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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