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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20022003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________________ to _________.__________.
Commission Registrant; State of Incorporation; IRS Employer
File Number Address; and Telephone Number Identification Number
- ----------- --------------------------------------------------------------- ---------------------
1-13739 UNISOURCE ENERGY CORPORATION 86-0786732
(An Arizona Corporation)
One South Church Avenue, Suite 100
Tucson, AZ 85701
(520) 571-4000
1-5924 TUCSON ELECTRIC POWER COMPANY 86-0062700
(An Arizona Corporation)
One South Church Avenue, Suite 100
Tucson, AZ 85701
(520) 571-4000
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Registrant Title of Each Class on Which Registered
- ---------- ------------------- ------------------------------------------
UniSource Energy Common Stock, no par value and New York Stock Exchange
Corporation value and Preferred Pacific Exchange Share Purchase Rights Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether each registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X_X No ----- -----__
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of each registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ][X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act).
UniSource Energy Corporation Yes X No
----- --------- ---
Tucson Electric Power Company Yes No X
---- ----
The aggregate market value of UniSource Energy Corporation voting
Common Stock held by non-affiliates of the registrant was $622,739,272$630,807,609 based on
the last reported sale price thereof on the consolidated tape on June 28, 2002.30, 2003.
At March 4, 2003, 33,583,18210, 2004, 34,029,653 shares of UniSource Energy Corporation
Common Stock, no par value (the only class of Common Stock), were outstanding.
At March 4, 2003, UniSource Energy Corporation is the holder of
32,139,43410, 2004, 32,139,555 shares of the outstanding common stock of Tucson Electric Power Company.Company's
common stock, no par value, were outstanding, of which 32,139,434 shares were
held by UniSource Energy Corporation.
Documents incorporated by reference: Specified portions of UniSource
Energy Corporation's Proxy Statement relating to the 20032004 Annual Meeting of
Shareholders are incorporated by reference into PART III.
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This combined Form 10-K is separately filed by UniSource Energy Corporation and
Tucson Electric Power Company. Information contained in this document relating
to Tucson Electric Power Company is filed by UniSource Energy Corporation and
separately by Tucson Electric Power Company on its own behalf. Tucson Electric
Power Company makes no representation as to information relating to UniSource
Energy Corporation or its subsidiaries, except as it may relate to Tucson
Electric Power Company.
TABLE OF CONTENTS
Page
----
Definitions................................................................Table of Contents
Definitions v
--- PART I ---
Item 1. - Business 1
Overview of Consolidated Business.........................................1Business 1
TEP Electric Utility Operations 3
Service Area and Customers..............................................2Customers 4
Generating and Other Resources..........................................5Resources 6
Fuel Supply.............................................................7Supply 8
Water Supply............................................................9Supply 10
Transmission Access.....................................................9Access 11
Rates and Regulation...................................................10Regulation 12
TEP's Utility Operating Statistics.....................................12Statistics 15
Environmental Matters..................................................13Matters 16
UniSource Energy Services 17
UNS Electric 17
Service Territory and Customers 17
Power Supply and Transmission 17
Rates and Regulation 17
UNS Gas 18
Service Territory and Customers 18
Gas Supply and Transmission 18
Rates and Regulation 19
Millennium Energy Businesses.............................................14Holdings 19
UniSource Energy Development Company.....................................15
Employees................................................................16Company 21
Employees 21
SEC Reports available on UniSource Energy's Website......................16Website 22
Item 2. - Properties.......................................................18Properties 23
TEP Properties 23
UES Properties 24
Item 3. - Legal Proceedings................................................19Proceedings 24
Item 4. - Submission of Matters to a Vote of Security Holders..............19
- PARTHolders 25
-- Part II ---
Item 5. - Market for Registrant's Common Equity and Related Stockholder
Matters..............................................20Matters 26
Item 6. - Selected Consolidated Financial Data 27
UniSource Energy.........................................................21
TEP......................................................................22Energy 27
TEP 28
Non-GAAP Financial Measures 29
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations....................................................23Operations 32
K-ii
Outlook and Strategies 32
UniSource Energy Consolidated..........................................23Consolidated 32
Results of Operations 33
Contribution by Business Segment.......................................24Segment 34
Liquidity and Capital Resources 35
Tucson Electric Power Company 39
Results of TEP.........................................................24
Results of Millennium Energy Businesses................................28
Results of UED.........................................................29
Income Tax Position......................................................29
Asset Purchase Agreements................................................29Operations 39
Factors Affecting Results of Operations Competition............................................................30
Industry Restructuring.................................................31
Market Risks...........................................................34
Outlook and Strategies.................................................37
Critical Accounting Policies...........................................37
TABLE OF CONTENTS
(continued)
Page
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Liquidity and Capital Resources 44
UniSource Energy - Consolidated Cash Flows.............................42Services 50
Results of Operations 50
Factors Affecting Results of Operations 51
Liquidity and Capital Resources 52
Millennium Energy Holdings, Inc. 54
Results of Operations 54
UniSource Energy - Parent Company......................................43
TEP - Electric Utility.................................................43
Operating Activities.................................................43
Investing Activities.................................................44
Financing Actitities.................................................45
Millennium - Unregulated Energy Businesses.............................47
UED - Unregulated Energy Business......................................49
Financing Risks........................................................49
Contractual Obligations................................................50
Guarantees and Indemnities.............................................51
Dividends on Common Stock..............................................52Development Company 56
Results of Operations 56
Springerville Generating Station Expansion 56
Critical Accounting Policies 56
New Accounting Pronouncements............................................52Pronouncements 63
Safe Harbor for Forward-Looking Statements...............................53Statements 64
Item 7A.-7A. - Quantitative and Qualitative Disclosures about Market Risk.......54Risk 65
Item 8. - Consolidated Financial Statements and Supplementary Data.........54Data 68
Report of Independent Accountants........................................55Auditors 69
UniSource Energy Corporation
Consolidated Statements of Income......................................56Income 70
Consolidated Statements of Cash Flows..................................57Flows 71
Consolidated Balance Sheets............................................58Sheets 72
Consolidated Statements of Capitalization..............................59Capitalization 73
Consolidated Statements of Changes in Stockholders' Equity.............60Equity 74
Tucson Electric Power Company
Consolidated Statements of Income......................................61Income 75
Consolidated Statements of Cash Flows..................................62Flows 76
Consolidated Balance Sheets............................................63Sheets 77
Consolidated Statements of Capitalization..............................64Capitalization 78
Consolidated Statements of Changes in Stockholders' Equity.............65Equity 79
Notes to Consolidated Financial Statements
Note 1. Nature of Operations and Summary of Significant
Accounting Policies......................................................66Policies 80
Note 2. Regulatory Matters..............................................72Proposed Acquisition of UniSource Energy 88
Note 3. Establishment of UES 88
Note 4. TEP Regulatory Matters 91
Note 5. Accounting Change: Accounting for Asset Retirement
Obligations 94
Note 6. Segment and Related Information 96
Note 7. Accounting for Derivative Instruments, Trading
Activities and Hedging Activities........................................75Activities 98
Note 4.8. Millennium Energy Businesses....................................7799
Note 5. Business Segments...............................................80
Note 6. TEP's9. Utility Plant and Jointly-Owned Facilities................82Facilities 101
Note 7.10. Debt and Capital Lease Obligations..............................83Obligations 103
Note 8.11. Fair Value of TEP's Financial Instruments.......................85Instruments 106
Note 9.12. Stockholders' Equity............................................86Equity 107
Note 10. Commitments and Contingencies...................................87
Note 11.13. TEP Wholesale Accounts Receivable and Allowances....................91Allowances 108
Note 12.14. Springerville Expansion 109
K-iii
Note 15. Commitments and Contingencies 109
Note 16. Income Taxes....................................................92and Other Taxes 115
Note 13.17. Employee Benefits Plans.........................................94Benefit Plans 118
Note 14.18. Stock-Based Compensation Plans 122
Note 19. UniSource Energy Earnings Per Share (EPS).......................98123
Note 15. Asset Purchase Agreements.......................................99
Note 16.20. Supplemental Cash Flow Information.............................100Information 125
Note 17.21. Quarterly Financial Data (Unaudited)...........................103
TABLE OF CONTENTS
(concluded)
Page
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Schedule II - Valuation and Qualifying Accounts.........................106
- PART III -Accounts 130
Item 9.9 - Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................107Disclosure 131
Item 10.9A - Controls and Procedures 131
-- Part III --
Item 10 - Directors and Executive Officers of the Registrants............107Registrants 131
Item 11.11 - Executive Compensation.........................................109Compensation 134
Item 12.12 - Security Ownership of Certain Beneficial Owners and Management.....................................................109Management 134
Item 13.13 - Certain Relationships and Related Transactions.................110Transactions 134
Item 14 - PARTPrincipal Accountant Fees and Services 134
-- Part IV ---
Item 14. - Controls and Procedures........................................111
Item 15.15 - Exhibits, Financial Statement Schedules, and Reports onof Form 8-K...........................................................111
Signatures..............................................................113
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act.........1178-K 135
Signatures 137
Exhibit Index...........................................................121Index 141
K-iv
DEFINITIONS
The abbreviations and acronyms used in the 20022003 Form 10-K are defined below:
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ACC..........................--------------------------------------------------------------------------------
ACC.............................. Arizona Corporation Commission.
ACC Holding Company Order....Order........ The order approved by the ACC in November
1997 allowing TEP to form a holding
company.
AHMSA........................AHMSA............................ Altos Hornos de Mexico, S.A. de C.V.
AHMSA owns 50% of Sabinas.
ALJ.......................... Administrative Law Judge.
APS..........................AMT.............................. Alternative Minimum Tax.
APS.............................. Arizona Public Service Company.
Btu..........................Btu.............................. British thermal unit(s).
Capacity.....................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.........................CISO............................. California Independent System Operator.
Citizens.....................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.................Stock..................... UniSource Energy's common stock, without
par value.
Company or UniSource Energy..Energy...... UniSource Energy Corporation.
Cooling Degree Days..........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..........................CPX.............................. California Power Exchange.
Credit Agreement.............Agreement................. Credit Agreement between TEP and a
syndicate of banks, dated as of November
14, 2002.
EmissionEmissions Allowance(s)................... An EPA-issued allowance issued by the Environmental
Protection Agency which permits emission
of one ton of sulfur dioxide.dioxide or one ton
of nitrogen oxide. These allowances can
be bought and sold.
Energy.......................Energy........................... The amount of power produced over a given
period of time; measured in MWh.
EPA..........................EPA.............................. The Environmental Protection Agency.
ESP..........................ESP.............................. Energy Service Provider.
Express Line.................Line..................... 345-kV circuit connecting Springerville
Unit 2 to the Tucson 138 kV138-kV system.
FAS 71.......................71........................... Statement of Financial Accounting
Standards No. 71: Accounting for the
Effects of Certain Types of Regulation.
FAS 133......................132.......................... Statement of Financial Accounting
Standards No. 132: Employers'
Disclosures about Pensions and
Other Postretirement Benefits.
FAS 133.......................... Statement of Financial Accounting
Standards No. 133: Accounting for
Derivative Instruments and Hedging
Activities.
FAS 143......................143.......................... Statement of Financial Accounting
Standards No. 143: Accounting for Asset
Retirement Obligations.
FERC.........................FAS 149.......................... Statement of Financial Accounting
Standards No. 149: Amendment of
Statement 133 on Derivative Instruments
and Hedging Activities.
FERC............................. Federal Energy Regulatory Commission.
First Collateral Trust Bonds......................Bonds..... Bonds issued under the Indenture of Trust,
dated as of August 1, 1998, of TEP to
the Bank of New York, successor trustee.
First Mortgage Bonds.........Bonds............. First mortgage bonds issued under the
Indenture, dated as of April 1, 1941, of
TEP to JPMorgan Chase Bank, successor
trustee, as supplemented and amended.
Four Corners.................Corners..................... Four Corners Generating Station.
GAAP.........................GAAP............................. Generally Accepted Accounting Principles.
Global Solar.................Solar..................... Global Solar Energy, Inc., a company that
develops and manufactures thin-film
photovoltaic cells. Millennium owns 87%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.
IDBs.........................IDBs............................. Industrial development revenue or
pollution control revenue bonds.
IPS..........................IPS.............................. Infinite Power Solutions, Inc., a company
that develops thin-film batteries.
Millennium owns 77.5%72% of IPS.
IRS..........................K-v
IRS.............................. Internal Revenue Service.
DEFINITIONS
(continued)
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Irvington.................... Irvington Generating Station.
Irvington Lease.............. The leveraged lease arrangement relating to
Irvington Unit 4.
ISO..........................ISO.............................. Independent System Operator.
ITN..........................ITN.............................. ITN Energy Systems, Inc. was formed to
provide research, development, and other
services. MilleniumMillennium exchanged its
ownership of ITN for increased ownership
of Global Solar and currently owns 49% but has agreed
to reduce its ownership to 9%.
ITC..........................no
interest in ITN.
ITC.............................. Investment tax credit.
kWh..........................kWh.............................. Kilowatt-hour(s).
kV...........................kV............................... Kilovolt(s).
LOC..........................LOC.............................. Letter of Credit.
MEG..........................MEG.............................. Millennium Environmental Group, Inc., a
wholly-
ownedwholly-owned subsidiary of Millennium,
which manages and trades emission
allowances, coal, and related financial
instruments.
MEH.......................... MEH Corporation, a wholly-owned subsidiary
of Millennium, which formerly held a 50%
interest in NewEnergy.
MicroSat.....................MicroSat......................... 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....................... Millennium Energy Holdings, Inc., a
wholly-owned subsidiary of UniSource
Energy.
Mimosa.......................Mimosa........................... Minerales de Monclova, S.A. de C.V., an
owner of coal and associated gas
reserves and a supplier of metallurgical
coal to the steel industry and thermal
coal to the Mexican electricity
commission. Sabinas owns 19.5% of
Mimosa.
MMBtus.......................MMBtus........................... Million British Thermal Units.
MW...........................MW............................... Megawatt(s).
MWh..........................MWh.............................. Megawatt-hour(s).
Nations Energy............... Nations Energy Corporation, a wholly-owned
subsidiary of Millennium, and holder of a
minority interest in an independent power
project in Panama.
Navajo.......................Navajo........................... Navajo Generating Station.
NewEnergy.................... NewEnergy, Inc., formerly New Energy Ventures,
Inc., a company in which a 50% interest was
owned by MEH.
NOL..........................NOL.............................. Net Operating Loss carryback or
carryforward for income tax purposes.
PG&E......................... PacificPGA.............................. Purchased Gas and Electric Company.
PNM..........................Adjuster, a retail rate
mechanism designed to recover the cost
of gas purchased for retail gas
customers.
PNM.............................. Public Service Company of New Mexico.
Powertrusion.................Powertrusion..................... POWERTRUSION International, Inc., a
company owned 50.5%77% by Millennium, which
manufactures lightweight utility poles.
PPFAC............................ Purchase Power and Fuel Adjustor Clause.
PWCC............................. Pinnacle West Capital Corporation.
Revolving Credit Facility....Facility........ $60 million revolving credit facility
entered into under the Credit Agreement
between a syndicate of banks and TEP.
RTO..........................RTO.............................. Regional Transmission Organization.
Rules........................Rules............................ Retail Electric Competition Rules.
Sabinas......................Sabinas.......................... Carboelectrica Sabinas, S. de R.L. deR.L.de C.V.,
a Mexican limited liability company.
Millennium owns 50% of Sabinas.
Saguaro Utility.................. An Arizona limited partnership, whose
general partner is Sage Mountain,
L.L.C. and whose limited partners
include investment funds affiliated with
Kohlberg Kravis Roberts & Co., L.P.,
J.P. Morgan Partners, L.L.C. and
Wachovia Capital Partners.
San Carlos...................Carlos....................... San Carlos Resources Inc., a wholly-owned
subsidiary of TEP.
San Juan.....................Juan......................... San Juan Generating Station.
Second Mortgage Bonds........Bonds............ TEP's second mortgage bonds issued under
the Indenture of Mortgage and Deed of
Trust, dated as of December 1, 1992, of
TEP to the Bank of New York, successor
trustee, as supplemented.
SCE..........................SCE.............................. Southern California Edison Company.
SES..........................SES.............................. Southwest Energy Solutions, Inc., a
wholly-owned subsidiary of Millennium.
Springerville.................... Springerville Generating Station.
Springerville Coal Handling
Facilities Leases.............. Leveraged lease arrangements relating to
the coal handling facilities serving
Springerville.
Springerville Common
Facilities..................... Facilities at Springerville used in common
with Springerville Unit 1 and
Springerville Unit 2
Springerville Common
K-vi
Facilities Leases.............. Leveraged lease arrangements relating to
an undivided one-half interest in
certain Springerville Common Facilities.
Springerville Unit 1............. Unit 1 of the Springerville Generating
Station.
Springerville Unit 1 Lease....... Leveraged lease arrangement relating to
Springerville Unit 1 and an undivided
one-half interest in certain
Springerville Common Facilities.
Springerville Unit 2............. Unit 2 of the Springerville Generating
Station.
SRP.............................. Salt River Project Agricultural
Improvement and Power District.
Sundt Generating Station......... H. Wilson Sundt Generating Station
(formerly known as the Irvington
Generating Station).
Sundt Lease...................... The leveraged lease arrangement relating
to Sundt Unit 4.
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.
Springerville................ Springerville Generating Station.
DEFINITIONS
(concluded)
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Springerville Coal Handling
Facilities Leases............ Leveraged lease arrangements relatingTherm............................ A unit of heating value equivalent to
the
coal handling facilities serving
Springerville.
Springerville Common
Facilities................. Facilities at Springerville used in common
with Springerville Unit 1 and Springerville
Unit 2.
Springerville Common
Facilities Leases.......... Leveraged lease arrangements relating to an
undivided one-half interest in certain
Springerville Common Facilities.
Springerville Unit 1......... Unit 1 of the Springerville Generating Station.
Springerville Unit 1 Lease... Leveraged lease arrangement relating to
Springerville Unit 1 and an undivided
one-half interest in certain Springerville
Common Facilities.
Springerville Unit 2......... Unit 2 of the Springerville Generating Station.
SRP.......................... Salt River Project Agricultural Improvement
and Power District.
TEP.......................... Tucson Electric Power Company, the principal
subsidiary of UniSource Energy.
TEP Warrants................. Warrants for the purchase of TEP common stock
which were issued in 1992.
Tri-State....................100,000 British thermal units (Btu).
Tri-State........................ Tri-State Generation and Transmission
Association.
TruePricing..................TruePricing...................... TruePricing, Inc., a start-up company
established to market energy related
products.
UED..........................UED.............................. UniSource Energy Development Company,
a wholly-
ownedwholly-owned subsidiary of UniSource
Energy, which engages in developing
generation resources and other project
development services and related
activities.
UES.............................. UniSource Energy.............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.
UniSource Energy Warrants.... Warrants forUNS Electric..................... UNS Electric, Inc., a wholly-owned
subsidiary of UES, which acquired the
purchaseCitizens Arizona electric utility
assets.
UNS Gas.......................... UNS Gas, Inc., a wholly-owned subsidiary
of UniSource Energy
Common Stock that were issued in exchange for
TEP Warrants.
WestConnect..................UES, which acquired the Citizens
Arizona gas utility assets.
WestConnect...................... The proposed for-profit RTO in which TEP
is a participant.
K-vii
PART I
This Annual Report on Form 10-K contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. You should read
forward-looking statements together with the cautionary statements and important
factors included in this Form 10-K. (See Item 7. - Management's Discussion and
Analysis of Financial Condition and Results of Operations, Safe Harbor for
Forward-Looking Statements.) Forward-looking statements include statements
concerning plans, objectives, goals, strategies, future events or performance
and underlying assumptions. Forward-looking statements are not statements of
historical facts. Forward-looking statements may be identified by the use of
words such as "anticipates," "estimates," "expects," "intends," "plans,"
"predicts," "projects," and similar expressions. We express our expectations,
beliefs and projections in good faith and believe them to have a reasonable
basis. However, we make no assurances that management's expectations, beliefs or
projections will be achieved or accomplished.
ITEM 1. --- BUSINESS
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OVERVIEW OF CONSOLIDATED BUSINESS
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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 UniSource Energy
Services, Inc. (UES), 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. UES, through its two operating
subsidiaries, provides gas and electric service to 30 communities in northern
and southern Arizona. Millennium invests in unregulated ventures,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 threefour primary
business segments-TEP'ssegments -- TEP's Electric Utility Segment, UES' Gas and Electric
Utility Segment, the Millennium Energy Businesses Segment, and the UniSource
Energy DevelopmentUED Segment. See Notes 4 and 5 of Notes to Consolidated
Financial Statements. See Millennium Energy Businesses and UniSource Energy
Development Company below.
In October 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase
by UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million. The purchase price of each is
subject to adjustment based on the date on which the transaction is closed
and, in each case, on the amount of certain assets and liabilities of the
purchased business at the time of closing. The closing of these transactions
is subject to approval by the Arizona Corporation Commission (ACC), the
Federal Energy Regulatory Commission (FERC) and the SEC. If completed, these
transactions would add to our customer base approximately 77,500 retail
electric customers in Arizona, and approximately 122,000 retail gas customers
in Arizona. See Item 7.-Management's Discussion and Analysis of Financial
Condition and Results of Operations, Asset Purchase Agreements, for more
information regarding these transactions.
TEP was incorporated in the State of Arizona on December 16, 1963. TEP
is the successor by merger as of February 20, 1964, to a Colorado corporation
that was incorporated on January 25, 1902.
UniSource Energy was incorporated in the State of Arizona on March 8,
1995 and obtained regulatory approval to form a holding company in November
1997. On January 1, 1998, TEP and UniSource Energy exchanged shares of stock
resulting in TEP becoming a subsidiary of UniSource Energy. Following the share
exchange, TEP transferred the stock of its subsidiary Millennium to UniSource
Energy. See Note 1 of Notes to Consolidated Financial Statements-NatureStatements--Nature of
Operations and Summary of Significant Accounting Policies.
ESTABLISHMENT OF UES
On August 11, 2003, UniSource Energy completed the purchase of the
Arizona gas and electric system assets from Citizens Communications Company
(Citizens) for a total of $223 million, comprised of the base purchase price
plus other operating capital adjustments and transaction costs. UniSource Energy
formed two new operating companies called UNS Electric, Inc. (UNS Electric) and
UNS Gas, Inc. (UNS Gas) to acquire these assets, as well as UES, an intermediate
holding company that holds the common stock of the operating companies.
AGREEMENT AND PLAN OF MERGER
On November 21, 2003, UniSource Energy and Saguaro Acquisition Corp., a
Delaware corporation, entered into an acquisition agreement providing for the
acquisition of all of the common stock of UniSource Energy for $25.25 per share
by an affiliate of Saguaro Utility Group L.P., an Arizona limited partnership
(Saguaro Utility), whose general partner is Sage Mountain, L.L.C. and whose
limited partners include investment funds affiliated with Kohlberg Kravis
Roberts & Co., L.P., J.P. Morgan Partners, LLC and Wachovia Capital Partners.
Frederick B. Rentschler is the managing member of Sage Mountain,
L.L.C., an Arizona limited liability company, and Saguaro Acquisition Corp. is a
wholly-owned indirect subsidiary of Saguaro Utility.
K-1
Pursuant to the terms of the acquisition agreement, Saguaro Acquisition
Corp. will merge with and into UniSource Energy. UniSource Energy will be the
surviving corporation, but will become an indirect wholly-owned subsidiary of
Saguaro Utility. Trading in our common stock on the New York Stock Exchange and
the Pacific Exchange will cease immediately as of the effective time of the
acquisition. After that time, the surviving corporation will delist our shares
from the New York Stock Exchange and the Pacific Exchange and de-register our
shares under the Securities Exchange Act of 1934, as amended. UniSource Energy's
and TEP's headquarters will remain in Tucson, and we expect that UniSource
Energy's and TEP's senior management team will remain generally in place.
Upon the closing of the acquisition, Saguaro Utility will cause the
surviving corporation to pay approximately $880 million in cash to UniSource
Energy's shareholders and holders of stock options, stock units, restricted
stock and performance shares awarded under our stock based compensation plans.
In connection with the closing of the acquisition, Saguaro Utility intends to
cause the surviving corporation (i) to repay the $95 million intercompany loan
to UniSource Energy from TEP and (ii) to contribute up to $168 million to TEP.
TEP will use a significant portion of these proceeds to retire some of its
outstanding debt.
We expect that the proceeds for all of the above mentioned payments
will come from a combination of equity contributions by the partners of Saguaro
Utility and borrowings and issuances of debt securities by another affiliate of
Saguaro Acquisition Corp. We expect the partners of Saguaro Utility to
contribute approximately $557 million to Saguaro Utility, which will contribute
the net proceeds to Saguaro Acquisition Corp. immediately prior to the
acquisition. We expect that the remaining proceeds necessary to finance this
transaction will be obtained by Saguaro Acquisition Corp.'s affiliate, at the
closing of the acquisition, through a $360 million borrowing from a syndicate of
lenders and an issuance of $300 million in notes. Saguaro Acquisition Corp. and
its affiliate obtained commitments from lenders for the $360 million in
borrowings. In addition, Saguaro Acquisition Corp. and its affiliate obtained
commitments for (i) a $50 million revolving credit facility for general
corporate purposes, (ii) a $40 million revolving credit facility for UES and
(iii) a loan to refinance TEP's existing Credit Facility. Each of these
commitments expires February 21, 2005, and is subject to various closing
conditions customary for bank commitment letters in connection with an
acquisition of this type. Saguaro Acquisition Corp. and its affiliate also
obtained a letter from a group of investment banks that they were highly
confident that they could arrange for the sale of up to $300 million in notes
of the affiliate through a private sale and/or a public offering. The letter
from the investment banks relating to the sale of the $300 million in notes is
not a commitment or undertaking by such banks to underwrite, place or purchase
the notes or otherwise provide financing.
The acquisition is subject to several closing conditions, including
without limitation, (i) the absence of any material adverse effect in the
business, properties, assets, condition, prospects or results of operations of
UniSource Energy and its subsidiaries taken together as a whole; (ii) the
receipt of the required shareholder approval; (iii) the receipt of required
regulatory approvals; (iv) that no final order with respect to any regulatory
approval necessary to effect the acquisition either (A) has or could reasonably
be expected to have a material adverse effect on us or Saguaro Utility or (B)
causes or could reasonably be expected to cause the rates of any of our utility
subsidiaries to be less favorable than the rates that were in effect on the date
of the acquisition agreement; (v) that restrictions on the ability of TEP to pay
dividends of all of its net income be effectively eliminated; and (vi) that
Saguaro Acquisition Corp. receives its financing for the acquisition on terms
and conditions that, in the reasonable judgment of Saguaro Acquisition Corp.,
are comparable to, or more favorable to Saguaro Acquisition Corp. in the
aggregate than the terms and conditions contemplated by the acquisition
agreement.
UniSource Energy's shareholders of record will formally consider a
proposal to approve the acquisition agreement at a special meeting scheduled for
March 29, 2004. The acquisition is also subject to the receipt of certain
regulatory approvals, including ACC approval, SEC approval under the Public
Utility Holding Company Act of 1935, as amended, FERC approval and approval
under federal antitrust laws. We filed an application with the ACC for approval
of the acquisition on December 29, 2003. We expect the acquisition to close in
the second half of 2004.
The acquisition agreement contains operating covenants with respect to
the operations of our business pending the consummation of the acquisition.
Generally, unless UniSource Energy obtains Saguaro Acquisition Corp.'s prior
written consent, we must carry on our business in the ordinary course consistent
with past practice and use all commercially reasonable efforts to preserve
substantially intact our present business organization and present regulatory,
business and employee relationships. In addition, the acquisition agreement
restricts
K-2
our activities, subject to the receipt of Saguaro Acquisition Corp.'s
prior written consent, including the issuance or repurchase of capital stock,
the amendment of organizational documents, acquisitions and dispositions of
assets, capital expenditures, incurrence of indebtedness, modification of
employee compensation and benefits, changes in accounting methods, discharge of
liabilities, and matters relating to UniSource Energy's investment in
Millennium. For a more complete understanding of these restrictions we encourage
you to read the acquisition agreement which UniSource Energy has previously
filed with the SEC and is publicly available.
Either UniSource Energy or Saguaro Acquisition Corp. may terminate the
acquisition agreement in certain circumstances, including if not consummated by
March 31, 2005, certain regulatory approvals are not obtained or if our
shareholders do not approve the acquisition. In certain circumstances, upon the
termination of the acquisition agreement, UniSource Energy would be required to
pay Saguaro Acquisition Corp.'s expenses and a termination fee in an aggregate
amount of up to $25 million.
As a result of the approval of the acquisition by UniSource Energy's
Board of Directors, the acquisition will not trigger the provisions of UniSource
Energy's shareholder rights plan or the restrictions on "business combinations"
or "control share acquisitions" under the Arizona Business Corporation Act.
BUSINESS SEGMENT CONTRIBUTIONS
The table below shows the contributions to our consolidated after-tax
earnings by our threefour business segments, as well as parent company expenses.
2002 2001 2000
--------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------- ------------ ----------- -----------
Business Segment - Millions of Dollars -
TEP (1) $128 $ 54 $ 75
UES (2) 3 - -
Millennium (16) (16) (9)
UED 7 1 1
UniSource Energy Standalone (3) (9) (6) (6)
---------------------------------------------------------------- ------------ ----------- -----------
Consolidated Net Income $113 $ 33 $ 61
================================================================ ============ =========== ===========
(1) TEP results in 2003 include an after-tax gain of Dollars -
Business Segment
TEP $ 53.7 $ 75.3 $ 51.2
Millennium (15.5) (9.2) (4.1)
UED 0.8 0.8 -
UniSource Energy Standalone (1) (5.8) (5.6) (5.2)
--------------------------------------------------------------------
Consolidated Net Income $ 33.2 $ 61.3 $ 41.9
====================================================================
(1) Represents$67 million for
the Cumulative Effect of Accounting Change from the adoption of
Statement of Financial Accounting Standards No. 143, Accounting for
Asset Retirement Obligations (FAS 143).
(2) Results are for the period from August 11, 2003 to December 31,
2003.
(3) Primarily represents interest expense (net of tax) on the note
payable from UniSource Energy to TEP.TEP, as well as costs in 2003
associated with the Citizens acquisition and the proposed acquisition
of UniSource Energy as previously discussed.
The electric utility industry has undergone significant regulatory
change in recent years. See Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations, Factors Affecting Results of Operations, Outlook and Strategies, for a
discussion of our plans and strategies to remain competitive and flexible in
this changing environment and Rates and Regulation, below, for the status of
competition in Arizona.
References in this report to "we" and "our" are to UniSource Energy and
its subsidiaries, collectively.
References in this report to the "utility
business" are to TEP.
TEP ELECTRIC UTILITY OPERATIONS
- -------------------------------TEP was incorporated in the State of Arizona on December 16, 1963. TEP
is the successor by merger as of February 20, 1964, to a Colorado corporation
that was incorporated on January 25, 1902. TEP is the principal operating
subsidiary of UniSource Energy. In 2002,2003, TEP's electric utility operations
contributed 99%88% of UniSource Energy's operating revenues and comprised 94%86% of
its assets.
K-3
SERVICE AREA AND CUSTOMERS
TEP is a vertically integrated utility that provides regulated electric
service to over 355,000more than 367,000 retail customers in its service territory. ThisSoutheastern Arizona. TEP's
service territory consists of a 1,155 square mile area of Southeastern
Arizona withand includes a population
of approximately 891,000911,000 in the greater Tucson metropolitan area in Pima County,
as well as parts of Cochise County. TEP holds a franchise to provide electric
distribution service to customers in the Cities of Tucson and South Tucson.
These franchises expire in 2026 and 2017, respectively. TEP also sells
electricity to other utilities and power marketing entities in the western U.S.
RETAIL CUSTOMERS
TEP's retail sales are influenced by several factors, including seasonal
weather patterns, competitive conditions and the overall economic climate.
The peak demand for TEP's retail service area occurs during the summer months
due to the cooling requirements of TEP's retail customers. TEP's retail peak
demand has grown at an average annual rate of approximately 2.7% during the
past five years.
In 2002,2003, TEP's number of retail customers increased by 2.4% while2.2% and total
retail energy consumption decreasedincreased by approximately 3%. This decrease in
kWh energy sales was primarily attributable to reduced sales to copper mining
customers. See Sales to Large Industrial Customers, below. The table below shows
the trend in the percentage distribution of TEP's energy sales by major customer class over
the last three years.
2003 2002 2001 2000
---- ---- ----
Residential 41% 40% 38% 37%
Commercial 20% 20% 19% 18%
Non-mining Industrial 27% 28% 27% 28%
Mining 9% 9% 13% 14%
Public Authority 3% 3% 3%
TEP uses population and demographic studies prepared by unrelated third
parties to forecast the growth in the number of customers, peak demand and
retail sales. TEP also makes assumptions about the weather, the economy and
competitive conditions. Based on these factors,
TEP expects that its peak demand, its number of retail customers and theirretail
energy consumption will increase at 2 - 3% annually through 2006.
During that period, TEP expects total2007. The retail energy
consumption by customer class willis expected to be distributed similarlysimilar to the 20022003
distribution.
Beginning January 1, 2001, all of TEP's retail customers were eligible
to choose alternative energy providers. Even though some of TEP's retail
customers may choose other energy providers, the forecasted customer growth
rates in
the number of customers referred to above would continue to apply to TEP'sits distribution business. AsAt
March 10, 2004, none of March 4, 2003, no TEP retailTEP's customers are currentlybeing served by alternatean alternative
energy providers.provider. See Rates and Regulation, State, below.
Sales to Large Industrial Customers
-----------------------------------
TEP provides electric utility service to a diversifieddiverse group of commercial,
industrial, and public sector customers. Major industries served include copper
mining, cement manufacturing, defense, health care, education, military bases
and other governmental entities. Local, regional, and national economic factors
can impact the financial condition and operations of TEP's large industrial
customers. Such economic conditions may directly impact energy consumption by
large industrial customers, and may indirectly impact residential and small
commercial sales and revenues if employment levels and consumer spending isare
affected.
Two of TEP's largest retail customers are in the copper mining
industry. TEP has contracts with its two mining customers to provide electric
powerservice at negotiated rates. These contracts expire in 2006 and 2008. Whether these
contracts are extended or terminated will depend, in part, on market
conditions and available alternatives. TEP's
sales to mining customers depend on a variety of factors including changes in
supply and demand in the world copper market and the economics of
self-generation. Average U.S. copper prices were approximately 77 cents per pound in February 2003, and have ranged between 63 cents$0.62 and 91 cents$1.00
per pound during the last five years. As thea result of low copper prices in 2002
and 2003, TEP's mining customers have reduced operations in recentduring those years and have
correspondingly reduced energy consumption. See
Item 7. - Management's DiscussionSince October 2003, U.S. copper
prices have risen steadily and Analysis of Financial Condition and
Results of Operations, Results of TEP, Utility Sales and Revenues.
Energy sales to and revenues from TEP's mining customers may continue to
declinewere approximately $1.19 per pound in the future.February
2004. One of TEP's mining customers substantially curtailed
mining operations at one of its minesannounced in December of 2002. This reduction in
operations will further decrease sales. TEP's revenue from this customer was
approximately $11 million in 2002. Any reduction of this retail revenueJanuary 2004, it would be
mitigated, however,increasing its energy requirements by an opportunity for TEP to sellapproximately 15 MW this generation capacity in the wholesale market or to reduce generation with
resulting fuel costs reductions. Depending on wholesale market price
assumptions, TEP's pre-tax net income in 2003 could be reduced by $1 million
to $3 million from the 2002 level if this customer ceases mining operations
at this location.year.
WHOLESALE BUSINESS
TEP's electric utility operations include the wholesale marketing of
electricity to other utilities and power marketers. These wholesaleWholesale sales transactions
are made on both a firm basis and an interruptible basis. A firm basis means that
contractually, TEP must supply the power (except under limited emergency
circumstances), while an interruptible basis means that TEP may stop supplying
power under various circumstances.defined conditions. See Other Purchases and Interconnections, below.
K-4
TEP typically uses its own generation to serve the requirements of its
retail and long-term wholesale customers. Generally, TEP commits to future sales
based on expected excess generating capability, forward prices and generation
costs, using a diversified portfolio approach to provide a balance between
long-term, mid-term and spot energy sales. When TEP expects to have excess
generating capacity (usually in the first, second and fourth calendar quarters),
its wholesale sales consist primarily of three types of sales:
(1) Sales under long-term contracts for periods of more than one year.
TEP may enter intocurrently has long-term contracts with three entities to sell
firm capacity and energy: Salt River Project Agricultural
Improvement and Power District (SRP), the Navajo Tribal Utility
Authority and the Tohono O'odham Utility Authority. TEP also has a
multi-year interruptible contract with Phelps Dodge Energy
Services, which requires a fixed contract demand of 60 MW at all
times except during TEP's peak customer energy demand period, from
July through September of each year. Under the contract, TEP can
interrupt delivery of power if TEP experiences significant loss of
any electric generating resources.
(2) Other sales include forward sales and short-term sales. Under
forward contracts, TEP commits to sell a portionspecified amount of
this
forecasted excess generating capacity. Then, during the coursecapacity or energy at a specified price over a given period of
each
month,time, typically for one-month, three-month or one-year periods.
Under short-term sales, TEP will analyze any remaining excess short-term generating capacity
and makesells energy sales in the daily or hourly
markets at fluctuating spot market prices and hourly markets.other non-firm
energy sales.
(3) Sales of transmission service.
TEP also enters into
limited forward sales and purchases to take advantage of favorable market
opportunities.
TEP also purchases power in the wholesale markets under certain
situations. Itwhen economic. TEP may
enter into forward contracts: (a) to purchase energy under long-term contracts
to serve retail load and long-term wholesale contracts, (b) to purchase capacity
or energy during periods of planned outages or for peak summer load conditions,
and (c) to purchase energy to resell to certain wholesale customers under load
and resource management agreements. Finally, TEP may purchase energy in the
daily and hourly markets to meet higher than anticipated demands, to cover
unplanned generation outages, or when it is more economical than generating.generating its
own energy.
As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes affectingimpacting these markets and market participants. In 2000 and 2001, a
significant portion of TEP's revenues and earnings resulted from its wholesale
marketing activities (including unrealized gains or losses on sales and
purchases of energy), which benefited from strong demand and high wholesale
prices in the western U.S. These market conditions were the result of a number
of factors, including power supply shortages, high natural gas prices, and
transmission and environmental constraints. During this period, these markets
experienced unprecedented price volatility, as well as payment defaults and
bankruptcies by several of its largest participants. Regulatory agencies became
concerned with the outcomes of deregulation of the electric power industry and
intervened in the operation of these markets by, among other things, imposing
price caps and initiating investigations into potential market manipulation.
Since mid-2001, conditions in the western U.S. energy markets have
changed significantly as a result of various regulatory actions, moderate weather, a
decrease in natural gas prices, the addition of
new generation in the region the slowdown of the regional economy, and the energy crisis in California.other factors. In addition, the presence of
fewer creditworthy counterparties, as well as legal, political and regulatory
uncertainties havehas reduced market liquidity and trading volume. Several companies
that were large market participants have either curtailed their activities or
exited the business completely. These factors placed downward pressure on
wholesale electricity prices, and resulted in significantly lower wholesale
electricity sales and revenues at TEP in 2002.2002 and 2003.
In the first quarter of 2003, both the natural gas and western U.S.
wholesale electricity markets have experienced some price spikes and volatility due
to severe winter weather in certain regions, as well asweather. Gas and power prices remained high gas storage withdrawalsthroughout 2003 due
to lagging production.continued gas production and storage concerns. TEP cannot predict, however,
whether averagegas and wholesale electricity prices will remain higher than
in 2002elevated and what the
impact will be on TEP's sales and revenues in 2003.2004.
TEP expects to continue to be a participant in the wholesale energy
markets, primarily by making sales and purchases in the short-term and forward
markets. TEP expects the market price in the western U.S. and demand for
capacity and energy to continue to be influenced by the following factors, among
others, during the next few years:
-K-5
o continued population growth andgrowth;
o economic conditions in the western U.S.;
-o availability of generation capacity throughout the western U.S.;
-o the extent of electric utility industry restructuring in Arizona,
California and other western states;
-o the effect of FERC regulation of wholesale energy markets;
-o the availability and price of natural gas;
- precipitation, which affects hydropower availability;
-o availability of hydropower;
o transmission constraints; and
-o environmental restrictionsrequirements and the cost of compliance.
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Tucson Electric Power Company, Factors
Affecting Results of Operations, Competition, Western Energy Markets, and Market Risks, for additional
discussion of TEP's wholesale marketing activities.
GENERATING AND OTHER RESOURCES
TEP GENERATING RESOURCESResources
At December 31, 2002,2003, TEP owned or leased 2,0022,003 MW of net generating
capability as set forth in the following table:
Net
TEP's Share
Unit Fuel Owned/ Capability Operating -----------TEP's Share
Generating Source No. Location Type Leased MW Agent
% MW
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Springerville Station 1 Springerville, AZ Coal Leased 380 TEP 100.0 380
Springerville Station 2 Springerville, AZ Coal Owned 380 TEP 100.0 380
San Juan Station 1 Farmington, NM Coal Owned 327 PNM 50.0 164
San Juan Station 2 Farmington, NM Coal Owned 316 PNM 50.0 158
Navajo Station 1 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 2 Page, AZ Coal Owned 750 SRP 7.5 56
Navajo Station 3 Page, AZ Coal Owned 750 SRP 7.5 56
Four Corners Station 4 Farmington, NM Coal Owned 784 APS 7.0 55
Four Corners Station 5 Farmington, NM Coal Owned 784 APS 7.0 55
IrvingtonSundt Station 1 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
IrvingtonSundt Station 2 Tucson, AZ Gas/Oil Owned 81 TEP 100.0 81
IrvingtonSundt Station 3 Tucson, AZ Gas/Oil Owned 104 TEP 100.0 104
IrvingtonSundt Station 4 Tucson, AZ Coal/Gas Leased 156 TEP 100.0 156
Internal Combustion Turbines Tucson, AZ Gas/Oil Owned 122 TEP 100.0 122
Internal Combustion Turbines Tucson, AZ Gas Owned 95 TEP 100.0 95
Solar Electric Generation Springerville/ Solar Owned 4 TEP 100.0 4
Tucson, AZ
Solar Owned 3 TEP 100.0 3
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total TEP Capacity (1) 2,002
====================================================================================================
(1) Excludes 380 MW of additional resources, which consist of certain capacity purchases
and interruptible retail load. At December 31, 2002, total owned capacity was 1,4662,003
===========================================================================================================================
(1) Excludes 486 MW of additional resources, which consist of certain capacity
purchases and interruptible retail load. At December 31, 2003, total owned
capacity was 1,467 MW and leased capacity was 536 MW.
The Springerville Generating Station, located in northeast Arizona,
consists of two coal-fired units. Springerville Unit 1 began commercial
operation in 1985 and is leased and operated by TEP. Springerville Unit 2
started commercial operation in June 1990 and is owned by TEP's wholly-owned
subsidiary, San Carlos Resources Inc. (San Carlos), and operated by TEP. These
units are rated at 380 MW for continuous operation, but may be operated
for up to eight hours at a time at a net capacity of 400 MW each.operation. The Springerville Station
was originally designed for four generating units. UED is currently evaluating opportunitiesmanages the
construction of Unit 3, which will be 100% leased by a financial owner to
expandTri-State Generation and Transmission Association (Tri-State). Construction of
Unit 3 began in October 2003. We expect commercial operation of Unit 3 to occur
in December 2006. TEP will operate the Springerville Station by
assigningunit. SRP has the rightsright to construct Springerville Units 3 and
own Unit 4 to unrelated
third parties. TEP will be the operator of the new units.at a later date. See UniSource Energy Development Company, below.
The Springerville Generating Station also includes the Springerville
Coal Handling Facilities and the Springerville Common Facilities. In 1984, TEP
sold and leased back the Springerville Coal Handling Facilities. In 1985, TEP
sold and leased back a 50% interest in the Springerville Common Facilities. The
other 50% interest is included in the Springerville Unit 1 leases.
K-6
TEP obtains approximately 600 MW, or 30%, of its generating capacity
from jointly-owned facilities at the San Juan, Four Corners, and Navajo
Generating Stations in New Mexico and northern Arizona.
Irvington is a four-unit generating stationThe Sundt Generating Station (Sundt) includes four units located in
Tucson, Arizona. Units 1, 2 and 3 are gas or oil burning units. IrvingtonSundt Unit 4
operates primarily on coal in combination with natural gas or landfill gas, but
it is also able to operate solely on natural gas. Units 1, 2, and 3 are
wholly-
ownedwholly-owned by TEP, and Unit 4 was soldis leased. The Sundt Generating Station and leased back in 1988 under the Irvington
4 lease. The Irvington Station, along with the
internal combustion turbines located in Tucson are designated as "must-run
generation" facilities. Must-
runMust-run generating units are those which are required
to run in certain circumstances to maintain distribution system reliability and
meet local load requirements.
To improve local system reliability in Tucson and to serve increasing
load requirements, TEP added 95 MW of new peaking resources in June 2001,
consisting of a 75 MW gas turbine it purchased and a 20 MW gas turbine leased
from UED. In September 2002, TEP purchased the 20 MW gas turbine from UED.
See Note 710 of Notes to Consolidated Financial Statements, and Item 7.
- - Management's Discussion and Analysis of Financial Condition and Results of
Operations, Tucson Electric Power Company, Liquidity and Capital Resources,
Contractual Obligations, for more information regarding the Springerville and
IrvingtonSundt leases.
POWER EXCHANGE AGREEMENT
TEP and Southern California Edison Company (SCE) have a ten-year power
exchange agreement which requires SCE to provide firm system capacity of 110 MW
to TEP during the summer months. TEP is then obligated to return to SCE in the
winter months the same amount of energy that TEP received during the preceding
summer. For example, in the summer of 2002,2003, TEP received approximately 133,000136,000
MWh from SCE and returned the same amount during the winter months from November
20022003 to February 2003.2004. This agreement expires in February 2005. The net
incremental increase in cost due to the loss of the SCE exchange agreement is
expected to be less than $2 million annually. We expect to purchase additional
resource needs through a competitive bidding process and short-term purchases.
OTHER PURCHASES AND INTERCONNECTIONS
TEP purchases additional electric energy from other utilities and power
marketers. The amount of energy purchased varies substantially from time to time
depending on the demand for energy, the cost of purchased energy compared with
TEP's cost of generation, and the availability of such energy. TEP may also sell
electric energy at wholesale.in the wholesale market. See also Wholesale Business, above and
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations, Tucson Electric Power Company, Factors Affecting Results
of Operations, Market Risks.below.
TEP is also a member of various regional reserve sharing, reliability and
power sharing organizations. These relationships allow TEP to call upon other
utilities during emergencies such as plant outages and system disturbances, and
also reduce the amount of reserves TEP is required to carry.
PEAK DEMAND AND RESOURCES
Peak Demand 2003 2002 2001 2000 1999
1998
-------------------------------------
- MW ----------- ---------- ---------- ---------- ----------
-MW-
Retail Customers-Net One Hour 2,060 1,899 1,840 1,862 1,754 1,786
Firm Sales to Other Utilities 171 228 151 143 178
179
-------------------------------------------------------------------------------------------------------------------------- ---------- ---------- ---------- ---------- ----------
Coincident Peak Demand (A) 2,231 2,127 1,991 2,005 1,932
1,965
Total Generating Resources 2,003 2,002 1,999 1,904 1,904
1,896
Other Resources (1) 486 308 217 248 235
235
-------------------------------------------------------------------------------------------------------------------------- ---------- ---------- ---------- ---------- ----------
Total TEP Resources (B) 2,489 2,310 2,216 2,152 2,139 2,131
Total Margin (B) - (A) 258 183 225 147 207 166
Reserve Margin (% of Coincident
Peak Demand) 12% 9% 11% 7% 11%
8%----------------------------------------------- ---------- ---------- ---------- ---------- ----------
(1) Other Resources includes firm power purchases and interruptible
retail and wholesale loads.
---------------------------------------------------------------------------
TEP's retail sales are influenced by several factors, including
seasonal weather patterns, competitive conditions and the overall economic
climate. The peak demand for TEP's retail service area occurs during the summer months due to the
K-7
cooling requirements of itsTEP's retail customers. TEP's retailRetail peak demand has grown at
an average annual rate of approximately 2.7% during the
past five years.4% from 1999 to 2003.
The chart above shows the relationship over a five-year period between
TEP's peak demand and its energy resources. TEP's margin is the difference
between total energy resources and coincident peak demand, and the reserve
margin is the ratio of margin to coincident peak demand. TEP maintains a minimum
reserve margin in excess of 7% to comply with reliability criteria set forth by
the Western Electricity Coordinating Council (WECC), (formerly the Western
Systems Coordinating Council). TEP's actual reserve margin in 20022003 was 9%12%.
In 2002,2003, TEP purchasedentered into two power purchase agreements for the period
2003 through 2006 as listed below:
o PPL Energy Plus, LLC supplied 37 MW from June 2003 through December
2003 and will supply 75 MW from January 2004 through December 2006,
under a unit contingent contract.
o Panda Gila River generating station will supply 50 MW of firm capacityon-peak for the
June through September time period, from 2003 (which has been supplied)
through 2005, under a unit contingent contract between TEP and energy in the
forward energy marketsPanda
Gila River, L.P.
We believe these and other short-term purchases will provide adequate
reserve margins during the summer peak period to ensure an adequate
reserve margin.
TEP's forecastedperiod.
Forecasted retail peak demand for 20032004 is approximately 1,9502,083 MW,
compared with actual peak demand of 1,8992,060 MW in 2002.2003. Except for certain peak
hours during the summer, peak period, TEP believes it has sufficient resources to meet
this expected demand in 20032004 with its existing resources.
TEP plans to make forward purchases to ensure adequate supply during its
summer peak period. Beginning in early 2003, any future resource needs are
expected to be procured through a competitive bidding process being
established by the ACC.generation and power purchase
agreements.
See Future Generating Resources--TEP,Resources, TEP, below and Item 7. - Management's
DiscussionRates and Analysis of Financial Condition and Results of Operations,
Factors Affecting Results of Operations, Recent Developments in the Arizona
Regulatory Environment,Regulation,
State, Track B, below.
FUTURE GENERATING RESOURCES -- TEP
In the past, TEP assessed its need for future generating resources
based on the premise of a continued regulatory requirement to serve customers in
TEP's retail service area. However, the ACC's electric competition rules, as
currently in effect, modified the obligation to provide generation services to
all customers. These rules and TEP's ability to retain and attract customers
will affect the need for future resources. For those customers who do not choose
other energy providers, TEP remains obligated to supply energy. However, TEP is
not obligated to supply this energy from TEP-owned generating assets. The energy
may be acquired by purchasingthrough purchase in the wholesale markets. See Rates and
Regulation, Recent Arizona Court of Appeals Decision below and Item 7. -
Management's Discussion and Analysis of Financial Condition and Results of
Operations, Tucson Electric Power Company, Factors Affecting Results of
Operations, Competition.Competition, below.
TEP will continue to add peaking resources in the Tucson area as needed
based upon our forecasts of retail and firm wholesale load, as well as the
statewide transmission infrastructure. TEP currently forecasts that new peaking
resources of 75 MW may be needed in both 2008 and 2010. To
facilitateIn conjunction with the proposed
expansion of the Springerville Generating Station, TEP is also planning to enterentered into a power
purchase contract with Tri-State for up to 100 MW of capacity from the proposed addition of Unit 3 at Springerville under
development by UED.Tri-State's
system resources. This contract would bewith Tri-State is for up to five years,
beginning with commercial operation of Unit 3, expected in December 2006. TEP
anticipates that any power purchased by it under such athis contract will be sold in the
wholesale markets. If power purchased under this contract is to be used by TEP could not use Springerville Unit 3 power
to serve its retail load, without complyingTEP must comply with the Track B competitive bidding
procedures being established by the ACC. See UniSource Energy Development Company,
below and Item 7. - Management's DiscussionRates and AnalysisRegulation, State, Track B, below.
FUEL SUPPLY
TEP purchases coal and natural gas in the normal course of Financial Condition and
Resultsbusiness to
fuel its generating plants. The majority of Operations, Factors Affecting Results of Operations, Industry
Restructuring.
FUEL SUPPLYits coal supplies are purchased
under long-term contracts, which result in more predictable prices.
TEP's principal fuel for electric generation is low-sulfur coal. Fuel
information is provided below:
K-8
Average Cost Per MMBTUper MMBtu Consumed Percentage of Total BTU Consumed
- --------------- ------------- ----------- ----------- -- ----------- ------------- ------------
2003 2002 2001 20002003 2002 2001 2000
- ---------------------------------------------------------------------------------
Coal (A) $1.58 $1.59 $1.63 $1.6196% 94% 90%
91%
Gas 6.38 4.28 5.99 5.704 6 10
9
- ---------------------------------------------------------------------------------
All Fuels $1.79 $1.76 $2.08 $1.95 100% 100% 100%
(A) The average cost per ton of coal for 2002, 2001, and 2000 was $30.86
$30.96, and $30.69, respectively.
- --------------- ------------- ----------- ----------- -- ----------- ------------- ------------
(A) The average cost per ton of coal for 2003, 2002, and 2001 was $30.31,
$30.86, and $30.96, respectively.
TEP'S COAL AND GAS SUPPLY
Year Contract Average
ContractTerminates Sulfur
Station Coal Supplier Terminates Content Coal Obtained From (A)
------- ------------- ---------- ------- ------------------------------- --------------------- ------------------------------------ --------------- ----------- -----------------------------------
Springerville Peabody Coalsales Company 20102020 0.9% Lee Ranch Coal Company
Four Corners BHP Billiton 2004 (B)2016 0.8% Navajo Indian Tribe
San Juan San Juan Coal Company 2017 0.8% Federal and State Agencies
Navajo Peabody Coalsales Company 2011 0.6% Navajo and Hopi Indian Tribes
IrvingtonSundt Various approved suppliers -2006 - Various locations
- --------------------- ------------------------------------ --------------- ----------- -----------------------------------
(A) Substantially all of the suppliers' mining leases extend at least as long as
coal is being mined in economic quantities.
(B) Contract is under negotiation to be extended through 2016.
TEP Operated Generating Facilities
----------------------------------
TEP is the sole owner (or lessee) and operator of the Springerville and
IrvingtonSundt Generating Stations. The coal supplies for these plants are transported
from northwestern New Mexico and Colorado by railroad.
TheIn October 2003, TEP amended and extended the long-term coal supply
contract for the Springerville Generating Station ends
in June 2010, with an option to extend the term for another ten years. The
Springerville contract has an adjustment clause that will affect the future
cost of coal delivered.Units 1 and 2 through 2020. We expect coal reserves
to be sufficient to supply the estimated requirements of Springerville for itsUnits 1 and 2 for
their presently estimated remaining life. The Springerville coallives. We estimate future minimum annual
payments under this contract requires TEP to take 1.9
million tons of coal per year through June 2010 at an estimated annual cost
ofbe $45 million forthrough 2010, the next five yearsinitial
contract expiration date, and requires TEP$14 million in 2011 through 2020. TEP's coal
transportation contract at Springerville runs through 2011. We estimate minimum
annual payments under this contract to pay a take-or-pay
charge if minimum quantities of coal are not purchased. TEP's present fuel
requirements are in excess of the take-or-pay minimums. The Springerville
rail contract expires in 2009. This contract requires TEP to transport 1.9
million tons of coal per year through 2009 at an estimated annual cost ofbe $13 million for the next five years.through 2010 and $7
million in 2011.
In July 2002, TEP terminated the long-term coal supply contract for the
Irvington station.Sundt Generating Station. TEP incurred a pre-tax charge of $11.3$11 million related
to the cost of terminating this contract. The termination fee relievesrelieved TEP of up
to $3.5$3 million in annual pre-tax take-or-pay payments.
In the fourth quarter of 2003, TEP is currently
purchasingentered into agreements for the
purchase and transportation of coal for Irvingtonto the Sundt Generating Station through
2006. The total amount paid under short-term contractsthese agreements depends on the number of tons
of coal purchased and transported. The coal agreements require TEP to take
advantage300,000 tons annually with estimated future minimum payments of favorable price opportunities. At this time, there is no concern for$4 million in
2004 and $6 million in 2005 and 2006. The rail agreement requires TEP to
transport 300,000 tons with estimated future coal availability for the lifeminimum payments of this station. While the Irvington coal
supply contract was terminated, the$2 million in
each year from 2004 through 2006.
The rail contract for the Irvington stationSundt Generating Station is in effect until
the earlierearliest of 2015 or the remaining life of Unit 4. The rail contract requires
TEP to transport at least 75,000 tons of coal per year through 2015 at an
estimated annual cost of $1.5$2 million or to make a minimum payment of $0.5 million$1 million.
TEP expects to use the rail contracts for at least the next five years if coal deliveries are not
chosen.minimum delivery amounts
through at least 2006. See Note 1015 of Notes to Consolidated Financial Statements
- Commitments and Contingencies, TEP Commitments, Fuel Purchase and Transportation
Commitments.
Generating Facilities Operated by Others
----------------------------------------
TEP also participates in jointly-owned generating facilities at Four
Corners, Navajo and San Juan, where coal supplies are under long-term contracts
administered by the operating agents. TheIn July 2003, the Four Corners coal
contract for Four
Corners terminates in 2004 unless extended pursuant to its terms. The Four
Corners contract is under negotiation and is expected to bewas extended through July 1, 2016. TheThis contract requires TEP to purchase
minimum
K-9
amounts of coal quantities under contractat an estimated annual cost of $5 million for the Navajo and San Juan
mine-mouth coal-firednext 13 years.
We expect coal reserves available to these three jointly-owned generating
stations are expectedfacilities to be sufficient for the remaining lives of the stations.
In September 2000, TEP terminated the San Juan Generating Station's
coal supply contract and entered into a new coal supply contract, replacing two
surface mining operations with one underground operation. San Juan Coal Company,
the coal supplier to San Juan, commenced development of the underground mine in
the fourth quarter of 2000 with full station supply expected in March 2003. The
underground mine did not achieve full station supply until December 2003 due to
geological issues. PNM, TEP, and San Juan Coal Company have begun a review of
long term coal cost projections given the production issues encountered and the
experience gained from mining operations.
The contracts to purchase coal for use at the jointly-owned facilities
require TEP to purchase minimum amounts of coal at an estimated average annual
cost of $16$19 million for the next five years.
NATURAL GASNatural Gas
TEP purchasestypically uses generation from its facilities fueled by natural gas
fromto meet the summer peak demands of its retail customers and to meet local
reliability needs. Due to its increasing seasonal gas usage, TEP hedges a
portion of its natural gas purchases with fixed price contracts for a maximum of
three years, and purchases its remaining gas needs in the spot and short-term
markets through its supplier Southwest Gas Corporation (SWG) for its
natural gas-fired facilities. TEP is a retail customer of SWG under a
special procurement agreement. In 2001,. TEP entered into a
new five-year
agreement that providesGas Procurement Agreement with SWG effective June 1, 2001 with a primary term of
five years. The contract provided for all of TEP's natural gas commodity and
transportation needs for use in power generation. SWG purchases gas at TEP's
direction at spot or forward market prices. Thea minimum volume obligation during the
first two years of 10 million MMBtu's annually. TEP negotiated new pricing and one-halfa
lower minimum annual volume obligation of 4 million MMBtu's for 2004 and TEP
expects to use more gas than this minimum requirement. In the event fewer
MMBtu's are purchased, TEP is obligated to pay only the transportation component
for any shortfall. TEP will negotiate terms for the remaining two years of the
contract through October 31,in late 2004. TEP made payments under this contract of $34 million in
2003, as extended, require that TEP take
a minimum$33 million in 2002 and $28 million in 2001.
In 2003, the average market price of 10 million MMBtus annuallynatural gas at transportation rates establishedthe San Juan basin
was $4.42 per MMBtu, or 68% higher than 2002, due to low gas storage levels and
reductions in gas production. The increase in the contract. Minimumregional supply of
gas-generated energy and the completion of a 500-kV transmission connection,
however, allowed TEP to decrease use of its less efficient gas transportation costs for 2003 are expected to
be $6 million. SWG is affected by recent FERC actions relating to its gas
allocations from the Permian and San Juan basins. A FERC order on this issue
is expectedgeneration units
in favor of more economical purchases of energy in the summerwholesale market. TEP's
generation output fueled by natural gas was approximately 433,000 MWh, or 4% of
2003. At that time,total generation in 2003, compared with approximately 720,000 MWh, or 6% of
total generation in 2002. In 2003, TEP and SWG will
renegotiate the termspurchased approximately 125,000 MWh of
gas-fired energy under long-term purchased power contracts. The majority of the
special procurement agreement. TEP does not
anticipate any material difference in operational or economic termsenergy purchased under these agreements is adjusted for changes in the new agreement, which is estimated to begin November 1, 2003. Actual gas
commodity costs will depend on the volumesprice of
natural gas. See Rates and Regulation, State, Track B, below for discussion of
purchased and the market prices.
During 2002, TEP received natural gas sufficient to meet all of its needs.
During 2002, natural gas supplied approximately 6% of TEP's generation.
TEP's gas usage was significantly higher in 2000 and 2001 because of: (1)
higher wholesale energy prices in the western U.S. in the second half of 2000
and the first half of 2001, which made it profitable for TEP to sell gas-
generated energy into the wholesale markets, and (2) the addition of the two
new gas turbines in 2001, providing 95 MW in new generating capacity. TEP
also burns small amounts of landfill gas at Irvington Unit 4.power contracts.
WATER SUPPLY
TEP believes there will be sufficient water to supply the requirements
of TEP's existing and planned electric generating stations in Arizona.
However, droughtDrought conditions in the Four Corners region, combined with water
usage in upper New Mexico, have resulted in decreasing water levels in the lake
that indirectly supplies water to the San Juan and Four Corners generating stations locatedGenerating
Stations. These drought conditions may affect the water supply of the plants in
New Mexico.the future if adequate moisture is not received in the watershed that supplies
the area. The moisture levels in the region during the 2003-2004 winter season
have been above historic averages. TEP has a 50% ownership interest in each of
San Juan units 1 and 2 (322 MW capacity) and a 7% ownership interest in each of
Four Corners units 4 and 5 (110 MW capacity).
PNM, the operating agent for San Juan, has negotiated supplemental
water contracts with the U.S. Bureau of Reclamation projects that, based on historical factors and seasonal usage, there should
be adequate capacitythe Jicarilla Apache
Nation to assist San Juan in meeting its water requirements in the lake for allevent of a
water users. The projected water
levels areshortage. TEP does not expected tobelieve that its operations will be materially
affected by this drought. However, TEP cannot predict the ultimate outcome of
the drought, or whether it will adversely affect the operationsamount of power available
from the generating stations
in 2003.San Juan and Four Corners Generating Stations.
K-10
TRANSMISSION ACCESS
TEP has transmission access and power transaction arrangements with
over 120 electric systems or suppliers. In May 2003, TEP completed construction
of a one mile 500-kV transmission line and related substations to enhance its
distribution system link to the regional high voltage transmission system.
Tucson to Nogales Transmission Line
In January 2001, TEP and Citizens (now UES) entered into a project
development agreement for the joint construction of a 62-mile transmission line
from Tucson to Nogales, Arizona. In January 2002, the ACC approved the location
and construction of the proposed 345 kV line, almost
half of which runs through a national forest. A drought-caused closure of345-kV line. TEP is currently seeking approvals
for the forest in June 2002 has delayedproject from the progress on the environmental impact
study required for Federal project approval. A U.S. Department of Energy (DOE) and, the U.S. Forest Service,
decision is expectedthe U.S. Bureau of Land Management, and the International Boundary and Water
Commission. The DOE has completed a draft Environmental Impact Statement (EIS)
for the project which identified the ACC-approved Western Corridor route as its
preferred alternative. We expect to occur byreceive a final EIS in 2004. The DOE will
use the end of 2003.
Construction could begin as early as mid-2004 with an expected in-service
date eight months afterEIS to help it decide whether to issue a Presidential Permit that would
allow TEP to extend the start of construction. Constructionline across the border into Mexico. Other federal
agencies will also use the EIS for their own permitting processes. The
construction costs to Nogales, Arizona are expected to be approximately $75
million. In 2000, TEP appliedThrough December 31, 2003, approximately $9 million in engineering and
environmental expenses have been capitalized related to this project. If the
DOE
for a Presidential Permit to allow extension of thetransmission line across the
international border with Mexico to connect with Mexico's utility system,
providing further reliabilitydoes not proceed, these costs would be immediately expensed.
Regional and market opportunities in the region.Federal Transmission Issues
In 1997, TEP and other transmission owners and users located in the
southwestern U.S. began to investigate the feasibility of forming an Independent
System Operator (ISO) for the region. In December 1999, the FERC issued FERC
Order 2000, which established timelines for all transmission owning entities to
join a Regional Transmission Organization (RTO) and defined the minimum
characteristics and functions of an RTO. TEP and three other southwestern
utilities filed agreements and operating protocols with the FERC in October 2001
to form a new, for-profit RTO to be known as WestConnect RTO, LLC (WestConnect).
WestConnect will be responsible for security, reservations, scheduling,
transmission expansion and planning, and congestion management for the regional
transmission system. It will also focus on ensuring reliability,
nondiscriminatory open-access, and independent governance. Regional transmission
owners would have the option, but not be required, to transfer ownership of
transmission assets to the RTO. At present, TEP intends to turn over only
operating control of its transmission assets to the RTO. Additionally, the RTO
may build new transmission lines in the region, which wouldcould be owned by the RTO.
In October, 2002, the FERC issued a provisional order approving, in
part, the WestConnect RTO proposal. The FERC also required WestConnect, along
with the other two RTOs in the western region (the California Independent System
Operator (CISO) and RTO West), to participate in a steering group to encourage
the development of a seamless wholesale electric energy market. WestConnect's
operation is dependent on the resolution of these issues and is also subject to
approval by state regulatory agencies in
the region.agencies. WestConnect is not expectedfollowing a phased
approach for development that will progress from development of a regional Open
Access Same Time Information System (OASIS) to becomefull RTO implementation in three
or four phases. The first phase includes the regional OASIS (to be called
WesTTrans) and an energy posting system that will be operational prior to 2005.on April 1,
2004. The WesTTrans system includes the WestConnect participants as well as some
other public power entities throughout the west. WestConnect is currently
developing its phasing plans.
On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking
(NOPR) proposing standard market design rules that would significantly alter the
markets for wholesale electricity and transmission and ancillary services in the
U.S. The new rules would establish a generation adequacy requirement for
"load-serving entities" and a standard platform for the sale of electricity and
transmission services. Under the new rules, Independent Transmission Providers
would administer spot markets for wholesale power, ancillary services and
transmission congestion rights, and electric utilities, including TEP, would be
required to transfer control over transmission facilities to the applicable
Independent Transmission Provider. The FERC expects to release for commentsreleased a white paper on the
standard market design in April2003. This effort by FERC provoked extensive response
from the industry as well as state regulators, stalling the standard market
design effort.
In late 2003, followed in July 2003 by final rules. Once the final rules
areFERC issued a phased compliance schedule will begin. TEP is currently in the
processfinal rule on Standards of determining the impact the proposedConduct that
apply equally to natural gas and
K-11
electricity. These rules would haveexpand on its
operations.existing
requirements that utilities must follow regarding non-discriminatory treatment
of customers.
RATES AND REGULATION
The FERC and the ACC regulate portions of TEP's utility accounting
practices and electricity rates. The FERC regulates the terms and prices of
TEP's transmission services and sales to other utilitiesof electricity at wholesale. In 1996, TEP
filed a tariff at FERC governing the rates, terms and resellers.conditions of open access
transmission services. In 1997, TEP was granted a FERC tariff to sell power at
market based rates. The ACC has authority over rates charged to retail
customers, the issuance of securities, and transactions with affiliated parties.
STATE
Historically, the ACC determined TEP's rates for retail sales of
electric energy on a "cost of service" basis, which was designed to provide,
after recovery of allowable operating expenses, an opportunity to earn a
reasonable rate of return on TEP's "fair value rate base." Fair value rate base
was generally determined by reference to the original cost and the
reconstruction cost (net of depreciation) of utility plant in service to the
extent deemed used and useful, and to various adjustments for deferred taxes and
other items, plus a working capital component. Over time, rate base was
increased by additions to utility plant in service and reduced by depreciation
and retirements of utility plant.
TEP's Settlement Agreement and Retail Electric Competition Rules
In September 1999, the ACC approved the Retail Electric Competition
Rules (Rules) that provided a framework for the introduction of retail electric
competition in Arizona. In November 1999, the ACC approved the Settlement
Agreement between TEP and certain customer groups related to the implementation
of retail electric competition in Arizona.
The Rules and TEP's Settlement Agreement required the unbundling of
electric services, with separate rates or prices for generation, transmission,
distribution, metering, meter reading, billing and collection, and ancillary
services. Generation services at market prices may be provided by Energy Service
Providers (ESPs) licensed by the ACC. Transmission and distribution services and
must-run generation facilities will remain subject to regulation on a cost of
service basis. TEP has met all conditions required by the ACC to facilitate
electric retail competition, including ACC approval of TEP's direct access
tariffs. However, ESPs and their related service providers must meet certain
conditions before they can competitively sell electricity in TEP's service
territory. Examples of these conditions include ACC certification of ESPs and
completion of direct access service agreements with TEP.
The Settlement Agreement also provided for certain retail rate
reductions from 1998 through 2000, after which TEP's retail rates are frozen
until December 31, 2008, except under certain circumstances.2000. In addition, TEP is required to file by June
1, 2004 a general rate case, including an updated cost of service study. Under
the terms of the Settlement Agreement, no rate case filed by TEP through 2008,
including the rate case to be filed by June 1, 2004, may result in a net rate
increase. Any rate changedecrease resulting from this rate case would be effective no
sooner than June 1, 2005.
The ACC order approving the Citizens acquisition also requires that TEP
submit as part of its June 2004 general rate case filing, a feasibility study
and consolidation plan, or in the alternative, a plan for coordination of
operations of UNS Electric's operations in Santa Cruz County with those of TEP.
During 2002, the ACC reexamined circumstances that had changed since it
approved the Rules in 1999. The outstanding issues were divided into two groups.
Track A related primarily to the divestiture of generation assets while Track B
related primarily to the competitive energy bidding process.
Track A
In September 2002, the ACC issued the Track A Order, which eliminated
the requirement in the TEP Settlement Agreement that TEP transfer its generation
assets to a subsidiary. At the same time, the ACC ordered the parties, including
TEP, to develop a competitive bidding process, and reduced the amount of power
to be acquired in the competitive bidding process to only that portion not
supplied by TEP's existing resources.
K-12
Track B
On February 27, 2003, the ACC issued the Track B Order, which defined
the competitive bidding process TEP must use to obtain capacity and energy
requirements beyond what is supplied by TEP's existing resources. For the period
2003 through 2006, TEP estimated these amounts to be 50,000 MWh of energy in
2003, or approximately 0.5% of its retail load, gradually increasing to 104,000
MWh by 2006. The Track B Order further required TEP to bid out "Economy Energy",
or short-term energy purchases, that it estimates it will make in the 2003 to
2006 period (210,000 to 181,000 MWh).
TEP was also required to bid out its Reliability Must Run (RMR)
generation requirements, which are currently met by its existing local
generation units. TEP's RMR generation requirements are estimated at 471 MW of
capacity and 37,000 MWh of energy in 2003 increasing to 687 MW of capacity and
38,000 MWh of energy in 2005. TEP does not anticipate that any near-term RMR
requirements will be met through this competitive bidding process because of the
locational and operational requirements of TEP's RMR generation as well as TEP's
belief that its existing RMR generation solutions are economically sound.
TEP is not required to purchase any power through this process that it
deems to be uneconomical, unreasonable or unreliable. The Track B bidding
process involved the ACC Staff and an independent monitor. The Track B Order
also confirmed that it is not intended to change the current retail rates for
generation services.
TEP entered into two agreements to meet its 2003 bid requirements
under the Track B Order for the period 2003 through 2006 as listed below:
o PPL Energy Plus, LLC contract for 37 MW from June 2003 through December
2003 and 75 MW from January 2004 through December 2006, under a unit
contingent contract.
o Panda Gila River generating station will supply 50 MW on-peak for the
June through September time period, from 2003 (which has been supplied)
through 2005, under a unit contingent contract between TEP and wouldPanda
Gila River, L.P.
o No RMR bids were received.
Recent Arizona Court of Appeals Decision
On January 27, 2004, the Arizona Court of Appeals issued a decision
that resolved challenges to the ACC's Retail Electric Competition Rules. The
Court determined that certain rules established by the ACC relating to the entry
of new competitive electric service providers into the market were invalid. The
ultimate impact on TEP's Settlement Agreement is not resultknown. A Motion for
Reconsideration was filed by Arizona Electric Power Cooperative (AEPCO) and
Duncan Valley Electric Cooperative (Duncan Valley), and a separate Motion to
Reconsider was filed by Trico Electric Cooperative (Trico). A Motion for
Reconsideration is a prerequisite to filing an appeal. AEPCO generates and
transmits electricity for its members in a net rate
increase.Arizona and California. Duncan Valley
and Trico provide electric service to rural areas in Arizona.
See Note 24 of Notes to Consolidated Financial Statements - TEP
Regulatory Matters, for more information on TEP's Settlement Agreement.
In October 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens for the purchase by UniSource Energy of Citizens'
Arizona electric utility and gas utility businesses for a total of $230
million. The purchase price of each is subject to adjustment based on the
date on which the transaction is closed and, in each case, on the amount of
certain assets and liabilities of the purchased business at the time of
closing. The closing of these transactions is subject to approval by the
ACC, the FERC and the SEC. Citizens had two cases pending before the ACC
requesting rate relief for both the Arizona electric and Arizona gas assets
prior to entering into the Asset Purchase Agreements with UniSource Energy.
The requested electric rate increase is to recover purchased power costs
and the gas rate increase is a base rate increase. In December 2002,
UniSource Energy and Citizens filed a Joint Application with the ACC
requesting smaller increases in both pending cases. Under the proposal,
UniSource Energy asked that the 45% electric increase requested by
Citizens be reduced to 22%, and that the 29% increase in gas rates be reduced
to 23%. UniSource Energy believes that the smaller proposed rate increases
are sufficient in light of the negotiated purchase price. We are currently
in settlement discussions with the ACC Staff and intervenors regarding this
Joint Application. See Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations, Asset Purchase Agreements.
FEDERAL
During 2000 and 2001, the FERC ordered hearings and issued several
orders to mitigate volatile energy prices in the western U.S. and to address the
energy emergency in California. During 2000, the FERC established certain soft
caps on prices for power sold to the CISO. In June 2001, the FERC adopted a
price mitigation plan applicable to certain wholesale power sales in the western
U.S. This plan, which had a price cap of $91.87 per MWh, was in effect until
October 31, 2002. The FERC adopted a price cap for the period thereafter of $250
per MWh.
Market Manipulation Investigations
On June 25, 2003, the FERC alleged that 60 energy companies, including
TEP, may have engaged in manipulative practices that disrupted western energy
markets in 2001 and 2000. On January 22, 2004, FERC granted a Motion to Dismiss
all charges against TEP.
K-13
See Item 7. - Management's Discussion and Analysis of Financial
Condition and Results of Operations, Tucson Electric Power Company, Factors
Affecting Results of Operations, Western Energy Markets, below, for a discussion
of various FERC proceedings, including refund hearings on power sold to
California in 2000 and 2001, which may impact TEP's results.
K-14
TEP's UTILITY OPERATING STATISTICS
For Years Ended December 31,
2003 2002 2001 2000 1999
1998
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Generation and Purchased Power-kWh (000)
Remote Generation (Coal) 10,182,706 10,067,069 10,362,211 10,278,393 10,000,401 10,002,250
Local Tucson Generation (Oil, Gas & Coal) 1,082,058 1,402,504 1,820,783 1,667,308 1,115,277
720,515
Purchased Power 1,842,7391,153,305 1,329,574 3,656,978 3,174,244 2,712,570
2,227,773
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Generation and Purchased Power 13,312,31212,418,069 12,799,147 15,839,972 15,119,945 13,828,248 12,950,538
Less Losses and Company Use 824,506 769,101 846,287 724,677 814,945
810,117
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Energy Sold 12,543,21111,593,563 12,030,046 14,993,685 14,395,268 13,013,303
12,140,421
===================================================================================================================================================================================================================================
Sales-kWh (000)
Residential 3,370,541 3,188,726 3,122,332 3,027,963 2,736,837
2,662,598
Commercial 1,679,502 1,609,367 1,573,213 1,496,558 1,383,756
1,355,319
Industrial 2,233,113 2,261,463 2,270,446 2,262,212 2,220,900
2,139,464
Mining 697,694 695,221 1,040,762 1,140,811 1,200,214
1,230,259
Public Authorities 248,703 257,641 254,130 258,470 247,361
242,845
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total - Electric Retail Sales 8,229,553 8,012,418 8,260,883 8,186,014 7,789,068
7,630,485
Electric Wholesale Sales 4,530,7933,364,010 4,017,628 6,732,802 6,209,254 5,224,235
4,509,936
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Electric Sales 12,543,21111,593,563 12,030,046 14,993,685 14,395,268 13,013,303
12,140,421
===================================================================================================================================================================================================================================
Operating Revenues (000)
Residential $307,023 $290,091 $283,673 $276,720$ 283,673 $ 276,720 $253,352
$248,821
Commercial 175,247 168,159 164,345 157,744 148,039
146,269
Industrial 160,355 160,862 161,584 162,790 160,963
157,735
Mining 27,929 28,168 41,994 48,484 49,399
51,965
Public Authorities 18,089 18,769 18,521 18,908 18,147
17,950
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total - Electric Retail Sales 688,643 666,049 670,117 664,646 629,900
622,740
Electric Wholesale Sales 177,908 733,559151,030 157,108 921,280 359,814 171,219
143,269
Net Unrealized Gain (Loss) on Forward
Electric Sales and Purchases 533 (1,315) - - -
Other Revenues 6,603 6,3089,018 8,618 8,508 3,908 2,964
2,981
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Operating Revenues $851,093 $1,408,669$848,691 $831,775 $1,599,905 $1,028,368 $804,083
$768,990
===================================================================================================================================================================================================================================
Customers (End of Period)
Residential 334,131 326,847 318,976 311,673 303,653
295,469
Commercial 32,369 31,767 31,194 30,467 29,714
28,648
Industrial 676 695 705 711 705
684
Mining 2 2 2 42 4
Public Authorities 61 61 61 61 61
- -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Retail Customers 367,239 359,372 350,938 342,914 334,137
324,866
===================================================================================================================================================================================================================================
Average Retail Revenue per kWh Sold (cents)
Residential 9.1 9.1 9.1 9.39.1 9.3
Commercial 10.4 10.5 10.5 10.5 10.7
10.8
Industrial and Mining 6.4 6.4 6.1 6.2 6.1 6.2
Average Retail Revenue per kWh Sold 8.4 8.3 8.1 8.1 8.1 8.2
Average Revenue per Residential Customer $928 $886 $899 $899 $845 $855
Average kWh Sales per Residential Customer 10,191 9,737 9,897 9,834 9,132 9,144
K-15
ENVIRONMENTAL MATTERS
TEP is subject to environmental regulation of air and water quality,
resource extraction, waste disposal and land use by federal, state and local
authorities. TEP believes that all existing generating facilities are in
compliance with all existing regulations and will be in compliance with expected
environmental regulations, except as described below.
The 1990 Federal Clean Air Act Amendments (CAAA) require reductions of
sulfur dioxide (SO2) and nitrogen oxide (NOx) emissions in two phases, more
complex facility permits and other requirements.phases. TEP is
subject only to Phase II of the SO2 and NOx emission reductions, which became
effective January 1, 2000. All of TEP's generating facilities (except 142 MW of
its internal combustion turbines) are affected.
In 1993, TEP's generating units affected by Phase II were allocated SO2
Emission Allowances based on past operational history. Each allowance gives the
owner the right to emit one ton of SO2. Beginning in 2000, generating units
subject to Phase II must hold Emission Allowances equal to the level of
emissions in the compliance year or pay penalties and offset excess emissions in
future years. TEP had sufficient Emission Allowances to comply with the Phase II
SO2 regulations for compliance year 2002. However,2003. We expect to continue to have adequate
Emission Allowances until Springerville Unit 3 goes into service. At that point,
due to increased
energy output, TEP may have to purchase additionalreduced usage of Emission Allowances forat Springerville Unit 1 and Unit 2,
TEP expects to have excess Emission Allowances. Potential changes to the
regulation of SO2 emissions may impact these expectations in future compliance years.
Title V of the CAAA requires that all of TEP's generating facilities
obtain more complex air quality permits. All TEP facilities (including those
jointly owned and operated by others) have obtained these permits. In 1999, TEP
received Title V permits for the Springerville and IrvingtonSundt generating stations.
These permits are valid for five years.years, and, as a result, TEP has submitted a
permit renewal application. TEP must pay an annual emission-based fee for each
generating facility subject to a Title V permit. These emission-based fees are
included in the CAAA compliance expenses discussed below. The CAAA also requires
multi-year studies of visibility impairment in specified areas and studies of
hazardous air pollutants. The results of these studies will impact the
development of future regulation of electric utility generating units. Since
these activities involve the gathering of information not currently available,
TEP cannot predict the outcome of these studies.
Arizona and New Mexico have adopted regulations restricting the
emissions from existing and future coal, oil and gas-fired plants. These
regulations are in some instances more stringent than those adopted by the
Environmental Protection Agency (EPA). The principal generating units of TEP are
located relatively close to national parks, monuments, wilderness areas and
Indian reservations. Since these areas have relatively high air quality, TEP
could be subject to control standards that relate to the "prevention of
significant deterioration" of visibility and tall stack limitation rules. In
addition, the ACC mandated under the Environmental Portfolio Standard (EPS) that
TEP spent approximately $2.5 millionderive a percentage of its total retail energy sold from new solar resources
or environmentally-friendly renewable electricity technologies. The percentage
changes each year, increasing to a maximum of 1.1 percent in 2002, $2 million2007. In 2003, the
percentage was 0.6 percent of which at least 50 percent must be derived from
solar electric generation.
The EPA has issued a determination that coal and oil-fired electric
utility steam generating units must control their mercury emissions. Final
regulations are expected to be issued in 2001 and $1
million in 2000, and expects to spend approximately $2December 2004.
TEP capitalized $11 million in 2003 and $8 million in 2002 and 2001
in construction costs to comply with environmental requirements and expects to
capitalize $6 million in 2004 complying with these requirements.and 2005. In addition, TEP recorded expenses of $8
million in 2003 and $6 million in 2002 and 2001 related to environmental
compliance, including the cost of lime used to scrub the stacks. TEP expects
environmental expenses to be $7 million in 2004 and 2005. TEP may incur
additional costs to comply with recent and future changes in federal and state
environmental laws, regulations and permit requirements at existing electric
generating facilities. Compliance with these changes may result in a reduction
in operating efficiency.
FailureIn order to complymeet Title V permit requirements in connection with any EPAthe
construction of Springerville Unit 3, the Unit 3 project will pay for
approximately $90 million of capital expenditures related to pollution control
equipment upgrades on Springerville Unit 1 and Unit 2.
K-16
See Note 15. Commitments and Contingencies, TEP Contingencies,
Springerville Generating Station Complaint.
UNISOURCE ENERGY SERVICES
On August 11, 2003, UniSource Energy completed the purchase of the
Arizona gas and electric system assets from Citizens for a total of $223
million, comprised of the base purchase price plus other operating capital
adjustments and transaction costs. UES was formed to hold the common stock of
UNS Electric and UNS Gas, which operate these electric and gas system assets,
respectively.
UNS ELECTRIC
Service Territory and Customers
UNS Electric is an electric transmission and distribution company
serving approximately 81,000 retail customers in Mohave and Santa Cruz counties.
These counties had a population of approximately 212,000 in 2003.
UNS Electric's customer base is primarily residential, with some small
commercial and both light and heavy industrial customers. Peak demand for 2003
was 365 MW.
Power Supply and Transmission
UNS Electric has a full requirements power supply agreement with
Pinnacle West Capital Corporation (PWCC). The agreement expires May 31, 2008.
The agreement obligates PWCC to supply all of UNS Electric's power requirements
at a fixed price. Payments under the contract are usage based, with no fixed
customer or state compliance
requirements may resultdemand charges. UNS Electric imports the power it purchases from
PWCC into its Mohave County and Santa Cruz County service territories over the
Western Area Power Administration's (WAPA) transmission lines. UNS Electric's
transmission capacity agreement with WAPA expires in substantial penalties or fines.
The EPA has issued a determination that coal and oil fired electric
utility steam generating units must control their mercury emissions. Final
regulationsFebruary 2008. Under the
terms of the agreement, UNS Electric's aggregate minimum fixed transmission
charges are expected to be issued$5 million in 2004. On April 29, 2002,UNS Electric also has a long-term
electric transmission capacity agreement with WAPA that expires in 2011. Under
the Arizona Departmentterms of Environmental Quality
(ADEQ) issuedthis contract, the aggregate minimum transmission payments are $1
million per year.
UNS Electric owns and operates the Valencia Power Plant (Valencia),
located in Nogales, Arizona. The Valencia plant consists of three gas and
diesel-fueled combustion turbine units and provides approximately 48 MW of
peaking resources. The facility is directly interconnected with the distribution
system serving the city of Nogales and the surrounding areas. Under the PWCC
agreement, Valencia will be dispatched by PWCC when needed for local reliability
or when it is economic relative to other PWCC resources.
Rates and Regulation
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 final permit grantingpurchase
power and fuel adjustment clause (PPFAC), which allows for adjustment to the
expansionbase rate for delivered purchase power through a separate surcharge or credit.
The ACC order and settlement agreement include the following terms related to
UNS Electric rates:
o A 22% 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 per kWh, to fully recover the cost of the
Springerville
Generating Station to allow for two new 400 MW coal fired generating units.
TEP workedcurrent contract with the EPAPWCC, WAPA transmission charges and the ADEQcost of
running the Valencia turbines.
K-17
o UniSource Energy must attempt to determine mutually acceptable levelsrenegotiate the PWCC purchase power
contract, and any savings that result from a renegotiated contract must
be allocated in a ratio of emissions90% to ratepayers and 10% to shareholders.
Discussions are underway relating to restructuring options, however at
March 10, 2004, no agreement had been reached.
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 all four unitscoordination 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 may not become
effective until August 1, 2007. The settlement agreement also limits dividends
payable by UNS Electric to accomplish significant emission reductions75% of earnings until the ratio of common equity to
total capitalization reaches 40%. The ratio of common equity to total
capitalization for UNS Electric at December 31, 2003 was 38%.
UNS GAS
Service Territory and Customers
UNS Gas is a gas distribution company serving approximately 128,000
retail customers in Mohave, Yavapai, Coconino, and Navajo Counties in northern
Arizona, as well as Santa Cruz County in southeast Arizona. These counties
comprise approximately 50% of the territory of the state of Arizona, with a
population of approximately 702,000 in 2003.
UNS Gas' customer base is primarily residential. Total revenues derived
from current levels. If constructed, Springerville Unit 3 will be equipped
with modern emissions control technology and the emissions controls on Units
1 and 2 will be upgraded. SO2 emissions from all four units will be up to
55 percent less than those currently produced from the two existing units,
while NOx emissions will be up to 39 percent less. Upgrades to Units
1 and 2 will be paid for by the Unit 3 project. The Grand Canyon Trust
(GCT), an environmental activist group, has filed a petition with the EPA
to revoke the permit, based on the allegationsresidential customers were approximately 55% in the litigation set forth
below.
On November 13, 2001,five months of
operation in 2003, while sales to other retail customer classes accounted for
approximately 29% of total revenues. Approximately 16% of total revenues in
2003 were derived from gas transportation services and a Negotiated Sales
Program (NSP). UNS Gas is supplying natural gas transportation service to the
GCT filed600 MW Griffith Power Plant located near Kingman, Arizona, under a complaint20-year
contract which expires in U.S. District Court
against TEP for alleged violations2021. UNS Gas also supplies natural gas to some of the Clean Air Act at the Springerville
Generating Station. The complaint alleged that more stringent emission
standards should apply to Units 1 and 2 and that new permits and the
installation of additional facilities meeting Best Available Control
Technology standards are required for the continued operation of Units 1 and
2 in accordance with applicable law. TEP believes the claims by the GCT are
without merit and will vigorously contest them.
On September 10, 2002, the U.S. District Court granted TEP's motion for
summary judgment on one of the primary issues in the case: whether TEP
commenced construction within 18 months and/or by March 19, 1979, after the
original 1977 air permit covering Units 1 and 2 was issued. The Court found
that TEP had commenced consturction of the Springerville Generating Station
in the time periods required by the original permits. There were two
remaining allegations: (1) TEP discontinued construction for a period of 18
months or longer and did not complete construction in a reasonable period of
time and (2) TEP did not commence construction, for purposes of New Source
Performance Standard applicability, by September 18, 1978. On March 4, 2002,
the U.S. District Court determined that the GCT had not commenced the case
on a timely basis and dismissed the case.
On November 1, 2002 the ACC granted TEP siting approval to construct
Unit 3 (and Unit 4, if Unit 4 is built) at Springerville subject to certain
conditions. Both the GCT and the Land and Water Fund of the Rockies have
opposed this approval and have filed for reconsideration which was deniedits
large transportation customers, through an NSP approved by the ACC. One half of
the margin earned on these NSP sales is retained by UNS Gas, while the other
half benefits retail customers through a credit to the purchased gas adjustor
(PGA) mechanism which reduces the gas commodity price.
Gas Supply and Transmission
UNS Gas has a natural gas supply and management agreement with BP
Energy Company (BP). Under the contract, BP manages UNS Gas' existing supply and
transportation contracts and its incremental requirements. The GCTinitial term of
the agreement extends through August 31, 2005. The term of the agreement is
automatically extended one year on an annual basis unless either party provides
180 days notice of its intent to terminate. The market price for gas supplied by
BP will vary based upon the period during which the commodity is delivered. UNS
Gas hedges its gas supply prices by entering into fixed price forward contracts
at various times during the year to provide more stable prices to its customers.
These purchases are made up to three years in advance with the goal of hedging
at least 45% and not more than 80% of the expected monthly gas consumption with
fixed prices prior to entering into the month. UNS Gas hedged approximately 70%
of its expected monthly consumption for the 2003/2004 winter season (November
through March). Currently, UNS Gas has approximately 15% of its expected gas
consumption hedged for November and December of 2004, and 10% hedged for the
period January through March of 2005.
Most of the gas distributed by UNS Gas in Arizona is procured from the
San Juan Basin in the Four Corners region and delivered on the El Paso and
Transwestern interstate pipeline systems. 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 transmission service under a full requirements contract under
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 will have
specific volume limits in each month and specific receipt point rights from the
available
K-18
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. These costs will be the same
through 2005 (pending a 2006 EPNG rate case) as under UNS Gas' existing full
requirements contract. The average daily capacity rights of UNS Gas upon
conversion to contract demand will be approximately 870,000 therms per day, with
an average of 1,200,000 therms per day in the winter season (November through
March). UNS Gas has capacity rights of 250,000 therms per day on the San Juan
Lateral and Mainline of the Transwestern pipeline. The Transwestern pipeline
principally delivers gas to the portion of UNS Gas' distribution system serving
customers in Flagstaff and Kingman, Arizona, and also delivers gas to UNS Gas'
facilities serving the Griffith Power Plant in Mohave County. This contract
expires in January 2007. The aggregate annual minimum transportation charges are
expected to be approximately $4 million and $3 million for the EPNG and
Transwestern contracts, respectively.
Rates and Regulation
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 Landcost of gas (expressed in cents per therm), and Water Funda 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 refunded through the PGA mechanism. When under or over recovery
reaches approximately $4 million, UNS Gas may request a PGA surcharge or
surcredit with the goal of collecting or refunding the amount deferred from or
to customers over a twelve month period.
The ACC order and settlement agreement include the following terms
related to UNS Gas rates:
o An increase in retail delivery base rates, effective August 11, 2003,
equivalent to a 20.9% increase over 2001 test year retail revenues.
o 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).
o Change in rate design to include an increase in the monthly residential
customer charge from $5 to $7 and an increase in the base cost of gas
to $0.400 per therm from $0.250 in northern Arizona and $0.3884 in
Santa Cruz County.
o The existing PGA rate change limit of $0.10 per therm over a
twelve-month period is increased to $0.15 through July 2004 and
thereafter will revert to $0.10.
Under the terms of the Rockies have
judicially appealed this decision.
MILLENNIUM ENERGY BUSINESSES
- ----------------------------
Millennium's assets comprised approximately 6%ACC order, UNS Gas may not file a general rate
increase until August 2006 and any resulting rate increase may not become
effective until August 1, 2007. The settlement agreement also limits dividends
payable by UNS Gas to 75% of earnings until the consolidated
assetsratio of UniSource Energycommon equity to total
capitalization reaches 40%. The ratio of common equity to total capitalization
for UNS Gas at December 31, 2002. Millennium had an after-tax
loss2003 was 35%.
The PGA bank balance acquired by UNS Gas on August 11, 2003 was
approximately $7 million. On September 9, 2003, the ACC approved a new PGA
surcharge of $15.5 million in 2002 and $9.2 million in 2001, which included a $6
million after-tax gain on$0.1155 per therm that took effect October 1, 2003. At December 31,
2003, the sale of a power project. In 2000, Millennium
reported losses of $4.1PGA bank balance was $3 million.
MILLENNIUM ENERGY HOLDINGS
Through its affiliates, Millennium holds investments in unregulated energy
and emerging technology companies. At December 31, 2003, Millennium's assets
represented 5% of UniSource Energy's total assets. The acquisition agreement
discussed in Overview of Consolidated Businesses - Agreement and Plan of
K-19
Merger, above, limits the energy-related businesses which are described below.amount UniSource Energy may invest in Millennium.
Consequently, Millennium's ability to provide future funding for the operations
of emerging companies could be affected.
Technology Investments
-----------------------------
Millennium participates in various companies designed to develop
renewable energy, thin-film technologies and other emerging energy
technologies, including:
-
Global Solar Energy, Inc. (Global Solar), a developer of flexible thin-
film develops and manufactures
light weight thin-film photovoltaic cells started limited production of photovoltaic
cells in 1999.and panels. Global Solar's target
markets for its products include
commercial,have included military, space and militarycommercial applications. In 2003,
Millennium currently ownsincreased its ownership in Global Solar to 99% from 87% of Global Solar.
-.
Infinite Power Solutions, Inc. (IPS), a developer of develops thin-film lithium ion
batteries. At December 31, 2002, Millennium owns approximately 77.5% of
IPS, however this ownership share is anticipated to be reduced inIn 2003, as a result of planned additional external investment by Dow Corning
Enterprises, Inc. Millennium anticipates that its ultimateMillennium's ownership in IPS will be between 59% andwas reduced to 72% from 77%.
-
MicroSat Systems, Inc. (MicroSat) is a developer of small scale
satellites. MicroSat funds much of the development activities through
Federal Governmentdevelops small-scale satellites under
U.S. government contracts. In 2003, Millennium currently owns 49% of
MicroSat, but pursuant to a restructuring agreement signed earlier in
the year, has agreed to reducereduced its ownership in MicroSat
to 35% from 49%. Millennium expects
this change to occur in 2003.
As technology developers, these entities face many challenges, such as
developing technologies that can be manufactured on an economic scale,
technological obsolescence, competitors and possible reductions in government
spending to advance technological research and development activities. While
in the short-term we believe Millennium will incur losses from the funding of
the development efforts, we believe that the investments will be profitable
in the long-term. Millennium expects to fund between $7 million and $15
million to its various technology investments in 2003. In 2002, Millennium
provided $18.5 million in debt and equity funding to the Energy Technology
Investments. See Item
7. - Management's Discussion and Analysis of Financial Condition and Results of
Operations, Millennium Energy Holdings, Inc., Results of Millennium Energy BusinessesOperations, below, for
more information regarding these entities, including research and development
activities.
Sabinas
-------
In 2002,Other Millennium invested $20 million in a company created to develop
up to 800 megawatts (MW) of coal-fired generation inInvestments
Millennium also has the Sabinas region of
Coahuila, Mexico. Millennium received a 50% share of Carboelectrica Sabinas,
S. de R.L. de C.V.following investments:
Southwest Energy Solutions, Inc. (SES), a Mexican limited liability company (Sabinas). The other
50% of Sabinas is owned by Altos Hornos de Mexico, S.A. de C.V. (AHMSA)wholly-owned Millennium
subsidiary, provides electrical contracting services in Arizona to commercial,
industrial and certain of its affiliates. Sabinas also owns approximately 19.5% of
Minerales de Monclova, S.A. de C.V.governmental customers in both high voltage and inside wiring
capacities and meter reading services to TEP. We have determined SES performs
only business to our utility operations and are moving it under TEP.
Millennium Environmental Group, Inc. (MEG), (Mimosa). Mimosa is an owner ofa wholly-owned Millennium
subsidiary, established in September 2001, manages and trades emission
allowances, coal and associated gas reserves, a supplier of metallurgical coal to the steel
industry, and a supplier of thermal coal to the Mexican electricity commission.
Since 1999, both AHMSA and Mimosa are parties to a suspension of payments
procedure, under applicable Mexican law, which is the equivalent of a U.S.
Chapter 11 proceeding. Under certain circumstances, Millennium has the right
to sell its interest (a put option) in Sabinas to an AHMSA affiliate for $20
million plus an accrued service fee. These circumstances include failure of
Sabinas to reach financial closing on the generation project within three
years. Millennium's put option is secured by collateral with a value currently
in excess of $20 million. UniSource Energy's Chairman, President and Chief
Executive Officer is a member of the board of directors of AHMSA.
Nations Energy
--------------other environmental related products including derivative
instruments.
Nations Energy Corporation (Nations Energy), a wholly-owned subsidiary
of Millennium was established in 1995, to developdevelops and investinvests in independent power
projects worldwide. In 2001, Nations Energy sold its 26% equity interest in a
power project located in Curacao, Netherland Antilles. Nations Energy has one
remaining investment, a 40% equity interest in an independent power producer
that owns and operates a 43 MW power plant near Panama City, Panama. Nations
Energy intends to sell its interest in this project, which hashad a book value of
less than $1 million at December 31, 2002.2003. Millennium does not currently intend to make
any additional investments in Nations Energy.
See Item 7. - Management's DiscussionHaddington Energy Partners II, LP (Haddington) is a limited partnership
that funds energy-related investments. A member of the UniSource Energy Board of
Directors has an investment in Haddington and Analysisis a managing director of Financial
Conditionthe
general partner of the limited partnership. Millennium committed $15 million in
capital, excluding fees, to Haddington in exchange for approximately 31% of
Haddington. At December 31, 2003 Millennium had funded $9 million of this
commitment, of which $2 million was funded in 2003. Millennium expects the
balance to be funded in the next three years.
Valley Ventures III, LP (Valley Ventures) is a venture capital fund
that focuses on investments in information technology, microelectronics and
Resultsbiotechnology, primarily within the southwestern U.S. A different member of Operation - Resultsthe
UniSource Energy Board of Directors is a general partner of the company that
manages the fund. Millennium Energy Businesses,
Nations Energy.
Othercommitted $6 million, including fees, to the fund
and owns approximately 15% of the fund. Millennium Investments
----------------------------had funded approximately $1
million of this commitment through December 31, 2003 and expects the balance to
be funded by the end of 2007.
K-20
Carboelectrica Sabinas, S. de R.L. de C.V. (Sabinas) is a Mexican
limited liability company created to develop up to 800 MW of coal-fired
generation in the Sabinas region of Coahuila, Mexico. Sabinas also owns 19.5% of
Minerales de Monclova, S.A. de C.V. (Mimosa). Mimosa is an owner of coal and
associated gas reserves and a supplier of metallurgical coal to the Mexican
steel industry and thermal coal to the major electric utility in Mexico.
Millennium owns 50% of Sabinas. Altos Hornos de Mexico, S.A. de C.V. (AHMSA) and
affiliates also own 50%. Also, UniSource Energy's Chairman, President and Chief
Executive Officer is a member of the Board of Directors of AMHSA. Since 1999,
both AHMSA and Mimosa are parties to a suspension of payments procedure, under
applicable Mexican law, which is the equivalent of a U.S. Chapter 11 proceeding.
Under certain circumstances, Millennium has the following investments which are consolidated:
- Southwest Energy Solutions, Inc. (SES),right to sell (a put option) its
interest in Sabinas to an AHMSA affiliate for $20 million plus an accrued
service fee. These circumstances include failure of Sabinas to reach financial
closing on the generation project within a wholly-ownedspecified time. Millennium's put
option is secured by collateral valued in excess of $20 million. In 2003
Millennium subsidiary, provides electrical contracting servicesreceived $1 million of returned capital from the investment. At
December 31, 2003, the book value of the investment in Arizona to
commercial, industrial and governmental customers in both high voltage
and inside wiring capacities and meter reading services to TEP.
- Millennium Environmental Group, Inc. (MEG), a wholly-owned Millennium
subsidiary, established in September 2001, manages and trades emission
allowances, coal and other environmental related products including
derivative instruments.
- POWERTRUSION International, Inc. (Powertrusion) is a manufacturer of
lightweight utility poles, which is 50.5% owned by Millennium.Sabinas was approximately
$19 million.
We describe the results of Millennium's unregulated energy businesses
and other investments in more detail in Note 4 of Notes to Consolidated Financial
Statements - Millennium Energy Businesses, and in Item 7. - Management's Discussion and Analysis of
Financial Condition and Results of Operations, -Millennium Energy Holdings, Inc.,
Results of Millennium Energy Businesses and in Liqiudity and Capital
Resources, Millennium - Unregulated Businesses.Operations.
UNISOURCE ENERGY DEVELOPMENT COMPANY
- ------------------------------------On October 21, 2003, UED, established in February 2001, is facilitatingTEP, Tri-State and SRP entered into an
Amended and Restated Joint Development Agreement (Agreement), which provides for
the expansiondevelopment of thetwo 400 MW coal-fired units at TEP's existing Springerville
Generating Station. TheStation by parties other than TEP. Based on the Agreement, TEP
transferred the right to construct Unit 3, together with associated rights, to
Tri-State.
Springerville Generating Station was originally designed for four units. If constructed, each of UnitsSpringerville
Unit 3, and if constructed Unit 4, wouldwill each consist of a 400 MW coal-fired,
base-load generating unitfacility at the same site as Springerville Units 1 and 2.
IfWhen Unit 3 (and subsequentlypossibly Unit 4) is built, thisTEP would allow TEP to spread the fixed costs of
the existing common facilities over the additional generating unit (or units).
UED currently expects to act as project manager for the development of
Springerville Unit 3 (and Unit 4, if Unit 4 is built) and anticipates thatOn October 21, 2003, Tri-State completed financing and ownership will occur through third parties. The entire output of Unit 3 is expectedand
immediately began construction. UED received reimbursement of its development
costs totaling $29 million, and an $11 million development fee. On October 24,
2003, part of the proceeds were used to be taken by regional power companies, including
Tri-State Generation and Transmission Association (Tri-State), Salt River
Project Agricultural Improvement and Power District (SRP), and TEP. It is
currently expected that SRP will purchase 100 MW, andrepay UniSource Energy's $35 million
short-term bridge loan obtained to help fund the Citizens Acquisition.
Once built, Tri-State will lease 100% of Unit 3 from a financial owner
and take 300 MW.MW of the 400 MW capacity. TEP wouldwill operate Unit 3 and will
purchase from Tri-State up to 100 MW of Tri-State system capacity for no more than five years
from the time the plant begins commercial operation. SRP also has an option to
own Unit 4 at a later date. If SRP exercises the option to own Unit 4,
TEP would be required to purchase SRP's 100 MW of output from Unit 3,
beginning with the commercial operation of Unit 4.
Tri-State and UED signed a Development Cost Agreement in January 2003
to each share 50% of the development costs of Unit 3 effective from November
6, 2002 until financial closing. As of December 31, 2002, UED had
approximately $22 million of capitalized project development costs on its
balance sheet.
On October 29, 2002, the ACC issued an order that affirms the
Certificate of Environmental Compatibility (CEC) granted to TEP authorizing
the construction of Unit 3, subject to compliance with certain conditions,
and approved the CEC for Unit 4 subject to certain conditions occurring. The
ACC approved construction of a third and fourth unit at the Springerville
Generating Station in 1977 and 1987, respectively, but with respect to Unit
4, the ACC provided that TEP, as plant operator, demonstrate that the fourth
unit was needed to provide an adequate, economical and reliable supply of
electric power to its customers. That demonstration was made as part of the
proceedings that resulted in the issuance of the ACC Order.
Environmental activist groups have expressed concerns regarding the
construction of any new units. Such concerns have been expressed during the
permitting and ACC proceedings and may extend to other forums and to issues
apart from the proposed construction. See Environmental Matters above.
UED expects to finalize the power purchase agreements, the engineering,
procurement and construction contract, and other required project agreements
during the first half of 2003. UED expects a third party to obtain
construction financing in 2003 and then begin construction. UED expects commercial
operation of Unit 3 to occur in December 2006. We can make no assurances,
however, aboutSRP will purchase 100 MW of
capacity from Unit 3 under a 30 year power purchase agreement and will have the
ultimate timing, or whetherright to construct and own Unit 4 at a later date. If SRP decides to construct
Unit 4, TEP may be required, along with Tri-State, to exercise best efforts to
find a replacement purchaser for SRP to purchase 100 MW of capacity from Unit 3.
If TEP and Tri-State are unable to find such a replacement purchaser, TEP would
then purchase 100 MW of output from Unit 4, beginning with the commercial
operation of Unit 4.
UED will proceed with thiscontinue to manage the development of Unit 3. Upon the
completion of construction, TEP expects to receive annual pre-tax benefits of
approximately $15 million in the form of cost savings, rental payments,
transmission revenues, and other fees. TEP will also benefit from upgraded
emissions controls for Units 1 and 2, totaling approximately $90 million, which
will be paid for by the Unit 3 project.
See Note 10 of Notes to Consolidated Financial Statements - UED
Commitments.
EMPLOYEES - ---------
As(As of December 31, 2002,2003)
TEP had 1,1341,155 employees, andof which approximately 58% are represented by
the wholly-owned
subsidiaries of Millennium had 118 employees. The International Brotherhood of Electrical Workers (IBEW) Local 1116 represents approximately 58% of TEP's
employees.No. 1116. A new
three-year collective bargaining agreement between the IBEW and TEP was ratified
in December 2002 and extends through 2005. Wages for bargaining unit employees
will increase 3.5% in 2003.increased 3% effective January 5, 2004. Wage increases for 20042005 and 20052006 will be
determined annually during July and August of each preceding year.
K-21
UNS Gas had 187 employees, of which 5 employees in Santa Cruz County
are represented by IBEW Local No. 387. The existing agreement with the IBEW
Local No. 387 expires in February 2005.
UNS Electric had 152 employees, of which 34 employees in Santa Cruz
County are represented by the IBEW Local No. 387 and 53 employees in Mohave
County are represented by the IBEW Local No. 769. The existing agreement with
the IBEW Local No. 387 expires in February 2005 and the agreement with IBEW
Local No. 769 expires in June 2004.
Millennium and its wholly-owned subsidiaries, which include SES and
MEG, had 208 employees. SES had 200 employees, of which approximately 92% are
represented by unions. Of the employees represented by unions, 59% are
represented by IBEW Local No. 1116, 34% by IBEW Local 769 and 7% by IBEW Local
No. 570. The existing agreements expire as follows: IBEW Local No. 1116, October
2006; IBEW Local No. 769, March 2004 and April 2006; and IBEW Local No. 570, May
2006.
SEC REPORTS AVAILABLE ON UNISOURCE ENERGY'S WEBSITE
- ---------------------------------------------------
UniSource Energy and TEP make available their annual reports on Form
10-
K,10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after they
electronically file them with, or furnish them to, the SEC. These reports are
available free of charge through UniSource Energy's website address:
http://www.unisourceenergy.com. A link from UniSource Energy's website to these
SEC reports is accessible as follows: At the UniSource Energy main page, select
Investor Relations from the menu shown at the top of the page; next select SEC
filings from the menu shown on the Investor Relations page.
Information contained at UniSource Energy's website is not part of any
report filed with the SEC by UniSource Energy or TEP.
The SEC also maintains an Internet site that contains reports, proxy
and information statements, and other information regarding issuers that file
electronically with the SEC. The SEC website address is http://www.sec.gov.
Interested parties may also read and copy any materials UniSource Energy and TEP
file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. Information on the operation of the Public Reference Room
is available by calling the SEC at 1-800-SEC-0030.
K-22
ITEM 2. --- PROPERTIES
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
TEP PROPERTIES
TEP's transmission facilities, located in Arizona and New Mexico,
transmit electricity from TEP's remote electric generating stations at Four
Corners, Navajo, San Juan and Springerville to the Tucson area for use by TEP's
retail customers (see Item 1. - Business - Generating and Other Resources). The
transmission system is directly interconnected at various points in Arizona and New
Mexico with a number of regional utilities. TEP has arrangements with
approximately 120 companies to interchange generation capacity and transmission
of energy.
As of December 31, 2002,2003, TEP owned, or participated in, an overhead
electric transmission and distribution system consisting of:
- 511o 512 circuit-miles of 500 kV500-kV lines;
-o 1,122 circuit-miles of 345 kV345-kV lines;
-o 371 circuit-miles of 138 kV138-kV lines;
-o 434 circuit-miles of 46 kV46-kV lines; and
- 12,095o 12,511 circuit-miles of lower voltage primary lines.
The underground electric distribution system is comprised of 7,353 cable-
miles.7,843
cable-miles. TEP owns approximately 77% of the poles on which the lower voltage
lines are located. Electric substation capacity consisted of 192197 substations
with a total installed transformer capacity of 5,602,522 kilovoltamperes.6,011,272 kilovolt amperes.
The electric generating stations (except as noted below), operating
headquarters, warehouse and service center are located on land owned by TEP. The
electric distribution and transmission facilities owned by TEP are located:
-o on property owned by TEP;
-o under or over streets, alleys, highways and other public places, the
public domain and national forests and state lands under franchises,
easements or other rights which are generally subject to termination;
-o under or over private property as a result of easements obtained
primarily from the record holder of title; and
-or
o over American Indian reservations under grant of easement by the
Secretary of Interior or lease by American Indian tribes.
It is possible that some of the easements, and the property over which
the easements were granted, may have title defects or may be subject to
mortgages or liens existing at the time the easements were acquired.
Springerville is located on land parcels held by TEP under a long-term
surface ownership agreement with the State of Arizona.
Four Corners and Navajo are located on properties held under easements
from the United States and under leases from the Navajo Nation. TEP,
individually and in conjunction with Public Service Company of New Mexico (PNM)
in connection with San Juan, has acquired easements and leases for transmission
lines and a water diversion facility located on land owned by the Navajo Nation.
TEP has also acquired easements for transmission facilities, related to San
Juan, Four Corners, and Navajo, across the Zuni, Navajo and Tohono O'odham
Indian Reservations.
TEP's rights under these various easements and leases may be subject to
defects such as:
-o possible conflicting grants or encumbrances due to the absence of or
inadequacies in the recording laws or record systems of the Bureau of
Indian Affairs and the American Indian tribes;
-o possible inability of TEP to legally enforce its rights against adverse
claimants and the American Indian tribes without Congressional consent;
and
-or
o failure or inability of the American Indian tribes to protect TEP's
interests in the easements and leases
K-23
from disruption by the U.S. Congress, Secretary of the Interior, or
other adverse claimants.
These possible defects have not interfered and are not expected to
materially interfere with TEP's interest in and operation of its facilities.
TEP, under separate sale and leaseback arrangements, leases the
following generation facilities (which do not include land):
-o coal handling facilities at Springerville;
-o a 50% undivided interest in the Springerville Common Facilities;
-o Springerville Unit 1 and the remaining 50% undivided interest in
Springerville Common Facilities; and
- Irvingtono Sundt Unit 4 and related common facilities.
See Note 710 of Notes to Consolidated Financial Statements, and Item 7.
- - Management's Discussion and Analysis of Financial Condition and Results of
Operations, Tucson Electric Power Company, Liquidity and Capital Resources,
Contractual Obligations, for additional information on TEP's capital lease
obligations.
Substantially all of the utility assets owned by TEP are subject to the
lien of the General First Mortgage and the General Second Mortgage.
Springerville Unit 2, which is owned by San Carlos, is not subject to those
liens.
UES PROPERTIES
UNS Electric
As of December 31, 2003, UNS Electric's transmission and distribution
system consisted of approximately 56 circuit-miles of 115-kV transmission lines,
234 circuit-miles of 69-kV transmission lines, and 3,116 circuit-miles of
underground and overhead distribution lines. UNS Electric also owns 39
substations having a total installed capacity of 1,161,300 kilovolt amperes and
the 48 MW Valencia plant described above.
UNS Gas
As of December 31, 2003, UNS Gas' transmission and distribution system
consisted of approximately 168 miles of steel transmission mains, 2,459 miles of
steel and plastic distribution mains, and 128,108 customer service lines.
ITEM 3. --- LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
See Item 7. - Management's Discussion and Analysis of Financial Condition
and Results of Operations, -Tucson Electric Power Company, Factors Affecting Results of
Operations, for litigation related to ACC orders and retail competition.
We discuss other legal proceedings in Note 1015 of Notes to Consolidated Financial
Statements.
California Attorney General's Unfair Competition Lawsuits
Beginning in April 2002, the California Attorney General filed eleven
virtually identical actions against TEP and other wholesale electricity
suppliers or marketers in San Francisco Superior Court. The complaints seek to
impose civil penalties on defendants under California's unfair competition law
based upon allegations that defendants violated the Federal Power Act by failing
to properly file their rates with FERC and by charging "unjust and unreasonable"
rates.
Defendants removed the cases to the United States District Court for
the Northern District of California, which dismissed the California Attorney
General's complaints finding them barred by federal preemption and the filed
rate doctrine. The California Attorney General appealed the District Court's
dismissal of the complaints. A decision from the Ninth Circuit is expected in
the second or third quarter of 2004.
K-24
TEP believes these claims are without merit and intends to vigorously
contest them.
Cross-Complaints in Wholesale Electricity Antitrust Cases I and II
In late 2000, various California municipalities and citizens filed
suits against Duke Energy Trading and Marketing, L.L.C., Reliant Energy
Services, Inc. and other large suppliers of wholesale electricity alleging that
Duke, Reliant, and the other large suppliers violated antitrust laws by
colluding to effect the price of electricity in the California wholesale
electricity market. These actions were subsequently consolidated in San Diego
Superior Court in March 2002 as Wholesale Electricity Antitrust Cases I and II.
Duke and Reliant responded by filing cross-complaints against TEP and
numerous other wholesale electricity market participants in April 2002. The
cross complaints allege that cross-defendants sold power in significant amounts
at prices the antitrust plaintiffs allege were excessive, and as participants in
power sales, cross-defendants are equally liable for plaintiffs alleged damages.
The entire action was removed to the United States District Court for the
Southern District of California in May 2002. The antitrust plaintiffs responded
to the removal by filing a motion for remand, and on December 13, 2002, the
District Court remanded the case back to state court.
Duke and Reliant promptly appealed the District Court's remand order
and requested that the order be stayed pending resolution of their appeal. A
ruling on the remand order from the Ninth Circuit is expected in the second or
third quarter of 2004.
TEP believes these claims are without merit and intends to vigorously
contest them.
ITEM 4. --- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
Not applicable.
K-25
PART II
ITEM 5. --- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
Stock Trading
-------------
UniSource Energy's Common Stock is traded under the ticker symbol UNS.
It is listed on the New York Stock Exchange and the Pacific Exchange. As ofOn March
4, 2003,10, 2004, the closing price was $16.58,$24.20, with 15,18113,010 shareholders of record. Dividends
---------If
UniSource Energy paysis acquired by Saguaro Utility, UniSource Energy will no longer
be a publicly held company, and thus its common stock will no longer be traded
on any such exchange.
Dividends
The acquisition agreement allows UniSource Energy to continue to pay
regular quarterly cash dividends on its Common Stock after itsuntil the closing of the acquisition, subject
to limitations upon our ability to increase the amount of such dividends.
UniSource Energy's Board of Directors declares them. There is no limitation on UniSource Energy payingcurrently expects to continue to pay
regular quarterly cash dividends on its Common Stock.our common stock until the closing of the
acquisition, subject, however, to the directors' evaluation of our financial
condition, earnings, cash flows and dividend policy.
TEP pays dividends on its common stock after its Board of Directors
declares them. UniSource Energy is the primary shareholder of TEP's common
stock. UniSource Energy relies on dividends from its subsidiaries, primarily
TEP, has certainto declare and pay dividends to its shareholders. See Note 12 to Notes to
Consolidated Financial Statements for a discussion of limitations on UniSource
Energy's subsidiaries ability to pay dividends to UniSource Energy. Also see
Item 1. - Business, Agreement and Plan of Merger, for a discussion on the
possible elimination of restrictions on paying dividends, as listed below:
- TEP canTEP's ability to pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that
requires TEP to
maintain a minimum level of net worth, and so long as
the dividends and certain investments in affiliates would not exceed 65%
of TEP's net income.
- Under ACC restrictions, TEP can pay dividends so long as the dividends
do not exceed 75% of TEP's earnings until its equity ratio equals 37.5%
of total capital (excluding capital lease obligations).
- Under the Federal Power Act, TEP cannot pay dividends out of funds
that are properly included in the capital account.UniSource Energy.
See Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations, -UniSource Energy Consolidated, Dividends on Common Stock.
Common Stock Dividends and Price Ranges
------------------------------------------------------------------------------------------------ ---------------------------------------- -- -----------------------------------------
2003 2002 2001
Quarter: Market Price per Dividends Market Price per Dividends
Share of Common Stock (1) Declared Share of Common Declared
Stock (1) Stock (1)Declared
-------------- ------------ ------------ -------------- -- ------------ ------------ ---------------
High Low High Low
---- --- ---- ---
First $18.10 $16.00 $ 0.150 $20.60 $16.74 $0.125 $21.00 $15.13 $0.10$ 0.125
Second 19.27 17.05 0.150 20.75 17.91 0.125
25.98 20.16 0.10
Third 19.80 17.65 0.150 18.89 14.05 0.125
24.05 13.80 0.10
Fourth 24.90 19.01 0.150 17.90 13.69 0.125
19.30 13.80 0.10
------------------------------------------------------------------------------------------------ ------------ ------------ -------------- -- ------------ ------------ ---------------
-------------- ------------ ------------ -------------- -- ------------ ------------ ---------------
Total $0.500 $0.40
==================================================================================
(1) UniSource Energy's Common Stock price on the consolidated tape as reported by
Dow Jones.
$ 0.600 $ 0.500
============== ============ ============ ============== == ============ ============ ===============
(1) UniSource Energy's Common Stock composite price on the New York Stock
Exchange.
On February 7, 2003,6, 2004, UniSource Energy declared a cash dividend of $0.15$0.16
per share on its Common Stock. The dividend is payablewas paid March 7, 200310, 2004 to
shareholders of record at the close of business February 21, 2003.17, 2004.
TEP declared and paid cash dividends of $80 million in 2003, $35
million in 2002 and $50 million in 2001, and $30 million in 2000.2001.
K-26
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
UniSource Energy 2003 2002 2001 2000 1999 1998
------------------------------------------------------
- In Thousands -
Summary of Operations (except per share data)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Operating Revenues $856,222 $1,417,012(1) $969,895 $836,904 $1,608,248 $1,033,669 $814,828 $770,597
Gain on Sale of NewEnergy - - - - $34,651 -
Loss Before Income Taxes of Millennium Energy
Businesses (1)(2) $(26,350) $(30,702) $(14,455) $(12,059) $(11,276) $(11,884)
Income Before Extraordinary Item and Accounting
Change (1) $45,146 $33,275 $60,875 $41,891 $56,510
$28,032
Net Income (1) (3) $112,617 $33,275 $61,345 $41,891 $79,107 $28,032
Basic Earnings per Share:
Before Extraordinary Item & Accounting Change $1.34 $0.99 $1.83 $1.29 $1.75
$0.87
Net Income $3.33 $0.99 $1.84 $1.29 $2.45 $0.87
Diluted Earnings per Share:
Before Extraordinary Item & Accounting Change $1.31 $0.97 $1.79 $1.27 $1.74
$0.87
Net Income $3.28 $0.97 $1.80 $1.27 $2.43 $0.87
Shares of Common Stock Outstanding
Average 33,828 33,665 33,398 32,445 32,321
32,177
End of Year 33,788 33,579 33,502 33,219 32,349 32,258
Year-end Book Value per Share $13.05 $12.68 $11.20$ 15.97 $13.14 $12.75 $11.26 $10.02 $7.65
Cash Dividends Declared per Share $0.60 $0.50 $0.40 $0.24 $0.08
- - -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Financial Position
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Utility Plant - Net $1,668,350 $1,677,671 $1,706,290 $1,729,856 $1,915,590$2,069,215 $1,835,904 $1,832,164 $1,848,975 $1,860,733
Investments in Lease Debt and Equity $178,789 $191,867 $84,459$71,459 $71,639 $44,550 $17,813
Other Investments and Other Property $109,570 $123,238 $98,288$111,289 $50,172 $69,933
$92,476
Total Assets $2,690,734 $2,746,717 $2,671,384 $2,656,255 $2,634,049$3,092,129 $2,858,288 $2,901,210 $2,814,069 $2,787,132
Long-Term Debt (2)(4) $1,286,320 $1,128,963 $802,804 $1,132,395 $1,135,820
$1,184,423
Non-Current Capital Lease Obligations 762,968 801,611 853,793 857,829 880,427
889,543
Common Stock Equity 438,229 424,722 372,169539,655 441,147 427,293 374,137 324,248
246,646
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Capitalization $2,368,803 $2,081,319 $2,362,393$2,588,943 $2,371,721 $2,083,890 $2,364,361 $2,340,495
$2,320,612
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Selected Cash Flow Data
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Operating Activities $259,642 $172,963 $215,379 $215,034 $113,228
$160,933
Capital Expenditures $(137,282) $(112,706) $(121,622)$(121,735) $(105,996) $(92,808) $(81,147)
Other Investing Cash Flows (213,450) (158,184) 4,7754,888 (7,554) (242)
(27,810)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Investing Activities $(350,732) $(270,890) $(116,847) $(113,550) $(93,050)
$(108,957)
- -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Financing Activities $101,428 $(39,299) $(33,382) $(83,768) $(20,057)
$(53,065)
- --------------------------------------------------------------------------------------------------
(1) Loss Before Income Taxes of Millennium Energy Businesses for 1999 excludes the Gain on
Sale of NewEnergy.
(2) TEP's tax-exempt variable rate bonds in the amount of $329 million are backed by LOCs
under TEP's Credit Agreement. TEP's obligations under the Credit Agreement are
collateralized with Second Mortgage Bonds. In November 2002, TEP entered into two new
LOCs for $341 million to replace the LOCs provided under its then existing credit
agreement that would have expired on December 30, 2002. These new LOCs expire in 2006.
Accordingly, these IDBs were classified as short-term debt at December 31, 2001 and
classified as long-term debt at December 31, 2002.
See Item 7. - Management's Discussion and Analysis of Financial Condition and Results of
Operations.
-----------------------------------------------------------------------------------------------------------------------------
ITEM 6.(1) In 2003, Operating Revenues, Income Before Extraordinary Item and
Accounting Change and Net Income include results from UES for the
period from August 11, 2003 to December 31, 2003.
(2) Loss Before Income Taxes of Millennium Energy Businesses for 1999
excludes the Gain on Sale of NewEnergy.
(3) Net Income includes an after-tax gain of $67 million for the Cumulative
Effect of Accounting Change from the adoption of FAS 143 in 2003, $0.5
million for the Cumulative Effect of Accounting Change from the
Adoption of FAS 133 in 2001 and an Extraordinary Gain of $23 million
for the discontinued application of FAS 71 to generation operations in
1999.
(4) TEP's tax-exempt variable rate bonds in the amount of $329 million are
backed by LOCs under TEP's Credit Agreement. TEP's obligations under
the Credit Agreement are collateralized with Second Mortgage Bonds. In
November 2002, TEP entered into two new LOCs for $341 million to
replace the LOCs provided under its then existing credit agreement that
would have expired on December 30, 2002. These new LOCs expire in 2006.
Accordingly, these IDBs were classified as short-term debt at December
31, 2001 and classified as long-term debt at December 31, 2002.
See Item 7. - SELECTED CONSOLIDATED FINANCIAL DATA
- --------------------------------------------------------------------------------Management's Discussion and Analysis of Financial Condition and
Results of Operations.
K-27
ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------------
TEP 2003 2002 2001 2000 1999
1998
-----------------------------------------------------------------------------------------------------------------------------
- Thousands of Dollars -
Summary of Operations
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Operating Revenues $851,093 $1,408,669$848,691 $831,775 $1,599,905 $1,028,368 $804,083 $768,990
Income Before Extraordinary Item and Accounting
Change $60,118 $53,737 $74,814 $51,169 $50,878
$41,676
Net Income (1) $127,589 $53,737 $75,284 $51,169 $73,475
$41,676
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Financial Position
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Utility Plant - Net $1,668,350 $1,677,671 $1,706,290 $1,729,856 $1,915,590$1,832,156 $1,835,904 $1,832,164 $1,848,975 $1,860,733
Investments in Lease Debt and Equity $178,789 $191,867 $84,459 $69,474 $44,550 $17,813
Other Investments and Other Property $41,285 $21,358 $21,416 $22,860 $23,288
$45,165
Total Assets $2,613,590 $2,645,335 $2,600,935 $2,600,508 $2,628,588$2,736,457 $2,781,144 $2,799,828 $2,743,620 $2,731,385
Long-Term Debt (1)(2) $1,126,320 $1,128,410 $801,924 $1,132,395 $1,135,820
$1,184,423
Non-Current Capital Lease Obligations 762,323 801,508 853,447 857,519 880,111
889,543
Common Stock Equity 337,463 322,471 295,660389,237 338,339 323,242 296,250 270,134
229,861
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Total Capitalization $2,267,381 $1,977,842 $2,285,574$2,277,880 $2,268,257 $1,978,613 $2,286,164 $2,286,065
$2,303,827
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Selected Cash Flow Data
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Operating Activities $257,788 $203,517 $261,169 $234,190 $139,957
$180,487
Capital Expenditures $(121,854) $(103,307) $(103,913) $(98,063) $(90,940)
$(81,011)
Other Investing Cash Flows (145,271) (11,981)11,408 (151,035) (8,861) (23,273) (24,480)
(43,937)
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Investing Activities $(248,578) $(115,894)$(110,446) $(254,342) $(112,774) $(121,336) $(115,420)
$(124,948)
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Net Cash Flows From Financing Activities $(58,841) $(74,307)$(137,858) $(53,077) $(77,427) $(112,544) $(54,371)
$(83,559)
- --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Ratio of Earnings to Fixed Charges 1.49 1.58 1.82 1.47 1.45
1.35
- --------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------
(1) Net Income includes an after-tax gain of $67 million for the Cumulative
Effect of Accounting Change from the Adoption of FAS 143 in 2003, $0.5
million for the Cumulative Effect of Account Change from the Adoption of
FAS 133 in 2001 and an Extraordinary Gain of $23 million for the
discontinued application of FAS 71 to generation operations in 1999.
(2) TEP's tax-exempt variable rate bonds in the amount of $329 million are
backed by LOCs under TEP's Credit Agreement. TEP's obligations under the
Credit Agreement are collateralized with Second Mortgage Bonds. In
November 2002, TEP entered into two new LOCs for $341 million to replace
the LOCs provided under its then existing credit agreement that would
have expired on December 30, 2002. These new LOCs expire in 2006.
Accordingly, these IDBs were classified as short-term debt at December
31, 2001 and classified as long-term debt at December 31, 2002.
Note: Disclosure of earnings per share information for TEP is not presented
as the common stock of TEP is not publicly traded.
See Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations.
K-28
NON-GAAP MEASURES
Adjusted EBITDA
Adjusted EBITDA represents EBITDA excluding the cumulative effect of
accounting change which is a non-cash item. EBITDA is earnings before interest,
taxes, depreciation and amortization. Adjusted EBITDA is presented here as a
measure of liquidity because it can be used as an indication of a company's
ability to incur and service debt and is commonly used as an analytical
indicator in our industry. Adjusted EBITDA measures presented may not be
comparable to similarly titled measures used by other companies. Adjusted EBITDA
is not a measurement presented in accordance with United States generally
accepted accounting principles (GAAP), and we do not intend Adjusted EBITDA to
represent cash flows from operations as defined by GAAP. Adjusted EBITDA should
not be considered to be an alternative to cash flows from operations or any
other items calculated in accordance with GAAP or an indicator of our operating
performance.
UniSource Energy and TEP view Adjusted EBITDA, a non-GAAP financial
measure, as a liquidity measure. The most directly comparable GAAP measure to
Adjusted EBITDA is Net Cash Flows from Operating Activities.
Adjusted EBITDA and Net Cash Flows from Operating Activities
UniSource Energy 2003 2002 2001 2000
- ---------------------------------- --------------- --------------- -------------- --------------
-Millions of Dollars-
Adjusted EBITDA $392 $364 $415 $359
Net Cash Flows from Operating
Activities $260 $173 $215 $215
- ---------------------------------- --------------- --------------- -------------- --------------
TEP 2003 2002 2001 2000
- ---------------------------------- --------------- --------------- -------------- --------------
-Millions of Dollars-
Adjusted EBITDA $400 $398 $433 $380
Net Cash Flows from Operating
Activities $258 $204 $261 $234
- ---------------------------------- --------------- --------------- -------------- --------------
Reconciliation of Adjusted EBITDA to Cash Flows from Operations
UniSource Energy 2003 2002 2001 2000
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
-Millions of Dollars-
Adjusted EBITDA (1) $392 $364 $415 $359
Amounts from the Income Statements:
Less: Income Taxes (11) (17) (48) (15)
Less: Total Interest Expense (167) (155) (159) (166)
Changes in Assets and Liabilities and Other Non-
Cash Items 46 (19) 7 37
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
Net Cash Flows from Operating Activities $260 $173 $215 $215
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
K-29
TEP 2003 2002 2001 2000
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
-Millions of Dollars-
Adjusted EBITDA (1) $400 $398 $433 $380
Amounts from the Income Statements:
Less: Income Taxes (20) (35) (56) (27)
Less: Total Interest Expense (161) (154) (158) (166)
Changes in Assets and Liabilities and Other Non-
Cash Items 39 (5) 42 47
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
Net Cash Flows from Operating Activities $258 $204 $261 $234
- ----------------------------------------------------------------------- --------------- -------------- ------------- -------------
(1) Adjusted EBITDA was calculated as follows:
UniSource Energy 2003 2002 2001 2000
------------------------------------------------------------------------ -----------------------------------------------
-Millions of Dollars-
Net Income $113 $33 $61 $42
Amounts from the Income Statements:
Less: Cumulative Effect of Accounting Change (67) - (1) -
Plus: Income Taxes 11 17 48 15
Plus: Total Interest Expense 167 155 159 166
Plus: Depreciation and Amortization 131 128 120 114
Plus: Amortization of Transition Recovery Asset 31 25 22 17
Plus: Depreciation included in Fuel and Other
O&M Expense (see Note 20 of Notes to
Consolidated Financial Statements) 6 6 6 5
------------------------------------------------------------------------ ----------- ----------- ----------- -----------
Adjusted EBITDA $392 $364 $415 $359
------------------------------------------------------------------------ ----------- ----------- ----------- -----------
TEP 2003 2002 2001 2000
----------------------------------------------------------------------- -------------------------------------------------
-Millions of Dollars-
----------------------------------------------------------------------- -------------------------------------------------
Net Income $128 $54 $75 $51
Amounts from the Income Statements:
Less: Cumulative Effect of Accounting Change (67) - (1) -
Plus: Income Taxes 20 35 56 27
Plus: Total Interest Expense 161 154 158 166
Plus: Depreciation and Amortization 121 124 117 114
Plus: Amortization of Transition Recovery Asset 31 25 22 17
Plus: Depreciation included in Fuel and Other
O&M Expense (see Note 20 of Notes to
Consolidated Financial Statements) 6 6 6 5
----------------------------------------------------------------------- ---------- ------------ ------------- -----------
Adjusted EBITDA $400 $398 $433 $380
----------------------------------------------------------------------- ---------- ------------ ------------- -----------
Net Debt and Total Debt and Capital Lease Obligations--TEP
As of December 31, 2003 2002 2001 2000
- ---------------------------------- --------------- --------------- -------------- --------------
-Millions of Dollars-
Net Debt $1,761 $1,783 $1,921 $1,944
Total Debt and classified as long-term debt atCapital Lease
Obligations $1,940 $1,975 $2,005 $2,013
- ---------------------------------- --------------- --------------- -------------- --------------
K-30
Net Debt represents the current and non-current portions of
TEP's long-term debt and capital lease obligations less
investment in lease debt. We have subtracted investment in lease debt because it
represents TEP's ownership of its own capital lease obligations. Net Debt
measures presented may not be comparable to similarly titled measures used by
other companies. Net Debt is not a measurement presented in accordance with GAAP
and we do not intend Net Debt to represent debt as defined by GAAP. You should
not consider Net Debt to be an alternative to debt or any other items calculated
in accordance with GAAP.
Reconciliation of Total Debt and Capital Lease Obligations to Net Debt
As of December 31, 2002.
Note: Disclosure2003 2002 2001 2000
- ---------------------------------- --------------- ------------- -------------- -------------
-Millions of earnings per share information for TEP is not presented as the common
stock of TEP is not publicly traded.
See Item 7.Dollars-
Long-Term Debt $1,126 $1,128 $802 $1,132
Current Portion - Management's DiscussionLong-Term Debt
$2 $2 $330 $2
- ---------------------------------- --------------- ------------- -------------- -------------
Total Debt $1,128 $1,130 $1,132 $1,134
- ---------------------------------- --------------- ------------- -------------- -------------
Capital Lease Obligations
$762 $802 $853 $858
Current Portion - Capital Lease
Obligations
$50 $43 $20 $21
- ---------------------------------- --------------- ------------- -------------- -------------
Total Debt and Analysis of Financial Condition and Results of Operations.
Capital Lease
Obligations
$1,940 $1,975 $2,005 $2,013
- ---------------------------------- --------------- ------------- -------------- -------------
Investment in
Lease Debt ($179) ($192) ($84) ($69)
- ---------------------------------- --------------- ------------- -------------- -------------
Net Debt $1,761 $1,783 $1,921 $1,944
================================== =============== ============= ============== =============
K-31
ITEM 7. --- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
Management's Discussion and Analysis explains the results of
operations, the general financial condition, and the outlook for UniSource
Energy and its threefour primary business segments-the electric utility business of TEPsegments and the
unregulated energy businesses of Millennium and UED-and includes the following:
-o outlook and strategy,
o operating results during 2003 compared with 2002, and 2002 compared
with 2001,
and 2001 compared with
2000,
-o factors which affect our results and outlook,
- our outlook and strategy, and
- ouro liquidity, capital needs, capital resources, and contractual
obligations.obligations,
o dividends, and
o critical accounting policies.
TEP is the principal operating subsidiary of UniSource Energy and, accounts for substantially allat
December 31, 2003, represented approximately 86% of its assets. The seasonal
nature of TEP's business causes operating results to vary significantly from
quarter to quarter. UniSource Energy's results for 2003 include 143 days of
operations of UES. Due to sales of both winter-peaking gas and summer-peaking
electricity, UES' consolidated operating results are expected to be less
seasonal than TEP's. Although representing approximately 5% of UniSource
Energy's total assets, and revenues. Income andnet losses from Millennium's energy-relatedunregulated businesses have
had a significant impact on earnings reported by UniSource Energy for 2003, 2002
2001, and 2000. UED`s2001. UED's unregulated business segment, which was established in February
2001, may
havehad a significant impact on consolidated net income and cash flows in 2003
due to the future.financial closing of Springerville Unit 3 which occurred on October
21, 2003. UED is not expected to significantly impact net income or cash flows
in future periods.
UNISOURCE ENERGY CONSOLIDATED
OUTLOOK AND STRATEGIES
Agreement and Plan of Merger
On November 21, 2003, UniSource Energy and Saguaro Acquisition Corp.
entered into an acquisition agreement, providing for the acquisition of all of
the common stock of UniSource Energy for $25.25 per share by an affiliate of
Saguaro Utility.
Pursuant to the terms of the acquisition agreement, Saguaro Acquisition
Corp. will merge with and into UniSource Energy. UniSource Energy will be the
surviving corporation, but will become an indirect wholly-owned subsidiary of
Saguaro Utility. Trading in our common stock on the New York Stock Exchange and
the Pacific Exchange will cease immediately as of the effective time of the
acquisition. After that time, the surviving corporation will delist our shares
from the New York Stock Exchange and the Pacific Exchange and de-register our
shares under the Securities Exchange Act of 1934, as amended. UniSource Energy's
and TEP's headquarters will remain in Tucson, and we expect that UniSource
Energy's and TEP's senior management team will remain generally the same.
Subject to the satisfaction of various closing conditions, including the receipt
of our shareholders' approval and required regulatory approvals, we expect the
acquisition to close in the second half of 2004.
Upon consummation of the acquisition, Saguaro Utility will cause the
surviving corporation to pay approximately $880 million in cash to UniSource
Energy's shareholders and holders of stock options, stock units, restricted
stock, and performance shares awarded under our stock-based compensation plans.
In addition, in 2002,Saguaro Utility intends to cause the surviving corporation (i) to
repay the $95 million inter-company loan to UniSource Energy entered into asset purchase
agreementsfrom TEP and (ii)
to contribute up to $168 million to TEP. TEP will use a significant portion of
these proceeds to retire some of its outstanding debt.
K-32
Operating Plans and Strategies
Our financial prospects and outlook for the purchasenext few years will be
affected by many competitive, regulatory and economic factors. Our plans and
strategies include the following:
o Obtain all necessary regulatory approvals and the required shareholder
approval and satisfy all of the other closing conditions contained in
the acquisition agreement so that the acquisition of UniSource Energy
by an of affiliate Saguaro Utility can occur in a timely manner.
o Integrate UES' businesses with UniSource Energy's other businesses to
achieve the strategic and financial objectives of the acquisition.
o Oversee the construction of Springerville Unit 3 and continue to
enhance the value of existing assets by working with SRP to facilitate
the development of Springerville Unit 4.
o Enhance the value of TEP's transmission system while continuing to
provide reliable access to generation for TEP's retail electriccustomers and
gasmarket access for all generating assets. This will include focusing on
completing the Tucson - Nogales transmission line, which could
eventually be connected to Mexico's utility assets in
various locations in Arizona, which if completed,system and improve
reliability for customers of UNS Electric.
o Improve the value of our existing Millennium investments.
o Improve production and sales of Global Solar's thin-film photovoltaic
cells and seek strategic partners.
o Reduce TEP's debt, using some of our excess cash flows.
o Efficiently manage TEP's generating resources and look for ways to
reduce or control our operating expenses while maintaining and
enhancing reliability and profitability.
To accomplish our goals, during 2004 we expect TEP to spend
approximately $106 million on capital expenditures and UES to spend
approximately $37 million on capital expenditures.
While we believe that our plans and strategies will continue to have a
significantpositive impact on our financial conditionprospects and results of operations.position, we recognize that we
continue to be highly leveraged, and as a result, our access to the capital
markets may be limited or more expensive than for less leveraged companies.
RESULTS OF OPERATIONS
- ---------------------
UNISOURCE ENERGY CONSOLIDATED
UniSource Energy recorded net incomeNet Income of $113 million in 2003, including
an after-tax gain of $67 million for the Cumulative Effect of Accounting Change
from the adoption of Statement of Financial Accounting Standards No. 143,
Accounting for Asset Retirement Obligations (FAS 143). Income Before Cumulative
Effect of Accounting Change was $45 million. This compares with Net Income of
$33 million in 2002 compared
withand $61 million in 2001,2001.
Change in Net Income, 2003 Compared With 2002
o A $133 million increase in Total Operating Revenues resulting from warm
summer weather, a 2.2% increase in TEP's number of retail customers,
and $42$103 million of Total Operating Revenues at UES.
o A $6 million decline in 2000.TEP's revenues from Electric Wholesale Sales is
primarily attributable to unplanned outages at several of TEP's
coal-fired generating facilities during the first half of 2003,
unfavorable wholesale opportunities for its gas generation resources
and record retail kWh demand in the third quarter. In addition, TEP
recorded a $2 million increase in reserves against receivables from
California wholesale sales in 2003.
o Purchased Energy expense, which includes purchased power and purchased
gas expense, was higher by $92 million. This resulted from $70 million
of Purchased Energy expense at UES, replacement power costs in the
first half of 2003 related to planned and unplanned outages at TEP's
generating facilities, and increased economic wholesale electric
purchases in lieu of running gas-fired generation.
K-33
o Other O&M was higher by $25 million due primarily to $15 million of O&M
at UES and increased costs resulting from planned and unplanned outages
at TEP's generating facilities.
o Higher Total Interest Expense of $12 million related to higher interest
rates under TEP's Credit Agreement, interest expense at UES, and
interest expense related to UniSource Energy's total
revenues decreased by 40% to $856borrowing under a bridge
loan for the Citizens Acquisition.
o Despite higher Income Before Taxes and Cumulative Effect of Accounting
Change, income tax expense was $6 million less in 2003 than in 2002,
due primarily to a $15 million tax benefit resulting from significantly decreased wholesale marketing activities at TEP. The following
factors contributedguidance
issued by the IRS clarifying rules on limitations of the use of net
operating loss carry forwards.
o Expenses of $3 million related to the change in netproposed acquisition of UniSource
Energy.
o UED's income in 2003 included an $11 million pre-tax development fee
received at the financial closing of Springerville Unit 3.
o 2002 compared with 2001:
-results included a pre-tax coal contract termination fee of $11
million. TEP terminated a coal contract related to the Sundt Generating
Station, eliminating annual take-or-pay payments of approximately $3
million.
Change in Net Income, 2002 Compared With 2001
o TEP's wholesale revenues decreased by $556$764 million or 76%, due to significantly
lower prices in the western U.S. energy markets and decreased sales
activity, partially offset by a reduction of $527$738 million or 66%, in fuel and
purchased power expenses.
-o Mild weather and lower demand from TEP's mining customers contributed
to lower retail energy sales and revenues in 2002. Despite these
factors, retail revenues fell only one percent due to continued strong
growth in number of retail customers and increased usage by residential
and commercial customers.
-o TEP recorded a one-time $7an $11 million after-tax coal contract termination fee expense in the third
quarter of 2002, which will relieve TEP of
annual $2 million after-tax take-or-pay payments in future years.
-2002.
o Millennium's after-tax losses were $6$7 million higher in 2002 than 2001
because 2001 results included a $6 million after-tax gain on the sale
of a power project.
-o TEP recognized $5 million in tax benefits from the favorable settlement
of IRS audits and the recognition of tax credits in 2002, and
Millennium recognized $2.5$2 million in tax benefits from the recognition
of foreign tax losses and favorable settlement of IRS audits.
The following factors contributed to the change in net income in 2001
compared with 2000:
- TEP's average number of retail customers grew by 2.5% to 347,099 in
2001 and retail revenues grew by 0.8% to $670 million.
- TEP's wholesale revenues more than doubled due to sales of available
generating capacity, increased trading activities and significantly
higher prices in the western U.S. energy markets in the first half of
2001.
- Interest expense at TEP decreased by 5% due to lower debt balances and
lower rates on variable rate debt.
- Nations Energy sold an independent power project in 2001 for a $6
million after-tax gain.
- TEP recorded a one-time $8 million after-tax expense related to the
amendment of a coal supply contract in the third quarter of 2000.
CONTRIBUTION BY BUSINESS SEGMENT
The table below shows the contributions to our consolidated after-tax
earnings by our threefour business segments, as well as parent company expenses.
2002 2001 2000
--------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------- ------------ ----------- -----------
Business Segment - Millions of Dollars -
TEP (1) $128 $ 54 $ 75
UES (2) 3 - -
Millennium (16) (16) (9)
UED 7 1 1
UniSource Energy Standalone (3) (9) (6) (6)
---------------------------------------------------------------- ------------ ----------- -----------
Consolidated Net Income $113 $ 33 $ 61
================================================================ ============ =========== ===========
(1) TEP results in 2003 include an after-tax gain of Dollars -
Business Segment
TEP $ 53.7 $ 75.3 $ 51.2
Millennium (15.5) (9.2) (4.1)
UED 0.8 0.8 -
UniSource Energy Standalone (1) (5.8) (5.6) (5.2)
--------------------------------------------------------------------
Consolidated Net Income $ 33.2 $ 61.3 $ 41.9
====================================================================
(1) Represents$67 million for
the Cumulative Effect of Accounting Change from the adoption of FAS
143.
(2) Results are for the period from August 11, 2003 to December 31,
2003.
(3) Primarily represents interest expense (net of tax) on the note
payable from UniSource Energy to TEP.TEP,
K-34
as well as costs in 2003 associated with the Citizens acquisition and
the proposed acquisition of UniSource Energy as previously discussed.
LIQUIDITY AND CAPITAL RESOURCES
UNISOURCE ENERGY CONSOLIDATED CASH FLOWS
2003 2002 2001
------------------------------------------- ------------- -------------- --------------
-Millions of Dollars -
Cash provided by (used in):
Operating Activities $ 260 $ 173 $ 215
Investing Activities (351) (271) (117)
Financing Activities 101 (39) (33)
------------------------------------------- ------------- -------------- --------------
Net Increase (Decrease) in Cash $ 10 $ (137) $ 65
=========================================== ============= ============== ==============
UniSource Energy's consolidated cash flows are provided primarily from
retail and wholesale energy sales at TEP and UES, net of the related payments
for fuel and purchased power. Cash from operations is lowest in the first
quarter and highest in the third quarter due to TEP's summer peaking load.
We use our available cash primarily to:
o finance capital expenditures at TEP and UES;
o make investments in our technology affiliates;
o pay dividends to shareholders; and
o reduce leverage at TEP by repaying high coupon debt and investing in
lease debt.
The primary source of liquidity for UniSource Energy, the parent
company, is dividends it receives from its subsidiaries, primarily TEP, from
their cash flow from operations.
Accrued interest on UniSource Energy's promissory note to TEP of
approximately $20 million is payable every two years; the last payment of $20
million was made to TEP in December 2003. Under our tax allocation procedures
our subsidiaries make income tax payments to UniSource Energy, which makes
payments on behalf of the consolidated group.
In August 2003, UniSource Energy used approximately $50 million of its
available cash and borrowed $35 million from a financial institution in the form
of short-term debt to help finance the purchase of the Citizens Arizona electric
and gas utility assets. The funds were used as an equity contribution in the
capitalization of UES. On October 24, 2003, as required by the debt agreement,
UniSource Energy repaid the $35 million loan upon the financial close of the
Springerville Unit 3 project.
As of March 10, 2004, cash and cash equivalents available to UniSource
Energy was approximately $79 million.
In addition, as part of our ACC Holding Company Order, we must invest
at least 30% of any proceeds of UniSource Energy equity issuances in TEP until
TEP's equity reaches 37.5% of total capital (excluding capital leases).
Operating Activities
In 2003, net cash flows from operating activities increased by $87
million compared with 2002. The following factors contributed to the increase:
o receipt of $43 million in proceeds for the financial closing of the
Springerville Unit 3 project;
o a $23 million decrease in income taxes paid due primarily to lower
taxable income;
o an $18 million increase in cash receipts from retail and wholesale
energy customers, net of fuel
K-35
and purchased energy costs, due to warm summer weather, an increase in
TEP's retail customers and energy sales at UES;
o a $16 million increase in income tax refunds of taxes previously paid,
which was received in the fourth quarter of 2003;
o a $9 million increase in interest received due to interest received on
investments in lease debt; and
o a $27 million cash payment made in 2002 to terminate and amend coal
contracts; partially offset by:
o a $17 million increase in interest paid (including capital
lease interest paid), due primarily to higher letter of
credit fees under TEP's Credit Agreement;
o a $17 million deposit by TEP in 2003 with its second mortgage
trustee; and
o a $4 million increase in other taxes paid.
Investing Activities
Net cash used for investing activities was $80 million higher in 2003
than in 2002, primarily due to the following factors:
o $223 million for the acquisition of the Citizens Arizona gas and
electric utility assets; and
o a $25 million increase in capital expenditures at TEP and UES, due in
part to $10 million spent to complete a new one mile 500-kV
transmission line and related substations to enhance TEP's distribution
system link to the regional high-voltage transmission system; partially
offset by:
o a $22 million decline in investments and loans to equity
investees. In 2002, $20 million was invested in Sabinas; and
o In 2002, TEP paid $138 million to purchase Springerville
Lease debt; in 2003, TEP received principal payments related
to its investment in Springerville Lease debt of $12 million.
Financing Activities
Net cash provided by financing activities was $101 million in 2003,
compared with net cash used for financing activities of $39 million in 2002.
o In 2003, UNS Gas and UNS Electric issued $160 million aggregate
principal amount of senior unsecured notes in a private placement to
provide funding for the acquisition of the Citizens' Arizona gas and
electric utility assets.
o TEP retired $23 million more of its capital lease obligations in 2003
than in 2002.
o UniSource Energy paid $3 million more in common stock dividends in 2003
than in 2002.
As a result of the activities described above, our consolidated cash
and cash equivalents increased to $101 million at December 31, 2003, from $91
million at December 31, 2002. At March 10, 2004, our consolidated cash balance,
including cash equivalents, was approximately $79 million. We invest cash
balances in high-grade money market securities with an emphasis on preserving
the principal amounts invested.
In the event that we experience lower cash from operations in 2004, we
will adjust our discretionary uses of cash accordingly. We believe, however,
that we will continue to have sufficient cash flow to cover our capital needs,
as well as required debt payments and dividends to shareholders. Furthermore, we
believe we will have sufficient excess cash flow to continue to make annual
discretionary debt reductions or lease debt
K-36
investments at TEP in the range of $30 - $50 million.
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. We
entered into these agreements primarily to support or enhance the
creditworthiness of a subsidiary on a stand-alone basis. The most significant of
these guarantees are UES' guarantee of $160 million of aggregate principal
amount of senior unsecured notes issued by UNS Gas and UNS Electric to purchase
the Citizens' Arizona gas and electric system assets, UniSource Energy's
guarantee of approximately $22 million in natural gas and supply payments and
building lease payments for UNS Gas and UES, and subsidiaries of Millennium
guarantee of approximately $5 million in commodity-related payments for MEG at
December 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 that UniSource Energy or TEP would be
required to perform or otherwise incur any significant losses associated with
any of these guarantees is remote.
CONTRACTUAL OBLIGATIONS
The following charts display UniSource Energy's consolidated
contractual obligations by maturity and by type of obligation as of December 31,
2003.
- -------------- -------------------------------------------------------------------------------------------------------------------
UniSource Energy's Contractual Obligations
- Millions of Dollars -
- ---------------- ------------ --------- ------------- ------------ -------------- ---------------- ----------------- -------------
Payments
Due IDBs Pension and
in Supported Capital Other Total
Years by Long- Lease Purchase Postretirement Funding Contractual
Ending Expiring Term Obligations Operating Obligations Benefit Commitments Cash
December 31, LOCs(1) Debt (2) Leases (3) Obligations(4) (5) Obligations
- ---------------- ------------ --------- ------------- ------------ -------------- ---------------- ----------------- -------------
2004 $ - $ 2 $120 $ 3 $113 $ 6 $ 4 $ 248
2005 - 2 120 2 97 3 3 227
2006 329 21 123 2 95 4 3 577
2007 - 1 126 2 82 4 1 216
2008 - 89 121 1 82 5 - 298
- ---------------- ------------ --------- ------------- ------------ -------------- ---------------- ----------------- -------------
Total 2004 -
2008 329 115 610 10 469 22 11 1,566
Thereafter - 844 836 6 436 177 - 2,299
Less: Imputed
Interest
- - (633) - - - - (633)
- ---------------- ------------ --------- ------------- ------------ -------------- ---------------- ----------------- -------------
Total $329 $959 $813 $16 $905 $199 $11 $3,232
================ ============ ========= ============= ============ ============== ================ ================= =============
(1) TEP's tax-exempt variable rate bonds (IDBs) in the amount of $329
million are backed by LOCs issued pursuant to TEP's Credit Agreement.
TEP's obligations under the Credit Agreement are collateralized with
Second Mortgage Bonds.
(2) See TEP's Capital Lease Obligations table in Tucson Electric Power
Company, Liquidity and Capital Resources, below.
(3) These obligations represent future minimum payments under open purchase
orders, UES' transmission and gas transportation contracts and TEP's
natural gas, coal and rail transportation contracts. The total amount
paid under these contracts depends on the quantity purchased and
transported. UES and TEP's requirements are expected to be in excess of
these minimums. TEP expects to spend approximately $175 million
annually for the purchase and transportation of coal through 2010. TEP
is unable to estimate how much it will spend under these contracts
beyond 2010 due to the impact of the new Springerville coal contract.
UES and TEP do not have any minimum gas commodity purchase obligations,
and are unable to estimate the amounts payable under the gas and
purchase power contracts due to the variability of gas prices and
customer load and interplay of generation costs and wholesale market
prices. UniSource Energy has not included in the minimum purchase
obligations above amounts payable to PWCC as payments under this
contract are usage based with no fixed demand charges. We expect to
spend approximately $92 million annually under this contract through
May 2008. In addition, 2004 includes $10 million in contingent
transaction fees payable upon the closing of the acquisition of
UniSource Energy by Saguaro Utility.
K-37
(4) These obligations represent TEP and UES' minimum required contributions
to pension plans in 2004 and TEP's expected postretirement benefit
costs to cover medical and life insurance claims as determined by the
plans' actuaries. TEP and UES do not know and have not included pension
contributions beyond 2004 due to the significant impact that returns on
plan assets and changes in discount rates might have on such amounts.
TEP funds the postretirement benefit plan on a pay-as-you-go basis.
(5) These obligations represent Millennium's equity commitments to fund
subsidiaries (Haddington and Valley Ventures) as suitable investments
are identified.
MEG conducts its emissions and coal trading activities using certain
contracts which contain provisions whereby MEG may be required to post margin
collateral due to a change in contract values. As of December 31, 2003, MEG had
posted $0.7 million in cash collateral to its trading counterparties.
MEG has a $5 million bank line of credit for the purpose of issuing
LOCs to counterparties to support its emission allowance and coal marketing and
trading activities. As of December 31, 2003, MEG had $5 million in outstanding
LOCs. This facility expires in March 2005.
In addition, UniSource Energy has contingent obligations under various
surety bonds that total approximately $0.5 million.
We have reviewed our contractual obligations and provide the following
additional information:
o We do not have any provisions in any of our debt or lease agreements
that would cause an event of default or cause amounts to become due and
payable in the event of a credit rating downgrade.
o None of our contracts or financing structures contains provisions or
acceleration clauses due to changes in our stock price.
DIVIDENDS ON COMMON STOCK
On February 6, 2004, UniSource Energy declared a cash dividend of $0.16
per share on its Common Stock. The dividend, totaling approximately $5 million,
was paid March 10, 2004 to shareholders of record at the close of business
February 17, 2004. During 2003, UniSource Energy paid quarterly dividends to its
shareholders of $0.15, totaling approximately $20 million. In 2002, we paid
quarterly dividends of $0.125 per share, totaling approximately $17 million.
The acquisition agreement allows UniSource Energy to continue to pay
regular quarterly cash dividends until the closing of the acquisition, subject
to limitations upon our ability to increase the amount of such dividends.
UniSource Energy's Board of Directors currently expects to continue to pay
regular quarterly cash dividends on UniSource Energy's Common Stock until the
closing of the acquisition, subject, however, to its evaluation of our financial
condition, earnings, cash flows and dividend policy.
INCOME TAX POSITION
At December 31, 2003, UniSource Energy and TEP had, for federal and
state income tax filing purposes, the following carryforward amounts:
----------------------------------- ---------------------------------------- ------------------------ ---------------
UniSource Energy TEP
---------------------------------------- ----------------------------------------
Amount Expiring Amount Expiring
------------------------ --------------- ------------------------ ---------------
-Millions of Dollars- Year -Millions of Dollars- Year
----------------------------------- ------------------------ --------------- ------------------------ ---------------
Net Operating Losses $ 83 2006-2023 $ 59 2006-2009
Investment Tax Credit 9 2004-2023 9 2004-2023
AMT Credit 83 - 80 -
----------------------------------- ------------------------ --------------- ------------------------ ---------------
Of the $83 million in NOL carryforwards, $18 million is subject to
limitation. Due to a reorganization of certain Millennium entities in December,
2002, $18 million of Federal and State net operating losses are subject to
limitation. The future utilization of these losses is dependant upon the
generation of sufficient future taxable income at the separate company level.
See Critical Accounting Policies, Deferred Tax Valuation - TEP and Millennium,
below.
K-38
TUCSON ELECTRIC POWER COMPANY
RESULTS OF TEPOPERATIONS
The financial condition and results of operations of TEP are currently
the principal factors affecting the financial condition and results of
operations of UniSource Energy on an annual basis. The following discussion
relates to TEP's utility operations, unless otherwise noted.
The results of
our unregulated energy businesses are discussed in Results of Millennium
Energy Businesses and Results of UED, below.
UTILITY SALES AND REVENUES
Customer growth, weather and other consumption factors affect retail
sales of electricity. Price changes also contribute to changes in retail
revenues. Electric wholesale revenues are affected by market prices
in the wholesale energy market, availability of TEP generating resources, and
the level of wholesale forward contract activity.
TEP experienced a significant decrease in wholesale energy sales and
revenues during 2002 compared with 2001. Market demand in the western region
declined primarily as a result of mild temperatures, and market prices fell
as a result of increased capacity in the region and declining natural gas
prices, as well as reduced demand. In comparison, during the first five
months of 2001 and the last half of 2000, TEP experienced significant growth
in wholesale energy sales and revenues, primarily due to significantly higher
regional market prices, which increased to unprecedented levels, and
opportunities to sell its excess generating capacity to California and other
western wholesale market participants. However, in June 2001 wholesale
market prices began a steady decline and by 2002, reached levels that were
more consistent with historical prices. By 2002, electric wholesale revenues
comprised only 21% of total revenues, compared with 52% in 2001 and 35% in
2000. TEP's electric wholesale sales consist primarily of four types of
sales:
(1) Sales under long-term contracts for periods of more than one year.
TEP currently has long-term contracts with three entities to sell
firm capacity and energy: SRP, the Navajo Tribal Utility Authority
and the Tohono O'odham Utility Authority. TEP also has a multi-year
interruptible contract with Phelps Dodge Energy Services, which
requires a fixed contract demand of 60 MW at all times except during
TEP's peak customer energy demand period, from July through September
of each year. Under the contract, TEP can interrupt delivery of power
if the utility experiences significant loss of any electric generating
resources.
(2) Forward contracts to sell energy for periods through the end of the
next calendar year. Under forward contracts, TEP commits to sell a
specified amount of capacity or energy at a specified price over a
given period of time, typically for one-month, three-month or one-year
periods.
(3) Short-term economy energy sales in the daily or hourly markets at
fluctuating spot market prices and other non-firm energy sales.
(4) Sales of transmission service.
The table below provides trend information on retail sales by major
customer class and on the four types of electric wholesale sales made by TEP in the last three years.
Sales Operating Revenue
2003 2002 2001 20002003 2002 2001
2000
- ----------------------------------------------------------------------------------------------------------------------------------------- ----------- ------------ ----------- ----------- ----------- -----------
- Millions of kWh - - Millions of Dollars -
Electric Retail Sales:
Residential 3,371 3,189 3,122 3,028$ 307 $ 290 $ 284
$ 276
Commercial 1,679 1,609 1,573 1,497175 168 164
158
Industrial 2,233 2,261 2,271 2,262161 161 162
163
Mining 698 695 1,041 1,14128 28 42
48
Public Authorities 249 258 254 25818 19 18
19
- ----------------------------------------------------------------------------------------------------------------------------------------- ----------- ------------ ----------- ----------- ----------- -----------
Total Electric Retail Sales 8,230 8,012 8,261 8,186689 666 670
664
- ----------------------------------------------------------------------------------------------------------------------------------------- ----------- ------------ ----------- ----------- ----------- -----------
Electric Wholesale Sales Delivered:
Forward Contracts 983 3,546 2,612 32 480 129
Long-term Contracts 981 1,219 1,234 51 52 52
Short-term1,199 982 1,218 31 29 24
Other Sales and Other 2,567 1,968 2,363 91 198 1742,165 3,035 5,515 115 125 705
Transmission - - - 6 4 4
5Net Unrealized Gain
(Loss) on Forward Sales of Energy
- ------------------------------------------------------------------------------------------------ - (1) (1) 188
------------------------------------------ ----------- ------------ ----------- ----------- ----------- -----------
Total Electric Wholesale Sales 4,5313,364 4,017 6,733 6,209 178 734 360
- -----------------------------------------------------------------------------------------------151 157 921
------------------------------------------ ----------- ------------ ----------- ----------- ----------- -----------
Total 12,54311,594 12,029 14,994 14,395 $ 844 $1,404 $1,024
===============================================================================================840 $ 823 $1,591
========================================== =========== ============ =========== =========== =========== ===========
2003 Compared with 2002
Total retail kWh sales in 2003 increased by 3% compared with 2002. Hot
summer weather and a 2.2% increase in the number of retail customers more than
offset mild weather during the first six months of 2003. Cooling degree days
increased by 9% in 2003 compared with 2002, and were up 8% compared with the
10-year average. Kilowatt-hour sales to residential customers were up 6% and kWh
sales to commercial customers were up 4% in 2003, resulting from customer growth
and warmer weather compared with a year ago. Revenue from sales to retail
customers increased by 3% in 2003, reflecting higher kWh demand.
Electric wholesale revenues delivered decreased by 4% in 2003. The 4%
decline in wholesale revenues is not as large as the 16% decline in wholesale
kWh sales due to higher average power prices. Average-around-the-clock energy
prices based on the Dow Jones Palo Verde Index for 2003 were $42 per MWh
compared with $27 per MWh during 2002, reflecting higher gas prices. Planned and
unplanned outages at TEP's coal-fired generating plants, particularly in the
first six months of 2003, reduced opportunities to sell excess power in the
wholesale markets. In addition, the increase in the regional supply of
gas-generated energy caused TEP to decrease use of its less efficient gas
generation units for wholesale market opportunities.
In addition, wholesale revenues were reduced by a $2 million reserve
for doubtful accounts recorded in the first quarter related to wholesale sales
made to the California Independent System Operator (CISO) and the California
Power Exchange (CPX) in 2001 and 2000. See Payment Defaults and Allowances for
Doubtful Accounts, below.
K-39
2002 Compared with 2001
-----------------------
TEP's average number of retail customers increased by 2.4% to 355,486,, while kWh
sales to retail customers decreased by 3.0% in 2002 compared with
2001.3%. This decrease in kWh energy sales was
primarily due to a 33% reduction in sales to copper mining customers. SalesKWh sales to
residential, commercial and
non-mining industrial customers as a group actually increased by 1.3%1% in
2002, despite milder temperatures in 2002. Cooling Degree Days decreased 3%
for the year, and also decreased slightly when compared with the 10-year
average. Heating Degree Days decreased 16% for 2002 and 4% compared with the
10-year average. Revenue from sales to retail customers decreased only
slightly in 2002 compared with 2001, reflecting the increased kWh sales to
non-mining customers.temperatures.
Electric wholesale sales decreased by 33% in 2002 compared with 2001
while revenues decreased by
76%83%. The decreaseA decline in revenue resulted from
decreased sales activity and the sharp decline in market prices from those in
2001.were contributing factors.
The average market price for around-the-clock energy decreased $67 per MWh,
compared with 2001. Factors contributing to the lower market prices included
more generation online in the western U.S., lower natural gas prices, increased
hydropower supply, and weaker demand. Sales and revenues from forward contracts
experienced the largest declines, reflecting lower demand and lower market
prices in the forward energy markets.declines. Short-term sales were higher, however, due to
sales of excess energy in the daily and hourly markets.
OPERATING EXPENSES
2003 Compared with 2002
Fuel and Purchased Power Expense
Fuel expense at TEP's generating plants was approximately $210 million
in both 2003 and 2002. Despite running its gas-fired generation less in 2003,
fuel expense remained the higher short-term sales volumes, revenues from short-term sales were
significantly lower in 2002same due to the lower average market prices. Factors
contributing to the lower market prices include more generation online in the
western U.S., lower naturalhigher gas prices increased hydropower supply, and weaker demand.
2001 Compared with 2000
-----------------------higher output from
TEP's coal-fired generation.
The table below shows the average cost per kWh sales to retail customers increasedfor TEP's generating
plants by 1% in 2001 compared
with 2000, despite a 2.5%fuel type.
2003 2002 2001
- -------------------- ---------- ---------- -----------
-cents per kWh-
Coal 1.65 1.65 1.65
Gas 7.40 4.45 7.05
All fuels 1.87 1.83 2.13
- -------------------- ---------- ---------- -----------
The increase in the average numberregional supply of retail customersnew gas-generated energy and the
completion of a 500-kV transmission connection allowed TEP to 347,099. Salesdecrease use of
its older, less efficient gas generation units in favor of more economical
purchases of energy in the wholesale market. TEP's Purchased Power expense
increased approximately $22 million, or 51%, in 2003. In addition to mining customers decreased by 9%, offset by increased
sales to residential and commercial customers. The decrease in mining
consumption isenergy
purchases made during the third quarter of 2003, TEP purchased replacement power
during the first half of 2003 due to cutbacksplanned and unplanned outages at some of
its generating facilities.
Other Operating Expenses
Other Operations and Maintenance expense increased by $6 million, or
4%, in production by both2003 primarily attributable to unplanned outages and longer-than-expected
planned outages at some of TEP's large mining
customersgenerating facilities during the first quarter
of 2003.
Depreciation and Amortization expense decreased $3 million in response to lower copper prices. Milder summer temperatures
also reduced demand by retail customers. Cooling Degree Days decreased by 4%2003. The
adoption of FAS 143 in 2001, from 1,552 to 1,484 days. Revenue from sales to retail customersthe first quarter of 2003 resulted in a $6 million
decrease because asset retirement costs are no longer recorded as a component of
depreciation expense. See Critical Accounting Policies, Accounting for Asset
Retirement Obligations, below.
Amortization of the Transition Recovery Asset (TRA) increased by 1%$7
million in 20012003 compared with 2000, reflecting2002. Amortization of the slight increase in
consumption.
Kilowatt-hour electric wholesale sales increased by 8% in 2001 compared
with 2000, while revenues increased by 104%. The largest increase in sales
and revenues was in forward contracts, which represents increased purchase
and resale transactions. Revenues also increased as aTRA is the result of the
settlement1999 Settlement Agreement (TEP Settlement Agreement) with the ACC, which changed
the accounting method for TEP's generation operations. This item reflects the
recovery, through 2008, of sales contracts thattransition recovery assets which were established when market prices were
higher earlierpreviously
regulatory assets of the generation business. The amount of amortization is a
function of the TRA balance and total kWh consumption by TEP's distribution
customers.
K-40
The table below shows estimated TRA amortization and unamortized TRA
balances for 2004-2008.
Future Estimated Unamortized
TRA Amortization TRA Balance
-Millions of Dollars-
- ---------- ----------------------------------------------
2004 $ 46 $ 229
2005 53 176
2006 62 114
2007 71 43
2008 43 -
- ---------- ----------------------- ----------------------
Other Income (Deductions)
TEP's income statement includes inter-company Interest Income of $10
million for 2003, and $9 million for 2002. This represents Interest Income on
the promissory note TEP received from UniSource Energy in exchange for the
year. Short-term economy salestransfer to UniSource Energy of its stock in the dailyMillennium in 1998. On UniSource
Energy's Consolidated Statement of Income, this Interest Income, as well as
UniSource Energy's related interest expense, is eliminated as an inter-company
transaction. Interest Income remained unchanged between 2003 and hourly
markets at higher market prices made it economical for TEP to run its gas
generation units to produce energy to sell to other regional utilities and
marketers during the first six months of 2001. Although kWh sales2002.
Interest Expense
Long-Term Debt Interest Expense increased by $11 million, or 17%, in
the
short-term economy markets were lower in 2001 than 2000, revenues from these
sales were higher,2003 due to higher average market pricesLetter of Credit fees under TEP's Credit Agreement entered
into in 2001. Factors
contributing to the higher market prices include increased demandNovember, 2002. Interest on Capital Leases decreased $4 million in 2003
due to populationscheduled repayments of lease debt.
Income Tax Expense
Income Tax Expense, before Cumulative Effect of Accounting Change,
decreased $15 million in 2003 compared with 2002, due primarily to a $15 million
tax benefit resulting from guidance issued by the IRS clarifying rules on
limitations of the use of net operating loss carry forwards.
Cumulative Effect of Accounting Change
TEP adopted FAS 143 on January 1, 2003 and economic growthrecorded a one-time $67
million after-tax gain. Upon adoption of FAS 143, TEP recorded an asset
retirement obligation of $38 million at its net present value of $1 million;
increased depreciable assets by $0.1 million for asset retirement costs,
reversed $113 million of costs previously accrued for final removal recorded in
accumulated depreciation, and reversed previously recorded deferred tax assets
of $44 million. Adopting FAS 143 results in a reduction to depreciation expense
charged throughout the region, higher natural gas prices,
dysfunctionyear as well because asset retirement costs are no longer
recorded as a component of depreciation expense. For the year 2003, the
reduction in the California marketplace, increased maintenance outages due
to higher than normal operating levels, lower availability of hydropower
resources, transmission constraints, and environmental constraints.
OPERATING EXPENSESdepreciation expense is approximately $6 million. See Critical
Accounting Policies, Accounting for Asset Retirement Obligations, below.
2002 Compared with 2001
-----------------------
Fuel and Purchased Power expenses decreased by $527 million, or 66%, in
2002 compared with 2001.Expense
Fuel expense at TEP's generating plants decreased by $49 million, or
19%, in 2002 primarily attributable to lower wholesale demand, which resulted in
decreased natural gas usage for generation, and
lower gas purchase prices.generation. Contributing to higher gas purchase pricesfuel expense
in 2001 was approximately $9 million in costs associated with two gas swap
agreements entered into in May 2001 to hedge the risk of price fluctuation. Fuel
expense in 2002 included $2.3 million related to an arbitration ruling that
increased the price of coal purchased between 1997 and May 2002 for the Navajo
Generating Facility. The average cost of fuel per kWh generated was
1.83 cents in 2002See Item 7A. - Quantitative and 2.12 cents in 2001. SeeQualitative Disclosures
about Market Risks - Commodity
Price Risk.Risk, below.
Purchased Power expense decreased by $478$688 million, or 88%94%, due
principally to decreased volume of wholesale forward contract activity and
significantly lower wholesale prices. In the third quarter of 2001, TEP incurred approximately $12
million in additional costs from several forward purchase contracts that were
entered into in May 2001 to assure service reliability in the summer months. TEP
paid an average price of $186 per MWh for
K-41
those forward contracts in 2001. TEP entered into similar contracts in 2002 at
an average price of $37 per MWh. Forward purchase contract activity decreased
corresponding with the reduction in forward sales activity discussed above.
Other Operating Expense
TEP recorded an $11 million (pre-tax) charge in the third quarter of
2002 as a result of terminating the IrvingtonSundt long-term coal supply agreement. This
expense will be mitigatedis off-set by TEP not being required to makethe elimination of future take-or-pay payments of up to $3.5$3
million annually. In July 2002, TEP
reversed the $2.4 million accrued portion of the 2002 take-or-pay penalty.
Despite the large decreases in Fuel and Purchased Power expenses, TEP's
gross margin (Operating Revenue less Fuel and Purchased Power expense)
decreased by $30 million or 5% in 2002 compared with 2001. This decline was
primarily due to decreased sales volumes and lower prices in the wholesale
energy markets.
Other Operations and Maintenance expense increased by $5 million, or
3%, in 2002 compared with 2001, due primarily to a $2 million increase in pension and
post-retirement medical benefit costs and maintenance at the Four Corners and
Springerville generating stations.
Depreciation and Amortization expense increased by $7 million, or 6%,
in 2002 compared with 2001. Depreciation expense increased due to depreciation
of solar generating facilities and a $125 million increase in the depreciable
asset base, which represents: (i) new line extensions to support new business,
(ii) the addition of a 75 MW gas turbine placed in-service in June 2001, and
(iii) routine improvements to TEP's system. These increases were partially
offset by reduced depreciation resulting from a change in the second quarter of
2002 to increase the estimated useful lives of gas-fired generating units and
internal combustion turbines located in Tucson. See Note 69 of Notes to
Consolidated Financial Statements. See Critical
Accounting Policies, below, for expected changes to depreciation expense
resulting from adopting Statement of Financial Accounting Standards No. 143
(FAS 143), Accounting for Asset Retirement Obligations.
Amortization of Transition Recovery AssetStatements - Utility Plant and Jointly-Owned Facilities.
TRA amortization increased by $3 million or
14%, in 2002 compared with 2001.
The Transition Recovery Asset (TRA) and its
related amortization result from the Settlement Agreement reached with the
ACC in 1999. The Amortization of Transition Recovery Asset totaled $25
million in 2002, up from $22 million in 2001. Amortization amounts are
scheduled to increase annually until the entire TRA has been amortized, no
later than December 31, 2008. The monthly amount of amortization recorded is
a function of the remaining TRA balance and total retail kWh consumption by
TEP distribution customers.
2001 Compared with 2000
-----------------------
Fuel and Purchased Power expenses increased by $354 million, or 79%, in
2001 compared with 2000. Fuel expense at TEP's generating plants increased
by $19 million, or 8%, primarily because of higher natural gas prices and
increased usage of gas generation to meet increased kWh sales in the first
five months of 2001. This increase was partially offset by decreased usage
of gas generation in the last half of the year, as wholesale market prices
fell, making it less economical for TEP to run its gas generation units to
produce energy to sell to other regional utilities and marketers. Gas
expense also includes the new gas-fired peaking units, which went in-service
in June 2001, and the $9 million additional cost associated with gas swap
agreements we entered into in May 2001. The average cost of fuel per kWh
generated was 2.12 cents in 2001 and 2.01 cents in 2000. See Market Risks,
Commodity Price Risk.
Purchased Power expense increased by $335 million, or 161%, because of
higher wholesale energy prices and increased purchases in the forward and
spot energy markets to resell to wholesale customers. Purchased Power
expense remained high, even after wholesale market prices began to fall in
June 2001, due to the settlement of wholesale energy purchase contracts,
which were established when forward power prices were higher. Also, in May
2001, TEP entered into several forward purchase contracts to assure service
reliability in the summer months and to mitigate the risk of the potential
loss of 110 MW under an exchange agreement with SCE. The additional cost to
assure service reliability was approximately $12 million.
TEP recorded a $13 million pre-tax ($8 million after-tax) one-time
charge in the third quarter of 2000 as a result of a coal supply contract
amendment related to the San Juan Generating Station. See Note 10 of Notes
to Consolidated Financial Statements.
Despite the large increases in Fuel and Purchased Power expenses, TEP's
gross margin (Operating Revenue less Fuel and Purchased Power expense)
improved by $27 million or 5% in 2001 compared with 2000. This improvement
was primarily due to increased sales volumes and higher prices in the
wholesale energy markets.
Other Operations and Maintenance expense decreased by $4 million, or 3%
in 2001 compared with 2000. TEP established a reserve in 2000 for wholesale
energy sales to California, $7 million of which was recorded as an expense.
In contrast, in 2001, TEP recorded an additional reserve of $7 million in the
first quarter of 2001, of which $5 million was charged to expense, but
reversed $8 million in December. See Note 11 of Notes to Consolidated
Financial Statements. Various other production expenses increased by $4
million and maintenance expense increased by $2 million in 2001 compared with
2000. The higher Maintenance expense is the result of scheduled maintenance
at the Irvington, Springerville Unit 2 and San Juan generating plants.
The Amortization of Transition Recovery Asset totaled $22 million in
2001, up from $17 million in 2000.
INTEREST INCOMEIncome (Deductions)
TEP's income statement for both 2002 and 2001 includes interest income
of $9 million on its promissory note from UniSource Energy.
See Note 1 of
Notes to Consolidated Financial Statements - Nature of Operations and Summary
of Significant Accounting Policies-Basis of Presentation. On UniSource
Energy's consolidated income statement, this income is eliminated as an
intercompany transaction.
Other Interest Income was $8 million higher in 2002 compared with 2001
due to interest received
on TEP's additional $132 million investment in Springerville lease debt in 2002.
Other Interest Income was higher in 2001 compared with 2000 due to
higher average cash balances and increased interest income on investments in
Springerville Unit 1 Lease Debt.
INTEREST EXPENSEExpense
Interest Expense was $5 million, or 3% lower in 2002 than in 2001 due
to lower average interest rates on variable rate tax-exempt debt and lower debt
balances.
In 2001, InterestIncome Tax Expense was $8 million or 5% lower than in 2000
for the same reasons. See TEP Credit Agreement, below, for the impact of
TEP's new Credit Agreement on future interest expense.
INCOME TAXES
Income taxes decreased $21 million in 2002 compared with 2001 due
primarily to lower pre-tax income, a $4$1 million tax benefit from the reduction
of the valuation allowance and the favorable settlement of an IRS audit in the
third quarter of 2002, and $2$4 million in tax credits recognized in 2002.
Income taxes increased $29 million in 2001 compared with 2000 as a
result of higher pre-tax income and the recognition of $6 million in tax
benefits in the second quarter of 2000 from the resolution of various IRS
audits.
See Note 1015 of Notes to Consolidated Financial Statements - Commitments
and Contingencies.
RESULTS OF MILLENNIUM ENERGY BUSINESSES
The table below provides a breakdown of the net income and losses
recorded by the Millennium Energy Businesses for the last three years. These
results exclude sales and related costs to TEP.
2002 2001 2000
- -------------------------------------------------------------------------------------------------
- Millions of Dollars -
Energy Technology Investments
Global Solar and IPS
Research & Development Contract Revenues from Third Parties $ 1.1 $ 1.7 $ 3.6
Research & Development Contract Expenses and Losses (3.4) (4.6) (4.9)
Research & Development - Internal Development Expenses (3.8) (4.0) (2.8)
Depreciation & Amortization Expense (2.9) (2.1) (1.0)
Administrative & Other Costs (13.2) (8.3) (4.5)
Income Tax Benefits 8.9 6.7 3.6
- -------------------------------------------------------------------------------------------------
Total Global Solar and IPS Net Loss (13.3) (10.6) (6.0)
MicroSat and ITN Energy Systems Inc. Net Loss (0.6) (3.3) -
- -------------------------------------------------------------------------------------------------
Total Energy Technology Investments Net Loss (13.9) (13.9) (6.0)
Nations Energy Net Income 0.4 4.5 0.7
Other Millennium Investments Net (Loss) Income (2.0) 0.2 1.2
- -------------------------------------------------------------------------------------------------
Total Millennium Loss, after-tax $(15.5) $ (9.2) $ (4.1)
=================================================================================================
Energy Technology Investments
-----------------------------
Global Solar is primarily engaged in the development of thin-film
flexible photovoltaic material. These products are designed to be
lightweight and durable. Thin-film photovoltaic cells can be used for
military, commercial and space applications. IPS' business focus is the
development of thin-film solid state rechargeable batteries. Thin-film
batteries are intended to be used in various products including medical
devices, "smart cards" and semi-conductors. Global Solar's research and
development costs, the costs of refining Global Solar's manufacturing
processes to increase efficiency, and administrative costs all contributed to
Global Solar and IPS' after-tax losses of $13.3 million, $10.6 million and
$6.0 million in 2002, 2001 and 2000, respectively. In 2002 and 2001,
Millennium recorded after-tax losses relating to MicroSat and ITN Energy
Systems Inc. (ITN) of $0.6 million and $3.3 million, respectively. These
losses are related to the development of small-scale satellites and other
research and development activities.
Nations Energy
--------------
Nations Energy had minimal activity in 2002 as it is attempting to sell
its remaining investment, an interest in a project in Panama with a book
value of less than $1 million.
In 2001, Nations Energy sold its investment in a power project in
Curacao, resulting in an after-tax gain of $6 million. Nations Energy
received a promissory note as part of the sale. See Market Risks, Credit
Risk, below.
In 2000, Nations Energy sold a minority interest in a power project in
the Czech Republic for a pre-tax gain of $3 million. During 2000, Nations
Energy recorded decreases of $3 million in the market value of its Panama
investment. This was offset by a tax benefit of $3 million recorded in 2000
related to market value adjustments on the Panama investment.
Other Millennium Investments
----------------------------
Results from Other Millennium Investments in 2002 include an after-tax
loss of $2.2 million from Powertrusion. Powertrusion's efforts have been
focused on development and sale of lightweight utility pole products. MEG,
SES and TruePricing, Inc. (TruePricing), each recorded after-tax losses of
less than $1 million. These losses were offset by earned interest and a tax
benefit from final resolution of IRS audits.
In 2000, Millennium recorded net income of $1 million from interest
income on a note receivable received as part of the sale of NewEnergy to AES
Corporation in 1999.
RESULTS OF UED
UED, established in February 2001, recorded a net profit of $0.8 million
in both 2002 and 2001. This income represents rental income, less expenses,
under the operating lease of a 20 MW gas turbine to TEP through September
2002, when TEP purchased the turbine from UED. This rental income was
eliminated from UniSource Energy's consolidated after-tax earnings as an
intercompany transaction.
INCOME TAX POSITION
- -------------------
At December 31, 2002, UniSource Energy and TEP had, for consolidated
federal income tax filing purposes:
- $21 million of NOL carryforwards expiring in 2006 through 2009;
- $6 million of unused ITC expiring in 2003 through 2022; and
- $91 million of Alternative Minimum Tax credit that will carry forward
to future years.
We have recorded deferred tax assets and valuation allowances related to
these amounts. See Note 12 of Notes to Consolidated Financial Statements-
Income Taxes.
Due to the issuance of common stock to various creditors of TEP in 1992,
a change in TEP ownership was deemed to have occurred for tax purposes in
December 1991. As a result, TEP's use of the NOL and ITC generated before
1992 is limited under the tax code. At December 31, 2002, pre-1992 federal
NOL and ITC carryforwards which are subject to the limitation were
approximately $21 million and $4 million, respectively. See Critical
Accounting Policies Deferred Tax Valuation, below.
ASSET PURCHASE AGREEMENTS
- -------------------------
On October 29, 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase
by UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million in cash. The purchase price of each
is subject to adjustment based on the date on which the transaction is closed
and, in each case, on the amount of certain assets and liabilities of the
purchased business at the time of closing. 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
FERC and the SEC under the Public Utility Holding Company Act of 1935, as
amended. The closing is also subject to the filing of the requisite
notification with the Federal Trade Commission and the Department of Justice
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and other
customary closing conditions.
The Asset Purchase Agreements are subject to termination if the closing
has not occurred within 15 months of the date of the Asset Purchase
Agreements (subject to extension in limited circumstances), if a governmental
authority seeks to prohibit the transactions, if required regulatory
approvals are not obtained with satisfactory terms and conditions, or if
either party is in material breach and such breach is not cured. If one
Asset Purchase Agreement is terminated, the other will also be automatically
terminated. If the Asset Purchase Agreements are terminated by Citizens due
to UniSource Energy's breach, UniSource Energy must pay to Citizens a $25
million termination fee as liquidated damages. If the Asset Purchase
Agreements are terminated by UniSource Energy due to Citizen's breach,
Citizens must pay to UniSource Energy a $10 million termination fee as
liquidated damages. The termination fees are also payable in certain other
limited circumstances.
Citizens had two cases pending before the ACC requesting rate relief for
both the Arizona electric and Arizona gas assets prior to entering into the
Asset Purchase Agreements with UniSource Energy. The requested electric rate
increase is to recover purchased power costs and the gas rate increase is a
base rate increase. In December 2002, UniSource Energy and Citizens filed a
Joint Application with the ACC requesting smaller increases in both pending
cases. Under the proposal, UniSource Energy asked that the 45% electric rate
increase requested by Citizens be reduced to 22%, and that the 29% increase
in gas rates be reduced to 23%. UniSource Energy believes that the smaller
proposed rate increases are sufficient in light of the discounted purchase
price. We are currently in settlement discussions with the ACC Staff and
intervenors regarding the Joint Application. The ACC Administrative Law
Judge (ALJ) set a hearing date of May 1, 2003 for this matter. We currently
anticipate the ACC to review this case and issue a decision by June 2003.
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. See Liquidity and Capital
Resources, Financing Activities, TEP Credit Agreement, below. UniSource
Energy may also consider financing a portion of the purchase with new equity,
depending on market conditions and other considerations. UniSource Energy
expects to form a new subsidiary to hold the purchased assets. This new
subsidiary will maintain a separate rate structure from TEP. 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.
FACTORS AFFECTING RESULTS OF OPERATIONS
- ---------------------------------------
COMPETITION
The electric utility industry has undergone significant regulatory
change in the last few years designed to encourage competition in the sale of
electricity and related services. However, the recent experience in California
with deregulation has caused many states, including Arizona, to step back and reexaminere-examine the
viability of retail electric deregulation.
As of January 1, 2001, all of TEP's retail customers wereare eligible to
choose an alternate energy supplier. Although there is one ESPEnergy Service
Provider (ESP) certified to provide service in TEP's retail service area,
currently none of TEP's retail customers have opted to receiveare receiving service from this ESP.
TEP has met all conditions required by the ACC to facilitate electric retail
competition, including obtaining ACC approval of TEP's direct access tariffs. ESPs must
meet certain conditions before electricity can be sold competitively in TEP's
service territory.
K-42
Examples of these conditions include ACC certification of
ESPs, and execution of and compliance with direct access service agreements with
TEP.
On January 27, 2004, the Arizona Court of Appeals issued a decision
that resolved challenges to the ACC's Retail Electric Competition Rules. The
Court determined that certain rules established by the ACC relating to the entry
of new competitive electric service providers into the market were invalid. The
ultimate impact on TEP's Settlement Agreement is not known. A Motion for
Reconsideration was filed by Arizona Electric Power Coopertive (AEPCO) and
Duncan Valley Electric Cooperative (Duncan Valley), and a separate Motion for
Reconsideration was filed by Trico Electric Cooperative (Trico). A Motion for
Reconsideration is a prerequisite to filing an appeal. AEPCO generates and
transmits electricity for its members in Arizona and California. Duncan Valley
and Trico provide electric service to rural areas in Arizona.
TEP also competes against gas service suppliers and others whothat provide
energy services. Other forms of energy technologies such as fuel cells, may provide competition to
TEP's services in the future, but to date, are not financially viable
alternatives.alternatives for its retail customers. Self-generation by TEP's large industrial
customers could also provide competition for TEP's services in the future, but
has not had a significant impact to date.
In the wholesale market, TEP competes with other utilities, power
marketers and independent power producers in the sale of electric capacity and
energy.
INDUSTRY RESTRUCTURING
RETAIL
TEP's Settlement Agreement and Retail Electric Competition Rules
----------------------------------------------------------------
In September 1999, the ACC approved Rules that provided a framework for
the introduction of retail electric competition in Arizona. In November
1999, the ACC approved the Settlement Agreement between TEP and certain
customer groups relating to the implementation of retail electric
competition, including TEP's recovery of its transition recovery assets and
the unbundling of tariffs. See Note 2 of Notes to Consolidated Financial
Statements for more information on TEP's Settlement Agreement.
The Settlement Agreement originally required TEP to transfer its
generation and other competitive assets to a wholly-owned subsidiary by
December 31, 2002. The Settlement Agreement also required that by December
31, 2002, TEP as the Utility Distribution Company (UDC) would acquire at
least 50% of its requirements through a competitive bidding process, while
the remainder may be purchased under contracts with TEP's generation
subsidiary or other energy suppliers. These requirements were amended by the
September 2002 ACC order described below.
Recent Developments in the Arizona Regulatory Environment
---------------------------------------------------------
In February 2002, the ACC consolidated several retail competition
proceedings to reexamine circumstances that had changed since the ACC
approved the Rules in 1999. The outstanding issues were divided into two
groups-"Track A" and "Track B" issues. Track A related primarily to the
divestiture of generation assets while Track B related primarily to the
competitive energy bidding process.
On September 10, 2002, the ACC issued the Track A Order, which
eliminated the requirement that TEP transfer its generating assets to a
subsidiary. At the same time, the ACC ordered the parties, including TEP, to
develop a competitive bidding process, and reduced the amount of power to be
acquired in the competitive bidding process to only that portion not supplied
by TEP's existing resources.
On February 27, 2003, the ACC issued the Track B Order, which defines
the process by which TEP will be required to obtain its capacity and energy
requirements beyond what is supplied by TEP's existing resources. For the
period 2003 through 2006, TEP estimates the amount it will be required to
bid for is 50,000 MWh of energy in 2003, or approximately 0.5% of its retail
load, gradually increasing to 104,000 MWh by in 2006.
TEP is also required to bid out its Reliability Must Run (RMR)
generation requirements, amounting to 758 MW of capacity and 183,000 MWh of
energy in 2003, and increasing to 898 MW and 276,000 MWh in 2006. TEP's RMR
generation requirements are currently met by its existng local generation
units. TEP does not anticipate that any near-term RMR requirements will be
met through this competitive bidding process because of the locational and
operational restrictions of TEP's RMR requirements as well as TEP's belief
that its existing RMR generation solutions are economically sound.
The Track B Order further requires TEP to bid out "Economy Energy", or
short-term energy purchases, that it estimates it will make in the 2003 to
2006 period (210,000 to 181,000 MWh). TEP will then evaluate if purchases
through this process will provide a better economic result than purchases
made as needed in the short-term markets.
TEP is not required to purchase any power through this process that it
deems to be uneconomical, unreasonable or unreliable. The Track B bidding
process will involve the ACC Staff and an independent monitor. The Track B
Order also confirms that it is not intended to change the current rate-base
status of TEP's existing assets.
TEP expects to issue requests for proposals in March 2003 and complete
the selection process by June 1, 2003.
As part of its reexamination of the Rules, the ACC had planned to
address the requirement for Arizona electric utilities to participate in the
Arizona Independent Scheduling Administrator (AISA) organization. The Rules
originally required the formation and implementation of the AISA; however,
the ACC opened a docket in July 2001 to revisit this obligation. This issue
is pending and will be addressed separately from the issues identified above.
The status of the Rules and the ability of ESPs to continue to sell
competitive services may also be subject to change due to recent court
proceedings. Several parties, including certain rural electric cooperatives
(Cooperatives), filed lawsuits in Maricopa County Superior Court challenging
the Rules. In November 2000, the Court found the Rules to be
unconstitutional and unlawful due to failure to establish a fair value rate
base for ESPs and because certain Rules were not submitted to the Arizona
Attorney General for certification. The decision was appealed to the Court
of Appeals and implementation of the judgment was stayed and the Rules remain
in effect pending the outcome of the appeals.
TEP cannot predict the effect of the recent court decision or the
outcome of these appeals to which it is a party or the effect of the
judgment, if affirmed upon appeal, on the introduction of retail electric
competition in Arizona.
State and Federal Legislation
-----------------------------
In the current session, the state legislature will address a power plant
valuation proposal that will clarify the valuation methodology of centrally
assessed generation facilities and may affect TEP's property tax expense.
The Congress will debate the President's Clear Sky Initiative which
proposes a new regulatory regime for controlling power plant emissions. The
Congress will also consider legislation that proposes to expand the
regulatory authority of EPA in the area of carbon dioxide. Proposed Federal
energy legislation has considered the implementation of a national renewable
portfolio standard of 10% of retail energy sold by certain utilities.
WESTERN ENERGY MARKETS
As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes affecting these marketsin market conditions and market
participants. In 2000TEP competes with other utilities, power marketers and 2001, a significant portion of TEP's
revenues and earnings resulted from its wholesale marketing activities, which
benefited from strong demand and high wholesale pricesindependent
power producers in the western U.S.
These market conditions weresale of electric capacity and energy at market-based
rates in the wholesale market.
As of the end of 2003, electric generating capacity in Arizona has
grown to approximately 25,000 MW; an increase of more than 60% since 2000. A
majority of the growth over the last three years is the result of 19 new or
upgraded gas-fired generating units with a numbercombined capacity of factors, including
power supply shortages, high natural gas prices, transmission, and
environmental constraints. During this period, these markets experienced
unprecedented price volatility, as well as payment defaults and bankruptcies
by several of its largest participants. Regulatory agencies became concerned
with the outcomes of deregulation of the electric power industry and
intervened in the operation of these markets.
In the last 18 months, conditions in the western energy markets have
changed significantly as a result of various regulatory actions, moderate
weather, a decrease in natural gas prices, the addition of new generation in
the region, and the slowdown of the regional economy.approximately
9,300 MW. In addition, the presence of fewer creditworthy counterparties, as
well as legal, political and regulatory uncertainties, havehas reduced market
liquidity and trading volume.
Several companies that were large market participants have either
curtailed their activities or exited the business completely. These factors
placed downward pressure on wholesale electricity prices, and resulted in
significantly lower wholesale electricity sales and revenues at TEP in 2002.
Market Prices
-------------
The chart below shows the quarterly and annual average market prices in
2002, 2001, and 2000price for around-the-clock energy based on the Dow
Jones Palo Verde Index:Index increased in 2003 compared with 2002, as did the average
price for natural gas based on the San Juan Index. Average market prices for
around-the-clock energy began to rise in February 2003 due to increased demand
and higher natural gas prices resulting from low gas storage levels resulting
from colder temperatures in other regions of the U.S. and reduced gas
production. Reduced hydropower supply in the western U.S. also contributed to
the higher market prices. As a result of all these factors, TEP's natural gas
and purchased power expenses were higher in 2003 than in 2002. Prices have
continued in this range to date; however, we cannot predict whether these higher
prices will continue, or whether changes in various factors that influence
demand and supply will cause prices to fall during 2004.
Average Market Price for Around-the-Clock Energy 2002 2001 2000
--------------------------------------------------------------------------
$/MWh
------------------------------------------------------------------ -------------
Quarter ended March 31, $24 $178 $ 27
Quarter ended June 30, 24 135 65
Quarter ended September 30, 28 40 124
Quarter ended December 31, 31 23 129
Year2003 $38
Quarter ended December 31, 26 94 86
--------------------------------------------------------------------------2002 32
12 months ended December 31, 2003 41
12 months ended December 31, 2002 27
------------------------------------------------------------------ -------------
Beginning
Average Market Price for Natural Gas $/MMBtu
------------------------------------------------------------------ -------------
Quarter ended December 31, 2003 $4.05
Quarter ended December 31, 2002 3.31
12 months ended December 31, 2003 4.42
12 months ended December 31, 2002 2.63
------------------------------------------------------------------ -------------
K-43
TEP typically uses its generation from its facilities fueled by natural
gas to meet the summer peak demands of its retail customers and to meet local
reliability needs. Due to its increasing seasonal gas usage, TEP hedges a
portion of its natural gas purchases with fixed price contracts for a maximum of
three years, and purchases its remaining gas needs in the spot and short-term
markets through its supplier Southwest Gas Corporation (SWG). TEP entered into a
Gas Procurement Agreement with SWG effective June 1, 2001 average market prices declined sharply,
returning to historical price levels throughout 2002. Inwith a primary term of
five years. The contract provided for a minimum volume obligation during the
first quartertwo years of 2003, however, both the natural10 million MMBtus annually. TEP negotiated new pricing and a
lower minimum annual volume obligation of 4 million MMBtus for 2004 and expects
to burn more gas and western U.S. wholesale electricity
markets have experienced some price spikes and volatility due to severe
winter weather in certain regions, as well as high gas storage withdrawals
due to lagging production. As of March 2003, the average forward around-the-
clock market pricethan this minimum requirement. TEP will negotiate terms for the
balanceremaining two years of the yearcontract in late 2004. TEP made payments under this
contract of $34 million in 2003, was approximately $51 per
MWh, based on forward broker market quotes. TEP cannot predict, however,
whether average wholesale electricity prices will remain higher than$33 million in 2002 and what the impact will be on TEP's sales and revenues$28 million in 2003.
TEP expects2001.
We expect the market price and demand for capacity and energy to
continue to be influenced by the following factors among others, during the
next few years:
-including:
o weather;
o continued population growth in the western U.S.;
-o economic conditions in the western U.S.;
-o availability of generating capacity throughout the
western U.S.;
-o the extent of electric utility industry restructuring in
Arizona, California and other western states;
-o the effect of FERC regulation of wholesale energy markets;
-o the availability and price of natural gas;
- precipitation, which affects hydropower availability;
-o availability of hydropower;
o transmission constraints; and
-o environmental restrictionsregulations and the cost of compliance.
Payment Defaults and Allowances for Doubtful Accounts
-----------------------------------------------------
In early 2001, California's two largest utilities, SCE and Pacific Gas &
Electric Company (PG&E), defaulted on payment obligations owed to various
energy sellers, including the California Power Exchange (CPX) and the CISO.
The CPX and the CISO defaulted on their payment obligations to market
participants, including TEP. While SCE subsequently satisfied its
obligations to the CPX, TEP has not received a corresponding payment from the
CPX. The total amount owed to TEP by the CPX and CISO is $16 million. In
late 2001, Enron Corp. (Enron) filed for bankruptcy protection. At that
time, TEP had an outstanding receivable from Enron of $0.8 million. TEP has
established an allowance for doubtful accounts of $8 million related to these
payment defaults.
See Critical Accounting Policies, - Payment Defaults and Allowances for
Doubtful Accounts, below, and Note 11 of Notes to Consolidated Financial
Statements.
California Refund Proceedings
-----------------------------
On June 25, 2001, a FERC ALJ convened a settlement conference to address
potential refunds owed by sellers of energy into the California market.
California claims that it was overcharged up to $9 billion for wholesale
power purchases since May 2000, and is seeking refunds from numerous power
generators, including TEP. The settlement conference, which included
representatives from over 100 parties and participants in the western power
market, including the State of California and power generators, was
unsuccessful. On July 25, 2001, the FERC ordered hearings to determine
refunds/offsets applicable to wholesale sales into the CISO's spot markets
for the period from October 2, 2000 to June 20, 2001. The order established
a methodology to calculate the amount of refunds and specified that the price-
mitigation formula contained in its June 19, 2001 order be applied to the
period from October 2, 2000 to June 20, 2001.
In August 2002, the FERC staff proposed revised calculations to
determine amounts due from the CPX and the CISO, based on concern that
natural gas prices were manipulated. If TEP were to apply these proposed
adjustments to amounts due to TEP, TEP could receive as little as $4 million,
plus interest, of the amounts due from the CPX and the CISO. The FERC has
not yet confirmed or rejected the calculation proposed by its staff. Under
earlier calculations proposed by the FERC staff, TEP could receive up to $11
million plus interest. The ALJ has issued a proposed finding under which TEP
would receive approximately $8.4 million, plus interest. This represents
amounts owed to TEP net of TEP's estimated refund liability. FERC is
accepting additional information and is expected to issue a ruling on the
recommended order later in 2003.
TEP is not able to predict the length and outcome of the FERC hearings
and the outcome of any subsequent lawsuits and appeals that might be filed.
As a participant in the June 2001 refund proceedings, TEP will be subject to
any final refund orders. TEP does not expect its refund liability, if any,
to have a significant impact on the financial statements. See Critical
Accounting Policies -TEP- Payment Defaults and Allowances
for Doubtful Accounts, below.
Market Manipulation Investigations
----------------------------------
In May 2002, the FERC initiated an investigation into potential
manipulation of the California electric and natural gas markets. The FERC
requested specific data and information with respect to certain trading
strategies in which companies may have engaged. This request was made to
all sellers of wholesale electricity and/or ancillary services, including
TEP, to the CISO and/or the CPX during 2000 and 2001. In May 2002, TEP
responded to the FERC, certifying that TEP did not engage in any of the
trading activities listed in the data request during 2000 and 2001. TEP also
certified that it had not in the past, nor does it now, model or forecast
California's energy markets and did not purchase energy from, or sell energy
to, any company as part of any of the types of potentially market manipulative
transactions as identified by the FERC during 2000 and 2001.
MARKET RISKS
We are exposed to various forms of market risk. Changes in interest
rates, returns on marketable securities, and changes in commodity prices may
affect our future financial results.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements, below.
Interest Rate Risk
------------------
TEP is exposed to risk resulting from changes in interest rates on
certain of its variable rate debt obligations. At December 31, 2002 and
2001, TEP's debt included $329 million of tax-exempt variable rate debt. The
average interest rate on TEP's variable rate debt (excluding letter of credit
fees) was 1.41% in 2002 and 2.68% in 2001. TEP also has approximately $70
million in outstanding principal amount of variable rate lease debt related
to its Springerville Common Facilities Leases. Interest on this lease debt
is payable at LIBOR plus 2.50%. The average interest rate on this lease debt
was 5.14% in 2002 and 8.63% in 2001. A one percent increase (decrease) in
average interest rates would result in a decrease (increase) in TEP's pre-tax
net income of approximately $4 million.
Marketable Securities Risk
--------------------------
TEP is exposed to fluctuations in the return on its marketable
securities, comprised of investments in debt securities. At December 31,
2002 and 2001, TEP had marketable debt securities with an estimated fair
value of $196 million and $74 million. At December 31, 2002 and 2001, the
fair value exceeded the carrying value by $4 million and $3 million,
respectively. These debt securities represent TEP's investments in lease
debt underlying certain of TEP's capital lease obligations. Changes in the
fair value of such debt securities do not present a material risk to TEP, as
TEP intends to hold these investments to maturity.
Risk Management Committee
-------------------------
We have a Risk Management Committee responsible for the oversight of
commodity price risk and credit risk related to the wholesale energy
marketing activities of TEP and the emissions allowance and coal trading
activities of MEG. Our Risk Management Committee consists of officers from
the finance, accounting, legal, wholesale marketing, and the generation
operations departments of UniSource Energy. To limit TEP and MEG's exposure
to commodity price risk, the Risk Management Committee sets trading policies
and limits, which are reviewed frequently to respond to constantly changing
market conditions. To limit TEP and MEG's exposure to credit risk in these
activities, the Risk Management Committee reviews counterparty credit
exposure, as well as credit policies and limits, on a monthly basis.
Commodity Price Risk
--------------------
We are exposed to commodity price risk primarily relating to changes in
the market price of electricity, natural gas, coal and emissions allowances.
To manage its exposure to energy price risk, TEP enters into forward
contracts to buy or sell energy at a specified price for a future delivery
period. Generally, TEP commits to future sales based on expected excess
generating capability, forward prices and generation costs, using a
diversified market approach to provide a balance between long-term, mid-term
and spot energy sales. TEP enters into forward purchases during its summer
peaking period to ensure it can meet its load and reserve requirements and
account for other contract and resource contingencies. TEP also enters into
limited forward purchases and sales to optimize its resource portfolio and
take advantage of locational differences in price. These positions are
managed on both a volumetric and dollar basis and are closely monitored using
risk management policies and procedures overseen by the Risk Management
Committee. For example, risk management policies provide that TEP should not
take a short position in the third quarter and must have owned generation
backing all forward sales positions at the time the sale is made. TEP's risk
management policies also restrict entering into forward positions with
maturities extending beyond the end of the next calendar year.
The majority of TEP's forward contracts are considered to be "normal
purchases and sales" of electric energy and are not considered to be
derivatives under Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities (FAS 133).
TEP records revenues on its "normal sales" and expenses on its "normal
purchases" in the period in which the energy is delivered. From time to
time, however, TEP enters into forward contracts that meet the definition
of a derivative under FAS 133. When TEP has derivative forward contracts, it
marks them to market on a daily basis using actively quoted prices obtained
from brokers for power traded over-the-counter at Palo Verde and at other
southwestern U.S. trading hubs. TEP believes that these broker quotations
used to calculate the mark-to-market values represent accurate measures of
the fair values of TEP's positions, because of the short-term nature of TEP's
positions, as limited by risk management policies, and the liquidity in the
short-term market. When TEP has derivative forward contracts, it uses a
sensitivity analysis to measure the impact of an unfavorable change in market
prices on the fair value of its derivative forward contracts. As of December
31, 2002, TEP had no forward contracts that are considered derivatives. TEP
had no unrealized gain or loss on its December 31, 2002 balance sheet. TEP
had a cumulative unrealized loss of $0.5 million on its December 31, 2001
balance sheet, which was reversed during 2002 as the contracts settled. This
demonstrates the limited derivative forward contract activity conducted by
TEP and the limited impact on TEP's operating results and financial
condition.
During the fourth quarter of 2001, MEG began managing and trading
emission allowances, coal and related instruments. We manage the market risk
of this line of business by setting notional limits by product, as well as
limits to the potential change in fair market value under a 33% change in
price or volatility. We closely monitor MEG's trading activities, including
swap agreements, options and forward contracts, using risk management
policies and procedures overseen by the Risk Management Committee. MEG marks
its trading positions to market on a daily basis using actively quoted prices
obtained from brokers and options pricing models for positions that extend
through 2005. As of December 31, 2002, the fair value of MEG's trading
positions combined with emissions allowances it holds in escrow was $0.2
million. At December 31, 2001, the fair value of MEG's trading positions was
($0.1) million. During 2002, MEG had a $0.2 million unrealized gain and a
$0.1 million realized loss on its income statement.
Unrealized Gain (Loss) of MEG's Trading Activities
- Millions of Dollars -
----------------------------------------------------------
Source of Fair Value Maturity Maturity Maturity over Total Unrealized
At December 31, 2002 0 - 6 mos. 6 - 12 mos. 1 yr. Gain (Loss)
- --------------------------------------------------------------------------------------
Prices actively quoted $(0.8) $(0.2) $3.6 $ 2.6
Prices provided by other
external sources - - - -
Prices based on models and
other valuation methods (1.7) (0.7) - (2.4)
- --------------------------------------------------------------------------------------
Total $(2.5) $(0.9) $3.6 $ 0.2
======================================================================================
TEP also purchases coal and natural gas in the normal course of business
to fuel its generating plants. The majority of its coal supplies are
purchased under long-term contracts, which result in very predictable prices.
TEP's usage of natural gas to fuel generating plants has historically comprised
less than 5% of its generation output and 2% of its total fuel costs. This
historical natural gas usage has been to meet the summer peak demands of its
firm electric wholesale and retail customers and transmission import
requirements. Natural gas usage to meet these demands is expected to
increase at approximately 1% - 2% of total generation output per year. Due
to its limited and historically seasonal usage of natural gas for firm
electric wholesale and retail customers, TEP typically purchases its gas
needs in the spot and short-term markets. In 2002, natural gas fueled 6% of
our total generation output and resulted in $32 million of fuel expense,
compared with 9% gas usage and $76 million in expense in 2001. The higher
usage and costs during 2001 are primarily the result of strong wholesale
power markets and higher natural gas prices in the first half of 2001.
TEP obtains its gas supply as a retail customer of the local gas
supplier, Southwest Gas Corporation (SWG). TEP periodically negotiates its
contract with its gas supplier to establish terms relating to pricing and
scheduling of gas delivery. TEP entered into fixed price gas purchase
agreements in May and June 2002 to hedge its risk of fluctuations in the
market price of gas for June through October 2002. The agreements covered
approximately 30% of TEP's anticipated gas purchases for that period. SWG is
affected by recent FERC actions relating to its gas allocations from the San
Juan and Permian basins. A FERC order is expected on this issue in the
summer of 2003, and at that time, TEP will renegotiate its gas supply and
transportation agreement with SWG. In the interim, TEP and SWG have agreed
on an extension of the current contract terms through October 31, 2003. TEP
does not anticipate any material difference in operational or economic terms
in the new agreement, which is estimated to begin November 1, 2003.
Credit Risk
-----------
UniSource Energy is exposed to credit risk in its energy-related
marketing and trading activities related to potential nonperformance by
counterparties. We manage 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.
Despite such mitigation efforts, there is a potential for defaults by
counterparties to occur from time to time. In the fourth quarter of 2000 and
the first quarter of 2001, TEP was affected by payment defaults by SCE and
PG&E for amounts owed to the CPX and CISO. In the fourth quarter of 2001,
Enron defaulted on amounts owed to TEP for energy sales.
We calculate counterparty credit exposure by adding any outstanding
receivable (net of amounts payable if a netting agreement exists) to the mark-
to-market value of any forward contracts. As of December 31, 2002, TEP's
total credit exposure related to its wholesale marketing activities
(excluding defaulted amounts owed by the CPX, the CISO and Enron), was less
than $7 million and MEG's total credit exposure related to its trading
activities was $7 million. TEP and MEG's credit exposure is diversified
across approximately 26 counterparties. Approximately $1 million of exposure
is to non-investment grade companies.
UniSource Energy is also exposed to credit risk related to the sale of
assets owned by Nations Energy. In September 2001, 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 proceeds and recorded an $11 million note
receivable from the sale at its net present value of $8 million, with the
discount amortized to interest income over the five-year life of the note.
The note is guaranteed by Mirant Americas, Inc., a subsidiary of Mirant.
Payments on the note receivable are expected as follows: $2 million in July
2004, $4 million in July 2005, and $5 million in July 2006.
In October 2002, the major rating agencies downgraded the ratings of
Mirant and certain of its subsidiaries 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. Their ratings are
now below investment grade. As of December 31, 2002, Nations Energy's
receivable from Mirant is approximately $9 million. We cannot predict what
effect the downgrade of Mirant will have on its ability to make its required
payments to Nations Energy when due, beginning in July 2004. Nations Energy
has not recorded an allowance for doubtful accounts and we will continue to
evaluate whether any further ratings events or actions by Mirant will impact
the collectibility of the receivable.
OUTLOOK AND STRATEGIES
Our financial prospects and outlook for the next few years will be
affected by many competitive, regulatory and economic factors. Our plans and
strategies include the following:
- Complete the Arizona electric utility and gas utility asset
acquisition from Citizens described above.
- Facilitate the construction of Springerville Unit 3, which will allow
TEP to spread the fixed costs of its Springerville Units 1 and 2 Common
Facilities over an additional unit.
- Enhance the value of TEP's transmission system while continuing to
provide reliable access to generation for TEP's retail customers and
market access for all generating assets. This will include focusing on
completing the Tucson - Nogales transmission line, which could
eventually be connected to Mexico's utility system, and completing a new
one mile 500-kV line to enhance TEP's distributin system's link to the
regional high voltage transmission system.
- Improve production of Global Solar's thin-film photovoltaic cells and
seek strategic partners.
- Reduce TEP's debt as appropriate, using some of our excess cash flows.
Although no specific retirements are planned at this time, TEP expects
to use $30 million to $50 million annually for debt reductions.
- Efficiently manage TEP's generating resources and look for ways to
reduce or control our operating expenses in order to improve
profitability.
To accomplish our goals, we estimate that during 2003, TEP will spend
$121 million on capital expenditures, Millennium will provide between $7
million and $15 million of funding to its Energy Technology Investments, and
we will provide between $4 million and $50 million in funding to UED. Our
funding to UED will depend upon the timing of the financial close of the
Springerville expansion project and UED's ultimate ownership percentage. In
addition, we plan to pay $230 million for the acquisition of the Arizona
electric utility and gas utility assets from Citizens.
While we believe that our plans and strategies will continue to have a
positive impact on our financial prospects and position, we recognize that we
continue to be highly leveraged, and as a result, our access to the capital
markets may be limited or more expensive than for less leveraged companies.
CRITICAL ACCOUNTING POLICIES
In preparing financial statements under Generally Accepted Accounting
Principles (GAAP), management exercises judgment in the selection and
application of accounting principles, including making estimates and
assumptions. UniSource Energy and TEP consider Critical Accounting Policies
to be those that could result in materially different financial statement
results if our assumptions regarding application of accounting principles
were different. UniSource Energy and TEP describe our Critical Accounting
Policies below. Other significant accounting policies and recently issued
accounting standards are discussed in Note 1 of Notes to Consolidated
Financial Statements - Nature of Operations and Summary of Significant
Accounting Policies.
ACCOUNTING FOR RATE REGULATION
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 ACC may not allow
TEP to currently charge its customers to recover certain expenses, but instead
requires that these expenses be charged to customers in the future. In this
situation, FAS 71 requires that TEP defer these items and show them as
regulatory assets on the balance sheet until TEP is allowed to charge its
customers. TEP then amortizes these items as expense to the income statement
as those charges are recovered from customers. Similarly, certain revenue
items may be deferred as regulatory liabilities, which are also eventually
amortized to the income statement as rates to customers are reduced.
The conditions a regulated company must satisfy to apply the accounting
policies and practices of FAS 71 include:
- an independent regulator sets rates;
- the regulator sets the rates to cover specific costs of delivering
service; and
- the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
In November 1999, upon approval by the ACC of TEP's Settlement Agreement
relating to recovery of TEP's transition costs and standard retail rates, we
stopped applying FAS 71 to our generation operations.
TEP continues to apply FAS 71 in accounting for the distribution and
transmission portions of TEP's business, its regulated operations. TEP
periodically assesses whether it can continue to apply FAS 71. If TEP stopped
applying FAS 71 to its remaining regulated operations, TEP would write off
the related balances of TEP's regulatory assets as a charge in the income
statement. Based on the balances of TEP's regulatory assets at December 31,
2002, if TEP had stopped applying FAS 71 to TEP's remaining regulated
operations, TEP would have recorded an extraordinary loss, after-tax, of
approximately $233 million. TEP's cash flows would not be affected if TEP
stopped applying FAS 71 unless a regulatory order limited its ability to
recover the cost of regulatory assets.
See Note 2 of Notes to Consolidated Financial Statements - Regulatory
Matters.
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
FAS 143 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 will adopt FAS 143 on January 1, 2003, as required. 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. TEP has estimated that its
share of the cost to remove the Navajo and Four Corners facilities and settle
the San Juan environmental obligations is approximately $38 million at the
date of retirement. No other legally binding retirement obligations for
generation plant assets were identified. Millennium and UED have no asset
retirement obligations.
TEP has various Transmission and Distribution lines that operate under
various 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 expects to record an
asset retirement obligation of $38 million at its net present value of $1.1
million, increase depreciable assets by $0.1 million for asset retirement
costs, reverse $112.8 million of costs accrued for final removal from
accumulated depreciation, reverse previously recorded deferred tax assets by
$44.2 million and recognize the cumulative effect of accounting change as
gain of $111.7 million ($67.5 million net of tax). TEP expects that adopting
FAS 143 will result in a reduction to depreciation expense charged throughout
the year as well. For 2003, this amount is approximately $6 million.
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 utilized on discounting future liabilities. Changes that may
arise over time with regard to these assumptions will change amounts recorded
in the future as expense for asset retirement obligations.
If TEP in fact 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 have been determined pursuant to
the Settlement Agreement.
PAYMENT DEFAULTS AND ALLOWANCES FOR DOUBTFUL ACCOUNTS
We record an allowance for doubtful accounts when we determine that an
account receivable will not be collected. As a result of payment defaults
made by market participants in California, TEP's collection shortfall from
the CPX and CISO was approximately $9 million for sales made in 2000 and $7
million for sales made in 2001. TEP recorded an allowance for doubtful
accounts for the full amount of these uncollected amounts in the fourth
quarter of 2000 and the first quarter of 2001, totaling $16 million. In the
fourth quarter of 2001, TEP decreased the reserve by $8 million, or 50%, of
the outstanding receivable because events during 2001 caused us to believe
that it is probable that at least 50% of the amount due to TEP will be
repaid. These include: (1) the stabilization of western power markets, (2)
rate increases achieved by PG&E and SCE, (3) settlements made by California
utilities with various power providers, (4) the CPUC approval of SCE's
financing plan to pay its creditors by the end of the first quarter of 2002,
and (5) data in filings of FERC refund hearings. The amount that TEP
ultimately collects would have an impact on earnings if the amount is more
or less than the $8 million TEP has reserved. If TEP collects all of the $16
million, pre-tax income will increase by $8 million. If TEP does not collect
any of the $16 million, pre-tax income will decrease by $8 million. TEP also
believes that it is due interest on the amounts TEP is owed. In addition,
TEP has cash collateral of approximately $1 million on deposit in an escrow
account with the CPX, which is currently unavailable to TEP due to the CPX's
bankruptcy stay.
At December 31, 2002 and December 31, 2001, the reserve for electric
wholesale accounts receivable on TEP's balance sheet was approximately $8
million.
See Note 11 of Notes to Consolidated Financial Statements.
CAPITALIZATION OF UED PROJECT DEVELOPMENT COSTS
UED capitalizes project development costs when it is probable that the
project will be completed and it expects to recover the costs of the project.
At December 31, 2002, capitalized project development costs on UED's balance
sheet were approximately $22.4 million. If the Springerville expansion
project does not proceed, the capitalized project development costs will be
immediately expensed.
PENSION AND OTHER POSTRETIREMENT BENEFIT PLAN ASSUMPTIONS
TEP records plan assets, obligations, and expenses as appropriate,
related to its pension and other postretirement benefit plans based on
actuarial valuations. Inherent in these valuations are key assumptions
including discounts rates, expected returns on plan assets, compensation
increases and health care cost trend rates. These actuarial assumptions are
reviewed annually and modified as appropriate. The effect of modifications
is generally recorded or amortized over future periods. TEP believes that
the assumptions utilized in recording obligations under the plans are
reasonable based on prior experience, market conditions and from the advice
of plan actuaries.
TEP discounted its future pension and other postretirement plan
obligations using a rate of 6.75% at December 31, 2002, compared to 7.25% at
December 31, 2001. TEP determines the appropriate discount annually based on
the current rates earned on long-term bonds that receive one of the two
highest ratings given by a recognized rating agency. The pension liability
and future pension expense both increase as the discount rate is reduced.
For TEP's pension plans, a 25 basis point decrease in the discount rate would
increase the accumulated benefit obligation by approximately $3.7 million and
the related plan expense for 2003 by approximately $0.6 million. A similar
increase in the discount rate would decrease the accumulated benefit
obligation by approximately $3.5 million and the related plan expense for 2003
by approximately $0.6 million. For TEP's plan for other postretirement
benefits, a 25 basis point decrease in the discount rate would increase the
accumulated benefit obligation by approximately $1.5 million and the related
plan expense for 2003 by approximately $0.1 million. A similar increase in
the discount rate would decrease the accumulated benefit obligation by
approximately $1.5 million and the related plan expense for 2003 by
approximately $0.1 milllion.
At December 31, 2002, TEP assumed that its plans' assets would generate
a long-term rate of return of 8.75%. This rate is lower than the assumed
rate of 9.0% used at December 31, 2001. In establishing its assumption as to
the expected return on plan assets, TEP reviews the plans' asset allocation
and develops return assumptions for each asset class based on advice from the
plans' actuaries that includes both historical performance analysis and
forward looking views of the financial markets. Pension expense increases as
the expected rate of return on plan assets decreases. A 25 basis point
decrease in the expected return on plan assets would increase pension expense
for 2003 by approximately $0.3 million. A similar increase in the expected
return on plan assets would decrease pension expense for 2003 by approximately
$0.3 million.
In recognition of significant increases in health care costs, TEP
increased the initial health care cost trend rate used in valuing its
postretirement benefit obligation to 12.0% at December 31, 2002. The rate
assumed at December 31, 2001 was 8.5%. Assumed health care cost trend rates
have a significant effect on the amounts reported for health care plans. A
one percentage-point increase in assumed health care cost trend rates would
increase the postretirement benefit obligation by approximately $5 million
and the related plan expense by approximately $1 million. A similar decrease
in assumed health care cost trend rates would decrease the postretirement
benefit obligation by approximately $4 million and the related plan expense
by approximately $1 million.
As discussed in Note 13, TEP recorded a minimum pension liability of
$6.7 million at December 31, 2002 primarily because of current stock market
conditions and a reduction in the assumed discount rate.
Based on the above assumptions, TEP will record pension expense of $8.5
million and other postretirement benefit expense of $6.6 million in 2003.
TEP will make required pension plan contributions of $2.8 million in 2003.
TEP's other postretirement benefit plan is not funded. TEP expects to make
benefit payments to retirees under this plan of approximately $2 million in
2003.
See Note 13 of Notes to Consolidated Financial Statements.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING
ACTIVITIES
On January 1, 2001, TEP adopted FAS 133. A derivative financial
instrument or other contract derives its value from another investment or
designated benchmark. When TEP adopted FAS 133, some of the forward
contracts that it used to buy and sell wholesale power were considered to be
derivatives based on the accounting guidance at that time. Other contracts
qualified for hedge accounting.
Because of the complexity of derivatives, the FASB established a
Derivatives Implementation Group (DIG). During 2001, the DIG issued new
guidance, which changed the contracts that qualified as derivatives under FAS
133. To date, the DIG has issued more than 100 interpretations to provide
guidance in applying FAS 133. As the DIG or the FASB continues to issue
interpretations, TEP may change the conclusions that it has reached and, as a
result, the accounting treatment and financial statement impact could change
in the future.
Under FAS 133, TEP records unrealized gains and losses on its derivative
forward contracts and adjusts the related assets and liabilities on a monthly
basis to reflect the market prices at the end of the month. Similarly, in
accordance with the accounting guidance for energy-related trading
activities, MEG records unrealized gains and losses on its trading activities
and adjusts the related assets and liabilities on a monthly basis to reflect
the market prices at the end of the month. The market prices used to
determine fair value for these derivative instruments and trading activities
are estimated based on various factors including broker quotes, exchange
prices, over the counter prices and time value. TEP reports its unrealized
gain/loss on derivative forward sales net of its unrealized gain/loss on
derivative forward purchases as a component of Operating Revenues. MEG
reports its unrealized gain/loss on trading activities net of its realized
gain/loss on trading activities as a component of Operating Revenues. The
net pre-tax gain on TEP forward contracts and MEG trading activities for the
year ended December 31, 2002, were approximately $0.5 million and $0.1
million, respectively. At December 31, 2002, the fair value of MEG's trading
assets totaled $10.5 million, which is reported in Other Current Assets, and
the fair value of MEG's trading liabilities totaled $10.3 million, which is
reported in Other Current Liabilities. TEP had no open forward contracts at
December 31, 2002 that are considered derivatives.
See Note 3 of Notes to Consolidated Financial Statements.
UNBILLED REVENUE
TEP's electric retail sales revenues include an estimate of MWhs
delivered but unbilled at the end of each period. The unbilled revenue is
estimated by comparing the actual MWhs generated to the MWhs billed to our
retail customers. The excess of MWhs generated over MWhs billed is then
allocated to the retail customer classes based on estimated usage by each
customer class. TEP then records revenue for each customer class based on
the various bill rates for each customer class. Due to the seasonal
fluctuations of TEP's actual load, the unbilled revenue amount is greater in
the summer months than in the winter months.
DEFERRED TAX VALUATION
We record deferred tax liabilities for amounts that will increase income
taxes on future tax returns. We record deferred tax assets for amounts that
could be used to reduce income taxes on future tax returns. We record a
valuation allowance, or reserve, for the deferred tax asset amount that we
may not be able to use on future tax returns. We estimate the valuation
allowance based on our interpretation of the tax rules, prior tax audits, tax
planning strategies, scheduled reversal of deferred tax liabilities, and
projected future taxable income.
The valuation allowance of $16 million at December 31, 2002, which
reduces the Deferred Tax Asset balance, relates to net operating loss and
investment tax credit carryforward amounts. In the future, if TEP determines
that TEP would be able to use all or a portion of these amounts on tax
returns, then TEP would reduce the reserve and recognize a tax benefit up to
$16 million. Factors that could cause TEP to recognize the tax benefit
include new or additional guidance through tax regulations, tax rulings, case
law and/or the use of such benefits on future tax returns.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
UNISOURCE ENERGY CONSOLIDATEDTEP CASH FLOWS
2002 2001 2000
---------------------------------------------------------------------
- Millions of Dollars -
Cash provided by (used in):
Operating Activities $ 173 $ 215 $ 215
Investing Activities (271) (117) (113)
Financing Activities (39) (33) (84)
---------------------------------------------------------------------
Net Increase (Decrease) in Cash $(137) $ 65 $ 18
=====================================================================
UniSource Energy's primary source of liquidity is its cash flow from
operations, which is derived primarily from retail and wholesale energy sales
at TEP, net of the related payments for fuel and purchased power. In 2001
and 2000, our cash flows benefited from higher margins on wholesale energy
sales in the western U.S. power markets. This enabled us to increase our
cash levels from $163 million at year-end 2000 to $228 million at year-end
2001. We used our available cash to finance capital expenditures, primarily
at TEP, to make investments in our energy technology affiliates, to pay
dividends to shareholders, and to reduce leverage at TEP by repaying high
coupon debt and investing in lease debt.
Net cash flows from operating activities in 2002 decreased from 2001,
primarily as a result of the following factors:
- $42 million decrease in cash receipts from sales to wholesale and
retail customers, net of fuel and purchased power costs;
- $11 million cash payment to terminate an Irvington coal supply
agreement in September 2002;
- $15 million cash payment to amend a San Juan coal supply agreement in
December 2002; offset by
- $11 million decrease in capital lease interest paid as a result of
lower lease obligation balances and lower interest rates on variable
rate lease debt; and
- $10 million decrease in income taxes paid due to lower pre-tax income
and income tax benefits in 2002.
In 2001, net cash flows from operating activities increased slightly
compared with 2000 due to higher cash receipts from sales to retail and
wholesale customers, net of fuel and purchased power costs and lower capital
lease interest payments, offset by higher income tax payments and higher
wages and other operations and maintenance costs.
Net cash used for investing activities was higher in 2002 than in 2001
primarily due to investment in $135 million of Springerville lease debt. TEP
spent $113 million for construction expenditures and Millennium contributed
$24 million in investments and loans to Millennium Energy Businesses in 2002.
Other significant investing activities in 2001 included: (1) TEP spent $104
million for construction expenditures; (2) we received $5 million in proceeds
from the sale of Nations Energy's interest in the Curacao project, along with
the return of $16 million in deposits; (3) UED purchased a 20 MW gas turbine
for $15 million; (4) we received the final promissory note payment of $11
million from NewEnergy; and (5) TEP sold real estate for $7 million.
Net cash used for financing activities was higher in 2002 compared with
2001 primarily due to increased common stock dividends and expenses
associated with the refinance of TEP's bank credit facility. In 2002,
UniSource Energy paid approximately $17 million in dividends to its common
shareholders and TEP retired $20 million in capital lease obligations and
made $2 million in bond payments. In addition, in November 2002, TEP paid $5
million in upfront fees associated with the refinance of its bank facility.
See TEP - Electric Utility, Financing Activities, TEP Bank Credit Agreement,
below. In contrast, in 2001 UniSource Energy paid $13 million in dividends
to its common shareholders and TEP paid $26 million to retire capital lease
obligations and made $2 million in bond payments.
As a result of the activities described above, our consolidated cash and
cash equivalents decreased to $91 million at December 31, 2002 from $228
million at December 31, 2001. TEP's cash and cash equivalents decreased to
$56 million at December 31, 2002 compared with $160 million at December 31,
2001. At March 4, 2003, our consolidated cash balance, including cash
equivalents, was approximately $30 million, including TEP's cash balance of
approximately $10 million. We invest cash balances in high-grade money market
securities with an emphasis on preserving the principal amounts invested.
In the event that we experience lower cash from operations in 2003, we
will adjust our discretionary uses of cash accordingly. We believe, however,
that we will continue to have sufficient cash flow to cover our capital
needs, as well as required debt payments and dividends to shareholders.
Furthermore, we believe that even with lower wholesale energy prices and
lower demand from mining customers, we will have sufficient excess cash flow
to continue to make annual discretionary debt reductions or lease debt
investments at TEP in the range of $30 - $50 million.
UNISOURCE ENERGY - PARENT COMPANY
Our primary cash needs are to fund investments in the unregulated energy
businesses, to pay dividends to shareholders, and interest payments on our
promissory note to TEP. In addition, as part of our
ACC Holding Company Order, we must invest 30% of any proceeds of equity
issuances in TEP until TEP's equity reaches 37.5% of total capital (excluding
capital leases).
Our primary sources of cash are dividends from TEP. In 2002, TEP paid
dividends to UniSource Energy of $35 million, compared with $50 million in
2001 and $30 million in 2000.
In 2003, UniSource Energy will need funds to finance the purchase of the
Citizens Arizona electric and gas utility assets. To finance this purchase,
we plan to issue debt secured by the purchased assets and may also consider
financing a portion of the purchase with new equity, depending on market
conditions and other factors.
If cash flows fall short of expectations, we will reevaluate the
investment requirements of the unregulated energy businesses and/or seek
additional financing for, or investments in, those businesses by unrelated
parties.
TEP - ELECTRIC UTILITY
TEP's capital requirements consist primarily of capital expenditures
and optional and mandatory redemptions of long-term debt and capital lease
obligations. As shown in the chart below, during the last three years, TEP had
sufficient cash available after capital expenditures, scheduled
debt payments and capital lease obligations to provide for other investing and
financing activities:
2002 2001 2000
----------------------------------------------------------------------
- Millions of Dollars -
Cash from Operations $ 204 $ 261 $ 234
Capital Expenditures (103) (104) (98)
Debt Maturities (2) (2) (48)
Retirement of Capital Lease Obligations (20) (26) (39)
----------------------------------------------------------------------
Net Cash Flows Available after Required
Payments $ 79 $ 129 $ 49
======================================================================
2003 2002 2001
---------------------------------------------------------------- ------------ ------------ -----------
-Millions of Dollars -
Cash from Operations $ 258 $ 204 $ 261
Capital Expenditures (122) (103) (104)
Debt Maturities (2) (2) (2)
Retirement of Capital Lease Obligations (43) (20) (26)
---------------------------------------------------------------- ------------ ------------ -----------
Net Cash Flows Available after Required Payments $ 91 $ 79 $ 129
================================================================ ============ ============ ===========
During 2003,2004, TEP expects to generate sufficient internal cash flows to
fund its operating activities, construction expenditures, required debt
maturities, and to pay dividends to UniSource Energy. However, TEP's cash flows
may vary due to changes in wholesale revenues, changes in short-term interest
rates, and other factors. At December 31, 2002, TEP hadcurrently has $60 million available under its
Revolving Credit Facility. In January 2003, TEP borrowed
$25 million under its Revolving Credit Facility and repaidwhich it within 20 days.
Ifmay borrow if cash flows fall short of
expectations or if monthly cash requirements temporarily exceed available cash
balances, TEP will borrow from its
Revolving Credit Facility.balances.
Operating Activities
--------------------
In 2002,2003, net cash flows from operating activities at TEP exceeded $200were $258
million, for the third year in a row, but were lower than 2001up $54 million from 2002,
K-44
primarily due to decreased salesthe following factors:
o a $24 million decrease in income taxes paid due primarily to wholesale customers. TEP made cash paymentslower
taxable income;
o a $20 million receipt of interest related to the inter-company note to
UniSource Energy;
o a $16 million increase in income tax refunds of taxes previously paid,
which was received in the fourth quarter of 2003; and
o a $27 million cash payment made in 2002 related to terminate and amend coal
contract amendment and termination fees.
Partially offsetting these cash decreases were lower income tax payments due
to lower pre-tax income and certain tax benefits received, and lowercontracts; partially offset by:
o a $17 million increase in interest paid (including capital lease
interest paidpaid), due primarily to lower lease obligation balanceshigher letter of credit fees under
TEP's Credit Agreement; and
lower
variable interest rates.
Wholesale energy market conditions were not as favorableo a deposit of $17 million in 2002 as they
were in the previous two years,2003 with market prices and margins significantly
lower. Another factor that affects TEP's cash flows from operations is reduced
energy demand by its large mining customers. As reported elsewhere in this
document, TEP's two major mining customers have reduced operations during the
last few years due to lower copper prices. This trend is likely to continue
in 2003. TEP expects that these load reductions will be offset, however, by
lower purchased power costs to cover summer peaking needs and by sales of
excess capacity, when profitable, in the first, second and fourth quarters.
TEP does not, therefore, expect these reductions to have a significant impact
on cash flows.mortgage trustee.
Investing Activities
--------------------
Net cash used for investing activities was higher$144 million lower in 20022003
compared with 2001,2002, primarily due to TEP's investment in Springerville lease debt.the following factors:
o In 2002, TEP paid $135$138 million to purchase Springerville Lease debt, spent $103
million on construction expenditures, andDebt; in
2003, TEP received principal payments related to its investment in
Springerville Lease Debt of $12 million.
o TEP paid $15 million in 2002 to purchase the 20 MW
gasa combustion turbine from
UED. In 2001, construction expenditures were $104UniSource Energy Development.
The decrease in cash used for investing activities was partially offset
by a $19 million increase in capital expenditures. Part of this increase
resulted from $10 million spent on completing a new one mile 500-kV transmission
line and TEP received $7 million in proceeds fromrelated substations to enhance TEP's distribution system link to the
sale of real estate.regional high voltage transmission system.
Investments in Springerville Lease Debt and Equity
--------------------------------------------------
TEP made the following investments in Springerville Lease debt in 2002:
Principal Average Coupon
Date Amount Debt Purchased Coupon Rate
- ---------------------------------------------------------------------------------------------------------- ------------------- --------------------------------------------- ------------------
January 2002 $ 96 million Springerville Coal Handling Lease Debt 14.3%
May 2002 3 million Springerville Unit 1 Lease Debt 10.7%
September 2002 33 million Springerville Unit 1 Lease Debt 10.7%
September 2002 33 million Springerville Unit 1 Lease Debt 10.6%
---------------------- ------------------- --------------------------------------------- ------------------
In March of 2004, TEP purchased $2approximately $4 million principal
amount of Springerville Unit 1 Lease debt in 2001 from
Millennium. Millennium previously purchased these notes in the open market
in the first quarterDebt with an average coupon of 2000.10.7%. As of
December 31, 2002,March 10, 2004, TEP's total investment in Springerville lease debtLease Debt was
$192approximately $175 million, at yields ranging from 8.9% to 12.7%.
In December 2001, TEP purchased a 13% equity ownership interest in the
Springerville Coal Handling Facilities Leases for $13 million. In March 2002,
TEP terminated the leaseslease related to its equity interest and cancelled the
associated debt that weTEP held. As a result of the lease termination, TEP
recorded a $21 million reduction to the capital lease obligation, a $27 million
reduction of its investment in lease debt, and a $6 million increase in the
capital lease asset, which represents the residual value of TEP's interest in
the leased asset and is carried at cost.
See Note 710 of Notes to Consolidated Financial Statements.Statements - Debt and
Capital Lease Obligations.
K-45
Capital Expenditures
--------------------
TEP's forecasted construction expenditures for the next five years are:
$121 million in 2003, $126$106 million in 2004, $163$119 million in 2005, $107$162 million in 2006, and $110$123 million
in 2007.2007, and $135 million in 2008. These estimated capital expenditures for
2003-20072004-2008 break down in the following categories:
- $347o $351 million for transmission, distribution and other facilities in the
Tucson area;
- $154o $146 million for production facilities;
- $32o $28 million infor renewable energy projects, including expansion of its
solar
generation portfolio;
- $15o $44 million in afor new production facility for a 75 MW combustion turbine;
- $4o $10 million infor environmental projects; and
- $75o $66 million for thea proposed 345 kV345-kV transmission line to Nogales,
Arizona.
These estimated expenditures include costs for TEP to comply with
current federal and state environmental regulations. All of these estimates are
subject to continuing review and adjustment. Actual construction expenditures
may be different from these estimates due to changes in business conditions,
construction schedules, environmental requirements, and changes to ourTEP's
business arising from retail competition. TEP plans to fund these expenditures
through internally generated cash flow.
Forecasted construction expenditures forAs of December 31, 2003, include approximately $10$9 million for completing a new one mile 500-kV transmission line to enhance
TEP's distribution system linkin engineering and
environmental expenses have been capitalized related to the regional high voltageNogales transmission
system.
In January 2001, TEPline. If the required environmental permits are not obtained and Citizens entered into athe project
development
agreement for the joint construction of a 62-mile transmission line fromdoes not proceed, these costs would be immediately expensed. See Item 1.
Business, Tucson Electric Utility Operations, Transmission Access, Tucson to
Nogales Arizona. In January 2002, the ACC approved the location
and construction of the proposed 345 kV line. Pending federal studies and
approvals for the portion of the line that will pass through a national
forest, construction could begin as early as mid-2004, with an expected in-
service date eight months following start of construction. Construction costs
are expected to be approximately $75 million. TEP has also applied to the
U.S. Department of Energy for a Presidential Permit that would allow building
an extension of the line across the international border with Mexico to
interconnect with Mexico's utility system, providing further reliability and
market opportunities in the region.
The estimated expenditures listed above do not include any amounts for
the potential expansion of the Springerville Generating Station.
Springerville generation expenditures are expected to be made by another
UniSource Energy subsidiary. See UED - Unregulated Energy Business, below.Transmission Line.
In addition to TEP's forecasted construction expenditures, TEP's other
capital requirements include its required debt maturities and capital lease
obligations. SeeSEC Note 710 of Notes to Consolidated Financial Statements.Statements - Debt
and Capital Lease Obligations.
Financing Activities
--------------------
Net cash used for financing activities was significantly less$85 million higher in 20022003
compared with 20012002, due primarily because TEP's dividends to its common
shareholders and payments on capital leases obligations were lower. In
2002, TEP paid $35the following factors:
o a $45 million increase in dividends paid from TEP to UniSource EnergyEnergy;
and
its other
common shareholders, retired $20o a $23 million increase in scheduled payments for capital lease
obligations and
paid $2 million in bond sinking fund payments and other redemptions. In
addition, we paid approximately $5 million in bank financing fees associated
with our new bank facilities. In contrast, in 2001, TEP paid $50 million in
dividends to UniSource Energy and its other common shareholders, retired $26
million in capital lease obligations and paid $2 million in bond sinking fund
payments and other redemptions.obligations.
Bond Issuance and Redemption
----------------------------During 2003, TEP purchased and retired $0.4 million of its 8.50% First
Mortgage Bonds due in 2009 and made required sinking fund payments of $2
million. During 2002, TEP purchased and retired $0.4 million of its 8.50% First
Mortgage Bonds due in 2009 and made required sinking fund payments of $2
million.
During 2001, TEP purchased and retired $0.2 million of its 8.50%
First Mortgage Bonds due in 2009 and made required sinking fund payments of
$2 million.
TEP Bank Credit Agreement
-------------------------
In November 2002, TEP entered into a newTEP's $401 million Credit Agreement
to replace the credit facilities provided under its then existing $441
million credit agreement that would have expired December 30, 2002. The new
agreement consists of a $60 million Revolving
Credit Facility and two letter of credit (LOC) facilities (Tranche A and Tranche
B) totaling $341 million. The Revolving Credit Facility is used to provide
liquidity for general corporate purposes. The LOC Facilities support $329
million aggregate principal amount of tax-exempt variable rate debt obligations.
The Revolving Credit Facility is a 364-day facility that expires on November 13, 2003.11,
2004. The Tranche A letters of credit, totaling $135 million, expire in January
2006, and the Tranche B letters of credit, totaling $206 million, expire in
November 2006.
The new facilities are secured by $401 million in aggregate principal
amount of Second Mortgage Bonds issued under TEP's General Second Mortgage
Indenture. The new Credit Agreement contains a number of restrictive covenants, that are similar to TEP's previous credit agreement,
including restrictions on additional indebtedness, liens, sale of assets,
mergers and sale-leasebacks. The new Credit Agreement like the previous agreement, also contains several
financial covenants including: (a) a minimum Consolidated Tangible Net Worth,
(b) a minimum Cash Coverage Ratio, and (c) a maximum Leverage Ratio. Under the
terms of the new Credit Agreement, TEP may pay dividends so long as it maintains
compliance with the Credit Agreement; however, dividends and certain investments
in affiliates may not exceed 65% of TEP's net
K-46
income so long as the Tranche B LOCs are outstanding. The new Credit Agreement also
provides that under certain circumstances, certain regulatory actions could
result in a required reduction of the commitments. As of December 31, 2002,2003, TEP
was in compliance with these financial covenants.
The $329 million in aggregate principal amount of tax-exempt variable
rate debt that is supported by the LOC Facilities were classified as Current
Maturities of Long-Term Debt on TEP's Balance Sheet at December 31, 2001
because the previous letter of credit facility matured on December 30, 2002.
When the new LOCs were issued on November 25, 2002, TEP classified the bonds
as Long-Term Debt because the maturities of the new LOCs are in January 2006
and November 2006.
Due to prevailing market conditions at the time of refinancing,
particularly in the energy sector, the amount of interest and fees that TEP
will pay on its new Credit Facilities is significantly higher than that of
its previous credit agreement. TEP's annual interest expense, including LOC
fees, related to its Credit Agreement will increase from approximately $6
million to approximately $19 million.
If TEP borrows under the Revolving Credit Facility, the borrowing costs
would be at a variable interest rate consisting of a spread over LIBOR or an
alternate base rate. The spread is based upon a pricing grid tied to TEP's
credit ratings. Also, TEP pays a commitment fee on the unused portion of the
Revolving Credit Facility, and a fee on the LOC Facilities. The chart below
shows the per annum rates and fees in effect on TEP's Credit Facilities as of
December 31, 2002,2003, based on its credit ratings, as well as the possible range of
rates and fees if TEP's credit ratings were to change:
Current Rate/ Range of
Fee Rate / Fees
-------------------------------------------------------------------------
Revolving Credit Facility
- Commitment Fee 0.35% 0.25% to 0.40%
-change.
Current Rate / Range of
Fee Rates / Fees
-------------------------------------------------------- ------------------ ------------------------
Revolving Credit Facility
o Commitment Fee 0.35% 0.25% to 0.40%
o Borrowing Rate (spread over LIBOR) 4.00% 3.50% to 4.25%
Tranche A LOCs (including LOC Fronting Fee) 4.25% 3.75% to 4.50%
Tranche B LOCs (including LOC Fronting Fee) 5.75% 5.75%
-------------------------------------------------------- ------------------ ------------------------
At December 31, 2002,2003, there were no outstanding borrowings under this
facility.the
Revolving Credit Facility. In January 2003,2004, TEP borrowed $25$20 million under its
Revolving Credit Facility and repaid it within 2030 days.
IfSpringerville Common Facilities Leases
In 1985, TEP encounters temporary
cash needs duringsold and leased back its undivided one-half ownership
interest in the coursecommon facilities at the Springerville Generating Station. Under
the terms of the Springerville Common Facilities Leases, TEP must periodically
arrange for refinancing or refunding of the secured notes underlying the leases
prior to the named date in order to avoid a special event of loss. TEP was
required to arrange for the refinancing of the lease debt prior to the special
event of loss date of June 30, 2003 or the leases would have been terminated and
TEP would have been required to repurchase the facilities for $125 million.
TEP finalized the arrangements for the refinancing of $70 million of
lease debt on June 26, 2003 and the special event of loss date was reset for
June 30, 2006. TEP incurred a total of $0.3 million in debt costs related to the
refinancing. These costs were deferred and are being amortized over a three year
it will borrow from its Revolving
Credit Facility.period. Interest on the new debt is payable at LIBOR plus 4.25%. The LIBOR rate
is reset every six months and the rate in effect on December 31, 2003 was 0.99%,
which resulted in a total interest rate on the lease debt of 5.24% at year end.
Prior to the refinancing, the interest rate was LIBOR plus 2.50%.
Tax-Exempt Local Furnishing Bonds
---------------------------------
TEP has financed a substantial portion of utility plant assets with
industrial development revenue bonds issued by the Industrial Development
Authorities of Pima County and Apache County. The interest on these bonds is
excluded from gross income of the bondholder for federal tax purposes. This
exclusion is allowed because the facilities qualify as "facilities for the local
furnishing of electric energy" as defined by the Internal Revenue Code. These
bonds are sometimes referred to as "tax-exempt local furnishing bonds." To
qualify for this exclusion, the facilities must be part of a system providing
electric service to customers within not more than two contiguous counties. TEP
provides electric service to retail customers in the City of Tucson and certain
other portions of Pima County, Arizona and to Fort Huachuca in contiguous
Cochise County, Arizona.
TEP has financed the following facilities, in whole or in part, with
the proceeds of tax-exempt local furnishing bonds: Springerville Unit 2, IrvingtonSundt
Unit 4, a dedicated 345-kV transmission line from Springerville Unit 2 to TEP's
retail service area (the Express Line), and a portion of TEP's local
transmission and distribution system in the Tucson metropolitan area. As of
December 31, 2002,2003, TEP had approximately $584 million of tax-
exempttax-exempt local
furnishing bonds outstanding. Approximately $331 million in principal amount of
such bonds financed Springerville Unit 2 and the Express Line. In addition,
approximately $65$59 million of remaining lease debt related to the IrvingtonSundt Unit 4
lease obligation was issued as tax-exempt local furnishing bonds.
Various events might cause TEP to have to redeem or defease some or all
of these bonds:
-K-47
o formation of an RTO or ISO;
-o asset divestiture;
-o changes in tax laws; or
-o changes in system operations.
TEP believes that its qualification as a local furnishing system should
not be lost so long as (1) the RTO or ISO would not change the operation of the
Express Line or the transmission facilities within TEP's local service area, (2)
the RTO or ISO allows pricing of transmission service such that the benefits of
tax-exempt financing continue to accrue to retail customers, and (3) energy
produced by Springerville Unit 2 and by TEP's local generating units continues
to be consumed in TEP's local service area. However, there is no assurance that
such qualification can be maintained. Any redemption or defeasance of tax-exempt
local furnishing bonds would likely require the issuance and sale of higher cost
taxable debt securities in the same or a greater principal amount.
Mortgage Indentures
-------------------
TEP's first mortgage indenture and second mortgage indenture create
liens on and security interests in most of TEP's utility plant assets.
Springerville Unit 2, which is owned by San Carlos, is not subject to these
liens and security interests. TEP's mortgage indentures allow TEP to issue
additional mortgage bonds on the basis of: (1) a percentage of net utility
property additions and/or (2) the principal amount of retired mortgage bonds.
The amount of bonds that TEP may issue is also subject to a net earnings test
under each mortgage indenture.
TEP's Credit Agreement contains limits on the amount of First and
Second Mortgage Bonds that may be outstanding. The Credit Agreement allows no
more than $222 million of First Mortgage Bonds to be outstanding, and no more
than a total of $623 million in First and Second Mortgage bonds combined to be
outstanding. At December 31, 2002,2003, TEP had $222$220 million of First Mortgage Bonds
and a total of $623$621 million in First and Second Mortgage Bonds outstanding.
Although the first and second mortgage indentures would allow TEP to issue
additional bonds based on property additions and/or retired bond credits, the
limits imposed by the Credit Agreement are more restrictive and are currently
the governing limitations.
TEP also has the ability to release property from the liens of the
mortgage indentures on the basis of net property additions and/or retired bond
credits. The Credit Agreement also limits the amount of property that can be
released from the second mortgage indenture to $25 million. Springerville Common Facilities Leases
--------------------------------------
In 1985, TEP sold and leased back its undivided one-half ownership
interest in the common facilities at the Springerville Generating Station.
Under the terms of the Springerville Common Facilities Leases, TEP must
periodically refinance or refund the secured notes underlying the leases
prior to the named date in order to avoid a special event of loss. If the
lease debt is not refinanced prior to the special event of loss date
(currently June 30, 2003), the leases would be terminated and TEP would be
required to repurchase the facilities.
In January 2003, TEP filed an application with the ACC for authorization
to amend the Springerville Common Facilities Leases and refinance the $70
million of associated lease debt. The interest rate on new lease debt will
be a function of market conditions at the time of refinancing, the lender's
view of TEP's creditworthiness, and the lender's evaluation of the collateral
for the secured notes. As a result, of the current market conditions and a
smaller financing market overall, we expect that the interest rate on the new
debt will likely be higher than the current variable interest rate of LIBOR
plus 2.50%, resulting in higher rents payable by TEP.
MILLENNIUM -- UNREGULATED ENERGY BUSINESSES
Below we discuss our significant investments, commitments and investment
proceeds from 2002, 2001 and 2000.
Investments in Energy Technologies
----------------------------------
Millennium provided the following funding to its Energy Technology
Investments:
2002 2001 2000
---------------------------------------------------------------------
- Millions of Dollars -
Cash Funding Provided To:
Global Solar $ 13 $ 15 $ 18
IPS 4 6 -
ITN 1 5 -
MicroSat - 10 -
---------------------------------------------------------------------
Total Cash Funding Provided to Energy
Technology Investments $ 18 $ 36 $ 18
=====================================================================
Millennium expects to fund between $7 million and $15 million to its
various Energy Technology Investments in 2003. By March 5, 2003,
approximately $4 million of Millennium's remaining commitment had been
funded. A significant portion of the funding under these agreements has been
and will be used for research and development purposes, establishment of the
production line, and other administrative costs. As these funds are expended
for research and development and for administrative costs, Millennium
recognizes expense.
As of December 31, 2002, including accumulated deferred tax benefits
relating to these investments, Millennium had approximately $50 million
remaining investment in the Energy Technology Investments. As discussed
above, we may commit to provide additional funding to these investments.
During 2003, we will analyze the prospects for each of these investments and
determine if additional internal funding is needed. In addition, external
sources of funding are being sought for these investments. If management
determines that any of these entities are not viable, Millennium would record
expense up to the entire remaining investment balance of such entity.
Nations Energy
--------------
In 2002, Millennium did not and currently does not intend to make any
material investments in new projects through Nations Energy. Millennium
continues to review options for the sale of Nations Energy's remaining
investment, a power project in Panama with a book value of less than $1
million.
In 2001, Nations Energy recorded an after-tax gain of $6 million from
the sale of its interest in the Curacao project. Nations Energy received $5TEP
deposited $17 million in cash proceeds and recorded a net present valued $8 million note
receivable in connection with this transaction. In addition, $15 million in
related construction deposits were returned to Nations Energy. At December
31, 2002, including accretion, the note receivable balance is $9 million. We
describe this note more fully in Note 4 of Notes to Consolidated Financial
Statements - Millennium Energy Businesses - Nations Energy Contingency.
In 2000, Nations Energy sold its interest in a project locatedsecond mortgage trustee in the Czech Republic resulting in a $3 million pre-tax gain.
Other Investments and Commitments
---------------------------------
Millennium provided funding to the following investments:
Millennium invested $20 million in Sabinas. Sabinas also owns 19.5% of
Mimosa. In December 2002, Millennium received a return of capital of $0.5
million, bringing Millennium's investment at December 31, 2002 to
approximately $19.5 million. In the firstfourth
quarter of 2003 Millennium
received an additional returnin conjunction with the release of capital of $0.5 million. Millennium owns
50% of Sabinas; the other half is owned by AHMSA. UniSource Energy's
Chairman, President and Chief Executive Officer is a member of the board of
directors of AHMSA.
In 2002, Millennium provided a loan of approximately $5 million to MEG.
In 2001, Millennium contributed $5$42 million in equity and a $4 million loan to
MEG. These funds were used to provide working capital to facilitate MEG's
activities in the emission allowance and coal markets.
Millennium contributed $2 million in 2002 and $3 million in 2001 in
equity funding to Powertrusion. Millennium owns a controlling 50.5% interest
in Powertrusion.
Millennium provided funding to TruePricing of $2 million in 2002 and
$1.1 million in 2001. TruePricing is a start-up company established to
market energy related products. In February 2003, Millennium committed to
fund up to an additional $1.2 million in equity to TruePricing of which $0.4
million was funded on March 5, 2003.
Millennium contributed $1 million in 2002, $4.2 million in 2001 and $1.4
million in 2000 to Haddington Energy Partners II LP, a limited partnership
that funds energy related investments. This investment brings Millennium's
funding to approximately $6.6 million. The funding is part of a $15 million
commitment made during 2000. The remaining funds are expected to be invested
within two to three years. A member of the UniSource Energy Board of
Directors has a minor investment in the project. An affiliate of such board
member serves as the general partner.
Millennium has a $6 million capital commitment to a venture capital fund
that focuses on information technology, microelectronics, and biotechnology
investments in Arizona, Southern California, New Mexico, Colorado and Utah.
Approximately $1 million has been fundedproperty from
inception through December 31,
2002. Millennium does not currently expect to provide additional funding to
this commitment in 2003. Another member of the UniSource Energy Board of
Directors is a general partner of the company that manages the fund.
UED -- UNREGULATED ENERGY BUSINESS
UED is responsible as project developer for facilitating the
Springerville Generating Station expansion project construction. If
constructed, each of Units 3 and 4 would consist of a 400 MW coal-fired, base-
load generating unit at the same site as Springerville Units 1 and 2. This
would allow TEP to spread the fixed costs of the existing common facilities
over the additional generating unit (or units). Upon completion of Unit 3,
TEP expects to receive annual benefits of approximately $10 million to $15
million in the form of cost savings, rental payments and other fees. TEP
will also benefit from upgraded emissions controls for Units 1 and 2 that
will be paid for by the Unit 3 project.
To date, we have funded approximately $22 million for development of the
project. In January 2003, UED and Tri-State signed a Development Cost
Agreement to each share 50% of the remaining development costs of Unit 3
effective from November 6, 2002 until financial close. UED expects to
provide an additional $4 million in funding for development prior to a third
party obtaining the construction financing. UED expects the third party to
obtain construction financing in the second quarter of 2003. Our funding to
UED for equity will depend upon the level of ownership by the third party.
We can make no assurances, however, about the ultimate timing, or whether UED
will proceed with this project.
FINANCING RISKS
UniSource Energy and TEP are exposed to risks related to the ability to
obtain financing at reasonable costs for various projects, agreements to
which they are a party, and their debt obligations. During 2002, the market
for bank financings was less liquid and more volatile than in recent years
due to a number of defaults and deteriorating financial condition of many
corporate borrowers, particularly in the energy industry. As a result, when
TEP refinanced its bank Credit Agreement in November 2002, it was required to
pay significantly higher interest and fees on its new credit facilities than
it paid on its previous credit facilities. See TEP Bank Credit Agreement,
above. During 2003, UniSource Energy, TEP and UED will be subject to
financing risks and capital market conditions related to the following:
- UniSource Energy has entered into Asset Purchase Agreements to
purchase the Citizens Arizona electric utility and gas utility assets
for $230 million. UniSource Energy expects that a portion of the
purchase price will be financed with debt secured by the purchased
assets. UniSource Energy may also consider financing a portion of the
purchase price with new equity, depending on market conditions and other
considerations. If UniSource Energy were unable to obtain financing,
and therefore were unable to consummate the purchase of these assets,
this would constitute a breach under the contracts and termination
damages would be payable.
- UED is currently evaluating opportunities to expand the Springerville
Station by assigning the rights to construct Springerville Units 3 and 4
to unrelated third parties. As of December 31, 2002, UED had
approximately $22 million of capitalized project development costs on
its balance sheet. If a third party does not obtain financing for this
project and as a result, this project does not proceed, the capitalized
project development costs would immediately be expensed.
- TEP must refinance or extend the $70 million of lease debtmortgage indentures related to the Springerville Common Facilities Leases before June 30, 2003. Due to the
ongoing difficult captial market conditions in the energy sector, TEP
will likely be required to pay a higher rate of interest on the new debt
than its existing rate of LIBOR plus 2.5%.
- TEP intends to refinance or extend its 364 day Revolving Credit Facility,
which expires on November 13, 2003.Unit 3 transaction.
K-48
CONTRACTUAL OBLIGATIONS
The following charts display TEP's contractual obligations as of
December 31, 2003 by maturity and by type of obligation, and provide additional
detail on TEP's capital lease obligations.
TEP's Contractual Obligations
- Millions of Dollars -
- ---------------------------------------------------------------------------------------------------------
IDBs Total
Supported Long- Capital Unconditional Contractual----------------- --------------- -------- --------------- ------------- -------------- -------------------- ---------------
Payments
Due in IDBs Pension and Other Total
Years Supported by Long- Capital Postretirement Contractual
Ending Expiring Term Lease Operating Purchase Benefit Cash
Ending
December 31, LOCs (1) Debt Obligations (2) Leases Obligations (3)Obligations Obligations
- -------------------------------------------------------------------------------------------------------------------------- --------------- -------- --------------- ------------- -------------- -------------------- ---------------
2003
2004 $ - $ 2 $120 $1 $ 12191 $ 25 $ 81 $ 206
2004 - 2 124 1 78 205219
2005 - 2 125120 1 75 20390 3 216
2006 329 21 127122 1 72 55087 4 564
2007 - 1 128127 1 72 20277 4 210
2008 - ---------------------------------------------------------------------------------------------------------29 120 1 77 5 232
- ----------------- --------------- -------- --------------- ------------- -------------- -------------------- ---------------
Total 20032004 - 2007 329 28 625 6 378 1,36655 609 5 422 21 1,441
2008
Thereafter - 773 965 3 278 2,019744 836 1 424 177 2,182
Less: Imputed - - (633) - - - (633)
Interest
- - (746) - - (746)
- -------------------------------------------------------------------------------------------------------------------------- --------------- -------- --------------- ------------- -------------- -------------------- ---------------
Total $329 $799 $812 $6 $846 $ 329 $801 $ 844 $ 9 $ 656 $2,639
=========================================================================================================
(1) TEP's tax-exempt variable rate bonds (IDBs) in the amount of $329 million are backed by LOCs
under TEP's Credit Agreement. TEP's obligations under the Credit Agreement are collateralized
with Second Mortgage Bonds. These IDBs were classified as short-term debt at December 31,
2001, because the existing LOCs were scheduled to expire on December 30, 2002. New LOC
facilities were obtained in November 2002 and the IDBs were classified as long-term debt
December 31, 2002.
(2) See TEP's Capital Lease Contractual Obligations table below.
(3) These obligations represent future guaranteed payments under TEP's natural gas, coal and rail
transportation contracts.
198 $2,990
================= =============== ======== =============== ============= ============== ==================== ===============
See UniSource Energy Consolidated, Liquidity and Capital Resources, Contractual
Obligations, above, for a description of these obligations.
TEP's Capital Lease Obligations
- Millions of Dollars -
- -------------------------------------------------------------------------------------------------------------------------------------------- ---------------- --------------- ------------ ---------------- ----------- ----------------
Springerville Springerville Irvington Springerville Rail Car Total Capital
Payments Due in Years Ending Springerville Coal Handling Sundt Unit Springerville Rail Car Lease
December 31, Unit 1 Coal Unit 4 Common Lease Lease
Ending December 31, Handling Obligations
- --------------------------------------------------------------------------------------------------------------
------------------------------ ---------------- --------------- ------------ ---------------- ----------- ----------------
2003
2004 $ 8486 $ 1916 $13 $ 13 $ 5 $ - $ 121
2004 86 18 13 6 1 1244 $1 $120
2005 86 1917 12 7 1 1255 - 120
2006 85 24 11 722 10 5 - 127122
2007 85 24 1312 6 - 128127
2008 85 18 12 5 - --------------------------------------------------------------------------------------------------------------120
- ------------------------------ ---------------- --------------- ------------ ---------------- ----------- ----------------
Total 20032004 - 2007 426 104 62 31 2 6252008 427 97 59 25 1 609
Thereafter 606 148 39 172521 129 27 159 - 965836
Less: Imputed Interest (529) (120) (20) (77)(464) (97) (15) (57) - (746)(633)
- -------------------------------------------------------------------------------------------------------------------------------------------- ---------------- --------------- ------------ ---------------- ----------- ----------------
Total $ 503 $ 132 $ 81 $ 126 $ 2 $ 844
==============================================================================================================$484 $129 $71 $127 $1 $812
============================== ================ =============== ============ ================ =========== ================
Contractual obligations of Millennium, UED, and UniSource Energy
stand-alone are not significant. UniSource Energy has contingent
obligations under various surety bonds that total approximately $0.5
million.
As discussed above, TEP has the full amount available under its $60
million Revolving Credit Facility. If TEP draws any amount under this
facility, such borrowing would become a contractual obligation of TEP at that
time.
We have no other commercial commitments to report.
We have reviewed our contractual obligations and provide the following
additional information:
- TEP does not have any provisions in any of its debt or lease
agreements that would cause an event of default or cause amounts to
become due and payable in the event of a credit rating downgrade.
- None of our contracts or financing structures contains provisions or
acceleration clauses due to changes in our stock price.
-o TEP's Credit Agreement contains pricing tied to a grid based on the
ratings of TEP's Credit Facilities. A change in TEP's credit rating can
cause an increase or decrease in the amount of interest and fees TEP
pays for these facilities.
-o TEP's Credit Agreement contains certain financial and other restrictive
covenants, including interest coverage, leverage and net worth tests.
Failure to comply with these covenants would entitle the lenders to
accelerate the maturity of all amounts outstanding. At December 31,
2002,2003, TEP was in compliance with these covenants. See TEP Bank Credit
Agreement, above.
-o TEP conducts its wholesale trading activities under the Western Systems
Power Pool Agreement (WSPP) which contains provisions whereby TEP may
be required to post margin collateral due to a change in credit rating
or changes in contract values. As of December 31, 2002,2003, TEP has not
been
K-49
required to post such collateral.
- MEG conducts its emissions and coal trading activities using certain
contracts which contain provisions whereby MEG may be required to post
margin collateral due to a change in contract values. As of December
31, 2002, MEG had posted $2 million in cash collateral to its trading
counterparties.
- MEG has a $5 million bank line of credit for the purpose of issuing
LOCs to counterparties to support its emission allowance and coal
marketing and trading activities. As of December 31, 2002, MEG had $2
million in outstanding LOCs. This facility expires in August 2004.
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 supports up to approximately $3.5 million in
commodity-related payments for MEG at December 31, 2002. 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.
DIVIDENDS ON COMMON STOCK
UniSource Energy
----------------
On February 7, 2003, UniSource Energy declared a cash dividend of $0.15
per share on its Common Stock. The dividend, totaling approximately $5
million, is payable March 7, 2003 to shareholders of record at the close of
business February 21, 2003. During 2002 and 2001, UniSource Energy paid
equal quarterly dividends to its shareholders of $0.125 and $0.10 per share,
totaling $17 million and $13 million, respectively.
UniSource Energy's Board of Directors will review our dividend level on
a continuing basis, taking into consideration a number of factors including
our results of operations and financial condition, general economic and
competitive conditions and the cash flows from our subsidiary companies, TEP,
Millennium and UED.
TEP
---
TEP declared and paid dividends of $80 million in 2003, $35 million in
2002, and $50 million in 2001, and $30 million in 2000.2001. UniSource Energy is the primary holder of TEP's
common stock.
TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants, including a covenant that requires
TEP to maintain a minimum level of net worth. As of December 31, 2002,2003, the
required minimum net worth was $286$325 million. TEP's actual net worth at December
31, 20022003 was $337 million. See TEP - Electric Utility, Financing
Activities, TEP Bank$389 million, and was $359 million as defined for the purposes of
the Credit Agreement, above.Agreement. As of December 31, 2002,2003, TEP was in compliance with the
terms of the Credit Agreement. Under the terms of the Credit Agreement,
dividends and certain investments in affiliates may not exceed 65% of TEP's net
income, for the immediately preceding fiscal year, so long as the Tranche B LOCs are outstanding. See Financing Activities
- - TEP Credit Agreement, above.
The ACC Holding Company Order statesstated that TEP may not pay dividends to
UniSource Energy in excess of 75% of its earnings until TEP's common equity ratio
equals 37.5% of total capitalization (excluding capital lease obligations). The
Citizens Settlement Agreement, as approved by the ACC, modified this dividend
limitation so that it will remain in place until TEP's common equity equals 40%
of total capitalization (excluding capital lease obligations). As of December
31, 2002,2003, TEP's common equity ratio on that basis was 23%(as determined by the ACC for the purpose of this
limitation) equaled 25% of total capitalization (excluding capital lease
obligations).
In connection with the proposed acquisition, Saguaro Utility intends to
cause the surviving corporation (i) to repay the $95 million intercompany loan
to UniSource Energy from TEP and (ii) to contribute up to $168 million to TEP.
TEP will use a significant portion of these proceeds to retire some of its
outstanding debt. We expect these transactions to improve TEP's common equity
(as determined by the ACC) to 40% of total capitalization (excluding capital
lease obligations).
In addition to these limitations, the Federal Power Act states that
dividends shall not be paid out of funds properly included in the capital account.accounts.
Although the terms of the Federal Power Act are unclear, we believe that there
is a reasonable basis to pay dividends from current year earnings. Therefore,
TEP declared its December 2002, 2001, and 20002003 dividends from 2002, 2001,its current year earnings since TEP had an
accumulated deficit, rather than positive retained earnings.
UNISOURCE ENERGY SERVICES
RESULTS OF OPERATIONS
UniSource Energy formed two operating companies, UNS Gas and 2000 earnings, respectively.
MillenniumUNS
Electric, to acquire the Arizona electric and UED
------------------
Millennium didgas assets from Citizens, as well
as an intermediate holding company, UES, to hold the common stock of UNS Gas and
UNS Electric. Results of operations for UNS Electric and UNS Gas cover the
period from August 11, 2003, the date the assets were acquired from Citizens, to
December 31, 2003.
UES' net income for the period was approximately $3 million. Similar to
TEP's operations, we expect UNS Electric's operations to be seasonal in nature,
with peak energy demand occurring in the summer months. We also expect
operations at UNS Gas to vary with the seasons, with peak energy usage occurring
in the winter months.
UNS Electric
The table below shows UNS Electric's kWh sales and revenues for the
period August 11, 2003 to December 31, 2003.
K-50
Sales Operating Revenue
- ------------------------------------------------------------------------------------------------------------------
For the Period August 11 - December 31, 2003 2003
Electric Retail Sales: -Millions of kWh- -Millions of Dollars-
Residential 302 $30
Commercial 153 16
Industrial 59 4
Other 47 5
- ------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------
Total Electric Retail Sales 561 $55
==================================================================================================================
UNS Gas
The table below shows UNS Gas' therm sales and revenues for the period
August 11, 2003 to December 31, 2003.
Sales Operating Revenue
- -------------------------------------------------------------------------------------------------------------------------
For the Period August 11 - December 31, 2003 2003
- -------------------------------------------------------------------------------------------------------------------------
Retail Therm Sales: -Millions of Therms- -Millions of Dollars-
Residential 25 $25
Commercial 12 11
Industrial 1 1
Public Authority 3 2
- -------------------------------------------------------------------------------------------------------------------------
Total Retail Therm Sales 41 39
Transport - 1
Negotiated Sales Program (NSP) 13 7
- -------------------------------------------------------------------------------------------------------------------------
Total 54 $47
=========================================================================================================================
Through a Negotiated Sales Program (NSP) approved by the ACC, UNS Gas
supplies natural gas to some of its large transportation customers.
Approximately one half of the margin earned on these NSP sales is retained by
UNS Gas, while the remainder benefits retail customers through a credit to the
Purchased Gas Adjustor (PGA) mechanism which reduces the gas commodity price.
FACTORS AFFECTING RESULTS OF OPERATIONS
COMPETITION
As required by the ACC order approving UniSource Energy's acquisition
of the Citizens' Arizona gas and electric assets, on November 3, 2003, UNS
Electric filed with the ACC a plan to open its service territories to retail
competition by December 31, 2003. The plan addresses all aspects of
implementation. It includes UNS Electric's unbundled distribution tariffs for
both standard offer customers and customers that choose competitive retail
access, as well as Direct Access and Settlement Fee schedules. UNS Electric
direct access rates for both transmission and ancillary services will be based
upon its FERC Open Access Transmission Tariff. The plan is subject to review and
approval by the ACC. As a result of the court decisions concerning the ACC's
Retail Electric Competition Rules, we are unable to predict when and how the ACC
will address this plan. See Tucson Electric Power Company, Factors Affecting
Results of Operations, Competition, above for information regarding the recent
Arizona Court of Appeals decision.
RATES AND REGULATION
ACC Order on Citizens Acquisition
On July 3, 2003, the ACC issued an order approving the acquisition of
Citizens Arizona gas and electric assets. 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. Key provisions of the order include:
K-51
UNS Gas
o 20.9% overall increase in retail rates through a base rate increase.
o Restricts the filing of a general rate case until August 2006 and any
resulting rate increase shall not pay anybecome effective prior to August 1,
2007.
o Limits dividends payable by UNS Gas to UniSource Energy to 75% of
earnings until the ratio of common equity to total capitalization
reaches 40%.
UNS Electric
o 22% overall increase in retail rates through its Purchased Power Fuel
Adjustor Clause (PPFAC).
o UNS Electric must file a plan with the ACC to open its service
territories to retail competition by no later than December 31, 2003
(which was filed by UNS Electric on November 3, 2003).
o Restricts the filing of a general rate case until August 2006 and any
resulting rate increase shall not become effective prior to August 1,
2007.
o Limits dividends payable by UNS Electric to UniSource Energy to 75% of
earnings until the ratio of common equity to total capitalization
reaches 40%.
o Requires UNS Electric to enter into negotiations with Pinnacle West
Capital Corporation (PWCC) to seek to reduce the cost of its purchased
power contract with PWCC.
Energy Cost Adjustment Mechanisms
UNS Gas
UNS Gas' retail rates include a PGA mechanism 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.
On September 9, 2003, the ACC approved a new PGA surcharge of $0.1155
per therm that took effect October 1, 2003.
UNS Electric
UNS Electric's retail rates include a PPFAC, which 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 ACC Order, a new PPFAC surcharge of $0.01825 per kWh was approved to fully
recover the cost of the current full-requirements power supply agreement with
PWCC. UNS Electric is required to enter into negotiations with PWCC to
potentially reduce the cost of this purchased power contract; 90% of any savings
from the negotiations is to be passed on to UNS Electric rate payers.
LIQUIDITY AND CAPITAL RESOURCES
UES' capital requirements consist primarily of capital expenditures. In
the nearly five months of operation during 2003, capital expenditures were
approximately $13 million. During 2004, UES expects to generate sufficient
internal cash flows to fund its operating activities and its construction
expenditures.
UES' forecasted construction expenditures for the next five years are:
$37 million in 2004, $41 million in 2005, $54 million in 2006, $40 million in
2007, and $40 million in 2008.
Senior Unsecured Notes
On August 11, 2003, UNS Gas and UNS Electric issued a total of $160
million of aggregate principal amount of senior unsecured notes in a private
placement. Proceeds from the note issuance were paid to Citizens to purchase the
Arizona gas and electric system assets. UNS Gas issued $50 million of 6.23%
Notes
K-52
due in 2011 and $50 million of 6.23% Notes due in 2015. UNS Electric
issued $60 million of 7.61% Notes due in 2008. The notes are guaranteed by UES.
The note purchase agreements for both UNS Gas and UNS Electric contain
certain restrictive covenants, including restrictions on transactions with
affiliates, mergers, liens to secure indebtedness, restricted payments,
incurrence of indebtedness, and minimum net worth. Consolidated Net Worth, as
defined by the note purchase agreements for both UNS Gas and UNS Electric, is
approximately equal to the balance sheet line item, Common Stock Equity. The
table below outlines the actual and required minimum net worth levels of UES,
UNS Gas, and UNS Electric, at December 31, 2003.
Required Actual
Company Net Worth Net Worth
- ------------------- ----------------- -----------------
-Millions of Dollars-
UES $50 $90
UNS Gas 43 53
UNS Electric 26 37
- ------------------- ----------------- -----------------
The incurrence of indebtedness covenant requires each of UNS Gas and
UNS Electric to meet certain tests before additional indebtedness may be
incurred. These tests include:
o A ratio of Consolidated Long-Term Debt to Consolidated Total
Capitalization of no greater than 0.67 to 1.00 prior to September
30, 2004, and no greater than 0.65 to 1.00 after September 30, 2004.
o An Interest Coverage Ratio (a measure of cash flow to cover interest
expense) of at least 2.50 to 1.00.
However, UNS Gas and UNS Electric may, without meeting these tests,
refinance indebtedness and incur short-term debt in an amount not to exceed $7
million in the case of UNS Gas, and $5 million in the case of UNS Electric.
Neither UNS Gas, nor UNS Electric, may declare or make distributions or
dividends (restricted payments) on their common stock unless (a) immediately
after giving effect to such action no default or event of default would exist
under such company's note purchase agreement and (b) immediately after giving
effect to such action, such company would be permitted to incur an additional
dollar of indebtedness under the debt incurrence test for such company.
CONTRACTUAL OBLIGATIONS
The following section includes UES' significant contractual obligations or
other commercial commitments:
UNS Gas Supply Contracts
UNS Gas has a natural gas supply and management agreement with BP
Energy Company (BP). Under the contract, BP manages UNS Gas' existing supply and
transportation contracts and its incremental requirements. The initial term of
the agreement extends through August 31, 2005. The term of the agreement is
automatically extended one year on an annual basis unless either party provides
180 days notice of its intent to terminate. Prices for incremental gas supplied
by BP will vary based upon the period during which the gas is delivered. UNS Gas
hedges its gas supply prices by entering into fixed price forward contracts at
various times during the year to provide more stable prices to its customers.
These purchases are made up to three years in advance with the goal of hedging
at least 45% and not more than 80% of the expected monthly gas consumption with
fixed prices prior to entering into the month. Currently, UNS Gas has
approximately 15% of its expected monthly consumption hedged for November
through December 2004 and 10% for January through March 2005.
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 transmission service
under a full requirements contract under which UNS Gas pays a fixed reservation
charge. This contract expires on September 1, 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
K-53
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 on March 1, 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 Power Supply and Transmission Contracts
UNS Electric has a full requirements power supply agreement with PWCC.
The agreement expires May 31, 2008. The agreement obligates PWCC to supply all
of UNS Electric's power requirements at a fixed price per MWh. Payments under
the contract are usage based, with no fixed customer or demand charges.
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 $6 million
in 2004 and $1 million in 2005 through 2011.
DIVIDENDS ON COMMON STOCK
The Citizens Settlement Agreement, as approved by the ACC, limits
dividends payable by UNS Gas and UNS Electric to 75% of earnings until the ratio
of common equity to total capitalization reaches 40%. At December 31, 2003, the
ratio of common equity to total capitalization for UNS Gas was 35% and for UNS
Electric was 38%.
The note purchase agreements for both UNS Gas and UNS Electric contain
restrictive covenants including restrictions on dividends. According to the note
purchase agreements, neither UNS Gas, nor UNS Electric, may declare or make
distributions or dividends (restricted payments) on their common stock unless,
(a) immediately after giving effect to such action no default or event of
default would exist under such company's note purchase agreement and (b)
immediately after giving effect to such action, such company would be permitted
to incur an additional dollar of indebtedness under the debt incurrence test for
such company.
MILLENNIUM ENERGY HOLDINGS, INC.
RESULTS OF OPERATIONS
Millennium accounts for its investments under the consolidation method
and the equity method. In some cases, Millennium is an investment's sole
provider of funding. When this is the case, Millennium recognizes 100% of an
investment's losses, because as sole provider of funds it bears all of the
financial risk. To the extent that an investment becomes profitable and
Millennium has recognized losses in excess of its percentage ownership,
Millennium will recognize 100% of an investment's net income until Millennium's
recognized losses equal its ownership percentage of losses.
The table below provides a breakdown of the net income and losses
recorded by Millennium for the last three years. These results exclude sales and
related costs to TEP.
K-54
2003 2002 2001
------------------------------------------------------------------------------ -------------- ------------- --------------
-Millions of Dollars -
Technology Investments
Global Solar and IPS
Research & Development Contract Revenues from Third Parties $1 $ 1 $ 2
Research & Development Contract Expenses & Losses (5) (2) (5)
Research & Development - Internal Development Expenses (2) (7) (4)
Depreciation & Amortization Expense (3) (3) (2)
Administrative & Other Costs (8) (11) (9)
Income Tax Benefits 7 9 7
------------------------------------------------------------------------------ -------------- ------------- --------------
Total Global Solar and IPS Net Loss (10) (13) (11)
MicroSat and ITN Energy Systems Inc. Net Loss (1) (1) (3)
------------------------------------------------------------------------------ -------------- ------------- --------------
------------------------------------------------------------------------------ -------------- ------------- --------------
Total Technology Investments Net Loss (11) (14) (14)
Nations Energy and Other Millennium Investments Net (Loss) Income (5) (2) 5
------------------------------------------------------------------------------ -------------- ------------- --------------
------------------------------------------------------------------------------ -------------- ------------- --------------
Total Millennium Loss, after-tax $ (16) $ (16) $ (9)
============================================================================== ============== ============= ==============
Technology Investments
Millennium accounts for Global Solar under the consolidation method and
recognizes 100% of Global Solar's losses. In 2003 Millennium funded debt and
equity contributions of $10 million to Global Solar. Global Solar recognizes
expense when funding is used for research, development and administrative costs.
Millennium has no remaining funding commitments to Global Solar.
Millennium also accounts for IPS under the consolidation method. In
2003, Millennium provided IPS funding of $3 million. Dow Corning Enterprises,
Inc. (DCEI) continued to support IPS through 2003 with preferred equity and debt
contributions totaling $2 million. IPS recognizes expense when funding is used
for research, development and administrative costs. At December 31, 2003,
Millennium had less than $1 million of unfunded commitments to IPS. In early
2004 these funds were drawn by IPS.
Millennium's after-tax losses relating to MicroSat and ITN Energy
Systems Inc. (ITN) related to the development of small-scale satellites and
other research and development activities. Millennium accounts for MicroSat
under the equity method. In 2003, Millennium made no contributions to MicroSat.
As sole funder, Millennium recognizes 100% of MicroSat's net losses. Millennium
has no further funding commitments to MicroSat. ITN results are included at 100%
of ITN's losses only through June 2003, when Millennium exchanged its ITN shares
for shares of Global Solar.
As technology developers, these entities face many challenges, such as
developing technologies that can be manufactured on an economic scale,
technological obsolescence, competitors and possible reductions in government
spending to advance technological research and development activities.
Nations Energy and Other Millennium Investments
Results from Nations Energy and Other Millennium investments in 2003
include an after-tax loss of less than $2 million from each of Powertrusion and
TruePricing, Inc. (TruePricing) and less than $1 million each from Nations
Energy, SES and MEG.
Results from Nations Energy and Other Millennium Investments in 2002
include an after-tax loss of $2 million from Powertrusion. Powertrusion produces
and sells lightweight utility pole products. Nations Energy had income of less
than $1 million. MEG, SES and TruePricing, each recorded after-tax losses of
less than $1 million. These losses were offset by earned interest and a tax
benefit from final resolution of IRS audits.
In 2001, or 2000. We cannot predictNations Energy sold its investment in a power project in
Curacao, resulting in an after-tax gain of $6 million. Nations Energy received a
promissory note as part of the amount or timingsale. See Item 7A. - Quantitative and Qualitative
Disclosures about Market Risk, Credit Risk, below.
Millennium consolidates the results of SES, MEG, Powertrusion and
Nations Energy. Millennium uses the equity method to reflect its investment in
Haddington, Valley Ventures, and Sabinas. Sabinas, however,
K55
accounts for its investment in Mimosa under the cost method.
Millennium Commitments
Millennium is currently finalizing possible future dividendscommitments to each
of its investments to help insure that these investments conform to Millennium's
business plans. Millennium's funding levels and share ownership are subject to
change in the future. Millennium's outstanding equity commitments are currently
limited to $6 million to Haddington and $5 million to Valley Ventures.
Millennium's only outstanding debt commitment at December 31, 2003, to IPS, was
funded in early 2004.
Global Solar and MicroSat have commitments to incur future expenses
relating to government contracts. The following is a table of remaining
government contract commitments at:
December 31,
2003 2002 2001
- ----------------------------- -------------- -------------- --------------
-Millions of Dollars-
Global Solar $ 1 $ 3 $ -
MicroSat - 6 8
- ----------------------------- -------------- --------------- --------------
Total $ 1 $ 9 $ 8
============================= ============== =============== ==============
UNISOURCE ENERGY DEVELOPMENT COMPANY
RESULTS OF OPERATIONS
UED recorded net income of $7 million in 2003 compared with $1 million
in 2002. UED's income in 2003 primarily represents an $11 million pre-tax
development fee received at the financial closing of the Springerville Unit 3
Project. See Springerville Generating Station Expansion, below.
UED's net income in 2002 represented rental income (less expenses)
under an operating lease of the 20 MW North Loop turbine to TEP. The rental
income was eliminated from Millennium.UniSource Energy's consolidated after-tax earnings as
an inter-company transaction. TEP purchased the turbine from UED has notin September
2002.
SPRINGERVILLE GENERATING STATION EXPANSION
On October 21, 2003, Tri-State completed financing of Unit 3 and
immediately began construction. UED received reimbursement of its development
costs totaling $29 million, and an $11 million development fee. On October 24,
2003, UniSource Energy used the proceeds to repay a $35 million short-term
bridge loan.
UED will continue to manage the development of Unit 3. Upon the
completion of construction in December 2006, TEP expects to receive annual
pre-tax benefits of approximately $15 million in the form of cost savings,
rental payments, transmission revenues, and other fees. TEP will also benefit
from upgraded emissions controls for Units 1 and 2, totaling approximately $90
million, which will be paid any dividendsfor by the Unit 3 project.
CRITICAL ACCOUNTING POLICIES
In preparing financial statements under Generally Accepted Accounting
Principles (GAAP), management exercises judgment in the selection and
application of accounting principles, including making estimates and
assumptions. UniSource Energy and TEP consider Critical Accounting Policies to
be those that could result in materially different financial statement results
if our assumptions regarding application of accounting principles were
different. UniSource Energy.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
SeeEnergy and TEP describe their Critical Accounting Policies
below. Other significant accounting policies and recently issued accounting
standards are discussed in Note 1 of Notes to Consolidated Financial Statements.Statements
- - Nature of Operations and Summary of Significant Accounting Policies.
K-56
ACCOUNTING FOR RATE REGULATION
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),
issued by the Financial Accounting Standards Board (FASB), 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 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 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:
o an independent regulator sets rates;
o the regulator sets the rates to recover specific costs of delivering
service; and
o the service territory lacks competitive pressures to reduce rates below
the rates set by the regulator.
TEP
In November 1999, upon approval by the ACC of the 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 transmission and distribution regulatory assets, net of regulatory
liabilities, total $287 million at December 31, 2003, $21 million of which is
not presently included in the rate base and consequently is not earning a return
on investment.
TEP continues to apply FAS 71 to its regulated business, distribution
and transmission, and continues to assess whether it can 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 and would write off its regulatory liabilities as income on its
income statement. Based on regulatory asset and liability balances at December
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 $173 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.
UES
UES' regulatory assets, net of regulatory liabilities, total $1 million
at December 31, 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 regulatory assets and liabilities at
December 31, 2003, if UES had stopped applying FAS 71 to its regulated
operations, it would have recorded an extraordinary loss, after-tax, of
approximately $1 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.
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
FAS 143, issued by the FASB in June 2001, 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
K-57
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.
TEP
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. TEP has estimated that its share of the cost to remove the Navajo and
Four Corners facilities and 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. As of December
31, 2002, TEP had accrued $113 million for the final decommissioning of its
generating facilities. This amount has been reclassified from accumulated
depreciation to an accrued asset retirement obligation. As discussed below,
this amount was reversed for 2002 and included as part of the cumulative effect
of accounting change adjustment when FAS 143 was adopted on January 1, 2003.
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. As of
December 31, 2003, TEP had accrued $60 million for the net cost of removal for
the interim retirements from its transmission, distribution and general plant.
As of December 31, 2002, TEP had accrued $55 million for these removal costs.
The amount has been reclassified from accumulated depreciation to a regulatory
liability.
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 million,
increased depreciable assets by $0.1 million for asset retirement costs,
reversed $113 million of costs previously accrued for final removal from
accumulated depreciation, reversed previously recorded deferred tax assets by
$44 million and recognized the cumulative effect of accounting change as a gain
of $112 million ($67 million net of tax). Adopting FAS 143 has resulted 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 ended December 31, 2003 and future years, the
annual reduction in depreciation expense is approximately $6 million.
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 have been determined pursuant
to the TEP Settlement Agreement.
UES, MILLENNIUM AND UED
UES has various transmission and distribution lines that operate
under land leases and rights of way that contain end dates and restorative
clauses. UES 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, UES is not recognizing the cost of final removal of
the transmission and distribution lines in the financial statements. As of
December 31, 2003, UES had accrued $0.6 million for the net cost of removal for
interim retirements from
K-58
its transmission, distribution and general plant. The
amount has been reclassified from accumulated depreciation to a regulatory
liability.
Millennium and UED have no asset retirement obligations.
TEP - PAYMENT DEFAULTS AND ALLOWANCES FOR DOUBTFUL ACCOUNTS
We record an allowance for doubtful accounts when we determine that an
account receivable will not be collected. As a result of payment defaults made
by market participants in California, TEP's collection shortfall from the CPX
and CISO was approximately $9 million for sales made in 2000 and $7 million for
sales made in 2001. Prior to 2003 and since December 31, 2001, TEP had an
allowance for doubtful accounts recorded for $8 million, or 50% of these
uncollected amounts based on the amount TEP believed would be collected. In the
first quarter of 2003, as a result of a FERC order, TEP estimated that $6
million of its $16 million receivable will be collected. Therefore, in the first
quarter of 2003, TEP increased its reserve for sales to the CPX and the CISO by
$2 million by recording a reduction of wholesale revenues. The amount that TEP
ultimately collects would have an impact on earnings if the amount received is
more or less than the $6 million TEP has on its balance sheet. If TEP collects
all of the $16 million, pre-tax income will increase by $10 million. If TEP does
not collect any of the $16 million, pre-tax income will decrease by $6 million.
In addition, TEP has cash collateral of approximately $1 million on deposit in
an escrow account with the CPX, which is currently unavailable to TEP due to the
CPX's bankruptcy stay.
At December 31, 2003 and December 31, 2002, TEP's reserve for electric
wholesale accounts receivable on its balance sheet was approximately $11 million
and $8 million, respectively.
PENSION AND OTHER POSTRETIREMENT BENEFIT PLAN ASSUMPTIONS
We record plan assets, obligations, and expenses related to pension and
other postretirement benefit plans based on actuarial valuations. These
valuations include key assumptions on discount rates, expected returns on plan
assets, compensation increases and health care cost trend rates. These actuarial
assumptions are reviewed annually and modified as appropriate. The effect of
modifications is generally recorded or amortized over future periods. We believe
that the assumptions used in recording obligations under the plans are
reasonable based on prior experience, market conditions and the advice of plan
actuaries.
TEP
TEP discounted its future pension plan obligations using a rate of
6.25% at December 31, 2003, compared with 6.75% at December 31, 2002. TEP
discounted its other postretirement plan obligations using a rate of 5.5% at
December 31, 2003, compared with 6.75% at December 31, 2002. TEP determines the
discount rate annually based on the rates currently available on high-quality,
long-term bonds. TEP looks to bonds that receive one of the two highest ratings
given by a recognized rating agency and are expected to be available during the
period to maturity of the pension benefits. In selecting the appropriate rate,
TEP also considers the durations of plan obligations.
The pension liability and future pension expense both increase as the
discount rate is reduced. A decrease in the discount rate results in an increase
in the Projected Benefit Obligation (PBO) and the service cost component of
pension expense. Additionally, the recognized actuarial loss is significantly
impacted by a reduction in the discount rate. Since the PBO increases with the
decrease in discount rate, the obligation is that much larger than would
normally occur due to normal growth of the plan. This leads to an actuarial loss
(or a greater actuarial loss than would occur in the absence of the discount
rate change), which is amortized over future periods leading to a greater
expense. The resulting change in the interest cost component of pension expense
is dependent on the effect that the change in the discount rate has on the PBO
and will vary based on employee demographics. The effect of the lower rate used
to calculate the interest cost is offset to some degree by a larger obligation.
The relative magnitude of these two changes determines whether interest cost
will increase or decrease. For TEP's pension plans, a 25 basis point decrease in
the discount rate would increase the accumulated benefit obligation (ABO) by
approximately $5 million and the related plan expense for 2004 by approximately
$1 million. A similar increase in the discount rate would decrease the ABO by
approximately $4 million and the related plan expense for 2004 by approximately
$1 million. For TEP's plan for other postretirement benefits, a 25 basis point
change in the discount rate would increase or decrease the
K-59
accumulated postretirement benefit obligation (APBO) by approximately $2
million. A 25 basis point change in the discount rate would not have a
significant impact on the related plan expense for 2004.
TEP calculates the market-related value of plan assets using the fair
value of plan assets on the measurement date. At December 31, 2003 and 2002, TEP
assumed that its plans' assets would generate a long-term rate of return of
8.75%. In establishing its assumption as to the expected return on plan assets,
TEP reviews the plans' asset allocation and develops return assumptions for each
asset class based on advice from an investment consultant and the plans' actuary
that includes both historical performance analysis and forward looking views of
the financial markets. Pension expense increases as the expected rate of return
on plan assets decreases. A 25 basis point change in the expected return on plan
assets would not have a significant impact on pension expense for 2004.
TEP increased the initial health care cost trend rate used in valuing
its postretirement benefit obligation to 12.1% at December 31, 2003. Assumed
health care cost trend rates have a significant effect on the amounts reported
for health care plans. A 1% increase in assumed health care cost trend rates
would increase the postretirement benefit obligation by approximately $5 million
and the related plan expense by approximately $1 million. A similar decrease in
assumed health care cost trend rates would decrease the postretirement benefit
obligation by approximately $5 million and the related plan expense by less than
$1 million.
TEP recorded a minimum pension liability of approximately $4 million at
December 31, 2003, compared with $7 million at December 31, 2002. Improved stock
market conditions offset a further reduction in the assumed discount rate.
Based on the above assumptions, TEP will record pension expense of
approximately $8 million and other postretirement benefit expense of $7 million
ratably throughout 2004. TEP will make required pension plan contributions of $5
million in 2004. TEP's other postretirement benefit plan is not funded. TEP
expects to make benefit payments to retirees under the postretirement benefit
plan of approximately $3 million in 2004.
UES
Concurrent with the acquisition of the Arizona gas and electric system
assets from Citizens on August 11, 2003, UES established a pension plan for
substantially all of its employees. UES did not assume the pension obligation
for employees' years of service with Citizens. UES performed an actuarial
valuation, as of the date of acquisition, to determine its pension expense for
the balance of 2003. A discount rate of 6.5% was assumed based on rates
available at that date and the duration of plan obligations.
UES discounted its future pension plan obligations using a rate of
6.25% at December 31, 2003. For UES' pension plan, a 25 basis point change in
the discount rate would have minimal effect on either the ABO or the related
pension expense. UES recorded a minimum pension liability of approximately $1
million at December 31, 2003. UES will record pension expense of $1 million in
2004. The pension plan is not yet funded but all required contributions will be
made in accordance with minimum funding standards. UES will make a pension plan
contribution of $1 million in 2004.
On the acquisition date, UES assumed the obligation to provide
postretirement benefits for a small population of former Citizens employees,
both active and retired. The obligation has been recorded at a discounted value
of $2 million using a discount rate of 5.25%. The plan is not funded. UES does
not expect postretirement medical benefit expenses to have a material impact on
its operations.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND TRADING ACTIVITIES
A derivative financial instrument or other contract derives its value
from another investment or designated benchmark. 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. The majority of TEP's forward contracts are considered
normal purchases and sales 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 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
K-60
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.
UNS Gas and UNS Electric do not currently have any contracts that are
required to be marked to market. 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. 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. This 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 45%
and not more than 80% 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 and therefore are not required
to be marked to market.
Because of the complexity of derivatives, the FASB established a
Derivatives Implementation Group (DIG). To date, the DIG has issued more than
100 interpretations to provide guidance in applying Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (FAS 133). As the DIG or the FASB continues to issue interpretations,
TEP, UNS Gas and UNS Electric may change the conclusions they have reached and,
as a result, the accounting treatment and financial statement impact could
change in the future.
MEG enters into swap agreements, options and forward contracts relating
to Emissions Allowances and coal. MEG also marks its trading contracts to market
by recording unrealized gains and losses on its trading activities 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 values for TEP's and MEG's
derivative instruments are estimated based on various factors including broker
quotes, exchange prices, over the counter prices and time value.
TEP's and MEG's derivative activities are reported as follows:
o TEP's net unrealized and realized gains and losses on forward sales
contracts are components of Electric
Wholesale Sales;
o TEP's net unrealized and realized gains and losses on forward purchase
contracts are components of Purchased Power; and
o MEG's net unrealized and realized gains and losses on trading
activities are components of Other Operating Revenues. Although MEG's
realized gains and losses 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.
TEP's net unrealized gains (losses) on forward contracts were as follows:
Years Ended December 31,
2003 2002 2001
- -----------------------------------------------------------------------------------------
-Millions of Dollars-
Included in Electric Wholesale Sales $ (1) $ (1) $ 188
Included in Purchased Power Expense - 2 (189)
- -----------------------------------------------------------------------------------------
The net pre-tax gains and losses from MEG's trading activities were
less than $1 million for each of the years ended December 31, 2003, 2002 and
2001.
At December 31, 2003, the fair value of TEP's derivative liabilities
was less than $1 million and is reported in Other Current Liabilities 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 Emissions Allowance inventory,
was $22 million at December 31, 2003 and $15 million at December 31,
K-61
2002. The fair value of MEG's trading liabilities was $19 million at December
31, 2003 and $10 million at December 31, 2002.
See Market Risks - Commodity Price Risk in Item 7A.
UNBILLED REVENUE - TEP AND UES
TEP's and UES' retail revenues include an estimate of MWhs/therms
delivered but unbilled at the end of each period. The unbilled revenue is
estimated by comparing the actual MWhs/therms consumed to the MWhs/therms billed
to TEP and UES retail customers. The excess of MWhs/therms consumed over
MWhs/therms billed is then allocated to the retail customer classes based on
estimated usage by each customer class. TEP and UES then record revenue for each
customer class based on the various bill rates for each customer class. Due to
the seasonal fluctuations of TEP's actual load, the unbilled revenue amount
increases during the spring months and decreases during the fall months. The
unbilled revenue amount for UES gas sales increases during the fall months and
decreases during the spring months, whereas, the unbilled revenue amount for UES
electric sales increases during the spring months and decreases during the fall
months.
PLANT ASSET DEPRECIABLE LIVES - TEP AND UES
We calculate depreciation expense based on our estimate of the useful
lives of our plant assets. The estimated useful lives, and resulting
depreciation rates, used to calculate depreciation expense for the transmission
and distribution businesses of both UES and TEP have been approved by the ACC in
prior rate decisions. Depreciation rates for transmission and distribution
cannot be changed without ACC approval; however, TEP's rates may change in the
future as a result of the TEP General Rate Case to be filed in June 2004. We are
currently reviewing the estimated useful lives of all our assets due to a
variety of factors including TEP's need to file a depreciation study as part of
the June 2004 General Rate Case, the construction of Springerville Unit 3 and
the related environmental upgrades being made to Springerville Unit 2, new
information received from the operators of the remote generating stations, and
information received in connection with an analysis of FAS 143 retirement
obligations. See Item 1. -Business, TEP Electric Utility operations, Rates and
Regulations. The ACC is currently reviewing the status of electric competition
rules.
The estimated remaining useful lives of TEP's generating facilities are
based on management's best estimate of the economic life of the units. These
estimates are based on engineering estimates, economic analysis, and statistical
analysis of TEP's past experience in maintaining the stations. Individual
depreciation periods vary from plant to plant; however, we estimate that annual
depreciation expense would decrease by $10 million, $15 million, $19 million or
$21 million if the remaining useful lives of all our steam generation units were
increased by five, ten, fifteen or twenty years, respectively. In 2003,
depreciation expense related to generation assets was $34 million, and our
generation assets are currently depreciated over periods ranging from 23 to 70
years from the original in-service dates.
DEFERRED TAX VALUATION - TEP AND MILLENNIUM
We record deferred tax liabilities for amounts that will increase
income taxes on future tax returns. We record deferred tax assets for amounts
that could be used to reduce income taxes on future tax returns. We record a
valuation allowance, or reserve, for the deferred tax asset amount that we may
not be able to use on future tax returns. We estimate the valuation allowance
based on our interpretation of the tax rules, prior tax audits, tax planning
strategies, scheduled reversal of deferred tax liabilities, and projected future
taxable income.
The valuation allowance of $9 million at December 31, 2003 and $22
million at December 31, 2002, which reduces the Deferred Tax Asset balance,
relates to net operating loss and investment tax credit carryforward amounts.
The decrease of $15 million reflects UniSource Energy's and TEP's expectation to
be able to use a portion of these carryforward amounts on future tax returns,
primarily based on guidance issued by the Internal Revenue Service in September,
2003.
In the future, if UniSource Energy and TEP determine that it is
probable that TEP will not be able to use all or a portion of the net operating
loss and investment tax credit carryforward amounts, then UniSource Energy and
TEP would record a valuation allowance and recognize tax expense. Factors that
could cause TEP to
K-62
record a valuation allowance would be a change in expected future taxable income
or a change in tax filing status due to the proposed acquisition. The valuation
allowance of $9 million remaining at December 31, 2003 relates to losses
generated by the Millennium entities. In the future if UniSource Energy and the
Millennium entities determine that all or a portion of the remaining amounts may
be used on tax returns, then UniSource Energy and the Millennium entities would
reduce the valuation allowance and recognize a tax benefit of up to $9 million.
The primary factor that could cause the Millennium entities to recognize a tax
benefit would be a change in expected future taxable income
NEW ACCOUNTING PRONOUNCEMENTS
The FASB recently issued the following Statements of Financial Accounting
Standards (FAS) and FASB Interpretations (FIN):
o FIN 46, Consolidation of Variable Interest Entities, issued in January
2003, and subsequently revised in December 2003. The guidance 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
enterprises 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. For public companies, the revised FIN 46 is
effective for financial periods ending after March 15, 2004. Early
application is permissible. Companies that implemented FIN 46 prior to
its revision may continue to apply that guidance until the
implementation date of the revision. The adoption of FIN 46 and
revisions did not and are not expected to have a significant impact on
our financial statements.
o 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 is to be applied prospectively. The provisions of FAS 149
that relate to FAS 133 Implementation Issues that have been in effect
for fiscal quarters that began prior to June 15, 2003 are to be applied
in accordance with their respective effective dates. The adoption of
FAS 149 did not have a significant impact on our financial statements.
o FAS 132, Employers' Disclosures about Pensions and Other Postretirement
Benefits (revised 2003), was issued by the FASB in December 2003. FAS
132 requires additional disclosures about the assets, obligations, cash
flows, and net periodic benefit cost of defined benefit pension plans
and other defined benefit postretirement plans beyond those in the
original Statement 132 which it replaces. FAS 132, as revised, is
effective for fiscal years ending after December 15, 2003. The revised
disclosure requirements are included in Note 16.
The Emerging Issues Task Force (EITF) published Issue No. 01-08,
Determining Whether An Arrangement Contains a Lease (EITF 01-08), in May 2003.
EITF 01-08 discusses how to determine whether an arrangement contains a lease
and states that the evaluation of whether an arrangement conveys the right to
use property, plant, or equipment should be based on the substance of an
arrangement and that the property that is the subject of a lease must be
specified (explicitly or implicitly) either at inception of the arrangement or
at the beginning of the lease term. EITF 01-08 is effective for arrangements
entered into or modified after July 1, 2003. Since July 1, 2003, we have not
entered into any new arrangements, or modified any arrangements that would fall
under this EITF.
In August 2003, the EITF published Issue No. 03-11, Reporting Realized
Gains and Losses on Derivative Instruments That Are Subject to FASB Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities, and Not
"Held for Trading Purposes" as Defined in EITF Issue No. 02-3 (EITF 03-11). EITF
03-11 discusses whether realized gains and losses should be shown gross or net
in the income statement for contracts that are not held for trading purposes, as
defined in EITF 02-3, but are derivatives subject to FAS 133. Determining
whether realized gains and losses on derivative contracts not held for trading
purposes should be
K-63
reported in the income statement on a gross or net basis is a
matter of judgment that depends on the relevant facts and circumstances with
respect to the various activities of the entity. Retroactive application of EITF
03-11 is not required. Therefore, any derivative instruments that are not held
for trading purposes but are subject to FAS 133 will be evaluated based on this
new guidance and will be reported accordingly in the financial statements
beginning January 1, 2004
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
- ------------------------------------------
This Annual Report on Form 10-K contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. UniSource
Energy and TEP are including the following cautionary statements to make
applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statements made
by or for UniSource Energy or TEP in this Annual Report on Form 10-K.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance and underlying assumptions and
other statements that are not statements of historical facts. Forward-
lookingForward-looking
statements may be identified by the use of words such as "anticipates,"
"estimates," "expects," "intends," "plans," "predicts," "projects," and similar
expressions. From time to time, we may publish or otherwise make available
forward-looking statements of this nature. All such forward-looking statements,
whether written or oral, and whether made by or on behalf of UniSource Energy or
TEP, are expressly qualified by these cautionary statements and any other
cautionary statements which may accompany the forward-looking statements. In
addition, UniSource Energy and TEP disclaim any obligation to update any
forward-looking statements to reflect events or circumstances after the date of
this report.
Forward-looking statements involve risks and uncertainties, which could
cause actual results or outcomes to differ materially from those expressed in
the forward-looking statements. We express our expectations, beliefs and
projections in good faith and believe them to have a reasonable basis. However,
we make no assurances that management's expectations, beliefs or projections
will be achieved or accomplished. We have identified the following important
factors that could cause actual results to differ materially from those
discussed in our forward-looking statements. These may be in addition to other
factors and matters discussed in other parts of this report:
1. Effects of restructuring initiatives in the electric industry
and other energy-related industries.
2. Effects of competition in retail and wholesale energy markets.
3. Changes in economic conditions, demographic patterns and weather
conditions in TEP'sour retail service area.areas.
4. Supply and demand conditions in wholesale energy markets,
including volatility in market prices and illiquidity in
markets, which are affected by a variety of factors. These
factors include the availability of generating capacity in the
western U.S., including hydroelectric resources, weather,
natural gas prices, the extent of utility restructuring in
various states, transmission constraints, environmental
restrictionsregulations and cost of compliance, FERC regulation of wholesale
energy markets, and economic conditions in the western U.S.
5. The creditworthiness of the entities with whom UniSource Energy,
TEP, Millennium and their affiliateswhich we transact
business or have transacted business.
6. Changes affecting TEP'sour cost of providing electrical service
including changes in fuel costs, generating unit operating
performance, scheduled and unscheduled plant outages, interest
rates, tax laws, environmental laws, and the general rate of
inflation.
7. Changes in governmental policies and regulatory actions with
respect to financing and rate structures.
8. Changes affecting the cost of competing energy alternatives,
including changes in available generating technologies and
changes in the cost of natural gas.
9. Changes in accounting principles or the application of such
principles to UniSource Energy or TEP.our businesses.
K-64
10. Changes in the depreciable lives of our assets.
11. Market conditions and technological changes affecting UniSource
Energy's unregulated businesses.
11. Regulatory conditions12. Ability to the approval of the acquisition of
Citizens' Arizona electricsuccessfully integrate UES' businesses and gas utility assets.
12. The level of rate relief granted with respect to Citizens' Arizona
electric utility and gas utility assets.achieve
expected earnings.
13. Unanticipated changes in future liabilities relating to employee
benefit plans due to changes in market values of its retirement
plan assets and health care costs.
14. The outcome of any ongoing litigation.
15. Ability to obtain financing through debt and/or equity issuance,
which can be affected by various factors, including interest
rate fluctuations and capital market conditions.
16. Whether the proposedAbility to develop and operate Springerville Generating Station
expansion
proceeds;Unit 3 and achieve expected cost savings.
17. Ability to obtain necessary approvals and satisfy the roleother
closing conditions contained in the acquisition agreement, so
that the acquisition of Tri-State, SRP, and other third partiesUniSource Energy by an affiliate Saguaro
Utility can occur in such
expansion; and the terms of the ownership, operating and power
purchase arrangements ultimately utilized.a timely manner.
ITEM 7A. --- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
See Item 7.-------------------------------------------------------------------------------
MARKET RISKS
We are exposed to various forms of market risk. Changes in interest
rates, returns on marketable securities, and changes in commodity prices may
affect our future financial results.
For additional information concerning risk factors, including market
risks, see Safe Harbor for Forward-Looking Statements, above.
Interest Rate Risk
TEP is exposed to risk resulting from changes in interest rates on
certain of its variable rate debt obligations. At December 31, 2003 and 2002,
TEP's debt included $329 million of tax-exempt variable rate debt. The average
interest rate on TEP's variable rate debt (excluding letter of credit fees) was
1.07% in 2003 and 1.41% in 2002. TEP also has approximately $70 million in
outstanding principal amount of variable rate lease debt related to its
Springerville Common Facilities Leases. Interest on this lease debt is payable
at LIBOR plus 4.25%. The average interest rate on this lease debt was 4.58% in
2003 and 5.14% in 2002. A one percent increase (decrease) in average interest
rates would result in a decrease (increase) in TEP's pre-tax net income of
approximately $4 million.
Marketable Securities Risk
TEP is exposed to fluctuations in the return on its marketable
securities, comprised of investments in debt securities. At December 31, 2003
and 2002, TEP had marketable debt securities with an estimated fair value of
$198 million and $196 million. At December 31, 2003 and 2002, the fair value
exceeded the carrying value by $19 million and $4 million, respectively. These
debt securities represent TEP's investments in lease debt underlying certain of
TEP's capital lease obligations. Changes in the fair value of such debt
securities do not present a material risk to TEP, as TEP intends to hold these
investments to maturity.
Risk Management Committee
We have a Risk Management Committee responsible for the oversight of
commodity price risk and credit risk related to the wholesale energy marketing
activities of TEP, the emissions and coal trading activities
K-65
of MEG, and the fuel and power procurement activities at TEP and UES. Our Risk
Management Committee consists of officers from the finance, accounting, legal,
wholesale marketing, and the generation operations departments of UniSource
Energy. To limit TEP's, UES' and MEG's exposure to commodity price risk, the
Risk Management Committee sets trading and hedging policies and limits, which
are reviewed frequently to respond to constantly changing market conditions. To
limit TEP's, UES' and MEG's exposure to credit risk, the Risk Management
Committee reviews counterparty credit exposure, as well as credit policies and
limits on a quarterly basis and as needed.
Commodity Price Risk
We are exposed to commodity price risk primarily relating to changes in
the market price of electricity, natural gas, coal and Emission Allowances.
TEP
To manage its exposure to energy price risk, TEP enters into forward
contracts to buy or sell energy at a specified price and future delivery period.
Generally, TEP commits to future sales based on expected excess generating
capability, forward prices and generation costs, using a diversified market
approach to provide a balance between long-term, mid-term and spot energy sales.
TEP generally enters into forward purchases during its summer peaking period to
ensure it can meet its load and reserve requirements and account for other
contract and resource contingencies. TEP also enters into limited forward
purchases and sales to optimize its resource portfolio and take advantage of
locational differences in price. These positions are managed on both a
volumetric and dollar basis and are closely monitored using risk management
policies and procedures overseen by the Risk Management Committee. For example,
the risk management policies provide that TEP should not take a short position
in the third quarter and must have owned generation backing up all forward sales
positions at the time the sale is made. TEP's risk management policies also
restrict entering into forward positions with maturities extending beyond the
end of the next calendar year.
The majority of TEP's forward contracts are considered to be "normal
purchases and sales" of electric energy and are not considered to be derivatives
under FAS 133. TEP records revenues on its "normal sales" and expenses on its
"normal purchases" in the period in which the energy is delivered. From time to
time, however, TEP enters into forward contracts that meet the definition of a
derivative under FAS 133. When TEP has derivative forward contracts, it marks
them to market on a daily basis using actively quoted prices obtained from
brokers for power traded over-the-counter at Palo Verde and at other
southwestern U.S. trading hubs. TEP believes that these broker quotations used
to calculate the mark-to-market values represent accurate measures of the fair
values of TEP's positions, because of the short-term nature of TEP's positions,
as limited by risk management policies, and the liquidity in the short-term
market. As of December 31, 2003, all of TEP's derivative forward contracts were
for settlement within twelve months. To adjust the value of its derivative
forward contracts to fair value on its income statement, TEP recorded an
unrealized loss of $0.4 million and an unrealized gain of $0.5 million,
respectively, on its income statements for the twelve months ended December 31,
2003 and December 31, 2002. This demonstrates the limited derivative forward
contract activity conducted by TEP and the limited impact on TEP's operating
results and financial condition.
TEP is also subject to commodity price risk from changes in the price of
natural gas. TEP typically uses generation from its facilities fueled by natural
gas to meet the summer peak demands of its retail customers and to meet local
reliability needs. Due to its increasing seasonal gas usage, TEP hedges a
portion of its natural gas purchases with fixed price contracts for a maximum of
three years, and purchases its remaining gas needs in the spot and short-term
markets through its supplier Southwest Gas Corporation (SWG).
In 2003, the average price of natural gas was $4.42 per MMBtu, or 68%
higher than 2002, due to low gas storage levels and reductions in gas
production. The increase in the regional supply of gas-generated energy and the
completion of a 500-kV transmission connection, however, allowed TEP to decrease
use of its less efficient gas generation units in favor of more economical
purchases of energy in the wholesale market. TEP's generation output fueled by
natural gas was approximately 433,000 MWh, or 4% of total generation in 2003,
compared with approximately 720,000 MWh, or 6% of total generation in 2002.
TEP entered into two purchased power agreements in 2003 for the period
2003 through 2006. During 2003, TEP purchased approximately 125,000 MWh under
these contracts; energy purchased under these agreements is adjusted for changes
in the price of natural gas.
K-66
UES
UES is also subject to commodity price risk, primarily from the changes
in the price of natural gas purchased for its UNS Gas customers. This risk is
mitigated through the PGA mechanism in UNS Gas' retail rates which provides an
adjustment to recover the actual costs of gas and transportation. UNS Gas
further reduces this risk by purchasing forward fixed price contracts for a
portion of its projected gas needs under its Price Stabilization Plan. UNS Gas
purchases between 45% and 80% of its estimated gas needs in this manner.
UNS Electric is not exposed to commodity price risk for its purchase of
electricity as it has a fixed price full-requirements supply agreement with PWCC
through May 2008.
MEG
During the fourth quarter of 2001, MEG began managing and trading
Emission Allowances, coal and related instruments. We manage the market risk of
this line of business by setting notional limits by product, as well as limits
to the potential change in fair market value under a 33% change in price or
volatility. We closely monitor MEG's trading activities, which include swap
agreements, options and forward contracts, using risk management policies and
procedures overseen by the Risk Management Committee. MEG marks its trading
positions to market on a daily basis using actively quoted prices obtained from
brokers and options pricing models for positions that extend through 2005. As of
December 31, 2003 and December 31, 2002, the fair value of MEG's trading assets
combined with Emission Allowances it holds in escrow was $21.5 million and $15.1
million, respectively. The fair value of MEG's trading liabilities was $18.8
million at December 31, 2003 and $10.3 million at December 31, 2002. During
2003, MEG reflected a $1 million unrealized gain and a $0.4 million realized
loss on its income statement, compared with an unrealized gain of $0.2 million
and a realized loss of $0.1 million in 2002.
Unrealized Gain (Loss) of MEG's Trading Activities
- Millions of Dollars -
------------------------------------------------------------------------------
Source of Fair Value Maturity Maturity Maturity over Total Unrealized
At December 31, 2003 0 - 6 mos. 6 - 12 mos. 1 yr. Gain (Loss)
----------------------------------- ----------------- ------------------- ------------------- --------------------
Prices actively quoted $(0.8) $(0.9) $ - $(1.7)
Prices based on models and other
valuation methods 1.1 1.5 0.3 2.9
----------------------------------- ----------------- ------------------- ------------------- --------------------
Total $ 0.3 $ 0.6 $0.3 $ 1.2
=================================== ================= =================== =================== ====================
Credit Risk
UniSource Energy is exposed to credit risk in its energy-related
marketing and trading activities related to potential nonperformance by
counterparties. We manage 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. Despite
such mitigation efforts, there is a potential for defaults by counterparties. In
the fourth quarter of 2000 and the first quarter of 2001, TEP was affected by
payment defaults by SCE and PG&E for amounts owed to the CPX and CISO. In the
fourth quarter of 2001, Enron defaulted on amounts owed to TEP for energy sales.
We calculate counterparty credit exposure by adding any outstanding
receivable (net of amounts payable if a netting agreement exists) to the
mark-to-market value of any forward contracts. As of December 31, 2003, TEP's
total credit exposure related to its wholesale marketing activities (excluding
defaulted amounts owed by the CPX, the CISO and Enron), was approximately $7
million and MEG's total credit exposure related to its trading activities was $8
million. TEP and MEG's credit exposure is diversified across approximately 27
counterparties. Approximately $5 million of exposure is to non-investment grade
companies.
UniSource Energy is also exposed to credit risk related to the sale of
assets owned by Nations Energy Corporation (Nations Energy). In September 2001,
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%
K-67
discount rate, the discount being recognized as interest income over the
five-year life of the note. As of December 31, 2003, Nations Energy's receivable
from Mirant Curacao is approximately $10 million. The note is primarily included
in Investments and Other Property - Management's DiscussionOther 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 Analysis$5 million in July 2006. The note is
guaranteed by Mirant Americas, Inc., a subsidiary of Financial
ConditionMirant. On July 14, 2003,
Mirant, Mirant Americas, Inc. and Resultsvarious other Mirant companies filed for
Chapter 11 bankruptcy protection. Mirant Curacao was not included in the Chapter
11 filings. Based on a review of Operations, Factors Affecting Resultsthe projected cash flows for the power project,
it appears Mirant Curacao will have sufficient future cash flows to pay the note
receivable and any applicable interest. However, we cannot predict the ultimate
outcome that Mirant's bankruptcy will have on the collectibility of Operations,
Market Risks.the note
from Mirant Curacao. Nations Energy will continue to evaluate the collectibility
of the receivable, but currently expects to collect the note in its entirety and
has not recorded any reserve for this note.
ITEM 8. --- CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
See Item 15 page 111, for a list of the Consolidated Financial Statements that
are included in the following pages. See Note 1620 of the Notes to Consolidated
Financial Statements.
APPROVAL OF NON-AUDIT SERVICES
On February 6, 2002, the Audit Committee of the Board of Directors of
UniSource Energy pre-approved ongoing non-audit related services, for fees
not to exceed $600,000, to be performed by our independent auditor,
PricewaterhouseCoopers LLP (PwC), consisting of accounting and tax research
in connection with the financings of Springerville Units 3 and 4.
On August 1, 2002, the Audit Committee of the Board of Directors of
UniSource Energy pre-approved certain non-audit related services, for fees
not to exceed $30,000, to be performed by PwC, including rate case training
for certain of our employees.
On October 17, 2002, the Audit Committee of the Board of Directors of
UniSource Energy pre-approved non-audit related services, for fees not to
exceed $100,000, to be performed by PwC, consisting of performance of certain
tests of financial, statistical and rate-making data relating to the Arizona
gas and electric assets of Citizens.
On December 5, 2002, the Audit Committee of the Board of Directors of
UniSource Energy pre-approved PwC to perform audit related services of the
gas and electric asset balances and results of operations therefore for
Citizens Utilities, Inc., located in Arizona, for fees not to exceed
$250,000. This replaces the Audit Committee's previous authorization of
October 17, 2002 for non-audit related services, for fees not to exceed
$100,000. The audits cover periods prior to the proposed acquisition date of
such assets by UniSource Energy.K-68
Report of Independent AccountantsAuditors
To the Board of Directors and Stockholders of
UniSource Energy Corporation and to the
Board of Directors and Stockholders of
Tucson Electric Power Company
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of UniSource Energy Corporation and its subsidiaries (the
Company) and Tucson Electric Power Company and its subsidiaries (TEP) at
December 31, 20022003 and 2001,2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 20022003 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's and TEP's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 35 to the consolidated financial statements, the Company and
TEP changed the manner in which they account for asset retirement costs as of
January 1, 2003. As discussed in Note 7 to the consolidated financial
statements, the Company and TEP changed their method of accounting for
derivative instruments as of January 1, 2001.
PricewaterhouseCoopers LLP
Los Angeles, California
February 6, 200320, 2004
K-69
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 666,049 $ 670,117 $ 664,646
Electric Wholesale Sales 177,908 733,559 359,814
Net Gain (Loss) on TEP Forward
Contracts and MEG Trading Activities 644 (1,347) -
Other Revenues 11,621 14,683 9,209
- -----------------------------------------------------------------------------
Total Operating Revenues 856,222 1,417,012 1,033,669
- -----------------------------------------------------------------------------
Operating Expenses
Fuel 209,712 258,761 239,939
Purchased Power 64,504 542,587 207,596
Coal Contract Termination and
Amendment Fees 11,250 - 13,231
Other Operations and Maintenance 188,910 179,036 181,392
Depreciation and Amortization 127,923 120,346 114,038
Amortization of Transition Recovery
Asset 24,554 21,609 17,008
Taxes Other Than Income Taxes 45,508 46,213 50,137
- -----------------------------------------------------------------------------
Total Operating Expenses 672,361 1,168,552 823,341
- -----------------------------------------------------------------------------
Operating Income 183,861 248,460 210,328
- -----------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 20,654 14,600 13,532
Other Income (Deductions) 189 3,868 (468)
- -----------------------------------------------------------------------------
Total Other Income (Deductions) 20,843 18,468 13,064
- -----------------------------------------------------------------------------
Interest Expense
Long-Term Debt 65,620 68,678 75,076
Interest on Capital Leases 87,801 90,559 92,869
Interest Imputed on Losses Recorded at
Present Value 1,166 820 198
Other Interest Expense, Net of Amounts
Capitalized (36) (1,478) (1,797)
- -----------------------------------------------------------------------------
Total Interest Expense 154,551 158,579 166,346
- -----------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 50,153 108,349 57,046
Income Taxes 16,878 47,474 15,155
- -----------------------------------------------------------------------------
Income Before Cumulative Effect of
Accounting Change 33,275 60,875 41,891
Cumulative Effect of Accounting Change
- Net of Tax - 470 -
- -----------------------------------------------------------------------------
Net Income $ 33,275 $ 61,345 $ 41,891
=============================================================================
Average Shares of Common Stock
Outstanding (000) 33,665 33,398 32,445
=============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of
Accounting Change $0.99 $1.83 $1.29
Cumulative Effect of Accounting Change
- Net of Tax - $0.01 -
Net Income $0.99 $1.84 $1.29
=============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of
Accounting Change $0.97 $1.79 $1.27
Cumulative Effect of Accounting Change
- Net of Tax - $0.01 -
Net Income $0.97 $1.80 $1.27
=============================================================================
Dividends Paid per Share $0.50 $0.40 $0.32
=============================================================================
Years Ended December 31,
2003 2002 2001
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 743,718 $ 666,049 $ 670,117
Electric Wholesale Sales 151,111 157,108 921,280
Gas Revenue 46,520 - -
Other Revenues 28,546 13,747 16,851
- ------------------------------------------------------------------------------
Total Operating Revenues 969,895 836,904 1,608,248
- ------------------------------------------------------------------------------
Operating Expenses
Fuel 210,163 209,712 258,761
Purchased Energy 135,171 43,171 731,623
Coal Contract Termination Fee - 11,250 -
Other Operations and Maintenance 213,906 188,910 179,036
Depreciation and Amortization 130,643 127,923 120,346
Amortization of Transition Recovery
Asset 31,184 24,554 21,609
Taxes Other Than Income Taxes 48,115 45,508 46,213
- ------------------------------------------------------------------------------
Total Operating Expenses 769,182 651,028 1,357,588
- ------------------------------------------------------------------------------
Operating Income 200,713 185,876 250,660
- ------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 20,493 20,654 14,600
Other Income 7,306 6,200 16,632
Other Expense (5,620) (8,026) (14,964)
- ------------------------------------------------------------------------------
Total Other Income (Deductions) 22,179 18,828 16,268
- ------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 80,844 65,620 68,678
Interest on Capital Leases 84,080 87,801 90,559
Other Interest Expense, Net of
Amounts Capitalized 1,708 1,130 (658)
- ------------------------------------------------------------------------------
Total Interest Expense 166,632 154,551 158,579
- ------------------------------------------------------------------------------
Income Before Income Taxes and
Cumulative Effect of Accounting Change 56,260 50,153 108,349
Income Tax Expense 11,114 16,878 47,474
- ------------------------------------------------------------------------------
Income Before Cumulative Effect of
Accounting Change 45,146 33,275 60,875
Cumulative Effect of Accounting Change
- Net of Tax 67,471 - 470
- ------------------------------------------------------------------------------
Net Income $ 112,617 $ 33,275 $ 61,345
==============================================================================
Average Shares of Common Stock
Outstanding (000) 33,828 33,665 33,398
==============================================================================
Basic Earnings per Share
Income Before Cumulative Effect of
Accounting Change $1.34 $0.99 $1.83
Cumulative Effect of Accounting Change
- Net of Tax $1.99 - $0.01
Net Income $3.33 $0.99 $1.84
==============================================================================
Diluted Earnings per Share
Income Before Cumulative Effect of
Accounting Change $1.31 $0.97 $1.79
Cumulative Effect of Accounting Change
- Net of Tax $1.97 - $0.01
Net Income $3.28 $0.97 $1.80
==============================================================================
Dividends Paid per Share $0.60 $0.50 $0.40
==============================================================================
See Notes to Consolidated Financial Statements.
K-70
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2002 2001 2000
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $731,404 $ 731,379 $ 716,955
Cash Receipts from Electric Wholesale Sales 248,305 760,258 301,281
MEG Cash Receipts from Trading Activity 57,889 49 -
Interest Received 13,820 14,747 14,835
Income Tax Refunds Received 921 59 11,833
Performance Deposits 6,147 (8,629) -
Fuel Costs Paid (201,124) (262,283) (213,999)
Purchased Power Costs Paid (135,320) (544,472) (196,137)
Wages Paid, Net of Amounts Capitalized (75,479) (71,043) (61,862)
Payment of Other Operations and
Maintenance Costs (126,623) (127,382) (96,722)
MEG Cash Payments for Trading Activity (63,766) - -
Capital Lease Interest Paid (68,975) (79,745) (90,418)
Taxes Paid, Net of Amounts Capitalized (106,550) (105,484) (101,263)
Interest Paid, Net of Amounts Capitalized (62,241) (64,814) (71,439)
Income Taxes Paid (29,238) (38,951) (3,503)
Coal Contract Termination and Amendment
Fees Paid (26,649) - -
Other 10,442 11,690 5,473
- -------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 172,963 215,379 215,034
- -------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (112,706) (121,622) (105,996)
Purchase of Springerville Lease Debt
and Equity (134,989) (13,000) (27,633)
Investments in and Loans to Equity Investees (23,592) (18,474) (18,552)
Proceeds from the Sale of Millennium Energy
Businesses - 16,631 31,350
Return of Nations Energy's Construction
Deposits - 15,574 -
Proceeds from the Sale of Real Estate - 6,580 -
Other 397 (2,536) 7,281
- -------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (270,890) (116,847) (113,550)
- -------------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayment of Long-Term Debt (2,138) (1,871) (50,116)
Proceeds from Borrowings under the Revolving
Credit Facility - - 25,000
Payments on Borrowings under the Revolving
Credit Facility - - (25,000)
Payment of Debt Issue Costs (5,410) - -
Payments on Capital Lease Obligations (19,842) (26,015) (39,019)
Proceeds from the Exercise of Warrants - - 12,671
Common Stock Dividends Paid (16,806) (13,376) (10,349)
Other 4,897 7,880 3,045
- -------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (39,299) (33,382) (83,768)
- -------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash
Equivalents (137,226) 65,150 17,716
Cash and Cash Equivalents, Beginning of Year 228,154 163,004 145,288
- -------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 90,928 $ 228,154 $ 163,004
===============================================================================
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2003 2002 2001
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 814,425 $ 731,404 $ 731,379
Cash Receipts from Electric Wholesale Sales 203,717 248,305 760,258
Cash Receipts from Gas Sales 38,171 - -
Other Cash Receipts 7,155 23,087 21,643
MEG Cash Receipts from Trading Activity 101,743 57,889 49
UED Springerville 3 Financial
Closing Proceeds 43,265 - -
Interest Received 22,428 13,820 14,747
Income Tax Refunds Received 17,093 921 59
Performance Deposits (3,499) 6,147 (8,629)
Fuel Costs Paid (204,920) (201,124) (262,283)
Purchased Energy Costs Paid (190,462) (135,320) (544,472)
Wages Paid, Net of Amounts Capitalized (82,482) (75,479) (71,043)
Payment of Other Operations and
Maintenance Costs (115,350) (126,623) (127,345)
MEG Cash Payments for Trading Activity (100,963) (63,766) -
Capital Lease Interest Paid (74,865) (68,975) (79,745)
Taxes Paid, Net of Amounts Capitalized (110,391) (106,550) (105,484)
Interest Paid, Net of Amounts Capitalized (73,565) (62,241) (64,814)
Income Taxes Paid (6,716) (29,238) (38,951)
Coal Contract Termination and Amendment
Fees Paid - (26,649) -
Deposit-Second Mortgage Indenture (17,040) - -
Other (8,102) (12,645) (9,990)
- ------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 259,642 172,963 215,379
- ------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (137,282) (112,706) (121,735)
Purchase of Citizens Assets (223,430) - -
Proceeds from Investment in Springerville
Lease Debt and Equity 12,087 3,078 -
Payments for Investment in Springerville
Lease Debt and Equity - (138,067) (13,000)
Investments in and Loans to Equity Investees (2,072) (23,592) (18,474)
Proceeds from the Sale of Millennium Energy
Businesses - - 16,631
Return of Nations Energy's Construction
Deposits - - 15,574
Proceeds from the Sale of Real Estate - - 6,580
Other (26) 397 (2,423)
- ------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (350,723) (270,890) (116,847)
- ------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from Borrowings under the Revolving
Credit Facility 45,000 - -
Payments on Borrowings under the Revolving
Credit Facility (45,000) - -
Proceeds from Issuance of Short-Term Debt 36,125 1,194 793
Repayments of Short-Term Debt (35,960) (1,078) (252)
Proceeds from Issuance of Long-Term Debt 160,000 - -
Repayment of Long-Term Debt (2,976) (2,138) (1,871)
Payment of Debt Issue Costs (3,283) (5,410) -
Payments on Capital Lease Obligations (42,657) (19,842) (26,015)
Common Stock Dividends Paid (20,208) (16,806) (13,376)
Other 10,387 4,781 7,339
- ------------------------------------------------------------------------------
Net Cash Flows - Financing Activities 101,428 (39,299) (33,382)
- ------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash
Equivalents 10,338 (137,226) 65,150
Cash and Cash Equivalents, Beginning of Year 90,928 228,154 163,004
- ------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 101,266 $ 90,928 $ 228,154
==============================================================================
See Note 1720 for supplemental cash flow information.
See Notes to Consolidated Financial Statements.
K-71
UNISOURCE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
2002 2001
- -----------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,598,884 $ 2,498,046
Utility Plant under Capital Leases 747,556 741,446
Construction Work in Progress 59,926 70,992
- -----------------------------------------------------------------------------
Total Utility Plant 3,406,366 3,310,484
Less Accumulated Depreciation and Amortization (1,346,101) (1,270,089)
Less Accumulated Depreciation of Capital
Lease Assets (391,915) (362,724)
- -----------------------------------------------------------------------------
Total Utility Plant - Net 1,668,350 1,677,671
- -----------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 191,867 84,459
Other 123,238 98,288
- -----------------------------------------------------------------------------
Total Investments and Other Property 315,105 182,747
- -----------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 90,928 228,154
Trade Accounts Receivable - Net 76,635 119,646
Materials and Fuel Inventory 46,657 45,052
Current Regulatory Assets 11,778 11,392
Deferred Income Taxes - Current 15,917 11,165
Interest Receivable - Current 12,178 3,630
Other 30,912 27,261
- -----------------------------------------------------------------------------
Total Current Assets 285,005 446,300
- -----------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 307,120 331,674
Income Taxes Recoverable Through Future Revenues 57,044 64,239
Other Regulatory Assets 10,504 9,072
Other Assets 47,606 35,014
- -----------------------------------------------------------------------------
Total Regulatory and Other Assets 422,274 439,999
- -----------------------------------------------------------------------------
Total Assets $ 2,690,734 $ 2,746,717
=============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 438,229 $ 424,722
Capital Lease Obligations 801,611 853,793
Long-Term Debt 1,128,963 802,804
- -----------------------------------------------------------------------------
Total Capitalization 2,368,803 2,081,319
- -----------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 42,960 20,158
Current Maturities of Long-Term Debt 1,840 330,424
Accounts Payable 48,934 84,011
Interest Accrued 60,238 53,300
Taxes Accrued 33,850 42,572
Accrued Employee Expenses 13,644 14,240
Other 17,914 16,105
- -----------------------------------------------------------------------------
Total Current Liabilities 219,380 560,810
- -----------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 34,552 37,568
Other 67,999 67,020
- -----------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 102,551 104,588
- -----------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
- -----------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,690,734 $ 2,746,717
=============================================================================
December 31,
2003 2002
- ------------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,899,305 $ 2,598,884
Utility Plant under Capital Leases 748,239 747,556
Construction Work in Progress 105,804 59,926
- ------------------------------------------------------------------------------
Total Utility Plant 3,753,348 3,406,366
Less Accumulated Depreciation and Amortization (1,262,962) (1,178,547)
Less Accumulated Amortization of Capital
Lease Assets (421,171) (391,915)
- ------------------------------------------------------------------------------
Total Utility Plant - Net 2,069,215 1,835,904
- ------------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 178,789 191,867
Other 109,570 123,238
- ------------------------------------------------------------------------------
Total Investments and Other Property 288,359 315,105
- ------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 101,266 90,928
Trade Accounts Receivable 89,449 75,787
Unbilled Accounts Receivable 30,118 9,910
Allowance for Doubtful Accounts (11,522) (9,062)
Materials and Fuel Inventory 58,299 46,657
Trading Assets 21,507 15,150
Current Regulatory Assets 12,129 11,778
Deferred Income Taxes - Current 15,925 15,917
Interest Receivable - Current 11,561 12,178
Other 21,117 15,762
- ------------------------------------------------------------------------------
Total Current Assets 349,849 285,005
- ------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 275,936 307,120
Income Taxes Recoverable Through Future Revenues 49,849 57,044
Other Regulatory Assets 12,327 10,504
Other Assets 46,594 47,606
- ------------------------------------------------------------------------------
Total Regulatory and Other Assets 384,706 422,274
- ------------------------------------------------------------------------------
Total Assets $ 3,092,129 $ 2,858,288
==============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 539,655 $ 441,147
Capital Lease Obligations 762,968 801,611
Long-Term Debt 1,286,320 1,128,963
- ------------------------------------------------------------------------------
Total Capitalization 2,588,943 2,371,721
- ------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 50,269 42,960
Current Maturities of Long-Term Debt 1,742 1,840
Accounts Payable 65,745 48,934
Interest Accrued 62,927 60,238
Trading Liabilities 19,136 10,255
Taxes Accrued 42,136 33,850
Accrued Employee Expenses 16,081 13,644
Other 15,456 7,659
- ------------------------------------------------------------------------------
Total Current Liabilities 273,492 219,380
- ------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 91,403 34,552
Net Cost of Removal for Interim
Retirements 60,998 54,748
Accrued Asset Retirement Obligation - 112,807
Other 77,293 65,080
- ------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 229,694 267,187
- ------------------------------------------------------------------------------
Commitments and Contingencies (Note 15)
- ------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 3,092,129 $ 2,858,288
==============================================================================
See Notes to Consolidated Financial Statements.
K-72
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CAPITALIZATION
December 31,
2002 2001
- ----------------------------------------------------------------------------
COMMON STOCK EQUITY -Thousands of Dollars-
Common Stock--No Par Value $ 661,185 $ 660,123
2002 2001
---------- ----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding 33,578,959 33,502,007
Accumulated Deficit (218,932) (235,401)
Accumulated Other Comprehensive Income (Loss) (4,024) -
- ----------------------------------------------------------------------------
Total Common Stock Equity 438,229 424,722
- ----------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- ----------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 503,237 492,838
Springerville Coal Handling Facilities 132,333 156,427
Springerville Common Facilities 126,277 131,744
Irvington
December 31,
2003 2002
- ----------------------------------------------------------------------------
COMMON STOCK EQUITY -Thousands of Dollars-
Common Stock--No Par Value $ 668,022 $ 664,103
2003 2002
---------- ----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding 33,787,941 33,578,959
Accumulated Deficit (126,523) (218,932)
Accumulated Other Comprehensive Loss (1,844) (4,024)
- ----------------------------------------------------------------------------
Total Common Stock Equity 539,655 441,147
- ----------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- ----------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 484,219 503,237
Springerville Coal Handling Facilities 129,415 132,333
Springerville Common Facilities 125,717 126,277
Sundt Unit 4 72,196 81,268 90,831
Other Leases 1,690 1,456 2,111
- ----------------------------------------------------------------------------
Total Capital Lease Obligations 813,237 844,571 873,951
Less Current Maturities (50,269) (42,960) (20,158)
- ----------------------------------------------------------------------------
Total Long-Term Capital Lease Obligations 762,968 801,611 853,793
- ----------------------------------------------------------------------------
LONG-TERM DEBT
Interest
Issue Maturity Interest Rate
- ----------------------------------------------------------------------------
First Mortgage Bonds
Corporate 2009 8.50% 27,000 27,365 27,754
Industrial Development
Revenue Bonds (IDBs) 2006 - 2008 6.10% to 7.50% 54,875 56,600 58,325
First Collateral Trust
Bonds 2008 7.50% 138,300 138,300
Second Mortgage IDBs* 2018 - 2022 Variable** 328,600 328,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 579,270
Senior Unsecured Notes 2008 - 2015 6.23% to 7.61% 160,000 -
Other Long-Term Debt 17 668
- ----------------------------------------------------------------------------
Total Stated Principal Amount 1,288,062 1,130,803
Less Current Maturities (1,742) (1,840)
- ----------------------------------------------------------------------------
Total Long-Term Debt 1,286,320 1,128,963
- ----------------------------------------------------------------------------
Total Capitalization $2,588,943 $2,371,721
============================================================================
* 328,600 328,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 579,270
Other Long-Term Debt 668 979
- ----------------------------------------------------------------------------
Total Stated Principal Amount 1,130,803 1,133,228
Less Current Maturities* (1,840) (330,424)
- ----------------------------------------------------------------------------
Total Long-Term Debt 1,128,963 802,804
- ----------------------------------------------------------------------------
Total Capitalization $2,368,803 $2,081,319
============================================================================
*The Second Mortgage IDBs are backed by $341 million of LOCs (Tranche A and
Tranche B) under TEP's Credit Agreement. TEP's obligations under the Credit
Agreement are collateralized with Second Mortgage Bonds. In November 2002, TEP entered into two new LOCs (Tranche A
and Tranche B) for $341 million to replace the LOCs provided under its then
existing credit agreement that would have expired on December 30, 2002.
These new LOCs expire in 2006. Accordingly, these IDBs were classified as
short-term debt atAt December 31, 20012003
and classified as long-term debt at
December 31, 2002.2002, the annual LOC fees (including fronting fees) were 4.25% of the
Tranche A commitment and 5.75% of the Tranche B commitment.
** Weighted average interest rates on variable rate tax-exempt debt (IDBs)
ranged from 1.23%0.78% to 3.92%1.88% during 20022003 and 2001,2002, and the average interest rate
on such debt was 1.07% in 2003 and 1.41% in 2002 and 2.67% in 2001. The annual LOC fee
on TEP's previous LOC Facility was 1.25% in 2002 (until it was replaced in
November 2002) and in 2001. At December 31, 2002, the annual LOC fee for
Tranche A (including fronting fees) was 4.25% of the Tranche A commitment
and for Tranche B (including fronting fees) was 5.75% of the Tranche B
commitment.2002.
UniSource Energy also has stock options outstanding. See Note 18.
See Notes to Consolidated Financial Statements.
K-73
UNISOURCE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Common Accumulated Other Total
Shares Common Earnings Comprehensive Stockholders'
Outstanding* Stock (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
-In Thousands-
Balances at
December 31, 1999 32,349 $641,723 $(317,475) $ - $324,248
2000 Net Income - - 41,891 - 41,891
Dividends Declared - - (7,786) - (7,786)
Shares Issued under
Stock Compensation
Plans 75 1,123 - - 1,123
Shares Purchased by
Deferred Compensation
Trust Less
Distributions (5) (75) - - (75)
Shares Issued for
Warrants and Stock
Options 800 12,768 - - 12,768
- -------------------------------------------------------------------------------
Balances at
December 31, 2000 33,219 655,539 (283,370) - 372,169
Comprehensive Income
(Loss):
2001 Net Income - - 61,345 - 61,345
Cumulative Effect of
Accounting Change
(net of $9,179,000
income tax benefit) - - - (13,827) (13,827)
Reversal of
Unrealized Loss
on Cash Flow
Hedges included
in Cumulative
Effect of
Accounting Change
(net of $9,179,000
income tax expense) - - - 13,827 13,827
Unrealized Loss on Cash
Flow Hedges (net of
$5,537,000 income tax
benefit) - - - (8,340) (8,340)
Reversal of
Unrealized Loss on
Cash Flow Hedges
(net of $5,537,000
income tax expense) - - - 8,340 8,340
Total Comprehensive -------
Income 61,345
-------
Dividends Declared - - (13,376) - (13,376)
Shares Issued under
Stock Compensation
Plans 113 2,210 - - 2,210
Shares Purchased by
Deferred Compensation
Trust Less
Distributions (7) (215) - - (215)
Shares Issued for
Stock Options 177 2,589 - - 2,589
- -------------------------------------------------------------------------------
Balances at
December 31, 2001 33,502 660,123 (235,401) - 424,722
Comprehensive Income:
2002 Net Income - - 33,275 - 33,275
Minimum Pension
Liability (net of
$2,639,000 income
tax benefit) - - - (4,024) (4,024)
Total Comprehensive -------
Income 29,251
-------
Dividends Declared - - (16,806) - (16,806)
Shares Issued under
Stock Compensation
Plans 9 80 - - 80
Shares Distributed
by Deferred
Compensation Trust 3 48 - - 48
Shares Issued for
Stock Options 65 934 - - 934
- -------------------------------------------------------------------------------
Balances at
December 31, 2002 33,579 $661,185 $(218,932) $ (4,024) $438,229
Accumulated
Common Accumulated Other Total
Shares Common Earnings Comprehensive Stockholders'
Outstanding* Stock (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
-In Thousands-
Balances at
December 31, 2000 33,219 $657,507 $(283,370) $ - $374,137
Comprehensive Income
(Loss):
2001 Net Income - - 61,345 - 61,345
Cumulative Effect of
Accounting Change
(net of $9,179,000
income tax benefit) - - - (13,827) (13,827)
Reversal of
Unrealized Loss
on Cash Flow
Hedges included
in Cumulative
Effect of
Accounting Change
(net of $9,179,000
income tax expense) - - - 13,827 13,827
Unrealized Loss on Cash
Flow Hedges (net of
$5,537,000 income tax
benefit) - - - (8,340) (8,340)
Reversal of
Unrealized Loss on
Cash Flow Hedges
(net of $5,537,000
income tax expense) - - - 8,340 8,340
Total Comprehensive --------
Income 61,345
--------
Dividends Declared - - (13,376) - (13,376)
Shares Issued under
Stock Compensation
Plans 113 2,210 - - 2,210
Shares Purchased by
Deferred Compensation
Trust Less
Distributions (7) (215) - - (215)
Shares Issued for
Stock Options 177 2,589 - - 2,589
Other - 603 - - 603
- -------------------------------------------------------------------------------
Balances at
December 31, 2001 33,502 662,694 (235,401) - 427,293
Comprehensive Income:
2002 Net Income - - 33,275 - 33,275
Minimum Pension
Liability (net of
$2,639,000 income
tax benefit) - - - (4,024) (4,024)
Total Comprehensive --------
Income 29,251
--------
Dividends Declared - - (16,806) - (16,806)
Shares Issued under
Stock Compensation
Plans 9 80 - - 80
Shares Distributed
by Deferred
Compensation Trust 3 48 - - 48
Shares Issued for
Stock Options 65 934 - - 934
Other - 347 - - 347
- -------------------------------------------------------------------------------
Balances at
December 31, 2002 33,579 664,103 (218,932) (4,024) 441,147
Comprehensive Income:
2003 Net Income - - 112,617 - 112,617
Minimum Pension
Liability Adjustment
(net of $1,430,000
income tax expense) - - - 2,180 2,180
Total Comprehensive --------
Income 114,797
--------
Dividends Declared - - (20,208) - (20,208)
Shares Issued under
Stock Compensation
Plans 7 55 - - 55
Shares Distributed
by Deferred
Compensation Trust 3 52 - - 52
Shares Issued for
Stock Options 199 3,489 - - 3,489
Other - 323 - - 323
- -------------------------------------------------------------------------------
Balances at
December 31, 2003 33,788 $668,022 $(126,523) $ (1,844) $539,655
===============================================================================
* UniSource
*UniSource Energy has 75 million authorized shares of common stock.
We describe limitations on our ability to pay dividends in Note 9.12.
See Notes to Consolidated Financial Statements.
K-74
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
2002 2001 2000
Years Ended December 31,
2003 2002 2001
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 688,643 $ 666,049 $ 670,117
Electric Wholesale Sales 151,030 157,108 921,280
Other Revenues 9,018 8,618 8,508
- -------------------------------------------------------------------------------
Total Operating Revenues 848,691 831,775 1,599,905
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 210,163 209,712 258,761
Purchased Power 65,127 43,171 731,623
Coal Contract Termination Fee - -------------------------------------------------------------------------------
-Thousands of Dollars-
Operating Revenues
Electric Retail Sales $ 666,049 $ 670,117 $ 664,646
Electric Wholesale Sales 177,908 733,559 359,814
Net Unrealized Gain (Loss) on Forward
Electric Sales and Purchases 533 (1,315) -
Other Revenues 6,603 6,308 3,908
- -------------------------------------------------------------------------------
Total Operating Revenues 851,093 1,408,669 1,028,368
- -------------------------------------------------------------------------------
Operating Expenses
Fuel 209,712 258,761 239,939
Purchased Power 64,504 542,587 207,596
Coal Contract Termination and
Amendment Fees 11,250 - 13,231
Other Operations and Maintenance 170,086 163,616 158,118 162,322
Depreciation and Amortization 121,037 124,054 117,063 113,507
Amortization of Transition Recovery Asset 31,184 24,554 21,609 17,008
Taxes Other Than Income Taxes 44,228 45,047 49,445
- -------------------------------------------------------------------------------
Total Operating Expenses 641,918 1,143,185 803,048
- -------------------------------------------------------------------------------
Operating Income 209,175 265,484 225,320
- -------------------------------------------------------------------------------
Other Income
Interest Income 20,094 11,910 8,550
Interest Income - Note Receivable from
UniSource Energy 9,329 9,330 9,329
Other Income 4,338 2,499 820
- -------------------------------------------------------------------------------
Total Other Income 33,761 23,739 18,699
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 65,620 68,678 75,076
Interest on Capital Leases 87,783 90,506 92,815
Interest Imputed on Losses Recorded at
Present Value 1,166 820 198
Other Interest Expense, Net of Amounts
Capitalized (720) (1,505) (1,805)
- -------------------------------------------------------------------------------
Total Interest Expense 153,849 158,499 166,284
- -------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative
Effect of Accounting Change 89,087 130,724 77,735 Income Taxes 42,388 44,228 45,047
- -------------------------------------------------------------------------------
Total Operating Expenses 639,985 620,585 1,332,221
- -------------------------------------------------------------------------------
Operating Income 208,706 211,190 267,684
- -------------------------------------------------------------------------------
Other Income (Deductions)
Interest Income 20,328 20,094 11,910
Interest Income - Note Receivable from
UniSource Energy 10,242 9,329 9,330
Other Income 3,272 4,102 2,925
Other Expense (1,604) (1,779) (2,626)
- -------------------------------------------------------------------------------
Total Other Income (Deductions) 32,238 31,746 21,539
- -------------------------------------------------------------------------------
Interest Expense
Long-Term Debt 76,585 65,620 68,678
Interest on Capital Leases 84,053 87,783 90,506
Other Interest Expense, Net of
Amounts Capitalized 66 446 (685)
- -------------------------------------------------------------------------------
Total Interest Expense 160,704 153,849 158,499
- -------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative
Effect of Accounting Change 80,240 89,087 130,724
Income Tax Expense 20,122 35,350 55,910 26,566
- -------------------------------------------------------------------------------
Income Before Cumulative Effect of
Accounting Change 60,118 53,737 74,814 51,169
Cumulative Effect of Accounting Change
- Net of Tax 67,471 - 470 -
- -------------------------------------------------------------------------------
Net Income $ 127,589 $ 53,737 $ 75,284 $ 51,169
===============================================================================
See Notes to Consolidated Financial Statements.
K-75
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2002 2001 2000
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 731,404 $ 731,379 $ 716,955
Cash Receipts from Electric Wholesale Sales 248,305 760,258 301,281
Interest Received 13,288 11,894 7,764
Interest Received from UniSource Energy - 9,330 9,329
Income Tax Refunds Received 921 - 11,831
Fuel Costs Paid (201,124) (262,283) (213,999)
Purchased Power Costs Paid (135,320) (544,472) (196,137)
Wages Paid, Net of Amounts Capitalized (60,871) (61,839) (54,469)
Payment of Other Operations and
Maintenance Costs (105,844) (98,628) (82,750)
Capital Lease Interest Paid (68,911) (79,663) (90,365)
Taxes Paid, Net of Amounts Capitalized (101,866) (101,729) (100,400)
Interest Paid, Net of Amounts Capitalized (62,209) (64,830) (71,439)
Income Taxes Paid (29,109) (38,950) (3,503)
Coal Contract Termination and Amendment
Fees Paid (26,649) - -
Other 1,502 702 92
- ------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 203,517 261,169 234,190
- ------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (103,307) (103,913) (98,063)
Purchase of Springerville Lease Debt
and Equity (134,989) (15,167) (25,070)
Purchase of North Loop Gas Turbine from UED (14,853) - -
Proceeds from the Sale of Real Estate - 6,580 -
Investment in Equity Method Entity - - (2,000)
Other 4,571 (3,394) 3,797
- ------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (248,578) (115,894) (121,336)
- ------------------------------------------------------------------------------
Cash Flows from Financing Activities
Repayments of Long-Term Debt (2,114) (1,871) (50,116)
Proceeds from Borrowings under the Revolving
Credit Facility - - 25,000
Payments on Borrowings under the Revolving
Credit Facility - - (25,000)
Payment of Debt Issue Costs (5,410) - -
Dividends Paid to UniSource Energy (35,000) (50,000) (30,000)
Payments on Capital Lease Obligations (19,544) (25,875) (38,855)
Other 3,227 3,439 6,427
- ------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (58,841) (74,307) (112,544)
Years Ended December 31,
2003 2002 2001
- ------------------------------------------------------------------------------
-Thousands of Dollars-
Cash Flows from Operating Activities
Cash Receipts from Electric Retail Sales $ 753,424 $ 731,404 $ 731,379
Cash Receipts from Electric Wholesale Sales 203,644 248,305 760,258
Interest Received 22,049 13,288 11,894
Interest Received from UniSource Energy 19,571 - 9,330
Income Tax Refunds Received 16,926 921 -
Fuel Costs Paid (204,920) (201,124) (262,283)
Purchased Power Costs Paid (119,635) (135,320) (544,472)
Wages Paid, Net of Amounts Capitalized (63,409) (60,871) (61,839)
Payment of Other Operations and
Maintenance Costs (99,530) (105,844) (98,628)
Capital Lease Interest Paid (74,851) (68,911) (79,663)
Taxes Paid, Net of Amounts Capitalized (100,622) (101,866) (101,729)
Interest Paid, Net of Amounts Capitalized (73,071) (62,209) (64,830)
Income Taxes Paid (5,230) (29,109) (38,950)
Coal Contract Termination and Amendment
Fees Paid - (26,649) -
Deposit-Second Mortgage Indenture (17,040) - -
Other 482 1,502 702
- ------------------------------------------------------------------------------
Net Cash Flows - Operating Activities 257,788 203,517 261,169
- ------------------------------------------------------------------------------
Cash Flows from Investing Activities
Capital Expenditures (121,854) (103,307) (103,913)
Proceeds from Investment in Springerville
Lease Debt and Equity 12,078 3,078 -
Payments for Investment in Springerville
Lease Debt and Equity - (138,067) (15,167)
Purchase of North Loop Gas Turbine from UED - (14,853) -
Proceeds from the Sale of Real Estate - - 6,580
Other (670) (1,193) (274)
- ------------------------------------------------------------------------------
Net Cash Flows - Investing Activities (110,446) (254,342) (112,774)
- ------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from Borrowings under the Revolving
Credit Facility 45,000 - -
Payments on Borrowings under the Revolving
Credit Facility (45,000) - -
Repayments of Long-Term Debt (2,090) (2,114) (1,871)
Payment of Debt Issue Costs (788) (5,410) -
Dividends Paid to UniSource Energy (80,000) (35,000) (50,000)
Payments on Capital Lease Obligations (42,553) (19,544) (25,875)
Other (12,427) 8,991 319
- ------------------------------------------------------------------------------
Net Cash Flows - Financing Activities (137,858) (53,077) (77,427)
- ------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and
Cash Equivalents 9,484 (103,902) 70,968 310
Cash and Cash Equivalents, Beginning of Year 55,778 159,680 88,712 88,402
- ------------------------------------------------------------------------------
Cash and Cash Equivalents, End of Year $ 65,262 $ 55,778 $ 159,680 $ 88,712
==============================================================================
See Note 1720 for supplemental cash flow information.
See Notes to Consolidated Financial Statements.
K-76
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED BALANCE SHEETS
December 31,
2002 2001
- -------------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,598,884 $ 2,498,046
Utility Plant under Capital Leases 747,556 741,446
Construction Work in Progress 59,926 70,992
- -------------------------------------------------------------------------------
Total Utility Plant 3,406,366 3,310,484
Less Accumulated Depreciation and Amortization (1,346,101) (1,270,089)
Less Accumulated Depreciation of Capital
Lease Assets (391,915) (362,724)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,668,350 1,677,671
- -------------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 191,867 84,459
Other 21,358 21,416
- -------------------------------------------------------------------------------
Total Investments and Other Property 213,225 105,875
- -------------------------------------------------------------------------------
Note Receivable from UniSource Energy 79,462 70,132
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 55,778 159,680
Trade Accounts Receivable - Net 67,724 113,224
Intercompany Accounts Receivable 14,851 11,263
Materials and Fuel Inventory 44,500 43,682
Current Regulatory Assets 11,778 11,392
Deferred Income Taxes - Current 15,917 4,603
Interest Receivable - Current 12,178 3,630
Other 8,407 4,184
- -------------------------------------------------------------------------------
Total Current Assets 231,133 351,658
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 307,120 331,674
Income Taxes Recoverable Through Future Revenues 57,044 64,239
Other Regulatory Assets 10,504 9,072
Other Assets 46,752 35,014
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 421,420 439,999
- -------------------------------------------------------------------------------
Total Assets $ 2,613,590 $ 2,645,335
December 31,
2003 2002
- -------------------------------------------------------------------------------
-Thousands of Dollars-
ASSETS
Utility Plant
Plant in Service $ 2,681,133 $ 2,598,884
Utility Plant under Capital Leases 747,533 747,556
Construction Work in Progress 82,210 59,926
- -------------------------------------------------------------------------------
Total Utility Plant 3,510,876 3,406,366
Less Accumulated Depreciation and Amortization (1,257,585) (1,178,547)
Less Accumulated Amortization of Capital
Lease Assets (421,135) (391,915)
- -------------------------------------------------------------------------------
Total Utility Plant - Net 1,832,156 1,835,904
- -------------------------------------------------------------------------------
Investments and Other Property
Investments in Lease Debt and Equity 178,789 191,867
Other 41,285 21,358
- -------------------------------------------------------------------------------
Total Investments and Other Property 220,074 213,225
- -------------------------------------------------------------------------------
Note Receivable from UniSource Energy 70,132 79,462
- -------------------------------------------------------------------------------
Current Assets
Cash and Cash Equivalents 65,262 55,778
Trade Accounts Receivable 61,960 66,826
Unbilled Accounts Receivable 7,632 9,910
Allowance for Doubtful Accounts (11,034) (9,012)
Intercompany Accounts Receivable 10,938 14,851
Materials and Fuel Inventory 50,107 44,500
Current Regulatory Assets 8,969 11,778
Deferred Income Taxes - Current 18,847 15,917
Interest Receivable - Current 11,561 12,178
Other 8,444 8,407
- -------------------------------------------------------------------------------
Total Current Assets 232,686 231,133
- -------------------------------------------------------------------------------
Regulatory and Other Assets
Transition Recovery Asset 275,936 307,120
Income Taxes Recoverable Through Future Revenues 49,849 57,044
Other Regulatory Assets 11,973 10,504
Other Assets 43,651 46,752
- -------------------------------------------------------------------------------
Total Regulatory and Other Assets 381,409 421,420
- -------------------------------------------------------------------------------
Total Assets $ 2,736,457 $ 2,781,144
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 389,237 $ 338,339
Capital Lease Obligations 762,323 801,508
Long-Term Debt 1,126,320 1,128,410
- -------------------------------------------------------------------------------
Total Capitalization 2,277,880 2,268,257
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 50,126 42,872
Current Maturities of Long-Term Debt 1,725 1,725
Accounts Payable 37,998 41,704
Intercompany Accounts Payable 8,413 14,520
Interest Accrued 58,620 60,238
Taxes Accrued 29,535 35,772
Accrued Employee Expenses 14,716 13,370
Other 8,063 7,543
- -------------------------------------------------------------------------------
Total Current Liabilities 209,196 217,744
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 123,469 67,490
Other Regulatory Liabilities 60,417 54,748
Accrued Asset Retirement Obligation - 112,807
Other 65,495 60,098
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 249,381 295,143
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 15)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,736,457 $ 2,781,144
===============================================================================
CAPITALIZATION AND OTHER LIABILITIES
Capitalization
Common Stock Equity $ 337,463 $ 322,471
Capital Lease Obligations 801,508 853,447
Long-Term Debt 1,128,410 801,924
- -------------------------------------------------------------------------------
Total Capitalization 2,267,381 1,977,842
- -------------------------------------------------------------------------------
Current Liabilities
Current Obligations under Capital Leases 42,872 19,971
Current Maturities of Long-Term Debt 1,725 330,325
Accounts Payable 41,704 79,133
Intercompany Accounts Payable 12,478 10,060
Interest Accrued 60,238 53,300
Taxes Accrued 35,772 39,826
Accrued Employee Expenses 13,370 13,741
Other 7,543 6,531
- -------------------------------------------------------------------------------
Total Current Liabilities 215,702 552,887
- -------------------------------------------------------------------------------
Deferred Credits and Other Liabilities
Deferred Income Taxes - Noncurrent 67,490 50,824
Other 63,017 63,782
- -------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 130,507 114,606
- -------------------------------------------------------------------------------
Commitments and Contingencies (Note 10)
- -------------------------------------------------------------------------------
Total Capitalization and Other Liabilities $ 2,613,590 $ 2,645,335
===============================================================================
See Notes to Consolidated Financial Statements.
K-77
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CAPITALIZATION
December 31,
2002 2001
- ---------------------------------------------------------------------------
COMMON STOCK EQUITY -Thousands of Dollars-
Common Stock--No Par Value $ 653,529 $ 653,250
2002 2001
---------- ----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding* 32,139,555 32,139,554
Warrants Outstanding** - 918,325
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (305,685) (324,422)
Accumulated Other Comprehensive Income (Loss) (4,024) -
- ---------------------------------------------------------------------------
Total Common Stock Equity 337,463 322,471
- ---------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- ---------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 503,237 492,838
Springerville Coal Handling Facilities 132,333 156,427
Springerville Common Facilities 126,277 131,744
Irvington Unit 4 81,268 90,831
Other Leases 1,265 1,578
- ---------------------------------------------------------------------------
Total Capital Lease Obligations 844,380 873,418
Less Current Maturities (42,872) (19,971)
- ---------------------------------------------------------------------------
Total Long-Term Capital Lease Obligations 801,508 853,447
- ---------------------------------------------------------------------------
LONG-TERM DEBT
Interest
Issue Maturity Rate
- ---------------------------------------------------------------------------
First Mortgage Bonds
Corporate 2009 8.50% 27,365 27,754
Industrial Development
Revenue Bonds (IDBs) 2006 - 2008 6.10% to 7.50% 56,600 58,325
First Collateral Trust
Bonds 2008 7.50% 138,300 138,300
Second Mortgage Bonds
(IDBs)*** 2018 - 2022 Variable**** 328,600 328,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 579,270
- ---------------------------------------------------------------------------
Total Stated Principal Amount 1,130,135 1,132,249
Less Current Maturities*** (1,725) (330,325)
- ---------------------------------------------------------------------------
Total Long-Term Debt 1,128,410 801,924
- ---------------------------------------------------------------------------
Total Capitalization $2,267,381 $1,977,842
===========================================================================
December 31,
2003 2002
- -----------------------------------------------------------------------------
COMMON STOCK EQUITY -Thousands of Dollars-
Common Stock--No Par Value $ 655,534 $ 654,405
2003 2002
---------- ----------
Shares Authorized 75,000,000 75,000,000
Shares Outstanding* 32,139,555 32,139,555
Capital Stock Expense (6,357) (6,357)
Accumulated Deficit (258,096) (305,685)
Accumulated Other Comprehensive Loss (1,844) (4,024)
- -----------------------------------------------------------------------------
Total Common Stock Equity 389,237 338,339
- -----------------------------------------------------------------------------
PREFERRED STOCK
No Par Value, 1,000,000 Shares Authorized,
None Outstanding - -
- -----------------------------------------------------------------------------
CAPITAL LEASE OBLIGATIONS
Springerville Unit 1 484,219 503,237
Springerville Coal Handling Facilities 129,415 132,333
Springerville Common Facilities 125,717 126,277
Sundt Unit 4 72,196 81,268
Other Leases 902 1,265
- -----------------------------------------------------------------------------
Total Capital Lease Obligations 812,449 844,380
Less Current Maturities (50,126) (42,872)
- -----------------------------------------------------------------------------
Total Long-Term Capital Lease Obligations 762,323 801,508
- -----------------------------------------------------------------------------
LONG-TERM DEBT
Interest
Issue Maturity Rate
- -----------------------------------------------------------------------------
First Mortgage Bonds
Corporate 2009 8.50% 27,000 27,365
Industrial Development
Revenue Bonds (IDBs) 2006 - 2008 6.10% to 7.50% 54,875 56,600
First Collateral Trust
Bonds 2008 7.50% 138,300 138,300
Second Mortgage Bonds
(IDBs)** 2018 - 2022 Variable*** 328,600 328,600
Unsecured IDBs 2020 - 2033 5.85% to 7.13% 579,270 579,270
- -----------------------------------------------------------------------------
Total Stated Principal Amount 1,128,045 1,130,135
Less Current Maturities (1,725) (1,725)
- -----------------------------------------------------------------------------
Total Long-Term Debt 1,126,320 1,128,410
- -----------------------------------------------------------------------------
Total Capitalization $2,277,880 $2,268,257
=============================================================================
* UniSource Energy is the holder of all but 121 shares of TEP's outstanding
common stock.
** There were 4.6 million warrants that entitled the holder of five warrants
to purchase one share of TEP common stock for $16.00. They were
exercisable until December 15, 2002, when they expired.
***The Second Mortgage IDBs are backed by $341 million of LOCs (Tranche A and
Tranche B) under TEP's Credit Agreement. TEP's obligations under the Credit
Agreement are collateralized with Second Mortgage Bonds. In November 2002, TEP entered into two new LOCs (Tranche A
and Tranche B) for $341 million to replace the LOCs provided under its then
existing credit agreement that would have expired on December 30, 2002.
These new LOCs expire in 2006. Accordingly, these IDBs were classified as
short-term debt atAt December 31, 20012003
and classified as long-term debt at
December 31, 2002.2002, the annual LOC fees (including fronting fees) were 4.25% of the
Tranche A commitment and 5.75% of the Tranche B commitment.
**** Weighted average interest rates on variable rate tax-exempt debt (IDBs)
ranged from 1.23%0.78% to 3.92%1.88% during 20022003 and 2001,2002, and the average interest rate
on such debt was 1.07% in 2003 and 1.41% in 2002 and 2.67% in 2001. The annual LOC fee
on TEP's previous LOC Facility was 1.25% in 2002 (until it was replaced in
November 2002) and in 2001. At December 31, 2002, the annual LOC fee for
Tranche A (including fronting fees) was 4.25% of the Tranche A commitment
and for Tranche B (including fronting fees) was 5.75% of the Tranche B
commitment.2002.
See Notes to Consolidated Financial Statements.
K-78
TUCSON ELECTRIC POWER COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Accumulated
Capital Accumulated Other Total
Common Stock Earnings Comprehensive Stockholders'
Stock Expense (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Balances at
December 31, 1999 $647,366 $(6,357) $(370,875) $ - $270,134
2000 Net Income - - 51,169 - 51,169
Dividend Paid - - (30,000) - (30,000)
Capital Contribution
from UniSource Energy 4,140 - - - 4,140
Other 217 - - - 217
- -------------------------------------------------------------------------------
Balances at
December 31, 2000 651,723 (6,357) (349,706) - 295,660
Comprehensive Income
(Loss):
2001 Net Income - - 75,284 - 75,284
Cumulative Effect of
Accounting Change
(net of $9,179,000
income tax benefit) - - - (13,827) (13,827)
Reversal of
Unrealized Loss on
Cash Flow Hedges
included in
Cumulative Effect
of Accounting
Change (net of
$9,179,000 income
tax expense) - - - 13,827 13,827
Unrealized Loss on
Cash Flow Hedges (net
of $5,537,000 income
tax benefit) - - - (8,340) (8,340)
Reversal of
Unrealized Loss on
Cash Flow Hedges
(net of $5,537,000
income tax expense) - - - 8,340 8,340
Total Comprehensive ---------
Income 75,284
---------
Dividend Paid - - (50,000) - (50,000)
Capital Contribution
from UniSource Energy 1,411 - - - 1,411
Other 116 - - - 116
- -------------------------------------------------------------------------------
Balances at
December 31, 2001 653,250 (6,357) (324,422) - 322,471
Comprehensive Income:
2002 Net Income - - 53,737 - 53,737
Minimum Pension
Liability (net of
$2,639,000 income
tax benefit) - - - (4,024) (4,024)
Total Comprehensive ---------
Income 49,713
---------
Dividend Paid - - (35,000) - (35,000)
Capital Contribution
from UniSource Energy 241 - - - 241
Other 38 - - - 38
- -------------------------------------------------------------------------------
Balances at
December 31, 2002 $653,529 $(6,357) $(305,685) $ (4,024) $337,463
Accumulated
Capital Accumulated Other Total
Common Stock Earnings Comprehensive Stockholders'
Stock Expense (Deficit) Income (Loss) Equity
- -------------------------------------------------------------------------------
-Thousands of Dollars-
Balances at
December 31, 2000 $ 652,313 $(6,357) $(349,706) $ - $ 296,250
Comprehensive Income
(Loss):
2001 Net Income - - 75,284 - 75,284
Cumulative Effect of
Accounting Change
(net of $9,179,000
income tax benefit) - - - (13,827) (13,827)
Reversal of
Unrealized Loss on
Cash Flow Hedges
included in
Cumulative Effect
of Accounting
Change (net of
$9,179,000 income
tax expense) - - - 13,827 13,827
Unrealized Loss on
Cash Flow Hedges (net
of $5,537,000 income
tax benefit) - - - (8,340) (8,340)
Reversal of
Unrealized Loss on
Cash Flow Hedges
(net of $5,537,000
income tax expense) - - - 8,340 8,340
Total Comprehensive ---------
Income 75,284
---------
Dividend Paid - - (50,000) - (50,000)
Capital Contribution
from UniSource
Energy 1,592 - - - 1,592
Other 116 - - - 116
- -------------------------------------------------------------------------------
Balances at
December 31, 2001 654,021 (6,357) (324,422) - 323,242
Comprehensive Income:
2002 Net Income - - 53,737 - 53,737
Minimum Pension
Liability (net of
$2,639,000 income
tax benefit) - - - (4,024) (4,024)
Total Comprehensive ---------
Income 49,713
---------
Dividend Paid - - (35,000) - (35,000)
Capital Contribution
from UniSource
Energy 346 - - - 346
Other 38 - - - 38
- -------------------------------------------------------------------------------
Balances at
December 31, 2002 654,405 (6,357) (305,685) (4,024) 338,339
Comprehensive Income:
2003 Net Income - - 127,589 - 127,589
Minimum Pension
Liability Adjustment
(net of $1,430,000
income tax expense) - - - 2,180 2,180
Total Comprehensive ---------
Income 129,769
---------
Dividend Paid - - (80,000) - (80,000)
Capital Contribution
from UniSource Energy 1,129 - - - 1,129
- -------------------------------------------------------------------------------
Balances at
December 31, 2003 $ 655,534 $(6,357) $(258,096) $ (1,844) $ 389,237
===============================================================================
We describe limitations on ourTEP's ability to pay dividends in Note 9.12.
See Notes to Consolidated Financial Statements.
K-79
UNISOURCE ENERGY, TEP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------
NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ----------------------------------------------------------------------------
NATURE OF OPERATIONS
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 holdsowns 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 represents substantially allrepresented approximately
86% of UniSource Energy's assets. Millennium holds the energy-related businesses
described in Note 4 and UED's services are described in Note 5.assets as of December 31, 2003. TEP generates,
transmits and distributes electricity. TEP serves more than 367,000 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. Approximately 58%U.S.
On August 11, 2003, UniSource Energy completed the purchase of TEP's work force is subjectthe Arizona
gas and electric system assets from Citizens Communications Company (Citizens)
and established UES to a
collective bargaining unit. The collective bargaining agreementhold such assets. UES' businesses are described in place at
December 31, 2001 terminated on January 6, 2003. New collective bargaining
agreements were ratified by union membersNote
3.
Millennium's unregulated businesses are described in December 2002. The agreements
took effect on January 7, 2003,Note 8 and extend through the end of 2005.UED's
services are described in Note 6.
References to "we" and "our" are to UniSource Energy and its subsidiaries,
collectively. References to the "utility business" are to TEP.
BASIS OF PRESENTATION
On January 1, 1998, TEP and UniSource Energy exchanged all the outstanding
common stock of TEP on a share-for-share basis for the common stock of
UniSource Energy. Following the share exchange, in January 1998 TEP transferred
the stock of Millennium to UniSource Energy for a $95 million ten-
yearten-year
promissory note. Approximately $25 million of this note represents a gain to
TEP. TEP has not recordedand will not record this gain. Instead, this gain will be
reflected as an increase in TEP's common stock equity when UniSource Energy
pays the principal portion of the note which is required to be paid in 2008. In
accordance with the Arizona Corporation Commission (ACC) order authorizing the
formation of the holding company, the note bears interest at 9.78% payable
every two years beginning January 1, 2000. For the interest payment due January
1, 2002,2004, UniSource Energy paid TEP $9$20 million in eachDecember 2003. We expect that
this intercompany note will be repaid in full in connection with the proposed
acquisition of 2001 and 2000. UniSource Energy expects to make the next payment, of approximately $18 million, by the
January 1, 2004 due date.
UniSource Energy, TEP and Millennium useEnergy. See Note 2.
We used the following accounting methods to report investments in
their subsidiaries or other companies:
- Consolidation: When UniSource Energy, TEP or Millennium ownsCONSOLIDATION: The consolidation method is used where a majority of the
voting stock of a subsidiary is held and has control over the subsidiary theis
exercised. The accounts of the subsidiary are combined with the accounts of the
parent and intercompany balances and transactions are eliminated.
- The Equity Method:THE EQUITY METHOD: The equity method is used to report corporate joint
ventures, partnerships, and affiliated companiescompany investments when UniSource Energy,
TEP or Millennium holds a 20% to 50% voting interest or has the ability to
exercise significant influence over the operating and financial policies of an
investee company is demonstrated. The equity method is typically used when 20%
to 50% of the investee company.voting interest is held. Under the equity method, UniSource
Energy, TEP and Millennium report:method:
- Their interest inThe investment appears on a single line item on the equity of an entity as an investment on their balance sheet; and
- Their percentage share of theThe net income (loss) from the entity asis reflected in Other Income in theiron
the income statements. For investments where UniSource Energy, TEP, UES or
Millennium is committed to providing all of the financing, they recognize 100%
of the losses (see Note 4)8).
- THE COST METHOD: The Cost Method: When UniSource Energy, TEP or Millennium doescost method is used when not own enough shares are owned
to exercise significant influence over an investee company,
they use the cost method to report these investments.company. Typically the cost
method is used for investments of less than 20% of the voting interest in an
investee company. Under the cost method UniSource Energy, TEP and
Millennium report:method:
K-80
- Their interest inThe investment appears on a single line item on the equity of an entity as an investment on their balance sheet; and
- Income based onfrom investee dividend distributions from the investee companyis reflected as Other
Income in theiron the income statements; and - Loss is included in Other Income
on the income statements when impairment of the value of the investment
becomes evident as
Other Income in their income statements.evident.
USE OF ACCOUNTING ESTIMATES
Management makes estimates and assumptions when preparing financial
statements under accounting principles generally accepted in the United States
of America (GAAP). These estimates and assumptions affect:
- A portion of the reported amounts of assets and liabilities at the dates
of the financial statements; - Our disclosures regarding contingent assets
and liabilities at the dates of the financial statements; and - A portion
of the reported revenues and expenses during the financial statement
reporting periods.
Because these estimates involve judgments, the actual amounts may differ
from the estimates.
ACCOUNTING FOR RATE REGULATION
The ACC and the Federal Energy Regulatory Commission (FERC) regulate
portions of TEP's and UES' utility accounting practices and electric rates. The
ACC has authority over certain rates charged to retail customers, the issuance
of securities, and transactions with affiliated parties. The FERC regulates
TEP's and UES' rates for wholesale power sales and transmission services.
TEP and UES generally usesuse the same accounting policies and practices used
by unregulated companies for financial reporting under GAAP. However, sometimes
these principles, such as the Financial Accounting Standards Board's (FASB)
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. These
effectsFor 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 may
require 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 described in Note 2.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 item s 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.
CASH AND CASH EQUIVALENTS
UniSource Energy and TEP define Cash and Cash Equivalents as cash
(unrestricted demand deposits) and all highly liquid investments purchased with
an original maturity of three months or less.
UTILITY PLANT
TEP reports its utility plant on its balance sheets at cost. UES reports
the utility plant of its originaltwo operating companies, UNS Gas and UNS Electric, at
cost. Utility plant includes:
- Material and labor costs,
- Contractor costs,
- Construction overhead costs (where applicable), and
- An Allowance for Funds Used During Construction (AFUDC) or capitalized
interest during construction.
K-81
AFUDC reflects the cost of financing construction for transmission and
distribution projects with borrowed funds and equity funds. In 2002, 2001
and 2000,
TEP imputed the cost of capital on transmission and distribution
construction expenditures at an average of 8.43% in 2003, 8.40%, in 2002 and
8.46% and 7.64%, respectively,in 2001, to reflect the cost of using borrowed and equity funds to finance
construction. The component of AFUDC attributable to borrowed funds is included
as a reduction of Other Interest Expense on the income statement and totaled $1
million in each of2003, 2002 2001
and 2000.2001. The equity component is included in Other Income
and totaled $1 million in each of2003, 2002 2001 and 2000.2001.
The interest capitalized interest during construction onof TEP's generation-related
construction projects is included as a reduction of Other Interest Expense on
the income statement and totaled $1 million in each of 2002 and 2001 and less
than2003, $0.5 million in 2000.2002 and $1
million in 2001. The average capitalized interest rate during construction rate
applied to generation-related construction expenditures was 4.14% in 2003, 4.26%, 4.93% and 5.58%
in 2002 2001 and 2000, respectively.4.93% in 2001.
For the period August 11, 2003 through December 31, 2003, UES imputed the
cost of capital on construction expenditures at an average of 8.73% for UNS
Electric and 7.85% for UNS Gas. The component of AFUDC attributable to borrowed
funds is included as a reduction of Other Interest Expense on the income
statement and totaled $0.2 million in 2003. The equity component is included in
Other Income and totaled $0.2 million in 2003.
Depreciation
------------
TEP computesand UES compute depreciation for owned utility plant on a straight-line
basis at rates based on the economic lives of the assets. See Note 6. These9. The
depreciation rates are approved by the ACC for all plant except TEP's
deregulated generation assets. The average depreciation rates for TEP's utility plant
were 4.01%, 3.88%, and 3.85% in 2002, 2001 and 2000, respectively. The
depreciable lives for TEP's generation plant
are based on remaining useful lives. Changes made to the depreciable lives of
TEP's generation plant are discussed in Note 6.9. The depreciable livesdepreciation rates for
transmissiongeneration plant distributionreflect interim retirements. Interim retirements of generation
plant, general
plant and intangible plant are based on average lives. The rates also
reflect estimatedtogether with removal costs net of estimatedless salvage, value.are charged to accumulated
depreciation. The costs of planned major maintenance activities are recorded as
the costs are actually incurred and are not accrued in advance of the planned
maintenance. Planned major maintenance activities include the scheduled
overhauls at TEP's generation plants. Minor replacements and repairs are
expensed as incurred.
The depreciable lives for transmission, distribution, general and
intangible plant are based on average lives. The rates reflect estimated removal
costs, net of estimated salvage value for interim retirements. Retirements of
utilitytransmission plant, distribution plant, general plant and intangible plant,
together with the cost of removal costs less salvage, are charged to accumulated
depreciation. As of December 31, 2003, the net cost of removal of interim
retirements for transmission, distribution, general and intangible plant have
been reclassified from accumulated depreciation to a regulatory liability and
prior period amounts have been reclassified to conform to this presentation.
The average annual depreciation rates for TEP's amortization of capitalized
computer software costs was $6 millionutility plant were 3.78% in
2003, 4.01% in 2002, $6 millionand 3.88% in 20012001. The average annual depreciation rates
for UES' utility plant for the period of August 11, 2003 through December 31,
2003 were 3.88% for UNS Electric and $5
million in 2000.1.47% for UNS Gas.
Computer Software Costs
-----------------------
TEP capitalizesand UES capitalize all costs incurred to purchase computer software and
amortizesamortize those costs over the estimated economic life of the product.
Capitalized computer software costs would be immediately charged to expense if
TEP determines that the software inis determined to be no longer useful. TEP's amortization of
capitalized computer software costs was $6 million in 2003, 2002 and 2001.
K-82
TEP Utility Plant under Capital Leases
--------------------------------------
TEP financed the following generation assets with capital leases:
- Springerville Common Facilities, - Springerville Unit 1, - Springerville
Coal Handling Facilities, and - IrvingtonSundt (Irvington) Unit 4.
The following table shows the amount of lease expense incurred for TEP's
generation-related capital leases. We describe the lease terms in TEP Capital
Lease Obligations in Note 7.
Years Ended December 31,
2002 2001 2000
---------------------------------------------------------------
-Millions of Dollars-
Lease Expense:
Interest Expense on Capital
Leases $ 88 $ 90 $ 93
Depreciation10.
Years Ended December 31,
2003 2002 2001
---------------------------------------------------------------
-Millions of Dollars-
Lease Expense:
Interest Expense on Capital
Leases $ 84 $ 88 $ 90
Amortization - Included in:
Operating Expenses - Fuel 4 4 4
Operating Expenses -
Depreciation and Amortization 25 25 25
---------------------------------------------------------------
Total Lease Expense $113 $117 $119 $122
===============================================================
MILLENNIUM AND UED PROPERTIES AND EQUIPMENT
MillenniumMillennium's and UED's properties and equipment are included, net of
accumulated depreciation, in UniSource Energy's balance sheets in the
Investments and Other Property-Other line item. Properties and equipment are
stated at original cost and are depreciated using the straight-line method over
the estimated useful lives of the assets. Maintenance, repairs and minor
renewals are charged to expense as incurred, while major renewals and
betterments are capitalized.
Millennium capitalizes all costs incurred to
purchase computer software and amortizes those costs over the estimated
economic life of the product. Millennium's unamortized computer software
costs were $2 million as of December 31, 2002 and December 31, 2001.
Millennium's amortization of capitalized computer software costs was less
than $0.5 million in each of 2002, 2001 and 2000. Capitalized computer
software costs would be immediately charged to expense if Millennium
determines that the software is no longer useful.
Interest is capitalized in connection with the construction of major
equipment at Global Solar Energy, Inc. (Global Solar). The capitalized
interest is recorded as part of the asset to which it relates and is
depreciated over the asset's estimated useful life.
UED capitalizes project development costs because UED believes it is
probable that the project will be completed and UED expects to recover the
costs of the project. These costs include dedicated employee salaries,
professional services and other third party costs. Capitalized project costs
would be immediately charged to expense if UED determines that the project is
impaired.
DEBT
TEP defers allWe defer costs related to the issuance of debt. These costs include
underwriters' commissions, discounts or premiums, and other costs such as legal,
accounting and regulatory fees and printing costs. TEP
amortizesWe amortize these costs over
the life of the debt using the straight-line method, which approximates the
effective interest method.
TEP recognizes gains and losses on reacquired debt associated with the
generation portion of TEP's operations as incurred. TEP defers and amortizes the
gains and losses on reacquired debt associated with TEP's regulated operations
to interest income or interest expense over the remaining life of the original
debt.
ELECTRIC UTILITY OPERATING REVENUES
TEP records electricand UES record utility operating revenues when TEP delivers
electricityservices are provided or
commodities are delivered to customers. Operating revenues include unbilled
revenues which are earned (service has been provided) but not billed by the end
of an accounting period.
TEP recordsAn Allowance for Doubtful Accounts is recorded as an expense and reduces
accounts receivable by an Allowance
for Doubtful Accounts for revenue amounts that TEP estimates willare estimated to become
uncollectible. TheTEP's Allowance for Doubtful Accounts was $9$11 million at December
31, 20022003 and 2001.$9 million at 2002. See Note 1113 for further discussion of TEP's
wholesale accounts receivable and allowances. UES' Allowance for Doubtful
Accounts was $0.4 million at December 31, 2003.
K-83
REVENUE FROM LONG-TERM RESEARCH AND DEVELOPMENT CONTRACTS
UniSource Energy's income statements have included Global Solar's long-
termlong-term
contract revenue in Other Operating Revenues since Global Solar was consolidated
on June 1, 2000. Global Solar recognized long-term contract revenue of
$1.1approximately $1 million in 2003, $1 million in 2002 $1.7and $2 million in 2001 and $3.6 million in
2000.2001.
Global Solar recognized total annual research and development expense of
$7.2approximately $7 million in 2003 and 2002, $8.6and $9 million in 2001, and $7.7 million in 2000.2001. These
expenses include both costs associated with revenue producing contracts and
internal development costs. Global Solar derives much of its revenue from
funding received under research and development contracts with various U.S.
governmental agencies. Revenues on these contracts are recognized as follows:
- Cost Reimbursement ContractsCOST REIMBURSEMENT CONTRACTS - Revenue is recognized as costs are
incurred;
- Cost Plus Fixed Fee ContractsCOST PLUS FIXED FEE CONTRACTS - Revenues are recognized using the
percentage of completion method of accounting by relating contract costs
incurred to date to total contract costs; and - Fixed Fee ContractsFIXED FEE CONTRACTS -
Revenues are recognized when applicable milestones are met.
Contract costs include direct material, direct labor and overhead costs.
FUEL AND PURCHASED ENERGY COSTS
TEP
Fuel inventory, primarily coal, is recorded at weighted average cost. TEP
uses full absorption costing. Under full absorption costing, all handling and
procurement costs are included in the cost of the inventory. Examples of these
costs are direct material, direct labor and overhead costs. TEP has long-term
contracts for the purchase and transportation of coal with expiration dates from
20042006 through 2017.2020. The contracts require TEP to pay a take-or-pay fee if certain
minimum quantities of coal are not purchased or transported. TEP expenses such
fees as they are incurred. See Fuel Purchase and Transportation Commitments in
Note 10,15, below. Fuel costs include coal mine reclamation expenses as they are
charged to TEP on an ongoing basis.
UES
UNS Electric defers differences between purchased energy costs and the
recovery of such costs in revenues. Future billings are adjusted for such
deferrals through use of a Purchased Power and Fuel Adjustment Clause (PPFAC)
approved by the ACC. The PPFAC allows for a revenue surcharge or surcredit (that
adjusts the customer's base rate for delivered purchased power) to collect or
return under or over recovery of costs. At December 31, 2003, UNS Electric had a
liability of $0.5 million for over recovered purchased power costs that is
included in Deferred Credits and Other Liabilities - Other on UniSource Energy's
consolidated balance sheet.
UNS Gas defers differences between actual gas purchase costs and the
recovery of such costs in revenues under a Purchase 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 is 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. At December 31, 2003, UNS Gas had a $3.2 million
asset for under rec overed purchased gas costs that is included in Current
Regulatory Assets on UniSource Energy's consolidated balance sheet.
INCOME TAXES
We are required by GAAP to report some of our assets and liabilities
differently for our financial statements than we do for income tax purposes. The
tax effects of differences in these items are reported as deferred income tax
assets or liabilities in our balance sheets. We measure these tax assets and
liabilities using income tax rates that are currently in effect. Federal
Investment Tax Credits (ITC) as well as applicable state income tax credits are
accounted for as a reduction of income tax expense in the year in which the
credit arises.
K-84
We allocate income taxes to the subsidiaries based on their taxable income
and deductions usedas reported in the consolidated and/or combined tax return.
EMISSIONreturn
filings.
EMISSIONS ALLOWANCES
EmissionEmissions Allowances wereare issued to qualifying utilities by the
Environmental Protection Agency (EPA) based on past operational history, and
eachhistory. Each
allowance permits emission of one ton of sulfur dioxide (SO(2))(SO2) in its vintage
year or a subsequent year. These allowances have no book value for accounting
purposes but may be sold if TEP does not need them for operations. TEP also may
purchase additional allowances if needed. See Note 10.15. TEP did not sell any
excess allowances in 2003. In 2002, TEP sold 4,000 allowances that were in
excess of those required for compliance to Millennium Environmental Group, Inc.
(MEG) at their fair market value of $0.5 million. This intercompany sale was
eliminated in UniSource Energy consolidation. MEG subsequently sold these
allowances to a third party.
DERIVATIVE FINANCIAL INSTRUMENTS
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. The majority of TEP's forward
contracts are considered to be normal purchases and sales 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 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.
UNS Gas and UNS Electric do not currently have any contracts that are
required to be marked to market.
MEG enters into swap agreements, options and forward contracts relating to
Emissions Allowances and coal. MEG marks its trading contracts to market 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.
STOCK-BASED COMPENSATION
At December 31, 2002,2003, UniSource Energy hashad two stock-based compensation
plans, which are described in Note 13.18. 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 stock-
based employee compensation cost is reflected in net income forOur stock options as all optionsare granted under those plans hadwith an exercise price equal to the market
value of the underlying common stock onat the date of the grant. Accordingly, no compensation
expense is recorded for these awards. However, compensation expense is
recognized for restricted stock, stock unit, and performance share awards over
the performance/vesting period.
The following table illustrates the effect on UniSource Energy's net income
and earnings per share and TEP's net income ifhad we had applied the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (FAS 123), to stock-based
employee compensation:
UniSource Energy:
- -----------------
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $ 33,275 $ 61,345 $ 41,891
Deduct: Totalall stock-based employee
compensation awards:
K-85
UniSource Energy:
- ----------------
Years Ended December 31,
2003 2002 2001
-----------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $112,617 $ 33,275 $ 61,345
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 850 486 544
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (1,840) (1,757) (1,565)
-----------------------------------------------------------------
Pro Forma Net Income $111,627 $ 32,004 $ 60,324
=================================================================
Earnings per Share:
Basic - As Reported $ 3.33 $ 0.99 $ 1.84
Basic - Pro Forma $ 3.30 $ 0.95 $ 1.81
Diluted - As Reported $ 3.28 $ 0.97 $ 1.80
Diluted - Pro Forma $ 3.25 $ 0.93 $ 1.77
-----------------------------------------------------------------
TEP:
- ---
Years Ended December 31,
2003 2002 2001
-----------------------------------------------------------------
-Thousands of Dollars-
Net Income - As Reported $127,589 $ 53,737 $ 75,284
Add: Stock-based employee
compensation expense included
in reported net income, net of
related tax effects 787 467 521
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (1,761) (1,725) (1,539)
-----------------------------------------------------------------
Pro Forma Net Income $126,615 $ 52,479 $ 74,266
=================================================================
The fair value based method for
all awards, net of related tax
effects (1,271) (1,021) (794)
-----------------------------------------------------------------
Pro Forma Net Income $ 32,004 $ 60,324 $ 41,097
=================================================================
Earnings per Share:
Basic - As Reported $ 0.99 $ 1.84 $ 1.29
Basic - Pro Forma $ 0.95 $ 1.81 $ 1.27
Diluted - As Reported $ 0.97 $ 1.80 $ 1.27
Diluted - Pro Forma $ 0.93 $ 1.77 $ 1.25
-----------------------------------------------------------------
TEP:
- ----
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------------------
-Thousandseach stock option grant is estimated on the date of Dollars-
(except per share data)
Net Income - As Reported $ 53,737 $ 75,284 $ 51,169
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects (1,271) (1,021) (794)
-----------------------------------------------------------------
Pro Forma Net Income $ 52,466 $ 74,263 $ 50,375
=================================================================grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
2003 2002 2001
-------------------------------------------------------------
Expected life (years) 5 5 5
Interest rate 2.78% 1.45% 4.70%
Volatility 23.38% 23.74% 23.93%
Dividend yield 3.44% 2.83% 2.08%
Weighted-average grant-date
fair value of options
granted during the period $2.92 $2.90 $4.27
-------------------------------------------------------------
K-86
NEW ACCOUNTING STANDARDS
The FASB recently issued the following Statements of Financial Accounting
Standards (FAS) and FASB Interpretations (FIN):
- FIN 46, Consolidation of Variable Interest Entities, was issued in
January 2003, and was subsequently revised in December 2003. The guidance
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 enterprises 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. For public companies, the
revised FIN 46 is effective for financial periods ending after March 15, 2004.
Early application is permissible. Companies that implemented FIN 46 prior to
its revision may continue to apply that guidance until the implementation date
of the revision. The adoption of FIN 46 and revisions did not and are not
expected to have a significant impact on our financial statements.
- 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 is to be applied prospectively. The provisions of FAS 149 that
relate to FAS 133 Implementation Issues that have been in effect for fiscal
quarters that began prior to June 15, 2003 are to be applied in accordance with
their respective effective dates. The adoption of FAS 149 did not have a
significant impact on our financial statements.
- FAS 132, Employers' Disclosures about Pensions and Other Postretirement
Benefits (revised 2003), was issued by the FASB in December 2003. FAS 132
requires additional disclosures about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other defined
benefit postretirement plans beyond those in the original Statement 132 which it
replaces. FAS 132, as revised, is effective for fiscal years ending after
December 15, 2003. The revised disclosure requirements are included in Note 16,
below.
The Emerging Issues Task Force (EITF) published Issue No. 01-08,
Determining Whether An Arrangement Contains a Lease (EITF 01-08), in May 2003.
EITF 01-08 discusses how to determine whether an arrangement contains a lease
and states that the evaluation of whether an arrangement conveys the right to
use property, plant, or equipment should be based on the substance of an
arrangement and that the property that is the subject of a lease must be
specified (explicitly or implicitly) either at inception of the arrangement or
at the beginning of the lease term. EITF 01-08 is effective for arrangements
entered into or modified after July 1, 2003. Since July 1, 2003, we have not
entered into any new arrangements, or modified any arrangements that would fall
under this EITF.
In August 2003, the EITF also published Issue No. 03-11, Reporting Realized
Gains and Losses on Derivative Instruments That Are Subject to FASB Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities, and Not
"Held for Trading Purposes" as Defined in EITF Issue No. 02-3 (EITF 03-11). EITF
03-11 discusses whether realized gains and losses should be shown gross or net
in the income statement for contracts that are not held for trading purposes, as
defined in EITF 02-3, but are derivatives subject to FAS 133. Determining
whether realized gains and losses on derivative contracts not held for trading
purposes should be reported in the income statement on a gross or net basis is a
matter of judgment that depends on the relevant facts and circumstances with
respect to the various activities of the entity. Retroactive application of EITF
03-11 is not required. Therefore, any derivative instruments that are not held
for trading purposes but are subject to FAS 133 will be evaluated bas ed on this
new guidance and will be reported accordingly in the financial statements
beginning January 1, 2004.
K-87
RECLASSIFICATIONS
UniSource Energy and TEP have made reclassifications to the prior year
financial statements for comparative purposes. See Note 5, Note 7 and Note 21.
These reclassifications had no effect on net income.
NOTE 2. PROPOSED ACQUISITION OF UNISOURCE ENERGY
- ------------------------------------------------
On November 21, 2003, UniSource Energy and Saguaro Acquisition Corp., a
Delaware corporation, entered into an acquisition agreement, providing for the
acquisition of all of the common stock of UniSource Energy for $25.25 per share
by an affiliate of Saguaro Utility Group L.P., an Arizona limited partnership
("Saguaro Utility"), whose general partner is Sage Mountain, L.L.C. and whose
limited partners include investment funds affiliated with Kohlberg Kravis
Roberts & Co., L.P., J.P. Morgan Partners, LLC and Wachovia Capital Partners.
Pursuant to the terms of the acquisition agreement, Saguaro Acquisition
Corp., will merge with and into UniSource Energy. UniSource Energy will be the
surviving corporation, but and will become an indirect wholly-owned subsidiary
of Saguaro Utility. Upon consummation of the acquisition, Saguaro Utility will
cause the surviving corporation to pay approximately $880 million in cash to
UniSource Energy's shareholders and holders of stock options, stock units,
restricted stock and performance shares awarded under our performance
incentivestock based compensation plans.
UniSource Energy's shareholders will formally consider a proposal to
approve the acquisition agreement at a meeting scheduled for March 29, 2004. We
expect the acquisition, which is subject to several conditions, including
receipt of certain regulatory approvals, to occur in the second half of 2004.
The acquisition agreement contains operating covenants with respect to the
operations of our business pending the consummation of the acquisition.
Generally, unless UniSource Energy obtains Saguaro Acquisition Corp.'s prior
written consent, we must carry on our business in the ordinary course consistent
with past practice and use all commercially reasonable efforts to preserve
substantially intact our present business organization and present regulatory,
business and employee relationships. In addition, the acquisition agreement
restricts our activities, subject to the receipt of Saguaro Acquisition Corp.'s
prior written consent, including the issuance or repurchase of capital stock,
the amendment of organizational documents, acquisitions and dispositions of
assets, capital expenditures, incurrence of indebtedness, modification of
employee compensation and benefits, changes in accounting methods, discharge of
liabilities, and matters relating to UniSource Energy's investment in
Millennium.
Either UniSource Energy or Saguaro Acquisition Corp. may terminate the
acquisition agreement in certain circumstances, including if the acquisition is
not consummated by March 31, 2005, certain regulatory approvals are not obtained
or our shareholders fail to approve the transaction. In certain circumstances,
upon the termination of the acquisition agreement, UniSource Energy would be
required to pay Saguaro Acquisition Corp.'s expenses and a termination fee in an
aggregate amount of up to $25 million. See Note 15 for a description of
litigation related to the acquisition of UniSource Energy by Saguaro Acquisition
Corporation.
NOTE 3. ESTABLISHMENT OF UES
- -----------------------------
On August 11, 2003, UniSource Energy acquired the Arizona gas and electric
system assets from Citizens for $223 million, comprised of the base purchase
price plus other operating capital adjustments and transaction costs. This
acquisition added over 128,000 retail gas customers and 81,000 retail electric
customers in Arizona to UniSource Energy's customer base as of December 31,
2003. 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. The operating results of UNS Gas, UNS Electric, and UES have been
included in UniSource Energy's consolidated financial statements since the
acquisition date.
K-88
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: -Thousands of Dollars-
-----------------------------------------------------------
Cash Paid $218,558
Transaction Costs 4,872
-----------------------------------------------------------
Total Purchase Price $223,430
===========================================================
Allocation of Purchase Price: -Thousands of Dollars-
-----------------------------------------------------------
Property, Plant & Equipment $228,001
Current Assets 33,079
Regulatory Assets 384
Other Assets 580
Long-Term Debt (487)
Current Liabilities (31,142)
Deferred Credits and Other Liabilities (6,985)
-----------------------------------------------------------
Total Purchase Price $223,430
===========================================================
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 ACC on July 3, 2003, when it approved
the acquisition and the terms of the April 1, 2003 settlement agreement (UES
Settlement Agreement) among UniSource Energy, Citizens, and the ACC Staff.
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 PGA
mechanism.
The related ACC order and the UES 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 UES 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 35% at December 31, 2003.
On September 9, 2003, the ACC approved a new PGA surcharge of $0.1155 per
therm that took effect on October 1, 2003.
K-89
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.
The ACC order and UES 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 of $0.01825 per kWh, which combined with the current base
purchased power rate of $0.05194 per kWh, results in a new PPFAC rate of
$0.07019. This allows UNS Electric to fully recover the cost of purchased
power under its current contract with its sole energy supplier, Pinnacle
West Capital Corporation (PWCC). - 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.
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 UES 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 38% at December 31, 2003.
On November 3, 2003, UNS Electric filed a plan to open its service
territories to retail electric competition. The plan is subject to review and
approval by the ACC. As a result of the court decisions concerning the ACC's
Retail Electric Competition Rules, we are unable to predict when and how the ACC
will address this plan.
Income Statement Impact of Applying FAS 71
If UES had not applied FAS 71, net income would have been $2 million
greater, primarily as a result of the recovery of deferred purchased gas costs.
Future Implications of Discontinuing Application of FAS 71
UES' regulatory assets, net of regulatory liabilities, total $1 million at
December 31, 2003, and are all presently included in rate base and consequently
are earning a return on investment. 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 regulatory asset and liability balances at
December 31, 2003, if UES had stopped applying FAS 71 to its regulated
operations, it would have recorded an extraordinary after-tax loss of $1
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 its
regulatory assets.
K-90
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$4 million and $3.0 million annually through August 2011 for
the EPNG contract and $3 million annually through January 2007 for the
Transwestern contract. UNS Gas made payments under these contracts,
respectively of $2 million in 2003.
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 $6 million
in 2004 and $1 million in 2005 through 2011. UNS Electric made payments under
these contracts of $2 million in 2003.
NOTE 4. TEP REGULATORY MATTERS
- -------------------------------
Upon approval of the TEP Settlement Agreement in November 1999, TEP
discontinued regulatory accounting under FAS 71 for its generation operations.
TEP continues to report its transmission and distribution operations under FAS
71.
TEP Settlement Agreement
In November 1999, the ACC approved the TEP Settlement Agreement between TEP
and certain customer groups relating to recovery of TEP's transition costs and
standard retail rates. The TEP Settlement Agreement included:
- CONSUMER CHOICE: By January 1, 2001, consumer choice for energy supply
was available to all customers.
- NO RATE INCREASE: TEP's retail rates may not be increased until December
31, 2008. TEP expects to recover the costs of transmission and distribution
under regulated unbundled rates both during and after this period.
- RECOVERY OF TRANSITION COSTS: TEP's rates include Fixed and Floating
Competition Transition Charge (CTC) components designated for the recovery of
transition costs, including generation-related regulatory assets and a portion
of TEP's generation plant assets. Retail rates will decrease by the Fixed CTC
amount after TEP has recovered $450 million or on December 31, 2008, whichever
occurs first. The Floating CTC equals retail rates less the price of retail
electric service. The price of retail electric service includes TEP's
transmission and distribution charge and a market energy component based on a
market index for electric energy. Because TEP's total retail rates are
effectively frozen, the Floating CTC is expected to allow TEP to recoup the
balance of transition recovery assets not otherwise recovered through the Fixed
CTC. The Floating CTC will end no later than December 31, 2008.
- GENERAL RATE CASE: TEP is required to file a general rate case by June 1,
2004, including an updated cost-of-service study. TEP's rates cannot be
increased as a result of this general rate case. Any decrease resulting from
this rate case would be effective no sooner than June 1, 2005.
K-91
Transition Recovery Asset
TEP's Transition Recovery Asset consists of generation-related regulatory
assets and a portion of TEP's generation plant asset costs. Transition costs
being recovered through the Fixed CTC include: (1) the Transition Recovery
Asset; (2) generation-related plant assets included in Plant in Service on the
balance sheet; and (3) excess capacity deferrals related to operating and
capital costs associated with Springerville Unit 2 which are being amortized as
an off-balance sheet regulatory asset. These transition costs were amortized as
follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------------------------
-Millions of Dollars-
Amortization of Transition Costs Being
Recovered Through the Fixed CTC:
Transition Costs Being Recovered Through
the Fixed CTC, beginning of year $349 $386 $419
Amortization of Transition Recovery Asset
recorded on the income statement (31) (25) (21)
Amortization of Generation-Related Plant
Assets (5) (3) (3)
Amortization of Excess Capacity Deferrals
(off-balance sheet) (9) (9) (9)
------------------------------------------------------------------------
Transition Costs Being Recovered Through
the Fixed CTC, end of year $304 $349 $386
========================================================================
The portion of the Transition Recovery Asset that is recorded on the
balance sheet was amortized as follows:
Years Ended December 31,
2003 2002 2001
------------------------------------------------------------------------
-Millions of Dollars-
Amortization of Transition Recovery Asset
Recorded on the Balance Sheet:
Transition Recovery Asset, beginning of
year $307 $332 $353
Amortization of Transition Recovery Asset
recorded on the income statement (31) (25) (21)
------------------------------------------------------------------------
Transition Recovery Asset, end of year $276 $307 $332
========================================================================
The remaining transition costs being recovered through the Fixed CTC differ
from the Transition Recovery Asset recorded on the balance sheet as follows:
December 31,
2003 2002
------------------------------------------------------------------------
-Millions of Dollars-
Transition Costs Being Recovered Through
the Fixed CTC, end of year $304 $349
Unamortized Generation-Related Plant Assets (28) (33)
Unamortized Excess Capacity Deferrals
(off-balance sheet) - (9)
------------------------------------------------------------------------
Transition Recovery Asset, end of year $276 $307
========================================================================
The remaining Transition Recovery Asset balance will be amortized as costs
are recovered through rates until TEP has recovered $450 million of transition
costs or until December 31, 2008, whichever occurs first.
K-92
OTHER REGULATORY ASSETS AND LIABILITIES
In addition to the Transition Recovery Asset related to TEP's
othergeneration assets, the following regulatory assets and liabilities
includeare being recovered through TEP's transmission and distribution
businesses:
December 31,
2003 2002
-----------------------------------------------------------
-In Millions-
Other Regulatory Assets
Income Taxes Recoverable Through
Future Revenues $ 50 $ 57
Current Regulatory Assets 9 12
Other Regulatory Assets 12 11
-----------------------------------------------------------
Total Regulatory Assets $ 71 $ 80
===========================================================
Other Regulatory Liabilities
Net Cost of Removal for Interim
Retirements $ 60 $ 55
===========================================================
Regulatory assets of approximately $21 million are not presently included
in rate base and consequently are not earning a return on investment. These
regulatory assets are being recovered through cost of service or are authorized
to be collected in future base rates. Current regulatory assets of $9 million
are related to differences between expenses recorded on the accrual basis for
GAAP accounting and on a pay-as-you-go basis for regulatory accounting. The
remaining recovery period generally ranges from 1 to 1.5 years. Regulatory
compliance costs of $9 million require specific rate action and the recovery
period will be determined in the rate case to be filed in 2004. The remaining $3
million represents unamortized loss on reacquired debt that is not included in
rate base, but the amortization of these costs is included in the ratemaking
calculation of the cost of debt, which is a component of the cost of capital
(rate of return). All regulatory assets are probable of recovery.
See Note 5 for a discussion of the amounts included in Other Regulatory
Liabilities.
INCOME STATEMENT IMPACT OF APPLYING FAS 71
The amortization of TEP's regulatory assets had the following effect on
UniSource Energy's and TEP's income statements:
Years Ended December 31,
2003 2002 2001
-----------------------------------------------------------
-Millions of Dollars-
Operating Expenses
Amortization of Transition
Recovery Asset $ 31 $ 25 $ 21
Interest Expense
Long-Term Debt - 1 1
Income Taxes 7 7 5
-----------------------------------------------------------
If TEP had not applied FAS 71 in these years, the above amounts would have
been reflected in the income statements in prior periods. The reclassification
of TEP's generation-related regulatory assets to the Transition Recovery Asset
shortened the amortization period for these assets to nine years.
K-93
FUTURE IMPLICATIONS OF DISCONTINUING APPLICATION OF FAS 71
TEP continues to apply FAS 71 to its regulated operations, which include
the transmission and distribution 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 and its
regulatory liabilities as income on its income statement. Based on the
regulatory asset balances, net of regulatory liabilities, at December 31, 2003,
if TEP had stopped applying FAS 71 to its remaining regulated operations, it
would have recorded an extraordinary after-tax loss of approximately $173
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 its regulatory
assets.
NOTE 5. 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 issued by the FASB
in June 2001,(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, statue,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 will adopt FAS 143 on January 1, 2003, as required. TEP has identified legal obligations to retire generation plant assets
specified in land leases for its jointly-owned Navajo and Four Corners
generating
stations.Generating Stations. The land on which the Navajo and Four Corners generatingthese 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.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 iswill be approximately $38 million at the date of retirement. No
other legal obligations to retire generation plant assets were identified. Millennium and UED have noAs
of December 31, 2002, TEP had accrued $113 million for the final
decommissioning of its generating facilities. This amount has been reclassified
from accumulated depreciation to an accrued asset retirement obligations.obligation. As
discussed below, this amount was reversed for 2002 and included as part of the
cumulative effect of accounting change adjustment when FAS 143 was adopted on
January 1, 2003.
TEP hasand UES have various Transmissiontransmission and Distributiondistribution lines that operate
under
various land leases and rights of way that contain end dates and restorative
clauses. TEP operates its Transmission and Distribution
linesUES operate their transmission and distribution systems as if
they will be operated in perpetuity and would continue to be used or sold
without land remediation. As a result, TEP willand UES are not recognizerecognizing the costs
of final removal of the Transmissiontransmission and Distributiondistribution lines in thetheir financial
statements. As of December 31, 2003, TEP had accrued $60 million and UES had
accrued $0.6 million for the net cost of removal for interim retirements from
its transmission, distribution and general plant. As of December 31, 2002, TEP
had accrued $55 million for these removal costs. These amounts have been
reclassified from accumulated depreciation to a regulatory liability.
K-94
Millennium and UED have no asset retirement obligations.
Upon adoption of FAS 143 on January 1, 2003, TEP expects to recordrecorded an asset
retirement obligation of $38 million at its net present value of $1.1 million,
increaseincreased depreciable assets by $0.1 million for asset retirement costs,
reversereversed $112.8 million of costs previously accrued for final removal from
accumulated depreciation, reversereversed previously recorded deferred tax assets byof
$44.2 million and recognizerecognized the cumulative effect of accounting change as a
gain of $111.7 million ($67.5 million net of tax). TEP expects that adoptingThe adoption of FAS 143 will resultalso
resulted in a $6 million reduction toof current depreciation expense charged
throughout the year because asset retirement costs are no longer recorded as well. For 2003, thisa
component of depreciation expense.
The following table illustrates on a pro forma basis the amount is approximately $6 million.of the
asset retirement obligation as if FAS 143 had been applied during all periods
presented:
Years Ended December 31,
2003 2002 2001
Actual Pro Forma Pro Forma
---------------------------------------------------------------
-Thousands of Dollars-
Asset Retirement Obligation,
beginning of year $1,119 $1,017 $ 925
Accretion Expense 112 102 92
---------------------------------------------------------------
Asset Retirement Obligation,
end of year $1,231 $1,119 $1,017
===============================================================
The following tables illustrate 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:
- ----------------
Years Ended December 31,
2002 2001
-------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $33,275 $61,345
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2001 3,461 3,341
-------------------------------------------------------------------
Pro Forma Net Income $36,736 $64,686
===================================================================
Basic Earnings per Share:
As Reported $ 0.99 $ 1.84
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2001 $ 0.10 $ 0.10
-------------------------------------------------------------------
Pro Forma $ 1.09 $ 1.94
===================================================================
Diluted Earnings per Share:
As Reported $ 0.97 $ 1.80
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2001 $ 0.10 $ 0.10
-------------------------------------------------------------------
Pro Forma $ 1.07 $ 1.90
===================================================================
K-95
TEP:
- ---
Years Ended December 31,
2002 2001
-------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
Net Income - As Reported $53,737 $75,284
Adjustment to accrued expense (net
of tax) as if FAS 143 had been
applied effective January 1, 2001 3,461 3,341
-------------------------------------------------------------------
Pro Forma Net Income $57,198 $78,625
===================================================================
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 utilized on discountingused
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 in fact 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 have beenwere determined pursuant to the TEP Settlement
Agreement.
NOTE 6. SEGMENT AND RELATED INFORMATION
- FAS 146, Accounting for Costs Associated with Exit or Disposal
Activities, issued in July 2002, requires entities to record a liability
for costs related to exit or disposal activities when the costs are
incurred. Previous accounting guidance required the liability to be
recorded at the date of commitment to an exit or disposal plan. We are
required to comply with FAS 146 beginning January 1, 2003, which will
affect any restructuring activities after that date. Although unknown at
this time, the timing of expense recognition in our financial statements
for future restructuring activities could differ significantly.
- FAS 148, Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FAS 123, issued in December 2002, provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. In
addition, FAS 148 requires prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
compensation and the effect of the method used on reported results.
Although we are required to comply with interim disclosure requirements of
FAS 148 beginning January 1, 2003, we have elected to continue to apply the
recognition and measurement provisions of APB 25. Therefore, we do not
expect the adoption of FAS 148 to have a significant effect on our
financial statements. The annual disclosure requirements of FAS 148 are
included in Stock-Based Compensation in Note 1, above.
- 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 10, below.
- 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 (the "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. We are currently in the
process of evaluating the impact of FIN 46 on UniSource Energy and TEP's
financial statements.
RECLASSIFICATIONS
UniSource Energy and TEP have made minor reclassifications to the prior
year financial statements for comparative purposes. See Note 17. These
reclassifications had no effect on net income.
NOTE 2. REGULATORY MATTERS
- --------------------------
TEP generally uses the same accounting policies and practices used by
unregulated companies for financial reporting under GAAP. However, sometimes
these principles, such as FAS 71, require special accounting treatment for
regulated companies to show the effect of regulation. For example, in
setting TEP's retail rates, the 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.
Approval of the Settlement Agreement caused TEP to discontinue
regulatory accounting under FAS 71 for its generation operations in November
1999. TEP continues to report its transmission and distribution operations
under FAS 71.
NOVEMBER 1999 ACC APPROVAL OF SETTLEMENT AGREEMENT
The Settlement Agreement
------------------------
In November 1999, the ACC approved a Settlement Agreement between TEP
and certain customer groups relating to recovery of TEP's transition costs
and standard retail rates. The major provisions of the Settlement Agreement,
as approved, were:
- Consumer choice: Consumer choice for energy supply began in January 2000
and by January 1, 2001 consumer choice was available to all customers.
- Rate freeze: In accordance with the Rate Settlement approved by the ACC
in 1998, TEP decreased rates to retail customers by 1.1% on July 1, 1998,
1% on July 1, 1999 and 1% on July 1, 2000. These reductions applied to all
retail customers except for certain customers that have negotiated non-
standard rates. The Settlement Agreement provides that, after these
reductions, TEP's retail rates will be frozen until December 31, 2008,
except under certain circumstances. TEP expects to recover the costs of
transmission and distribution under regulated unbundled rates both during
and after the rate freeze.
- Recovery of transition costs: TEP's frozen rates include Fixed and Floating
Competition Transition Charge (CTC) components designated for the recovery
of transition costs, including generation-related regulatory assets and a
portion of TEP's generation plant assets. Retail rates will decrease by
the Fixed CTC amount after TEP has recovered $450 million or on December
31, 2008, whichever occurs first. The Floating CTC equals the amount of the
frozen retail rate less the price of retail electric service. The price of
retail electric service includes TEP's transmission and distribution charge
and a market energy component based on a market index for electric energy.
Because TEP's total retail rate will be frozen, the Floating CTC is
expected to allow TEP to recoup the balance of transition recovery assets
not otherwise recovered through the Fixed CTC. The Floating CTC will end
no later than December 31, 2008.
- General rate case: TEP is required to file by June 1, 2004 a general
rate case, including an updated cost-of-service study. Any rate change
resulting from this rate case would be effective no sooner than June 1,
2005 and would not result in a net rate increase.
Transition Recovery Asset
-------------------------
The Transition Recovery Asset consists of generation-related regulatory
assets and a portion of TEP's generation plant asset costs. The total
Transition Costs Being Recovered through the Fixed CTC, which includes the
Transition Recovery Asset as well as generation-related plant in service and
excess capacity deferral costs which are not included in the Transition
Recovery Asset (see table below), were amortized as follows:
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------------------------
-Millions of Dollars-
Amortization of Transition Costs Being
Recovered Through the Fixed CTC
Transition Costs Being Recovered Through
Fixed CTC, beginning of year $386 $419 $448
Amortization of Transition Recovery Asset
recorded on the income statement (25) (21) (17)
Generation-Related Plant Asset Amortization (3) (3) (3)
Excess Capacity Deferral Amortization(off
balance sheet) (9) (9) (9)
-----------------------------------------------------------------------
Transition Costs Being Recovered Through
the Fixed CTC, end of year $349 $386 $419
=======================================================================
The portion of the Transition Recovery Asset that is recorded on the
balance sheet was amortized as follows:
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------------------------
-Millions of Dollars-
Amortization of Transition Recovery Asset
Recorded on the Balance Sheet
Transition Recovery Asset recorded on the
balance sheet, beginning of year $332 $353 $370
Amortization of Transition Recovery Asset
recorded on the income statement (25) (21) (17)
-----------------------------------------------------------------------
Remaining Transition Recovery Asset on
the balance sheet, end of year $307 $332 $353
=======================================================================
The remaining Transition Recovery Costs Being Recovered Through the
Fixed CTC differs from the Transitions Recovery Asset recorded on the balance
sheet as follows:
December 31,
2002 2001
---------------------------------------------------------------
-Millions of Dollars-
Remaining Transition Recovery Costs to
be Recovered Through the Fixed CTC,
end of year $349 $386
Unamortized balance of generation-related
costs included in Plant in Service on
the balance sheet (33) (36)
Excess Capacity Deferrals relating to
operating and capital costs associated
with Springerville Unit 2, amortized as
an off-balance sheet regulatory asset (9) (18)
---------------------------------------------------------------
Remaining Transition Recovery Asset on
the balance sheet, end of year $307 $332
===============================================================
The remaining Transition Recovery Asset balance will be amortized as
costs are recovered through rates until TEP has recovered $450 million of
transition costs or until December 31, 2008, whichever occurs first.
OTHER REGULATORY ASSETS AT DECEMBER 31, 2002 AND 2001
In addition to the Transition Recovery Asset related to generation
assets, the following regulatory assets are being recovered through TEP's
transmission and distribution business:
December 31,
2002 2001
-------------------------------------------------------------
-Millions of Dollars-
Other Regulatory Assets Related to
Transmission and Distribution
Income Taxes Recoverable Through
Future Revenues $ 57 $ 64
Current Regulatory Assets 12 11
Other Regulatory Assets 11 9
-------------------------------------------------------------
Total Regulatory Assets $ 80 $ 84
=============================================================
There are no remaining regulatory liabilities recorded on the balance
sheets at December 31, 2002 and 2001.
INCOME STATEMENT IMPACT OF APPLYING FAS 71
The amortization of the regulatory assets discussed in the previous
sections of this note have had the following effect on UniSource Energy and
TEP's income statements:
Years Ended December 31,
2002 2001 2000
--------------------------------------------------------------
-Millions of Dollars-
Operating Expenses
Amortization of Transition
Recovery Asset $ 25 $ 21 $ 17
Interest Expense
Long-Term Debt 1 1 2
Income Taxes 7 5 5
--------------------------------------------------------------
If TEP had not applied FAS 71 in these years, the above amounts would
have been reflected in the income statements in prior periods. The
reclassification of TEP's generation-related regulatory assets to the
Transition Recovery Asset shortened the amortization period for these assets
to nine years.
FUTURE IMPLICATIONS OF CEASING TO APPLY FAS 71 TO TEP'S REGULATED BUSINESS
TEP continues to apply FAS 71 to the distribution and transmission
portions of its business, its regulated operations, and assesses whether it
can continue to apply FAS 71 to these operations. If TEP stopped applying
FAS 71 to its remaining regulated operations, it would write off the related
balances of its regulatory assets as an expense on its income statement.
Based on the balances of TEP's regulatory assets at December 31, 2002, if TEP
had stopped applying FAS 71 to its remaining regulated operations, it would
have recorded an extraordinary loss, after-tax, of approximately $233
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 2002, the ACC consolidated several pending matters related
to retail electric competition in order to make a comprehensive reexamination
of the Rules. On September 10, 2002, the ACC issued an order that eliminated
the requirement that TEP transfer its generating assets to a subsidiary. At
the same time, the ACC ordered the parties, including TEP, to develop a
competitive bidding process and reduced the amount of power to be acquired in
the competitive bidding process to only that portion not supplied by TEP's
existing resources.
On February 27, 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 expects to
issue requests for proposals in March 2003 and complete the selection process
by June 1, 2003.
As part of its reexamination of the Rules, the ACC had planned to
address the requirement for Arizona electric utilities to participate in the
Arizona Independent Scheduling Administrator (AISA) organization. The Rules
originally required the formation and implementation of the AISA; however,
the ACC opened a docket in July 2001 to revisit this obligation. This issue
is pending and will be addressed separately from the issues identified above.
NOTE 3. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND
HEDGING ACTIVITIES
- ---------------------------------------------------------------------------
On January 1, 2001, TEP recorded a $0.5 million after-tax gain in its
income statement for the cumulative effect of adopting Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities (FAS 133). TEP enters into forward contracts to purchase
or sell a specified amount of capacity or energy at a specified price over a
given period of time, typically for one month, three months, or one year,
within established limits to take advantage of favorable market
opportunities. Some of these forward contracts are considered to be
derivatives, 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. However,
the majority of TEP's forward contracts are considered normal purchases and
sales under FAS 133 and, therefore, are not required to be marked to market.
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.
MEG, a wholly-owned subsidiary of Millennium, began operations in
November 2001 and enters into swap agreements, options and forward contracts
relating to emission allowances and coal. MEG 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's and MEG's
derivative instruments are estimated based on various factors including
broker quotes, exchange prices, over the counter prices and time value.
In June 2002, new guidance was issued that requires all realized and
unrealized gains and losses on energy-related trading contracts to be shown
net in the income statement whether or not physically settled. This guidance
is effective for financial statements issued after July 15, 2002, and
requires financial statements for all comparative periods to be reclassified
to conform to the new presentation. MEG adopted this guidance on July 1,
2002 for its trading activity and reclassified its net realized gains and
losses from Other Revenue into a single line in Operating Revenue. The
impact of MEG adopting this guidance was immaterial to the financial
statements. This guidance does not apply to TEP because TEP's forward
contracts are not "energy-related trading contracts" as defined by the
guidance.
TEP's activity in derivative forward contracts and MEG's trading
activity are now reported as follows:
- TEP's unrealized gain/loss on forward sales and purchase contracts is a
component of Operating Revenues;
- TEP's realized gain/loss on forward sales contracts is a component of
Electric Wholesale Revenues;
- TEP's realized gain/loss on forward purchase contracts is a component of
Purchased Power; and
- MEG's unrealized and realized gain/loss on trading activities are
components of Operating Revenues.
During the year ended December 31, 2002, MEG physically settled the
purchase of 394,000 Emission Allowances and the sale of 416,000 Emission
Allowances under its trading contracts.
The net pre-tax gains (losses) were as follows:
Years Ended
December 31,
2002 2001
-------------------------------------------------------------
-Millions of Dollars-
TEP's derivative forward contracts $ 0.5 $ (0.5)
MEG's trading activities 0.1 (0.1)
-------------------------------------------------------------
UniSource Energy $ 0.6 $ (0.6)
=============================================================
At December 31, 2002, TEP had no open forward contracts that are
considered derivatives. At December 31, 2002, the fair value of MEG's
trading assets totaled $10.5 million, which is reported in Other Current
Assets, and the fair value of MEG's trading liabilities totaled $10.3
million, which is reported in Other Current Liabilities. At December 31,
2001, the fair value of MEG's trading assets was $8.7 million, which is
reported in Other Current Assets, and the fair value of TEP's derivative
liabilities and MEG's trading liabilities totaled $9.3 million, which is
reported in Other Current Liabilities.
TEP treated certain forward sale and purchase contracts as cash flow
hedges when it adopted FAS 133 and recorded an unrealized gain/loss related
to these hedges in Other Comprehensive Income. However, during 2001, new
guidance was issued by the FASB which provided that certain forward power
purchase or sale agreements, including capacity contracts, could be excluded
from the requirements of FAS 133. TEP implemented this new guidance in 2001
and determined that the items designated as cash flow hedges upon adoption
could be excluded from the FAS 133 requirements. Therefore, as these
contracts settled in 2001, TEP reversed the unrealized gain/loss included in
Other Comprehensive Income and recorded the realized gain/loss in the income
statement. As of December 31, 2002 and December 31, 2001, TEP had no cash
flow hedges and, therefore, its balance in Accumulated Other Comprehensive
Income was zero.
NOTE 4. MILLENNIUM ENERGY BUSINESSES
- -------------------------------------
See Note 5 for selected financial data of Millennium.
At December 31, 2002, Millennium recognized 100% of the losses of the
following: Global Solar Energy, Inc. (Global Solar), MicroSat Systems, Inc.
(MicroSat), ITN Energy Systems, Inc. (ITN), POWERTRUSION International, Inc.
(Powertrusion), and TruePricing, Inc. (TruePricing). At December 31, 2001,
Millennium recognized 100% of the losses of the following: Global Solar,
Infinite Power Solutions, Inc. (IPS), MicroSat and ITN. At December 31,
2000, Millennium recognized 100% of the losses from Global Solar and IPS.
Millennium recognizes 100% of an investment's losses when it, as sole
provider of funds, bears all of the financial risk. In addition, when one of
these investments becomes profitable, Millennium will recognize 100% of net
income to the extent Millennium's recognized losses are greater than
Millennium's ownership percentage of such losses.
ENERGY TECHNOLOGY INVESTMENTS
We refer to Global Solar, IPS, MicroSat and ITN collectively as
Millennium's Energy Technology Investments. In addition to the above,
Millennium recognized substantially all of IPS's losses in 2002. In December
2002, IPS received a cash equity contribution from Dow Corning Enterprises,
Inc. (Dow Corning). This investment permits Millennium to recognize only its
ratable share of losses from the investment going forward.
Millennium's total investment (capital contributions and loans) in its
Energy Technology Investments totaled $18.5 million during 2002.
- Global Solar is primarily a developer and manufacturer of flexible thin-
film photovoltaic cells. Global Solar began limited production of
photovoltaic cells in 1999. Target markets for its products include
military, space and commercial applications. In 2002, Millennium increased
its ownership of Global Solar from 67% to 87%. In addition, Millennium
converted $27.4 million of debt and accumulated interest due from Global
Solar to an equity contribution. Millennium accounts for the Global Solar
investment under the consolidation method. At December 31, 2002, there
remained $4.7 million of unfunded commitments from Millennium to Global
Solar, of which $3 million was drawn through March 5, 2003.
- IPS, established in 2000, is a developer of thin-film batteries. In
2002, Millennium increased its ownership in IPS from 67% to 77.5%. In
2002, Millennium converted $9.8 million of debt and accumulated interest
due from IPS to an equity contribution. In addition, Millennium provided
$1 million of equipment to IPS in exchange for equity. In December 2002,
Dow Corning provided a corresponding $1 million cash equity contribution.
IPS received an additional $1 million equity contribution from Dow Corning
on March 4, 2003. Millennium had committed an additional $1.5 million in
future funding to IPS. Millennium contributed $1 million of its future
funding commitment in January 2003. Millennium accounts for the IPS
investment under the consolidation method. Depending on warrant exercise
and additional funding from Dow Corning, Millennium anticipates its
ownership of IPS will be between 59% and 72%.
- MicroSat is a space systems company formed in 2001 to develop and
commercialize small-scale satellites. Millennium currently owns 49%, but
has agreed to reduce its ownership to 35%. Millennium accounts for the
MicroSat investment under the equity method. Millennium currently has no
further funding commitments to MicroSat.
- ITN was formed in 2001 to provide research and development and other
services to affiliates, government agencies and other third parties. In
2002, Millennium provided $1 million in equity funding. Currently
Millennium owns 49%, but has agreed to reduce its ownership to 9%. Because
Millennium is the primary funder of ITN's operations, it will continue to
account for ITN under the equity method. At December 31, 2002, Millennium
had $0.8 million in open funding commitments to ITN, primarily relating to
the establishment of a new solid oxide fuel cell subsidiary called Ascent
Power Systems.
Global Solar and IPS have each agreed to provide ITN $1 million in
research and development contracting through 2004. Global Solar, MicroSat
and ITN have certain government contracts that require them to contribute to
the research and development effort under cost share arrangements. Global
Solar, MicroSat and ITN's share of costs are expensed as incurred or
capitalized in accordance with the terms of the contracts. Global Solar,
MicroSat and ITN had the following approximate remaining cost share
commitments at:
December 31,
2002 2001 2000
---------------------------------------------------
-Millions of Dollars-
Global Solar $ 2.6 $ - $ 1.0
MicroSat 6.2 7.7 -
ITN 0.9 2.2 -
---------------------------------------------------
Total $ 9.7 $ 9.9 $ 1.0
===================================================
Millennium is currently finalizing its ownership and future debt
commitments for each of the Energy Technology Investments in order to help
ensure that these investments conform to Millennium's business plans.
Therefore, Millennium's ownership share is subject to change in 2003.
Millennium expects to fund between $7 million and $15 million to its various
Energy Technology Investments in 2003. Millennium may commit to provide
additional funding to these investments. A significant portion of the
funding under these agreements will be used for research and development
purposes and administrative costs. As funds are expended for these purposes,
Millennium recognizes expense.
OTHER MILLENNIUM INVESTMENTS AND COMMITMENTS
Millennium has a $15 million capital commitment to Haddington Energy
Partners II LP, a limited partnership that funds energy related investments.
As of December 31, 2002, Millennium had funded $6.6 million of this
commitment and owns approximately 31% of this entity. The remaining $8.4
million is expected to be funded within the next two to three years. A
member of the UniSource Energy Board of Directors has an investment in the
limited partnership and is a managing director of the general partner of the
limited partnership. Millennium accounts for this investment under the
equity method.
Millennium has a $6 million capital commitment to a venture capital fund
that focuses on information technology, microelectronics and biotechnology
investments. During 2002, this venture capital fund merged with another fund
that focuses on similar investments in Arizona, Southern California, New
Mexico, Colorado and Utah. As a result, Millennium owns 14.8% of the merged
venture. Millennium uses the cost method to account for this investment.
Before the merger, Millennium accounted for this investment under the equity
method. Another member of the UniSource Energy Board of Directors is a
general partner of the company that manages the fund. At December 31, 2002,
Millennium had funded approximately $1 million of the $6 million commitment.
Millennium does not currently expect to provide funding to this investment in
2003.
On July 15, 2002, Millennium invested $20 million in a company created
to develop up to 800 megawatts (MW) of coal-fired generation in the Sabinas
region of Coahuila, Mexico. Millennium received a 50% share of
Carboelectrica Sabinas, S. de R.L. de C.V., a Mexican limited liability
company (Sabinas). The other 50% of Sabinas is owned by Altos Hornos de
Mexico, S.A. de C.V. (AHMSA) and certain of its affiliates. Sabinas also
owns 19.5% of Minerales de Monclova, S.A. de C.V., (Mimosa) an owner of coal
and associated gas reserves and a supplier of metallurgical coal to the steel
industry and thermal coal to the Mexican electricity commission. Since 1999,
both AHMSA and Mimosa are parties to a suspension of payments procedure,
under applicable Mexican law, which is the equivalent of a U.S. Chapter 11
proceeding. Under certain circumstances, Millennium has the right to sell (a
put option) its interest in Sabinas to an AHMSA affiliate for $20 million
plus an accrued service fee. These circumstances include failure of Sabinas
to reach financial closing on the generation project within three years.
Millennium's put option is secured by collateral with a value currently in
excess of $20 million. UniSource Energy's Chairman, President and Chief
Executive Officer is a member of the board of directors of AHMSA. In
December 2002, Millennium received a return of capital of $0.5 million,
bringing Millennium's investment to approximately $19.5 million at December
31, 2002. In addition, in the first quarter of 2003, Millennium received a
second $0.5 million also representing a return of capital. Millennium
accounts for the Sabinas investment under the equity method, however, Sabinas
accounts for the Mimosa investment under the cost method.
Millennium owns a controlling 50.5% interest in Powertrusion, a
manufacturer of lightweight utility poles. During the third quarter of 2002,
Millennium provided an additional $2 million of funding to maintain its
controlling interest. Millennium accounts for the Powertrusion investment
under the consolidation method. In addition, during the third quarter of 2002
Millennium began recognizing 100% of Powertrusion's losses, as it became the
sole funder of Powertrusion's operations.
On April 1, 2002, Millennium invested an additional $2 million in
TruePricing, a start-up company established to market energy related
products, bringing Millennium's total investment to $3.1 million at December
31, 2002. Following this additional investment, Millennium began recognizing
100% of TruePricing's losses. Millennium accounts for the TruePricing
investment under the equity method. In February 2003, Millennium committed
to fund up to an additional $1.2 million in equity contributions to
TruePricing, of which $0.4 million was funded on March 5, 2003.
Nations Energy is a wholly-owned subsidiary of Millennium, accounted for
under the consolidation method. Through its subsidiaries, Nations Energy has
a 40% equity interest in a 43 MW power plant near Panama City, Panama. No
impairment was recorded in 2002, however, Nations Energy recorded decreases
in the market value of its Panama investment of $0.5 million in 2001 and $3
million in 2000. In 2000, Nations Energy recognized a $3 million deferred
tax benefit related to the decreased value. Nations Energy intends to sell
its interest in this project, which has a book value of less than $1 million
at December 31, 2002.
NATIONS ENERGY CONTINGENCY
In September 2001, 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
proceeds and an $11 million note receivable from the sale. The note was
recorded at its net present value of $8 million, with the discount being
amortized to interest income over the five-year life of the note. Millennium
utilizes an 8% discount rate, established on the date this note was
initiated. The note is included in Investments and Other Property - Other on
UniSource Energy's consolidated balance sheet. 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, 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. Their ratings are now below
investment grade. As of December 31, 2002, Nations Energy's receivable from
Mirant is approximately $9 million. We cannot predict what effect the
downgrade of Mirant will have on its ability to make its required payments to
Nations Energy when due, beginning in July 2004. Nations Energy has not
recorded an allowance for doubtful accounts and we will continue to evaluate
whether any further ratings events or actions by or to Mirant will impact the
collectibility of the receivable.
NOTE 5. BUSINESS SEGMENTS
- ------------------------------------------------------------------
Based on the way we organize our operations and evaluate performance, we
have threefour reportable business segments:
(1) TEP, ana 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.
Results from UES are for the period from August 11, 2003 through December 31,
2003 only (see Notes 1 and 3).
(3) Millennium holds interests in unregulated energy and emerging
technology businesses (see Note 4)8).
(3)(4) UED established in 2001, is responsible for developingdevelops generating resources and other project development
activities, including facilitating the expansion project atof 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.
Significant reconciling adjustments consist of the elimination of
intercompany activity and balances. Millennium recorded revenue from
transactions with TEP of $16 million, $14 million and $13 million in 2003, 2002
and $3 million in 2002,
2001, and 2000, 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.
As discussed in Note 1, 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 4.8. Our portion of the net income (loss) of the
entities in which TEP and Millennium own a 20-50% interest or have the ability
to exercise significant influence is shown below in Net Loss from Equity Method
Entities.
K-96
We disclose selected financial data for our business segments in the
following tables:
Segments UniSource
--------------------- Reconciling Energy
2002 TEP Millennium UED Adjustments Consolidated
- -----------------------------------------------------------------------------
-Millions of Dollars-
Income Statement
- ----------------
Operating Revenues
- External $ 851 $ 5 $ - $ - $ 856
Segments UniSource
--------------------------- Reconciling Energy
2003 TEP UES Millennium UED Adjustments Consolidated
- -----------------------------------------------------------------------------
-Millions of Dollars-
Income Statement
- ----------------
Operating Revenues
- External $ 848 $ 103 $ 8 $ 11 $ - $ 970
- -----------------------------------------------------------------------------
Operating Revenues
- Intersegment 1 - 16 - (17) -
- -----------------------------------------------------------------------------
Depreciation and
Amortization 121 5 5 - - 131
- -----------------------------------------------------------------------------
Amortization of
Transition Recovery
Asset 31 - - - - 31
- -----------------------------------------------------------------------------
Interest Income 31 - - - (11) 20
- -----------------------------------------------------------------------------
Net Loss from Equity
Method Entities - - (3) - - (3)
- -----------------------------------------------------------------------------
Interest Expense 161 4 1 - 1 167
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 20 2 (10) 5 (6) 11
- -----------------------------------------------------------------------------
Net Income (Loss) 128 3 (16) 7 (9) 113
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Capital Expenditures (122) (14) (1) - - (137)
- -----------------------------------------------------------------------------
Investments in and
Loans to Equity
Method Entities - - (2) - - (2)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,736 306 144 3 (97) 3,092
- -----------------------------------------------------------------------------
Investments in
Equity Method
Entities 5 - 31 - - 36
- -----------------------------------------------------------------------------
2002
- -----------------------------------------------------------------------------
Income Statement
- ----------------
Operating Revenues
- External $ 832 $ 5 $ - $ - $ 837
- -----------------------------------------------------------------------------
Operating Revenues
- Intersegment - 14 3 (17) -
- -----------------------------------------------------------------------------
Depreciation and
Amortization 124 4 - - 128
- -----------------------------------------------------------------------------
Amortization of
Transition Recovery
Asset 25 - - - 25
- -----------------------------------------------------------------------------
Interest Income 29 1 - (9) 21
- -----------------------------------------------------------------------------
Net Loss from Equity
Method Entities (1) (3) - - (4)
- -----------------------------------------------------------------------------
Interest Expense 154 1 - - 155
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 35 (15) 1 (4) 17
- -----------------------------------------------------------------------------
Net Income (Loss) 54 (16) 1 (6) 33
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Capital Expenditures (103) (10) - - (113)
- -----------------------------------------------------------------------------
Purchase of North
Loop Gas Turbine
from UED (15) - 15 - -
- -----------------------------------------------------------------------------
Investments in and
Loans to Equity
Method Entities - (24) - - (24)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,781 151 38 (112) 2,858
- -----------------------------------------------------------------------------
Investments in
Equity Method
Entities 6 35 - - 41
- -----------------------------------------------------------------------------
2001
- -----------------------------------------------------------------------------
Income Statement
- ----------------
Operating Revenues
- External $1,600 $ 8 $ - $ - $1,608
- -----------------------------------------------------------------------------
Operating Revenues
- Intersegment - 13 2 (15) -
- -----------------------------------------------------------------------------
Depreciation and
Amortization 117 3 - - 120
- -----------------------------------------------------------------------------
Amortization of
Transition Recovery
Asset 22 - - - 22
- -----------------------------------------------------------------------------
Interest Income 21 3 - (9) 15
- -----------------------------------------------------------------------------
Net Loss from Equity
Method Entities (1) (10) - - (11)
- -----------------------------------------------------------------------------
Interest Expense 159 - - - 159
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 56 (5) - (4) 47
- -----------------------------------------------------------------------------
Net Income (Loss) 75 (9) 1 (6) 61
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Capital Expenditures (104) (17) (1) - (122)
- -----------------------------------------------------------------------------
Investments in and
Loans to Equity
Method Entities - (18) - - (18)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,800 176 27 (102) 2,901
- -----------------------------------------------------------------------------
Investments in and Loans
to Equity Method Entities - (24) - - (24)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,614 151 38 (112) 2,691
- -----------------------------------------------------------------------------
Investment in Equity
Method Entities 6 35 - - 41
- -----------------------------------------------------------------------------
2001
- -----------------------------------------------------------------------------
Income Statement
- ----------------
Operating Revenues
- External $1,409 $ 8 $ - $ - $1,417
- -----------------------------------------------------------------------------
Operating Revenues
- Intersegment - 13 2 (15) -
- -----------------------------------------------------------------------------
Depreciation and
Amortization 117 3 - - 120
- -----------------------------------------------------------------------------
Amortization of Transition
Recovery Asset 22 - - - 22
- -----------------------------------------------------------------------------
Interest Income 21 3 - (9) 15
- -----------------------------------------------------------------------------
Net Loss from
Equity Method Entities (1) (10) - - (11)
- -----------------------------------------------------------------------------
Interest Expense 159 - - - 159
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 56 (5) - (4) 47
- -----------------------------------------------------------------------------
Net Income (Loss) 75 (9) 1 (6) 61
- -----------------------------------------------------------------------------
Cash Flow Statement
- -------------------
Capital Expenditures (104) (17) (1) - (122)
- -----------------------------------------------------------------------------
Investments in and Loans
to Equity Method Entities - (18) - - (18)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,645 176 27 (101) 2,747
- -----------------------------------------------------------------------------
Investment in
Equity Method
Entities 7 14 - - 21
- -----------------------------------------------------------------------------
2000
K-97
NOTE 7. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING
ACTIVITIES
- -------------------------------------------------------------------------------------------------------------------------------------------------------------
On January 1, 2001, TEP recorded an after-tax gain of less than $1 million
in its income statement for the cumulative effect of adopting Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (FAS 133). 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 energy 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
contract s are considered to be normal purchases and sales 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 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.
UNS Gas and UNS Electric do not currently have any contracts that are
required to be marked to market. 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. This 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 45% and not more than 80% 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 and
therefore are not required to be marked to market.
MEG, a wholly-owned subsidiary of Millennium, began operations in November
2001 and enters into swap agreements, options and forward contracts relating to
Emissions Allowances and coal. MEG marks its trading contracts to market 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 values for TEP's and MEG's
derivative instruments are estimated based on various factors including broker
quotes, exchange prices, over the counter prices and time value.
TEP's and MEG's derivative activities are reported as follows:
- TEP's net unrealized and realized gains and losses on forward sales
contracts are components of Electric Wholesale Sales; - TEP's net
unrealized and realized gains and losses on forward purchase contracts are
components of Purchased Power; and
- MEG's net unrealized and realized gains and losses on trading activities
are components of Other Operating Revenues. Although MEG's realized gains and
losses 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.
TEP's net unrealized gains (losses) on forward contracts were as follows:
Years Ended December 31,
2003 2002 2001
---------------------------------------------------
-Millions of Dollars-
Included in Electric
Wholesale Sales $ (1) $ (1) $ 188
Included in Purchased
Power Expense - 2 (189)
---------------------------------------------------
K-98
The net pre-tax gains and losses from MEG's trading activities were less
than $1 million for each of the years ended December 31, 2003, 2002 and 2001.
At December 31, 2003, the fair value of TEP's derivative liabilities was
less than $1 million and is reported in Other Current Liabilities 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 Emissions Allowance inventory,
was $22 million at December 31, 2003 and $15 million at December 31, 2002. The
fair value of MEG's trading liabilities was $19 million at December 31, 2003 and
$10 million at December 31, 2002.
TEP treated certain forward sale and purchase contracts as cash flow hedges
when it adopted FAS 133 and recorded an unrealized gain/loss related to these
hedges in Other Comprehensive Income. However, during 2001, new guidance was
issued by the FASB which provided that certain forward power purchase or sale
agreements, including capacity contracts, could be excluded from the
requirements of FAS 133. TEP implemented this new guidance in 2001 and
determined that the items designated as cash flow hedges upon adoption could be
excluded from the FAS 133 requirements. Therefore, as these contracts settled in
2001, TEP reversed the unrealized gain/loss included in Other Comprehensive
Income Statement
- ----------------
Operating Revenues
- External $1,028 $ 6 $ - $ - $1,034
- -----------------------------------------------------------------------------
Operating Revenues
- Intersegment - 3 - (3) -
- -----------------------------------------------------------------------------
Depreciation and Amortization 114 - - - 114
- -----------------------------------------------------------------------------
Amortizationrecorded the realized gain/loss in the income statement. As of
Transition
Recovery Asset 17 - - - 17
- -----------------------------------------------------------------------------
Interest Income 18 4 - (8) 14
- -----------------------------------------------------------------------------
Net Loss from
Equity Method Entities (2) (2) - - (4)
- -----------------------------------------------------------------------------
Interest Expense 166 - - - 166
- -----------------------------------------------------------------------------
Income Tax (Benefit)
Expense 27 (8) - (4) 15
- -----------------------------------------------------------------------------
Net Income (Loss) 51 (4) - (5) 42
- -----------------------------------------------------------------------------
Cash Flow StatementDecember 31, 2003 and December 31, 2002, TEP had no material cash flow hedges.
NOTE 8. MILLENNIUM
- -------------------
Capital Expenditures (98) (8)See Note 6 for selected financial data of Millennium.
Through affiliates, Millennium holds investments in unregulated energy and
emerging technology companies. As presented in Note 6, Millennium's assets
represent 45% in 2003 and 6% in 2002 of UniSource Energy's total assets. Under
the acquisition agreement described in Note 2, UniSource Energy is limited as to
the amount it can invest in Millennium. Consequently, Millennium's continued
willingnessability to provide future funding for the operations of emerging
companies could be influenced, directly or indirectly, by the individual
investment's ability to conform to new investment guidelines, necessity and
business plansaffected.
Millennium accounts for these investments under the consolidation and
equity methods. In some cases, Millennium is an investment's sole funder. When
this is the case, Millennium recognizes 100% of an investment's losses, because
as sole provider of funds it bears all of the financial risk. To the extent that
an investment becomes profitable and Millennium has recognized losses in excess
of its percentage ownership, Millennium will recognize 100% of an investment's
net income until Millennium's recognized losses equal its ownership percentage
of losses.
A brief summary of Millennium's investments follows:
GLOBAL SOLAR ENERGY, INC. (Global Solar) primarily develops and
manufactures light weight thin-film photovoltaic cells and panels. Global
Solar's target markets have included military, space and commercial
applications. In 2003, Millennium increased its ownership of Global Solar to 99%
from 87%. Millennium accounts for Global Solar under the consolidation method
and recognizes 100% of Global Solar's losses. In 2003, Millennium funded debt
and equity contributions of $10 million to Global Solar. We recognizeGlobal
Solar recognizes expense when the funding is utilizedused for research,
development and administrative costs. Millennium has no remaining funding
commitments to Global Solar.
INFINITE POWER SOLUTIONS, INC. (IPS) develops thin-film lithium ion
batteries. Millennium's ownership in IPS was reduced in 2003 from 77% to 72%.
Millennium accounts for IPS under the consolidation method. In 2003, Millennium
provided IPS debt and equity funding of $3 million. In 2003, Dow Corning
Enterprises, Inc. (DCEI) continued to support IPS with preferred equity and debt
contributions totaling $2 million. We recognizeIPS recognizes expense when
funding is utilizedused for research, development and administrative costs. At
December 31, 2003, Millennium had committed less than an additional $1 million
to IPS. In early 2004 these funds were drawn by IPS. DCEI holds warrants to
purchase additional preferred shares of IPS that if exercised, could result in
Millennium's ownership of IPS being reduced to as low as 59%.
K-99
MICROSAT SYSTEMS, INC. (MicroSat) develops small-scale satellites under
U.S. government contracts. In February 2004, MicroSat obtained confirmation that
the unfunded cost share commitment under this contract had been eliminated. The
change and related adjustments will be reflected in 2004. In 2003 Millennium
reduced its ownership of MicroSat to 35% from 49%. Millennium made no
contributions to MicroSat in 2003. As sole funder, Millennium recognizes 100% of
MicroSat's net losses. Millennium has no further funding commitments to
MicroSat.
MEG is a wholly-owned subsidiary of Millennium, which manages and trades
emissions allowances, coal, and related financial instruments. MEG's activities
are described in Note 7.
HADDINGTON ENERGY PARTNERS II, LP (Haddington) funds energy-related
investments. A member of the UniSource Energy Board of Directors has an
investment in Haddington and is a managing director of the general partner of
the limited partnership. Millennium committed $15 million in capital, excluding
fees, to Haddington in exchange for approximately 31% of Haddington. At December
31, 2003, Millennium has funded $9 million of this commitment, of which $2
million was funded in 2003. Millennium expects the balance to be funded in the
next three years. Millennium accounts for the investment under the equity
method.
VALLEY VENTURES III, LP (Valley Ventures) is a venture capital fund that
invests in information technology, microelectronics and biotechnology, primarily
within the Southwestern U.S. A different member of the UniSource Energy Board of
Directors is a general partner of the company that manages the fund. Millennium
committed $56 million, excludingincluding fees, to the fund and owns
approximately 15% of the fund. Millennium hashad funded $1 million of this
commitment through as of December 31, 2003. Millennium expects the balance to be
funded by the end of 2007. Millennium accounts for this investment under the
equity method due to an ability to exercise significant influence over the fund
based on the related party disclosure above.
CARBOELECTRICA SABINAS, S.DE R.L. DE C.V. (Sabinas) is a Mexican limited
liability company created to develop up to 800 megawatts (MW) of coal-fired
generation in the Sabinas region of Coahuila, Mexico. Sabinas also owns 19.5% of
Minerales de Monclova, S.A. de C.V. (Mimosa). Mimosa is an owner of coal and
associated gas reserves. Mimosa supplies metallurgical coal to the Mexican steel
industry and thermal coal to the Mexican electricity commission. major electric
utility in Mexico. Millennium owns 50% of Sabinas. Altos Hornos de Mexico, S.A.
de C.V. (AHMSA) and affiliates also own 50%. Also, UniSource Energy's Chairman,
President and Chief Executive Officer is a member of the board of directors of
AMHSA. Since 1999, both AHMSA and Mimosa are parties to a suspension of payments
procedure, under applicable Mexican law, which is the equivalent of a U.S.
Chapter 11 proceeding. Under certain circumstances, Millennium has the right to
sell (a put option) its interest in Sabinas to an AHMSA affiliate f or $20
million plus an accrued service fee. These circumstances include failure of
Sabinas to reach financial closing on the generation project within a specified
time. Millennium's put option is secured by collateral initially valued in
excess of $20 million. In 2003 Millennium received $1 million of returned
capital from the investment. Millennium accounts for the investment in Sabinas
under the equity method, however Sabinas accounts for its investment in Mimosa
under the cost method.
NATIONS ENERGY CORPORATION (Nations Energy) is wholly owned by Millennium.
Through subsidiaries, Nations Energy has a 40% interest in a 43 MW power plant
in Panama. Nations Energy intends to sell its interest in this plant, whose book
value is currently less than $1 million.
Nations Energy Contingency
In September 2001, 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 December 31, 2003, Nations Energy's
receivable from Mirant Curacao is approximately $10 million. The note is
primarily included in Investments and Other Property - - (106)
- -----------------------------------------------------------------------------
InvestmentsOther 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 Loans$5 million in July 2006.
K-100
The note is guaranteed by Mirant Americas, Inc., a subsidiary of Mirant. On
July 14, 2003, Mirant, Mirant Americas, Inc. and various other Mirant companies
filed for Chapter 11 bankruptcy protection. Mirant Curacao was not included in
the Chapter 11 filings. Based on a review of the projected cash flows for the
power project, it appears Mirant Curacao will have sufficient future cash flows
to Equity Method Entities (2) (17) - - (19)
- -----------------------------------------------------------------------------
Balance Sheet
- -------------
Total Assets 2,601 167 - (97) 2,671
- -----------------------------------------------------------------------------
Investmentpay the note receivable and any applicable interest. However, we cannot
predict the ultimate outcome that Mirant's bankruptcy will have on the
collectibility of the note from Mirant Curacao. Nations Energy will continue to
evaluate the collectibility of the receivable, but currently expects to collect
the note in Equity
Method Entities 9 6 - - 15
- -----------------------------------------------------------------------------its entirety and has not recorded any reserve for this note.
Millennium Commitments
Millennium is currently finalizing possible future commitments to each of
its investments to help insure that these investments conform to Millennium's
business plans. Millennium's funding levels and share ownership are subject to
change in the future. Millennium's outstanding equity commitments are currently
limited to $6 million to Haddington and $45 million to Valley Ventures.
Millennium's only remaining debt commitment, to IPS, was funded by Februaryin
early 2004. Millennium may commit to provide additional funding to its
investments in the future.
Global Solar and MicroSat have commitments to incur future expenses
relating to government contracts. The following is a table of remaining
government contract commitments at:
December 31,
2003 2002 2001
---------------------------------------------------
-Millions of Dollars-
Global Solar $ 1 $ 3 $ -
MicroSat - 6 8
---------------------------------------------------
Total $ 1 $ 9 $ 8
===================================================
NOTE 6. TEP'S9. UTILITY PLANT AND JOINTLY-OWNED FACILITIES
- ------------------------------------------------------------------------------------------------------------
UTILITY PLANT
The following table shows TEP's Utility Plant in Service by company and major
class:class at December 31,
2002 2001
-------------------------------------------------------------------
-Millions of Dollars-
Plant in Service:
Generation Plant $ 1,166 $ 1,133
Transmission Plant 515 508
Distribution Plant 741 692
General Plant 130 120
Intangible Plant 46 44
Electric Plant Held for Future Use 1 1
-------------------------------------------------------------------
Total Plant in Service $ 2,599 $ 2,498
===================================================================
Utility Plant under Capital Leases $ 747 $ 741
===================================================================31:
2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
UniSource UniSource
Energy Energy
TEP UES Consolidated TEP UES Consolidated
- -----------------------------------------------------------------------------
Plant in Service:
Electric Generation
Plant $1,187 $ 5 $1,192 $1,166 $ - $1,166
Electric Transmission
Plant 531 11 542 515 - 515
Electric Distribution
Plant 780 61 841 741 - 741
Gas Distribution
Plant - 120 120 - - -
Gas Transmission
Plant - 9 9 - - -
General Plant 133 10 143 130 - 130
Intangible Plant 49 2 51 46 - 46
Electric Plant Held
for Future Use 1 - 1 1 - 1
- -----------------------------------------------------------------------------
Total Plant in
Service $2,681 $ 218 $2,899 $2,599 $ - $2,599
=============================================================================
Utility Plant under
Capital Leases $ 747 $ 1 $ 748 $ 747 $ - $ 747
=============================================================================
K-101
Intangible Plant primarily represents computer software costs. TEP's
unamortized computer software costs were $28 million and $30$24 million as of December 31, 20022003 and
2001, respectively.$28 million as of December 31, 2002. UES' unamortized computer software costs
were $2 million as of December 31, 2003.
All Utility Plant under Capital Leases is used in TEP's generation
operations.
The depreciable lives currently used by TEP are as follows:
Major Class of Utility Plant in Service: Depreciable Lives:
----------------------------------------------------------------
Generation Plant 23-60
Major Class of Utility Plant in Service Depreciable Lives
---------------------------------------------------------------
Electric Generation Plant 23-70 years
Electric Transmission Plant 10-50 years
Electric Distribution Plant 24-60 years
General Plant 5-45 years
Intangible Plant 3-10 years
---------------------------------------------------------------
In the second quarter of 2002, TEP increased its estimates of useful lives
from 40 years to 60by 20 years for its IrvingtonSundt Generating Station gas-
firedgas-fired generating units and from 25 years to 40by
15 years for its internal combustion turbines. TheseThe changes in estimates
decreased depreciation expense from 2001 levels by approximately$4 million in 2003 and by $3
million for the year ended December 31,in 2002. TEP continues to evaluate the depreciable lives of its other
generating stations.
See TEP Utility Plant in Note 1 and TEP Capital Lease Obligations in Note
7.10.
The depreciable lives currently used by UES are as follows:
Major Class of Utility Plant in Service Depreciable Lives
---------------------------------------------------------------
Electric Generation Plant 23-40 years
Electric Transmission Plant 11-45 years
Electric Distribution Plant 14-26 years
Gas Distribution Plant 17-48 years
Gas Transmission Plant 37-55 years
General Plant 3-33 years
---------------------------------------------------------------
JOINTLY-OWNED FACILITIES
At December 31, 2002,2003, TEP's interests in generating stations and
transmission systems that are jointly-owned with other utilities were as
follows:
Percent Plant Construction
Owned by in Work in Accumulated
TEP Service* Progress Depreciation
- -----------------------------------------------------------------------------
-Millions of Dollars-
San Juan Units 1 and 2 50.0% $ 289 $ 9 $ 228
Navajo Station Units 1,2 and 3 7.5 125 2 72
Four Corners Units 4 and 5 7.0 79 2 73
Transmission Facilities 7.5 to 95.0 225 - 152
- -----------------------------------------------------------------------------
Total $ 718 $ 13 $ 525
Percent Plant Construction
Owned by in Work in Accumulated
TEP Service* Progress Depreciation
- -----------------------------------------------------------------------------
-Millions of Dollars-
San Juan Units 1 and 2 50.0% $ 295 $ 10 $ 203
Navajo Station Units 1,2 and 3 7.5 126 4 66
Four Corners Units 4 and 5 7.0 80 2 64
Transmission Facilities 7.5 to 95.0 225 - 146
- -----------------------------------------------------------------------------
Total $ 726 $ 16 $ 479
=============================================================================
*Included in Utility Plant shown above.
TEP has financed or provided funds for the above facilities and TEP's share
of their operating expenses is reflected in the income statements. See Note 1015
for commitments related to TEP's jointly-owned facilities.
K-102
NOTE 7.10. DEBT AND CAPITAL LEASE OBLIGATIONS
- ---------------------------------------------------------------------------------------
UNISOURCE ENERGY DEBT
UniSource Energy summarizes its consolidated long-term debt in the
statements of capitalization.
Bridge Loan
In August 2003, UniSource Energy borrowed $35 million from a financial
institution in the form of short-term debt to help finance the purchase of
Citizens Arizona electric and gas utility assets. The funds were used as an
equity contribution in the capitalization of UES. On October 24, 2003, as
required by the debt agreement, UniSource Energy repaid the $35 million loan
upon the financial close of the Springerville Unit 3 project. See Note 14.
TEP LONG-TERM DEBT
Long-term debt matures more than one year from the date of the financial
statements. We summarize ourTEP summarizes its long-term debt in the statements of
capitalization.
TEP made the required sinking fund payments of $2 million on its First
Mortgage IDBs in each of 20022003 and 2001.2002. TEP redeemed $0.4 million of its 8.5%
First Mortgage Bonds in 2002each of 2003 and $0.2 million in 2001.2002. TEP did not issue any new bonds
in 20022003 or 2001.
During 2000, TEP repaid as scheduled $47 million of its 12.22% Series
First Mortgage Bonds. Also during 2000, TEP redeemed $2 million of its 7.5%
First Collateral Trust Bonds at a discount and made required sinking fund
payments on First Mortgage Bonds of $2 million.2002.
TEP OTHER DEBT AND AGREEMENTS
First and Second Mortgage
-------------------------
TEP's first and second mortgage indentures are collateralized by a $956
million liencreate liens on and security
interests in most of TEP's utility plant assets, with the exception of
Springerville Unit 2. San Carlos Resources Inc., a wholly-owned subsidiary of
TEP, holds title to Springerville Unit 2. Utility Plant under Capital Leases is
not subject to such liens or available to TEP creditors, other than the lessors.
The net book value of TEP's utility plant subject to the lien of the indentures
was $1,124 million at December 31, 2003.
Bank Credit Agreement
---------------------
In November 2002, TEP entered into a new $401 million Credit Agreement to
replace the credit facilities provided under its then existing $441 million
Credit Agreement that would have expired December 30, 2002. The new agreement
providesprovided a $60 million Revolving Credit Facility and two Letter of Credit
facilities (Tranche A and Tranche B; collectively, LOC) totaling $341 million.
The Revolving Credit Facility, used to provide liquidity for general corporate
purposes, is a 364-day facility that expireswas to expire on November 13, 2003. In
October 2003, TEP's revolving credit lenders agreed to extend the Revolving
Credit Facility under the same terms and conditions to November 11, 2004. The
LOC secures the payment of principal and interest on $329 million of tax-exempt
variable rate bonds (IDBs). Tranche A provides $135 million and expires in
January 2006; Tranche B provides $206 million and expires in November 2006. The
new facilities are collateralized by $401 million of Second Mortgage Bonds.
The new Credit Agreement contains a number of restrictive covenants, that
are similar to TEP's previous credit agreement, including
restrictions on additional indebtedness, liens, sale of assets or mergers and
sale-
leasebacks.sale-leasebacks. The newproposed acquisition of UniSource Energy by an affiliate of
Saguaro Utility, as discussed in Note 2, is not restricted by these covenants.
The Credit Agreement like the prior agreement, also contains several financial covenants including net
worth, cash coverage and leverage tests. As of December 31, 2002,2003, TEP was in
compliance with these financial covenants.
K-103
At December 31, 20022003 and 2001,2002, TEP had no outstanding borrowings under these facilities.the
Revolving Credit Facility. When TEP borrows under the Revolving Credit Facility,
the borrowing costs are at a variable interest rate consisting of a spread over
LIBORthe London Interbank Offered Rate (LIBOR) or an alternate base rate. The spread
is based upon a pricing grid tied to TEP's credit ratings. Also, TEP pays an
annual commitment fee on the unused portion of the Revolving Credit Facility and
a fee on the LOC facilities. The chart below shows the per annum rates and fees
in effect on TEP's Credit Facilities as of December 31, 2002,2003, based on its
credit ratings, as well as the possible range of rates and fees if TEP's credit
ratings were to change:
Current Rate/ Range of
Fee Rates/Fees
-------------- ------------
Revolving Credit Facility
-Commitment Fee 0.35% 0.25% to 0.40%
-Borrowing Rate (spread over LIBOR) 4.00% 3.50% to 4.25%
Tranche A LOCs (including LOC
Fronting Fee) 4.25% 3.75% to 4.50%
Tranche B LOCs (including LOC
Fronting Fee) 5.75% 5.75%
The $329 million in aggregate principal amount of tax-exempt variable
rate debt that is supported by the LOCs was classified as short-term debt at
December 31, 2001 because the previous letter of credit facility matured on
December 30, 2002. When the new LOCs were issued in November 2002, TEP
classified the bonds as long-term debt because the new LOCs mature in 2006.
Current Rate/ Range of
Fee Rates/Fees
-----------------------------------------------------------------------
Revolving Credit Facility
- Commitment Fee 0.35% 0.25% to 0.40%
- Borrowing Rate (spread over LIBOR) 4.00% 3.50% to 4.25%
Tranche A LOCs (including LOC
Fronting Fee) 4.25% 3.75% to 4.50%
Tranche B LOCs (including LOC
Fronting Fee) 5.75% 5.75%
-----------------------------------------------------------------------
TEP CAPITAL LEASE OBLIGATIONS
The terms of TEP's capital leases are as follows:
- The IrvingtonSundt Lease has an initial term to January 2011 and provides for
renewal periods of two or more years through 2020.
- The Springerville Common Facilities Leases have an initial term to
JuneDecember 2017 for one lease and July 2020January 2021 for the other two leases,
subject to optional renewal periods of two or more years through 2025.
- The Springerville Unit 1 Leases have an initial term to January 2015 and
provide for renewal periods of three or more years through 2030.
- The Springerville Coal Handling Facilities Leases have an initial term to
April 2015 and provide for one renewal period of six years, then additional
renewal periods of five or more years through 2035.
Springerville Lease Debt and Equity
-----------------------------------TEP held Springerville Unit 1 lease debt totaling $100 million at December
31, 2003 and $108 million at December 31, 2002. In 2003, TEP made no additional
purchases of Springerville Unit 1 lease debt, but received principal payments
related to its investment in Springerville Unit 1 lease debt of $7 million. In
2002, TEP purchased $36 million of Springerville Unit 1 lease debt.
At December 31, 2003 and December 31, 2002, TEP held $79 million and $84
million, respectively, of Springerville Coal Handling Facilities lease debt and
equity. TEP purchased a 13% ownership interest in the Springerville Coal
Handling Facilities Leases for $13 million in December 2001 and all $96 million
of the debt related to these capital leases in January 2002. In March 2002, TEP
terminated the lease related to its equity interest and cancelled the associated
debt. As a result of the lease termination, TEP recorded a $21 million reduction
to the capital lease obligation, a $27 million reduction of its investment, and
a $6 million increase in the capital lease asset, which represents the residual
value of TEP's interest in the leased asset and is carried at cost.
At December 31, 2002 and December 31,
2001, TEP held $84 million and $13 million, respectively, of Springerville
Coal Handling Facilities lease debt and equity.
In addition, TEP purchased $36 million of Springerville Unit 1 lease
debt in 2002. At December 31, 2002 and December 31, 2001, TEP held $108
million and $71 million, respectively, of Springerville Unit 1 lease debt.
TEP recognizes interest income on these investments. TEP's purchases of
lease debt and equity are reflected in investing activities on TEP's cash flow
statements.
K-104
In 1985, TEP MATURITIES AND SINKING FUND REQUIREMENTS
TEP's long-term debt, including sinking funds,sold and lease obligations
mature onleased back its undivided one-half ownership interest
in the following dates:
Scheduled
IDBs Long-Term Capital
Supported by Debt Lease
LOCs Retirements Obligations Total
------------------------------------------------------------------------
-Millionscommon facilities at the Springerville Generating Station. Under the
terms of Dollars-
2003 $ - $ 2 $ 121 $ 123
2004 - 2 124 126
2005 - 2 125 127
2006 329 21 127 477
2007 - 1 128 129
------------------------------------------------------------------------
Total 2003 - 2007 329 28 625 982
Thereafter - 773 965 1,738
Less: Imputed Interest - - (746) (746)
------------------------------------------------------------------------
Total $ 329 $ 801 $ 844 $1,974
========================================================================
In addition to the capital lease obligations above, TEP must ensure $70
million of notes underlying the Springerville Common Facilities Leases, are
refinanced by June 30, 2003TEP must periodically
arrange for refinancing or refunding of the secured notes underlying the leases
prior to the named date in order to avoid a special event of loss underloss. TEP was
required to arrange for the lease.
Thisrefinancing of the lease debt prior to the special
event of loss date of June 30, 2003 or the leases would requirehave been terminated and
TEP would have been required to repurchase the property leasedfacilities for $125 million. TEP
finalized the arrangements for the refinancing of $70 million of lease debt on
June 26, 2003 and the special event of loss date was reset for June 30, 2006.
TEP incurred a total of $0.3 million in debt costs related to the refinancing.
These costs were deferred and are being amortized over a three year period.
Interest on the new debt is payable at LIBOR plus 4.25%. The LIBOR rate is re
set every six months and the rate in effect on December 31, 2003 was 0.99%,
which resulted in a total interest rate on the lease debt of 5.24% at year end.
Prior to the refinancing, the interest rate was LIBOR plus 2.50%.
UES LONG-TERM DEBT
Senior Unsecured Notes
On August 11, 2003, UNS Gas and UNS Electric issued a total of $160 million
of aggregate principal amount of senior unsecured notes in a private placement.
Proceeds from the note issuance were paid to Citizens to purchase the Arizona
gas and electric system assets. 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. UNS
Gas and UNS Electric incurred a total of $2 million in debt costs related to the
issuance of the notes. These costs were deferred and are being amortized over
the life of the notes. The notes are guaranteed by UES.
The note purchase agreements for both UNS Gas and UNS Electric contain
certain restrictive covenants, including restrictions on transactions with
affiliates, mergers, liens to secure indebtedness, restricted payments,
incurrence of indebtedness, and minimum net worth. For purposes of these notes,
net worth equals common stock equity less amounts attributable to minority
interests and intangible assets not recoverable through rates. The actual and
required minimum net worth levels at December 31, 2003 were as follows:
Required
Minimum Actual
Net Worth Net Worth
--------------------------------------------
-Millions of Dollars-
UES $ 50 $ 90
UNS Gas 43 53
UNS Electric 26 37
--------------------------------------------
The incurrence of indebtedness covenant requires each of UNS Gas and UNS
Electric to meet certain tests before an additional dollar of indebtedness may
be incurred. These tests include (a) a ratio of Consolidated Long-Term Debt to
Consolidated Total Capitalization of no greater than 0.67 to 1.00 prior to
September 30, 2004, and no greater than 0.65 to 1.00 after September 30, 2004,
and (b) an Interest Coverage Ratio (a measure of cash flow to cover interest
expense) of at least 2.50 to 1.00. However, UNS Gas and UNS Electric may,
without meeting these tests, refinance indebtedness and incur short-term debt in
an amount not to exceed $7 million in the case of UNS Gas, and $5 million in the
case of UNS Electric. Neither UNS Gas, nor UNS Electric, may declare or make
distributions or dividends (restricted payments) on their common stock unless
(a) immediately after giving effect to such action no default or event of
default would exist under such company's note purchase agreement and (b)
immediately aft er giving effect to such action, such company would be permitted
to incur an additional dollar of indebtedness under the Springerville Common Facilities Leases atdebt incurrence test for
such company. As of December 31, 2003, UNS Gas and UNS Electric were in
compliance with the higherterms of the stipulated loss value of $125 million or the fair market value of the
facilities. Upon suchnote purchase the lease would be terminated.agreements.
K-105
MEG LINE OF CREDIT
MEG has a $5 million bank line of credit for the purpose of issuing letters
of credit to counterparties to support its emissionemissions allowance and coal trading
activities. asAs of December 31, 2002,2003, MEG had $2$5 million in outstanding LOCS. thisLOCs.
This facility expires in August 2004.March 2005.
MATURITIES AND SINKING FUND REQUIREMENTS
Long-term debt, including sinking funds, and lease obligations mature on
the following dates:
Scheduled
IDBs Long-Term Capital UniSource
Supported Debt Lease TEP Energy
by LOCs Retirements Obligations Total UES Total
---------------------------------------------------------------------------
-Millions of Dollars-
2004 $ - $ 2 $ 120 $ 122 $ - $ 122
2005 - 2 120 122 - 122
2006 329 21 122 472 - 472
2007 - 1 127 128 - 128
2008 - 29 120 149 61 210
---------------------------------------------------------------------------
Total
2004-2008 329 55 609 993 61 1,054
Thereafter - 744 836 1,580 100 1,680
Less:
Imputed
Interest - - (633) (633) - (633)
--------------------------------------------------------------------------
Total $ 329 $ 799 $ 812 $1,940 $ 161 $2,101
==========================================================================
NOTE 8.11. FAIR VALUE OF TEP'S FINANCIAL INSTRUMENTS
- ------------------------------------------------------------------------------------------------
The carrying values and fair values of TEP's financial instruments are as
follows:
December 31,
2002 2001
December 31,
2003 2002
- -----------------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
- -----------------------------------------------------------------------------
-Millions of Dollars-
Assets:
TEP Springerville Lease Debt
Securities (included in
Investments and Other Property) $ 179 $ 198 $ 192 $ 196
Liabilities:
TEP First Mortgage Bonds - Fixed
Rate:
Corporate 27 27 27 28
IDBs 55 55 57 57
First Collateral Trust Bonds 138 155 138 140
TEP Second Mortgage Bonds - IDBs
(Variable Rate) 329 329 329 329
TEP Unsecured IDBs - Fixed Rate 579 582 579 569
UES Senior Unsecured Notes 160 160 - -
- -----------------------------------------------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
- -----------------------------------------------------------------------------
-Millions of Dollars-
Assets:
Springerville Lease Debt
Securities (Included in
Investments and Other Property) $ 192 $ 196 $ 71 $ 74
Springerville Lease Ownership
Interest (Included in
Investments and Other Property) - - 13 13
Liabilities:
First Mortgage Bonds - Fixed Rate:
Corporate 27 28 28 28
Industrial Development Revenue
Bonds (IDBs) 57 57 58 59
First Collateral Trust Bonds 138 140 138 138
Second Mortgage Bonds - IDBs
(Variable Rate) 329 329 329 329
Unsecured IDBs - Fixed Rate 579 569 579 534
- -----------------------------------------------------------------------------
See Note 710 for a description of TEP's 2002 investment in Springerville Lease
Debt. TEP intends to hold the $192$179 million investment in Springerville Lease
Debt Securities to maturity ($5346 million matures through January 1, 2009, $84$78
million matures through July 1, 2011, and $55 million matures through January 1,
2013). This investment is stated at amortized cost, which means the purchase
cost has been adjusted for the amortization of the premium and discount to
maturity. TEP bases the fair value of this investment on quoted market prices
for the same or similar debt.
K-106
TEP considers the principal amounts of variable rate debt outstanding to be
reasonable estimates of their fair value. TEP determined the fair value of its
fixed rate obligations including the Corporate First Mortgage Bonds, the First
Mortgage Bonds-IDBs, First Collateral Trust Bonds and the Unsecured IDBs by
calculating the present value of the cash flows of each fixed rate obligation.
TEP used a rate consistent with market yields generally available as of December
20022003 for 20022003 amounts and December 20012002 for 20012002 amounts for bonds with similar
characteristics with respect to credit rating, time-to-maturity, and the tax
status of the bond coupon for federal income tax purposes. The use of different
market assumptions and/or estimation methodologies may yield different estimated
fair value amounts.
UES considers the principal amounts of the $160 million of senior unsecured
notes issued in August 2003 to be reasonable estimates of their fair value. In
addition to being issued recently, the notes were privately placed and not
assigned credit ratings by the major credit rating agencies, making the notes
difficult to value based on bonds with comparable credit ratings,
time-to-maturity, and trading patterns.
The carrying amounts of our current assets and liabilities approximate fair
value.
NOTE 9.12. STOCKHOLDERS' EQUITY
- -----------------------------------------------------------
DIVIDEND LIMITATIONS
UniSource Energy
----------------
In February 2003,2004, UniSource Energy declared a quarterly dividend to the
shareholders of $0.15$0.16 per share of UniSource Energy Common Stock. The dividend,
totaling approximately $5 million, will bewas paid on March 7, 200310, 2004 to common
shareholders of record as of February 21, 2003.17, 2004. In 2003, UniSource Energy paid
quarterly dividends to the shareholders of $0.15 per share, for a total of $0.60
per share, or $20 million, for the year. During 2002, UniSource Energy paid
quarterly dividends to the shareholders of $0.125 per share, for a total of
$0.50 per share, or $17 million, for the year. During 2001, UniSource Energy
paid quarterly dividends to the shareholders of $0.10 per share, for a total of
$0.40 per share, or $13 million, for the year.
During
2000, UniSource Energy paid quarterly dividends to the shareholders of $0.08
per share, for a total of $0.32 per share, or $10 million, for the year.
Our ability to pay cash dividends on common stock outstanding depends, in
part, upon cash flows from our subsidiaries: TEP, UES, Millennium and UED.
Additionally, pending consummation of the acquisition discussed in Note 2,
UniSource Energy's quarterly dividend payment is limited to no more than $0.16
per share in 2004 and $0.17 per share in 2005.
TEP
---
TEP paid dividends of $80 million in 2003, $35 million in 2002, and $50
million in 2001, and $30
million in 2000.2001. UniSource Energy is the primary holder of TEP's common stock.
TEP met the following requirements before paying these dividends:
- Bank Credit Agreement
During 2000 through2001 and 2002, TEP's bank Credit Agreement allowed TEP to pay
dividends as long as TEP maintained compliance with the agreement and met its
financial covenants. TEP's new Credit Agreement as of November 2002 applies
those same restrictions as well as restricting TEP's dividends to 65% of TEP's
consolidated net income for the immediately preceding fiscal year, as long as the Tranche B LOCs are outstanding.
- ACC Holding Company Order
The ACC Holding Company Order does not allow TEP to pay dividends in excess
of 75% of its annual earnings until TEP's equity ratio equals 37.5% of total
capitalization, excluding capital lease obligations. The UES Settlement
Agreement, as approved by the ACC, modifies this dividend limitation so that it
will remain in place until TEP's common equity equals 40% of total
capitalization (excluding capital lease obligations).
- Federal Power Act
This Act states that dividends shall not be paid out of funds properly
included in capital accounts. TEP's 2003, 2002 2001 and 20002001 dividends were paid from
current year earnings.
K-107
UES
UES did not pay any dividends to UniSource Energy in 2003. UES' ability to
pay dividends is limited by restrictions placed on its subsidiaries, UNS Gas and
UNS Electric. As discussed in Note 3, the UES Settlement Agreement limits
dividends payable by both UNS Gas and UNS Electric to UniSource Energy to 75% of
earnings until the ratio of common equity to total capitalization reaches 40%.
Additionally, the terms of the senior unsecured note agreements entered into by
both UNS Gas and UNS Electric contain dividend restrictions. See Note 10.
Millennium and UED
------------------
Millennium did not pay any dividends to UniSource Energy in 2003, 2002 2001
or
2000.2001. UED haspaid a dividend to UniSource Energy of $50 million in 2003. UED did
not paidpay any dividends to UniSource Energy.in 2002 or 2001. Millennium and UED have no dividend
restrictions.
WARRANTS
UniSource Energy
----------------
At December 31, 2002 and 2001, UniSource Energy had no outstanding
warrants. In December 2000, 791,966 UniSource Energy Warrants, that were
scheduled to expire on December 15, 2000, were exercised resulting in a $13
million increase in common stock equity. The remaining 700,445 warrants
expired unexercised.
TEP
---
At December 31, 2002, TEP had no outstanding warrants. On December 15,
2002, 4.6 million TEP Warrants expired unexercised. UniSource Energy is the
primary holder of the common stock of TEP and TEP common stock is not
publicly traded.
UNISOURCE ENERGY SHAREHOLDER RIGHTS PLAN
In March 1999, UniSource Energy adopted a Shareholder Rights Plan. As of
April 1, 1999, each Common Stock shareholder receives one Right for each share
held. Each Right initially allows shareholders to purchase UniSource Energy's
Series X Preferred Stock at a specified purchase price. However, the Rights are
exercisable only if a person or group (the "acquirer") acquires or commences a
tender offer to acquire 15% or more of UniSource Energy Common Stock. Each
Right would entitle the holder (except the acquirer) to purchase a number of
shares of UniSource Energy Common or Preferred Stock (or, in the case of a
merger of UniSource Energy into another person or group, common stock of the
acquiring person) having a fair market value equal to twice the specified
purchase price. At any time until any person or group has acquired 15% or more
of the Common Stock, UniSource Energy may redeem the Rights at a redemption
price of $0.001 per Right. The Rights trade automatically with the Common Stock
when it is bought and sold. The Rights expire on March 31, 2009. UNISOURCE ENERGY POTENTIAL COMMON STOCK ISSUE
On February 21, 2003, we filed a "shelf" registration statement on Form
S-3 to issue up to 4 million sharesThe proposed
acquisition of UniSource Energy, Common Stock.as discussed in Note 2, will not be an event
that triggers the provisions of the Shareholder Rights Plan as the proposed
acquisition was approved by the UniSource Energy Board of Directors.
NOTE 10.13. TEP WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
- ----------------------------------------------------------
At December 31, 2003, TEP's Allowance for Doubtful Accounts on the balance
sheet includes $10 million related to 2001 and 2000 sales to the California
Power Exchange (CPX) and the California Independent System Operator (CISO). At
December 31, 2002, the allowance for these receivables was approximately $8
million.
CPX and CISO
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 a
FERC order in March 2003 (as reaffirmed by the FERC on October 16, 2003), TEP
estimated 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 million by recording a reduction of
wholesale revenues.
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. We cannot predict the outcome of these issues or lawsuits.
We believe, however, that TEP is adequately reserved for its transactions with
the CPX and the CISO.
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 $26 million at December 31, 2003 and $31 million at
December 31, 2002. Excluding the receivables from the CPX and the CISO, as
described above, substantially all of the December 31, 2003 wholesale receivable
balance has been collected as of the date of this filing.
K-108
Enron
In late 2001, Enron filed for bankruptcy protection. At that time, TEP had
an outstanding receivable from Enron of $0.8 million. In early 2003, a 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 allowance for doubtful accounts for its
sales to Enron by $0.4 million, to fully reserve its $0.8 million receivable
from Enron. In November 2003, TEP unconditionally sold its claim against Enron
for $0.5 million and reversed both the recorded receivable and the related
allowance.
NOTE 14. SPRINGERVILLE EXPANSION
- ---------------------------------
On October 21, 2003 (the Closing Date), UED, TEP, Tri-State Generation and
Transmission Association, Inc. (Tri-State) and Salt River Project Agricultural
Improvement and Power District (SRP) entered into an Amended and Restated Joint
Development Agreement, which provides for the development of two 400 MW
coal-fired units at TEP's existing Springerville Generating Station by parties
other than TEP.
On the Closing Date, TEP transferred the right to construct Unit 3,
together with associated rights, to Tri-State. Tri-State completed financing of
Unit 3 on that date and immediately began construction. Once the unit is
completed, Tri-State will lease 100% of Unit 3 through a 34-year leveraged lease
agreement with GE Structured Finance and will take 300 MW of the 400 MW
capacity.
Under the Joint Development Agreement, SRP will purchase 100 MW of Unit 3's
capacity from Tri-State under a 30-year power purchase agreement and will have
the right to construct and own Unit 4 at a later date. If SRP decides to
construct Unit 4, TEP and Tri-State may be required to find a replacement
purchaser for SRP's 100 MW power purchase obligation from Unit 3. If TEP and
Tri-State are unable to find a replacement purchaser, TEP would then purchase
100 MW of output from Unit 4, beginning with its commercial operation.
TEP executed contracts to provide operating, maintenance and other services
to Units 3 and 4. TEP also agreed to purchase up to 100 MW of Tri-State system
capacity for no more than five years from the time Unit 3 begins commercial
operation, which we expect to occur in December 2006. TEP will benefit from
approximately $90 million in upgraded emissions control equipment for Units 1
and 2 and other facilities at the Springerville Generating Station that will be
paid for by the Unit 3 project. Due to the transfer of Unit 3 rights to
Tri-State, in November 2003 TEP deposited $17 million with TEP's Second Mortgage
Trustee.
On the Closing Date, UED received reimbursement of all project development
costs which it incurred in connection with Units 3 and 4 of approximately $29
million, plus a development fee (including accrued interest on development funds
advanced) of $11 million. We recognized the development fee as income in the
fourth quarter of 2003. On October 24, 2003, UniSource Energy repaid its $35
million short-term bridge loan with the proceeds.
NOTE 15. COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
TEP COMMITMENTS
Fuel Purchase and Transportation Commitments
--------------------------------------------In 2003, the ACC issued the Track B Order which defined the competitive
bidding process TEP must use to obtain capacity and energy requirements beyond
what is supplied by TEP's existing resources. For the period 2003 through 2006,
TEP estimated this to be approximately 0.5% of its retail load in the first year
and gradually increasing over the period. This order further required TEP to bid
out short-term energy purchases that it estimated it will make in the 2003 to
2006 period. The order does not require TEP to purchase any power that it deems
to be uneconomical, unreasonable or unreliable. In 2003, TEP entered into two
power purchase agreements for the period 2003 through 2006 as listed below:
K-109
- PPL Energy Plus, LLC supplied 37 MW from June 2003 through December 2003
and will supply 75 MW from January 2004 through December 2006, under a unit
contingent contract.
- Panda Gila River generating station will supply 50 MW on-peak from June
through September, from 2003 (which has been supplied) through 2005, under a
unit contingent contract between TEP and Panda Gila River, L.P.
These purchases are intended to provide adequate reserve margins during the
summer peak period. In 2003, TEP made $7 million of payments under these
contracts.
TEP has several long-term contracts for the purchase and transportation of
coal with expiration dates from 20042006 through 2017.2020. The total amount paid under
these contracts depends on the number of tons of coal purchased and transported.
All of these contracts (i) include a price adjustment clause that will affect
the future cost of coal and (ii) require TEP to pay a take-
or-paytake-or-pay charge or
liquidated damages if certain minimum quantities of coal are not purchased
and/or transported. TEP's present fuel requirements are in excess of the
take-or-
paytake-or-pay minimums. However, sometimesAt times, TEP has purchased coal from other suppliers,
resulting in take-or-pay minimum charges, but a lower overall cost of fuel. TEP
made payments under these contracts of $167 million in 2003, $161 million in
2002, and $173 million in 2001, and $157 million in 2000.2001.
TEP entered into a Gas Procurement Agreement with Southwest Gas Corporation
effective June 1, 2001 with a primary term of five years. The contract providesprovided
for a minimum volume obligation during the first two years of 10 million MMBtus
annually. TEP negotiated new pricing and a lower minimum annual volume
obligation of 4 million MMBtus for 2004. However, TEP expects to use more gas
than this minimum requirement. In the event TEP purchases fewer MMBtus, TEP is
obligated to pay only the transportation component for any shortfall. TEP will
negotiate terms for the remaining life of the contract in late 2004. TEP made
payments under this contract of $34 million in 2003, $33 million in 2002 and $28
million in 2001.
At December 31, 2002,2003, TEP estimates its future minimum payments under these
contracts to be:
Total Contractual
Obligations
--------------------------------------
-Millions of Dollars-
2003 $ 81
2004 78
2005 75
2006 72
2007 72
--------------------------------------
Total 2003 - 2007 378
Thereafter 278
--------------------------------------
Total $ 656
Purchase
Obligations
--------------------------------------
-Millions of Dollars-
2004 $ 91
2005 90
2006 87
2007 77
2008 77
--------------------------------------
Total 2004 - 2008 422
Thereafter 424
--------------------------------------
Total $ 846
======================================
Irvington Coal Contract Termination
-----------------------------------
In the third quarter of 2002, TEP terminated a coal supply agreement for
the Irvington Generating Station. As a result, TEP recorded a pre-tax charge
of $11.3 million and made an $11.3 million payment in the third quarter of
2002. The additional expense was mitigated by TEP not being required to make
a take-or-pay penalty payment of approximately $3.5 million for the year 2002
and subsequent years.
San Juan Coal Contract Amendment
--------------------------------
In September 2000, to reduce fuel costs over the next 17 years, TEP
terminated the San Juan Generating Station's coal supply contract and entered
into a new coal supply contract, replacing two surface mining operations with
one underground operation. To terminate the contract, TEP was required to
make a $15 million payment in January 2003. In September 2000, as a result
of this scheduled payment, TEP recorded a pre-tax $13 million Coal Contract
Amendment Fee expense and a non-current liability which equaled the present
value of the $15 million payment. TEP recognized interest expense, included
in the Interest Imputed on Losses Recorded at Present Value line item on the
income statements, and increased its liability until the payment was made in
December 2002. On a net present value basis, TEP expects the fuel savings to
significantly exceed the $15 million payment over the original term of the
contract.
Operating Leases
----------------
TEP, Millennium, UES and MillenniumUED have entered into operating leases, primarily
for office facilities and computer equipment, with varying terms, provisions,
and expiration dates. UniSource Energy's consolidated operating lease expense
was $3 million forin each of 2003, 2002 2001 and 2000.2001. TEP's operating lease expense was
$2 million forin each of 2003, 2002 2001 and 2000.2001. UniSource Energy and TEP's estimated
future minimum payments under non-cancelable operating leases at December 31,
20022003 are as follows:
UniSource
Energy
Consolidated TEP
-------------------------------------------
-Millions of Dollars-
2003K-110
UniSource
Energy
Consolidated TEP
-------------------------------------------
-Millions of Dollars-
2004 $ 3 $ 1
2005 2 1
2006 2 1
2007 2 1
2008 1 1
-------------------------------------------
Total 2004 - 2008 10 5
Thereafter 6 1
-------------------------------------------
Total $ 16 $ 3 $ 2
2004 2 1
2005 1 1
2006 1 1
2007 1 1
-------------------------------------------
Total 2003 - 2007 8 6
Thereafter 3 3
-------------------------------------------
Total $ 11 $ 9
===========================================
Environmental Regulation
------------------------
The 1990 Federal Clean Air Act Amendments requirecall for reductions of SO2 and
nitrogen oxide (NOx) emissions in two phases, more complex facility
permits and other requirements.phases. TEP is subject only to Phase II of
the SO2 and NOx emissionemissions reductions which was effective January 1, 2000. All of
TEP's generating facilities (except existing internal combustion turbines) are
affected. TEP spent approximately $2.5capitalized $11 million in 2003 and $8 million in 2002 approximately $2
millionand 2001 in
2001 and approximately $1 million in 2000construction costs to comply with environmental requirements and expects to
spend
approximately $2capitalize $6 million annuallyin 2004 and 2005. In addition, TEP recorded expenses of $8
million in 2003 and $6 million in 2002 and 2001 related to environmental
compliance, including the cost of lime used to scrub the stacks. TEP expects
environmental expenses to be $7 million in 2004 to comply with these
requirements.and 2005.
In 1993, TEP's generating units affected by Phase II were allocated SO2
EmissionEmissions Allowances based on past operational history. Beginning in the year
2000, Phase II generating units were required to hold EmissionEmissions Allowances equal
to the level of emissions in the compliance year or pay penalties and offset
excess emissions in future years. TEP had sufficient EmissionEmissions Allowances to
comply with the Phase II SO2 regulations for compliance year 2002.2003. However, due
to increased energy output and potential changes in the legislation affecting
SO2 Emission Allowances allocation, TEP may have to purchase additional
EmissionEmissions Allowances for future compliance years. Based on current estimates of
additional required EmissionEmissions Allowances and market prices, TEP believes that
purchases of EmissionEmissions Allowances will not have a material effect on TEP.
The EPA has issued a determination that coal and oil-fired electric utility
steam generating units must control their mercury emissions. Final regulations
are expected to be issued in December 2004. TEP may incur additional costs to
comply with recent and future changes in federal and state environmental laws,
regulations and permit requirements at existing electric generating facilities.
Compliance with these changes may result in a reduction in operating efficiency.
Income Tax Assessments
In 2003, the Arizona Department of Revenue issued a preliminary audit
report regarding its examination of state income tax returns for the period of
1990 through 2000. The initial review of the report resulted in a combined
additional expense of $1 million recorded on TEP and Nations Energy.
In 2002, the IRS audit for 1997-2000 was settled, and after reviewing the
impact of the audit findings as well as the effect of tax positions established
in relation to future tax years, TEP reversed $1 million of the deferred tax
valuation allowance. See Note 16.
In 2001, the IRS audit of 1994, 1995 and 1996 tax years was settled. After
reviewing the impact of the final assessment on TEP's accrued tax liabilities
and the potential for assessments related to later tax years, no adjustments to
the deferred tax valuation allowance were deemed necessary in 2001.
K-111
UES COMMITMENTS
See Note 3 for a description of UES' commitments.
MILLENNIUM COMMITMENTS AND CONTINGENCY
See Note 48 for a description of Millennium's commitments and contingency.
UED COMMITMENTS
UEDUNISOURCE ENERGY CONTINGENCIES
Litigation Concerning the Proposed Acquisition Agreement
On November 24, 2003 two shareholder derivative lawsuits, McBride v.
Pignatelli, et al. and Salt River Project Agricultural ImprovementZetooney v. Pignatelli, et al., were filed in the
Superior Court of the State of Arizona relating to the acquisition. In these two
lawsuits, which are virtually identical, the plaintiffs allege that UniSource
Energy's Board of Directors, in its consideration and Power District
(SRP)approval of the
acquisition agreement, breached its fiduciary duty to UniSource Energy's
shareholders in approving the acquisition agreement. The plaintiffs, who request
that their suits be permitted to proceed as class actions, seek damages and an
order from the court declaring that UniSource Energy's Board of Directors has
breached its fiduciary duties to UniSource Energy's shareholders, ordering that
UniSource Energy's Board of Directors take the steps specified in the complaint
to correct the alleged breaches of fiduciary duty and enjoining the acquisition
from proceeding. UniSource Energy believes that these lawsuits are without merit
and will vig orously defend them.
Acquisition Fees
UniSource Energy has entered into a Joint Development Agreementagreements with New Harbor Incorporated
(New Harbor) and Morgan Stanley & Co. Incorporated (Morgan Stanley) in
October 2001connection with the acquisition of UniSource Energy by Saguaro Utility. The
transaction fee payable to develop
two 400 MW coal-fired units at TEP's existing Springerville Station. As a
resultNew Harbor is $9 million. UniSource Energy paid New
Harbor $2 million upon announcement of recent developments, UEDthe transaction in November 2003, with
the balance of the transaction fee contingent and SRP are modifyingpayable upon the Joint
Development Agreement to provide forclosing of
the purchase by SRP of a specified
amount of power from Unit 3transaction. UniSource Energy paid Morgan Stanley $1 million in November
2003, and an option for SRP to own Unit 4. UEDwill pay Morgan Stanley $0.4 million contingent and SRP
each committed project development funding for professional servicespayable upon
shareholders approving the transaction and other third party costs. As of December 31, 2002, SRP met its funding
commitment for$1 million contingent and payable
upon the project. Tri-State Generation and Transmission
Association, Inc. (Tri-State)acquisition closing. UniSource Energy has agreed to purchasepay Morgan Stanley
a transaction fee of up to $4 million, including their monthly advisory fee, in
connection with the remaining power from
Unit 3. Tri-State and UED signed a Development Cost Agreementacquisition.
In certain circumstances, in January
2003 to each share 50%the event of termination of the remaining development costsacquisition
agreement, UniSource Energy would be required to pay Saguaro Acquisition Corp.'s
expenses and a termination fee in an aggregate amount of Unit 3 effective
from November 6, 2002 until financial closing. At December 31, 2002,
capitalized project development costs on UED's balance sheet were
approximately $22.4up to $25 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.
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 the
ACC's approval of the expansion at the Springerville Generating Station to the
Superior Court of the State of Arizona. Additionally, inOn October 22, 2003, the Superior Court
affirmed the ACC's issuance of the Certificate of Environmental Compatibility
for Springerville Generating Station. The Court granted TEP and the ACC's motion
for summary judgment from the environmental activist groups. The environmental
activist groups appealed the Superior Court decision on December 30, 2003 and
filed an amended notice of appeal on January 2, 2004.
K-112
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 that2. These standards would require new permits and the installation of
additional facilities, meeting Best Available Control Technology standards, are required for
the continued operation of Units 1 and 2 in
accordance with applicable law. TEP believes the claims by the GCT are without
merit and will vigorously contest them.2. 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 intends to vigorously
contest them.
Litigation and Claims Related to San Juan Coal Company
-------------------------------------------Generating Station
On July 30,May 16, 2002, Dugan Production Corp. (Dugan)the GCT and the Sierra Club filed a citizen lawsuit under
the Clean Air Act in federal district court in New Mexico against thePublic Service
Company of New Mexico (PNM) as operator of San Juan Coal Company, the coal supplier to the San Juan Generating
Station (San Juan).Juan. TEP owns 50% of San Juan
Units 1 and 2, which equates to 19.8% of the total San Juan Station. The lawsuit
alleges two violations of the Clean Air Act and related regulations and permits.
One of the two claims, concerning the initial permitting of San Juan, was
dismissed by the court in August 2003. The remaining claim went to trial in
November 2003 with a decision expected in early 2004, and alleged that PNM
violated its present Title V operating permit by exceeding the 20% opacity
standard on numerous occasions between 1998 and 2002; opacity is a means to
monitor the particulate matter contained in an emission.
In September 2003, the New Mexico Environment Department (NMED) notified
PNM, operator of San Juan, of alleged excess emissions and opacity in violation
of the permits at San Juan. The NMED issued a draft compliance order assessing
unspecified civil penalties. PNM has entered into discussions with the NMED
concerning the alleged excess emissions and opacity violations. No compliance
order has been issued in this matter.
Based on the information available to date, TEP does not believe resolution
of these matters will be material to TEP.
Postretirement and Pension Benefit Costs at Various Generating Stations
The coal suppliers to Springerville Generating Station and each of TEP's
remote generating stations have submitted demands for payment by TEP of
postretirement and pension benefit costs for these coal suppliers' employees
under the coal supply agreements with TEP. Peabody Western Coal Company
(Peabody), the coal supplier to the Navajo Generating Station, has filed a
lawsuit against the participants at Navajo, including TEP, for retiree
postretirement benefit costs. TEP owns 7.5% of the Navajo Generating Station. In
December 2003, the Navajo participants and Peabody agreed to stay the discovery
process in this litigation until August 31, 2004 to give the parties time to
explore a possible settlement. To the extent that amounts become known and
payment probable, TEP will record a liability for additional postretirement and
pension benefit costs at the Springerville, Navajo, and San Juan Generating
Stations. TEP does not expect any settlement to be material to TEP.
The claim for postretirement at Four Corners was settled as part of the
coal contract extension. TEP paid $0.3 million for postretirement benefits in
settlement in September 2003.
K-113
Environmental Reclamation at Remote Generating Stations
TEP pays on-going reclamation costs at each of its remote generating
stations, and it is probable that TEP will have to pay a portion of final
reclamation costs at the coal mines which supply the remote generating stations.
In June 2003, TEP received an estimate of the reclamation liability at the coal
mine that supplies San Juan in total.which post-term reclamation activities are
assumed to occur over a 16-year period beginning in 2028. The expected aggregate
undiscounted reclamation liability totals $122 million of which TEP's portion of
the liability, based on its ownership of San Juan, totals $24 million. The
present value of TEP's liability for post-term reclamation at a 10%
credit-adjusted risk free rate approximates $7 million at December 31, 2017, the
expiration date of the coal supply agreement, and will be recognized over the
remaining term of the coal supply agreement. At December 31, 2003, TEP has
recorded $0.3 million of its post-term reclamation liability at San Juan.
Amounts recorded for p ost-term reclamation are subject to various assumptions
and determinations, such as estimating the costs of reclamation, estimating when
final reclamation will occur, and the credit-adjusted risk-free interest rate 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 post-term reclamation. TEP does not believe that
recognition of its post-term reclamation obligation at San Juan will be material
to TEP in any single year since recognition occurs over the remaining 14 year
life of its coal supply agreement.
Although a cost is probable at TEP's other remote generating stations, it
is not possible at this time to reasonably estimate the amount of any obligation
for final reclamation because remediation alternatives have not yet advanced to
the stage where a reasonable estimate of any cost can be made. As amounts become
known, TEP will recognize a liability for final reclamation over the remaining
lives of its coal supply agreements.
RESOLUTION OF TEP COMMITMENTS AND CONTINGENCIES
Litigation Related to San Juan Coal Company
In August 2003, San Juan Coal Company, the coal supplier to San Juan,
entered into a settlement agreement with Dugan Production Corp. (Dugan). 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
ownowns certain oil and gas interests in portions of the land used
for the underground mine. Dugan allegesalleged that San Juan Coal Company's underground
coal mining operations have or will interfere with Dugan's gas production and
will result inreduce the dissipationamount of natural gas that itDugan would otherwise would be entitled to
recover. Dugan seeks a declaration by the courtThe settlement agreement provides that the rights
under its leases are senior and superior to the rights of the San Juan Coal Company and seeks to enjoin the underground mining of coalwill
compensate Dugan for any remaining gas production from a portion of
the land used for the underground mine as described above. Dugan also seeks
monetary damages.
Thewell when San Juan Coal
Company has informed Public Service Company of New
Mexico (PNM)determines that it intendsmining activity is close enough 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 coalwarrant shutting down
a well. Dugan agreed not to San Juan. TEP doesdrill any additional wells. This settleme nt is not
expect resolution of this litigationexpected to be material to TEP.
Sundt Coal Contract Termination
In the third quarter of 2002, TEP asterminated a 19.8% ownercoal supply agreement for
the Sundt Generating Station. As a result, TEP recorded a pre-tax charge of
$11.3 million and made an $11.3 million payment in the third quarter of 2002.
The additional expense was mitigated by TEP not being required to make a
take-or-pay penalty payment of approximately $3.5 million for the year 2002 and
subsequent years.
San Juan.
Litigation Related toJuan Coal Contract Amendment
In September 2000, TEP terminated the San Juan Generating Station
-------------------------------------------------
On May 16, 2002,Station's coal
supply contract and entered into a new coal supply contract, replacing two
surface mining operations with one underground operation. To terminate the
Grand Canyon Trustcontract, TEP made a $15 million payment in December 2002. In September 2000, as
a result of this scheduled payment, TEP recorded a pre-tax $13 million Coal
Contract Amendment Fee expense and a non-current liability which equaled 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
violationspresent value of the Clean Air Act$15 million payment. TEP recognized interest expense,
included in the Interest Imputed on Losses Recorded at Present Value line item
on the income statements, and related regulations and permits, seeks
penalties as well as injunctive and declaratory relief and is presently
scheduled for trial in June 2003. Based onincreased its investigation to date, PNM
has stated that it firmly believes thatliability until the allegations are without merit,
and vigorously disputes the allegations. Only one of those allegations
relates to a unit in which TEP owns an interest. While we are unable to
predict the ultimate outcome of the lawsuit, we do not believe the outcome
will be material to TEP.
Environmental Reclamation
-------------------------
TEP pays on-going reclamation costs at each of its remote generating
stations, and it is reasonably possible that we may have to pay a portion of
final reclamation costs as the coal companies from which the remote
generating stations purchase coal undertake final reclamation of their mines.
As amounts become known and probable, we will record a liability for final
reclamation.payment was
made.
K-114
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. TheseWe
enter into these agreements are entered into primarily to support or enhance the creditworthiness
otherwise attributed toof a subsidiary on a stand-
alone basis, thereby facilitating the extension of sufficient credit to
accomplish the subsidiaries' intended commercial purposes.stand-alone basis. The most significant of these guarantees
supports upare 1) UES' guarantee of $160 million of aggregate principal amount of senior
unsecured notes issued by UNS Gas and UNS Electric to purchase the Citizens
Arizona gas and electric system assets, 2) UniSource Energy's guarantee of
approximately $3.5$22 million in natural gas transportation and supply payments in
addition to building lease payments for UNS Gas, UES, UNS Electric, and
subsidiaries of Millennium, and 3) Millennium's guarantee of approximately $5
million in commodity-related payments for MEG at December 31, 2002.2003. To the
extent liabilities exist under the contracts subject to these guarantees, such
liabilities are includedinclu ded in theUniSource Energy's 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, TEP, UES, or TEPMillennium
would be required to perform or otherwise incur any significant losses
associated with any of these guarantees or indemnities is remote.
RESOLUTION OF TEP CONTINGENCIES
Income Tax Assessments
----------------------
In 2002, the IRS audit for 1997-2000 was settled, and after reviewing
the impact of the audit findings as well as the effect of tax positions
established in relation to future tax years, TEP reversed $1 million of the
deferred tax valuation allowance. See Note 12.
In 2000, the IRS issued an income tax assessment for the 1994, 1995 and
1996 tax years. After reviewing the impact of these items on TEP's accrued
tax liabilities, TEP reversed $1 million of the deferred tax valuation
allowance in 2000. See Note 12. The audit for such period was settled in
2001, and after reviewing the impact of the final assessment on TEP's accrued
tax liabilities and the potential for assessments related to later tax years,
no further adjustments to the deferred tax valuation allowance were deemed
necessary in 2001.
In February 1998, the IRS issued an income tax assessment for the 1992
and 1993 tax years. The IRS challenged TEP's treatment of various items
relating to a 1992 financial restructuring, including the amount of net
operating loss (NOL) and investment tax credit (ITC) generated before
December 1991 that may be used to reduce taxes in future periods. In 2000,
TEP settled the 1992 and 1993 audits. After reviewing the impact of these
items on its accrued tax liabilities, TEP reversed $7 million of the deferred
tax valuation allowance in 2000. See Note 12.
ACC Order on the Sierrita Contract
----------------------------------
In September 2000, TEP reversed a $3 million reserve, resulting in $3
million of revenue, related to a dispute between TEP and Cyprus Sierrita
Corporation (now known as Phelps Dodge Sierrita, Inc.) (Sierrita) over the
proper method of calculating energy costs that TEP charged to Sierrita under
an ACC-approved contract. Sierrita dismissed its appeals to the Court of
Appeals after TEP and Sierrita entered into an amendment to their contract,
which was subsequently approved by the ACC.
NOTE 11. Wholesale Accounts Receivable and Allowances16. INCOME AND OTHER TAXES
- ------------------------------------------------------
At December 31, 2002 and December 31, 2001, TEP's Accounts Receivable on
the balance sheet is net of an $8.4 million allowance for uncollectible
receivables related to 2000 and 2001 sales to the California Power Exchange
(CPX), the California Independent System Operator (CISO) and Enron Corp. and
certain of its affiliates (Enron). The receivable from the CPX and the CISO
is $16 million and the receivable from Enron is $0.8 million. This allowance
reflects a 50% reserve on amounts unpaid from the CPX, the CISO and Enron.
The reserve for the receivable from Enron was recorded in 2001.
TEP's collection shortfall from the CPX and CISO was approximately $9
million for sales made in 2000 and $7 million for sales made in 2001. We
recorded an allowance for doubtful accounts for the full amount of these
uncollected amounts in the fourth quarter of 2000 and the first quarter of
2001, totaling $16 million. In the fourth quarter of 2001, we decreased the
reserve by $8 million, or 50%, of the outstanding receivable because the
following events which occurred in late 2001 caused us to believe that it is
probable that TEP will collect at least 50% of this aggregate outstanding net
receivable: (a) the stabilization of the power markets, (b) rate increases
achieved by Pacific Gas and Electric Company (PG&E) and Southern California
Edison Company (SCE), (c) settlements made by California utilities with
various power providers, and (d) data in filings of FERC refund hearings.
SCE publicly disclosed that on March 1, 2002, it obtained financing and made
payments so that it has no material undisputed obligations that are past due
or in default. These payments included a payment to the CPX; however, TEP
has not received a corresponding payment from the CPX.
There are several other outstanding legal issues, complaints and
lawsuits concerning the California energy crisis related to the FERC,
wholesale power suppliers, SCE, PG&E, the CPX and the CISO, and concerning
Enron. In August 2002, the FERC staff proposed revised calculations to
determine amounts due from the CPX and the CISO, based on concern that
natural gas prices were manipulated. If we were to apply these proposed
adjustments to amounts due to TEP, TEP could receive as little as $4 million,
plus interest, of the amounts due from the CPX and the CISO. The FERC has
not yet confirmed or rejected the calculation proposed by its staff. Under
earlier calculations proposed by the FERC staff, TEP could receive up to $11
million plus interest. A FERC administrative law judge has issued a proposed
finding under which TEP would receive approximately $8.4 million, plus
interest. This represents amounts owed to TEP, net of TEP's estimated refund
liability. The FERC is accepting additional information and is expected to
issue a ruling on the recommended order later in 2003. We cannot predict the
outcome of these issues or lawsuits. We believe, however, that TEP is
adequately reserved for its transactions with the CPX, the CISO and Enron.
TEP's Accounts Receivable from Electric Wholesale Revenues, net of
allowances, totaled $31 million at December 31, 2002 and $70 million at
December 31, 2001. These amounts are included in Accounts Receivable on the
balance sheet. Excluding the receivables from the CPX, the CISO and Enron,
as described above, substantially all of the December 31, 2002 wholesale
receivable balance has been collected as of the date of this filing.
NOTE 12.--------------------------------
INCOME TAXES
- ----------------------
Deferred tax assets (liabilities) consist of the following:
UniSource Energy TEP
------------------ -----------------
December 31, December 31,
2002 2001 2002 2001
- -----------------------------------------------------------------------------
-Millions of Dollars-
Gross Deferred Income Tax Liabilities
Electric Plant - Net $(397) $(398) $(397) $(398)
Income Taxes Recoverable Through
Future Revenues Regulatory Asset (23) (25) (23) (25)
Transition Recovery Asset (122) (131) (122) (131)
Other (26) (59) (24) (26)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax
Liability (568) (613) (566) (580)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax Assets
Capital Lease Obligations 334 346 334 346
Net Operating Loss Carryforwards 7 46 1 34
Investment Tax Credit Carryforwards 6 9 6 9
Alternative Minimum Tax 91 91 88 78
Accrued Pension Liabilities 16 14 16 14
Emission Allowance Inventory 15 15 15 15
Coal Contract Termination Fees 18 19 18 19
Springerville Coal Handling Facility 9 - 9 -
Other 69 64 44 36
- -----------------------------------------------------------------------------
Gross Deferred Income Tax Asset 565 604 531 551
Deferred Tax Assets Valuation
Allowance (16) (17) (16) (17)
- -----------------------------------------------------------------------------
Net Deferred Income Tax
Liability $ (19) $
UniSource Energy TEP
---------------- ----------------
December 31, December 31,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
Gross Deferred Income Tax Liabilities
Plant - Net $(479) $(397) $(477) $(397)
Income Taxes Recoverable Through
Future Revenues Regulatory Asset (20) (23) (20) (23)
Transition Recovery Asset (109) (122) (109) (122)
Other (30) (26) (26) (24)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax Liability (638) (568) (632) (566)
- -----------------------------------------------------------------------------
Gross Deferred Income Tax Assets
Capital Lease Obligations 337 350 337 351
Net Operating Loss Carryforwards (NOL) 30 14 21 1
Investment Tax Credit Carryforwards 9 6 8 6
Alternative Minimum Tax Credit (AMT) 83 91 80 88
Accrued Postretirement Benefits 17 16 17 16
Emission Allowance Inventory 14 15 14 15
Coal Contract Termination Fees 16 18 16 18
Springerville Coal Handling Facility 7 9 7 9
Reserve for Uncollectible Accounts 4 4 4 4
Unregulated Investment Losses 30 23 1 1
Other 25 25 23 21
- -----------------------------------------------------------------------------
Gross Deferred Income Tax Asset 572 571 528 530
Deferred Tax Assets Valuation Allowance (9) (22) - (15)
- -----------------------------------------------------------------------------
Net Deferred Income Tax Liability $ (75) $ (19) $(104) $ (51) $ (46)
=============================================================================
K-115
The net deferred income tax liability is included in the balance sheets in
the following accounts:
UniSource Energy TEP
------------------ ----------------
December 31, December 31,
2002 2001 2002 2001
- -----------------------------------------------------------------------------
-Millions of Dollars-
Deferred Income Taxes - Current
Assets $ 16 $ 11 $ 16 $ 5
Deferred Income Taxes - Noncurrent
Liabilities (35) (37) (67) (51)
- -----------------------------------------------------------------------------
Net Deferred Income Tax Liability $ (19) $ (26)
UniSource Energy TEP
---------------- ---------------
December 31, December 31,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
Deferred Income Taxes - Current
Assets $ 16 $ 16 $ 19 $ 16
Deferred Income Taxes - Noncurrent
Liabilities (91) (35) (123) (67)
- -----------------------------------------------------------------------------
Net Deferred Income Tax Liability $(75) $ (19) $(104) $ (51) $ (46)
=============================================================================
We record deferred tax liabilities for amounts that will increase income
taxes on future tax returns. We record deferred tax assets for amounts that
could be used to reduce income taxes on future tax returns. We record a Deferred
Tax Assets Valuation Allowance for the amount of Deferred Tax Assets that we may
not be able to use on future tax returns. We estimate the valuation allowance
based on our interpretation of the tax rules, prior tax audits, tax planning
strategies, scheduled reversal of deferred tax liabilities, and projected future
taxable income.
The valuation allowance of $16$9 million at December 31, 2003 and $22 million
at December 31, 2002, which reduces the Deferred Tax Asset balance, relates to
NOL and ITCInvestment Tax Credit (ITC) carryforward amounts. The decrease of $15
million reflects UniSource Energy's and TEP's expectation to be able to use a
portion of these carryforward amounts on future tax returns, primarily based on
guidance issued by the Internal Revenue Service in September 2003. In the
future if UniSource Energy and TEP determinesdetermine that it is probable that TEP shouldwill
not be able to use all or a portion of thesethe NOL and ITC carryforward amounts,
then UniSource Energy and TEP would record a valuation allowance and recognize
tax expense. Factors that could cause TEP to record a valuation allowance would
be a change in expected future taxable income or a change in tax filing status
due to the proposed acquisition. See Note 2, Proposed Acquisition of UniSource
Energy. The valuation allowance of $9 million remaining at December 31, 2003
relates to losses generated by the Millennium entities. In the future if
UniSource Energy and the Millennium entities determine that all or a portion of
the remaining amounts may be used on tax returns, then TEPUniSource Energy and the
Millennium entities would reduce the valuation allowance and recognize a tax
benefit of up to $16$9 million. FactorsThe primary factor that could cause TEPthe Millennium
entities to recognize thea tax benefit include new or additional guidance through tax regulations, tax
rulings, case law and/or the use of such benefits onwould be a change in expected future
tax returns.taxable income.
In 2002, the Deferred Tax Assets Valuation Allowance decreased $1 million
due primarily to the settlement of audits. In 2001, there was no change in the
Deferred Tax Assets Valuation Allowance.
In 2000,2003, the Deferred
Tax Assets Valuation Allowance decreaseddeferred tax liability for timing differences related to
Plant-Net increased $82 million. This increase is primarily due to the reversal
of previously recorded deferred tax assets of $44 million related to the
adoption of FAS 143 (see Note 5), and the recognition of additional deferred tax
liabilities of $8 million due primarily to the improved likelihoodelection of utilizationbonus depreciation for federal
income tax purposes and $30 million due to a change in the method of
capitalizing indirect costs for income tax items.purposes.
TEP had a net intercompany tax receivable (payable) frompayable to affiliates of $2.0 million at
December 31, 2003 and zero at December 31, 2002 and ($5.0) million at December 31, 2001.2002. These amounts are included in
TEP's intercompany accounts on its balance sheet.
In 2003, UniSource Energy recognized $0.8 million of tax and interest
expense in anticipation of settlement of state income tax audits and settlement
of a state sales tax audit. These amounts are included in current and deferred
tax expense (benefit) in the following table.
In 2002, UniSource Energy recognized a tax benefit of $1.5 million as a
result of final agreement with the IRS on audit issues and a tax benefit of $1.0
million from recognition of losses generated by the sale of a Nations Energy
foreign entity.
These amountsK-116
In 2003, the tax effect of the exercise of certain employee stock options
that are includedrecognized differently for financial reporting and tax purposes was not
recorded as a timing difference, but rather was credited to shareholder's
equity. This resulted in a $0.8 million increase to the capital of UniSource
Energy. Additionally, in 2003, UniSource Energy and TEP incurred certain legal
and advisory fees that result in no current and deferredor future tax deductions, creating
current tax expense (benefit) in the following table.with no deferred asset, otherwise known as a permanent
difference.
Income tax expense (benefit) included in the income statements consists of
the following:
UniSource Energy TEP
-------------------- --------------------
UniSource Energy TEP
------------------- -------------------
Years Ended December 31,
2003 2002 2001 2003 2002 2001 2000 2002 2001 2000
- -----------------------------------------------------------------------------
-Millions of Dollars-
Current Tax Expense
Federal $ 19 $ 24 $ 14 $ 22 $ 25 $ 16
State 7 11 4 8 11 6
- -----------------------------------------------------------------------------
Total 26 35 18 30 36 22
Deferred Tax Expense (Benefit)
Federal (1) 16 6 9 22 13
State (7) (4) (1) (3) (2) -
- -----------------------------------------------------------------------------
Total (8) 12 5 6 20 13
- -----------------------------------------------------------------------------
Reduction in Valuation
Allowance - Benefit (1) - (8) (1) - (8)
- -----------------------------------------------------------------------------
Total Federal and State Income
Tax Expense $ 17 $ 47 $ 15 $ 35 $ 56 $ 27
- -----------------------------------------------------------------------------
-Millions of Dollars-
Current Tax Expense
Federal $ 10 $ 19 $ 24 $ 13 $ 22 $ 25
State 5 7 11 7 8 11
- -----------------------------------------------------------------------------
Total 15 26 35 20 30 36
- -----------------------------------------------------------------------------
Deferred Tax Expense (Benefit)
Federal 12 (1) 16 16 9 22
State (1) (7) (4) (1) (3) (2)
- -----------------------------------------------------------------------------
Total 11 (8) 12 15 6 20
- -----------------------------------------------------------------------------
Reduction in Valuation
Allowance - Benefit (15) (1) - (15) (1) -
- -----------------------------------------------------------------------------
Total Federal and State Income
Tax Expense Before Cumulative
Effect of Accounting Change 11 17 47 20 35 56
- -----------------------------------------------------------------------------
Tax on Cumulative Effect of
Accounting Change (See Note 5) 44 - - 44 - -
- -----------------------------------------------------------------------------
Total Federal and State Income
Tax Expense Including Cumulative
Effect of Accounting Change $ 55 $ 17 $ 47 $ 64 $ 35 $ 56
=============================================================================
The differences between the income tax expense and the amount obtained by
multiplying pre-tax income by the U.S. statutory federal income tax rate of 35%
are as follows:
UniSource Energy TEP
-------------------- --------------------
Years Ended December 31,
2003 2002 2001 2003 2002 2001 2000 2002 2001 2000
- -----------------------------------------------------------------------------
-Millions of Dollars-
Federal Income Tax Expense at
Statutory Rate $ 20 $ 18 $ 38 $ 28 $ 32 $ 46
State Income Tax Expense, Net
of Federal Deduction 3 2 5 4 4 6
Depreciation Differences (Flow
Through Basis) 4 4 5 4 4 5
Federal/State Credits (2) (4) - (2) (4) -
Reduction in Valuation
Allowance - Benefit (15) (1) - (15) (1) -
Other 1 (2) (1) 1 - (1)
- -----------------------------------------------------------------------------
Total Federal and State Income
Tax Expense Before Cumulative
Effect of Accounting Change $ 11 $ 17 $ 47 $ 20 $ 32 $ 46 $ 27
State Income Tax Expense, Net
of Federal Deduction 2 5 3 4 6 4
Depreciation Differences (Flow
Through Basis) 4 5 5 4 5 5
Federal/State Credits (4) - - (4) - -
Reduction in Valuation
Allowance - Benefit (1) - (8) (1) - (8)
Foreign Operations of Millennium
Energy Businesses - (1) (3) - - -
Other (2) - (2) - (1) (1)
- -----------------------------------------------------------------------------
Total Federal and State Income
Tax Expense $ 17 $ 47 $ 15 $ 35 $ 56 $ 27
=============================================================================
The Total Federal and State Income Tax Expense in the tables above is
included on UniSource Energy and TEP's income statements.
In addition, TEP
recorded a $2.6 million income tax benefit related to its minimum pension
liability at December 31, 2002 (see Note 13). This income tax benefit is
included in UniSource Energy and TEP's other comprehensive income at December
31, 2002.K-117
At December 31, 2002,2003, UniSource Energy and TEP had, for consolidated
federal and state
income tax filing purposes:
- $21purposes, the following carryforward amounts:
UniSource Energy TEP
------------------------------ ------------------------------
Amount Expiring Amount Expiring
------------------------------ ------------------------------
-Millions of Dollars- Year -Millions of Dollars- Year
- -----------------------------------------------------------------------------
Net Operating
Losses $ 83 2006-2023 $ 59 2006-2009
Investment Tax
Credit 9 2004-2023 9 2004-2023
AMT Credit 83 - 80 -
- -----------------------------------------------------------------------------
Of the $83 million in NOL carryforward, $18 million is subject to
limitation. Due to a reorganization of certain Millennium entities in December
2002, $18 million of NOL carryforwards expiring in 2006 through 2009;
- $6 million of unused ITC expiring in 2003 through 2022;Federal and - $91 million of AMT credit which will carry forward to future years.
Due to the issuance of common stock to various creditors of TEP in 1992,
a change in TEP's ownership was deemed to have occurred for tax purposes in
December 1991. As a result, TEP's use of the NOL and ITC generated before
1992 is limited under the tax code. At December 31, 2002, pre-1992 federal
NOL and ITC carryforwards whichState net operating losses are subject to
limitation. The future utilization of these losses is dependant upon the
limitation were
approximately $21 milliongeneration of sufficient future taxable income at the separate company level.
OTHER TAXES
TEP and $4 million, respectively. We had $2 million of
ITC not subjectUES act as conduits or collection agents for excise tax (sales tax)
as well as franchise fees and regulatory assessments. They record liabilities
payable to governmental agencies when they bill their customers for these
amounts. Neither the limitation. Because ofamounts billed nor payable are reflected in the appropriate valuation
allowance amounts recorded, we do not expect these annual limitations to have
a material adverse impact on the financial statements.income
statement.
NOTE 13.17. EMPLOYEE BENEFITSBENEFIT PLANS
- -----------------------------------------------------------------
PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
TEP maintainsand UES maintain noncontributory, defined benefit pension plans for
substantially all regular employees and certain affiliate employees. Benefits
are based on years of service and the employee's average compensation. TEP makes annual contributions toand
UES fund the plans sufficient
to meetby contributing at least the minimum funding requirements set forth by the Employee Retirement
Income Security Act of 1974, plus such additional tax deductible amounts as
may be advisable.amount required under
Internal Revenue Service regulations. Additionally, TEP provideswe provide supplemental
retirement benefits to certain employees whose benefits are limited by IRS
benefit or compensation limitations.
OTHER POSTRETIREMENT BENEFIT PLANS
TEP also provides limited health care and life insurance benefits for retirees.
All regular employees may become eligible for these benefits if they reach
retirement age while working for TEP.TEP or an affiliate.
TEP amended its other postretirement benefit plan to cap Medicare
supplement payments for all current retirees under age 65 and all classified
employees retiring after December 31, 2002 and eliminate post-65 medical
benefits for all salaried employees retiring after January 1, 2002. These
amendments required TEP to recalculate benefits related to participants' past
service. TEP is amortizing the change in the benefit cost from these plan
amendments on a straight-line basis over 10 years.
UniSource Energy acquired the Arizona gas and electric system assets from
Citizens on August 11, 2003, assuming a $2 million liability for postretirement
medical benefits for current retirees and a small group of active employees. The
majority of UES employees do not currently participate in the postretirement
medical plan.
The ACC allows TEP and UES to recover postretirement costs through rates
only as benefit payments are made to or on behalf of retirees. The
postretirement benefits are currently funded entirely on a pay-as-you-go basis.
Under current accounting guidance, TEP and UES cannot record a regulatory asset
for the excess of expense calculated per Statement of Financial Accounting
Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than
Pensions, over actual benefit payments.
TEP amended its other postretirement benefit plan as of January 1, 2003,
capping its annual cost for Post-Medicare coverage for both current
classified retirees under age 65 and all classified employees retiring after
December 31, 2002. As of June 1, 2001, TEP amended this plan to eliminate
post-65 medical benefits for salaried employees retiring after January 1,
2002 and cap Medicare supplement payments for salaried retirees under age 65.
These amendments required TEP to recalculate benefits related to
participants' past service. TEP is amortizing the change in the benefit cost
from these plan amendments on a straight-line basis over 10 years.
The actuarial present values of the pension benefit obligations and other
postretirement benefit planplans were measured at December 1. The change in benefit
obligation and plan assets and reconciliation of the funded status are as
follows:
K-118
Other Postretirement
Pension Benefits Benefits
---------------- -------------------
Years Ended December 31,
2002 2001 2002 2001
- -----------------------------------------------------------------------------
-Millions of Dollars-
Change in Benefit Obligation
Benefit Obligation at
Beginning of Year $ 117 $ 102 $ 59 $ 64
Actuarial (Gain) Loss 10 9 8 1
Interest Cost 8 8 4 4
Service Cost 4 4 2 2
Benefits Paid (6) (6) (2) (2)
Plan Amendments - - (12) (10)
-----------------------------------------
Benefit Obligation at
End of Year 133 117 59 59
-----------------------------------------
Change in Plan Assets
Fair Value of Plan Assets
at Beginning of Year 120 137 - -
Actual Return on Plan Assets (14) (13) - -
Benefits Paid (6) (6) (2) (2)
Employer Contributions 6 2 2 2
-----------------------------------------
Fair Value of Plan Assets
at End of Year 106 120 - -
-----------------------------------------
Reconciliation of Funded Status
to Balance Sheet
Funded Status (Difference
between Benefit Obligation
and Fair Value of Plan Assets) (27) 3 (59) (59)
Unrecognized Net (Gain) Loss 34 (1) 32 26
Unrecognized Prior Service Cost 14 16 (12) -
-----------------------------------------
Net Amount Recognized in
the Balance Sheets $ 21 $ 18 $ (39) $ (33)
=========================================
Amounts Recognized in the
Balance Sheets Consist of:
Prepaid Pension Costs Included
in Other Assets $ 13 $ 21 $ - $ -
Accrued Benefit Liability
Included in Other Liabilities (10) (3) (39) (33)
Intangible Asset Included in
Other Assets 11 - - -
Accumulated Other Comprehensive
Income 7 - - -
-----------------------------------------
Net Amount Recognized $ 21 $ 18 $ (39) $ (33)
=========================================
Benefit Obligation and Fair Value
of Plan Assets for Plans with
Benefit Obligations in Excess of
Plan Assets:
Benefit Obligation at
End of Year $ 133 $ 61 $ 59 $ 59
Fair Value of Plan Assets at
End of Year $ 106 $ 51 $ - $ -
- -----------------------------------------------------------------------------
At December 31, 2002, the pension
Other Postretirement
Pension Benefits Benefits
------------------ -------------------
Years Ended December 31,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
Change in Benefit Obligation
Benefit Obligation at
Beginning of Year $ 133 $ 117 $ 59 $ 59
Actuarial (Gain) Loss 16 10 3 8
Interest Cost 9 8 4 4
Service Cost 5 4 2 2
Benefits Paid (5) (6) (2) (2)
Plan Amendments 4 - - (12)
Acquisition - - 2 -
- -----------------------------------------------------------------------------
Benefit Obligation at
End of Year 162 133 68 59
- -----------------------------------------------------------------------------
Change in Plan Assets
Fair Value of Plan Assets
at Beginning of Year 106 120 - -
Actual Return on Plan Assets 20 (14) - -
Benefits Paid (5) (6) (2) (2)
Employer Contributions 3 6 2 2
- -----------------------------------------------------------------------------
Fair Value of Plan Assets
at End of Year 124 106 - -
- -----------------------------------------------------------------------------
Reconciliation of Funded Status
to Balance Sheet
Funded Status (Difference
between Benefit Obligation
and Fair Value of Plan Assets) (38) (27) (68) (59)
Unrecognized Net (Gain) Loss 37 34 33 32
Unrecognized Prior Service Cost 15 14 (11) (12)
- -----------------------------------------------------------------------------
Net Amount Recognized in
the Balance Sheets $ 14 $ 21 $ (46) $ (39)
=============================================================================
Amounts Recognized in the
Balance Sheets Consist of:
Prepaid Pension Costs Included
in Other Assets $ 10 $ 13 $ - $ -
Accrued Benefit Liability
Included in Other Liabilities (9) (10) (46) (39)
Intangible Asset Included in
Other Assets 10 11 - -
Accumulated Other Comprehensive
Income 3 7 - -
- -----------------------------------------------------------------------------
Net Amount Recognized $ 14 $ 21 $ (46) $ (39)
=============================================================================
The accumulated benefit obligation exceeded the fair
value of Plan Assets for all three defined benefit pension plans
maintained by TEP.
At December 31, 2001, the benefit obligation exceeded the fair value of Plan
Assets for only two of the three plans.
TEP recorded a minimum pension liability of $6.7was $130 million on one of its
defined benefit plansand $109 million at December 31, 2002. The adjustment is reflected in
other comprehensive income2003 and other long-term liabilities, as appropriate,
and is prescribed when the accumulated benefit obligation in the plan exceeds
the fair value of the underlying pension plan assets and accrued pension
liabilities. The adjustment is primarily attributable to current stock market
conditions and a reduction in the assumed discount rate.2002, respectively.
December 31,
2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
Information for Pension Plans with an
Accumulated Benefit Obligation
in Excess of Plan Assets:
Projected Benefit Obligation
at End of Year $ 87 $ 71
Accumulated Benefit Obligation
at End of Year 70 59
Fair Value of Plan Assets
at End of Year $ 61 $ 50
- -----------------------------------------------------------------------------
K-119
The components of net periodic benefit costs are as follows:
Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
Years Ended December 31,
2002 2001 2000 2002 2001 2000
Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
Years Ended December 31,
2003 2002 2001 2003 2002 2001
- -----------------------------------------------------------------------------
-Millions of Dollars-
Components of Net Periodic Cost
Service Cost $ 5 $ 5 $ 4 $ 2 $ 2 $ 2
Interest Cost 9 8 7 4 4 4
Expected Return on Plan Assets (9) (11) (12) - - -
Prior Service Cost Amortization 2 2 2 (1) - -
Recognized Actuarial (Gain) Loss 2 - (2) 2 2 2
Amortization of Transition Asset - - - - - -
- -----------------------------------------------------------------------------
Net Periodic Benefits Cost
(Benefit) $ 9 $ 4 $ (1) $ 7 $ 8 $ 8
=============================================================================
For all pension plans, prior service costs are amortized on a straight-line
basis over the average remaining service period of employees expected to receive
benefits under the plan.
Additional Information Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
Years Ended December 31,
2003 2002 2003 2002
- -----------------------------------------------------------------------------
-Millions of Dollars-
Minimum Pension Liability Included
in Other Comprehensive Income $3 $7 N/A N/A
- -----------------------------------------------------------------------------
-Millions of Dollars-
Components of Net Periodic Cost
Service Cost $ 5 $ 4 $ 4 $ 2 $ 2 $ 1
Interest Cost 8 7 7 4 4 3
Expected Return on Plan Assets (11) (12) (11)
Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
2003 2002 2003 2002
- -----------------------------------------------------------------------------
Weighted-Average Assumptions Used
to Determine Benefit Obligations
as of December 1,
Discount Rate 6.25% 6.75% 5.50% 6.75%
Rate of Compensation Increase 4.00% 4.00% - - -
Prior Service Cost Amortization 2 2 2 - - -
Recognized Actuarial (Gain) Loss - (2) (1) 2 2 1
Amortization of Transition Asset - - - - - 1
- -----------------------------------------------------------------------------
Net Periodic Benefits Cost
(Benefit) $ 4 $ (1) $ 1 $ 8 $ 8 $ 6
=============================================================================
Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
2002 2001 2002 2001
Other Postretirement
Pension Benefits Benefits
-------------------- --------------------
2003 2002 2003 2002
- -----------------------------------------------------------------------------
Weighted-Average Assumptions Used
to Determine Net Periodic Benefit
Cost for Years Ended December 31,
Discount Rate 6.75% 7.25% 6.75% 7.25%
Rate of Compensation Increase 4.00% 4.00% - -
Expected Return on Plan Assets 8.75% 9.00% - -
- -----------------------------------------------------------------------------
Actuarial Assumptions
Net periodic benefit cost is subject to various assumptions and
determinations, such as the discount rate, the rate of December 1,
Discount Rate 6.75% 7.25% 6.75% 7.25%
Ratecompensation increase,
and the expected return on plan assets. We estimated the expected return on plan
assets based on a review of Compensation Increase 4.00% 4.00% - -
Expected Return on Plan Assets 8.75% 9.00% - -
Initial Health Care Cost Trend
Rate - - 12.00% 8.50%the plans' asset allocations and consultations with
a third-party investment consultant and the plans' actuary considering market
and economic indicators, historical market returns, correlations and volatility,
central banks' and government treasury departments' forecasts and objectives,
and recent professional or academic research. Changes that may arise over time
with regard to these assumptions and determinations will change amounts recorded
in the future as net periodic benefit cost.
K-120
December 31,
2003 2002
- -----------------------------------------------------------------------------
Assumed Health Care Cost Trend Rates
Health Care Cost Trend Rate Assumed for
Next Year 12.10% 12.00%
Ultimate Health Care Cost Trend Rate Assumed 5.00% 5.00%
Year that the Rate Reaches the Ultimate Trend Rate 2013 2011
- -----------------------------------------------------------------------------
The initial health care cost trend rate as of December 1, 2002 was
assumed to decrease gradually to 5.00% in 2011 and beyond.
Assumed health care cost trend rates have a significant effect on the
amounts reported for health care plans. A one-percentage-point change in assumed
health care cost trend rates would have the following effects on the December
31, 2003 amounts:
One-Percentage- One-Percentage-
Point Increase Point Decrease
-----------------------------------------------------------------------
-Millions of Dollars-
Effect on Total of Service and
Interest Cost Components $ 1 $ (1)
Effect on Postretirement Benefit
Obligation $ 5 $ (5)
-----------------------------------------------------------------------
Plan Assets
TEP calculates the market-related value of plan assets using the fair value
of plan assets on the measurement date. TEP's pension plan asset allocations at
December 31, 2003 and 2002, amounts:
One-Percentage- One-Percentage-
Point Increase Point Decrease
------------------------------------------------------------------------
-Millionsby asset category are as follows:
Plan Assets
December 31,
2003 2002
-------------------------------------------------------
Asset Category
Equity Securities 68.1% 59.2%
Debt Securities 18.2% 24.1%
Real Estate 13.7% 15.1%
Other - 1.6%
-------------------------------------------------------
Total 100.0% 100.0%
=======================================================
TEP's investment policy for the pension plans targets a range of Dollars-
Effectexposure
to the various asset classes surrounding the following allocations: equity
securities 65%, debt securities 23% and real estate 12%. TEP rebalances the
portfolio periodically when the portfolio allocation is not within the desired
range of exposure. The plan seeks to provide returns in excess of the portfolio
benchmark. The portfolio benchmark consists of the following indices: 55% S&P
500; 10% MSCI EAFE; 23% Lehman Aggregate; and 12% NCREIF. A third party
investment consultant track's the plan's portfolio relative to the benchmark and
provides quarterly investment reviews which consist of a performance and risk
assessment on Totalall investment managers and on the portfolio.
Certain managers within the plan use, or have authorization to use,
derivative financial instruments for risk management purposes or as a part of
Servicetheir investment strategy. Currency hedges have also been used for defensive
purposes. Leverage is used by real estate managers but is limited by investment
policy.
The UES pension plan is not yet funded but is expected to follow a similar
investment policy and Interest Cost Components $ 1 $ (1)
Effect on Postretirement Benefit
Obligation $ 5 $ (4)
------------------------------------------------------------------------target asset allocation strategy.
K-121
Contributions
TEP expects to contribute $6 million to its pension plans in 2004 and UES
expects to contribute $0.5 million.
DEFINED CONTRIBUTION PLANS
All regular employees may contribute a percentage of their pre-tax
compensation, subject to certain limitations, in TEP's voluntary,TEP and UES sponsor defined contribution savings plans that are offered to
all eligible employees. Certain affiliate employees are also eligible to
participate. The plans are qualified 401(k) plans. TEP contributes cashplans under the Internal Revenue
Code. In a defined contribution plan, the benefits a participant is to the account of eachreceive
result from regular contributions to a participant based on each participant's contributions not exceeding 4.5% of
the participant's compensation.account. Participants direct
the investment of contributions to certain funds in their account. TEP incurredMatching
contributions to participant accounts are made under these plans. Matching
contributions to these plans were approximately $3 million in expense related to these plans in each of 2003, 2002
2001 and 2000.2001.
NOTE 18. STOCK-BASED COMPENSATION PLANS
On May 20, 1994, the Shareholders approved- ----------------------------------------
We have two stock-based compensation plans, the 1994 Outside Director Stock
Option Plan (1994 Directors'(Directors' Plan) and the 1994 Omnibus Stock and Incentive Plan
(1994 Omnibus(Omnibus Plan). The 1994 Directors' Plan provided for annual awards of non-qualified
stock options and restricted shares or stock units to each eligible director.
The Omnibus Plan allowed the annualCompensation Committee, a committee of non-employee
directors, to grant the following types of 1,200 non-
qualifiedawards to each eligible employee:
stock options; stock appreciation rights; restricted stock; stock units;
performance shares; and dividend equivalents.
Under the Directors' Plan and the Omnibus Plan, we were previously
authorized to grant up to a total of 324,000 and 4.1 million shares,
respectively. The acquisition agreement discussed in Note 2 limits the amount of
capital stock that UniSource Energy can issue under its stock plans, and
requires that all of UniSource Energy's stock plans must be terminated effective
as of the closing of the acquisition.
At December 31, 2003, we had stock options, stock units, performance shares
and restricted stock grants outstanding as discussed below.
Stock Options
We granted stock options to each eligible directorkey TEP and Millennium employees and members of
the Board of Directors during 2003, 2002, and 2001. All stock options were
granted at an exercise priceprices equal to the market price of the common stock at the
grant date, beginning January
3, 1995. These optionsdate. Options vest over three years, become exercisable in one-
thirdone-third
increments on each anniversary date of the grant and expire on the tenth
anniversary. In December 1998,anniversary of the Boardgrant.
A summary of Directors approved an
increase in the annual grantstock option activity of non-qualified stock options to 2,000
beginning January 1999.
In May 2002, the Directors' Plan was amended to provide each eligible
director an annual award of non-qualifiedand Omnibus
Plan is as follows:
2003 2002 2001
- -----------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- -----------------------------------------------------------------------------
Options Outstanding,
Beginning of Year 2,576,469 $15.77 2,075,421 $15.05 1,918,264 $14.36
Granted 120,236 $17.77 590,000 $18.14 410,000 $17.96
Exercised (199,400) $13.72 (64,851) $14.42 (177,602) $14.56
Forfeited (14,625) $14.23 (24,101) $15.43 (75,241) $14.60
---------- ---------- ----------
Options Outstanding,
End of Year 2,482,680 $16.04 2,576,469 $15.77 2,075,421 $15.05
========== ========== ==========
Options Exercisable,
End of Year 1,676,803 $15.27 1,441,829 $14.47 1,081,349 $14.38
Exercise Price Range of Options Outstanding at December 31, 2003: $11.00
to $18.84
Weighted Average Remaining Contractual Life at December 31, 2003: 6.30 years
- -----------------------------------------------------------------------------
K-122
As discussed in Note 1, we apply APB 25 in accounting for our stock option
plans. We have not recognized any compensation cost for these options because
our stock options are granted with an exercise price equal to be determined asthe market value
of the first business daystock at the grant date. We have also adopted the disclosure-only
provisions of FAS 123. We present, in Note 1, the calendar year. The numbereffect on net income and
earnings per share as if the company had applied the fair value recognition
provisions of FAS 123, as required by FAS 148.
Stock options granted will be calculated by dividing $10,000 byawarded on January 1, 2002 accrue dividend equivalents that
are paid in cash on the option's Black-Scholes
value onearlier of the date of grant. Additionally, each eligible director received an
initial award in Mayexercise of the underlying option
or the date the option expires. Compensation expense is recognized as dividends
are declared. In 2003 and 2002, we recognized compensation expense of $0.3
million for a number ofdividend equivalents on stock option grants.
Restricted Stock and Stock Units
In 2003 and 2002, we granted restricted stock awards to directors totaling
5,157 shares of Common Stock
equal to $10,000 divided by theand 4,644 shares, respectively. The grant date fair market value of athe
shares was $17.44 per share of Common Stock
as of that date. Similar awards will be granted annually on the first
business day of each calendar year during the term of the plan. Each
participantin 2003 and $19.35 per share in 2002. Directors may
elect to receive stock units in lieu of restricted shares. 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 the award is
recognized over the vesting period. In MayWe recorded compensation expense of less
than $0.1 million in 2003 and 2002 516 shares or unitsrelated to these awards.
There were awarded to each of nine directors. The total
number of shares of UniSource Energy Common Stock that may be awarded under
the Directors' Plan cannot exceed 324,000 shares.
The 1994 Omnibus Plan allows the Compensation Committee, a committee of
non-employee directors, to grant the following types ofno new stock unit awards to each
eligible employee: stock options; stock appreciation rights; restricted
stock; stock units; performance units; performance shares; and dividend
equivalents. The total number of shares of UniSource Energy Common Stock
that may be awardedgranted under the Omnibus Plan cannot exceed 4.1 million. There
were no stock unit awards granted in 2003,
2002 or 2001. Stock unitWhen awards of
10,000 units wereare granted, in 2000. Compensationcompensation expense equal to the fair
market value on the date of the award is recognized over a three or four year
vesting period for all stock unit awards. During 2002, 2001 and 2000, TEPperiod. We recognized compensation expense forrelated to earlier awards of
$0.3less than $1 million in 2003, $0.5 million in 2002 and $0.9 million in
2001.each of the last three years.
Fully vested but undistributed stock unit awards of $0.5 million, $0.9
million and $0.9 million, respectively.
Stock Options
-------------
The Compensation Committee grantedaccrue dividend equivalent
stock options to key employees during
2002, 2001, and 2000. These stock options were granted at exercise prices
equal to the market price of the common stock at the grant date. These
options vest over three years, become exercisable in one-third increments on
each anniversary date of the grant and expireunits based on the tenth anniversary of the
grant.
A summary of the stock option activity of the 1994 Directors' Plan and
1994 Omnibus Plan is as follows:
2002 2001 2000
- -----------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- -----------------------------------------------------------------------------
Options Outstanding,
Beginning of Year 2,075,234 $15.05 1,918,077 $14.36 1,390,033 $14.01
Granted 590,000 $18.14 410,000 $17.96 601,000 $15.14
Exercised (64,851) $14.42 (177,602) $14.56 (7,749) $12.88
Forfeited (23,564) $15.46 (75,241) $14.60 (65,207) $14.10
---------- ---------- ----------
Options Outstanding,
End of Year 2,576,819 $15.77 2,075,234 $15.05 1,918,077 $14.36
========== ========== ==========
Options Exercisable,
End of Year 1,442,179 $14.47 1,081,162 $14.38 856,656 $14.67
Exercise Price Range of Options Outstanding at December 31, 2002: $11.00
to $18.84
Weighted Average Remaining Contractual Life at December 31, 2002: 6.94
- -----------------------------------------------------------------------------
As discussed in Note 1, we apply APB 25 in accounting for our stock
option plans. Accordingly, we have not recognized any compensation cost for
these options. We have also adopted the disclosure-only provisions of FAS
123. As required by FAS 148, the effect on net income and earnings per share
if the company had applied the fair value recognition provisions of FAS 123
to stock-based employee compensation is presented in Note 1.
The fairmarket value of each stock option grant is estimatedcommon shares on the date of
grant using the
Black-Scholes option-pricing model with the following
weighted average assumptions:
2002 2001 2000
-------------------------------
Expected life (years) 5 5 5
Interest rate 1.45% 4.70% 6.10%
Volatility 23.74% 23.93% 23.04%
Dividend yield 2.83% 2.08% 2.14%
Stock options awarded after January 1, 2002 accrue dividend equivalents
that are paid in cash on the earlier of the date of exercise of the
underlying option or the date the option expires.is paid. Compensation expense is recognized aswhen dividends are
declared. In 2002, TEP recognizedWe recorded compensation expense of $0.3$0.2 million in 2003 for dividend
equivalentsequivalent stock units.
Performance Shares
In May 2003, the Board of Directors approved a grant of performance shares
to key employees under the Omnibus Plan. The shares may be awarded at the end of
a three-year performance period based on stock option grants.goal attainment. Exceptional
performance will result in an award of 134,000 shares. The grant date fair value
was $17.84 per share. Compensation expense is recorded over the performance
period based on the anticipated number and market value of shares to be awarded.
Compensation expense of $0.7 million was recorded in 2003 for this new incentive
plan.
NOTE 14.19. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
- ---------------------------------------------------
Basic EPS is computed by dividing net income by the weighted average number
of common shares outstanding during the period. Diluted EPS assumes that
proceeds from the hypothetical exercise of stock options and other stock-
basedstock-based
awards are used to repurchase outstanding shares of stock at the average fair
market price during the reporting period. The numerator in calculating both
basic and diluted earnings per share for each period is Net Income. The
following table shows the amounts used in computing EPS and the effects of potential dilutive common stock on the
weighted average number of shares:
Years Ended December 31,
2002 2001 2000
-----------------------------------------------------------------------
-In Thousands-
Basic EPS: (except per share data)
Numerator:
Income Before Cumulative Effect of
Accounting Change $33,275 $60,875 $41,891
Cumulative Effect of Accounting Change - 470 -
-----------------------------------------------------------------------
Net Income $33,275 $61,345 $41,891K-123
Years Ended December 31,
2003 2002 2001
-----------------------------------------------------------------------
Denominator: -In Thousands-
Average Shares of Common Stock
Outstanding 33,828 33,665 33,398
Effect of Dilutive Securities:
Warrants - 81 143
Options and Stock Issuable under
Employee Benefit Plans and the
Directors' Plan 511 476 625
-----------------------------------------------------------------------
Total Shares 34,339 34,222 34,166
=======================================================================
Denominator:
Average Shares of Common Stock
Outstanding 33,665 33,399 32,445
=======================================================================
Basic EPS:
Before Cumulative Effect of Accounting
Change $0.99 $1.83 $1.29
Cumulative Effect of Accounting Change - 0.01 -
-----------------------------------------------------------------------
Net Income $0.99 $1.84 $1.29
=======================================================================
Diluted EPS:
Numerator:
Income Before Cumulative Effect of
Accounting Change $33,275 $60,875 $41,891
Cumulative Effect of Accounting
Change - 470 -
-----------------------------------------------------------------------
Net Income $33,275 $61,345 $41,891
=======================================================================
Denominator:
Average Shares of Common Stock
Outstanding 33,665 33,399 32,445
Effect of Dilutive Securities:
Warrants 81 143 -
Options and Stock Issuable under
Employee Benefit Plans 476 625 434
-----------------------------------------------------------------------
Total Shares 34,222 34,167 32,879
=======================================================================
Diluted EPS:
Before Cumulative Effect of Accounting
Change $0.97 $1.79 $1.27
Cumulative Effect of Accounting Change - 0.01 -
-----------------------------------------------------------------------
Net Income $0.97 $1.80 $1.27
=======================================================================
Options to purchase an average of 274,000 and 525,000 shares of common
stock at
$16.56 to $18.84 per share were outstanding during the yearyears 2003 and 2002, respectively, but were
not included in the computation of diluted EPS because the options' exercise
price was greater than the average market price of the common stock.
At December 31, 2002,2003, UniSource Energy had no outstanding warrants. There
were 4.6 million warrants that were exercisable into TEP common stock until
December 15, 2002, when they expired. See Note 9. The dilutive effect of these warrants was
the same as it would have been if the warrants were exercisable into UniSource
Energy Common Stock.
K-124
NOTE 15. ASSET PURCHASE AGREEMENTS
- -----------------------------------
On October 29, 2002, UniSource Energy entered into two Asset Purchase
Agreements with Citizens Communications Company (Citizens) for the purchase
by UniSource Energy of Citizens' Arizona electric utility and gas utility
businesses for a total of $230 million in cash. The purchase price of each
is subject to adjustment based on the date on which the transaction is closed
and, in each case, on the amount of certain assets and liabilities of the
purchased business at the time of closing. 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
FERC and the SEC under the Public Utility Holding Company Act of 1935, as
amended. The closing is also subject to the filing of the requisite
notification with the Federal Trade Commission and the Department of Justice
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and other
customary closing conditions.
The Asset Purchase Agreements are subject to termination if the closing
has not occurred within 15 months of the date of the Asset Purchase
Agreements (subject to extension in limited circumstances), if a governmental
authority seeks to prohibit the transactions, if required regulatory
approvals are not obtained with satisfactory terms and conditions, or if
either party is in material breach and such breach is not cured. If one
Asset Purchase Agreement is terminated, the other will also be automatically
terminated. If the Asset Purchase Agreements are terminated by Citizens due
to UniSource Energy's breach, UniSource Energy must pay to Citizens a $25
million termination fee as liquidated damages. If the Asset Purchase
Agreements are terminated by UniSource Energy due to Citizen's breach,
Citizens must pay to UniSource Energy a $10 million termination fee as
liquidated damages. The termination fees are also payable in certain other
limited circumstances.
Citizens had two cases pending before the ACC requesting rate relief for
both the Arizona electric and Arizona gas assets prior to entering into the
Asset Purchase Agreements with UniSource Energy. In December 2002, UniSource
Energy and Citizens filed a Joint Application with the ACC requesting smaller
increases in both pending cases. Under the proposal, UniSource Energy asked
that the 45% electric rate increase requested by Citizens be reduced to 22%,
and that the 29% increase in gas rates be reduced to 23%. UniSource Energy
believes that the smaller proposed rate increases are sufficient in light of
the discounted purchase price. We are currently in settlement discussions
with the ACC Staff and intervenors regarding the Joint Application. The ACC
Administrative Law Judge set a hearing date of May 1, 2003 for this matter.
We currently anticipate the ACC to review this case and issue a decision by
June 2003.
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 it may make. UniSource Energy may also consider
financing a portion of the purchase with new equity, depending on market
conditions and other considerations. UniSource Energy expects to form a new
subsidiary to hold the purchased assets. This new subsidiary will maintain a
separate rate structure from TEP. 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.
NOTE 16.20. SUPPLEMENTAL CASH FLOW INFORMATION
- --------------------------------------------
UniSource Energy and TEP define Cash and Cash Equivalents as cash
(unrestricted demand deposits) and all highly liquid investments purchased
with an original maturity of three months or less.
A reconciliation of net income to net cash flows from operating activities
follows:
UniSource Energy
----------------------------------
Years Ended December 31,
2003 2002 2001
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $112,617 $ 33,275 $ 61,345
Adjustments to Reconcile Net Income
To Net Cash Flows
Cumulative Effect of Accounting Change
- Net of Tax (67,471) - (470)
Depreciation and Amortization Expense 130,643 127,923 120,346
Depreciation Recorded to Fuel and Other
O&M Expense 6,230 5,701 6,001
Coal Contract Amendment Fee - (14,248) -
Amortization of Transition Recovery Asset 31,184 24,554 21,609
Net Unrealized Loss (Gain) on TEP Forward
Electric Sales 761 1,302 (187,721)
Net Unrealized (Gain) Loss on TEP Forward
Electric Purchases (378) (1,835) 189,036
Net Unrealized (Gain) Loss on MEG Trading
Activities (1,046) (188) 32
Amortization of Deferred Debt-Related
Costs included in Interest Expense 2,972 2,058 1,996
Provision for Bad Debts 4,820 1,688 (529)
Deferred Income Taxes 20,001 2,066 8,005
Losses from Equity Method Entities 2,984 3,560 2,516
Gain on Sale of Nations Energy's Curacao
Project - - (10,737)
Gain on Sale of Real Estate (467) - (1,572)
Other 23,083 (15,811) 1,264
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable (15,547) 40,465 (3,577)
Materials and Fuel Inventory (7,412) (2,118) (653)
Accounts Payable (7,944) (35,193) 17,626
Interest Accrued 13,151 18,542 10,191
Taxes Accrued 9,538 (9,096) (907)
Other Current Assets (7,011) (12,199) (14,094)
Other Current Liabilities 8,934 2,517 (4,328)
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $259,642 $172,963 $ 215,379
=============================================================================
K-125
UniSource Energy
----------------------------------
Years Ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 33,275 $ 61,345 $ 41,891
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 127,923 120,346 114,038
Depreciation Recorded to Fuel and Other
O&M Expense 5,701 6,001 5,307
Coal Contract Amendment Fee (14,248) - 13,231
Amortization of Transition Recovery Asset 24,554 21,609 17,008
Net Unrealized (Gain) Loss on TEP Forward
Contracts and MEG Trading Activities (721) 564 -
Amortization of Deferred Debt-Related
Costs included in Interest Expense 2,058 1,996 3,167
Provision for Bad Debts 1,688 (529) 9,607
Deferred Income Taxes 2,066 8,317 13,905
Losses from Equity Method Entities 3,560 2,516 4,206
Gain on Sale of Nations Energy's Curacao
Project - (10,737) -
Gain on Sale of Real Estate - (1,572) -
Other (11,114) (7,391) 4,878
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable 40,465 (3,577) (57,423)
Materials and Fuel Inventory (2,118) (653) (6,744)
Accounts Payable (35,193) 17,626 37,655
Interest Accrued 18,542 10,191 2,543
Taxes Accrued (9,096) (907) 4,908
Other Current Assets (12,199) (14,094) (7,647)
Other Current Liabilities 2,517 (4,328) 5,891
Other Deferred Assets (14,120) (3,486) 4,958
Other Deferred Liabilities 9,423 12,142 3,655
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $172,963 $215,379 $215,034
TEP
----------------------------------
Years Ended December 31,
2003 2002 2001
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $127,589 $ 53,737 $ 75,284
Adjustments to Reconcile Net Income
To Net Cash Flows
Cumulative Effect of Accounting Change
- Net of Tax (67,471) - (470)
Depreciation and Amortization Expense 121,037 124,054 117,063
Depreciation Recorded to Fuel and Other
O&M Expense 6,230 5,701 6,001
Coal Contract Amendment Fee - (14,248) -
Amortization of Transition Recovery Asset 31,184 24,554 21,609
Net Unrealized Loss (Gain) on Forward
Electric Sales 761 1,302 (187,721)
Net Unrealized (Gain) Loss on Forward
Electric Purchases (378) (1,835) 189,036
Amortization of Deferred Debt-Related
Costs included in Interest Expense 2,921 2,058 1,996
Provision for Bad Debts 4,460 1,688 (529)
Deferred Income Taxes 22,027 15,186 17,893
(Gains) Losses from Equity Method
Entities (142) 530 1,812
Interest Accrued on Note Receivable
from UniSource Energy (10,242) (9,329) -
Gain on Sale of Real Estate (467) - (1,572)
Other (4,587) (2,757) 6,214
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable (5,642) 35,192 (3,984)
Materials and Fuel Inventory (5,607) (1,331) 165
Accounts Payable 8,225 (35,011) 15,238
Interest Accrued 28,576 18,542 10,191
Taxes Accrued 466 (4,428) (2,470)
Other Current Assets 581 (12,771) (1,229)
Other Current Liabilities (1,733) 2,683 (3,358)
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $257,788 $203,517 $ 261,169
=============================================================================
TEP
----------------------------------
Years Ended December 31,
2002 2001 2000
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Net Income $ 53,737 $ 75,284 $ 51,169
Adjustments to Reconcile Net Income
to Net Cash Flows
Depreciation and Amortization Expense 124,054 117,063 113,507
Depreciation Recorded to Fuel and Other
O&M Expense 5,701 6,001 5,307
Coal Contract Amendment Fee (14,248) - 13,231
Amortization of Transition Recovery Asset 24,554 21,609 17,008
Net Unrealized (Gain) Loss on Forward
Electric Sales and Purchases (533) 532 -
Amortization of Deferred Debt-Related
Costs included in Interest Expense 2,058 1,996 3,167
Provision for Bad Debts 1,688 (529) 9,607
Deferred Income Taxes 15,186 18,205 27,633
Losses from Equity Method Entities 530 1,812 2,414
Interest Accrued on Note Receivable
from UniSource Energy (9,329) - -
Gain on Sale of Real Estate - (1,572) -
Other 2,830 2,437 157
Changes in Assets and Liabilities which
Provided (Used) Cash Exclusive of
Changes Shown Separately
Accounts Receivable 35,192 (3,984) (56,255)
Materials and Fuel Inventory (1,331) 165 (6,276)
Accounts Payable (35,011) 15,238 36,981
Interest Accrued 18,542 10,191 2,543
Taxes Accrued (4,428) (2,470) 7,218
Other Current Assets (12,771) (1,229) (336)
Other Current Liabilities 2,683 (3,358) 973
Other Deferred Assets (13,265) (5,194) 2,498
Other Deferred Liabilities 7,678 8,972 3,644
- -----------------------------------------------------------------------------
Net Cash Flows - Operating Activities $203,517 $261,169 234,190
=============================================================================
Non-cash investing and financing activities of UniSource Energy and TEP
that affected recognized assets and liabilities but did not result in cash
receipts or payments were as follows:
Years Ended December 31,
2002 2001 2000
Years Ended December 31,
2003 2002 2001
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Capital Lease Obligations $10,731 $11,604 $20,743
Note Receivable Received From the Sale of
Nations Energy's Curacao Project* - - 8,300
- -----------------------------------------------------------------------------
-Thousands of Dollars-
Capital Lease Obligations $11,604 $20,743 $ 1,031
Notes Receivable Received From the Sale of
Nations Energy's Curacao Project* - 8,300 -
* This item is a non-cash investing activity of Millennium, and therefore,
is not reflected on TEP's financial statements.
The non-cash change in capital lease obligations represents interest
accrued for accounting purposes in excess of interest payments in 2003, 2002,
2001,
and 2000.2001.
On August 11, 2003, UniSource Energy acquired the Arizona gas and electric
system assets from Citizens for $219223 million, comprised of the base purchase
price plus other operating capital adjustments and transaction costs. In
conjunction with the acquisition, liabilities were assumed as follows:
K-126
-Thousands of Dollars-
-----------------------------------------------------------------
Fair Value of Assets Acquired $262,044
Liabilities Assumed 38,614
-----------------------------------------------------------------
Assets/Liabilities Purchased $223,430
=================================================================
Cash Paid for Citizens Assets $218,558
Transaction Costs 4,872
-----------------------------------------------------------------
Total Purchase Price $223,430
=================================================================
NOTE 17.21. QUARTERLY FINANCIAL DATA (UNAUDITED)
- ----------------------------------------------
UniSource Energy
----------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------
-ThousandsOur quarterly financial information has not been audited but, in
management's opinion, includes all adjustments necessary for a fair
presentation. Our utility business is seasonal in nature with the peak sales
periods generally occurring during the summer months. Accordingly, comparisons
among quarters of Dollars-
(except per share data)
2002
Operating Revenues $171,195 $227,203 $258,546 $199,278
Operating Income 24,686 51,971 65,211 41,993
Net Income (Loss) (6,314) 11,888 22,819 4,882
Basic EPS (0.19) 0.35 0.68 0.14
Diluted EPS (0.19) 0.35 0.67 0.14
- -----------------------------------------------------------------------------
2001
Operating Revenues $283,665 $397,466 $420,389 $315,492
Operating Income 70,822 63,036 55,276 59,326
Income Before Cumulative Effect of
Accounting Change 18,795 13,254 15,548 13,278
Cumulative Effect of Accounting
Change - Net of Tax 470 - - -
Net Income 19,265 13,254 15,548 13,278
Basic EPS:
- ------------------------
Income Before Cumulative Effect of
Accounting Change 0.57 0.40 0.46 0.40
Cumulative Effect of Accounting
Change - Net of Tax 0.01 - - -
Net Income 0.58 0.40 0.46 0.40
Diluted EPS:
- --------------------------
Income Before Cumulative Effect of
Accounting Change 0.56 0.39 0.45 0.39
Cumulative Effect of Accounting
Change - Net of Tax 0.01 - - -
Net Income 0.57 0.39 0.45 0.39
- -----------------------------------------------------------------------------
TEP
----------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------
-Thousands of Dollars-
2002
Operating Revenues $169,577 $226,362 $257,022 $198,132
Operating Income 29,170 58,163 71,833 50,009
Interest Income - Note Receivable
from UniSource Energy 2,301 2,325 2,352 2,351
Net Income (Loss) (1,930) 17,467 26,562 11,638
- -----------------------------------------------------------------------------
2001
Operating Revenues $281,800 $394,878 $418,210 $313,781
Operating Income 74,875 66,875 60,077 63,657
Interest Income - Note Receivable
from UniSource Energy 2,300 2,327 2,351 2,352
Income Before Cumulative Effect of
Accounting Change 23,041 18,904 14,440 18,429
Cumulative Effect of Accounting
Change - Net of Tax 470 - - -
Net Income 23,511 18,904 14,440 18,429
- -----------------------------------------------------------------------------a year may not represent overall trends and changes in
operations.
UniSource Energy
----------------------------------------
First Second Third Fourth
- ---------------------------------------------------------------------------
-Thousands of Dollars-
(except per share data)
2003
Operating Revenues $173,657 $212,073 $302,935 $281,230
Operating Income 13,597 43,115 82,574 61,427
Income (Loss) Before Cumulative
Effect of Accounting Change (14,201) 4,583 26,684 28,080
Cumulative Effect of Accounting
Change - Net of Tax 67,471 - - -
Net Income 53,270 4,583 26,684 28,080
Basic EPS:
- --------------
Income (Loss) Before Cumulative
Effect of Accounting Change (0.42) 0.14 0.79 0.83
Cumulative Effect of Accounting
Change - Net of Tax 2.00 - - -
Net Income 1.58 0.14 0.79 0.83
Diluted EPS:
- --------------
Income (Loss) Before Cumulative
Effect of Accounting Change (0.42) 0.13 0.78 0.81
Cumulative Effect of Accounting
Change - Net of Tax 2.00 - - -
Net Income 1.58 0.13 0.78 0.81
- ---------------------------------------------------------------------------
2002
Operating Revenues $168,513 $227,001 $250,260 $191,130
Operating Income 25,349 52,728 65,430 42,369
Net Income (Loss) (6,314) 11,888 22,819 4,882
Basic EPS (0.19) 0.35 0.68 0.14
Diluted EPS (0.19) 0.35 0.67 0.14
- ---------------------------------------------------------------------------
TEP
--------------------------------------
First Second Third Fourth
- ---------------------------------------------------------------------------
-Thousands of Dollars-
2003
Operating Revenues $173,038 $210,688 $264,552 $200,413
Operating Income 21,170 51,956 85,870 49,710
Interest Income - Note Receivable
from UniSource Energy 2,525 2,554 2,581 2,582
Income (Loss) Before Cumulative
Effect of Accounting Change (7,176) 11,174 31,502 24,618
Cumulative Effect of Accounting
Change - Net of Tax 67,471 - - -
Net Income 60,295 11,174 31,502 24,618
- ---------------------------------------------------------------------------
K-127
2002
Operating Revenues $166,895 $226,160 $248,736 $189,984
Operating Income 29,833 58,919 72,054 50,385
Interest Income - Note Receivable
from UniSource Energy 2,301 2,325 2,352 2,351
Net Income (Loss) (1,930) 17,467 26,562 11,638
- ---------------------------------------------------------------------------
EPS is computed independently for each of the quarters presented.
Therefore, the sum of the quarterly EPS doamounts may not necessarily equal the total for the
year.
Due to seasonal fluctuations in TEP'S sales and unusual items, each
quarter's results is not indicative of annual operating results. theThe principal unusual items for TEP and UniSource Energy include:
TEP and UniSource Energy
- Third QuarterFIRST QUARTER 2003: TEP recorded an after-tax gain of $67 million for the
cumulative effect of adopting FAS 143. See Note 5.
- FOURTH QUARTER 2003: TEP recognized a $15 million tax benefit due to a
reduction in its NOL valuation allowance. See Note 16. UniSource Energy
recorded $3 million of acquisition-related fees, 80% of which were allocated to
TEP. These fees do not result in a current or future tax deduction. See Note
16.
- THIRD QUARTER 2002: TEP recorded a one-time $11.3$11 million pre-tax expense
related to the termination of the IrvingtonSundt coal contract. See Note 10.15. TEP also
recognized a $2 million tax benefit due to the resolution of various tax items.
See Note 12.16.
UniSource Energy
- First Quarter 2001: TEP recorded a $0.5FOURTH QUARTER 2003: UED recognized an $11 million unrealized gainpre-tax development
fee for closing the cumulative effects of adopting FAS 133 for its forward wholesale trading
activity.Springerville expansion project. See Note 3.
In addition14. This quarter
also includes the first full quarter of activity for UES which was established
on August 11, 2003. UES contributed Operating Revenues of $69 million, Operating
Income of $7 million and Net Income of $3 million to the unusual TEP items mentioned above, UniSource Energy
results include:fourth quarter results.
- Third QuarterTHIRD QUARTER 2002: Millennium recognized a $2.8$3 million tax benefit due to
the resolution of various tax items. See Note 12.
- Third Quarter 2001: Nations Energy recorded a pre-tax gain of $11
million from the sale of its 26% equity interest in a power project located
in Curacao, Netherland Antilles. See Note 4.16.
Reclassifications
In the third quarter of 2002, TEP began reporting purchase and sale
transactions under a Resource Management agreement with one of its
counterparties on a net basis, because TEP's purchases and sales to this
counterparty exactly offset each other and are made only for scheduling
purposes. TEP reclassified purchased powerPurchased Power related to its purchases from the
counterparty as a reduction of Electric Wholesale RevenuesRevenuesSales related to its
sales to the counterparty. This reclassification to a net presentation was based
on TEP's interpretation of EITF 99-19, "Reporting Revenue Gross as a Principal
versus Net as an Agent". In the secondfourth quarter of 2001,2003, TEP began reporting Unrealized Gain
(Loss)identified an
additional contract with a subsidiary of the same counterparty that required a
similar reclassification.
In the fourth quarter of 2003, TEP changed its income statement
presentation of unrealized gains and losses on Forward Purchases net of Unrealized Gain (Loss)derivatives. Net unrealized gains
and losses on Forward Salesforward sales contracts are now presented as a component of
Operating Revenues. In the first quarter of 2001, TEPElectric Wholesale Sales and net unrealized gains and losses on forward purchase
contracts are presented Unrealized Gain (Loss) on Forward Purchases as a component of Operating Expenses. Also,Purchased Power expense consistent
with the presentation of realized gains and losses on such contracts. Previously
the unrealized gains and losses on forward sales and purchase contracts were
combined in the fourth quarter of 2001, UniSource Energy
and TEP consolidated Income Taxes into a singleseparate line item below Income Before
Income Taxes, Extraordinary Item and Cumulative Effect of Accounting Change.
Previously, Income Taxes were included inunder Operating Expenses and Other Income
(Deductions).Revenues.
K-128
UniSource Energy
----------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------
-Thousands of Dollars-
2003
Operating Revenues - As Reported $173,166 $211,341 $302,798 $281,230
Reclassification 491 732 137 -
Operating Revenues - Restated 173,657 212,073 302,935 281,230
Operating Income - As Reported 13,133 42,212 82,574 61,427
Reclassification 464 903 - -
Operating Income - Restated 13,597 43,115 82,574 61,427
- -----------------------------------------------------------------------------
2002
Operating Revenues - As Reported $171,195 $227,203 $258,765 $199,278
Reclassification (2,682) (202) (8,505) (8,148)
Operating Revenues - Restated 168,513 227,001 250,260 191,130
Operating Income - As Reported 24,686 51,971 65,430 41,993
Reclassification 663 757 - 376
Operating Income - Restated 25,349 52,728 65,430 42,369
- -----------------------------------------------------------------------------
-Thousands of Dollars-
2002
Operating Revenues - Historical $180,267 $236,375 $258,546 $199,278
Reclassification (9,072) (9,172) - -
Operating Revenues - Restated 171,195 227,203 258,546 199,278
TEP
----------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------
-Thousands of Dollars-
2003
Operating Revenues - As Reported $172,547 $209,956 $264,415 $200,413
Reclassification 491 732 137 -
Operating Revenues - Restated 173,038 210,688 264,552 200,413
Operating Income - As Reported 20,706 51,053 85,870 49,710
Reclassification 464 903 - -
Operating Income - Restated 21,170 51,956 85,870 49,710
- -----------------------------------------------------------------------------
2002
Operating Revenues - As Reported $169,577 $226,362 $257,243 $198,132
Reclassification (2,682) (202) (8,507) (8,148)
Operating Revenues - Restated 166,895 226,160 248,736 189,984
Operating Income - As Reported 29,170 58,163 72,054 50,009
Reclassification 663 756 - 375
Operating Income - Restated 29,833 58,919 72,054 50,384
- -----------------------------------------------------------------------------
2001
Operating Revenues - Historical $241,206 $406,615 $429,662 $324,766
Reclassification 42,459 (9,149) (9,273) (9,274)
Operating Revenues - Restated 283,665 397,466 420,389 315,492
Operating Income - Historical $ 57,250 $ 52,587 $ 47,846 $ 59,326
Reclassification 13,572 10,449 7,430 -
Operating Income - Restated 70,822 63,036 55,276 59,326
K-129
Schedule II - Valuation and Qualifying Accounts
Additions-
Beginning Charged to Ending
Description Balance Income Deductions Balance
- -----------------------------------------------------------------------------
Year Ended December 31, -Millions of Dollars-
Deferred Tax Assets Valuation
Allowance(1)
2003 $ 22 $ 2 $ 15 $ 9
2002 16 7 1 22
2001 16 - - 16
Allowance for Doubtful
Accounts(2)
2003 $ 9 $ 5 $ 3 $ 11
2002 9 2 2 9
2001 10 1 2 9
- -----------------------------------------------------------------------------
(1) The deferred tax assets valuation allowance reduces the deferred tax asset
balance. It relates to NOL and ITC carryforward amounts. UniSource, TEP ----------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------
-Thousandsand
Subsidiaries charged approximately $7 million to income in 2002 relating to the
limitation on the utilization of Dollars-operating losses generated by certain
Millennium entities. UniSource, TEP and Subsidiaries reduced the deferred tax
assets valuation in 2002 Operating Revenues - Historical $178,649 $235,534 $257,022 $198,132
Reclassification (9,072) (9,172) - -
Operating Revenues - Restated 169,577 226,362 257,022 198,132
- -----------------------------------------------------------------------------
2001
Operating Revenues - Historical $239,341 $404,027 $427,483 $323,055
Reclassification 42,459 (9,149) (9,273) (9,274)
Operating Revenues - Restated 281,800 394,878 418,210 313,781
Operating Income - Historical $ 59,680 $ 54,889 $ 50,721 $ 63,657
Reclassification 15,195 11,986 9,356 -
Operating Income - Restated 74,875 66,875 60,077 63,657
- -----------------------------------------------------------------------------
Schedule II - Valuationdue to the settlement of Internal Revenue Service
audits. UniSource, TEP and Qualifying Accounts
Additions-
Beginning ChargedSubsidiaries charged $2 million to Ending
Description Balance Income(1) Deductions(2) Balance
- -------------------------------------------------------------------------------
Year Ended December 31, -Millionsincome in 2003
relating to the limitation on the utilization of Dollars-
Allowance for Doubtful Accounts
2002 $ 9.2 $ 1.7 $ 1.9 $ 9.0
2001 9.7 1.3 1.8 9.2
2000 6.9 10.2 7.4 9.7
- -------------------------------------------------------------------------------
(1)operating losses generated by
certain Millennium entities. UniSource, TEP and Subsidiaries reduced the
deferred tax assets valuation in 2003 primarily based on guidance issued by the
Internal Revenue Service in September, 2003 (see Note 16 of Notes to
Consolidated Financial Statements).
(2) TEP recorded $7 million of expense in the first quarter of 2001 and $9
million in the fourth quarter of 2000 to reserve for uncollectible amounts
related to sales to the state of California in 2000 and the first quarter of
2001. TEP reversed $8 million of the $16 million reserve in the fourth quarter
of 2001 (see Note 112001. In the first quarter of Notes2003, TEP increased its reserve for sales to
Consolidated Financial
Statements).
(2)the CPX and the CISO by $2 million by recording a reduction of wholesale
revenues. Deductions principally reflect amounts charged off as uncollectible,
less amounts recovered.recovered (see Note 13 of Notes to Consolidated Financial
Statements).
K-130
ITEM 9. --- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
None.
ITEM 9A. -- CONTROLS AND PROCEDURES
- --------------------------------------------------------------------------------
UniSource Energy and TEP have disclosure controls and procedures to
ensure that material information recorded, processed, summarized and reported in
their filings with the SEC is on an accurate and timely basis. Management of
UniSource Energy and TEP, with the participation of the principal executive
officer and principal financial officer of UniSource Energy and TEP have
evaluated these disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)
as of December 31, 2003. Based on such evaluation, the principal executive
officer and principal financial officer of UniSource Energy and TEP have
concluded that such disclosure controls and procedures were, as of such date,
effective at ensuring that material information is recorded, processed,
summarized and reported accurately and within the time periods specified by the
SEC's rules and forms. Since such evaluation there have not been any significant
changes in UniSource Energy and TEP's internal controls, over financial
reporting that has, or is reasonably likely to, materially affect these
controls.
PART III
ITEM 10. --- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS
- --------------------------------------------------------------------------------
DIRECTORS
---------
Certain of the individuals serving as Directors of UniSource Energy
also serve as the Directors of TEP. Information concerning Directors will be
contained under Election of Directors in UniSource Energy's Proxy Statement
relating to the 20032004 Annual Meeting of Shareholders, which will be filed with
the SEC not later than 120 days after December 31, 2002,2003, which information is
incorporated herein by reference.
EXECUTIVE OFFICERS - UNISOURCE ENERGY
-------------------------------------
Executive Officers of UniSource Energy, who are elected annually by
UniSource Energy's Board of Directors, are as follows:
Executive
Officer
Name Age Position(s) Held Since
--------------------------------------------------------------------------------------------------------------------------- -------- ----------------------------------------------------------------- -------------
James S. Pignatelli 5960 Chairman, President and Chief Executive Officer 1998
Michael J. DeConcini 3839 Senior Vice President, Investments and Planning 1999
Dennis R. Nelson 5253 Senior Vice President, Utility Services 1998
Karen G. Kissinger 4849 Vice President, Controller and Chief Compliance Officer 1998
Kevin P. Larson 4647 Vice President, Chief Financial Officer and Treasurer 2000
Steven W. Lynn 5657 Vice President, Communications and Government Relations 2003
Vincent Nitido, Jr. 4748 Vice President, General Counsel and Chief Administrative Officer 2000
Catherine A. Nichols 4445 Corporate Secretary 2003
--------------------------- -------- ----------------------------------------------------------------- -------------
James S. Pignatelli Mr. Pignatelli joined TEP as Senior Vice President in
Pignatelli
August 1994 and was elected Senior Vice President and
Chief Operating Officer in 1996. He was named Senior
Vice President and Chief Operating Officer of
UniSource Energy in January 1998, and Executive Vice
President and Chief Operating Officer of TEP in March
1998. On June 23, 1998, Mr. Pignatelli was named
Chairman, President and CEO of UniSource Energy and
TEP. Prior to joining TEP, he was President and Chief
Executive Officer from 1988 to 1993 of Mission Energy
Company, a subsidiary of SCE Corp.
K-131
Michael J. DeConcini Mr. DeConcini joined TEP in 1988 and served in
various
DeConcini positions in finance, strategic planning and
wholesale marketing. He was Manager of TEP's
Wholesale Marketing Department in 1994, adding
Product Development and Business Development in 1997.
In November 1998, he was elected Vice President of
MEH, and elected Vice President, Strategic Planning
of UniSource Energy in February 1999. He was named
Senior Vice President, Investments and Planning of
UniSource Energy in October 2000. Mr. DeConcini was
elected Senior Vice President and Chief Operating
Officer of the Energy Resources business unit of TEP,
effective January 1, 2003.
Dennis R. Nelson Mr. Nelson joined TEP as a staff attorney in 1976.
He was
Nelson manager of the Legal Department from 1985 to
1990. He was elected Vice President, General Counsel
and Corporate Secretary in January 1991. He was
named Vice President, General Counsel and Corporate
Secretary of UniSource Energy in January 1998. Mr.
Nelson was named Senior Vice President and General
Counsel of TEP in November 1998. In December 1998 he
was named Chief Operating Officer, Corporate Services
of TEP. In October 2000, he was named Senior Vice
President, Governmental Affairs of UniSource Energy
and Senior Vice President and Chief Operating Officer
of the Energy Resources business unit of TEP. Mr.
Nelson was elected Senior Vice President of Utility
Services, effective January 1, 2003 and named Chief
Operating Officer of UES on August 11, 2003.
Karen G. Kissinger Ms. Kissinger joined TEP as Vice President and
Controller
Kissinger in January 1991. She was named Vice
President, Controller and Principal Accounting
Officer of UniSource Energy in January 1998. In
November 1998, Ms. Kissinger was also named Chief
Information Officer of TEP. She was named Chief
Compliance Officer of UniSource Energy and TEP,
effective January 1, 2003.
Kevin P. Larson Mr. Larson joined TEP in 1985 and thereafter held
various
Larson positions in its finance department and at
TEP's investment subsidiaries. In January 1991, he
was elected Assistant Treasurer of TEP and named
Manager of Financial Programs. He was elected
Treasurer of TEP in August 1994 and Vice President in
March 1997. In October 2000, he was elected Vice
President and Chief Financial Officer of both
UniSource Energy and TEP and remains Treasurer of
both organizations.
Steven W. Lynn Mr. Lynn joined TEP in 2000 as Manager of Corporate
Relations
Lynn for UniSource Energy and was named Manager
of Corporate Relations of both TEP and UniSource
Energy during 2000. In January 2003, he was elected
Vice President of Communications and Government
Relations at UniSource Energy and TEP. Prior to
joining TEP, Mr. Lynn was an owner-partner from 1984
- 2000 of Nordensson Lynn & Associates, Inc., a
Tucson-based advertising, marketing and public
relations firm.
Vincent Nitido, Jr. Mr. Nitido joined TEP as a staff attorney
in 1991. He
Nitido, Jr. was promoted to Manager of the Legal
Department in 1994, and elected Vice President and
Assistant General Counsel in 1998. In October 2000,
he was elected Vice President, General Counsel of
both UniSource Energy and TEP and Corporate Secretary
of UniSource Energy. Mr. Nitido was also named Chief
Administrative Officer of UniSource Energy and TEP,
effective January 1, 2003.
Catherine A. Nichols Ms. Nichols joined TEP as a staff attorney
in 1989.
Nichols She was promoted to Manager of the Legal
Department and elected Corporate Secretary of TEP in
1998. She assumed the additional role of Manager of
the Human Resources Department in 1999. Ms. Nichols
was elected Corporate Secretary of UniSource Energy,
effective January 1, 2003, and remains Corporate
Secretary of TEP.
EXECUTIVE OFFICERS - TUCSON ELECTRIC POWER COMPANY
--------------------------------------------------
Executive Officers of TEP, who are elected annually by TEP's Board of
Directors, are:
K-132
Executive
Officer
Name Age Position(s) Held Since
--------------------------------------------------------------------------------------------------------------------------- -------- ----------------------------------------------------------------- -------------
James S. Pignatelli 5960 Chairman, President and Chief Executive Officer 1994
Michael J. DeConcini 3839 Senior Vice President, Energy Resources Business Unit 2003
Steven J. Glaser 4546 Senior Vice President and Chief Operating Officer, Transmission 1994
and Distribution Business Unit
1994
Thomas A. Delawder 5657 Vice President, Energy Resources Business Unit 1985
Thomas N. Hansen 5253 Vice President / Technical Advisor 1992
Karen G. Kissinger 4849 Vice President, Controller and Chief Compliance Officer 1991
Kevin P. Larson 4647 Vice President, Chief Financial Officer and Treasurer 1994
Steven W. Lynn W. 5657 Vice President, Communications and Government Relations 2003
Vincent Nitido, Jr. 4748 Vice President, General Counsel and Chief Administrative Officer 1998
James Pyers 6162 Vice President, Utility Distribution Business Unit, Operations 1998
Catherine A. Nichols 4445 Corporate Secretary 1998
--------------------------- -------- ----------------------------------------------------------------- -------------
James S. Pignatelli See description shown under UniSource Energy
Corporation above.
Michael J. DeConcini See description shown under UniSource Energy
Corporation above.
Steven J. Glaser Mr. Glaser joined TEP in 1990 as a Senior Attorney in
Glaser
charge of Regulatory Affairs. He was Manager of
TEP's Legal Department from 1992 to 1994, and Manager
of Contracts and Wholesale Marketing from 1994 until
elected Vice President, Business Development. In
1995, he was named Vice President, Wholesale/Retail
Pricing and System Planning. He was named Vice
President, Energy Services in 1996 and Vice
President, Rates and Regulatory Support and
Utility Distribution Company Energy Services in
November 1998. In October 2000, he was named Senior
Vice President and Chief Operating Officer of the
Transmission and Distribution business unit.
Thomas A. Delawder Mr. Delawder joined TEP in 1974 and thereafter
served in
Delawder various engineering and operations
positions. In April 1985 he was named Manager,
Systems Operations and was elected Vice President,
Power Supply and System Control in November 1985.
In February 1991, he became Vice President,
Engineering and Power Supply and in January 1992
he became Vice President, System Operations. In 1994,
he became Vice President of the Energy Resources
business unit.
Thomas N. Hansen Mr. Hansen joined TEP in December 1992 as Vice
President,
Hansen Power Production. Prior to joining TEP,
Mr. Hansen was Century Power Corporation's Vice
President, Operations from 1989 and Plant Manager at
Springerville from 1987 through 1988. In 1994, he
was named Vice President / Technical Advisor.
Karen G. Kissinger See description shown under UniSource Energy
Corporation above.
Kevin P. Larson See description shown under UniSource Energy
Corporation above.
Steven W. Lynn See description shown under UniSource Energy
Corporation above.
Vincent Nitido, Jr. See description shown under UniSource Energy
Corporation above.
James Pyers Mr. Pyers joined TEP in 1974 as a Supervisor.
Thereafter, he
Pyers held various supervisory positions and
was promoted to Manager of Customer Service
Operations in February 1998. Mr. Pyers was elected
Vice President, Utility Distribution business unit,
Operations in November 1998.
Catherine A. Nichols See description shown under UniSource Energy
Corporation above.
K-133
ITEM 11. --- EXECUTIVE COMPENSATION
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
Information concerning Executive Compensation will be contained under
Executive Compensation and Other Information in UniSource Energy's Proxy
Statement relating to the 20032004 Annual Meeting of Shareholders, which will be
filed with the SEC not later than 120 days after December 31, 2002,2003, which
information is incorporated herein by reference.
ITEM 12. --- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
GENERAL
At March 4, 2003,10, 2004, UniSource Energy had outstanding 33,583,18234,029,653 shares
of Common Stock. As of March 4, 2003,10, 2004, the number of shares of Common Stock
beneficially owned by all directors and officers of UniSource Energy as a group
amounted to approximately 3%4.5% of the outstanding Common Stock.
At March 4, 2003,10, 2004, UniSource Energy owned greater than 99.9% of the
outstanding shares of common stock of TEP.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Information concerning the security ownership of certain beneficial
owners of UniSource Energy will be contained under Security Ownership of Certain
Beneficial Owners in UniSource Energy's Proxy Statement relating to the 20032004
Annual Meeting of Shareholders, which will be filed with the SEC not later than
120 days after December 31, 2002,2003, which information is incorporated herein by
reference.
SECURITY OWNERSHIP OF MANAGEMENT
Information concerning the security ownership of the Directors and
Executive Officers of UniSource Energy and TEP will be contained under Security
Ownership of Management in UniSource Energy's Proxy Statement relating to the
20032004 Annual Meeting of Shareholders, which will be filed with the SEC not later
than 120 days after December 31, 2002,2003, which information is incorporated herein
by reference.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Information concerning securities authorized for issuance under equity
compensation plans will be contained under Securities Authorized for Issuance
under Equity Compensation Plans in UniSource Energy's Proxy Statement relating
to the 20032004 Annual Meeting of Shareholders, which will be filed with the SEC not
later than 120 days after December 31, 2002,2003, which information is incorporated
herein by reference.
ITEM 13. --- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
Information concerning certain relationships and related transactions
of UniSource Energy and TEP will be contained under Transactions with Management
and Others and Compensation Committee Interlocks and Insider Participation in
UniSource Energy's Proxy Statement relating to the 20032004 Annual Meeting of
Shareholders, which will be filed with the SEC not later than 120 days after
December 31, 2002,2003, which information is incorporated herein by reference.
ITEM 14. - PRINCIPAL ACCOUNTANT FEES AND SERVICES
- -------------------------------------------------------------------------------
Information concerning principal accountant fees and services will be
contained in UniSource Energy's Proxy Statement relating to the 2004 Annual
Meeting of Shareholders, which will be filed with the SEC not later than 120
days after December 31, 2003, which information is incorporated herein by
reference.
K-134
PART IV
ITEM 14. - CONTROLS AND PROCEDURES
- --------------------------------------------------------------------------------
UniSource Energy and TEP have disclosure controls and procedures to
ensure that material information contained in their filings with the SEC is
recorded, processed, summarized and reported on an accurate and timely basis.
The principal executive officer and principal financial officer of UniSource
Energy and TEP have evaluated these disclosure controls and procedures as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended, within 90 days prior to the filing of this report. Based
on such evaluation, the principal executive officer and principal financial
officer of UniSource Energy and TEP have concluded that such disclosure
controls and procedures are effective at ensuring that material information
is recorded, processed, summarized and reported accurately and within the
time periods specified by the SEC's rules and forms. Since such evaluation
there have not been any significant changes in UniSource Energy and TEP's
internal controls, or in other factors that could significantly affect these
controls.
ITEM 15. --- EXHIBITS, FINANCIAL STATEMENT SCHEDULES,SCHEDULE, AND REPORTS ON FORM 8-K
- ---------------------------------------------------------------------------------------------------------------------------------------------------------------
Page
----
(a) 1. Consolidated Financial Statements as of December 31, 20022003
and 20012002 and for Each of the Three Years in the Period Ended
December 31, 2002.2003
UniSource Energy Corporation
----------------------------
Report of Independent Accountants 55Auditors 69
Consolidated Statements of Income 5670
Consolidated Statements of Cash Flows 5771
Consolidated Balance Sheets 5872
Consolidated Statements of Capitalization 5973
Consolidated Statements of Changes in Stockholders' Equity 6074
Notes to Consolidated Financial Statements 6680
Tucson Electric Power Company
-----------------------------
Report of Independent Accountants 55Auditors 69
Consolidated Statements of Income 6175
Consolidated Statements of Cash Flows 6276
Consolidated Balance Sheets 6377
Consolidated Statements of Capitalization 6478
Consolidated Statements of Changes in Stockholders' Equity 6579
Notes to Consolidated Financial Statements 6680
2. Financial Statement SchedulesSchedule
Schedule II
Valuation and Qualifying Accounts 106130
3. Exhibits.
Reference is made to the Exhibit Index commencing on page 121.141.
K-135
(b) Reports on Form 8-K.8-K
o UniSource Energy Corporation and Tucson Electric Power Company
--------------------------------------------------------------
-TEP Form 8-K, dated August 9, 2002 (filed20, 2003 regarding the
acquisition by UniSource Energy of the Citizens Arizona gas and
electric assets.
o UniSource Energy Form 8-K dated August 9, 2002)26, 2003 regarding Officer Sworn Statementsthe
acquisition by UniSource Energy of the Citizens Arizona gas and
electric assets.
o UniSource Energy Form 8-K dated October 2, 2003 regarding the
acquisition by UniSource Energy of the Citizens Arizona gas and
electric assets.
o UniSource Energy and TEP Form 8-K, dated October 23, 2003 furnished
pursuant to Order 4-460Item 12 "Disclosure of Results of Operations and Section 21
(a)(1) of the Securities Exchange Act of 1934.
-Financial
Condition", announcing third quarter 2003 earnings for UniSource Energy
and TEP.
o UniSource Energy and TEP Form 8-K, dated November 25, 2002 (filed November 27, 2002)21, 2003, regarding
the new TEP bank credit agreement.proposed acquisition of UniSource Energy Corporation
----------------------------
-by Saguaro Acquisition
Corp.
o UniSource Energy and TEP Form 8-K, dated October 31, 2002 (filed October 31, 2002) regardingJanuary 28, 2004, furnished
pursuant to Item 9 "Regulation FD Disclosure," providing
reconciliations of non-GAAP financial measures in connection with a
proposed refinancing of TEP's credit facilities.
o UniSource Energy Purchaseand TEP Form 8-K, dated February 17, 2004, furnished
pursuant to Item 12 "Disclosure of Citizens Communications Company
Electric Utility BusinessResults of Operations and Gas Utility Business in Arizona.Financial
Condition," announcing fourth quarter and year-end 2003 earnings for
UniSource Energy and TEP.
K-136
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
UNISOURCE ENERGY CORPORATION
Date: March 10, 200315, 2004 By: /s//s/ Kevin P. Larson
--------------------------------------------------------------------------
Kevin P. Larson
Vice President and Principal
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 10, 200315, 2004 /s/ James S. Pignatelli*
---------------------------------------------------------------------------
James S. Pignatelli
Chairman of the Board, President and
Principal Executive Officer
Date: March 10, 200315, 2004 /s/ Kevin P. Larson
---------------------------------------------------------------------------
Kevin P. Larson
Principal Financial Officer
Date: March 10, 200315, 2004 /s/ Karen G. Kissinger*
---------------------------------------------------------------------------
Karen G. Kissinger
Principal Accounting Officer
Date: March 10, 200315, 2004 /s/ Lawrence J. Aldrich*
---------------------------------------------------------------------------
Lawrence J. Aldrich
Director
Date: March 10, 200315, 2004 /s/ Larry W. Bickle*
---------------------------------------------------------------------------
Larry W. Bickle
Director
Date: March 10, 200315, 2004 /s/ Elizabeth T. Bilby*
---------------------------------------------------------------------------
Elizabeth T. Bilby
Director
K-137
Date: March 10, 200315, 2004 /s/ Harold W. Burlingame*
---------------------------------------------------------------------------
Harold W. Burlingame
Director
Date: March 10, 200315, 2004 /s/ John L. Carter*
---------------------------------------------------------------------------
John L. Carter
Director
Date: March 10, 200315, 2004 /s/ Daniel W. L. Fessler*
-----------------------------------------
Daniel W. L. FesslerRobert A. Elliott*
----------------------------------
Robert A. Elliott
Director
Date: March 10, 200315, 2004 /s/ Kenneth Handy*
---------------------------------------------------------------------------
Kenneth Handy
Director
Date: March 10, 200315, 2004 /s/ Warren Y. Jobe*
---------------------------------------------------------------------------
Warren Y. Jobe
Director
Date: March 10, 2003 /s/ H. Wilson Sundt*
-----------------------------------------
H. Wilson Sundt
Director
Date: March 10, 200315, 2004 By: /s/ /s/Kevin P. Larson
---------------------------------------------------------------------------
Kevin P. Larson
as attorney-in-fact for each
of the persons indicated
K-138
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TUCSON ELECTRIC POWER COMPANY
Date: March 10, 200315, 2004 By: /s/ /s/Kevin P. Larson
---------------------------------------------------------------------------
Kevin P. Larson
Vice President and Principal
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 10, 200315, 2004 /s/ James S. Pignatelli*
---------------------------------------------------------------------------
James S. Pignatelli
Chairman of the Board, President and
Principal Executive Officer
Date: March 10, 200315, 2004 /s/ Kevin P. Larson
---------------------------------------------------------------------------
Kevin P. Larson
Principal Financial Officer
Date: March 10, 200315, 2004 /s/ Karen G. Kissinger*
---------------------------------------------------------------------------
Karen G. Kissinger
Principal Accounting Officer
Date: March 10, 200315, 2004 /s/ Lawrence J. Aldrich*
---------------------------------------------------------------------------
Lawrence J. Aldrich
Director
Date: March 10, 200315, 2004 /s/ Elizabeth T. Bilby*
---------------------------------------------------------------------------
Elizabeth T. Bilby
Director
Date: March 10, 200315, 2004 /s/ Harold W. Burlingame*
---------------------------------------------------------------------------
Harold W. Burlingame
Director
K-139
Date: March 10, 200315, 2004 /s/ John L. Carter*
---------------------------------------------------------------------------
John L. Carter
Director
Date: March 10, 200315, 2004 /s/ Daniel W. L. Fessler*
-----------------------------------------
Daniel W. L. FesslerRobert A. Elliott*
----------------------------------
Robert A. Elliott
Director
Date: March 10, 200315, 2004 /s/ Kenneth Handy*
---------------------------------------------------------------------------
Kenneth Handy
Director
Date: March 10, 200315, 2004 /s/ Warren Y. Jobe*
---------------------------------------------------------------------------
Warren Y. Jobe
Director
Date: March 10, 200315, 2004 By: /s/ /s/Kevin P. Larson
---------------------------------------------------------------------------
Kevin P. Larson
as attorney-in-fact for each
of the persons indicated
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, James S. Pignatelli, certify that:
1. I have reviewed this annual report on Form 10-K of UniSource Energy
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 10, 2003 /s/ James S. Pignatelli
-------------- ----------------------------------------------
James S. Pignatelli
Chairman, President, and
Chief Executive Officer
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, Kevin P. Larson, certify that:
1. I have reviewed this annual report on Form 10-K of UniSource Energy
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 10, 2003 /s/ Kevin P. Larson
-------------- ----------------------------------------------
Kevin P. Larson
Vice President, Chief Financial Officer
and Treasurer
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, James S. Pignatelli, certify that:
1. I have reviewed this annual report on Form 10-K of Tucson Electric
Power Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 10, 2003 /s/ James S. Pignatelli
-------------- ----------------------------------------------
James S. Pignatelli
Chairman, President, and
Chief Executive Officer
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act
I, Kevin P. Larson, certify that:
1. I have reviewed this annual report on Form 10-K of Tucson Electric
Power Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 10, 2003 /s/ Kevin P. Larson
-------------- ----------------------------------------------
Kevin P. Larson
Vice President, Chief Financial Officer
and TreasurerK-140
EXHIBIT INDEX
*2(a) -- Agreement and Plan of Exchange, dated as of March 20, 1995,
between TEP, UniSource Energy and NCR
Holding, Inc.
*2(b) -- Agreement and Plan of Merger between UniSource Energy
Corporation and Saguaro Acquisition Corp., dated as of November
21, 2003. (Form 8-K dated November 21, 2003, File No. 1-13739 -
Exhibit 10.)
*3(a) -- Restated Articles of Incorporation of TEP, filed with the
ACC on August 11, 1994, as amended by Amendment to Article
Fourth of the Company's Restated Articles of Incorporation,
filed with the ACC on May 17, 1996. (Form 10-K for year ended
December 31, 1996, File No. 1-5924 -- Exhibit 3(a).)
*3(b) -- Bylaws of TEP, as amended May 20, 1994. (Form 10-Q for the
quarter ended June 30, 1994, File No. 1-5924No.1-5924 -- Exhibit 3.)
*3(c) -- Amended and Restated Articles of Incorporation of UniSource
Energy. (Form 8-A/A, dated January 30, 1998, File No. 1-13739
-- Exhibit 2(a).)
*3(d) -- Bylaws of UniSource Energy, as amended December 11, 1997.
(Form 8-A, dated December 23, 1997, File No. 1-13739 -- Exhibit
2(b).)
*4(a)(1) -- Indenture dated as of April 1, 1941, to The Chase National Bank
of the City of New York, as Trustee. (Form(Form S-7, File No. 2-59906
-- Exhibit 2(b)(1).)
*4(a)(2) -- First Supplemental Indenture, dated as of October 1, 1946.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(2).)
*4(a)(3) -- Second Supplemental Indenture dated as of October 1, 1947.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(3).)
*4(a)(4) -- Third Supplemental Indenture, dated as of April 1, 1949.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(4).)
*4(a)(5) -- Fourth Supplemental Indenture, dated as of December 1, 1952.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(5).)
*4(a)(6) -- Fifth Supplemental Indenture, dated as of January 1, 1955.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(6).)
*4(a)(7) -- Sixth Supplemental Indenture, dated as of January 1, 1958.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(7).)
*4(a)(8) -- Seventh Supplemental Indenture, dated as of November 1, 1959.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(8).)
*4(a)(9) -- Eighth Supplemental Indenture, dated as of November 1, 1961.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(9).)
*4(a)(10) -- Ninth Supplemental Indenture, dated as of February 20, 1964.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(10).)
*4(a)(11) -- Tenth Supplemental Indenture, dated as of February 1, 1965.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(11).)
*4(a)(12) -- Eleventh Supplemental Indenture, dated as of February 1, 1966.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(12).)
K-141
*4(a)(13) -- Twelfth Supplemental Indenture, dated as of November 1, 1969.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(13).)
*4(a)(14) -- Thirteenth Supplemental Indenture, dated as of January 20,
1970. (Form S-7, File No. 2-59906 -- Exhibit 2(b)(14).)
*4(a)(15) -- Fourteenth Supplemental Indenture, dated as of September 1,
1971. (Form S-7, File No. 2-59906 -- Exhibit 2(b)(15).)
*4(a)(16) -- Fifteenth Supplemental Indenture, dated as of March 1, 1972.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(16).)
*4(a)(17) -- Sixteenth Supplemental Indenture, dated as of May 1, 1973.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(17).)
*4(a)(18) -- Seventeenth Supplemental Indenture, dated as of November 1,
1975. (Form S-7, File No. 2-59906 -- Exhibit 2(b)(18).)
*4(a)(19) -- Eighteenth Supplemental Indenture, dated as of November 1,
1975. (Form S-7, File No. 2-59906 -- Exhibit 2(b)(19).)
*4(a)(20) -- Nineteenth Supplemental Indenture, dated as of July 1, 1976.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(20).)
*4(a)(21) -- Twentieth Supplemental Indenture, dated as of October 1, 1977.
(Form S-7, File No. 2-59906 -- Exhibit 2(b)(21).)
*4(a)(22) -- Twenty-first Supplemental Indenture, dated as of November 1,
1977. (Form 10-K for year ended December 31, 1980, File No.
1-5924 -- Exhibit 4(v).)
*4(a)(23) -- Twenty-second Supplemental Indenture, dated as of January 1,
1978. (Form 10-K for year ended December 31, 1980, File No.
1-5924 -- Exhibit 4(w).)
*4(a)(24) -- Twenty-third Supplemental Indenture, dated as of July 1,
1980. (Form 10-K for year ended December 31, 1980, File No.
1-5924 -- Exhibit 4(x).)
*4(a)(25) -- Twenty-fourth Supplemental Indenture, dated as of October 1,
1980. (Form 10-K for year ended December 31, 1980, File No.
1-5924 -- Exhibit 4(y).)
*4(a)(26) -- Twenty-fifth Supplemental Indenture, dated as of April 1,
1981. (Form 10-Q for quarter ended March 31, 1981, File No.
1-5924 -- Exhibit 4(a).)
*4(a)(27) -- Twenty-sixth Supplemental Indenture, dated as of April 1,
1981. (Form 10-Q for quarter ended March 31, 1981, File No.
1-5924 -- Exhibit 4(b).)
*4(a)(28) -- Twenty-seventh Supplemental Indenture, dated as of October
1, 1981. (Form 10-Q for quarter ended September 30, 1982, File
No. 1-5924 -- Exhibit 4(c).)
*4(a)(29) -- Twenty-eighth Supplemental Indenture, dated as of June 1,
1990. (Form 10-Q for quarter ended June 30, 1990, File No.
1-5924 -- Exhibit 4(a)(1).)
*4(a)(30) -- Twenty-ninth Supplemental Indenture, dated as of December 1,
1992. (Form S-1, Registration No. 33-55732 -- Exhibit
4(a)(30).)
*4(a)(31) -- Thirtieth Supplemental Indenture, dated as of December 1,
1992. (Form S-1, Registration No. 33-55732 -- Exhibit
4(a)(31).)
*4(a)(32) -- Thirty-first Supplemental Indenture, dated as of May 1,
1996. (Form 10-K for the year ended December 31, 1996, File No.
1-5924 -- Exhibit 4(a)(32).)
K-142
*4(a)(33) -- Thirty-second Supplemental Indenture, dated as of May 1,
1996. (Form 10-K for the year ended December 31, 1996, File No.
1-5924 -- Exhibit 4(a)(33).)
*4(a)(34) -- Thirty-third Supplemental Indenture, dated as of May 1, 1998.
(Form 10-Q for the quarter ended June 30, 1998, File No. 1-5924
-- Exhibit 4(a).)
*4(a)(35) -- Thirty-fourth Supplemental Indenture dated as of August 1,
1998. (Form 10-Q for the quarter ended June 30, 1998, File No.
1-5924 -- Exhibit 4(b).)
*4(b)(1) -- Installment Sale Agreement, dated as of December 1, 1973,
among the City of Farmington, New Mexico, Public Service
Company of New Mexico and TEP. (Form 8-K for the month of
January 1974, File No. 0-269
-- Exhibit 3.)
*4(b)(2) -- Ordinance No. 486, adopted December 17, 1973, of the City of
Farmington, New Mexico. (Form 8-K for the month of January
1974, File No. 0-269 -- Exhibit 4.)
*4(b)(3) -- Amended and Restated Installment Sale Agreement dated as of
April 1, 1997, between the City of Farmington, New Mexico and
TEP relating to Pollution Control Revenue Bonds, 1997 Series A
(Tucson Electric Power Company San Juan Project). (Form 10-Q
for the quarter ended March 31, 1997, File No.
1-5924 -- Exhibit 4(a).)
*4(b)(4) -- City of Farmington, New Mexico Ordinance No. 97-1055,
adopted April 17, 1997, authorizing Pollution Control Revenue
Bonds, 1997 Series A (Tucson Electric Power Company San Juan
Project). (Form 10-Q for the quarter ended March 31, 1997, File
No. 1-5924 -- Exhibit 4(b).)
*4(c)(1) -- Loan Agreement, dated as of October 1, 1982, between the
Pima County Authority and TEP relating to Floating Rate Monthly
Demand Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company IrvingtonSundt Project). (Form 10-Q for
the quarter ended September 30, 1982, File No. 1-5924 --
Exhibit 4(a).)
*4(c)(2) -- Indenture of Trust, dated as of October 1, 1982, between the
Pima County Authority and Morgan Guaranty authorizing Floating
Rate Monthly Demand Industrial Development Revenue Bonds, 1982
Series A (Tucson Electric Power Company IrvingtonSundt Project). (Form
10-Q for the quarter ended September 30, 1982, File No.
1-5924 -- Exhibit 4(b).)
*4(c)(3) -- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Pima County Authority and TEP relating to
Industrial Development Revenue Bonds, 1982 Series A (Tucson
Electric Power Company IrvingtonSundt Project). (Form S-4, Registration
No. 33-52860 -- Exhibit 4(h)(3).)
*4(c)(4) -- First Supplemental Indenture of Trust, dated as of March 31,
1992, between the Pima County Authority and Morgan Guaranty
relating to Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company IrvingtonSundt Project). (Form S-
4,S-4,
Registration No. 33-52860 -- Exhibit 4(h)(4).)
*4(d)(1) -- Loan Agreement, dated as of December 1, 1982, between the
Pima County Authority and TEP relating to Floating Rate Monthly
Demand Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company Projects). (Form 10-K for the
year ended December 31, 1982, File No. 1-5924 -- Exhibit
4(k)(1).)
*4(d)(2) -- Indenture of Trust, dated as of December 1, 1982, between
the Pima County Authority and Morgan Guaranty authorizing
Floating Rate Monthly Demand Industrial Development Revenue
Bonds, 1982 Series A (Tucson Electric Power Company Projects).
(Form 10-K for the year ended December 31, 1982, File No.
1-5924 -- Exhibit 4(k)(2).)
*4(d)(3) -- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Pima County Authority and TEP relating to
Industrial Development Revenue Bonds, 1982 Series A (Tucson
Electric Power Company Projects). (Form S-4, Registration No.
33-52860 -- Exhibit 4(i)(3).)
*4(d)(4) -- First Supplemental Indenture of Trust, dated as of March 31,
1992, between the Pima County Authority and Morgan Guaranty
relating to Industrial Development Revenue Bonds, 1982 Series A
(Tucson Electric Power Company Projects). (Form S-4,
Registration No. 33-52860 -- Exhibit 4(i)(4).)
K-143
*4(e)(1) -- Loan Agreement, dated as of December 1, 1983, between the
Apache County Authority and TEP relating to Floating Rate
Monthly Demand Industrial Development Revenue Bonds, 1983
Series A (Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1983, File No.
1-5924 -- Exhibit 4(l)(1).)
*4(e)(2) -- Indenture of Trust, dated as of December 1, 1983, between
the Apache County Authority and Morgan Guaranty authorizing
Floating Rate Monthly Demand Industrial Development Revenue
Bonds, 1983 Series A (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1983, File No. 1-5924 -- Exhibit 4(l)(2).)
*4(e)(3) -- First Supplemental Loan Agreement, dated as of December 1,
1985, between the Apache County Authority and TEP relating to
Floating Rate Monthly Demand Industrial Development Revenue
Bonds, 1983 Series A (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(k)(3).)
*4(e)(4) -- First Supplemental Indenture, dated as of December 1, 1985,
between the Apache County Authority and Morgan Guaranty
relating to Floating Rate Monthly Demand Industrial Development
Revenue Bonds, 1983 Series A (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(k)(4).)
*4(e)(5) -- Second Supplemental Loan Agreement, dated as of March 31,
1992, between the Apache County Authority and TEP relating to
Industrial Development Revenue Bonds, 1983 Series A (Tucson
Electric Power Company Springerville Project). (Form S-4,
Registration No. 33-52860 -- Exhibit 4(k)(5).)
*4(e)(6) -- Second Supplemental Indenture of Trust, dated as of March
31, 1992, between the Apache County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds, 1983
Series A (Tucson Electric Power Company Springerville Project).
(Form S-4, Registration No. 33-52860 -- Exhibit 4(k)(6).)
*4(f)(1) -- Loan Agreement, dated as of December 1, 1983, between the
Apache County Authority and TEP relating to Variable Rate
Demand Industrial Development Revenue Bonds, 1983 Series B
(Tucson Electric Power Company Springerville Project). (Form
10-K for the year ended December 31, 1983, File No. 1-5924 --
Exhibit 4(m)(1).)
*4(f)(2) -- Indenture of Trust, dated as of December 1, 1983, between
the Apache County Authority and Morgan Guaranty authorizing
Variable Rate Demand Industrial Development Revenue Bonds, 1983
Series B (Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1983, File No.
1-5924 -- Exhibit 4(m)(2).)
*4(f)(3) -- First Supplemental Loan Agreement, dated as of December 1,
1985, between the Apache County Authority and TEP relating to
Floating Rate Monthly Demand Industrial Development Revenue
Bonds, 1983 Series B (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(l)(3).)
*4(f)(4) -- First Supplemental Indenture, dated as of December 1, 1985,
between the Apache County Authority and Morgan Guaranty
relating to Floating Rate Monthly Demand Industrial Development
Revenue Bonds, 1983 Series B (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(l)(4).)
*4(f)(5) -- Second Supplemental Loan Agreement, dated as of March 31,
1992, between the Apache County Authority and TEP relating to
Industrial Development Revenue Bonds, 1983 Series B (Tucson
Electric Power Company Springerville Project). (Form S-4,
Registration No. 33-52860 -- Exhibit 4(l)(5).)
K-144
*4(f)(6) -- Second Supplemental Indenture of Trust, dated as of March
31, 1992, between the Apache County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds, 1983
Series B (Tucson Electric Power Company Springerville Project).
(Form S-4, Registration No. 33-52860 -- Exhibit 4(l)(6).)
*4(g)(1) -- Loan Agreement, dated as of December 1, 1983, between the
Apache County Authority and TEP relating to Variable Rate
Demand Industrial Development Revenue Bonds, 1983 Series C
(Tucson Electric Power Company Springerville Project). (Form
10-K for year ended December 31, 1983, File No. 1-5924 --
Exhibit 4(n)(1).)
*4(g)(2) -- Indenture of Trust, dated as of December 1, 1983, between
the Apache County Authority and Morgan Guaranty authorizing
Variable Rate Demand Industrial Development Revenue Bonds, 1983
Series C (Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1983, File No.
1-5924 -- Exhibit 4(n)(2).)
*4(g)(3) -- First Supplemental Loan Agreement, dated as of December 1,
1985, between the Apache County Authority and TEP relating to
Floating Rate Monthly Demand Industrial Development Revenue
Bonds, 1983 Series C (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(m)(3).)
*4(g)(4) -- First Supplemental Indenture, dated as of December 1, 1985,
between the Apache County Authority and Morgan Guaranty
relating to Floating Rate Monthly Demand Industrial Development
Revenue Bonds, 1983 Series C (Tucson Electric Power Company
Springerville Project). (Form 10-K for the year ended December
31, 1987, File No. 1-5924 -- Exhibit 4(m)(4).)
*4(g)(5) -- Second Supplemental Loan Agreement, dated as of March 31,
1992, between the Apache County Authority and TEP relating to
Industrial Development Revenue Bonds, 1983 Series C (Tucson
Electric Power Company Springerville Project). (Form S-4,
Registration No. 33-52860 -- Exhibit 4(m)(5).)
*4(g)(6) -- Second Supplemental Indenture of Trust, dated as of March
31, 1992, between the Apache County Authority and Morgan
Guaranty relating to Industrial Development Revenue Bonds, 1983
Series C (Tucson Electric Power Company Springerville Project).
(Form S-4, Registration No. 33-52860 -- Exhibit 4(m)(6).)
*4(h) -- Reimbursement Agreement, dated as of September 15, 1981, as
amended, between TEP and Manufacturers Hanover Trust Company.
(Form 10-K for the year ended December 31, 1984, File No.
1-5924 -- Exhibit 4(o)(4).)
*4(i)(1) -- Loan Agreement, dated as of December 1, 1985, between the
Apache County Authority and TEP relating to Variable Rate
Demand Industrial Development Revenue Bonds, 1985 Series A
(Tucson Electric Power Company Springerville Project). (Form
10-K for the year ended December 31, 1985, File No. 1-5924 --
Exhibit 4(r)(1).)
*4(i)(2) -- Indenture of Trust, dated as of December 1, 1985, between
the Apache County Authority and Morgan Guaranty authorizing
Variable Rate Demand Industrial Development Revenue Bonds, 1985
Series A (Tucson Electric Power Company Springerville Project).
(Form 10-K for the year ended December 31, 1985, File No.
1-5924 -- Exhibit 4(r)(2).)
*4(i)(3) -- First Supplemental Loan Agreement, dated as of March 31,
1992, between the Apache County Authority and TEP relating to
Industrial Development Revenue Bonds, 1985 Series A (Tucson
Electric Power Company Springerville Project). (Form S-4,
Registration No. 33-52860 -- Exhibit 4(o)(3).)
K-145
*4(i)(4) -- First Supplemental Indenture of Trust, dated as of March 31,
1992, between the Apache County Authority and Morgan Guaranty
relating to Industrial Development Revenue Bonds, 1985 Series A
(Tucson Electric Power Company Springerville Project). (Form
S-4, Registration No. 33-52860 -- Exhibit 4(o)(4).)
*4(j)(1) -- Indenture of Mortgage and Deed of Trust dated as of December
1, 1992, to Bank of Montreal Trust Company, Trustee. (Form S-1,
Registration No. 33-55732 -- Exhibit 4(r)(1).)
*4(j)(2) -- Supplemental Indenture No. 1 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series A, dated as
of December 1, 1992. (Form S-1, Registration No. 33-55732 --
Exhibit 4(r)(2).)
*4(j)(3) -- Supplemental Indenture No. 2 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series B, dated as
of December 1, 1997. (Form 10-K for year ended December 31,
1997, File No. 1-5924
-- Exhibit 4(m)(3).)
*4(j)(4) -- Supplemental Indenture No. 3 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series, dated as
of August 1, 1998. (Form 10-Q for the quarter ended June 30,
1998, File No. 1-5924
-- Exhibit 4(c).)
*4(j)(5) -- Supplemental Indenture No. 4 creating a series of bonds
designated Second Mortgage Bonds, Collateral Series C, dated as
of November 1, 2002. (Form 8-K dated November 27, 2002, File
Nos. 1-05924 and 1-13739 -- Exhibit 99.2.)
*4(k)(1) -- Loan Agreement, dated as of April 1, 1997, between Coconino
County, Arizona Pollution Control Corporation and TEP relating
to Pollution Control Revenue Bonds, 1997 Series A (Tucson
Electric Power Company Navajo Project). (Form 10-Q for the
quarter ended March 31, 1997, File No. 1-5924 -- Exhibit 4(c).)
*4(k)(2) -- Indenture of Trust, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1997 Series A (Tucson Electric
Power Company Navajo Project). (Form 10-Q for the quarter ended
March 31, 1997, File No. 1-5924 -- Exhibit 4(d).)
*4(l)(1) -- Loan Agreement, dated as of April 1, 1997, between Coconino
County, Arizona Pollution Control Corporation and TEP relating
to Pollution Control Revenue Bonds, 1997 Series B (Tucson
Electric Power Company Navajo Project). (Form 10-Q for the
quarter ended March 31, 1997, File No. 1-5924 -- Exhibit--Exhibit 4(e).)
*4(l)(2) -- Indenture of Trust, dated as of April 1, 1997, between
Coconino County, Arizona Pollution Control Corporation and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1997 Series B (Tucson Electric
Power Company Navajo Project). (Form 10-Q for the quarter ended
March 31, 1997, File No. 1-5924 -- Exhibit 4(f).)
*4(m)(1) -- Loan Agreement, dated as of September 15, 1997, between The
Industrial Development Authority of the County of Pima and TEP
relating to Industrial Development Revenue Bonds, 1997 Series A
(Tucson Electric Power Company Project). (Form 10-Q for the
quarter ended September 30, 1997, File No. 1-5924
-- Exhibit 4(a).)
*4(m)(2) -- Indenture of Trust, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima and
First Trust of New York, National Association, authorizing
Industrial Development Revenue Bonds, 1997 Series A (Tucson
Electric Power Company Project). (Form 10-Q for the quarter
ended September 30, 1997, File No. 1-5924 -- Exhibit 4(b).)
K-146
*4(n)(1) -- Loan Agreement, dated as of September 15, 1997, between The
Industrial Development Authority of the County of Pima and TEP
relating to Industrial Development Revenue Bonds, 1997 Series B
(Tucson Electric Power Company Project). (Form 10-Q for the
quarter ended September 30, 1997, File No. 1-5924
-- Exhibit 4(c).)
*4(n)(2) -- Indenture of Trust, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima and
First Trust of New York, National Association, authorizing
Industrial Development Revenue Bonds, 1997 Series B (Tucson
Electric Power Company Project). (Form 10-Q for the quarter
ended September 30, 1997, File No. 1-5924 -- Exhibit 4(d).)
*4(o)(1) -- Loan Agreement, dated as of September 15, 1997, between The
Industrial Development Authority of the County of Pima and TEP
relating to Industrial Development Revenue Bonds, 1997 Series C
(Tucson Electric Power Company Project). (Form 10-Q for the
quarter ended September 30, 1997, File No. 1-5924
-- Exhibit 4(e).)
*4(o)(2) -- Indenture of Trust, dated as of September 15, 1997, between
The Industrial Development Authority of the County of Pima and
First Trust of New York, National Association, authorizing
Industrial Development Revenue Bonds, 1997 Series C (Tucson
Electric Power Company Project). (Form 10-Q for the quarter
ended September 30, 1997, File No. 1-5924 -- Exhibit 4(f).)
*4(p)(1) -- Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
TEP relating to Pollution Control Revenue Bonds, 1998 Series A
(Tucson Electric Power Company Project). (Form 10-Q for the
quarter ended March 31, 1998, File No. 1-5924 -- Exhibit 4(a).)
*4(p)(2) -- Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1998 Series A (Tucson Electric
Power Company Project). (Form 10-Q for the quarter ended March
31, 1998, File No. 1-5924 -- Exhibit 4(b).)
*4(q)(1) -- Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
TEP relating to Pollution Control Revenue Bonds, 1998 Series B
(Tucson Electric Power Company Project). (Form 10-Q for the
quarter ended March 31, 1998, File No. 1-5924 -- Exhibit 4(c).)
*4(q)(2) -- Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
First Trust of New York, National Association, authorizing
Pollution Control Revenue Bonds, 1998 Series B (Tucson Electric
Power Company Project). (Form 10-Q for the quarter ended March
31, 1998, File No. 1-5924 -- Exhibit 4(d).)
*4(r)(1) -- Loan Agreement, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
TEP relating to Industrial Development Revenue Bonds, 1998
Series C (Tucson Electric Power Company Project). (Form 10-Q
for the quarter ended March 31, 1998, File No. 1-5924 --
Exhibit 4(e).)
*4(r)(2) -- Indenture of Trust, dated as of March 1, 1998, between The
Industrial Development Authority of the County of Apache and
First Trust of New York, National Association, authorizing
Industrial Development Revenue Bonds, 1998 Series C (Tucson
Electric Power Company Project). (Form 10-Q for the quarter
ended March 31, 1998, File No. 1-5924 -- Exhibit 4(f).)
*4(s)(1) -- Indenture of Trust, dated as of August 1, 1998, between TEP
and the Bank of Montreal Trust Company. (Form 10-Q for the
quarter ended June 30, 1998, File No. 1-5924 -- Exhibit 4(d).)
*4(t)(1) -- Rights Agreement dated as of March 5, 1999, between
UniSource Energy Corporation and The Bank of New York, as
Rights Agent. (Form 8-K dated March 5, 1999, File No. 1-13739
-- Exhibit 4.)
K-147
*10(a)(1) -- Lease Agreements, dated as of December 1, 1984, between
Valencia and United States Trust Company of New York, as
Trustee, and Thomas B. Zakrzewski, as Co-Trustee, as amended
and supplemented. (Form 10-K for the year ended December 31,
1984, File No. 1-5924 -- Exhibit 10(d)(1).)
*10(a)(2) -- Guaranty and Agreements, dated as of December 1, 1984,
between TEP and United States Trust Company of New York, as
Trustee, and Thomas B. Zakrzewski, as Co-Trustee. (Form 10-K
for the year ended December 31, 1984, File No. 1-5924 --
Exhibit 10(d)(2).)
*10(a)(3) -- General Indemnity Agreements, dated as of December 1, 1984,
between Valencia and TEP, as Indemnitors; General Foods Credit
Corporation, Harvey Hubbell Financial, Inc. and J. C. Penney
Company, Inc. as Owner Participants; United States Trust
Company of New York, as Owner Trustee; Teachers Insurance and
Annuity Association of America as Loan Participant; and Marine
Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the
year ended December 31, 1984, File No. 1-5924 -- Exhibit
10(d)(3).)
*10(a)(4) -- Tax Indemnity Agreements, dated as of December 1, 1984,
between General Foods Credit Corporation, Harvey Hubbell
Financial, Inc. and J. C. Penney Company, Inc., each as
Beneficiary under a separate Trust Agreement dated December 1,
1984, with United States Trust of New York as Owner Trustee,
and Thomas B. Zakrzewski as Co-Trustee, Lessor, and Valencia,
Lessee, and TEP, Indemnitors. (Form 10-K for the year ended
December 31, 1984, File No. 1-5924 -- Exhibit 10(d)(4).)
*10(a)(5) -- Amendment No. 1, dated December 31, 1984, to the Lease
Agreements, dated December 1, 1984, between Valencia and United
States Trust Company of New York, as Owner Trustee, and Thomas
B. Zakrzewski as Co-Trustee. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(5).)
*10(a)(6) -- Amendment No. 2, dated April 1, 1985, to the Lease
Agreements, dated December 1, 1984, between Valencia and United
States Trust Company of New York, as Owner Trustee, and Thomas
B. Zakrzewski as Co-Trustee. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(6).)
*10(a)(7) -- Amendment No. 3, dated August 1, 1985, to the Lease
Agreements, dated December 1, 1984, between Valencia and United
States Trust Company of New York, as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(7).)
*10(a)(8) -- Amendment No. 4, dated June 1, 1986, to the Lease Agreement,
dated December 1, 1984, between Valencia and United States
Trust Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee, under a Trust Agreement dated as of
December 1, 1984, with General Foods Credit Corporation as
Owner Participant. (Form 10-K for the year ended December 31,
1986, File No. 1-5924 -- Exhibit 10(e)(8).)
*10(a)(9) -- Amendment No. 4, dated June 1, 1986, to the Lease Agreement,
dated December 1, 1984, between Valencia and United States
Trust Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee, under a Trust Agreement dated as of
December 1, 1984, with J. C. Penney Company, Inc. as Owner
Participant. (Form 10-K for the year ended December 31, 1986,
File No. 1-5924 -- Exhibit 10(e)(9).)
*10(a)(10) -- Amendment No. 4, dated June 1, 1986, to the Lease Agreement,
dated December 1, 1984, between Valencia and United States
Trust Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee, under a Trust Agreement dated as of
December 1, 1984, with Harvey Hubbell Financial Inc. as Owner
Participant. (Form 10-K for the year ended December 31, 1986,
File No. 1-5924 -- Exhibit 10(e)(10).)
K-148
*10(a)(11) -- Lease Amendment No. 5 and Supplement No. 2, to the Lease
Agreement, dated July 1, 1986, between Valencia, United States
Trust Company of New York as Owner Trustee, and Thomas
Zakrzewski as Co-Trustee and J. C. Penney as Owner Participant.
(Form 10-K for the year ended December 31, 1986, File No.
1-5924 -- Exhibit 10(e)(11).)
*10(a)(12) -- Lease Amendment No. 5, to the Lease Agreement, dated June 1,
1987, between Valencia, United States Trust Company of New York
as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and
General Foods Credit Corporation as Owner Participant. (Form
10-K for the year ended December 31, 1988, File No.
1-5924 -- Exhibit 10(f)(12).)
*10(a)(13) -- Lease Amendment No. 5, to the Lease Agreement, dated June 1,
1987, between Valencia, United States Trust Company of New York
as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and
Harvey Hubbell Financial Inc. as Owner Participant. (Form 10-K
for the year ended December 31, 1988, File No. 1-5924
-- Exhibit 10(f)(13).)
*10(a)(14) -- Lease Amendment No. 6, to the Lease Agreement, dated June 1,
1987, between Valencia, United States Trust Company of New York
as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and J. C.
Penney Company, Inc. as Owner Participant. (Form 10-K for the
year ended December 31, 1988, File No. 1-5924
-- Exhibit 10(f)(14).)
*10(a)(15) -- Lease Supplement No. 1, dated December 31, 1984, to Lease
Agreements, dated December 1, 1984, between Valencia, as Lessee
and United States Trust Company of New York and Thomas B.
Zakrzewski, as Owner Trustee and Co-Trustee, respectively
(document filed relates to General Foods Credit Corporation;
documents relating to Harvey HubbelHubbell Financial, Inc. and JC
Penney Company, Inc. are not filed but are substantially
similar). (Form S-4, Registration No. 33-52860 -- Exhibit
10(f)(15).)
*10(a)(16) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, General Foods Credit
Corporation, as Owner Participant, United States Trust Company
of New York, as Owner Trustee, Teachers Insurance and Annuity
Association of America, as Loan Participant, and Marine Midland
Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(12).)
*10(a)(17) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, J. C. Penney Company, Inc.,
as Owner Participant, United States Trust Company of New York,
as Owner Trustee, Teachers Insurance and Annuity Association of
America, as Loan Participant, and Marine Midland Bank, N.A., as
Indenture Trustee. (Form 10-K for the year ended December 31,
1986, File No. 1-5924 -- Exhibit 10(e)(13).)
*10(a)(18) -- Amendment No. 1, dated June 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, Harvey Hubbell Financial,
Inc., as Owner Participant, United States Trust Company of New
York, as Owner Trustee, Teachers Insurance and Annuity
Association of America, as Loan Participant, and Marine Midland
Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(14).)
*10(a)(19) -- Amendment No. 2, dated as of July 1, 1986, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, J. C. Penney Company, Inc.,
as Owner Participant, United States Trust Company of New York,
as Owner Trustee, Teachers Insurance and Annuity Association of
America, as Loan Participant, and Marine Midland Bank, N.A., as
Indenture Trustee. (Form S-4,
Registration No. 33-52860 -- Exhibit 10(f)(19).)
K-149
*10(a)(20) -- Amendment No. 2, dated as of June 1, 1987, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, General Foods Credit
Corporation, as Owner Participant, United States Trust Company
of New York, as Owner Trustee, Teachers Insurance and Annuity
Association of America, as Loan Participant, and Marine Midland
Bank, N.A., as Indenture Trustee.
(Form S-4, Registration No. 33-52860 -- Exhibit 10(f)(20).)
*10(a)(21) -- Amendment No. 2, dated as of June 1, 1987, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, Harvey Hubbell Financial,
Inc., as Owner Participant, United States Trust Company of New
York, as Owner Trustee, Teachers Insurance and Annuity
Association of America, as Loan Participant, and Marine Midland
Bank, N.A., as Indenture Trustee. (Form S-4, Registration No.
33-52860 -- Exhibit 10(f)(21).)
*10(a)(22) -- Amendment No. 3, dated as of June 1, 1987, to the General
Indemnity Agreement, dated as of December 1, 1984, between
Valencia and TEP, as Indemnitors, J. C. Penney Company, Inc.,
as Owner Participant, United States Trust Company of New York,
as Owner Trustee, Teachers Insurance and Annuity Association of
America, as Loan Participant, and Marine Midland Bank, N.A., as
Indenture Trustee. (Form S-4,
Registration No. 33-52860 -- Exhibit 10(f)(22).)
*10(a)(23) -- Supplemental Tax Indemnity Agreement, dated July 1, 1986,
between J. C. Penney Company, Inc., as Owner Participant, and
Valencia and TEP, as Indemnitors. (Form 10-K for the year ended
December 31, 1986, File No. 1-5924 -- Exhibit 10(e)(15).)
*10(a)(24) -- Supplemental General Indemnity Agreement, dated as of July
1, 1986, among Valencia and TEP, as Indemnitors, J. C. Penney
Company, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance and
Annuity Association of America, as Loan Participant, and Marine
Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the
year ended December 31, 1986, File No. 1-5924 -- Exhibit
10(e)(16).)
*10(a)(25) -- Amendment No. 1, dated as of June 1, 1987, to the
Supplemental General Indemnity Agreement, dated as of July 1,
1986, among Valencia and TEP, as Indemnitors, J. C. Penney
Company, Inc., as Owner Participant, United States Trust
Company of New York, as Owner Trustee, Teachers Insurance and
Annuity Association of America, as Loan Participant, and Marine
Midland Bank, N.A., as Indenture Trustee.
(Form S-4, Registration No. 33-52860 -- Exhibit 10(f)(25).)
*10(a)(26) -- Valencia Agreement, dated as of June 30, 1992, among TEP, as
Guarantor, Valencia, as Lessee, Teachers Insurance and Annuity
Association of America, as Loan Participant, Marine Midland
Bank, N.A., as Indenture Trustee, United States Trust Company
of New York, as Owner Trustee, and Thomas B. Zakrzewski, as
Co-Trustee, and the Owner Participants named therein relating
to the Restructuring of Valencia's lease of the coal-handling
facilities at the Springerville Generating Station. (Form S-4,
Registration No. 33-52860 -- Exhibit 10(f)(26).)
*10(a)(27) -- Amendment, dated as of December 15, 1992, to the Lease
Agreements, dated December 1, 1984, between Valencia, as
Lessee, and United States Trust Company of New York, as Owner
Trustee, and Thomas B. Zakrzewski, as Co-Trustee. (Form S-1,
Registration No. 33-55732 -- Exhibit 10(f)(27).)
*10(b)(1) -- Lease Agreements, dated as of December 1, 1985, between TEP
and San Carlos Resources Inc. (San Carlos)(a (a wholly-owned
subsidiary of the Registrant) jointly and severally, as Lessee,
and Wilmington Trust Company, as Trustee, as amended and
supplemented. (Form 10-K for the year ended December 31, 1985,
File No. 1-5924 -- Exhibit 10(f)(1).)
K-150
*10(b)(2) -- Tax Indemnity Agreements, dated as of December 1, 1985,
between Philip Morris Credit Corporation, IBM Credit Financing
Corporation and Emerson Finance Co., each as beneficiary under
a separate trust agreement, dated as of December 1, 1985, with
Wilmington Trust Company, as Owner Trustee, and William J.
Wade, as Co-Trustee, and TEP and San Carlos, as Lessee. (Form
10-K for the year ended December 31, 1985, File No. 1-5924 --
Exhibit 10(f)(2).)
*10(b)(3) -- Participation Agreement, dated as of December 1, 1985, among
TEP and San Carlos as Lessee, Philip Morris Credit Corporation,
IBM Credit Financing Corporation, and Emerson Finance Co. as
Owner Participants, Wilmington Trust Company as Owner Trustee,
The Sumitomo Bank, Limited, New York Branch, as Loan
Participant, and Bankers Trust Company, as Indenture Trustee.
(Form 10-K for the year ended December 31, 1985, File No.
1-5924 -- Exhibit 10(f)(3).)
*10(b)(4) -- Restructuring Commitment Agreement, dated as of June 30,
1992, among TEP and San Carlos, jointly and severally, as
Lessee, Philip Morris Credit Corporation, IBM Credit Financing
Corporation and Emerson Capital Funding, William J. Wade, as
Owner Trustee and Co-Trustee, respectively, The Sumitomo Bank,
Limited, New York Branch, as Loan Participant and United States
Trust Company of New York, as Indenture Trustee. (Form S-4,
Registration No. 33-52860 -- Exhibit 10(g)(4).)
*10(b)(5) -- Lease Supplement No. 1, dated December 31, 1985, to Lease
Agreements, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee Trustee and
Co-Trustee, respectively (document filed relates to Philip
Morris Credit Corporation; documents relating to IBM Credit
Financing Corporation and Emerson Financing Co. are not filed
but are substantially similar). (Form S-4, Registration No.
33-52860 -- Exhibit 10(g)(5).)
*10(b)(6) -- Amendment No. 1, dated as of December 15, 1992, to Lease
Agreements, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, as Lessor. (Form S-1, Registration No.
33-55732 -- Exhibit 10(g)(6).)
*10(b)(7) -- Amendment No. 1, dated as of December 15, 1992, to Tax
Indemnity Agreements, dated as of December 1, 1985, between
Philip Morris Credit Corporation, IBM Credit Financing
Corporation and Emerson Capital Funding Corp., as Owner
Participants and TEP and San Carlos, jointly and severally, as
Lessee. (Form
S-1, Registration No. 33-55732 -- Exhibit 10(g)(7).)
*10(b)(8) -- Amendment No. 2, dated as of December 1, 1999, to Lease
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with Philip Morris
Capital Corporation as Owner Participant. (Form 10-K for the
year ended December 31, 1999, File No.
1-5924 -- Exhibit 10(b)(8).)
*10(b)(9) -- Amendment No. 2, dated as of December 1, 1999, to Lease
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with IBM Credit Financing
Corporation as Owner Participant. (Form 10-K for the year ended
December 31, 1999, File No.
1-5924 -- Exhibit 10(b)(9).)
*10(b)(10) -- Amendment No. 2, dated as of December 1, 1999, to Lease
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with Emerson Finance Co.
as Owner Participant. (Form 10-K for the year ended December
31, 1999, File No. 1-5924 -- Exhibit 10(b)(10).)
K-151
*10(b)(11) -- Amendment No. 2, dated as of December 1, 1999, to Tax
Indemnity Agreement, dated as of December 1, 1985, between TEP
and San Carlos, jointly and severally, as Lessee, and Philip
Morris Capital Corporation as Owner Participant, beneficiary
under a Trust Agreement dated as of December 1, 1985, with
Wilmington Trust Company and William J. Wade, as Owner Trustee
and Co-Trustee, respectively, together as Lessor. (Form 10-K
for the year ended December 31, 1999, File No. 1-5924 --
Exhibit 10(b)(11).)
*10(b)(12) -- Amendment No. 2, dated as of December 1, 1999, to Tax
Indemnity Agreement, dated as of December 1, 1985, between TEP
and San Carlos, jointly and severally, as Lessee, and IBM
Credit Financing Corporation as Owner Participant, beneficiary
under a Trust Agreement dated as of December 1, 1985, with
Wilmington Trust Company and William J. Wade, as Owner Trustee
and Co-Trustee, respectively, together as Lessor. (Form 10-K
for the year ended December 31, 1999, File No. 1-5924 --
Exhibit 10(b)(12).)
*10(b)(13) -- Amendment No. 2, dated as of December 1, 1999, to Tax
Indemnity Agreement, dated as of December 1, 1985, between TEP
and San Carlos, jointly and severally, as Lessee, and Emerson
Finance Co. as Owner Participant, beneficiary under a Trust
Agreement dated as of December 1, 1985, with Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, together as Lessor. (Form 10-K for the year ended
December 31, 1999, File No. 1-5924 -- Exhibit 10(b)(13).)
*10(b)(14) -- Amendment No. 3 dated as of June 1, 2003, to Lease
Agreements, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with Philip Morris
Capital Corporation as Owner Participant.
*10(b)(15) -- Amendment No. 3 dated as of June 1, 2003, to Lease
Agreements, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with IBM Credit, LLC as
Owner Participant.
*10(b)(16) -- Amendment No. 3 dated as of June 1, 2003, to Lease
Agreements, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Wilmington Trust
Company and William J. Wade, as Owner Trustee and Co-Trustee,
respectively, under a Trust Agreement with Emerson Finance Co.
as Owner Participant.
*10(b)(17) -- Amendment No. 3 dated as of June 1, 2003, to Tax Indemnity
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Philip Morris
Capital Corporation as Owner Participant, beneficiary under a
Trust Agreement dated as of December 1, 1985, with Wilmington
Trust Company and William J. Wade, as Owner Trustee and
Co-Trustee, respectively, together as Lessor.
*10(b)(18) -- Amendment No. 3 dated as of June 1, 2003, to Tax Indemnity
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and IBM Credit, LLC
as Owner Participant, beneficiary under a Trust Agreement dated
as of December 1, 1985, with Wilmington Trust Company and
William J. Wade, as Owner Trustee and Co-Trustee, respectively,
together as Lessor.
*10(b)(19) -- Amendment No. 3 dated as of June 1, 2003, to Tax Indemnity
Agreement, dated as of December 1, 1985, between TEP and San
Carlos, jointly and severally, as Lessee, and Emerson Finance
Co. as Owner Participant, beneficiary under a Trust Agreement
dated as of December 1, 1985, with Wilmington Trust Company and
William J. Wade, as Owner Trustee and Co-Trustee, respectively,
together as Lessor.
*10(c)(1) -- Amended and Restated Participation Agreement, dated as of
November 15, 1987, among TEP, as Lessee, Ford Motor Credit
Company, as Owner Participant, Financial Security Assurance
Inc., as Surety, Wilmington Trust Company and William J. Wade
in their respective individual capacities as provided therein,
but otherwise solely as Owner Trustee and Co-Trustee under the
Trust Agreement, and Morgan Guaranty, in its individual
capacity as provided therein, but Secured Party. (Form 10-K for
the year ended December 31, 1987, File No. 1-5924 -- Exhibit
10(j)(1).)
K-152
*10(c)(2) -- Lease Agreement, dated as of January 14, 1988, between
Wilmington Trust Company and William J. Wade, as Owner Trust
Agreement described therein, dated as of November 15, 1987,
between such parties and Ford Motor Credit Company, as Lessor,
and TEP, as Lessee. (Form 10-K for the year ended December 31,
1987, File No. 1-5924 -- Exhibit 10(j)(2).)
*10(c)(3) -- Tax Indemnity Agreement, dated as of January 14, 1988,
between TEP, as Lessee, and Ford Motor Credit Company, as Owner
Participant, beneficiary under a Trust Agreement, dated as of
November 15, 1987, with Wilmington Trust Company and William J.
Wade, Owner Trustee and Co-Trustee, respectively, together as
Lessor. (Form 10-K for the year ended December 31, 1987, File
No. 1-5924 -- Exhibit 10(j)(3).)
*10(c)(4) -- Loan Agreement, dated as of January 14, 1988, between the
Pima County Authority and Wilmington Trust Company and William
J. Wade in their respective individual capacities as expressly
stated, but otherwise solely as Owner Trustee and Co-Trustee,
respectively, under and pursuant to a Trust Agreement, dated as
of November 15, 1987, with Ford Motor Credit Company as Trustor
and Debtor relating to Industrial Development Lease Obligation
Refunding Revenue Bonds, 1988 Series A (TEP's IrvingtonSundt Project).
(Form 10-K for the year ended December 31, 1987, File No.
1-5924 -- Exhibit 10(j)(4).)
*10(c)(5) -- Indenture of Trust, dated as of January 14, 1988, between
the Pima County Authority and Morgan Guaranty authorizing
Industrial Development Lease Obligation Refunding Revenue
Bonds, 1988 Series A (Tucson Electric Power Company IrvingtonSundt
Project). (Form 10-K for the year ended December 31, 1987, File
No. 1-5924 -- Exhibit 10(j)(5).)
*10(c)(6) -- Lease Amendment No. 1, dated as of May 1, 1989, between TEP,
Wilmington Trust Company and William J. Wade as Owner Trustee
and Co-trustee, respectively under a Trust Agreement dated as
of November 15, 1987 with Ford Motor Credit Company. (Form 10-K
for the year ended December 31, 1990, File No. 1-5924
-- Exhibit 10(i)(6).)
*10(c)(7) -- Lease Supplement, dated as of January 1, 1991, between TEP,
Wilmington Trust Company and William J. Wade as Owner Trustee
and Co-Trustee, respectively, under a Trust Agreement dated as
of November 15, 1987, with Ford. (Form 10-K for the year ended
December 31, 1991, File No. 1-5924 -- Exhibit 10(i)(8).)
*10(c)(8) -- Lease Supplement, dated as of March 1, 1991, between TEP,
Wilmington Trust Company and William J. Wade as Owner Trustee
and Co-Trustee, respectively, under a Trust Agreement dated as
of November 15, 1987, with Ford. (Form 10-K for the year ended
December 31, 1991, File No. 1-5924 -- Exhibit 10(i)(9).)
*10(c)(9) -- Lease Supplement No. 4, dated as of December 1, 1991,
between TEP, Wilmington Trust Company and William J. Wade as
Owner Trustee and Co-Trustee, respectively, under a Trust
Agreement dated as of November 15, 1987, with Ford. (Form 10-K
for the year ended December 31, 1991, File No. 1-5924 --
Exhibit 10(i)(10).)
*10(c)(10) -- Supplemental Indenture No. 1, dated as of December 1, 1991,
between the Pima County Authority and Morgan Guaranty relating
to Industrial Lease Development Obligation Revenue Project.
(Form 10-K for the year ended December 31, 1991, File No.
1-5924 -- Exhibit 10(i)10(I)(11).)
*10(c)(11) -- Restructuring Commitment Agreement, dated as of June 30,
1992, among TEP, as Lessee, Ford Motor Credit Company, as Owner
Participant, Wilmington Trust Company and William J. Wade, as
Owner Trustee and Co-Trustee, respectively, and Morgan
Guaranty, as Indenture Trustee and Refunding Trustee, relating
to the restructuring of the Registrant's lease of Unit 4 at the
IrvingtonSundt Generating Station. (Form S-4, Registration No. 33-52860
-- Exhibit 10(i)(12).)
*10(c)(12) -- Amendment No. 1, dated as of December 15, 1992, to Amended
and Restated Participation Agreement, dated as of November 15,
1987, among TEP, as Lessee, Ford Motor Credit Company, as Owner
Participant, Wilmington Trust Company and William J. Wade, as
Owner Trustee and Co-Trustee, respectively, Financial Security
Assurance Inc., as Surety, and Morgan Guaranty, as Indenture
Trustee. (Form S-1, Registration No. 33-55732 -- Exhibit
10(h)(12).)
K-153
*10(c)(13) -- Amended and Restated Lease, dated as of December 15, 1992,
between TEP, as Lessee and Wilmington Trust Company and William
J. Wade, as Owner Trustee and Co-Trustee, respectively, as
Lessor. (Form S-1, Registration No. 33-55732 -- Exhibit
10(h)(13).)
*10(c)(14) -- Amended and Restated Tax Indemnity Agreement, dated as of
December 15, 1992, between TEP, as Lessee, and Ford Motor
Credit Company, as Owner Participant. (Form S-1, Registration
No. 33-55732 -- Exhibit 10(h)(14).)
*10(d) -- Power Sale Agreement for the years 1990 to 2011, dated as of
March 10, 1988, between TEP and Salt River Project Agricultural
Improvement and Power District. (Form 10-K for the year ended
December 31, 1987, File No. 1-5924 -- Exhibit 10(k).)
*10(e) -- Participation Agreement, dated as of June 30, 1992, among
TEP, as Lessee, various parties thereto, as Owner Wilmington
Trust Company and William J. Wade, as Owner Trustee and
Co-Trustee, respectively, and LaSalle National Bank, as
Indenture Trustee relating to TEP's lease of Springerville Unit
1. (Form S-1, Registration No. 33-55732 -- Exhibit 10(u).)
*10(f) -- Lease Agreement, dated as of December 15, 1992, between TEP,
as Lessee and Wilmington Trust Company and William J. Wade, as
Owner Trustee and Co-Trustee, respectively, as Lessor. (Form
S-1, Registration No. 33-55732 -- Exhibit 10(v).)
*10(g) -- Tax Indemnity Agreements, dated as of December 15, 1992,
between the various Owner Participants parties thereto and TEP,
as Lessee. (Form S-1, Registration No. 33-55732 -- Exhibit
10(w).)
*10(h) -- Restructuring Agreement, dated as of December 1, 1992,
between TEP and Century Power Corporation. (Form S-1,
Registration No. 33-55732 -- Exhibit 10(x).)
*10(i) -- Voting Agreement, dated as of December 15, 1992, between TEP
and Chrysler Capital Corporation (documents relating to CILCORP
Lease Management, Inc., MWR Capital Inc., US West Financial
Services, Inc. and Philip Morris Capital Corporation are not
filed but are substantially similar). (Form S-1, Registration
No. 33-55732 -- Exhibit 10(y).)
*10(j)(1) -- Wholesale Power Supply Agreement between TEP and Navajo
Tribal Utility Authority dated January 5, 1993. (Form 10-K for
the year ended December 31, 1992, File No. 1-5924 -- Exhibit
10(t).)
*10(j)(2) -- Amended and Restated Wholesale Power Supply Agreement
between TEP and Navajo Tribal Utility Authority, dated June 25,
1997. (Form 10-Q for the quarter ended June 30, 1997, File No.
1-5924 -- Exhibit 10.)
+*10(k) -- 1994 Omnibus Stock and Incentive Plan of UniSource Energy.
(Form S-8 dated January 6, 1998, File No. 333-43767.No.333-43767.)
+*10(l) -- Management and Directors Deferred Compensation Plan of
UniSource Energy. (Form S-8 dated January 6, 1998, File No.
333-43769.)
+*10(m) -- TEP Supplemental Retirement Account for Classified Employees.
(Form S-8 dated May 21, 1998, File No. 333-53309.No.333-53309.)
+*10(n) -- TEP Triple Investment Plan for Salaried Employees. (Form S-8
dated May 21, 1998, File No. 333-53333.)
+*10(o) -- UniSource Energy Management and Directors Deferred
Compensation Plan. (Form S-8 dated May 21, 1998, File No.
333-53337.)
K-154
+10(p) -- Officer Change in Control Agreement between TEP and
currently in effect with Thomas A. Delawder, Michael DeConcini,
Steven J. Glaser, Thomas N. Hansen, Neil Holstad, Karen G.
Kissinger, Kevin P. Larson, Steven W. Lynn, Dennis R. Nelson,
Vincent Nitido, Jr., James S. Pignatelli, and James Pyers dated
as of December 4, 1998.
*10(q)(1) -- Sworn Statement by UniSource Energy Principal Executive
Officer Regarding Facts and Circumstances Relating to Exchange
Act Filings pursuant to SEC Order No. 4-460. (Form 8-K dated
August 9, 2002, File No. 1-13739 -- Exhibit 99.1.)
*10(q)(2) -- Sworn Statement by UniSource Energy Principal Financial
Officer Regarding Facts and Circumstances Relating to Exchange
Act Filings pursuant to SEC Order No. 4-460. (Form 8-K dated
August 9, 2002, File No. 1-13739 -- Exhibit 99.2.)
+*10(r) -- Amended and Restated UniSource Energy 1994 Outside Director
Stock Option Plan of UniSource Energy. (Form S-8 dated
September 9, 2002, File No. 333-99317.)
*10(s)(1) -- Asset Purchase Agreement dated as of October 29, 2002, by
and between UniSource Energy and Citizens Communications
Company relating to the Purchase of Citizens' Electric Utility
Business in the State of Arizona. (Form 8-K dated October 31,
2002, File No. 1-13739 -- Exhibit 99-1.)
*10(s)(2) -- Asset Purchase Agreement dated as of October 29, 2002, by
and between UniSource Energy and Citizens Communications
Company relating to the Purchase of Citizens' Gas Utility
Business in the State of Arizona. (Form 8-K dated October 31,
2002, File No. 1-13739 -- Exhibit 99-2.)
*10(t) -- Credit Agreement dated as of November 14, 2002, among TEP,
Toronto Dominion (Texas), Inc., as Administrative Agent, The
Bank of New York and Union Bank of California as Co-Syndication
Agents, Credit Suisse First Boston as Documentation Agent, TD
Securities (USA) Inc. and Credit Suisse First Boston as Co-Lead
Arrangers and Joint Bookrunners, the lenders party hereto, and
the issuing banks party hereto. (Form 8-K dated November 27,
2002, File Nos. 1-5924 and 1-13739 -- Exhibit 99-1.)
*10(u) -- Note Purchase and Guaranty Agreement dated August 11, 2003
among UNS Gas, Inc., and UniSource Energy Services, Inc., and
certain institutional investors. (Form 8-K dated August 11,
2003, File Nos. 1-5924
and 1-13739 - Exhibit 99.2.)
*10(v) -- Note Purchase and Guaranty Agreement dated August 11, 2003
among UNS Electric, Inc., and UniSource Energy Services, Inc.,
and certain institutional investors. (Form 8-K dated August 11,
2003, File Nos.
1-5924 and 1-13739 - Exhibit 99.3.)
12 -- Computation of Ratio of Earnings to Fixed Charges -- TEP.
21 -- Subsidiaries of the Registrants.
23 -- Consents of experts.
24(a) -- Power of Attorney -- UniSource Energy.
24(b) -- Power of Attorney -- TEP.
9931(a) -- Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
- UniSource Energy, by James S. Pignatelli.
31(b) -- Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act - UniSource Energy, by Kevin P. Larson.
31(c) -- Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act - TEP, by James S. Pignatelli.
K-155
31(d) -- Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act - TEP, by Kevin P. Larson.
**32 - Statements of Corporate Officers pursuant(pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.2002).
(*) Previously filed as indicated and incorporated herein by reference.
(+) Management contracts or compensatory plans or arrangements required to be
filed as exhibits to this Form 10-K by item 601(b)(10)(iii) of Regulation
S-K.
**Pursuant to Item 601(b)(32)(ii) of Regulation S-K, this certificate is not
being filed for purposes of Section 18 of the Securities Act of 1934.
K-156