Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________.
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification Number
----------- ---------------------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
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
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Registrant Title of Each Class on Which Registered
---------- ------------------- -----------------------
UniSource Energy Common Stock, no par New York Stock Exchange
Corporation value and Preferred Pacific Exchange
Share Purchase Rights
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether each registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of each registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
----- -----
The aggregate market value of UniSource Energy Corporation voting Common
Stock held by non-affiliates of the registrant was $622,739,272 based on
the last reported sale price thereof on the consolidated tape on June 28, 2002.
At March 4, 2003, 33,583,182 shares of UniSource Energy Corporation
Common Stock, no par value (the only class of Common Stock), were outstanding.
At March 4, 2003, UniSource Energy Corporation is the holder of
32,139,434 shares of the outstanding common stock of Tucson Electric Power
Company.
Documents incorporated by reference: Specified portions of UniSource
Energy Corporation's Proxy Statement relating to the 2003 Annual Meeting of
Shareholders are incorporated by reference into PART III.
- --------------------------------------------------------------------------------
This combined Form 10-K is separately filed by UniSource Energy Corporation and
Tucson Electric Power Company. Information contained in this document relating
to Tucson Electric Power Company is filed by UniSource Energy Corporation and
separately by Tucson Electric Power Company on its own behalf. Tucson Electric
Power Company makes no representation as to information relating to UniSource
Energy Corporation or its subsidiaries, except as it may relate to Tucson
Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions................................................................ v
- PART I -
Item 1. - Business
Overview of Consolidated Business.........................................1
TEP Electric Utility Operations
Service Area and Customers..............................................2
Generating and Other Resources..........................................5
Fuel Supply.............................................................7
Water Supply............................................................9
Transmission Access.....................................................9
Rates and Regulation...................................................10
TEP's Utility Operating Statistics.....................................12
Environmental Matters..................................................13
Millennium Energy Businesses.............................................14
UniSource Energy Development Company.....................................15
Employees................................................................16
SEC Reports available on UniSource Energy's Website......................16
Item 2. - Properties.......................................................18
Item 3. - Legal Proceedings................................................19
Item 4. - Submission of Matters to a Vote of Security Holders..............19
- PART II -
Item 5. - Market for Registrant's Common Equity and Related
Stockholder Matters..............................................20
Item 6. - Selected Consolidated Financial Data
UniSource Energy.........................................................21
TEP......................................................................22
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................23
UniSource Energy Consolidated..........................................23
Contribution by Business Segment.......................................24
Results of TEP.........................................................24
Results of Millennium Energy Businesses................................28
Results of UED.........................................................29
Income Tax Position......................................................29
Asset Purchase Agreements................................................29
Factors Affecting Results of Operations
Competition............................................................30
Industry Restructuring.................................................31
Market Risks...........................................................34
Outlook and Strategies.................................................37
Critical Accounting Policies...........................................37
TABLE OF CONTENTS
(continued)
Page
- -----------------------------------------------------------------------------
Liquidity and Capital Resources
UniSource Energy - Consolidated Cash Flows.............................42
UniSource Energy - Parent Company......................................43
TEP - Electric Utility.................................................43
Operating Activities.................................................43
Investing Activities.................................................44
Financing Actitities.................................................45
Millennium - Unregulated Energy Businesses.............................47
UED - Unregulated Energy Business......................................49
Financing Risks........................................................49
Contractual Obligations................................................50
Guarantees and Indemnities.............................................51
Dividends on Common Stock..............................................52
New Accounting Pronouncements............................................52
Safe Harbor for Forward-Looking Statements...............................53
Item 7A.- Quantitative and Qualitative Disclosures about Market Risk.......54
Item 8. - Consolidated Financial Statements and Supplementary Data.........54
Report of Independent Accountants........................................55
UniSource Energy Corporation
Consolidated Statements of Income......................................56
Consolidated Statements of Cash Flows..................................57
Consolidated Balance Sheets............................................58
Consolidated Statements of Capitalization..............................59
Consolidated Statements of Changes in Stockholders' Equity.............60
Tucson Electric Power Company
Consolidated Statements of Income......................................61
Consolidated Statements of Cash Flows..................................62
Consolidated Balance Sheets............................................63
Consolidated Statements of Capitalization..............................64
Consolidated Statements of Changes in Stockholders' Equity.............65
Notes to Consolidated Financial Statements
Note 1. Nature of Operations and Summary of Significant Accounting
Policies......................................................66
Note 2. Regulatory Matters..............................................72
Note 3. Accounting for Derivative Instruments, Trading Activities
and Hedging Activities........................................75
Note 4. Millennium Energy Businesses....................................77
Note 5. Business Segments...............................................80
Note 6. TEP's Utility Plant and Jointly-Owned Facilities................82
Note 7. Debt and Capital Lease Obligations..............................83
Note 8. Fair Value of TEP's Financial Instruments.......................85
Note 9. Stockholders' Equity............................................86
Note 10. Commitments and Contingencies...................................87
Note 11. Wholesale Accounts Receivable and Allowances....................91
Note 12. Income Taxes....................................................92
Note 13. Employee Benefits Plans.........................................94
Note 14. UniSource Energy Earnings Per Share (EPS).......................98
Note 15. Asset Purchase Agreements.......................................99
Note 16. Supplemental Cash Flow Information.............................100
Note 17. Quarterly Financial Data (Unaudited)...........................103
TABLE OF CONTENTS
(concluded)
Page
- -----------------------------------------------------------------------------
Schedule II - Valuation and Qualifying Accounts.........................106
- PART III -
Item 9. - Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................107
Item 10. - Directors and Executive Officers of the Registrants............107
Item 11. - Executive Compensation.........................................109
Item 12. - Security Ownership of Certain Beneficial Owners and
Management.....................................................109
Item 13. - Certain Relationships and Related Transactions.................110
- PART IV -
Item 14. - Controls and Procedures........................................111
Item 15. - Exhibits, Financial Statement Schedules, and Reports
on Form 8-K...........................................................111
Signatures..............................................................113
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.........117
Exhibit Index...........................................................121
DEFINITIONS
The abbreviations and acronyms used in the 2002 Form 10-K 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.
AHMSA........................ Altos Hornos de Mexico, S.A. de C.V. AHMSA owns
50% of Sabinas.
ALJ.......................... Administrative Law Judge.
APS.......................... Arizona Public Service Company.
Btu.......................... British thermal unit(s).
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 November 14, 2002.
Emission Allowance(s)........ An EPA-issued allowance which permits
emission of one ton of sulfur dioxide.
These allowances can be bought and sold.
Energy....................... The amount of power produced over a given
period of time; measured in MWh.
EPA.......................... The Environmental Protection Agency.
ESP.......................... Energy Service Provider.
Express Line................. 345-kV circuit connecting Springerville
Unit 2 to the Tucson 138 kV system.
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.
FAS 143...................... Statement of Financial Accounting Standards
No. 143: Accounting for Asset Retirement
Obligations.
FERC......................... Federal Energy Regulatory Commission.
First Collateral Trust
Bonds...................... Bonds issued under the Indenture of Trust,
dated as of August 1, 1998, of TEP to the
Bank of New York, successor trustee.
First Mortgage Bonds......... First mortgage bonds issued under the Indenture,
dated as of April 1, 1941, of TEP to JPMorgan
Chase Bank, successor trustee, as supplemented
and amended.
Four Corners................. Four Corners Generating Station.
GAAP......................... Generally Accepted Accounting Principles.
Global Solar................. Global Solar Energy, Inc., a company that
develops and manufactures thin-film
photovoltaic cells. Millennium owns 87% of
Global Solar.
Heating Degree Days.......... An index used to measure the impact of weather
on energy usage calculated by subtracting the
average of the high and low daily temperatures
from 65.
IDBs......................... Industrial development revenue or pollution
control revenue bonds.
IPS.......................... Infinite Power Solutions, Inc., a company that
develops thin-film batteries. Millennium owns
77.5% of IPS.
IRS.......................... Internal Revenue Service.
DEFINITIONS
(continued)
- ------------------------------------------------------------------------------
Irvington.................... Irvington Generating Station.
Irvington Lease.............. The leveraged lease arrangement relating to
Irvington Unit 4.
ISO.......................... Independent System Operator.
ITN.......................... ITN Energy Systems, Inc. was formed to provide
research, development, and other services.
Millenium currently owns 49% but has agreed
to reduce its ownership to 9%.
ITC.......................... Investment tax credit.
kWh.......................... Kilowatt-hour(s).
kV........................... Kilovolt(s).
LOC.......................... Letter of Credit.
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which manages
and trades emission allowances, coal, and
related financial instruments.
MEH.......................... MEH Corporation, a wholly-owned subsidiary
of Millennium, which formerly held a 50%
interest in NewEnergy.
MicroSat..................... MicroSat Systems, Inc. is a company formed to
develop and commercialize small-scale
satellites. Millennium currently owns 49%
but has agreed to reduce its ownership to 35%.
Millennium................... Millennium Energy Holdings, Inc., a wholly-owned
subsidiary of UniSource Energy.
Mimosa....................... Minerales de Monclova, S.A. de C.V., an owner of
coal and associated gas reserves and a supplier
of metallurgical coal to the steel industry
and thermal coal to the Mexican electricity
commission. Sabinas owns 19.5% of Mimosa.
MMBtus....................... Million British Thermal Units.
MW........................... Megawatt(s).
MWh.......................... Megawatt-hour(s).
Nations Energy............... Nations Energy Corporation, a wholly-owned
subsidiary of Millennium, and holder of a
minority interest in an independent power
project in Panama.
Navajo....................... Navajo Generating Station.
NewEnergy.................... NewEnergy, Inc., formerly New Energy Ventures,
Inc., a company in which a 50% interest was
owned by MEH.
NOL.......................... Net Operating Loss carryback or carryforward for
income tax purposes.
PG&E......................... Pacific Gas and Electric Company.
PNM.......................... Public Service Company of New Mexico.
Powertrusion................. POWERTRUSION, International, Inc., a company
owned 50.5% by Millennium, which manufactures
lightweight utility poles.
Revolving Credit Facility.... $60 million revolving credit facility entered
into under the Credit Agreement between a
syndicate of banks and TEP.
RTO.......................... Regional Transmission Organization.
Rules........................ Retail Electric Competition Rules.
Sabinas...................... Carboelectrica Sabinas, S. de R.L. de C.V., a
Mexican limited liability company. Millennium
owns 50% of Sabinas.
San Carlos................... San Carlos Resources Inc., a wholly-owned
subsidiary of TEP.
San Juan..................... San Juan Generating Station.
Second Mortgage Bonds........ TEP's second mortgage bonds issued under the
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.
SCE.......................... Southern California Edison Company.
SES.......................... Southwest Energy Solutions, Inc., a wholly-owned
subsidiary of Millennium.
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.
DEFINITIONS
(concluded)
- ------------------------------------------------------------------------------
Springerville Coal Handling
Facilities Leases............ Leveraged lease arrangements relating to the
coal handling facilities serving
Springerville.
Springerville Common
Facilities................. Facilities at Springerville used in common
with Springerville Unit 1 and Springerville
Unit 2.
Springerville Common
Facilities Leases.......... Leveraged lease arrangements relating to an
undivided one-half interest in certain
Springerville Common Facilities.
Springerville Unit 1......... Unit 1 of the Springerville Generating Station.
Springerville Unit 1 Lease... Leveraged lease arrangement relating to
Springerville Unit 1 and an undivided
one-half interest in certain Springerville
Common Facilities.
Springerville Unit 2......... Unit 2 of the Springerville Generating Station.
SRP.......................... Salt River Project Agricultural Improvement
and Power District.
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
TEP Warrants................. Warrants for the purchase of TEP common stock
which were issued in 1992.
Tri-State.................... Tri-State Generation and Transmission
Association.
TruePricing.................. TruePricing, Inc., a start-up company
established to market energy related
products.
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.
UniSource Energy Warrants.... Warrants for the purchase of UniSource Energy
Common Stock that were issued in exchange for
TEP Warrants.
WestConnect.................. The proposed for-profit RTO in which TEP is a
participant.
PART I
This Annual Report on Form 10-K contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. You should
read forward-looking statements together with the cautionary statements and
important factors included in this Form 10-K. (See Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Safe Harbor for Forward-Looking Statements.) Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance and underlying assumptions. Forward-looking statements
are not statements of historical facts. Forward-looking statements may be
identified by the use of words such as "anticipates," "estimates," "expects,"
"intends," "plans," "predicts," "projects," and similar expressions. We
express our expectations, beliefs and projections in good faith and believe
them to have a reasonable basis. However, we make no assurances that
management's expectations, beliefs or projections will be achieved or
accomplished.
ITEM 1. - BUSINESS
- --------------------------------------------------------------------------------
OVERVIEW OF CONSOLIDATED BUSINESS
- ---------------------------------
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. Millennium
invests in unregulated ventures, 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. See Notes 4 and 5 of Notes to Consolidated
Financial Statements. See Millennium Energy Businesses and UniSource Energy
Development Company below.
In October 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. 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 closing of these transactions
is subject to approval by the Arizona Corporation Commission (ACC), the
Federal Energy Regulatory Commission (FERC) and the SEC. If completed, these
transactions would add to our customer base approximately 77,500 retail
electric customers in Arizona, and approximately 122,000 retail gas customers
in Arizona. See Item 7.-Management's Discussion and Analysis of Financial
Condition and Results of Operations, Asset Purchase Agreements, for more
information regarding these transactions.
TEP was incorporated in the State of Arizona on December 16, 1963. TEP
is the successor by merger as of February 20, 1964, to a Colorado corporation
that was incorporated on January 25, 1902. UniSource Energy was incorporated
in the State of Arizona on March 8, 1995 and obtained regulatory approval to
form a holding company in November 1997. On January 1, 1998, TEP and
UniSource Energy exchanged shares of stock resulting in TEP becoming a
subsidiary of UniSource Energy. Following the share exchange, TEP
transferred the stock of its subsidiary Millennium to UniSource Energy. See
Note 1 of Notes to Consolidated Financial Statements-Nature of Operations and
Summary of Significant Accounting Policies.
The table below shows the contributions to our consolidated after-tax
earnings by our three business segments, as well as parent company expenses.
2002 2001 2000
--------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $ 53.7 $ 75.3 $ 51.2
Millennium (15.5) (9.2) (4.1)
UED 0.8 0.8 -
UniSource Energy Standalone (1) (5.8) (5.6) (5.2)
--------------------------------------------------------------------
Consolidated Net Income $ 33.2 $ 61.3 $ 41.9
====================================================================
(1) Represents interest expense (net of tax) on the note payable
from UniSource Energy to TEP.
The electric utility industry has undergone significant regulatory
change in recent years. See Item 7. - Management's Discussion and Analysis
of Financial Condition and Results of Operations, Factors Affecting Results
of Operations, Outlook and Strategies, for a discussion of our plans and
strategies to remain competitive and flexible in this changing environment
and Rates and Regulation, below, for the status of competition in Arizona.
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.
TEP ELECTRIC UTILITY OPERATIONS
- -------------------------------
TEP is the principal operating subsidiary of UniSource Energy. In 2002,
TEP's electric utility operations contributed 99% of UniSource Energy's
operating revenues and comprised 94% of its assets.
SERVICE AREA AND CUSTOMERS
TEP is a vertically integrated utility that provides regulated electric
service to over 355,000 retail customers in its service territory. This
service territory consists of a 1,155 square mile area of Southeastern
Arizona with a population of approximately 891,000 in the greater Tucson
metropolitan area in Pima County, as well as parts of Cochise County. TEP
holds a franchise to provide electric distribution service to customers in
the Cities of Tucson and South Tucson. These franchises expire in 2026 and
2017, respectively. TEP also sells electricity to other utilities and power
marketing entities in the western U.S.
RETAIL CUSTOMERS
TEP's retail sales are influenced by several factors, including seasonal
weather patterns, competitive conditions and the overall economic climate.
The peak demand for TEP's retail service area occurs during the summer months
due to the cooling requirements of TEP's retail customers. TEP's retail peak
demand has grown at an average annual rate of approximately 2.7% during the
past five years.
In 2002, TEP's number of retail customers increased by 2.4% while total
retail energy consumption decreased by approximately 3%. This decrease in
kWh energy sales was primarily attributable to reduced sales to copper mining
customers. See Sales to Large Industrial Customers, below. The table below
shows the trend in the percentage distribution of energy sales by major
customer class over the last three years.
2002 2001 2000
---- ---- ----
Residential 40% 38% 37%
Commercial 20% 19% 18%
Non-mining Industrial 28% 27% 28%
Mining 9% 13% 14%
Public Authority 3% 3% 3%
TEP uses population and demographic studies prepared by unrelated third
parties to forecast the growth in the number of customers, peak demand and
retail sales. TEP also makes assumptions about the weather, the economy and
competitive conditions. Based on these factors, TEP expects that its peak
demand, its number of retail customers and their energy consumption will
increase at 2 - 3% annually through 2006.
During that period, TEP expects total retail energy consumption by customer
class will be distributed similarly to the 2002 distribution.
Beginning January 1, 2001, all of TEP's retail customers were eligible
to choose alternative energy providers. Even though some of TEP's retail
customers may choose other energy providers, the forecasted growth rates in
the number of customers referred to above would continue to apply to TEP's
distribution business. As of March 4, 2003, no TEP retail customers are
currently served by alternate energy providers. See Rates and Regulation,
State, below.
Sales to Large Industrial Customers
-----------------------------------
TEP provides electric utility service to a diversified group of
commercial, industrial, and public sector customers. Major industries served
include copper mining, cement manufacturing, defense, health care, education,
military bases and other governmental entities. Local, regional, and
national economic factors can impact the financial condition and operations
of TEP's large industrial customers. Such economic conditions may directly
impact energy consumption by large industrial customers, and may indirectly
impact residential and small commercial sales and revenues if employment
levels and consumer spending is affected.
Two of TEP's largest retail customers are in the copper mining industry.
TEP has contracts with its two mining customers to provide electric power at
negotiated rates. These contracts expire in 2006 and 2008. Whether these
contracts are extended or terminated will depend, in part, on market
conditions and available alternatives. TEP's sales to mining customers
depend on a variety of factors including changes in supply and demand in the
world copper market and the economics of self-generation. U.S. copper prices
were approximately 77 cents per pound in February 2003, and have ranged
between 63 cents and 91 cents per pound during the last five years. As the
result of low copper prices, TEP's mining customers have reduced operations
in recent years, and have correspondingly reduced energy consumption. See
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations, Results of TEP, Utility Sales and Revenues.
Energy sales to and revenues from TEP's mining customers may continue to
decline in the future. One of TEP's mining customers substantially curtailed
mining operations at one of its mines in December of 2002. This reduction in
operations will further decrease sales. TEP's revenue from this customer was
approximately $11 million in 2002. Any reduction of this retail revenue
would be mitigated, however, by an opportunity for TEP to sell this
generation capacity in the wholesale market or to reduce generation with
resulting fuel costs reductions. Depending on wholesale market price
assumptions, TEP's pre-tax net income in 2003 could be reduced by $1 million
to $3 million from the 2002 level if this customer ceases mining operations
at this location.
WHOLESALE BUSINESS
TEP's electric utility operations include the wholesale marketing of
electricity to other utilities and power marketers. These wholesale sales
transactions are made on both a firm basis and an interruptible basis. A
firm basis means that contractually, TEP must supply the power (except under
limited emergency circumstances), while an interruptible basis means that TEP
may stop supplying power under various circumstances. See Other Purchases
and Interconnections, below.
TEP typically uses its own generation to serve the requirements of its
retail and long-term wholesale customers. Generally, TEP commits to future
sales based on expected excess generating capability, forward prices and
generation costs, using a diversified portfolio approach to provide a balance
between long-term, mid-term and spot energy sales. When TEP expects to have
excess generating capacity (usually in the first, second and fourth calendar
quarters), TEP may enter into forward contracts to sell a portion of this
forecasted excess generating capacity. Then, during the course of each
month, TEP will analyze any remaining excess short-term generating capacity
and make energy sales in the daily and hourly markets. TEP also enters into
limited forward sales and purchases to take advantage of favorable market
opportunities.
TEP also purchases power in the wholesale markets under certain
situations. It may enter into forward contracts: (a) to purchase energy
under long-term contracts to serve retail load and long-term wholesale
contracts, (b) to purchase capacity or energy during periods of planned
outages or for peak summer load conditions, and (c) to purchase energy to
resell to certain wholesale customers under load and resource management
agreements. Finally, TEP may purchase energy in the daily and hourly markets
to meet higher than anticipated demands, to cover unplanned generation
outages, or when it is more economical than generating.
As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes affecting these markets and
market participants. In 2000 and 2001, a significant portion of TEP's
revenues and earnings resulted from its wholesale marketing activities, which
benefited from strong demand and high wholesale prices in the western U.S.
These market conditions were the result of a number of factors, including
power supply shortages, high natural gas prices, transmission, and
environmental constraints. During this period, these markets experienced
unprecedented price volatility, as well as payment defaults and bankruptcies
by several of its largest participants. Regulatory agencies became concerned
with the outcomes of deregulation of the electric power industry and
intervened in the operation of these markets by, among other things, imposing
price caps and initiating investigations into potential market manipulation.
Since mid-2001, conditions in the western energy markets have changed
significantly as a result of various regulatory actions, moderate weather, a
decrease in natural gas prices, the addition of new generation in the region,
the slowdown of the regional economy, and the energy crisis in California.
In addition, the presence of fewer creditworthy counterparties, as well as
legal, political and regulatory uncertainties have reduced market liquidity
and trading volume. Several companies that were large market participants
have either curtailed their activities or exited the business completely.
These factors placed downward pressure on wholesale electricity prices, and
resulted in significantly lower wholesale electricity sales and revenues at
TEP in 2002.
In the first quarter of 2003, both the natural gas and western U.S.
wholesale electricity markets have experienced some price spikes and
volatility due to severe winter weather in certain regions, as well as high
gas storage withdrawals due to lagging production. TEP cannot predict,
however, whether average wholesale electricity prices will remain higher than
in 2002 and what the impact will be on TEP's sales and revenues in 2003.
TEP expects to continue to be a participant in the wholesale energy
markets, primarily by making sales and purchases in the short-term and
forward markets. TEP expects the market price and demand for capacity and
energy to continue to be influenced by the following factors, among others,
during the next few years:
- continued population growth and economic conditions in the western U.S.;
- availability of capacity throughout the western U.S.;
- the extent of electric utility industry restructuring in Arizona,
California and other western states;
- the effect of FERC regulation of wholesale energy markets;
- the availability and price of natural gas;
- precipitation, which affects hydropower availability;
- transmission constraints; and
- environmental restrictions and the cost of compliance.
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of Operations,
Competition, Western Energy Markets and Market Risks, for additional
discussion of TEP's wholesale marketing activities.
GENERATING AND OTHER RESOURCES
TEP GENERATING RESOURCES
At December 31, 2002, TEP owned or leased 2,002 MW of net generating
capability as set forth in the following table:
Net TEP's Share
Unit Fuel Owned/ Capability Operating -----------
Generating Source No. Location Type Leased MW Agent % MW
- ----------------------------------------------------------------------------------------------------
Springerville Station 1 Springerville, AZ Coal Leased 380 TEP 100.0 380
Springerville Station 2 Springerville, AZ Coal Owned 380 TEP 100.0 380
San Juan Station 1 Farmington, NM Coal Owned 327 PNM 50.0 164
San Juan Station 2 Farmington, NM Coal Owned 316 PNM 50.0 158
Navajo Station 1 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 2 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 3 Page, AZ Coal Owned 750 SRP 7.5 56
Four Corners Station 4 Farmington, NM Coal Owned 784 APS 7.0 55
Four Corners Station 5 Farmington, NM Coal Owned 784 APS 7.0 55
Irvington Station 1 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
Irvington Station 2 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
Irvington Station 3 Tucson, AZ Gas/Oil Owned 104 TEP 100.0 104
Irvington Station 4 Tucson, AZ Coal/Gas Leased 156 TEP 100.0 156
Internal Combustion
Turbines Tucson, AZ Gas/Oil Owned 122 TEP 100.0 122
Internal Combustion
Turbines Tucson, AZ Gas Owned 95 TEP 100.0 95
Solar Electric Generation Springerville/
Tucson, AZ Solar Owned 3 TEP 100.0 3
- ----------------------------------------------------------------------------------------------------
Total TEP Capacity (1) 2,002
====================================================================================================
(1) Excludes 380 MW of additional resources, which consist of certain capacity purchases
and interruptible retail load. At December 31, 2002, total owned capacity was 1,466 MW
and leased capacity was 536 MW.
The Springerville Generating Station, located in northeast Arizona,
consists of two coal-fired units. Springerville Unit 1 began commercial
operation in 1985 and is leased and operated by TEP. Springerville Unit 2
started commercial operation in June 1990 and is owned by TEP's wholly-owned
subsidiary, San Carlos Resources Inc. (San Carlos), and operated by TEP.
These units are rated at 380 MW for continuous operation, but may be operated
for up to eight hours at a time at a net capacity of 400 MW each. The
Springerville Station was originally designed for four generating units. UED
is currently evaluating opportunities to expand the Springerville Station by
assigning the rights to construct Springerville Units 3 and 4 to unrelated
third parties. TEP will be the operator of the new units. See UniSource
Energy Development Company, below.
The Springerville Station also includes the Springerville Coal Handling
Facilities and the Springerville Common Facilities. In 1984, TEP sold and
leased back the Springerville Coal Handling Facilities. In 1985, TEP sold
and leased back a 50% interest in the Springerville Common Facilities. The
other 50% interest is included in the Springerville Unit 1 leases.
TEP obtains approximately 600 MW, or 30%, of its generating capacity
from jointly-owned facilities at the San Juan, Four Corners, and Navajo
Generating Stations in New Mexico and northern Arizona.
Irvington is a four-unit generating station located in Tucson, Arizona.
Units 1, 2, and 3 are gas or oil burning units. Irvington Unit 4 operates
primarily on coal in combination with natural gas or landfill gas, but it is
also able to operate solely on natural gas. Units 1, 2, and 3 are wholly-
owned by TEP, and Unit 4 was sold and leased back in 1988 under the Irvington
4 lease. The Irvington Station, along with the internal combustion turbines
located in Tucson, are designated as "must-run generation" facilities. Must-
run generating units are those which are required to run in certain
circumstances to maintain distribution system reliability and meet local load
requirements.
To improve local system reliability in Tucson and to serve increasing
load requirements, TEP added 95 MW of new peaking resources in June 2001,
consisting of a 75 MW gas turbine it purchased and a 20 MW gas turbine leased
from UED. In September 2002, TEP purchased the 20 MW gas turbine from UED.
See Note 7 of Notes to Consolidated Financial Statements, and Item 7. -
Management's Discussion and Analysis of Financial Condition and Results of
Operations, Liquidity and Capital Resources, Contractual Obligations, for
more information regarding the Springerville and Irvington leases.
POWER EXCHANGE AGREEMENT
TEP and Southern California Edison Company (SCE) have a ten-year power
exchange agreement which requires SCE to provide firm system capacity of 110
MW to TEP during the summer months. TEP is then obligated to return to SCE
in the winter months the same amount of energy that TEP received during the
preceding summer. For example, in the summer of 2002, TEP received
approximately 133,000 MWh from SCE and returned the same amount during the
winter months from November 2002 to February 2003. This agreement expires in
February 2005.
OTHER PURCHASES AND INTERCONNECTIONS
TEP purchases additional electric energy from other utilities and power
marketers. The amount of energy purchased varies substantially from time to
time depending on the demand for energy, the cost of purchased energy
compared with TEP's cost of generation, and the availability of such energy.
TEP may also sell electric energy at wholesale. See also Wholesale Business,
above and Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of Operations,
Market Risks.
TEP is also a member of various regional reserve sharing, reliability
and power sharing organizations. These relationships allow TEP to call upon
other utilities during emergencies such as plant outages and system
disturbances, and also reduce the amount of reserves TEP is required to
carry.
PEAK DEMAND AND RESOURCES
Peak Demand 2002 2001 2000 1999 1998
-------------------------------------
- MW -
Retail Customers-Net One Hour 1,899 1,840 1,862 1,754 1,786
Firm Sales to Other Utilities 228 151 143 178 179
---------------------------------------------------------------------------
Coincident Peak Demand (A) 2,127 1,991 2,005 1,932 1,965
Total Generating Resources 2,002 1,999 1,904 1,904 1,896
Other Resources (1) 308 217 248 235 235
---------------------------------------------------------------------------
Total TEP Resources (B) 2,310 2,216 2,152 2,139 2,131
Total Margin (B) - (A) 183 225 147 207 166
Reserve Margin (% of Coincident
Peak Demand) 9% 11% 7% 11% 8%
(1) Other Resources includes firm power purchases and interruptible retail
and wholesale loads.
---------------------------------------------------------------------------
TEP's retail sales are influenced by several factors, including seasonal
weather patterns, competitive conditions and the overall economic climate.
The peak demand for TEP's retail service area occurs during the summer months
due to the cooling requirements of its retail customers. TEP's retail peak
demand has grown at an average annual rate of approximately 2.7% during the
past five years.
The chart above shows the relationship over a five-year period between
TEP's peak demand and its energy resources. TEP's margin is the difference
between total energy resources and coincident peak demand, and the reserve
margin is the ratio of margin to coincident peak demand. TEP maintains a
minimum reserve margin in excess of 7% to comply with reliability criteria
set forth by the Western Electricity Coordinating Council (WECC), (formerly
the Western Systems Coordinating Council). TEP's actual reserve margin in
2002 was 9%. In 2002, TEP purchased 50 MW of firm capacity and energy in the
forward energy markets during the summer peak period to ensure an adequate
reserve margin.
TEP's forecasted retail peak demand for 2003 is approximately 1,950 MW,
compared with actual peak demand of 1,899 MW in 2002. Except for certain
peak hours during the summer peak period, TEP believes it has sufficient
resources to meet this expected demand in 2003 with its existing resources.
TEP plans to make forward purchases to ensure adequate supply during its
summer peak period. Beginning in early 2003, any future resource needs are
expected to be procured through a competitive bidding process being
established by the ACC.
See Future Generating Resources--TEP, and Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations,
Factors Affecting Results of Operations, Recent Developments in the Arizona
Regulatory Environment, below.
FUTURE GENERATING RESOURCES -- TEP
In the past, TEP assessed its need for future generating resources based
on the premise of a continued regulatory requirement to serve customers in
TEP's retail service area. However, the ACC's electric competition rules, as
currently in effect, modified the obligation to provide generation services
to all customers. These rules and TEP's ability to retain and attract
customers will affect the need for future resources. For those customers who
do not choose other energy providers, TEP remains obligated to supply energy.
However, TEP is not obligated to supply this energy from TEP-owned generating
assets. The energy may be acquired by purchasing in the wholesale markets.
See Rates and Regulation, below and Item 7. - Management's Discussion and
Analysis of Financial Condition and Results of Operations, Factors Affecting
Results of Operations, Competition.
TEP will continue to add peaking resources in the Tucson area as needed
based upon our forecasts of retail and firm wholesale load, as well as the
statewide transmission infrastructure. TEP currently forecasts that new
peaking resources of 75 MW may be needed in both 2008 and 2010. To
facilitate the proposed expansion of the Springerville Generating Station,
TEP is also planning to enter into a power purchase contract for up to 100 MW
of capacity from the proposed addition of Unit 3 at Springerville under
development by UED. This contract would be for up to five years, beginning
with commercial operation of Unit 3, expected in 2006. TEP anticipates that
any power purchased by it under such a contract will be sold in the wholesale
markets. TEP could not use Springerville Unit 3 power to serve its retail
load without complying with the competitive bidding procedures being
established by the ACC. See UniSource Energy Development Company, below and
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations, Factors Affecting Results of Operations, Industry
Restructuring.
FUEL SUPPLY
TEP's principal fuel for electric generation is low-sulfur coal. Fuel
information is provided below:
Average Cost Per MMBTU Consumed Percentage of Total BTU Consumed
2002 2001 2000 2002 2001 2000
- ---------------------------------------------------------------------------------
Coal (A) $1.59 $1.63 $1.61 94% 90% 91%
Gas 4.28 5.99 5.70 6 10 9
- ---------------------------------------------------------------------------------
All Fuels $1.76 $2.08 $1.95 100% 100% 100%
(A) The average cost per ton of coal for 2002, 2001, and 2000 was $30.86
$30.96, and $30.69, respectively.
TEP'S COAL SUPPLY
Year Average
Contract Sulfur
Station Coal Supplier Terminates Content Coal Obtained From (A)
------- ------------- ---------- ------- ------------------------------
Springerville Peabody Coalsales Company 2010 0.9% Lee Ranch Coal Company
Four Corners BHP Billiton 2004 (B) 0.8% Navajo Indian Tribe
San Juan San Juan Coal Company 2017 0.8% Federal and State Agencies
Navajo Peabody Coalsales Company 2011 0.6% Navajo and Hopi Indian Tribes
Irvington Various approved suppliers - - Various locations
(A) Substantially all of the suppliers' mining leases extend at least as long as coal
is being mined in economic quantities.
(B) Contract is under negotiation to be extended through 2016.
TEP Operated Generating Facilities
----------------------------------
TEP is the sole owner (or lessee) and operator of the Springerville and
Irvington Generating Stations. The coal supplies for these plants are
transported from northwestern New Mexico and Colorado by railroad.
The coal supply contract for the Springerville Generating Station ends
in June 2010, with an option to extend the term for another ten years. The
Springerville contract has an adjustment clause that will affect the future
cost of coal delivered. We expect coal reserves to be sufficient to supply
the estimated requirements of Springerville for its presently estimated
remaining life. The Springerville coal contract requires TEP to take 1.9
million tons of coal per year through June 2010 at an estimated annual cost
of $45 million for the next five years and requires TEP to pay a take-or-pay
charge if minimum quantities of coal are not purchased. TEP's present fuel
requirements are in excess of the take-or-pay minimums. The Springerville
rail contract expires in 2009. This contract requires TEP to transport 1.9
million tons of coal per year through 2009 at an estimated annual cost of $13
million for the next five years.
In July 2002, TEP terminated the long-term coal supply contract for the
Irvington station. TEP incurred a pre-tax charge of $11.3 million related to
the cost of terminating this contract. The termination fee relieves TEP of
up to $3.5 million in annual pre-tax take-or-pay payments. TEP is currently
purchasing coal for Irvington under short-term contracts to take advantage of
favorable price opportunities. At this time, there is no concern for future
coal availability for the life of this station. While the Irvington coal
supply contract was terminated, the rail contract for the Irvington station
is in effect until the earlier of 2015 or the remaining life of Unit 4. The
rail contract requires TEP to transport at least 75,000 tons of coal per year
through 2015 at an estimated annual cost of $1.5 million or to make a minimum
payment of $0.5 million for the next five years if coal deliveries are not
chosen. See Note 10 of Notes to Consolidated Financial Statements -
Commitments and Contingencies, TEP Commitments, Fuel Purchase and
Transportation Commitments.
Generating Facilities Operated by Others
----------------------------------------
TEP also participates in jointly-owned generating facilities at Four
Corners, Navajo and San Juan, where coal supplies are under long-term
contracts administered by the operating agents. The coal contract for Four
Corners terminates in 2004 unless extended pursuant to its terms. The Four
Corners contract is under negotiation and is expected to be extended through
July 1, 2016. The coal quantities under contract for the Navajo and San Juan
mine-mouth coal-fired generating stations are expected to be sufficient for
the remaining lives of the stations.
The contracts to purchase coal for use at the jointly-owned facilities
require TEP to purchase minimum amounts of coal at an estimated average
annual cost of $16 million for the next five years.
NATURAL GAS
TEP purchases natural gas from Southwest Gas Corporation (SWG) for its
natural gas-fired facilities. TEP is a retail customer of SWG under a
special procurement agreement. In 2001, TEP entered into a new five-year
agreement that provides for all of TEP's natural gas commodity and
transportation needs for use in power generation. SWG purchases gas at TEP's
direction at spot or forward market prices. The first two and one-half years
of the contract, through October 31, 2003, as extended, require that TEP take
a minimum of 10 million MMBtus annually at transportation rates established
in the contract. Minimum gas transportation costs for 2003 are expected to
be $6 million. SWG is affected by recent FERC actions relating to its gas
allocations from the Permian and San Juan basins. A FERC order on this issue
is expected in the summer of 2003. At that time, TEP and SWG will
renegotiate the terms of the special procurement agreement. TEP does not
anticipate any material difference in operational or economic terms in the
new agreement, which is estimated to begin November 1, 2003. Actual gas
commodity costs will depend on the volumes purchased and the market prices.
During 2002, TEP received natural gas sufficient to meet all of its needs.
During 2002, natural gas supplied approximately 6% of TEP's generation.
TEP's gas usage was significantly higher in 2000 and 2001 because of: (1)
higher wholesale energy prices in the western U.S. in the second half of 2000
and the first half of 2001, which made it profitable for TEP to sell gas-
generated energy into the wholesale markets, and (2) the addition of the two
new gas turbines in 2001, providing 95 MW in new generating capacity. TEP
also burns small amounts of landfill gas at Irvington Unit 4.
WATER SUPPLY
TEP believes there will be sufficient water to supply the requirements
of TEP's existing and planned electric generating stations in Arizona.
However, drought conditions in the Four Corners region, combined with water
usage in upper New Mexico, have resulted in decreasing water levels in the
lake that indirectly supplies water to the San Juan and Four Corners
generating stations located in New Mexico. The U.S. Bureau of Reclamation
projects that, based on historical factors and seasonal usage, there should
be adequate capacity in the lake for all water users. The projected water
levels are not expected to affect the operations of the generating stations
in 2003.
TRANSMISSION ACCESS
TEP has transmission access and power transaction arrangements with over
120 electric systems or suppliers. In January 2001, TEP and Citizens entered
into a project development agreement for the joint construction of a 62-mile
transmission line from Tucson to Nogales, Arizona. In January 2002, the ACC
approved the location and construction of the proposed 345 kV line, almost
half of which runs through a national forest. A drought-caused closure of
the forest in June 2002 has delayed the progress on the environmental impact
study required for Federal project approval. A U.S. Department of Energy
(DOE) and Forest Service decision is expected to occur by the end of 2003.
Construction could begin as early as mid-2004 with an expected in-service
date eight months after the start of construction. Construction costs are
expected to be approximately $75 million. In 2000, TEP applied to the DOE
for a Presidential Permit to allow extension of the line across the
international border with Mexico to connect with Mexico's utility system,
providing further reliability and market opportunities in the region.
In 1997, TEP and other transmission owners and users located in the
southwestern U.S. began to investigate the feasibility of forming an
Independent System Operator (ISO) for the region. In December 1999, the FERC
issued FERC Order 2000, which established timelines for all transmission
owning entities to join a Regional Transmission Organization (RTO) and
defined the minimum characteristics and functions of an RTO. TEP and three
other southwestern utilities filed agreements and operating protocols with
the FERC in October 2001 to form a new, for-profit RTO to be known as
WestConnect RTO, LLC (WestConnect).
WestConnect will be responsible for security, reservations, scheduling,
transmission expansion and planning, and congestion management for the
regional transmission system. It will also focus on ensuring reliability,
nondiscriminatory open-access, and independent governance. Regional
transmission owners would have the option, but not be required, to transfer
ownership of transmission assets to the RTO. At present, TEP intends to turn
over only operating control of its transmission assets to the RTO.
Additionally, the RTO may build new transmission lines in the region, which
would be owned by the RTO.
In October, 2002, the FERC issued a provisional order approving, in
part, the WestConnect RTO proposal. The FERC also required WestConnect,
along with the other two RTOs in the western region (the California
Independent System Operator (CISO) and RTO West), to participate in a
steering group to encourage the development of a seamless wholesale electric
energy market. WestConnect's operation is dependent on the resolution of
these issues and is also subject to approval by state regulatory agencies in
the region. WestConnect is not expected to become operational prior to 2005.
On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking (NOPR)
proposing standard market design rules that would significantly alter the
markets for wholesale electricity and transmission and ancillary services in
the U.S. The new rules would establish a generation adequacy requirement for
"load-serving entities" and a standard platform for the sale of electricity
and transmission services. Under the new rules, Independent Transmission
Providers would administer spot markets for wholesale power, ancillary
services and transmission congestion rights, and electric utilities,
including TEP, would be required to transfer control over transmission
facilities to the applicable Independent Transmission Provider. The FERC
expects to release for comments a white paper on the standard market design
in April 2003, followed in July 2003 by final rules. Once the final rules
are issued, a phased compliance schedule will begin. TEP is currently in the
process of determining the impact the proposed rules would have on its
operations.
RATES AND REGULATION
The FERC and the ACC regulate portions of TEP's utility accounting
practices and electricity rates. The FERC regulates the terms and prices of
TEP's sales to other utilities and resellers. In 1997, TEP was granted a
FERC tariff to sell power at market based rates. The ACC has authority over
rates charged to retail customers, the issuance of securities, and
transactions with affiliated parties.
STATE
Historically, the ACC determined TEP's rates for retail sales of
electric energy on a "cost of service" basis, which was designed to provide,
after recovery of allowable operating expenses, an opportunity to earn a
reasonable rate of return on "fair value rate base." Fair value rate base
was generally determined by reference to the original cost and the
reconstruction cost (net of depreciation) of utility plant in service to the
extent deemed used and useful, and to various adjustments for deferred taxes
and other items, plus a working capital component. Over time, rate base was
increased by additions to utility plant in service and reduced by
depreciation and retirements of utility plant.
In September 1999, the ACC approved the Retail Electric Competition
Rules (Rules) that provided a framework for the introduction of retail
electric competition in Arizona. In November 1999, the ACC approved the
Settlement Agreement between TEP and certain customer groups related to the
implementation of retail electric competition in Arizona.
The Rules and TEP's Settlement Agreement required the unbundling of
electric services, with separate rates or prices for generation,
transmission, distribution, metering, meter reading, billing and collection,
and ancillary services. Generation services at market prices may be provided
by Energy Service Providers (ESPs) licensed by the ACC. Transmission and
distribution services and must-run generation facilities will remain subject
to regulation on a cost of service basis. TEP has met all conditions
required by the ACC to facilitate electric retail competition, including ACC
approval of TEP's direct access tariffs. However, ESPs and their related
service providers must meet certain conditions before they can competitively
sell electricity in TEP's service territory. Examples of these conditions
include ACC certification of ESPs and completion of direct access service
agreements with TEP.
The Settlement Agreement also provided for certain retail rate
reductions from 1998 through 2000, after which TEP's retail rates are frozen
until December 31, 2008, except under certain circumstances. TEP is required
to file by June 1, 2004 a general rate case, including an updated cost of
service study. Any rate change resulting from this rate case would be
effective no sooner than June 1, 2005, and would not result in a net rate
increase.
See Note 2 of Notes to Consolidated Financial Statements - Regulatory
Matters, for more information on TEP's Settlement Agreement.
In October 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens for the purchase by UniSource Energy of Citizens'
Arizona electric utility and gas utility businesses for a total of $230
million. 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 closing of these transactions is subject to approval by the
ACC, the FERC and the SEC. Citizens had two cases pending before the ACC
requesting rate relief for both the Arizona electric and Arizona gas assets
prior to entering into the Asset Purchase Agreements with UniSource Energy.
The requested electric rate increase is to recover purchased power costs
and the gas rate increase is a base rate increase. In December 2002,
UniSource Energy and Citizens filed a Joint Application with the ACC
requesting smaller increases in both pending cases. Under the proposal,
UniSource Energy asked that the 45% electric increase requested by
Citizens be reduced to 22%, and that the 29% increase in gas rates be reduced
to 23%. UniSource Energy believes that the smaller proposed rate increases
are sufficient in light of the negotiated purchase price. We are currently
in settlement discussions with the ACC Staff and intervenors regarding this
Joint Application. See Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations, Asset Purchase Agreements.
FEDERAL
During 2000 and 2001, the FERC ordered hearings and issued several
orders to mitigate volatile energy prices in the western U.S. and to address
the energy emergency in California. During 2000, the FERC established
certain soft caps on prices for power sold to the CISO. In June 2001, the
FERC adopted a price mitigation plan applicable to certain wholesale power
sales in the western U.S. This plan, which had a price cap of $91.87 per
MWh, was in effect until October 31, 2002. The FERC adopted a price cap for
the period thereafter of $250 per MWh.
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Factors Affecting Results of
Operations, Western Energy Markets, for a discussion of various FERC
proceedings, including refund hearings on power sold to California in
2000 and 2001, which may impact TEP's results.
TEP's UTILITY OPERATING STATISTICS
For Years Ended December 31,
2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------
Generation and Purchased Power-kWh (000)
Remote Generation (Coal) 10,067,069 10,362,211 10,278,393 10,000,401 10,002,250
Local Tucson Generation (Oil, Gas & Coal) 1,402,504 1,820,783 1,667,308 1,115,277 720,515
Purchased Power 1,842,739 3,656,978 3,174,244 2,712,570 2,227,773
- -------------------------------------------------------------------------------------------------------
Total Generation and Purchased Power 13,312,312 15,839,972 15,119,945 13,828,248 12,950,538
Less Losses and Company Use 769,101 846,287 724,677 814,945 810,117
- -------------------------------------------------------------------------------------------------------
Total Energy Sold 12,543,211 14,993,685 14,395,268 13,013,303 12,140,421
=======================================================================================================
Sales-kWh (000)
Residential 3,188,726 3,122,332 3,027,963 2,736,837 2,662,598
Commercial 1,609,367 1,573,213 1,496,558 1,383,756 1,355,319
Industrial 2,261,463 2,270,446 2,262,212 2,220,900 2,139,464
Mining 695,221 1,040,762 1,140,811 1,200,214 1,230,259
Public Authorities 257,641 254,130 258,470 247,361 242,845
- -------------------------------------------------------------------------------------------------------
Total - Electric Retail Sales 8,012,418 8,260,883 8,186,014 7,789,068 7,630,485
Electric Wholesale Sales 4,530,793 6,732,802 6,209,254 5,224,235 4,509,936
- -------------------------------------------------------------------------------------------------------
Total Electric Sales 12,543,211 14,993,685 14,395,268 13,013,303 12,140,421
=======================================================================================================
Operating Revenues (000)
Residential $290,091 $283,673 $276,720 $253,352 $248,821
Commercial 168,159 164,345 157,744 148,039 146,269
Industrial 160,862 161,584 162,790 160,963 157,735
Mining 28,168 41,994 48,484 49,399 51,965
Public Authorities 18,769 18,521 18,908 18,147 17,950
- -------------------------------------------------------------------------------------------------------
Total - Electric Retail Sales 666,049 670,117 664,646 629,900 622,740
Electric Wholesale Sales 177,908 733,559 359,814 171,219 143,269
Net Unrealized Gain (Loss) on Forward
Electric Sales and Purchases 533 (1,315) - - -
Other Revenues 6,603 6,308 3,908 2,964 2,981
- -------------------------------------------------------------------------------------------------------
Total Operating Revenues $851,093 $1,408,669 $1,028,368 $804,083 $768,990
=======================================================================================================
Customers (End of Period)
Residential 326,847 318,976 311,673 303,653 295,469
Commercial 31,767 31,194 30,467 29,714 28,648
Industrial 695 705 711 705 684
Mining 2 2 2 4 4
Public Authorities 61 61 61 61 61
- -------------------------------------------------------------------------------------------------------
Total Retail Customers 359,372 350,938 342,914 334,137 324,866
=======================================================================================================
Average Retail Revenue per kWh Sold (cents)
Residential 9.1 9.1 9.1 9.3 9.3
Commercial 10.5 10.5 10.5 10.7 10.8
Industrial and Mining 6.4 6.1 6.2 6.1 6.2
Average Retail Revenue per kWh Sold 8.3 8.1 8.1 8.1 8.2
Average Revenue per Residential Customer $886 $899 $899 $845 $855
Average kWh Sales per Residential Customer 9,737 9,897 9,834 9,132 9,144
ENVIRONMENTAL MATTERS
TEP is subject to environmental regulation of air and water quality,
resource extraction, waste disposal and land use by federal, state and local
authorities. TEP believes that all existing generating facilities are in
compliance with all existing regulations and will be in compliance with
expected environmental regulations, except as described below.
The 1990 Federal Clean Air Act Amendments (CAAA) require reductions of
sulfur dioxide (SO2) and nitrogen oxide (NOx) emissions in two phases, more
complex facility permits and other requirements. TEP is subject only to
Phase II of the SO2 and NOx emission reductions, which became effective
January 1, 2000. All of TEP's generating facilities (except 142 MW of its
internal combustion turbines) are affected.
In 1993, TEP's generating units affected by Phase II were allocated SO2
Emission Allowances based on past operational history. Each allowance gives
the owner the right to emit one ton of SO2. Beginning in 2000, generating
units subject to Phase II must hold Emission Allowances equal to the level of
emissions in the compliance year or pay penalties and offset excess emissions
in future years. TEP had sufficient Emission Allowances to comply with the
Phase II SO2 regulations for compliance year 2002. However, due to increased
energy output, TEP may have to purchase additional Emission Allowances for
future compliance years.
Title V of the CAAA requires that all of TEP's generating facilities
obtain more complex air quality permits. All TEP facilities (including those
jointly owned and operated by others) have obtained these permits. In 1999,
TEP received Title V permits for the Springerville and Irvington generating
stations. These permits are valid for five years. TEP must pay an annual
emission-based fee for each generating facility subject to a Title V permit.
These emission-based fees are included in the CAAA compliance expenses
discussed below. The CAAA also requires multi-year studies of visibility
impairment in specified areas and studies of hazardous air pollutants. The
results of these studies will impact the development of future regulation of
electric utility generating units. Since these activities involve the
gathering of information not currently available, TEP cannot predict the
outcome of these studies.
Arizona and New Mexico have adopted regulations restricting the
emissions from existing and future coal, oil and gas-fired plants. These
regulations are in some instances more stringent than those adopted by the
Environmental Protection Agency (EPA). The principal generating units of TEP
are located relatively close to national parks, monuments, wilderness areas
and Indian reservations. Since these areas have relatively high air quality,
TEP could be subject to control standards that relate to the "prevention of
significant deterioration" of visibility and tall stack limitation rules.
TEP spent approximately $2.5 million in 2002, $2 million in 2001 and $1
million in 2000, and expects to spend approximately $2 million in 2003 and
2004 complying with these requirements. TEP may incur additional costs to
comply with recent and future changes in federal and state environmental
laws, regulations and permit requirements at existing electric generating
facilities. Compliance with these changes may result in a reduction in
operating efficiency. Failure to comply with any EPA or state compliance
requirements may result in substantial penalties or fines.
The EPA has issued a determination that coal and oil fired electric
utility steam generating units must control their mercury emissions. Final
regulations are expected to be issued in 2004.
On April 29, 2002, the Arizona Department of Environmental Quality
(ADEQ) issued a final permit granting the expansion of the Springerville
Generating Station to allow for two new 400 MW coal fired generating units.
TEP worked with the EPA and the ADEQ to determine mutually acceptable levels
of emissions for all four units to accomplish significant emission reductions
from current levels. If constructed, Springerville Unit 3 will be equipped
with modern emissions control technology and the emissions controls on Units
1 and 2 will be upgraded. SO2 emissions from all four units will be up to
55 percent less than those currently produced from the two existing units,
while NOx emissions will be up to 39 percent less. Upgrades to Units
1 and 2 will be paid for by the Unit 3 project. The Grand Canyon Trust
(GCT), an environmental activist group, has filed a petition with the EPA
to revoke the permit, based on the allegations in the litigation set forth
below.
On November 13, 2001, the GCT 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 alleged that more stringent emission
standards should apply to Units 1 and 2 and that new permits and the
installation of additional facilities meeting Best Available Control
Technology standards are required for the continued operation of Units 1 and
2 in accordance with applicable law. TEP believes the claims by the GCT are
without merit and will vigorously contest them.
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 Court found
that TEP had commenced consturction of the Springerville Generating Station
in the time periods required by the original permits. There were two
remaining allegations: (1) TEP discontinued construction for a period of 18
months or longer and did not complete construction in a reasonable period of
time and (2) TEP did not commence construction, for purposes of New Source
Performance Standard applicability, by September 18, 1978. On March 4, 2002,
the U.S. District Court determined that the GCT had not commenced the case
on a timely basis and dismissed the case.
On November 1, 2002 the ACC granted TEP siting approval to construct
Unit 3 (and Unit 4, if Unit 4 is built) at Springerville subject to certain
conditions. Both the GCT and the Land and Water Fund of the Rockies have
opposed this approval and have filed for reconsideration which was denied
by the ACC. The GCT and the Land and Water Fund of the Rockies have
judicially appealed this decision.
MILLENNIUM ENERGY BUSINESSES
- ----------------------------
Millennium's assets comprised approximately 6% of the consolidated
assets of UniSource Energy at December 31, 2002. Millennium had an after-tax
loss of $15.5 million in 2002 and $9.2 million in 2001, which included a $6
million after-tax gain on the sale of a power project. In 2000, Millennium
reported losses of $4.1 million. Through its affiliates, Millennium holds
investments in the energy-related businesses which are described below.
Energy Technology Investments
-----------------------------
Millennium participates in various companies designed to develop
renewable energy, thin-film technologies and other emerging energy
technologies, including:
- Global Solar Energy, Inc. (Global Solar), a developer of flexible thin-
film photovoltaic cells, started limited production of photovoltaic
cells in 1999. Global Solar's target markets for its products include
commercial, space and military applications. Millennium currently owns
87% of Global Solar.
- Infinite Power Solutions, Inc. (IPS), a developer of thin-film
batteries. At December 31, 2002, Millennium owns approximately 77.5% of
IPS, however this ownership share is anticipated to be reduced in 2003
as a result of planned additional external investment by Dow Corning
Enterprises, Inc. Millennium anticipates that its ultimate ownership
in IPS will be between 59% and 72%.
- MicroSat Systems, Inc. (MicroSat) is a developer of small scale
satellites. MicroSat funds much of the development activities through
Federal Government contracts. Millennium currently owns 49% of
MicroSat, but pursuant to a restructuring agreement signed earlier in
the year, has agreed to reduce its ownership to 35%. Millennium expects
this change to occur in 2003.
As technology developers, these entities face many challenges, such as
developing technologies that can be manufactured on an economic scale,
technological obsolescence, competitors and possible reductions in government
spending to advance technological research and development activities. While
in the short-term we believe Millennium will incur losses from the funding of
the development efforts, we believe that the investments will be profitable
in the long-term. Millennium expects to fund between $7 million and $15
million to its various technology investments in 2003. In 2002, Millennium
provided $18.5 million in debt and equity funding to the Energy Technology
Investments. See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Results of Millennium Energy Businesses
for more information regarding these entities, including research and
development activities.
Sabinas
-------
In 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 19.5% of
Minerales de Monclova, S.A. de C.V., (Mimosa). Mimosa is an owner of coal
and associated gas reserves, a supplier of metallurgical coal to the steel
industry, and a supplier of thermal coal to the Mexican electricity commission.
Since 1999, both AHMSA and Mimosa are parties to a suspension of payments
procedure, under applicable Mexican law, which is the equivalent of a U.S.
Chapter 11 proceeding. Under certain circumstances, Millennium has the right
to sell its interest (a put option) 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, President and Chief
Executive Officer is a member of the board of directors of AHMSA.
Nations Energy
--------------
Nations Energy Corporation (Nations Energy), a wholly-owned subsidiary
of Millennium, was established in 1995 to develop and invest in independent
power projects worldwide. In 2001, Nations Energy sold its 26% equity
interest in a power project located in Curacao, Netherland Antilles. Nations
Energy has one remaining investment, a 40% equity interest in an independent
power producer that owns and operates a 43 MW power plant near Panama City,
Panama. Nations Energy intends to sell its interest in this project, which
has a book value of less than $1 million at December 31, 2002. Millennium
does not currently intend to make any additional investments in Nations
Energy. See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operation - Results of Millennium Energy Businesses,
Nations Energy.
Other Millennium Investments
----------------------------
Millennium also has the following investments which are consolidated:
- Southwest Energy Solutions, Inc. (SES), a wholly-owned Millennium
subsidiary, provides electrical contracting services in Arizona to
commercial, industrial and governmental customers in both high voltage
and inside wiring capacities and meter reading services to TEP.
- Millennium Environmental Group, Inc. (MEG), a wholly-owned Millennium
subsidiary, established in September 2001, manages and trades emission
allowances, coal and other environmental related products including
derivative instruments.
- POWERTRUSION International, Inc. (Powertrusion) is a manufacturer of
lightweight utility poles, which is 50.5% owned by Millennium.
We describe Millennium's unregulated energy businesses and other
investments in more detail in Note 4 of Notes to Consolidated Financial
Statements - Millennium Energy Businesses, and in Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Results of Millennium Energy Businesses and in Liqiudity and Capital
Resources, Millennium - Unregulated Businesses.
UNISOURCE ENERGY DEVELOPMENT COMPANY
- ------------------------------------
UED, established in February 2001, is facilitating the expansion of the
Springerville Generating Station. The Springerville Generating Station was
originally designed for four units. If constructed, each of Units 3 and 4
would consist of a 400 MW coal-fired, base-load generating unit at the same
site as Springerville Units 1 and 2. If Unit 3 (and subsequently Unit 4) is
built, this would allow TEP to spread the fixed costs of the existing common
facilities over the additional generating unit (or units).
UED currently expects to act as project manager for the development of
Springerville Unit 3 (and Unit 4, if Unit 4 is built) and anticipates that
financing and ownership will occur through third parties. The entire output
of Unit 3 is expected to be taken by regional power companies, including
Tri-State Generation and Transmission Association (Tri-State), Salt River
Project Agricultural Improvement and Power District (SRP), and TEP. It is
currently expected that SRP will purchase 100 MW, and Tri-State will take
300 MW. TEP would purchase from Tri-State up to 100 MW of capacity for no
more than five years from commercial operation. SRP also has an option to
own Unit 4 at a later date. If SRP exercises the option to own Unit 4,
TEP would be required to purchase SRP's 100 MW of output from Unit 3,
beginning with the commercial operation of Unit 4.
Tri-State and UED signed a Development Cost Agreement in January 2003
to each share 50% of the development costs of Unit 3 effective from November
6, 2002 until financial closing. As of December 31, 2002, UED had
approximately $22 million of capitalized project development costs on its
balance sheet.
On October 29, 2002, the ACC issued an order that affirms the
Certificate of Environmental Compatibility (CEC) granted to TEP authorizing
the construction of Unit 3, subject to compliance with certain conditions,
and approved the CEC for Unit 4 subject to certain conditions occurring. The
ACC approved construction of a third and fourth unit at the Springerville
Generating Station in 1977 and 1987, respectively, but with respect to Unit
4, the ACC provided that TEP, as plant operator, demonstrate that the fourth
unit was needed to provide an adequate, economical and reliable supply of
electric power to its customers. That demonstration was made as part of the
proceedings that resulted in the issuance of the ACC Order.
Environmental activist groups have expressed concerns regarding the
construction of any new units. Such concerns have been expressed during the
permitting and ACC proceedings and may extend to other forums and to issues
apart from the proposed construction. See Environmental Matters above.
UED expects to finalize the power purchase agreements, the engineering,
procurement and construction contract, and other required project agreements
during the first half of 2003. UED expects a third party to obtain
construction financing in 2003 and then begin construction. UED expects
commercial operation of Unit 3 to occur in 2006. We can make no assurances,
however, about the ultimate timing, or whether UED will proceed with this
project. See Note 10 of Notes to Consolidated Financial Statements - UED
Commitments.
EMPLOYEES
- ---------
As of December 31, 2002, TEP had 1,134 employees and the wholly-owned
subsidiaries of Millennium had 118 employees. The International Brotherhood
of Electrical Workers (IBEW) Local 1116 represents approximately 58% of TEP's
employees. A new three-year collective bargaining agreement between the IBEW
and TEP was ratified in December 2002 and extends through 2005. Wages for
bargaining unit employees will increase 3.5% in 2003. Wage increases for
2004 and 2005 will be determined annually during July and August of each
preceding year.
SEC REPORTS AVAILABLE ON UNISOURCE ENERGY'S WEBSITE
- ---------------------------------------------------
UniSource Energy and TEP make available their annual reports on Form 10-
K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after they
electronically file them with, or furnish them to, the SEC. These reports
are available free of charge through UniSource Energy's website address:
http://www.unisourceenergy.com. A link from UniSource Energy's website to
these SEC reports is accessible as follows: At the UniSource Energy main
page, select Investor Relations from the menu shown at the top of the page;
next select SEC filings from the menu shown on the Investor Relations page.
Information contained at UniSource Energy's website is not part of any
report filed with the SEC by UniSource Energy or TEP.
The SEC also maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers that file
electronically with the SEC. The SEC website address is http://www.sec.gov.
Interested parties may also read and copy any materials UniSource Energy and
TEP file with the SEC at the SEC's Public Reference Room at 450 Fifth Street,
NW, Washington, DC 20549. Information on the operation of the Public
Reference Room is available by calling the SEC at 1-800-SEC-0030.
ITEM 2. - PROPERTIES
- --------------------------------------------------------------------------------
TEP's transmission facilities, located in Arizona and New Mexico,
transmit electricity from TEP's remote electric generating stations at Four
Corners, Navajo, San Juan and Springerville to the Tucson area for use by
TEP's retail customers (see Item 1. - Business - Generating and Other
Resources). The transmission system is directly interconnected at various
points in Arizona and New Mexico with a number of regional utilities. TEP
has arrangements with approximately 120 companies to interchange generation
capacity and transmission of energy.
As of December 31, 2002, TEP owned, or participated in, an overhead
electric transmission and distribution system consisting of:
- 511 circuit-miles of 500 kV lines;
- 1,122 circuit-miles of 345 kV lines;
- 371 circuit-miles of 138 kV lines;
- 434 circuit-miles of 46 kV lines; and
- 12,095 circuit-miles of lower voltage primary lines.
The underground electric distribution system is comprised of 7,353 cable-
miles. TEP owns approximately 77% of the poles on which the lower voltage
lines are located. Electric substation capacity consisted of 192 substations
with a total installed transformer capacity of 5,602,522 kilovoltamperes.
The electric generating stations (except as noted below), operating
headquarters, warehouse and service center are located on land owned by TEP.
The electric distribution and transmission facilities owned by TEP are
located:
- on property owned by TEP;
- under or over streets, alleys, highways and other public places, the
public domain and national forests and state lands under franchises,
easements or other rights which are generally subject to termination;
- under or over private property as a result of easements obtained
primarily from the record holder of title; and
- over Indian reservations under grant of easement by the Secretary of
Interior or lease by Indian tribes.
It is possible that some of the easements, and the property over which
the easements were granted, may have title defects or may be subject to
mortgages or liens existing at the time the easements were acquired.
Springerville is located on land parcels held by TEP under a long-term
surface ownership agreement with the State of Arizona.
Four Corners and Navajo are located on properties held under easements
from the United States and under leases from the Navajo Nation. TEP,
individually and in conjunction with Public Service Company of New Mexico
(PNM) in connection with San Juan, has acquired easements and leases for
transmission lines and a water diversion facility located on land owned by
the Navajo Nation. TEP has also acquired easements for transmission
facilities, related to San Juan, Four Corners, and Navajo, across the Zuni,
Navajo and Tohono O'odham Indian Reservations.
TEP's rights under these various easements and leases may be subject to
defects such as:
- possible conflicting grants or encumbrances due to the absence of or
inadequacies in the recording laws or record systems of the Bureau of
Indian Affairs and the Indian tribes;
- possible inability of TEP to legally enforce its rights against
adverse claimants and the Indian tribes without Congressional consent;
and
- failure or inability of the Indian tribes to protect TEP's interests
in the easements and leases from disruption by the U.S. Congress,
Secretary of the Interior, or other adverse claimants.
These possible defects have not and are not expected to materially
interfere with TEP's interest in and operation of its facilities.
TEP, under separate sale and leaseback arrangements, leases the
following generation facilities (which do not include land):
- coal handling facilities at Springerville;
- a 50% undivided interest in the Springerville Common Facilities;
- Springerville Unit 1 and the remaining 50% undivided interest in
Springerville Common Facilities; and
- Irvington Unit 4 and related common facilities.
See Note 7 of Notes to Consolidated Financial Statements, and Item 7. -
Management's Discussion and Analysis of Financial Condition and Results of
Operations, Liquidity and Capital Resources, Contractual Obligations, for
additional information on TEP's capital lease obligations.
Substantially all of the utility assets owned by TEP are subject to the
lien of the General First Mortgage and the General Second Mortgage.
Springerville Unit 2, which is owned by San Carlos is not subject to those
liens.
ITEM 3. - LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Factors Affecting Results of Operations
for litigation related to ACC orders and retail competition.
We discuss other legal proceedings in Note 10 of Notes to Consolidated
Financial Statements.
ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
Not applicable.
PART II
ITEM 5. - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
- --------------------------------------------------------------------------------
Stock Trading
-------------
UniSource Energy's Common Stock is traded under the ticker symbol UNS.
It is listed on the New York Stock Exchange and the Pacific Exchange. As of
March 4, 2003, the closing price was $16.58, with 15,181 shareholders of
record.
Dividends
---------
UniSource Energy pays dividends on its Common Stock after its Board of
Directors declares them. There is no limitation on UniSource Energy paying
dividends on its Common Stock.
TEP pays dividends on its common stock after its Board of Directors
declares them. UniSource Energy is the primary shareholder of TEP's common
stock. TEP has certain restrictions on paying dividends, as listed below:
- TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that
requires TEP to maintain a minimum level of net worth, and so long as
the dividends and certain investments in affiliates would not exceed 65%
of TEP's net income.
- Under ACC restrictions, TEP can pay dividends so long as the dividends
do not exceed 75% of TEP's earnings until its equity ratio equals 37.5%
of total capital (excluding capital lease obligations).
- Under the Federal Power Act, TEP cannot pay dividends out of funds
that are properly included in the capital account.
See Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Dividends on Common Stock.
Common Stock Dividends and Price Ranges
----------------------------------------------------------------------------------
2002 2001
Quarter: Market Price per Dividends Market Price per Dividends
Share of Common Declared Share of Common Declared
Stock (1) Stock (1)
High Low High Low
---- --- ---- ---
First $20.60 $16.74 $0.125 $21.00 $15.13 $0.10
Second 20.75 17.91 0.125 25.98 20.16 0.10
Third 18.89 14.05 0.125 24.05 13.80 0.10
Fourth 17.90 13.69 0.125 19.30 13.80 0.10
----------------------------------------------------------------------------------
Total $0.500 $0.40
==================================================================================
(1) UniSource Energy's Common Stock price on the consolidated tape as reported by
Dow Jones.
On February 7, 2003, UniSource Energy declared a cash dividend of $0.15
per share on its Common Stock. The dividend is payable March 7, 2003 to
shareholders of record at the close of business February 21, 2003.
TEP declared and paid cash dividends of $35 million in 2002, $50 million
in 2001, and $30 million in 2000.
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- --------------------------------------------------------------------------------
UniSource Energy 2002 2001 2000 1999 1998
------------------------------------------------------
- In Thousands -
Summary of Operations (except per share data)
- --------------------------------------------------------------------------------------------------
Operating Revenues $856,222 $1,417,012 $1,033,669 $814,828 $770,597
Gain on Sale of NewEnergy - - - $34,651 -
Loss Before Income Taxes of Millennium
Energy Businesses (1) $(30,702) $(14,455) $(12,059) $(11,276) $(11,884)
Income Before Extraordinary Item and
Accounting Change $33,275 $60,875 $41,891 $56,510 $28,032
Net Income $33,275 $61,345 $41,891 $79,107 $28,032
Basic Earnings per Share:
Before Extraordinary Item &
Accounting Change $0.99 $1.83 $1.29 $1.75 $0.87
Net Income $0.99 $1.84 $1.29 $2.45 $0.87
Diluted Earnings per Share:
Before Extraordinary Item &
Accounting Change $0.97 $1.79 $1.27 $1.74 $0.87
Net Income $0.97 $1.80 $1.27 $2.43 $0.87
Shares of Common Stock Outstanding
Average 33,665 33,398 32,445 32,321 32,177
End of Year 33,579 33,502 33,219 32,349 32,258
Year-end Book Value per Share $13.05 $12.68 $11.20 $10.02 $7.65
Cash Dividends Declared per Share $0.50 $0.40 $0.24 $0.08 -
- --------------------------------------------------------------------------------------------------
Financial Position
- --------------------------------------------------------------------------------------------------
Total Utility Plant - Net $1,668,350 $1,677,671 $1,706,290 $1,729,856 $1,915,590
Investments in Lease Debt and Equity $191,867 $84,459 $71,639 $44,550 $17,813
Other Investments and Other Property $123,238 $98,288 $50,172 $69,933 $92,476
Total Assets $2,690,734 $2,746,717 $2,671,384 $2,656,255 $2,634,049
Long-Term Debt (2) $1,128,963 $802,804 $1,132,395 $1,135,820 $1,184,423
Non-Current Capital Lease Obligations 801,611 853,793 857,829 880,427 889,543
Common Stock Equity 438,229 424,722 372,169 324,248 246,646
- --------------------------------------------------------------------------------------------------
Total Capitalization $2,368,803 $2,081,319 $2,362,393 $2,340,495 $2,320,612
- --------------------------------------------------------------------------------------------------
Selected Cash Flow Data
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Operating
Activities $172,963 $215,379 $215,034 $113,228 $160,933
Capital Expenditures $(112,706) $(121,622) $(105,996) $(92,808) $(81,147)
Other Investing Cash Flows (158,184) 4,775 (7,554) (242) (27,810)
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Investing
Activities $(270,890) $(116,847) $(113,550) $(93,050) $(108,957)
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Financing
Activities $(39,299) $(33,382) $(83,768) $(20,057) $(53,065)
- --------------------------------------------------------------------------------------------------
(1) Loss Before Income Taxes of Millennium Energy Businesses for 1999 excludes the Gain on
Sale of NewEnergy.
(2) TEP's tax-exempt variable rate bonds in the amount of $329 million are backed by LOCs
under TEP's Credit Agreement. TEP's obligations under the Credit Agreement are
collateralized with Second Mortgage Bonds. In November 2002, TEP entered into two new
LOCs for $341 million to replace the LOCs provided under its then existing credit
agreement that would have expired on December 30, 2002. These new LOCs expire in 2006.
Accordingly, these IDBs were classified as short-term debt at December 31, 2001 and
classified as long-term debt at December 31, 2002.
See Item 7. - Management's Discussion and Analysis of Financial Condition and Results of
Operations.
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- --------------------------------------------------------------------------------
TEP 2002 2001 2000 1999 1998
-----------------------------------------------------
- Thousands of Dollars -
Summary of Operations
- --------------------------------------------------------------------------------------------------
Operating Revenues $851,093 $1,408,669 $1,028,368 $804,083 $768,990
Income Before Extraordinary Item
and Accounting Change $53,737 $74,814 $51,169 $50,878 $41,676
Net Income $53,737 $75,284 $51,169 $73,475 $41,676
- --------------------------------------------------------------------------------------------------
Financial Position
- --------------------------------------------------------------------------------------------------
Total Utility Plant - Net $1,668,350 $1,677,671 $1,706,290 $1,729,856 $1,915,590
Investments in Lease Debt and Equity $191,867 $84,459 $69,474 $44,550 $17,813
Other Investments and Other Property $21,358 $21,416 $22,860 $23,288 $45,165
Total Assets $2,613,590 $2,645,335 $2,600,935 $2,600,508 $2,628,588
Long-Term Debt (1) $1,128,410 $801,924 $1,132,395 $1,135,820 $1,184,423
Non-Current Capital Lease Obligations 801,508 853,447 857,519 880,111 889,543
Common Stock Equity 337,463 322,471 295,660 270,134 229,861
- --------------------------------------------------------------------------------------------------
Total Capitalization $2,267,381 $1,977,842 $2,285,574 $2,286,065 $2,303,827
- --------------------------------------------------------------------------------------------------
Selected Cash Flow Data
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Operating
Activities $203,517 $261,169 $234,190 $139,957 $180,487
Capital Expenditures $(103,307) $(103,913) $(98,063) $(90,940) $(81,011)
Other Investing Cash Flows (145,271) (11,981) (23,273) (24,480) (43,937)
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Investing
Activities $(248,578) $(115,894) $(121,336) $(115,420) $(124,948)
- --------------------------------------------------------------------------------------------------
Net Cash Flows From Financing
Activities $(58,841) $(74,307) $(112,544) $(54,371) $(83,559)
- --------------------------------------------------------------------------------------------------
Ratio of Earnings to Fixed Charges 1.58 1.82 1.47 1.45 1.35
- --------------------------------------------------------------------------------------------------
(1) TEP's tax-exempt variable rate bonds in the amount of $329 million are backed by LOCs
under TEP's Credit Agreement. TEP's obligations under the Credit Agreement are
collateralized with Second Mortgage Bonds. In November 2002, TEP entered into two new
LOCs for $341 million to replace the LOCs provided under its then existing credit
agreement that would have expired on December 30, 2002. These new LOCs expire in 2006.
Accordingly, these IDBs were classified as short-term debt at December 31, 2001 and
classified as long-term debt at December 31, 2002.
Note: Disclosure of earnings per share information for TEP is not presented as the common
stock of TEP is not publicly traded.
See Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations.
ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Management's Discussion and Analysis explains the results of operations,
the general financial condition, and outlook for UniSource Energy and its
three primary business segments-the electric utility business of TEP and the
unregulated energy businesses of Millennium and UED-and includes the
following:
- operating results during 2002 compared with 2001, and 2001 compared with
2000,
- factors which affect our results and outlook,
- our outlook and strategy, and
- our liquidity, capital needs, capital resources and contractual
obligations.
TEP is the principal operating subsidiary of UniSource Energy and
accounts for substantially all of its assets and revenues. Income and losses
from Millennium's energy-related businesses have had a significant impact on
earnings reported by UniSource Energy for 2002, 2001, and 2000. UED`s
unregulated business segment, which was established in February 2001, may
have a significant impact on consolidated net income and cash flows in the
future. In addition, in 2002, UniSource Energy entered into asset purchase
agreements for the purchase of retail electric and gas utility assets in
various locations in Arizona, which if completed, will have a significant
impact on our financial condition and results of operations.
RESULTS OF OPERATIONS
- ---------------------
UNISOURCE ENERGY CONSOLIDATED
UniSource Energy recorded net income of $33 million in 2002, compared
with $61 million in 2001, and $42 million in 2000. UniSource Energy's total
revenues decreased by 40% to $856 million in 2002, resulting from
significantly decreased wholesale marketing activities at TEP. The following
factors contributed to the change in net income in 2002 compared with 2001:
- TEP's wholesale revenues decreased by $556 million, or 76%, due to
significantly lower prices in the western U.S. energy markets and
decreased sales activity, partially offset by a reduction of $527
million, or 66%, in fuel and purchased power expenses.
- Mild weather and lower demand from TEP's mining customers contributed
to lower retail energy sales and revenues in 2002. Despite these
factors, retail revenues fell only one percent due to continued strong
growth in number of retail customers and increased usage by residential
and commercial customers.
- TEP recorded a one-time $7 million after-tax coal contract termination
fee expense in the third quarter of 2002, which will relieve TEP of
annual $2 million after-tax take-or-pay payments in future years.
- Millennium's after-tax losses were $6 million higher in 2002 than 2001
because 2001 results included a $6 million after-tax gain on the sale of
a power project.
- TEP recognized $5 million in tax benefits from the favorable
settlement of IRS audits and the recognition of tax credits in 2002, and
Millennium recognized $2.5 million in tax benefits from the recognition
of foreign tax losses and favorable settlement of IRS audits.
The following factors contributed to the change in net income in 2001
compared with 2000:
- TEP's average number of retail customers grew by 2.5% to 347,099 in
2001 and retail revenues grew by 0.8% to $670 million.
- TEP's wholesale revenues more than doubled due to sales of available
generating capacity, increased trading activities and significantly
higher prices in the western U.S. energy markets in the first half of
2001.
- Interest expense at TEP decreased by 5% due to lower debt balances and
lower rates on variable rate debt.
- Nations Energy sold an independent power project in 2001 for a $6
million after-tax gain.
- TEP recorded a one-time $8 million after-tax expense related to the
amendment of a coal supply contract in the third quarter of 2000.
CONTRIBUTION BY BUSINESS SEGMENT
The table below shows the contributions to our consolidated after-tax
earnings by our three business segments, as well as parent company expenses.
2002 2001 2000
--------------------------------------------------------------------
- Millions of Dollars -
Business Segment
TEP $ 53.7 $ 75.3 $ 51.2
Millennium (15.5) (9.2) (4.1)
UED 0.8 0.8 -
UniSource Energy Standalone (1) (5.8) (5.6) (5.2)
--------------------------------------------------------------------
Consolidated Net Income $ 33.2 $ 61.3 $ 41.9
====================================================================
(1) Represents interest expense (net of tax) on the note payable
from UniSource Energy to TEP.
RESULTS OF TEP
The financial condition and results of operations of TEP are currently
the principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis. The following discussion
relates to TEP's utility operations, unless otherwise noted. The results of
our unregulated energy businesses are discussed in Results of Millennium
Energy Businesses and Results of UED, below.
UTILITY SALES AND REVENUES
Customer growth, weather and other consumption factors affect retail
sales of electricity. Price changes also contribute to changes in retail
revenues. Electric wholesale revenues are affected by market prices in the
wholesale energy market, availability of TEP generating resources, and the
level of wholesale forward contract activity.
TEP experienced a significant decrease in wholesale energy sales and
revenues during 2002 compared with 2001. Market demand in the western region
declined primarily as a result of mild temperatures, and market prices fell
as a result of increased capacity in the region and declining natural gas
prices, as well as reduced demand. In comparison, during the first five
months of 2001 and the last half of 2000, TEP experienced significant growth
in wholesale energy sales and revenues, primarily due