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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 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 November 6, 2003, 33,675,356 shares of UniSource Energy
Corporation's Common Stock, no par value (the only class of Common Stock),
were outstanding.
At November 6, 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 Corporation.
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This combined Form 10-Q is separately filed by UniSource Energy Corporation
and Tucson Electric Power Company. Information contained in this document
relating to Tucson Electric Power Company is filed by UniSource Energy
Corporation and separately by Tucson Electric Power Company on its own
behalf. Tucson Electric Power Company makes no representation as to
information relating to UniSource Energy Corporation or its subsidiaries,
except as it may relate to Tucson Electric Power Company.
TABLE OF CONTENTS
Page
Definitions................................................................ iv
Report of Independent Accountants.......................................... 1
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
UniSource Energy Corporation
Comparative Condensed Consolidated Statements of Income............... 2
Comparative Condensed Consolidated Statements of Cash Flows........... 3
Comparative Condensed Consolidated Balance Sheets..................... 4
Condensed Consolidated Statement of Changes in Stockholders' Equity... 5
Tucson Electric Power Company
Comparative Condensed Consolidated Statements of Income............... 6
Comparative Condensed Consolidated Statements of Cash Flows........... 7
Comparative Condensed Consolidated Balance Sheets..................... 8
Condensed Consolidated Statement of Changes in Stockholders' Equity... 9
Notes to Condensed Consolidated Financial Statements
Note 1. Nature of Operations, Basis of Accounting Presentation
and Stock-Based Compensation.................................. 10
Note 2. Establishment of UES.......................................... 12
Note 3. Regulatory Accounting......................................... 14
Note 4. Accounting Change: Accounting for Asset Retirement Obligations 15
Note 5. Stock-Based Compensation Plans................................ 17
Note 6. Accounting for Derivative Instruments and Trading Activities.. 18
Note 7. Business Segments............................................. 19
Note 8. Millennium.................................................... 20
Note 9. Commitments and Contingencies................................. 22
Note 10. TEP Wholesale Accounts Receivable and Allowances.............. 25
Note 11. UniSource Energy Earnings per Share (EPS)..................... 25
Note 12. Income and Other Taxes........................................ 26
Note 13. New Accounting Pronouncements................................. 27
Note 14. Subsequent Events............................................. 28
Note 15. Review by Independent Accountants............................. 28
Item 2. - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Overview of Consolidated Business....................................... 30
UniSource Energy Consolidated
Results of Operations................................................. 30
Contribution By Business Segment...................................... 32
Liquidity and Capital Resources....................................... 32
Tucson Electric Power Company
Results of Operations................................................. 34
Factors Affecting Results of Operations............................... 38
Liquidity and Capital Resources....................................... 42
UniSource Energy Services
Results of Operations................................................. 44
Factors Affecting Results of Operations............................... 45
Liquidity and Capital Resources....................................... 46
ii
TABLE OF CONTENTS
(concluded)
Millennium Energy Holdings, Inc.
Results of Operations................................................. 48
Liquidity and Capital Resources....................................... 48
UniSource Energy Development Company
Results of Operations................................................. 49
Springerville Generating Station Expansion............................ 50
Outlook and Strategies.................................................. 50
Critical Accounting Policies............................................ 51
New Accounting Pronouncements........................................... 55
Safe Harbor for Forward-Looking Statements.............................. 56
Item 3. - Quantitative and Qualitative Disclosures about Market Risk..... 57
Item 4. - Controls and Procedures........................................ 59
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings.............................................. 60
Item 5. - Other Information
Director Resignation.................................................... 61
Additional Financial Data............................................... 61
Approval of Non-Audit Services.......................................... 61
SEC Reports Available on UniSource Energy's Website..................... 61
Item 6. - Exhibits and Reports on Form 8-K............................... 62
Signatures................................................................. 63
Exhibit Index.............................................................. 64
iii
DEFINITIONS
The abbreviations and acronyms used in the 2003 Third Quarter Form 10-Q are
defined below:
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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 An agreement with the ACC Staff dated
April 1, 2003, addressing rate case and
financing issues in the acquisition by
UniSource Energy of the Citizens' Arizona
gas and electric assets.
Common Stock................. UniSource Energy's common stock, without par
value.
Cooling Degree Days.......... An index used to measure the impact of
weather on energy usage calculated by
subtracting 75 from the average of the high
and low daily temperatures.
CPX.......................... California Power Exchange.
Credit Agreement............. Credit Agreement between TEP and a syndicate
of banks, dated as of November 14, 2002.
Emission Allowance(s)........ An allowance issued by the Environmental
Protection Agency which permits emission of
one ton of sulfur dioxide or one ton of
nitrogen oxide. These allowances can be
bought and sold.
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 currently owns
99% 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
currently owns 72% of IPS.
ITN.......................... ITN Energy Systems, Inc., a company formed to
provide research, development, and other
services. Millennium finalized a 2002
Restructure Agreement and a share exchange
agreement reducing its ownership in ITN to
zero.
kWh.......................... Kilowatt-hour(s).
MEG.......................... Millennium Environmental Group, Inc., a wholly-
owned subsidiary of Millennium, which
manages and trades Emission Allowances, coal,
and related financial instruments.
MicroSat..................... MicroSat Systems, Inc., a company formed to
develop and commercialize small-scale
satellites. Millennium currently owns 35% of
MicroSat.
Millennium................... Millennium Energy Holdings, Inc., a wholly-
owned subsidiary of UniSource Energy.
MW........................... Megawatt(s).
MWh.......................... Megawatt-hour(s).
PGA.......................... Purchased Gas Adjuster, a retail rate mechanism
designed to recover the cost of gas purchased
for retail gas customers.
PWCC......................... Pinnacle West Capital Corporation.
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.
iv
DEFINITIONS
(concluded)
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.
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.
Sundt Generating Station..... H. Wilson Sundt Generating Station (formerly
known as the Irvington Generating Station).
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
TEP Settlement Agreement..... TEP's Settlement Agreement approved by the ACC
in November 1999 that provided for electric
retail competition and transition asset
recovery.
Therm........................ A unit of heating value equivalent to 100,000
British thermal units (Btu).
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 57% 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.
UES.......................... UniSource Energy Services, Inc., an intermediate
holding company established to own the
operating companies (UNS Gas and UNS Electric)
which acquired the Citizens Arizona gas and
electric utility assets.
UniSource Energy............. UniSource Energy Corporation.
UNS Electric................. UNS Electric, Inc., a wholly-owned subsidiary
of UES, which acquired the Citizens Arizona
electric utility assets.
UNS Gas...................... UNS Gas, Inc., a wholly-owned subsidiary of
UES, which acquired the Citizens Arizona gas
utility assets.
v
Report of Independent Accountants
To the Board of Directors and Stockholders of
UniSource Energy Corporation and
to the Board of Directors and Stockholder of
Tucson Electric Power Company
We have reviewed the accompanying condensed consolidated balance sheets of
UniSource Energy Corporation and its subsidiaries (the Company) and Tucson
Electric Power Company and its subsidiaries (TEP) as of September 30, 2003,
and the related condensed consolidated statements of income for each of the
three-month and nine-month periods ended September 30, 2003 and 2002 and the
condensed consolidated statement of stockholders' equity for the nine-month
period ended September 30, 2003, and the condensed consolidated statements of
cash flows for the nine-month periods ended September 30, 2003 and 2002.
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 sheets
and statements of capitalization of the Company and TEP as of December 31,
2002, and the related consolidated statements of income, of 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
sheets 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
Los Angeles, California
November 5, 2003
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
September 30,
2003 2002
(Unaudited)
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-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $253,391 $214,432
Electric Wholesale Sales 32,297 41,125
Gas Revenue 10,336 -
Net Gain on TEP Forward Contracts and MEG
Trading Activities 863 375
Other Revenues 5,911 2,833
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Total Operating Revenues 302,798 258,765
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Operating Expenses
Fuel 64,247 58,422
Purchased Energy 47,200 23,345
Coal Contract Termination Fee - 11,250
Other Operations and Maintenance 48,597 46,668
Depreciation and Amortization 34,032 31,107
Amortization of Transition Recovery Asset 13,472 10,790
Taxes Other Than Income Taxes 12,676 11,753
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Total Operating Expenses 220,224 193,335
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Operating Income 82,574 65,430
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Other Income (Deductions)
Interest Income 5,090 5,231
Other Income 1,358 2,113
Other Expense (950) (2,571)
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Total Other Income (Deductions) 5,498 4,773
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Interest Expense
Long-Term Debt 20,532 16,025
Interest on Capital Leases 21,257 21,944
Other Interest Expense, Net of Amounts Capitalized 603 208
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Total Interest Expense 42,392 38,177
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Income Before Income Taxes and Cumulative Effect
of Accounting Change 45,680 32,026
Income Tax Expense 18,996 9,207
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Income Before Cumulative Effect of Accounting Change 26,684 22,819
Cumulative Effect of Accounting Change - Net of Tax - -
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Net Income $ 26,684 $ 22,819
===============================================================================
Average Shares of Common Stock Outstanding (000) 33,838 33,692
===============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.79 $0.68
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.79 $0.68
===============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.78 $0.67
Cumulative Effect of Accounting Change - Net of Tax - -
Net Income $0.78 $0.67
===============================================================================
Dividends Paid per Share $0.15 $0.125
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2003 2002
(Unaudited)
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-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $557,174 $521,064
Electric Wholesale Sales 107,994 125,911
Gas Revenue 10,336 -
Net Gain on TEP Forward Contracts and MEG
Trading Activities 318 936
Other Revenues 12,850 10,672
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Total Operating Revenues 688,672 658,583
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Operating Expenses
Fuel 162,512 164,937
Purchased Energy 80,898 46,909
Coal Contract Termination Fee - 11,250
Other Operations and Maintenance 150,243 140,890
Depreciation and Amortization 95,472 96,075
Amortization of Transition Recovery Asset 24,842 20,311
Taxes Other Than Income Taxes 35,419 34,704
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Total Operating Expenses 549,386 515,076
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Operating Income 139,286 143,507
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Other Income (Deductions)
Interest Income 15,380 14,913
Other Income 3,440 4,657
Other Expense (3,242) (6,213)
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Total Other Income (Deductions) 15,578 13,357
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Interest Expense
Long-Term Debt 58,917 48,115
Interest on Capital Leases 62,791 65,896
Other Interest Expense, Net of Amounts Capitalized 903 799
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Total Interest Expense 122,611 114,810
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Income Before Income Taxes and Cumulative Effect
of Accounting Change 32,253 42,054
Income Tax Expense 15,187 13,661
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Income Before Cumulative Effect of Accounting Change 17,066 28,393
Cumulative Effect of Accounting Change - Net of Tax 67,471 -
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Net Income $ 84,537 $ 28,393
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Average Shares of Common Stock Outstanding (000) 33,799 33,654
===============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.50 $0.84
Cumulative Effect of Accounting Change - Net of Tax $2.00 -
Net Income $2.50 $0.84
===============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of Accounting Change $0.50 $0.83
Cumulative Effect of Accounting Change - Net of Tax $1.97 -
Net Income $2.47 $0.83
===============================================================================
Dividends Paid per Share $0.45 $0.375
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
2
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2003 2002
(Unaudited)
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-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $584,028 $550,291
Cash Receipts from Electric Wholesale Sales 155,505 191,468
Cash Receipts from Gas Sales 10,634 -
MEG Cash Receipts from Trading Activity 64,657 41,734
Interest Received 22,248 13,018
Other Cash Receipts 5,256 18,119
Fuel Costs Paid (158,327) (157,179)
Purchased Power Costs Paid (124,897) (108,875)
Wages Paid, Net of Amounts Capitalized (58,769) (57,378)
Payment of Other Operations and Maintenance Costs (83,260) (93,984)
MEG Cash Payments for Trading Activity (62,548) (46,039)
Capital Lease Interest Paid (74,142) (68,329)
Taxes Paid, Net of Amounts Capitalized (70,071) (69,040)
Debt Interest Paid, Net of Amounts Capitalized (62,301) (52,925)
Income Taxes Paid (4,616) (10,416)
MEG Performance Deposits (4,804) 4,632
Coal Contract Termination Fee - (11,250)
Other (5,189) (7,692)
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Net Cash Flows - Operating Activities 133,404 136,155
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Cash Flows from Investing Activities
Capital Expenditures (101,389) (81,728)
Purchase of Citizens Assets (224,138) -
Investment in Springerville Lease Debt and Equity 12,078 (134,989)
Investment in and Loans to Equity Investees (1,661) (23,262)
Other (3,869) (425)
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Net Cash Flows - Investing Activities (318,979) (240,404)
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Cash Flows from Financing Activities
Proceeds from Borrowings under Revolving
Credit Facility 45,000 -
Repayments on Revolving Credit Facility (25,000) -
Proceeds from Issuance of Short-Term Debt 35,850 957
Repayments of Short-Term Debt (960) (853)
Proceeds from Issuance of Long-Term Debt 160,000 -
Repayments of Long-Term Debt (1,826) (1,879)
Common Stock Dividends Paid (15,139) (12,602)
Payments on Capital Lease Obligations (42,444) (19,620)
Other 1,689 2,704
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Net Cash Flows - Financing Activities 157,170 (31,293)
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Net Decrease in Cash and Cash Equivalents (28,405) (135,542)
Cash and Cash Equivalents, Beginning of Year 90,928 228,154
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Cash and Cash Equivalents, End of Period $ 62,523 $ 92,612
===============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
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Net Income $ 84,537 $ 28,393
Adjustments to Reconcile Net Income to Net Cash Flows
Cumulative Effect of Accounting Change - Net of Tax (67,471) -
Depreciation and Amortization Expense 95,472 96,075
Depreciation Recorded to Fuel and Other O&M Expense 4,300 4,190
Amortization of Transition Recovery Asset 24,842 20,311
Net Unrealized Gain on Forward Electric Sales
and Purchases and MEG Trading Activities (2,683) (1,206)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 2,223 1,428
Provision for Bad Debts 4,018 1,753
Deferred Income Taxes 16,941 14,521
Losses from Equity Method Entities 2,391 3,888
Other, Net 3,187 (6,541)
Changes in Current Assets and Liabilities which
Provided (Used) Cash Exclusive of Changes Shown
Separately:
Accounts Receivable (21,441) 16,361
Materials and Fuel Inventory (2,332) 705
Accounts Payable (10,231) (40,011)
Interest Accrued (16,976) (9,817)
Taxes Accrued 11,094 7,728
Other Current Assets (9,888) 2,640
Other Current Liabilities 15,421 (4,263)
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Net Cash Flows - Operating Activities $133,404 $136,155
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
3
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
(Unaudited)
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ASSETS -Thousands of Dollars-
Utility Plant
Plant in Service $ 2,868,462 $ 2,598,884
Utility Plant under Capital Leases 747,533 747,556
Construction Work in Progress 120,017 59,926
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Total Utility Plant 3,736,012 3,406,366
Less Accumulated Depreciation and Amortization (1,296,775) (1,346,101)
Less Accumulated Depreciation of Capital Lease
Assets (413,741) (391,915)
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Total Utility Plant - Net 2,025,496 1,668,350
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Investments and Other Property
Investments in Lease Debt and Equity 179,010 191,867
Other 122,974 123,238
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Total Investments and Other Property 301,984 315,105
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Current Assets
Cash and Cash Equivalents 62,523 90,928
Trade Accounts Receivable 91,436 75,787
Unbilled Accounts Receivable 31,880 9,910
Allowance for Doubtful Accounts (12,184) (9,062)
Materials and Fuel Inventory 53,476 46,657
Trading Assets 29,199 15,150
Current Regulatory Assets 16,577 11,778
Deferred Income Taxes - Current 11,593 15,917
Interest Receivable - Current 6,210 12,178
Other 20,179 15,762
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Total Current Assets 310,889 285,005
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 282,278 307,120
Income Taxes Recoverable Through Future Revenues 51,648 57,044
Other Regulatory Assets 12,890 10,504
Other Assets 47,619 47,606
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Total Regulatory and Other Assets 394,435 422,274
- -------------------------------------------------------------------------------
Total Assets $ 3,032,804 $ 2,690,734
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 508,078 $ 438,229
Capital Lease Obligations 761,855 801,611
Long-Term Debt 1,286,685 1,128,963
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Total Capitalization 2,556,618 2,368,803
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 50,280 42,960
Current Maturities of Long-Term Debt 1,771 1,840
Borrowings under Revolving Credit Facility 20,000 -
Term Loan Payable 35,000 -
Accounts Payable 63,337 48,934
Interest Accrued 33,408 60,238
Trading Liabilities 23,184 10,255
Taxes Accrued 44,741 33,850
Accrued Employee Expenses 11,995 13,644
Other 18,056 7,659
- -------------------------------------------------------------------------------
Total Current Liabilities 301,772 219,380
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 86,009 34,552
Other 88,405 67,999
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 174,414 102,551
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 9)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 3,032,804 $ 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 - - 84,537 - 84,537
---------
Total Comprehensive
Income 84,537
---------
Dividends Declared - - (15,139) - (15,139)
Shares Issued under Stock
Compensation Plans 7 75 - - 75
Shares Distributed by
Deferred Compensation
Trust 3 50 - - 50
Shares Issued for Stock
Options 24 326 - - 326
- -------------------------------------------------------------------------------
Balances at
September 30, 2003 33,613 $661,636 $(149,534) $ (4,024) $508,078
===============================================================================
*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
Three Months Ended
September 30,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $229,735 $214,432
Electric Wholesale Sales 32,297 41,125
Net Unrealized Gain on Forward Electric Sales and
Purchases 148 85
Other Revenues 2,235 1,601
- -------------------------------------------------------------------------------
Total Operating Revenues 264,415 257,243
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 64,247 58,422
Purchased Power 22,826 23,345
Coal Contract Termination Fee - 11,250
Other Operations and Maintenance 36,676 39,712
Depreciation and Amortization 30,592 30,203
Amortization of Transition Recovery Asset 13,472 10,790
Taxes Other Than Income Taxes 10,732 11,467
- -------------------------------------------------------------------------------
Total Operating Expenses 178,545 185,189
- -------------------------------------------------------------------------------
Operating Income 85,870 72,054
- -------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 5,055 5,159
Interest Income - Note Receivable from UniSource
Energy 2,581 2,352
Other Income 590 1,877
Other Expense (255) (447)
- -------------------------------------------------------------------------------
Total Other Income (Deductions) 7,971 8,941
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 18,999 16,025
Interest on Capital Leases 21,254 21,923
Other Interest Expense, Net of Amounts Capitalized 144 93
- -------------------------------------------------------------------------------
Total Interest Expense 40,397 38,041
- -------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect
of Accounting Change 53,444 42,954
Income Tax Expense 21,942 16,392
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 31,502 26,562
Cumulative Effect of Accounting Change - Net of Tax - -
- -------------------------------------------------------------------------------
Net Income $ 31,502 $ 26,562
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended
September 30,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 533,518 $ 521,064
Electric Wholesale Sales 107,994 125,911
Net Unrealized Gain on Forward Electric Sales and
Purchases 39 807
Other Revenues 6,734 6,819
- -------------------------------------------------------------------------------
Total Operating Revenues 648,285 654,601
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 162,512 164,937
Purchased Power 56,524 46,909
Coal Contract Termination Fee - 11,250
Other Operations and Maintenance 122,757 123,605
Depreciation and Amortization 89,976 93,048
Amortization of Transition Recovery Asset 24,842 20,311
Taxes Other Than Income Taxes 32,678 33,735
- -------------------------------------------------------------------------------
Total Operating Expenses 489,289 493,795
- -------------------------------------------------------------------------------
Operating Income 158,996 160,806
- -------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 15,259 14,388
Interest Income - Note Receivable from UniSource
Energy 7,660 6,978
Other Income 1,713 2,798
Other Expense (790) (1,273)
- -------------------------------------------------------------------------------
Total Other Income(Deductions) 23,842 22,891
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 57,384 48,115
Interest on Capital Leases 62,781 65,843
Other Interest Expense, Net of Amounts Capitalized 211 273
- -------------------------------------------------------------------------------
Total Interest Expense 120,376 114,231
- -------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative Effect
of Accounting Change 62,462 69,466
Income Tax Expense 26,962 27,367
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of Accounting Change 35,500 42,099
Cumulative Effect of Accounting Change - Net of Tax 67,471 -
- -------------------------------------------------------------------------------
Net Income $ 102,971 $ 42,099
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
6
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 560,668 $ 550,291
Cash Receipts from Electric Wholesale Sales 155,505 191,468
Interest Received 22,004 12,527
Fuel Costs Paid (158,327) (157,179)
Purchased Power Costs Paid (92,762) (108,875)
Wages Paid, Net of Amounts Capitalized (46,101) (45,745)
Payment of Other Operations and Maintenance Costs (72,947) (78,967)
Capital Lease Interest Paid (74,131) (68,276)
Taxes Paid, Net of Amounts Capitalized (66,081) (65,526)
Debt Interest Paid, Net of Amounts Capitalized (62,095) (52,902)
Income Taxes Paid (3,718) (10,306)
Coal Contract Termination Fee - (11,250)
Other 259 93
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 162,274 155,353
- -------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (97,105) (72,181)
Purchase of North Loop Gas Turbine from UED - (14,853)
Investment in Springerville Lease Debt and Equity 12,078 (134,989)
Other (1,902) (789)
- -------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (86,929) (222,812)
- -------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from Borrowings under Revolving Credit
Facility 45,000 -
Repayments on Revolving Credit Facility (25,000) -
Repayments of Long-Term Debt (1,725) (1,879)
Dividends Paid to UniSource Energy (58,500) (10,000)
Payments on Capital Lease Obligations (42,379) (19,384)
Other (14,614) 6,926
- -------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (97,218) (24,337)
- -------------------------------------------------------------------------------
Net Decrease in Cash and Cash Equivalents (21,873) (91,796)
Cash and Cash Equivalents, Beginning of Year 55,778 159,680
- -------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Period $ 33,905 $ 67,884
===============================================================================
SUPPLEMENTAL CONDENSED CONSOLIDATED CASH FLOW INFORMATION
- -------------------------------------------------------------------------------
Net Income $ 102,971 $ 42,099
Adjustments to Reconcile Net Income to Net Cash Flows
Cumulative Effect of Accounting Change - Net of Tax (67,471) -
Depreciation and Amortization Expense 89,976 93,048
Depreciation Recorded to Fuel and Other O&M Expense 4,300 4,190
Amortization of Transition Recovery Asset 24,842 20,311
Net Unrealized Gain on Forward Electric Sales and
Purchases (39) (807)
Amortization of Deferred Debt-Related Costs included
in Interest Expense 2,199 1,428
Provision for Bad Debts 3,910 1,753
Deferred Income Taxes 25,504 25,557
(Income) Losses from Equity Method Entities (132) 279
Interest on Note Receivable from UniSource Energy (7,660) (6,978)
Other, Net 8,652 (894)
Changes in Current Assets and Liabilities which
Provided (Used) Cash Exclusive of Changes Shown
Separately:
Accounts Receivable (19,111) 18,625
Materials and Fuel Inventory (801) 1,338
Accounts Payable (1,046) (39,080)
Interest Accrued (18,661) (9,817)
Taxes Accrued 10,778 9,702
Other Current Assets 7,541 (4,981)
Other Current Liabilities (3,478) (420)
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities $ 162,274 $ 155,353
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
7
TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
(Unaudited)
- -------------------------------------------------------------------------------
ASSETS -Thousands of Dollars-
Utility Plant
Plant in Service $ 2,635,379 $ 2,598,884
Utility Plant under Capital Leases 747,533 747,556
Construction Work in Progress 107,493 59,926
- -------------------------------------------------------------------------------
Total Utility Plant 3,490,405 3,406,366
Less Accumulated Depreciation and Amortization (1,294,586) (1,346,101)
Less Accumulated Depreciation of Capital Lease
Assets (413,741) (391,915)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,782,078 1,668,350
- -------------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 179,010 191,867
Other 20,968 21,358
- -------------------------------------------------------------------------------
Total Investments and Other Property 199,978 213,225
- -------------------------------------------------------------------------------
Note Receivable from UniSource Energy 70,132 79,462
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 33,905 55,778
Trade Accounts Receivable 66,228 66,826
Unbilled Accounts Receivable 22,104 9,910
Allowance for Doubtful Accounts (11,828) (9,012)
Intercompany Accounts Receivable 20,999 14,851
Materials and Fuel Inventory 45,301 44,500
Interest on Note Receivable from UniSource Energy 16,990 -
Current Regulatory Assets 10,944 11,778
Deferred Income Taxes - Current 12,337 15,917
Interest Receivable - Current 6,210 12,178
Other 8,736 8,407
- -------------------------------------------------------------------------------
Total Current Assets 231,926 231,133
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 282,278 307,120
Income Taxes Recoverable Through Future Revenues 51,648 57,044
Other Regulatory Assets 11,596 10,504
Other Assets 45,890 46,752
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 391,412 421,420
- -------------------------------------------------------------------------------
Total Assets $ 2,675,526 $ 2,613,590
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 382,018 $ 337,463
Capital Lease Obligations 761,805 801,508
Long-Term Debt 1,126,685 1,128,410
- -------------------------------------------------------------------------------
Total Capitalization 2,270,508 2,267,381
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 50,205 42,872
Current Maturities of Long-Term Debt 1,725 1,725
Borrowings under Revolving Credit Facility 20,000 -
Accounts Payable 40,088 41,704
Intercompany Accounts Payable 8,522 12,478
Interest Accrued 31,568 60,238
Taxes Accrued 43,655 35,772
Accrued Employee Expenses 11,786 13,370
Other 7,954 7,543
- -------------------------------------------------------------------------------
Total Current Liabilities 215,503 215,702
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 119,122 67,490
Other 70,393 63,017
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 189,515 130,507
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 9)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,675,526 $ 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 - - 102,971 - 102,971
---------
Total Comprehensive
Income 102,971
---------
Dividends Declared - - (58,500) - (58,500)
Other 84 - - - 84
- -------------------------------------------------------------------------------
Balances at
September 30, 2003 $ 653,613 $ (6,357) $(261,214) $ (4,024) $ 382,018
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
NOTE 1. NATURE OF OPERATIONS, BASIS OF ACCOUNTING PRESENTATION AND STOCK-
BASED COMPENSATION
- ------------------------------------------------------------------------------
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 UniSource Energy Services, Inc. (UES), 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 represented approximately
86% of UniSource Energy's assets as of September 30, 2003. TEP generates,
transmits and distributes electricity. TEP serves retail electric 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.
On August 11, 2003, UniSource Energy completed the purchase of the
Arizona gas and electric system assets from Citizens Communications Company
(Citizens). This acquisition adds approximately 127,000 retail gas customers
and 80,000 retail electric customers in Arizona to UniSource Energy's customer
base. UniSource Energy formed two new operating companies called UNS Gas,
Inc. (UNS Gas) and UNS Electric, Inc. (UNS Electric) to acquire these assets,
as well as an intermediate holding company, UES, to hold the common stock of
UNS Gas and UNS Electric. See Note 2.
Millennium's unregulated businesses are 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.
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 audited 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 audited 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, among other factors, causes seasonal fluctuations in TEP and
UES'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.
STOCK-BASED COMPENSATION
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 (APB 25), and related interpretations. 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 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:
10
UniSource Energy:
- ----------------
Three Months Ended September 30,
2003 2002
--------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $ 26,684 $ 22,819
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (248) (318)
--------------------------------------------------------------------
Pro Forma Net Income $ 26,436 $ 22,501
====================================================================
Basic Earnings per Share:
As Reported $0.79 $0.68
Pro Forma $0.78 $0.67
====================================================================
Diluted Earnings per Share:
As Reported $0.78 $0.67
Pro Forma $0.77 $0.66
====================================================================
Nine Months Ended September 30,
2003 2002
--------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $ 84,537 $ 28,393
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (733) (953)
--------------------------------------------------------------------
Pro Forma Net Income $ 83,804 $ 27,440
====================================================================
Basic Earnings per Share:
As Reported $2.50 $0.84
Pro Forma $2.48 $0.82
====================================================================
Diluted Earnings per Share:
As Reported $2.47 $0.83
Pro Forma $2.45 $0.81
====================================================================
TEP:
- ---
Three Months Ended September 30,
2003 2002
--------------------------------------------------------------------
-Thousands of Dollars-
Net Income - As Reported $ 31,502 $ 26,562
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (244) (314)
--------------------------------------------------------------------
Pro Forma Net Income $ 31,258 $ 26,248
====================================================================
Nine Months Ended September 30,
2003 2002
--------------------------------------------------------------------
-Thousands of Dollars-
Net Income - As Reported $102,971 $ 42,099
Deduct: Total stock-based employee
compensation expense determined under
fair value based method, net of
related tax effects (723) (942)
--------------------------------------------------------------------
Pro Forma Net Income $102,248 $ 41,157
====================================================================
11
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) 5 5
Interest rate 2.78% 1.45%
Volatility 23.38% 23.74%
Dividend yield 3.44% 2.83%
Weighted-average grant-date fair value
of options granted during the period $2.92 $2.90
---------------------------------------------------------------
NOTE 2. ESTABLISHMENT OF UES
- -----------------------------
On August 11, 2003, UniSource Energy acquired the Arizona gas and
electric system assets from Citizens for $224 million, comprised of the base
purchase price plus other operating capital adjustments. The results of UNS
Gas, UNS Electric, and UES have been included in UniSource Energy's
consolidated financial statements since the acquisition date.
The purchase price and the allocation of the assets acquired and the
liabilities assumed based on their estimated fair market values as of the
acquisition date are as follows:
Purchase Price (in thousands):
Cash Paid $224,138
Transaction Costs 4,891
---------------------------------------------------------
Total Purchase Price $229,029
=========================================================
Allocation of Purchase Price (in thousands):
Property, Plant & Equipment $242,421
Current Assets 29,388
Regulatory Assets 1,321
Other Assets 580
Current Liabilities (30,962)
Deferred Credits and Other Liabilities (13,719)
---------------------------------------------------------
Total Purchase Price $229,029
=========================================================
UniSource Energy is in the process of evaluating the allocation of post-
closing purchase price adjustments. Potential adjustments to the purchase
price allocation are not expected to be material.
The investment was funded by $160 million in senior unsecured notes
issued by UNS Electric and UNS Gas in a private placement, $35 million from
short-term bridge financing debt issued by UniSource Energy (see Note 14),
and approximately $50 million in cash from UniSource Energy. UNS Gas issued
$50 million of 6.23% Notes due August 11, 2011 and $50 million of 6.23% Notes
due August 11, 2015. UNS Electric issued $60 million of 7.61% Notes due
August 11, 2008. All three series of notes may be prepaid with a make-whole
call premium reflecting a discount rate equal to an equivalent maturity U.S.
Treasury security yield plus 50 basis points. The notes are guaranteed by
UES.
RATES AND REGULATION
Concurrent with the closing of the acquisition, retail rate increases for
customers of both UNS Electric and UNS Gas went into effect on August 11,
2003. These rate increases were approved by the Arizona Corporation
Commission (ACC) on July 3, 2003, when it approved the acquisition and the
terms of the April 1, 2003 settlement agreement (Citizens Settlement
Agreement) among UniSource Energy, Citizens, and the ACC Staff.
12
UNS Gas
UNS Gas is regulated by the ACC with respect to retail gas rates, the
issuance of securities, and transactions with affiliated parties. UNS Gas'
retail gas rates include a monthly customer charge, a base rate charge for
delivery services and the cost of gas (expressed in cents per therm), and a
Purchased Gas Adjustor (PGA) mechanism.
The PGA mechanism is intended to address the volatility of natural gas
prices and allows UNS Gas to recover its costs through a price adjustor. The
PGA charge may be changed monthly based on an ACC approved mechanism that
compares the twelve-month rolling average gas cost to the base cost of gas,
subject to limitations on how much the price per therm may change in a twelve
month period. The difference between the actual cost of UNS Gas' gas supplies
and transportation contracts and that currently allowed by the ACC are
deferred and recovered or repaid through the PGA mechanism. When under or
over recovery trigger points are met, UNS Gas may request a PGA surcharge or
surcredit with the goal of collecting or returning the amount deferred from or
to customers over a twelve month period.
The related ACC order and the Citizens Settlement Agreement include the
following terms related to UNS Gas rates:
- An increase in retail delivery base rates, effective August 11, 2003,
equivalent to a 20.9% overall increase over 2001 test year retail revenues
through a base rate increase.
- Fair value rate base of $142 million and allowed rate of return of
7.49%, based on a cost of capital of 9.05%, derived from a cost of equity of
11.00% and a cost of debt of 7.75% (based on a capital structure of 60% debt
and 40% equity).
- The existing PGA rate may not change more than $0.15 per therm through
July 2004. Thereafter, the PGA rate may not change more than $0.10 per therm.
Under the terms of the ACC order, UNS Gas may not file a general rate
increase until August 2006 and any resulting rate increase shall not become
effective prior to August 1, 2007.
The Citizens Settlement Agreement also limits dividends payable by UNS
Gas to UniSource Energy to 75% of earnings until the ratio of common equity to
total capitalization reaches 40%. The ratio of common equity to total
capitalization for UNS Gas is 34% at September 30, 2003.
On September 9, 2003, the ACC approved a new PGA surcharge of $0.1155 per
therm that took effect on October 1, 2003.
UNS Electric
UNS Electric is regulated by the ACC with respect to retail electric
rates, the issuance of securities, and transactions with affiliated parties,
and by the FERC with respect to wholesale power contracts and interstate
transmission service.
UNS Electric's retail electric rates include a Purchased Power and Fuel
Adjustment clause (PPFAC), that allows for a separate surcharge or surcredit
to the base rate for delivered purchased power to collect or return under or
over recovery of costs. As part of the July 3, 2003 Order, the ACC approved a
new PPFAC surcharge of $0.01825 per kWh to fully recover the cost of the
current full-requirements power supply agreement with Pinnacle West Capital
Corporation (PWCC).
The ACC order and Citizens Settlement Agreement include the following
terms related to UNS Electric rates:
- A 22% overall increase in retail rates effective August 11, 2003 from
the rates previously in effect for Citizens. This reflects the implementation
of a PPFAC surcharge of $0.01825 per kWh, which combined with the current base
rate of $0.05194 per kWh, results in a new delivered purchase power price of
$0.07019. This allows UNS Electric to fully recover the cost of purchased
power under its current contract with its sole energy supplier, PWCC.
13
- UNS Electric must attempt to renegotiate the PWCC purchase power
contract, and any savings that result from a renegotiated contract must be
allocated in a ratio of 90% to ratepayers and 10% to shareholders.
- UNS Electric and Citizens forfeited all rights to recover from
ratepayers any of the under-collected PPFAC balance in the approximate amount
of $135 million through August 11, 2003.
The ACC order also requires that TEP submit in its next general rate case
filing in June 2004, a feasibility study and consolidation plan, or a plan for
coordination of operations of UNS Electric's operations in Santa Cruz County
with those of TEP.
Under the terms of the ACC order, UNS Electric may not file a general
rate increase until August 2006 and any resulting rate increase shall not
become effective prior to August 1, 2007.
The Citizens Settlement Agreement also limits dividends payable by UNS
Electric to UniSource Energy to 75% of earnings until the ratio of common
equity to total capitalization reaches 40%. The ratio of common equity to
total capitalization for UNS Electric was 37.5% at September 30, 2003.
UES COMMITMENTS
UNS Gas has firm transportation agreements with El Paso Natural Gas
(EPNG) and Transwestern Pipeline Company (Transwestern) with combined capacity
sufficient to meet its load requirements. EPNG provides gas transportation
service under a converted full requirements contract in which UNS Gas pays a
fixed reservation charge. This contract expires in August 2011. In July
2003, FERC required the conversion of UNS Gas' full requirements status under
the EPNG agreement to contract demand starting on September 1, 2003. Upon
conversion to contract demand status, UNS Gas now has specific volume limits
in each month and specific receipt point rights from the available supply
basins (San Juan and Permian). These changes will reduce the amount of less
expensive San Juan gas available to UNS Gas. The impact, however, is not
expected to be material. The annual cost of the EPNG capacity after
conversion to contract demand will not change. The Transwestern contract
expires in January 2007. The aggregate annual minimum transportation charges
are expected to be approximately $3.5 million and $3.0 million for the EPNG
and Transwestern contracts, respectively.
UNS Electric imports the power it purchases over the Western Area Power
Administration's (WAPA) transmission lines. UNS Electric's transmission
capacity agreements with WAPA provide for annual rate adjustments and expire
in February 2008 and June 2011. The contract that expires in 2008 also
contains a capacity adjustment clause. Under the terms of the agreements, UNS
Electric's aggregate minimum fixed transmission charges are expected to be
approximately $2 million for the last five months of 2003, $6 million in 2004,
and $1 million in 2005 through 2011.
NOTE 3. REGULATORY ACCOUNTING
- ------------------------------
TEP and UES generally use 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 and UES' retail
rates, the ACC may not allow TEP or UES to currently charge their 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 and
UES defer these items and show them as regulatory assets on the balance sheet
until TEP and UES are allowed to charge their customers. TEP and UES then
amortize 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.
14
IMPLICATIONS OF DISCONTINUING APPLICATION OF FAS 71
TEP
In November 1999, upon approval by the ACC of a settlement agreement (TEP
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 distribution regulatory assets total $356 million at September 30,
2003, $23 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 its regulated operations, which are the
distribution and transmission portions of its business. TEP regularly
assesses whether it can continue to apply FAS 71 to these operations. If TEP
stopped applying FAS 71 to its remaining regulated operations, it would write
off the related balances of its regulatory assets as an expense on its income
statement. Based on the regulatory asset balances at September 30, 2003, if
TEP had stopped applying FAS 71 to its remaining regulated operations, it
would have recorded an extraordinary loss, after-tax, of approximately $215
million. While regulatory orders and market conditions may affect cash flows,
TEP's 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.
UES
UES' regulatory assets, net of regulatory liabilities, total $5 million
at September 30, 2003. If UES stopped applying FAS 71 to its regulated
operations, it would write off the related balances of its regulatory assets
as an expense and would write off its regulatory liabilities as income on its
income statement. Based on the balances of UES' regulatory assets and
liabilities at September 30, 2003, if UES had stopped applying FAS 71 to its
regulated operations, it would have recorded an extraordinary loss, after-tax,
of approximately $3 million. UES' 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.
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.
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 these 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 will be approximately $38 million at the date of
retirement. No other legal obligations to retire generation plant assets were
identified. UES, Millennium and UED have no asset retirement obligations.
15
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 is not recognizing 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 first nine months of
2003, this amount is approximately $4 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:
Nine Months Ended September 30,
2003 2002
Actual Pro Forma
-----------------------------------------------------------------------
-Thousands of Dollars-
Asset Retirement Obligation - beginning
of period $ 1,119 $ 1,017
Accretion Expense 83 76
-----------------------------------------------------------------------
Asset Retirement Obligation - end
of period $ 1,202 $ 1,093
=======================================================================
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 Nine Months Ended
September 30, 2002 September 30, 2002
- -----------------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $ 22,819 $ 28,393
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2002 721 2,603
- -----------------------------------------------------------------------------
Pro Forma Net Income $ 23,540 $ 30,996
=============================================================================
Basic Earnings per Share:
As Reported $ 0.68 $ 0.84
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2002 0.02 0.08
- -----------------------------------------------------------------------------
Pro Forma $ 0.70 $ 0.92
=============================================================================
Diluted Earnings per Share:
As Reported $ 0.67 $ 0.83
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2002 0.02 0.08
- -----------------------------------------------------------------------------
Pro Forma $ 0.69 $ 0.91
=============================================================================
16
TEP:
- ---
Three Months Ended Nine Months Ended
September 30, 2002 September 30, 2002
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Net Income - As Reported $ 26,562 $ 42,099
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2002 721 2,603
- -----------------------------------------------------------------------------
Pro Forma Net Income $ 27,283 $ 44,702
=============================================================================
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 TEP
Settlement Agreement.
NOTE 5. STOCK-BASED COMPENSATION PLANS
- ---------------------------------------
We account for UniSource Energy's two stock-based compensation plans, the
Directors' Plan and the Omnibus Plan, under the recognition and measurement
principles of APB 25 and related interpretations (see
Note 1).
STOCK OPTIONS
The Directors' Plan granted a total of 22,418 stock options and 22,000
stock options, respectively, during the nine-month periods ended September 30,
2003 and 2002. Additionally, the UniSource Energy Board of Directors granted
97,818 stock options and 568,000 stock options, respectively, to key employees
under the Omnibus Plan during the nine-month periods ended September 30, 2003
and 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:
Nine Months Ended September 30,
2003 2002
------------------------------------------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------------------------------------------------------------------
Options Outstanding,
Beginning of Period 2,576,282 $15.77 2,075,234 $15.05
Granted 120,236 $17.77 590,000 $18.14
Exercised (24,569) $13.47 (59,685) $14.47
Forfeited (14,529) $14.24 (12,087) $14.21
---------- ----------
Options Outstanding,
End of Period 2,657,420 $15.89 2,593,462 $15.77
========== =========
Options Exercisable,
End of Period 1,851,543 $15.13 1,450,822 $14.47
Weighted Average Remaining
Contractual Life at September 30, 2003: 6.39
------------------------------------------------------------------
17
RESTRICTED STOCK UNITS
During the nine months ended September 30, 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. The fair market value on the award date was $17.44.
LONG-TERM INCENTIVE COMPENSATION
In May 2003, the Board of Directors approved a grant of performance
shares and performance units to key employees under the Omnibus Plan. The
shares and units may be awarded at the end of a three-year performance period
based on goal attainment. Compensation expense is recorded over the
performance period based on the anticipated number and market value of shares
to be awarded. Compensation expense of $415,000 was recorded for the nine-
month period ended September 30, 2003 for this new incentive plan.
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 to supplement 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 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 standard agreement which allows for the netting of
current period exposures to and from a single counterparty.
UNS Gas and UNS Electric do not currently have any contracts that are
required to be marked to market under FAS 133. UNS Gas does have a natural
gas supply and management agreement under which it purchases substantially all
of its gas requirements at market prices from BP Energy Company (BP).
However, the contract terms allow UNS Gas to lock in fixed prices on a portion
of its gas purchases by entering into fixed price forward contracts with BP at
various times during the year, which enables UNS Gas to provide more stable
prices to its customers. These purchases are made up to a year in advance with
the goal of locking in fixed prices on at least 30% of the expected monthly
gas consumption prior to entering into the month. These forward contracts, as
well as the main gas supply contract, meet the definition of normal purchases
under FAS 133 and therefore are not required to be marked to market.
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 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.
Statement of Financial Accounting Standards No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities (FAS 149), 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. The adoption of
FAS 149 did not have a significant impact on our financial statements. See
Note 13.
18
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 Sales;
- 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. Although MEG's realized gain/loss on
trading activities are reported net on UniSource Energy's income statement,
the related cash receipts and cash payments are reported separately on
UniSource Energy's statement of cash flows.
MEG physically settled the following transaction volumes under its
trading contracts in 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-in Thousands-
Emission Allowances Purchased 270 66 648 294
Emission Allowances Sold 248 113 586 329
Coal Purchase (in tons) 173 - 211 -
Coal Sold (in tons) 173 - 211 -
- -----------------------------------------------------------------------------
The net pre-tax gains were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
TEP Net Unrealized Gain on
Derivative Forward Contracts $ 0.2 $ 0.1 $ - $ 0.8
MEG Net Unrealized and Realized
Gain on Trading Activities 0.7 0.3 0.3 0.1
- -----------------------------------------------------------------------------
UniSource Energy Net Gain on
TEP Forward Contracts and MEG
Trading Activities $ 0.9 $ 0.4 $ 0.3 $ 0.9
=============================================================================
At September 30, 2003, the fair value of TEP's derivative assets was less
than $0.1 million and is reported in Other Current Assets on TEP's balance
sheet. At December 31, 2002, TEP had no open forward contracts that were
considered derivatives. MEG's trading assets and liabilities are reported in
Trading Assets and Trading Liabilities on UniSource Energy's balance sheet.
The fair value of MEG's trading assets, including its Emission Allowance
inventory, was $29.2 million at September 30, 2003 and $15.1 million at
December 31, 2002. The fair value of MEG's trading liabilities was $23.2
million at September 30, 2003 and $10.3 million at December 31, 2002.
NOTE 7. BUSINESS SEGMENTS
- --------------------------
Based on the way we organize our operations and evaluate performance, we
have four reportable business segments:
(1) TEP, a vertically integrated electric utility business, is UniSource
Energy's largest subsidiary.
(2) UES is the holding company for UNS Gas, a regulated gas distribution
business; and UNS Electric, a regulated electric distribution utility business
(see Notes 1 and 2).
(3) Millennium holds interests in unregulated businesses (see Note 8).
(4) UED engages in developing generating resources and other project
development activities, including facilitating the expansion of 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.
UniSource Energy's significant reconciling adjustments consist of the
elimination of intercompany activity and balances. Millennium recorded
revenue from transactions with TEP of $4 million and $6 million during the
three-month periods ended September 30, 2003 and September 30, 2002, and $11
million and $13 million during
19
the nine-month periods ended September 30, 2003 and September 30, 2002. 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,
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 UES Millennium UED Adjustments Consolidated
- ------------------------------------------------------------------------------------------------------
-Thousands of Dollars-
Income Statement
- ----------------
Three Months Ended
September 30, 2003:
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- External $ 264,221 $ 34,265 $ 4,312 $ - $ - $ 302,798
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- Intersegment 194 - 3,948 - (4,142) -
- ------------------------------------------------------------------------------------------------------
Income (Loss)Before
Income Taxes 53,444 244 (4,226) (90) (3,692) 45,680
- ------------------------------------------------------------------------------------------------------
Net Income (Loss) 31,502 141 (2,708) (50) (2,201) 26,684
- ------------------------------------------------------------------------------------------------------
Three Months Ended
September 30, 2002:
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- External $ 257,189 $ - $ 1,576 $ - $ - $ 258,765
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- Intersegment 54 - 5,622 840 (6,516) -
- ------------------------------------------------------------------------------------------------------
Income (Loss) Before
Income Taxes 42,954 - (9,428) 852 (2,352) 32,026
- ------------------------------------------------------------------------------------------------------
Net Income (Loss) 26,562 - (2,828) 518 (1,433) 22,819
- ------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30, 2003:
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- External $ 647,973 $ 34,265 $ 6,434 $ - $ - $ 688,672
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- Intersegment 312 - 11,198 - (11,510) -
- ------------------------------------------------------------------------------------------------------
Income (Loss) Before
Income Taxes and
Cumulative Effect of
Accounting Change 62,462 238 (19,764) (277) (10,406) 32,253
- ------------------------------------------------------------------------------------------------------
Net Income (Loss) 102,971 135 (12,141) (163) (6,265) 84,537
- ------------------------------------------------------------------------------------------------------
Nine Months Ended
September 30, 2002:
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- External $ 654,216 $ - $ 4,367 $ - $ - $ 658,583
- ------------------------------------------------------------------------------------------------------
Operating Revenues
- Intersegment 385 - 12,578 2,520 (15,483) -
- ------------------------------------------------------------------------------------------------------
Income (Loss) Before
Income Taxes 69,466 - (22,184) 1,750 (6,978) 42,054
- ------------------------------------------------------------------------------------------------------
Net Income (Loss) 42,099 - (10,539) 1,061 (4,228) 28,393
- ------------------------------------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets,
September 30, 2003 $2,675,526 $ 294,044 $ 149,029 $ 45,526 $ (131,321) $3,032,804
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. As described
below, as of July 3, 2003 Millennium owns no interest in ITN.
- Global Solar - Millennium funded $7.9 million to Global Solar in the
first nine months of 2003 and $0.4 million in October 2003. Millennium's
unfunded commitment to Global Solar is $1.5 million of a $5 million line of
credit committed in May 2003. In the third quarter, Millennium exchanged its
9% interest in ITN and other consideration for additional shares of Global
Solar. In October 2003, Millennium converted a $7 million loan, plus interest
to equity in Global Solar. Millennium's interest in Global
20
Solar is now 99%. As sole funder, Millennium recognizes 100% of Global
Solar's losses. Global Solar has a $0.5 million research and development
funding commitment to ITN in 2004.
- IPS - Millennium funded $1.5 million of equity and $0.5 million of debt
to IPS in the first nine months of 2003. Dow Corning Enterprises, Inc. funded
$1.5 million of equity contributions and $0.5 million of debt to IPS in the
first nine months of 2003. Millennium owns approximately 72% of IPS. In 2003,
Millennium has recorded its ratable share of IPS' losses. IPS has a $0.5
million annual research and development funding commitment to ITN through
2004.
- MicroSat - Millennium owns 35% of MicroSat. As sole funder, Millennium
continues to recognize 100% of MicroSat's losses.
- ITN - During the third quarter of 2003, Millennium exchanged its 9%
interest in ITN and other consideration for additional shares of Global Solar
which decreased Millennium's ownership in ITN to zero.
Millennium has a $2 million remaining commitment to its Energy Technology
Investments. Additional commitments may be made. A significant portion of
this funding is for manufacturing costs, administrative, research and
development costs primarily at Global Solar. Funding for administrative,
research and development costs are expensed as amounts are spent.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment, excluding fees, to
Haddington Energy Partners II LP (Haddington), a limited partnership which
funds energy-related investments. Millennium has invested $8.1 million of
this commitment, $2 million of which was funded in 2003. 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 $5 million commitment, excluding fees, to a venture
capital fund that focuses on information technology, microelectronics and
biotechnology, primarily within the southwestern U.S. At September 30, 2003,
Millennium has funded approximately $1.2 million of this commitment.
Millennium expects to fund the remaining $3.8 million by the end of 2007. A
member of the UniSource Energy Board of Directors is a general partner of the
company that manages the fund.
During 2003, Millennium contributed $1.2 million to TruePricing, Inc.
(TruePricing) and began accounting for TruePricing under the consolidation
method. Millennium and TEP collectively now own approximately 57% of the
outstanding shares of TruePricing. Prior to this investment, Millennium
accounted for TruePricing under the equity method. Millennium, as sole
funder, recognizes 100% of TruePricing's losses.
During 2003, Millennium contributed approximately $2.1 million to
POWERTRUSION International, Inc. (Powertrusion), most of which was contributed
in the third quarter. This investment brings Millennium's share of ownership
in Powertrusion to almost 77%. Millennium accounts for Powertrusion under the
consolidation method.
NATIONS ENERGY CONTINGENCY
In September 2001, Nations Energy Corporation (Nations Energy) sold its
26% equity interest in a power project located in Curacao, Netherlands
Antilles to Mirant Curacao Investments, Ltd. (Mirant Curacao) a subsidiary of
Mirant Corporation (Mirant). Nations Energy received $5 million in cash and
an $11 million note receivable from Mirant Curacao. The note was recorded at
its net present value of $8 million using an 8% discount rate, the discount
being recognized as interest income over the five-year life of the note. As
of September 30, 2003, Nations Energy's receivable from Mirant Curacao is
approximately $9.7 million. The note is included in Investments and Other
Property - Other on UniSource Energy's balance sheet. 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.
The note is guar