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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 2003
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
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
UniSource Energy Corporation Yes X No
----- -----
Tucson Electric Power Company Yes No X
----- -----
At May 8, 2003, 33,589,114 shares of UniSource Energy Corporation's
Common Stock, no par value (the only class of Common Stock), were outstanding.
At May 8, 2003, 32,139,555 shares of Tucson Electric Power Company's
common stock, no par value, were outstanding, of which 32,139,434 were held
by UniSource Energy.
- --------------------------------------------------------------------------------
This combined Form 10-Q is separately filed by UniSource Energy Corporation and
Tucson Electric Power Company. Information contained in this document relating
to Tucson Electric Power Company is filed by UniSource Energy Corporation and
separately by Tucson Electric Power Company on its own behalf. Tucson Electric
Power Company makes no representation as to information relating to UniSource
Energy Corporation or its subsidiaries, except as it may relate to Tucson
Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions.................................................................iv
Report of Independent Accountants............................................1
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements of Income (Loss)..........2
Comparative Condensed Consolidated Statements of Cash Flows.............3
Comparative Condensed Consolidated Balance Sheets.......................4
Condensed Consolidated Statement of Changes in Stockholders' Equity.....5
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income (Loss)..........6
Comparative Condensed Consolidated Statements of Cash Flows.............7
Comparative Condensed Consolidated Balance Sheets.......................8
Condensed Consolidated Statement of Changes in Stockholders' Equity.....9
Notes to Condensed Consolidated Financial Statements
Note 1. Nature of Operations and Basis of Accounting Presentation.......10
Note 2. Regulatory Accounting...........................................10
Note 3. Asset Purchase Agreements.......................................11
Note 4. Accounting Change: Accounting for Asset Retirement Obligations..12
Note 5. Stock-Based Compensation........................................14
Note 6. Accounting for Derivative Instruments and Trading Activities....15
Note 7. Business Segments...............................................16
Note 8. Millennium......................................................17
Note 9. Commitments and Contingencies...................................18
Note 10. Wholesale Accounts Receivable and Allowances....................20
Note 11. UniSource Energy Earnings per Share (EPS).......................21
Note 12. Income and Other Taxes..........................................21
Note 13. New Accounting Pronouncements...................................22
Note 14. Review by Independent Accountants...............................22
Item 2. - Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview of Consolidated Business........................................23
Results of Operations
UniSource Energy Consolidated..........................................23
Contribution by Business Segment.......................................24
Results of TEP.........................................................24
Results of Millennium..................................................27
Results of UED.........................................................27
Citizens Acquisition.....................................................27
Springerville Generating Station Expansion...............................29
Factors Affecting Results of Operations
Competition............................................................29
Industry Restructuring.................................................30
Market Risks...........................................................32
Liquidity and Capital Resources
UniSource Energy - Consolidated Cash Flows.............................34
UniSource Energy - Parent Company......................................35
TEP - Electric Utility.................................................35
ii
TABLE OF CONTENTS
(concluded)
Millennium - Unregulated Businesses....................................37
UED - Unregulated Energy Business......................................38
Financing Risks........................................................38
Contractual Obligations................................................38
Guarantees and Indemnities.............................................39
Dividends on Common Stock..............................................39
Outlook and Strategies...................................................40
Critical Accounting Policies.............................................40
New Accounting Pronouncements............................................44
Safe Harbor for Forward-Looking Statements...............................45
Item 3. - Quantitative and Qualitative Disclosures about Market Risk......46
Item 4. - Controls and Procedures.........................................46
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings...............................................47
Item 5. - Other Information
Additional Financial Data................................................48
Approval of Non-Audit Services...........................................48
SEC Reports Available on UniSource Energy's Website......................48
Item 6. - Exhibits and Reports on Form 8-K................................48
Signatures..................................................................49
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act............50
Exhibit Index...............................................................54
iii
DEFINITIONS
The abbreviations and acronyms used in the 2003 First Quarter Form 10-Q are
defined below:
- --------------------------------------------------------------------------------
ACC.......................... Arizona Corporation Commission.
ACC Holding Company Order.... The order approved by the ACC in November
1997 allowing TEP to form a holding company.
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.
Citizens Settlement
Agreement.................. A proposed agreement with the ACC Staff
dated April 1, 2003, addressing rate case and
financing issues in the planned acquisition by
UniSource Energy of the Citizens' Arizona gas
and electric assets.
Common Stock................. UniSource Energy's common stock, without par
value.
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 allowance issued by the Environmental
Protection Agency 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.
ESP.......................... Energy Service Provider.
FAS 71....................... Statement of Financial Accounting Standards No.
71: Accounting for the Effects of Certain Types
of Regulation.
FAS 133...................... Statement of Financial Accounting Standards No.
133: Accounting for Derivative Instruments and
Hedging Activities.
FAS 143...................... Statement of Financial Accounting Standards No.
143: Accounting for Asset Retirement
Obligations.
FERC......................... Federal Energy Regulatory Commission.
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.
IPS.......................... Infinite Power Solutions, Inc., a company that
develops thin-film batteries. Millennium owns
approximately 74% of IPS.
ITN.......................... ITN Energy Systems, Inc., was formed to provide
research, development, and other services.
Millennium currently owns 49% but has agreed to
reduce its ownership to 9%.
kWh.......................... Kilowatt-hour(s).
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which manages
and trades Emission Allowances, coal, and
related financial instruments.
MicroSat..................... MicroSat Systems, Inc., 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.
MW........................... Megawatt(s).
MWh.......................... Megawatt-hour(s).
PG&E......................... Pacific Gas and Electric Company.
Revolving Credit Facility.... $60 million revolving credit facility entered
into under the Credit Agreement between a
syndicate of banks and TEP.
Rules........................ Retail Electric Competition Rules.
SCE.......................... Southern California Edison Company.
Settlement Agreement......... TEP's Settlement Agreement approved by the ACC
in November 1999 that provided for electric
retail competition and transition asset
recovery.
Springerville................ Springerville Generating Station.
Springerville Common
Facilities Leases.......... Leveraged lease arrangements relating to an
undivided one-half interest in certain
Springerville facilities used in common by
Springerville Unit 1 and Springerville Unit 2.
iv
DEFINITIONS
(concluded)
Springerville Unit 1......... Unit 1 of the Springerville Generating Station.
Springerville Unit 2......... Unit 2 of the Springerville Generating Station.
SRP.......................... Salt River Project Agricultural Improvement and
Power District.
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
Tri-State.................... Tri-State Generation and Transmission
Association.
TruePricing.................. TruePricing, Inc., a start-up company
established to market energy related products.
Millennium and TEP collectively own 51% of the
outstanding shares of TruePricing.
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.
v
Report of Independent Accountants
To the Board of Directors and Stockholders of
UniSource Energy Corporation and
to the Board of Directors of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated balance sheets of
UniSource Energy Corporation and its subsidiaries (the Company) and Tucson
Electric Power Company and its subsidiaries (TEP) as of March 31, 2003 and
the related condensed consolidated statements of income (loss) and of cash
flows for each of the three-month periods ended March 31, 2003 and 2002 and
the condensed consolidated statement of changes in stockholders' equity for
the three-month period ended March 31, 2003. These financial statements are
the responsibility of the Company's and TEP's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated interim financial
statements for them to be in conformity with accounting principles generally
accepted in the United States of America.
We previously audited in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet and
statement of capitalization of the Company and TEP as of December 31, 2002,
and the related consolidated statements of income, of changes in
stockholders' equity, and of cash flows for the year then ended (not
presented herein), and in our report dated February 6, 2003 we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet information as of December 31, 2002 is fairly stated in all
material respects in relation to the consolidated balance sheets from which
it has been derived.
PricewaterhouseCoopers LLP
May 2, 2003
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
March 31,
2003 2002
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 130,545 $ 131,832
Electric Wholesale Sales 40,170 35,546
Net Gain (Loss) on TEP Forward Contracts and
MEG Trading Activities (342) 1,021
Other Revenues 2,793 2,796
- -----------------------------------------------------------------------------
Total Operating Revenues 173,166 171,195
- -----------------------------------------------------------------------------
Operating Expenses
Fuel 46,502 48,319
Purchased Power 15,656 1,470
Other Operations and Maintenance 52,156 48,876
Depreciation and Amortization 30,520 33,450
Amortization of Transition Recovery Asset 3,608 2,882
Taxes Other Than Income Taxes 11,591 11,512
- -----------------------------------------------------------------------------
Total Operating Expenses 160,033 146,509
- -----------------------------------------------------------------------------
Operating Income 13,133 24,686
- -----------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 5,234 4,756
Other Income 1,507 2,066
Other Expense (2,225) (1,871)
- -----------------------------------------------------------------------------
Total Other Income (Deductions) 4,516 4,951
- -----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 19,272 15,972
Interest on Capital Leases 20,738 22,244
Other Interest Expense, Net of Amounts Capitalized (93) 231
- -----------------------------------------------------------------------------
Total Interest Expense 39,917 38,447
- -----------------------------------------------------------------------------
Loss Before Income Taxes and Cumulative Effect of
Accounting Change (22,268) (8,810)
Income Tax Benefit (8,067) (2,496)
- -----------------------------------------------------------------------------
Loss Before Cumulative Effect of Accounting Change (14,201) (6,314)
Cumulative Effect of Accounting Change - Net of Tax 67,471 -
- -----------------------------------------------------------------------------
Net Income (Loss) $ 53,270 $ (6,314)
=============================================================================
Average Shares of Common Stock Outstanding (000) 33,739 33,586
=============================================================================
Basic and Diluted Earnings per Share
Loss Before Cumulative Effect of Accounting Change $ (0.42) $ (0.19)
Cumulative Effect of Accounting Change - Net of Tax $ 2.00 -
Net Income (Loss) $ 1.58 $ (0.19)
=============================================================================
Dividends Paid per Share $ 0.15 $ 0.125
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
2
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 153,697 $ 155,392
Cash Receipts from Electric Wholesale Sales 57,405 87,281
MEG Cash Receipts from Trading Activity 12,446 3,420
Interest Received 11,375 3,322
Fuel Costs Paid (49,760) (49,823)
Purchased Power Costs Paid (26,061) (56,299)
Wages Paid, Net of Amounts Capitalized (20,539) (21,696)
Payment of Other Operations and Maintenance Costs (27,341) (28,488)
MEG Cash Payments for Trading Activity (14,326) (4,799)
Capital Lease Interest Paid (41,967) (34,914)
Taxes Paid, Net of Amounts Capitalized (14,001) (14,408)
Debt Interest Paid, Net of Amounts Capitalized (25,362) (22,348)
Income Taxes Paid (4,367) (7,722)
Other (902) 254
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 10,297 9,172
- -------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (37,942) (27,060)
Investment in Springerville Lease Debt and Equity 8,778 (101,135)
Investment in and Loans to Equity Investees (4,606) (5,423)
Other (637) 5,425
- -------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (34,407) (128,193)
- -------------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayments of Long-Term Debt (1,261) (1,225)
Common Stock Dividends Paid (5,045) (4,198)
Payments on Capital Lease Obligations (37,374) (13,411)
Other 883 1,447
- -------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (42,797) (17,387)
- -------------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (66,907) (136,408)
Cash and Cash Equivalents, Beginning of Year 90,928 228,154
- -----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 24,021 $ 91,746
===============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -------------------------------------------------------------------------------
Net Income (Loss) $ 53,270 $ (6,314)
Adjustments to Reconcile Net Income (Loss) to Net
Cash Flows
Cumulative Effect of Accounting Change - Net
of Tax (67,471) -
Depreciation and Amortization Expense 30,520 33,450
Depreciation Recorded to Fuel and Other
Other O&M Expense 1,448 1,417
Amortization of Transition Recovery Asset 3,608 2,882
Net Unrealized (Gain) Loss on Forward Electric
Sales and Purchases and MEG Trading Activities (1,783) (1,085)
Amortization of Deferred Debt-Related Costs
included in Interest Expense 732 484
Provision for Bad Debts 3,192 667
Deferred Income Taxes 19,192 (8,723)
Losses from Equity Method Entities 1,929 1,113
Other, Net 11,468 (5,366)
Changes in Current Assets and Liabilities which
Provided (Used) Cash Exclusive of Changes
Shown Separately:
Accounts Receivable 12,655 55,649
Materials and Fuel Inventory (4,405) (1,120)
Accounts Payable (5,269) (41,648)
Interest Accrued (28,580) (20,095)
Taxes Accrued (23,358) 7,963
Other Current Assets 934 (2,444)
Other Current Liabilities 2,215 (7,658)
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 10,297 $ 9,172
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
3
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,609,615 $ 2,598,884
Utility Plant under Capital Leases 747,556 747,556
Construction Work in Progress 83,725 59,926
- -------------------------------------------------------------------------------
Total Utility Plant 3,440,896 3,406,366
Less Accumulated Depreciation and Amortization (1,254,988) (1,346,101)
Less Accumulated Depreciation of
Capital Lease Assets (399,218) (391,915)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,786,690 1,668,350
- -------------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 182,867 191,867
Other 121,091 123,238
- -------------------------------------------------------------------------------
Total Investments and Other Property 303,958 315,105
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 24,021 90,928
Trade Accounts Receivable 72,347 85,697
Allowance for Doubtful Accounts (11,559) (9,062)
Materials and Fuel Inventory 52,261 46,657
Trading Assets 22,808 15,150
Current Regulatory Assets 11,061 11,778
Deferred Income Taxes - Current 9,456 15,917
Interest Receivable - Current 6,337 12,178
Other 15,584 15,762
- -------------------------------------------------------------------------------
Total Current Assets 202,316 285,005
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 303,512 307,120
Income Taxes Recoverable Through Future Revenues 55,245 57,044
Other Regulatory Assets 10,851 10,504
Other Assets 47,981 47,606
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 417,589 422,274
- -------------------------------------------------------------------------------
Total Assets $ 2,710,553 $ 2,690,734
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 486,541 $ 438,229
Capital Lease Obligations 762,926 801,611
Long-Term Debt 1,127,829 1,128,963
- -------------------------------------------------------------------------------
Total Capitalization 2,377,296 2,368,803
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 48,900 42,960
Current Maturities of Long-Term Debt 1,832 1,840
Accounts Payable 43,202 48,934
Interest Accrued 26,953 60,238
Trading Liabilities 18,019 10,255
Taxes Accrued 10,492 33,850
Accrued Employee Expenses 12,097 13,644
Other 11,884 7,659
- -------------------------------------------------------------------------------
Total Current Liabilities 173,379 219,380
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 90,156 34,552
Other 69,722 67,999
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 159,878 102,551
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 9)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,710,553 $ 2,690,734
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
4
UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Common Accumulated Other Total
Shares Common Earnings Comprehensive Stockholders'
Outstanding* Stock (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
(Unaudited)
-In Thousands-
Balances at
December 31, 2002 33,579 $661,185 $(218,932) $ (4,024) $438,229
- -------------------------------------------------------------------------------
Comprehensive Income:
2003 Year-to-Date
Net Income - - 53,270 - 53,270
-----------
Total Comprehensive
Income 53,270
-----------
Dividend Declared - - (5,045) - (5,045)
Shares Issued under
Stock Compensation
Plans 5 49 - - 49
Shares Distributed by
Deferred Compensation
Trust 1 9 - - 9
Shares Issued for
Stock Options 2 29 - - 29
- -------------------------------------------------------------------------------
Balances at
March 31, 2003 33,587 $661,272 $(170,707) $ (4,024) $486,541
===============================================================================
* UniSource Energy has 75 million authorized shares of common stock.
See Notes to Condensed Consolidated Financial Statements.
5
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
Three Months Ended
March 31,
2003 2002
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 130,545 $ 131,832
Electric Wholesale Sales 40,170 35,546
Net Unrealized Gain on Forward Electric
Sales and Purchases 88 817
Other Revenues 1,744 1,382
- -----------------------------------------------------------------------------
Total Operating Revenues 172,547 169,577
- -----------------------------------------------------------------------------
Operating Expenses
Fuel 46,502 48,319
Purchased Power 15,656 1,470
Other Operations and Maintenance 45,301 44,268
Depreciation and Amortization 29,624 32,356
Amortization of Transition Recovery Asset 3,608 2,882
Taxes Other Than Income Taxes 11,150 11,112
- -----------------------------------------------------------------------------
Total Operating Expenses 151,841 140,407
- -----------------------------------------------------------------------------
Operating Income 20,706 29,170
- -----------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 5,167 4,483
Interest Income - Note Receivable from
UniSource Energy 2,525 2,301
Other Income 975 1,176
Other Expense (265) (425)
- -----------------------------------------------------------------------------
Total Other Income (Deductions) 8,402 7,535
- -----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 19,272 15,972
Interest on Capital Leases 20,734 22,230
Other Interest Expense, Net of Amounts Capitalized (247) 55
- -----------------------------------------------------------------------------
Total Interest Expense 39,759 38,257
- -----------------------------------------------------------------------------
Loss Before Income Taxes and
Cumulative Effect of Accounting Change (10,651) (1,552)
Income Tax Expense (Benefit) (3,475) 378
- -----------------------------------------------------------------------------
Loss Before Cumulative Effect of
Accounting Change (7,176) (1,930)
Cumulative Effect of Accounting Change - Net
of Tax 67,471 -
- -----------------------------------------------------------------------------
Net Income (Loss) $ 60,295 $ (1,930)
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
6
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
2003 2002
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 153,697 $ 155,392
Cash Receipts from Electric Wholesale Sales 57,405 87,281
Interest Received 11,244 3,050
Fuel Costs Paid (49,760) (49,823)
Purchased Power Costs Paid (26,061) (56,299)
Wages Paid, Net of Amounts Capitalized (16,688) (18,011)
Payment of Other Operations and Maintenance Costs (24,570) (25,262)
Capital Lease Interest Paid (41,963) (34,893)
Taxes Paid, Net of Amounts Capitalized (12,965) (13,201)
Debt Interest Paid, Net of Amounts Capitalized (25,351) (22,342)
Income Taxes Paid (3,469) (7,667)
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities 21,519 18,225
- -----------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (37,095) (23,988)
Investment in Springerville Lease Debt and Equity 8,778 (101,135)
Other (952) 2,152
- -----------------------------------------------------------------------------
Net Cash Flows - Investing Activities (29,269) (122,971)
- -----------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayments of Long-Term Debt (1,225) (1,225)
Payments on Capital Lease Obligations (37,347) (13,338)
Other 1,023 766
- -----------------------------------------------------------------------------
Net Cash Flows - Financing Activities (37,549) (13,797)
- -----------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (45,299) (118,543)
Cash and Cash Equivalents, Beginning of Year 55,778 159,680
- -----------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 10,479 $ 41,137
=============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -----------------------------------------------------------------------------
Net Income (Loss) $ 60,295 $ (1,930)
Adjustments to Reconcile Net Income (Loss)
to Net Cash Flows
Cumulative Effect of Accounting Change
- Net of Tax (67,471) -
Depreciation and Amortization Expense 29,624 32,356
Depreciation Recorded to Fuel and Other
O&M Expense 1,448 1,417
Amortization of Transition Recovery Asset 3,608 2,882
Net Unrealized (Gain) Loss on Forward Electric
Sales and Purchases (88) (817)
Amortization of Deferred Debt-Related Costs
included in Interest Expense 732 484
Provision for Bad Debts 3,192 667
Deferred Income Taxes 15,432 (5,769)
Losses from Equity Method Entities (52) 91
Interest on Note Receivable from UniSource
Energy (2,525) (2,301)
Other, Net 1,747 2,448
Changes in Current Assets and Liabilities
which Provided (Used) Cash Exclusive of Changes
Shown Separately:
Accounts Receivable 22,989 52,334
Materials and Fuel Inventory (221) 63
Accounts Payable (5,339) (47,489)
Interest Accrued (28,580) (20,095)
Taxes Accrued (19,552) 7,852
Other Current Assets 7,024 (1,857)
Other Current Liabilities (744) (2,111)
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 21,519 $ 18,225
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
7
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2003 2002
(Unaudited)
- -----------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,609,615 $ 2,598,884
Utility Plant under Capital Leases 747,556 747,556
Construction Work in Progress 83,725 59,926
- -----------------------------------------------------------------------------
Total Utility Plant 3,440,896 3,406,366
Less Accumulated Depreciation and Amortization (1,254,988) (1,346,101)
Less Accumulated Depreciation of
Capital Lease Assets (399,218) (391,915)
- -----------------------------------------------------------------------------
Total Utility Plant - Net 1,786,690 1,668,350
- -----------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 182,867 191,867
Other 21,198 21,358
- -----------------------------------------------------------------------------
Total Investments and Other Property 204,065 213,225
- -----------------------------------------------------------------------------
Note Receivable from UniSource Energy 70,132 79,462
- -----------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 10,479 55,778
Trade Accounts Receivable 58,097 76,736
Allowance for Doubtful Accounts (11,509) (9,012)
Intercompany Accounts Receivable 15,377 14,851
Materials and Fuel Inventory 45,921 44,500
Interest on Note Receivable from
UniSource Energy 11,855 -
Current Regulatory Assets 11,061 11,778
Deferred Income Taxes - Current 9,456 15,917
Interest Receivable - Current 6,337 12,178
Other 7,312 8,407
- -----------------------------------------------------------------------------
Total Current Assets 164,386 231,133
- -----------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 303,512 307,120
Income Taxes Recoverable Through Future Revenues 55,245 57,044
Other Regulatory Assets 10,851 10,504
Other Assets 46,595 46,752
- -----------------------------------------------------------------------------
Total Regulatory and Other Assets 416,203 421,420
- -----------------------------------------------------------------------------
Total Assets $ 2,641,476 $ 2,613,590
=============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 397,769 $ 337,463
Capital Lease Obligations 762,845 801,508
Long-Term Debt 1,127,185 1,128,410
- -----------------------------------------------------------------------------
Total Capitalization 2,287,799 2,267,381
- -----------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 48,813 42,872
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 35,918 41,704
Intercompany Accounts Payable 18,050 12,478
Interest Accrued 26,953 60,238
Taxes Accrued 16,220 35,772
Accrued Employee Expenses 11,762 13,370
Other 8,853 7,543
- -----------------------------------------------------------------------------
Total Current Liabilities 168,294 215,702
- -----------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 119,334 67,490
Other 66,049 63,017
- -----------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 185,383 130,507
- -----------------------------------------------------------------------------
Commitments and Contingencies (Note 9)
- -----------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,641,476 $ 2,613,590
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
8
TUCSON ELECTRIC POWER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Capital Accumulated Other Total
Common Stock Earnings Comprehensive Stockholders'
Stock Expense (Deficit) Income (Loss) Equity
- -----------------------------------------------------------------------------
(Unaudited)
-Thousands of Dollars-
Balances at
December 31, 2002 $ 653,529 $ (6,357) $(305,685) $ (4,024) $ 337,463
- -----------------------------------------------------------------------------
Comprehensive Income:
2003 Year-to-Date
Net Income - - 60,295 - 60,295
------------
Total Comprehensive
Income 60,295
------------
Other 11 - - - 11
- -----------------------------------------------------------------------------
Balances at
March 31, 2003 $ 653,540 $ (6,357) $(245,390) $ (4,024) $ 397,769
=============================================================================
See Notes to Condensed Consolidated Financial Statements.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. NATURE OF OPERATIONS AND BASIS OF ACCOUNTING PRESENTATION
- ------------------------------------------------------------------
UniSource Energy Corporation (UniSource Energy) is an exempt holding
company under the Public Utility Holding Company Act of 1935. UniSource Energy
has no significant operations of its own, but owns substantially all of the
common stock of Tucson Electric Power Company (TEP) and all of the common stock
of Millennium Energy Holdings, Inc. (Millennium) and UniSource Energy
Development Company (UED). TEP, a regulated public utility incorporated in
Arizona since 1963, is UniSource Energy's largest operating subsidiary and
represents substantially all of UniSource Energy's assets. TEP generates,
transmits and distributes electricity. TEP serves retail customers in a 1,155
square mile area in Southern Arizona. TEP also sells electricity to other
utilities and power marketing entities primarily located in the western U.S.
Millennium holds the unregulated businesses described in Note 8 and UED's
services are described in Note 7.
References to "we" and "our" are to UniSource Energy and its subsidiaries,
collectively. References to the "utility business" are to TEP.
The accompanying quarterly financial statements of UniSource Energy and
TEP are unaudited but reflect all normal recurring accruals and other
adjustments which we believe are necessary for a fair presentation of the
results for the interim periods presented. These financial statements are
presented in accordance with the Securities and Exchange Commission's (SEC)
interim reporting requirements which do not include all the disclosures
required by accounting principles generally accepted in the United States of
America (GAAP) for annual financial statements. The year-end condensed balance
sheet data was derived from audited financial statements, but does not include
disclosures required by GAAP for annual financial statements. This quarterly
report should be reviewed in conjunction with UniSource Energy and TEP's 2002
Annual Report on Form 10-K.
Weather causes seasonal fluctuations in TEP's sales; therefore, quarterly
results are not indicative of annual operating results. UniSource Energy and
TEP have made minor reclassifications to the prior year financial statements
for comparative purposes. These reclassifications had no effect on net income.
NOTE 2. REGULATORY ACCOUNTING
- ------------------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. However, sometimes
these principles, such as Statement of Financial Accounting Standards No. 71,
Accounting for the Effects of Certain Types of Regulation (FAS 71), require
special accounting treatment for regulated companies to show the effect of
regulation. For example, in setting TEP's retail rates, the Arizona
Corporation Commission (ACC) may not allow TEP to currently charge its
customers to recover certain expenses, but instead requires that these expenses
be charged to customers in the future. In this situation, FAS 71 requires that
TEP defer these items and show them as regulatory assets on the balance sheet
until TEP is allowed to charge its customers. TEP then amortizes these items
as expense to the income statement as those charges are recovered from
customers. Similarly, certain revenue items may be deferred as regulatory
liabilities, which are also eventually amortized to the income statement as
rates to customers are reduced.
The conditions a regulated company must satisfy to apply the accounting
policies and practices of FAS 71 include:
- an independent regulator sets rates;
- the regulator sets the rates to recover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates below
the rates set by the regulator.
In November 1999, upon approval by the ACC of a settlement agreement
(Settlement Agreement) relating to recovery of TEP's transition costs and
standard retail rates, TEP discontinued application of FAS 71 to its generation
operations.
TEP's regulatory assets total $381 million at March 31, 2003, $22 million
of which are not presently included in the rate base and consequently are not
earning a return on investment.
TEP continues to apply FAS 71 to the distribution and transmission
portions of its business, its regulated operations, and continues to assess
whether it can continue to apply FAS 71 to these operations. If TEP stopped
applying FAS 71 to its remaining regulated operations, it would write off the
related balances of its regulatory
10
assets as an expense on its income statement. Based on the balances of TEP's
regulatory assets at March 31, 2003, if TEP had stopped applying FAS 71 to its
remaining regulated operations, it would have recorded an extraordinary loss,
after-tax, of approximately $230 million. While regulatory orders and market
conditions may affect TEP's cash flows, its cash flows would not be affected if
it stopped applying FAS 71 unless a regulatory order limited its ability to
recover the cost of that regulatory asset.
RECENT DEVELOPMENTS IN THE ARIZONA REGULATORY ENVIRONMENT
In February 2003, the ACC issued an order that defines the process, for
the period 2003 through 2006, by which TEP will be required to obtain its
capacity and energy requirements beyond what is supplied by TEP's existing
resources, which represents approximately 0.5% of its retail load in the first
year and increases over the period. This order further requires TEP to bid out
short-term energy purchases that it estimates it will make in the 2003 to 2006
period; however, it does not require TEP to purchase any power that it deems to
be uneconomical, unreasonable or unreliable. TEP completed its review of the
proposals received and entered into the following two agreements to meet TEP's
2003 bid requirements under the Track B Order for the period 2003 through 2006:
(1) PPL EnergyPlus, LLC will supply 37 MW June 2003 through December 2003 and
75 MW January 2004 through December 2006 through a unit contingent contract;
and (2) Panda Gila River LP will supply 50 MW on-peak June through September of
2003 through 2005 through a unit contingent contract.
NOTE 3. ASSET PURCHASE AGREEMENTS
- ----------------------------------
On October 29, 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase by
UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million in cash. The purchase price of each
transaction is subject to adjustment based on the date the transaction closes
and, in each case, on the amount of certain assets and liabilities of the
purchased business at the time of closing. If the transaction closes before
July 28, 2003, the purchase price is reduced by $10 million. If the
transaction closes after October 29, 2003, the purchase price is increased by
$5 million. In addition, the purchase price in each transaction may also be
adjusted if there is a casualty loss, governmental taking, or discovery of
substantial additional environmental liabilities, in each case subject to
materiality thresholds, prior to the closing. UniSource Energy will assume
certain liabilities associated with the purchased assets, but will not assume
Citizens' obligations under the industrial development revenue bonds issued to
finance certain of the purchased assets for which Citizens will remain the
economic obligor. The asset purchases are expected to close in the second half
of 2003 after the conditions to the consummation of the transactions, including
federal and state regulatory approvals, are satisfied or waived.
The closing of the transactions is subject to approval by the ACC, the
Federal Energy Regulatory Commission (FERC) and the SEC under the Public
Utility Holding Company Act of 1935, as amended. As of March 31, 2003, all
required filings with the various governmental authorities have been made and
we are still waiting for approval from the ACC, the FERC and the SEC.
The Asset Purchase Agreements are subject to termination if the closing
has not occurred by January 29, 2004 (subject to extension in limited
circumstances), if a governmental authority seeks to prohibit the transactions,
if required regulatory approvals are not obtained with satisfactory terms and
conditions, or if either party is in material breach and such breach is not
cured. If one Asset Purchase Agreement is terminated, the other will also be
automatically terminated. If the Asset Purchase Agreements are terminated by
Citizens due to UniSource Energy's breach, UniSource Energy must pay to
Citizens a $25 million termination fee as liquidated damages. If the Asset
Purchase Agreements are terminated by UniSource Energy due to Citizens' breach,
Citizens must pay to UniSource Energy a $10 million termination fee as
liquidated damages. The termination fees are also payable in certain other
limited circumstances.
We expect that the purchase price will be financed by funds from UniSource
Energy and its affiliates and debt secured by the purchased assets. TEP is
limited by its credit agreement, however, as to the amount of affiliate
investments or loans it may make. TEP must also obtain ACC approval to make a
loan to an affiliate. Various financing alternatives are being discussed with
potential lenders and bridge financing arrangements are being evaluated.
UniSource Energy may also consider financing a portion of the purchase with new
equity, depending on market conditions and other considerations. If UniSource
Energy is unable to obtain financing and therefore fails to consummate the
purchase of these assets, this would constitute a breach under the contracts
and termination damages of $25 million would be payable.
11
PROPOSED SETTLEMENT AGREEMENT
Prior to entering into the Asset Purchase Agreements with UniSource
Energy, Citizens had two cases pending before the ACC requesting rate relief
for both the Arizona electric and Arizona gas assets. On April 1, 2003,
UniSource Energy and Citizens reached a proposed settlement agreement (Citizens
Settlement Agreement) with the ACC Staff addressing the rate case and financing
issues. If the ACC approves the Citizens Settlement Agreement, the changes in
rates and financing approvals will take effect once the acquisition is
completed, which is expected to occur by July 2003.
Under the terms of the Citizens Settlement Agreement, UniSource Energy
will form one or more wholly-owned subsidiaries to own and operate the acquired
assets (collectively, the New Companies) and it may also form an intermediate
holding company to finance and own the New Companies.
The Citizens Settlement Agreement includes the resolution of two pending
rate issues before the ACC: (1) a gas utility base rate case and (2) a review
of the electric utility purchase power and fuel adjustment clause. The
Citizens Settlement Agreement provides for a 20.9% increase in gas rates
compared with the 29% increase requested by Citizens. Because UniSource Energy
is acquiring the gas utility assets at a discounted purchase price, the amount
of rate recovery required is less than under the Citizens rate case. The gas
utility rate case also takes into account a $10 million permanent reduction to
the gas rate base due to a disallowance for certain capital expenditures for
gas infrastructure, thereby reducing the revenue level to be recovered from
ratepayers. In addition, the Citizens Settlement Agreement allows for a 22%
increase in electric utility rates, compared with the 45% requested by
Citizens. The allowed electric rate increase represents the full recovery in
rates of the costs of a long-term purchase power contract on a going forward
basis. At the same time, UniSource Energy agreed to forfeit the collection of
approximately $135 million in deferred purchased power costs under the same
contract that had been incurred by Citizens but had not been collected from
Citizens' customers. If the Citizens Settlement Agreement is approved, the
revised electric and gas tariffs would be effective upon the completion of the
acquisition. The Citizens Settlement Agreement also imposes a general rate
case moratorium for a period of three years from the date the ACC approves the
settlement order.
The financing provisions of the Citizens Settlement Agreement authorize
the New Companies to issue new debt and equity securities to fund the
acquisition of the Citizens gas and electric assets and to provide for initial
working capital requirements. The Citizens Settlement Agreement also
authorizes TEP to loan up to $50 million to UniSource Energy to fund the
purchase. In addition, the Citizens Settlement Agreement waives the existing
requirement that 30% of the proceeds of public stock issuance be invested in
TEP, so long as the purpose of the equity issuance is to help finance the
Citizens purchase.
The Citizens Settlement Agreement limits dividends from the New Companies
to 75% of earnings until the ratio of common equity to total capital return
reaches 40%. If approved, the Citizens Settlement Agreement would also modify
TEP's dividend limitation. Currently, TEP may not pay dividends in excess of
75% of its earnings until the ratio of common equity to total capital reaches
37.5%. Under the Citizens Settlement Agreement, the 75% earnings payout
limitation would remain in effect until TEP's ratio of common equity to total
capital reaches 40%.
The Citizens Settlement Agreement is subject to the review and approval of
the ACC and may be amended or supplemented prior to, or in conjunction with,
the approval. The ACC held hearings on the Citizens Settlement Agreement in
early May 2003. UniSource Energy expects that the ACC will act on the Citizens
Settlement Agreement by July 2003.
NOTE 4. ACCOUNTING CHANGE: ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
- ------------------------------------------------------------------------
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 143, Accounting for Asset
Retirement Obligations (FAS 143). It requires entities to record the fair value
of a liability for a legal obligation to retire an asset in the period in which
the liability is incurred. A legal obligation is a liability that a party is
required to settle as a result of an existing or enacted law, statute,
ordinance or contract. When the liability is initially recorded, the entity
should capitalize a cost by increasing the carrying amount of the related long-
lived asset. Over time, the liability is adjusted to its present value by
recognizing accretion expense as an operating expense in the income statement
each period, and the capitalized cost is depreciated over the useful life of
the related asset. Upon settlement of the liability, an entity either settles
the obligation for its recorded amount or incurs a gain or loss if the actual
costs differ from the recorded amount.
12
Prior to adopting FAS 143, costs for final removal of all owned generation
facilities were accrued as an additional component of depreciation expense.
Under FAS 143, only the costs to remove an asset with legally binding
retirement obligations will be accrued over time through accretion of the asset
retirement obligation and depreciation of the capitalized asset retirement
cost.
TEP has identified legal obligations to retire generation plant assets
specified in land leases for its jointly-owned Navajo and Four Corners
Generating Stations. The land on which the Navajo and Four Corners Generating
Stations reside is leased from the Navajo Nation. The provisions of the leases
require the lessees to remove the facilities upon request of the Navajo Nation
at the expiration of the leases. TEP also has certain environmental
obligations at the San Juan Generating Station (San Juan). TEP has estimated
that its share of the cost to remove the Navajo and Four Corners facilities and
to settle the San Juan environmental obligations is approximately $38 million
at the date of retirement. No other legal obligations to retire generation
plant assets were identified. Millennium and UED have no asset retirement
obligations.
TEP has various transmission and distribution lines that operate under
land leases and rights of way that contain end dates and restorative clauses.
TEP operates its transmission and distribution lines as if they will be
operated in perpetuity and would continue to be used or sold without land
remediation. As a result, TEP will not recognize the costs of final removal of
the transmission and distribution lines in the financial statements.
Upon adoption of FAS 143 on January 1, 2003, TEP recorded an asset
retirement obligation of $38 million at its net present value of $1.1 million,
increased depreciable assets by $0.1 million for asset retirement costs,
reversed $112.8 million of costs previously accrued for final removal from
accumulated depreciation, reversed previously recorded deferred tax assets of
$44.2 million and recognized the cumulative effect of accounting change as a
gain of $111.7 million ($67.5 million net of tax). TEP expects that adopting
FAS 143 will result in a reduction to current depreciation expense charged
throughout the year as well because asset retirement costs are no longer
recorded as a component of depreciation expense. For the year 2003, this
amount is approximately $6 million.
The following table illustrates on a pro forma basis the amount of the
asset retirement obligation as if FAS 143 had been applied during all periods
presented:
Three Months Ended
March 31,
2003 2002
Actual Pro Forma
----------------------------------------------------------------
-Thousands of Dollars-
Asset Retirement Obligation -
beginning of period $ 1,119 $ 1,017
Accretion Expense 27 25
----------------------------------------------------------------
Asset Retirement Obligation -
end of period $ 1,146 $ 1,042
================================================================
The following table illustrates on a pro forma basis the effect on
UniSource Energy's net income and earnings per share and TEP's net income as if
FAS 143 had been in effect for all income statement periods presented:
UniSource Energy:
- ----------------
Three Months Ended
March 31, 2002
----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Loss - As Reported $ (6,314)
Adjustment to accrued expense (net
of tax) as if FAS 143 had been applied
effective January 1, 2002 912
----------------------------------------------------------------
Pro Forma Net Loss $ (5,402)
================================================================
Basic and Diluted Earnings per Share:
As Reported $ (0.19)
Adjustment to accrued expense (net
of tax) as if FAS 143 had been applied
effective January 1, 2002 .03
----------------------------------------------------------------
Pro Forma $ (0.16)
================================================================
13
TEP:
- ---
Three Months Ended
March 31, 2002
----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Loss - As Reported $ (1,930)
Adjustment to accrued expense (net
of tax) as if FAS 143 had been applied
effective January 1, 2002 912
----------------------------------------------------------------
Pro Forma Net Loss $ (1,018)
================================================================
Amounts recorded under FAS 143 are subject to various assumptions and
determinations, such as determining whether a legal obligation exists to remove
assets, estimating the fair value of the costs of removal, estimating when
final removal will occur, and the credit-adjusted risk-free interest rates to
be used to discount future liabilities. Changes that may arise over time with
regard to these assumptions and determinations will change amounts recorded in
the future as expense for asset retirement obligations.
If TEP retires any asset at the end of its useful life, without a legal
obligation to do so, it will record retirement costs at that time as incurred
or accrued. TEP does not believe that the adoption of FAS 143 will result in
any change in retail rates since all matters relating to the rate-making
treatment of TEP's generating assets were determined pursuant to the Settlement
Agreement.
NOTE 5. STOCK-BASED COMPENSATION
- ---------------------------------
At March 31, 2003, UniSource Energy has two stock-based compensation
plans, the 1994 Outside Director Stock Option Plan (Directors' Plan) and the
1994 Omnibus Stock and incentive Plan (Omnibus Plan). We account for those
plans under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
STOCK OPTIONS
No compensation cost is reflected in net income for stock options, as all
options granted had an exercise price equal to the market value of the
underlying common stock on the date of grant.
The Directors' Plan granted 21,222 stock options in the first quarter of
2003 and 22,000 options in the first quarter of 2002. Additionally, the
Compensation Committee of the UniSource Energy Board of Directors granted
568,000 stock options to key employees under the Omnibus Plan in the first
quarter of 2002. These options vest over three years, become exercisable in one-
third increments on each anniversary date of the grant and expire on the tenth
anniversary of the grant.
A summary of the stock option activity of the Directors' Plan and Omnibus
Plan is as follows:
Three Months Ended March 31,
2003 2002
------------------------------------------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------------------------------------------------------------------
Options Outstanding,
Beginning of Period 2,576,819 $15.77 2,075,234 $15.05
Granted 21,222 $17.44 590,000 $18.14
Exercised (2,257) $12.61 (48,104) $14.65
Forfeited (2,866) $13.76 (6,953) $14.67
---------- ----------
Options Outstanding,
End of Period 2,592,918 $15.79 2,610,177 $15.76
========== =========
Options Exercisable,
End of Period 1,644,400 $14.91 1,049,188 $14.37
========== =========
Weighted Average Remaining
Contractual Life at March 31, 2003: 6.72
------------------------------------------------------------------
14
The following table illustrates the effect on UniSource Energy's net
income and earnings per share and TEP's net income if we had applied the fair
value recognition provisions of Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation:
UniSource Energy:
- ----------------
Three Months Ended March 31,
2003 2002
----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income (Loss) - As Reported $ 53,270 $ (6,314)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (238) (318)
----------------------------------------------------------------
Pro Forma Net Income (Loss) $ 53,032 $ (6,632)
================================================================
Basic and Diluted Earnings per Share:
As Reported $1.58 $(0.19)
Pro Forma $1.57 $(0.20)
================================================================
TEP:
- ---
Three Months Ended March 31,
2003 2002
----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income (Loss) - As Reported $ 60,295 $ (1,930)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (235) (314)
----------------------------------------------------------------
Pro Forma Net Income (Loss) $ 60,060 $ (2,244)
================================================================
The fair value of each stock option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions:
2003 2002
----------------------------------------------------------------
Expected life (years) 6 5
Interest rate 3.34% 1.45%
Volatility 23.74% 23.74%
Dividend yield 3.55% 2.83%
Weighted-average grant-date fair value
of options granted during the period $3.16 $2.90
----------------------------------------------------------------
RESTRICTED STOCK UNITS
During the quarter ended March 31, 2003, 573 restricted shares or stock
units were awarded under the Directors' Plan to each of nine directors, for a
total of 5,157 shares or units. The restricted shares or stock units become
100% vested on the third anniversary of the grant date. Compensation expense
equal to the fair market value on the date of award is recognized over the
vesting period. These equity instruments were issued at a fair market value of
$17.44.
NOTE 6. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND TRADING ACTIVITIES
- ---------------------------------------------------------------------
TEP enters into forward contracts to purchase or sell a specified amount
of capacity or energy at a specified price over a given period of time,
typically for one month, three months, or one year, within established limits
to take advantage of favorable market opportunities. In general, TEP enters
into forward purchase contracts when market conditions provide the opportunity
to purchase for its load at prices that are below the marginal cost of its
supply resources or when additional supply is needed in addition to TEP's own
resources (i.e., during plant outages and summer peaking periods). TEP enters
into forward sales contracts when TEP forecasts that it has
15
excess supply and the market price of energy exceeds its marginal cost. The
majority of TEP's forward contracts are considered normal purchases and sales
under Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities (FAS 133) and, therefore, are not
required to be marked to market. However, some of these forward contracts are
considered to be derivatives, which TEP marks to market under FAS 133 by
recording unrealized gains and losses and adjusting the related assets and
liabilities on a monthly basis to reflect the market prices at the end of the
month.
TEP manages the risk of counterparty default by performing financial
credit reviews, setting limits, monitoring exposures, requiring collateral when
needed, and using a standardized agreement which allows for the netting of
current period exposures to and from a single counterparty.
Millennium Environmental Group, Inc. (MEG), a wholly-owned subsidiary of
Millennium, enters into swap agreements, options and forward contracts relating
to emission allowances and coal. MEG also marks its trading contracts to
market under FAS 133 by recording unrealized gains and losses and adjusting the
related assets and liabilities on a monthly basis to reflect the market prices
at the end of the month.
The market prices used to determine fair value for TEP and MEG's
derivative instruments are estimated based on various factors including broker
quotes, exchange prices, over the counter prices and time value.
TEP and MEG's derivative activities are reported as follows:
- TEP's unrealized gain/loss on forward sales and purchase contracts is a
component of Operating Revenues;
- TEP's realized gain/loss on forward sales contracts is a component of
Electric Wholesale Revenues;
- TEP's realized gain/loss on forward purchase contracts is a component of
Purchased Power; and
- MEG's unrealized and realized gain/loss on trading activities are
components of Operating Revenues.
During the three months ended March 31, 2003, MEG physically settled the
purchase of 143,000 emission allowances and the sale of 121,000 emission
allowances under its trading contracts.
The net pre-tax gains (losses) were as follows:
Three Months Ended
March 31,
2003 2002
---------------------------------------------------------------
-Millions of Dollars-
TEP's Unrealized Gain on Derivative
Forward Contracts $ 0.1 $ 0.8
MEG's Unrealized and Realized Gain
(Loss) on Trading Activities (0.4) 0.2
---------------------------------------------------------------
UniSource Energy Net Gain (Loss) on
TEP's Forward Contracts and MEG's
Trading Activities $(0.3) $ 1.0
===============================================================
At March 31, 2003, the fair value of TEP's derivative assets was $0.1
million and is reported in Other Current Assets. At December 31, 2002, TEP had
no open forward contracts that were considered derivatives. MEG's trading
assets are reported in Current Assets and MEG's trading liabilities are
reported in Current Liabilities. At March 31, 2003 and December 31, 2002, the
fair value of MEG's trading assets was $22.8 million and $15.1 million,
respectively, including MEG's emission allowance inventory. At March 31, 2003
and December 31, 2002, the fair value of MEG's trading liabilities was $18.0
million and $10.3 million, respectively.
NOTE 7. BUSINESS SEGMENTS
- --------------------------
Based on the way we organize our operations and evaluate performance, we
have three reportable business segments:
(1) TEP, an electric utility business, is UniSource Energy's largest
subsidiary.
(2) Millennium holds interests in unregulated businesses (see Note 8).
(3) UED, established in 2001, is responsible for developing the expansion
project at the Springerville Generating Station. Prior to September 2002, UED
owned a 20 MW gas turbine, which it leased to TEP. In September 2002, UED sold
the turbine to TEP for its net book value of $15 million.
16
UniSource Energy's significant reconciling adjustments consist of the
elimination of intercompany activity and balances. Millennium recorded revenue
from transactions with TEP of $2 million and $2.5 million in the three months
ended March 31, 2003 and March 31, 2002, respectively. TEP's related expense
is reported in Other Operations and Maintenance expense on its income
statement. Millennium's revenue and TEP's related expense are eliminated in
UniSource Energy consolidation. Other significant reconciling adjustments
include the elimination of the intercompany note between UniSource Energy and
TEP, as well as the related interest income and expense; and the elimination of
UED's rental income and TEP's rental expense from UED's turbine lease to TEP
prior to UED's sale of the turbine to TEP in September 2002.
We record our percentage share of the earnings of affiliated companies
when we hold a 20% to 50% voting interest, except for investments where we
provide all of the financing, in which case we recognize 100% of the losses.
See Note 8.
We disclose selected financial data for our business segments in the
following tables:
Segments UniSource
------------------------ Reconciling Energy
TEP Millennium UED Adjustments Consolidated
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Income Statement
- ----------------
Three months ended
March 31, 2003:
- ------------------------------------------------------------------------------
Operating Revenues -
External $ 172,485 $ 681 $ - $ - $ 173,166
- ------------------------------------------------------------------------------
Operating Revenues -
Intersegment 62 2,036 - (2,098) -
- ------------------------------------------------------------------------------
Loss Before Income
Taxes and Cumulative
Effect of Accounting
Change (10,651) (8,275) (199) (3,143) (22,268)
- ------------------------------------------------------------------------------
Net Income (Loss) 60,295 (5,005) (120) (1,900) 53,270
- ------------------------------------------------------------------------------
Three months ended
March 31, 2002:
- ------------------------------------------------------------------------------
Operating Revenues -
External $ 169,392 $ 1,803 $ - $ - $ 171,195
- ------------------------------------------------------------------------------
Operating Revenues -
Intersegment 185 2,539 840 (3,564) -
- ------------------------------------------------------------------------------
Income (Loss) Before
Income Taxes (1,552) (5,462) 505 (2,301) (8,810)
- ------------------------------------------------------------------------------
Net Income (Loss) (1,930) (3,300) 305 (1,389) (6,314)
- ------------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
March 31, 2003 $2,641,476 $146,788 $ 38,919 $(116,630) $2,710,553
Total Assets,
December 31, 2002 2,613,590 151,468 37,839 (112,163) 2,690,734
- ------------------------------------------------------------------------------
NOTE 8. MILLENNIUM
- -------------------
ENERGY AND TECHNOLOGY INVESTMENTS
We refer to Global Solar Energy, Inc. (Global Solar), Infinite Power
Solutions, Inc. (IPS), MicroSat Systems, Inc. (MicroSat) and ITN Energy
Systems, Inc. (ITN) as our Energy and Technology Investments.
- Global Solar - Millennium funded $4 million to Global Solar in the first
quarter of 2003, and $0.8 million in April 2003. Millennium's unfunded
commitment to Global Solar is currently a $5 million line of credit committed
in May 2003. On February 21, 2003, Global Solar signed a license agreement
with ICP Global Technologies, a privately held Canadian solar product firm.
Millennium owns 87% of Global Solar, but as sole funder recognizes 100% of
their losses. Global Solar has an annual $0.5 million research and development
funding commitment to ITN through 2004.
- IPS - Millennium funded $1 million to IPS in the first quarter of 2003.
Dow Corning Enterprises, Inc. (Dow Corning) funded a corresponding $1 million.
In May 2003, Millennium and Dow Corning each funded an additional $0.5 million.
The investments were in exchange for preferred shares of IPS. Millennium
expects to commit an additional $1.5 million to IPS in the second quarter of
2003. As of March 31, 2003, Millennium owns approximately 74% of IPS and for
the first quarter of 2003 Millennium has recorded its ratable share of IPS's
losses. Millennium anticipates it will ultimately own between 59% and 72% of
IPS. IPS has a $0.5 million annual research and development funding commitment
to ITN though 2004.
17
- MicroSat - Millennium owns 49% of MicroSat, but as sole funder
recognizes 100% of their losses. Millennium anticipates its ownership of
MicroSat will be reduced to 35% in 2003, based on a 2002 Restructure Agreement.
- ITN - Millennium owns 49% of ITN, but anticipates its ownership will be
reduced to 9% in 2003, based on a 2002 Restructure Agreement. Millennium, as
sole funder, continues to recognize 100% of ITN's losses.
Millennium expects to fund an additional $7 million to $10 million to
these entities during the remainder of 2003. A significant portion of this
funding will be used for research, development and administrative costs and
will be recognized as expense.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment to Haddington Energy
Partners II LP (Haddington), a limited partnership which funds energy-related
investments. During the first quarter of 2003, Millennium invested
approximately $2 million in Haddington. Millennium has satisfied $8.1 million
of the $15 million commitment to date. The remaining $6.9 million is expected
to be funded within the next three years. A member of the UniSource Energy
Board of Directors has an investment in the limited partnership and is also a
managing director of the general partner of the limited partnership.
Millennium has a $6 million capital commitment to a venture capital fund
that will focus on information technology, microelectronics and biotechnology,
primarily within the southwestern U.S. A member of the UniSource Energy Board
of Directors is a general partner of the company that manages the fund. At
March 31, 2003, Millennium had funded approximately $1 million of this
commitment. Millennium does not expect to provide any additional funds to this
investment in 2003.
During the first quarter of 2003, Millennium contributed $0.4 million to
TruePricing, Inc. (TruePricing) and agreed to provide up to an additional $0.8
million in future funding. Following this investment Millennium began
accounting for TruePricing under the consolidation method. Millennium and TEP
collectively now own 51% of the outstanding shares of TruePricing. Previously,
Millennium accounted for TruePricing under the equity method. Millennium, as
sole funder, recognizes 100% of TruePricing's losses.
NATIONS ENERGY CONTINGENCY
In September 2001, Nations Energy Corporation (Nations Energy) sold its
26% equity interest in a power project located in Curacao, Netherland Antilles
to a subsidiary of Mirant Corporation (Mirant). Nations Energy received $5
million in cash and an $11 million note receivable from the sale. The note was
recorded at its net present value of $8 million using an 8% discount rate, the
discount being amortized to interest income over the five-year life of the
note. The note is included in Investments and Other Property - Other on
UniSource Energy's balance sheets. The note is guaranteed by Mirant Americas,
Inc., a subsidiary of Mirant. Payments on the note receivable are expected as
follows: $2 million in July 2004, $4 million in July 2005, and $5 million in
July 2006.
In late 2002 and continuing in 2003, the major rating agencies downgraded
the ratings of Mirant and certain of its subsidiaries citing Mirant's
significantly lower operating cash flow relative to its debt burden coupled
with the likelihood that future operating cash flow levels may weaken further.
Mirant's ratings are now below investment grade. As of March 31, 2003, Nations
Energy's receivable from Mirant is approximately $9.4 million. We cannot
predict what effect the downgrades of Mirant's ratings will have on its ability
to make its required payments to Nations Energy when due, beginning in July
2004. Although Nations Energy has not recorded an allowance for doubtful
accounts, we will continue to evaluate the collectibility of the receivable.
NOTE 9. COMMITMENTS AND CONTINGENCIES
- --------------------------------------
TEP CONTINGENCIES
Springerville Generating Station Complaint
Environmental activist groups have expressed concerns regarding the
construction of any new units at the Springerville Generating Station. In
January 2003, environmental activist groups appealed an ACC Order affirming
18
the ACC's approval of the expansion at Springerville Generating Station to the
Superior Court of the State of Arizona.
Additionally, in November 2001, the Grand Canyon Trust (GCT), an
environmental activist group, filed a complaint in U.S. District Court against
TEP for alleged violations of the Clean Air Act at the Springerville Generating
Station. The complaint 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. In
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 construction
of the Springerville Generating Station in the time periods required by the
original permits. There were two remaining allegations: that (a) TEP
discontinued construction for a period of 18 months or longer and did not
complete construction in a reasonable period of time, and (b) TEP did not
commence construction, for purposes of New Source Performance Standard
applicability, by September 18, 1978. On March 4, 2003, the U.S. District
Court determined that the GCT had not commenced the case on a timely basis and
dismissed the case. The GCT has appealed this decision to the U.S. Court of
Appeals. TEP believes these claims are without merit and will vigorously
contest them.
Litigation Related to San Juan Coal Company
On July 30, 2002, Dugan Production Corp. (Dugan) filed a lawsuit against
the San Juan Coal Company, the coal supplier to San Juan. TEP owns 50% of San
Juan Units 1 and 2, which equates to 19.8% of San Juan in total. The San Juan
Coal Company, through leases with the federal government and the State of New
Mexico, owns coal interests with respect to an underground mine. Dugan,
through leases with the federal government, the State of New Mexico and certain
private parties, claims to own certain oil and gas interests in portions of the
land used for the underground mine. Dugan alleges that San Juan Coal Company's
underground coal mining operations have or will interfere with Dugan's gas
production and will reduce the amount of natural gas that Dugan would otherwise
be entitled to recover. Dugan seeks a declaration by the court that the rights
under its leases are senior and superior to the rights of the San Juan Coal
Company and seeks to prohibit the underground mining of coal from a portion of
the land used for the underground mine as described above. Dugan also seeks
monetary damages.
The San Juan Coal Company has informed Public Service Company of New
Mexico (PNM) that it intends to strongly dispute the litigation. TEP cannot
predict the ultimate outcome of this litigation, or whether it will adversely
affect the amount of coal available or cost of coal to San Juan. TEP does not
expect resolution of this litigation to be material to TEP as a 19.8% owner of
San Juan.
Litigation Related to San Juan Generating Station
On May 16, 2002, the GCT and the Sierra Club filed a citizen lawsuit under
the Clean Air Act in federal district court in New Mexico against PNM as
operator of San Juan. The lawsuit, which alleges two violations of the Clean
Air Act and related regulations and permits, seeks penalties as well as
injunctive and declaratory relief and is presently scheduled for trial in the
third quarter of 2003. Based on its investigation to date, PNM has stated that
it firmly believes that the allegations are without merit, and vigorously
disputes the allegations. Only one of those allegations relates to a unit in
which TEP owns an interest. While TEP is unable to predict the ultimate
outcome of the lawsuit, TEP does not believe the outcome will be material to
TEP.
Postretirement and Pension Benefit Costs at Various Generating Stations
Certain coal suppliers have submitted demands for payment by TEP of
postretirement and pension benefit costs for these coal suppliers' employees
under the coal suppliers' agreements with various TEP generating stations. As
amounts become known and payment probable, TEP will record a liability for
additional postretirement and pension benefit costs at these generating
stations.
Environmental Reclamation at Remote Generating Stations
TEP pays on-going reclamation costs at each of its remote generating
stations, and it is reasonably possible that TEP may have to pay a portion of
final reclamation costs at the mines which supply the remote generating
stations. As amounts become known and probable, TEP will record a liability
for final reclamation.
19
TEP COMMITMENTS
See Note 2 for a description of TEP's power purchase agreements.
MILLENNIUM COMMITMENTS
See Note 8 for a description of Millennium's commitments.
UED COMMITMENTS
UED and Salt River Project Agricultural Improvement and Power District
(SRP) entered into a Joint Development Agreement in October 2001 to develop two
400 MW coal-fired units at TEP's existing Springerville Generating Station. As
a result of recent developments, UED and SRP are modifying the Joint
Development Agreement to provide for SRP's purchase of a specified amount of
power from Unit 3 and SRP's right to construct and own Unit 4 at a later date.
UED and SRP each committed project development funding for professional
services and other third party costs. As of December 31, 2002, SRP met its
funding commitment for the project. Tri-State Generation and Transmission
Association, Inc. (Tri-State) has agreed to purchase the remaining power from
Unit 3 and will be the owner of the facility. Tri-State and UED signed a
Development Cost Agreement in January 2003 to each share 50% of the remaining
development costs of Unit 3 effective from November 6, 2002 until financial
closing. At March 31, 2003, capitalized project development costs on UniSource
Energy's balance sheet were approximately $23 million. Management believes it
is probable that UED will proceed with this project. If the project does not
proceed, the capitalized project development costs will be immediately
expensed.
GUARANTEES AND INDEMNITIES
In the normal course of business, UniSource Energy and certain
subsidiaries, including TEP, enter into various agreements providing financial
or performance assurance to third parties on behalf of certain subsidiaries.
These agreements are entered into primarily to support or enhance the
creditworthiness otherwise attributed to a subsidiary on a stand-alone basis,
thereby facilitating the extension of sufficient credit to accomplish the
subsidiaries' intended commercial purposes. The most significant of these
guarantees is Millennium's guarantee of approximately $3.5 million in commodity-
related payments for MEG at March 31, 2003. To the extent liabilities exist
under the contracts subject to these guarantees, such liabilities are included
in the consolidated balance sheets.
In addition, UniSource Energy and its subsidiaries have indemnified the
purchasers of interests in certain investments from additional taxes due for
years prior to the sale. The terms of the indemnifications provide for no
limitation on potential future payments; however, we believe that we have
abided by all tax laws and paid all tax obligations. We have not made any
payments under the terms of these indemnifications to date.
We believe that the likelihood UniSource Energy or TEP would be required
to perform or otherwise incur any significant losses associated with any of
these guarantees is remote.
NOTE 10. WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- ------------------------------------------------------
At March 31, 2003, TEP's Allowance for Doubtful Accounts on the balance
sheet includes $11 million for uncollectible receivables related to 2000 and
2001 sales to the California Power Exchange (CPX), the California Independent
System Operator (CISO) and Enron Corp. and certain of its affiliates (Enron).
At December 31, 2002, the allowance for these receivables was $8 million.
TEP's collection shortfall from the CPX and the CISO was approximately $9
million for sales made in 2000 and $7 million for sales made in 2001. Since
that time, the FERC has held hearings and the FERC staff has proposed various
methodologies for calculating amounts of refunds/offsets applicable to
wholesale sales made into the CISO's spot markets from October 2000 to June
2001. As of December 31, 2002, TEP had reserved $8 million, or 50%, of its
outstanding receivable based on the amount TEP believed would be collected.
Based upon the most recent FERC order in March 2003, TEP estimates that it may
receive approximately $6 million of its $16 million receivable. This
represents amounts owed to TEP net of TEP's estimated refund liability.
Therefore, in the first quarter of 2003, TEP increased its reserve for sales to
the CPX and the CISO by $2.2 million by recording a reduction of wholesale
revenues.
20
Additionally, a recent FERC order recommended that Enron no longer be
allowed to trade and within a few days thereafter, Enron was delisted from its
stock exchange. As a result, in the first quarter of 2003, TEP increased its
reserve for sales to Enron by $0.4 million, to 100% of its $0.8 million
recorded receivable from Enron.
There are several other outstanding legal issues, complaints and lawsuits
concerning the California energy crisis related to the FERC, wholesale power
suppliers, Southern California Edison Company, Pacific Gas and Electric
Company, the CPX and the CISO, and concerning Enron. We cannot predict the
outcome of these issues or lawsuits. We believe, however, that TEP is
adequately reserved for its transactions with the CPX, the CISO and Enron.
TEP's Accounts Receivable from Electric Wholesale Sales are included in
Trade Accounts Receivable on the balance sheet. TEP's wholesale receivables,
net of allowances, totaled $22 million at March 31, 2003 and $31 million at
December 31, 2002. Excluding the receivables from the CPX, the CISO and Enron,
as described above, substantially all of the March 31, 2003 wholesale
receivable balance has been collected as of the date of this filing.
NOTE 11. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
- ---------------------------------------------------
Basic EPS is computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted EPS
assumes that proceeds from the hypothetical exercise of stock options and other
stock-based awards are used to repurchase outstanding shares of stock at the
average fair market price during the reporting period. There are no reconciling
items in calculating the numerator and denominator for basic and diluted net
income (loss) per share for any periods presented.
The dilutive share bases for the quarters ended March 31, 2003 and March
31, 2002 exclude incremental common shares related to options, warrants and
contingently issuable shares of 1,406,000 and 715,000, respectively. These
shares are excluded due to their antidilutive effect as a result of UniSource
Energy's loss before cumulative effect of accounting change for the quarter
ended March 31, 2003 and UniSource Energy's net loss for the quarter ended
March 31, 2002.
At March 31, 2003, UniSource Energy and TEP had no outstanding warrants.
At March 31, 2002, there were 4.6 million warrants outstanding that were
exercisable into TEP common stock at a ratio of five warrants to one common
share. These warrants expired unexercised on December 15, 2002. The dilutive
effect of these warrants was the same as it would have been if the warrants
were exercisable into UniSource Energy Common Stock.
NOTE 12. INCOME AND OTHER TAXES
- --------------------------------
INCOME TAXES
The differences between the income tax expense (benefit) and the amount
obtained by multiplying pre-tax income (loss) before cumulative effect of
accounting change by the U.S. statutory federal income tax rate of 35% are as
follows:
UniSource Energy TEP
------------------ ------------------
Three Months Ended Three Months Ended
March 31, March 31,
2003 2002 2003 2002
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Federal Income Tax (Benefit) at
Statutory Rate $(7,794) $(3,084) $(3,728) $ (543)
State Income Tax (Benefit), Net
of Federal Deduction (1,024) (406) (490) (71)
Depreciation Differences (Flow
Through Basis) 1,086 1,154 1,086 1,154
Tax Credits (380) (206) (380) (206)
Other 45 46 37 44
Tax on Cumulative Effect of
Accounting Change (see Note 4) 44,236 - 44,236 -
- ------------------------------------------------------------------------------
Total Expense (Benefit) for Federal
and State Income Taxes $36,169 $(2,496) $40,761 $ 378
==============================================================================
21
OTHER TAXES
TEP acts as a conduit or collection agent for excise tax (sales tax) as
well as franchise fees and regulatory assessments. TEP records liabilities
payable to governmental agencies when TEP bills its customers for these
amounts. Neither the amounts billed nor payable are reflected in the income
statement.
NOTE 13. NEW ACCOUNTING PRONOUNCEMENTS
- ---------------------------------------
The FASB recently issued the following Statement of Financial Accounting
Standards (FAS) and FASB Interpretations (FIN):
- FIN 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, issued
November 2002, requires disclosures to be made by a guarantor in its interim
and annual financial statements about its obligations under certain guarantees
that it has issued. FIN 45 also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The initial recognition
and initial measurement provisions of FIN 45 are applicable on a prospective
basis to guarantees issued or modified beginning January 1, 2003. The
disclosure requirements of FIN 45 are immediately effective. See Guarantees
and Indemnities in Note 9, above.
- FIN 46, Consolidation of Variable Interest Entities, issued January
2003, expands upon existing guidance that addresses when a company should
include in its financial statements the assets and liabilities of another
entity. The primary objectives of FIN 46 are to provide guidance on the
identification of entities for which control is achieved through means other
than through voting rights (variable interest entities) and to determine when
and which business enterprise should consolidate the variable interest entity
(primary beneficiary). FIN 46 requires that both the primary beneficiary and
all other enterprises with a significant variable interest make additional
disclosures. The transitional disclosure requirements of FIN 46 are effective
immediately. The effective date of the consolidation requirements of FIN 46
depends on the date the variable interest entity was created. FIN 46 is
effective for all variable interest entities created after January 31, 2003.
For variable interest entities created before February 1, 2003, the provisions
of FIN 46 are to be applied to a variable interest entity for interim reporting
periods beginning after June 30, 2003. UniSource Energy's investments in
MicroSat and ITN are accounted for under the equity method (see Note 8, above).
UniSource Energy is the primary funding source for these investments and
recognizes all of the losses. UniSource Energy may be required to consolidate
MicroSat and ITN beginning July 1, 2003. The consolidation of MicroSat and ITN
would not have a material impact on UniSource Energy's financial statements, as
these entities do not presently have significant assets or debt from outside
third parties.
- FAS 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities, was issued by the FASB in April 2003. FAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under FAS
133. FAS 149 is effective for contracts entered into or modified after June
30, 2003, except as stated below, and for hedging relationships designated
after June 30, 2003. The guidance should be applied prospectively. The
provisions of FAS 149 that relate to FAS 133 Implementation Issues that have
been effective for fiscal quarters that began prior to June 15, 2003, should
continue to be applied in accordance with their respective effective dates.
Due to TEP and MEG's limited amount of derivative activity, we do not expect
the adoption of FAS 149 to have a significant effect on UniSource Energy or
TEP's financial statements.
NOTE 14. REVIEW BY INDEPENDENT ACCOUNTANTS
- -------------------------------------------
With respect to the unaudited condensed consolidated financial information
of UniSource Energy and TEP for the three-month periods ended March 31, 2003
and 2002, PricewaterhouseCoopers LLP reported that they have applied limited
procedures in accordance with professional standards for a review of such
information. However, their separate report dated May 2, 2003 appearing herein
states that they did not audit and they do not express an opinion on that
unaudited condensed consolidated financial information. Accordingly, the
degree of reliance on their report on such information should be restricted in
light of the limited nature of the review procedures applied.
PricewaterhouseCoopers LLP is not subject to the liability provisions of
Section 11 of the Securities Act of 1933 (the Act) for their report on the
unaudited condensed consolidated financial information because that report is
not a "report" or a "part" of a registration statement prepared or certified by
PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.
22
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
OVERVIEW OF CONSOLIDATED BUSINESS
- ---------------------------------
UniSource Energy Corporation (UniSource Energy) is a holding company
that owns substantially all of the outstanding common stock of Tucson
Electric Power Company (TEP), and all of the outstanding common stock of
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 businesses, 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 Businesses Segment, and the UniSource Energy
Development Segment.
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 plus other operating capital
adjustments. The purchase price of each transaction 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 Securities and Exchange Commission (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 Citizens Acquisition below.
Management's Discussion and Analysis explains the results of operations,
the general financial condition, and the outlook for UniSource Energy and its
three primary business segments and includes the following:
- operating results during the first quarter of 2003 compared with the
same period in 2002,
- 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. The seasonal
nature of TEP's business causes operating results to vary significantly from
quarter to quarter. Income and losses from Millennium's unregulated
businesses have had a significant impact on earnings reported by UniSource
Energy for the quarters ended March 31, 2003 and 2002. 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, the planned acquisition by UniSource Energy of the Citizens
retail electric and gas utility assets, if completed, will have a significant
impact on our financial condition and results of operations.
Management's Discussion and Analysis should be read in conjunction with
UniSource Energy and TEP's 2002 Form 10-K and with the Condensed Consolidated
Financial Statements, beginning on page 2, which present the results of
operations for the quarters ended March 31, 2003 and 2002. Management's
Discussion and Analysis explains the differences between periods for specific
line items