ML042390223
| ML042390223 | |
| Person / Time | |
|---|---|
| Site: | Palo Verde  |
| Issue date: | 07/26/2004 |
| From: | Weikert J El Paso Electric Co |
| To: | Document Control Desk, Office of Nuclear Reactor Regulation |
| References | |
| Download: ML042390223 (105) | |
Text
P.O. Box 982 El Paso, Texas 79960-0982 (915) 543-5711 El Paso Electric Jeffrey T. Weikert Assistant General Counsel July 26, 2004 United States Nuclear Regulatory Commission Attention Document Control Desk Mail Station P1-37 Washington, D.C. 20555-0001
Subject:
Docket Nos. STN50-528/529/530 Submission of El Paso Electric Company Form 10-K Annual Report for the fiscal year ended December 31, 2002, Certified 2004 Cash Flow Projection, and Application for Withholding Information from Public Disclosure
Dear Ladies and Gentlemen:
In accordance with 10 C.F.R. § 140.21 (e), enclosed for submission to the United States Nuclear Regulatory Commission ("NRC") are the following documents:
- 1. Form 10-K Annual Report of El Paso Electric Company ("EPE") for the fiscal year ended December 31, 2003;
- 2. EPE's certified 2004 Cash Flow Projection marked "Confidential"; and
- 3. Application to the NRC pursuant to 10 C.F.R. § 2.790, including the Affidavit of Mr. Steven P. Busser, Treasurer of EPE, requesting that the Statement be withheld from public disclosure.
To maintain its confidentiality, the Statement was delivered to Pinnacle West Capital Corporation ("PWCC"), a public utility holding company and the parent company of Arizona Public Service Company ("APS"), the operating agent of the Palo Verde Nuclear Generating Station ("Palo Verde"), along with the Form 10-K and Application in a sealed envelope (915) 543-5759 - Direct 123 West Mills (915) 521-4747 - Facsimile El Paso, Texas 79901 P OLA
United States Nuclear Regulatory Commission July 26, 2004 Page 2 addressed to the NRC. By agreement, APS is forwarding the sealed envelope for submission to the NRC along with the projected cash flow statements of APS and the other Palo Verde participants. Please contact the undersigned if the seal of the EPE envelope is broken prior to your receipt.
Your assistance with this matter is appreciated in advance. If you have any questions or comments concerning this matter, please let me Je eikert cc: Mr. Steven P. Busser Mr. Juan M. Azcarate Mr. Matt Benac Mr. Stan Michaelis (915) 543-5759 - Direct 123 West Mills (915) 521-4747 - Facsimile El Paso, Texas 79901
To: Nuclear Regulatory Commission Application regarding NRC Regulation 10 C.F.R. Section 140.21(e)
El Paso Electric Company hereby applies for withholding from public disclosure the following document:
"El Paso Electric Company 2004 Cash Flow Projection" Affidavit:
I, Steven P. Busser, Treasurer of El Paso Electric Company, in my capacity as an officer of El Paso Electric Company, hereby represent, affirm, and request that the above-mentioned document, "El Paso Electric Company 2004 Cash Flow Projection" be withheld from public disclosure for the following reasons:
- 1. This information has not been released publicly;
- 2. This information is customarily held in confidence by El Paso Electric Company;
- 3. This information has not yet been transmitted to the NRC, but will be transmitted in a confidential matter;
- 4. This information cannot be constructed from any other source; and
- 5. Disclosure of this information may cause substantial harm to the El Paso Electric Company's competitive position and would give parties who have access to this information inside knowledge of El Paso Electric Company's projected operations that is not available to the general public.
Signed: _____ _ _
Ste P. Busser Treasurer El Paso Electric Company SubspleV a'dfswom to before me on this at ' day of .. Zy , 2004.
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OFFICER CERTIFICATE 1, Steven P. Busser, Treasurer of El Paso Electric Company (the "Company"), certify that the appended unaudited Cash Flow Projection for 2004 utilizes the Company's approach to projecting cash flows for internal management reporting and planning purposes. The amounts shown for January through May of 2004 reflect actual cash flow amounts for such period. The amounts shown for June through December of 2004 reflect projected cash flow amounts for such period based on the Company's projection as of the date of this certification. The Company does not undertake to update such projected amounts to reflect actual cash flow.
July 4 , 2004 _ _ _ _ _ _ _ _ _
STE1 P. BUSSER
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Securities and Records Form 10-K Report and The common stock of El Paso Electric Is Shareholder Inquiries traded on the New York Stock Exchange. A complete copy of EPE's Annual Report and form 10-K for the year The ticker symbol IsEE. ended December 31, 2003, which has been filed with the Securities and Exchange Commission, Induding financial statements and financial EPE and The Bank of New York (BONY) statement schedules, Isavailable without charge upon written request to:
act as co-registrars for EPE's common I stock. BONY maintains all shareholder Investor Relations records of EPE. El Paso Electric P.O. Box 982 El Paso, IX 79960 Or call: (800) 592-1634 E-mail: Investor relationsfepelectrlc.com Website: http:/Fwww.epelectriccom ; i i I I i j
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i4 Annual Meeting of Shareholder Services Shareholders Shareholders may obtain information relating to their share position, The annual meeting of El Paso Electrics transfer requirements, lost certificates, and other related matters by shareholders will be held at 10 a.m., contacting BONY Shareholder Services at (800) 524-4458. This service Mountain Daklfght Time on Wednesday, isavailable to all shareholders Monday through FRiday, 8 a.m. to 8p.m, ET.
May 5, 2004 at the Stanton Tower Buiding, 100 N. Stanton, El Paso, TX Address Shareholder Inquiries to:
79901. In connection wbit the meeting, The Bank of New York: Shareholder Relations proxies will be solicited by the Board of Church Street Station Directors of EPE. A notice of meeting, P.O. Box 11258 New York, NY 10286-1258 tgether with a proxy statement, a form Website: http:/wwwstxdx.com of proxy, and the Annual Report to Shareholders for 2003, were mailed on Send Certificates for Transfer and Address Changes to:
The Bank of New York: Receive and Deliver Dept or about March 31, 2004 to shareholders Church Street Station of record as of March 8, 2004. P.O. Box 11002 New York, NY 10286-1002
El Paso Electric Statements in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of El Paso Electric (EPE) from time to time, including statements contained in EPE's filings with the Securities and Exchange Commission and its reports to shareholders, involve known and unknown risks and other factors which may cause EPE's actual results in future periods to differ materially from those expressed in any forward-looking statements.
Please refer to EPE's 10-K for fiscal year ended December 31, 2003, and EPE's other 34 Act filings for a detailed discussion of these risks and uncertainties. EPE cautions that the risks and factors in such filings are not exclusive. EPE does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of EPE, except as required by law.
mn.
Annual Report
ILETTER TO THE SHAREHOLDERS We are pleased to report 2003 was a positive year for E Paso Federal Enegy Regulatory Commission (FERC) settiements with no Eectric (EPE on several fronts. Our robust cash flow supported ongoing comparable amount in2003.
improvement infinancial fundamentals; the stock pnce performed well, EPE's improving financial furdamentals continue to be recognized tracking market indices and returning to historic growth pattems; we by the financial community. In August 2003, Moodys Investor Service experienced significant improement in the wholesale market and our affirmed EPE's investment grade credit rating and changed its business customer growth in the region continued at an aboveaverage pace outlook from negative to stable. Standard & Poor's continues to rate EPE reflecting the inherent strength in our core business. We also resolved as an investment grade company with a stable outlokxk significant regulatory uncertainties at the federal and state levels, and on Although EPE exqrerienced the full-year impact of two wholesale the operations side the Palo Verde Nuclear Generating Station continued power conbacts that expired in 2002, it was successrul infinding other its exceptional performance. opportunities in the wholesale market Econny kWh sales increased During 2003, our free cash flow contributed to further 29.5 percent over 2002 levels and EPE's profit margins on economy sales improvement in our financial profile by reducing the leverage in our contributed $0.13 per share to earnings in2003. While we benefited from balance sheet and allowing us to complete the third of three share improved conditions inthe western wholesale power market in2003, and repurchase programs. EPE reduced its debt by approximately $39.4 will continue to aggressively pursue these opportunities, previous years' million in 2003, which decreased annual fixed charges on an ongoing experiences have demonstrated the inherent volatility inthis environment basis by approximately $3.2 million per year. In early 2004 EPE EPE provided some power to Mexico for peaking needs during the repurchased an additional $6 million in First Mortgage Bonds and will summer of 2003, marking the 16th consecutive year that we have sold continue to sbive towards attaining a more balanced capital structure to power to the Comisi6n Federal de Eleticidad (CFE). We continue to reduce financial risk, improve credit quality and enhance our financial work dosely with the CWE regarding its long-term energy requirements fexbiblity. EPE repurchased approximately 2.1 million common shares in and infrastructure needs.
2003, completing its 15 million share repurchase program initiated in EPE exhibited astong customer growth rate of 2.7 percent during 1999 at a purchase price of approximately $171 million. In February 2003. EPE's residential, commercial and industrial customer classes 2004, our Board of Directors authorized an additional stock repurchase experienced increased sales growth as the regional economy appeared program of up to two million shares. EPE remains committed to creating to show signs of improving during the fourth quarter. Our residential maximum value for its shareholders by pursuing its stodk repurchase segment posted annual growth inkWh sales of 3.3 percent Overall, EPE program when economically viable, strengthening its balance sheet, posted retail sales groA of 2percent far the year, which is inthe range of increasing its operating efficiencies, and seeking additional opportunities our historic level of sales. Growth in retail sales and our expanding inthe wholesale market, including Mexico. customer base enabled us to achieve a record native system peak of As a result of EPE' conse e financial policies, we have been 1,308 MW in 2003, surpassing the previous record of 1,282 MW set in able to significantly improve the Company's capital stucture. At year- the summer of 2002. We also reached a record total system peak end EPE posted a common stock equity ratio of 44 percent which demand of 1,546 MW during the year, which represents a 2.5 percent marks a dramatic improvement from the June 30, 1996 level of 19 increase over the previous record of 1,509 MW.
percent On July 23, 2003, the FERC approved a settlement agreement EPE stock tracked the performance of the utility sector and among EPE, the FERC staff and certain California intervenors, dosing the produced a one-year return of 21.36 petent, with a year-end dosing review of EPE's involvement inthe western power markets in2000 and stock price of $13.35. Over the past five-ear period, EPE stock has 2001. The U.S. Commodity Futures Trading Commission also notified significantly u tpfoe the utilities indices and the broader market, the Company that it has dosed its invesgation into EPE' western with a total return of 52.57 percent from 1998 to 2003. In comparison, power market activities during the 2000-2001 time period. The the Dow oes Industrial Average Total Return Index posted a gain of resolution of these matters allows us to refocus our efforts on our core 24.79 percent, while the S& PElectric Utilities Index and the Dow Jones business of providing electrk service to our customers.
Utilities Index have posted five-year total returns of 13.18 percent and A number of important state regulatory events also occurred 3.56 percent, respectively. The S & P500 Utilities Total Return Index during 2003 in both Texas and New Mexio. On April 8, 2003, the experienced an 11.88 percent decline from 1998 to 2003. Goveror of New Mexico signed the repeal of the New Mexico Electric In 2003, EPE reported diluted earnings per share of $0.64, before Utility Industry Restructuring Act of 1999, effectively ending a move the cumulative effect of implementing an accounting change related to toward retail competition. EPE's business inNew Mexico will continue as SFAS 143 'Accounting for Asset Retirement Obligations" and before the atraditional cost-Of-service regulated utility.
impact of a one-time Customer Information System (CIS) project In January 2004, we reached a unanimous settlement regarding impairment loss. EPE's earnings were affected by the expiration of two base and fuel rates in New Mexico. The agreement calls for a one long-term wholesale contracts and a ruling by the Public Utility percent reduction in base rates follwed by a three-year base rate Commission of Texas (PW) on EPE's fuel reconciliation case. This freeze, aslight increase inthe Palo Verde fuel-sharing mechanism which impact was partially offset by increased economy kWh sales and profit benefits our New Mexico customers, and a reconciliation of all New margins, higher retail sales, decreased loss on extinguishment of debt, Mexico fuel costs through May 31, 2004. The settlement, which is deceased MiraSol operating ioss, and by the 2002 accrual for the expected to be approved by the New Mexico Public Regulation
Commission (NMPRC) by mid-2004, provides continued rate stability in our New Mexico service territory which comprises 22 percent of our retail business.
In March 2004, the PUCT ruled on EPE's petition to reconcile fuel costs for the period from January 1999 through December 2001. EPE had filed a request to recover $15.8 million, before interest from its Texas customers because of fuel undertollections fonm 1999 to 2001.
The PUCT disallowed approximately $4.5 million of Texas jurisdictional fuel expenses, before interest the majority of which the PUCT charagdzed as imputed capacity charges. The PUCT decided all Wher material contested issues infavor of EPE. The disallowance by the PUCTr represented approximately 1.6 percent of the more than $277 million in fuel revenues at issue inthe case. The remainder of the undercollections, approximately $10.9 million plus interest, was deemed fully recmverable fuel epenses. After a written order has been issued by the PUCT, the decision will be subject to appeal by various affected parties.
Fnally, inDecember 2003, the PUCT initiated a project to evaluate the readiness of EPE's service area for retail competition. On March 4, 2004, the staff of the PUCT held a workshop hi El Paso to receive information from interested parties on how to pnoceed with intioducing retail electric competition inthe area. EPE presented an overview of the Companyls transmission and distribution operations along with specific information on the absence of various infrastnjcture and operational conditions that were contemplated by enabling legislation as EPE and its employees are not only committed to serving our preconditions to competition. Those attending the workshop generally customers with safe, effident and reliable electric service, we also have a urged the PUCT staff to address the issue of competition inthe El Paso tng-standing dedication to being a good corporate citizen and making area slowly and deliberately, making sure the right conditions exist for the communities we serve better places inwhich to live and work. During successful electric retail competition. 2003, EPE enwMyees volunteered more than 13,000 hours0 days <br />0 hours <br />0 weeks <br />0 months <br /> toward On the operations side, the Palo Verde Nuclear Generating Station community service, surpassed our United Way goals, and increased continued its record-setting performance and was once again the customer satisfaction scores over the previous year. Through their energy nation' largest power producer in2003, with an output of 28.6 billion and dedication, our empbcyees set an example of community service and kWh. This marks the twelfth consecutive year that Palo Verde has leadership for others to follow.
achieved this distinction. In addition, in February 2003, the Nuclear We are committed to continuing our conservative financial policies Regulatory Commission (NRC) completed its end-of-cycle plant and maximizing the opportunities arising from the inherent strength in performance assessment The NRC found that 'verall, Palo Verde our core business. In sum, our financial base is strong, our operational operated in a manner that preserved public health and safety and fuWy structure is stable and our corporate effort to be a good citizen in the met all cornerstone objectives." communities we serve continues to gain strength and recognition. We Several milestones were readhed during Palo Verde Unit 2s 79-day will uphold our commitment and responsibility to seek to enhance the refueling outage in 2003, including the replacement of two 800-ton value of your investment and provide our customers with the best steam generators and work on the low-pressure turbine rotors that possible service inwhatever environment we face in the coming years.
should ultimately contribute to an increase in capacity for Unit 2.The Thank ywu for the confidence and support you have given us.
plant continues to provide approximately 50 peatent of our energy at a cost well below that of new natural gas-fired generation. Gary R.Hedrick EPE and its Board of Directors are committed to ensuring all President and Chief Executive Officer business conducted by the Company and its employees is performed honestly and in strict adherence to the highest ethical practices. In response to passage of the Sarbanes-Odey Act EPE has formalized its existing practices and isdemonstrably committed to full corltance with the rlequirements ofthe Act. Our standlards of corporate governance meet the requirements of the Act, and we will continue our commitment to the George W.Edwards Jr.
Chairman of the Board highest standards inall our business dealings. Detailed information on our corporate governance standards and policies can be found on our website at www.epelectrconi.
Operating Revenues (intuowands): 2003 2001 Base Revenues:
Retail:
Residential $ 171,459 $ 166,320 $ 159,263 $ 157,341 Commercial and Industrial, Small 165,434 163,553 161,997 158,652 Commercial and Industrial, Large 43,294 43,419 43,644 44,105 Sales to Public Authorities 73,136 70,802 70,372 70,548 Total Retail 453,323 444,094 435,276 430,646 Wholesale: _
Sales for Resale 3,223 32,228 52,879 45,698 Total Base Revenues 456,546 476,322 488,155 476,344 Fuel Revenues 122,761 158,650 164,335 124,126 Economy Sales 76,536 43,654 92,452 84,918 Other 8,519 11,459 24,763 16,261 Total Operating Revenues 664,362 690,085 769,705 701,649 Number of Customers (end of year): l Residential 289,179 281,874 276,200 271,588 Commercial and Industrial, Small 30,254 29,281 28,573 27,947 Commercial and Industrial, Large 145 141 140 133 Other 4,524 4,431 4,308 4,054 Total Customers 324,102 315,727 309,221 303,722 Energy Supplied, Net, MWh: M Generated 7,740,923 7,785,938 8,183,713 8,706,790 Purchased and Interchanged 1,250,707 l 1,549,875 951,359 905,770 Total Energy Supplied 8,991,630 9,335,813 9,135,072 9,612,560 Energy Sales, MWh:
Retail: _
Residential 1,932,171 1,870,931 1,789,199 1,767,928 Commercial and Industrial, Small 2,096,860 2,076,758 2,069,517 2,026,768 Commercial and Industrial, Large 1,197,065 1,161,815 ___ 1,174,235 1,142,163 Sales to Public Authorities 1,224,349 1,212,180 1,185,521 1,177,883 Total Retail 6,450,445 6,321,684 6,218,472 6,114,742 Wholesale:
Sales for Resale 67,754 986,134 1,460,383 1,282,540 Economy Sales 1,920,882 1,483,465 929,914 1,714,288 Total Wholesale 1,988,636 2,469,599 2,390,297 2,996,828 Total Energy Sales 8,439,081 8,791,283 8,608,769 9,111,570 Losses and Company Use 552,549 544,530 526,303 500,990 Total, Net 8,991,630 9,335,813 9,135,072 9,612,560 Native System:
Peak Load, MW 1,308 1,282 1,199 1,159 Net Generating Capacity for Peak, MW 1,500 1,500 1,500 1,500 Total System:
Peak Load, MW 1,546 1,509 1,485 1,427 Net Generating Capacity for Peak, MW 1,500 1,500 1,500 1,500 System Capacity Factor 60.1% 61.1% 60.6% 66.0%
(a) Financial data Isbased on the results for the Predecessor Company for
OPERATING STATISTICS 1999 1997 1995
$ 145,618 $ 150,151 $ 146,412 $ 141,718 $ 128,294 $ 129,869 152,021 148,220 143,396 138,910 128,716 126,450 43,055 45,495 45,580 43,484 40,870 39,754 68,782 66,570 64,328 65,533 59,613 59,811 409,476 410,436 399,716 389,645 357,493 355,884 36,992 55,597 57,153 68,924 72,183 73,545 446,468 466,033 456,869 458,569 429,676 429,429 83,311 109,117 119,560 103,011 62,142 95,404 32,523 20,167 10,612 11,032 6,681 5,672 8,167 6,506 4,980 3,981 3,744 4,050 570,469 601,823 592,021 576,593 502,243 534,555 266,627 260,356 254,348 250,209 245,245 240,368 27,274 26,396 25,900 25,304 24,615 23,857 124 117 115 102 89 80 3,957 3,867 3,811 3,711 3,674 3,470 297,982 290,736 284,174 279,326 273,623 267,775 8,392,890 8,586,098 8,186,187 7,920,675 7,439,404 7,018,423 328,225 478,396 617,651 711,791 584,853 1,051,251 8,721,115 9,064,494 8,803,838 8,632,466 8,024,257 8,069,674 1,653,859 1,621,436 1,587,733 1,545,274 1,473,349 1,500,426 1,943,120 1,891,703 1,834,953 1,779,986 1,754,176 1,721,736 1,133,751 1,314,428 1,271,449 1,216,941 1,121,329 1,092,028 1,135,438 1,120,654 1,090,312 1.110,706 1,068,048 1,081,850 5,866,168 5,948,221 5,784,447 5,652,907 5,416,902 5,396,040 905,975 1,757,880 1,897,885 1,753,553 1,646,357 1,925,671 1,497,880 888,708 640,017 757,999 538,102 320,026 2,403,855 2,646,588 2,537,902 2,511,552 2,184,459 2,245,697 8,270,023 8,594,809 8,322,349 8,164,459 7,601,361 7,641,737 451,092 469,685 481,489 468,007 422,896 427,937 8,721,115 9,064,494 8,803,838 8,632,466 8,024,257 8,069,674 1,159 1,167 1,122 1,105 1,088 1,093 1,500 1,500 1,500 1,500 1,500 1,497 1,307 1,464 1,442 1,387 1,374 1,365 1,500 1,500 1,500 1,500 1,500 1,497 61.2% 61.9% 60.5% 57.2% 55.3% 56.3%
eriods prior to February 11, 1996 and the Reorganized Company thereafter.
Financial ($000)
Operating Revenues (net of enegy expenses) $ 45 9,847(a)
Retail Base Revenues $ 444,094 Economy Sales (net of fuel) $ 5,455 Net income (aftr cumulatire effect of accunin chav $ 28,967 Total Assets $1,646,9t89~
tCommon stock Dabta Earnings Per Share (diluted weighted average) $ 0.57 Market Price Per Share (year-end close) $ 11.00 Book Value Per Share 9.20 Market To Book Ratio 120%
Weighted Average Number of Shares
& Dilutive Potential Shares Outstanding 50,380,468 Number of Registered Holders 5,335 Relative Price Performance El Paso Electric vs.
S&P Electric and S&P 500 Utilities Indices 12/31/02 - 12/31/03 130%
125%
120%
115%A 110%
105% i.,.X 95%
85%
80%
_I03 6/30/03 9/30/03j.
S EE
- S&P Electrics m S&P 500 utilities
- 2003 data incdudes the one-time impact of the Customer Incnnatlon System project impairment toss of $10.7 million net of tax, or $0.22 diluted lss per share. 2002 data includes the effects of the FERC settlements of $9.5 million, net of tax or $0.19 diluted loss per share.
(a) operating Revenues (net of energy exnses) 8nr 2001 and 2002 changed from the 2002 pnesentation due to the inclusion of MraSol nevenues.
(b) Inctuded in 2003 net income and diluted earnings per share s a cumulative effect of an accounting change, net of tax, inthe amount of $39.6 million or $0.81 per diluted share.
>05_
+2003 OPERATIONAL HIGHLIGHTS Operational Retail GWh Sold
% Change Natve Peak (MW)
Customers at Year-End
% Change Employees at Year-End Generating Capacity Plant Fuel Source Palo Verde Nuclear Newman Natural Gas Rio Grande Natural Gas Copper Natural Gas Four Corners Coal Purchased Power TOTAL 1,500 MW ].ur/0 A pilot wind project began operating inApril 2001 with a capacity of 1.32 MW.
Palo Verde Capacity Factor 91% 91%93%
86% 86%
1999 2000 2001 2002 2003 Customers Served Per Employee 293299 309 324 1999 2000 2001 2002 2003
'I') (ic 7
BOARD OF DIRECTORS I I
Kenneth R.Heitz James W.Clcconi 1. Robert Brown Michael K. Parks A.Cardwell James W. Hamis Eric B. Segel Charles A. Yamarone K. Cadman George W. Edwards, Jr.
Gary R. Hedrick George W. Edwards, Jr. James W. Cicconi Patricia L Holland-Brandh Chairman of the Board General Counsel and Executive President, CEO and Owner Retired in 1995. Prior to retirement, President, Vice President Facilities Connection, Inc.
CEO and Director of Kansas City Southern Law and Government Affairs, AT&T El Paso, TX Railway Company Washington, D.C.
Kansas Oty, MO Michael K. Parks Ramiro Guzman Managing Director President Trust Company of the West J. Robert Brown Ramiro Guzman & Associates Los Angeles, CA President and Chairman of the Board El Paso, TX Desert Eagle Distributing El Paso, TX Eric B. Siegel James W. Harris Independent Investor and Wilson K. Cadman Founder and President Business Consultant Seneca Financial Group, Inc. Retired Lmited Partne of Apolo Ad&vs, LP Retired in 1992. Prior to retirement, Greenwich, Cr Los Angeles, CA Chairman of the Board, President and CEO, Kansas Gas and Electric Company, Wichita, KS and Vice Chairman of the Board of Western Gary R. Hedrick Stephen N. Wertheimer Resources, Inc. President and CEO Managing Director Topeka, KS El Paso Electric Company W Capital Management El Paso, TX Greenwich, CT James A. Cardwell Chairman of the Board and CEO Kenneth R. Heitz Charles A. Yamarone Petro Stopping Centers, LP Partner Executive Vice President El Paso, TX Irell & Manella, U.S. Bancorp Libra Securities, LLC Los Angeles, CA Los Angeles, CA Gary R. Hedrick Raul A. Carrillo, Jr. Helen Knopp President and Chief Executive Officer Senior Vice President, Vice President, Geaal Counsel and Corporate Secrtary Public Affairs Power Generation Terry Bassham Executive Vice President Steven P. Busser Kerry B. Lore Guillermo Silva, Jr.
Chief Financial and Administratve Officer Treasurer Vice President, Vice President, Fernando J. Gireud Administration Information Services J. Frank Bates Executive Vice President, Vice President, Robert C. McNiel John A. Whitacre Chief Operations Officer Power Marketing and Vice President, Vce President International Business New Mexico Affairs Transmission and Distribution Scott D. Wilson Controller
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K (Mark One) 1 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-296 El Paso Electric Company (Exact name of registrant as specified in its charter)
Texas 74-0607870 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
Stanton Tower, 100 North Stanton, El Paso, Texas 79901 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (915) 543-5711 Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which reeistered Common Stock, No Par Value New York Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act:
None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO _
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements Incorporated by reference in Part HI of this Form 10-K or any amendment to this Form 10-K. [XI Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES X NO As of June 30, 2003, the aggregate market value of the voting stock held by non-affiliates of the registrant was $586,138,226 (based on the closing price as quoted on the New York Stock Exchange on that date).
As of March 5, 2004, there were 47,588,360 shares of the Company's no par value common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for the 2004 annual meeting of its shareholders are incorporated by reference into Part III of this report.
DEFINITIONS The following abbreviations, acronyms or defined terms used in this report are defined below:
Abbreviations Acronyms or Defined Terms Terms ANPP Participation Agreement ............. Arizona Nuclear Power Project Participation Agreement dated August 23, 1973, as amended APS ........................... Arizona Public Service Company CFE .Comisi6n Federal de Electricidad de Mexico, the national electric utility of Mexico Common Plant or Common Facilities .... Facilities at or related to Palo Verde that are common to all three Palo Verde units Company................................................ El Paso Electric Company DOE ...... United States Department of Energy FASB .. . Financial Accounting Standards Board FERC. .. Federal Energy Regulatory Commission Four Corners .Four Corners Generating Station Freeze Period .............. ............. Ten-year period beginning August 2, 1995, during which base rates for most Texas retail customers are expected to remain frozen pursuant to the Texas Rate Stipulation IID .... , Imperial Irrigation District, an irrigation district in southern California kV.......................................................... .Kilovolt(s) kW.......... Kilowatt(s) kWh........................... Kilowatt-hour(s)
Las Cruces ........................... City of Las Cruces, New Mexico MiraSol ... MiraSol Energy Services, Inc., a wholly-owned subsidiary of the Company MW.............................Megawatt..s)...l, MW ......... Megawatt(s)
NMh.....Megawatt-hour(s)
New Mexico Commission ...................... New Mexico Public Regulation Commission New Mexico Restructuring Act.............. New Mexico Electric Utility Industry Restructuring Act of 1999 New Mexico Stipulation ......... Stipulation and Settlement Agreement in Case No. 03-00302-UT between the Company and all other parties to the Company's rate proceedings before the New Mexico Commission providing for a three-year freeze on base rates after an initial 1% reduction and other matters NRC ................ ........... Nuclear Regulatory Commission Palo Verde ........................... Palo Verde Nuclear Generating Station - ' ;
Palo Verde Participants ............... Those utilities who share in power and energy entitlements, and bear certain allocated costs, with respect to Palo Verde pursuant to the ANPP Participation Agreement PNM ........ Public Service Company dfNew Mexico SFAS ........ ................... Statement of Financial Accounting Standards SPS ........................... Southwestern Public Service Company TEP ....... .................... Tucson Electric Power Company Texas Comnmission ....... : Public Utility Conn issioni of Texas Texas Fuel Settlement ........................... Settlement Agreement in Texas Docket No. 23530, between the Company, the City of El Paso and various parties whereby the Company increased its fiel factors, implemented a fuel surcharge and revised its Palo Verde Nuclear Generating Station performance standards calculation Texas Rate Stipulation ........................... Stipulation and Settlement Agreement in Texas Docket No. 12700, between the Company, the City of El Paso, the Texas Office of Public Utility Counsel and most other parties to the Company's rate proceedings before the Texas Commission providing for a ten-year rate freeze and other matters Texas Restructuring Law ....................... Texas Public Utility Regulatory Act Chapter 39, Restructuring of the Texas Electric Utility Industry Texas Settlement Agreement .................. Settlement Agreement in Texas Docket No. 20450, between the Company, the City of El Paso and various parties providing for a reduction of the Company's jurisdictional base revenue and other matters TNP ........................... Texas-New Mexico Power Company (i)
TABLE OF CONTENTS Item Description Page PART I I Business. 1 2 Properties .19 3 Legal Proceedings .19 4 Submission of Matters to a Vote of Security Holders .21 PART II 5 Market for Registrant's Common Equity and Related Stockholder Matters ....... 22 6 Selected Financial Data .......................................................... 23 7 Management's Discussion and Analysis of Financial Condition and Results of Operations .................. ........................................ 24 7A Quantitative and Qualitative Disclosures About Market Risk ............................ 35 8 Financial Statements and Supplementary Data ................................................... 38 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ......................................................... 90 9A Controls and Procedures ......................................................... 90 PART III 10 Directors and Executive Officers of the Registrant ............................................. 90 11 Executive Compensation .......................................................... 90 12 Security Ownership of Certain Beneficial Owners and Management ................. 91 13 Certain Relationships and Related Transactions ................................................. 91 14 Principal Accounting Fees and Services ......................................................... 91 PART IV 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K .......... ........ 91 (ii)
- PART I Item 1. Business General El Paso Electric Company is a public utility engaged in the generation, transmission and distribution of electricity in an area of approximately 10,000 square miles in west Texas and southern New Mexico. The Company also serves wholesale customers in Texas and periodically in the Republic of Mexico. The Company owns or has significant ownership interests in six electrical generating facilities providing it with a total capacity of approximately 1,500 MW. For the year ended December 31, 2003, the Company's energy sources consisted of approximately 50% nuclear fuel, 27%
natural gas, 9% coal, 14% purchased power and less than 1% generated by wind turbines.
The Company serves approximately 324,000 residential, commercial, industrial and wholesale customers. The Company distributes electricity to retail customers principally in El Paso, Texas and Las Cruces, New Mexico (representing approximately 58% and 9%, respectively, of the Company's operating revenues for the year ended December 31, 2003). In addition, the Company's wholesale sales include sales for resale to other electric utilities and periodically sales to the CFE and power marketers.
Principal industrial and other large customers of the Company include steel production, copper and oil refining, and United States military installations, including the United States Army Air Defense Center at Fort Bliss in Texas and White Sands Missile Range and Holloman Air Force Base in New Mexico.
The Company's principal offices are located at the Stanton Tower, 100 North Stanton, El Paso, Texas 79901 (telephone 915-543-5711). The Company was incorporated in Texas in 1901. As of March 5, 2004, the 'Company had approximately 1,000 employees, 31% of whom are covered by a collective bargaining agreement. A new collective bargaining agreement, which expires June 2006, was entered into with these employees in July 2003. The Company has also begun collective bargaining negotiations with an additional 75 employees from the Company's meter reading and collections area and facilities services area who voted for union representation in 2003.
The Company makes available free of charge 'through its website, www.epelectric.com, its annual'report on Form 10-K, quarterly reports on Form 10-Q, current reports' on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such'material is electronically filed with or furnished to the Securities and Exchange Commission.
Facilities The Company's net installed generating capacity of approximately' 1,500 MW consists of approximately 600 MW from Palo Verde Units 1, 2 and 3, 482 MW from its Newman Power Station, 246 MW from its Rio Grande Power Station, 104 MW from Four Corners Units 4 and 5, 68 MW from its Copper Power Station and 1.32 MW from Hueco Mountain Wind Ranch.
Palo Verde Station The Company owns a 15.8% interest in each of the three nuclear generating units and Common Facilities at Palo Verde, in Wintersburg, Arizona. The Palo Verde Participants include the Company 1
and six other utilities: APS, Southern California Edison Company ("SCE"), PNM, Southern California Public Power Authority, Salt River Project Agricultural Improvement and Power District ("SRP") and the Los Angeles Department of Water and Power. APS serves as operating agent for Palo Verde.
The NRC has granted facility operating licenses and full power operating licenses for Palo Verde Units 1, 2 and 3, which expire in 2024, 2025 and 2027, respectively. In addition, the Company is separately licensed by the NRC to own its proportionate share of Palo Verde.
Pursuant to the ANPP Participation Agreement, the Palo Verde Participants share costs and generating entitlements in the same proportion as their percentage interests in the generating units, and each participant is required to fund its share of fuel, other operations, maintenance and capital costs. The ANPP Participation Agreement provides that if a participant fails to meet its payment obligations, each non-defaulting participant shall pay its proportionate share of the payments owed by the defaulting participant.
Decommissioning. Pursuant to the ANPP Participation Agreement and federal law, the Company must fund its share of the estimated costs to decommission Palo Verde Units 1, 2 and 3, including the Common Facilities, through the term of their respective operating licenses. The Company's decommissioning costs are estimated every three years based upon engineering cost studies performed by outside engineers retained by APS.
In accordance with the ANPP Participation Agreement, the Company is required to establish a minimum accumulation and a minimum funding level in its decommissioning account at the end of each annual reporting period during the life of the plant. In January 2003, the Company made an additional deposit of $4.7 million into the decommissioning trust fund such that the trust fund met ANPP minimum accumulation levels at December 31, 2002. The Company remained above its minimum funding level as of December 31, 2003. The Company will continue to monitor the status of its decommissioning funds and adjust its deposits, if necessary, to remain at or above its minimum accumulation requirements in the future.
In August 2002, the Palo Verde Participants approved the 2001 Palo Verde decommissioning study. Some changes in the cost calculations occurred between the prior 1998 study and the 2001 study.
The 2001 study estimated that the Company must fund approximately $311.6 million (stated in 2001 dollars) to cover its share of decommissioning costs. The previous cost estimate from the 1998 study estimated that the Company would fund approximately $280.5 million (stated in 1998 dollars). The 2001 estimate reflects an 11. 1% increase, or 3.6% average annual compound increase, from the 1998 estimate primarily due to increases in estimated costs for site restoration at each unit, pre and post-shutdown transitioning and decommissioning preparations, spent fuel storage after operations have ceased and the Unit 2 steam generator storage. The decommissioning study is stated in 2001 dollars and makes no inflation assumptions. See "Spent Fuel Storage" below.
Although the 2001 study was based on the latest available information, there can be no assurance that decommissioning cost estimates will not continue to increase in the future or that regulatory requirements will not change. In addition, until a new low-level radioactive waste repository opens and operates for a number of years, estimates of the cost to dispose of low-level radioactive waste are subject to significant uncertainty. The decommissioning study is updated every three years and a new study is expected to be completed in 2004. See "Disposal of Low-Level Radioactive Waste" below.
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Historically, regulated utilities such as the Company have been permitted to collect in rates' the costs of nuclear decommissioning. -Under the Texas Resfructuring Law,: which, among other things, deregulates generation services, the Company, through dn affiliat&d transmission and distribution utility, will be able to collect from customers the costs of decommissioning. The collection mechanism utilized in Texas is a "non-bypassable wires charge" through which all customers, even those who choose to purchase energy from a supplier other than the Company's retail affiliate, will be required to pay a fee, which includes the cost of nuclear decommissioning;- to the Company's affiliated transmission and distribution utility. 'In the Company's case;-collection of-the fee through the"Companys.transmission and distribution utility will begin'in-Texas if and when retail competition is implemented in the Company's Texas service territory. See "Regulation - Texas;Regulatory Matters -. Deregulation" for further discussion. .
Spent Fuel Storage. The original spent fuel storage facilities at Palo Verde had sufficient capacity to store all fuel discharged from normal operation of all three Palo Verde units through 2003.
Alternative ori-site. storage' facilities and casks have been constructed to supplement the original facilities. In -March 2003, APS began removing spent fuel from the original facilities as necessary, and placing it in special storage casks which are stored at the new facilities until it is accepted by the DOE for permanent disposal. The 2003 decommissioning study assumes that costs to store fuel on-site will become the responsibility of the DOE after 2037.- APS believes that :spent fuel storage or disposal methods 'will be available -f6r use by Palo -Verde to allow its continued operation'through the term of the operating license for each Palo Verde unit.:
Pursuant to the Nuclear Waste Policy Act of 1982, as ameided in 1987 (the "Waste Act"), the DOE is legally obligated to accept and dispose of all spent nuclear fuel 'and other high-level radioactive waste generated by all domestic power reactors. In accordance with the Waste Act, the DOE entered into a spent nuclear fuel contract with the Company and all other Palo Verde Participants. The DOE has previously reported that its spent nuclear fuel. disposal facilities would not be in operation until 2010.
Subsequent judicial decisions required the DOE to start accepting spent nuclear fuel by January 31, 1998. 'The DOE did not meet that deadline, and the Conipany. cannot currently predict when spent fuel shipments to the DOE's permanent disposal site will commence. .
The Company expects to incur significant on-site spent fuel storage costs during the life of Palo Verde that the Company believes -are the responsibility of the DOE.' These costs will be amortized over the burn period of the fuel that wilLnecessitate the use of the alternative on-site' storage facilities until an agreement is reached with the DOE for irecoveryof these costs.- In December 2003, APS, in conjunction With -other'nuclear plant operators, filed suit against the DOE on behalf of the Palo Verde Participants to recover monetary damage's assbciated-with the delay; in the DOE's acceptance of spent fuel. The Company is unable to predict the outcome of these matters at this time.
1
! - ;,' ,- a, ' 1 ;jj : i - ,a,. , :Xs A a Disposal of Low-Level 'Radioactive Waste, Congress has established requirements for the disposal by each state .of low-level radioactive waste 'generated within its borders. Arizona, California, North Dakota'and South Dakota have entered :into.a.compact (the "So'uthwestern Compact") for the disposal of low-level radioactive waste. -California will act, as the first host state of the Southwestern Compact, and Arizona - will. serve as ithe second host state. . The construction and opening of the California low-level radioactive waste'disposal site in Ward Valley has been delayed due to extensive public hearings, disputes over environmental issues and* review of technical issues related to the 3
proposed site. Palo Verde is projected to undergo decommissioning during the period in which Arizona will act as host for the Southwestern Compact. The opposition, delays, uncertainty and costs experienced in California demonstrate possible roadblocks that may be encountered when Arizona seeks to open its own waste repository. APS currently believes that interim low-level waste storage methods are or will be available for use by Palo Verde to allow its continued operation and to safely store low-level waste until a permanent disposal facility is available.
Steam Generators. Palo Verde has experienced degradation in the steam generator tubes of each unit. The projected service lives of the Palo Verde steam generators are reassessed by APS periodically in conjunction with inspections made during scheduled outages at the Palo Verde units. New steam generators were installed at Unit 2 during 2003 at an estimated total cost to the Company of
$47.1 million. This replacement was based on an analysis of the net economic benefit from expected improved performance of the unit and the need to realize continued production from that unit over its full licensed life.
APS has identified accelerated degradation in the steam generator tubes in Units 1 and 3 and has concluded that it is economically desirable to replace the steam generators at those units. While analyses related to timing of installation of steam generators at Units 1 and 3 are ongoing, the Company and the other participants approved the expenditure of $202.1 million (the Company's portion being
$31.9 million) for fabrication and transport of steam generators for Units 1 and 3. In addition, APS has proposed, and the participants have approved the expenditure of $28.4 million (the Company's portion being $4.5 million) for pre-installation and power uprate work for Units 1 and 3. In addition to these approved amounts, the installation of the Units I and 3 replacement steam generators and the completion of power uprates at those units will require the expenditure of $278.6 million (the Company's portion being $44.0 million). Present plans are for replacement steam generators to be installed at Units 1 and 3 in 2005 and 2007, respectively.
The eventual total cash expenditures for steam generator replacement for Units 1, 2 and 3 is currently estimated to be $718.9 million excluding replacement power costs (the Company's portion being $113.6 million). As of December 31, 2003, the Company has paid approximately $46.7 million of such costs. The remaining balance is expected to be paid over the course of the steam generator replacements. The Company expects its portion will be funded with internally generated cash.
The Texas Rate Stipulation precludes the Company from seeking a rate increase to recover additional capital costs incurred at Palo Verde during the Freeze Period. The Company cannot assure that its wholesale power rates and its competitive retail rates will be sufficient to recover its costs when or if retail competition for generation services begins. See also Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview."
Liability and Insurance Matters. In 1957, Congress enacted the Price-Anderson Act as an amendment to the Atomic Energy Act of 1954 to provide a system of financial protection for persons who may be injured or persons who may be liable for a nuclear incident. The Price-Anderson Act expired on December 31, 2003. Existing licensees, such as the Company, are grandfathered and will continue to be subject to the provisions of the Price-Anderson Act in the event Congress does not reauthorize the Price-Anderson Act. The Price-Anderson Amendments Act of 2003 has been placed on the legislative calendar under general order (Calendar No. 422). If passed the Act will amend the Atomic Energy Act to: (i) increase from $63 million to $94 million the maximum amount of standard 4
deferred premiums charged a licensee following any nuclear incident under an industry retrospective rating plan; and (ii) increase from $10 million to $15 million (adjusted for inflation) in any one year the maximum amount of such premiums for each facility for which the licensee must maintain the maximum amount of primary financial protection. The amount of DOE indemnification currently available under the act is $9.4 billion. Additionally, the Palo Verde Participants have public liability insurance against nuclear energy hazards up to the full limit of liability under the Price-Anderson Act.
The insurance consists of $200 million of primary liability insurance provided by commercial insurance carriers, with the balance being provided by an industry-wide retrospective assessment program, pursuant to which industry participants would be required to pay a retrospective assessment to cover any loss in excess of $200 million. Presently, the maximum retrospective assessment per reactor for each nuclear incident is approximately $88.1 million, subject to an annual limit of $10 million per incident.
Based upon the Company's 15.8% interest in Palo Verde, the Company's maximum potential retrospective assessment per incident is approximately $41.8 million for all three units with an annual payment limitation of approximately $4.7 million.
The Palo Verde Participants maintain "all risk" (including nuclear hazards) insurance for damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.8 billion, a substantial portion of which must first be applied to stabilization and decontamination. The Company also has obtained insurance against a portion of any increased cost of generation or purchased power which may result from an accidental outage of any of the three Palo Verde units if the outage exceeds 12 weeks.
Newman Power Station The Company's Newman Power Station, located in El Paso, Texas, consists of three steam-electric generating units and one combined cycle generating unit with an aggregate capacity 'of approximately 482 MW. The units operate primarily on natural gas but can also operate on fuel oil.
Rio Grande Power Station
-The Company's Rio Grande Power Station, located in Sunland Park, New Mexico, adjacent to El Paso, Texas,, consists of three steam-electric generating units with an aggregate capacity of approximately 246 MW. The units operate primarily on natural gas but can also operate on fuel oil.
Four Corners Station The Company owns a 7% interest, or approximately 104 MW, in Units 4 and 5 at Four Corners, located in northwestern New Mexico. Each of the two coal-fired generating units has a total generating capacity of 739 MW. The Company shares power entitlements and certain allocated costs of the two units with APS (the Four Corners operating agent) and the other participants, PNM, TEP, SCE and SRP.
Four Corners is located on land held on easements from the federal government and a lease from the Navajo Nation that expires in 2016, with a one-time option to extend the term for an additional 25 years. Certain of the facilities associated with Four Corners, including transmission lines and almost all of the contracted coal sources, are also located on Navajo land. Units 4 and 5 are located adjacent to a surface-mined supply of coal.
5
Copper Power Station The Company's Copper Power Station, located in El Paso, Texas, consists of a 68 MW combustion turbine used primarily to meet peak demands. The unit operates primarily on natural gas but can also operate on fuel oil. The Company leased the combustion turbine until December 2003 at which time the facilities were purchased at a total purchase price of $8.4 million, which included the balance of any remaining payments under the lease.
Hueco Mountain Wind Ranch The Company's Hueco Mountain Wind Ranch, located in Hudspeth County, east of El Paso County and adjacent to Horizon City, currently consists of two wind turbines with a total capacity of 1.32 MW.
Transmission and Distribution Lines and Agreements The Company owns or has significant ownership interests in four major 345 kV transmission lines in New Mexico, three 500 kV lines in Arizona, and owns the transmission and distribution network within its New Mexico and Texas retail service area and operates these facilities under franchise agreements with various municipalities. The Company is also a party to various transmission and power exchange agreements that, together with its owned transmission lines, enable the Company to deliver its energy entitlements from its remote generation sources at Palo Verde and Four Corners to its service area. Pursuant to standards established by the North American Electric Reliability Council and the Western Electricity Coordinating Council, the Company operates its transmission system in a way that allows it to maintain system integrity in the event that any one of these transmission lines is out of service.
Springerville-Diablo Line. The Company wholly owns a 310-mile, 345 kV transmission line from TEP's Springerville Generating Plant near Springerville, Arizona, to the Luna Substation near Deming, New Mexico, and to the Diablo Substation near Sunland Park, New Mexico. This transmission line provides an interconnection with TEP for delivery of the Company's generation entitlements from Palo Verde and, if necessary, Four Corners.
Arroyo-West Mesa Line. The Company wholly owns a 202-mile, 345 kV transmission line from the Arroyo Substation located near Las Cruces, New Mexico, to PNM's West Mesa Substation located near Albuquerque, New Mexico. This is the primary delivery point for the Company's generation entitlement from Four Corners, which is transmitted to the West Mesa Substation over approximately 150 miles of transmission lines owned by PNM.
Greenlee-Newman Line. The Company owns 40% of a 60-mile, 345 kV transmission line between TEP's Greenlee Substation near Duncan, Arizona to the Hidalgo Substation near Lordsburg, New Mexico, approximately 57% of a 50-mile, 345 kV transmission line between the Hidalgo Substation and the Luna Substation and 100% of an 86-mile, 345 kV transmission line between the Luna Substation and the Newman Power Station. These lines provide an interconnection with TEP for delivery of the Company's entitlements from Palo Verde and, if necessary, Four Corners. The Company owns the Afton 345 kV Substation located approximately 57 miles from the Luna Substation on the Luna-to-Newman portion of the line which interconnects a generator owned and operated by PNM.
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AMRlAD-Eddy County Line. The Company owns 66.7% of a 125-mile, 345 kV transmission line from the AMRAD Substation near Oro Grande, New Mexico, to the Company's and TNP's high voltage direct current terminal at the Eddy County*Substation near Artesia, New Mexico. This terminial enables the Company to connect its transmission system to that of SPS, providing the Company witliaccess to purchased'and emergency power from SPS and power markets to the eas't. '" '
Palo Verde Transmission and Switchyard. The Company owns 18.7% of two :45-mile, 500 kV lines frtom' Palo Verde to the Westwing Substation located northwest of Phoenix near Peoria, Arizota and 18:7% of a 75-mile, 500 kV line from Palo Verde to the Kyrene Substation located near Tempe, Arizona.' These lines' provide the Company with a transmission path for delivery of power from Pialo Verde. the Company also owns 18.7% of two 500 kV switchyards connected to the Palo Verde-Kyreii 500 kV' tine: the Hassayamp'a switchyard' adjacent to the southern edge of 'the -Palo, Verde' 500 kV swithhyard and the Joj oba switchyard approximately 24 miles from Palo Verde. These'switchyards were built to accommodate the addition of new generation and transmission ifithe Palo Verde 'area.'. '
Environmental Matters .
The Company is subject to regulation with respect to air, soil and water quality, solid waste disposal and other environmental matters by federal, state, tribal and local authorities. Those authorities govern current facility operations 'and have continuing jurisdiction over facility modifications. Failure to comply with these environmental regulatory requirements can result in a'ctions by regulatory agencies or other authorities that might seek to impose on the Company administrative, civil, and/or criminal penalties. In addition, unauthorized releases of pollutants or contaminants into the,-environment can result in costly cleanup obligations that are subject to enforcement by the regulatory agencies.
Environmental regulations can change rapidly and are,often difficult to predict. While the Company strives to prepare' for and implement changes necessary to comply with changing environmental regulations, substantial expenditures may be required for the Company to comply with such regulations in the future.
The Company analyzes the costs of its obligations arising from environmental matters on an ongoing basis and believes it has made adequate provision, in its financial statements to meet such obligations. As a result of this analysis, the Company has a provision for environmental remediation obligations of approximately $0.2 milion as of December 31, 2Q03, which is related to compliance with federal and state environmental standards. Hloweyer, unforeseen expenses associated with compliance could have a material adverse effect on the future operations and financial condition of the Company.
The Company is not aware of any active investigation of its compliance with environmental requirements by the Environmental Protection Agency, the Texas Commission on Environmental Quality, or the New Mexico Environment Department. Furthermore, the Company is not aware of any unresolved, potentially material liability it would face pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, also known as the Superfund law.
7
Construction Program Utility construction expenditures reflected in the following table consist primarily of expanding and updating the transmission and distribution systems and the cost of capital improvements and replacements at Palo Verde and other generating facilities, including the fabrication and shipment of Palo Verde Units 1 and 3 steam generators. Replacement power costs expected to be incurred during replacements of Palo Verde steam generators are not included in construction costs. Preliminary studies indicate that the Company will need additional supply-side and demand-side resources in 2006 to meet increasing load requirements on its system. As a result, the Company released a Request for Proposals
("RFP") seeking bids to supply 150 MW of additional resources beginning in 2006 and an additional 100 MW beginning in 2009. Responses to the Company's RFP have been received and analyzed. Based on the analysis of the RFPs received to date, it does not appear as if the selection will require the use of cash by the Company to construct a facility to obtain power for its 2006 requirements. The Company is still evaluating its 2009 requirements.
The Company's estimated cash construction costs for 2004 through 2007 are approximately
$277.0 million. Actual costs may vary from the construction program estimates shown. Such estimates are reviewed and updated periodically to reflect changed conditions.
By Year (1)(2) By Function (In millions) (In millions) 2004 .................... $ 74 Production (1)(2) .................. $ 90 2005 ................... 63 Transmission ................... 19 2006 ................... 71 Distribution ................... 127 2007 ................... 69 General ................... 41 Total ................... $ 277 Total .................... $. 277 (1) Does not include acquisition costs for nuclear fuel. See "Energy Sources -
Nuclear Fuel."
(2) Includes $21.8 million for local generation, $9.2 million for the Four Corners Station, $59.8 million for the Palo Verde Station (of which
$33.7 million relates to the fabrication and shipment of the steam generators for Units 1 and 3). Excludes $44.0 million for the installation of Palo Verde Units I and 3 steam generators, which have yet to be approved by the Palo Verde Participants.
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Energy Sources General The following table summarizes the percentage contribution of nuclear fuel, natural gas, coal and purchased power to the total kWh energy mix of the Company. Energy generated by wind turbines accounted for less than 1% of the total kWh energy mix.
Years Ended December 31, Power Source 2003 2002 2001 Nuclear fuel ....................................... 50% 52% 49%
Natural gas ...... : ............. 27 25 32 Coal ........................................ 9 6 8 Purchased power ........... ............................ 14 17 11 Total ....... 1.% . .% 100%
Allocated fuel and purchased power costs are generally passed through directly to customers in Texas and New Mexico pursuant to applicable regulations. Historical fuel costs and revenues are reconciled periodically in proceedings before the Texas and New Mexico Commissions to determine whether a refund or surcharge based on such historical costs and revenues is necessary. See "Regulation
- Texas Regulatory Matters" and "-New Mexico Regulatory Matters."
Nuclear Fuel The nuclear fuel cycle for Palo Verde consists of the following stages: the mining and milling of uranium ore to produce uranium concentrates; the conversion of the uranium concentrates to uranium hexafluoride ("conversion services"); the enrichment of uranium hexafluoride ("enrichment services");
the fabrication of fuel assemblies ("fabrication services"); the utilization of the fuel assemblies in the reactors; and the storage and disposal of the spent fuel. The Palo Verde Participants have contracts in place that will furnish 100% of Palo Verde's operational requirements for uranium concentrates, conversion services and enrichment services through 2008. Such contracts could also provide 100% of enrichment services in 2009 and 2010. The Palo Verde Participants have a contract for fabrication services through 2015 for each Palo Verde unit.
Nuclear Fuel Financing. Pursuant to the ANPP Participation Agreement, the Company owns an undivided interest in nuclear fuel purchased in connection with Palo Verde. The Company has available a total of $100 million under a revolving credit facility that provides for both working capital and up to
$70 million for the financing of nuclear fuel. At December 31, 2003, approximately $42.2 million had been drawn to finance nuclear fuel. This financing is accomplished through a trust that borrows under the credit facility to acquire and process the nuclear fuel. The Company is obligated to repay the trust's borrowings with interest and has secured this obligation with First Mortgage Collateral Series Bonds. In the Company's financial statements, the assets and liabilities of the trust are consolidated and reported as assets and liabilities of the Company.
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Natural Gas The Company manages its natural gas requirements through a combination of a long-term supply contract and spot market purchases. The long-term supply contract provides for firm deliveries of gas at market based index prices. In 2003, the Company's natural gas requirements at the Rio Grande Power Station were met with both short-term and long-term natural gas purchases from various suppliers.
Interstate gas is delivered under a firm transportation agreement which expires in 2005 but which is expected to continue beyond 2005. The Company anticipates it will continue to purchase natural gas at spot market prices on a monthly basis for a portion of the fuel needs for the Rio Grande Power Station for the near term. The Company will continue to evaluate the availability of short-term natural gas supplies versus long-term supplies to maintain a reliable and economical supply for the Rio Grande Power Station.
Natural gas for the Newman and Copper Power Stations was primarily supplied pursuant to an intrastate natural gas contract that expires in 2007. The Company will also continue to evaluate short-term natural gas supplies to maintain a reliable and economical supply for the Newman and Copper Power Stations.
Coal APS, as operating agent for Four Corners, purchases Four Corners' coal requirements from a supplier with a long-term lease of coal reserves owned by the Navajo Nation. APS, on behalf of the Company and the other Four Corners Participants, has extended the Four Corners coal contract with the supplier to 2016 to coincide with the Four Corners Plant lease with the Navajo Nation. Based upon information from APS, the Company believes that Four Corners has sufficient reserves of coal to meet the plant's operational requirements for its useful life.
Purchased Power To supplement its own generation and operating reserves, the Company engages in firm and non-firm power purchase arrangements which may vary in duration and amount based on evaluation of the Company's resource needs and the economics of the transactions. The Company purchased 103 MW of firm energy in 2003 and will continue to purchase an identical annual amount through 2005 based on a purchase agreement entered into in 2001. This agreement includes demand, energy and transmission charges. Other purchases of shorter duration were made primarily to replace the Company's generation resources during planned and unplanned outages.
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Operating Statistics Years Ended December 31.
2003 2002 2001 Operating revenues:
Base revenues:
Retail:
Residential .................................. S171,459 $ 166,320 $ 159,263 Commercial and industrial, small............. ..... 165,434 163,553 161,997 Commercial and industrial, large.............. .... 43,294 43,419 43,644 Sales to public authorities ....... .............. J 3i13 70Q,802 70Q322 Total retail base revenues ....... I.......... . 453,323 444,094 435,276
-Wholesale: I..
Sales for resale........................ ...... . 3223 3228.5,7, Total base revenues ................... . ...... 456,546 ~ 476,322 . 488,155.-
Fuel revenues.............il........................ . 122,761 158,650.. 164,335, Ecnm ales...53 43,654 9,5 Other. lI,24,763' !
Total operating reven~ues .. $ 6432 L..................... _79 Number of customers (end of year):j Residential ;............ ............ 289,179 281,874 -276,200 Commercial and industrial, small................ . ...... 30,254 29,281 28,573 Commercial and industrial, large................... .... 145 141 1140 Other............................................ 4,524 4i41 430 Total................................................
Average annual kWh use per residential customer.................2 Energy supplied, niet,' kWh: (in thousands):
,Generated .. i........." ........ 7,740,923 7,785,938 8,183,713 Purchased and interchanged . .................... I.... 1,50,07 ITotal . .......;... ...........................
Energy sales, kWh (in thousands):
Reta i: ta ..................................... 1,932,171 1,870,931 1,789,199 Commercial and industrial, small ..~. ..... .... ..... 2,096,860 2,076,758 2,069,517 Commercial and industrial, large... 1,197,065 .I 1161,815 -1,174,235 Sales to public authorities..; . ..... ..... ..... ,224,349~ 1.212.180 1,185521 Total retail .......... 6450,445 6,2,8 6,1A Wholesale:--
Sae or resale ......................... 67,754 986,134 1,638 Saeoom saef j~2 2~ 6 9j4638 Total wholesale.. ......... ............ 1,8,'3 2~,46 99 -'239,297 Total energy sales ................. 8,439,081. 8,791,283 _:8,608,769 Losses and Company use ........................ 5,4 54453 526Q30 Total ............ U9135,022 Native system:
Peak load, kW ..................................... 1,308,000 1,282,000 1,199,000 Net generating capacity for peak, kW...................... 1.~ 1 Q50Q JL5QQMQ Total system:~
Pei oaiW 1.1546,000 1`509,O00 -1,485,000 Net generating capacity for peak, kW (2) ............ '1500,000. 1,500,000 .1,500,000:
System capacity factor (3). .... ... ........... . . % ~ jA % ~ Q%
(1) Includes spot firm sales of 355,000 kW, 150,000 kW. and 60,000 kWfor 2003, 2002 and 200 1, espectively.
(2). Excludes 103,0010 kW, 153,000 kW and 163,000 kW of firm on and off-peak purchases for 2003, 20.02 and 2001, Respectively.
(3 ytmcpct atricue vrge firm systm pchases of 103,000 kw, 143,000 kW, and 123,000 kW for 2003, 2002 and 200 1, 'respectively
Regulation General In 1999, both the Texas and New Mexico legislatures enacted electric utility industry restructuring laws requiring competition in certain functions of the industry and ultimately in the Company's service area. In Texas, the Company is exempt from the requirements of the Texas Restructuring Law, including utility restructuring and retail competition, until the expiration of the Freeze Period in August 2005. In April 2003, the New Mexico Restructuring Act was repealed and as a result, the Company's operations in New Mexico will continue to be fully regulated. The Company cannot predict at this time the full effects the repeal of the New Mexico Restructuring Act will have on the Company as it prepares for retail competition in Texas. However, the Company believes that the New Mexico Commission will have to approve the separation of the Company's operations if and when the Company implements utility restructuring and retail competition for compliance with the Texas Restructuring Law.
Federal Regulatory Matters FederalEnergy Regulatory Commission. The FERC has been conducting an investigation into potential manipulation of electricity prices in the western United States during 2000 and 2001. On August 13, 2002, the FERC initiated a Federal Power Act ("FPA") investigation into the Company's wholesale power trading in the western United States during 2000 and 2001 to determine whether the Company engaged in misconduct and, if so, to determine potential remedies. The Company reached settlements with the FERC and other parties in 2002 and 2003. Under the terms of the settlements, the Company agreed to refund a total of $15.5 million of revenues it earned on wholesale power transactions. In July 2003, the FERC approved the settlements and on August 5, 2003, the Company deposited the $15.5 million into an interest bearing escrow account to consummate the settlements. The Company believes the FERC's order resolved all issues between the FERC and the other parties to this investigation. Under the settlements, the Company has agreed to make wholesale sales pursuant to its cost of service rate authority rather than its market-based rate authority for the period December 1, 2002 through December 31, 2004. This agreement allows the Company to sell power into wholesale markets at its incremental cost plus $21.11 per MWh. To the extent that wholesale market prices exceed these agreed upon amounts, the Company will forego the opportunity to realize these additional revenues.
Although this provision has not had a significant impact on the Company's revenues through December 31, 2003, the Company is unable to predict the effect, if any, this will have on the Company's 2004 revenues.
RTOs. FERC's rule ("Order 2000") on Regional Transmission Organizations ("RTOs") strongly encourages, but does not require, public utilities to form and join RTOs. The Company is an active participant in the development of WestConnect, formerly known as the Desert Southwest Transmission and Reliability Operator. As a participating transmission owner, the Company will ultimately transfer operational authority of its transmission system to WestConnect subject to receiving any necessary regulatory approvals. On October 10, 2002, FERC issued an order indicating that the Company's WestConnect proposal satisfied, or with certain modifications would satisfy, the FERC requirements for an RTO under Order 2000. WestConnect will continue to work with the FERC and two other proposed RTOs in the west to achieve a seamless market structure. The Company, however, is anticipated to be 12
no more than a 9% participant in WestConnect and cannot control the terms or timing of its establishment. WestConnect will not be operational before the end of the Freeze Period. The establishment of an RTO in the Company's service area is an important factor in the Company's ability to establish a Qualified Power Region as defined in the Texas Restructuring Law and the timing of the operations of WestConnect could affect when and whether the Company's Texas service territory participates in the Texas deregulated market.
Department of Energy. The DOE regulates the Company's exports of power to the CFE in Mexico pursuant to a license granted by the DOE and a presidential permit. The DOE has determined that all such exports over international transmission lines shall be made in accordance with Order No. 888, which established the FERC rules for open access.
The DOE is authorized to assess operators of nuclear generating facilities a share of the costs of decommissioning the DOE's uranium enrichment facilities and for the ultimate costs of disposal of spent nuclear fuel. See "Facilities - Palo Verde Station - Spent Fuel Storage" for discussion of spent fuel storage and disposal costs.
Nuclear Regulatory -Commission. The NRC has jurisdiction over the Company's licenses for Palo Verde and regulates the operation of nuclear generating stations to protect the health and safety of the public from radiation hazards. The NRC also has the authority to conduct environmental reviews pursuant to the National Environmental Policy Act.
Texas Regulatory Matters The rates and services of the Company are regulated in Texas by municipalities and by the Texas Commission. The largest municipality in the Company's service area is the City of El Paso. The Texas Commission has exclusive appellate jurisdiction to review municipal orders and ordinances regarding rates and services within municipalities in Texas and original jurisdiction over certain other activities of the Company. The decisions of the Texas Commission are subject to judicial review.
Deregulation. The Texas Restructuring Law required certain investor-owned electric utilities to separate power generation activities from transmission and distribution activities by January 1, 2002, and on that date, retail competition for generation services was instituted in some parts of Texas. The Texas Restructuring Law, however, specifically recognized and preserved the Company's Texas Rate Stipulation and Texas Settlement Agreement by, among other things, exempting the Company's Texas service area from retail competition until the end of the Freeze Period. The Texas Commission recently opened a project (Project No. 28971) to evaluate the readiness of the Company's service area in Texas for retail. competition for generation services. In this project, the Texas Commission may specify in advance the factors that are important in deciding when and whether to open the Company's service area in Texas to customer choice. One of the key factors that will likely be utilized by the Texas Commission in its determination is the progress .that has been made in developing an RTO in the Company's service area. Public hearings to discuss the readiness of the Company's service area were held on March 4, 2004 in El Paso and will be held in Austin in April 2004. There is substantial uncertainty about both the regulatory framework and market conditions that will exist if and when retail competition is implemented in the Company's service territory and. the Company may incur substantial preparatory, restructuring and other costs that may not ultimately be recoverable. There can be no assurance that 13
deregulation will not adversely affect the future operations, cash flows and financial condition of the Company.
Fuel. Although the Company's base rates are frozen in Texas, pursuant to Texas Commission rules and the Texas Rate Stipulation, the Company can request adjustments to its fuel factor to more accurately reflect projected energy costs associated with providing electricity and seek recovery of past undercollections of fuel revenues, subject to periodic final review by the Texas Commission in fuel reconciliation proceedings.
On March 10, 2004, the Texas Commission announced its decision in PUC Docket No. 26194, a case in which the Company sought to reconcile its Texas jurisdictional fuel costs for the period January 1, 1999 through December 31, 2001. At issue was the Company's request to recover an additional $15.8 million, before interest, from its Texas customers as a surcharge because of fuel undercollections from January 1999 through December 2001. The Texas Commission disallowed approximately $4.5 million of Texas jurisdictional expenses, before interest, consisting primarily of (i) approximately $4.2 million of purchased power expenses which the Texas Commission characterized as "imputed capacity charges," and (ii) approximately $0.3 million in fees which were deemed to be administrative costs, not recoverable as fuel. In Texas, capacity charges are not eligible for recovery as fuel expenses, but are to be recovered through the Company's base rates. As the Company's base rates were frozen during the time period in question, the $4.2 million of "imputed capacity charges" would be permanently disallowed, and hence not recoverable from its Texas customers.
The Texas Commission's decision modifies the Proposal for Decision issued September 19, 2003 by the Administrative Law Judges ("ALJs"). The ALJs had recommended that approximately
$21.2 million of the Company's purchased power expense should be disallowed as imputed capacity charges and not recovered from Texas jurisdictional customers.
The Company has incurred similar purchased power costs for the fuel reconciliation period beginning January 1, 2002. The Company believes that it has accounted for its purchased power costs during the reconciliation period beginning January 2002 in a manner consistent with the Texas Commission's decision in PUC Docket No. 26194. However, the Texas Commission has indicated its desire to conduct a generic rulemaking proceeding to determine a statewide policy for the appropriate pricing of capacity in purchased power contracts. There can be no assurance, however, as to the outcome of such rulemaking and the potential impact on the Company with respect to fuel recovery in future reconciliation periods if the Texas Commission adopts a different methodology in a subsequent rulemaking proceeding.
The Texas Commission's decision is subject to appeal by the various parties and the Company is unable to predict the ultimate outcome of any appeals that may be filed in this case.
Palo Verde Performance Standards. The Texas Commission established performance standards for the operation of Palo Verde pursuant to which each Palo Verde unit is evaluated annually to determine whether its three-year rolling average capacity factor entitles the Company to a reward or subjects it to a penalty. The capacity factor is calculated as the ratio of actual generation to maximum possible generation. If the capacity factor, as measured on a station-wide basis for any consecutive 24-month period, should fall below 35%, the Texas Commission can also reconsider the rate treatment 14
of Palo Verde, regardless of the; provisions of the Texas Rate Stipulation and the Texas Settlement Agreement. The removal of Palo Verde from rate base 'could have a significant negative impact on the Company's revenues and financial condition. Under the performance standards as modified by the Texas Fuel Settlement, the Company has calculated the performance awards for the reporting periods ending in 2003, '2002 and 2001 to':be approximately'-$0.8 million, $1.3 million and'$1.1 million, respectively.
These rewards will be included, along with energy costs incurred and .revenues billed,: as part of the Texas Commission's review during a future periodic:fuel reconciliation proceeding as discussed above.
Performance rewards are not recorded on the Company's books until the Texas Commission has ordered a; final determination in a fuel proceeding or comparable. evidence of collectibility is obtained.
Performance penalties are recorded when'assessed as probable by the Company.
Texas Renewable Energy Requirement. Chapter 39 of the Public Utility Regulatory Act
("PURA"), implemented by Senate Bill 7 in the .1999 legislative session, requires that, by January 1; 2009, an additional 2,000 'M\Vof generating capacity from renewable energy technologies be installed in the state. 'The renewable energy requirement is. to be added in increments with the cumulative installed renewable capacity in Texas totaling 1,703 MW. by January 1, 2005, 2,280 MW by January 1,'2007, and 2,880 MW by January. 11. 2009. The requirements of this goal are placed on retail'electric providers
("REPs"), who provide competitive retail electric, service inwthe state of Texas. Utilities that have not implemented retail competition may have renewable energy requirements based on orders.of the Texas Commission.
Until the end of the Freeze Period, the Company is exempt from PURA Chapter'39 and Texas Commission rules -implementing the renewable requirements. However, once the Freeze Period ends, ahy renewable energy requirement applicable to: the Company could be based on the percentage of the competitive retail load that will be served bythe Company (or the Company's REP) in relation to the total competitive ,retail load served in Texas. 'It is not clear when the 'Company will need to meet a renewable energy requirement in iTexas or What the obligation will 'be.. The Company is currently reviewing, the outcome of its New Mexico; RFPs, for renewable energy to-assess possible scenarios for meeting possible future Texas requirements, which includes the purchase of renewable power and/or credits.'
New Mexico Regulatory Matters The New Mexico Commission has jurisdiction over the Company's rates and services in New Mexico and over certain other activities of the Company, including prior approval of the issuance, assumption or guarantee of securities. The New Mexico Commission's decisions are subject to judicial review. The largest city in thedCompany's New Mexico service territory is Las Cruces.
Deregulation. In April 2003, the New Mexico Restructuring Act was repealed and as a result the Company's operations in New Mexico will continue to be fully regulated. The Company cannot predict at this time the full effects the repeal of the New Mexico Restructuring Act will have on the Company as it prepares for retail competition in Texas.
Fuel. In June 2001, the New Mexico Commission approved a fuel and purchased power cost adjustment clause. On May 31, 2003, the Company submitted a rate compliance filing whereby the Company proposed to continue a base rate recovery of $0.01949 per kWh and continue the fuel and 15
purchased power cost adjustment to recover the remainder of fuel and purchased power costs. The Company and all intervenors entered into the New Mexico Stipulation on the Company's compliance filing.
New Mexico Rate Stipulation. On January 21, 2004, the Company and all intervenors to the rate compliance filing entered into and filed the New Mexico Stipulation whereby, among other things, the Company agreed for a period of three years beginning June 1, 2004 to (i) freeze base rates after an initial non-fuel base rate reduction of 1%; (ii) fix fuel and purchased power cost associated with 10% of the Company's jurisdictional retail sales in New Mexico at $0.021 per kWh; (iii) leave subject to reconciliation the remaining 90% of the Company's New Mexico jurisdictional fuel and purchased power costs; (iv) continue the collection of a portion of fuel and purchased power costs in base rates as presently collected in the amount of $0.01949 per kWh; (v) price power provided from Palo Verde Unit 3 to the extent of its availability at an 80% nuclear, 20% gas fuel mix (currently such power is priced at 75% nuclear, 25% gas fuel mix) and (vi) deem reconciled, for the period June 15, 2001 through May 31, 2004, the Company's fuel and purchased power costs for the New Mexico jurisdiction. The New Mexico Stipulation is subject to the New Mexico Commission's approval. The New Mexico Commission hearing on the New Mexico Stipulation was held on February 25, 2004. The Company anticipates a ruling on the New Mexico Stipulation prior to June 2004 with the new rates implemented on or about June 1, 2004. The Company cannot predict the outcome of these proceedings or how the New Mexico Commission will rule.
New Mexico Renewable Energy Requirement. The New Mexico Commission has adopted renewable energy portfolio requirements and has mandated that 5% of all New Mexico retail jurisdictional energy sales in 2006 be supplied by renewable resources or certificates. The renewable portfolio standard increases by 1% each year until 2011, and is set at 10% in 2011 and thereafter. In February 2004, the Company issued a RFP for renewable energy from certified renewable sources to meet the renewable energy portfolio requirements. Based on responses to the RFP, the Company will develop a plan to meet the New Mexico Commission's renewable energy requirements. In the 2004 New Mexico legislative session, the Renewable Energy Act was enacted which directs the New Mexico Commission to adopt a rule consistent with the law, and requires rate recovery for the reasonable costs of compliance with the renewable requirements.
Sales for Resale The Company provides up to 10 MW of firm capacity, associated energy, and transmission service to the Rio Grande Electric Cooperative pursuant to an ongoing contract which requires a two-year notice to terminate. No such notice has been received. The Company also made sales of interruptible energy to CFE during the months of June and July 2003 of 13,711 MWh and 4,525 MWh, iespectively.
Power Sales Contracts As of March 5, 2004, the Company had entered into one significant agreement with a counterparty for forward off-peak firm sales of electricity of 50 MW for 2004.
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The Company also has an agreement with a counterparty for power exchanges under which the Company received 30 MW of on-peak capacity and associated energy during 2003 at the Eddy County tie and concurrently delivered the same amount at Palo Verde and/or Four Corners. The on-peak exchange amount remains at 30 MW through 2005. The agreement also gives the counterparty the option to deliver up to 133 MW of off-peak capacity and associated energy to the Company at the Eddy County tie through 2005 in exchange for the same amount of energy concurrently delivered by the Company at Palo Verde and/or Four Corners. The Company will receive a guaranteed margin on any energy exchanged under the off-peak agreement. See "Purchased Power."
Franchises and Significant Customers City of El Paso Franchise The Company's major franchise is with the City of El Paso, Texas ("City"). The franchise agreement includes a 2% annual franchise fee (approximately $7.7 million per year currently) and provides an arrangement for the Company's utilization of public rights-of-way necessary to serve its retail customers within the City. The franchise with the City extends through August 1, 2005.
In a provision of the franchise agreement, the City has an option to acquire all of the non-cash assets of the Company at the end of the term of the franchise on August 1, 2005, at a purchase price equal to the fair market value of the assets (measured on a cost of reproduction basis) on the date one year prior to the end of the term. The purchase price is then subject to certain adjustments to roll the value of the assets forward to the end of the term. If the City wishes to exercise its option, it must deliver written notice to the Company one year prior to the expiration of the franchise term.
Las Cruces Franchise In February 2000, the Company and Las Cruces entered into a seven-year franchise agreement with a 2% annual franchise fee (approximately $1.1 million per year currently) for the provision of electric distribution service. Las Cruces is prohibited during this seven-year period from taking any action to condemn or otherwise attempt to acquire the Company's distribution system, or attempt to operate or build its own electric distribution system. Las Cruces will have a 90-day non-assignable option at the end of the Company's seven-year franchise agreement to purchase the portion of the Company's distribution system that serves Las Cruces at a purchase price of 130% of the Company's book value at that time.' If Las Cruces exercises this option, it is prohibited from reselling the distribution assets for two years. If Las Cruces fails to exercise this option, the franchise and standstill agreements will be extended for an additional two years.
Military Installations The Company currently serves Holloman Air Force Base ("Holloman"), White Sands Missile Range ("White Sands") and the United States Army Air Defense Center at Fort Bliss ("Ft. Bliss"). The Company's sales to the military bases represent approximately 3% of annual operating revenues. The Company currently has long-term contracts with all three military bases that it serves. The Company signed a contract with Ft. Bliss in December 1998 under which Ft. Bliss will take service from the Company through December 2008. The Company has a contract to provide retail electric service to Holloman for a ten-year term which began in December 1995. In May 1999, the Army and the Company entered into a new ten-year contract to provide retail electric service to White Sands.
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Executive Officers of the Registrant The executive officers of the Company as of March 5, 2004, were as follows:
Name Age Current Position and Business Experience Gary R. Hedrick ............ 49 Chief Executive Officer, President and Director since November 2001; Executive Vice President, Chief Financial and Administrative Officer from August 2000 to November 2001; Vice President, Chief Financial Officer and Treasurer from August 1996 to August 2000.
Terry Bassham ............ 43 Executive Vice President, Chief Financial and Administrative Officer since November 2001; Executive Vice President and General Counsel from August 2000 to November 2001; Vice President and General Counsel from January 1999 to August 2000; General Counsel from August 1996 to January 1999.
J. Frank Bates .... ........ 53 Executive Vice President and Chief Operations Officer since November 2001; Vice President - Transmission and Distribution from August 1996 to November 2001.
Raul A. Carrillo, Jr . ............ 42 Senior Vice President, General Counsel and Corporate Secretary since February 2003; Senior Vice President and General Counsel from July 2002 to February 2003; General Counsel from January 2002 to July 2002; Associate and Shareholder with Sandenaw, Carrillo & Piazza, P.C. from March 1996 to January 2002.
Steven P. Busser ............ 35 Treasurer since February 2003; Assistant Chief Financial Officer from June 2002 to February 2003; Vice President - International Controller for Affiliated Computer Services, Inc. from August 2001 to June 2002; Vice President - International Controller for National Processing Company, Inc. from June 2000 to August 2001; Assurance Manager with KPMG, LLP from June 1998 to June 2000.
Fernando J. Gireud ............ 46 Vice President - Power Marketing and International Business since February 2003; Vice President - International Business from July 2002 to February 2003; Director - International Business Affairs from February 2002 to July 2002; Director - International Business Affairs - MiraSol from November 1999 to February 2002; Manager of Environmental Affairs from April 1994 to November 1999.
Helen Knopp ............ 61 Vice President - Customer and Public Affairs since April 1999; Executive Director of the Rio Grande Girl Scout Council from September 1991 to April 1999.
Kerry B. Lore ............ 44 Vice President - Administration since May 2003; Controller from October 2000 to May 2003; Assistant Controller from April 1999 to October 2000; Manager of Accounting Services from July 1993 to April 1999.
Robert C. McNiel ........... 57 Vice President - New Mexico Affairs since December 1997.
Hector R. Puente ........... 47 Vice President - Power Generation since April 2001; Manager - Substations and Relaying from August 1996 to April 2001.
Guillermo Silva, Jr ........... 50 Vice President - Information Services since February 2003; Secretary from January 1994 to February 2003.
John A. Whitacre ........... 54 Vice President - Transmission and Distribution since July 2002; Assistant Vice President - System Operations from August 1989 to July 2002.
Scott D. Wilson ........... 50 Controller since September 2003; Owner of Wilson Consulting Group from June 1992 to September 2003.
The executive officers of the Company are elected annually and serve at the discretion of the Board of Directors.
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Item 2. Properties The'principal properties of the Company are described in Item 1, "Business," and such descriptions are incorporated herein by reference. 'Transmission lines are located either on private rights-of-way, easements, or on streets or-highways'by public consent. Substantially all of the Company's utility plant is subject to liens to secure the'First Mortgage Bonds.
In addition, the Company leases executive and administrative offices in El Paso, Texas under a lease which expires in May 2007.
Item 3. Legal Proceedings; The Company is a party to various legal actions. In many of these matters, the Company has excess casualty liability insurance that covers the various claims, actions and complaints. 'Based upon a review of these 'claims 'and applicable insurance coverage,; the Company, believes thatj except as described'below, none 'of these claims will have a material adverse effect on the financial position, results of 'operations and cash flows of the Company.
On January 16, 2003, the Company was served with a complaint on behalf of a purported class of shareholders alleging violations' of the federal securities laws (Roth v. El Paso Electric Company, et al.;
No. EP-03-CA-0004).' 'The complaint was filed in the El Paso Division of the United States District Court for the Western District of Texas. The suit seeks undisclosed compensatory damages for the class as well as costs and attorneys' fees. The lead plaintiff, Carpenters Pension Fund of Illinois, filed a consolidated amended complaint on July.2, 2003, alleging, among other things;'that the Company and certain of its currentfand former directors and officers violated securities laws by failing to disclose that some of the Company's revenues and income were derived from an allegedly unlawful relationship with Enron. .The allegations arise out of the FERC tinvestigation of the power markets 'in the western United States during 2000 and 2001, which the Company previously settled with the FERC Trial Staff and certain intervening parties. See -Part 1,' Item' I, "'Regulation Federal -Regulatory Matters." On August 15, 2003, the Company and the individual defendants filed a motion to dismiss the complaint for failure to state a claim upon which relief canbe 'granted. 'On November 26, 2003,' the Court denied the motion to dismiss as to the Company and three 'of the individual defendants and granted the motion to dismiss as to two individual' defendants. The lead plaintiff filed its motion for class certification on January 9, 2004, seeking to certify a class consisting' of all persons who purchased or otherwise acquired Company securities between February 14, 2000 and October 21, 2002. This matter is presently set for trial on'March 28, 2005. While the Company believes the lawsuit is without merit and intends to defend itself vigorously, the Company is unable to predict the outcome... . i I . : .' , I,,'
- E. . ,,
- :, ',.' ) '!';.!
-On;February 10, 2003,' the Company received a letter written by a Pennsylvania law firm on behalf of the holder of approximately 200.shares of common stock, of the Company (the '"shareholder"),
that demands that the Company commence a lawsuit; against each member of the Board: of Directors to recover, damages allegedly sustained by the Company as a'result of alleged breaches of fiduciary:duties by.the 'Board. '-T~he shareholder contends -that, from 1997 to 2002, the Board knowingly caused. or allowed the Company to participate in improper' transactions with Enron Corporation and certain of its 19
subsidiaries. The allegations appear to duplicate factual questions first raised by the FERC in an investigation of the power markets in the western United States during 2000 and 2001. As noted above, the Company reached a settlement of the FERC investigation with the FERC Trial Staff and certain intervenors. In accordance with Texas law, the independent and disinterested directors of the Company conducted an independent inquiry and concluded that a lawsuit against the Board is not in the best interests of the Company. To date, the shareholder has not filed a shareholder derivative lawsuit against the members of the Board. The Company is unable to predict the outcome of this matter.
On May 21, 2003, the Company was served with a complaint by the Port of Seattle seeking civil damages under the Sherman Act, the Racketeer Influenced and Corrupt Organization Act, and state anti-trust laws, as well as for breach of contract and fraud (Port of Seattle v. Avista Corporation, et al.,
No. CV03-1170P). The complaint was filed in the United States District Court for the Western District of Washington. The complaint alleges that the Company, indirectly through its dealings with Enron, conspired with the other named defendants to manipulate the California energy market, which had the effect of artificially inflating the price that the Port of Seattle paid for electricity. On December 4, 2003, the case was transferred to the United States District Court for the Southern District of California for inclusion in the California Wholesale Electricity Antitrust Multi-District Litigation cases pending in that district (re-styled Port of Seattle v. Avista Corporation, et al., No. CV 03-2474-RHW, MDL No. 1403).
The Company, together with several other defendants, filed a motion to dismiss on July 29, 2003. The motions to dismiss are scheduled for oral argument on March 26, 2004. While the Company believes the lawsuit is without merit and will defend itself vigorously, it is unable to predict the outcome of this case.
The IRS has disputed whether the Company was entitled to deduct certain payments made in 1996 related to Palo Verde and its treatment of a litigation settlement in 1997 related to a terminated merger agreement. The Company has reached a tentative agreement, subject to IRS final approval, to settle these and all other issues relative to its 1996 through 1998 federal income tax returns. The Company expects the IRS will make a final decision regarding the proposed settlement by mid 2004.
Should the proposed settlement be rejected by the IRS, the Company cannot predict the eventual outcome of this matter. However, the Company has established, and periodically reviews and re-evaluates, an estimated contingent tax liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax proceedings. Although the ultimate outcome cannot be predicted with certainty, and while the contingent tax reserve may not in fact be sufficient, the Company believes that the amount at December 31, 2003 is a reasonable estimate of any additional tax that may be due.
On February 9, 2004, Enron North America Corp. ("ENA") filed suit against the Company seeking payment of approximately $5.4 million, plus interest and costs, relating to certain natural gas supply contracts (Enron North America Corp. v. El Paso Electric Co., Case No. 0 1-16034, United States Bankruptcy Court, Southern District of New York). The complaint alleges that ENA entered into two natural gas supply contracts with the Company which automatically terminated as a result of ENA's bankruptcy. ENA contends that, under the terms of the contracts, the Company owes ENA termination payments because the market price of natural gas at the date of termination was lower than the contract price. While ENA acknowledges that the contracts contain a provision (the "One-Way Payment Provision") under which the termination payment would be calculated to be zero, ENA seeks a ruling 20
from the court that the One-Way Payment Provision is unenforceable and that the Company should be required to pay termination payments in the amount of approximately $5.4 million, plus interest and costs. The first of these two contracts covers gas to be supplied by ENA during the months of November and December of 2001 (the "2001 Contract"). The Company estimates that the value of the termination payment claimed by ENA under the 2001 Contract is approximately $1.8 million: The second of these two contracts covers gas to be supplied by ENA during the months of January through December of 2002 (the "2002 Contract"). The Company estimates that the value of the termination payment claimed by ENA under the 2002 Contract is approximately $3.6 million. Based upon the Company's assessment of the probability of an adverse outcome, the Company has expensed a pre-tax amount of $1.5 million as of December 31, 2003 for this matter. The Company intends to defend itself vigorously, but cannot predict the outcome of this matter.
On October 2 and 3, 2003, employees in the Company's meter reading and collections areas, comprised of 68 employees, voted in favor of representation by the International Brotherhood of Electrical Workers, Local 960 ("Local 960"). This vote was certified by the National Labor Relations Board ('NLRB'") on October 14, 2003. In addition, employees in the Company's facilities services area, comprised of seven employees, voted in favor of representation by Local 960 on October 16, 2003. This vote was certified by the NLRB on October 24, 2003. The Company has begun collective bargaining negotiations with Local 960 on behalf of these employees.
On November 3, 2003, TNP filed a complaint against the Company with the FERC, asking the FERC to make a determination that TNP has a rollover right to network-type transmission service over the Company's transmission system. TNP asserts that it has such rights under the rollover provisions of FERC Order No. 888 relating to its power sale agreement with the Company that expired on December 31, 2002. The Company's position is that the transmission service provided by the Company to TNP under the expired power sale agreement was point-to-point service and not network service and that the Company does not have the capacity to provide the network service that TNP seeks. Due to existing transmission constraints, a FERC ruling granting TNP's request could adversely impact the Company's ability to import lower cost power from Palo Verde and Four Corners to serve its base load to the extent of the transmission rights granted to TNP. A hearing on this matter before an administrative law judge is scheduled for June 15, 2004. The Company cannot predict the likely outcome of this matter or the full effect that an adverse ruling would have on the Company.
Item 4. Submission of Matters to a Vote of Security Holders Not applicable.
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PART 11 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's common stock began trading on the New York Stock Exchange on December 4, 2002, under the symbol "EE." Prior to that date, the Company's common stock traded on the American Stock Exchange. The high, low and close sales prices for the Company's common stock, as reported in the consolidated reporting system of the New York Stock Exchange and the American Stock Exchange for the periods indicated below were as follows:
Sales Price High Low Close (End of period) 2002 First Quarter ................................... $ 16.05 $ 13.25 $ 15.65 Second Quarter ................................. 16.20 12.20 13.85 Third Quarter .................................. 14.16 10.90 11.88 Fourth Quarter .................................. 12.60 9.25 11.00 2003 First Quarter ............... .......... $ 11.99 $ 10.10 $ 10.80 Second Quarter ......................... 12.50 10.76 12.33 Third Quarter ......................... 12.55 10.90 11.55 Fourth Quarter ......................... 13.63 11.55 13.35 As of March 5, 2004, there were 4,646 holders of record of the Company's common stock. The Company does not anticipate paying dividends on its common stock in the near-term. The Company intends to continue its deleveraging and stock repurchase programs with the goal of improving its capital structure, bond ratings, and earnings per share.
During 2003, the Company repurchased 2.1 million shares of common stock for $24.2 million to complete its previously approved stock repurchase programs. Since the inception of the stock repurchase programs in 1996, the Company repurchased 15 million shares in total at an aggregate cost of
$171.0 million, including commissions. In February 2004, the Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock. The Company may make purchases of its stock at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.
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Item 6. Selected Financial Data As of and for the following periods (in thousands except for share data):
.. .. : - . : .. .,, i . ,I : ..... _e , I ; - I . . . .
,1 ' .; .'" ;I, rf ' ' Years Ended December 31, '
f . I - . % I II :
I I
. I.
i 2003 - 2002 ; 2001 ; 2000 - 1999
'Operating revenues........................'... ............ 664,362 $ 690,085 $ 769,705 S 701,649 $ 57'0,469 Operatingincome .... ..... _' . :.-.-' 80,215 110,607 167,602 168,974 1557,336 Income before cumulative effect of ,; , - .
accounting change ............... 20,616 28,967 63,659 58,392 440,473 . , f Cumulative effect of accounting change, net of income tax expense ........... - '-39,635 . i ,
.Net incomeapplicable to commonstock ...... 60,251 28,967 63,659 58,392 228,276 Basic earnings per common share: , .
Income before cumulative effect o0f ' 0 1 1.0 accounting change ............ : .....- 'i.42: 0.58 1.25 1.08 '0.48 Cumulative effect of accounting change, net ,
ofincome tax expense . .. 0.82 - -
Net income........................................ ..... -1.24 0.58 1.25 1.08 0.48 Weighted average number of common '
shares outstanding.................................. '48,424,212 '49,862,417 50,821,140 54,183,915 59,34 9,468 D'Diluted earnings per common share: , ' ' -
Income before cumulative effect of accounting change ........... .. 0.42 , 0.57 123 1.06 0.47 Cumulative effect of accounting change, net of income tax expense . .............. '.'I'... 0.81 - ' - - -7 Net income . .......
.. .... .. : 1.23 0.57 1.23 1.06 0.47 Weighted average number of common shares; and dilutive potential common shares outstanding ........ . . . ...... 48,814,761 50,380,468 51,722,351 55,001,625 59,731,649 Cash additions to utility property, plant - -
and equipment...................................... 77,080 65,065 70,739 64,612 51,826 Total assets...................................................... 1,595,854 1,646,989 1,644,439, 1,660,105 1,664,436 Long-term debt'and financing and capital ' ' I i : I , - I : I I-lease obligations ........... , .,., ,.;.,.,,.,.;, 608,722 614,375 619,365' :740,223 :' 811,607 Cornmon stock equity ............. 499,822 456,642 .450,193 412,034 421,258 The selected financial data should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of an Item 8,,ertions," "Financial Statements and Supplementaiy Data." ' a II I I . 4, 23
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Statements in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of the Company from time to time, including statements contained in the Company's filings with the Securities and Exchange Commission and its reports to shareholders, involve known and unknown risks and other factors which may cause the Company's actual results in future periods to differ materially from those expressed in any forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to:
(i) increased prices for fuel and purchased power and determinations by regulators that may adversely affect the Company's ability to recover incurred fuel costs in rates; (ii) fluctuations in wholesale margins due to uncertainty in the wholesale power market; (iii) unanticipated increased costs associated with scheduled and unscheduled outages; (iv) the cost of replacing steam generators for Palo Verde Units I and 3 and other costs at Palo Verde; (v) the costs of legal defense and possible judgments which may accrue as the result of litigation arising out of the FERC investigation or any other regulatory proceeding; (vi) deregulation of the electric utility industry; and (vii) other factors discussed below under the headings "Summary of Critical Accounting Policies and Estimates," "Overview" and "Liquidity and Capital Resources." The Company's filings are available from the Securities and Exchange Commission or may be obtained through the Company's website, www.epelectric.com. Any such forward-looking statement is qualified by reference to these risks and factors. The Company cautions that these risks and factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company except as required by law.
Summary of Critical Accounting Policies and Estimates Note A to the Consolidated Financial Statements contains a summary of the significant accounting policies utilized by the Company. The preparation of these statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented and actual results could differ in future periods from those estimates. Critical accounting estimates, which are both important to the portrayal of the Company's financial condition and results of operations and which require complex, subjective judgments, include the following:
- Collection of fuel expense
- Value of net utility plant in service
- Decommissioning costs
- Future pension and other postretirement obligations
- Reserves for tax dispute Collection of Fuel Expense In general, through regulation, the Company's fuel and purchased power expenses are passed through to its regulated customers. These costs are subject to reconciliation by the Texas and New Mexico Commissions. Prior to the completion of a reconciliation, the Company records fuel expenses as incurred. In the event that a disallowance occurs during a reconciliation proceeding, the 24
amounts recorded for fuel and purchased power expenses could differ from the amounts allowed to be collected by the Company from its customers and the Company could incur a loss to the extent of the disallowance.
Value ofNet Utility Plant in Service In 1996, when it emerged from bankruptcy, the Company recast its financial statements by applying fresh-start reporting in accordance with - Statement of Position 90-7 "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code." In this process, the Company attributed value to its integrated utility system, including its generation assets, after it had established the value of its pro forma capital structure based on management's estimates of future operating results. The Company valued its generation assets such that the depreciated value of its generation assets would be approximately equal to their estimated fair value at the end of the Freeze Period. This is important because at the beginning of retail competition in Texas, the Company will no longer be permitted to recover in rates any "stranded costs", that is, the difference between the book value and the market value of its electric generation assets. If at any time the Company determines that estimated, undiscounted future net cash flows from the operations of the generation assets are not sufficient to recover their net book value, then it will be required to write down the value of these assets to their fair values. Any such writedown would be charged to earnings. The Company currently believes that its rates are sufficient to collect before 2005 substantially all costs that would otherwise be "stranded" under -relevant laws in Texas and that future net cash flows after 2005 from the generating assets will be sufficient to recover their net book values.
Decommissioning Costs Pursuant to the ANPP Participant Agreement and federal law, the Company must fund its share of the estimated costs to decommission Palo Verde Units 1, 2, and 3 and associated common areas. The Company and other Palo Verde Participants rely upon decommissioning cost studies and make interest rate, rate of return and inflation projections to determine funding requirements and estimate liabilities related to decommissioning. Every third year, outside engineers perform a study to estimate decommissioning costs associated with Palo Verde Units 1, 2 and 3 and associated common areas. The Company determines how it will fund its share of those estimated costs by making assumptions about future investment returns and future cost escalations. The funds are invested in professionally managed investment trust accounts. The Company is required to establish a minimum accumulation and a minimum funding level in its decommissioning trust accounts'at the end of each annual reporting period in accordance with the ANPP Participation Agreement. If actual decommissioning costs exceed estimates, the Company would incur additional expenses related to decommissioning. Further, if the rates of return earned by the trusts fail to meet expectations, the Company will be required to increase its funding to the decommissioning trust accounts. Although the Company cannot predict the results of future studies, the Company believes that the liability it has recorded for its decommissioning costs will be adequate to provide for the Company's share of the costs, assuming that Palo Verde Units 1, 2 and 3 operate over their remaining lives (which includes an assessment of the probability of a license extension) and that the DOE assumes responsibility; for permanent disposal of spent fuel at plant shut down. The Company believes that its current annual funding levels of the decommissioning trust will adequately provide for the cash requirements associated with decommissioning. Historically, regulated utilities such as the Company have been permitted to collect in rates the costs of nuclear 25
decommissioning. Under deregulation legislation in Texas, the Company expects to continue to be able to collect from customers the costs of decommissioning.
Future Pension and Other PostretirementObligations In accounting for its retirement plans and other postretirement benefits, the Company makes assumptions regarding the valuation of benefit obligations and the performance of plan assets. The accounting for retirement plans and other postretirement obligations allows for a smoothed recognition of changes in benefit obligations and plan performance over the service lives of the employees who benefit under the plans. The primary assumptions are discount rate, expected return on plan assets, rate of compensation increase and health care cost inflation. A change in any of these assumptions could have a significant impact on future costs, which may be reflected as an increase or decrease in net income in the period, or on the amount of related liabilities reflected on the Company's consolidated balance sheet.
Reserves for Tax Dispute The IRS has disputed whether the Company was entitled to deduct certain payments made in 1996 related to Palo Verde and its treatment of a litigation settlement in 1997 related to a terminated merger agreement. The Company has reached a tentative agreement, subject to IRS final approval, to settle these and all other issues relative to its 1996 through 1998 federal income tax returns. The Company expects the IRS will make a final decision regarding the proposed settlement by mid 2004.
Should the proposed settlement be rejected by the IRS, the Company cannot predict the eventual outcome of this matter. However, the Company has established, and periodically reviews and re-evaluates, an estimated contingent tax liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax proceedings. Although the ultimate outcome cannot be predicted with certainty, and while the contingent tax reserve may not in fact be sufficient, the Company believes that the amount at December 31, 2003 is a reasonable estimate of any additional tax that may be due.
Overview El Paso Electric Company is an investor owned electric utility that serves retail customers in west Texas and southern New Mexico and wholesale customers in Texas and periodically in the Republic of Mexico. The Company owns or has substantial ownership interests in six electrical generating facilities providing it with a total capacity of approximately 1,500 MW. The Company's energy sources consist of nuclear fuel, natural gas, coal, wind powered resources and purchased power. The Company owns or has significant ownership interests in four major 345 kV transmission lines and three 500 kV transmission lines utilized to transfer power from Palo Verde and Four Corners, and owns the transmission and distribution network within its retail service territory. The Company is subject to regulation by the Texas and New Mexico Commissions and, with respect to wholesale power sales, transmission of electric power and the issuance of securities, by the FERC.
The Company faces a number of risks and challenges that could negatively impact its operations and financial results. The most significant of these risks and challenges are the deregulation of the electric utility industry, the possibility of increased costs especially from Palo Verde and the Company's debt service obligations.
26
The electric utility industry in general and the Company in particular are facing significant challenges and increased competition as a result of changes in federal provisions relating to third-party transmissioh service's and independent power production, as 'well as changes innstate laws and regulatory provisions relating 'to :wholesale-and retail service. In 1999, both Texas Iand New Mexico passed industry deregulation legislation, requiring the !Company to separate its, transmission and distribution functions, which would remain regulated, from its power generation and energy services businesses, which would operate in a competitive market in the future. New Mexico repealed the New Mexico Restructuring' Act in 'April 2003,:'and 'the -Company's operations in New MexiC'6 will' remain fully regulated. In Texas, the Company's service territory has not yet been deregulated, but the Company is preparing for-retail competition. 'If-the.'Company does not enter-retail competition for generating services at thelend of the Freeze Period, the Company's generating services will continue to be regulated by the Texas Commission. There is -substantial uncertainty about both the regulatory framework and market conditions that will exist if and when retail competition is implemented in the Company's service territory and the Company may incur substaintial preparatory, restructuring and other costs that may not ultimately be recoverable. There 'can be Rio assurance that deregulation will not adversely affect the future operations, cash flows and financial condition of the Comnpany. e a the The changing regulatory environment and the potential for unregulated power production have created a substantial risk that the Company will lose important customers. The Company's wholesale and large retail customers already have, in varying degrees, alternate sources of economical 'power, including co-generation of electric power:; In fact,, the Company has lost certain large retail customers to self-generation and/or co-generation and has seen reductions in wholesale sales due to new sources of generation. If the Company loses a significant portion of its retail customer base, the Company may not be able to replace such revenues through 'either the addition of new customers, an increase in rates to remaining customers, or sales in the economy market.
Another risk to the Company is potential increased costs, including the risk-'of additional or unanticipated costs 'at Palo Verde resulting from' (i)' increases 'In operation 'and maintenance expenses; (ii) the replacement of steam generators in Palo Verde Units 1 and 3; (iii) an extended -outage of any of the Palo Verde units; (iv) increases' hEslit`imates of dec6mmis'sIoiiing'cost§; (v) the stofage of radioactiv'e waste,' including' spent ' nuclear fifiel; (vi) insolvency 6f'--othier 'Palo' Verde Participants; and (vii) compliance with the various requirements and regulations governing commercial nuclear generating stations. At tie same'time,'the Company's 'retail base rates in Texas are effectiely capped through a rate freeze ending in August 2005. As a result, the Company cannot faise its base rates' in Texas in the event of increases in non-fuel costs or loss' of revenue. 'Additionally,:upon'initiation of competition, 'there may be competitive pressure on the Company's power generation rates which could reduce its profitability.
The Company cannot assure that its revenues will be sufficient to recover any increased costs, including any-increased hosts in 'connection with Pilo Verde' or cther 'operations, whether as 'a'resuit of inflation, changes in tax laws'or regulatory requirements' oroth&r causes.'i "1 ; - .;!'zi&,i l,,r*!!;<;
'S .f1 : : . ,,.' 1 : ' :I,'. : L 27
Liquidity and Capital Resources The Company's principal liquidity requirements in the near-term are expected to consist of interest payments on the Company's indebtedness, operating and capital expenditures related to the Company's generating facilities and transmission and distribution systems, income and other taxes, and reorganization costs related to deregulation in Texas, if and when deregulation occurs. The Company expects that cash flows from operations will be sufficient for such purposes.
The Company's contractual obligations as of December 31, 2003 are as follows (in thousands):
Payments due by period 2005 and 2007 and 2009 and Total 2004 2006 2008 Later Long-Tenn Debt:
First mortgage bonds .......... $ 395,366 $ - $ 186,182 (1) $ - $ 209,184 (2)
Pollution control bonds 1......
93,135 - 193,135 (3) -
Promissory note .................. 151 116 35 Financing Obligations:
Nuclear fuiel ...................... 42,176 21,990 20,186 Purchase Obligations:
Capacity power contract ..... 16,818 8,409 8,409 - -
Fuel contracts:
Coal .................... . 88,350 7,068 14,136 14,136 53,010 Gas (4) . .............. 80,040 20,010 40,020 20,010 Nuclear fuel (5) ............... 16,652 12,427 4,225 -
Operating lease (6) 3.40 1.................... 2.000 1000 400 Total $ $ 7 $ 34,546 $ 262,194 (1) In early 2004, the Company repurchased $4.0 million of its first mortgage bonds which were scheduled to mature in 2006.
(2) In early 2004, the Company repurchased $2.0 million of its first mortgage bonds which become callable in 2006.
(3) The pollution control bonds are scheduled for remarketing in 2005.
(4) This amount is based on the minimum volumes per the contract at the current market price at the end of the year.
(5) Some of the nuclear fuel contracts are based on a fixed price adjusted for an index. The index used is the current index at the end of the year.
(6) The Company has one significant operating lease for administrative offices which expires in May 2007.
Pollution control bonds of $193.1 million are subject to remarketing in 2005, and first mortgage bonds of $182.2 million are scheduled to mature in 2006. The Company expects that these obligations and the $100 million revolving credit facility, which matures in January 2005 (against which approximately $42.2 million had been drawn for nuclear fuel purchases as of December 31, 2003) will be refinanced through the capital and credit markets. Additionally, the Company has $207.2 million of first mortgage bonds which become callable in 2006. The Company's ability to access capital and credit markets may be adversely affected by uncertainties related to operating in a competitive energy market, tight credit markets and debt rating agency actions.
28
Long-term capital requirements of the Company will consist primarily of construction of electric utility plant and the payment of interest on and retirement and refinancing of debt. Utility construction expenditures will consist primarily of expanding and updating the transmission and distribution systems, possible addition of new generation, and the cost of capital improvements and replacements at Palo Verde and other generating facilities, including the replacement steam generators in Palo Verde Units 1 and 3. See Part I, Item 1, "Business - Construction Program."
During 2003, 2002 and 2001, the Company generated $0.7 million and utilized $96.6 million and
$128.0 million, respectively, of regular federal tax loss carryforwards. The Company anticipates that existing regular federal tax loss carryforwards will be fully utilized by mid-2004, should the IRS settlement for the tax years 1996 through 1998 be approved by the IRS, and that the Company's cash flow requirements for income taxes in 2004 will increase compared to the requirement for 2003.
The Company anticipates its cash flow requirements associated with its retirement plans and other postretirement benefit plans and its cash flow requirements related to contributions to the decommissioning trust funds will decrease as compared to the related cash flow requirements in 2003.
The Company contributed an additional $4.7 million to the decommissioning trust funds in January 2003 and an additional $3.2 million to one of its retirement plans in September 2003 in order to meet its funding requirements as of December 31, 2002. The Company is continually evaluating its funding requirements related to its retirement plans, other postretirement benefit plans, and decommissioning trust funds.
As of December 31, 2003, the Company had approximately $34.4 million in cash and cash equivalents, a decrease of $40.7 million from the balance of $75.1 million on December 31, 2002. This decrease was primarily the result of the retirement in February 2003 of the Company's Series C First Mortgage Bonds, Any amounts not borrowed under the Company's $ 100 million revolving credit facility for nuclear fuel purchases may be used by the Company for working capital needs. As' of December 31, 2003, approximately $42.2 million had been drawn for nuclear fuel purchases. No amounts are currently outstanding on this facility for working capital needs.
The Company has significant debt service obligations. Since inception of its deleveraging program in 1996, the Company has repurchased or retired with internally generated cash $556.5 million of first mortgage bonds, including the repayment of approximately $36.1 million of Series C First Mortgage Bonds at their maturity and the repurchase of approximately $3.3 million of first mortgage bonds during the first quarter of 2003. First Mortgage Bonds totaling $6.0 million were repurchased in early 2004. Common stock equity as a percentage of capitalization, including current portion of long-term debt and financing obligations, was 44% as of December, 31, 2003.
The degree to which the Company is leveraged could have important consequences for the Company's liquidity, including (i) limiting the Company's ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate or other purposes in the future, and (ii) placing the Company at a competitive disadvantage by limiting its financial flexibility to respond to the demands of the competitive market and making it more vulnerable to adverse economic or business changes.
29
During 2003, the Company repurchased 2.1 million shares of common stock for $24.2 million to complete its previously approved stock repurchase programs. Since the inception of the stock repurchase programs in 1996, the Company repurchased 15 million shares in total at an aggregate cost of
$171.0 million, including commissions. In February 2004, the Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock. The Company may make purchases of its stock at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.
Historical Results of Operations Years ended December 31, 2003 2002 2001 Actual Actual Pro forma Actual Pro forma Income before cumulative effect of accounting change (in thousands) ............ $ 20,616 $ 28,967 $ 33,590 $ 63,659 $ 68,102 Diluted earnings per share before cumulative effect of accounting change ............. 0.42 0.57 0.67 1.23 1.32 Beginning on January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations," which substantially changed the reporting of the Company's decommissioning obligation at Palo Verde and Four Corners. During 2003, the Company recognized the effect of this accounting change, which increased net income by $39.6 million, net of tax. The above table compares historical results to pro forma results which assume SFAS No. 143 had been applied in both 2002 and 2001. Income before the cumulative effect of accounting change decreased $13.0 million, or $0.25 diluted earnings per share in 2003 compared to the pro forma results for 2002. This after-tax decrease resulted primarily from (i) decreased wholesale sales revenue of $15.6 million primarily related to the expiration of two long-term contracts; (ii) the impairment loss on the CIS project of $10.7 million; (iii) increased pension and benefits expenses of $3.1 million; (iv) Texas fuel disallowance of
$2.8 million; (v) increased insurance expenses of $2.8 million; (vi) increased outside services of
$2.2 million; and (vii) increased expense at Palo Verde of $1.3 million. These decreases were partially offset by (i) the 2002 accrual for the FERC settlements of $9.5 million with no comparable amount in 2003; (ii) increased sales and margins on economy sales of $6.3 million; (iii) increased retail sales of
$5.6 million; (iv) decreased interest on long-term debt of $2.3 million; (v) decreased loss on extinguishment of debt of $2.1 million; and (vi) decreased MiraSol operating loss of $1.9 million.
Pro forma income before cumulative effect of accounting change decreased $34.5 million or
$0.65 diluted earnings per share in 2002 compared to the pro forma results for 2001. This after-tax decrease was primarily due to (i) decreased economy sales margins of $20.3 million related to significantly reduced wholesale prices in the western United States; (ii) the FERC settlements of
$9.5 million; (iii) increased demand charges of $4.5 million; (iv) decreased wholesale sales of
$3.7 million; (v) increased expense at Palo Verde of $2.8 million; (vi) increased regulatory expense of
$2.4 million; (vii) decreased investment performance of $2.1 million; and (viii) a reduction in the estimate of a contingent tax liability in 2001 of $2.5 million with no comparable amount in 2002. These 30
decreases were partially offset by (i) the recovery, of energy expenses in New Mexico of $6.3 million; (ii) increased retail sales of $5.4 million; and (iii) decreased interest expense on long-term debt of
$4.7 million. -
Operating revenues net of energy expenses decreased $16.4 million in 2003 compared to 2002 primarily due to (i) decreased wholesale sales of $25.5 million; (ii) Texas fuel disallowance of
$4.5 million; and (iii) a $4.0 million, decrease in revenue from the energy, service operations partially offset by increased sales and margins on economy sales of $10.3 million and increased retail sales of
$9.2 million.,,- , -,-
Operating revenues net of energy expenses decreased $38.8 million in 2002 compared to 2001 primarily due to (i) decreased economy 'sales margins of $33.2 million related to the significantly reduced wholesale prices'in the western United States; (ii) decreased revenue from the energy services operations of $10.6 million; (iii) increased demand charges of $7.3 million; and (iv)-decreased wholesale sales of"$6.0 million. ;This decrease was partially offset by the recovery of 'energy expenses in New Mexico in 2002 of $10.3 million, with no comparable recovery in 2001 and increased retail sales of
$8.8 million.
~I'
- 1. ..
i -
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4 4 t 4 4 I 4 4 4 1 41 4 4 31
Comparisons of kWh sales and operating revenues are shown below (in thousands):
Increase (Decrease)
Years Ended December 31: 2003 2002 Amount Percent kWh sales:
Retail:
Residential...................................... 1,932,171 1,870,931 61,240 3.3%
Commercial and industrial, small..... 2,096,860 2,076,758 20,102 1.0 Commercial and industrial, large ...... 1,197,065 1,161,815 35,250 3.0 Sales to public authorities ................. 1.224.349 1.212.180 12.169 1.0 Total retail sales............................ 6.450,445 6.321,684 128,761 2.0 Wholesale:
Sales for resale .................................. 67,754 986,134 (918,380) (93.1) (1)
Economy sales................................... 1,920,882 1,483.465 437.417 29.5 (2)
Total wholesale sales..................... 1,988,636 2,469.599 (480.963) (19.5)
Total kWh sales ................... 8,439,081 _ 8.79 1.283 (4.0)
Operating revenues:
Base revenues:
Retail:
Residential ..................................... $ 171,459 $ 166,320 $ 5,139 3.1%
Commercial and industrial, small.. 165,434 163,553 1,881 1.2 Commercial and industrial, large... 43,294 43,419 (125) (0.3)
Sales to public authorities.............. 73,136 70,802 2,334 3.3 Total retail base revenues........... 453,323 444,094 9,229 2.1 Wholesale:
Sales for resale ............................... 3,223 32,228 (29.,005) (90.0) (1)
Total base revenues................... 456,546 476,322 (19,776) (4.2)
Fuel revenues........................................ 122,761 158,650 (35,889) (22.6) (3)
Economy sales...................................... 76,536 43,654 32,882 75.3 (2)
Other..................................................... 8,519 11,459 (2.940) (25.7) (4)(5)
Total operating revenues........... $ 64,362 $ 690,085 $ (25723) (3.7)
(1) Primarily due to the expiration of wholesale power contracts with 1ID on April 30, 2002 and TNP on December 31, 2002, and reduced sales to the CFE.
(2) Primarily due to increased available power as a result of the expiration of the wholesale contracts mentioned above and higher prices in the economy market.
(3) Primarily due to the expiration of wholesale power contracts with 1ID and TNP, decreased energy expenses passed through to Texas and New Mexico customers, and reduced sales to the CFE.
(4) Primarily due to decreased energy services revenues.
(5) Represents revenues with no related kWh sales.
32
Increase (Decrease)
Years Ended December 31: 2002 2001 Amount Percent kWh sales:
Retail:
Residential...................................... 1,870,931 1,789,199 . I-81,732 4.6%
Commercial and industrial, small ....... 2,076,758. 2,069,517 7,241 . 0.3 Commercial and industrial, large ...... 1,161,815 1,174,235 (12,420) =(1.1)
Sales to public authorities ................... 1,212,180- 1,185.521 26x659 1.2 Total retail sales ............ : 6.321,684 6.218.472 ' 103.212
.. 17 i?
I Wholesale:
Sales for resale ......... 986,134 1,460,383 (474,249)' (32.5) '(1)
Economy sales..................................... 1.483,465 929,914 553.551 ' '59.5 (2)
Total wholesale sales .................. 2.469.599 2.390.297 79.302 3.3 Total kWh sales..................... 8,791,283 .18,608,762 ' 2.1 Operating revenues:
- Base revenues:
Retail:
Residential .......... $ 166,320 '$ 159,263 $' 7,057 4.4%
Commercial and industrial, small 163,553 161,997 1,556 ' 1.0 Commercial and industrial, large..... 43,419 43,644 (225) (0.5)
Sales to public authorities............... -70.802 70.372 , 430 0.6 Total retail base revenues........... 444,094 . 435,276 8,818 -.2.0 Wholesale:
Sales for resale................................ 32.228 52.879 . (20.651). (39.1), (1)
Total base revenues..................... 476,322 , 488,155 (11,833) (2.4)
Fuel revenues...................................... 158,650' 164,335 ' (5,685) (3.5)
Economy sales........................................ 43,654 92,452 (48,798) (52.8) (3)
Other...................................................... 11,459 24.763 (13.304) (53.7) (4)(5)
Total operating revenues..... $ 690,085 $ 769,705 ' $' 79,620) ' (10.3)
(1) Primarily due to the expiration of a wholesale power contract with IID on April 30, 2002 and decreased sales to CFE, partially offset by increased kWh sales to TNP..
(2) Primarily due to increased available power as a result of decreased sales to IIID and increased sales at
- Palo Verde due to transmission constraints.
(3) Primarily due to a weaker power market in 2002 compared to the previous year.
(4) Primarily due to decreased energy services revenues.
(5) Represents revenues with no related kWh sales.
Other operations expense increased $14.6 million in 2003 compared to 2002 primarily due to (i) increased pension. and benefits expense of $5.0 million resulting from declines in the financial markets; (ii) accretion expense of $4.8 million related io the implementation of SFASNo. 143; (iii) increased insurance related expenses of $4.5 million; (iv) increased legal and consulting fees of
$3.7 million; and (v) increased Palo Verde expense of $3.4 million., These increases were partially offset by decreased energy. services operations expense of $7.2 million primarily due to ,a warranty reserve recorded by the Company in 2002 and the cessation of additional marketing activities by MiraSol in 33
2002. Other operations expense slightly increased in 2002 compared to 2001 primarily due to increased professional fees related to regulatory matters of $3.9 million and increased Palo Verde expense of
$2.9 million, partially offset by decreased energy services operations expenses of $7.7 million due to the cessation of additional marketing activities in 2002.
In July 2002, the Company suspended work on its CIS project to perform an assessment of the project and of alternatives to completion of the project. This assessment included analyzing the impact of potential delays in the implementation of deregulation and resulting changes in billing requirements, and the software's ability to perform to specification. Based on this assessment and on events related to the project which occurred in 2003, the Company abandoned the CIS project and recognized an asset impairment loss of $17.6 million. The Company is now analyzing various options to meet its current and projected CIS needs.
The FERC settlements relate to the settlements with the FERC Trial Staff and principal California parties pursuant to which the Company agreed to refund $15.5 million of revenues it earned on wholesale power transactions in 2000 and 2001. These settlements were recorded in December 2002.
Maintenance expense increased slightly in 2003 compared to 2002 primarily due to maintenance outages in 2003 at local generating stations of $1.7 million offset by reduced maintenance at Palo Verde of $1.2 million due to timing of scheduled refueling and maintenance outages. Maintenance expense increased $2.0 million in 2002 compared to 2001 primarily due to the timing of refueling and maintenance outages at Palo Verde of $1.8 million.
Depreciation and amortization expense decreased $2.4 million in 2003 compared to 2002 primarily due to decreased depreciation expense of $3.7 million resulting from the implementation of SFAS No. 143. Depreciation and amortization expense remained relatively unchanged in 2002 compared to 2001.
Taxes other than income taxes decreased by $0.5 million in 2003 compared to 2002 due to a decrease in property tax. Taxes other than income taxes remained relatively unchanged in 2002 compared to 2001.
Other income (deductions) increased $6.9 million in 2003 compared to 2002 primarily due to losses on extinguishments of debt of $3.4 million recorded in 2002 with no comparable activity in 2003 and increased investment and interest income of $2.8 million primarily related to the decommissioning trust fund. Other income (deductions) decreased $3.8 million in 2002 compared to 2001 primarily due to a decrease of (i) $1.4 million in interest income on the undercollection of Texas fuel revenues; (ii) $1.1 million on investment income related to the decommissioning trust finds; and (iii) a
$0.5 million insurance reimbursement recognized in 2001 with no comparable activity in 2002.
Interest charges decreased $11.8 million in 2003 compared to 2002 primarily due to (i) an
$8.3 million decrease resulting from the implementation of SFAS No. 143 and (ii) a $3.5 million decrease resulting from a reduction of outstanding debt as a result of open market purchases and retirements of the Company's first mortgage bonds. Interest charges decreased $7.8 million in 2002 compared to 2001 primarily due to (i) a $6.7 million decrease resulting from a reduction of outstanding 34
debt as a result of open market purchases of the Company's first mortgage bonds; (ii) increased capitalized interest related to construction work in progress; and (iii) decreased interest rates.
Income tax expense, excluding the tax effect of a cumulative effect of accounting change, decreased $3.3 million in 2003 compared to 2002, and $183 million in 2002 compared to 2001 primarily due to changes in pretax income and certain permanent differences and adjustments.,
The cumulative effect. of accounting change relates to the=;adoption of SFAS No. 143 on January 1, 2003. SFAS No. 143 provides guidance on the recognition-and measurement of liabilities associated with the retirement of tangible long-lived assets. SFAS No. 143 affected the accounting for the decommissioning of the Company's Palo Verde and Four Corners Stations and changed the method used to report the decommissioning obligation.
In December 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46R") (revised December 2003), "Consolidation of Variable Interest Entities," which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than-voting rights and accordingly should7 consolidate the entity. FIN? 46R replaces FASB Interpretation No.46, "Consolidation of Variable Interest Entities," which was issued in January 2003. The 'Company currently does not have a controlling financial interest in any entities through means other than voting rights and FIN 46R will not have an impact on the Company's consolidated financial statements.
SFAS No.- 150, "Accounting 'for Certain Financial Instruments with Characteristics of both Liabilities and Equity," 'was issued. in May- 2003. This statement establishes -standards 'for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The statement also includes requited disclosures for financial instruments within its scope. For the Company, the statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, the statement will be effective for the Company on January 1, 2005. The Company currently does not have any financial instruments that are within the scope of this statement.'
- For the last several years, inflation has been relatively low and, therefore, has had little impact on the Company's results of operations and financial condition.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk" The following discussion regarding the Company's market-risk sensitive instruments contains forward-looking information involving risks and uncertainties. The statements regarding potential gains and losses -are only estimates of what cdUld ?ccur in the fiture7 -Actual future results mnay 'differ materially from those estimates presented due to the characteristics of the risks and uncertainties involved..
The Company is exposed to market risk -due' to changes in interest-rates, equity prices and commodity prices. Substantially all financial instruments and positions held by the Company described below are held for purposes other than trading.
35
Interest Rate Risk The Company's long-term debt obligations are all fixed-rate obligations with varying maturities, except for its revolving credit facility, which provides for nuclear fuel financing and working capital, and is based on floating rates. Interest rate risk, if any, related to the revolving credit facility is substantially mitigated through the operation of the Texas and New Mexico Commission rules which establish energy cost recovery clauses ("fuel clauses"). See Part I, Item 1, "Regulation - New Mexico Regulatory Matters
- New Mexico Stipulation." Under these rules and fuel clauses, energy costs, including interest expense on nuclear fuel financing, are passed through to customers. Currently, the Company anticipates remarketing its pollution control bonds in 2005 and issuing additional long-term debt in 2006 to retire the then outstanding 8.9% Series D First Mortgage Bonds.
The Company's decommissioning trust funds consist of equity securities and fixed income instruments and are carried at market value. The Company faces interest rate risk on the fixed income instruments, which consist primarily of municipal, federal and corporate bonds and which were valued at
$32.8 million and $26.2 million as of December 31, 2003 and 2002, respectively. A hypothetical 10%
increase in interest rates would reduce the fair values of these funds by $0.5 million and $0.4 million based on their fair values at December 31, 2003 and 2002, respectively.
Equity Price Risk The Company's decommissioning trust funds include marketable equity securities of approximately $47.7 million and $33.7 million at December 31, 2003 and 2002, respectively. A hypothetical 20% decrease in equity prices would reduce the fair values of these funds by $9.5 million and $6.7 million based on their fair values at December 31, 2003 and 2002, respectively.
Commodity Price Risk The Company utilizes contracts of various durations for the purchase of natural gas, uranium concentrates and coal to effectively manage its available fuel portfolio. These agreements contain variable pricing provisions and are settled by physical delivery. The fuel contracts with variable pricing provisions, as well as substantially all of the Company's purchased power requirements, are exposed to fluctuations in prices due to unpredictable factors, including weather and various other worldwide events, which impact supply and demand. However, the Company's exposure to fuel and purchased power price risk is substantially mitigated through the operation of the Texas and New Mexico Commission rules and the Company's fuel clauses, as discussed previously.
In the normal course of business, the Company utilizes contracts of various durations for the forward sales and purchases of electricity to effectively manage its available generating capacity and supply needs. Such contracts include forward contracts for the sale of generating capacity and energy during periods when the Company's available power resources are expected to exceed the requirements of its native load and sales for resale. They also include forward contracts for the purchase of wholesale capacity and energy during periods when the market price of electricity is below the Company's expected incremental power production costs or to supplement the Company's generating capacity when demand is anticipated to exceed such capacity. As of March 5, 2004, the Company had entered into forward sales and purchase contracts for energy as discussed in Part 1, Item 1, "Business - Energy Sources -
36
Purchased Power" and "Regulation - Power Sales Contracts."- These agreements are generally fixed-priced contracts which qualify for the "normal purchases and normal sales" exception provided in SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," including any effective implementation guidance discussed by the FASB Derivatives Implementation Group and are not recorded at their fair value in the Company's financial statements. Because of the operation of the Texas and New Mexico Commission rules and the Company's fuel clauses, these contracts do not expose the Company to significant commodity price risk.
37
Item 8. Financial Statements and Supplementary Data INDEX TO FINANCIAL STATEMENTS Page Independent Auditors' Report ....................................................................... 39 Consolidated Balance Sheets at December 31, 2003 and 2002 ............................ ........................... 40 Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001 ....................................................................... 42 Consolidated Statements of Comprehensive Operations for the years ended December 31, 2003, 2002 and 2001 ....................................................................... 43 Consolidated Statements of Changes in Common Stock Equity for the years ended December 31, 2003, 2002 and 2001 ....................................................................... 44 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 .... 45 Notes to Consolidated Financial Statements ....................................................................... 46 38
INDEPENDENT AUDITORS' REPORT The Shareholders and Board of Directors El Paso Electric Company:
We have-audited the- accompanying consolidated balance sheets of El Paso Electric Company and subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive operations, changes in common stock equity, and cash flows for each of the years in the three-year period ended, December31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an 9pinion on these consolidated financial statements based on our audits.
. ¢, 1,- .................................. ., . .,. ,':
..'i:'!*
We conducted our audits in accordance with auditing standards. generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements. referred to above Present fairly, in all material respects, the financial position of El Paso Electric Company and subsidiary as of December 3 i, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity.with accounting principles generally accepted in the United States of America. .
As discussed in Note D to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations in 2003.
., .i - !
, KPMG LLP . :
El Paso, Texas March 10, 2004 .;
39
EL PASO ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS December 31.
(In thousands) 2003 2002 Utility plant:
Electric plant in service.............................................................. $ 1,784,134 $ 1,753,022 Less accumulated depreciation and amortization ...................... 591,613 565.209 Net plant in service.............................................................. 1,192,521 1,187,813 Construction work in progress ................................................... 69,175 117,595 Nuclear fuel; includes fuel in process of $6,878 and
$9,639, respectively............................................................. 70,198 74,070 Less accumulated amortization. ...................................... 33,888 34,474 Net nuclear fuel ................................................................... 361310 394596 Net utility plant ............................................................. 1i298,006 1.345.004 Current assets:
Cash and temporary investments. ...................................... 34,426 75,142 Accounts receivable, principally trade, net of allowance for doubtful accounts of $3,470 and $3,234, respectively ........ 66,589 66,818 Accumulated deferred income taxes.......................................... 36,248 28,149 Inventories, at cost...................................................................... 25,321 24,713 Undercollection of fuel revenues ............................................... 12,399 6,401 Prepayments and other ............................................................... 27,190 11.961 Total current assets........................................................ 202.173-- 213.184
_ *_s * -
Deferred charges and other assets:
Decommissioning trust funds. ...................................... 80,475 59,923 Undercollection of fuel revenues - noncurrent.......................... 12,404 Other........................................................................................... 15.200 16.474 Total deferred charges and other assets ........................ Q9s A7S 88.801 Total assets ............................................................ $ 1,595,54 $ 1,46,98 See accompanying notes to consolidated financial statements.
40
EL PASO ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Continued)
CAPITALIZATION AND LIABILITIES December 31, (In thousands except for share data) 2003 2002 Capitalization:
Common stock, stated value $1 per share, 100,000,000 shares authorized, 62,487,263 and 62,389,415 shares issued, and 146,489 and 203,046 restricted shares, respectively .$ 62,633 $ 62,592 Capital in excess of stated value ................................................... 264,235 262,480 Unearned compensation - restricted stock awards ....................................... . (878) (1,442)
Retained earnings .......... . .......................... 354,993 294,742 Accumulated other comprehensive loss, net of tax. ...................................... (9.613) (14.421) 671,370 603,951 Treasury stock, 15,070,266 and 12,982,995, shares respectively; at cost .... (171,548) (147.30)
Common stock equity................................................................................ 499,822 456,642 Long-term debt, net of current portion.......................................................... 588,536 588,650 Financing obligations, net of current portion.. 20,186 25,725 Total capitalization ... .......................
1,108.544 1.071.017 Current liabilities:
Current maturities of long-term debt and financing obligations ................... 22,106 - 60,961 Accounts payable, principally trade............................................................... 19,197 24,899 FERC settlements payable ..................- 15,500 Taxes accrued other than federal income taxes ......................... 1....................
5,167 17,827 Interest accrued............................................................................................. 14,706 15,965 Overcollection of fuel revenues ................................................... 10,070 Other.............................................................................................................. 20,781 20,556 Total current liabilities ................ ....... 102.027 155,708 Deferred credits and other liabilities:
Asset retirement obligation (see Note D) .............................. ..,.,.,.-...55,149 ; 145,871 Accumulated deferred income taxes ....................... .. 139,605 97,084 Accrued postretirement benefit liability ................................................... 94,510 88,569 Accrued pension liability ................ . . . . ............. 53,000 51,086 Other ............................................................................................................. j. 4 30199 3 7.654 Total deferred credits and other liabilities ..................................... 385.283 420.264 Commitments and contingencies Total capitalization and liabilities ................................... $ 1,595,854 $ 1,646,982 See accompanying notes to consolidated financial statements.
41
EL PASO ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except for share data)
Years Ended December 31.
2003 2002 2001 Operating revenues...................................................................... 664,362 $
690,085 769,705 Energy expenses:
Fuel ............................................... 165,367 132,413 185,449 Purchased and interchanged power ......................................... 55,592 97,825 85,587 220,959 230,238 271,036 Operating revenues net of energy expenses . 443,403 459,847 498,669 Other operating expenses:
Other operations . 167,497 152,917 152,376 Impairment loss on CIS project...................................... 17,576 FERC settlements................................................................... 15,500 -
Maintenance. 48,246 48,022 46,009 Depreciation and amortization. ...................................... 87,141 89,582 89,462 Taxes other than income taxes. ...................................... 42,728 43.219 43,220 363,188 349,240 331.067 Operating income......................................................................... 80,215 110.607 167,602 Other income (deductions):
Investment and interest income (loss), net. 1,840 (990) 2,453 Loss on extinguishments of debt. (1) (3,410) (3,634)
Other, net. (1,496) (2,195) (1,576) 343 (6,595) (2,757)
Income before interest charges. ...................................... 80.558 104,012 164.845 Interest charges (credits):
Interest on long-term debt and financing obligations. 51,400 55,160 62,902 Other interest. 695 8,835 7,998 Interest capitalized.................................................................. (5.572) (5.641) (4.723) 46,523 58.354 66.177 Income before income taxes and cumulative effect of accounting change. 34,035 45,658 98,668 Income tax expense...................................................................... 13,419 16,691 35,009 Income before cumulative effect of accounting change. 20,616 28,967 63,659 Cumulative effect of accounting change, net of tax . 39,635 Net income ................................................. $ 60,251 S 28,967 $ 63,65 Basic earnings per share:
Income before cumulative effect of accounting change.......... $ 0.42 $ 0.58 $ 1.25 Cumulative effect of accounting change, net of tax ................ 0.82 Net income............................................................... $ 1.24 $ 0.58 $ US25 Diluted earnings per share:
Income before cumulative effect of accounting change.......... $ 0.42 $ 0.57 $ 1.23 Cumulative effect of accounting change, net of tax ................ 0.81 Net income ............................................................... $ 1.23 $ 0.57 $ 1.23 Weighted average number of shares outstanding..................... 48,424,212 49,862,417 50,21140 Weighted average number of shares and dilutive potential shares outstanding .................................. 48,814,761 50,380,468 51,722,351 See accompanying notes to consolidated financial statements.
42
-1 EL PASO . .1 ELECTRIC .
COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSINE OPERATIONS (In thousands)
I . - . . I ; I Years Ended December 31,
" .. - ,' . w. .' ; 2003 2002 2001 Net income 60,251 $ 28,967 $ 63,659 Other comprehensive income (loss):
Minimum pension liability adjustment........... ....... (4,234) (21,148) (824)
Net unrealized gains (losses) on marketable securities:
Net holding gains (losses) arising during period. 8,764 (7,657) (5,611)
Reclassification adjustments for net losses included in net income....................................................................... 722 4.245 3.089 Total other comprehensive income (loss) before income taxes 5,252 (24.560) (3.346)
Income tax benefit (expense) related to items of other comprehensive income (loss):
Minimum pension liability adjustment....................................... 1,673 8,193 313 Net unrealized gains (losses) on marketable securities .............. (2,117) 1.194, 883 Total income tax benefit (expense) ................................................... (444) 9.387 1.196 Other comprehensive income (loss), net of tax..................................... 4.808 (15,173) (2.150)
Comprehensive Income ........................ $ 65,2 13,7 $ 61,509 See accompanying notes to consolidated financial statements.
,. , ( .- I ;I I I i
. I. - I.
.. I , . .
- I- ,,1~
I II.... 1 I . -. . I .
43
EL PASO ELECTRIC COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK EQUITY (In thousands except for share data)
Unearned Accumulated Capital Compensation Other Total in Excess - Restricted Comprehensive Common Common Stock of Stated Stock Retained Income (Loss), Treasury Stock Shares Amount Value Awards Earnings Net of Tax Stock Equity Balances at December 31, 2000 .................. 60,705,173 $ 60,705 $244,528 $ (1,309) $ 202,116 $ 2,902 $ (96,908) $412,034 Grants of restricted common stock.................................................... 187,270 187 2,410 (2,597)
Stock options exercised or remeasured... 1,396,045 1,396 7,309 8,705 Amortization of unearned compensation . 1,835 1,835 Stock awards withheld for taxes ............. (34,995) (35) (416) (451)
Forfeitures of restricted common stock.................................................... (3,196) (3) (27) 30 Deferred taxes on stock incentive plan 41 41 Adjustment to state income tax valuation allowance. 4,046 4,046 Net income....................................... 63,659 63,659 Other comprehensive loss. (2,150) (2,150)
Treasury stock acquired, 2,760,851 shares; at costs......... (37.526) (37.526)
Balances at December 31, 2001 .................. 62,250,297 62,250 257,891 (2,041) 265,775 752 (134,434) 450,193 Grants of restricted common stock. ...................................... 109,240 109 1,477 (1,586)
Stock options exercised or remeasured... 280,000 280 1,966 2,246 Amortization of unearned compensation . 1,865 1,865 Stock awards withheld for taxes ............. (23,727) (24) (312) (336)
Forfeitures of restricted common stock.................................................... (23,349) (23) (297) 320 Deferred taxes on stock incentive plan (553) (553)
Adjustment to federal valuation allowance ...................................... 2,308 2,308 Net income......................................... 28,967 28,967 Other comprehensive loss. (15,173) (15,173)
Treasury stock acquired, 991,358 shares; at costs........................ _(12.875) (12.875)
Balances at December 31, 2002 .................. 62,592,461 62,592 262,480 (1,442) 294,742 (14,421) (147,309) 456,642 Grants of restricted common stock.................................................... 63,090 63 661 (724)
Amortization of unearned compensation . 1,288 1,288 Stock awards withheld for taxes ............. (21,799) (22) (209) (231)
Deferred taxes on stock incentive plan 1,008 1,008 Adjustment to federal valuation allowance...................................... 295 295 Net income...................................... 60,251 60,251 Other comprehensive income. 4,808 4,808 Treasury stock acquired, 2,087,271 shares; at costs..................... (24,239) (24.239)
Balances at December 31, 2003 .................. $ 264,235 $I-4~22 LOAJ) $(171548 49,2 See accompanying notes to consolidated financial statements.
44
EL PASO ELECTRIC COMPANY AND SUBSIDLARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, 2003 2002 2001 Cash Flows From Operating 'Activities:
Net income ................................................. $ 60,251 28,967 $ 63,659 Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of electric plant in service ...... 87,141 89,582 89,462 Impairment loss on CIS project ...... ................ :.;......... 17,576 - -
Amortization of nuclear fuel ... ; 16,374 17,968 16,272 Cumulative effect of accounting change, net of tax (39,635) -
Deferred income taxes, net ......................................... . 10,249 2,515 31,655 Loss on extinguishments of debt .. 3,410 3,634 Other amortization and accretion ...................... 7................
,744 11,703 11,279 Other operating activities........................................................ 1,432 2,918' 2,261 Change in:
FERC settlements payable .(15,500) 15,500 Accounts receivable ............ (1,258) 8,207 11,622 Inventories............................................................................ (366) (357) 489 Net under/overcollection'of fuel revenues ........................... 16,476 4,727 2,044 Prepayments and other.. ............................................... . (17 10,871 Accounts payable.......... .......... I.............................. .......... 73 (1573)
Taxes accrued other than federal income taxes .(2,660) 1,674 (901)
Interest accrued................................................... r.............. .. .. (1,259) (895) 332 Other current liabilities ..... 225 4,054 1,534 Deferred charges and credits....................................... .. 1.612 2.281' 6.312 Net cash provided by operating'activities . . . 135.014 190.307 235.352 Cash Flows From Investing Activities:
Cash additions to utility property, plant and equipment ............. (77,080) (65,065) (70,739)
Cash additions to nuclear fuel . . .(13,848) (16,036) (17,031)
Interest capitalized:
Utility property, plant and equipment ................ (5,322) (5,290) (4,246)
Nuclear fuel... . (250) (351) (477)
Decommissioning trust funds:
Purchases . . .(21,079) (19,308) (21,791)
Sales and maturities . . .9,384 14,190 16,772 Other investing activities .'1.467 .......................
46(469) 101 Cash 'Net cash used for investing activities . . .. (106.72 ..................
'72D (92.322) (97.411)
FCashlows From Financing Activities:
Proceeds from exercise of stock options .............. ..........-. 2,006 ; 8,275 Purchases of treasury stock........................................................ (24,239) (12,875) . (37,526)
Repurchases of and payments on first mortgage bonds (39,360) (36,344) (91,555)
Pollution control bonds:
.................... ........- 70,400 Payments .... .... ' -_(70,400)
Nuclear fuel financing obligations:
Proceeds. ................................................................................. 15,169 18,235 19,468 Payments....................................... ........................... (20,207) (19,310)(19,336)
Other financing activities............................................6...................I (365 '.2) (617)
Net cash used for financing activifes.' - (69.002) ' ' 50.30! (121.291)
Net increase (decrease) in cash and temporaryinestments . .... (40,716) 47,148 16,650 Cash and temporary investments at beginning of period. ............... . 75.142 27.994 11.344 Cash and temporary Investments at end of period .............. . .$ 34, 75,142 $ 727994 See accompanying notes to consolidated financial statements.
45
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. Summary of Significant Accounting Policies General. El Paso Electric Company is a public utility engaged in the generation, transmission and distribution of electricity in an area of approximately 10,000 square miles in west Texas and southern New Mexico. El Paso Electric Company also serves wholesale customers in Texas and periodically in the Republic of Mexico.
Principles of Consolidation. The consolidated financial statements include the accounts of El Paso Electric Company and its wholly-owned subsidiary, MiraSol Energy Services, Inc. ("MiraSol")
(collectively, the "Company"). MiraSol, which began operations as a separate subsidiary in March 2001, provided energy efficiency products and services previously provided by the Company's Energy Services Business Group. On July 19, 2002, all marketing activities of MiraSol ceased. MiraSol remains a going concern in order to satisfy current contracts and warranty and service obligations on previously installed projects. See Note I. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Basis of Presentation. The Company maintains its accounts in accordance with the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission (the "FERC"). The Company previously determined that it does not meet the criteria for the application of Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation," and accordingly does not currently report the effects of certain actions of regulators as assets or liabilities unless such actions result in assets or liabilities under generally accepted accounting principles for commercial enterprises in general. The Company continues to review whether, on a prospective basis, it may meet the criteria for applying SFAS No. 71 to its general purpose financial statements for some or all of its operations.
Comprehensive Income. Certain gains and losses that are not recognized currently in the statements of operations are reported as other comprehensive income in accordance with SFAS No. 130, "Reporting Comprehensive Income."
Utility Plant. Depreciation is provided on a straight-line basis over the estimated remaining lives of the assets (ranging from 5 to 31 years), except for approximately $298 million of reorganization value allocated primarily to net transmission, distribution and general plant in service. This amount is being depreciated over the ten-year period of the Texas Rate Stipulation, which ends August 2005. For all other utility plant, Texas and New Mexico depreciation lives are the same. Amortization of intangible 46
EL PASO ELECTRIC COMPANY AND SUBSIDLARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS plant (software) is provided on a straight-line basis over the estimated useful life of the asset (ranging from 3 to 10 years).,
The Company charges the cost of repairs and minor replacements to the appropriate operating expense accounts and capitalizes the cost of renewals and betterments. Gains or losses resulting from retirements or other dispositions of operating property in the normal course of business are credited or charged to the accumulated provision for depreciation.
The cost of nuclear fuel is amortized to fuel expense on a units-of-production basis. A provision for spent fuel disposal costs is charged to expense based on requirements of the Department of Energy (the "DOE") for disposal cost of approximately one-tenth -of one cent on each kWh generated. The Company is also amortizing its share of costs associated with on-site spent fuel storage casks :at Palo Verde over the burn period of the fuel that will necessitate the use of the storage casks. See Note C.
Impairment of Long-Lived Assets. In accordance with SFAS No. 144, "Accounting for the Inpairment or Disposal of Long-Lived Assets," long-lived assets, such as property, plant, and equipment and purchased intangibles subject to amortization,. are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.-
Recoverability- of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimate undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
CapitalizedInterest. The Company capitalizes interest cost to construction work in progress and nuclear fuel in process in accordance with SFAS No. 34, "Capitalization of Interest Cost."
Asset Retirement Obligation. Effective January 1, 2003, .the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 sets forth accounting requirements for the recognition and measurement of liabilities associated with the retirement of tangible long-lived assets. An asset retirement obligation ("ARO") associated with long-lived.assets included within the scope of SFAS No. 143 is that for which a legal obligation exists under enacted laws,.statutes, written or oral contracts, including obligations arising under. the doctrine- of promissory 'estoppel. Under the statement, these liabilities are recognized as incurred if a reasonable estimate of fair value can be established and are capitalized.as part of the cost of the related tangible long-lived assets:.The increase in the ARO due to the passage of time is iecorded as an operating expense (accretion expense). See Note D.
Cash and Cash Equivalents. All temporary cash investments with an original maturity of three months or less are considered cash equivalents.
- A 47
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Investments. The Company's marketable securities, included in decommissioning trust funds in the balance sheets, are reported at fair market value and consist primarily of equity securities and municipal, federal and corporate bonds in trust funds established for decommissioning of its interest in Palo Verde. Such marketable securities are classified as "available-for-sale" securities and, as such, unrealized gains and losses are included in accumulated other comprehensive income as a separate component of common stock equity. However, if declines in fair value of marketable securities below original cost basis are determined to be other than temporary, then the declines are reported as losses in the consolidated statement of operations and a new cost basis is established for the affected securities at fair value. See Note M.
Inventories. Inventories, primarily parts, materials, supplies and fuel oil are stated at average cost not to exceed recoverable cost.
Operating Revenues Net of Energy Expenses. The Company accrues revenues for services rendered, including unbilled electric service revenues. Energy expenses are stated at actual cost incurred. The Company's Texas retail customers are presently being billed under a fixed fuel factor approved by the Texas Commission. As of June 2003, the Company's New Mexico retail customers are being billed under a fuel adjustment clause which is adjusted monthly, pending a final order from the New Mexico Commission in the Company's July 2003 rate compliance filing. The Company's recovery of energy expenses in these jurisdictions is subject to periodic reconciliations of actual energy expenses incurred to actual fuel revenues collected. The difference between energy expenses incurred and fuel revenues charged to the Company's Texas and New Mexico customers, as determined under Texas and New Mexico Commission rules, is reflected as net over/undercollection of fuel revenues in the balance sheets. See Note B.
Allowance for Doubtful Accounts. Additions, deductions and balances for allowance for doubtful accounts for 2003, 2002 and 2001 are as follows (in thousands):
2003 2002 2001 Balance at beginning of year ........................... $ 3,234 $ 3,525 $ 3,325 Additions:
Charged to costs and expense ................. 3,096 2,909 3,962 Charged to other accounts (1) ................ 981 835 689 Deductions (2) ............................... . 3,841 4035 4.451 Balance at end of year ............................... $ 3470 $ 3,234 $ 3.525 (1) Recovery of amounts previously written off.
(2) Uncollectible receivables written off.
Income Taxes. The Company accounts for federal and state income taxes under the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the estimated future tax consequences of "temporary differences" by applying enacted 48
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS statutory tax rates for each taxable jurisdiction applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The Company records a valuation allowance to reduce its deferred tax assets to the extent it is more likely than not that such deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date.
Earnings per Share. Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of shares and the dilutive impact of stock options which were outstanding during the period calculated by the treasury stock method and unvested restricted stock.
Stock Options and Restricted Stock. The Company has two stock-based long-term incentive plans and accounts for them under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Stock options have typically been granted with an exercise price equal to fair market value on the date of grant and, accordingly, no compensation expense is recorded by the Company. Restricted stock has been granted at fair market value. Accordingly, the Company recognizes compensation expense by ratably amortizing the fair market value of the grant over the restriction period. If compensation expense for the option portion of the plans hadbeen determined based on the fair value of the option at the grant date and amortized on a straight-line basis over the vesting period,!consistent with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's net earnings and earnings per share would have been reduced to the pro forma amounts presented below:
Years Ended December 31, 2003 2002 2001 Net income, as reported ................... $ 60,251 $ 28,967 $ 63,659 Deduct: Compensation expense, net of tax 916 1.326 1,384 Pro forma net income ................................ $.59,335 $ 622752 $
Basic earninggs per share:
'Asreported ................................................ $ 1.24 $ 0.58 $ 1.25 Proforma ..... ....... 1.22 0.55 1.23 Diluted earnings per share:
As reported...........I......... . 1.23 - 0.57 1.23 Pro forma. ...................................... 1.22 0.55 1.20 49
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value for these options was estimated at the grant date using the Black-Scholes option pricing model. Weighted average assumptions and grant-date fair value for 2003, 2002 and 2001 are presented below:
2003 2002 2001 Risk-free interest rate .................. 4.13% 5.22% 5.06%
Expected life, in years ................. 7.4 10 10 Expected volatility ...................... 24.72% 26.10% 27.92%
Expected dividend yield .............. - -
Fair value per option ................... $4.83 $6.75 $7.18 Compensation expense for the restricted stock awards is recognized on a fair value basis and is measured by referencing the quoted market price of the shares at the grant date, amortized ratably over the restriction period. Unearned compensation related to restricted stock awards is shown as a reduction of common stock equity.
Other New Accounting Standards. During 2003, the Company adopted SFAS No. 132 (revised 2003), "Employers' Disclosure about Pensions and Other Postretirement Benefits," SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," SFAS No. 148, "Accounting for Stock-based Compensation Transition and Disclosure, an Amendment of FASB Statement No. 123,"
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" and FASB Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements of Guarantees, Including Indirect Guarantees of Indebtedness to Others, an Interpretation of FASB Statements No. 5, 57, and 107 and a Rescission of FASB Interpretation No. 34" and certain provisions of SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The implementation of these standards did not have a significant impact on the Company's financial position or results of operations.
Additionally, during 2003, the Company adopted SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections."
SFAS No. 145 required the Company to classify gains and losses on the extinguishment of debt in other income (deductions) and the Company reclassified prior period amounts to conform with this presentation.
Reclassification. Certain amounts in the consolidated financial statements for 2002 and 2001 have been reclassified to conform with the 2003 presentation.
50
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES' TO CONSOLIDATED-FINANCIAL STATEMENTS B. Regulation General; ; .':-. '. -. '.:.{:- : 1 .' '.. !:.-- -. =:
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- .In 1999, both -the ;Texas and New -Mexico legislatures-;. enacted. electric. utility industry restructuring laws -requiring competition in dertainmfimctions of the industry and ultimately in the Company's service- area In Texas, the Company is -exempt from the requirements of the Texas Restructuring Law, including utility restructuring and retail, competition, until the expiration of the Freeze Period in August 2005.: In April 2003,-the'New Mexico Electric-Utility InidustryRestructuring Act of 1999 (','New. Mexico Restructuring Act!) was-repealed and asea result, the, Company's operations in New Mexico will continue to be fully regulated. The Company cannot predict at this time the' full effects the repeal of the New Mexico Restructuring Act will have on the Company as it prepares for retail competition in Texas. However, the Company believes 'that the New Mexico Commission will have to approve the separation of the Company's operations if and when 'the Company implements utility restructuring and retail competition for compliance with the Texas Restructuring Law. - ' -: -.
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- FederalEnergy Regulatory Commission.-- The FERC has been conducting an investigation into potential manipulation of electricity prices in the Western 'United; States during 2000 and 2001. ,'On August 13, 2002, the FERC initiated a Federal Power Act ("FPA") investigation into the Company's wholesale powver trading in 'the western United rStates ;during 2000 and 2001 to determine whether the Company engaged in misconduct and, if so,, to determine potential remedies. The Company reached settlements with the FERCAnd other parties in-2002 and 2003. Under the terms of the settlements, the Company agreed to refund a' total of ,$15.5 nillion of revenues -it ,earned on wholesale- power transactions. In July 2003, the FERC approved the settlements and on August 5, 2003, the Company deposited the $15.5 million into an interest bearing escrow account to consummate the. settlements. The Company believes the FERC's order resolved all issues between the FERC and the other parties to this investigation Under: he&settlements, the Company hasiagreed to iake wholesale sales pursuant to its cost ofservice rate authorityrather than-its market-based rate auth6rity-for the period December il 2002 through December 31, 2004. This'agreement allows the Company to sell power into wholesale markets at its increm'entil cost plus $21.11 per MWh." To the; extent that'wholesald'itarket prices exceed these agreed upon amounts, the oli pany Will-forego the 6pportunityto'realizd these additional revenues.!
Although this provision has not had a significant impact on the Company's revenues through December 3i;, 2003, the Company is uiiablet predidt the effect, if any, this willhave oh the Company's 2004revenues. -! - - ; [i- J i i" - v
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RTOs. FERC's rule ("Order 2000") on Regional Tralsimission. Organizations ("RTOs") strongly encourages, 'but does not require, public'utilities to form and join RTOs. The Company is an active participant in the development of WestConnect, formerly known as the Desert Southwest-Transmission and Reliability Operator.q! As a participating trahkmissioi owner, the'Company will ultimately transfer 51
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS operational authority of its transmission system to WestConnect subject to receiving any necessary regulatory approvals. On October 10, 2002, FERC issued an order indicating that the Company's WestConnect proposal satisfied, or with certain modifications would satisfy, the FERC requirements for an RTO under Order 2000. WestConnect will continue to work with the FERC and two other proposed RTOs in the west to achieve a seamless market structure. The Company, however, is anticipated to be no more than a 9% participant in WestConnect and cannot control the terms or timing of its establishment. WestConnect will not be operational before the end of the Freeze Period. The establishment of an RTO in the Company's service area is an important factor in the Company's ability to establish a Qualified Power Region as defined in the Texas Restructuring Law and the timing of the operations of WestConnect could affect when and whether the Company's Texas service territory participates in the Texas deregulated market.
Department of Energy. The DOE regulates the Company's exports of power to the Comision Federal de Electricidad de Mexico ("CFE") in Mexico pursuant to a license granted by the DOE and a presidential permit. The DOE has determined that all such exports over international transmission lines shall be made in accordance with Order No. 888, which established the FERC rules for open access.
The DOE is authorized to assess operators of nuclear generating facilities a share of the costs of decommissioning the DOE's uranium enrichment facilities and for the ultimate costs of disposal of spent nuclear fuel. See Note C for discussion of spent fuel storage and disposal costs.
Nuclear Regulatory Commission. The Nuclear Regulatory Commission ("NRC") has jurisdiction over the Company's licenses for Palo Verde and regulates the operation of nuclear generating stations to protect the health and safety of the public from radiation hazards. The NRC also has the authority to conduct environmental reviews pursuant to the National Environmental Policy Act.
Texas Regulatory Matters The rates and services of the Company are regulated in Texas by municipalities and by the Texas Commission. The largest municipality in the Company's service area is the City of El Paso. The Texas Commission has exclusive appellate jurisdiction to review municipal orders and ordinances regarding rates and services within municipalities in Texas and original jurisdiction over certain other activities of the Company. The decisions of the Texas Commission are subject to judicial review.
Deregulation. The Texas Restructuring Law required certain investor-owned electric utilities to separate power generation activities from transmission and distribution activities by January 1, 2002, and on that date, retail competition for generation services was instituted in some parts of Texas. The Texas Restructuring Law, however, specifically recognized and preserved the Company's Texas Rate Stipulation and Texas Settlement Agreement by, among other things, exempting the Company's Texas service area from retail competition until the end of the Freeze Period. The Texas Commission recently opened a project (Project No. 28971) to evaluate the readiness of the Company's service area in Texas for retail competition for generation services. In this project, the Texas Commission may specify in 52
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS advance the factors that are important inmdeciding when and whether to open the Company's service area in Texas to customer choice.: One of the key factors that will likely be utilized by the Texas Commission in its determination is the progress that has been made in developing an RTO in the Company's service area. Public hearings to discuss the readiness of the Company's service area were held on March 4, 2004 in El Paso and will be held in Austin in April 2004. There is substantial uncertainty about both the regulatory framework and market conditions that will exist if and when retail* competition is implemented in the Company's service territory and the Company may incur substantial preparatory, restructuring and other costs that may not ultimately be recoverable. 'There can be no assurance that deregulation will not adversely affect the future operations, cash flows and financial condition of the Company.
Fuel. Although the Company's base rates are frozen in Texas, pursuant to Texas Commission rules and the Texas Rate Stipulation, the Company can request adjustments to its fuel factor to more accurately reflect projected energy costs associated with providing electricity and seek recovery of past undercollections of fuel revenues, subject to periodic final review by the Texas Commission in fuel reconciliation proceedings. -
On March 10, 2004, the Texas Commission announced its decision in PUC Docket No. 26194, a case in which the Company sought to reconcile its Texas jurisdictional fuel costs for the period January 1, 1999 through December 31, 2001. At issue was the Company's request to recover an additional $15.8 million, before interest, from its Texas -customers as a surcharge because of fuel undercollections from January 1999 through December 2001. The Texas Commission disallowed approximately $4.5 million of Texas jurisdictional expenses, before interest, consisting primarily of (i) approximately $4.2 million of purchased power expenses which the Texas Commission characterized as "imputed capacity charges," and (ii) approximately $03 million in fees which were deemed to be administrative costs, not recoverable as fuel. In Texas, capacity charges are not eligible for recovery as fuel expenses, but are to be recovered through the Company's base rates. 'As the Company's base rates were frozen during the time period in question, the $4.2 million of "imputed capacity charges" would be permanently disallowed, and hence not recoverable from its Texas customers.
The Texas Commission's decision modifies-the Proposal for Decision issued September 19, 2003 by the Administrative Law Judges; ("ALJs"). The ALJs had recommended that approximately
$21.2 million of the Company's purchased power expense should be disallowed as imputed capacity charges and not recovered from Texas jurisdictional customers.
The Company has incurred similar purchased power costs for the fuel reconciliation period beginning January 1, 2002. The Company believes that it has accounted for its purchased power costs during the reconciliation period beginning January 2002 in a manner consistent with the Texas Commission's decision in PUC Docket No. 26194. However, the Texas Commission has indicated its desire to conduct a generic rulemaking proceeding to determine a statewide policy for the appropriate pricing -of capacity in purchased power contracts. There can be no assurance, however, as to the 53
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS outcome of such rulemaking and the potential impact on the Company with respect to fuel recovery in future reconciliation periods if the Texas Commission adopts a different methodology in a subsequent rulemaking proceeding.
The Texas Commission's decision is subject to appeal by the various parties and the Company is unable to predict the ultimate outcome of any appeals that may be filed in this case.
Palo Verde Performance Standards. The Texas Commission established performance standards for the operation of Palo Verde pursuant to which each Palo Verde unit is evaluated annually to determine whether its three-year rolling average capacity factor entitles the Company to a reward or subjects it to a penalty. The capacity factor is calculated as the ratio of actual generation to maximum possible generation. If the capacity factor, as measured on a station-wide basis for any consecutive 24-month period, should fall below 35%, the Texas Commission can also reconsider the rate treatment of Palo Verde, regardless of the provisions of the Texas Rate Stipulation and the Texas Settlement Agreement. The removal of Palo Verde from rate base could have a significant negative impact on the Company's revenues and financial condition. Under the performance standards as modified by the Texas Fuel Settlement, the Company has calculated the performance awards for the reporting periods ending in 2003, 2002 and 2001 to be approximately $0.8 million, $1.3 million and $1.1 million, respectively.
These rewards will be included, along with energy costs incurred and revenues billed, as part of the Texas Commission's review during a future periodic fuel reconciliation proceeding as discussed above.
Performance rewards are not recorded on the Company's books until the Texas Commission has ordered a final determination in a fuel proceeding or comparable evidence of collectibility is obtained.
Performance penalties are recorded when assessed as probable by the Company.
Texas Renewable Energy Requirement. Chapter 39 of the Public Utility Regulatory Act
("PURA"), implemented by Senate Bill 7 in the 1999 legislative session, requires that, by January 1, 2009, an additional 2,000 MW of generating capacity from renewable energy technologies be installed in the state. The renewable energy requirement is to be added in increments with the cumulative installed renewable capacity in Texas totaling 1,703 MW by January 1, 2005, 2,280 MW by January 1, 2007, and 2,880 MW by January 1, 2009. The requirements of this goal are placed on retail electric providers
("REPs") who provide competitive retail electric service in the state of Texas. Utilities that have not implemented retail competition may have renewable energy requirements based on orders of the Texas Commission.
Until the end of the Freeze Period, the Company is exempt from PURA Chapter 39 and Texas Commission rules implementing the renewable requirements. However, once the Freeze Period ends, any renewable energy requirement applicable to the Company could be based on the percentage of the competitive retail load that will be served by the Company (or the Company's REP) in relation to the total competitive retail load served in Texas. It is not clear when the Company will need to meet a renewable energy requirement in Texas or what the obligation will be. The Company is currently reviewing the outcome of its New Mexico RFPs, for renewable energy to assess possible scenarios for 54
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS meeting possible future Texas requirements, which includes the purchase of renewable power and/or credits. . . .,' . .: . aI ,
New Mexico Regulatory Matters! ,-.- -. ..
'The NewMexico Commission -has-jurisdiction over the ;Company's rate's and rservices in New Mexico and over certain other activities of the Company, including .prior-approval of the issuance, assumption or guarantee of securities. The New Mexico Commission's decisions are'subject to judicial review. The largest city in the Company's New Mexico service territory is Las Cruces.
Deregulation. In April 2003, the New Mexico Restructuring Act was repealed and as a result the Company's operations in New.Mexico will continue tobe fully regulated.. 'The, Company~cannot predict at this time the full effects the 'epeal of the New Mexico Restructuring Act will have on the Company as it prepares for retail competition-iri'Texas. ':
Fuel. In June 2001, the New Mexico Commission approved a fuel and purchased power cost adjustment clause. On May 31, 2003, the Company submitted a rate compliance filing whereby the Company proposed to continue a base rate recovert.of ,$0.01949 per kWh and continue the fuel and purchased power cost adjustment to recover the remainder of fuel and purchased power costs. The Company and all -intervenors entered into the' New; Mexico Stipulation 'on the Company's compliance filing. ' .. . ; ', .' <. ;i . ;l .. .r i'.' .'
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!' New Mexico Rate Stipulation. .On Jahuary 2112004, the Company and all intervenors to therate compliance filing entered 'into and filed the New.Mexico Stipulation whereby, amongbother things, the Company agreed. for a period of three'years beginning June 1,2004'to (i) freeze base rates after an initial non-fuel base rate-reduction of 1%; (ii) fix fuel and purchased' power costs associated with 10% of the Company's jurisdictional retail ¶sales-'in-NewMexico at' $0.02UI per. kWh,; (iii)leave sosbject!,to reconciliation the remaining 90% of the Company's New Mexico jurisdictional fuel and purchased power costs; r(iv) continue the collection of.a portion of fuel and'purchased power costs'in 'base rates as presently' collected in the. 'amount 'of $0.01949 per kWh; (vYprice power provided from rPalo Verde Unit.3'to the extent of its'availability at an :80%-nuclear, 20% gas 'fuel mik (currently sudh'power is priced at 75%'riuclear, 25% gas -fuel nmix)'and (vi) deem reconciled, for the period June 15, 2001 through May31, 2004, the: Company's fuel and: purchased 'power-costs for-the iNew Mexico jurisdiction.' -The New Mexico Stipulation )is 'subjectr to the: New Mexico 'Commission's approval' ,iThe iNew.Mexico Commission hearing oin! the: New Mexico., Stipulation Iwas held on'debruary 25,i 2004. iThe. Company anticipates a ruling on the New Mexico Stipulation prior to June 2004 with the new rates implemented on or about June 1, 2004. The Company cannot predict the outcome of these proceedings or how the New Mexico Commission will rule.
New Mexico Renewable Energy Requirement. The New Mexico Commission has adopted renewable energy portfolio requirements and has mandated that 5% of all New Mexico retail 55
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS jurisdictional energy sales in 2006 be supplied by renewable resources or certificates. The renewable portfolio standard increases by 1% each year until 2011, and is set at 10% in 2011 and thereafter. In February 2004, the Company issued a RFP for renewable energy from certified renewable sources to meet the renewable energy portfolio requirements. Based on responses to the RFP, the Company will develop a plan to meet the New Mexico Commission's renewable energy requirements. In the 2004 New Mexico legislative session, the Renewable Energy Act was enacted which directs the New Mexico Commission to adopt a rule consistent with the law, and required rate recovery for the reasonable costs of compliance with the renewable requirements.
Sales for Resale The Company provides up to 10 MW of firm capacity, associated energy, and transmission service to the Rio Grande Electric Cooperative pursuant to an ongoing contract which requires a two-year notice to terminate. No such notice has been received. The Company also made sales of interruptible energy to CFE during the months of June and July 2003 of 13,711 MWh and 4,525 MWh, respectively.
C. Palo Verde and Other Jointly-Owned Utility Plant The Company owns a 15.8% interest in each of the three nuclear generating units and Common Facilities at Palo Verde, in Wintersburg, Arizona. The Palo Verde Participants include the Company and six other utilities: Arizona Public Service Company ("APS"), Southern California Edison Company
("SCE"), Public Service Company of New Mexico ("PNM"), Southern California Public Power Authority, Salt River Project Agricultural Improvement and Power District ("SRP") and the Los Angeles Department of Water and Power. APS serves as operating agent for Palo Verde. The operation of Palo Verde and the relationship among the Palo Verde Participants is governed by the Arizona Nuclear Power Project Participation Agreement (the "ANPP Participation Agreement").
Pursuant to the ANPP Participation Agreement, the Palo Verde Participants share costs and generating entitlements in the same proportion as their percentage interests in the generating units, and each participant is required to fund its share of fuel, other operations, maintenance and capital costs. The ANPP Participation Agreement provides that if a participant fails to meet its payment obligations, each non-defaulting participant shall pay its proportionate share of the payments owed by the defaulting participant. Because it is impracticable to predict defaulting participants, the Company cannot estimate the maximum potential amount of future payment, if any, which could be required under this provision.
56
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other jointly-owned utility plant includes a -7% interest in Units 4 and 5 at Four Corners Generating Station ("Four Corners") and certain other transmission:facilities. A summary of the Company's investment in jointly-owned utility plant, excluding fuel, at December 31, 2003 and 2002 is as follows (in thousands):
December 31. 2003' December 31, 2002 PaloVerde, Other PaloVerie Other Electric piant in service .................... $ 588,071 (1) $ 1'87,036' $ 611,580 $ 184,429'
- Accumulated depreciation............... .(108,765)(1) (113,845) (139,271) (99,136)
-Construction work inprogress 23,251 2,729 46,761_ 3,649 (1) The decline in these balances is primarily the result of the implementation of SFAS No. 143 at January 1,2003. 'See Note D.
Decommissioning! Pursuant to the ANPP Participation Agreement and federal law, the Company must fund its share of the estimated costs to decommission Palo Verde Units 1, 2 'and3, including the Common Facilities,' through the term of their respective operating licenses. The Company's decommissioning costs are 'estimated every three years based upon engineering cost studies performed by outside engineers retained by APS.
In accordance with the' ANPP Participation Agreement, the Company is required to establish a minimum accumulation and a minimum funding level in its decommissioning account atfthe end of each annual reporting period during the life of the plant. In January 2003, the Company made an additional deposit of $4.7 million 'into the decommissioning trust fund such that the trust fund met ANPP minimum accumulation'levels at December 31, 2002. The Company remained 'above its minimum funding level as of December 31, 2003. The Company will continue to monitor the status of its decommissioning funds and adjust its deposits if necessary, to remain at or above its minimum accumulation requirements infthe future.r The Company has established external trusts' with independent trustees, which enable the Company to record a current deduction for federal income tax purposes of a portion of amounts funded.
As of December31, 2003' and 2002, the fair market value of the trust'funds was approximately
$80.5 million and $59.9 rmillion, respectively, which 'is reflected in the Company's balance sheets in deferred charges and other assets'.,
In August 2002, the' Palo Verde Participants approved the 2001' Palo Verde decommissioning Otudy. Some changes in the cost calculations occurred between the prior 1998 study and the 2001 study The 2001 study estimated hiat the Company must fund approximately $311.6 million (stated in 2001 dollars) to cover its share of decommissioning costs.' The previous cost estimate from' the 1998 study estimated that the Company would fund approximately $280.5 million (stated in 1998 dollars). The 2001 estimate reflects an 11.1 % increase, or 3.6% average annual compound increase, from the 1998 estimate 57
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS primarily due to increases in estimated costs for site restoration at each unit, pre and post-shutdown transitioning and decommissioning preparations, spent fuel storage after operations have ceased and the Unit 2 steam generator storage. The decommissioning study is stated in 2001 dollars and makes no inflation assumptions. See "Spent Fuel Storage" below.
Although the 2001 study was based on the latest available information, there can be no assurance that decommissioning cost estimates will not continue to increase in the future or that regulatory requirements will not change. In addition, until a new low-level radioactive waste repository opens and operates for a number of years, estimates of the cost to dispose of low-level radioactive waste are subject to significant uncertainty. The decommissioning study is updated every three years and a new study is expected to be completed in 2004. See "Disposal of Low-Level Radioactive Waste" below.
Historically, regulated utilities such as the Company have been permitted to collect in rates the costs of nuclear decommissioning. Under the Texas Restructuring Law, which, among other things, deregulates generation services, the Company, through an affiliated transmission and distribution utility, will be able to collect from customers the costs of decommissioning. The collection mechanism utilized in Texas is a "non-bypassable wires charge" through which all customers, even those who choose to purchase energy from a supplier other than the Company's retail affiliate, will be required to pay a fee, which includes the cost of nuclear decommissioning, to the Company's affiliate transmission and distribution utility. In the Company's case, collection of the fee through the Company's transmission and distribution utility will begin in Texas if and when retail competition is implemented in the Company's Texas service territory. See Note B for further discussion.
Spent Fuel Storage. The original spent fuel storage facilities at Palo Verde had sufficient capacity to store all fuel discharged from normal operation of all three Palo Verde units through 2003.
Alternative on-site storage facilities and casks have been constructed to supplement the original facilities. In March 2003, APS began removing spent fuel from the original facilities as necessary, and placing it in special storage casks which are stored at the new facilities until it is accepted by the DOE for permanent disposal. The 2003 decommissioning study assumes that costs to store fuel on-site will become the responsibility of the DOE after 2037.
Pursuant to the Nuclear Waste Policy Act of 1982, as amended in 1987 (the "Waste Act"), the DOE is legally obligated to accept and dispose of all spent nuclear fuel and other high-level radioactive waste generated by all domestic power reactors. In accordance with the Waste Act, the DOE entered into a spent nuclear fuel contract with the Company and all other Palo Verde Participants. The DOE has previously reported that its spent nuclear fuel disposal facilities would not be in operation until 2010.
Subsequent judicial decisions required the DOE to start accepting spent nuclear fuel by January 31, 1998. The DOE did not meet that deadline, and the Company cannot currently predict when spent fuel shipments to the DOE's permanent disposal site will commence.
58
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company expects to-incur significant on-site spent fuel storage.costs during the life of Palo Verde that the Company believes are the responsibility of the DOE. :These costs will be amortized over the burn period of the fuel that will necessitate the use of thealternative on-site storage facilities until an agreement is reached with the DOE fornrecovery of.these costs.. In December 2003; APS, in conjunction with other nuclear plant -operators,'filed 'suit against the -DOE on behalf of the Palo Verde Participants to recover monetary damages associated with the delay in the DOE's acceptance of spent fuel.. The Company is unable topredict the outcome of these matters at this time..,:
Disposal of Low-Level Radioactive Waste. Congress has established requirements for the disposal by each state of low-level radioactive waste generated within its borders. Arizona, California, North Dakota and South Dakota have entered into a compact (the "Southwestern Compact") for the disposal of low-level radioactive waste. California will act as the first host state of the Southwestern Compact, and Arizona will serve as;the second -host -state. The construction and opening of .the California low-level radioactive waste- disposal site in Ward Valley has been delayed due to extensive public hearings, rdisputes .over environmental issues and review :of technical issues related to. the proposed site. Palo Verde is projected -toundergo decommissioning during the period in which Arizona will act Gas host 'for the Southwestern Compact! :>;The opposition, delays, uncertainty and costs experienced in California demonstrate possible roadblocks that may be encountered when Arizona seeks to open its own waste repository. . .
Steam Generators. Palo Verde has experienced degradation in the steam generator tubes of each unit. -The projected service lives of-the Palo Verde steam generators are reassessed by'APS periodically in conjunction with inspections made during scheduled outages at the Palo Verde units. New steam generators 1Were installed at Unit 2. during 2003 sat' an 'estimated total 'cost to. the, Company of
$47.1 million. -This replacement was based on an 'analysis of the net economic benefit from expected improved performance of the unit and the need .to realize. 'continued production from that unit over its full licensed life.:. . . ;I
APS has identified accelerated degradation in the steam'generator tubes in Units- and 3 and has concluded that it'is economically'desirable to replace the steam generators at those units. While analyses related to timing of installation of steam generators at Units 1L and 3 are ongoing, the Company and the other. participants approved Athe expenditure of :$202.1 -million':(the .Company's portion being
$31.9 million) for fabrication and transport of steam generators for Units; 1 and 3. 'In addition, APS has proposed, and the participants have approved the expenditure of $28.4 million (the Company's portion being $4.5 million) for pre-installation and power uprate'work for Units '1and 3. In addition 'to these approved amounts, the installation oflthe Units 1 'and 3replacement steam generators and the completion
- power of uprtes at: those units' will require the expenditure of $278.6 million (the Company's portion being $44.0 million). Present plans are for replacement steam 'generators to be installed at Units I and 3 in 2005.and 2007, respectively. ' -
59
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS an ARO. However, substantial uncertainty exists surrounding the ultimate removal date for these facilities. Due to the nature of these assets and the uncertainty of final removal timing and costs, an ARO has not been included for these assets as the ARO cannot be reasonably estimated at this time.
Amounts recorded under SFAS No. 143 are subject to various assumptions and determinations such as (i) whether a legal obligation exists to remove assets; (ii) estimation of the fair value of the costs of removal; (iii) when final removal will occur; (iv) future changes in decommissioning cost escalation rates; and (v) the credit-adjusted risk-free interest rates to be utilized in discounting future liabilities.
Changes that may arise over time with regard to these assumptions and determinations will change amounts recorded in the future as an expense for AROs. If the Company incurs or assumes any liability in retiring any asset at the end of its useful life without a legal obligation to do so, it will record such retirement costs as incurred.
The Company's most recent Palo Verde decommissioning study, completed in 2001, estimates that the Company's share of Palo Verde decommissioning costs would be approximately $311.6 million, in year 2001 dollars. This estimated liability differs from the ARO liability of $55.1 million recorded by the Company as of December 31, 2003. This difference can be attributed to how SFAS No. 143 measures the ARO liability, relative to current cost estimates, and the inherent assumption in SFAS No. 143 that Palo Verde will operate until the end of its useful life (which includes an assessment of the probability of a license extension). The ARO liability calculation begins with the same current cost estimate referenced above, then escalates that cost over the remaining life of the plant, finally discounting the resulting cost at a credit-risk adjusted discount rate. Since the Company assumed an escalation rate of 3.6% and a credit-risk adjusted discount rate of 9.5% in its calculation of the ARO liability, the ARO liability is significantly less than the Company's share of the current estimated cost to decommission Palo Verde in 2001 dollars. As Palo Verde approaches the end of its estimated useful life, the difference between the ARO liability and future current cost estimates will narrow over time due to the accretion of the ARO liability.
E. Common Stock Overview The Company's common stock has a stated value of $1 per share, with no cumulative voting rights or preemptive rights. Holders of the common stock have the right to elect the Company's directors and to vote on other matters.
Long-Term Incentive Plans The Company shareholders have approved the adoption of two stock-based long-term incentive plans. The first plan was approved in 1996 (the "1996 Plan") and authorized the issuance of up to 3.5 million shares of common stock for the benefit of officers, key employees and directors. The second 62
EL PASOUELEC-TRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL'STATEMENTS plan was approved in 1999 (the "1999 Plan") and authorized the issuance of up to two million shares of common stock for the benefits of directors, officers, managers, other employeey 'and consultants. -The common stock may be issued through the award or grant of non-statutory stock options, incentive stock options, stock appreciation rights, restricted stock, bonus stock and performance stock.
Stock Options. Stock options have been granted at exercise prices equal to or greater than the market value of the underlying shares at the date of grant. Th options expire ten years from the date of grant unless terminated'earlier by'the Board of Directors. -- The' following table summarizes the transactions of the Companys stock options for 2003, 2002 and 2001. .
Average i Number of i' Exercise Shares Price-Unexercised options outstanding at December 31, 2000,.....-, 2,944,848 -. ,$ 6.86 Optionsgrant ............. ..................... 706,677., 14.4 Options exercised ...................................... (1.396,045) 5.93 Unexercised options outstanding at December 31, 2001 2,255,480 9.64 Options granted . 257,257 13.39 Options exercised -.(280,000)..8.02....................
Options forfeited . . .............. '(20.000) 8.'75 Unexercised options outstanding at December 3, '2002 2,212,737 1'.40 Options granted .................. : ... , 08,717 12.67 Options forfeited. . .................. (150,000) 12.60 Unexercised options outstanding at December 31, 2003 2,171A454 10.36 Stock option awards provide for vesting periods of up to. six-years. Stock options outstanding and exercisable at December 31, 2003 are as follows: . ;; ,
Options Outstanding , n T, ,f,- OptionsExercisable Average Weighted Weighted Exercise , . . Remaining Average N w Average, Price " ' Number' ' trct Exercise Number Exercise Range Outstanding LifeinYears ' Price Exercisable Price
$ 5.56 j-$ :9.8125 ,,' 71,09,076,*. !: :;33: $. 7.03 1,057,076.,,
'$ 6.97 10.375 15:99 '98378 81 A " i' 171,454 ; . 1374 13.8, 63
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The number of stock options exercisable and the weighted average exercise price of these stock options at December 31, 2003, 2002 and 2001 are as follows:
December 31.
2003 2002 2001 Number of stock options exercisable ......... 1,325,454 1,183,737 1,233,480 Weighted average exercise price................ $ 8.36 $ 8.04 $ 7.55 Restricted Stock. The Company has awarded vested and unvested restricted stock awards under the 1996 and 1999 Plans. Restrictions from resale generally lapse, and unvested awards vest, over periods of four to five years. The market value of vested restricted stock awards is expensed at the time of grant. The market value of the unvested restricted stock at the time of grant is recorded as unearned compensation as a separate component of common stock equity and is amortized to expense over the restriction period. During 2003, 2002 and 2001, approximately $1.3 million, $1.9 million and
$1.8 million, respectively, related to restricted stock awards was charged to expense. The following table summarizes the vested and unvested restricted stock awards for 2003, 2002 and 2001:
Vested Unvested Total Restricted shares outstanding at December 31, 2000. 90,027 186,039 276,066 Restricted stock awards. ...................................... 15,929 171,341 187,270 Lapsed restrictions and vesting..................................... (105,956) (86,850) (192,806)
Forfeitures ..................................................................... (3,196) (3.196)
Restricted shares outstanding at December 31, 2001. 267,334 267,334 Restricted stock awards. ...................................... 10,420 98,820 109,240 Lapsed restrictions and vesting..................................... (10,420) (139,759) (150,179)
Forfeitures ..................................................................... (23.349) (23.349)
Restricted shares outstanding at December 31, 2002. 203,046 203,046 Restricted stock awards. ...................................... 63,090 63,090 Lapsed restrictions and vesting..................................... (119,647) (119,647)
Restricted shares outstanding at December 31, 2003. 146,489 146,489 The weighted average market values at grant date for restricted stock awarded during 2003, 2002 and 2001 are $11.47, $14.52 and $13.87, respectively.
The holder of a restricted stock award has rights as a shareholder of the Company, including the right to vote and, if applicable, receive cash dividends on restricted stock, except that certain restricted stock awards require any cash dividend on restricted stock to be delivered to the Company in exchange for additional shares of restricted stock of equivalent market value.
64
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Common Stock Repurchase Program During 2003, the Company repurchased 2.1 million shares of common stock for $24.2 million to complete its previously approved stock repurchase programs. Since the inception of the stock repurchase programs in 1996, the Company repurchased 15 million shares in total at an aggregate cost of
$171.0 million, including commissions. In February 2004, the Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock. The Company may make purchases of its stock at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.
Reconciliation of Basic and Diluted Earnings Per Share The reconciliation of basic and diluted earnings per share before cumulative effect of accounting change is presented below:
Year Ended December 31, 2003 I Per Income Shares Share (In thousands)
Basic earnings per share:
Income before cumulative effect of accounting change ......................... $ 20,616 48,424,212 $ 0.4 Effect of dilutive securities:
Unvested restricted stock.................................. 51,809 Stock options ............ ., . ,- 338.740 Diluted earnings per share:
Income before cumulative effect of accounting change : ........ $ 20.61 48,814,761 1 0.42 Year Ende !d December 31. 2002 Per
- - Income Shares Share (In thousands)
Basic earnings per share:
Income before cumulative effect of accounting change........................ ........... $ 28,967 49,862,417 $ 0.58 I
Effect of dilutive securities:
Unvested restricted stock............... ; ........... - 77,890 Stock options ........ .. . ,.......... -_._._..... 4404161 Diluted earnings per share:
Income before cumulative effect of accounting change.................................. 28,967 _.......$
_ 846 65
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended December 31. 2001 Per Income Shares Share (In thousands)
Basic earnings per share:
Income before cumulative effect of accounting change ................................. $ 63,659 50,821,140 $ 125 Effect of dilutive securities:
Unvested restricted stock . ............................... - 66,426 Stock options ................................ - 834.785 Diluted earnings per share:
Income before cumulative effect of accounting change ................................ & 63j59 51722,351 $ 1,23 Options excluded from the computation of diluted earnings per share because the exerciseI price was greater than the average market price for the periods presented are as follows:
Years Ended December 31, 2003 2002 2001 Options excluded ............. 1,029,411 633,588 177,372 Exercise price range ............. $11.00 - $15.99 $11.19 - $15.99 $ 12.60 - $15.99 F. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) consists of the following components (in thousands):
Net Unrealized Gains (Losses) Minimum Accumulated on Pension Other Marketable Liability Comprehensive Securities Adjustments Income (Loss)
Balance at December 31, 2000.................... $ 2,902 $ 2,902 Other comprehensive loss ....................... (2,522) (824) (3,346)
Income tax benefit................................... 883 313 1,196 Balance at December 31, 2001 ..................... 1,263 (511) 752 Other comprehensive loss ....................... (3,412) (21,148) (24,560)
Income tax benefit................................... 1,194 8,193 9.387 Balance at December 31, 2002.................... (955) (13,466) (14,421)
Other comprehensive income (loss). 9,486 (4,234) 5,252 Income tax (expense) benefit .................. 1.673 (444)
Balance at December 31, 2003....................
$ 6,414 $ (16,027) $ (9,1i) 66
EL PASO ELECTRIC COMPANY AND'SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. Long-Term Debt and Financing Obligations Outstanding long-term debt and financing obligations are as follows:
- a. December 31, 2003 2002
, ,(In thousands)
Long-Term Debt:'
First Mortgage Bonds'():-
'8.25% Series C, issud1996, ................. $ - '$ 39,360
'8.90% Series D, issued 1996, due 2006 .....'1 86,182 186,182
,9,40% Series E,issued 1996, due 2011 .... ......... ......... .......... 209,184 209,184 Pollution Control Bonds (2): L',
6.375% 1994 Series A bonds, due 2014 ................ _......j;,........ , 63,500-0, 63,500 6.375% 1985 Series A refunding bonds, due 2015 59,235 59,235 6.250% 2002 Series A refunding bonds, due 2037 . . ................. 37,100 37,100 6.375% 2002 Series A refunding bonds, due 2032 .33,300 33,300 Promissory note, due 2005 ($116 due in 2004) (3) . . ................. , 151 -. 259 Total long-term debt ........ 588,652 628,120 Financing Obligations: j - ; '-
Nuclear fuel ($21,990 due in 2004) (4) . ........ -42.176 47.216 Total long-term debt and financing obligations .............................. 630,828 675,336 Current Maturities (amount due within one year) .(22.106) (60.961)
- i. , 60822$ 614,375 (1) First Mortgage Bonds '- ' ' '
Substajntially all o1 the Company's utility plant is subject to liens under the First'Mortgage Indenture.
The First Mortgage identure imposes certain limitations on the ability of the Company to (i) declare or pay dividends on common stock; (i)' incur addftional indebtedness or liens on mortgaged property and (iii) enter into a consolidation, merger or sale of assets.
The Series D bonds may' not be redeemed by the Company prior to maturity. '; The Series 'E bonds may be redeemed at the option of the Company, in -whole or in part, at 104.70% of 'par value beginning February 1, 2006, 102.35% of par value beginning February 1, 2007, -and at par value beginning February 1, 2008. The Company is not'required to make mandatory redemption or sinking fund payments with respect to the bonds prior to maturity. "The Series C lbonds were 'repaid at maturity in 2003. , ;
67
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Repurchases, excluding repayment upon maturity, of First Mortgage Bonds made during 2003, 2002 and 2001 are as follows (in thousands):
lYears Ended December 31 2003 2002 _ 2001 8.25% Series C ....................... $ 3,278 $ 3,553 $ 41,592 8.90% Series D . 20,500 370 9.40% Series E............. 9,150 11.666 Total ....................... $ 3,278 $ 33,203 L 53,628 Internally generated funds were used for the above repurchases. Losses of $3.4 million and
$3.6 million were recorded in 2002 and 2001, respectively, relating to these repurchases and include premiums paid and unamortized issuance costs.
(2) Pollution Control Bonds The Company has four series of tax exempt Pollution Control Bonds in an aggregate principal amount of approximately $193.1 million. Upon the occurrence of certain events, which includes the remarketing of the bonds, the bonds may be required to be repurchased at the holder's option or are subject to mandatory redemption. All of the pollution control bonds interest rates remain at their current fixed interest rates until remarketing in August 2005.
(3) Promissory Note The note has an annual interest rate of 5.5% and is secured by certain furniture and fixtures.
(4) Nuclear Fuel Financing The Company has available a $100 million credit facility that was renewed for a three-year term in January 2002. The credit facility provides for up to $70 million for the financing of nuclear fuel, which is accomplished through a trust that borrows under the facility to acquire and process the nuclear fuel. The Company is obligated to repay the trust's borrowings with interest and has secured this obligation with Collateral Series First Mortgage Bonds. In the Company's financial statements, the assets and liabilities of the trust are reported as assets and liabilities of the Company. Any amounts not borrowed by the trust may be borrowed by the Company for working capital needs.
The $100 million credit facility requires compliance with certain total debt and interest coverage ratios. The Company was in compliance with these requirements throughout 2003. No amounts are currently outstanding on this facility for working capital needs.
68
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2003, the scheduled maturities for the next five years of long-term debt and financing obligations are as follows (in thousands):
2004 ................................. $ 116
, 05 2005 .......................................... .............. 193,170 2006 ............................. 186,182 2007 ........................... . . . . .
2008 . , - .
The table above does not reflect future obligations and maturities related to nuclear fuel purchase commitments.
H. Income Taxes The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2003 and 2002 are presented below (in thousands):
December 31, 2003 2002 Deferred tax assets:
Benefits of federal tax loss carryforwards .......................... $ 26,650 $ 26,398 Pensions and benefits.......................................................... 55,140 53,453 Asset retirement obligation .............. . 19,302' - 51,055 Alternative minimum tax credit carryforward .................... 37,073 34,981 Investment tax credit carryforward ..................................... 4,570 5,725 Reorganization expenses financed with bonds ................... -
Other................................................................................... 7,186 C 15.650 Total gross deferred tax assets ................................ 149,921 189,868 Less federal valuation allowance ....................................... 2,284 3.069 Net deferred tax assets .......................... !.......... 147.637 186.799 Deferred tax liabilities:
Plant, principally due to depreciation and basis differences ..................................... (215,056) (229,375)
Decommissioning .......... .(24,077) (14,111)
Other ....................................... (11.861) (12.248)
Total gross deferred tax liabilities .......................... (250.994) (255.734)
Net accumulated deferred income taxes ............. I (103,3) $ (68,935)
The deferred tax asset valuation allowance decreased by approximately $0.8 million, $6.8 million and $17.7 million in 2003, 2002 and 2001, respectively. The 2003 valuation allowance decrease of
$0.8 million consists of (i) a $0.3 million adjustment to capital in excess of stated value in accordance with Statement of Position ("SOP") 90-7, "Financial Reporting by Entities in Reorganization Under Bankruptcy Code" to recognize a tax benefit for valuation allowance that was not used as a result of 69
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS investment tax credits that were utilized in 2003 and (ii) a $0.5 million writedown related to expired investment tax credits of $0.8 million less deferred tax benefits of $0.3 million. The 2002 valuation allowance decrease of $6.8 million consists of (i) a $4.5 million writedown related to expired investment tax credits of $6.9 million less deferred tax benefits of $2.4 million and (ii) a $2.3 million adjustment to capital in excess of stated value in accordance with SOP 90-7 to recognize a tax benefit for a valuation allowance that was not used as a result of investment tax credits that were utilized in 2002. The 2001 valuation allowance decrease of $17.7 million consists of (i) a $2.8 million writedown related to expired investment tax credits of $4.3 million less deferred tax benefits of $1.5 million; (ii) an $8.7 million writedown related to the expiration of state net operating loss ("NOL") carryforwards at the end of 2001 and (iii) a $6.2 million adjustment of state valuation allowance, which netted with associated federal tax benefits of $2.2 million resulted in a credit to capital in excess of stated value of $4.0 million to recognize a tax benefit for valuation allowance that was not used.
Based on the average annual book income before taxes for the prior three years, excluding the effects of the cumulative effect of accounting change and future projected annual book income, the Company believes that the net deferred tax assets will be fully realized at current levels of book and taxable income. The Company's valuation allowance of $2.3 million at December 31, 2003, if subsequently recognized as a tax benefit, would be credited directly to capital in excess of stated value in accordance with SOP 90-7.
The Company recognized income taxes as follows (in thousands):
Years Ended December 31.
2003 2002 2001 Income tax expense:
Federal:
Current ............................................................. $ 1,873 $ 9,668 $ 3,354 Deferred ........................................................... 30,699 6.482 26,902 Total federal income tax............................ 32,572 16,150 30,256 State:
Current ............................................................. 1,297 4,508 Deferred ........................................................... 4,581 (3,967) 4,753 Total state income tax................................ 5,878 541 4,753 Total income tax expense................................... 38,450 16,691 35,009 Tax benefit classified as cumulative effect of accounting change ....................................... (25,031) - -
Total income tax expense before cumulative effect of accounting change .......................... $13419 $ 16691 $ 35,009 The current federal income tax expense for 2003, 2002 and 2001 results primarily from the accrual of alternative minimum tax ("AMT"). Deferred federal income tax includes an offsetting AMT 70
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL4 STATEMENTS benefit of $2.1 million, $13.0 million and $3.1 million for 2003, 2002 and 2001, respectively. The current state income tax expense for 2003 and 2002 results from the expiration of state NOL carryforwards at the end of 2001.
Income tax provisions differ from amounts computed by applying the federal statutory rate of 35% to book income beforefederal income tax as follows (in thousands):
Years Ended December 31, 2003 2002 2001 Federal income tax expense computed on income at statutory rate.......................... ... '$ 34,545 $ 15,980 $ 34,534 Difference due to:
Reduction in estimated contingent ' -
tax liability I.............
- - ' -.'..........;(2,596)'
State taxes, net of federal benefit . . 3,820 - 352`* 3,089 Other............................................................. . ; '85 359 - ' (18)
-Total income tax expense .. . 38,450 16,691' 35,009 Tax benefit classified as cumulative effect'of accounting change.. . _(25.031) - -
Total income tax expense before cumulative effect of accounting change ...........................
419 Effective income tax rate . ................................ 39.0% 36.6% 35.5%
As of December 31, 2003, the Company had $76.1 million of federal tax NOL canyforwards,
$4.6 million of investment tax Credit (!1lTC") including; $0.1 million of wind energy credits and
$37.0 million of AMT credit carryforwards. If unused, the NOL carryforwards would expire at the end of 2011, the ITC can-yforwards would expire in 2005, and theWind energy tax credits would expire in 2016 through 2018. The AMT credit carryforwards have- an unlimited life. The Company recorded a writedown of its expired state NOL carryforwards at the end of 2001. These tax attributes are subject to change should the tentative IRS settlement for tax ye-ars, 1996,through 1998 be. approved by the IRS. In 2001,- the Company recorded a $2,6 million adjustment -to; reduce. its estimated contingent. ax liabilities based-upon .discussions and agreed issues with taxing authorities. This $2.6 million adjustment was included as a component of deferred income tax expense. See Note I for further discussion of the IRS examination.
j;. i .. A', s ' ; .1 : z -i.a;. : , !- C Z*)-
- XoXi9ja'**Ilij A .
71
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. Commitments, Contingencies and Uncertainties Power Contracts As of December 31, 2003, the Company had entered into the following significant agreements with various counterparties for forward firm purchases and sales of electricity:
Type of Contract Quantity Term Sale off-peak 50 MW 2004 Purchase on-peak 103 MW 2004 through 2005 The Company also has an agreement with a counterparty for power exchanges under which the Company will receive 30 MW of on-peak capacity and associated energy through 2005 at the Eddy County tie and concurrently deliver the same amount at Palo Verde and/or Four Corners. The agreement also gives the counterparty the option to deliver up to 133 MW of off-peak capacity and associated energy through 2005 at the Eddy County tie and concurrently receive the same amount at Palo Verde and/or Four Corners. The Company will receive a guaranteed margin on any energy exchanged under the off-peak agreement.
Environmental Matters The Company is subject to regulation with respect to air, soil and water quality, solid waste disposal and other environmental matters by federal, state, tribal and local authorities. Those authorities govern current facility operations and have continuing jurisdiction over facility modifications. Failure to comply with these environmental regulatory requirements can result in actions by regulatory agencies or other authorities that might seek to impose on the Company administrative, civil, and/or criminal penalties. In addition, unauthorized releases of pollutants or contaminants into the environment can result in costly cleanup obligations that are subject to enforcement by the regulatory agencies.
Environmental regulations can change rapidly and are often difficult to predict. While the Company strives to prepare for and implement changes necessary to comply with changing environmental regulations, substantial expenditures may be required for the Company to comply with such regulations in the future.
The Company analyzes the costs of its obligations arising from environmental matters on an ongoing basis, and believes it has made adequate provision in its financial statements to meet such obligations. As a result of this analysis, the Company has a provision for environmental remediation obligations of approximately $0.9 million as of December 31, 2003, which is related to compliance with federal and state environmental standards. However, unforeseen expenses associated with compliance could have a material adverse effect on the future operations and financial condition of the Company.
72
EL PASO ELECTRIC COMPANY AND SUBSIIADRY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following are expenditures incurred by the Company in 2003, 2002' and 2001 for complying with federal environmental statutes' (in thousands):
- - 2003 - 2002 2001 Clean Air Act ............. $1,060 $ 739 $ 745 Federal Clean Water Act ........ I. I 649 '1,930 794 The Company is not aware of any active investigation of its compliance with the environmental requirements by the Environmental Protection Agency, the Texas Commission on Environmental Quality, or the New Mexico Environment Department. Furthermore, the Company is not aware of any unresolved, potentially material liability it would face pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, also known as the Superfund law.
Tax Matters The IRS has disputed whether the Company was entitled to deduct certain payments made in 1996 related to Palo Verde and its treatment of a litigation settlement in 1997 related to a terminated merger agreement. The Company has reached a tentative agreement, subject to IRS final approval, to settle these and all other issues relative to its 1996 through 1998 federal income tax returns. The Company expects the IRS will make a final decision regarding the'proposed settlement by mid 2004.
Should the proposed settlement be rejected by the IRS, the Company cannot predict the eventual outcome of this matter. However, the Company has established, and periodically reviews and re-evaluates, an estimated contingent tax liability on its consolidated balance sheet to provide for the possibility of adverse outcomes in tax proceedings. Although the ultimate outcome cannot be predicted with certainty, and while the contingent tax reserve may not in fact be sufficient, the Company believes that the amount at December 31, 2003 is a reasonable estimate of any additional tax that may be due.
MiraSol Warranty Obligations MiraSol is an energy services subsidiary which offered a variety of services to reduce energy use and/or lower energy costs. MiraSol was not 'a power marketer. On July 19, 2002, all marketing activities of MiraSol ceased. MiraSol remains a going concern in order to satisfy current contracts and warranty and service obligations on previously installed projects. Management of MiraSol continues to assess projects for potential warranty obligations.' As part of the assessment, several discussions have been held with a large customer on a $5.6 million generator project. Two warranty 'issues associated With the project have been identified, and management has contracted with a third party to address the warranty claims. During the year ended December 31, 2002,i'the Company expensed $2.0 million and created a reserve related to these Warranty claims and reduced this liability by approximately
$0.6 million related to payments for this item. During the year ended December 31,'2603, the Company had reduced this liability by approximately $0.4 million for payments made related to these matters.
Based on a probability analysis performed by the Company, an additional $0.5 million in potential 73
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS warranty claims were identified and expensed during 2003. As of December 31, 2003, a reserve for those warranty claims in the amount of $1.5 million remains. While no other probable warranty liabilities have been identified at this time, if it is determined at a future date that MiraSol has further obligations to this customer or any other customer, and contributions from MiraSol, its subcontractors or any other third party are insufficient to honor the warranty obligations, the Company intends to honor any such warranty obligations after making appropriate regulatory filings, if any.
Customer Information System During the third quarter of 2003 the Company completed an assessment of the Customer Information System ("CIS") project and of alternatives to completion of the project. This assessment included analyzing the impact that potential delays in the implementation of deregulation and resulting changes in billing requirements, and the software's ability to perform to specification. Based on this assessment and on events related to the project which occurred, the Company abandoned the CIS project and recognized an asset impairment loss of approximately $17.6 million. The Company is now analyzing various options to meet its current and projected CIS needs.
Lease Agreements The Company has an operating lease for administrative offices. The lease has a 10-year term ending May 31, 2007. The minimum lease payments are $1.0 million annually and are adjusted each year by 50% of the percentage change of the Consumer Price Index. The lease agreement does not impose any restrictions relating to issuance of additional debt, payment of dividends or entering into other lease arrangements. The Company has no significant capital lease agreements.
As of December 31, 2003, the Company's minimum future rental payments for the next five years are as follows (in thousands):
2004 ................................... $ 1,000 2005 .................................. 1,000 2006 .................................. 1,000 2007 .................................. 400 2008 .................................. -
Union Matters On October 2 and 3, 2003, employees in the Company's meter reading and collections areas, comprised of 68 employees, voted in favor of representation by the International Brotherhood of Electrical Workers, Local 960 ("Local 960"). This vote was certified by the National Labor Relations Board ("NLRB") on October 14, 2003. In addition, employees in the Company's facilities services area, comprised of seven employees, voted in favor of representation by Local 960 on October 16, 2003. This vote was certified by the NLRB on October 24, 2003. The Company has begun collective bargaining negotiations with Local 960 on behalf of these employees.
74
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS J. Litigation
- - .-The Company is a party to various legal actions. In many..of these matters, the Company has excess casualty liability insurance that covers the.various claims, actions and complaints. Based upon a review of these claims and applicable insurance coverage, the Company' believes that,-except as described. below,' none of these claims will have a 'material'adverse effect on the financial 'position, results of' operations and cash flows of the Comhpany.: The 'Company expenses legal costs, including expenses related to loss contingencies, as they are incurred. -. ' . :
On January 16, 2003, the Company was served with a complaint on behalf of a purported class of shareholders alleging violations of the federal securities laws (Roth v..wEl Paso Electric Company,. et al.,
No. EP-03-CA-0004). The complaint was filed in-the El Paso Division of the.United States District Court for the Western'District of Texas. The suit seeks undisclosed compensatory damages for the.class as well as costs and. attorneys' fees. The lead plaintiff, Carpenters Pension Fund of Illinois, filed a consolidated amended complaint on July 2, 2003, alleging, among other things, that the Company and certain of its current and former directors and officers violated securities laws by failing to disclose that some of the Company's revenues and income were derived from 'an-allegedly unlawful relationship with Enron.' The allegations arise out of the FERC investigation of the power markets in the western United States during 2000 and 2001,' which the Company, previously settled with the FERC Trial Staff and certain intervening parties.. See Part I, Item:,', "Regulation - Federal Regulatory Matters.". '-On August 15,' 2003,the Company and the individual defendants filed-a motion to dismiss the complaint for failure to state a-claim upon which relief can be granted. ;On November 26, 2003, the Court denied .the motion to 'dismiss as to the Company and three of the individual 'defendants and granted the motion to dismiss as to two individual defendants.' The lead plaintiff filed its. motion for class certification on January 9, 2004, seeking to. certify a class consisting of all persons who purchased or otherwise acquired Company securities" between February 14, 2000 and October 21,-2002. This matter is presently set for trial on March 28,.2005. The.Company is unable to predict the outcome of this case.
- On February! 10, 2003; the Company received a letter written by 'a Pennsylvania law firm on behalf of the holder of approximately200 shares of common stock of the Company (the "shareholder"),
that demands that the Company commence a lawsuit against eachlimember of the Board of Directors to recover damages allegedly sustained by the Company as a result, of alleged breaches of fiduciary duties by the Board. . The shareholder. contends ;that, 'from 1l9 97r0.to 2002; the Board knowingly caused or allowed the Company to participate in improper transactions 'with Enron Corporation and certain of its subsidiaries. 'The allegations appear to 'duplicate factual;.uestions first :raised by the FERC in an investigation of the power markets in the western United States during 2000 and 2001. As noted above, the Company reached a settlement of the FERC investigation with the FERC Trial Staff and certain intervenors. In accordance with Texas law,;the independent and disinteregted-ditectors of the Company conducted an independent inquiry-and concluded that a lawsuit against the:Board is. not in the best interests of the Company. To date, the shareholder has not filed a shareholder derivative lawsuit against the members of the Board.'The. Company is unable to predict the outcome of this matter.
75
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On May 21, 2003, the Company was served with a complaint by the Port of Seattle seeking civil damages under the Sherman Act, the Racketeer Influenced and Corrupt Organization Act, and state anti-trust laws, as well as for breach of contract and fraud (Port of Seattle v. Avista Corporation, et al.,
No. CV03-1170P). The complaint was filed in the United States District Court for the Western District of Washington. The complaint alleges that the Company, indirectly through its dealings with Enron, conspired with the other named defendants to manipulate the California energy market, which had the effect of artificially inflating the price that the Port of Seattle paid for electricity. On December 4, 2003, the case was transferred to the United States District Court for the Southern District of California for inclusion in the California Wholesale Electricity Antitrust Multi-District Litigation cases pending in that district (re-styled Port of Seattle v. Avista Corporation, et al., No. CV 03-2474-RHW, MDL No. 1403).
The Company, together with several other defendants, filed a motion to dismiss on July 29, 2003. The motions to dismiss are scheduled for oral argument on March 26, 2004. While the Company believes the lawsuit is without merit and will defend itself vigorously, it is unable to predict the outcome of this case.
On February 9, 2004, Enron North America Corp. ("ENA") filed suit against the Company seeking payment of approximately $5.4 million, plus interest and costs, relating to certain natural gas supply contracts (Enron North America Corp. v. El Paso Electric Co., Case No. 01-16034, United States Bankruptcy Court, Southern District of New York). The complaint alleges that ENA entered into two natural gas supply contracts with the Company which automatically terminated as a result of ENA's bankruptcy. ENA contends that, under the terms of the contracts, the Company owes ENA termination payments because the market price of natural gas at the date of termination was lower than the contract price. While ENA acknowledges that the contracts contain a provision (the "One-Way Payment Provision") under which the termination payment would be calculated to be zero, ENA seeks a ruling from the court that the One-Way Payment Provision is unenforceable and that the Company should be required to pay termination payments in the amount of approximately $5.4 million, plus interest and costs. The first of these two contracts covers gas to be supplied by ENA during the months of November and December of 2001 (the "2001 Contract"). The Company estimates that the value of the termination payment claimed by ENA under the 2001 Contract is approximately $1.8 million. The second of these two contracts covers gas to be supplied by ENA during the months of January through December of 2002 (the "2002 Contract"). The Company estimates that the value of the termination payment claimed by ENA under the 2002 Contract is approximately $3.6 million. Based upon the Company's assessment of the probability of an adverse outcome, the Company has expensed a pre-tax amount of $1.5 million as of December 31, 2003 for this matter. The Company intends to defend itself vigorously, but cannot predict the outcome of this matter.
On November 3, 2003, TNP filed a complaint against the Company with the FERC, asking the FERC to make a determination that TNP has a rollover right to network-type transmission service over the Company's transmission system. TNP asserts that it has such rights under the rollover provisions of FERC Order No. 888 relating to its power sale agreement with the Company that expired on 76
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2002. The Company's position is that the transmission service provided by the Company to TNP under the expired power sale agreement was point-to-point service and not network service and that the Company does not have the capacity to provide the network service that TNP seeks. Due to existing transmission constraints, a FERC ruling granting TNP's request could adversely impact the Company's ability to import lower cost power from Palo Verde and Four Corners to serve its base load to the extent of the transmission rights granted to TNP. A hearing on this matter before an administrative law judge is scheduled for June 15, 2004. The Company cannot predict the likely outcome of this matter or the full effect that an adverse ruling would have on the Company.
K. Employee Benefits Retirement Plans The Company's Retirement Income Plan (the "Retirement Plan") covers employees who have completed one year of service with the Company, and work at least a minimum number of hours each year. The Retirement Plan is a qualified noncontributory defined benefit plan. Upon retirement or death of a vested plan participant, assets of the Retirement Plan are used to pay benefit obligations under the Retirement Plan. Contributions from the Company are based on the minimum funding amounts required by the Department of Labor and IRS under provisions of the Retirement Plan, as actuarially calculated.
The assets of the Retirement Plan are invested in equity securities, debt securities and cash equivalents and are managed by professional investment managers appointed by the Company.
The Company's Non-Qualified Retirement Income Plan is a non-funded defined benefit plan which covers certain former employees of the Company. During 1996, as part of the Company's reorganization, the Company terminated the Non-Qualified Retirement Income Plan with respect to all active employees. The benefit cost for the Non-Qualified Retirement, Income Plan is based on substantially the: same actuarial methods and economic assumptions as those used for the Retirement Plan.'
The Company uses a measurement date of December 31 for its retirement plans. The Company accounts for the Retirement Plan and the Non-Qualified Retirement Income Plan under SFAS No. 87, "Employers' Accounting for Pensions." In accordance with SFAS No. 87, the net periodic benefit cost includes amortization of unrecognized net gains or losses which exceeded '10% of the benefit obligation at the beginning of the year. Unrecognized gains or losses on investment assets of the plans are not amortized.; Thortizrtization reflects the excess divided by the average remaining service period of active employees expected to receive benefits.;
In 2003, the Company adopted SFAS No. 132 (revised 2003), "Employers' Disclosure about Pensions and Other Postretirement Benefits," ("SFAS No. 132 revised") which expands the original disclosure requirements of SFAS No. 132.
77
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amounts recognized in the Company's balance sheets and the funded status of the plans at December 31, 2003 and 2002 are presented below (in thousands):
Years Ended December 31.
2003 2002 Non- Non-Qualified Qualified Retirement Retirement Retirement Retirement Income Income Income Income Plan Plan Plan Plan Change in benefit obligation:
Benefit obligation at beginning of year............. $ (130,754) $ (19,185) $ (114,166) $ (18,434)
Service cost....................................................... (3,812) - (3,359)
Interest cost....................................................... (8,403) (1,207) (7,867) (1,257)
Actuarial loss (1) .............................................. (11,513) (1,074) (9,168) (1,146)
Benefits paid..................................................... 4,304 1,650 4,045 1,652 Plan amendments (2)........................................ _ (2394)
Benefit obligation at end of year ................. (150.178) (19~ 8 16) (1-30 .754) (19.185)
Change in fair value of plan assets:
Fair value of plan assets at beginning of year... 72,466 81,559 Actual gain/(loss) on plan assets....................... 11,106 (9,112)
Employer contribution ...................................... 8,290 1,650 4,064 1,652 Benefits paid..................................................... (4.304) (1,650) (4,045) (1.652)
Fair value of plan assets at end of year........ 87,558 72.466 Funded status ......................................................... (62,620) (19,816) (58,288) (19,185)
Unrecognized net loss............................................ 52,613 3,029 46,389 1,970 Intangible asset....................................................... 196 218 Balance of additional liability (3) .......................... (23.373) (3,029) (20.220) (1,970)
Accrued benefit liability ................................... $~- 33,184) $ (19.816) $- 131901) $ (19,185)
(1) Represents a decrease in the discount rate.
(2) Represents changes in accordance with the Economic Growth and Tax Relief Reconciliation Act of 2001.
(3) As necessary, an additional liability is included in the accrued benefit liability if the accumulated benefit obligation exceeds the fair value of plan assets. The accumulated benefit obligation is an alternative measure of the retirement plans obligations. It is calculated similar to the above benefit obligation, except that current or past compensation levels, instead of future compensation levels, are used to determine retirement plans benefits. The additional liability is calculated at the end of each fiscal year and any change in it is recorded as a component of other comprehensive income (loss). Other comprehensive income (loss) includes ($4,234) and ($21,148) for 2003 and 2002, respectively.
78
EL PASO'ELECTRIC COMPANY AND SUBSIDLARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Weighted average actuarial assumptions used in determining the actuarial present value of the benefit obligations are as follows: - -
2003 2002 Non- Non-Qualified , , Qualified Retirement Retirement Retirement Retirement Income Income Income Income Plan Plan Plan Plan Discount rate ....... , 6.00% 6.00% 6.50% 6.50%
Expected return on plan assets 8.50% N/A ,8.,50% N/A Rate of compensation increase -, 5.00% N/A 5.00% N/A Amounts recognized in the Company's balance sheet consist'of th'e following (in thousands):
2003 2002
.. Non-' Non-Qualified Qualified Retirement Retirement Retirement Retirement Income Income Income Income
-'Plan Plan Plan Plan Prepaid benefit cost ................. ............. $ - $ , , , $_
Accrued benefit cost ............ ............. (9,811) (16,787) (11,681) (17,215)
Balance of additional liability . .(23,373) (3,029) (20,220) (1,970)
Intangible assets .......... 196 218 Acctumulatied other comprehensive' income .............................. !....23.177 ! ' 3.029' 20.002 -j 1.970 Net amount recognized ... ;i$ 1.8 1) $$'(17,215 (The accumulated benefit .obligation' for bthe!retirement' plans was'$140.6.million and
$123.6 million at December 31, 2003 and 2002, respectively. : .
The accumulated benefit obligation in excess ofvplan assets are as follows (in thousands):
-20o3 : 2002'
- ' ' i' 1 NOn- j ; Non-
--oQualified (' 'Qualified Retirement Retirement Retirement Retirement Income Income Income Income Plan Plan Plan: ' Plan Projected benefit obligation . $ (150,178) .$ (19,816).$ (130,754) $ (19,185)
Accumulated benefit obligation ..... (120,742). (19,816) -J(104,367) '(19,185)
Fair alue of plan assets .................. 87,558 - 72,466 '
79
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net periodic benefit cost is made up of the components listed below as determined using the projected unit credit actuarial cost method (in thousands):
Years Ended December 31, 2003 2002 2001 Components of net periodic benefit cost:
Service cost . ............................... $ 3,812 $ 3,359 $ 3,085 Interest cost .................. ............ 9,610 9,124 8,641 Expected return on plan assets ................. (7,536) (7,761) (7,673)
Amortization of:
Unrecognized gain .............................. 1,736 Unrecognized prior service cost .......... 21 21 Net periodic benefit cost ............... 7.64 $ 4,74 Weighted average actuarial assumptions used in determining the net periodic benefit costs are as follows:
2003 2002 2001 Discount rate.......................................... 6.50% 7.00% 7.25%
Expected return on plan assets............... 8.50% 8.50% 8.50%
Rate of compensation increase............... 5.00% 5.00% 5.00%
The Company's overall expected long-term rate of return on assets is 8.50%, which is both a pre-tax and after-tax rate as pension funds are generally not subject to income tax. The expected long-term rate of return is based on the sum of the expected returns on individual asset categories with a target asset allocation of 65% equity and 35% debt securities. The expected returns for equity securities are based on historical risk premiums above the current fixed income rate, while the expected returns for the debt securities are based on the portfolio's yield to maturity.
Given recent market conditions, the Company has emphasized capital preservation and therefore, the asset allocations at December 31, 2003 and 2002 do not reflect the targeted long-term asset allocation which remains unchanged. The Company's Retirement Plan weighted-average asset allocations at December 31, 2003 and 2002, by asset category are as follows:
December 31.
Asset Category: 2003 2002 Equity securities...................................................... 41% 44%
Debt securities......................................................... 35 46 Cash equivalents. ...................................... 24 10 Total..................................................................... 100% 100Q%
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EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's investment goals for the Retirement Plan are to maximize returns subject to specific risk management policies. Its risk management policies permit investments in equity and debt securities, mutual funds and cash/cash equivalents and prohibit direct investments in fixed income derivatives, foreign debt securities, real estate or commingled funds, private placements and tax-exempt debt of state and local governments.. The Company addresses diversification by the use of mutual fund investments whose underlying investments are in domestic and international equity securities and domestic fixed income securities. The liquidity of these funds is enhanced through the purchase of highly marketable securities.
The Company expects to contribute $7.6 million to its retirement plans in 2004. Contributions for the Retirement Plan are based on the minimum funding amounts required by the Department of Labor and IRS as actuarially calculated.
Other Postretirement Benefits The Company provides certain health care benefits for retired employees and their eligible dependents and life insurance benefits for retired employees only. Substantially all of the Company's employees may become eligible for those benefits if they retire while working for the Company. Those benefits are accounted for under SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." In accordance with SFAS No. 106, the 2003, 2002 and 2001 net periodic benefit cost includes amortization of unrecognized net gains or losses which exceeded 10% of the benefit obligation at the beginning of the year in which they occurred. The amortization reflects the excess divided by the average remaining service period of active employees expected to receive benefits.
Unrecognized gains or losses on investment assets of the plans are not amortized. Contributions from the Company- are based on the funding amounts .required by the Texas Cormmission in the Texas Rate Stipulation. The assets of the plan are invested in equity securities, debt securities, and cash equivalents and are managed by professional investment managers appointed by the Company. The Company uses a measurement date of December 31 for its other postretirement benefits plan.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") became law in the United States. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to the Medicare benefit. In accordance with FASB Staff Position FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," the Company has elected to defer recognition of the effects of the Act in any measures of the benefit obligation or cost. Specific authoritative guidance on the accounting for the federal subsidy is pending and that guidance, when issued, could require the Company to change previously reported information. Currently, the Company cannot predict whether it will need to amend its plan to benefit from the Act. In 2003, the Company adopted SFAS No. 132 revised, which expands the disclosure requirements of SFAS No. 132.
81
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amounts recognized in the Company's balance sheets and the funded status of the plan at December 31, 2003 and 2002 are presented below (in thousands):
December 31, 2003 2002 Change in benefit obligation:
Benefit obligation at beginning of year. $ (96,561) $ (88,506)
Service cost. (3,915) (3,118)
Interest cost. (6,468) (5,692)
Actuarial loss (1). (13,525) (1,093)
Retirees' contributions..................................... (310) (297)
Benefits paid. 2.597 2.145 Benefit obligation at end of year. (118,182) (96,561)
Change in fair value of plan assets:
Fair value of plan assets at beginning of year. 16,716 16,233 Actual gain (loss) on plan assets. 3,055 (1,091)
Employer contribution ...................................... 3,422 3,422 Retirees' contributions..................................... 310 297 Benefits paid. (2.597) (2,145)
Fair value of plan assets at end of year. 20.906 16,716 Funded status................................................................ (97,276) (79,845)
Unrecognized net (gain) loss. 2.766 (8,724)
Accrued benefit liability...................................... $ (94,510) $ (88,562)
(1) Represents a decrease in the discount rate.
Amounts recognized in the Company's balance sheet consist of accrued postretirement costs of
$94.5 million and $88.6 million for 2003 and 2002, respectively.
82
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL'STATEMENTS Net periodic benefit cost is made up of the components listed below (in thousands):
Years Ended December 31.
2003 2002 2001 Components of net periodic ;
benefit cost:'
Service cost . : $ 3,915 $ 3,118' $ 3,170 Interest cost . . ...... 6,468 5,692 '5,548 Expected return on plan assets -(1,020) (999) (942)
Amortization of unrecognized'gain ' - - (794)! (1.164)
Net periodic benefit cost .$.. 9, $ 7,017 $ 6,612 Weighted average assumptions are as folloWs':
2003 2002 2001 Discount rate ......... ..................... 6.00% 6.50% 7.00%
Expected return on plan assets, after-tax ...... i...
- 5.90% 5.90% 5.90%
Rate of compensation increase .................... 0..........
5.00.00% 5.00%-
For measurement purposes, a 9.6% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2Q04; the rate was assumed to decrease gradually to 6% for 2006 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plan.: The effect of a 1% change in these assumed health care .cost trend rates would increase or decrease the benefit obligation by $20.1 million or $15.9 million, respectively. In addition, such a 1% change would increase or decrease the aggregate service and interest cost components of net periodic benefit cost by,$1.9 million or $1,5 million, respectively.
The Company's overall expected long-ten' rate of return on assets, on an after-tax basis, is 5.90%. This return is based on the sum of the expected returns on individual asset categories with a target asset allocation of 60% equity and 40% debt securities. T'he expected returns for equity securities are based on historical risk premiums above the current fixed income rate, while the expected returns for the debt securities are based on the portfolio's yield to maturity.
- Given recent market conditions,:the Company has emphasized capital preservation and therefore, the asset' allocations at December 31,; 2003 'anid 2002 do -not reflect the targeted' long-term 'asset allocation which remains unchanged. 'The 'Co'ipanis' other 'postretirement benefits plan weighted average asset allocations at December 31, 2003 and 2002, by a6set category are as follows:
- i' i ;i - ' December 31, Asset Category
- ' ',2003 -2002-cbr' Xiye Equity qsecunties uiis......................................s..:...
..... ............ - 4 55W/i- -
Debt securities .... ... 33... 36 Cash equivalents .. 13 9 Total..................................................................... 100% 100%
83
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's investment goals for the postretirement benefits plan are to maximize returns subject to specific risk management policies. Its risk management policies permit investments in equity and debt securities, mutual funds and cash/cash equivalents and prohibit direct investments in fixed income derivatives, foreign debt securities, real estate or commingled funds and private placements. The Company's investment policies and strategies for the postretirement benefits plan are based on target allocations for individual asset categories. The Company addresses diversification by the use of mutual fund investments whose underlying investments are in domestic and international equity securities and domestic fixed income securities. The liquidity of these funds is enhanced through the purchase of highly marketable securities.
The Company expects to contribute $3.4 million to its other postretirement benefits plan in 2004.
All Employee Cash Bonus Plan The All Employee Cash Bonus Plan (the "Bonus Plan"), was established to reward employees for their contribution in helping the Company attain its corporate goals. Eligible employees below manager level would receive a cash bonus if the Company attained established levels of safety, customer satisfaction and financial results during 2003. The Company was able to attain the required minimum levels of improvement in safety performance measures for 2003 and 2002 and quarterly safety bonuses totaling $0.7 million and $1.0 million, respectively, were expensed. However, the financial goal had to be met before any bonus amounts would be paid relating to customer satisfaction and financial results.
The Company was unable to attain the required minimum level of improvement for the financial goal for 2003 and 2002. As a result, the Company did not pay a cash bonus relating to customer satisfaction and financial results for 2003 and 2002. The Company expensed in 2001 approximately $3.7 million in cash bonuses. The Company has renewed the Bonus Plan in 2004 with similar goals.
L. Franchises and Significant Customers City of El Paso Franchise The Company's major franchise is with the City of El Paso, Texas ("City"). The franchise agreement includes a 2% annual franchise fee (approximately $7.7 million per year currently) and provides an arrangement for the Company's utilization of public rights-of-way necessary to serve its retail customers within the City. The franchise with the City extends through August 1, 2005.
In a provision of the franchise agreement, the City has an option to acquire all of the non-cash assets of the Company at the end of the term of the franchise on August 1, 2005, at a purchase price equal to the fair market value of the assets (measured on a cost of reproduction basis) on the date one year prior to the end of the term. The purchase price is then subject to certain adjustments to roll the 84
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS value of the assets forward to the end of the term. If the City wishes to exercise its option, it must deliver written notice to the Company one year prior to the expiration of the franchise term.
Las Cruces Franchise In February 2000, the Company and Las Cruces entered into a seven-year franchise agreement with a 2% annual franchise fee (approximately $1.1 million per year currently) for the provision of electric distribution service. Las Cruces is prohibited during this seven-year period from taking any action to condemn or otherwise attempt to acquire the Company's distribution system, or attempt to operate or build its own electric distribution system. Las Cruces will have a 90-day non-assignable option at the end of the Company's seven-year franchise agreement to purchase the portion of the Company's distribution system that serves Las Cruces at a purchase price of 130% of the Company's book value at that time. If Las Cruces exercises this option, it is prohibited from reselling the distribution assets for two years. If Las Cruces fails to exercise this option, the franchise and standstill agreements will be extended for an additional two years.
Military Installations The Company currently serves Holloman Air Force Base ("Holloman"), White Sands Missile Range ("White Sands") and the United States Army Air Defense Center at Fort Bliss ("Ft., Bliss"). The Company's sales to the military bases represent approximately 3% of annual operating revenues. The Company currently has long-term contracts with all three military bases that it serves. The Company signed a contract with Ft. Bliss in December 1998, under which Ft. Bliss will take service from the Company through December 2008. The Company has a contract to provide retail electric service to Holloman for a ten-year term which began in December 1995. In May 1999, the Army and the Company entered into a new ten-year contract to provide retail electric service to White Sands.
M. Financial Instruments and Investments SFAS No. 107, "Disclosure about Fair Value of Financial Instruments," requires the Company to disclose estimated fair values for its financial instruments. The Company has determined that cash and temporary investments, accounts receivable, decommissioning trust funds, long-term debt and financing obligations, accounts payable and customer deposits meet the definition of financial instruments. The carrying amounts of cash and temporary investments, accounts receivable, accounts payable and customer deposits approximate fair value because of the short maturity of these, items.
Decommissioning trust funds are carried at market value.;
85
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair values of the Company's long-term debt and financing obligations, including the current portion thereof, are based on estimated market prices for similar issues at December 31, 2003 and 2002 and are presented below (in thousands):
2003 2002 Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value First Mortgage Bonds .............................. $ 395,366 $ 447,662 $ 434,726 $ 451,800 Pollution Control Bonds ............................ 193,135 201,700 193,135 194,667 Nuclear Fuel Financing (1) ........................ 42,176 42,176 47.216 47,216 Total.................................................. $630677 $ 691,538 $ 675,077 $ 693.683 (I) The interest rate on the Company's financing for nuclear fuel purchases is reset every quarter to reflect current market rates. Consequently, the carrying value approximates fair value.
As of January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," including any effective implementation guidance discussed by the Financial Accounting Standards Board's (the "FASB") Derivatives Implementation Group. This standard requires the recognition of derivatives as either assets or liabilities in the balance sheet with measurement of those instruments at fair value. Any changes in the fair value of these instruments are recorded in earnings or other comprehensive income.
The Company uses commodity contracts to manage its exposure to price and availability risks for fuel purchases and power sales and purchases and these contracts generally have the characteristics of derivatives. The Company does not trade or use these instruments with the objective of earning financial gains on the commodity price fluctuations. The Company has determined that all such contracts, except for certain natural gas commodity contracts with optionality features, that had the characteristics of derivatives met the "normal purchases and normal sales" exception provided in SFAS No. 133, and, as such, were not required to be accounted for as derivatives pursuant to SFAS No. 133 and other guidance.
The Company determined that certain of its natural gas commodity contracts with optionality features are not eligible for the normal purchases exception and, therefore, are required to be accounted for as derivative instruments pursuant to SFAS No. 133. However, as of December 31, 2003, the variable, market-based pricing provisions of existing gas contracts are such that these derivative instruments have no significant fair value.
The fair value of the Company's marketable securities at December 31, 2003 was $80.5 million.
Gross unrealized losses on marketable securities and the fair value of the related securities, aggregated 86
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS by investment category and length of time that -individual securities have been in a continuous unrealized loss position, at December 31, 2003, were as follows:
- - Less than 12 Months 12 Months or Loneer Total Unrealized Unrealized Unrealized Fair Value Losses Fair Value Losses Fair Value Losses:
Description of Securities:
U.S. Treasury Obligations :- ,
and Direct Obligations of U.S. Government Agencies .$ 344 $ (8) $ 497 $ (41) $ 841 $ (49)
Federal Agency Mortgage Backed Securities . .782 (9) - - 782 (9).
Municipal Obligations . .2,710 (29) 642 (23) 3,352 (52)
Corporate Obligations.............................. 1.221 (26- - 1.221 (26 Total debt securities .... 5,057 (72) 1,139 (64) - 6,196i (136)
Common stock . . . ......... 4 .960 (244 3,248 .. (810) i:-8.208 (1.054)
Total temporarily Impaired securities ... 10,017.$.(3) A4) $L4,3871.i..
& 14j404 $AW jS--)
The total impaired securities are comprised of approximately fifty investments that are in an unrealized loss position. The Company monitors the length of time the investment trades below its cost basis along with the amount and percentage of the unrealized ioss in d'etermining if a decline in fair value of marketable securities below original cost is determined to be other than temporary. in addition, the Company will research the future prospects of individual securities as necessary. As a result of these factors, as well as the Company's intent and ability to hold these inVestnients until their market price recovers, these investments are not considered other-than-temporarily impaired. During the years ended December 31, 2003, 2002 and 2001, the Company recognized other than temporary impairment losses of marketable securities of $0.6 million, $2.7 million and $1.8 million, respectively.
87
EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS N. Supplemental Statements of Cash Flows Disclosures Years Ended December 31, 2003 2002 _ 2001 (In thousands)
Cash paid for:
Interest on long-term debt and financing obligations ........................... $ 51,596 $ 55,785 $ 61,067 Income taxes. ..................................... 17,660 15,133 3,550 Other interest...................................... 12 16 23 Non-cash investing and financing activities:
Grants of restricted shares of common stock...................................... 724 1,586 2,597 Remeasurements of options ....................... 240 430 Change in estimate of decommissioning liability capitalized to electric plant in service..................................... 1,795 Change in federal and state deferred tax valuation allowance credited to capital in excess of stated value (1)..... 295 2,308 4,046 Plant in service acquired through incurring obligation subject to a service agreement...................................... 8,139 (1) See Note H.
88
I EL PASO ELECTRIC COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- 0. Selected Quarterly Financial Data (Unaudited) ;r 2003 Ouarters - 2002 Ouarters 4th 3rd 2nd 1st 4th 3rd 2nd 1st (In thousands except for share data)
Operating Tvenues(1) ............. $156,953 $197,425 $162,498 $147,486 $153,798 $206,068 $181,022 $149,197 Opeatingincoie(Ioss).............. . . .......... 16,786 28,600 19,295 15,534 (95) 48,187 35,448 27,067 Incone,Qoss) before amrlative effect of accourfingcae ...................... ..... .. 2,259 11,246 4,995 2,116 (8,705) 19,503 12,318 5,851 Cnidative efeatofaccmthgVchange,netoftax ........... 39,635 - - - -
N 2,259 11,246 4,995 41,751 (8,705) 19,503 12,318 5,851 Basic earnirgs per sh:
I=o=n os)before mulative eflect of acunzingchange. 0.05 0.23 0.10 0.04 (0.18) 0.39 E 0.25 0.12 Cmulative efectofacaxu inadoge, net oftm E...... - - 0.81 Net nom (loss) ... .
.... .... ,. 0.05 0.23 0.10 0.85 (0.18) 0.39 0.25 0.12 D uted earrgs pershar:
Income i;s) befoie cmuldative eflect of accoimting hange ........................................................ 0.05 0.23 0.10 ' 0.04 (0.18) 0.39 0.24 0.12 Cumulative effect ofaccounfin change, net oftax ...... 0.80 -
Net inxone (loss).............................................................. 0.05 0.23 . 0.10 - 0.84 (0.18) 0.39 0.24 0.12 (1) Operating revenues are seasonal in nature, with the peak sales periods generally occurring during the summer months. Comparisons among quarters of a year may not represent overall trends and changes in operations.
89
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable.
Item 9A. Controls and Procedures Evaluation of disclosure controls and procedures. The Company's chief executive officer and chief financial officer, after evaluating the effectiveness of the Company's "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of December 31, 2003, (the "Evaluation Date"), have concluded that as of the Evaluation Date, the Company's disclosure controls and procedures (as required by paragraph (b) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15) were adequate and designed to ensure that material information relating to the Company and the Company's consolidated subsidiary would be made known to them by others within those entities.
Changes in internal control overfinancial reporting. There were no changes in the Company's internal control over financial reporting in connection with the evaluation required by paragraph (d) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15, that occurred during the quarter ended December 31, 2003, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART III and PART IV The information set forth in Part III and Part IV has been omitted from this Annual Report to Shareholders.
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