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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 September 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 November 7, 2002, 33,574,515 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. Nature of Operations and Basis of Accounting Presentation.......10
Note 2. Regulatory Accounting...........................................10
Note 3. Accounting for Derivative Instruments, Trading Activities
and Hedging Activities........................................11
Note 4. Millennium Energy Businesses....................................12
Note 5. Business Segments...............................................14
Note 6. Capital Leases and Investments in Lease Debt and Equity.........15
Note 7. Commitments and Contingencies...................................15
Note 8. Wholesale Accounts Receivable and Allowances....................16
Note 9. Income Taxes....................................................16
Note 10. UniSource Energy Earnings Per Share (EPS).......................17
Note 11. Change in Depreciable Asset Lives...............................18
Note 12. Coal Contract Termination Fee...................................18
Note 13. Asset Purchase Agreements.......................................18
Note 14. New Accounting Pronouncements...................................19
Note 15. Review by Independent Accountants...............................19
Item 2. - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview.................................................................20
Asset Purchase Agreements................................................21
Factors Affecting Results of Operations
Sales to Mining Customers..............................................22
Competition............................................................22
Industry Restructuring.................................................23
Western Energy Markets.................................................25
Market Risks...........................................................26
Generating Resources...................................................29
Future Generating Resources............................................29
Critical Accounting Policies.............................................30
Results of Operations....................................................32
Results of Millennium Energy Businesses..................................36
Results of UED...........................................................37
Dividends on Common Stock................................................37
TABLE OF CONTENTS
(concluded)
Liquidity and Capital Resources
Overall Liquidity......................................................37
Cash Flows
UniSource Energy.....................................................38
TEP..................................................................39
Investing and Financing Activities
UniSource Energy.....................................................39
TEP..................................................................39
Millennium...........................................................41
UED..................................................................42
Safe Harbor for Forward-Looking Statements...............................42
Item 3. - Quantitative and Qualitative Disclosures About Market Risk.......44
Item 4. - Controls and Procedures..........................................44
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings................................................45
Item 5. - Other Information
Additional Financial Data..............................................46
Approval of Non-Audit Services.........................................46
SEC Reports Available on UniSource Energy's Website....................46
Item 6. - Exhibits and Reports on Form 8-K.................................46
Signature Page.............................................................47
Certification Pursuant to Section 302 of the Sarabanes-Oxley Act...........48
Exhibit Index..............................................................52
DEFINITIONS
The abbreviations and acronyms used in the 2002 Third 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.
Citizens..................... Citizens Communications Company.
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 was a participant.
Emission Allowance(s)........ An Environmental Protection Agency-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.
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., was merged
into Global Solar as a result of the letter
agreement signed April 3, 2002.
Global Solar................. Global Solar Energy, Inc., a company that
develops and manufactures thin-film
photovoltaic cells. As a result of a letter
agreement signed April 3, 2002, Millennium
will own at least 81% of Global Solar.
IPS.......................... Infinite Power Solutions, Inc., a company that
develops thin-film batteries. As a result
of a letter agreement signed April 3, 2002,
Millennium will own at least 70% of IPS.
IRS.......................... Internal Revenue Service.
Irvington.................... Irvington Generating Station.
ISO.......................... Independent System Operator.
ITN.......................... ITN Energy Systems, Inc., a company owned 9%
by Millennium, which was formed to provide
research, development, and other services.
kWh.......................... Kilowatt-hour(s).
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which manages
and trades emission allowances, coal, and
related financial instruments.
MicroSat..................... MicroSat Systems, Inc., a company owned 35% by
Millennium, which was formed to develop and
commercialize small-scale satellites.
Millennium................... Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
MW........................... Megawatt(s).
MWh.......................... Megawatt-hour(s).
NOPR......................... Notice of Proposed Rulemaking; a notice issued
by the FERC proposing standard market design
rules for wholesale electricity, transmission,
and ancillary services in the United States.
PG&E......................... Pacific Gas and Electric Company.
Powertrusion................. Powertrusion International, Inc.
Revolving Credit Facility.... $100 million revolving credit facility entered
into under the Credit Agreement between a
syndicate of banks and TEP.
DEFINITIONS
(concluded)
RTO.......................... Regional Transmission Organization.
Rules........................ Retail Electric Competition Rules.
San Juan..................... San Juan Generating Station.
San Juan Unit 1.............. Unit 1 of the San Juan Generating Station, which
is 50% owned by TEP.
San Juan Unit 2.............. Unit 2 of the San Juan Generating Station, which
is 50% owned by TEP.
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 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
engages in developing generation resources and
other project development services and related
activities.
UniSource Energy............. UniSource Energy Corporation.
WestConnect.................. The 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 September
30, 2002, and the related condensed consolidated statements of income for
each of the three-month and nine-month periods ended September 30, 2002 and
2001 and the condensed consolidated statements of stockholders' equity for
the nine-month period ended September 30, 2002, and the condensed
consolidated statements of cash flows for the nine-month periods ended
September 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
November 1, 2002
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $214,432 $212,108
Electric Wholesale Revenues 41,125 206,913
Net Gain (Loss) on TEP Forward Contracts and MEG
Trading Activities 375 (2,916)
Other Revenues 2,614 4,284
- -------------------------------------------------------------------------------
Total Operating Revenues 258,546 420,389
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 58,422 67,807
Purchased Power 23,345 202,419
Coal Contract Termination Fee 11,250 -
Other Operations and Maintenance 46,668 42,825
Depreciation and Amortization 31,107 30,401
Amortization of Transition Recovery Asset 10,790 9,627
Taxes Other Than Income Taxes 11,753 12,034
- -------------------------------------------------------------------------------
Total Operating Expenses 193,335 365,113
- -------------------------------------------------------------------------------
Operating Income 65,211 55,276
- -------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 5,231 3,566
Other Income (Deductions) (239) 9,268
- -------------------------------------------------------------------------------
Total Other Income (Deductions) 4,992 12,834
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,225 14,996
Interest on Capital Leases 21,905 22,919
Other Interest Expense 2,047 1,871
- -------------------------------------------------------------------------------
Total Interest Expense 38,177 39,786
- -------------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 32,026 28,324
Income Tax Expense 9,207 12,776
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 22,819 15,548
Cumulative Effect of Accounting Change - Net of Tax - -
- -------------------------------------------------------------------------------
Net Income $ 22,819 $ 15,548
===============================================================================
Average Shares of Common Stock Outstanding (000) 33,692 33,472
===============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.68 $0.46
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.68 $0.46
===============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.67 $0.45
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.67 $0.45
===============================================================================
Dividends Paid per Share $0.125 $0.10
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $521,064 $518,452
Electric Wholesale Revenues 125,911 567,657
Net Gain (Loss) on TEP Forward Contracts and
MEG Trading Activities 936 4,253
Other Revenues 9,033 11,158
- -------------------------------------------------------------------------------
Total Operating Revenues 656,944 1,101,520
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 164,937 203,900
Purchased Power 46,909 419,251
Coal Contract Termination Fee 11,250 -
Other Operations and Maintenance 140,890 147,450
Depreciation and Amortization 96,075 88,451
Amortization of Transition Recovery Asset 20,311 17,464
Taxes Other Than Income Taxes 34,704 35,870
- -------------------------------------------------------------------------------
Total Operating Expenses 515,076 912,386
- -------------------------------------------------------------------------------
Operating Income 141,868 189,134
- -------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 14,913 11,293
Other Income (Deductions) 83 5,408
- -------------------------------------------------------------------------------
Total Other Income (Deductions) 14,996 16,701
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 42,649 46,672
Interest on Capital Leases 65,778 68,307
Other Interest Expense 6,383 4,995
- -------------------------------------------------------------------------------
Total Interest Expense 114,810 119,974
- -------------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 42,054 85,861
Income Tax Expense 13,661 38,264
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 28,393 47,597
Cumulative Effect of Accounting Change - Net of Tax - 470
- -------------------------------------------------------------------------------
Net Income $ 28,393 $ 48,067
===============================================================================
Average Shares of Common Stock Outstanding (000) 33,665 33,360
===============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.84 $1.43
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income $0.84 $1.44
===============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.83 $1.39
Cumulative Effect of Accounting Change - Net of Tax - $0.01
Net Income $0.83 $1.40
===============================================================================
Dividends Paid per Share $0.375 $0.30
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $550,291 $542,747
Cash Receipts from Electric Wholesale Sales 191,468 575,613
Interest Received 13,018 13,246
MEG Cash Receipts from Trading Activity 41,734 -
MEG Performance Deposits 4,632 371
Other Cash Receipts 18,119 15,928
Fuel Costs Paid (157,179) (213,890)
Purchased Power Costs Paid (108,875) (387,877)
Wages Paid, Net of Amounts Capitalized (57,378) (52,809)
Payment of Other Operations and Maintenance Costs (93,984) (102,544)
Capital Lease Interest Paid (68,329) (78,861)
Taxes Paid, Net of Amounts Capitalized (69,040) (68,104)
Interest Paid, Net of Amounts Capitalized (52,925) (56,506)
Income Taxes Paid (10,416) (30,259)
MEG Cash Payments for Trading Activity (46,039) -
Coal Contract Termination Fee (11,250) -
Other Cash Payments (7,692) (5,411)
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 136,155 151,644
- -------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (81,728) (95,202)
Investments in and Loans to Equity Investees (28,553) (19,101)
Proceeds from the Sale of Millennium
Energy Businesses - 16,631
Proceeds from the Sale of Real Estate - 6,580
Purchase of Springerville Lease Debt and Equity (134,989) -
Other 4,866 (2,968)
- -------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (240,404) (94,060)
- -------------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayments of Long-Term Debt (1,879) (1,871)
Payments on Capital Lease Obligations (19,620) (25,894)
Common Stock Dividends Paid (12,602) (10,021)
Other 2,808 7,744
- -------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (31,293) (30,042)
- -------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (135,542) 27,542
Cash and Cash Equivalents, Beginning of Year 228,154 163,004
- -------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 92,612 $190,546
===============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -------------------------------------------------------------------------------
Net Income $ 28,393 $ 48,067
Adjustments to Reconcile Net Income to Net Cash Flows
Depreciation and Amortization Expense 96,075 88,451
Depreciation Recorded to Fuel and Other Operations
and Maintenance Expense 4,190 4,442
Amortization of Transition Recovery Asset 20,311 17,464
Net Unrealized Gain on TEP Forward Contracts and MEG
Trading Activities (1,206) (4,723)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 1,428 1,507
Deferred Income Taxes 14,521 7,961
Losses of Unconsolidated Affiliates 3,888 10,205
Gain on Sale of Nations Energy's Holdings - (10,737)
Other (5,607) (13,201)
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 18,114 (26,024)
Materials and Fuel 705 (1,383)
Accounts Payable (40,011) 37,971
Interest Accrued (9,817) (18,349)
Taxes Accrued 7,728 11,791
Other Current Assets 2,640 (5,213)
Other Current Liabilities (4,263) (4,274)
Other Deferred Assets (7,669) (2,898)
Other Deferred Liabilities 6,735 10,587
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities $136,155 $151,644
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,571,739 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 63,618 70,992
- -------------------------------------------------------------------------------
Total Utility Plant 3,382,452 3,310,484
Less Accumulated Depreciation and Amortization (1,326,579) (1,270,089)
Less Accumulated Depreciation of Capital Lease
Assets (384,536) (362,724)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,671,337 1,677,671
- -------------------------------------------------------------------------------
Investments and Other Property 313,751 182,747
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 92,612 228,154
Accounts Receivable - Net 96,666 119,646
Materials and Fuel 43,758 45,052
Deferred Income Taxes - Current 7,392 11,165
Current Regulatory Assets 9,912 11,392
Other 29,534 30,891
- -------------------------------------------------------------------------------
Total Current Assets 279,874 446,300
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 311,363 331,674
Income Taxes Recoverable Through Future Revenues 58,506 64,239
Other Regulatory Assets 10,287 9,072
Other Assets 41,450 35,014
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 421,606 439,999
- -------------------------------------------------------------------------------
Total Assets $2,686,568 $2,746,717
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 441,496 $ 424,722
Capital Lease Obligations 801,750 853,793
Long-Term Debt 800,669 802,804
- -------------------------------------------------------------------------------
Total Capitalization 2,043,915 2,081,319
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 43,237 20,158
Current Maturities of Long-Term Debt 330,448 330,424
Accounts Payable 44,104 84,011
Interest Accrued 32,482 53,300
Taxes Accrued 42,870 36,633
Accrued Employee Expenses 13,784 13,577
Other 28,348 16,768
- -------------------------------------------------------------------------------
Total Current Liabilities 535,273 554,871
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 48,522 43,507
Other 58,858 67,020
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 107,380 110,527
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,686,568 $2,746,717
===============================================================================
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 - - 28,393 - 28,393
---------
Total Comprehensive
Income 28,393
---------
Shares Issued under
Stock Compensation
Plans 8 75 - - 75
Shares Distributed by
Deferred Compensation
Trust 3 45 - - 45
Shares Issued for
Stock Options 60 864 - - 864
Dividends Declared - - (12,603) - (12,603)
- -------------------------------------------------------------------------------
Balances at
September 30, 2002 33,573 $661,107 $(219,611) $ - $441,496
===============================================================================
*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
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $214,432 $212,108
Electric Wholesale Revenues 41,125 206,913
Net Unrealized Gain (Loss) on Forward Electric
Sales and Purchases 85 (2,916)
Other Revenues 1,380 2,105
- -------------------------------------------------------------------------------
Total Operating Revenues 257,022 418,210
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 58,422 67,807
Purchased Power 23,345 202,419
Coal Contract Termination Fee 11,250 -
Other Operations and Maintenance 39,712 37,497
Depreciation and Amortization 30,203 29,047
Amortization of Transition Recovery Asset 10,790 9,627
Taxes Other Than Income Taxes 11,467 11,736
- -------------------------------------------------------------------------------
Total Operating Expenses 185,189 358,133
- -------------------------------------------------------------------------------
Operating Income 71,833 60,077
- -------------------------------------------------------------------------------
Other Income
Interest Income 5,159 3,107
Interest Income - Note Receivable from UniSource
Energy 2,352 2,351
Other Income 1,651 349
- -------------------------------------------------------------------------------
Total Other Income 9,162 5,807
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 14,225 14,996
Interest on Capital Leases 21,885 22,907
Other Interest Expense 1,931 1,858
- -------------------------------------------------------------------------------
Total Interest Expense 38,041 39,761
- -------------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 42,954 26,123
Income Tax Expense 16,392 11,683
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 26,562 14,440
Cumulative Effect of Accounting Change - Net of Tax - -
- -------------------------------------------------------------------------------
Net Income $ 26,562 $ 14,440
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Operating Revenues
Electric Retail Revenues $ 521,064 $ 518,452
Electric Wholesale Revenues 125,911 567,657
Net Unrealized Gain (Loss) on Forward Electric
Sales and Purchases 807 4,253
Other Revenues 5,179 4,526
- -------------------------------------------------------------------------------
Total Operating Revenues 652,961 1,094,888
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 164,937 203,900
Purchased Power 46,909 419,251
Coal Contract Termination Fee 11,250 -
Other Operations and Maintenance 123,605 131,499
Depreciation and Amortization 93,048 85,992
Amortization of Transition Recovery Asset 20,311 17,464
Taxes Other Than Income Taxes 33,735 34,955
- -------------------------------------------------------------------------------
Total Operating Expenses 493,795 893,061
- -------------------------------------------------------------------------------
Operating Income 159,166 201,827
- -------------------------------------------------------------------------------
Other Income
Interest Income 14,388 8,956
Interest Income - Note Receivable from UniSource
Energy 6,978 6,978
Other Income 3,165 2,264
- -------------------------------------------------------------------------------
Total Other Income 24,531 18,198
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 42,649 46,672
Interest on Capital Leases 65,726 68,267
Other Interest Expense 5,856 4,982
- -------------------------------------------------------------------------------
Total Interest Expense 114,231 119,921
- -------------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 69,466 100,104
Income Tax Expense 27,367 43,719
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 42,099 56,385
Cumulative Effect of Accounting Change - Net of Tax - 470
- -------------------------------------------------------------------------------
Net Income $ 42,099 $ 56,855
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
- Thousands of Dollars -
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $550,291 $542,747
Cash Receipts from Electric Wholesale Sales 191,468 575,613
Interest Received 12,527 10,736
Fuel Costs Paid (157,179) (213,890)
Purchased Power Costs Paid (108,875) (387,877)
Wages Paid, Net of Amounts Capitalized (45,745) (46,079)
Payment of Other Operations and Maintenance Costs (78,967) (80,193)
Capital Lease Interest Paid (68,276) (78,824)
Taxes Paid, Net of Amounts Capitalized (65,526) (65,403)
Interest Paid, Net of Amounts Capitalized (52,902) (56,531)
Income Taxes Paid (10,306) (30,318)
Coal Contract Termination Fee (11,250) -
Other 93 690
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 155,353 170,671
- -------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (72,181) (78,957)
Purchase of North Loop Gas Turbine from UED (14,853) -
Proceeds from the Sale of Real Estate - 6,580
Purchase of Springerville Lease Debt and Equity (134,989) -
Other 3,943 (5,950)
- -------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (218,080) (78,327)
- -------------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayments of Long-Term Debt (1,879) (1,871)
Dividends Paid to UniSource Energy (10,000) -
Payments on Capital Lease Obligations (19,384) (25,802)
Other 2,194 2,940
- -------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (29,069) (24,733)
- -------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (91,796) 67,611
Cash and Cash Equivalents, Beginning of Year 159,680 88,712
- -------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 67,884 $156,323
===============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -------------------------------------------------------------------------------
Net Income $ 42,099 $ 56,855
Adjustments to Reconcile Net Income to Net Cash Flows
Depreciation and Amortization Expense 93,048 85,992
Depreciation Recorded to Fuel and Other Operations
and Maintenance Expense 4,190 4,442
Amortization of Transition Recovery Asset 20,311 17,464
Net Unrealized Gain on Forward Electric Sales and
Purchases (807) (4,723)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 1,428 1,507
Deferred Income Taxes 25,557 14,805
Losses of Unconsolidated Affiliates 279 1,530
Interest on Note Receivable from UniSource Energy (6,978) (6,978)
Other 701 (1,874)
Changes in Assets and Liabilities which Provided
(Used) Cash Exclusive of Changes Shown Separately
Accounts Receivable 20,378 (25,752)
Materials and Fuel 1,338 (757)
Accounts Payable (39,080) 35,972
Interest Accrued (9,817) (18,349)
Taxes Accrued 9,702 10,297
Other Current Assets (4,981) 665
Other Current Liabilities (420) (2,721)
Other Deferred Assets (7,669) (4,606)
Other Deferred Liabilities 6,074 6,902
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities $155,353 $170,671
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
(Unaudited)
- -------------------------------------------------------------------------------
ASSETS - Thousands of Dollars -
Utility Plant
Plant in Service $2,571,739 $2,498,046
Utility Plant Under Capital Leases 747,095 741,446
Construction Work in Progress 63,618 70,992
- -------------------------------------------------------------------------------
Total Utility Plant 3,382,452 3,310,484
Less Accumulated Depreciation and Amortization (1,326,579) (1,270,089)
Less Accumulated Depreciation of Capital Lease
Assets (384,536) (362,724)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,671,337 1,677,671
- -------------------------------------------------------------------------------
Investments and Other Property 214,251 105,875
- -------------------------------------------------------------------------------
Note Receivable from UniSource Energy 77,110 70,132
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 67,884 159,680
Accounts Receivable - Net 100,166 124,487
Materials and Fuel 41,755 43,682
Deferred Income Taxes - Current 7,392 4,603
Current Regulatory Assets 9,912 11,392
Other 13,070 7,814
- -------------------------------------------------------------------------------
Total Current Assets 240,179 351,658
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 311,363 331,674
Income Taxes Recoverable Through Future Revenues 58,506 64,239
Other Regulatory Assets 10,287 9,072
Other Assets 41,450 35,014
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 421,606 439,999
- -------------------------------------------------------------------------------
Total Assets $2,624,483 $2,645,335
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 354,829 $ 322,471
Capital Lease Obligations 801,083 853,447
Long-Term Debt 800,199 801,924
- -------------------------------------------------------------------------------
Total Capitalization 1,956,111 1,977,842
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations Under Capital Leases 42,855 19,971
Current Maturities of Long-Term Debt 330,325 330,325
Accounts Payable 50,113 89,193
Interest Accrued 32,482 53,300
Taxes Accrued 41,955 33,744
Accrued Employee Expenses 13,410 13,078
Other 22,754 7,194
- -------------------------------------------------------------------------------
Total Current Liabilities 533,894 546,805
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 79,519 56,906
Other 54,959 63,782
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 134,478 120,688
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 7)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $2,624,483 $2,645,335
===============================================================================
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 - - 42,099 - 42,099
---------
Total Comprehensive Income 42,099
---------
Dividend Declared - - (10,000) - (10,000)
Other 259 - - - 259
- -------------------------------------------------------------------------------
Balances at
September 30, 2002 $ 653,509 $ (6,357) $(292,323) $ - $ 354,829
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
NOTE 1. NATURE OF OPERATIONS AND BASIS OF ACCOUNTING PRESENTATION
- ------------------------------------------------------------------
UniSource Energy Corporation (UniSource Energy) is an exempt holding
company under the Public Utility Holding Company Act of 1935. UniSource
Energy has no significant operations of its own, but holds the stock of Tucson
Electric Power Company (TEP), Millennium Energy Holdings, Inc. (Millennium)
and UniSource Energy Development Company (UED). TEP, a regulated public
utility incorporated in Arizona in 1963, is UniSource Energy's largest
operating subsidiary and represents substantially all of UniSource Energy's
assets. TEP generates, transmits and distributes electricity. TEP serves
retail customers in a 1,155 square mile area in Southern Arizona. TEP also
sells electricity to other utilities and power marketing entities primarily
located in the Western United States. Millennium holds the energy-related
businesses described in Note 4 and UED's services are described in Note 5.
References to "we" and "our" are to UniSource Energy and its
subsidiaries, collectively. References to the "utility business" are to TEP.
The accompanying quarterly financial statements of UniSource Energy and
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) for annual financial
statements. The year-end condensed balance sheet data was derived from
audited financial statements, but does not include disclosures required by
GAAP for annual financial statements. 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 (see Note 3). 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, TEP
discontinued application of FAS 71 to its generation operations.
TEP continues to apply FAS 71 to the distribution and transmission
portions of its business, its regulated operations, and periodically assesses
whether it can continue to apply FAS 71 to these operations. If TEP stopped
applying FAS 71 to its remaining regulated operations, it would write off the
related balances of its regulatory assets as an expense on its income
statement. Based on the balances of TEP's regulatory assets at September 30,
2002, if TEP had stopped applying FAS 71 to its remaining regulated
operations, it would have recorded an extraordinary loss, after-tax, of
approximately $236 million. While regulatory orders and market conditions may
affect TEP's cash flows, its cash flows would not be affected if it stopped
applying FAS 71.
NOTE 3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITES AND HEDGING
ACTIVITIES
- ------------------------------------------------------------------------------
On January 1, 2001, TEP recorded a $0.5 million after-tax gain in its
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. Some
of these forward contracts are considered to be derivatives.
Millennium Environmental Group, Inc. (MEG), a wholly-owned subsidiary of
Millennium, began operations in November 2001 and enters into swap agreements,
options and forward contracts relating to emission allowances and coal. MEG
follows the accounting guidance for energy-related trading activities under
EITF Issue No. 98-10 (EITF 98-10), Accounting for Contracts Involved in Energy
Trading and Risk Management Activities. The Emerging Issues Task Force
rescinded EITF 98-10 on October 25, 2002, requiring mark-to-market accounting
in the future for only those energy-related trading contracts within the scope
of FAS 133. This will have no effect on TEP since TEP is not engaged in
"trading" activities as defined in EITF 98-10, and we do not expect the impact
to MEG to be material to the financial statements.
Under FAS 133, TEP records unrealized gains and losses on its derivative
forward contracts and adjusts the related assets and liabilities on a monthly
basis to reflect the market prices at the end of the month. Similarly, under
EITF 98-10, MEG records unrealized gains and losses on its trading activities
and adjusts 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 and trading activities
are estimated based on various factors including broker quotes, exchange
prices, over the counter prices and time value.
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 for financial statements issued after July 15, 2002, and
requires financial statements for all comparative periods to be reclassified
to conform to the new presentation. MEG adopted the new guidance on July 1,
2002 for its trading activity and reclassified its net realized gains and
losses from Other Revenue into a single line in Operating Revenue. The impact
of MEG adopting the new guidance was immaterial to the financial statements.
The new guidance does not apply to TEP.
TEP's derivative activity and MEG's trading activity are now reported as
follows:
- TEP's unrealized gain/loss on forward sales and purchase contracts 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;
- MEG's unrealized gain/loss on trading activities is a component of
Operating Revenues; and
- MEG's realized gain/loss on trading activities is a component of
Operating Revenues.
MEG physically settled the following transaction volumes under its
trading contracts in 2002:
Three Months Nine Months
Ended Ended
September 30, 2002
-------------------------------------------------------------
Emission Allowances Purchased 78,450 284,075
Emission Allowances Sold 113,375 329,040
The net pre-tax gain on TEP's forward contracts and MEG's trading
activities for the three and nine months ended September 30, 2002, totaled
approximately $0.4 million and $0.9 million, respectively. At September 30,
2002, the fair value of TEP's derivative assets and MEG's trading assets
totaled $8.9 million, which is reported in Other Current Assets, and the fair
value of MEG's trading liabilities totaled $5.2 million, which is reported in
Other Current Liabilities. Our trading assets exceed our trading liabilities
primarily because at September 30, 2002, the fair value of MEG's forward sale
and purchase contracts at a gain (assets) exceeded the fair value of its
forward sale and purchase contracts at a loss (liabilities).
TEP treated certain forward sale and purchase contracts as cash flow
hedges when it 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. TEP 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, TEP 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 TEP's accounting for derivatives. As of September 30, 2002 and
December 31, 2001, TEP had no cash flow hedges and, therefore, its balance in
Accumulated Other Comprehensive Income was zero.
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. (ITN) collectively as Millennium's 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 its Energy
Technology Investments totaled $17.1 million during the first nine months of
2002.
On April 3, 2002, Millennium signed a letter agreement that facilitates
the change in the ownership structure of its Energy Technology Investments to
better align Millennium's ownership interest in these investments with its
business plans. Millennium retains its preferred shareholder and distribution
status. Under the letter agreement and related documents, Millennium:
- increases its ownership of Global Solar from 67% to at least 81%;
- increases its ownership of IPS from 67% to at least 70%;
- decreased its ownership of MicroSat from 49% to 35%;
- decreased its ownership of ITN from 49% to 9%; and
- provided an additional $1 million in equity contributions to ITN and will
provide additional contingent capital contributions of up to $0.5
million. Such contingent contributions are subject to Millennium's
approval of subsidiary business plans.
We anticipate that the Energy Technology Investments letter agreement
provisions will be finalized during the fourth quarter of 2002. Regardless of
ownership percentage, as the current 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 $3 million
and $7 million of its commitments to its Energy Technology Investments in the
fourth quarter of 2002. Including Millennium's unfunded commitments at
September 30, 2002 of approximately $7 million, Millennium expects to fund
between $11 million and $14 million to these investments in the next twelve
months. 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 Millennium 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.
If an Energy Technology Investment company receives funding from an external
investor and Millennium is no longer the sole funder of that company,
Millennium will stop recognizing 100% of the losses from operations of that
company and recognize only its percentage share based on its ownership
interest.
During the third quarter of 2002, Millennium and Dow Corning Corporation
(Dow Corning) signed a letter of intent regarding additional investments in
IPS. Under the letter of intent, both Millennium and Dow Corning will provide
additional funding to IPS in exchange for preferred shares of IPS. If the
transaction is consummated, Dow Corning would own approximately 15% of IPS and
would have future rights to preferred stock warrants based on established
milestones. Millennium would agree to fund an additional $2.5 million in the
form of cash and equipment and maintain a 70% share ownership.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment to a limited partnership
which funds energy related investments. As of September 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. During
2002, this venture capital fund merged with another fund that will focus on
investments in Arizona, Southern California, New Mexico, Colorado and Utah.
As a result, Millennium owns approximately 15% of the merged venture.
Millennium will use the cost method to account for this investment. Before
the merger, Millennium accounted for this investment under the equity method.
Another member of the UniSource Energy Board of Directors is a general partner
of the company that manages the fund. At September 30, 2002, Millennium had
funded approximately $1 million of the $5 million commitment. Millennium
expects to fund no more than $1 million in the fourth quarter of 2002.
Millennium owns a controlling 50.5% interest in Powertrusion
International, Inc. (Powertrusion), a manufacturer of lightweight utility
poles. During the third quarter of 2002, Millennium provided an additional $2
million of funding to maintain its controlling interest. In addition, during
the third quarter Millennium began recognizing 100% of Powertrusion's losses,
as it became the sole funder of Powertrusion's operations. Millennium's
remaining investment in Powertrusion at September 30, 2002 was $1.9 million.
On April 1, 2002, Millennium invested an additional $2 million in
TruePricing, Inc., 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
$1.4 million at September 30, 2002.
On July 15, 2002, Millennium invested $20 million in a company created to
develop up to 800 megawatts (MW) 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 the Mexican
electricity commission. Under certain circumstances, Millennium has the right
to sell 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.
NATIONS ENERGY CONTINGENCY
In September 2001, Nations Energy, a wholly-owned subsidiary of
Millennium, sold its 26% equity interest in a power project located in
Curacao, Netherland Antilles to a subsidiary of Mirant Corporation (Mirant).
Nations Energy received $5 million in cash proceeds and recorded an $11
million note receivable from the sale at its net present value of $8 million,
with the discount being amortized to interest income over the five-year life
of the note. The note is guaranteed by Mirant Americas, Inc., a subsidiary of
Mirant. Payments on the note receivable are expected as follows: $2 million
in July 2004, $4 million in July 2005, and $5 million in July 2006.
In October 2002, the major rating agencies downgraded the ratings of
Mirant and certain of its subsidiaries due to significantly lower operating
cash flow relative to its debt burden coupled with the likelihood that future
operating cash flow levels may weaken further. Their ratings are now below
investment grade. As of September 30, 2002, Nations Energy's receivable from
Mirant is approximately $9 million. We cannot predict what effect the
downgrade of Mirant will have on its ability to make its required payments to
Nations Energy when due, beginning in July 2004. Nations Energy has not
recorded an allowance for doubtful accounts and we will continue to evaluate
whether any further ratings events or actions by or to Mirant will impact the
collectibility of the receivable.
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) UED, established in 2001, engages in developing generating resources
and other project development activities. Prior to September 2002,
UED owned a 20 MW gas turbine, which it leased to TEP. In September
2002, UED sold the turbine to TEP for its net book value of $15
million. UED 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
September 30, 2002:
- ----------------------------------------------------------------------------
Operating
Revenues
- External $ 256,968 $ 1,578 $ - $ - $ 258,546
- ---------------------------------------------------------------------------
Operating
Revenues
- Intersegment 54 5,622 840 (6,516) -
- ---------------------------------------------------------------------------
Income (Loss)
Before Income
Taxes 42,954 (9,428) 852 (2,352) 32,026
- ---------------------------------------------------------------------------
Net Income
(Loss) 26,562 (2,828) 518 (1,433) 22,819
- ---------------------------------------------------------------------------
Three months ended
September 30, 2001:
- ----------------------------------------------------------------------------
Operating
Revenues
- External $ 418,088 $ 2,301 $ - $ - $ 420,389
- ---------------------------------------------------------------------------
Operating
Revenues
- Intersegment 122 5,741 840 (6,703) -
- ---------------------------------------------------------------------------
Income (Loss)
Before Income
Taxes 26,123 3,809 742 (2,350) 28,324
- ---------------------------------------------------------------------------
Net Income
(Loss) 14,440 2,076 446 (1,414) 15,548
- ---------------------------------------------------------------------------
Nine months ended
September 30, 2002:
- ----------------------------------------------------------------------------
Operating
Revenues
- External $ 652,576 $ 4,368 $ - $ - $ 656,944
- ---------------------------------------------------------------------------
Operating
Revenues
- Intersegment 385 12,578 2,520 (15,483) -
- ---------------------------------------------------------------------------
Income (Loss)
Before Income
Taxes 69,466 (22,184) 1,750 (6,978) 42,054
- ---------------------------------------------------------------------------
Net Income
(Loss) 42,099 (10,539) 1,061 (4,228) 28,393
- ---------------------------------------------------------------------------
Nine months ended
September 30, 2001:
- ----------------------------------------------------------------------------
Operating
Revenues
- External $1,094,539 $ 6,981 $ - $ - $1,101,520
- ---------------------------------------------------------------------------
Operating
Revenues
- Intersegment 349 9,554 1,120 (11,023) -
- ---------------------------------------------------------------------------
Income (Loss)
Before Income
Taxes and
Cumulative
Effect of
Accounting
Change 100,104 (8,288) 1,019 (6,974) 85,861
- ---------------------------------------------------------------------------
Cumulative
Effect of
Accounting
Change 470 - - - 470
- ---------------------------------------------------------------------------
Net Income
(Loss) 56,855 (5,206) 612 (4,194) 48,067
- ---------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
September 30,
2002 $2,624,483 $ 127,228 $ 30,752 $ (95,895) $2,686,568
Total Assets,
December 31,
2001 2,645,335 176,097 26,895 (101,610) 2,746,717
- ---------------------------------------------------------------------------
NOTE 6. CAPITAL LEASES AND INVESTMENTS IN LEASE DEBT AND EQUITY
- ----------------------------------------------------------------
TEP purchased a 13% ownership interest in the Springerville Coal Handling
Facilities Leases for $13 million in December 2001 and all $96 million of the
debt related to these capital leases in January 2002. In March 2002, TEP
terminated the lease related to its equity interest and cancelled the
associated debt. As a result of the lease termination, TEP recorded a $21
million reduction to the capital lease obligation, a $27 million reduction of
its investment in lease debt, and a $6 million increase in the capital lease
asset, which represents the residual value of TEP's interest in the leased
asset and is carried at cost. TEP's interest expense is reduced as a result
of these transactions.
In May 2002, TEP purchased $3 million and in September 2002, TEP
purchased another $33 million of Springerville Unit 1 lease debt. These
investments are included in Investments and Other Property on TEP's balance
sheet.
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 modifying 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 September 30, 2002, capitalized project development costs on UED's
balance sheet were approximately $16.1 million. We can make no assurances,
however, about the ultimate timing, or whether UED will proceed with this
project. 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. On
September 10, 2002, the U.S. District Court granted TEP's motion for summary
judgment on one of the primary issues in the case: whether TEP commenced
construction within 18 months and/or by March 19, 1979, after the original
1977 air permit covering Units 1 and 2 was issued. The case is presently
scheduled for trial in March 2003 on the remaining issues:(a) whether TEP
discontinued construction for a period of 18 months or longer or did not
complete construction in a reasonable period of time, and (b) whether TEP
commenced construction, for purposes of New Source Performance Standard
applicability, by September 18, 1978. TEP believes the claims are without
merit and will continue to vigorously contest them.
Litigation Related to San Juan Coal Company
-------------------------------------------
On July 30, 2002, Dugan Production Corp. (Dugan) filed a lawsuit against
the San Juan Coal Company, the coal supplier to the San Juan Generating
Station (San Juan). TEP owns 50% of San Juan Units 1 and 2, which equates to
19.8% of San Juan in total. The San Juan Coal Company, through leases with
the federal government and the State of New Mexico, owns coal interests with
respect to an underground mine. Dugan, through leases with the federal
government, the State of New Mexico and certain private parties, claims to own
certain oil and gas interests in portions of the land used for the underground
mine. Dugan alleges that San Juan Coal Company's underground coal mining
operations have or will interfere with Dugan's gas production and will result
in the dissipation of natural gas that it otherwise would be entitled to
recover. Dugan seeks a declaration by the court that the rights under its
leases are senior and superior to the rights of the San Juan Coal Company and
seeks to enjoin the underground mining of coal from a portion of the land used
for the underground mine as described above. Dugan also seeks monetary
damages.
The San Juan Coal Company has informed Public Service Company of New
Mexico (PNM) that it intends to strongly dispute the litigation. We cannot
predict the ultimate outcome of this litigation, or whether it will adversely
affect the amount of coal available or cost of coal to San Juan. We do not
expect resolution of this litigation to be material to TEP as a 19.8% owner of
San Juan.
Litigation Related to San Juan Generating Station
-------------------------------------------------
On May 16, 2002, the Grand Canyon Trust and the Sierra Club filed a
citizen lawsuit under the Clean Air Act in federal district court in New
Mexico against PNM as operator of San Juan. The lawsuit, which alleges two
violations of the Clean Air Act and related regulations and permits, seeks
penalties as well as injunctive and declaratory relief and is presently
scheduled for trial in June 2003. Based on its investigation to date, PNM has
stated that it firmly believes that the allegations are without merit, and
vigorously disputes the allegations. Only one of those allegations relates to
a unit in which TEP owns an interest. While we are unable to predict the
ultimate outcome of the lawsuit, we do not believe the outcome will be
material to TEP.
NOTE 8. WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- -----------------------------------------------------
At September 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 TEP 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
Federal Energy Regulatory Commission (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. In August
2002, the FERC staff proposed revised calculations to determine amounts due
from the CPX and the CISO, based on concern that natural gas prices were
manipulated. If we were to apply these proposed adjustments to amounts due to
TEP, TEP could receive as little as $4 million, plus interest, of the amounts
due from the CPX and the CISO. The FERC has not yet confirmed or rejected the
calculation proposed by its staff. Under earlier calculations proposed by the
FERC staff, TEP could receive up to $11 million plus interest. We cannot
predict the outcome of these issues or lawsuits. We believe, however, that
TEP is adequately reserved for its transactions with the CPX, the CISO and
Enron.
TEP's Accounts Receivable from Electric Wholesale Revenues, net of
allowances, totaled $27 million at September 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 September 30, 2002 receivable
balance has been collected as of the date of this filing.
NOTE 9. INCOME TAXES
- ---------------------
We record deferred tax liabilities for amounts that will increase income
taxes on future tax returns. We record deferred tax assets for amounts that
could be used to reduce income taxes on future tax returns. We record a
valuation allowance, or reserve, for the deferred tax asset amount that we may
not be able to use on future tax returns. We estimate the valuation allowance
based on our interpretation of the tax rules, prior tax audits, tax planning
strategies, scheduled reversal of deferred tax liabilities, and projected
future taxable income.
The valuation allowance of $15.4 million at September 30, 2002, which
reduces the Deferred Tax Asset balance, relates to net operating loss (NOL)
and investment tax credit (ITC) carryforward amounts. In the future if TEP
determines that TEP would be able to use all or a portion of these amounts on
tax returns, then TEP would reduce the reserve and recognize a tax benefit up
to $15.4 million. Factors that could cause TEP to recognize the tax benefit
include new or additional guidance through tax regulations, tax rulings, case
law and/or the use of such benefits on future tax returns.
In the third quarter of 2002, UniSource Energy and TEP recognized a tax
benefit of $1.3 million from the reduction of the valuation allowance based on
future use of ITC carryforward amounts. Additionally, UniSource Energy
recognized a tax benefit of $1.5 million as a result of final agreement with
the IRS on audit issues and a tax benefit of $1.0 million from recognition of
losses generated by the sale of a Nations Energy foreign entity in the third
quarter of 2002.
UniSource Energy and TEP's Cumulative Effect of Accounting Change for the
nine months ended September 30, 2001 is net of income tax expense of $312,000
(see Note 3). The differences between the Income Tax Expense lines on
UniSource Energy and TEP's 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 Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense at
Statutory Rate $ 11,209 $ 9,913 $ 14,719 $ 30,325
State Income Tax Expense,
Net of Federal Deduction 1,473 1,387 1,935 4,245
Depreciation Differences
(Flow Through Basis) 1,154 1,250 3,463 3,856
Tax Credits (553) - (2,472) -
Reduction in Valuation
Allowance - Benefit (1,300) - (1,300) -
Reduction in Deferred
Liability Due to IRS
Audit Outcomes (1,524) - (1,524) -
Foreign Losses Recognized (1,007) - (1,007) -
Other (245) 226 (153) 150
Tax on Cumulative Effect of
Accounting Change - - - (312)
- --------------------------------------------------------------------------
Total Federal and State Income
Tax Expense $ 9,207 $ 12,776 $ 13,661 $ 38,264
==========================================================================
TEP
---------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------
- Thousands of Dollars -
Federal Income Tax Expense at
Statutory Rate $ 15,034 $ 9,143 $ 24,313 $ 35,310
State Income Tax Expense,
Net of Federal Deduction 1,976 1,280 3,195 4,943
Depreciation Differences
(Flow Through Basis) 1,154 1,250 3,463 3,856
Tax Credits (553) - (2,472) -
Reduction in Valuation
Allowance - Benefit (1,300) - (1,300) -
Other 81 10 168 (78)
Tax on Cumulative Effect of
Accounting Change - - - (312)
- --------------------------------------------------------------------------
Total Federal and State Income
Tax Expense $ 16,392 $ 11,683 $ 27,367 $ 43,719
==========================================================================
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 Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
- ------------------------------------------------------------------------------
- In Thousands -
Denominator:
Average Shares of Common Stock
Outstanding 33,692 33,472 33,665 33,360
Effect of Dilutive Securities:
Warrants 26 123 102 180
Options and Stock Issuable
Under Employee Benefit Plans 397 642 514 676
- ------------------------------------------------------------------------------
Total Shares 34,115 34,237 34,281 34,216
=============================================================================
At September 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. These warrants expire on December 15, 2002.
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 third quarter of 2002 and $2 million for the
nine months ended September 30, 2002. TEP is currently evaluating the
depreciable lives of its other generating stations.
NOTE 12. COAL CONTRACT TERMINATION FEE
- ---------------------------------------
In the third quarter of 2002, TEP terminated a coal supply agreement for
the Irvington Generating Station. As a result, TEP recorded a pre-tax expense
of $11.3 million and made an $11.3 million payment in the third quarter of
2002. The additional expense is mitigated by TEP not being required to make a
take-or-pay penalty payment of approximately $3.5 million for the year 2002.
Payment of the termination fee also eliminates payment of $3.5 million per
year of take-or-pay payments in future years. The termination of this
contract is expected to provide TEP with a pre-tax rate of return in excess of
20%.
NOTE 13. ASSET PURCHASE AGREEMENTS
- -----------------------------------
On October 29, 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase by
UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million in cash. The purchase price of each is
subject to adjustment based on the date on which the transaction is closed
and, in each case, on the amount of certain assets and liabilities of the
purchased business at the time of closing. The purchase price in each
transaction may also be adjusted if there is a casualty loss, governmental
taking, or discovery of substantial additional environmental liabilities, in
each case subject to materiality thresholds, prior to the closing. UniSource
Energy will assume certain liabilities associated with the purchased assets,
but will not assume Citizens' obligations under the industrial development
revenue bonds issued to finance certain of the purchased assets for which
Citizens will remain the economic obligor. The asset purchases are expected
to close in the second half of 2003 after the conditions to the consummation
of the transactions, including federal and state regulatory approvals, are
satisfied or waived.
The closing of the transactions is subject to approval by the ACC, the
FERC and the SEC under the Public Utility Holding Company Act of 1935, as
amended. The closing is also subject to the filing of the requisite
notification with the Federal Trade Commission and the Department of Justice
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as well as
other customary closing conditions.
The Asset Purchase Agreements are subject to termination if the closing
has not occurred within 15 months of the date of the Asset Purchase Agreements
(subject to extension in limited circumstances), if a governmental authority
seeks to prohibit the transactions, if required regulatory approvals are not
obtained with satisfactory terms and conditions, or if either party is in
material breach and such breach is not cured. If one Asset Purchase Agreement
is terminated, the other will also be automatically terminated. If the Asset
Purchase Agreements are terminated by Citizens due to UniSource Energy's
breach, UniSource Energy must pay to Citizens a $25 million termination fee as
liquidated damages. If the Asset Purchase Agreements are terminated by
UniSource Energy due to Citizen's breach, Citizens must pay to UniSource
Energy a $10 million termination fee as liquidated damages. The termination
fees are also payable in certain other limited circumstances. Under the Asset
Purchase Agreements, UniSource Energy and Citizens will assume joint
responsibility for completing two utility rate cases that Citizens has pending
before the ACC. UniSource Energy expects to reduce the amount of rate relief
requested due to the discount represented by the purchase price.
We expect that the purchase price will be financed by funds from
UniSource Energy and its affiliates and debt secured by the purchased assets.
UniSource Energy may also consider financing a portion of the purchase with
new equity, depending on market conditions and other considerations.
UniSource Energy expects to form a new subsidiary to hold the purchased
assets, which subsidiary will maintain a separate rate structure from TEP.
NOTE 14. 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 15. REVIEW BY INDEPENDENT ACCOUNTANTS
- -------------------------------------------
With respect to the unaudited condensed consolidated financial
information of UniSource Energy and TEP for the three-month and nine-month
periods ended September 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 November 1, 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 third quarter and first nine months of
2002 compared with the same periods in 2001,
- changes in liquidity and capital resources during the third quarter
and first nine 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 September 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 September 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 financial
statements, beginning on page 2, which present the results of operations
for the quarters and nine month periods ended September 30, 2002 and 2001.
Management's Discussion and Analysis explains the differences between
periods for specific line items of the financial statements.
References in this report to "we" and "our" are to UniSource Energy
and its subsidiaries, collectively. References in this report to the
"utility business" are to TEP.
OVERVIEW
- --------
UniSource Energy and TEP's net income and UniSource Energy's earnings
per share of Common Stock for the quarters and nine months ended September
30, 2002 and September 30, 2001 are shown in the table below:
UniSource Energy TEP
Net Income Earnings Net Income
- -------------------------------------------------------------------------------
-Millions- -Per Share- -Millions-
Quarter Ended September 30, 2002 $ 22.8 $ 0.68 $ 26.6
Quarter Ended September 30, 2001 15.5 0.46 14.4
Nine Months Ended September 30, 2002 28.4 0.84 42.1
Nine Months Ended September 30, 2001 48.1 1.44 56.9
UniSource Energy and TEP's net income for the three months ended
September 30, 2002 increased from the net income reported for the
comparable period in 2001. The primary reasons for the increases include
the significantly reduced purchased power and fuel expenses incurred by TEP
due to lower electric wholesale activity, the increase in TEP's retail
sales revenue, and $4.2 million in income tax benefits. A coal contract
termination fee of $6.8 million (after-tax) partially offset the increase
for the quarter.
UniSource Energy and TEP's net income for the nine months ended
September 30, 2002 decreased from the same period in 2001 as a result of
significant reduction in electric wholesale revenues due to lower wholesale
energy prices, milder weather compared to the prior year, decreased
consumption by TEP's mining customers, an adverse ruling on a coal price
arbitration, and the coal contract termination fee. These factors were
partially offset by increased consumption by TEP's residential, commercial,
and industrial customers, the $4.2 million in tax benefits recorded in the
third quarter of 2002, and $1.7 million of income tax credits recorded in
the second quarter of 2002.
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
continuing its review of 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 TEP's transmission system while continuing to
provide reliable access to generation for TEP's 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 TEP to spread the fixed costs of its Springerville Units 1 and 2
over additional units. This includes obtaining construction financing in
early 2003.
- Facilitate the completion of the Arizona electric utility and gas
utility asset acquisition from Citizens Communications Company described
below.
- Reduce TEP's debt as appropriate, using some of our excess cash flows.
- Proactively maintain TEP's transmission and distribution system to
ensure reliable service to its retail customers.
- Efficiently manage TEP's 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 in the next twelve months,
TEP will spend approximately $119 million on capital expenditures,
Millennium will provide between $11 million and $14 million of funding to its
technology investments, and we will provide between $40 million and $80
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. In addition, we will spend $230 million for the
acquisition of the Arizona electric utility and gas utility assets from
Citizens Communications Company, which we expect to finance from funds from
UniSource Energy and its affiliates and debt secured by the purchased
assets. UniSource Energy may also consider financing a portion of the
purchase with new equity, depending on market conditions and other
considerations.
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.
ASSET PURCHASE AGREEMENTS
- -------------------------
On October 29, 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase
by UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million in cash. The purchase price of each
is subject to adjustment based on the date on which the transaction is
closed and, in each case, on the amount of certain assets and liabilities
of the purchased business at the time of closing. The purchase price in
each transaction may also be adjusted if there is a casualty loss,
governmental tak