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| UNS > SEC Filings for UNS > Form 10-Q on 6-Aug-2009 | All Recent SEC Filings |
6-Aug-2009
Quarterly Report
Management's Discussion and Analysis explains the results of operations, the
general financial condition, and the outlook for UniSource Energy and its three
primary business segments and includes the following:
• outlook and strategies;
• operating results during the second quarter and six-months ended June 30, 2009 compared with the same periods in 2008;
• factors which affect our results and outlook;
• liquidity, capital needs, capital resources, and contractual obligations;
• dividends; and
• critical accounting estimates.
Management's Discussion and Analysis should be read in conjunction with
UniSource Energy and TEP's 2008 Annual Report on Form 10-K and with the
Comparative Condensed Consolidated Financial Statements, beginning on page 3,
which present the results of operations for the three and six months ended
June 30, 2009 and 2008. Management's Discussion and Analysis explains the
differences between periods for specific line items of the Comparative Condensed
Consolidated Financial Statements.
References in this report to "we" and "our" are to UniSource Energy and its
subsidiaries, collectively.
UNISOURCE ENERGY CONSOLIDATED
OVERVIEW OF CONSOLIDATED BUSINESS
UniSource Energy is a holding company that has no significant operations of its
own. Operations are conducted by UniSource Energy's subsidiaries, each of which
is a separate legal entity with its own assets and liabilities. UniSource Energy
owns the outstanding common stock of TEP, UniSource Energy Services, Inc. (UES),
UniSource Energy Development Company (UED) and Millennium Energy Holdings, Inc.
(Millennium).
TEP, an electric utility, has provided electric service to the community of
Tucson, Arizona, for over 100 years. UES was established in 2003, when it
acquired the Arizona gas and electric properties from Citizens. UES, through its
two operating subsidiaries, UNS Gas, Inc. (UNS Gas) and UNS Electric, Inc. (UNS
Electric), provides gas and electric service to 30 communities in Northern and
Southern Arizona. UED developed and owns the Black Mountain Generating Station
(BMGS), a 90 MW natural gas-fired peaking facility in Northern Arizona that,
through a power sales agreement, is providing energy to UNS Electric. Millennium
has existing investments in unregulated businesses; however no new investments
are planned at Millennium. At June 30, 2009, the investment in Millennium
represented 1% of UniSource Energy's total assets. We conduct our business in
three primary business segments - TEP, UNS Gas and UNS Electric.
OUTLOOK AND STRATEGIES
Our financial prospects and outlook for the next few years will be affected by
many factors including: the 2008 TEP Rate Order that freezes base rates through
2012, the recent national and regional economic downturn, the financial market
disruptions and volatility, potential regulations impacting greenhouse gas
emissions and other regulatory factors. Our plans and strategies include the
following:
• Maintain and enhance TEP's system reliability and safety while operating
under a base rate freeze through 2012;
• Maintain an appropriate cost structure while operating under a base rate freeze through 2012;
• Ensure UniSource Energy continues to have adequate liquidity by maintaining sufficient lines of credit and regularly reviewing and adjusting UniSource Energy's short-term investment strategies in response to market conditions;
• Expand TEP and UNS Electric's portfolio of renewable energy sources and demand side management programs to meet Arizona's renewable energy standards;
• Enhance the value of TEP's transmission system while continuing to provide reliable access to generation for TEP and UNS Electric's retail customers and market access for all generating assets;
• Obtain ACC approval of rate increases for UNS Gas and UNS Electric to provide adequate revenues to cover the rising cost of providing reliable and safe service to their customers; and
• Develop strategic responses to potential new legislation on carbon emissions and define steps to achieve environmental objectives that provide an appropriate return on investment and are consistent with earnings growth.
Economic Conditions
As a result of general economic conditions, retail customer growth and energy
sales to all classes of customers at UniSource Energy's utility subsidiaries are
below the average levels experienced in prior periods. UniSource Energy's future
results of operations may continue to be impacted by weak economic conditions.
While we cannot predict if customer growth will return to historic levels, we
expect combined customer growth to average approximately 0.5% per year during
the next 18 months. Despite the weak economic conditions, we did not experience
a material increase in uncollectible accounts at TEP, UNS Gas or UNS Electric in
the last 12 months.
To date, UniSource Energy and its subsidiaries have not been materially impacted
by volatility and disruptions in the financial markets. Our banking
relationships remain stable. UniSource Energy and its subsidiaries have access
to $280 million of revolving credit facilities, of which $153 million was unused
as of July 31, 2009, which we believe is sufficient to meet current operating,
capital and financing needs. UniSource Energy, TEP, UNS Gas and UNS Electric
have not experienced, nor do they expect to experience, any difficulties
obtaining funding under their respective revolving credit facilities. None of
these credit facilities have any bankrupt financial institutions as lenders, and
no lenders in the bank groups have refused to fund when requested.
As of July 31, 2009, TEP, UNS Electric and UNS Gas did not have any material
power or gas trading exposure to financially distressed counterparties. We
cannot predict whether in the future our financial condition or results of
operations will be impacted by current economic conditions or liquidity concerns
in the financial markets.
TEP, UNS Gas and UNS Electric maintain noncontributory, defined benefit pension
plans for substantially all regular employees and certain affiliate employees.
The pension assets are invested in a diversified portfolio of domestic and
international equity securities, fixed income securities, real estate and
alternative investments. As of June 30, 2009, the total value of the pension
assets was approximately $149 million, compared with $135 million as of
December 31, 2008. Our projected benefit obligation at December 31, 2008 was
$230 million. Due to the decline in the total asset value of the plans during
2008, 2009 funding requirements are expected to be $19 million, compared with
the $10 million annual contribution that was funded in 2008.
For a further discussion of economic conditions and their impact on UniSource
Energy, see Part II, Item 7. Management's Discussion and Analysis of Financial
Condition and Result of Operations, UniSource Energy Consolidated - Economic
Conditions in UniSource Energy and TEP's 2008 Annual Report on Form 10-K.
Environmental Matters
UniSource Energy's utility subsidiaries are subject to numerous federal, state
and local environmental laws and regulations affecting present and future
operations, including regulations regarding air emissions, water quality,
wastewater discharges, solid waste and hazardous waste.
These laws and regulations can result in increased capital, operating and other
costs, particularly with regard to enforcement efforts focused on existing power
plants and compliance plans with regard to new and existing power plants. There
are proposals and ongoing studies at the state, federal and international levels
to address global climate change that could result in the regulation of CO2 and
other greenhouse gases. There are federal strategic initiatives underway
addressing renewable energy and energy efficiency standards. The cost impact of
legislation or regulation to address these initiatives depends on the specific
legislation or regulation enacted and cannot be determined at this time although
such costs could be substantial due to TEP's use of coal as the primary fuel for
generation. We would seek rate relief in the event of the imposition of a
federal carbon tax or related federal carbon regulations.
For other environmental matters related to TEP, see Item 5. Other Information,
Environmental Matters, below.
RESULTS OF OPERATIONS
Executive Overview
2009 compared with 2008
We expect UniSource Energy's net income and results from operations to improve
in 2009 compared with 2008 due primarily to the following reasons:
• A 6% base rate increase that was effective December 1, 2008 for TEP's
customers and the implementation of a purchased power and fuel adjustment
clause (PPFAC) at TEP beginning January 1, 2009. The base rate increase
should generate approximately $50 million of additional revenue based on
2008 retail kWh sales levels, while the PPFAC allows TEP to pass through
the actual cost of fuel and purchased power costs to retail customers.
Through the first six months of 2009, TEP's retail kWh sales were 3.3%
below kWh sales levels during the same period of 2008. If sales volumes
continue to lag behind 2008 levels during the second half the year, the
additional revenue generated from the base rate increase could be less
than $50 million. As a result of the PPFAC, relative to prior periods,
TEP's net income should not be as sensitive to changes in fuel and
purchased power costs or revenues from short-term wholesale sales which
are an off-set to the recoverable PPFAC costs;
• No amortization expense related to TEP's Transition Recovery Asset (TRA) will be recorded in 2009 since that asset became fully amortized in May 2008. In 2008, TEP recorded TRA amortization of $24 million; and
• TEP will not defer recognition of any revenues subject to refund during 2009. During 2008, TEP deferred $58 million of revenue to be refunded.
These factors will be partially offset by:
• Higher operating costs due to increases in general O&M costs,
pension-related expenses and planned generating plant maintenance; and
• An increase in depreciation and amortization expense caused by an increase in plant in service, and the effects of the December 2008 TEP rate order that increased depreciation rates on certain assets and amortization expense related to certain regulatory assets.
Seasonality of Utility Operations
The net income and results of operations of UniSource Energy's utility
businesses are seasonal in nature. TEP and UNS Electric are summer-peaking
utilities and historically have recorded a majority of their net income during
the second and third quarters, when hot weather drives increases in energy
consumption. Energy demand from UNS Gas customers typically peaks during the
winter, and that company records the majority of its net income during the first
and fourth quarters.
TEP's new rates, which include higher charges for higher levels of energy use,
are expected to shift an even greater share of our earnings to summer peak
periods. Moreover, our earnings will no longer benefit from the sale of excess
energy during periods of lower consumption, including the first and fourth
quarters, since that wholesale revenue is now credited against charges included
in the new PPFAC.
Second Quarter of 2009 Compared with the Second Quarter of 2008
UniSource Energy reported net income of $31 million in the second quarter of
2009 compared with net income of $5 million in the second quarter of 2008.
The increase in UniSource Energy's net income in the second quarter of 2009 is
due primarily to: no provision for rate refunds recorded by TEP in the second
quarter of 2009 compared with $15 million in the same period last year; an
increase in retail revenues from the 6% average base rate increase that took
effect at TEP in December 2008; the PPFAC that allows TEP to collect actual fuel
and purchased power costs from retail customers; no TRA amortization expense
recorded by TEP in the second quarter of 2009 compared with $7 million in the
second quarter of 2008; and a $6 million pre-tax gain related to the sale of an
investment by Millennium. See Tucson Electric Power Company,and Other
Non-Reportable Business Segments, Results of Operations, below.
Six Months Ended June 30, 2009 Compared with the Six Months Ended June 30, 2008
UniSource Energy reported net income of $36 million for the first six months of
2009 compared with net income of $2 million in the same period last year.
The increase in UniSource Energy's net income in the first six months of 2009 is
due primarily to: the base rate increase and PPFAC at TEP; no TRA amortization
expense recorded by TEP in the first six months of 2009 compared with
$24 million in the same period last year; no provision for rate refunds recorded
by TEP in the first six months of 2009 compared with $15 million in the same
period last year; and a $6 million pre-tax gain related to the sale of an
investment by Millennium. See Tucson Electric Power Company, and Other
Non-Reportable Business Segments, Results of Operations, below.
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