SECURITIES AND EXCHANGE COMMISSION

Washington, D. C.  20549

 

 

FORM 10-Q

 

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the period ended June 30, 2003

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 0-32667

 

CAP ROCK ENERGY CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý  No  o

 

As of June 30, 2003, the Registrant had 1,273,945 shares of its $.01 par value common stock outstanding.

 

 

CAP ROCK ENERGY CORPORATION

 

PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements		Page
		No.
	Consolidated Statements of Operations -
	Three and Six months ended June 30, 2003 and  2002	3
	Consolidated Balance Sheets -
	June 30, 2003 and December 31, 2002	4
	Consolidated Statements of Cash Flows -
	Six Months Ended June 30, 2003 and 2002	5
	Notes to Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		9
Item 3. Quantitative and Qualitative Disclosures About Market Risk		13
Item 4. Controls and Procedures		14
PART II.  OTHER INFORMATION
Item 1. Legal Proceedings		14
Item 6. Exhibits and Reports on Form 8-K		15

 

2

 

CAP ROCK ENERGY CORPORATION

Consolidated Statements of Operations

In thousands, except per share amounts

(Unaudited)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2003			2002			2003			2002
Operating revenues:
Electric sales		$	18,814		$	17,946		$	40,801		$	35,835
Other		436			354			793			584
Total operating revenues		19,250			18,300			41,594			36,419
Operating expenses:
Purchased power		8,533			9,587			19,498			18,347
Operations and maintenance		2,446			1,957			4,826			3,630
General and administrative		1,458			2,173			2,971			3,587
Depreciation and amortization		1,772			1,555			3,589			3,101
Property taxes		337			469			658			913
Other		76			50			244			106
Total operating expenses		14,622			15,791			31,786			29,684
Operating income		4,628			2,509			9,808			6,735
Other income (expense):
Allocation of income from associated organizations		—			—			—			7
Interest expense, net of capitalized interest		(1,662		)	(1,879		)	(3,374		)	(3,597		)
Interest and other income		265			278			531			537
Equity earnings in MAP		52			17			78			25
Total other expense		(1,345		)	(1,584		)	(2,765		)	(3,028		)
Net income before income taxes		3,283			925			7,043			3,707
Income tax expense		678			—			1,377			—
Net income		$	2,605		$	925		$	5,666		$	3,707
Net income per common share:
Basic		$	2.00		$	0.71		$	4.35		$	2.85
Diluted		$	1.92		$	0.71		$	4.18		$	2.85
Weighted average number of common shares oustanding:		1,301,325			1,302,355			1,301,705			1,302,355
Basic		1,356,623			1,302,355			1,357,003			1,302,355
Diluted

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

CAP ROCK ENERGY CORPORATION

Consolidated Balance Sheets

(In thousands)

 

		June 30, 2003			December 31, 2002
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	10,477		$	9,899
Accounts receivable:
Electric sales, net		8,012			4,680
Other		352			380
Current portion of notes receivable		11,975			12,490
Purchased power subject to recovery		1,967			3,501
Other current assets		8,582			7,805
Total current assets		41,365			38,755
Investments and notes receivable		12,434			12,490
Utility plant, net		154,497			157,447
Nonutility property, net		1,540			1,564
Other assets		1,108			1,038
Total Assets		$	210,944		$	211,294
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	31,081		$	33,924
Accounts payable:
Purchased power		3,120			3,381
Other		1,383			1,796
Equity redemption credits		486			732
Accrued and other current liabilities		3,683			3,066
Current income tax payable		891			414
Total current liabilities		40,644			43,313
Long-term debt, net of current portion:
Mortgage notes		145,660			147,744
Note payable and other capital leases		250			308
Total long-term debt		145,910			148,052
Deferred credits		4,248			5,191
Stockholders’ equity:
Preferred stock, par value $1 per share, 50,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, par value $.01 per share, 50,000,000 shares authorized, 1,302,355 shares issued and outstanding at December 31, 2002, and 1,356,355 shares issued and 1,273,945 shares outstanding at June 30, 2003		14			13
Paid in capital		6,510			5,949
Retained earnings		14,442			8,776
Less:  Treasury stock of 82,410 shares		(824		)	—
Total stockholders’ equity		20,142			14,738
Total Liabilities and Stockholders’ Equity		$	210,944		$	211,294

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

CAP ROCK ENERGY CORPORATION

Consolidated Statements of Cash Flows

Six Months Ended June 30, 2003 and 2002

(In thousands)

(Unaudited)

 

		2003				2002
Cash Flows From Operating Activities:
Net income		$	5,666			$	3,707
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,263				5,708
Noncash employee compensation		559				—
Equity earnings in Map		(78			)	(25		)
Changes in:
Other assets/deferred credits		(1,597			)	1,073
Accounts receivable		(3,304			)	(805		)
Purchased power cost subject to refund/recovery		1,534				(4,250		)
Other current assets		(777			)	1,188
Accounts payable and accrued expenses		420				(841		)
Net cash provided by operating activities		8,686				5,755
Cash Flows From Investing Activities:
Utility plant additions, net		(2,705			)	(2,067		)
Additions/deletions to nonutility investments		134				75
Collection of notes receivable		515				500
Net cash used in investing activities		(2,056			)	(1,492		)
Cash Flows From Financing Activities:
Payments on mortgage notes		(1,758			)	(1,422		)
Payments on other long-term debt and capital leases		(3,227			)	(3,047		)
Repurchase/acquisition of common stock		(821			)	—
Retirement of former member equity		(246			)	(624		)
Net cash used in financing activities		(6,052			)	(5,093		)
Increase (Decrease)  In Cash and Cash Equivalents		578				(830		)
Cash and Cash Equivalents:
Beginning of period		9,899				5,498
End of period		$		10,477		$	4,668
Supplemental Cash Flow Information:
Cash paid during the period for interest		$	3,872			$	4,436

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

CAP ROCK ENERGY CORPORATION

Notes to Consolidated Financial Statements

 

1.                                      Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of the Registrant, Cap Rock Energy Corporation (the “Company”) and its wholly owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation.  In the opinion of management of Cap Rock Energy Corporation, the accompanying unaudited consolidated financial statements contain all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the Company’s financial position as of June 30, 2003 and 2002, and its consolidated results of operations and cash flows for the six months ended June 30, 2003, and 2002.  The consolidated results of operations for the six months ended June 30, 2003, are not necessarily indicative of the results to be expected for the entire year.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2002, and the quarterly reports on Form 10-Q.

 

2.                                      Stock – Based Compensation

 

Effective January 1, 2003, the Company adopted the fair value method of accounting for its employee stock incentive plan in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,  “Accounting for Stock-Based  Compensation, Transition and Disclosure.”  Under the historical or retroactive transition method allowed by SFAS No. 148, the compensation expense for the three and six months ended June 30, 2003, would not have been different had the fair value method been originally applied.

 

During the quarter ended June 30, 2003, an aggregate of 54,000 shares of stock were awarded to all full-time employees.  The shares are 40% vested as of June 30, 2003, with 20% vesting each year thereafter.  One of the restrictions of the awards is that 25% of the vested shares is required to be held by the employee as long as the individual is employed by the Company.  Compensation expense of $275,000 is reflected in the three and six month periods ended June 30, 2003.  Based on generally accepted accounting principles and the vesting schedules, compensation expense  of $176,000 will be recognized over the next twelve months.

 

In July 2003, an aggregate of 302,500 shares of stock were awarded to officers, directors and certain retired directors.  The shares will be 50% vested in July 2004, with the remaining 50% vesting in 2005.  A similar 25% holding restriction also applies to this award.  Compensation expense of $2,364,000 will be recognized over the next twelve months.

 

3.                                      Change in Accounting Principle

 

Prior to March 2003, the Company utilized the cycle billing method to recognize revenue under its board approved rate structure.  The cycle billing method recognized revenue on an “as billed basis” when the customer was billed and not on an accrual basis.

 

During the first quarter of 2003, the Company’s Board of Directors changed the Company’s rate-making policy to recognize unbilled revenue.  Therefore, the Company is required to change accounting principles in order to recognize revenue on the accrual basis.  The Company believes the accrual method more closely matches revenues and expenses and  is more consistent with its current rate-making policies.  The effect of the change in accounting principle is an increase in operating revenues for the three and six month periods ended March 31, and June 30, 2003, respectively, in the amount of $2,346,000.

 

Also due to this change in accounting principle, the Company is no longer deferring certain purchased power costs associated with electric services delivered to customers but unbilled at period end.  This change resulted

 

6

 

in an increase to purchased power costs for the three and six month periods ended March 31, and June 30, 2003, respectively, in the amount of $1,318,000.

 

4.                                      Repurchase Offer

 

Shares of the Company’s common stock were originally distributed to certain former members of Cap Rock Electric Cooperative, Inc. (the “Cooperative”), the Company’s predecessor, who elected to receive shares of stock as payment for their equity and membership interest in the Cooperative.  Pursuant to the conversion plan, the Company made a commitment to purchase those shares, held continuously by the original owners of record until the first anniversary of the distribution of the shares, at a price of $10 per share if the Company had sufficient cash available to purchase all shares tendered.

 

On February 5, 2003, the Company filed Schedule TO with the Securities and Exchange Commission,  thus commencing the repurchase period, which expired April 30, 2003.  In an effort to be inclusive rather than exclusive, the Company made the offer to all shareholders of the Company.  The number of shares ultimately tendered to and accepted by the Company for repurchase was 82,140, with $821,400 being paid to tendering shareholders in early May 2003.  At June 30, 2003, such amount is shown as Treasury stock within the Stockholders’ equity section of the balance sheet.  There are no further obligations related to the Company’s repurchase commitment.

 

5.                                      Income Taxes

 

Unlike the predecessor company, Cap Rock Energy Corporation is a taxable entity.  One of it’s wholly-owned subsidiaries, NewCorp Resources Electric Cooperative, Inc. (NewCorp), is a tax-exempt cooperative under IRS Code Section 501(c)(12), and files a separate tax return.  Income tax expense of $678,000 and $1,377,000 has been recorded for the three and six months ended June 30, 2003, based upon the Company’s estimate of its ability to utilize its net operating loss carryforwards in future periods.  No income tax expense was recorded for the three and six month periods ended June 30, 2002, because net operating loss carryforwards were available to reduce any taxable income those quarters

 

6.                                      Earnings per Common Share

 

The table below shows the reconciliation between the basic and diluted weighted average number of common shares outstanding for the three and six month periods ended June 30, 2003 and 2002:

 

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2003		2002		2003		2002
Basic		1,301,325		1,302,355		1,301,705		1,302,355
Stock for Compensation shares that have been deferred		55,298		—		55,298		—
Diluted		1,356,623		1,302,355		1,357,003		1,302,355

 

7.                                      Change in Oversight Authority

 

On June 22, 2003, the Governor of the State of Texas signed Senate Bill 1280 (“SB 1280”) into law which will become effective September 1, 2003.  The definition of “electric cooperative” under the Public Utility Regulatory Act (“PURA”) included a “successor to an electric cooperative created before June 1, 1999, in accordance with a conversion plan approved by a vote of the electric cooperative, regardless of whether the successor later purchases, acquires, merges with or consolidates with, other electric cooperatives.”  SB 1280 amends the PURA to treat a successor to an electric cooperative as an investor owned utility.  This legislation also provided for establishment of schedules and procedures by the Public Utility Commission of Texas (“PUCT”) for such a successor that was not previously subject to regulation as an investor owned utility prior to September 1, 2003, in order to comply with the requirements of deregulation and competition.  The Company’s rates will be subject to regulation and approval by the PUCT beginning September 1, 2003.

 

8.                                      New Accounting Standards

 

Effective January 1, 2003, the Company adopted SFAS No. 143, “Asset Retirement Obligations,” which addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  The implementation of this standard did not have a material impact on the Company’s financial position or results of operations because the Company has no legal obligation for removal costs.

 

SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred.  SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, and was adopted by the Company effective January 1, 2003.  The implementation of this standard did not have an impact on the Company’s financial position or results of operations.

 

7

 

FASB Interpretation No. 46, “Consolidation of Variable Interest Entities – an interpretation of ARB No. 51” (“FIN 46”), requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity.  FIN 46 provisions are effective for all arrangements entered into after January 31, 2003.  For those arrangements entered into prior to January 31, 2003, the FIN 46 provisions are required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003.  The Company does not expect that the provisions of FIN 46 will have a material impact on the Company’s results of operations or financial position.

 

In December, 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure” (SFAS No. 148), an amendment of FASB Statement No. 123.  SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  Effective January 1, 2003, the Company changed its method of accounting from the intrinsic method per APB Opinion No. 25, to the fair value method per SFAS No. 148.

 

On April 22, 2003, the FASB announced its decision to require all companies to expense the fair value of employee stock options.  Companies will be required to measure the cost according to the fair value of the options.  Although the new guidelines and ultimate measurement valuation methodology have not yet been released, it is expected that they will be finalized soon and effective in 2004.  When final rules are announced, the Company will assess the impact to its financial statements.

 

In May 2003, the FASB issued Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS No. 150).  This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The Company does not expect the adoption of SFAS No. 150 to have a material impact on its financial statements.

 

9.                                      Contingencies

 

As described in Footnote 7, effective September 1, 2003, the Company will be regulated as an investor owned utility by the PUCT.  Therefore, in addition to having its rates regulated by the PUCT, the Company will  be required to comply with the other provisions of the PURA regarding  investor owned utilities, including offering customer choice for customer power requirements.  The PUCT is charged with establishing the procedures and timelines for the Company to comply with these provisions of PURA.  While the Company cannot predict the procedures and timelines that will be established by the PUCT, it is anticipated that the PUCT will take relevant factors into consideration in establishing procedures and timelines that are appropriate and will not adversely affect the Company’s customers.

 

The Company is currently negotiating with Beal Bank, S.S.B. (“Beal Bank”) for a loan collateralized by NewCorp’s transmission system.  While a commitment letter with Beal Bank has not been executed at this time, NewCorp submitted an application to the Federal Energy Regulatory Commission (“FERC”) on July 25, 2003, seeking authorization to borrow $31.5 million.  This refinancing will not result in any increase in rates to the transmission customers.  If FERC approval is received and the loan is consummated, the proceeds of the loan will be used to make the final balloon payment due on the transmission capital lease; establish cash reserves for operations and maintenance of the transmission system, as well as working capital; allow NewCorp to purchase transmission assets from Cap Rock Energy Corporation; and pay all costs and expenses associated with the loan.  The proposed loan is subject to additional conditions such as completion of due diligence by Beal Bank and preparation of all loan and collateral documents. The financing arrangements will allow the Company to make system upgrades, improvements and expansions as may be necessary.

 

10.                               Subsequent Events

 

On August 7, 2003, the PUCT approved the transfer of the Certificate of Convenience and Necessity (“CCN”)

 

8

 

from the Cooperative to the Company effective September 1, 2003.  The transfer of the CCN is the culmination of the conversion of the Company from a member-owned cooperative to a shareholder owned corporation.  The Company may now provide service directly to customers in its service territory and operate totally independent from its predecessor.

 

The note payable to a bank and the notes receivable from United Fuel and Energy Corporation have original maturity dates of July 2003.  Effective July 12, 2003, the notes were modified and extended with new maturity dates of September 2, 2003.

 

11.                               Reclassifications

 

Certain reclassifications have been made to prior periods’ financial statements to conform to the presentation  adopted in the current period.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Caution Regarding Forward-Looking Statements

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements regarding matters that could have an impact on our business, financial condition and future operations.  These statements, based on our expectation and estimates, are not guarantees of future performance and are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements.  These risks, uncertainties and other factors include, but are not limited to:

 

•                  General business conditions;

•                  Increased competition in the electric utility industry;

•                  Changes in our tax status;

•                  Demands for and cost of electric power;

•                  Federal and state legislative and regulatory actions and legal and administrative proceedings;

•                  Changes in and compliance with environmental laws and policies;

•                  Change in rate structure and ability to earn a fair return on our rate base and recover our cost of operations;

•                  Ability to obtain and/or refinance capital;

•                  Weather conditions; and,

•                  Unexpected changes in operating expenses and capital expenditures.

 

Our actual results may vary materially from those discussed in the forward-looking statements as a result of these and other factors.  Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made even if new information becomes available or other events occur in the future.

 

Overview

 

The Company is successor in interest to Cap Rock Electric Cooperative, Inc.,  which was a member-owned cooperative founded in 1939.  The Company was formed on January 1, 1999, in conjunction with a corporate restructuring plan involving the conversion of the Cooperative from a Texas electric cooperative to a Texas business corporation.  Effective January 1, 2002, all assets and liabilities of the Cooperative were transferred to the Company in exchange for common stock.  The financial statements presented for the periods ending on or before December 31, 2001, are the historical consolidated financial statements of the Cooperative,  and the financial statements for periods ending after January 1, 2002, are those of the successor, Cap Rock Energy Corporation.

 

9

 

Results of Operations

 

Six Months ended June 30, 2003, Compared With Six Months Ended June 30, 2002

 

Net Income

 

For the six months ended June 30, 2003, net income was $5,666,000 as compared to net income of $3,707,000 for the six months ended June 30, 2002, an increase of $1,959,000.  The majority of the increase is due to:

 

•                  An increase in operating revenues of $5,175,000; and

•                  A net increase in operating expenses of $2,102,000; and

•                  An increase in income tax expense of $1,377,000.

 

Operating Revenues

 

Operating revenues for the six months ended June 30, 2003, were $5,175,000 greater than those of the six months ended June 30, 2002.  The increase was due primarily to $2,346,000 in accrued revenues related to a change in accounting principle in March 2003, and approximately $2,600,000 of  increased electric sales  due to adjustments for 2003 power cost recovery and regulatory surcharge.  See Note 3 to the Financial Statements  for a discussion of the accounting change.

 

Operating Expenses

 

Operating expenses for the six months ended June 30, 2003 and 2002, were $31,786,000 and $29,684,000, respectively, an increase of $2,102,000, for the following reasons:

 

Purchased power cost increased by $1,151,000 primarily due to an adjustment of $1,318,000 for the lag in purchased power cost related to a change in accounting principle from the cycle billing method to accrued revenues at March 31, 2003. Maintenance and operations expenses increased by $1,196,000 because personnel devoted more time to maintenance activities that result in current expenses as opposed to engaging in construction activities that result in capitalized cost.

 

Income Taxes

 

Current income tax expense was $1,377,000 in 2003.  The effective tax rate of 20% for the six months ended June 30, 2003, is lower than the statutory rate due to the nontaxable status of some of the entities and the reversal of a portion of the valuation allowance related to net operating loss carryforwards expected to be utilized by the Company in future periods.  There was no current income tax expense in 2002 due to utilization of net operating loss carryforwards.

 

Three Months ended June 30, 2003, Compared With Three Months Ended June 30, 2002

 

Net Income

 

For the three months ended June 30, 2003, net income was $2,605,000 as compared to net income of $925,000 for the three months ended June 30, 2002, an increase of $1,680,000.  The majority of the increase is due to:

 

•                  An increase in operating revenues of $950,000; and

•                  A net decrease in operating expenses of $1,169,000; and

•                  An increase in tax expense of $678,000.

 

10

 

Operating Revenues

 

Operating revenues for the three months ended June 30, 2003, were $950,000 greater than those of the three months ended June 30, 2002.  The increase was due primarily to increased electric sales of $880,000 due to 2003 adjustments for power cost recovery and regulatory surcharge and $80,000 of new fee charges.

 

Operating Expenses

 

Operating expenses for the three months ended June 30, 2003, and 2002, were $14,622,000 and $15,791,000, respectively, a decrease of $1,169,000, for the following reasons:

 

Purchased power cost decreased by $1,054,000 due to lower contract prices.  Additionally, there was a decrease of $715,000 in general and administrative costs due to reduced legal and public reporting services, offset by an increase in maintenance and operations expenses of $489,000 due to more personnel time devoted to maintenance activities and fewer construction activities that result in capital cost.

 

Income Taxes

 

Current income tax expense was $678,000 in 2003.  The effective tax rate of 21% for the three months ended June 30, 2003, is lower than the statutory rate due to the nontaxable status of some of the entities and the reversal of a portion of the valuation allowance related to net operating loss carryforwards expected to be utilized by the Company in future periods.  There was no current income tax expense in 2002 due to utilization of net operating loss carryforwards.

 

Liquidity and Capital Resources

 

As of June 30, 2003, the Company had:

 

•                                          Cash and cash equivalents of $10,477,000;

•                                          Working capital of $721,000;

•                                          Long-term indebtedness of $145,910,000, net of current portion.

 

Historically, the Company’s primary sources of liquidity have been cash flows from operations and borrowings from CFC, the Company’s primary lender. These borrowings are collateralized by substantially all of the Company’s utility distribution assets. The existing long-term debt consists of a series of loans from CFC that impose various restrictive covenants, including the prohibition of additional secured indebtedness, or the guaranty of such, and requires the maintenance of a debt service coverage ratio as defined in the CFC loan agreements. In addition, the Company may not make any cash distribution or any general cancellation or abatement of charges for electric energy or services to its customers if the ratio of equity to total assets is less than a stated percentage. At December 31, 2002, the Company was in compliance with its CFC loan agreements or had obtained waivers of those covenants therein as they related to the conversion, issuance of equity credits and common stock.

 

As of June 30, 2003, the Company had utilized all available borrowing capacity under the CFC loan agreements. Historically, the majority of the Company’s distribution property additions have been financed with long-term borrowings from CFC. In order for the Company to meet its working capital needs, debt service requirements and planned capital expenditures, the following options may be available:

 

•                                          Securing financing from new sources;

•                                          Reducing short-term capital expenditures;

•                                          Selling or collateralizing non-strategic assets; and

•                                          Refinancing existing debt obligations.

 

Additionally, effective December 1, 2002, the Company converted its existing long-term debt from variable interest rates to one-year, two-year and three-year fixed rates in order to minimize its interest rate exposure.  Interest rates were fixed for the next three years at rates under 5%.  Approximately 10% of the note balances were fixed for one year, 60% for two years and 30% for 3 years.

 

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The Company has debt service payment obligations for the next 12 months as summarized below:

 

		Quarter ended
		September 30, 2003			December 31, 2003			March 31, 2004			June 30, 2004
Long-term debt payments		$	13,020		$	902		$	909		$	1,150
Capital lease payments		15,011			32			28			29
Total cash commitments		$	28,031		$	934		$	937		$	1,179

 

In December 2002, CFC approved the conversion of the prior line of credit for $28 million to a five year term loan.  The terms of the new arrangement include quarterly payments of approximately $233,000 based on a 30 year amortization schedule with a final balloon payment at the end of year five, initial principal payment deferral of one year and a fee of $210,000.  The execution and delivery of the new loan documents was completed in May 2003, with a fixed interest rate of 4.3% for four years.

 

The Company has notes receivable from United Fuel and Energy Corporation, who is currently in negotiations with lenders in order to obtain financing that would provide funds to allow it to fully repay the Company’s notes receivable.  These proceeds will be used to satisfy the cross-collateralized note payable of the same amount included in the table above.  Both the notes receivable and note payable have been modified and extended with  new maturity dates in September 2003, and the balance for both at maturity is $11.9 million.  In the event United Fuel is not successful in obtaining financing for the entire balance, the Company has an additional option available. United Fuel, or its shareholders who have provided the Company with personal guarantees of the notes receivable, would pay down the notes and provide funds to the Company such that the Company would together with its cash flow from operations, be able to satisfy its debt obligations as they become due in the third quarter of 2003.

 

The Company believes cash generated from normal operations will be sufficient to service the remaining debt obligations listed in the table above, which includes the transmission system capital lease balloon payment of approximately $14 million due in the third quarter of 2003.  This capital lease balloon payment will be offset by sinking fund monies of over $8 million at September 2003.  The current sinking fund balance of $8,103,000 is reflected in Other current assets.

 

One of the Company’s subsidiaries, NewCorp Resources Electric Cooperative, Inc. (“NewCorp”), owns a 305 mile transmission system in West Texas.  Even though, as described above, there is sufficient cash flow to satisfy debt obligations, the Company is currently negotiating with Beal Bank S.S.B. (“Beal Bank”) for a loan collateralized by NewCorp’s transmission system.  While a commitment letter with Beal Bank has not been executed at this time, NewCorp submitted an application to the Federal Energy Regulatory Commission (“FERC”) on July 25, 2003, seeking authorization to borrow $31.5 million.  This refinancing will not result in any increase in rates to transmission customers.  If FERC approval is received and the loan is consummated, the proceeds of the loan will be used to make the final balloon payment due on the transmission capital lease; establish cash reserves for operations and maintenance of the transmission system, as well as working capital; allow NewCorp to purchase transmission assets from Cap Rock Energy Corporation; and pay all costs and expenses associated with the loan.  The proposed loan is subject to additional conditions such as completion of due diligence by Beal Bank and preparation of all loan and collateral documents.  The financing arrangements will allow the Company to make system upgrades, improvements and expansions as may be necessary.

 

Historically, revenues from sales of electricity have been based upon Board approved rates for power distribution.  As the Company comes under the oversight authority of the Public Utility Commission of Texas (“PUCT”) effective September 1, 2003, the rates and fees charged to customers by the Company will be subject to PUCT approval, and will be cost based rates with an approved rate of return.  We are unable to predict the outcome of any rate proceedings mandated by the PUCT, but a significant change in the rate structure could have a material impact on our financial condition and cash flows from operations.

 

Commencing one year from the date of the distribution of the Company’s common stock to the former members of the Cooperative in connection with the conversion plan and ending 60 days thereafter, the Company  offered to purchase at a price of $10 per share all of its shares of common stock that were distributed in connection with the Plan.  Shares of the Company’s common stock were originally distributed to certain former members of the Cooperative who elected to receive shares of stock as payment for their equity and membership interest in the Cooperative.  Pursuant to the conversion plan, the Company made a commitment to purchase those shares, held continuously by the original owners of record until the first

 

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anniversary of the distribution of the shares at a price of $10 per share if the Company had sufficient cash available to purchase all shares tendered.  The Company’s original purchase commitment was only to those shareholders who were the original holders of record, and who had held those shares continuously until the first anniversary of the distribution of the shares.  In an effort to be inclusive, rather than exclusive, the Company made the offer to all shareholders and extended the offering period beyond the original 60 days.  The offering period began February 5, 2003, and  ended April 30, 2003, with 82,140 shares of common stock  tendered to and accepted by the Company at $10 per share, totaling $821,400.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Market risk represents the risk of changes in the value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign currency exchange rates, prices of commodities and equity price risks.

 

Commodity Price Risk

 

All purchases of electricity are pursuant to long-term wholesale electric power contracts based on a fixed price for kWh usage, transportation and auxiliary services and a variable charge for fuel cost, which is generally natural gas. All of the actual costs associated with the purchase of electricity are able to be recovered from billings to our customers, which mitigates most of the risk of variations in gas costs.

 

In the first quarter of 2001, the Company entered into two derivative transactions to fix a portion of the natural gas component of the related power costs over the next twelve months to minimize the fluctuations in their customer’s power bills. These transactions fixed the price on approximately 35,000 to 260,000 MMBtus of natural gas at fixed prices ranging from $3.79 to $5.31 an MMBtu. All payments made or received in connection with these transactions were collected or rebated to the customers through the power cost recovery component of the customers’ power bills.  The last derivative contract expired in May 2002.  The Company may use this type of instrument from time to time to manage costs for its customers.

 

Regulatory Risk

 

All revenues from sales of electricity are based upon Board approved rates for power distribution.  As the Company comes under the oversight authority of the PUCT, the rates and fees charged to customers by the Company will be subject to PUCT approval, and will be cost based rates with an approved rate of return.

 

Credit Risk

 

The Company’s concentrations of credit risk consist primarily of cash, trade accounts receivable, sales concentrations with certain customers and a note receivable from a third party.

 

Credit risk with financial institutions is considered minimal because of the number and various physical locations of different financial institutions utilized.  The Company has utilized repurchase agreements, and may consider using that vehicle again in the future to maximize return and minimize credit risk.

 

The Company conducts credit evaluations of new customers and assesses the need for a deposit by that customer.  The deposit amount is normally set as 1/6 of an annual customer billing, with such amounts being refunded or credited to the customer after one year if they have paid timely at least 10 of the last 12 billings.  No customer accounted for 10% or more of operating revenues of the Company.

 

In connection with an investment in United Fuel and Energy Corporation, the Company has a note receivable from United Fuel with a current balance of $11,975,000, with a final balloon payment due in September 2003.  The interest rate is variable, and is tied to the interest rate on the Company’s note payable to a bank.

 

Interest Rate Risk

 

We are subject to market risk associated with interest rates on our CFC long-term indebtedness.  The Company’s mortgage debt with CFC allows for a change from variable rate to fixed rate with no additional fees.  In order to take advantage of the interest rate environment in late 2002 as well as employ an interest rate management strategy, the Company fixed the interest rates on $11,525,000 of its debt at 3.35% for a period of one year, on $70,519,000 at 4.20% for a period of two years and on $35,189,000 at 4.70% for a

 

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period of three years.  During the three months ended June 30, 2003, the Company fixed $28,000,000 at 4.3% for four years  and $6,167,000 at 4.5%.

 

Market risk is also associated with the variable interest rate on the note payable to a bank.  This risk is mitigated by the variable interest rate on the cross-collateralized note receivable from United Fuel.

 

Company Purchase Commitment

 

Shares of the Company’s common stock were originally distributed to certain former members of the Cooperative who elected to receive shares of stock as payment for their equity and membership interest in the Cooperative.  Pursuant to the terms of the conversion plan, the Company made a commitment to offer to purchase those shares, held continuously by the original owners of record until the first anniversary of the distribution of the shares at a price of $10 per share if the Company had sufficient cash available to purchase all shares tendered.  Although the original purchase commitment was only to original holders, the Company, in its desire to be inclusive rather than exclusive, extended the offer to all shareholders.  The offering period began February 5, 2003, and ended April 30, 2003, with 82,140 shares of common stock tendered to and accepted by the Company at $10 per share, totaling $821,400.  At June 30, 2003, such amount is shown as Treasury stock within the Stockholders’ equity section of the balance sheet.

 

Item 4.  Controls and Procedures

 

Within the 90-day period prior to the date of this report, an evaluation was carried out, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934.  Based upon that evaluation, the chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective, subject to the limitations below, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

The Company, including its CEO and CFO, does not expect that the Company’s disclosure and internal controls and procedures will prevent or detect all error and all fraud.  A control system, no matter how well  conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of a control system are met.

 

PART II.  OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Other than certain legal proceedings arising in the ordinary course of business, litigation arising out of the Company’s proposed acquisition of Lamar County Electric Cooperative Association, litigation involving every utility that provides or receives transmission services in the state and a threat of a derivative lawsuit by one or more former members of the cooperative, none of which management believes will have a material adverse impact on the results of operations or financial condition of the Company, there is no other litigation pending or threatened against the Company.

 

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Item 6.  Exhibits and Reports on Form 8-K.

 

	(a)	Exhibits
		31.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		31.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer).
		32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer).
	(b)	Reports on Form 8-K
		The following reports on Form 8-K were filed either during the three months ended June 30, 2003, or between June 30, 2003, and the date of this report:
			1.	April 14, 2003, Item 9. Regulation FD Disclosure.  RE:  Disclosure of 2002 year-end financial results.
			2.	April 17, 2003, Item 9. Regulation FD Disclosure. RE:  Announcement that the Texas Senate had passed SB 1280 on April 15, 2003.
			3.	May 19, 2003, Item 9. Regulation FD Disclosure.  RE:  Disclosure of financial results for the quarter ended March 31, 2003.
			4.	May 20, 2003, Item 9. Regulation FD Disclosure.  RE:  Announcement that the Texas House of Representatives had passed SB 1280 on May 16, 2003.
			5.	June 25, 2003, Item 9. Regulation FD Disclosure.  RE:  Announced that Texas Governor Rick Perry had signed SB 1280 on June 22, 2003.
			6.	June 27, 2003, Item 9. Regulation FD Disclosure.  RE: Announcement of Employee Grants of Restricted Stock Awards.
			7.	July 15, 2003, Item 5. Other Events. RE: Announcement of the date of Annual Meeting of Shareholders and record date for voting at the annual meeting.
			8.	August 12, 2003 Item 5.  Other Events. RE:  Announcement of the transfer of the Certificate of Convenience and Necessity.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	CAP ROCK ENERGY CORPORATION
August  19, 2003
	/s/ Lee D. Atkins
	Lee D. Atkins
	Senior Vice President and Chief Financial Officer

 

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Exhibit Number		Description of Document
31.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
31.2		Certification of Chief Financial Officer Pursuant to U.S.C. Section 1350, As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer). *
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer). *

 

* filed herewith

 

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