----
Loss from Operations (15) -
Net Loss (40) (14)
------------------------------------------------------------------
NEV Technologies
NEV Technologies, a subsidiary of NEV, together with its two joint
ventures hold exclusive distribution rights for the AlliedSignal
TurboGeneratorTM in the western U.S. and certain international markets. NEV
Technologies and Dames and Moore Ventures each own 50% of the two joint
ventures. In October 1998, The Mission Group, an affiliate of Edison
International, made a $10 million minority interest equity investment in NEV
Technologies.
PHOTOVOLTAIC MANUFACTURING - ADVANCED ENERGY TECHNOLOGIES, INC.
AET owns 50% of Global Solar Energy, L.L.C. which develops and
manufactures photovoltaic materials.
NOTE 6. TEP'S UTILITY PLANT AND JOINTLY-OWNED FACILITIES
- ---------------------------------------------------------
UTILITY PLANT
The following table shows TEP's Utility Plant in Service by major class:
December 31,
1998 1997
- -------------------------------------------------------------------------
- Thousands of Dollars -
Plant in Service:
Production Plant $1,069,079 $1,045,423
Transmission Plant 477,016 471,230
Distribution Plant 586,150 562,336
General Plant 110,899 104,344
Intangible Plant 20,013 9,175
Electric Plant Held for Future Use 714 1,642
- -------------------------------------------------------------------------
Total Plant in Service $2,263,871 $2,194,150
=========================================================================
See TEP Utility Plant in Note 1.
JOINTLY-OWNED FACILITIES
At December 31, 1998, TEP's interests in generating stations and
transmission systems that are jointly-owned with other utilities are as
follows:
Percent Plant Construction
Owned By in Work in Accumulated
TEP Service* Progress Depreciation
- ---------------------------------------------------------------------------
- Thousands of Dollars -
San Juan Units 1 and 2 50.0 $296,837 $ 8,170 $226,162
Navajo Station Units 1,2 and 3 7.5 114,022 7,563 49,727
Four Corners Units 4 and 5 7.0 78,882 2 60,311
Transmission Facilities 7.5 to 95.0 218,284 1,240 122,199
- ---------------------------------------------------------------------------
Total $708,025 $16,975 $458,399
===========================================================================
*Included in Utility Plant shown above.
TEP has financed or provided funds for the above facilities and TEP's
share of their operating expenses is included in the income statements.
NOTE 7. TEP'S LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
- -----------------------------------------------------------
LONG-TERM DEBT
LONG-TERM DEBT MATURES MORE THAN ONE YEAR FROM THE DATE OF THE FINANCIAL
STATEMENTS. WE SUMMARIZE OUR LONG-TERM DEBT IN THE STATEMENTS OF
CAPITALIZATION.
SALE AND REDEMPTION OF BONDS - 1998
During 1998, TEP issued $386.9 million in new bonds and redeemed $416.4
million of previously outstanding bonds. TEP achieved the following
objectives with this refinancing activity:
- extended maturities,
- replaced variable rate debt with fixed rate debt, and
- eliminated restrictive covenants contained in existing First Mortgage
Bonds.
Bonds issued in 1998 include:
Amount Rate Maturity Security
- ----------------------------------------------------------------------------
- Millions of Dollars -
1998 Apache A IDBs $ 83.7 5.85% 2028 Unsecured
1998 Apache B IDBs 99.8 5.875% 2033 Unsecured
1998 Apache C IDBs 16.5 5.85% 2026 Unsecured
12.22% Exchange Series
First Mortgage Bonds 46.9 12.22% 2000 First Mortgage
7.50% First Collateral
Trust Bonds 140.0 7.50% 2008 First Mortgage Bonds
- ----------------------------------------------------------------------------
Total $386.9
============================================================================
TEP exchanged $46.9 million of its existing 12.22% First Mortgage Bonds
due 2000 for the same amount of new 12.22% Exchange Series First Mortgage
Bonds due 2000. With the exception of the covenants restricting the payment
of dividends, the new bonds have substantially the same terms and conditions
as the prior bonds.
Bonds redeemed in 1998 include:
Amount Rate Maturity Security
- ----------------------------------------------------------------------------
- Millions of Dollars -
1981 Apache A IDBs $ 100.0 Variable 2020 Second Mortgage Bonds
1981 Apache B IDBs 100.0 Variable 2021 First Mortgage Bonds
First Mortgage Bonds 15.0 8.50% 1999 First Mortgage
First Mortgage Bonds 25.0 8.125% 2001 First Mortgage
First Mortgage Bonds 40.0 7.65% 2003 First Mortgage
First Mortgage Bonds 25.0 7.55% 2002 First Mortgage
First Mortgage Bonds* 78.8 12.22% 2000 First Mortgage
First Mortgage Bonds 32.1 8.50% 2009 First Mortgage
1976 Farmington(sinking fund) 0.5 7.50% 2006 First Mortgage Bonds
- ----------------------------------------------------------------------------
Total $416.4
============================================================================
* $31.9 million were redeemed and $46.9 million were exchanged for the newly
issued 12.22% Exchange Series First Mortgage Bonds.
When TEP redeemed all of its First Mortgage Bonds due in 1999, 2001,
2002, and 2003, as well as the $31.9 million of 12.22% First Mortgage Bonds
due 2000 not tendered for exchange as described above, it eliminated
covenants that restricted the payment of common stock dividends.
Sale and Redemption of Bonds - 1997
During 1997, TEP issued $379.3 million in new bonds and redeemed $356.8
million of previously outstanding bonds.
Bonds issued in 1997 include:
Amount Rate Maturity Security
------------------------------------------------------------------
- Millions of Dollars -
1997 Farmington A $ 80.4 6.95% 2020 Unsecured
1997 Coconino A** 36.7 7.125% 2032 Unsecured
1997 Coconino B 14.7 7.00% 2032 Unsecured
1997 Pima A*** 22.5 6.10% 2025 Unsecured
1997 Pima B 150.0 6.00% 2029 Unsecured
1997 Pima C 75.0 6.00% 2029 Unsecured
------------------------------------------------------------------
Total $379.3
==================================================================
** $20 million of the proceeds from this issuance are being used to fund
additional pollution abatement facilities at Navajo Generating Station.
***$2.5 million of the proceeds from this issuance were used to finance
improvements to TEP's lower voltage electric transmission and distribution
system in Pima County, Arizona.
Bonds redeemed in 1997 include:
Amount Rate Maturity Security
- ----------------------------------------------------------------------------
- Millions of Dollars -
1996 Coconino Series
A IDBs $ 16.7 Variable 2031 First Mortgage Bonds
1996 Coconino Series
B IDBs 14.7 Variable 2031 First Mortgage Bonds
1973 Farmington A IDBs 47.9 6.25% 2003 Unsecured
1977 Farmington A IDBs 32.5 6.10% 2007 First Mortgage Bonds
1982 Monthly Pima A General
IDBs 75.0 Variable 2022 Credit Agreement****
1982 Quarterly Pima A General
IDBs 75.0 Variable 2022 Credit Agreement****
1983 Pima A General IDBs 75.0 Variable 2018 Credit Agreement****
1990 Pima A 20.0 Variable 2025 First Mortgage Bonds
- ----------------------------------------------------------------------------
Total $356.8
============================================================================
****Letters of credit under the Master Restructuring Agreement secured these
IDBs. The Master Restructuring Agreement was terminated in December 1997
upon origination of TEP's new bank Credit Agreement.
The proceeds from the issuance of certain bonds were held by a trustee
and subsequently used, by the trustee, to redeem previously outstanding
bonds. See Note 15 for a description of the non-cash financing activities
related to the sale and redemption of bonds for 1998 and 1997.
OTHER LONG-TERM DEBT AND AGREEMENTS
FIRST AND SECOND MORTGAGE
TEP's General First Mortgage and General Second Mortgage are secured by
a lien on TEP's utility plant, with the exception of Springerville Unit 2.
San Carlos, a subsidiary of TEP, holds title to Springerville Unit 2.
BANK CREDIT AGREEMENT
TEP has a $441 million Credit Agreement which provides a $100 million
Revolving Credit Facility and a $341 million Letter of Credit Facility.
These credit facilities mature on December 30, 2002 and are secured by $441
million of Second Mortgage Bonds. The Credit Agreement initially totaled
$544 million, but was reduced by $103 million in 1998 due to the redemption
of $100 million of bonds supported by a letter of credit under the Credit
Agreement. The Credit Agreement contains certain financial covenants,
including cash coverage, leverage and net worth tests. As of December 31,
1998, TEP was in compliance with these covenants.
The Revolving Credit Facility can be used for general corporate
purposes. At December 31, 1998, TEP had no outstanding borrowings under this
facility. If we were to borrow under the Revolving Credit Facility, the
variable interest rate that we would pay would be dependent, in part, on the
credit rating on TEP's senior secured debt. We pay an annual commitment fee
on the unused portion of the Revolving Credit Facility. This fee is also
dependent on TEP's credit ratings. At December 31, 1998, the commitment fee
equaled 0.38% per year.
The $341 million Letter of Credit Facility secures the payment of
principal and interest on $328.6 million of tax-exempt variable rate bonds
(IDBs). The amount of commitment fee on the Letter of Credit Facility
depends on TEP's credit ratings. At December 31, 1998, the commitment fee
equaled 1.50% per year.
CAPITAL LEASE OBLIGATIONS
The terms of TEP's capital leases are as follows:
- The Irvington Lease has an initial term to January 2011 and provides for
renewal periods of two or more years through 2020.
- The Springerville Common Facilities Leases have an initial term to 2017
for one lease and 2021 for the other two leases, subject to optional renewal
periods of two or more years through 2025.
- The Springerville Unit 1 Leases have an initial term to January 2015 and
provide for renewal periods of three or more years through 2030.
- The Springerville Coal Handling Facilities Leases have an initial term
to April 2015 and provide for one renewal period of six years, then
additional renewal periods of five or more years through 2035.
MATURITIES AND SINKING FUND REQUIREMENTS
Our long-term debt, including sinking funds, and lease obligations
mature on the following dates:
Expiring Scheduled
LOCs Long-Term
Supporting Debt Capital Lease
IDBs Retirements Obligations Total
-------------------------------------------------------------------
Years Ending
December 31, - Thousands of Dollars -
1999 $ 1,725 $ 103,277 $ 105,002
2000 48,603 129,680 178,283
2001 1,725 101,781 103,506
2002 $328,600 1,725 89,301 419,626
2003 - 1,725 120,474 122,199
-------------------------------------------------------------------
Total 1999 - 2003 328,600 55,503 544,513 928,616
Thereafter - 802,045 1,472,668 2,274,713
Less: Imputed
Interest - - (1,115,991) (1,115,991)
-------------------------------------------------------------------
Total $328,600 $857,548 $ 901,190 $2,087,338
===================================================================
In addition to the capital lease obligations above, we must ensure $70
million of secured notes underlying the Springerville Common Facilities
leases are refinanced by December 31, 1999 to avoid a special event of loss
under the lease. This special event of loss would require us to repurchase
the Springerville Common Facilities at the higher of a specified price or the
fair market value of the facilities. TEP has the intent and the ability to
cause the underlying debt on these leases to be refinanced in 1999.
NOTE 8. FAIR VALUE OF TEP'S FINANCIAL INSTRUMENTS
- --------------------------------------------------
The carrying value and fair value of TEP's financial instruments are as
follows:
December 31,
1998 1997
-----------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-----------------------------------------------------------------------
- Thousands of Dollars -
Assets:
Debt Securities (Included
in Investments and Other
Property) $ 17,813 $ 22,091 $ 17,781 $ 19,911
Liabilities:
First Mortgage Bonds:
Corporate 74,778 79,359 243,750 255,928
Industrial Development
Revenue Bonds (IDBs)
Fixed Rate 63,500 63,500 64,000 64,000
Variable Rate - - 100,000 100,000
First Collateral Trust
Bonds 140,000 141,989 - -
Second Mortgage Bonds:
IDBs (Variable Rate) 328,600 328,600 428,600 428,600
Unsecured IDBs 579,270 587,344 379,270 413,694
-----------------------------------------------------------------------
TEP intends to hold the investment in Debt Securities to maturity
(January 1, 2013). These Debt Securities are stated at amortized cost which
means the purchase cost is adjusted for the amortization of the discount to
maturity. We base the fair value of this investment on quoted market prices
for the same or similar debt.
TEP considers the principal amounts of variable rate debt outstanding to
be reasonable estimates of their fair value. We determined the fair value of
TEP's fixed rate obligations including the Corporate First Mortgage Bonds,
the First Mortgage Bonds-IDBs (fixed rate), First Collateral Trust Bonds and
the Unsecured IDBs by calculating the present value of the cash flows of each
fixed rate obligation. We used a rate consistent with market yields
generally available as of December 1998 for 1998 amounts and December 1997
for 1997 amounts for bonds with similar characteristics with respect to:
credit rating, time-to-maturity, and the tax status of the bond coupon for
Federal income tax purposes. The use of different market assumptions and/or
estimation methodologies may yield different estimated fair value amounts.
NOTE 9. DIVIDEND LIMITATIONS
- -----------------------------
UNISOURCE ENERGY
Our ability to pay cash dividends on common stock outstanding depends,
in part, upon cash flows from our subsidiaries, TEP and Millennium.
TEP
In December 1998, TEP paid a $30 million dividend to UniSource Energy,
the holder of all of TEP's common stock. TEP must meet the following
requirements before paying dividends to UniSource Energy:
- Bank Credit Agreement
TEP's bank Credit Agreement allows TEP to pay dividends as long as TEP
maintains compliance with the agreement and meets financial covenants. As of
December 31, 1998, TEP was in compliance with the terms of the Credit
Agreement.
- ACC Holding Company Order
The ACC Holding Company Order does not allow TEP to pay dividends to
UniSource Energy in excess of 75% of its annual earnings until TEP's equity
ratio equals 37.5% of total capitalization, excluding capital lease
obligations. As of December 31, 1998, TEP was in compliance with this
requirement.
- Federal Power Act
This Act states that dividends shall not be paid out of funds properly
included in capital accounts. TEP's 1998 dividend to UniSource Energy was
paid from current year earnings.
NOTE 10. COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
TEP COMMITMENTS - FUEL PURCHASE
TEP has the following commitments to purchase coal:
- The Springerville contract expires in 2010, but includes an option to
extend the initial term for ten years. See Deferred Springerville Contract
Termination Fee in Note 2.
- The Irvington contract expires in 2015 or at the end of the useful life
of the coal-fired unit, whichever is earlier.
- The contracts for jointly-owned facilities expire at various dates from
2005 to 2017. See Jointly-Owned Facilities in Note 6.
The Springerville and Irvington contracts combined require TEP to take
2.1 million tons of coal per year from 1999 to 2009 at an estimated annual
cost of $62 million in 1999. The contracts to purchase coal for use at the
jointly-owned facilities require TEP to take 1.5 million tons of coal per
year from 1999 to 2005 at an estimated annual cost of $45 million in 1999.
All of these contracts include a price adjustment clause that will affect the
future cost of coal.
Each of TEP's coal purchase contracts requires TEP to pay a take-or-pay
charge if certain minimum quantities of coal are not purchased. Our present
fuel requirements are in excess of the take-or-pay minimums. However,
sometimes, TEP purchases coal from other suppliers or switches fuel burn from
one generating station to another to reduce overall fuel costs, resulting in
take-or-pay minimum charges. TEP incurred take-or-pay charges of $3.5
million in 1998, none in 1997 and $4.4 million in 1996.
COMMITMENTS - ENVIRONMENTAL REGULATION
Clean Air
The 1990 Federal Clean Air Act Amendments require reductions of sulfur
dioxide (SO2) and nitrogen oxide (NOx) emissions in two phases, more complex
facility permits and other requirements which are currently in effect. TEP
is subject only to Phase II of the SO2 and NOx emission reductions which is
effective January 1, 2000. All of TEP's generating facilities (except
internal combustion turbines) are affected. TEP spent approximately $1
million in each of 1996, 1997 and 1998 and expects to spend approximately $1
million annually in 1999 and 2000 complying with these requirements.
In 1993, our generating units affected by Phase II were allocated SO2
Emission Allowances based on past operational history. Beginning in the year
2000, Phase II generating units must hold Emission Allowances equal to the
level of emissions in the compliance year or pay penalties and offset excess
emissions in future years. Due to increased energy output at Springerville,
TEP may not have sufficient Emission Allowances to permit normal plant
operation in compliance with the Phase II SO2 regulations. TEP may have to
purchase additional Emission Allowances. Based on current estimates of
additional required Emission Allowances and market prices, we believe that
purchases of additional Emission Allowances will not have a material effect
on TEP.
TEP may incur additional costs to comply with recent and future changes
in federal and state environmental laws, regulations and permit requirements
at existing electric generating facilities. Compliance with these changes
may result in a reduction in operating efficiency.
Jointly-Owned Facilities - SO2 Emission Capital Improvements
- Navajo: In 1991, the EPA adopted a rule requiring the reduction of
Navajo's SO2 annual emissions by 90% to improve visibility at Grand Canyon
National Park. TEP's share of the remaining required capital expenditures as
of December 31, 1998 is approximately $4.5 million through 2000.
- San Juan: To improve the efficiency of SO2 removal, the existing system
is being replaced. TEP's estimated share of the remaining costs as of
December 31, 1998 is approximately $2.0 million.
UNISOURCE ENERGY COMMITMENTS - ENERGY RELATED AFFILIATES
For a discussion of UniSource Energy's commitments to energy-related
affiliates, see Note 5.
CONTINGENCIES
Ruling on Arizona Sales Tax Assessments - Coal Sales
We received and are protesting sales tax assessments received from the
ADOR alleging that a former TEP subsidiary is liable for sales tax on gross
income from coal sales, transportation and coal-handling services provided to
TEP from November 1985 through May 1996. Arizona law generally requires
payment of an assessment prior to pursuing the appellate process. We have
previously paid, under protest, a total of $23 million of the disputed sales
tax assessments. In September 1996, the Arizona Court of Appeals upheld the
validity of the assessment issued for the period November 1985 through March
1990. However, in May 1998, the Arizona Supreme Court remanded the case back
to the Arizona Tax Court to be reheard. The payments previously made will be
refunded if we are successful in the appeals process.
TEP has recorded an expense and a related liability for the sales taxes
and interest for the period November 1985 through May 1996 that we believe
are probable of incurrence. On May 31, 1996, the former subsidiary was
merged into TEP. Because TEP now acquires coal directly from unaffiliated
companies, we do not believe we are liable for sales tax computed on a basis
similar to the assessments described above after May 31, 1996. For periods
prior to May 31, 1996, we continue to record an estimated interest expense on
the disputed assessments.
Arizona Sales Tax Assessments - Leases
The ADOR has issued sales tax assessments to some of TEP's lessors of
generation-related facilities and equipment. The assessments allege sales
tax liability on a component of rents we paid on the Springerville Unit 1
Leases, the Springerville Common Facilities Leases, the Irvington Lease and
the Springerville Coal Handling Facilities Lease from August 1, 1988 to June
30, 1997. Due to indemnification provisions in the lease agreements, if the
ADOR prevails, we would be required to reimburse the lessors for the sales
taxes that they pay. We filed an appeal of the assessments in the Arizona
Tax Court in February 1998. In July 1998, the Arizona Tax Court upheld the
assessment issued on the Irvington lease for the period August 1988 through
September 1990, and we have appealed the decision. Arizona law generally
requires payment of an assessment prior to pursuing the appellate process.
Under protest, we paid a total of $2 million of the disputed assessments.
These payments will be refunded if we are successful in the appeals process.
We have recorded a liability for the probable amount of sales taxes and
interest due as of December 31, 1998. If the ADOR prevails, we would need to
record an additional expense and related liability. Even though it is
reasonably possible that the resolution of this issue could result in
approximately $23 million of additional sales tax expense, we do not believe
this outcome is likely. We do not expect that the resolution of this
assessment will have a material negative impact on the financial statements.
We believe that the ultimate resolution of this issue could occur between two
to four years from now.
INCOME TAX ASSESSMENTS
In February 1998, the IRS issued an income tax assessment for the 1992
and 1993 tax years. The IRS is challenging our treatment of various items
relating to a 1992 financial restructuring, including the amount of NOL and
ITC generated before December 1991 that may be used to reduce taxes in future
periods.
Due to a financial restructuring, a change in TEP's ownership occurred
for tax purposes in December 1991. As a result, our use of the NOL and ITC
generated before 1992 may be limited under the tax code. The IRS is
challenging our calculation of this limitation. At December 31, 1998, pre-
1992 federal NOL and ITC carryforwards were approximately $209 million and
$23 million, respectively. In addition to the pre-1992 NOL and ITC which are
subject to the limitation, $168 million of federal NOL at December 31, 1998,
is not subject to the limitation.
We do not expect the resolution of these issues to have a material
adverse impact on the financial statements.
NOTE 11. INCOME TAXES
- ----------------------
Deferred tax assets (liabilities) consist of the following:
UniSource Energy TEP
---------------------------------------------
December 31, December 31,
1998 1997 1998 1997
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Gross Deferred Income Tax
Liabilities:
Electric Plant - Net $(559,008) $(568,365) $(559,008) $(568,365)
Income Taxes Recoverable
Through Future Revenues
Regulatory Asset (60,692) (68,680) (60,692) (68,680)
Deferred Inventory Costs (24,072) (24,995) (24,072) (24,995)
Deferred Lease Payments (12,465) (13,273) (12,465) (13,273)
Property Taxes (9,048) (9,450) (9,048) (9,450)
Other (21,092) (12,809) (11,673) (12,809)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax
Liability (686,377) (697,572) (676,958) (697,572)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax
Assets:
Capital Lease Obligations 359,575 364,445 359,575 364,445
Net Operating Loss
Carryforwards 116,046 141,048 116,046 141,048
Springerville Unit 1
Disallowed Costs 68,394 67,760 68,394 67,760
Investment Tax Credit
Carryforwards 23,316 26,396 23,316 26,396
Lease Interest Payable 17,627 18,424 17,627 18,424
Regulatory Deferred Capital
Lease Expense 17,395 17,163 17,395 17,163
Sales Tax Assessments 14,686 14,406 14,686 14,406
Financial Restructuring Costs 9,451 10,775 9,451 10,775
Deferred Gain on Emission
Allowances 12,315 6,926 12,315 6,926
Capital Loss Carryforwards - 4,520 - 4,520
Alternative Minimum Tax (AMT) 17,395 5,594 15,326 5,594
Retiree and Employee Benefits 9,777 8,388 9,777 8,388
Other 30,378 16,965 14,552 16,965
- -----------------------------------------------------------------------------
Gross Deferred Income Tax
Asset 696,355 702,810 678,460 702,810
Deferred Tax Assets
Valuation Allowance (57,186) (67,934) (57,186) (67,934)
- -----------------------------------------------------------------------------
Net Deferred Income Tax
Liability $ (47,208) $ (62,696) $ (55,684) $ (62,696)
=============================================================================
We record a Deferred Tax Assets Valuation Allowance for the amount of
Deferred Tax Assets that we do not believe we can use to reduce income taxes
on a future tax return. The Valuation Allowance reduces the amount of
Deferred Tax Assets to the amount that we believe we can use in the future.
The $11 million decrease in the Deferred Tax Assets Valuation Allowance in
1998 is due primarily to the use of capital loss and investment tax credit
carryforwards. The $43 million decrease in the deferred tax assets valuation
allowance in 1997 resulted from an increase in the estimated amount of NOLs
that we believe we will use to reduce future taxable income and the use of
NOL carryforwards.
UniSource Energy and TEP recognize NOL benefits in the income statement
based on changes in the estimated amount of prior period NOLs that are likely
to be used on future tax returns. A significant factor in estimating this
amount is the average annual book income before income taxes for the prior
three years. Prior to 1995, UniSource Energy and TEP provided a Deferred Tax
Assets Valuation Allowance against all the NOL carryforwards, ITC
carryforwards and capital loss carryforwards due to the uncertainty of their
future use. Because results from operations improved, the amount of NOL
carryforwards that UniSource Energy and TEP believe is likely to reduce
future taxable income increased. Accordingly, UniSource Energy and TEP
recognized in 1997 and 1996 income tax benefits of $43 million and $89
million, respectively, related to the current and expected future use of
federal and state NOL carryforwards. These benefits are included in Income
Taxes in Other Income (Deductions) in the income statements. In future
periods when NOLs are used on tax returns to reduce income taxes paid, income
tax expense shown on the income statements will not be reduced.
At December 31, 1997, both UniSource Energy and TEP had recorded the
amount of prior period NOL benefit that we expect to use on future income tax
returns. At the present time, we are not able to estimate additional amounts
of NOL benefit that we may recognize in the income statements of either
UniSource Energy or TEP. This is because there are still open tax years for
which additional assessments may be made and because federal and state NOL
carryforwards expire at various dates. We do not expect to recognize
additional amounts of NOL benefit until these items are resolved.
The net deferred income tax liability is included in the balance sheets
in the following accounts:
UniSource Energy TEP
---------------------------------------------
December 31, December 31,
1998 1997 1998 1997
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Deferred Income Taxes-Current $ 14,820 $ 14,910 $ 14,820 $ 14,910
Deferred Income Taxes-Noncurrent (62,028) (77,606) (70,504) (77,606)
- -----------------------------------------------------------------------------
Net Deferred Income Tax
Liability $ (47,208) $ (62,696) $ (55,684) $ (62,696)
=============================================================================
Income tax expense (benefit) included in the income statements consist of the
following:
UniSource Energy
-------------------------------
Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Expenses:
Deferred Tax Expense
Federal $ 22,554 $ 15,262 $ 7,836
State (4,182) 4,045 2,019
- ---------------------------------------------------------------------------
Total 18,372 19,307 9,855
Investment Tax Credit Amortization - (10) (60)
- ---------------------------------------------------------------------------
Total Expense Included in
Operating Expenses 18,372 19,297 9,795
- ---------------------------------------------------------------------------
Other Income (Deductions):
Deferred Tax Expense
Federal (1,264) 6,505 725
State 1,275 1,648 252
- ---------------------------------------------------------------------------
Total 11 8,153 977
Reduction in Valuation
Allowance - Benefit - (43,443) (88,638)
Investment Tax Credit Amortization (4,548) (3,273) (4,355)
- ---------------------------------------------------------------------------
Total Benefit Included in Other
Income (Deductions) (4,537) (38,563) (92,016)
- ---------------------------------------------------------------------------
Unregulated Energy Business - Net:
Deferred Tax Expense
Federal (2,631) (2,255) 52
State (1,130) (583) 14
- ---------------------------------------------------------------------------
Total Benefit Included in Unregulated
Energy Business - Net (3,761) (2,838) 66
- ---------------------------------------------------------------------------
Total Federal and State Income Tax
Expense (Benefit) $ 10,074 $ (22,104) $ (82,155)
===========================================================================
TEP
-------------------------------
Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Expenses:
Deferred Tax Expense
Federal $ 22,554 $ 15,262 $ 7,836
State (4,182) 4,045 2,019
- ---------------------------------------------------------------------------
Total 18,372 19,307 9,855
Investment Tax Credit Amortization - (10) (60)
- ---------------------------------------------------------------------------
Total Expense Included in
Operating Expenses 18,372 19,297 9,795
- ---------------------------------------------------------------------------
Other Income (Deductions):
Deferred Tax Expense
Federal 1,778 4,250 777
State 1,976 1,065 266
- ---------------------------------------------------------------------------
Total 3,754 5,315 1,043
Reduction in Valuation
Allowance - NOL Benefit - (43,443) (88,638)
Investment Tax Credit Amortization (4,548) (3,273) (4,355)
- ---------------------------------------------------------------------------
Total Benefit Included in Other
Income (Deductions) (794) (41,401) (91,950)
- ---------------------------------------------------------------------------
Total Federal and State Income Tax
Expense (Benefit) $ 17,578 $ (22,104) $ (82,155)
===========================================================================
The differences between the income tax expense (benefit) and the amount
obtained by multiplying pre-tax income by the U.S. statutory federal income
tax rate of 35% are as follows:
UniSource Energy
-------------------------------
Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 13,337 $ 21,514 $ 13,544
State Income Tax Expense, Net of
Federal Deduction 1,849 3,314 2,081
Depreciation Differences (Flow Through
Basis) 3,791 - -
Investment Tax Credit Amortization (4,548) (3,283) (4,415)
Reduction in Valuation Allowance -
NOL Benefit - (43,443) (88,638)
Capital Loss Carryforwards (4,463) - (5,616)
Other 108 (206) 889
- ---------------------------------------------------------------------------
Total Federal and State Income
Tax Expense (Benefit) $ 10,074 $ (22,104) $ (82,155)
===========================================================================
TEP
-------------------------------
Years Ended December 31,
1998 1997 1996
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 20,739 $ 21,514 $ 13,544
State Income Tax Expense, Net of
Federal Deduction 2,876 3,314 2,081
Depreciation Differences (Flow Through
Basis) 3,791 - -
Investment Tax Credit Amortization (4,548) (3,283) (4,415)
Reduction in Valuation Allowance -
NOL Benefit - (43,443) (88,638)
Capital Loss Carryforwards (4,463) - (5,616)
Other (817) (206) 889
- ---------------------------------------------------------------------------
Total Federal and State Income
Tax Expense (Benefit) $ 17,578 $ (22,104) $ (82,155)
===========================================================================
At December 31, 1998, UniSource Energy and TEP had, for federal income
tax purposes:
- $377 million of NOL carryforwards expiring in 2005 through 2009;
- $23 million of unused ITC expiring in 2002 through 2005;
- $18 million of AMT credit which will carry forward to future years.
See discussion of pre-1992 NOL and ITC in Income Tax Assessments in Note
10.
NOTE 12. EMPLOYEE BENEFITS PLANS
- ---------------------------------
VOLUNTARY SEVERANCE PLAN (VSP)
In May 1996, TEP offered employees a VSP. The VSP resulted in $14
million of employee termination benefit expense in 1996 for termination
benefits that are included in Voluntary Severance Plan Expense - Net on the
income statement. Approximately $10 million of the termination benefits were
paid in 1996 with the remaining benefits paid over the following three years.
As a result of partial settlements and curtailments of employee benefit plans
related to the VSP, TEP recognized a $3.4 million gain in 1996 and a $3
million loss in the first quarter of 1997.
PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
TEP has noncontributory pension plans for all regular employees.
Benefits are based on years of service and the employee's average
compensation. TEP makes annual contributions to the plans that are not
greater than the maximum tax-deductible contribution and not less than the
minimum funding requirement by the Employee Retirement Income Security Act of
1974. Contributions are intended to provide for both current and future
accrued benefits. TEP provides supplemental retirement benefits to employees
whose benefits are limited by IRS benefit or compensation limitations.
TEP also provides health care and life insurance benefits for retirees.
All regular employees may become eligible for these benefits if they reach
retirement age while working for TEP. The ACC allows TEP to recover through
rates postretirement costs only as benefit payments are made to or on behalf
of retirees. The postretirement benefits are currently funded entirely on a
pay-as-you-go basis. Under current accounting guidance, TEP cannot record a
regulatory asset for the excess of expense calculated per Statement of
Financial Accounting Standards No. 106, Employers' Accounting for
Postretirement Benefits Other Than Pensions, over actual benefit payments.
The actuarial present value of the benefit obligations are measured at
October 1 for our pension plans and December 31 for our other postretirement
benefit plan. The following table sets forth the plans' funded status and
amounts of retirement plan assets and liabilities recognized in the balance
sheets at December 31, 1998 and 1997:
Other Postretirement
Pension Benefits Benefits
--------------------------------------------
Years Ended December 31,
1998 1997 1998 1997
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Change in Benefit Obligation
Benefit Obligation at
Beginning of Year $ 84,542 $ 66,760 $ 30,277 $ 29,602
Actuarial (Gain) Loss 13,541 19,907 11,975 (2,920)
Interest Cost 6,068 4,806 2,068 2,068
Service Cost 3,917 2,750 1,004 975
Benefits Paid (3,157) (16,143) (1,421) (1,234)
Plan Amendment - 6,462 - -
Curtailment Loss - - - 1,125
Special Termination Benefit Loss - - - 661
--------------------------------------------
Benefit Obligation at End
of Year 104,911 84,542 43,903 30,277
--------------------------------------------
Change in Plan Assets
Fair Value of Plan Assets
at Beginning of Year 88,316 73,089 - -
Actual Return on Plan Assets (1,797) 28,491 - -
Benefits Paid (3,157) (16,143) (1,421) (1,234)
Employer Contributions 3,992 3,332 1,421 1,234
--------------------------------------------
Fair Value of Plan Assets
at End of Year 87,354 88,769 - -
--------------------------------------------
Reconciliation of Funded Status
to Balance Sheet
Funded Status (Difference
between Benefit Obligation
and Fair Value of Plan
Assets) (17,557) 4,227 (43,903) (30,277)
Unrecognized Net (Gain) Loss 16,562 (6,799) 12,261 286
Unrecognized Prior Service Cost 12,706 13,957 - -
Unrecognized Transition (Asset)
Obligation (568) (757) 12,156 13,025
--------------------------------------------
Net Amount Recognized in
the Balance Sheets $ 11,143 $ 10,628 $(19,486) $(16,966)
============================================
Amounts Recognized in the
Balance Sheets Consist of:
Prepaid Benefit Cost Included
in Other Current Assets $ 7,673 $ 11,094 $ - $ -
Accrued Benefit Liability
Included in Other Liabilities (6,740) (1,033) (19,486) (16,966)
Intangible Asset Included in
Deferred Debits 10,210 567 - -
--------------------------------------------
Net Amount Recognized $ 11,143 $ 10,628 $(19,486) $(16,966)
============================================
Benefit Obligation and
Fair Value of Plan Assets
for Plans with Benefit
Obligations in Excess of
Plan Assets:
Benefit Obligation at
End of Year $104,911 $ 37,897 $ 43,903 $ 30,277
Fair Value of Plan
Assets at End of Year $ 87,354 $ 32,260 $ - $ -
- -----------------------------------------------------------------------------
We recorded a transition asset or obligation when we adopted accounting
standards requiring recognition of pension and other postretirement benefit
obligations and costs in the financial statements. The transition asset or
obligation equaled the difference between the fair value of plan assets and
the accumulated benefit obligation. The unrecognized transition asset
recognized on the pension plans is being amortized over 15 years. The
unrecognized transition obligation on the postretirement benefit plan is
being amortized over 20 years.
Pension Benefits
Years Ended December 31,
1998 1997 1996
- --------------------------------------------------------------------------
- Thousands of Dollars -
Components of Net Pension Cost
Service Cost of Benefits Earned During Period $ 3,917 $ 2,750 $ 2,835
Interest Cost on Projected Benefit Obligation 6,068 4,806 5,924
Expected Return on Plan Assets (7,955) (6,180) (7,298)
Amortization of Unrecognized Prior Service
Cost 1,252 669 (128)
Amortization of Unrecognized Transition Asset (189) (160) 921
Recognized Actuarial (Gain) Loss (68) - (268)
Curtailment/Settlement (Gain) Loss - - (3,407)
- --------------------------------------------------------------------------
Net Periodic Pension Cost $ 3,025 $ 1,885 $(1,421)
==========================================================================
Actuarial Assumptions: 1998 1997 1996
- --------------------------------------------------------------------------
Discount Rate - Funding Status 6.5% 7.3% 8.0%
Average Compensation Increase 4.0 4.0 5.0
Expected Long-Term Rate of Return on Plan Assets 9.0 9.0 9.0
- --------------------------------------------------------------------------
Other Postretirement Benefits
Years Ended December 31,
1998 1997 1996
- --------------------------------------------------------------------------
- Thousands of Dollars -
Components of Net Postretirement Benefit Cost
Service Cost of Benefits Earned During Period $ 1,004 $ 975 $ 1,025
Interest Cost on Projected Benefit Obligation 2,068 2,068 2,071
Amortization of Unrecognized Transition
Obligation 868 868 913
Amortization of the Unrecognized (Gain) Loss - - 42
Curtailment/Settlement (Gain) Loss - 2,272 -
Special Termination Benefit Loss - 661 -
- --------------------------------------------------------------------------
Net Periodic Postretirement Benefit Cost $ 3,940 $ 6,844 $ 4,051
==========================================================================
The accumulated postretirement benefit obligation was determined using a
6.50% and 7.00% discount rate for 1998 and 1997, respectively. Assumed
health care cost trend rates have a significant effect on the amounts
reported for health care plans. The health care cost trend rates were
assumed to be 6.5% for 1999, gradually declining to 4.0% in 2003 and
thereafter. A one-percentage-point change in assumed health care cost trend
rates would have the following effects on the December 31, 1998 amounts:
One-Percentage- One-Percentage-
Point Increase Point Decrease
-----------------------------------------------------------------------
- Thousands of Dollars -
Effect on Total of Service and
Interest Cost Components $ 513 $ (313)
Effect on Postretirement Benefit
Obligation $ 6,565 $ (5,319)
-----------------------------------------------------------------------
DEFINED CONTRIBUTION PLANS
All regular employees may contribute up to 15 percent of their pre-tax
compensation, subject to certain limitations, in TEP's voluntary, defined
contribution 401(k) plans. TEP contributes cash to the account of each
participant based on each participant's contributions not exceeding 4.5
percent of the participant's compensation. Participants direct the
investment of contributions to their account be invested in certain
investment funds. In 1998, 1997 and 1996, TEP incurred approximately $2
million annually in expense related to these plans.
STOCK OPTION PLANS
On May 20, 1994, the Shareholders approved two stock option plans, the
1994 Outside Director Stock Option Plan (1994 Directors' Plan) and the 1994
Omnibus Stock and Incentive Plan (1994 Omnibus Plan).
The 1994 Directors' Plan provided for the annual grant of 1,200 non-
qualified stock options to each eligible director at an exercise price equal
to the market price of the common stock at the grant date, beginning January
3, 1995. These options vest over three years, become exercisable in one-
third increments on each anniversary date of the grant and expire on the
tenth anniversary. In December 1998, the Board of Directors approved an
increase in the annual grant of non-qualified stock options to 2000 beginning
January 1999.
The 1994 Omnibus Plan allows the Compensation Committee, a committee of
non-employee directors, to grant the following types of awards to each
eligible employee: stock options; stock appreciation rights; restricted
stock; performance units; performance shares; and dividend equivalents. The
total number of shares of UniSource Energy stock which may be awarded under
the Omnibus Plan cannot exceed 1.6 million.
The Compensation Committee granted stock options to key employees during
1998, 1997 and 1996 and to all employees during 1994. These stock options
were granted at exercise prices equal to the market price of the common stock
at the grant date. These options vest over three years, become exercisable
in one-third increments on each anniversary date of the grant and expire on
the tenth anniversary.
A summary of the activity of the 1994 Directors' Plan and 1994 Omnibus
Plan is as follows:
1998 1997 1996
- -------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- -------------------------------------------------------------------------
Options Outstanding,
Beginning of Year 800,541 $15.17 688,123 $15.30 525,522 $16.26
Granted 222,446 $15.69 144,190 $14.59 212,684 $13.16
Exercised (74,177) $14.79 (6,630) $16.25 (2,886) $16.25
Forfeited (60,351) $14.66 (25,142) $15.18 (47,197) $16.25
-------- -------- --------
Options Outstanding,
End of Year 888,459 $15.37 800,541 $15.17 688,123 $15.30
======== ======== ========
Options Exercisable,
End of Year 549,254 $15.55 491,763 $15.17 286,944 $16.27
Option Price Range of Options Outstanding at December 31, 1998: $13.00
to $18.13
Weighted Average Remaining Contractual Life at December 31, 1998: 7.25
- -------------------------------------------------------------------------
We apply Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, in accounting for our stock option plans.
Accordingly, we have not recognized any compensation cost for the plans
during 1996 though 1998. We have also adopted the disclosure-only provisions
of Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation (FAS 123). Had our compensation costs for the stock
option plans been determined based on the fair value at the grant date for
awards in 1998, 1997 and 1996 consistent with the provisions of FAS 123, net
income and net income per average share would have been reduced to the pro
forma amounts indicated below:
Years Ended December 31,
1998 1997 1996
- ----------------------------------------------------------------------------
- Thousands of Dollars -
(except per share data)
Net Income - As Reported $ 28,032 $ 83,572 $120,852
Pro Forma $ 27,724 $ 83,201 $120,594
Basic Earnings Per Share - As Reported $0.87 $2.60 $3.76
Pro Forma $0.86 $2.59 $3.75
Diluted Earnings per Share - As Reported $0.87 $2.59 $3.75
Pro Forma $0.86 $2.58 $3.74
- -----------------------------------------------------------------------------
The fair value of each stock option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted average assumptions:
1998 1997 1996
--------------------------------------------------------------
Expected life (years) 4 3 4
Interest rate 5.41% 6.16% 6.51%
Volatility 23.59% 23.15% 23.51%
Dividend yield None None None
--------------------------------------------------------------
NOTE 13. WARRANTS
- ------------------
In 1998, we exchanged a portion of the outstanding TEP Warrants for
warrants exercisable into UniSource Energy Common Stock. The remaining 4.6
million of TEP Warrants entitle the holder of five warrants to purchase one
share of TEP common stock for $16.00. The TEP common stock which would be
issued upon the exercise of TEP Warrants cannot be converted into UniSource
Energy Common Stock. Currently, UniSource Energy owns 100% of the common
stock of TEP and TEP common stock is not publicly traded. Each new UniSource
Energy Warrant entitles the holder to purchase one share of UniSource Energy
Common Stock for $16.00.
After the exchange, the following warrants are outstanding:
- 1.5 million of UniSource Energy Warrants expiring March 15, 1999;
- 1.5 million of UniSource Energy Warrants expiring December 15, 2000; and
- 4.6 million of TEP Warrants expiring December 15, 2002; exercisable for
920,000 shares of TEP common stock.
NOTE 14. SHAREHOLDER RIGHTS PLAN
- ---------------------------------
In March 1999, UniSource Energy adopted a Shareholder Rights Plan. On
April 1, 1999, each Common Stock shareholder will receive one Right.
Initially, each Right will allow shareholders to purchase one ten-thousandth
of a share of UniSource Energy's Series X Preferred Stock for $50, subject to
adjustment. The Rights will only be exercisable if a person or group
acquires or commences a tender offer to acquire 15% or more of UniSource
Energy Common Stock. Upon any such acquisition, each Right would entitle the
holder to purchase a number of shares of UniSource Energy Common Stock (or,
in the case of a merger of UniSource Energy into another person or group,
common stock of the acquiring person) having a fair market value equal to
twice the purchase price. In no event will the Rights be exercisable by a
person which has acquired 10% or more of the Common Stock. At any time until
any person or group has acquired 15% or more of the Common Stock, UniSource
Energy may redeem the Rights at a redemption price of $0.001 per Right.
Initially, the Rights will trade automatically with the Common Stock when it
is bought and sold. The Rights will expire on March 31, 2009.
NOTE 15. SUPPLEMENTAL CASH FLOW INFORMATION
- --------------------------------------------
We define Cash and Cash Equivalents as cash (unrestricted demand
deposits) and all highly liquid investments purchased with a maturity of
three months or less. A reconciliation of net income to net cash flows from
operating activities follows:
UniSource Energy
----------------------------------
Years Ended December 31,
1998 1997 1996
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Net Income $ 28,032 $ 83,572 $120,852
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 90,358 86,405 98,246
Deferred Income Taxes and Investment
Tax Credit 966 (23,089) (83,722)
Lease Payments Deferred 32,624 33,679 30,756
Deferred Springerville Unit 2 Costs - - (286)
Regulatory Amortizations, Net of Interest
Imputed on Losses Recorded at
Present Value 3,657 (3,485) (16,544)
Reversal of Loss Provision - (10,154) (8,472)
Deferred Contract Termination Fee (6,154) (38,077) -
Unremitted (Earnings) Losses of
Unconsolidated Subsidiaries 5,678 5,625 (123)
Emission Allowances 11,368 (11,463) 2,353
Other 3,338 (437) (3,913)
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable (1,542) (5,320) (4,188)
Materials and Fuel (2,223) (3,649) 11,812
Accounts Payable 977 6,103 1,644
Taxes Accrued 2,770 390 8,311
Other Current Assets and Liabilities (1,347) 4,191 (8,261)
Other Deferred Assets and Liabilities (5,757) 1,992 4,467
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $162,745 $126,283 $152,932
=============================================================================
TEP
----------------------------------
Years Ended December 31,
1998 1997 1996
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Net Income $ 41,676 $ 83,572 $120,852
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 90,358 86,405 98,246
Deferred Income Taxes and Investment
Tax Credit 6,910 (23,089) (83,722)
Lease Payments Deferred 32,624 33,679 30,756
Deferred Springerville Unit 2 Costs - - (286)
Regulatory Amortizations, Net of Interest
Imputed on Losses Recorded at
Present Value 3,657 (3,485) (16,544)
Reversal of Loss Provision - (10,154) (8,472)
Deferred Contract Termination Fee (6,154) (38,077) -
Unremitted (Earnings) Losses of
Unconsolidated Subsidiaries (1,017) 5,625 (123)
Emission Allowances 11,368 (11,463) 2,353
Interest Accrued on Note Receivable from
UniSource Energy (9,329) - -
Other 6,478 (437) (3,913)
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable (1,924) (5,320) (4,188)
Materials and Fuel (2,218) (3,649) 11,812
Accounts Payable 4,833 6,103 1,644
Taxes Accrued 2,717 390 8,311
Other Current Assets and Liabilities 7,638 4,191 (8,261)
Other Deferred Assets and Liabilities (5,759) 1,992 4,467
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $181,858 $126,283 $152,932
=============================================================================
Non-cash investing and financing activities of UniSource Energy and TEP
that affected recognized assets and liabilities but did not result in cash
receipts or payments were as follows:
Years Ended December 31,
1998 1997 1996
- -----------------------------------------------------------------------------
- Thousands of Dollars -
Capital Lease Obligations $ 13,613 $ 11,788 $ 8,336
Proceeds from the Issuance of Long-Term
Debt 290,699 379,270 31,400
Payments to Retire Long-Term Debt (286,878) (356,810) (14,700)
Minimum Pension Liability 10,036 - -
The non-cash change in capital lease obligations represents interest
accrued for accounting purposes in excess of interest payments.
When issuing new bonds and redeeming outstanding bonds, a trustee may
hold the proceeds from our issuance of new long-term debt and use the
proceeds to redeem previously outstanding long-term debt. When this occurs,
the Proceeds from the Issuance of Long-Term Debt and the related Payments to
Retire Long-Term Debt are not reported in our cash flow statements because
these transactions did not affect our cash balances.
NOTE 16. 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 following table
shows the amounts used in computing earnings per share and the effects of
potential dilutive common stock on the weighted average number of shares.
Years Ended December 31,
1998 1997 1996
------------------------------------------------------------------------
- Thousands of Dollars -
Basic Earnings Per Share: (except per share data)
Numerator: Net Income $ 28,032 $ 83,572 $120,852
Denominator: Average Shares
of Common Stock - Outstanding 32,178 32,138 32,136
------------------------------------------------------------------------
Basic Earnings Per Share $ 0.87 $ 2.60 $ 3.76
========================================================================
Diluted Earnings per Share:
Numerator: Net Income $ 28,032 $ 83,572 $120,852
Denominator: Average Shares
of Common Stock - Outstanding 32,178 32,138 32,136
Effect of Dilutive Securities:
Warrants 79 53 81
Options 90 87 36
------------------------------------------------------------------------
Total Shares 32,347 32,278 32,253
------------------------------------------------------------------------
Diluted Earnings Per Share $ 0.87 $ 2.59 $ 3.75
========================================================================
Options to purchase 460,000 shares of common stock at $16.25 per share
were outstanding at the end of the year 1998 but were not included in the
computation of diluted EPS because the options' exercise price was greater
than the average market price of the common shares.
4.6 million of the 7.6 million warrants outstanding are exercisable into
TEP common stock. See Note 13. However, the dilutive effect is the same as
it would be if the warrants were exercisable into UniSource Energy Common
Stock.
NOTE 17. QUARTERLY FINANCIAL DATA (UNAUDITED)
- ----------------------------------------------
UniSource Energy
---------------------------------------
First Second Third Fourth
- ----------------------------------------------------------------------------
- Thousands of Dollars -
(except per share data)
1998
Operating Revenue $160,941 $179,603 $253,229 $174,903
Operating Income 23,820 29,866 54,610 26,892
NOL Benefit Recognition (see Note 11) - - - -
Net Income (Loss) (7,035) 1,058 33,673 336
Basic Earnings Per Share (0.22) 0.03 1.05 0.01
Diluted Earnings Per Share (0.22) 0.03 1.05 0.01
- ----------------------------------------------------------------------------
1997
Operating Revenue $154,281 $182,970 $231,089 $161,553
Operating Income 20,790 33,830 56,110 23,293
NOL Benefit Recognition (see Note 11) 14,318 14,975 13,120 1,030
Net Income (Loss) 11,492 29,901 43,415 (1,236)
Basic Earnings Per Share 0.36 0.93 1.35 (0.04)
Diluted Earnings Per Share 0.36 0.93 1.34 (0.04)
- ----------------------------------------------------------------------------
TEP
---------------------------------------
First Second Third Fourth
- ----------------------------------------------------------------------------
1998
Operating Revenue $161,003 $179,686 $253,280 $175,021
Operating Income 23,882 29,949 54,661 27,010
Interest Income - Note Receivable
from UniSource Energy 2,300 2,326 2,352 2,351
NOL Benefit Recognition (see Note 11) - - - -
Net Income (Loss) (1,607) 8,073 29,374 5,836
- ----------------------------------------------------------------------------
1997
Operating Revenue $154,281 $182,970 $231,089 $161,553
Operating Income 20,790 33,830 56,110 23,293
NOL Benefit Recognition (see Note 11) 14,318 14,975 13,120 1,030
Net Income (Loss) 11,492 29,901 43,415 (1,236)
- ----------------------------------------------------------------------------
DUE TO SEASONAL FLUCTUATIONS IN TEP'S SALES, UNUSUAL ITEMS AND THE
RECOGNITION OF NOL BENEFITS, THE QUARTERLY RESULTS ARE NOT INDICATIVE OF
ANNUAL OPERATING RESULTS. THE PRINCIPAL UNUSUAL ITEMS INCLUDE:
- FIRST QUARTER 1997: SEE NOTE 12 REGARDING THE VSP RELATED AMOUNTS
RECORDED.
- SECOND QUARTER 1997: UPON DISSOLUTION OF CERTAIN SUBSIDIARIES THAT WERE
PART OF TEP'S FORMER INVESTMENT OPERATIONS, TEP REVERSED A LOSS PROVISION,
RECORDED IN PRIOR YEARS, RESULTING IN $10.2 MILLION OF INCOME.
- FOURTH QUARTER 1997: TEP RECEIVED A $2.8 MILLION INTEREST REFUND
RELATING TO INCOME TAXES. THIS INTEREST REFUND IS INCLUDED IN OTHER INCOME
(DEDUCTIONS) ON THE 1997 INCOME STATEMENT.
- THIRD QUARTER 1998: TEP CHANGED ITS METHOD OF ESTIMATING UNBILLED
REVENUES TO MORE ACCURATELY REFLECT REVENUES BETWEEN MONTHS. IF WE HAD
CONTINUED USING THE PREVIOUS METHOD OF CALCULATING UNBILLED REVENUES,
REVENUES FOR THE THIRD QUARTER OF 1998 WOULD HAVE BEEN $7.1 MILLION GREATER.
- FOURTH QUARTER 1998: SEE UTILITY OPERATING REVENUES IN NOTE 1 REGARDING
THE IMPACT OF CHANGING THE METHOD OF CALCULATING UNBILLED REVENUES ON
REVENUES FOR THE FOURTH QUARTER.
Financial Statement Schedules
New Energy Ventures, Inc.
Report and
Consolidated Financial Statements
December 31, 1998 and 1997
Report of Independent Accountants
To the Board of Directors and Stockholders of
New Energy Ventures, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash
flows present fairly, in all material respects, the financial position of New
Energy Ventures, Inc. and its subsidiaries ("NEV") at December 31, 1998 and
1997, and the results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles. These
financial statements are the responsibility of NEV's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Los Angeles, California
March 30, 1999
NEW ENERGY VENTURES, INC.
CONSOLIDATED BALANCE SHEET
- ---------------------------------------------------------------------
As of December 31,
---------------------------
1998 1997
------------- ------------
Assets
Current assets:
Cash and cash equivalents $ 16,558,000 $ 3,426,000
Restricted cash 25,406,000 -
Accounts receivable, net of $905,000
and $0, respectively, allowance for
doubtful accounts 72,630,000 4,897,000
Prepaids and other current assets 508,000 83,000
------------- -------------
115,102,000 8,406,000
Properties and equipment, net 1,690,000 630,000
Other assets 4,085,000 1,500,000
------------- -------------
$120,877,000 $ 10,536,000
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,493,000 $ 872,000
Payable to joint ventures 2,595,000 -
Payable to utility distribution
companies 36,693,000 -
Accrued purchased power 35,875,000 6,326,000
Current portion of unrealized
losses on adverse commitments 5,216,000 -
Deposits and deferred revenue 3,423,000 -
Other current liabilities 4,670,000 674,000
------------- -------------
89,965,000 7,872,000
============= =============
Long-term liabilities:
Notes to stockholder 36,805,000 4,000,000
Long-term debt 10,000,000 -
Deferred purchased power
obligation (Note 8) 17,368,000 5,254,000
Other long-term liabilities 2,729,000 397,000
------------- -------------
66,902,000 9,651,000
------------- -------------
156,867,000 17,523,000
------------- -------------
Commitments and contingencies
(see Notes 8 and 9)
Minority interest (of which
$4,000,000 is manditorily redeemable) 9,174,000 -
------------- -------------
Stockholders' Equity
Common stock, $.001 par value;
20,000,000 authorized; 10,000,000
and 0 shares issued and outstanding 10,000 -
Additional paid in capital 11,881,000 10,166,000
Accumulated deficit (57,055,000) (17,153,000)
------------- -------------
(45,164,000) (6,987,000)
------------- -------------
$120,877,000 $ 10,536,000
============= =============
See accompanying notes to consolidated financial statements.
NEW ENERGY VENTURES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
- ---------------------------------------------------------------------
Year ended December 31,
----------------------------
1998 1997
------------- -------------
Retail customer revenue $206,093,000 $ 1,524,000
Less: Utility distribution
company payments 102,158,000 -
------------- -------------
103,935,000 1,524,000
Cost of sales 108,289,000 1,530,000
Net unrealized losses on adverse
commitments 10,570,000 -
------------- -------------
(14,924,000) (6,000)
Proprietary purchases and sales, net 2,567,000 (3,242,000)
------------- -------------
(12,357,000) (3,248,000)
------------- -------------
Operating expenses
Employee costs 13,850,000 5,147,000
Outside services 6,781,000 2,542,000
Other general and administrative 8,604,000 3,208,000
------------- -------------
29,235,000 10,897,000
------------- -------------
(41,592,000) (14,145,000)
------------- -------------
Other income and expense, net
Gain from settlement 4,000,000 -
Interest expense (3,008,000) (92,000)
Other 229,000 63,000
------------- -------------
1,221,000 (29,000)
------------- -------------
Net loss before minority interest (40,371,000) (14,174,000)
Minority interest in loss of
consolidated subsidiary 469,000 -
------------- -------------
Net loss $(39,902,000) $(14,174,000)
============= =============
See accompanying notes to consolidated financial statements.
NEW ENERGY VENTURES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------
Additional
Common Paid in Accumulated
Shares Stock Capital Deficit
Total
--------- ------- -------- ---------- ----------
As of December 31, 1996 - $ - $ 3,183,000 $ (2,979,000) $
204,000
Capital contributions - - 6,582,000 -
6,582,000
Employee stock awards - - 401,000 -
401,000
Net loss - - - (14,174,000)
(14,174,000)
--------- ------- --------- ---------- ----------
As of December 31, 1997 - - 10,166,000 (17,153,000)
(6,987,000)
--------- ------- --------- ---------- ----------
Preference
contribution - - 9,000,000 -
9,000,000 Equity to debt
conversion - - (8,448,000) -
(8,448,000)
Preferred return
conversion - - (1,768,000) -
(1,768,000) Conversion to a corporation 10,000,000 10,000
(10,000) - - Issuance of
convertible debt - - 1,719,000 -
1,719,000 Employee stock awards - - 1,222,000
- - 1,222,000 Net loss - - -
(39,902,000) (39,902,000) --------- ------- -----
- ---- ---------- ----------
As of December 31, 1998 10,000,000 $10,000 $11,881,000 $(57,055,000)
$(45,164,000)
========== ======== =========== ============
============
See accompanying notes to consolidated financial statements.
NEW ENERGY VENTURES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
- ---------------------------------------------------------------------
Year ended December 31,
----------------------------
1998 1997
------------- -------------
Cash flows from operating activities:
Net loss $(39,902,000) $(14,174,000)
Adjustments to reconcile net loss
to cash used in operating
activities:
Unrealized losses on adverse
commitments 10,570,000 -
Realization of losses on
adverse commitments (4,096,000) -
Provision for doubtful accounts 1,167,000 -
Minority interest in net loss (469,000) -
Other noncash expense 1,998,000 491,000
Changes in assets and liabilities:
Restricted cash (25,406,000) -
Accounts receivable (68,900,000) (4,897,000)
Prepaids and other current assets (425,000) (60,000)
Accounts payable 621,000 838,000
Payable to joint ventures 2,595,000 -
Payable to utility distribution
companies 36,693,000 -
Accrued purchased power 29,549,000 6,326,000
Deposits and deferred revenue 3,423,000 -
Other current liabilities 3,996,000 608,000
Deferred purchased power
obligation 12,114,000 5,254,000
Other liabilities 1,074,000 359,000
------------- -------------
(35,398,000) (5,255,000)
------------- -------------
Cash flows from investing activities:
Capital expenditures (1,385,000) (646,000)
Acquisition of distribution rights (2,500,000) (1,500,000)
Sale of minority interest in
subsidiary, net 9,643,000 -
------------- -------------
5,758,000 (2,146,000)
------------- -------------
Cash flows from financing activities:
Proceeds from long-term debt 34,000,000 4,000,000
Debt issuance costs (228,000) -
Preference contributions 9,000,000 -
Capital contributions - 6,582,000
------------- -------------
42,772,000 10,582,000
------------- -------------
Cash and cash equivalents:
Net change in cash and cash
equivalents 13,132,000 3,181,000
Beginning of period 3,426,000 245,000
------------- -------------
$ 16,558,000 $ 3,426,000
============= =============
Supplemental cash flow information:
Cash paid during the year for:
Interest $ 237,000 $ -
Income taxes $ - $ -
Non-cash investing and financing
activities:
Conversion of equity to notes, net $ 10,216,000 $ -
Conversion of notes $ 13,000,000 $ -
Issuance of convertible debt $ (1,719,000) $ -
Employee stock awards $ 1,222,000 $ 401,000
See accompanying notes to consolidated financial statements.
New Energy Ventures, Inc.
Notes to Consolidated Financial Statements
- -----------------------------------------------------------------------------
NOTE 1: The Company
New Energy Ventures, Inc. ("NEV") was organized in January 1995 as a
subchapter S corporation. On February 6, 1995, NEV entered into a consulting
agreement (the "Agreement") with Tucson Electric Power Company ("TEP"), a
wholly-owned subsidiary of UniSource Energy Corporation ("UniSource Energy").
Under the terms of the Agreement, as amended, TEP agreed to provide funding
for operating expenses to NEV in exchange for an option to acquire 50% of the
capital stock of NEV or, at the option of the parties, to acquire a 50%
interest in a newly organized limited liability company formed through the
contribution of the assets of NEV.
On September 1, 1997, TEP exercised its option and the Agreement was
terminated. In accordance with the terms of the Agreement, NEV was
reorganized as a limited liability company. All tangible and intangible
assets and liabilities obtained and incurred by NEV during the term of the
Agreement were contributed to the newly formed organization. The assets and
liabilities transferred were accounted for at historical cost in a manner
similar to a pooling of interests. TEP's interest in NEV was subsequently
transferred to MEH Corporation ("MEH"), an indirect wholly-owned subsidiary
of UniSource Energy.
On October 9, 1998, NEV changed its form of organization to its present form
as a Delaware corporation. The capital accounts prior to the conversion date
have been reclassified to reflect NEV's current form of organization.
Nature of Operations
NEV was formed to provide electricity, energy products and services, and
technology-based energy solutions to customers in deregulating energy
markets. NEV also engages in wholesale purchases and sales to support its
retail customer base and for other proprietary purposes.
Retail Electricity and Services
NEV currently serves retail electricity customers in certain Eastern and
Western states where markets have opened to competition. NEV establishes
separate subsidiaries in each of the major markets in which it intends to
compete. Through its wholly-owned subsidiary, NEV California, L.L.C. ("NEV
California"), NEV commenced substantive operations as a retail energy
provider in California on March 31, 1998. NEV expanded operations in June
1998, when NEV East, L.L.C. ("NEV East") began serving customers in New York
City. NEV East has also delivered energy under limited pilot programs in
Pennsylvania and upstate New York since November 1997 and served customers in
Rhode Island from July 1997 to December 1997.
In addition, during the year ended December 31, 1998, NEV established NEV
Midwest, L.L.C. and NEV Texas, L.L.C. for the purpose of competing in other
competitive markets across the nation.
NEV typically enters into one to three year electricity supply contracts with
its retail customers. These contracts include shared savings agreements,
fixed savings arrangements and fixed price supply contracts. Under the terms
of its typical shared savings agreements, NEV receives a contractually agreed-
upon percentage of the customer's savings compared to the applicable tariff
rate, market clearing price or California Power Exchange price, plus a
volumetric transaction fee.
NEV is also developing products and services in the area of energy efficiency
and information systems for the purpose of enhancing the overall efficiency
of its customers' facilities and to avail its customers of more timely energy
information.
Technology-Based Energy Solutions
NEV's wholly-owned subsidiary NEV Technologies, L.L.C. ("NEV Technologies")
was established to distribute and service advanced technology, energy
generation products. NEV has exclusive distribution agreements with
AlliedSignal Power Systems, Inc. ("AlliedSignal") to market and distribute
its distributed generation products in the Western United States and certain
Pacific Rim nations. In addition, on June 15, 1998, NEV Technologies formed
two joint ventures, NEVTech Americas, L.L.C. ("NEVTech Americas") and NEVTech
Pacifica, L.L.C. ("NEVTech Pacifica"), to distribute and service
AlliedSignal's distributed generation products in certain countries located
in South America and the South Pacific.
Wholesale Purchases and Sales
NEV engages in wholesale purchases and sales activities to generate savings
for its retail customers and for proprietary purposes (see Note 8).
NOTE 2: Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of NEV and its
wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. NEV accounts for NEV Technologies' investments
in NEVTech Americas and NEVTech Pacifica under the equity method of
accounting.
Revenue Recognition
Retail revenues consist of billings to customers for consumption of
electricity and accruals for electricity sold but not yet billed. In
California, revenues include amounts related to transmission and distribution
services provided by the local utility distribution companies ("UDCs"). NEV
estimates the portion of the bill related to UDC services based on historical
and other billing information provided by the UDCs and any difference between
billed and actual costs is adjusted through subsequent billings.
In California, NEV procures energy through bilateral contracts, the
California Power Exchange and the over-the-counter market to reduce costs for
its shared savings and fixed savings retail customers. Savings generated
through these activities are pooled and distributed over a rolling twelve-
month period as a reduction to the NEV energy price charged to non-fixed
price retail customers. The amount of energy savings applicable to retail
customers is established on a monthly basis. There were no undistributed
savings as of December 31, 1998.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. The carrying amount of cash
and cash equivalents approximates fair value because of the short maturity of
these instruments.
Restricted Cash
Restricted cash includes cash receipts from California retail customer sales.
These amounts are held as collateral by Donaldson, Lufkin & Jenrette, Inc.
("DLJ") for guarantees issued to the UDCs on behalf of NEV California. On a
daily basis, the estimated non-UDC portion of customer cash receipts are
transferred to NEV's general cash account; UDC-related receipts are
transferred as needed to remit UDC payments.
Properties and Equipment, Net
Properties and equipment are stated at cost. Depreciation is computed using
the straight-line method based on the estimated lives of the assets as
follows: computer hardware and software, 3 to 5 years; leasehold
improvements, furniture and fixtures, and office and general equipment, 5
years.
Employee Stock Plans
Compensation expense related to employee stock awards is recorded on a
straight-line basis over the applicable vesting period based on the fair
value of the stock at the measurement date as determined by an independent
valuation.
Purchase and Sale Commitments
NEV enters into purchase and sale commitments for energy, transmission and
capacity to support its retail customer load and for other proprietary
purposes. NEV uses accrual accounting to account for its over-the-counter
commodity contracts. Under this method, NEV evaluates over-the-counter
contracts to determine if changes in market conditions have resulted in
unrealized gains or losses on those contracts. Gains on non-exchange traded
contracts are recognized when realized; however, unrealized losses are
recorded in the period in which they are identified (see Note 8). Gains and
losses, and the related costs paid or premiums received, are recognized
currently in income. Gains and losses related to activities to support NEV's
retail customer base are included in Cost of sales. All other wholesale
activities are included in Proprietary purchases and sales, net.
New Accounting Standards
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This SOP provides guidance
on accounting for certain costs in connection with obtaining or developing
computer software for internal use and requires that entities capitalize such
costs once certain criteria are met. NEV currently expenses these costs as
incurred. NEV adopted SOP 98-1 on January 1, 1999, as required.
In November 1998, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") reached a consensus related to the
accounting for energy trading activities. In accordance with EITF 98-10,
energy trading contracts must be marked to market with the gains and losses
included in earnings and separately disclosed in the financial statements.
NEV adopted EITF 98-10 on January 1, 1999, as required. NEV has not
determined the impact that adoption of this statement will have on its
consolidated financial statements.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities, effective
for fiscal years beginning after June 15, 1999. Statement 133 requires
companies to record derivatives on the balance sheet as assets and
liabilities, measured at fair value. Gains and losses resulting from changes
in value of these derivatives would be reported in income or other
comprehensive income, depending on the use of the derivative and whether it
qualifies for hedge accounting. NEV is evaluating the timing of adoption of
Statement 133 and does not believe it will have a material impact on its
result of operations.
Reclassifications
Certain prior period amounts have been reclassified to conform to current
period presentation.
NOTE 3: NEV Technologies
Minority Interest
In October 1998, The Mission Group ("Mission") entered into an agreement with
NEV to contribute $10 million to NEV Technologies in exchange for a future
equity interest in NEV Technologies. In accordance with the terms of the
agreement, Mission's contribution will convert to members' equity in NEV
Technologies on or prior to October 13, 2000. Upon conversion, Mission will
receive a percentage ownership in NEV Technologies equal to the greater of
13.33% or $10 million divided by the appraised value as of May 31, 2000.
Mission may elect to redeem $4 million of its contribution on the conversion
date. If Mission elects to redeem such amount, the $6 million remaining
investment would convert on a pro-rata basis in accordance with the above
referenced conversion formula. Upon conversion, NEV Technologies' capital
accounts will be adjusted so that the members' capital account balances are
in proportion to their respective percentage interests immediately following
the conversion.
Prior to conversion, Mission is entitled to receive distributions and
allocations of taxable income or loss, but has no voting rights. Mission was
also provided with certain limited protective rights which require its
consent to, among other things, liquidation and other matters related to NEV
Technologies, under certain conditions.
NEV recorded Mission's investment as minority interest, net of related costs.
Prior to the conversion date, net income and losses attributable to NEV
Technologies are allocated to Mission based on the terms for liquidation
distributions, as provided in the agreement.
Distribution Agreements
NEV Technologies has entered into distribution agreements for the exclusive
right to distribute and service AlliedSignal distributed generation
technology in the fourteen states comprising the Western United States and
certain countries outside the United States, including Hong Kong, Taiwan,
Vietnam, the Philippines and Singapore (together, the "Distribution
Agreements"). During 1998 and 1997, NEV made payments of $2.5 million and
$1.5 million, respectively, to obtain and maintain its exclusive rights.
These payments have been capitalized as Other assets and will be amortized on
a straight-line basis over the contract term of ten years from the date of
first delivery of a basic unit.
In order to maintain its exclusive rights over the contract terms, NEV will
be required to make additional payments under the Distribution Agreements as
follows:
- $2.5 million by March 31, 1999;
- $1 million upon satisfaction of certain performance standards, in no
event prior to June 30, 1999;
- $4 million upon delivery of a basic unit which meets certain
specified pricing levels which are required to be satisfied by January 1,
2003.
NEV Technologies must also purchase minimum quantities of the product at
specified prices from 1999 through 2009. Failure to meet these quotas may
result in a reduction of the scope of NEV's exclusive distribution
territories.
Management anticipates delivery of a prototype and production unit during the
second quarter of 1999. If AlliedSignal fails to meet its contractual
delivery obligations, NEV Technologies has certain liquidated damages
provisions under the Distribution Agreements.
Joint Ventures
In June 1998, NEV Technologies and Dames & Moore Ventures, Inc. ("Dames &
Moore") established NEVTech Americas and NEVTech Pacifica to provide on-site
electric generation capabilities and services in specified South American and
South Pacific countries. These equally-owned joint ventures are development
stage enterprises which have entered into agreements for the exclusive right
to market and distribute AlliedSignal distributed generation technology in
these markets. NEV's basis in these joint ventures is currently zero.
NEV Technologies also serves as the manager of the joint ventures and is
entitled to reimbursement of out-of-pocket expenses and certain promotional
costs and expenses. During the year ended December 31, 1998, the joint
ventures collectively reimbursed NEV approximately $628,000 for direct and
other costs in accordance with the operating agreements. The joint ventures
had no other operating expenses or revenues during the year ended December
31, 1998.
During 1998, NEVTech Americas and NEVTech Pacifica made payments of $800,000
and $200,000, respectively, to AlliedSignal to maintain the exclusive
distribution agreements. NEVTech Americas will be required to make an
additional payment of $500,000 after delivery of 150 units to Brazil; this
payment will be due no earlier than December 31, 1999.
During 1998, Dames & Moore made capital contributions totaling $5,000,000 to
the joint ventures. No other capital contributions are currently required for
the joint ventures.
NOTE 4: Properties and Equipment
Properties and equipment consist of the following:
As of December 31,
----------------------------
1998 1997
-----------------------------------------------------------------
Computer hardware and software $ 1,684,000 $ 483,000
Leasehold improvements 154,000 91,000
Furniture and fixtures 131,000 126,000
Office and general equipment 98,000 67,000
------------- -------------
2,067,000 767,000
Accumulated depreciation and
amortization (377,000) (137,000)
------------- -------------
$ 1,690,000 $ 630,000
============= =============
NOTE 5: Notes to Stockholder and Long-term Debt
Notes to stockholder and Long-term debt consists of the following:
As of December 31,
Interest Rate at -------------------------
December 31, 1998 1998 1997
----------------------------------------------------------------
Bridge Loan 10.41% $10,000,000 $ -
Notes to stockholder
Due December 1999 - - 1,000,000
Due June 2000 9.44% 15,000,000 -
Due August 2000 7.94% 19,000,000 -
Due August 2003 8.00% 4,768,000 -
Due August 2006 - - 3,000,000
----------- -----------
Total principal amount 48,768,000 4,000,000
Unamortized discount (1,963,000) -
----------- -----------
$46,805,000 $ 4,000,000
=========== ===========
Bridge Loan
On August 8, 1998, NEV obtained a Bridge Loan from Energy Funding, Inc.
("Energy Funding"), an affiliate of DLJ, with a maximum funding commitment of
$10 million. Under the terms of the Bridge Loan agreement, as amended,
borrowings bear interest at LIBOR plus 5%, payable every 90 days. NEV paid
$200,000 in commitment and takedown fees during 1998. In addition, the
amended agreement requires a commitment fee payable monthly of .5%, based on
the outstanding principal amount at the first business day of each month.
Borrowings under the Bridge Loan agreement may be redeemed on 10 days notice,
at any time, at par plus accrued interest to the redemption date. The
redemption price (whether early or at maturity) will be 103% of par plus
accrued interest if the notes are not redeemed with funds raised through a
transaction led by DLJ. The Bridge Loan contains certain financial covenants
that restrict the sale of assets, the incurrence of additional indebtedness
and certain investments and acquisitions.
In connection with the consummation of the funding agreement, UniSource
Energy issued an irrevocable guarantee to Energy Funding, providing the
prompt payment and performance of all obligations of NEV under the Bridge
Loan agreement. In accordance with a separate agreement between UniSource
Energy and NEV, if UniSource Energy is required to make payment under its
guarantee, NEV will not be required to reimburse UniSource Energy until June
1, 2000. Any amounts owed to UniSource Energy as a result of this guarantee
will bear interest at LIBOR plus 7%.
Borrowings under the Bridge Loan agreement, as amended, must be repaid at
maturity on March 31, 1999. As of March 1, 1999, the maturity date was
extended to April 30, 1999. NEV has recorded the Bridge Loan as a long-term
liability as it intends to either use loan proceeds or to call upon the
UniSource Energy guarantee for repayment on the maturity date.
Notes to Stockholder
On December 27, 1997, MEH agreed to provide a one-year irrevocable Credit
Facility (the "Facility") to NEV with an aggregate funding commitment of $20
million, including up to $10 million in loans and $10 million in preference
or additional equity. During the period through September 1, 1998, NEV
obtained $10 million in loans, bearing interest at LIBOR plus 2.5% and
maturing on December 31, 1999, under the Facility. NEV also obtained $9
million in preference equity. The preference equity required a 5% per annum
priority distribution and included a repurchase option for an amount which
provided MEH with a 25% annualized return. On September 1, 1998, the
borrowings and preference equity obtained under the Facility were exchanged
for a stockholder note bearing interest at LIBOR plus 2.5% per annum,
maturing at the earlier of August 31, 2000 or the closing of the sale of debt
securities with net cash proceeds to NEV of at least $60 million. The note
permits borrowings of up to $20 million in aggregate and may be prepaid at
any time without penalty.
Also on September 1, 1998, NEV converted a preference return entitlement of
$1,768,000, bearing interest at 10% per annum, and a $3,000,000 note due
August 31, 2006 bearing interest at 8% per annum to a $4,768,000 stockholder
note due August 31, 2003, bearing interest at 8% per annum. The stockholder
note may be prepaid at any time without penalty. Interest outstanding at the
date of conversion related to the preference return was forgiven. The equity
exchange was recorded as a treasury stock transaction and the difference in
the fair value of the obligations exchanged of $552,000 was recorded as an
equity contribution which will be amortized over the term of the related
notes.
On December 14, 1998, MEH provided a convertible credit facility (the
"Convertible Facility") to NEV in the amount of $30 million. In accordance
with the terms of the Convertible Facility, as amended, the facility is
subject to the availability and assignment of assets from NEV to
collateralize amounts outstanding (see Note 9). Interest accrues at a rate of
LIBOR plus 4 1/2% and will be reset every 90 days following the date of a
drawdown. The facility matures on June 1, 2000 at which time interest and
principal outstanding are due. Borrowings outstanding under the convertible
credit facility may be prepaid at any time without penalty.
At any time after April 1, 1999, MEH may elect to convert up to 5% of the
outstanding principal balance into an amount of NEV common stock not
exceeding 5% of the total NEV stock issued and outstanding following the
conversion. The conversion price will be based on the fair market value of
NEV at the time of conversion, less a discount in the amount of $114,609 for
each $1 million of outstanding principal balance under the credit facility.
The outstanding value of the beneficial conversion feature is recorded as
paid-in-capital and is being amortized as interest expense over the vesting
period. At December 31, 1998, amounts advanced under the credit facility
totaled $15,000,000 of which $13,281,000 was recorded as long-term debt and
$1,719,000 as paid-in-capital.
During the years ended December 31, 1998 and 1997, NEV incurred interest
expense of $1.3 million and $80,000, respectively, related to its notes to
stockholder. At December 31, 1998 and 1997, accrued interest of $1.2 million
and $80,000, respectively, related to the notes to stockholder was included
in Long-term liabilities.
Fair Value
The fair value of Notes to stockholder and Long-term debt was $48.1 million
and $3.7 million at December 31, 1998 and 1997, respectively. Management has
estimated fair value based on the present value of interest and principal
payments on the long-term debt, discounted using current interest rates
obtainable by NEV for debt of similar quality and maturities.
NOTE 6: Stock and Incentive Programs for Management
NEV entered into agreements with executive management to provide restricted
stock awards in New Energy Holdings, Inc. ("NEH"), a 50% shareholder in NEV.
Certain of these awards are contingent upon employment at specified vesting
dates through 2000. NEH and the other shareholders have the right to
repurchase the stock at fair value upon termination of employment. In
addition, shares may not be sold or transferred without providing the
opportunity to NEH and the other shareholders to repurchase the shares. Under
limited circumstances, certain of the awards provide that any nonvested
shares will vest immediately upon change in control of NEV.
Information with respect to stock awards is as follows (amounts represent
percentage ownership in NEH):
Stock awards Outstanding Vested
---------------------------------------------------
At January 1, 1997 5.00% 2.50%
Additions 11.50% 3.50%
------ ------
At December 31, 1997 16.50% 6.00%
Additions 8.00% 9.67%
------ ------
At December 31, 1998 24.50% 15.67%
====== ======
Compensation expense of $1.2 million and $401,000 related to these awards was
recognized during the years ended December 31, 1998 and 1997, respectively.
The fair value of awards granted during the years ended December 31, 1998 and
1997 was approximately $1.2 million and $775,000, respectively.
Phantom Stock Awards
During the year ended December 31, 1998, certain of NEV's subsidiaries
established separate performance incentive plans (together, the "Incentive
Plans"). Under the terms of the Incentive Plans, officers and employees of
the specified subsidiary or affiliated companies may be granted performance
units which represent the right to receive payment for appreciation of the
fair value of the subsidiary as determined by a defined formula based on net
income. Payments under the plans will be made after a trigger date which may
be (a) a fixed date set forth in the award agreement; (b) the participant's
termination of employment; (c) the termination of the plan by the subsidiary;
or (d) a change in control as defined in the agreements (unless the managing
committee provides otherwise).
Certain of these awards are contingent upon employment at specified vesting
dates through 2002. All nonvested awards will vest immediately upon a change
of control.
Performance units awarded during the year ended December 31, 1998 were as
follows:
Units Units Units
Authorized Awarded Vested
----------------------------------------------------------
NEV East, L.L.C. 200,000 120,000 90,000
NEV California, L.L.C. 200,000 30,000 20,000
NEV Technologies, L.L.C. 200,000 120,000 25,000
NEV Midwest, L.L.C. 200,000 100,000 -
The Incentive Plans follow variable plan accounting with recognition of
changes in fair value, as defined, recorded currently in income. No
compensation expense related to these awards was recognized during 1998 or
1997.
Stock Options
In October 1998, NEV established a stock option plan which provides for the
granting of incentive stock options or non-qualified stock options to
specified officers and key employees. The plan also provides for issuance of
restricted stock awards, stock appreciation rights and performance awards.
The plan is administered by the Board of Directors. No option can be for a
term of more than ten years from the date of grant. The purchase price of
options will be determined by the Board, but cannot be less than 100% and 85%
of the fair market value of the common stock on the date that incentive stock
options or non-qualified stock options are granted, respectively. Unless
otherwise determined, options granted under the plan will be exercisable
ratably over five years. As of December 31, 1998, 1.1 million shares are
reserved for issuance under this plan and NEV was authorized to grant 390,000
shares at an exercise price of $10 per share. No awards were made during
1998.
During 1999, an additional 500,000 options were authorized for issuance and
NEV issued 400,000 options at an exercise price of $10 per share under the
plan.
NOTE 7: Income Taxes
Upon conversion from a limited liability company ("LLC") to a corporation on
October 9, 1998, NEV adopted Statement of Financial Accounting Standards No.
109, Accounting for Income Taxes. This statement requires that deferred
income tax assets and liabilities be recorded to reflect the tax consequences
on future years of temporary differences of revenue and expense items for
financial statement and income tax purposes. Valuation allowances are
provided against assets that are not likely to be realized. Prior to October
1998, net income and losses were distributed to members of the LLC.
NEV did not recognize a provision or benefit for income taxes during 1998. A
reconciliation of the statutory federal income tax rate and the effective tax
rate for the period from October 9, 1998 through December 31, 1998 follows:
Statutory federal income tax rate 35.0%
State and local taxes net of federal income tax 5.0%
Change in valuation allowance -40.0%
------
0.0%
======
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets at December 31, 1998 and October 9, 1998
are as follows:
As of December As of October
31, 1998 9, 1998
----------- -----------
Deferred tax asset
Deferred purchased power expense $ 7,159,000 $ 5,997,000
Unrealized losses on adverse commitments 2,590,000 3,585,000
Other assets 748,000 286,000
----------- -----------
10,497,000 9,868,000
Less: valuation allowance (10,497,000) (9,868,000)
----------- -----------
Net deferred tax $ - $ -
=========== ===========
A valuation allowance has been established due to the uncertainty of
realizing tax loss carryforwards and other deferred tax assets.
NOTE 8: Wholesale Energy Supply and Risk Management
NEV enters into forward purchase commitments involving the physical delivery
of energy to serve its retail customer load. In addition, NEV enters into
physical commodity contracts and derivative instruments, including swaps,
options and financial contracts, to provide savings to its retail customers
and for proprietary purposes.
Market Risk
NEV is exposed to price risk in the markets in which it conducts electricity
purchases and sales. Market risk arises from the potential change in the
value of financial instruments and physical commodities based on fluctuations
in electricity commodity exchange prices and bases. Market risk is also
affected by changes in volatility and liquidity in markets in which these
instruments are traded. NEV manages its wholesale risk exposure by balancing
commodity purchases through a combination of long-term and short-term (spot
market) agreements. NEV also will at times create a net open position to take
advantage of anticipated market opportunities.
NEV has further established trading policies and limits designed to manage
NEV's exposure to price risk. The Company periodically reviews its exposures
against the stipulated limits. NEV also continually reviews its policies to
ensure that they are responsive to changing market conditions. NEV measures
its exposure to market risk by comparing its open positions to a market
estimate of fair value. The market prices used to determine fair value are
based on management's best estimates, which consider various factors
including broker quotes, exchange, over the counter prices and time value.
Credit Risk
NEV is exposed to credit risk related to potential nonperformance by its
wholesale counterparties under the terms of contractual agreements. During
1998 and 1997, wholesale sales to trading counterparties, including utility
companies and energy marketers, totaled amounts equal to approximately 38%
and 92%, respectively, of NEV's combined wholesale and retail revenue. During
1997, sales contracts with Noram Energy Services and Conagra Energy Services,
Inc. equaled 41% and 40%, respectively, of total revenue.
Management manages the risk of counterparty default by performing financial
credit reviews of its counterparties and through the use of standardized
agreements which allow for the netting of positive and negative exposures
associated with a single counterparty. In addition, NEV may require
collateral to support trading positions from certain counterparties. NEV does
not anticipate any nonperformance by any of its counterparties and has no
reserves related to nonperformance as of December 31, 1998. NEV did not
experience any material counterparty default during 1998 or 1997.
Retail sales also potentially expose NEV to concentrations of credit risk. As
of and for the year ended December 31, 1998, customers located in California
and New York City accounted for approximately 80% and 10%, respectively, of
NEV's accounts receivable and 89% and 9%, respectively, of NEV's retail
revenue. NEV performs ongoing credit evaluations of its customers' financial
condition and reserves the right to require collateral under its retail
contracts. NEV's customer base in California and New York City consists
primarily of large retailers, manufacturers and government agencies and
management does not believe that this concentration of sales and credit risk
represents a material risk of loss with respect to its financial position as
of December 31, 1998. During the year ended December 31, 1998, Ralphs Grocery
Company accounted for 17% of total revenue.
Forward Commitments
A summary of NEV's open forward commitments is as follows:
Purchases Sales
-----------------------------------------------
MWhs Amount MWhs Amount
-----------------------------------------------
Year Ending
December 31,
1999 4,024,000 $ 81,952,000 2,093,000 $45,681,000
2000 3,514,000 $ 79,860,000 1,064,000 $24,530,000
2001 4,165,000 $110,869,000 1,351,000 $32,964,000
2002 3,281,000 $ 92,852,000 839,000 $21,118,000
2003 1,752,000 $ 51,283,000 - $ -
Certain of NEV's energy purchase commitments provide changing prices over the
contract terms. For financial reporting purposes, all energy received under
these contracts is recorded in the income statement as cost of sales or
proprietary purchases and sales, net at the average contract price;
differences between the average price and amounts paid currently under the
contracts are recorded in the balance sheet as Deferred purchase power
obligation. During the year ended December 31, 1998, NEV recorded deferred
purchased power costs of $12.7 million, of which $8.1 million and $4.6
million were included in retail Cost of sales and Proprietary purchases and
sales, net, respectively. During 1997, NEV deferred $5.3 million under these
contracts.
During 1998 and 1997, wholesale purchases were concentrated with a few large
suppliers; however, NEV has purchase relationships with numerous
counterparties and management does not believe that NEV is dependent on any
single supplier.
Retail Sales Commitments
As of December 31, 1998, NEV had entered into a limited number of retail
contracts requiring a certain minimum level of savings below the exchange or
current tariff rate. In addition, NEV entered into one below market fixed
price retail contract. As a result, NEV recorded net losses for adverse
commitments aggregating $10.6 million during the year ended December 31,
1998, reflecting management's belief that these contracts are priced below
current market rates. Management estimated this amount based on current and
anticipated market conditions and historical customer consumption;
differences between these assumptions and actual prices and usage will impact
actual losses recorded related to these contracts, which will generally occur
over the next two years.
NOTE 9: Commitments and Contingencies
UDC Guarantee and Reimbursement Agreements
As of August 24, 1998, DLJ issued guarantees to the California UDCs related
to NEV California's obligations to the UDCs arising from distribution and
transmission services provided in the California retail business. DLJ's
aggregate commitment under these guarantees is $61.3 million, of which $36.7
million was outstanding as of December 31, 1998.
NEV and DLJ entered into a reimbursement agreement related to the guarantees.
Pursuant to the terms of the reimbursement agreement, NEV is required to pay
a monthly fee of .125% of the exposure amount during the immediately
proceeding month under the outstanding UDC guarantees. In addition, amounts
advanced by DLJ under the guarantees will bear interest at an annual rate of
LIBOR plus 4.0% and will be subject to a takedown fee of 1.0%. No amounts
were advanced by DLJ under the guarantees during the year ended December 31,
1998. The reimbursement agreement includes certain financial covenants that
restrict the sale of assets, the incurrence of certain additional
indebtedness and certain investments and acquisitions. On March 23, 1999, the
UDC credit facility termination date was extended to the earlier of the
closing of a private placement offering or June 30, 1999. Management is
currently evaluating alternative sources of credit support.
Pledged Assets
NEV has assigned California retail accounts receivable to DLJ as collateral
to support the UDC guarantees. In addition, NEV has further assigned certain
assets to UniSource Energy and MEH as collateral for credit support and
stockholder notes. UniSource Energy provided credit support to NEV in the
form of guarantees and surety bonds to support NEV's wholesale and retail
electricity purchases and sales activities. As of December 31, 1998,
UniSource Energy had extended guarantees and surety bonds aggregating $39.6
million, of which $14.4 million was outstanding. In addition, UniSource
Energy has guaranteed repayment of the Bridge Loan.
As of December 31, 1998, assets pledged or assigned to support the guarantees
and notes include Restricted cash and Accounts receivable of $25.4 million
and $72.6 million, respectively. DLJ has a first priority interest in the
restricted cash and California retail accounts receivable balances. MEH and
UniSource Energy have a first priority interest in wholesale and non-
California retail accounts receivable and a second priority interest in the
energy portion of California retail accounts receivable.
NEV also assigned to UniSource Energy two years of its rights to receive
power from certain purchase power contracts under which it is entitled to
receive firm power of approximately 400 MW.
Service Agreement
NEV entered into an agreement with LG&E Power Marketing Inc. ("LG&E") to
obtain scheduling, metering and billing services through December 31, 2001.
In exchange for these services, NEV pays LG&E a declining fee ranging from
$0.40 - $0.14 per MWh, depending on the aggregate quantity of MWhs delivered
by NEV. The base rate will be adjusted annually based on changes in the
Consumers Price Index. Minimum fees required under this contract are as
follows: $262,000, $273,000 and $285,000 for each of the calendar years 1999,
2000 and 2001, respectively. During the year ended December 31, 1998, NEV
paid LG&E servicing fees of $1 million. Currently, MEH and UniSource Energy
have guaranteed any amounts owed by NEV up to $9.1 million for the term of
the Agreement. This contract may be terminated by either party without cause,
with one year written notice which may be given at any time after July 1,
1999.
Lease Commitments
NEV has commitments under non-cancelable long-term leases, primarily for
office space and equipment. At December 31, 1998, the future minimum lease
payments under operating leases are as follows:
Year Ending December 31,
-------------------------------------------------------
1999 $1,060,000
2000 852,000
2001 747,000
2002 597,000
2003 37,000
-----------
$3,293,000
===========
Rental expense amounted to $863,000 and $324,000 during 1998 and 1997,
respectively.
Settlement Agreement
In November 1998, NEV entered into a settlement agreement with a service
provider relating to disputes with respect to services received under related
agreements. The settlement provided NEV with a $4 million initial payment and
the right to receive two additional payments of $1 million in each of the two
years following the date of settlement. These additional payments are subject
to conditions which restrict similar claims during the settlement period. NEV
recorded the initial payment as Gain from settlement and will recognize
remaining payments due under the settlement in the period received.
NEV is party to legal actions and other claims with respect to matters
arising in the ordinary course of business. While the final outcome of these
matters cannot be predicted with certainty, it is the opinion of management
that any ultimate liability which may arise from these claims will not
materially affect NEV's consolidated financial position or results of
operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
- -----------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
- ------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS
- -------------------------------------------------------------------------
DIRECTORS
---------
Certain of the individuals serving as Directors of UniSource
Energy also serve as the Directors of TEP. Information concerning
Directors is contained under Election of Directors in the Company's
Proxy Statement relating to the 1999 Annual Meeting of Shareholders,
which information is incorporated herein by reference.
EXECUTIVE OFFICERS
------------------
Executive Officers of UniSource Energy who are elected annually
by the Company's Board of Directors, are as follows:
Executive
Name Age Title Officer Since
- ---- --- ----- -------------
James S. Pignatelli 55 Chairman, President and 1994
Chief Executive Officer (a)
Ira R. Adler 48 Executive Vice President, 1988
Chief Financial Officer and
Treasurer (b)
Dennis R. Nelson 48 Vice President, General 1991
Counsel and Corporate
Secretary (c)
Karen G. Kissinger 44 Vice President, Controller 1991
and Principal Accounting
Officer (d)
Michael J. DeConcini 34 Vice President - Strategic 1999
Planning (e)
Executive Officers of TEP who are elected annually by TEP's Board
of Directors, are:
Executive
Name Age Title Officer Since
- ---- --- ----- -------------
James S. Pignatelli 55 Chairman, President and Chief 1994
Executive Officer (a)
Ira R. Adler 48 Executive Vice President and 1988
Chief Financial Officer,
Chief Operating Officer,
Generation (b)
Dennis R. Nelson 48 Senior Vice President and 1991
General Counsel (c)
Thomas A. Delawder 52 Vice President - Energy 1985
Resources (f)
Gary L. Ellerd 48 Vice President - 1985
Transmission (g)
Steven J. Glaser 41 Vice President - Rates and
Regulatory Support, and Utility 1994
Distribution Company Energy
Services (h)
Thomas Hansen 48 Vice President - Technical 1992
Advisor (i)
Karen G. Kissinger 44 Vice President, Controller and 1991
Chief Information Officer (d)
Kevin P. Larson 42 Vice President and Treasurer (j) 1994
Vincent Nitido 43 Vice President and Assistant 1998
General Counsel (k)
James Pyers 56 Vice President - Engineering 1998
Operations (l)
(a) James S. Pignatelli: Mr. Pignatelli joined TEP as Senior Vice
President in August 1994 and was elected Senior Vice President and
Chief Operating Officer in 1996. He was named Senior Vice President
and Chief Operating Officer of UniSource Energy in January 1998, and
Executive Vice President and Chief Operating Officer of TEP in March
1998. On June 23, 1998, Mr. Pignatelli was named Chairman, President
and CEO of UniSource Energy and TEP. Prior to joining TEP, he was
President and Chief Executive Officer from 1988 to 1993 of Mission
Energy Company, a subsidiary of SCE Corp.
(b) Ira R. Adler: Mr. Adler joined TEP in 1986 as Manager of Financial
Planning. In 1987 he was elected as Vice President and Treasurer of
TRI, one of TEP's investment subsidiaries, from which position he
resigned in October 1988, when he was elected Treasurer of TEP. He
was elected Vice President - Finance and Treasurer in July 1989 and
was elected Senior Vice President and Chief Financial Officer in July
1990 and President of TRI and SRI in April 1992. He was named Senior
Vice President, Chief Financial Officer and Treasurer of UniSource
Energy in January 1998. Mr. Adler was named Executive Vice President
of TEP in March 1998 and Executive Vice President of UniSource Energy
in June 1998. In November 1998, Mr. Adler also became Chief Operating
Officer _ Generation. Prior to joining TEP, he was Vice President -
Finance of US WEST Financial Services, Inc.
(c) Dennis R. Nelson: Mr. Nelson joined TEP as a staff attorney in 1976.
He was manager of the Legal Department from 1985 to 1990. He was elected
Vice President, General Counsel and Corporate Secretary in January 1991.
He was named Vice President, General Counsel and Corporate Secretary of
UniSource Energy in January 1998. Mr. Nelson was named Senior Vice
President and General Counsel of TEP in November 1998.
(d) Karen G. Kissinger: Ms. Kissinger joined TEP as Vice President and
Controller in January 1991. She was named Vice President, Controller and
Principal Accounting Officer of UniSource Energy in January 1998. In
November 1998, Ms. Kissinger was also named Chief Information Officer of
TEP. Prior to joining TEP, she was a Manager with Deloitte & Touche from
1986 through 1989 and a Senior Manager through 1990.
(e) Michael J. DeConcini: Mr. DeConcini joined TEP in 1988 and served
in various positions in finance, strategic planning and wholesale
marketing. He was Manager of TEP's Wholesale Marketing Department in
1994, adding Product Development and Business Development in 1997. In
November 1998, he was elected Vice President of MEH, and elected Vice
President - Strategic Planning of UniSource Energy in February 1999.
(f) Thomas A. Delawder: Mr. Delawder joined TEP in 1974 and thereafter
served in various engineering and operations positions. In April 1985
he was named Manager, Systems Operations and was elected Vice President -
Power Supply and System Control in November 1985. In February 1991,
he became Vice President - Engineering and Power Supply and in January
1992 he became Vice President - System Operations. In 1994, he became
Vice President - Energy Resources.
(g) Gary L. Ellerd: Mr. Ellerd joined TEP as Vice President and
Controller in January 1985. He was elected Vice President - Services and
Chief Information Officer in January 1991 and in January 1992 he became
Vice President - Corporate Information Services and Chief Information
Officer. In 1994, he was named Vice President - Retail Customers. In
1995, he was named Vice President - Operations. Mr. Ellerd became Vice
President - Transmission in November 1998.
(h) Steven J. Glaser: Mr. Glaser joined TEP in 1990 as a Senior
Attorney in charge of Regulatory Affairs. He was Manager of TEP's Legal
department from 1992 to 1994, and Manager of Contracts and Wholesale
Marketing from 1994 until elected Vice President - Business Development.
In 1995, he was named Vice President - Wholesale/Retail Pricing and
System Planning. He was named Vice President - Energy Services in 1996
and Vice President - Rates and Regulatory Support and UDC Energy Services
in November 1998.
(i) Thomas Hansen: Mr. Hansen joined TEP in December 1992 as Vice
President - Power Production. Prior to Joining TEP, Mr. Hansen was
Century Power Corporation's Vice President - Operations from 1989 and
Plant Manager at Springerville from 1987 through 1988. In 1994, he was
named Vice President - Technical Advisor.
(j) Kevin P. Larson: Mr. Larson joined TEP in 1985 and thereafter held
various positions in its finance department and at TEP's investment
subsidiaries. In January 1991, he was elected Assistant Treasurer of
TEP and named Manager of Financial Programs. He was elected Treasurer
of TEP in August 1994 and Vice President in March 1997.
(k) Vincent Nitido: Mr. Nitido joined TEP as a staff attorney in 1991.
He was promoted to manager of the Legal Department in 1994, and elected
Vice President and Assistant General Counsel in 1998.
(l) James Pyers: Mr. Pyers joined TEP in 1974 as a Supervisor.
Thereafter, he held various supervisory positions and was promoted to
Manager of Customer in Service Operations in February 1998. Mr. Pyers
was elected Vice President - Utility Distribution Company Operations
in November 1998.
Mr. George W. Miraben, Executive Vice President and Chief Operating
Officer, Utility Distribution Company, resigned from TEP in January 1999.
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------------------------------------------------
Information concerning Executive Compensation is contained under
Executive Compensation and Other Information in the Company's Proxy
Statement relating to the 1999 Annual Meeting of Shareholders, which
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
GENERAL
-------
At March 8, 1999, UniSource Energy had outstanding 32,290,859
shares of Common Stock. As of March 8, 1999, the number of shares of
Common Stock beneficially owned by all directors and officers of the
Company as a group amounted to less than 1% of the outstanding Common
Stock.
At March 8, 1999, UniSource Energy owned all of the outstanding
shares of common stock of TEP.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
-----------------------------------------------
Information concerning the security ownership of certain beneficial
owners of UniSource Energy is contained under Security Ownership of
Certain Beneficial Owners in the Company's Proxy Statement relating to
the 1999 Annual Meeting of Shareholders, which information is
incorporated herein by reference.
SECURITY OWNERSHIP OF MANAGEMENT
--------------------------------
Information concerning the security ownership of the Directors
and Executive Officers of UniSource Energy and TEP is contained under
Security Ownership of Management in the Company's Proxy Statement
relating to the 1999 Annual Meeting of Shareholders, which information
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- ------------------------------------------------------------------------
None.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------
Page
----
(a) 1. Consolidated Financial Statements as of
December 31, 1998 and 1997 and for Each
of the Three Years in the Period Ended
December 31, 1998.
UniSource Energy Corporation
----------------------------
Independent Auditors' Report 46
Report of Independent Accountants 47
Consolidated Statements of Income 48
Consolidated Statements of Cash Flows 49
Consolidated Balance Sheets 50
Consolidated Statements of Capitalization 51
Consolidated Statements of Changes in Stockholders'
Equity 52
Notes to Consolidated Financial Statements 58
Tucson Electric Power Company
-----------------------------
Independent Auditors' Report 46
Report of Independent Accountants 47
Consolidated Statements of Income 53
Consolidated Statements of Cash Flows 54
Consolidated Balance Sheets 55
Consolidated Statements of Capitalization 56
Consolidated Statements of Changes in Stockholders'
Equity 57
Notes to Consolidated Financial Statements 58
2. Supplemental Consolidated Schedules for the Years
Ended December 31, 1996 to 1998.
Financial Statement Schedules
-----------------------------
New Energy Ventures, Inc.
Report and Consolidated Financial Statements
December 31, 1998 and 1997 93
Schedules I to V, inclusive, are omitted because they are not
applicable or not required.
3. Exhibits.
Reference is made to the Exhibit Index commencing on page 121
(b) Reports on Form 8-K.
UniSource Energy Corporation and Tucson Electric Power Company
--------------------------------------------------------------
-- Form 8-K dated November 25, 1998 (filed December 15,
1998), reporting on TEP settlement agreement with the ACC
Staff and the approval of the ACC retail electric competition
rules.
-- Form 8-K dated December 4, 1998 (filed December 8, 1998),
reporting on dividend paid by TEP to UniSource Energy
-- Form 8-K dated January 4, 1999 (filed January 8, 1999),
reporting on the delay of retail electric competition in
Arizona.
-- Form 8-K dated February 5, 1999 (filed February 16, 1999),
reporting on Proposed Orders by ACC Hearing Officer and 1998
Earnings.
UniSource Energy Corporation
----------------------------
-- Form 8-K dated March 5, 1999 (filed March 15, 1999),
reporting on adoption of a shareholder rights plan.
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly
authorized.
UNISOURCE ENERGY CORPORATION
Date: March 31, 1999 By Ira R. Adler
------------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates
indicated.
Date: March 31, 1999 James S. Pignatelli*
---------------------------------
James S. Pignatelli
Chairman of the Board, President and
Principal Executive Officer
Date: March 31, 1999 Ira R. Adler
---------------------------------
Ira R. Adler
Executive Vice President, Principal
Financial Officer and Director
Date: March 31, 1999 Karen G. Kissinger*
---------------------------------
Karen G. Kissinger
Principal Accounting Officer
Date: March 31, 1999 Larry W. Bickle*
---------------------------------
Larry W. Bickle
Director
Date: March 31, 1999 Elizabeth T. Bilby*
---------------------------------
Elizabeth T. Bilby
Director
Date: March 31, 1999 Harold W. Burlingame*
---------------------------------
Harold W. Burlingame
Director
Date: March 31, 1999 Jose L. Canchola*
---------------------------------
Jose L. Canchola
Director
Date: March 31, 1999 John L. Carter*
---------------------------------
John L. Carter
Director
Date: March 31, 1999 Daniel W. L. Fessler*
---------------------------------
Daniel W. L. Fessler
Director
Date: March 31, 1999 John A. Jeter*
---------------------------------
John A. Jeter
Director
Date: March 31, 1999 R. B. O'Rielly*
---------------------------------
R. B. O'Rielly
Director
Date: March 31, 1999 Martha R. Seger*
---------------------------------
Martha R. Seger
Director
Date: March 31, 1999 H. Wilson Sundt*
---------------------------------
H. Wilson Sundt
Director
Date: March 31, 1999 By Ira R. Adler
-------------------------------
Ira R. Adler
as attorney-in-fact for each
of the persons indicated
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly
authorized.
TUCSON ELECTRIC POWER COMPANY
Date: March 31, 1999 By Ira R. Adler
------------------------------
Ira R. Adler
Executive Vice President and
Principal Financial Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates
indicated.
Date: March 31, 1999 James S. Pignatelli*
---------------------------------
James S. Pignatelli
Chairman of the Board, President and
Principal Executive Officer
Date: March 31, 1999 Ira R. Adler
---------------------------------
Ira R. Adler
Executive Vice President, Principal
Financial Officer and Director
Date: March 31, 1999 Karen G. Kissinger*
---------------------------------
Karen G. Kissinger
Principal Accounting Officer
Date: March 31, 1999 Elizabeth T. Bilby*
---------------------------------
Elizabeth T. Bilby
Director
Date: March 31, 1999 Harold W. Burlingame*
---------------------------------
Harold W. Burlingame
Director
Date: March 31, 1999 John. L. Carter*
---------------------------------
John L. Carter
Director
Date: March 31, 1999 Daniel W. L. Fessler*
---------------------------------
Daniel W. L. Fessler
Director
Date: March 31, 1999 John A. Jeter*
---------------------------------
John A. Jeter
Director
Date: March 31, 1999 Martha R. Seger*
---------------------------------
Martha R. Seger
Director
Date: March 31, 1999
By Ira R. Adler
------------------------------
Ira R. Adler
as attorney-in-fact for each
of the persons indicated
EXHIBIT INDEX
*2(a) -- Agreement and Plan of Exchange, dated as of March 20,
1995, between TEP, UniSource Energy and NCR Holding, Inc.
*3(a) -- Restated Articles of Incorporation of TEP, filed with the
ACC on August 11, 1994, as amended by Amendment to Article
Fourth of the Company's Restated Articles of
Incorporation, filed with the ACC on May 17, 1996. (Form
10-K for year ended December 31, 1996, File No. 1-5924--
Exhibit 3(a).)
*3(b) -- Bylaws of TEP, as amended May 20, 1994. (Form 10-Q for
the quarter ended June 30, 1994, File No. 1-5924--Exhibit
3.)
*3(c) -- Amended and Restated Articles of Incorporation of
UniSource Energy. (Form 8-A/A, dated January 30, 1998,
File No. 1-13739--Exhibit 2(a).)
*3(d) -- Bylaws of UniSource Energy, as amended December 11, 1997.
(Form 8-A, dated December 23, 1997, File No. 1-13739--
Exhibit 2(b).)
*4(a)(1)-- Indenture dated as of April 1, 1941, to The Chase
National Bank of the City of New York, as Trustee. (Form
S-7, File No. 2-59906--Exhibit 2(b)(1).)
*4(a)(2)-- First Supplemental Indenture, dated as of October 1,
1946. (Form S-7, File No. 2-59906--Exhibit 2(b)(2).)
*4(a)(3)-- Second Supplemental Indenture dated as of October 1,
1947. (Form S-7, File No. 2-59906--Exhibit 2(b)(3).)
*4(a)(4)-- Third Supplemental Indenture, dated as of April 1, 1949.
(Form S-7, File No. 2-59906--Exhibit 2(b)(4).)
*4(a)(5)-- Fourth Supplemental Indenture, dated as of December 1,
1952. (Form S-7, File No. 2-59906--Exhibit 2(b)(5).)
*4(a)(6)-- Fifth Supplemental Indenture, dated as of January 1,
1955. (Form S-7, File No. 2-59906--Exhibit 2(b)(6).)
*4(a)(7)-- Sixth Supplemental Indenture, dated as of January 1,
1958. (Form S-7, File No. 2-59906--Exhibit 2(b)(7).)
*4(a)(8)-- Seventh Supplemental Indenture, dated as of November 1,
1959. (Form S-7, File No. 2-59906--Exhibit 2(b)(8).)
*4(a)(9)-- Eighth Supplemental Indenture, dated as of November 1,
1961. (Form S-7, File No. 2-59906--Exhibit 2(b)(9).)
*4(a)(10)-- Ninth Supplemental Indenture, dated as of February
20, 1964. (Form S-7, File No. 2-59906--Exhibit 2(b)(10).)
*4(a)(11)-- Tenth Supplemental Indenture, dated as of February
1, 1965. (Form S-7, File No. 2-59906--Exhibit 2(b)(11).)
*4(a)(12)-- Eleventh Supplemental Indenture, dated as of
February 1, 1966. (Form S-7, File No. 2-59906--Exhibit
2(b)(12).
*4(a)(13)-- Twelfth Supplemental Indenture, dated as of
November 1, 1969. (Form S-7, File No. 2-59906 Exhibit
2(b)(13).)
EXHIBIT INDEX (CONTINUED)
*4(a)(14)-- Thirteenth Supplemental Indenture, dated as of
January 20, 1970. (Form S-7, File No. 2-59906--Exhibit
2(b)(14).)
*4(a)(15)-- Fourteenth Supplemental Indenture, dated as of
September 1, 1971. (Form S-7, File No. 2-59906--Exhibit
2(b)(15).)
*4(a)(16)-- Fifteenth Supplemental Indenture, dated as of March
1, 1972. (Form S-7, File No. 2-59906--Exhibit 2(b)(16).)
*4(a)(17)-- Sixteenth Supplemental Indenture, dated as of May
1, 1973. (Form S-7, File No. 2-59906--Exhibit 2(b)(17).)
*4(a)(18)-- Seventeenth Supplemental Indenture, dated as of
November 1, 1975. (Form S-7, File No. 2-59906--Exhibit
2(b)(18).)
*4(a)(19)-- Eighteenth Supplemental Indenture, dated as of
November 1, 1975. (Form S-7, File No. 2-59906--Exhibit
2(b)(19).)
*4(a)(20)-- Nineteenth Supplemental Indenture, dated as of July
1, 1976. (Form S-7, File No. 2-59906--Exhibit 2(b)(20).)
*4(a)(21)-- Twentieth Supplemental Indenture, dated as of
October 1, 1977. (Form S-7, File No. 2-59906--Exhibit
2(b)(21).)
*4(a)(22)-- Twenty-first Supplemental Indenture, dated as of
November 1, 1977. (Form 10-K for year ended December 31,
1980, File No. 1-5924--Exhibit 4(v).)
*4(a)(23)-- Twenty-second Supplemental Indenture, dated as of
January 1, 1978. (Form 10-K for year ended December 31,
1980, File No. 1-5924--Exhibit 4(w).)
*4(a)(24)-- Twenty-third Supplemental Indenture, dated as of
July 1, 1980. (Form 10-K for year ended December 31,
1980, File No. 1-5924--Exhibit 4(x).)
*4(a)(25)-- Twenty-fourth Supplemental Indenture, dated as of
October 1, 1980. (Form 10-K for year ended December 31,
1980, File No. 1-5924--Exhibit 4(y).)
*4(a)(26)-- Twenty-fifth Supplemental Indenture, dated as of
April 1, 1981. (Form 10-Q for quarter ended March 31,
1981, File No. 1-5924--Exhibit 4(a).)
*4(a)(27)-- Twenty-sixth Supplemental Indenture, dated as of
April 1, 1981. (Form 10-Q for quarter ended March 31,
1981, File No. 1-5924--Exhibit 4(b).)
*4(a)(28)-- Twenty-seventh Supplemental Indenture, dated as of
October 1, 1981. (Form 10-Q for quarter ended September
30, 1982, File No. 1-5924--Exhibit 4(c).)
EXHIBIT INDEX (CONTINUED)
*4(a)(29)-- Twenty-eighth Supplemental Indenture, dated as of
June 1, 1990. (Form 10-Q for quarter ended June 30, 1990,
File No. 1-5924--Exhibit 4(a)(1).)
*4(a)(30)-- Twenty-ninth Supplemental Indenture, dated as of
December 1, 1992. (Form S-1, Registration No. 33-55732--
Exhibit 4(a)(30).)
*4(a)(31)-- Thirtieth Supplemental Indenture, dated as of
December 1, 1992. (Form S-1, Registration No. 33-55732--
Exhibit 4(a)(31).)
*4(a)(32)-- Thirty-first Supplemental Indenture, dated as of
May 1, 1996. (Form 10-K for the year ended December 31,
1996, File No. 1-5924--Exhibit 4(a)(32).)
*4(a)(33)-- Thirty-second Supplemental Indenture, dated as of
May 1, 1996. (Form 10-K for the year ended December 31,
1996, File No. 1-5924--Exhibit 4(a)(33).)
*4(a)(34)-- Thirty-third Supplemental Indenture, dated as of May 1,
1998. (Form 10-Q for the quarter ended June 30, 1998,
File No. 1-5924 - Exhibit 4(a).)
*4(a)(35)-- Thirty-fourth Supplemental Indenture dated as of August
1, 1998. (Form 10-Q for the quarter ended June 30, 1998,
File No. 1-5924 - Exhibit 4(b).)
*4(b)(1)-- Installment Sale Agreement, dated as of December 1,
1973, among the City of Farmington, New Mexico, Public
Service Company of New Mexico and TEP. (Form 8-K for the
month of January 1974, File No. 0-269--Exhibit 3.)
*4(b)(2)-- Ordinance No. 486, adopted December 17, 1973, of the
City of Farmington, New Mexico. (Form 8-K for the month of
January 1974, File No. 0-269--Exhibit 4.)
*4(b)(3)-- Amended and Restated Installment Sale Agreement dated as
of April 1, 1997, between the City of Farmington, New
Mexico and TEP relating to Pollution Control Revenue
Bonds, 1997 Series A (Tucson Electric Power Company San
Juan Project). (Form 10-Q for the quarter ended March 31,
1997, File No. 1-5924--Exhibit 4(a).)
*4(b)(4)-- City of Farmington, New Mexico Ordinance No. 97-1055,
adopted April 17, 1997, authorizing Pollution Control
Revenue Bonds, 1997 Series A (Tucson Electric Power
Company San Juan Project). (Form 10-Q for the quarter
ended March 31, 1997, File No. 1-5924--Exhibit 4(b).)
*4(c)(1)-- Loan Agreement, dated as of October 1, 1982, between the
Pima County Authority and TEP relating to Floating Rate
Monthly Demand Industrial Development Revenue Bonds, 1982
Series A (Tucson Electric Power Company Irvington
Project). (Form 10-Q for quarter ended September 30, 1982,
File No. 1-5924--Exhibit 4(a).)
EXHIBIT INDEX (CONTINUED)
*4(c)(2)-- Indenture of Trust, dated as of October 1, 1982, between
the Pima County Authority and Morgan Guaranty authorizing
Floating Rate Monthly Demand Industrial Development
Revenue Bonds, 1982 Series A (Tucson Electric Power
Company Irvington Project). (Form 10-Q for quarter ended
September 30, 1982, File No. 1-5924--Exhibit 4(b).)
*4(c)(3)-- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Pima County Authority and TEP relating
to Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company Irvington Project). (Form
S-4, Registration No. 33-52860--Exhibit 4(h)(3).)
*4(c)(4)-- First Supplemental Indenture of Trust, dated as of March
31, 1992, between the Pima County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds,
1982 Series A (Tucson Electric Power Company Irvington
Project). (Form S-4, Registration No. 33-52860--Exhibit
4(h)(4).)
*4(d)(1)-- Loan Agreement, dated as of December 1, 1982, between
the Pima County Authority and TEP relating to Floating
Rate Monthly Demand Industrial Development Revenue Bonds,
1982 Series A (Tucson Electric Power Company Projects).
(Form 10-K for year ended December 31, 1982, File No. 1-
5924--Exhibit 4(k)(1).)
*4(d)(2)-- Indenture of Trust, dated as of December 1, 1982,
between the Pima County Authority and Morgan Guaranty
authorizing Floating Rate Monthly Demand Industrial
Development Revenue Bonds, 1982 Series A (Tucson Electric
Power Company Projects). (Form 10-K for year ended
December 31, 1982, File No. 1-5924--Exhibit 4(k)(2).)
*4(d)(3)-- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Pima County Authority and TEP relating
to Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company Projects). (Form S-4,
Registration No. 33-52860--Exhibit 4(i)(3).)
*4(d)(4)-- First Supplemental Indenture of Trust, dated as of March
31, 1992, between the Pima County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds,
1982 Series A (Tucson Electric Power Company Projects).
(Form S-4, Registration No. 33-52860--Exhibit 4(i)(4).)
*4(e)(1)-- Loan Agreement, dated as of December 1, 1983, between
the Apache County Authority and TEP relating to Floating
Rate Monthly Demand Industrial Development Revenue Bonds,
1983 Series A (Tucson Electric Power Company Springerville
Project). (Form 10-K for year ended December 31, 1983,
File No. 1-5924--Exhibit 4(l)(1).)
*4(e)(2)-- Indenture of Trust, dated as of December 1, 1983,
between the Apache County Authority and Morgan Guaranty
authorizing Floating Rate Monthly Demand Industrial
EXHIBIT INDEX (CONTINUED)
Development Revenue Bonds, 1983 Series A (Tucson Electric
Power Company Springerville Project). (Form 10-K for year
ended December 31, 1983, File No. 1-5924--Exhibit
4(l)(2).)
*4(e)(3)-- First Supplemental Loan Agreement, dated as of December
1, 1985, between the Apache County Authority and TEP
relating to Floating Rate Monthly Demand Industrial
Development Revenue Bonds, 1983 Series A (Tucson Electric
Power Company Springerville Project). (Form 10-K for the
year ended December 31, 1987, File No. 1-5924--Exhibit
4(k)(3).)
*4(e)(4)-- First Supplemental Indenture, dated as of December 1,
1985, between the Apache County Authority and Morgan
Guaranty relating to Floating Rate Monthly Demand
Industrial Development Revenue Bonds, 1983 Series A
(Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1987, File No.
1-5924--Exhibit 4(k)(4).)
*4(e)(5)-- Second Supplemental Loan Agreement, dated as of March
31, 1992, between the Apache County Authority and TEP
relating to Industrial Development Revenue Bonds, 1983
Series A (Tucson Electric Power Company Springerville
Project). (Form S-4, Registration No. 33-52860--Exhibit
4(k)(5).)
*4(e)(6)-- Second Supplemental Indenture of Trust, dated as of
March 31, 1992, between the Apache County Authority and
Morgan Guaranty relating to Industrial Development Revenue
Bonds, 1983 Series A (Tucson Electric Power Company
Springerville Project). (Form S-4, Registration No. 33-
52860--Exhibit 4(k)(6).)
*4(f)(1)-- Loan Agreement, dated as of December 1, 1983, between
the Apache County Authority and TEP relating to Variable
Rate Demand Industrial Development Revenue Bonds, 1983
Series B (Tucson Electric Power Company Springerville
Project). (Form 10-K for year ended December 31, 1983,
File No. 1-5924--Exhibit 4(m)(1).)
*4(f)(2)-- Indenture of Trust, dated as of December 1, 1983,
between the Apache County Authority and Morgan Guaranty
authorizing Variable Rate Demand Industrial Development
Revenue Bonds, 1983 Series B (Tucson Electric Power
Company Springerville Project). (Form 10-K for year ended
December 31, 1983, File No. 1-5924--Exhibit 4(m)(2).)
*4(f)(3)-- First Supplemental Loan Agreement, dated as of December
1, 1985, between the Apache County Authority and TEP
relating to Floating Rate Monthly Demand Industrial
Development Revenue Bonds, 1983 Series B (Tucson Electric
Power Company Springerville Project). (Form 10-K for the
year ended December 31, 1987, File No. 1-5924--Exhibit
4(l)(3).)
EXHIBIT INDEX (CONTINUED)
*4(f)(4)-- First Supplemental Indenture, dated as of December 1,
1985, between the Apache County Authority and Morgan
Guaranty relating to Floating Rate Monthly Demand
Industrial Development Revenue Bonds, 1983 Series B
(Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1987, File No.
1-5924--Exhibit 4(l)(4).)
*4(f)(5)-- Second Supplemental Loan Agreement, dated as of March
31, 1992, between the Apache County Authority and TEP
relating to Industrial Development Revenue Bonds, 1983
Series B (Tucson Electric Power Company Springerville
Project). (Form S-4, Registration No. 33-52860--Exhibit
4(l)(5).)
*4(f)(6)-- Second Supplemental Indenture of Trust, dated as of
March 31, 1992, between the Apache County Authority and
Morgan Guaranty relating to Industrial Development Revenue
Bonds, 1983 Series B (Tucson Electric Power Company
Springerville Project). (Form S-4, Registration No. 33-
52860--Exhibit 4(l)(6).)
*4(g)(1)-- Loan Agreement, dated as of December 1, 1983, between
the Apache County Authority and TEP relating to Variable
Rate Demand Industrial Development Revenue Bonds, 1983
Series C (Tucson Electric Power Company Springerville
Project). (Form 10-K for year ended December 31, 1983,
File No. 1-5924--Exhibit 4(n)(1).)
*4(g)(2)-- Indenture of Trust, dated as of December 1, 1983,
between the Apache County Authority and Morgan Guaranty
authorizing Variable Rate Demand Industrial Development
Revenue Bonds, 1983 Series C (Tucson Electric Power
Company Springerville Project). (Form 10-K for year ended
December 31, 1983, File No. 1-5924--Exhibit 4(n)(2).)
*4(g)(3)-- First Supplemental Loan Agreement, dated as of December
1, 1985, between the Apache County Authority and TEP
relating to Floating Rate Monthly Demand Industrial
Development Revenue Bonds, 1983 Series C (Tucson Electric
Power Company Springerville Project). (Form 10-K for the
year ended December 31, 1987, File No. 1-5924--Exhibit
4(m)(3).)
*4(g)(4)-- First Supplemental Indenture, dated as of December 1,
1985, between the Apache County Authority and Morgan
Guaranty relating to Floating Rate Monthly Demand
Industrial Development Revenue Bonds, 1983 Series C
(Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1987, File No.
1-5924--Exhibit 4(m)(4).)
*4(g)(5)-- Second Supplemental Loan Agreement, dated as of March
31, 1992, between the Apache County Authority and TEP
relating to Industrial Development Revenue Bonds, 1983
Series C (Tucson Electric Power Company Springerville
EXHIBIT INDEX (CONTINUED)
Project). (Form S-4, Registration No. 33-52860--Exhibit
4(m)(5).)
*4(g)(6)-- Second Supplemental Indenture of Trust, dated as of
March 31, 1992, between the Apache County Authority and
Morgan Guaranty relating to Industrial Development Revenue
Bonds, 1983 Series C (Tucson Electric Power Company
Springerville Project). (Form S-4, Registration No. 33-
52860--Exhibit 4(m)(6).)
*4(h) -- Reimbursement Agreement, dated as of September 15, 1981,
as amended, between TEP and Manufacturers Hanover Trust
Company. (Form 10-K for the year ended December 31, 1984,
File No. 1-5924--Exhibit 4(o)(4).)
*4(i)(1)-- Loan Agreement, dated as of December 1, 1985, between
the Apache County Authority and TEP relating to Variable
Rate Demand Industrial Development Revenue Bonds, 1985
Series A (Tucson Electric Power Company Springerville
Project). (Form 10-K for the year ended December 31, 1985,
File No. 1-5924---Exhibit 4(r)(1).)
*4(i)(2)-- Indenture of Trust, dated as of December 1, 1985,
between the Apache County Authority and Morgan Guaranty
authorizing Variable Rate Demand Industrial Development
Revenue Bonds, 1985 Series A (Tucson Electric Power
Company Springerville Project). (Form 10-K for the year
ended December 31, 1985, File No. 1-5924--Exhibit
4(r)(2).)
*4(i)(3)-- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Apache County Authority and TEP relating
to Industrial Development Revenue Bonds, 1985 Series A
(Tucson Electric Power Company Springerville Project).
(Form S-4, Registration No. 33-52860--Exhibit 4(o)(3).)
*4(i)(4)-- First Supplemental Indenture of Trust, dated as of March
31, 1992, between the Apache County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds,
1985 Series A (Tucson Electric Power Company Springerville
Project). (Form S-4, Registration No. 33-52860--Exhibit
4(o)(4).)
*4(j)(1)-- Warrant Agreement and Form of Warrant, dated as of
December 15, 1992. (Form S-1, Registration No. 33-55732--
Exhibit 4(q).)
* 4(j)(2)-- Form of Warrant Agreement relating to the UniSource
Energy Warrants, dated as of August 4, 1998. (Form S-4,
Registration Statement No. 333-60809--Exhibit 4(a).)
*4(k)(1)-- Indenture of Mortgage and Deed of Trust dated as of
December 1, 1992, to Bank of Montreal Trust Company,
Trustee. (Form S-1, Registration No. 33-55732--Exhibit
4(r)(1).)
EXHIBIT INDEX (CONTINUED)
*4(k)(2)-- Supplemental Indenture No. 1 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series A,
dated as of December 1, 1992. (Form S-1, Registration No.
33-55732--Exhibit 4(r)(2).)
*4(k)(3)-- Supplemental Indenture No. 2 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series B,
dated as of December 1, 1997. (Form 10-K for year ended
December 31, 1997, File No. 1-5924 -- Exhibit 4(m)(3).)
*4(k)(4)-- Supplemental Indenture No. 3 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series, dated
as of August 1, 1998. (Form 10-Q for the quarter ended
June 30, 1998, File No. 1-5924 -- Exhibit 4(c).)
*4(l)(1)-- Loan Agreement, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
TEP relating to Pollution Control Revenue Bonds, 1997
Series A (Tucson Electric Power Company Navajo Project).
(Form 10-Q for the quarter ended March 31, 1997, File No.
1-5924--Exhibit 4(c).)
*4(l)(2)-- Indenture of Trust, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1997 Series A (Tucson
Electric Power Company Navajo Project). (Form 10-Q for
the quarter ended March 31, 1997, File No. 1-5924--Exhibit
4(d).)
*4(m)(1)-- Loan Agreement, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
TEP relating to Pollution Control Revenue Bonds, 1997
Series B (Tucson Electric Power Company Navajo Project).
(Form 10-Q for the quarter ended March 31, 1997, File No.
1-5924-Exhibit 4(e).)
*4(m)(2)-- Indenture of Trust, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1997 Series B (Tucson
Electric Power Company Navajo Project). (Form 10-Q for the
quarter ended March 31, 1997, File No. 1-5924-Exhibit
4(f).)
*4(n)(1)-- Loan Agreement, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima
and TEP relating to Industrial Development Revenue Bonds,
1997 Series A (Tucson Electric Power Company Project).
(Form 10-Q for the quarter ended September 30, 1997, File
No. 1-5924-Exhibit 4(a).)
*4(n)(2)-- Indenture of Trust, dated as of September 15, 1997,
between The Industrial Development Authority of the County
of Pima and First Trust of New York, National Association,
authorizing Industrial Development Revenue Bonds, 1997
Series A (Tucson Electric Power Company Project). (Form
EXHIBIT INDEX (CONTINUED)
10-Q for the quarter ended September 30, 1997, File No. 1-
5924-Exhibit 4(b).)
*4(o)(1)-- Loan Agreement, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima
and TEP relating to Industrial Development Revenue Bonds,
1997 Series B (Tucson Electric Power Company Project).
(Form 10-Q for the quarter ended September 30, 1997, File
No. 1-5924--Exhibit 4(c).)
*4(o)(2)-- Indenture of Trust, dated as of September 15, 1997,
between The Industrial Development Authority of the County
of Pima and First Trust of New York, National Association,
authorizing Industrial Development Revenue Bonds, 1997
Series B (Tucson Electric Power Company Project). (Form
10-Q for the quarter ended September 30, 1997, File No. 1-
5924--Exhibit 4(d).)
*4(p)(1)-- Loan Agreement, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima
and TEP relating to Industrial Development Revenue Bonds,
1997 Series C (Tucson Electric Power Company Project).
(Form 10-Q for the quarter ended September 30, 1997, File
No. 1-5924--Exhibit 4(e).)
*4(p)(2)-- Indenture of Trust, dated as of September 15, 1997,
between The Industrial Development Authority of the County
of Pima and First Trust of New York, National Association,
authorizing Industrial Development Revenue Bonds, 1997
Series C (Tucson Electric Power Company Project). (Form
10-Q for the quarter ended September 30, 1997, File No. 1-
5924-Exhibit 4(f).)
*4(q)(1) Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
and TEP relating to Pollution Control Revenue Bonds, 1998
Series A (Tucson Electric Power Company Project). (Form
10-Q for the quarter ended March 31, 1998, File No. 1-5924
- Exhibit 4(a).)
*4(q)(2) Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
and First Trust of New York, National Association,
authorizing Pollution Control Revenue Bonds, 1998 Series A
(Tucson Electric Power Company Project). (Form 10-Q for
the quarter ended March 31, 1998, File No. 1-5924 -
Exhibit 4(b).)
*4(r)(1) Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
and TEP relating to Pollution Control Revenue Bonds, 1998
Series B (Tucson Electric Power Company Project). (Form
10-Q for the quarter ended March 31, 1998, File No. 1-5924
- Exhibit 4(c).)
*4(r)(2) Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
EXHIBIT INDEX (CONTINUED)
and First Trust of New York, National Association,
authorizing Pollution Control Revenue Bonds, 1998 Series B
(Tucson Electric Power Company Project). (Form 10-Q for
the quarter ended March 31, 1998, File No. 1-5924 -
Exhibit 4(d).)
*4(s)(1) Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
and TEP relating to Industrial Development Revenue Bonds,
1998 Series C (Tucson Electric Power Company Project).
(Form 10-Q for the quarter ended March 31, 1998, File No.
1-5924 - Exhibit 4(e).)
*4(s)(2) Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache
and First Trust of New York, National Association,
authorizing Industrial Development Revenue Bonds, 1998
Series C (Tucson Electric Power Company Project). (Form
10-Q for the quarter ended March 31, 1998, File No. 1-5924
- Exhibit 4(f).)
*4(t)(1)-- Indenture of Trust, dated as of August 1, 1998, between
TEP and the Bank of Montreal Trust Company. (Form 10-Q
for the quarter ended June 30, 1998, File No. 1-5924 -
Exhibit 4(d).)
*4(u)(1)-- Rights Agreement dated as of March 5, 1999, between
UniSource Energy Corporation and The Bank of New York, as
Rights Agent. (Form 8-K dated March 5, 1999, File No. 1-
13739 - Exhibit 4.)
*10(a)(1)-- Lease Agreements, dated as of December 1, 1984,
between Valencia and United States Trust Company of New
York, as Trustee, and Thomas B. Zakrzewski, as Co-Trustee,
as amended and supplemented. (Form 10-K for the year ended
December 31, 1984, File No. 1-5924--Exhibit 10(d)(1).)
*10(a)(2)-- Guaranty and Agreements, dated as of December 1,
1984, between TEP and United States Trust Company of New
York, as Trustee, and Thomas B. Zakrzewski, as Co-Trustee.
(Form 10-K for the year ended December 31, 1984, File No.
1-5924--Exhibit 10(d)(2).)
*10(a)(3)-- General Indemnity Agreements, dated as of December
1, 1984, between Valencia and TEP, as Indemnitors; General
Foods Credit Corporation, Harvey Hubbell Financial, Inc.
and J. C. Penney Company, Inc. as Owner Participants;
United States Trust Company of New York, as Owner Trustee;
Teachers Insurance and Annuity Association of America as
Loan Participant; and Marine Midland Bank, N.A., as
Indenture Trustee. (Form 10-K for the year ended December
31, 1984, File No. 1-5924--Exhibit 10(d)(3).)
*10(a)(4)-- Tax Indemnity Agreements, dated as of December 1,
1984, between General Foods Credit Corporation, Harvey
Hubbell Financial, Inc. and J. C. Penney Company, Inc.,
each as Beneficiary under a separate Trust Agreement dated
EXHIBIT INDEX (CONTINUED)
December 1, 1984, with United States Trust of New York as
Owner Trustee, and Thomas B. Zakrzewski as Co-Trustee,
Lessor, and Valencia, Lessee, and TEP, Indemnitors. (Form
10-K for the year ended December 31, 1984, File No. 1-
5924--Exhibit 10(d)(4).)
*10(a)(5)-- Amendment No. 1, dated December 31, 1984, to the
Lease Agreements, dated December 1, 1984, between Valencia
and United States Trust Company of New York, as Owner
Trustee, and Thomas B. Zakrzewski as Co-Trustee. (Form 10-
K for the year ended December 31, 1986, File No. 1-5924--
Exhibit 10(e)(5).)
*10(a)(6)-- Amendment No. 2, dated April 1, 1985, to the Lease
Agreements, dated December 1, 1984, between Valencia and
United States Trust Company of New York, as Owner Trustee,
and Thomas B. Zakrzewski as Co-Trustee. (Form 10-K for the
year ended December 31, 1986, File No. 1-5924--Exhibit
10(e)(6).)
*10(a)(7)-- Amendment No. 3, dated August 1, 1985, to the Lease
Agreements, dated December 1, 1984, between Valencia and
United States Trust Company of New York, as Owner Trustee,
and Thomas Zakrzewski as Co-Trustee. (Form 10-K for the
year ended December 31, 1986, File No. 1-5924--Exhibit
10(e)(7).)
*10(a)(8)-- Amendment No. 4, dated June 1, 1986, to the Lease
Agreement, dated December 1, 1984, between Valencia and
United States Trust Company of New York as Owner Trustee,
and Thomas Zakrzewski as Co-Trustee, under a Trust
Agreement dated as of December 1, 1984, with General Foods
Credit Corporation as Owner Participant. (Form 10-K for
the year ended December 31, 1986, File No. 1-5924--Exhibit
10(e)(8).)
*10(a)(9)-- Amendment No. 4, dated June 1, 1986, to the Lease
Agreement, dated December 1, 1984, between Valencia and
United States Trust Company of New York as Owner Trustee,
and Thomas Zakrzewski as Co-Trustee, under a Trust
Agreement dated as of December 1, 1984, with J. C. Penney
Company, Inc. as Owner Participant. (Form 10-K for the
year ended December 31, 1986, File No. 1-5924--Exhibit
10(e)(9).)
*10(a)(10) -- Amendment No. 4, dated June 1, 1986, to the Lease
Agreement, dated December 1, 1984, between Valencia and
United States Trust Company of New York as Owner Trustee,
and Thomas Zakrzewski as Co-Trustee, under a Trust
Agreement dated as of December 1, 1984, with Harvey
Hubbell Financial Inc. as Owner Participant. (Form 10-K
for the year ended December 31, 1986, File No. 1-5924--
Exhibit 10(e)(10).)
*10(a)(11) -- Lease Amendment No. 5 and Supplement No. 2, to the
Lease Agreement, dated July 1, 1986, between Valencia,
United States Trust Company of New York as Owner Trustee,
EXHIBIT INDEX (CONTINUED)
and Thomas Zakrzewski as Co-Trustee and J. C. Penney as
Owner Participant. (Form 10-K for the year ended December
31, 1986, File No. 1-5924--Exhibit 10(e)(11).)
*10(a)(12) -- Lease Amendment No. 5, to the Lease Agreement,
dated June 1, 1987, between Valencia, United States Trust
Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee and General Foods Credit
Corporation as Owner Participant. (Form 10-K for the year
ended December 31, 1988, File No. 1-5924--Exhibit
10(f)(12).)
*10(a)(13) -- Lease Amendment No. 5, to the Lease Agreement,
dated June 1, 1987, between Valencia, United States Trust
Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee and Harvey Hubbell Financial Inc.
as Owner Participant. (Form 10-K for the year ended
December 31, 1988, File No. 1-5924--Exhibit 10(f)(13).)
*10(a)(14) -- Lease Amendment No. 6, to the Lease Agreement,
dated June 1, 1987, between Valencia, United States Trust
Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee and J. C. Penney Company, Inc. as
Owner Participant. (Form 10-K for the year ended December
31, 1988, File No. 1-5924--Exhibit 10(f)(14).)
*10(a)(15) -- Lease Supplement No. 1, dated December 31, 1984, to
Lease Agreements, dated December 1, 1984, between
Valencia, as Lessee and United States Trust Company of New
York and Thomas B. Zakrzewski, as Owner Trustee and Co-
Trustee, respectively (document filed relates to General
Foods Credit Corporation; documents relating to Harvey
Hubbel Financial, Inc. and JC Penney Company, Inc. are not
filed but are substantially similar). (Form S-4,
Registration No. 33-52860--Exhibit 10(f)(15).)
*10(a)(16) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, General Foods Credit
Corporation, as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance
and Annuity Association of America, as Loan Participant,
and Marine Midland Bank, N.A., as Indenture Trustee. (Form
10-K for the year ended December 31, 1986, File No. 1-
5924--Exhibit 10(e)(12).)
*10(a)(17) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, J. C. Penney Company,
Inc., as Owner Participant, United States Trust Company of
New York, as Owner Trustee, Teachers Insurance and Annuity
Association of America, as Loan Participant, and Marine
Midland Bank, N.A., as Indenture Trustee. (Form 10-K for
the year ended December 31, 1986, File No. 1-5924--Exhibit
10(e)(13).)
EXHIBIT INDEX (CONTINUED)
*10(a)(18) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, Harvey Hubbell
Financial, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance
and Annuity Association of America, as Loan Participant,
and Marine Midland Bank, N.A., as Indenture Trustee.
(Form 10-K for the year ended December 31, 1986, File No.
1-5924--Exhibit 10(e)(14).)
*10(a)(19) -- Amendment No. 2, dated as of July 1, 1986, to the
General Indemnity Agreement, dated as of December 1, 1984,
between Valencia and TEP, as Indemnitors, J. C. Penney
Company, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance
and Annuity Association of America, as Loan Participant,
and Marine Midland Bank, N.A., as Indenture Trustee. (Form
S-4, Registration No. 33-52860--Exhibit 10(f)(19).)
*10(a)(20) -- Amendment No. 2, dated as of June 1, 1987, to the
General Indemnity Agreement, dated as of December 1, 1984,
between Valencia and TEP, as Indemnitors, General Foods
Credit Corporation, as Owner Participant, United States
Trust Company of New York, as Owner Trustee, Teachers
Insurance and Annuity Association of America, as Loan
Participant, and Marine Midland Bank, N.A., as Indenture
Trustee. (Form S-4, Registration No. 33-52860--Exhibit
10(f)(20).)
*10(a)(21) -- Amendment No. 2, dated as of June 1, 1987, to the
General Indemnity Agreement, dated as of December 1, 1984,
between Valencia and TEP, as Indemnitors, Harvey Hubbell
Financial, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance
and Annuity Association of America, as Loan Participant,
and Marine Midland Bank, N.A., as Indenture Trustee. (Form
S-4, Registration No. 33-52860--Exhibit 10(f)(21).)
*10(a)(22) -- Amendment No. 3, dated as of June 1, 1987, to the
General Indemnity Agreement, dated as of December 1, 1984,
between Valencia and TEP, as Indemnitors, J. C. Penney
Company, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance
and Annuity Association of America, as Loan Participant,
and Marine Midland Bank, N.A., as Indenture Trustee. (Form
S-4, Registration No. 33-52860--Exhibit 10(f)(22).)
*10(a)(23) -- Supplemental Tax Indemnity Agreement, dated July 1,
1986, between J. C. Penney Company, Inc., as Owner
Participant, and Valencia and TEP, as Indemnitors. (Form
10-K for the year ended December 31, 1986, File No. 1-
5924--Exhibit 10(e)(15).)
*10(a)(24) -- Supplemental General Indemnity Agreement, dated as
of July 1, 1986, among Valencia and TEP, as Indemnitors,
J. C. Penney Company, Inc., as Owner Participant, United
States Trust Company of New York, as Owner Trustee,
EXHIBIT INDEX (CONTINUED)
Teachers Insurance and Annuity Association of America, as
Loan Participant, and Marine Midland Bank, N.A., as
Indenture Trustee. (Form 10-K for the year ended December
31, 1986, File No. 1-5924--Exhibit 10(e)(16).)
*10(a)(25) -- Amendment No. 1, dated as of June 1, 1987, to the
Supplemental General Indemnity Agreement, dated as of July
1, 1986, among Valencia and TEP, as Indemnitors, J. C.
Penney Company, Inc., as Owner Participant, United States
Trust Company of New York, as Owner Trustee, Teachers
Insurance and Annuity Association of America, as Loan
Participant, and Marine Midland Bank, N.A., as Indenture
Trustee. (Form S-4, Registration No. 33-52860--Exhibit
10(f)(25).)
*10(a)(26) -- Valencia Agreement, dated as of June 30, 1992,
among TEP, as Guarantor, Valencia, as Lessee, Teachers
Insurance and Annuity Association of America, as Loan
Participant, Marine Midland Bank, N.A., as Indenture
Trustee, United States Trust Company of New York, as Owner
Trustee, and Thomas B. Zakrzewski, as Co-Trustee, and the
Owner Participants named therein relating to the
Restructuring of Valencia's lease of the coal-handling
facilities at the Springerville Generating Station. (Form
S-4, Registration No. 33-52860--Exhibit 10(f)(26).)
*10(a)(27) -- Amendment, dated as of December 15, 1992, to the
Lease Agreements, dated December 1, 1984, between
Valencia, as Lessee, and United States Trust Company of
New York, as Owner Trustee, and Thomas B. Zakrzewski, as
Co-Trustee. (Form S-1, Registration No. 33-55732--Exhibit
10(f)(27).)
*10(b)(1)-- Lease Agreements, dated as of December 1, 1985,
between TEP and San Carlos Resources Inc. (San Carlos) (a
wholly-owned subsidiary of the Registrant) jointly and
severally, as Lessee, and Wilmington Trust Company, as
Trustee, as amended and supplemented. (Form 10-K for the
year ended December 31, 1985, File No. 1-5924--Exhibit
10(f)(1).)
*10(b)(2)-- Tax Indemnity Agreements, dated as of December 1,
1985, between Philip Morris Credit Corporation, IBM Credit
Financing Corporation and Emerson Finance Co., each as
beneficiary under a separate trust agreement, dated as of
December 1, 1985, with Wilmington Trust Company, as Owner
Trustee, and William J. Wade, as Co-Trustee, and TEP and
San Carlos, as Lessee. (Form 10-K for the year ended
December 31, 1985, File No. 1-5924--Exhibit 10(f)(2).)
*10(b)(3)-- Participation Agreement, dated as of December 1,
1985, among TEP and San Carlos as Lessee, Philip Morris
Credit Corporation, IBM Credit Financing Corporation, and
Emerson Finance Co. as Owner Participants, Wilmington
Trust Company as Owner Trustee, The Sumitomo Bank,
Limited, New York Branch, as Loan Participant, and Bankers
Trust Company, as Indenture Trustee. (Form 10-K for the
EXHIBIT INDEX (CONTINUED)
year ended December 31, 1985, File No. 1-5924--Exhibit
10(f)(3).)
*10(b)(4)-- Restructuring Commitment Agreement, dated as of
June 30, 1992, among TEP and San Carlos, jointly and
severally, as Lessee, Philip Morris Credit Corporation,
IBM Credit Financing Corporation and Emerson Capital
Funding William J. Wade, as Owner Trustee and Co-Trustee,
respectively, The Sumitomo Bank, Limited, New York Branch,
as Loan Participant and United States Trust Company of New
York, as Indenture Trustee. (Form S-4, Registration No.
33-52860--Exhibit 10(g)(4).)
*10(b)(5)-- Lease Supplement No. 1, dated December 31, 1985, to
Lease Agreements, dated as of December 1, 1985, between
TEP and San Carlos, jointly and severally, as Lessee
Trustee and Co-Trustee, respectively (document filed
relates to Philip Morris Credit Corporation; documents
relating to IBM Credit Financing Corporation and Emerson
Financing Co. are not filed but are substantially
similar). (Form S-4, Registration No. 33-52860--Exhibit
10(g)(5).)
*10(b)(6)-- Amendment No. 1, dated as of December 15, 1992, to
Lease Agreements, dated as of December 1, 1985, between
TEP and San Carlos, jointly and severally, as Lessee, and
Wilmington Trust Company and William J. Wade, as Owner
Trustee and Co-Trustee, respectively, as Lessor. (Form S-
1, Registration No. 33-55732--Exhibit 10(g)(6).)
*10(b)(7)-- Amendment No. 1, dated as of December 15, 1992, to
Tax Indemnity Agreements, dated as of December 1, 1985,
between Philip Morris Credit Corporation, IBM Credit
Financing Corporation and Emerson Capital Funding Corp.,
as Owner Participants and TEP and San Carlos, jointly and
severally, as Lessee. (Form S-1, Registration No. 33-
55732--Exhibit 10(g)(7).)
*10(c)(1)-- Amended and Restated Participation Agreement, dated
as of November 15, 1987, among TEP, as Lessee, Ford Motor
Credit Company, as Owner Participant, Financial Security
Assurance Inc., as Surety, Wilmington Trust Company and
William J. Wade in their respective individual capacities
as provided therein, but otherwise solely as Owner Trustee
and Co-Trustee under the Trust Agreement, and Morgan
Guaranty, in its individual capacity as provided therein,
but Secured Party. (Form 10-K for the year ended December
31, 1987, File No. 1-5924--Exhibit 10(j)(1).)
*10(c)(2)-- Lease Agreement, dated as of January 14, 1988,
between Wilmington Trust Company and William J. Wade, as
Owner Trust Agreement described therein, dated as of
November 15, 1987, between such parties and Ford Motor
Credit Company, as Lessor, and TEP, as Lessee. (Form 10-K
for the year ended December 31, 1987, File No. 1-5924--
Exhibit 10(j)(2).)
EXHIBIT INDEX (CONTINUED)
*10(c)(3)-- Tax Indemnity Agreement, dated as of January 14,
1988, between TEP, as Lessee, and Ford Motor Credit
Company, as Owner Participant, beneficiary under a Trust
Agreement, dated as of November 15, 1987, with Wilmington
Trust Company and William J. Wade, Owner Trustee and Co-
Trustee, respectively, together as Lessor. (Form 10-K for
the year ended December 31, 1987, File No. 1-5924--Exhibit
10(j)(3).)
*10(c)(4)-- Loan Agreement, dated as of January 14, 1988,
between the Pima County Authority and Wilmington Trust
Company and William J. Wade in their respective individual
capacities as expressly stated, but otherwise solely as
Owner Trustee and Co-Trustee, respectively, under and
pursuant to a Trust Agreement, dated as of November 15,
1987, with Ford Motor Credit Company as Trustor and Debtor
relating to Industrial Development Lease Obligation
Refunding Revenue Bonds, 1988 Series A (TEP's Irvington
Project). (Form 10-K for the year ended December 31, 1987,
File No. 1-5924--Exhibit 10(j)(4).)
*10(c)(5)-- Indenture of Trust, dated as of January 14, 1988,
between the Pima County Authority and Morgan Guaranty
authorizing Industrial Development Lease Obligation
Refunding Revenue Bonds, 1988 Series A (Tucson Electric
Power Company Irvington Project). (Form 10-K for the year
ended December 31, 1987, File No. 1-5924--Exhibit
10(j)(5).)
*10(c)(6)-- Lease Amendment No. 1, dated as of May 1, 1989,
between TEP, Wilmington Trust Company and William J. Wade
as Owner Trustee and Co-trustee, respectively under a
Trust Agreement dated as of November 15, 1987 with Ford
Motor Credit Company. (Form 10-K for the year ended
December 31, 1990, File No. 1-5924--Exhibit 10(i)(6).)
*10(c)(7)-- Lease Supplement, dated as of January 1, 1991,
between TEP, Wilmington Trust Company and William J. Wade
as Owner Trustee and Co-Trustee, respectively, under a
Trust Agreement dated as of November 15, 1987, with Ford.
(Form 10K for the year ended December 31, 1991, File No.
1-5924--Exhibit 10(i)(8).)
*10(c)(8)-- Lease Supplement, dated as of March 1, 1991,
between TEP, Wilmington Trust Company and William J. Wade
as Owner Trustee and Co-Trustee, respectively, under a
Trust Agreement dated as of November 15, 1987, with Ford.
(Form 10-K for the year ended December 31, 1991, File No.
1-5924--Exhibit 10(i)(9).)
*10(c)(9)-- Lease Supplement No. 4, dated as of December 1,
1991, between TEP, Wilmington Trust Company and William J.
Wade as Owner Trustee and Co-Trustee, respectively, under
a Trust Agreement dated as of November 15, 1987, with
Ford. (Form 10-K for the year ended December 31, 1991,
File No. 1-5924--Exhibit 10(i)(10).)
EXHIBIT INDEX (CONTINUED)
*10(c)(10) -- Supplemental Indenture No. 1, dated as of December
1, 1991, between the Pima County Authority and Morgan
Guaranty relating to Industrial Lease Development
Obligation Revenue Project). (Form 10-K for the year ended
December 31, 1991, File No. 1-5924--Exhibit 10(I)(11).)
*10(c)(11) -- Restructuring Commitment Agreement, dated as of
June 30, 1992, among TEP, as Lessee, Ford Motor Credit
Company, as Owner Participant, Wilmington Trust Company
and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, and Morgan Guaranty, as Indenture Trustee
and Refunding Trustee, relating to the restructuring of
the Registrant's lease of Unit 4 at the Irvington
Generating Station. (Form S-4, Registration No. 33-52860--
Exhibit 10(i)(12).)
*10(c)(12) -- Amendment No. 1, dated as of December 15, 1992, to
Amended and Restated Participation Agreement, dated as of
November 15, 1987, among TEP, as Lessee, Ford Motor Credit
Company, as Owner Participant, Wilmington Trust Company
and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, Financial Security Assurance Inc., as
Surety, and Morgan Guaranty, as Indenture Trustee. (Form
S-1, Registration No. 33-55732--Exhibit 10(h)(12).)
*10(c)(13) -- Amended and Restated Lease, dated as of December
15, 1992, between TEP, as Lessee and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-
Trustee, respectively, as Lessor. (Form S-1, Registration
No. 33-55732--Exhibit 10(h)(13).)
*10(c)(14) -- Amended and Restated Tax Indemnity Agreement, dated
as of December 15, 1992, between TEP, as Lessee, and Ford
Motor Credit Company, as Owner Participant. (Form S-1,
Registration No. 33-55732--Exhibit 10(h)(14).)
*10(d)-- Power Sale Agreement for the years 1990 to 2011, dated as
of March 10, 1988, between TEP and Salt River Project
Agricultural Improvement and Power District. (Form 10-K
for the year ended December 31, 1987, File No. 1-5924--
Exhibit 10(k).)
+*10(e)(1) -- Employment Agreements between TEP and currently in
effect with Ira R. Adler, Michael DeConcini, Thomas A.
Delawder, Gary L. Ellerd, Steven J. Glaser, Thomas N.
Hansen, Karen G. Kissinger, Kevin P. Larson, Dennis R.
Nelson, Vincent Nitido, James S. Pignatelli, James Pyers
and Romano Salvatori. (Form 10-K for the year ended
December 31, 1996, File No. 1-5924-Exhibit 10(g)(1).)
+*10(e)(2) -- Employment Agreement between TEP and Romano
Salvatori. (Form 10-K for the year ended December 31,
1996, File No. 1-5924-Exhibit 10(g)(2).)
*10(e)(3)-- Letter, dated February 25, 1992, from Dr. Martha R.
Seger to TEP and Capital Holding Corporation. (Form S-4,
Registration No. 33-52860--Exhibit 10(k)(4).)
EXHIBIT INDEX (CONTINUED)
+*10(e)(4) -- Amendment No. 1 to Employment Agreement among
Romano Salvatori, TEP and Nations Energy Corporation.
(Form 10-K for the year ended December 31, 1997, File Nos.
1-5924 and 1-13739--Exhibit 10(e)(4).)
+*10(e)(5) -- Amendment No. 1 to Amended and Restated Employment
Agreement between TEP and currently in effect with Ira R.
Adler, Michael DeConcini, Thomas A. Delawder, Gary L.
Ellerd, Steven J. Glaser, Thomas N. Hansen, Karen G.
Kissinger, Kevin P. Larson, Dennis R. Nelson, Vincent
Nitido, James S. Pignatelli, James Pyers and Romano
Salvatori. (Form 10-K for the year ended December 31,
1997, File Nos. 1-5924 and 1-13739--Exhibit 10(e)(5).)
*10(f)-- Power Sale Agreement, dated April 29, 1988, for the dates
of May 16, 1990 to December 31, 1995, between TEP and
Nevada Power Company. (Form 10-K for the year ended
December 31, 1988, File No 1-5924--Exhibit 10(m)(2).)
*10(g)-- Participation Agreement, dated as of June 30, 1992, among
TEP, as Lessee, various parties thereto, as Owner
Wilmington Trust Company and William J. Wade, as Owner
Trustee and Co-Trustee, respectively, and LaSalle National
Bank, as Indenture Trustee relating to TEP's lease of
Springerville Unit 1. (Form S-1, Registration No. 33-
55732--Exhibit 10(u).)
*10(h)-- Lease Agreement, dated as of December 15, 1992, between
TEP, as Lessee and Wilmington Trust Company and William J.
Wade, as Owner Trustee and Co-Trustee, respectively, as
Lessor. (Form S-1, Registration No. 33-55732--Exhibit
10(v).)
*10(i)-- Tax Indemnity Agreements, dated as of December 15, 1992,
between the various Owner Participants parties thereto and
TEP, as Lessee. (Form S-1, Registration No. 33-55732,
Exhibit 10(w).)
*10(j)-- Restructuring Agreement, dated as of December 1, 1992,
between TEP and Century Power Corporation. (Form S-1,
Registration No. 33-55732--Exhibit 10(x).)
*10(k)-- Voting Agreement, dated as of December 15, 1992, between
TEP and Chrysler Capital Corporation (documents relating
to CILCORP Lease Management, Inc., MWR Capital Inc., US
West Financial Services, Inc. and Philip Morris Capital
Corporation are not filed but are substantially similar).
(Form S-1, Registration No. 33-55732--Exhibit 10(y).)
EXHIBIT INDEX (CONCLUDED)
*10(l)(1)-- Wholesale Power Supply Agreement between TEP and
Navajo Tribal Utility Authority dated January 5, 1993.
(Form 10-K for the year ended December 31, 1992, File No.
1-5924--Exhibit 10(t).)
*10(l)(2)-- Amended and Restated Wholesale Power Supply
Agreement between TEP and Navajo Tribal Utility Authority,
dated June 25, 1997. (Form 10-Q for the quarter ended
June 30, 1997, File No. 1-5924-Exhibit 10.)
*10(m)-- Credit Agreement dated as of December 30, 1997, among TEP,
Toronto Dominion (Texas), Inc., as Administrative Agent,
The Bank of New York, as Syndication Agent, Societe
Generale, as Documentation Agent, the lenders party
hereto, and the issuing banks party hereto. (Form 10-K for
year ended December 31, 1997, File No. 1-5924-Exhibit
10(m).)
+*10(n)--1994 Omnibus Stock and Incentive Plan of UniSource Energy.
(Form S-8 dated January 6, 1998, File No. 333-43767.)
+*10(o)--1994 Outside Director Stock Option Plan of UniSource
Energy. (Form S-8 dated January 6, 1998, File No. 333-
43765.)
+*10(p)--Management and Directors Deferred Compensation Plan of
UniSource Energy. (Form S-8 dated January 6, 1998, File
No. 333-43769.)
+*10(q)--TEP Supplemental Retirement Account for Classified
Employees. (Form S-8 dated May 21, 1998, File No. 333-
53309.)
+*10(r)--TEP Triple Investment Plan for Salaried Employees. (Form
S-8 dated May 21, 1998, File No. 333-53333.)
+*10(s)--UniSource Energy Management and Directors Deferred
Compensation Plan. (Form S-8 dated May 21, 1998, File No.
333-53337.)
11 -- Statement re computation of per share earnings-UniSource
Energy.
12 -- Computation of Ratio of Earnings to Fixed Charges--TEP.
21 -- Subsidiaries of the Registrants.
23(a) -- Consents of experts (PricewaterhouseCoopers).
23(b) -- Consents of experts (Deloitte & Touche).
24(a) -- Power of Attorney--UniSource Energy.
24(b) -- Power of Attorney--TEP.
27(a) -- Financial Data Schedule--UniSource Energy.
EXHIBIT INDEX (CONCLUDED)
27(b) -- Financial Data Schedule--TEP.
(*)Previously filed as indicated and incorporated herein by
reference.
(+)Management contracts or compensatory plans or arrangements
required to be filed as exhibits to this Form 10-K by item
601(b)(10)(iii) of Regulation S-K.