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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Registrant; State of
Commission Incorporation; Address; IRS Employer
File Number and Telephone Number Identification Number
------------ ----------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
One South Church Avenue, Suite 100
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
One South Church Avenue, Suite 100
Tucson, AZ 85701
(520) 571-4000
Indicate by check mark whether each registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ___
At August 5, 2002, 33,569,850 shares of UniSource Energy Corporation's
Common Stock, no par value (the only class of Common Stock) were outstanding.
UniSource Energy Corporation is the holder of 32,139,434 shares of the
outstanding common stock of Tucson Electric Power Company.
- --------------------------------------------------------------------------------
This combined Form 10-Q is separately filed by UniSource Energy Corporation and
Tucson Electric Power Company. Information contained in this document relating
to Tucson Electric Power Company is filed by UniSource Energy Corporation and
separately by Tucson Electric Power Company on its own behalf. Tucson Electric
Power Company makes no representation as to information relating to UniSource
Energy Corporation or its subsidiaries, except as it may relate to Tucson
Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions................................................................iv
Report of Independent Accountants...........................................1
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements of Income.................2
Comparative Condensed Consolidated Statements of Cash Flows.............3
Comparative Condensed Consolidated Balance Sheets.......................4
Condensed Consolidated Statement of Changes in Stockholders' Equity.....5
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income.................6
Comparative Condensed Consolidated Statements of Cash Flows.............7
Comparative Condensed Consolidated Balance Sheets.......................8
Condensed Consolidated Statement of Changes in Stockholders' Equity.....9
Notes to Condensed Consolidated Financial Statements
Note 1. Basis of Accounting Presentation................................10
Note 2. Regulatory Accounting...........................................10
Note 3. Accounting for Derivative Instruments and Hedging Activities....10
Note 4. Millennium Energy Businesses....................................11
Note 5. Business Segments...............................................12
Note 6. Springerville Coal Handling Facilities Leases...................13
Note 7. Commitments and Contingencies...................................13
Note 8. Wholesale Accounts Receivable and Allowances....................14
Note 9. Income Taxes....................................................14
Note 10. UniSource Energy Earnings Per Share (EPS).......................15
Note 11. Change in Depreciable Asset Lives...............................15
Note 12. Significant Subsequent Events...................................16
Note 13. New Accounting Pronouncements...................................16
Note 14. Review by Independent Accountants...............................16
Item 2. - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview.................................................................17
Factors Affecting Results of Operations
Competition............................................................18
Industry Restructuring.................................................19
Western Energy Markets.................................................20
Market Risks...........................................................22
Future Generating Resources............................................24
Critical Accounting Policies.............................................25
Results of Operations....................................................27
Results of Millennium Energy Businesses..................................31
Results of UED...........................................................31
Dividends on Common Stock................................................31
TABLE OF CONTENTS
(concluded)
Liquidity and Capital Resources
Overall Liquidity......................................................32
Cash Flows
UniSource Energy.....................................................33
TEP..................................................................33
Investing and Financing Activities
UniSource Energy.....................................................34
TEP..................................................................34
Millennium...........................................................35
UED..................................................................36
Safe Harbor for Forward-Looking Statements...............................36
Item 3. - Quantitative and Qualitative Disclosures About Market Risk.......37
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings................................................38
Item 4. - Submission of Matters to a Vote of Security Holders..............38
Item 5. - Other Information
Additional Financial Data..............................................39
Item 6. - Exhibits and Reports on Form 8-K.................................39
Signature Page.............................................................40
Exhibit Index..............................................................41
DEFINITIONS
The abbreviations and acronyms used in the 2002 Second Quarter Form 10-Q
are defined below:
- --------------------------------------------------------------------------------
ACC.......................... Arizona Corporation Commission.
ACC Holding Company Order.... The order approved by the ACC in November 1997
allowing TEP to form a holding company.
AISA......................... Arizona Independent Scheduling Administrator,
a temporary organization required by the ACC
Retail Electric Competition Rules.
Capacity..................... The ability to produce power; the most power
a unit can produce or the maximum that can
be taken under a contract; measured in MWs.
CISO......................... California Independent System Operator.
Common Stock................. UniSource Energy's common stock, without par
value.
Company or UniSource Energy.. UniSource Energy Corporation.
Cooling Degree Days.......... An index used to measure the impact of weather
on energy usage calculated by subtracting 75
from the average of the high and low daily
temperatures.
CPX.......................... California Power Exchange.
Credit Agreement............. Credit Agreement between TEP and a syndicate
of banks, dated as of December 30, 1997.
Desert STAR.................. The ISO formed in the southwestern U.S., in
which TEP is a participant.
Emission Allowance(s)........ An EPA-issued allowance which permits
emission of one ton of sulfur dioxide.
These allowances can be bought or sold.
Energy....................... The amount of power produced over a given
period of time; measured in MWh.
EPA.......................... The Environmental Protection Agency.
ESP.......................... Energy Service Provider.
FAS 71....................... Statement of Financial Accounting Standards
No. 71: Accounting for the Effects of
Certain Types of Regulation.
FAS 133...................... Statement of Financial Accounting Standards
No. 133: Accounting for Derivative
Instruments and Hedging Activities.
FERC......................... Federal Energy Regulatory Commission.
GAAP......................... Generally Accepted Accounting Principles.
GES.......................... Global Energy Solutions, Inc., a subsidiary
owned 67% by Millennium, which owns 100% of
Global Solar and Infinite Power Solutions.
As a result of a letter agreement signed
April 3, 2002, GES will be dissolved.
Global Solar................. Global Solar Energy, Inc., a wholly-owned
subsidiary of GES, which develops and
manufactures thin-film photovoltaic cells.
As a result of a letter agreement signed
April 3, 2002, Global Solar will become an
81% owned subsidiary of Millennium.
IPS.......................... Infinite Power Solutions, Inc., a wholly-owned
subsidiary of GES, which develops thin-film
batteries. As result of a letter agreement
signed April 3, 2002, Global Solar will become
an 81% owned subsidiary of Millennium.
IRS.......................... Internal Revenue Service.
ISO.......................... Independent System Operator.
ITN.......................... ITN Energy Systems, Inc., a company owned 49%
by Millennium, which was formed to provide
research, development, and other services.
As a result of a letter agreement signed
April 3, 2002, the ownership percentage may
decrease to 19% in the future.
Irvington.................... Irvington Generating Station.
kWh.......................... Kilowatt-hour(s).
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which manages
and trades emission allowances, coal, and
related financial instruments.
MicroSat..................... MicroSat Systems, Inc., a company owned 49% by
Millennium, which was formed to develop and
commercialize small-scale satellites. As a
result of a letter agreement signed April 3,
2002, the ownership percentage may decrease
to 35% in the future.
Millennium................... Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
MW........................... Megawatt(s).
MWh.......................... Megawatt-hour(s).
DEFINITIONS
(concluded)
PG&E......................... Pacific Gas and Electric Company.
Revolving Credit Facility.... $100 million revolving credit facility entered
into under the Credit Agreement between a
syndicate of banks and TEP.
RTO.......................... Regional Transmission Organization.
Rules........................ Retail Electric Competition Rules.
SCE.......................... Southern California Edison Company.
Second Mortgage Bonds........ TEP's second mortgage bonds issued under the
Indenture of Mortgage and Deed of Trust, dated
as of December 1, 1992, of TEP to the Bank of
New York, successor trustee, as supplemented.
Settlement Agreement......... TEP's Settlement Agreement approved by the ACC
in November 1999 that provided for electric
retail competition and transition recovery
asset recovery.
Springerville................ Springerville Generating Station.
Springerville Coal Handling
Facilities Leases.......... Leveraged lease arrangements relating to the
coal handling facilities serving
Springerville.
Springerville Common
Facilities................. Facilities at Springerville used in common
with Springerville Unit 1 and Springerville
Unit 2.
Springerville Unit 1......... Unit 1 of the Springerville Generating Station.
Springerville Unit 2......... Unit 2 of the Springerville Generating Station.
SRP.......................... Salt River Project Agricultural Improvement
and Power District.
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
UED.......................... UniSource Energy Development Company, a wholly-
owned subsidiary of UniSource Energy, which
owns a 20 MW gas turbine under lease to TEP
and engages in developing generation
resources and other project development
services and related activities.
UniSource Energy............. UniSource Energy Corporation.
WestConnect.................. The proposed for-profit RTO formed by the
reorganization of Desert STAR, in which TEP
is a participant.
WECC......................... Western Electricity Coordinating Council, the
organization formed upon the merger of the
Western Systems Coordinating Council,
Southwest Regional Transmission Association
and Western Regional Transmission Association.
Report of Independent Accountants
To the Board of Directors and Stockholders of
UniSource Energy Corporation and to the
Board of Directors and Stockholder of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated
balance sheets of UniSource Energy Corporation and its
subsidiaries (the Company) and of Tucson Electric Power Company
and its subsidiaries (TEP) as of June 30, 2002, and the related
condensed consolidated statements of income for each of the
three-month and six-month periods ended June 30, 2002 and 2001
and the condensed consolidated statements of stockholders'
equity for the six-month period ended June 30, 2002, and the
condensed consolidated statements of cash flows for the six-
month periods ended June 30, 2002 and 2001. These financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards
established by the American Institute of Certified Public
Accountants. A review of interim financial information
consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in
scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material
modifications that should be made to the accompanying condensed
consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the
United States of America.
We previously audited in accordance with auditing standards
generally accepted in the United States of America, the
consolidated balance sheets and statements of capitalization of
the Company and of TEP as of December 31, 2001, and the related
consolidated statements of income, of changes in stockholders'
equity, and of cash flows for the year then ended (not
presented herein), and in our report dated February 1, 2002 we
expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth
in the accompanying condensed consolidated balance sheets as of
December 31, 2001, is fairly stated in all material respects in
relation to the consolidated balance sheet from which it has
been derived.
PricewaterhouseCoopers LLP
Los Angeles, California
August 2, 2002
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- ----------------------------------------------------------------------------
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $174,800 $171,667
Electric Wholesale Revenues 58,412 226,206
Net Unrealized Gain(Loss)on Trading Activities (258) 4,477
Other Revenues 3,421 4,265
- ---------------------------------------------------------------------------
Total Operating Revenues 236,375 406,615
- ---------------------------------------------------------------------------
Operating Expenses
Fuel 58,196 65,142
Purchased Power 31,266 179,609
Other Operations and Maintenance 45,346 52,022
Depreciation and Amortization 31,518 29,352
Amortization of Transition Recovery Asset 6,639 5,491
Taxes Other Than Income Taxes 11,439 11,963
- ---------------------------------------------------------------------------
Total Operating Expenses 184,404 343,579
- ---------------------------------------------------------------------------
Operating Income 51,971 63,036
- ---------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 4,926 3,812
Other Income (Deductions) 127 (2,676)
- ---------------------------------------------------------------------------
Total Other Income (Deductions) 5,053 1,136
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,291 15,904
Interest on Capital Leases 21,668 22,682
Other Interest Expense 2,227 1,660
- ---------------------------------------------------------------------------
Total Interest Expense 38,186 40,246
- ---------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect of
Accounting Change 18,838 23,926
Income Tax Expense 6,950 10,672
- ---------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 11,888 13,254
Cumulative Effect of Accounting Change - Net of Tax - -
- ---------------------------------------------------------------------------
Net Income $ 11,888 $ 13,254
===========================================================================
Average Shares of Common Stock Outstanding (000) 33,684 33,342
===========================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.35 $0.40
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.35 $0.40
===========================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.35 $0.39
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.35 $0.39
===========================================================================
Dividends Paid per Share $0.125 $0.10
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $306,632 $306,344
Electric Wholesale Revenues 103,030 369,893
Net Unrealized Gain(Loss)on Trading Activities 763 7,169
Other Revenues 6,217 6,874
- ---------------------------------------------------------------------------
Total Operating Revenues 416,642 690,280
- ---------------------------------------------------------------------------
Operating Expenses
Fuel 106,515 136,093
Purchased Power 41,808 225,981
Other Operations and Maintenance 94,222 104,625
Depreciation and Amortization 64,968 58,050
Amortization of Transition Recovery Asset 9,521 7,837
Taxes Other Than Income Taxes 22,951 23,836
- ---------------------------------------------------------------------------
Total Operating Expenses 339,985 556,422
- ---------------------------------------------------------------------------
Operating Income 76,657 133,858
- ---------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 9,682 7,727
Other Income (Deductions) 322 (3,860)
- ---------------------------------------------------------------------------
Total Other Income (Deductions) 10,004 3,867
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 28,424 31,676
Interest on Capital Leases 43,873 45,388
Other Interest Expense 4,336 3,124
- ---------------------------------------------------------------------------
Total Interest Expense 76,633 80,188
- ---------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect of
Accounting Change 10,028 57,537
Income Tax Expense 4,454 25,488
- ---------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 5,574 32,049
Cumulative Effect of Accounting Change - Net of Tax - 470
- ---------------------------------------------------------------------------
Net Income $ 5,574 $ 32,519
===========================================================================
Average Shares of Common Stock Outstanding (000) 33,651 33,304
===========================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.17 $0.97
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income $0.17 $0.98
===========================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.16 $0.94
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income $0.16 $0.95
===========================================================================
Dividends Paid per Share $0.25 $0.20
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $317,195 $321,752
Cash Receipts from Electric Wholesale Sales 137,930 355,693
Interest Received 3,535 7,819
Other Cash Receipts 36,297 9,378
Fuel Costs Paid (96,853) (143,176)
Purchased Power Costs Paid (78,388) (181,888)
Wages Paid, Net of Amounts Capitalized (41,289) (36,876)
Payment of Other Operations and Maintenance Costs (65,344) (71,987)
Capital Lease Interest Paid (66,013) (42,474)
Taxes Paid, Net of Amounts Capitalized (51,184) (51,233)
Interest Paid, Net of Amounts Capitalized (30,437) (33,145)
Income Taxes Paid (10,569) (15,175)
Other Cash Payments (24,149) -
Other (7,486) (4,233)
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities 23,245 114,455
- ---------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (52,681) (70,310)
Investments in and Loans to Equity Investees (7,423) (14,333)
Proceeds from the Sale of Real Estate - 6,580
Purchase of Springerville Lease Debt and Equity (104,368) -
Other 4,966 (2,351)
- ---------------------------------------------------------------------------
Net Cash Flows - Investing Activities (159,506) (80,414)
- ---------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (18,230) (14,542)
Common Stock Dividends Paid (8,400) (6,669)
Other 2,007 4,603
- ---------------------------------------------------------------------------
Net Cash Flows - Financing Activities (25,848) (17,833)
- ---------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (162,109) 16,208
Cash and Cash Equivalents, Beginning of Year 228,154 163,004
- ---------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 66,045 $179,212
===========================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- ---------------------------------------------------------------------------
Net Income $ 5,574 $ 32,519
Adjustments to Reconcile Net Income to Net Cash Flows
Depreciation and Amortization Expense 64,968 58,050
Amortization of Transition Recovery Asset 9,521 7,837
Net Unrealized Gain on Trading Activities (763) (7,639)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 967 1,007
Deferred Income Taxes (2,364) 9,660
Losses of Unconsolidated Affiliates 1,393 5,158
Other (7,701) (345)
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 11,976 (19,151)
Materials and Fuel (755) 802
Accounts Payable (20,933) 31,422
Interest Accrued (22,165) 2,566
Taxes Accrued (3,466) (1,137)
Other Current Assets (12,891) (5,563)
Other Current Liabilities 1,508 (5,348)
Other Deferred Assets (5,410) (1,153)
Other Deferred Liabilities 3,786 5,770
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 23,245 $114,455
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,536,413 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 67,621 70,992
- ---------------------------------------------------------------------------
Total Utility Plant 3,351,129 3,310,484
Less Accumulated Depreciation and Amortization (1,310,869) (1,270,089)
Less Accumulated Depreciation of Capital Lease
Assets (377,316) (362,724)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,662,944 1,677,671
- ---------------------------------------------------------------------------
Investments and Other Property 273,420 182,747
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 66,045 228,154
Accounts Receivable - Net 107,670 119,646
Materials and Fuel 47,815 45,052
Deferred Income Taxes - Current 5,668 11,165
Current Regulatory Assets 12,672 -
Other 44,013 30,891
- ---------------------------------------------------------------------------
Total Current Assets 283,883 434,908
- ---------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 322,152 331,674
Income Taxes Recoverable Through Future Revenues 60,417 64,239
Other Regulatory Assets 9,932 9,072
Other Assets 40,014 35,014
- --------------------------------------------------------------- -----------
Total Regulatory and Other Assets 432,515 439,999
- ---------------------------------------------------------------------------
Total Assets $2,652,762 $2,735,325
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 422,825 $ 424,722
Capital Lease Obligations 805,389 853,793
Long-Term Debt 801,094 802,804
- ---------------------------------------------------------------------------
Total Capitalization 2,029,308 2,081,319
- ---------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 40,111 20,158
Current Maturities of Long-Term Debt 330,352 330,424
Accounts Payable 63,025 84,011
Interest Accrued 20,736 53,300
Taxes Accrued 34,435 25,904
Accrued Employee Expenses 11,462 13,577
Other 35,262 16,105
- ---------------------------------------------------------------------------
Total Current Liabilities 535,383 543,479
- ---------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 31,824 43,507
Other 56,247 67,020
- ---------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 88,071 110,527
- ---------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- ---------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,652,762 $2,735,325
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Common Accumulated Other Total
Shares Common Earnings Comprehensive Stockholders'
Outstanding* Stock (Deficit) Income Equity
- -------------------------------------------------------------------------------
(Unaudited)
- In Thousands -
Balances at
December 31, 2001 33,502 $660,123 $(235,401) $ - $424,722
- -------------------------------------------------------------------------------
Comprehensive Income:
2002 Year-to-Date Net
Income - - 5,574 - 5,574
---------
Total Comprehensive
Income 5,574
-----------
Shares Issued under
Stock Compensation
Plans 7 66 - - 66
Shares Distributed by
Deferred Compensation
Trust 2 35 - - 35
Shares Issued for
Stock Options 57 828 - - 828
Dividend Declared - - (8,400) - (8,400)
- -------------------------------------------------------------------------------
Balances at
June 30, 2002 33,568 $661,052 $(238,227) $ - $422,825
===============================================================================
*UniSource Energy has 75 million authorized shares of common stock.
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $174,800 $171,667
Electric Wholesale Revenues 58,412 226,206
Net Unrealized Gain (Loss) on Forward Electric Sales
and Purchases (95) 4,477
Other Revenues 2,417 1,677
- ---------------------------------------------------------------------------
Total Operating Revenues 235,534 404,027
- ---------------------------------------------------------------------------
Operating Expenses
Fuel 58,196 65,142
Purchased Power 31,266 179,609
Other Operations and Maintenance 39,625 46,749
Depreciation and Amortization 30,489 28,465
Amortization of Transition Recovery Asset 6,639 5,491
Taxes Other Than Income Taxes 11,156 11,696
- ---------------------------------------------------------------------------
Total Operating Expenses 177,371 337,152
- ---------------------------------------------------------------------------
Operating Income 58,163 66,875
- ---------------------------------------------------------------------------
Other Income
Interest Income 4,746 3,076
Interest Income - Note Receivable from UniSource
Energy 2,325 2,327
Other Income 763 1,598
- ---------------------------------------------------------------------------
Total Other Income 7,834 7,001
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,291 15,904
Interest on Capital Leases 21,650 22,668
Other Interest Expense 1,992 1,661
- ---------------------------------------------------------------------------
Total Interest Expense 37,933 40,233
- ---------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect
of Accounting Change 28,064 33,643
Income Tax Expense 10,597 14,739
- ---------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 17,467 18,904
Cumulative Effect of Accounting Change - Net of Tax - -
- ---------------------------------------------------------------------------
Net Income $ 17,467 $ 18,904
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $306,632 $306,344
Electric Wholesale Revenues 103,030 369,893
Net Unrealized Gain (Loss) on Forward Electric Sales
and Purchases 722 7,169
Other Revenues 3,799 2,421
- ---------------------------------------------------------------------------
Total Operating Revenues 414,183 685,827
- ---------------------------------------------------------------------------
Operating Expenses
Fuel 106,515 136,093
Purchased Power 41,808 225,981
Other Operations and Maintenance 83,893 94,002
Depreciation and Amortization 62,845 56,945
Amortization of Transition Recovery Asset 9,521 7,837
Taxes Other Than Income Taxes 22,268 23,219
- ---------------------------------------------------------------------------
Total Operating Expenses 326,850 544,077
- ---------------------------------------------------------------------------
Operating Income 87,333 141,750
- ---------------------------------------------------------------------------
Other Income
Interest Income 9,229 5,849
Interest Income - Note Receivable from UniSource
Energy 4,626 4,627
Other Income 1,514 1,915
- ---------------------------------------------------------------------------
Total Other Income 15,369 12,391
- ---------------------------------------------------------------------------
Interest Expense
Long-Term Debt 28,424 31,676
Interest on Capital Leases 43,841 45,360
Other Interest Expense 3,925 3,124
- ---------------------------------------------------------------------------
Total Interest Expense 76,190 80,160
- ---------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect
of Accounting Change 26,512 73,981
Income Tax Expense 10,975 32,036
- ---------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 15,537 41,945
Cumulative Effect of Accounting Change - Net of Tax - 470
- ---------------------------------------------------------------------------
Net Income $ 15,537 $ 42,415
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $317,195 $321,752
Cash Receipts from Electric Wholesale Sales 137,930 355,693
Interest Received 3,091 5,849
Fuel Costs Paid (96,853) (143,176)
Purchased Power Costs Paid (78,388) (181,888)
Wages Paid, Net of Amounts Capitalized (32,719) (32,853)
Payment of Other Operations and Maintenance Costs (55,219) (56,458)
Capital Lease Interest Paid (65,974) (42,450)
Taxes Paid, Net of Amounts Capitalized (48,795) (49,741)
Interest Paid, Net of Amounts Capitalized (30,423) (33,145)
Income Taxes Paid (10,459) (15,175)
Other 72 90
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities 39,458 128,498
- ---------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (47,419) (55,779)
Proceeds from the Sale of Real Estate - 6,580
Purchase of Springerville Lease Debt and Equity (104,368) -
Other 2,159 (3,407)
- ---------------------------------------------------------------------------
Net Cash Flows - Investing Activities (149,628) (52,606)
- ---------------------------------------------------------------------------
Cash Flows from Financing Activities
Payments to Retire Long-Term Debt (1,225) (1,225)
Payments to Retire Capital Lease Obligations (18,066) (14,482)
Other 1,442 2,049
- ---------------------------------------------------------------------------
Net Cash Flows - Financing Activities (17,849) (13,658)
- ---------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (128,019) 62,234
Cash and Cash Equivalents, Beginning of Year 159,680 88,712
- ---------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 31,661 $150,946
==========================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- ---------------------------------------------------------------------------
Net Income $ 15,537 $ 42,415
Adjustments to Reconcile Net Income to Net
Cash Flows
Depreciation and Amortization Expense 62,845 56,945
Amortization of Transition Recovery Asset 9,521 7,837
Net Unrealized Gain on Forward Electric Sales and
Purchases (722) (7,639)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 967 1,007
Deferred Income Taxes 4,294 16,354
Losses of Unconsolidated Affiliates 182 517
Interest on Note Receivable from UniSource Energy (4,626) (4,627)
Other 598 3,751
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 17,823 (20,094)
Materials and Fuel 1,817 1,431
Accounts Payable (31,614) 30,201
Interest Accrued (22,165) 2,566
Taxes Accrued (3,589) (1,362)
Other Current Assets (8,376) (268)
Other Current Liabilities (1,803) (3,558)
Other Deferred Assets (5,411) (2,678)
Other Deferred Liabilities 4,180 5,700
- ---------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 39,458 $128,498
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
(Unaudited)
- ---------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,536,413 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 67,621 70,992
- ---------------------------------------------------------------------------
Total Utility Plant 3,351,129 3,310,484
Less Accumulated Depreciation and Amortization (1,310,869) (1,270,089)
Less Accumulated Depreciation of Capital Lease
Assets (377,316) (362,724)
- ---------------------------------------------------------------------------
Total Utility Plant - Net 1,662,944 1,677,671
- ---------------------------------------------------------------------------
Investments and Other Property 184,242 105,875
- ---------------------------------------------------------------------------
Note Receivable from UniSource Energy 74,759 70,132
- ---------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 31,661 159,680
Accounts Receivable - Net 104,505 124,487
Materials and Fuel 43,873 43,682
Deferred Income Taxes - Current - 4,603
Current Regulatory Assets 12,672 -
Other 16,380 7,814
- ---------------------------------------------------------------------------
Total Current Assets 209,091 340,266
- ---------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 322,152 331,674
Income Taxes Recoverable Through Future Revenues 60,417 64,239
Other Regulatory Assets 9,932 9,072
Other Assets 40,014 35,014
- --------------------------------------------------------------- -----------
Total Regulatory and Other Assets 432,515 439,999
- ---------------------------------------------------------------------------
Total Assets $2,563,551 $2,633,943
===========================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 338,265 $ 322,471
Capital Lease Obligations 804,855 853,447
Long-Term Debt 800,699 801,924
- ---------------------------------------------------------------------------
Total Capitalization 1,943,819 1,977,842
- ---------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 39,798 19,971
Current Maturities of Long-Term Debt 330,325 330,325
Accounts Payable 57,579 89,193
Interest Accrued 20,736 53,300
Taxes Accrued 31,423 23,015
Accrued Employee Expenses 11,171 13,078
Deferred Income Taxes - Current 895 -
Other 22,522 6,531
- ---------------------------------------------------------------------------
Total Current Liabilities 514,449 535,413
- ---------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 51,880 56,906
Other 53,403 63,782
- ---------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 105,283 120,688
- ---------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- ---------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,563,551 $2,633,943
===========================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Capital Accumulated Other Total
Common Stock Earnings Comprehensive Stockholders'
Stock Expense (Deficit) Income Equity
- ----------------------------------------------------------------------------
(Unaudited)
- Thousands of Dollars -
Balances at
December 31, 2001 $ 653,250 $ (6,357) $(324,422) $ - $ 322,471
- ----------------------------------------------------------------------------
Comprehensive Income:
2002 Year-to-Date
Net Income - - 15,537 - 15,537
---------
Total Comprehensive Income 15,537
---------
Other 257 - - - 257
- ----------------------------------------------------------------------------
Balances at
June 30, 2002 $ 653,507 $ (6,357) $(308,885) $ - $ 338,265
============================================================================
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
NOTE 1. BASIS OF ACCOUNTING PRESENTATION
- -----------------------------------------
The accompanying quarterly financial statements for UniSource Energy
Corporation (UniSource Energy) and Tucson Electric Power (TEP) are unaudited but
reflect all normal recurring accruals and other adjustments which we believe are
necessary for a fair presentation of the results for the interim periods
presented. These financial statements are presented in accordance with the
SEC's interim reporting requirements which do not include all the disclosures
required by accounting principles generally accepted in the United States of
America (GAAP). The year-end condensed balance sheet data was derived from
audited financial statements, but does not include disclosures required by GAAP.
This quarterly report should be reviewed in conjunction with UniSource Energy
and TEP's 2001 Form 10-K.
Weather causes seasonal fluctuations in TEP's sales; therefore, quarterly
results are not indicative of annual operating results. We have made
reclassifications to the prior year financial statements for comparative
purposes. These reclassifications had no effect on net income.
NOTE 2. REGULATORY ACCOUNTING
- ------------------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. However, sometimes
these principles, such as Statement of Financial Accounting Standards No. 71
(FAS 71), Accounting for the Effects of Certain Types of Regulation, require
special accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the Arizona Corporation
Commission (ACC) may not allow TEP to currently charge its customers to recover
certain expenses, but instead requires that these expenses be charged to
customers in the future. In this situation, FAS 71 requires that TEP defer
these items and show them as regulatory assets on the balance sheet until TEP is
allowed to charge its customers. TEP then amortizes these items as expense to
the income statement as those charges are recovered from customers. Similarly,
certain revenue items may be deferred as regulatory liabilities, which are also
eventually amortized to the income statement as rates to customers are reduced.
The conditions a regulated company must satisfy to apply the accounting
policies and practices of FAS 71 include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates below
the rates set by the regulator.
In November 1999, upon approval by the ACC of a Settlement Agreement
relating to recovery of TEP's transition costs and standard retail rates, we
discontinued application of FAS 71 to our generation operations.
We continue to apply FAS 71 to the distribution and transmission portions
of TEP's business, our regulated operations. We periodically assess whether we
can continue to apply FAS 71 to these operations. If we stopped applying FAS 71
to TEP's remaining regulated operations, we would write off the related balances
of TEP's regulatory assets as an expense on our income statement. Based on the
balances of TEP's regulatory assets at June 30, 2002, if we had stopped applying
FAS 71 to TEP's remaining regulated operations, we would have recorded an
extraordinary loss, after-tax, of approximately $245 million. While regulatory
orders and market conditions may affect our cash flows, our cash flows would not
be affected if we stopped applying FAS 71.
NOTE 3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- ---------------------------------------------------------------------
On January 1, 2001, we recorded a $0.5 million after-tax gain in our income
statement for the cumulative effect of adopting Statement of Financial
Accounting Standards No. 133 (FAS 133), Accounting for Derivative Instruments
and Hedging Activities.
TEP enters into forward contracts to purchase or sell a specified amount of
capacity or energy at a specified price over a given period of time, typically
for one month, three months or one year, within established limits to take
advantage of favorable market opportunities. Millennium Environmental Group,
Inc. (MEG), a wholly-owned subsidiary of Millennium Energy Holdings, Inc.
(Millennium), enters into swap agreements, options and forward contracts
relating to emission allowances and coal. These activities are considered
trading activities.
Under FAS 133, we record unrealized gains and losses on our trading
activities and adjust the related assets and liabilities on a monthly basis to
reflect the market prices at the end of the month. The market prices used to
determine fair value for these derivative instruments are estimated based on
various factors including broker quotes, exchange prices, over the counter
prices and time value. We report the unrealized gain/loss on trading activities
as a component of Operating Revenues. The net pre-tax unrealized loss for the
quarter ended June 30, 2002 was approximately $0.3 million. For the six months
ended June 30, 2002, the net pre-tax unrealized gain was approximately $0.8
million. At June 30, 2002, the fair value of our trading assets totaled $11.4
million, which is reported in Other Current Assets, and the fair value of our
trading liabilities totaled $11.4 million, which is reported in Other Current
Liabilities.
We treated certain of TEP's forward sale and purchase contracts as cash
flow hedges when we adopted FAS 133. However, during 2001, new guidance was
issued by the Financial Accounting Standards Board which provided that certain
forward power purchase or sale agreements, including capacity contracts, could
be excluded from the requirements of FAS 133. We implemented this new guidance
in 2001 and determined that the items designated as cash flow hedges upon
adoption could be excluded from the FAS 133 requirements. Therefore, as these
contracts settled in 2001, we reversed the unrealized gain/loss included in
Other Comprehensive Income and recorded the realized gain/loss in the income
statement. Additional guidance was issued in late 2001 that had no impact on
our accounting for derivatives. As of June 30, 2002 and December 31, 2001, we
had no cash flow hedges and, therefore, our balance in Accumulated Other
Comprehensive Income was zero.
In June 2002, new guidance was issued that requires all realized and
unrealized gains and losses on energy-related trading contracts to be shown net
in the income statement whether or not physically settled. The new guidance is
effective July 1, 2002 and requires financial statements for all comparative
periods to be reclassified to conform to the new presentation. Currently, we
report our trading activity as follows:
- TEP and MEG's net unrealized gain/loss on trading activities is a
component of Operating Revenues;
- TEP's realized gain/loss on forward sales contracts is a component of
Electric Wholesale Revenues;
- TEP's realized gain/loss on forward purchase contracts is a component of
Purchased Power; and
- MEG's net realized gain/loss on trading activities is a component of
Other Revenues.
Beginning July 1, 2002, we will report the net realized and unrealized
gain/loss on TEP and MEG's trading activities as a component of Operating
Revenues to conform to the new presentation.
NOTE 4. MILLENNIUM ENERGY BUSINESSES
- -------------------------------------
ENERGY TECHNOLOGY INVESTMENTS
We refer to Global Solar Energy, Inc. (Global Solar), Infinite Power
Solutions, Inc. (IPS), MicroSat Systems, Inc. (MicroSat) and ITN Energy Systems,
Inc. collectively as our Energy Technology Investments. During the first
quarter of 2002, Millennium reallocated a $10 million line of credit commitment
from MicroSat to Global Solar and IPS. During the second quarter of 2002
Millennium committed an additional $10 million in funding to Global Solar.
Millennium's advances to the Energy Technology Investments totaled $12.7 million
during the first half of 2002.
On April 3, 2002, Millennium signed a letter agreement that facilitates the
change in the ownership structure of the Energy Technology Investments to better
align our ownership interest in these investments with Millennium's business
plans. Millennium retains its preferred shareholder and distribution status.
Under the letter agreement Millennium:
- increases its ownership of Global Solar from 67% to 81%;
- increases its ownership of IPS from 67% to 70%;
- decreases its ownership of MicroSat from 49% to 35%;
- decreases its ownership of ITN from 49% to 19%; and
- will provide additional contingent capital contributions of up to $2.7
million, primarily to fund research and development activities at ITN.
Regardless of ownership percentage, as sole funder of the Energy Technology
Investments, Millennium continues to recognize 100% of the losses from
operations of these companies. Millennium expects to fund between $10 million
and $13 million of its commitments to its Energy Technology Investments in the
second half of 2002. A significant portion of the funding under these
agreements will be used for research and development purposes and administrative
costs. As funds are expended for these purposes we will recognize expense.
Additional investment commitments may be made to these technology investments
depending on their funding requirements and business outlook. In addition,
Millennium is seeking external investors for the Energy Technology Investment
companies.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment to a limited partnership
which funds energy related investments. As of June 30, 2002, Millennium had
funded $6 million of this commitment. The remaining $9 million is expected
to be funded within the next three years. A member of the UniSource Energy
Board of Directors has an investment in the limited partnership and is a
managing director of the general partner of the limited partnership.
Millennium has a $5 million capital commitment to a venture capital fund
that will focus on information technology, optics and biotechnology, primarily
within the retail service territory of TEP. A second member of the UniSource
Energy Board of Directors owns the company that manages the fund. At June 30,
2002, Millennium had funded approximately $1 million of this commitment.
Millennium expects to fund no more than $1 million in the second half of 2002.
Millennium owns a controlling 50.5% interest in Powertrusion International,
Inc., a manufacturer of lightweight utility poles. During the second quarter of
2002, Millennium committed to provide an additional $2 million of funding to
maintain its controlling interest. On July 1, 2002 Millennium contributed $1
million. The remaining $1 million will be remitted by August 15, 2002.
On April 1, 2002, Millennium invested $2 million in a start-up company
established to market energy related products, bringing Millennium's total
investment to $3.1 million. Millennium's net remaining investment, after the
results of operations, was $1.9 million at June 30, 2002.
NOTE 5. BUSINESS SEGMENTS
- --------------------------
Based on the way we organize our operations and evaluate performance, we
have three reportable business segments:
(1) TEP, an electric utility business, is UniSource Energy's principal
business segment.
(2) Millennium holds interests in unregulated energy businesses (see
Note 4).
(3) UniSource Energy Development Company (UED), established in 2001,
engages in developing generating resources and other project
development activities. UED owns a 20 MW gas turbine under lease
to TEP. It is also responsible for developing the possible expansion
project at the Springerville Generating Station.
Significant reconciling adjustments consist of the elimination of
intercompany activity and balances, including:
- the elimination of intercompany sales between business segments;
- the elimination of an intercompany note between UniSource Energy and TEP,
as well as the related interest income and expense; and
- the elimination of UED's rental income and TEP's rental expense from
UED's turbine lease to TEP.
We disclose selected financial data for our business segments in the
following tables:
Segments UniSource
------------------------ Reconciling Energy
TEP Millennium UED Adjustments Consolidated
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Income Statement
- ----------------
Three months ended
June 30, 2002:
Operating Revenues -
External $ 235,389 $ 986 $ - $ - $ 236,375
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 145 4,418 840 (5,403) -
- -------------------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 28,064 (7,294) 393 (2,325) 18,838
- -------------------------------------------------------------------------------
Net Income (Loss) 17,467 (4,411) 238 (1,406) 11,888
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Three months ended
June 30, 2001:
Operating Revenues -
External $ 403,905 $ 2,710 $ - $ - $ 406,615
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 122 1,838 280 (2,240) -
- -------------------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 33,643 (7,670) 277 (2,324) 23,926
- -------------------------------------------------------------------------------
Net Income (Loss) 18,904 (4,420) 167 (1,397) 13,254
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Six months ended
June 30, 2002:
Operating Revenues -
External $ 413,853 $ 2,789 $ - $ - $ 416,642
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 330 6,957 1,680 (8,967) -
- -------------------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes 26,512 (12,756) 898 (4,626) 10,028
- -------------------------------------------------------------------------------
Net Income (Loss) 15,537 (7,711) 543 (2,795) 5,574
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Six months ended
June 30, 2001:
Operating Revenues -
External $ 685,600 $ 4,680 $ - $ - $ 690,280
- -------------------------------------------------------------------------------
Operating Revenues -
Intersegment 227 3,813 280 (4,320) -
- -------------------------------------------------------------------------------
Net Income (Loss)
Before Income Taxes
and Cumulative Effect
of Accounting Change 73,981 (12,097) 277 (4,624) 57,537
- -------------------------------------------------------------------------------
Cumulative Effect of
Accounting Change 470 - - - 470
- -------------------------------------------------------------------------------
Net Income (Loss) 42,415 (7,283) 167 (2,780) 32,519
- -------------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
June 30, 2002 $2,563,551 $137,466 $ 30,508 $ (78,763) $2,652,762
Total Assets,
December 31, 2001 2,633,943 176,097 26,895 (101,610) 2,735,325
- -------------------------------------------------------------------------------
NOTE 6. SPRINGERVILLE COAL HANDLING FACILITIES LEASES
- ------------------------------------------------------
In December 2001, TEP purchased a 13% ownership interest in the
Springerville Coal Handling Facilities Leases for $13 million. In January 2002,
TEP purchased all $96 million of the capital lease debt related to these leases.
In a related transaction, in March 2002, TEP canceled that portion of the leases
related to its equity interest, as it held both the ownership interest and the
debt. This transaction resulted in a $21 million reduction to the capital lease
obligation. The residual value in the leased asset is carried at cost.
NOTE 7. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
MILLENNIUM COMMITMENTS
See Note 4 for a description of Millennium's commitments.
UED COMMITMENTS
UED and Salt River Project Agricultural Improvement and Power District
(SRP) entered into a Joint Development Agreement in October 2001 to develop two
400 MW coal-fired units at TEP's existing Springerville Station. As a result
of recent developments, UED and SRP are discussing a modification of the Joint
Development Agreement to provide for the purchase by SRP of a specified amount
of power from Unit 3 and an option for SRP to own Unit 4. UED and SRP each
committed project development funding for professional services and other third
party costs. At June 30, 2002, capitalized project development costs on our
balance sheet were approximately $13.1 million. If the project does not
proceed, the capitalized project development costs will be immediately expensed.
TEP CONTINGENCIES
Springerville Generating Station Complaint
On November 13, 2001, the Grand Canyon Trust, an environmental activist
group, filed a complaint in U.S. District Court against TEP for alleged
violations of the Clean Air Act at the Springerville Generating Station. The
complaint alleges that more stringent emission standards should apply to Units 1
and 2 and that new permits and the installation of additional facilities meeting
Best Available Control Technology standards are required for the continued
operation of Units 1 and 2 in accordance with applicable law. TEP believes the
claims are without merit and will vigorously contest these claims.
NOTE 8. WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- -----------------------------------------------------
At June 30, 2002 and December 31, 2001, TEP's Accounts Receivable on the
balance sheet is net of an $8.4 million allowance for uncollectible receivables
related to 2000 and 2001 sales to the California Power Exchange (CPX), the
California Independent System Operator (CISO) and Enron Corp. and certain of its
affiliates (Enron). The receivable from the CPX and the CISO is $16 million and
the receivable from Enron is $0.8 million. This allowance reflects a 50% reserve
on amounts unpaid from the CPX, the CISO and Enron, as we believe it is probable
that we will collect at least 50% of this aggregate outstanding net receivable
due to the recent (a) stabilization of the power markets, (b) rate increases
achieved by Pacific Gas and Electric Company (PG&E) and Southern California
Edison Company (SCE), (c) settlements made by California utilities with various
power providers, and (d) data in filings of FERC refund hearings. SCE publicly
disclosed that on March 1, 2002, it obtained financing and made payments so that
it has no material undisputed obligations that are past due or in default.
These payments included a payment to the CPX; however, TEP did not receive a
corresponding payment from the CPX.
There are several other outstanding legal issues, complaints and lawsuits
concerning the California energy crisis related to the FERC, wholesale power
suppliers, SCE, PG&E, the CPX and the CISO, and concerning Enron. We cannot
predict the outcome of these issues or lawsuits. We believe, however, that we
are adequately reserved for our transactions with the CPX, the CISO and Enron.
Accounts Receivable from Electric Wholesale Revenues, net of allowances, totaled
$35 million at June 30, 2002 and $70 million at December 31, 2001. These
amounts are included in Accounts Receivable on the balance sheet. Excluding the
receivables from the CPX, the CISO and Enron, as described above, substantially
all of the June 30, 2002 receivable balance has been collected as of the date of
this filing.
NOTE 9. INCOME TAXES
- ---------------------
UniSource Energy and TEP reduced income tax expense in the second quarter
of 2002 by $1.7 million of tax credits. UniSource Energy and TEP's Cumulative
Effect of Accounting Change for the six months ended June 30, 2001 is net of
income tax expense of $312,000 (see Note 3). The differences between the Income
Tax Expense lines on our income statements and the amounts obtained by
multiplying pre-tax income by the U.S. statutory federal income tax rate of 35%
are as follows:
UniSource Energy
--------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 6,593 $ 8,374 $ 3,510 $ 20,412
State Income Tax Expense,
Net of Federal
Deduction 866 1,172 461 2,858
Depreciation Differences
(Flow Through Basis) 1,154 1,356 2,309 2,606
Tax Credits (1,713) - (1,919) -
Other 50 (230) 93 (76)
Tax on Cumulative Effect
Of Accounting Change - - - (312)
- ----------------------------------------------------------------------
Total Expense for Federal
and State Income Taxes $ 6,950 $ 10,672 $ 4,454 $ 25,488
======================================================================
TEP
--------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense
at Statutory Rate $ 9,822 $ 11,775 $ 9,279 $ 26,167
State Income Tax Expense,
Net of Federal
Deduction 1,291 1,648 1,219 3,663
Depreciation Differences
(Flow Through Basis) 1,154 1,356 2,309 2,606
Tax Credits (1,713) - (1,919) -
Other 43 (40) 87 (88)
Tax on Cumulative Effect
Of Accounting Change - - - (312)
- ----------------------------------------------------------------------
Total Expense for Federal
and State Income Taxes $10,597 $ 14,739 $ 10,975 $ 32,036
======================================================================
NOTE 10. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
- ---------------------------------------------------
Basic EPS is computed by dividing net income by the weighted average number
of common shares outstanding during the period. Diluted EPS assumes that
proceeds from the hypothetical exercise of stock options and other stock-based
awards are used to repurchase outstanding shares of stock at the average fair
market price during the reporting period. The numerator in calculating both
basic and diluted earnings per share for each period is net income. The
following table shows the effects of potential dilutive common stock on the
weighted average number of shares.
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ----------------------------------------------------------------------------
- In Thousands -
Denominator:
Average Shares of Common
Stock Outstanding 33,684 33,342 33,651 33,304
Effect of Dilutive Securities:
Warrants 163 288 140 209
Options and Stock Issuable
Under Employee Benefit
Plans 588 738 572 693
- ----------------------------------------------------------------------------
Total Shares 34,435 34,368 34,363 34,206
============================================================================
At June 30, 2002, UniSource Energy had no outstanding warrants; however,
there were 4.6 million warrants outstanding that were exercisable into TEP
common stock at a ratio of five warrants to one common share. The dilutive
effect is the same as it would be if the warrants were exercisable into
UniSource Energy Common Stock and is reflected in the calculation for all
periods presented.
NOTE 11. CHANGE IN DEPRECIABLE ASSET LIVES
- -------------------------------------------
In the second quarter of 2002, TEP increased its estimates of useful lives
from 40 years to 60 years for its Irvington Generating Station gas-fired
generating units and from 25 years to 40 years for its internal combustion
turbines. These changes in estimates decreased depreciation expense by
approximately $1 million for the quarter. TEP is currently evaluating the
depreciable lives of its other generating stations.
NOTE 12. SIGNIFICANT SUBSEQUENT EVENTS
- ---------------------------------------
On July 15, 2002, Millennium invested $20 million in a company created to
develop up to 800 megawatts of coal-fired generation in the Sabinas region of
Coahuila, Mexico. Millennium received a 50% share of Carboelectrica Sabinas, S.
de R.L. de C.V., a Mexican limited liability company (Sabinas). The other 50%
of Sabinas is owned by Altos Hornos de Mexico, S.A. de C.V. (AHMSA) and certain
of its affiliates. Sabinas also owns approximately 19% of Minerales de Monclova,
S.A. de C.V., an owner of coal reserves and a supplier of metallurgical coal to
the steel industry and thermal coal to CFE, the Mexican electricity commission.
Under certain circumstances, Millennium has the right to put its interest in
Sabinas to an AHMSA affiliate for $20 million plus an accrued service fee.
These circumstances include failure of Sabinas to reach financial closing on the
generation project within three years. Millennium's put option is secured by
collateral with a value currently in excess of $20 million. UniSource Energy's
Chairman and Chief Executive Officer is a member of the board of directors of
AHMSA.
TEP's fuel expense in the second quarter of 2002 includes a pre-tax expense
of $2.3 million related to a July 2002 arbitration ruling that increases the
price of coal purchased from 1997 to 2001 for the Navajo Generating Facility.
TEP owns 7.5% of the Navajo facility. The increased coal prices established by
the arbitration ruling will increase fuel expense by approximately $0.4 million
per year in the future.
On July 23, 2002, TEP notified the coal supplier for the Irvington
Generating Station of its intent to terminate the Irvington coal supply
agreement. To terminate the agreement, TEP will make a payment of $11.25
million on or before September 15, 2002. As a result, TEP recorded $11.25
million of additional expense in July 2002. The additional expense will be
mitigated by TEP not being required to make a take-or-pay penalty payment of
approximately $3.5 million for the year 2002. On a net present value basis, TEP
expects the fuel savings to significantly exceed the termination payment.
NOTE 13. NEW ACCOUNTING PRONOUNCEMENTS
- ---------------------------------------
Statement of Financial Accounting Standards No. 143 (FAS 143), Accounting
for Asset Retirement Obligations, requires entities to record the fair value of
a liability when an asset removal obligation is incurred. We are required to
comply with FAS 143 beginning January 1, 2003. We are currently in the process
of evaluating the impact of FAS 143 on our financial statements.
Statement of Financial Accounting Standards No. 146 (FAS 146), Accounting
for Costs Associated with Exit or Disposal Activities, issued in July 2002,
requires entities to record a liability for costs related to exit or disposal
activities when the costs are incurred. Previous accounting guidance required
the liability to be recorded at the date of commitment to an exit or disposal
plan. We are required to comply with FAS 146 beginning January 1, 2003. We do
not expect the adoption of FAS 146 to have a significant effect on our financial
statements.
NOTE 14. REVIEW BY INDEPENDENT ACCOUNTANTS
- -------------------------------------------
With respect to the unaudited condensed consolidated financial information
of UniSource Energy and TEP for the three-month and six-month periods ended June
30, 2002 and 2001, PricewaterhouseCoopers LLP reported that they have applied
limited procedures in accordance with professional standards for a review of
such information. However, their separate report dated August 2, 2002 appearing
herein states that they did not audit and they do not express an opinion on that
unaudited condensed consolidated financial information. Accordingly, the degree
of reliance on their report on such information should be restricted in light of
the limited nature of the review procedures applied. PricewaterhouseCoopers LLP
is not subject to the liability provisions of Section 11 of the Securities Act
of 1933 (the "Act") for their report on the unaudited condensed consolidated
financial information because that report is not a "report" or a "part" of a
registration statement prepared or certified by PricewaterhouseCoopers LLP
within the meaning of Sections 7 and 11 of the Act.
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
UniSource Energy Corporation (UniSource Energy) is a holding company
that owns the outstanding common stock of Tucson Electric Power Company
(TEP), Millennium Energy Holdings, Inc. (Millennium), and UniSource Energy
Development Company (UED). TEP, an electric utility, has provided electric
service to the community of Tucson, Arizona, for over 100 years. TEP is
the principal operating subsidiary of UniSource Energy and represents most
of its assets. Millennium invests in unregulated ventures related
primarily to the energy business, including a developer of thin-film
batteries, a developer of small-scale commercial satellites, and a
developer and manufacturer of thin-film photovoltaic cells. UED engages in
developing generating resources and other project development activities,
including facilitating the expansion of the Springerville Generating
Station. We conduct our business in these three primary business
segments-TEP's Electric Utility Segment, the Millennium Energy Businesses
Segment, and the UniSource Energy Development Segment.
Management's Discussion and Analysis explains the general financial
condition and the results of operations for UniSource Energy and its three
primary business segments and includes the following:
- operating results during the second quarter and first six months of
2002 compared with the same periods in 2001,
- changes in liquidity and capital resources during the second quarter
and first six months of 2002, and
- expectations of identifiable material trends which may affect our
business in the future.
The financial condition and results of operations of TEP are currently
the principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis. However, the seasonal
nature of TEP's business causes operating results to vary significantly
from quarter to quarter. At June 30, 2002, Millennium's unregulated energy-
related affiliates comprised approximately 5% of total assets, but at times
have had a significant impact on our consolidated net income and cash
flows. At June 30, 2002, UED's unregulated business segment comprised
approximately 1% of total assets, but may have a significant impact on our
consolidated net income and cash flows in the future.
Management's Discussion and Analysis should be read in conjunction
with UniSource Energy and TEP's 2001 Form 10-K and with the Condensed
Consolidated Financial Statements, beginning on page 2, which present the
results of operations for the quarters and six month periods ended June 30,
2002 and 2001. Management's Discussion and Analysis explains the
differences between periods for specific line items of the Condensed
Consolidated Financial Statements.
OVERVIEW
- --------
UniSource Energy and TEP net income and UniSource Energy earnings per
share of Common Stock for the quarters and six months ended June 30, 2002
and June 30, 2001 are shown in the table below:
UniSource Energy TEP
Net Income Earnings Net Income
------------------------------------------------------------------------
-Millions- -Per Share- -Millions-
Quarter Ended June 30, 2002 $ 11.9 $ 0.35 $ 17.5
Quarter Ended June 30, 2001 13.3 0.40 18.9
Six Months Ended June 30, 2002 5.6 0.17 15.5
Six Months Ended June 30, 2001 32.5 0.98 42.4
UniSource Energy and TEP's net income for the three months and six
months ended June 30, 2002 decreased from the net income reported for the
comparable periods in 2001. The primary reason for the decrease in both
periods was the significant reduction in electric wholesale sales and
revenues due to lower wholesale energy prices.
Other factors which contributed to the decreases included milder
weather compared to the prior year, decreased consumption by TEP's mining
customers, and an adverse ruling on a coal price arbitration. These
factors were somewhat offset in the second quarter of 2002 by increased
consumption by TEP's residential, commercial, and industrial customers.
Outlook and Strategy
--------------------
In recent years, the electric utility industry has undergone
significant regulatory change designed to encourage competition in the sale
of electric generation services. However, given changing market conditions
including recent events in California related to deregulation and the Enron
Corp. (Enron) bankruptcy, the Arizona Corporation Commission (ACC) is in
the process of reviewing the Retail Electric Competition Rules (Rules).
Additionally, the Federal Energy Regulatory Commission (FERC) issued
various orders in response to the California energy crisis which have
impacted our businesses. We continually evaluate our position to develop
strategies to remain competitive and flexible in this changing environment.
Our plans and strategies include the following:
- Enhance the value of our transmission system while continuing to
provide reliable access to generation for our retail customers and market
access for all generating assets. This will include focusing on completing
a transmission line to an electric distribution company in Nogales,
Arizona. This line could eventually be connected to Mexico's utility
system.
- Facilitate the construction of Springerville Unit 3 and Unit 4, which
will allow us to spread the fixed costs of TEP's Springerville Units 1 and
2 over additional units. This includes obtaining construction financing in
late 2002 or early 2003.
- Reduce TEP's debt as appropriate, using some of our excess cash flows.
- Proactively maintain our transmission and distribution system to
ensure reliable service to our retail customers.
- Efficiently manage our generating resources and look for ways to
reduce or control operating costs in order to improve profitability.
- Actively participate in the formulation of regulatory policies and
actions.
- Focus the efforts of Millennium's technology entities to begin larger
scale production of Global Solar Energy, Inc.'s (Global Solar) thin-film
photovoltaic cells and to develop thin-film battery technology. Seek
strategic partners and investors to achieve commercial operation of these
businesses.
To accomplish our goals, we estimate that during 2002, TEP will spend
approximately $104 million on capital expenditures, Millennium will provide
between $23 and $26 million of funding to its technology investments, and
we will provide between $20 million and $100 million to UED. Our funding
of UED will depend upon the timing of financial close of the Springerville
expansion project and UED's ultimate ownership percentage.
While we believe that our plans and strategies will continue to have a
positive impact on our financial prospects and position, we recognize that
we continue to be highly leveraged, and as a result, our access to the
capital markets may be limited or more expensive than for less leveraged
companies.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
The electric utility industry has undergone significant regulatory
change in the last few years designed to encourage competition in the sale
of electricity and related services. However, the recent experience in
California with deregulation has caused many states, including Arizona, to
reexamine retail electric deregulation.
Since January 1, 2001, all of TEP's retail customers have been
eligible to choose an alternate energy supplier. Although there is one
Energy Service Provider (ESP) certified by the ACC to provide service in
TEP's retail service area, currently none of TEP's retail customers have
opted to receive service from this ESP.
In the wholesale market, TEP competes with other utilities, power
marketers and independent power producers in the sale of electric capacity
and energy.
TEP also competes against gas service suppliers and others that
provide energy services. Other forms of energy technologies, such as fuel
cells, may provide competition to TEP's services in the future, but to
date, are not financially viable alternatives. Self-generation by TEP's
large industrial customers could also provide competition for TEP's
services in the future, but has not had a significant impact to date.
INDUSTRY RESTRUCTURING
TEP'S Settlement Agreement and Retail Electric Competition Rules
----------------------------------------------------------------
In December 1996, the ACC adopted the Rules that provided a framework
for the introduction of retail electric competition in Arizona. These
Rules, as amended and modified, were approved by the ACC in September 1999.
In November 1999, the ACC approved the Settlement Agreement between
TEP and certain customer groups relating to the implementation of retail
electric competition, including TEP's recovery of its transition recovery
assets and the unbundling of tariffs. The major provisions of the
Settlement Agreement, as approved, were:
- Consumer choice for energy supply began in 2000, and by January 1,
2001 consumer choice was available to all retail customers.
- After certain rate reductions implemented in 1998 through 2000, TEP's
retail rates are frozen until December 31, 2008, except under certain
circumstances.
- TEP's frozen rates include a fixed Competition Transition Charge (CTC)
component designated for the recovery of its transition recovery assets.
- TEP is required to file a general rate case for its transmission and
distribution business, including an updated cost-of-service study, by
June 1, 2004.
- TEP is currently required to transfer its generation and other
competitive assets to a wholly-owned subsidiary by December 31, 2002. The
Settlement Agreement also requires that by December 31, 2002, TEP, as the
Utility Distribution Company, must acquire at least 50% of its requirements
through a competitive bidding process, while the remainder may be purchased
under contracts with TEP's generation subsidiary or other energy suppliers.
Approval of the Settlement Agreement caused TEP to discontinue
regulatory accounting under FAS 71 for its generation operations in
November 1999. See Note 2 of Notes to Condensed Consolidated Financial
Statements.
Recent Developments in the Arizona Regulatory Environment
---------------------------------------------------------
In January 2002, the ACC began a formal proceeding to reexamine the
circumstances that have changed since it adopted the Rules in 1996 and to
revisit the path to deregulation of the retail electric market. The ACC
opened a generic docket to consolidate this issue with several related
issues, including the future of the Arizona Independent Scheduling
Administrator (AISA) and TEP's subsequent application for variance of
certain provisions of the Rules. In this application, TEP requested an
extension of the generation assets transfer requirement and the 50%
competitive bid requirement until the latter of December 31, 2003 or six
months after the ACC issues a final order in the generic docket.
On March 22, 2002, the ACC's Utilities Division (Staff) submitted a
Staff Report to provide general guidance to the Commissioners on issues
contained in the generic docket. In its Report, the Staff recommended that
the ACC address issues affecting the smooth transition to competition,
including market power and market monitoring, competitive bidding, transfer
of generation assets, transmission constraints and reliability, adjustor
mechanisms, retail direct access and shopping credits, and other issues.
On July 23, 2002, an ACC administrative law judge issued a recommended
order on various matters in the generic docket. The order recommends that
the separation of assets requirements be stayed until the ACC concludes
that the wholesale market is workably competitive, or until at least July
1, 2004. The recommended order also proposes to stay the requirement that
by December 31, 2002, TEP must acquire at least 50% of its power through a
competitive bidding process, while the remainder may be purchased under
contracts with TEP's generation subsidiary or other energy suppliers. The
ACC commissioners may sign, deny or amend the recommended order.
TEP cannot predict the outcome of these proceedings on its extension
application or of the ultimate resolution of issues contained in the
generic docket.
The status of the Rules and the ability of ESPs to continue to sell
competitive services may also be subject to change due to court
proceedings. Several parties, including certain rural electric
cooperatives, filed lawsuits in Maricopa County Superior Court challenging
the Rules. In November 2000, the Court found the Rules to be
unconstitutional and unlawful. The decision was appealed to the Court of
Appeals, and implementation of the judgment was stayed and the Rules remain
in effect pending the outcome of the appeals. TEP cannot predict the effect
of the court decision or the outcome of the appeals to which it is a party
or the effect of the judgment, if affirmed upon appeal, on the introduction
of retail electric competition in Arizona.
Transmission Access
-------------------
In 1997, TEP and other transmission owners and users located in the
southwestern U.S. began to investigate the feasibility of forming an
Independent System Operator (ISO) for the region. As a result, they formed
a not-for-profit corporation named Desert STAR in September 1999. In
December 1999, the FERC issued FERC Order 2000, which established timelines
for all transmission owning entities to join a Regional Transmission
Organization (RTO) and defined the minimum characteristics and functions of
an RTO. In October 2001, TEP and three other southwestern utilities filed
agreements and operating protocols with the FERC to form a new, for profit
RTO to be known as WestConnect to replace Desert STAR. The reorganization
of Desert STAR into WestConnect will be subject to approval by the FERC and
certain state regulatory authorities in the region. The FERC plans to
issue an order on the WestConnect RTO proposal by the end of the third
quarter of 2002. See Item 1 - Business - Transmission Access in the 2001
Form 10-K.
On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking
(NOPR) proposing standard market design rules that would significantly
alter the markets for wholesale electricity and transmission and ancillary
services in the United States. See FERC Matters below.
The Rules also required the formation and implementation of an AISA.
In July 2001, the ACC Commissioners provided stakeholders the opportunity
to comment on a list of issues related to the AISA, including a proposal by
one of the Commissioners to end the obligation of Arizona utilities to fund
and participate in the AISA. The AISA docket is one of those that was
consolidated with the generic docket related to retail electric competition
issues. See Recent Developments in the Arizona Regulatory Environment,
above.
On April 18, 2002, the Western Systems Coordinating Council (WSCC),
Southwest Regional Transmission Association (SWRTA), and Western Regional
Transmission Association (WRTA) merged to form the Western Electricity
Coordinating Council (WECC). The new organization, WECC, will continue to
be responsible for coordinating and promoting electric system reliability
and will support efficient competitive power markets in the Western
Interconnection. WECC's interconnection-wide focus is intended to
complement current efforts to form RTOs in various parts of the West.
WESTERN ENERGY MARKETS
As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes affecting these markets and
market participants. During 2000 and 2001, these markets experienced
unprecedented price volatility, bankruptcies and payment defaults by
several of its largest participants, and increased attention and
intervention by regulatory agencies concerned with the outcomes of
deregulation of the electric power industry.
Rates and Market Prices
-----------------------
TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy at market-based
rates in the wholesale market. The average market price for around-the-
clock energy based on the Dow Jones Palo Verde Index decreased
significantly in 2002 compared with 2001, as shown below.
Average Market Price for Around-the-Clock Energy MWh
---------------------------------------------------------------
Quarter ended June 30, 2002 $ 24
Quarter ended June 30, 2001 135
Six months ended June 30, 2002 24
Six months ended June 30, 2001 156
Beginning in June 2000 and continuing through May 2001, the average
market price for around-the-clock energy in the western U.S. energy market
increased to unprecedented levels due to a number of factors, including
unusually high natural gas prices, decreased hydropower supply, increased
demand and insufficient generation to meet the increased demand. Prices
began a steady decline in June 2001, and now have reached levels that are
more consistent with historical prices. As of July 31,2002, the average
forward around-the-clock market price for the balance of the year 2002 was
approximately $29 per MWh, based on the Dow Jones Palo Verde Index. As a
result, we expect our wholesale revenues to be significantly lower in 2002
than in 2001. We cannot predict whether these lower prices will continue,
or whether changes in various factors that influence demand and capacity
will cause prices to rise again during the remainder of 2002.
We expect the market price and demand for capacity and energy to
continue to be influenced by the following factors during the next few
years:
- continued population growth in the western U.S.;
- economic conditions in the western U.S.;
- availability of capacity throughout the western U.S.;
- the extent of electric utility industry restructuring in Arizona,
California and other western states;
- the effect of FERC regulation of wholesale energy markets;
- the availability and price of natural gas;
- precipitation, which affects hydropower availability;
- transmission constraints; and
- environmental restrictions and the cost of compliance.
Payment Defaults and Allowances for Doubtful Accounts
-----------------------------------------------------
See Critical Accounting Policies - Payment Defaults and Allowances for
Doubtful Accounts, below and Note 8 of Notes to Condensed Consolidated
Financial Statements.
FERC Matters
------------
As described more fully in the 2001 Form 10-K, the FERC ordered
hearings and issued several orders during 2000 and 2001 to mitigate
volatile energy prices in the western U.S. and to address the energy
emergency in California. Certain soft price caps on power sold to the
California Independent System Operator (CISO) were enacted in 2000, and
were later replaced in 2001 with an order for price mitigation applicable
to certain wholesale power sales to California and throughout the entire
western U.S. which applies through September 30, 2002. The FERC replaced
the price mitigation order with a firm price cap in July 2002, effective
through September 30, 2002. On July 17, 2002, the FERC established a new
market power mitigation plan, effective October 1, 2002. TEP does not
expect the FERC orders to have a significant impact on its wholesale power
sales.
Also, as described more fully in the 2001 Form 10-K, the FERC issued
several orders specifying the methodology to calculate refunds/offsets
applicable to wholesale sales into the CISO's and the California Power
Exchange's (CPX) spot markets for the period from October 2, 2000 to June
20, 2001. The administrative hearing before a FERC judge to determine the
amount of refunds/offsets, based on the FERC-specified methodology, is in
progress.
On May 8, 2002, the FERC issued a data request regarding potential
manipulation of electric and natural gas prices in California energy
markets. The FERC requested specific data and information with respect to
certain trading strategies in which companies may have engaged. This
request was made to all sellers of wholesale electricity and/or ancillary
services, including TEP, to the CISO and/or the CPX during the period 2000
and 2001. In May 2002, TEP responded to the FERC, certifying that TEP did
not engage in any of the trading activities listed in the data request
during 2000 and 2001. TEP also certified that it had not in the past, nor
does it now, model or forecast California's energy markets and did not
purchase energy from, or sell energy to any company as part of a megawatt
laundering transaction during the period 2000-2001. FERC then issued a
follow-up data request with respect to "wash" trades. TEP responded by
certifying that it had not engaged in any wash trades during the period
2000-2001.
We are not able to predict the length and outcome of the FERC hearings
and the outcome of any subsequent lawsuits and appeals that might be filed.
As a participant in the June 2001 refund proceedings, TEP will be subject
to any final refund orders. TEP does not expect its refund liability, if
any, to have a significant impact on the financial statements. See
Critical Accounting Policies - Payment Defaults and Allowances for Doubtful
Accounts, below.
There are several other outstanding legal issues, complaints, and
lawsuits concerning the California energy crisis related to the FERC,
wholesale power suppliers, Southern California Edison Company (SCE),
Pacific Gas & Electric Company (PG&E), the CPX and CISO, and to Enron. We
cannot predict the outcome of these issues or lawsuits. We believe,
however, that we are adequately reserved for our transactions with the CPX,
CISO and Enron. See Note 8 of Notes to Condensed Consolidated Financial
Statements.
On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking
(NOPR) proposing standard market design rules that would significantly
alter the markets for wholesale electricity and transmission and ancillary
services in the United States. The new rules would establish a generation
adequacy requirement for "load-serving entities" and a standard platform
for the sale of electricity and transmission services. Under the new
rules, Independent Transmission Providers would administer spot markets for
wholesale power, ancillary services and transmission congestion rights, and
electric utilities, including TEP, would be required to transfer control
over transmission facilities to the applicable Independent Transmission
Provider. The NOPR is open for a 75-day comment period with final rules
expected to be issued by the end of 2002. Once the final rules are issued,
a phased compliance schedule will begin with final implementation expected
to take effect no later than September 30, 2004. TEP is currently in the
process of determining the impact the proposed rules would have on its
operations.
SCE Power Exchange Agreement
----------------------------
A power exchange agreement between TEP and SCE requires SCE to provide
firm system capacity of 110 MW to TEP during summer months. TEP is then
obligated to return to SCE in the winter months the same amount of energy
that TEP received from SCE during the preceding summer. Since 1995, TEP
has relied upon this 110 MW from SCE. During 2000 and 2001, volatility in
the western energy markets and the deterioration in SCE's financial
condition created uncertainty for TEP regarding the availability of this
resource for TEP's summer peaking needs. Except for a few occasions in
2000 and 2001, SCE provided TEP with requested energy under the power
exchange agreement. Since June 2001, western power markets have stabilized
and SCE's financial condition appears to be improving. As such, we believe
that there is more certainty to the availability of this resource for TEP
in the summer of 2002. As of August 5, 2002, SCE has delivered energy to
TEP as required under the terms of the agreement.
MARKET RISKS
We are exposed to various forms of market risk. Changes in interest
rates, returns on marketable securities, and changes in commodity prices
may affect our future financial results. The market risks resulting from
changes in interest rates and returns on marketable securities have not
changed materially from the market risks reported in the 2001 Form 10-K.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements below.
Risk Management Committee
-------------------------
We have a Risk Management Committee responsible for the oversight of
commodity price risk and credit risk related to the wholesale energy
marketing activities of TEP and the emissions and coal trading activities
of Millennium Environmental Group, Inc. (MEG). Our Risk Management
Committee consists of officers with responsibility for finance, accounting,
legal, wholesale marketing, and the generation operations of UniSource
Energy. To limit our exposure to commodity price risk, the Risk Management
Committee sets trading policies and limits, which are reviewed frequently
to respond to constantly changing market conditions. To limit our exposure
to credit risk in these activities, the Risk Management Committee approves
credit policies and limits and reviews counterparty credit exposure on a
monthly basis.
Commodity Price Risk
--------------------
We are exposed to commodity price risk primarily relating to changes
in the market price of electricity, natural gas, coal and emissions
allowances. To manage its exposure to energy price risk, TEP enters into
forward contracts to buy or sell energy at a specified price and future
delivery period. Generally, TEP commits to future sales based on expected
excess generating capability, forward prices and generation costs, using a
diversified market approach to provide a balance between long-term, mid-
term and spot energy sales. Similarly, TEP enters into forward purchases
during its summer peaking period to ensure it can meet its load and reserve
requirements and account for other contract and resource contingencies.
These positions are managed on both a volumetric and dollar basis and are
closely monitored using risk management policies and procedures with
oversight by the Risk Management Committee. For example, the risk
management policies provide that TEP should not take a short position in
the third quarter and should have supply backing up all forward sales
positions.
TEP also enters into limited forward purchases and sales to take
advantage of market price changes with the intent to reverse the forward
positions at a profit. These types of transactions are considered to be
our trading positions. TEP marks its trading positions to market on a
daily basis using actively quoted prices obtained from brokers for power
traded over-the-counter at Palo Verde and at other southwestern U.S.
trading hubs for forward periods of up to five years. As of June 30, 2002,
all of TEP's forward trading contracts were for settlement within twelve
months. TEP's trading policies restrict forward trading positions to
mature no longer than the end of the next calendar year. Because of the
short-term duration of these trading positions, we believe that the market
is liquid and that the various broker quotations used to calculate the mark-
to-market values represent accurate measures of the fair values of these
positions. To adjust the value of its trading positions to fair value on
its income statement, TEP recorded an unrealized loss of $0.1 million in
the second quarter of 2002, and an unrealized gain of $0.7 million for the
six months ended June 30, 2002. TEP had a cumulative unrealized loss of
$0.5 million on its December 31, 2001 balance sheet and a cumulative
unrealized gain of $0.2 million on its June 30, 2002 balance sheet.
TEP uses a sensitivity analysis to measure the impact of an
unfavorable change in market prices on the fair value of its trading
positions. As of June 30, 2002, a 10% unfavorable change in the market
prices of electric power from year-end levels would have decreased the fair
value of these instruments by less than $1 million. Beginning in 2001,
changes in the fair value of these derivative instruments are measured in
our financial statements in accordance with FAS 133. See Critical
Accounting Policies - Accounting for Derivative Instruments and Hedging
Activities, below and Note 3 of Notes to Condensed Consolidated Financial
Statements.
During the fourth quarter of 2001, we began managing and trading
emission allowances, coal and related financial instruments through MEG.
We manage the market risk of this new line of business by setting notional
limits by product, as well as limits to the potential change in fair market
value under a hypothetical 33% change in price or volatility. MEG's
trading activities, including swap agreements, options and forward
contracts, are closely monitored using risk management policies and
procedures with oversight by the Risk Management Committee. MEG marks its
trading positions to market on a daily basis using actively quoted prices
obtained from brokers and options pricing models for positions that extend
through 2004. As of June 30, 2002, the fair value of MEG's trading assets
totaled $11.2 million and the fair value of MEG's trading liabilities
totaled $11.4 million. These amounts include a cumulative unrealized gain
of less than $0.1 million to adjust to fair market value as of June 30,
2002.
TEP is generally subject to increased commodity price risk during the
third quarter of each year, due to the seasonal nature of its business as a
summer-peaking utility. To mitigate the risk of unexpected losses of
generation resources due to unplanned outages or natural disasters or
unavailability of other power resources, TEP purchased 50 MW of energy on a
forward basis to protect its retail customers from power interruptions for
the summer of 2002. TEP also plans to rely upon two new peaking units
which went in service in June 2001, interruptible contracts, and reserve
sharing arrangements with other utilities as resources. Under the terms of
its Settlement Agreement, TEP's retail rates are frozen through December
31, 2008, except under certain circumstances. As such, TEP cannot recover
increased purchased power costs without further ACC action. See Factors
Affecting Results of Competition - Industry Restructuring, above.
TEP also purchases coal and natural gas in the normal course of
business for fuel for its generating plants. TEP acquires its coal under
long-term coal supply contracts. Purchases of gas historically provided
fuel for only 3-4% of total generation. During the quarter ended June 30,
2001, approximately 12% of TEP's kWh generated was fueled by natural gas.
Market prices of natural gas also increased significantly in the second
quarter and first six months of 2001, which, combined with increased usage,
caused gas costs to comprise 32% of total fuel expense for the quarter
ended June 30, 2001 and 36% for the first six months of 2001. With the
significant reduction in wholesale energy prices in the second quarter and
first six months of 2002, only 6% of TEP's kWh generated was fueled by
natural gas in the second quarter of 2002. Natural gas prices were also
lower in 2002, causing gas costs to comprise only 15% of fuel expense in
the second quarter of 2002 and 13% in the first six months of 2002. TEP is
assured of its gas supply as a retail customer of the local gas supplier.
TEP periodically negotiates its contract with its gas supplier to establish
terms relating to pricing and scheduling of gas delivery. TEP entered into
fixed price gas purchase agreements in May and July 2002 to hedge our risk
of fluctuations in the market price of gas for June through October of
2002. The agreements cover approximately 30% of TEP's anticipated gas
purchases for that period.
On July 23, 2002, TEP notified the coal supplier for the Irvington
Generating Station (Irvington) of its intent to terminate the Irvington
coal supply agreement. To terminate the agreement, TEP will make a payment
of $11.25 million on or before September 15, 2002. As a result, TEP
recorded $11.25 million of additional expense in July 2002. The additional
expense will be mitigated by TEP not being required to make a take-or-pay
penalty payment of approximately $3.5 million for the year 2002. On a net
present value basis, TEP expects the fuel savings to significantly exceed
the termination payment.
Credit Risk
-----------
UniSource Energy is exposed to credit risk in its energy trading
activities related to potential nonperformance by counterparties. We
manage the risk of counterparty default by performing financial credit
reviews and setting limits and monitoring exposures, requiring collateral
when needed, and using a standardized agreement which allows for the
netting of current period exposures to and from a single counterparty.
Despite such mitigation efforts, there is a potential for defaults by
counterparties to occur from time to time. In the fourth quarter of 2000
and the first quarter of 2001, TEP was affected by payment defaults by SCE
and PG&E for amounts owed to the CPX and CISO. In the fourth quarter of
2001, Enron defaulted on amounts owed to TEP for energy sales.
We calculate counterparty credit exposure by adding any outstanding
receivable (net of amounts payable if a netting agreement exists) to the
mark-to-market value of any forward contracts. As of June 30, 2002, TEP's
total credit exposure related to its wholesale trading activities
(excluding defaulted amounts owed by CPX, CISO and Enron), was less than $7
million and MEG's total credit exposure was less than $6 million. Our
credit exposure is diversified across approximately 35 counterparties.
Only $2.3 million of exposure is to non-investment grade companies.
FUTURE GENERATING RESOURCES
Springerville Generating Station Expansion
------------------------------------------
As reported in the 2001 Annual Report on Form 10-K, UED and Salt River
Project Agricultural Improvement and Power District (SRP) signed a joint
development agreement, in October 2001, which set forth certain terms
associated with the ownership and development of two new coal-fired
electric generating units (Springerville Units 3 and 4). The arrangement
contemplated that SRP would effectively obtain 50% (or approximately 400
MW) of the interest in the total output of the project. The balance of the
electric output was expected to be sold to other regional power companies,
possibly including TEP. As a result of recent developments, UED and SRP
are discussing a modification of the joint development agreement to provide
for the purchase by SRP of a specified amount of power from Unit 3 and an
option for SRP, at a later date, to own Unit 4. No agreement has yet been
reached. With respect to Unit 3, the entire output of 400 MW is now
expected to be sold under power purchase arrangements with regional power
companies, including TriState Generation and Transmission Association, SRP
and TEP. UED still anticipates that at least some portion of the project
will be financed with the proceeds of project financing.
Springerville was originally designed for four units. If constructed,
each of Units 3 and 4 would consist of a 400 MW coal-fired, base-load
generating unit at the same site as Springerville Units 1 and 2, and would
allow us to spread the fixed costs of the existing common facilities over
the additional generating unit (or units). The revised project scope and
schedule are currently being refined in connection with the terms of an
engineering, procurement, and construction contract. We are also
continuing the permitting process, evaluating financing alternatives, and
negotiating with other potential long-term power purchasers in addition to
SRP.
The ACC approved construction of a third and fourth unit at the
Springerville Generating Station in 1977 and 1987, respectively, provided
that TEP, as plant operator, demonstrate that the fourth unit was needed to
provide an adequate, economical and reliable supply of electric power to
its customers. In July 2001, TEP filed an application requesting the ACC
to schedule a hearing addressing the need for the fourth electric
generating unit. Evidentiary hearings regarding the need for Unit 4 were
held in November 2001 in Springerville and Phoenix. The matter is pending
before the ACC.
TEP worked with the Environmental Protection Agency (EPA) and the
Arizona Department of Environmental Quality (ADEQ) to determine mutually
acceptable levels of emissions for all four units to accomplish significant
emission reductions from current levels. The ADEQ issued a final permit on
April 29, 2002. If constructed, Springerville Units 3 and 4 will be
equipped with modern emissions control technology, and the emissions
controls on Units 1 and 2 will be upgraded. Sulfur dioxide emissions from
all four units will be up to 55 percent less than those currently produced
from the two existing units, while nitrogen oxide emissions will be up to 39
percent less. TEP also volunteered to undertake some operational changes
on the existing units to reduce emissions as early as July 2003, rather
than waiting until the expansion project is scheduled for completion.
Environmental activist groups have expressed concerns regarding the
construction of any new units. Such concerns have been expressed during
the permitting and ACC proceedings and may extend to other forums and to
issues apart from the proposed construction. On November 13, 2001, the
Grand Canyon Trust, an environmental activist group, filed a complaint in
U.S. District Court against TEP for alleged violations of the Clean Air Act
at the Springerville Generating Station. The complaint alleges that more
stringent emission standards should apply to Units 1 and 2 and that new
permits and the installation of additional facilities meeting Best
Available Control Technology standards are required for the continued
operation of Units 1 and 2 in accordance with applicable law. TEP believes
the claims are without merit and is vigorously contesting these claims.
We presently anticipate that power purchase agreements with other
project off-takers, the engineering, procurement and construction contract,
and other required project agreements will be finalized during the third
and fourth quarters of 2002 and that the construction financing will be in
place by late 2002 or early 2003. We expect that construction will begin
by the first quarter of 2003, with commercial operation of Unit 3 expected
to occur in late 2005 or early 2006. We can make no assurances, however,
about the ultimate timing, or whether we will proceed with this project.
See Note 7 of Notes to Condensed Consolidated Financial Statements - UED
Commitments.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
In preparing financial statements under GAAP, management exercises
judgment in the selection and application of accounting principles,
including making estimates and assumptions. We consider Critical
Accounting Policies to be those that could result in materially different
financial statement results if our assumptions regarding application of
accounting principles were different. We describe our Critical Accounting
Policies below. Other significant accounting policies are discussed in the
2001 Form 10-K, Note 1 - Nature of Operations and Summary of Significant
Accounting Policies. Recently issued accounting standards are discussed in
Note 11 of Notes to Condensed Consolidated Financial Statements - New
Accounting Pronouncements.
Accounting for Rate Regulation
------------------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. However,
sometimes these principles, such as FAS 71, require special accounting
treatment for regulated companies to show the effect of regulation. For
example, in setting TEP's retail rates, the ACC may not allow TEP to
currently charge its customers to recover certain expenses, but instead
requires that these expenses be charged to customers in the future. In
this situation, FAS 71 requires that TEP defer these items and show them as
regulatory assets on the balance sheet until TEP is allowed to charge its
customers. TEP then amortizes these items as expense to the income
statement as those charges are recovered from customers. Similarly,
certain revenue items may be deferred as regulatory liabilities, which are
also eventually amortized to the income statement as rates to customers are
reduced.
The conditions a regulated company must satisfy to apply the
accounting policies and practices of FAS 71 include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
In November 1999, upon approval by the ACC of TEP's Settlement
Agreement relating to recovery of TEP's transition costs and standard
retail rates, we stopped applying FAS 71 to our generation operations.
We continue to apply FAS 71 in accounting for the distribution and
transmission portions of TEP's business, our regulated operations. We
periodically assess whether we can continue to apply FAS 71 to these
operations. If we stopped applying FAS 71 to TEP's remaining regulated
operations, we would write off the related balances of TEP's regulatory
assets as an expense on our income statement. Based on the balances of
TEP's regulatory assets at June 30, 2002, if we had stopped applying FAS 71
to TEP's remaining regulated operations, we would have recorded an
extraordinary loss, after-tax, of approximately $245 million. While
regulatory orders and market conditions may affect our cash flows, our cash
flows would not be affected if we stopped applying FAS 71.
Accounting for Derivative Instruments and Hedging Activities
------------------------------------------------------------
On January 1, 2001, we adopted Statement of Financial Accounting
Standards No. 133 (FAS 133), Accounting for Derivative Instruments and
Hedging Activities. A derivative financial instrument or other contract
derives its value from another investment or designated benchmark. Because
of the complexity of derivatives, the FASB established a Derivatives
Implementation Group (DIG). During 2001, the DIG issued new guidance,
which changed the contracts that qualified as derivatives under FAS 133.
When we adopted FAS 133, some of the forward contracts that we used to
buy and sell wholesale power were considered to be derivatives based on the
accounting guidance at that time. Some of the contracts qualified for
hedge accounting while some were considered to be trading activities.
Under FAS 133, we record unrealized gains and losses on our trading
activities and adjust the related assets and liabilities on a monthly basis
to reflect the market prices at the end of the month. The market prices
used to determine fair value for these derivative instruments are estimated
based on various factors including broker quotes, exchange prices, over the
counter prices and time value. We report the unrealized gain/loss on
trading activities as a component of Operating Revenues. The net pre-tax
unrealized loss for the quarter ended June 30, 2002 was approximately $0.3
million. For the six months ended June 30, 2002, the net pre-tax unrealized
gain was approximately $0.8 million. At June 30, 2002, the fair value of
our trading assets totaled $11.4 million, which is reported in Other
Current Assets, and the fair value of our trading liabilities totaled $11.4
million, which is reported in Other Current Liabilities.
In June 2002, new guidance was issued by the Financial Accounting
Standards Board that requires all realized and unrealized gains and losses
on energy-related trading contracts to be shown net in the income statement
whether or not physically settled. The new guidance is effective July 1,
2002 and requires financial statements for all comparative periods to be
reclassified to conform to the new presentation. Currently, we report our
trading activity as follows:
- TEP and MEG's net unrealized gain/loss on trading activities is a
component of Operating Revenues;
- TEP's realized gain/loss on forward sales contracts is a component of
Electric Wholesale Revenues;
- TEP's realized gain/loss on forward purchase contracts is a component
of Purchased Power; and
- MEG's net realized gain/loss on trading activities is a component of
Other Revenues.
Beginning July 1, 2002, we will report the net realized and unrealized
gain/loss on TEP and MEG's trading activities as a component of Operating
Revenue to conform to the new presentation.
To date, the DIG has issued more than 100 interpretations to provide
guidance in applying FAS 133. As the DIG or the FASB continues to issue
interpretations, we may change the conclusions that we have reached and, as
a result, the accounting treatment and financial statement impact could
change in the future.
See Note 3 of Notes to Condensed Consolidated Financial Statements.
Payment Defaults and Allowances for Doubtful Accounts
-----------------------------------------------------
We record an allowance for doubtful accounts when we determine that an
account receivable will not be collected. At June 30, 2002 and December
31, 2001, TEP's Accounts Receivable on the balance sheet is net of an $8.4
million allowance for uncollectible receivables related to 2000 and 2001
sales to the CPX, the CISO and Enron. This allowance reflects a 50%
reserve on amounts unpaid from the CPX, the CISO and Enron, as TEP believes
it is probable that it will collect at least 50% of this aggregate
outstanding net receivable due to the recent (a) stabilization of the power
markets, (b) rate increases achieved by PG&E and SCE, (c) settlements made
by California utilities with various power providers, and (d) data in
filings of FERC refund hearings.
SCE publicly disclosed that on March 1, 2002, it obtained financing
and made payments so that it has no material undisputed obligations that
are past due or in default. These payments included a payment to the CPX;
however, TEP did not receive a corresponding payment from the CPX. In
addition, TEP has cash collateral of approximately $1 million on deposit in
an escrow account with the CPX, which is currently unavailable to TEP due
to the bankruptcy stay.
In addition to TEP's net receivable exposure of $0.8 million to Enron,
at December 31, 2001, TEP had forward electricity sales contracts with
Enron for periods through June 30, 2002 with an estimated mark-to-market
value of approximately $1 million. The unrealized gains associated with
these contracts were removed from TEP's revenues as of December 31, 2001.
TEP has filed a claim in Enron's bankruptcy proceedings for its receivable
and for the mark-to-market value of defaulted forward contracts.
The amount that we ultimately collect from the CPX, the CISO and Enron
would have an impact on our earnings if the amount is more or less than the
$8.4 million we have reserved. If we collect all of the $16.8 million, pre-
tax income will increase by $8.4 million. If we do not collect any of the
$16.8 million, pre-tax income will decrease by $8.4 million. We also
believe that we are due interest on the amounts we are owed.
Capitalization of UED Project Development Costs
-----------------------------------------------
UED capitalizes project development costs when it is probable that the
project will be completed and we expect to recover the costs of the
project. UED and SRP entered into a Joint Development Agreement in October
2001 to develop two 400 MW coal-fired units at TEP's existing Springerville
Station. As a result of recent developments, UED and SRP are discussing a
modification of the joint development agreement to provide for the purchase
by SRP of a specified amount of power from Unit 3 and an option for SRP to
own Unit 4. See Future Generating Resources above. UED and SRP each
committed project development funding for professional services and other
third party costs. At June 30, 2002, capitalized project development costs
on UED's balance sheet were approximately $13.1 million. If the project
does not proceed, the capitalized project development costs will be
immediately expensed.
Unbilled Revenue
----------------
TEP's electric retail revenues include an estimate of MWhs delivered
but unbilled at the end of each period. The unbilled revenue is estimated
by comparing the MWhs consumed to the MWhs billed to our retail customers.
The excess of MWhs consumed over MWhs billed is then allocated to the retail
customer classes based on estimated usage by each customer class. We then
record revenue for each customer class based on the various bill rates for
each customer class. Due to the seasonal fluctuations of our actual load,
the unbilled revenue amount is greater in the summer months than it is in
the winter months.
RESULTS OF OPERATIONS
- ---------------------
UniSource Energy recorded net income of $11.9 million, or $0.35 per
average share of Common Stock in the second quarter of 2002, compared with
net income of $13.3 million or $0.40 in the second quarter of 2001. Net
income for the first six months of 2002 was $5.6 million, or $0.17 per
share in the first six months of 2002, compared with net income of $32.5
million or $0.98 per share in the first six months of 2001.
The primary reason for the decrease in both periods was the
significant reduction in electric wholesale sales and revenues due to lower
wholesale energy prices. Other factors which contributed to the decreases
included milder weather compared to the prior year, decreased consumption
by TEP's mining customers, and an adverse ruling on a coal price
arbitration. These factors were somewhat offset in the second quarter and
first six months of 2002 by increased consumption by TEP's residential,
commercial, and industrial customers.
Contribution By Business Segment
--------------------------------
The table below shows the contributions to our consolidated after-tax
net income by our three business segments, as well as parent company
expenses and intercompany eliminations, for the second quarter and first
six months of 2002 and 2001:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- -----------------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $ 17.5 $ 18.9 $ 15.5 $ 42.4
Millennium (4.4) (4.4) (7.7) (7.3)
UED 0.2 0.2 0.6 0.2
Intercompany Eliminations (1.4) (1.4) (2.8) (2.8)
- -----------------------------------------------------------------------------
Consolidated Net Income $ 11.9 $ 13.3 $ 5.6 $ 32.5
=============================================================================
Intercompany Eliminations include:
- elimination of intercompany sales between business segments;
- elimination of intercompany interest on the note payable from
UniSource Energy to TEP; and
- elimination of UED's rental income and TEP's rental expense from UED's
turbine lease to TEP.
The financial condition and results of operations of TEP are currently
the principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis. The following
discussion relates to TEP's utility operations, unless otherwise noted. The
results of our unregulated energy businesses are discussed in Results of
Millennium Energy Businesses and Results of UED below.
Utility kWh Sales and Revenues
------------------------------
Customer growth, weather and other consumption factors affect retail
sales of electricity. Price changes also contribute to changes in retail
revenues. Electric wholesale revenues are affected by market prices in the
wholesale energy market, availability of TEP generating resources, and the
level of wholesale trading activity.
TEP experienced a significant decline in wholesale energy sales and
revenues during the second quarter and first six months of 2002. Market
demand in the western region declined primarily as a result of mild
temperatures, and market prices fell as a result of increased capacity in
the region and declining natural gas prices, as well as reduced demand.
TEP's electric wholesale sales consist primarily of four types of sales:
(1) Sales under long-term contracts for periods of more than one year.
TEP currently has long-term contracts with three entities to sell
firm capacity and energy: SRP, the Navajo Tribal Utility Authority
and the Tohono O'odham Utility Authority. TEP also has a long-term
interruptible contract with Phelps Dodge Energy Services, which
requires a fixed contract demand of 60 MW at all times except during
TEP's peak customer energy demand period, from July through September
of each year. Under the contract, TEP can interrupt delivery of
power if the utility experiences significant loss of any electric
generating resources.
(2) Forward contracts to sell energy for periods through the end of the
next calendar year. Under forward contracts, TEP commits to sell a
specified amount of capacity or energy at a specified price over a
given period of time, typically for one-month, three-month or one-year
periods.
(3) Short-term economy energy sales in the daily or hourly markets at
fluctuating spot market prices and other non-firm energy sales.
(4) Sales of transmission service.
Comparisons of TEP's kilowatt-hour sales delivered and the
corresponding electric revenues for the second quarter and first six months
of 2002, compared with the same periods in 2001, are shown below:
Sales Operating Revenue
- ------------------------------------------------------------------------------------------------------
Percent Percent
Three Months Ended June 30, 2002 2001 Change 2002 2001 Change
- ------------------------------------------------------------------------------------------------------
- Millions of kWh - - Millions of Dollars -
Electric Retail Sales 2,097 2,120 (1.1%) $ 174.8 $ 171.7 1.8%
- ------------------------------------------------------------------------------------------------------
Electric Wholesale Sales Delivered:
Long-term Contracts 191 305 (37.4%) 11.4 10.5 8.6%
Forward Contracts 443 1,053 (57.9%) 14.1 153.0 (90.8%)
Short-term Sales and Other 792 596 32.9% 32.1 61.5 (47.8%)
Transmission - - - 0.8 1.2 (33.3%)
- ------------------------------------------------------------------------------------------------------
Total Electric Wholesale Sales 1,426 1,954 (27.0%) 58.4 226.2 (74.2%)
- ------------------------------------------------------------------------------------------------------
Total 3,523 4,074 (13.5%) $ 233.2 $ 397.9 (41.4%)
======================================================================================================
Sales Operating Revenue
- ------------------------------------------------------------------------------------------------------
Percent Percent
Six Months Ended June 30, 2002 2001 Change 2002 2001 Change
- ------------------------------------------------------------------------------------------------------
- Millions of kWh - - Millions of Dollars -
Electric Retail Sales 3,778 3,889 (2.9%) $ 306.6 $ 306.3 0.1%
- ------------------------------------------------------------------------------------------------------
Electric Wholesale Sales Delivered:
Long-term Contracts 472 639 (26.1%) 26.0 27.0 (3.7%)
Forward Contracts 504 1,671 (69.8%) 16.4 202.1 (91.9%)
Short-term Sales and Other 1,471 1,179 24.8% 59.1 138.7 (57.4%)
Transmission - - - 1.5 2.1 (28.6%)
- ------------------------------------------------------------------------------------------------------
Total Electric Wholesale Sales 2,447 3,489 (29.9%) 103.0 369.9 (72.2%)
- ------------------------------------------------------------------------------------------------------
Total 6,225 7,378 (15.6%) $ 409.6 $ 676.2 (39.4%)
======================================================================================================
TEP's kWh sales to retail customers decreased 1.1% in the second
quarter of 2002 compared with the same period in 2001, despite a 2.4%
increase in retail customers. Sales to mining customers decreased by 37%
because of cutbacks in production by both of our large mining customers in
response to lower copper prices. This reduction in sales was almost
completely offset by a 4% increase in sales to residential, commercial and
industrial customers. Despite an extraordinarily hot month of June, milder
temperatures in April and May resulted in a 2.6% decrease in Cooling Degree
Days for the quarter. On June 26, 2002, the maximum net hourly peak reached
an all time high of 1899 MW. Revenues from sales to retail customers
increased 1.8% in the second quarter of 2002, reflecting the increased kWh
sales to non-mining customers. For the first six months of 2002, retail
kWh sales decreased by 2.9%, while revenues increased slightly compared
with the same period in 2001, primarily due to a favorable change in sales
mix with decreased sales to mining customers offset by increased sales to
residential, commercial and other industrial customers.
Kilowatt-hour electric wholesale sales decreased by 27%, while
revenues decreased by 74% in the second quarter of 2002 compared with 2001.
For the first six months of 2002, kilowatt-hour electric wholesale sales
decreased by 30% and the sales revenues decreased by 72% compared with the
same period in 2001. The decrease in revenues in the second quarter and
first six months of 2002 resulted from decreased sales activity and the
sharp decline in market prices from those in the same periods of 2001.
Sales and revenues from forward contracts experienced the largest declines,
reflecting the lower demand and market prices. Short-term sales were
higher, however, in both the second quarter and six month period of 2002,
due to sales of excess energy in the daily and hourly markets. Despite the
higher short-term sales volumes, revenues from short-term sales were
significantly lower in 2002 due to the lower average market prices.
Factors contributing to the lower market prices included more generation
online in the western U.S., lower natural gas prices, increased hydropower
supply, and weaker demand.
Fuel and Purchased Power Expenses
---------------------------------
Fuel expense at TEP's generating plants decreased by $7 million, or
11%, in the quarter ended June 30, 2002 compared with the same quarter in
2001. Reasons for the decreased fuel expense include lower wholesale
sales, which resulted in decreased natural gas usage for generation,
partially offset by a $2.3 million increase related to a July 2002
arbitration ruling that increases the price of coal purchased from 1997 to
2001 for the Navajo Generating Facility. TEP owns 7.5% of the Navajo
facility. The increased coal prices established by the arbitration ruling
will increase fuel expense by approximately $0.4 million per year in the
future. Natural gas prices were lower in the second quarter of 2002
compared with the same period in 2001. The average cost of fuel per kWh
generated for the second quarter of 2002 and 2001 was 1.98 cents and 2.12
cents, respectively. For the six months ended June 30, 2002, fuel expense
decreased $30 million, a 22% decrease. The average cost of fuel per kWh
generated for the first six months of 2002 and 2001 was 1.92 cents and 2.26
cents, respectively. See Market Risks - Commodity Price Risk, above.
Purchased Power expense decreased by $148 million, or 83%, in the
second quarter of 2002 compared with the same period in 2001 due
principally to decreased volume of wholesale trading activity and lower
wholesale prices in the forward and spot energy markets. Electric
wholesale sales decreased 528,000 MWh and the average market price for
around-the-clock energy decreased $111 per MWh for the second quarter 2002,
compared with the same period in 2001. For the six months ended June 30,
2002, Purchased Power expense decreased $184 million, a 82% decrease from
the same period in 2001. In the six months ended June 30, 2002, electric
wholesale sales decreased 1,042,000 MWh and the average around-the-clock
market price decreased $132 per MWh, compared with 2001.
Other Operating Expenses
------------------------
Other Operations and Maintenance expense decreased $7 million, or 15%,
in the second quarter of 2002 compared with the same period in 2001. The
primary reasons for this decrease include: $4 million expense related to a
month-long scheduled maintenance outage at the San Juan Unit 2 generating
plant; $2 million in scheduled repairs to the Irvington Unit 3 turbine
generator and contracting fees at North Loop generating plant, and $1
million in additional post-retirement medical and other benefits, all of
which occurred in 2001. Other Operations and Maintenance expense decreased
by $10 million, or 11%, in the first six months of 2002 for the reasons
mentioned above as well as a $5 million reduction in bad debt expense,
offset by a $2 million increase in maintenance expense in the first quarter
of 2002 related to a scheduled outage at Springerville Unit 1. The
decrease in bad debt expense occurred because in January 2001, we recorded
$7 million in reserves, of which $5 million was recorded as expense, to
cover our credit exposure for risk of non-payment from electric wholesale
sales to California made in January 2001. See Note 8 of Notes to Condensed
Consolidated Financial Statements. We recorded no such reserves in 2002.
Depreciation and amortization expense increased $6 million, or 10%, in
the first six months of 2002, compared with the same period in 2001.
Depreciation expense increased due to a $125 million increase in the
depreciable asset base, which represents (i) new line extensions to support
new business, (ii) the addition of a 75 MW gas turbine placed in-service in
June 2001, and (iii) routine improvements to TEP's system. These increases
were partially offset by reduced depreciation in the second quarter of 2002
resulting from an increase in the estimated useful lives of gas-fired
generating units and internal combustion turbines located in Tucson. See
Note 11 of Notes to Condensed Consolidated Financial Statements.
Other Income
------------
TEP's income statements for the quarters ended June 30, 2002 and 2001
each include $2 million of Interest Income on the promissory note TEP
received from UniSource Energy in exchange for the transfer of its stock in
Millennium. On UniSource Energy's consolidated income statement, this
income is eliminated as an intercompany transaction.
TEP's Interest Income for the second quarter and first six months of
2002 was $2 million and $3 million higher, respectively, compared with the
same periods in 2001, due to our January 2002 investment in $96 million of
Springerville Coal Handling Facilities Lease debt and our May 2002
investment in $3 million of Springerville Unit 1 lease debt. See Liquidity
and Capital Resources, below, and Note 6 of Notes to Condensed Consolidated
Financial Statements.
Interest Expense
----------------
Interest Expense for the second quarter and first six months of 2002
decreased by $2 million and $4 million, respectively, compared with the
same periods in 2001, primarily due to decreases in the average interest
rate on long-term variable rate tax-exempt debt and reduced capital lease
obligations in 2002.
Income Tax Expense
------------------
Income taxes decreased $4 million, or 28%, for the second quarter of
2002 and $21 million, or 66%, for the first six months of 2002, compared
with the same periods in 2001, primarily due to $1.7 million of tax
credits recognized in the second quarter of 2002, as well as lower pre-tax
income.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
- ---------------------------------------
The table below provides a breakdown of the after-tax net losses
recorded by Millennium Energy Businesses:
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
- ------------------------------------------------------------------------------
- Millions of Dollars -
Energy Technology Investments $ (2.8) $ (4.6) $ (6.1) $ (7.8)
Other (1.6) 0.2 (1.6) 0.5
- ------------------------------------------------------------------------------
Total Millennium $ (4.4) $ (4.4) $ (7.7) $ (7.3)
==============================================================================
Energy Technology Investments
-----------------------------
Millennium's Energy Technology Investments include Global Solar,
Infinite Power Solutions, Inc. (IPS), MicroSat Systems, Inc. (MicroSat) and
ITN Energy Systems, Inc. (ITN). The major factors contributing to the
losses in 2002 and 2001 are development efforts of solar modules by Global
Solar, expenditures to develop thin-film and solid-state rechargeable
batteries by IPS, research and development work performed by ITN and
contract work performed by MicroSat on satellite development. See Note 4
of Notes to Condensed Consolidated Financial Statements.
RESULTS OF UED
- --------------
UED was established in February 2001 and owns a 20 MW gas turbine,
which it leases to TEP under an operating lease arrangement. UED recorded
a net profit of $0.2 million for the quarter ended June 30, 2002 and $0.6
million for the first six months of 2002. UED's income represents rental
income, less expenses, under the operating lease. This rental income is
eliminated from UniSource Energy's after-tax earnings as an intercompany
transaction.
UED is developing the expansion of the Springerville Generating
Station. As of June 30, 2002, the capitalized costs on UED's balance sheet
were approximately $13.1 million. If the project does not proceed, the
capitalized project development costs will be immediately expensed. See
Future Generating Resources and Critical Accounting Policies -
Capitalization of UED Project Development Costs, above.
DIVIDENDS ON COMMON STOCK
- -------------------------
UniSource Energy
----------------
On May 10, 2002, UniSource Energy declared a cash dividend of $0.125
per share on its Common Stock. This dividend, totaling approximately $4
million, was paid June 10, 2002 to shareholders of record at the close of
business on May 24, 2002. On August 1, 2002, UniSource Energy declared a
cash dividend in the amount of $0.125 per share on its Common Stock,
payable September 10, 2002 to shareholders of record at the close of
business August 16, 2002.
UniSource Energy's Board of Directors will review our dividend level
on a continuing basis, taking into consideration a number of factors
including our results of operations and financial condition, general
economic and competitive conditions, and the cash flow from our subsidiary
companies, TEP, Millennium and UED.
TEP
---
On August 1, 2002, TEP declared a cash dividend in the amount of $10
million, which it paid to UniSource Energy on August 5, 2002. In December
2001, TEP declared and paid a dividend of $50 million. UniSource Energy is
the primary holder of TEP's common stock.
TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that
requires TEP to maintain a minimum level of net worth. As of June 30,
2002, the required minimum net worth was $269 million. TEP's actual net
worth at June 30, 2002 was $338 million. As of June 30, 2002, TEP was in
compliance with the terms of the Credit Agreement. See Investing and
Financing Activities - TEP Bank Credit Agreement, below.
The ACC Holding Company Order states that TEP may not pay dividends to
UniSource Energy in excess of 75% of its earnings until TEP's equity ratio
equals 37.5% of total capital (excluding capital lease obligations). As of
June 30, 2002, TEP's equity ratio on that basis was 23%.
In addition to these limitations, the Federal Power Act states that
dividends shall not be paid out of funds properly included in the capital
account. Although the terms of the Federal Power Act are unclear, we
believe that there is a reasonable basis to pay dividends from current year
earnings. Therefore, TEP declared its August 2002 dividend from year to
date 2002 earnings and its December 2001 dividend from 2001 earnings since
TEP had an accumulated deficit, rather than positive retained earnings.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
OVERALL LIQUIDITY
Our primary source of liquidity is our cash flow from operations,
which exceeded $200 million in each of the past two years. These cash
flows are derived primarily from retail and wholesale energy sales at TEP,
net of the related payments for fuel and purchased power. In the last two
years, our cash flows have benefited from higher margins on wholesale
energy sales in the western U.S. power markets. This enabled us to
increase our cash levels from $145 million at year-end 1999 to $228 million
at year-end 2001. We have been using our available cash to finance capital
expenditures, primarily at TEP, to make investments in our energy
technology affiliates, to pay dividends to shareholders, and to reduce
leverage at TEP by repaying high coupon debt and investing in lease debt.
For example, in January 2002, we purchased $96 million principal amount of
lease debt bearing an average coupon of 14.3% and in May 2002, we purchased
$3 million principal amount of Springerville Unit 1 lease debt bearing a
coupon of 10.7%.
We do not expect the wholesale energy market conditions to be as
favorable in 2002, with market prices and margins lower than we saw in the
last two years. Another factor that could affect our cash flows from
operations is reduced energy demand by our large mining customers. As we
have reported elsewhere in this document, our two major mining customers
have reduced operations during the last few years due to lower copper
prices. This trend will continue and as we entered 2002, we expected a 40
MW load reduction to our system peak demand related to these mining
customers. While this load reduction by our mining customers did occur, we
experienced increased consumption by our other retail customers, which
caused us to reach a new peak demand in June 2002. We cannot predict,
however, whether continued higher consumption by our other retail customers
will offset the decreased mining load.
In the event that we experience lower cash from operations due to
these, or other events, we will adjust our discretionary uses of cash
accordingly. We believe, however, that we will continue to have sufficient
cash flow to cover our capital needs, as well as required debt payments and
dividends to shareholders. Furthermore, we believe that even with lower
wholesale energy prices and lower demand from mining customers, we will
have sufficient excess cash flow to continue to make annual discretionary
debt reductions or lease debt investments at TEP in the range of $30
million. TEP's $100 million Revolving Credit Facility provides us with
another major source of liquidity. TEP has borrowed under this facility
only one time for a period of approximately one month during the past four
years. At June 30, 2002, there were no outstanding borrowings under this
facility. If TEP encountered temporary cash needs during the course of the
year, it would borrow from this Revolving Credit Facility.
The Revolving Credit Facility is part of TEP's Bank Credit Agreement,
which matures on December 30, 2002. The Credit Agreement also includes a
$341 million Letter of Credit Facility (LOC) which supports $329 million of
tax-exempt variable rate bonds. If TEP fails to extend or replace the LOCs
or to otherwise refinance the bonds prior to the expiration date, the bonds
would be subject to mandatory redemption. Therefore, the $329 million in
bonds have been classified as current liabilities on our balance sheet as
of June 30, 2002 and December 31, 2001. TEP is negotiating with its banks
and believes that it will be able to complete a new credit agreement prior
to the maturity of its existing Credit Agreement. At that time, the $329
million in tax-exempt variable rate bonds will be classified as Long-Term
Debt. See Investing and Financing Activities - TEP Bank Credit Agreement,
below.
There have been no significant changes in our contractual obligations
or other commercial commitments from those reported in our 2001 Annual
Report on Form 10-K.
CASH FLOWS
UniSource Energy
----------------
Consolidated cash and cash equivalents decreased from the June 30,
2001 balance of $179 million to $66 million at June 30, 2002. For the
twelve-month period ended June 30, 2002, net cash outflows for investing
and financing activities exceeded the cash generated from operating
activities.
Net cash flows from operating activities decreased by $91 million in
the first six months of 2002 compared with the same period in 2001. The
net decrease resulted primarily from the following factors:
- $72 million decrease in cash receipts from sales to wholesale and
retail customers, net of fuel and purchased power costs paid;
- $24 million increase in capital lease interest paid as a result of
early payment of Springerville Lease payments; offset by
- $5 million decrease in income taxes paid due to lower pre-tax income.
Net cash used for investing activities totaled $160 million in the
first six months of 2002, compared with $80 million during the same period
in 2001. TEP spent $101 million to purchase and hold outstanding
Springerville Coal Handling Facilities Lease debt in January 2002 and $3
million to purchase and hold outstanding Springerville Unit 1 lease debt in
May 2002. See Investment in Springerville Lease Debt and Equity, below.
Capital expenditures were $18 million higher in 2001 than in 2002, and
included $15 million incurred by UED in its purchase of a 20 MW gas
turbine, which was placed in-service in June 2001. Investments in and
loans to Millennium Energy Businesses decreased $7 million in 2002 and $7
million in proceeds from the sale of real estate was received in 2001.
Net cash used for financing activities totaled $26 million in the
first six months of 2002, compared with $18 million in the same period in
2001. In 2002, UniSource Energy paid approximately $18 million to retire
capital lease obligations and $8 million in dividends.
UniSource Energy's consolidated cash balance, including cash
equivalents, at August 5, 2002 was approximately $92 million. We invest
cash balances in high-grade money market securities with an emphasis on
preserving the principal amounts invested.
TEP
---
Cash and cash equivalents decreased from the June 30, 2001 balance of
$151 million to $32 million at June 30, 2002. For the twelve-month period
ended June 30, 2002, net cash outflows for investing and financing
activities exceeded the cash generated from operating activities.
The reasons for the changes in TEP's statement of cash flows are
incorporated above in the analysis of the changes in UniSource Energy's
consolidated cash flows.
TEP's consolidated cash balance, including cash equivalents, at August
5, 2002 was approximately $74 million.
INVESTING AND FINANCING ACTIVITIES
- ----------------------------------
UNISOURCE ENERGY
During the next 12 months, UniSource Energy expects to use cash to
fund investments in Millennium and UED's unregulated energy businesses and
to pay dividends to shareholders. We expect our sources of cash to be
dividends from our subsidiaries, primarily TEP. Although no specific
offerings are currently contemplated, UniSource Energy may also seek to
issue debt and/or equity securities from time to time. If available cash
falls short of expectations, we would reevaluate the investment
requirements of Millennium's unregulated energy businesses and/or seek
additional financing for, or investments in, those businesses by unrelated
parties.
TEP
TEP's capital requirements consist primarily of capital expenditures
and optional and mandatory redemptions of long-term debt and capital lease
obligations.
Capital Expenditures
--------------------
TEP's capital expenditures for the three months and six months ended
June 30, 2002 were $23 million and $47 million respectively. TEP's
forecast for capital expenditures for the year ending December 31, 2002 was
originally expected to be approximately $124 million, including expected
expenditures in 2002 for the construction of a 62-mile transmission line
from Tucson to Nogales, Arizona. This forecast has been adjusted downward
to approximately $104 million to reflect a change in the timing of the
expenditures for the 62-mile transmission line. These expenditures include
costs for TEP to comply with current federal and state environmental
regulations. Actual construction expenditures may differ from these
estimates due to changes in business conditions, construction schedules,
environmental requirements and changes to our business arising from retail
competition. TEP plans to fund these expenditures through internally-
generated cash flow.
In January 2001, TEP and Citizens Communications Company entered into
a project development agreement for the joint construction of the 62-mile
transmission line. In January 2002, the ACC approved the location and
construction of the proposed 345 kV line, almost half of which runs through
a national forest. A drought-caused closure of the forest in June 2002 has
delayed the progress on the environmental impact study required for Federal
project approval. A U.S. Department of Energy (DOE) and Forest Service
record of decision is expected to occur in the third or fourth quarter of
2003, and construction could begin in the fourth quarter of 2003, with
completion expected by the second or third quarter of 2004. Construction
costs are expected to be approximately $70 million. TEP has also applied
to the DOE for a Presidential Permit that would allow building an extension
of the line across the international border with Mexico to interconnect
with Mexico's utility system, providing further reliability and market
opportunities in the region.
The estimated expenditures listed above do not include any amounts for
the potential expansion of the Springerville Generating Station.
Springerville generation expenditures are expected to be made by UED. See
Investing and Financing Activities - UED, below.
TEP Bank Credit Agreement
-------------------------
TEP has a $441 million Credit Agreement with a number of banks which
matures on December 30, 2002. The agreement consists of a $100 million
Revolving Credit Facility and a $341 million Letter of Credit Facility.
The Revolving Credit Facility is used to provide liquidity for general
corporate purposes. The Letter of Credit Facility supports $329 million
aggregate principal amount of tax-exempt variable rate debt. The
facilities are secured by $441 million in aggregate principal amount of
Second Mortgage Bonds. The Credit Agreement contains a number of
restrictive covenants including restrictions on additional indebtedness,
liens, sale of assets or mergers and sale-leasebacks. The Credit Agreement
also contains several financial covenants including (a) a minimum
Consolidated Tangible Net Worth equal to the sum of $133 million plus 40%
of cumulative Consolidated Net Income since January 1, 1997, (b) a minimum
Cash Coverage Ratio of 1.55 in 2002, and (c) a maximum Leverage Ratio of
6.20 in 2002. As of June 30, 2002, TEP was in compliance with these
financial covenants.
As of June 30, 2002 and as of August 2, 2002, TEP had no borrowings
outstanding under its $100 million Revolving Credit Facility.
TEP intends to enter into a new credit agreement prior to the maturity
of its existing Credit Agreement, in a structure substantially similar to
its existing facilities. TEP has filed an application with the ACC for
authority to refinance its Credit Agreement. We cannot, however, predict
the terms and the pricing that will be available. The $329 million in
aggregate principal amount of tax-exempt variable rate debt that is
supported by the Letter of Credit Facility has been classified as Current
Maturities of Long-Term Debt on TEP's Balance Sheet for the period ended
June 30, 2002 because the Letter of Credit Facility matures on December 30,
2002. Once a longer term Letter of Credit Facility has been completed, the
bonds will be classified as Long-Term Debt.
Investment in Springerville Lease Debt and Equity
-------------------------------------------------
In May 2002, TEP purchased $3 million of the outstanding Springerville
Unit 1 lease debt.
In December 2001, TEP purchased a 13% ownership interest in the
Springerville Coal Handling Facilities Leases for $13 million. In January
2002, TEP purchased all $96 million of the capital lease debt related to
these leases for $101 million. In a related transaction, in March 2002,
TEP cancelled that portion of the leases related to its equity interest, as
it held both the ownership interest and the debt. This transaction
resulted in a $21 million reduction to the capital lease obligation. The
residual value of the leased asset is carried at cost.
MILLENNIUM
Millennium's significant investments, commitments and investment
proceeds are discussed below.
Energy Technology Investments
-----------------------------
We refer to Global Solar, IPS, MicroSat and ITN collectively as our
Energy Technology Investments. During the first quarter of 2002,
Millennium reallocated a $10 million line of credit commitment from
MicroSat to Global Solar and IPS. During the second quarter of 2002,
Millennium committed an additional $10 million in funding to Global Solar.
Millennium's advances to the Energy Technology Investments totaled $12.7
million during the first half of 2002.
On April 3, 2002, Millennium signed a letter agreement that
facilitates the change in the ownership structure of the Energy Technology
Investments to better align our ownership interest in these investments
with Millennium's business plans. Millennium retains its preferred
shareholder and distribution status. Under the letter agreement,
Millennium:
- increases its ownership of Global Solar from 67% to 81%;
- increases its ownership of IPS from 67% to 70%;
- decreases its ownership of MicroSat from 49% to 35%;
- decreases its ownership of ITN from 49% to 19%; and
- will provide additional contingent capital contributions of up to $2.7
million, primarily to fund research and development activities at ITN.
Regardless of ownership percentage, as sole funder of the Energy
Technology Investments, Millennium continues to recognize 100% of the
losses from operations of these companies. Millennium expects to fund
between $10 million and $13 million of its commitments to its Energy
Technology Investments in the second half of 2002. A significant portion
of the funding under these agreements will be used for research and
development purposes and other administrative costs. As funds are expended
for these purposes, we will recognize expense. Additional investment
commitments may be made to these technology investments depending on their
funding requirements and business outlook. In addition, Millennium is
seeking external investors for the Energy Technology Investment companies.
Other Millennium Investments and Commitments
--------------------------------------------
Millennium has a $15 million capital commitment to a limited
partnership that funds energy related investments. As of June 30, 2002,
Millennium had funded $6 million of this commitment. The remaining $9
million is expected to be funded within the next three years. A member
of the UniSource Energy Board of Directors has an investment in the
limited partnership and is a managing director of the general partner
of the limited partnership.
Millennium has a $5 million capital commitment to a venture capital
fund that will focus on information technology, optics and biotechnology,
primarily within the retail service territory of TEP. A second member of
the UniSource Energy Board of Directors owns the company that manages the
fund. At June 30, 2002, Millennium had funded approximately $1 million of
this commitment. Millennium expects to fund no more than $1 million in
the second half of 2002.
Millennium owns a controlling 50.5% interest in Powertrusion
International, Inc., a manufacturer of lightweight utility poles. During
the second quarter of 2002, Millennium committed to provide an additional
$2 million of funding to maintain its controlling interest. On July 1,
2002, Millennium contributed $1 million. The remaining $1 million will be
remitted by August 15, 2002.
On April 1, 2002, Millennium invested $2 million in a start-up company
established to market energy-related products, bringing Millennium's total
investment to $3.1 million. Millennium's net remaining investment, after
the results of operations, was $1.9 million at June 30, 2002.
On July 15, 2002, Millennium invested $20 million in a company created
to develop up to 800 megawatts of coal-fired generation in the Sabinas
region of Coahuila, Mexico. Millennium received a 50% share of
Carboelectrica Sabinas, S. de. R.L. of C.V., a Mexican limited liability
company ("Sabinas"). The other 50% of Sabinas is owned by Altos Hornos de
Mexico, S.A. de C.V., ("AHMSA") and certain of its affiliates. Sabinas also
owns approximately 19% of Minerales de Monclova , S.A. de C.V., an owner of
coal reserves and a supplier of metallurgical coal to the steel industry
and thermal coal to CFE, the Mexican electricity commission. Under certain
circumstances, Millennium has the right to put its interest in Sabinas to
an AHMSA affiliate for $20 million plus an accrued service fee. These
circumstances include failure of Sabinas to reach financial closing on the
generation project within three years. Millennium's put option is secured
by collateral with a value currently in excess of $20 million. UniSource
Energy's Chairman and Chief Executive Officer is a member of the board of
directors of AHMSA.
UED
UED is responsible as project developer for facilitating the
Springerville Generating Station expansion project construction. See
Future Generating Resources above. To date, we have funded approximately
$13 million for development of the project. We expect to provide an
additional $20 million to $100 million in funding for development prior to
closing of construction financing. Our funding to UED will depend upon the
timing of the financial closing of the project and UED's ultimate ownership
percentage of the project. We presently anticipate closing construction
financing in late 2002 or early 2003. Total construction costs for the
project, to the extent UED builds two units, are expected to range from
$900 million to $1.1 billion from 2002 to 2006, and total project costs,
which include construction costs, various development costs and interest
during construction, are expected to exceed $1.3 billion. We can make no
assurances, however, about the ultimate timing, or whether we will proceed
with this project.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Quarterly Report on Form 10-Q contains forward-looking statements
as defined by the Private Securities Litigation Reform Act of 1995.
UniSource Energy and TEP are including the following cautionary statements
to make applicable and take advantage of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995 for any forward-looking
statements made by or for UniSource Energy or TEP in this Quarterly Report
on Form 10-Q. Forward-looking statements include statements concerning
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not statements of
historical facts. Forward-looking statements may be identified by the use
of words such as "anticipates," "estimates," "expects," "intends," "plans,"
"predicts," "projects," and similar expressions. From time to time, we may
publish or otherwise make available forward-looking statements of this
nature. All such forward-looking statements, whether written or oral, and
whether made by or on behalf of UniSource Energy or TEP, are expressly
qualified by these cautionary statements and any other cautionary
statements which may accompany the forward-looking statements. In
addition, UniSource Energy and TEP disclaim any obligation to update any
forward-looking statements to reflect events or circumstances after the
date of this report.
Forward-looking statements involve risks and uncertainties that could
cause actual results or outcomes to differ materially from those expressed
in the forward-looking statements. We express our expectations, beliefs
and projections in good faith and believe them to have a reasonable basis.
However, we make no assurances that management's expectations, beliefs or
projections will be achieved or accomplished. We have identified the
following important factors that could cause actual results to differ
materially from those discussed in our forward-looking statements. These
may be in addition to other factors and matters discussed in other parts of
this report:
1. Effects of restructuring initiatives in the electric industry and
other energy-related industries.
2. Effects of competition in retail and wholesale energy markets.
3. Changes in economic conditions, demographic patterns and weather
conditions in TEP's retail service area.
4. Supply and demand conditions in wholesale energy markets, including
volatility in market prices and illiquidity in markets, which are
affected by a variety of factors. These factors include the
availability of generating capacity in the western U.S., including
hydroelectric resources, weather, natural gas prices, the extent of
utility restructuring in various states, transmission constraints,
environmental restrictions and cost of compliance, and FERC regulation
of wholesale energy markets.
5. The creditworthiness of the entities to which TEP sells capacity and
energy.
6. Changes affecting TEP's cost of providing electrical service including
changes in fuel costs, generating unit operating performance, scheduled
and unscheduled plant outages, interest rates, tax laws, environmental
laws, and the general rate of inflation.
7. Changes in governmental policies and regulatory actions with respect
to financing and rate structures.
8. Changes affecting the cost of competing energy alternatives, including
changes in available generating technologies and changes in the cost of
natural gas.
9. Changes in accounting principles or the application of such principles
to UniSource Energy or TEP.
10. Market conditions and technological changes affecting UniSource
Energy's unregulated businesses.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
The information contained in this Item updates, and should be read in
conjunction with, information included in Part II, Item 7A in UniSource
Energy and TEP's Annual Report on Form 10-K for the year ended December 31,
2001, in addition to the interim condensed consolidated financial
statements and accompanying notes presented in Items 1 and 2 of this Form
10-Q.
See Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of
Operations, Market Risks.
PART II - OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
LITIGATION RELATED TO ACC ORDERS AND RETAIL COMPETITION
See Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Developments in the Arizona
Regulatory Environment.
SPRINGERVILLE GENERATING STATION COMPLAINT
See Note 7 of Notes to Condensed Consolidated Financial Statements -
TEP Contingencies.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
UniSource Energy conducted its annual meeting of shareholders on May
10, 2002. At that meeting, the shareholders of UniSource Energy elected
members of the Board of Directors.
The total votes were as follows:
Against Broker
For or Withheld Abstain Non-Votes
--- ----------- ------- ---------
Lawrence J. Aldrich 29,943,941 566,202 439,473 -
Larry W. Bickle 30,127,780 566,202 255,634 -
Elizabeth T. Bilby 30,235,093 566,202 148,321 -
Harold W. Burlingame 30,165,695 566,202 217,719 -
John L. Carter 29,931,651 566,202 451,763 -
Daniel W.L. Fessler 29,949,164 566,202 434,250 -
Kenneth Handy 30,162,441 566,202 220,973 -
Warren Y. Jobe 30,154,098 566,202 229,316 -
James S. Pignatelli 30,242,774 566,202 140,640 -
H. Wilson Sundt 30,145,383 566,202 238,031 -
At UniSource Energy's annual meeting of shareholders on May 10, 2002,
an amended and restated UniSource Energy Outside Director Stock Option Plan
was approved.
The total votes were as follows:
Against Broker
For or Withheld Abstain Non-Votes
--- ----------- ------- ---------
Amended and Restated
Outside Director
Stock Option Plan 18,371,036 12,365,911 212,670 -
ITEM 5. - OTHER INFORMATION
- --------------------------------------------------------------------------------
ADDITIONAL FINANCIAL DATA
The following table reflects the ratio of earnings to fixed charges
for TEP:
6 Months Ended 12 Months Ended
June 30, June 30,
2002 2002
-------------- ---------------
Ratio of Earnings to 1.35 1.54
Fixed Charges
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
(a) Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K.
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
each registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized. The signature for each
undersigned company shall be deemed to relate only to matters having
reference to such company or its subsidiary.
UNISOURCE ENERGY CORPORATION
----------------------------
(Registrant)
Date: August 9, 2002 /s/ Kevin Larson
----------------------------
Kevin Larson
Vice President and Principal
Financial Officer
TUCSON ELECTRIC POWER COMPANY
-----------------------------
(Registrant)
Date: August 9, 2002 /s/ Kevin Larson
-----------------------------
Kevin Larson
Vice President and Principal
Financial Officer
EXHIBIT INDEX
12 - Computation of Ratio of Earnings to Fixed Charges - TEP.
15 - Letter regarding unaudited interim financial information.
99 - Statements of Corporate Officers (pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002).