(As filed on May 8, 2003)
File No. 70-10116
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM U-1/A
AMENDMENT NO. 1
TO
APPLICATION OR DECLARATION
UNDER THE
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
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UNISOURCE ENERGY CORPORATION
One South Church Avenue, Suite 100
Tucson, Arizona 85701
(520) 571-4000
(Name of company filing this statement and
address of principal executive offices)
---------------------------------------
None
(Name of top registered holding company parent)
-------------------------------------
Kevin P. Larson, Vice President,
Chief Financial Officer and Treasurer
UniSource Energy Corporation
One South Church Avenue, Suite 100
Tucson, Arizona 85701
(520) 571-4000
(Name and address of agent for service)
-------------------------------------
The Commission is requested to send copies of all
notices, orders and other communications in connection
with this Application/Declaration to:
Vincent Nitido, Jr., Vice President and John T. Hood, Esq.
General Counsel Andrew F. MacDonald, Esq.
UniSource Energy Corporation Thelen Reid & Priest LLP
One South Church Avenue, Suite 100 875 Third Avenue
Tucson, Arizona 85701 New York, New York 10022
2
TABLE OF CONTENTS
Item 1. Description of Proposed Transaction....................................4
1.1 Introduction....................................................4
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1.2 Description of UniSource Energy and its Subsidiaries............6
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1.3 Description of Citizens' Arizona Public Utility Assets.........13
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1.4 Principal Terms of Transaction Agreements......................14
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1.5 Financing of the Purchase Price................................16
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1.6 The HoldCo Structure...........................................18
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Item 2. Fees, Commissions and Expenses........................................18
Item 3. Applicable Statutory Provisions.......................................19
3.1 General Overview of Applicable Statutory Provisions............19
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3.2 Compliance with Standards of Section 10........................21
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a. The Acquisition is Lawful Under Section 8 of the Act
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and Is Not Detrimental to the Carrying Out of the
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Provisions of Section 11................................21
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b. The Acquisition Will Serve the Public Interest by
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Tending Toward the Economical and Efficient
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Development of an Integrated Public-Utility System......27
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c. Compliance with Relevant State Law......................29
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d. The Acquisition Will Not Tend Towards Interlocking
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Relations or Concentration of Control of Public-
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Utility Companies that is Detrimental to the Public
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Interest or Interest of Investors or Consumers..........30
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(i) Interlocking Relationships.......................30
(ii) Concentration of Control.........................30
e. The Consideration To Be Paid Is Reasonable and Bears
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a Fair Relation to the Value of the Utility Assets
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Underlying the Securities To Be Acquired................32
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f. The Acquisition Will Not Unduly Complicate the
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Capital Structure of the UniSource Energy System
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and Will Not Be Detrimental to the Public Interest,
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the Interest of Investors or Consumers, or the
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Proper Functioning of the UniSource Energy System.......34
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3.3 Exemption of UniSource Energy, TEP and HoldCo under
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Section 3(a)(1)................................................36
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Item 4. Regulatory Approvals..................................................40
4.1 State Approvals:...............................................40
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4.2 Federal Approvals:.............................................40
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Item 5. Procedure. ........................................................41
Item 6. Exhibits and Financial Statements.....................................41
(a) Exhibits.........................................41
(b) Financial Statements.............................43
Item 7. Information as to Environmental Effects...............................44
3
The Application/Declaration filed in this proceeding on February 21, 2003
is hereby amended and restated in its entirety to read as follows:
ITEM 1. DESCRIPTION OF PROPOSED TRANSACTION.
-----------------------------------
1.1 Introduction.
------------
UniSource Energy Corporation ("UniSource Energy"), an Arizona
corporation, is an exempt holding company pursuant to Section 3(a)(1) of the
Public Utility Holding Company Act of 1935, as amended (the "Act"), and Rule 2
thereunder.(1) UniSource Energy owns substantially all of the issued and
outstanding common stock of Tucson Electric Power Company ("TEP"), also an
Arizona corporation, which provides electric utility service in Tucson, Arizona
and surrounding areas.
UniSource Energy is filing this Application/Declaration pursuant to
Sections 9(a)(2) and 10 of the Act to request approval for the acquisition,
directly or indirectly, of all of the issued and outstanding common stock of one
or more newly formed Arizona corporations (each a "New Utility Company," and
together the "New Utility Companies"). UniSource Energy intends to organize the
New Utility Company(ies) to serve as the corporate vehicle(s) through which
UniSource Energy will acquire the operating electric and gas utility properties
of Citizens Communications Company ("Citizens") that are located in Arizona (the
"Transaction"). As part of this Application/Declaration, UniSource Energy is
also requesting that the Commission issue an order pursuant to Section 3(a)(1)
of the Act finding that, following completion of the Transaction described
-------------------
(1) See Statement, dated February 28, 2003, on Form U-3A-2 filed by UniSource
Energy in File No. 69-427.
4
herein, UniSource Energy and its subsidiary companies as such will be entitled
to an exemption from all provisions of the Act, except Section 9(a)(2).
As more fully explained below, UniSource Energy may either combine the
purchased assets in one New Utility Company or keep the purchased electric and
gas utility assets separate in two different New Utility Companies. (Solely for
the sake of convenience, the New Utility Companies will hereafter generally be
referred to in the plural). The New Utility Companies will be incorporated under
Arizona law. UniSource Energy will either acquire and hold the common stock of
the New Utility Companies directly or, alternatively, as direct subsidiaries of
a newly formed Arizona corporation (referred to as "HoldCo") that will be a
direct subsidiary of UniSource Energy (hereafter referred to as the "HoldCo
Structure"). UniSource Energy has not yet determined the optimum structure for
the Transaction from the standpoint of financing, rates and ongoing regulation.
In the event that the HoldCo Structure is employed, it is requested that HoldCo
be deemed to be an additional applicant in this proceeding and that the
Commission's order granting UniSource Energy an exemption under Section 3(a)(1)
of the Act also grant HoldCo an exemption.
The Transaction is subject to, among other conditions precedent, receipt by
the parties of required state and federal regulatory approvals and filing of
pre-merger notification statements under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended ("HSR Act"), and expiration or early
termination of the statutory waiting period thereunder. (See Item 4 - Regulatory
Approvals). The boards of directors of UniSource Energy and Citizens have each
approved the proposed Transaction. The Transaction does not require shareholder
approval by either company.
5
1.2 Description of UniSource Energy and its Subsidiaries.
----------------------------------------------------
UniSource Energy became a holding company over TEP in January 1998 as a
result of a statutory share exchange in which the holders of the outstanding
shares of TEP common stock became the holders of shares of UniSource Energy
common stock and TEP became a subsidiary of UniSource Energy.(2) UniSource
Energy owns substantially all of the issued and outstanding common stock of
TEP,(3) as well as all of the issued and outstanding common stock of two direct
non-utility subsidiaries, Millennium Energy Holdings, Inc. ("Millennium") and
UniSource Energy Development Company ("UED"). UniSource Energy itself does not
engage in any business activities or have any material assets, other than the
stock of its subsidiaries.
In 2002, TEP, UniSource Energy's predominant subsidiary, accounted for
approximately 94% of UniSource Energy's total consolidated assets and more than
-------------------
(2) The share exchange was approved by the Arizona Corporation Commission by
order dated November 25, 1997. See In the Matter of the Notice and Intent of
Tucson Electric Power Company to Organize a Public Utility Holding Company and
for Related Approvals of Waivers Pursuant to R14-2-1801, ET SEQ., Docket
No. U-1933-97-176, Decision 60480 (Nov. 25, 1997) (hereafter, the "Holding
Company Order"). TEP also sought and obtained a "no-action" letter from the
Division of Investment Management ("Division") in which the Division agreed not
to recommend any enforcement action to the Commission if the share exchange were
consummated without the approval of the Commission under Section 9(a)(2) of the
Act. See Tucson Electric Power Co., SEC No-Action Letter, 1995 SEC No-Act. LEXIS
890 (Sept. 27, 1995) (hereafter, the "1995 No-Action Letter").
(3) UniSource Energy holds all but 121 shares of TEP's outstanding common
stock. In 1992, TEP issued warrants to purchase its common stock to certain
institutional investors in connection with the financial restructuring of TEP
that is described below. The subsequent statutory share exchange that
established UniSource Energy as a holding company over TEP did not alter the
rights of TEP warrant holders to continue to acquire TEP common stock. In August
1998, UniSource Energy offered warrants to purchase UniSource Energy common
stock in exchange for the outstanding TEP warrants. Warrants representing the
right to acquire approximately 918,000 shares of TEP common stock were not
exchanged for the UniSource Energy warrants. Of that number, warrants to acquire
121 shares of TEP common stock were exercised. The remaining TEP warrants
expired in December 2002.
6
99% of UniSource Energy's operating revenues. TEP is a vertically integrated
electric utility company that provides retail service to over 355,000 customers
in a 1,155 square-mile area of southeastern Arizona having a population of
approximately 891,000. This area includes the City of Tucson and adjoining areas
of Pima County. (See Exhibit E-1). TEP also supplies the power requirements of a
military base that is located in Cochise County, to the east of Tucson, and
sells electricity at wholesale to other utilities and power marketing entities
in the western U.S. Substantially all of these sales take place in Arizona.
At December 31, 2002, TEP owned or leased 2,002 MW of net generating
capability as set forth in the following table:
--------------------------- --------------------- ------------ --------------------
Generating Source Location Fuel Type Net Capability - MW
(TEP's share)
--------------------------- --------------------- ------------ --------------------
Springerville Sta. - Springerville, AZ Coal 380
Unit 1
--------------------------- --------------------- ------------ --------------------
Springerville Sta. - Springerville, AZ Coal 380
Unit 2 *
--------------------------- --------------------- ------------ --------------------
San Juan Sta. - Unit 1 Farmington, NM Coal 164
--------------------------- --------------------- ------------ --------------------
San Juan Sta. - Unit 2 Farmington, NM Coal 158
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Navajo Sta. - Unit 1 Page, AZ Coal 56
--------------------------- --------------------- ------------ --------------------
Navajo Sta. - Unit 2 Page, AZ Coal 56
--------------------------- --------------------- ------------ --------------------
Navajo Sta. - Unit 3 Page, AZ Coal 56
--------------------------- --------------------- ------------ --------------------
Four Corners Sta. - Unit 4 Farmington, NM Coal 55
--------------------------- --------------------- ------------ --------------------
Four Corners Sta. - Unit 5 Farmington, NM Coal 55
--------------------------- --------------------- ------------ --------------------
Irvington Sta.- Unit 1 Tucson, AZ Gas/Oil 81
--------------------------- --------------------- ------------ --------------------
Irvington Sta. - Unit 2 Tucson, AZ Gas/Oil 81
--------------------------- --------------------- ------------ --------------------
Irvington Sta. - Unit 3 Tucson, AZ Gas/Oil 104
--------------------------- --------------------- ------------ --------------------
Irvington Sta. - Unit 4 Tucson, AZ Coal/Gas 156
--------------------------- --------------------- ------------ --------------------
Combustion Turbine Tucson, AZ Gas/Oil 122
--------------------------- --------------------- ------------ --------------------
Combustion Turbine Tucson, AZ Gas 75
--------------------------- --------------------- ------------ --------------------
Combustion Turbine Tucson, AZ Gas 20
--------------------------- --------------------- ------------ --------------------
Solar Electric Generation Springerville and Solar 3
Tucson, AZ
--------------------------- --------------------- ------------ --------------------
* Title to Springerville Unit 2 is held by San Carlos Resources, Inc., a
wholly-owned subsidiary of TEP.
7
TEP is the sole owner (or lessee) and the operator of the Springerville and
Irvington generating stations. The Four Corners, Navajo and San Juan stations
are jointly owned with and operated by other utilities. TEP's generating
facilities located in or about the City of Tucson, Arizona are sometimes herein
called the "Local TEP Generating Facilities." All other TEP generating
facilities are sometimes herein called the "Remote TEP Generating Facilities."
TEP's transmission facilities transmit electricity from the Four Corners,
Navajo, San Juan and Springerville generating stations to the Tucson area for
use by TEP's retail customers. TEP is directly interconnected to Arizona Public
Service Company ("APS"), Southwest Transmission Cooperative, Inc. ("Southwest
Transmission Cooperative"), El Paso Electric Company, Public Service Company of
New Mexico, The Salt River Project Agricultural Improvement and Power District
("Salt River"), Nevada Power Company, and Tri-State Generation Transmission
Cooperative. As of December 31, 2002, TEP owned, or participated in, an overhead
electric transmission and distribution system consisting of 511 circuit-miles of
500 kV lines, 1,122 circuit-miles of 345 kV lines, 371 circuit-miles of 138 kV
lines, 434 circuit-miles of 46 kV lines, and 12,095 circuit-miles of lower
voltage primary lines. TEP's underground electric distribution system is
comprised of 7,353 cable-miles. Electric substation capacity associated with the
above-described electric system consisted of 192 substations having a total
installed transformer capacity of 5,602,522 kVA. The above facilities are all
located in Arizona except for approximately 560 circuit-miles of 345 kV
transmission lines in which TEP has a fractional undivided interest that are
located in New Mexico and used to deliver electric energy produced at the Four
Corners and San Juan stations to TEP at the Arizona-New Mexico border.
Exhibit E-2 hereto shows the location of the principal electric generation
and transmission facilities owned by TEP.
8
TEP is subject to regulation by the Arizona Corporation Commission ("ACC")
with respect to retail electric rates, the issuance of securities, affiliate
transactions, the maintenance of books and records, and other matters and by the
Federal Energy Regulatory Commission ("FERC") with respect to wholesale electric
rates and electric transmission service.
Millennium, which serves as the holding company for most of UniSource
Energy's non-utility operations, invests in various unregulated ventures related
primarily to the energy business, including investments in a developer of
thin-film batteries, a developer of small-scale commercial satellites, and a
developer and manufacturer of thin-film photovoltaic cells. UED, established in
2001, is the developer of the expansion project at the Springerville Generating
Station.
TEP has five direct, wholly-owned, non-utility subsidiaries, as follows:
Escavada Company, which is engaged in the business of maintaining miscellaneous
assets and property; San Carlos Resources, Inc. ("San Carlos"), which holds
legal title to Unit No. 2 of the Springerville Generating Station, and is the
lessee, jointly and severally with TEP, of an undivided one-half interest in
certain facilities shared in common between Unit No. 1 and Unit No. 2 of the
Springerville Generating Station;(4) Sierrita Resources, Inc., which holds
investments in financial assets; Tucson Resources, Inc., which also holds
investments in financial assets; and Tucsonel Inc., which holds an undivided
interest in the Springerville Generating Station coal-handling facility. TEP
also holds minority interests in entities that provide demand side and energy
-------------------
(4) In the 1995 No-Action Letter, supra note 2, the Division agreed not to
recommend any enforcement action to the Commission under Section 2(a)(3) of the
Act if San Carlos were treated by TEP and UniSource Energy as not being an
"electric utility company" based on the passive nature of its ownership interest
in the Springerville station facilities and various other factors.
9
management services and engage in development activities relating to
technologies that provide pricing and other related services to consumers for a
wide variety of products, including utility services.
A more complete description of UniSource Energy's direct and indirect
non-utility subsidiaries and investments will be filed by amendment as Exhibit I
hereto.
For the twelve months ended December 31, 2002, UniSource Energy reported
consolidated operating revenues of $856 million, more than 98% of which were
derived from retail and wholesale sales of electricity and related transmission
and distribution services. At December 31, 2002, UniSource Energy had $2.7
billion in total assets, including total net utility plant of $1.7 billion.
As of March 4, 2003, UniSource Energy had issued and outstanding 33,583,182
shares of common stock, no par value, which are listed and traded on the New
York Stock Exchange and the Pacific Exchange. UniSource Energy's only
outstanding debt (on a standalone basis) is a $95 million intercompany note
payable to TEP. The note bears interest at 9.78% per annum and is due in 2008.
The note was issued by UniSource Energy to TEP shortly after UniSource Energy
was organized in 1998 in exchange for the stock of Millennium, which was a
subsidiary of TEP prior to the reorganization. The ACC approved this transaction
as part of the Holding Company
10
Order.(5)
TEP has issued and outstanding 32,139,555 shares of common stock, no par
value, of which 32,139,434 are held by UniSource Energy. Also, as of
December 31, 2002, TEP had issued and outstanding $1.128 billion principal
amount of long-term debt (excluding current portion), including first and second
mortgage bonds that are secured by a lien on substantially all of the properties
and assets owned by TEP, and long-term capital lease obligations (excluding
current portion) totaling $802 million. At December 31, 2002, TEP did not have
any outstanding short-term debt, other than the current portion of TEP's
long-term debt and capital lease obligations, which totaled $45 million at
December 31, 2002. TEP's senior secured debt is currently rated BBB- by Standard
& Poor's ("S&P"), Ba2 by Moody's Investor Service ("Moody's"), and BB+ by Fitch
Inc. ("Fitch").
On a consolidated basis, UniSource Energy's capitalization at December 31,
2002 was as follows:
Common equity $438,229,000 18.16%
Capital lease obligations $801,611,000 33.21%
Long-term debt $1,128,963,000 46.78%
Current portion of Long-term debt and $44,800,000 1.85%
Capital lease obligations
============== ==========
Total capitalization $2,413,603,000 100.00%
-------------------
(5) Various restrictions and conditions were imposed under the Holding Company
Order, as later modified by order dated November 30, 1999, in order to protect
TEP's financial integrity. Among other restrictions, TEP may not declare or pay
dividends in excess of 75% of its annual earnings until TEP's equity ratio
equals 37.5% of total capitalization, excluding capital lease obligations.
(Under the terms of a proposed Settlement Agreement (see Item 1.4 below), this
percentage would be increased to 40%). Further, without prior ACC approval, TEP
may not guarantee any debt obligations of UniSource Energy or any associate
companies, and UniSource Energy may not pledge TEP's common stock as collateral
security for debt of UniSource Energy or any associate company.
11
TEP's consolidated capitalization at December 31, 2002 was as follows:
Common equity $337,463,000 14.59%
Capital lease obligations $801,508,000 34.67%
Long-term debt $1,128,410,000 48.81%
Current portion of Long-term debt and $44,597,000 1.93%
Capital lease obligations
============== =========
Total capitalization $2,311,978,000 100.00%
In December 1992, TEP completed a comprehensive restructuring in order to
address severe financial difficulties that had developed in the late 1980s and
early 1990s primarily as a result of TEP's inability to sell that portion of its
generating capacity that was in excess of its retail demand, plus reserves, on a
profitable basis, certain adverse retail rate actions by the ACC in 1989 and
1991, above-market costs associated with existing long-term commitments under
fuel supply and transportation contracts, losses on non-utility investments, and
high debt leverage. Effective January 31, 1991, TEP began to withhold required
payments under its bank credit facilities, as well as under certain lease and
fuel supply and transportation contracts. By December 1992, TEP had withheld
payments aggregating approximately $232 million (excluding matured or
accelerated principal payments) under these arrangements. Under a financial
restructuring plan negotiated between TEP and certain of its creditors and
suppliers in 1992, TEP issued common stock and warrants to certain lenders and
lease participants in consideration of, among other things, the modification of
the terms of such debt and lease obligations and forgiveness of payment of
certain amounts previously withheld. In addition, TEP's outstanding cumulative
preferred stock was reclassified as common stock.
Following the completion of TEP's 1992 financial restructuring, TEP had a
$38 million deficit in common stock equity. Its common stock equity ratio has
12
improved steadily since the 1992 financial restructuring, even after payment of
dividends of $34 million in 1999, $30 million in 2000, $50 million in 2001, and
$35 million in 2002.
1.3 Description of Citizens' Arizona Public Utility Assets.
------------------------------------------------------
Citizens, a Delaware corporation, operates as an electric and gas utility
in Arizona through two operating divisions. Through its Arizona Electric
Division, Citizens is certificated to provide electric service in most of Mohave
County in northwest Arizona and in all of Santa Cruz County in southeast Arizona
between TEP's service area and the U.S.-Mexico border. (See Exhibit E-1).
Citizens provides electric service to approximately 77,500 customers in these
two counties. Through its Arizona Gas Division, Citizens provides natural gas
service in most of northern Arizona, including portions of Mohave, Yavapai,
Coconino, Navajo, Greenlee, and Apache Counties, as well as Santa Cruz County in
southeast Arizona. Citizens currently serves approximately 125,000 retail
natural gas customers in Arizona. (See Exhibit E-3).
Citizens purchases substantially all of its electric requirements under a
long-term contract with Pinnacle West Capital Corporation, an affiliate of APS.
Citizens owns one generating station with three units having a combined capacity
of approximately 47 MW. These units are typically run only at times of impending
outages or otherwise during periods of system emergencies. Citizens' electric
transmission and distribution system in Arizona consists of approximately 56
circuit-miles of 115 kV transmission lines, 229 circuit-miles of 69 kV
transmission lines, and 3,116 circuit-miles of underground and overhead
distribution lines. Citizens also owns 38 substations having a total installed
transformer capacity of 1,077,300 kVA.
Citizens' gas transmission and distribution system in Arizona consists of
approximately 168 miles of steel transmission mains, 2,459 miles of steel and
plastic distribution mains, and 127,015 customer service lines. Citizens
purchases substantially all of its gas requirements in Arizona under a variety
13
of long-term and short-term contracts with marketers and producers. Most of the
gas distributed by Citizens in Arizona is produced in the San Juan Basin in the
Four Corners region and delivered on the El Paso and Transwestern interstate
pipeline systems.
Citizens is subject to regulation in Arizona by the ACC with respect to
retail electric and gas rates, the issuance of securities, affiliate
transactions, the maintenance of books and records, and other matters and by the
FERC with respect to wholesale power sales and interstate transmission service.
1.4 Principal Terms of Transaction Agreements.
-----------------------------------------
Citizens and UniSource Energy have entered into separate Asset Purchase
Agreements, each dated October 29, 2002, relating to the purchase of Citizens'
electric and gas utility businesses in Arizona. Under the terms of the Asset
Purchase Agreement relating to Citizens' electric utility business (Exhibit B-1
hereto), Citizens has agreed to sell and UniSource Energy has agreed to purchase
all of the assets (subject to certain stated exceptions) used by Citizens in
connection with or otherwise necessary for the conduct of its electric utility
business in Arizona. These assets include, but are not limited to, real property
and real property leases, accounts receivable, machinery and other equipment,
certain assigned agreements, Citizens' Certificates to provide electric service
and other transferable permits, and certain other assets related to its Arizona
electric utility business ("Electric Assets").
Under the terms of the Asset Purchase Agreement relating to Citizens' gas
utility business (Exhibit B-2 hereto), Citizens has agreed to sell and UniSource
Energy has agreed to purchase all of the assets (subject to certain stated
exceptions) used by Citizens in connection with or otherwise necessary for the
conduct of its gas utility business in Arizona. These assets include, but are
not limited to, real property and real property leases, accounts receivable,
14
machinery and other equipment, certain assigned agreements, Citizens'
Certificates to provide gas service and other transferable permits, and certain
other assets related to its gas utility business in Arizona ("Gas Assets").
UniSource Energy has agreed to pay Citizens $92 million in cash for the
Electric Assets and $138 million in cash for the Gas Assets, subject in each
case to adjustment based on the date on which the Transaction closes and on the
amount of certain assets and liabilities associated with the purchased assets at
the time of closing. In addition, the base price for the Electric Assets and the
Gas Assets will be reduced by $10 million in the aggregate if the Transaction
closes by July 28, 2003. However, whether or not the Transaction closes by
July 28, 2003, UniSource Energy has agreed to reduce rate base for the Gas
Assets by $10 million. UniSource Energy will not assume Citizens' obligations
under existing industrial development revenue bonds that were issued to finance
portions of the purchased assets. Citizens will remain liable on these
obligations.
Under the Asset Purchase Agreements, UniSource Energy and Citizens also
agreed to coordinate the overall development of the positions to be taken and
the regulatory actions to be requested regarding the two utility rate cases that
Citizens has pending before the ACC. As part of the Joint Application filed with
the ACC, UniSource Energy is seeking approval for a reduced level of rate
increases. (See Item 4 - Regulatory Approvals). On April 1, 2003, UniSource
Energy, Citizens, TEP and the Staff of the Utilities Division ("Staff") of the
ACC entered into a Settlement Agreement ("Settlement") (filed as Exhibit D-1(A)
hereto), which sets forth the agreement and understanding of the parties with
respect to the settlement of all issues arising under the Joint Application, the
amount of the reduction in Citizens' proposed gas rate increase, UniSource
Energy's forfeiture of any right to seek recovery of the under-collected balance
15
under Citizens' purchase power and fuel adjustment clause, and other matters.(6)
The proposed Settlement is subject to approval by the ACC. Under the proposed
Settlement, Citizens' electric and gas customers would save a total of about
$29 million per year, as compared to the amount of rate increases proposed in
Citizens' pending applications. The proposed Settlement also contains the
agreement of the parties with respect to UniSource Energy's plan for financing
the Transaction, as described below.
1.5 Financing of the Purchase Price.
-------------------------------
UniSource Energy intends to fund the purchase price under the Asset
Purchase Agreements using a combination of several sources, including: (1)
available cash at UniSource Energy, (2) possibly the issuance of new equity by
UniSource Energy, (3) a loan from TEP, and (4) debt issued by the New Utility
Companies or HoldCo (if the HoldCo Structure is utilized), which will be repaid
either directly or indirectly from the cash flows of the New Utility Companies.
More specifically, in the Joint Application, UniSource Energy is requesting
the authorization of the ACC for the New Utility Companies to (1) issue or
guarantee up to $175 million of debt securities for the purpose of funding a
portion of the purchase price and initial working capital requirements of the
New Utility Companies; (2) issue or guarantee additional debt securities from
time to time under the terms of a new revolving credit agreement that will
-------------------
(6) Under the proposed Settlement, UniSource Energy has agreed to seek an
increase in rates of the new gas utility of approximately 20.9%, versus the
28.9% increase requested by Citizens. In addition, UniSource Energy has agreed
to forfeit its right to seek recovery of the under-collected balance under
Citizens' electric purchase power and fuel adjuster clause (estimated to be at
least $135 million as of July 28, 2003). As a result, electric rates of the new
electric utility would increase by 22%, rather than the 45% increase proposed by
Citizens.
16
provide ongoing liquidity support to the New Utility Companies; (3) enter into
indentures or security agreements which grant liens on some or all of the
properties held by such companies to secure the debt obligations of such
companies; and (4) issue common stock to UniSource Energy (or to HoldCo if the
HoldCo Structure is used). Additionally, UniSource Energy and TEP are seeking
authority from the ACC to allow TEP to fund up to $50 million of the aggregate
purchase price through a loan to UniSource Energy. Authorization of this loan
from TEP would provide financing flexibility to UniSource Energy in the event
that, at the time of the consummation of the Transaction, UniSource Energy is
unable to issue common stock on reasonable terms in order to fund the purchase
price.
Under the proposed Settlement filed with the ACC, the New Utility Companies
are expected to have an initial capital structure of about 40% common equity and
60% long-term debt. UniSource Energy's objective is to capitalize the New
Utility Companies at a level that is consistent with an investment grade rating,
in accordance with current ratings criteria published by the principal rating
agencies. UniSource Energy has agreed that, until common equity as a percentage
of total capitalization (i.e., common and preferred equity and long-term debt,
including current portion) of each New Utility Company equals 40%, such company
will not pay dividends to UniSource or HoldCo, as the case may be, in an amount
exceeding 75% of such company's earnings. The $50 million loan from TEP would
have a maturity not to exceed four years, would be secured by a pledge of 100%
of the common stock of the New Utility Companies or HoldCo (if the HoldCo
Structure is used), and would bear interest at 383 basis points above the
yield-to-maturity of an equivalent four-year U.S. Treasury security as
determined on the date of the loan. The Settlement further specifies that 264
basis points of the interest income earned by TEP on the TEP loan will be
recorded as a deferred credit and used to offset rates in the future, and that
17
the balance of the interest income will be used to build the equity
capitalization of TEP.
1.6 The HoldCo Structure.
--------------------
Under the proposed HoldCo Structure - that is, inserting an intermediate
holding company between UniSource Energy and the New Utility Companies - HoldCo,
rather than the New Utility Companies, would issue the debt securities for the
acquisition and use the proceeds thereof, together with the equity funds
provided by UniSource Energy (including the proceeds of a loan by TEP to
UniSource Energy), to fund the asset purchases and working capital needs of the
New Utility Companies. The principal benefit of the HoldCo Structure is the
ability to realize possibly lower financing costs associated with a larger debt
offering. Similar financing savings could be achieved by combining the Electric
Assets and Gas Assets in a single New Utility Company that would be a direct
subsidiary of UniSource Energy. In that case, however, the benefits of having
separate operating companies for the acquired gas and electric businesses would
be lost.
ITEM 2. FEES, COMMISSIONS AND EXPENSES.
------------------------------
It is currently estimated that the fees, commissions and expenses paid or
incurred, or to be paid or incurred, directly or indirectly, in connection with
the Transaction, will total approximately $5.6 million, as follows:
Investment bankers fees and expenses.............................$3,000,000
Lenders fees and expenses........................................$1,500,000
Accountants fees...................................................$300,000
18
Legal fees and expenses............................................$600,000
Other..............................................................$200,000
---------
TOTAL.........................................$5,600,000
ITEM 3. APPLICABLE STATUTORY PROVISIONS.
-------------------------------
3.1 General Overview of Applicable Statutory Provisions.
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The acquisition of the common stock of the New Utility Companies by
UniSource Energy (or by HoldCo if the HoldCo Structure is used) is subject to
Sections 9(a)(2) and 10 of the Act. The relevant standards for approval of an
application under Section 10 are set forth in subsections (b), (c) and (f)
thereof. Section 10(b) provides that, if the requirements of Section 10(f) are
satisfied, the Commission shall approve an acquisition under Section 9(a) unless
the Commission finds that:
(1) such acquisition will tend towards interlocking relations or the
concentration of control of public-utility companies, of a kind or to
an extent detrimental to the public interest or the interest of
investors or consumers;
(2) in case of the acquisition of securities or utility assets, the
consideration, including all fees, commissions, and other
remuneration, to whomsoever paid, to be given, directly or indirectly,
in connection with such acquisition is not reasonable or does not bear
a fair relation to the sums invested in or the earning capacity of the
utility assets to be acquired or the utility assets underlying the
securities to be acquired; or
(3) such acquisition will unduly complicate the capital structure of the
holding company system of the applicant or will be detrimental to the
public interest or the interest of investors or consumers or the
proper functioning of such holding company system.
Section 10(f) provides that the Commission:
19
shall not approve any acquisition . . . unless it appears to the
satisfaction of the Commission that such State laws as may apply in
respect of such acquisition have been complied with, except where the
Commission finds that compliance with such State laws would be
detrimental to the carrying out of the provisions of section 11.
Finally, Section 10(c) of the Act provides that, notwithstanding the
provisions of Section 10(b), the Commission shall not approve:
(1) an acquisition of securities or utility assets, or of any other
interest, which is unlawful under the provisions of section 8 or is
detrimental to the carrying out of the provisions of section 11; or
(2) the acquisition of securities or utility assets of a public-utility or
holding company unless the Commission finds that such acquisition will
serve the public interest by tending towards the economical and the
efficient development of an integrated public-utility system.
An "integrated public-utility system" is defined in Section 2(a)(29) to mean:
(A) As applied to electric utility companies, a system consisting of one
or more units of generating plants and/or transmission lines and/or
distributing facilities, whose utility assets, whether owned by one or
more electric utility companies, are physically interconnected or
capable of physical interconnection and which under normal conditions
may be economically operated as a single interconnected and
coordinated system confined in its operations to a single area or
region, in one or more States, not so large as to impair (considering
the state of the art and the area or region affected) the advantages
of localized management, efficient operation, and the effectiveness of
regulation; and
(B) As applied to gas utility companies, a system consisting of one or
more gas utility companies which are so located and related that
substantial economies may be effectuated by being operated as a single
coordinated system confined in its operations to a single area or
region, in one or more States, not so large as to impair (considering
the state of the art and the area or region affected) the advantages
of localized management, efficient operation, and the effectiveness of
regulation: Provided, That gas utility companies deriving natural gas
from a common source of supply may be deemed to be included in a
single area or region.
20
3.2 Compliance with Standards of Section 10.
---------------------------------------
The proposed Transaction meets all the substantive requirements of
subsections (b), (c) and (f) of Section 10 and therefore should be approved.
a. The Acquisition is Lawful Under Section 8 of the Act and Is Not
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Detrimental to the Carrying Out of the Provisions of Section 11.
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Section 10(c)(1) provides that the Commission shall not approve an
acquisition that "is unlawful under the provisions of section 8 or is
detrimental to the carrying out of the provisions of section 11." Section 8
prohibits an acquisition by a registered holding company of an interest in an
electric utility and a gas utility serving substantially the same territory
without the express approval of the State commission when State law prohibits or
requires approval of such acquisition. By its terms, Section 8 applies only to
registered holding companies and is thus inapplicable to UniSource Energy, which
is seeking an exemption under Section 3(a)(1) of the Act. In any event, the
Transaction for which approval is sought herein must be approved by the ACC,
which has jurisdiction over both TEP and Citizens (with respect to its Arizona
utility operations). Nor will approval of the Transaction be detrimental to the
carrying out of the provisions of Section 11, which provides, in
subsection (b)(1) thereof, that every registered holding company and its
subsidiaries shall limit their operations "to a single integrated public-utility
system . . .." Section 11(b)(1) permits a registered holding company to own one
or more additional integrated public-utility systems only if the requirements of
21
Section 11(b)(1)(A)-(C) (the "ABC clauses") are satisfied.(7) Like Section 8,
Section 11(b)(1) by its terms applies only to registered holding companies and
therefore does not preclude the acquisition and ownership of a combination gas
and electric system by an exempt holding company whose ownership of both gas and
electric operations is permitted and subject to "affirmative state regulation."
See WPL Holdings, Inc., 49 S.E.C. 761, 772 (1988), aff'd in part and rev'd in
part sub nom., Wisconsin's Environmental Decade v. SEC, 882 F.2d 523 (D.C. Cir.
1989), reaffirmed, 50 S.E.C. 728 (1991).
The Commission has also previously held that a holding company may acquire
additional utility assets that will not, when combined with its existing utility
assets, make up an integrated system or comply fully with the "ABC" clauses,
provided that there is de facto integration of contiguous utility properties and
the holding company will be exempt from registration under Section 3(a) of the
Act following the acquisition. See TUC Holding Company, 53 S.E.C. 101, 109-110
(1997), citing Gaz Metropolitain, Inc., 52 S.E.C. 56 (1994). De facto
integration exists where the utility systems of the acquiring company and the
acquired company generally overlap, the systems will be coordinated
administratively following the proposed acquisition, and the proposed
acquisition will allow the systems to compete more effectively without giving
rise to any of the abuses that the Act was designed to prevent, such as
ownership of scattered utility properties, inefficient operations, lack of local
management or evasion of state regulation. Id. In Sierra Pacific Resources, et
-------------------
(7) Under the "ABC" clauses, a registered holding company can own "one or more"
additional integrated public-utility systems if the Commission finds that:
"(A) Each of such additional systems cannot be operated as an independent system
without the loss of substantial economies which can be secured by the retention
of control by such holding company of such system; (B) All of such additional
systems are located in one State, or in adjoining States, or in a contiguous
foreign country; and (C) The continued combination of such systems under the
control of such holding company is not so large (considering the state of the
art and the area or region affected) as to impair the advantages of localized
management, efficient operation, or the effectiveness of regulation."
22
al., Holding Co. Act Release No. 27054 (July 26, 1999), de facto integration of
separate electric utility systems was found to exist where the service
territories of the parties were not contiguous or overlapping, but were "in
close proximity to one another." Accord The AES Corporation, Holding Co. Act
Release No. 27363 (Mar. 23, 2001) (combination of non-contiguous electric
utilities operating in different states).
The service areas of TEP and Citizens in southeast Arizona are contiguous.
Moreover, in January 2001, TEP and Citizens' entered into a project development
agreement for the joint construction of a new 62-mile 345 kV transmission line
extending from Tucson to Nogales, which is served by Citizens. The ACC has
approved the location and construction of the line and TEP is currently seeking
a special use permit from the U.S. Forest Service. Shortly after approval by the
U.S. Forest Service, construction will commence with completion expected within
eight months of that date. Upon completion of this line, TEP and the portion of
the Citizens system south of Tucson will be directly interconnected.(8) Among
other benefits, this project will improve reliability in Citizens' service area
and could be used to wheel power produced by Remote TEP Generating Facilities
(other than Springerville Unit No. 2) or purchased from third parties to that
portion of Citizens system south of Tucson.
TEP's service area is not contiguous to the portion of Citizens' electric
system located in Mohave County (northwest Arizona) and also does not overlap or
-------------------
(8) The Commission has previously held that two electric systems that are not
currently interconnected may nevertheless demonstrate that they are "capable of
physical interconnection" within the meaning of Section 2(a)(29)(A) of the Act
based on a commitment to construct a new interconnecting transmission line. See,
e.g., New Century Energies, Inc., 53 S.E.C. 54 (1997) and WPL Holdings, Inc., et
al., 53 S.E.C. 501 (1998). The plans for construction of the new 345 kV line in
this case are at a much more advanced stage than in either of the two cited
cases.
23
touch Citizens' gas service area in northern Arizona. However, TEP owns
substantial generation and transmission assets (or interests therein) that are
located within Citizens' gas service territory in northern Arizona, including
the Springerville Generating Station (in Apache County), the Navajo Generating
Station (in Coconino County), and a 500 kV transmission line that runs north to
south through Citizens' service area in northern Arizona. Thus, TEP has a
substantial physical presence in parts of northern Arizona that are served by
Citizens.
As described below, after the Transaction is completed, the combined
properties of TEP and Citizens will be coordinated administratively, and
Citizens' Arizona customers will realize significant rate savings and important
benefits from being a part of a much larger, locally managed, enterprise.
Nevertheless, in order to preserve the benefits associated with certain existing
financing arrangements, UniSource Energy will have to observe restrictions on
the physical operations of the combined electric utility properties. Citizens
has financed portions of its electric properties in Arizona with the proceeds of
industrial development revenue bonds ("IDBs") issued for its benefit by the
respective industrial development authorities of Santa Cruz and Mohave Counties.
Likewise, TEP has financed portions of its utility system with the proceeds of
IDBs issued for its benefit by the respective industrial development authorities
of Pima and Apache Counties. As a general rule, under the Internal Revenue Code
of 1986, as amended (the "Code"), interest on debt issued by a State or local
government is taxable to the recipient if the proceeds thereof are used to
finance a private business activity, absent an applicable exception. One of the
exceptions in the Code is the so called "two-county" rule, which permits the
issuance of tax-exempt IDBs to finance "facilities for the local furnishing of
electric energy," as defined in the Code. To qualify for this exception, the
facilities must be part of a system used to provide electric service to the
24
general populace of an area consisting solely of (1) a city and one contiguous
county or (2) two contiguous counties. See section 142(a)(8) and (f) of the Code
and Treasury Regulations section 1.103-8(f)(2)(iii).
TEP and Citizens have each utilized the "two county" rule to obtain
tax-exempt treatment for IDBs issued for their benefit. TEP has financed in this
manner (i) substantial portions of its local low voltage transmission and
distribution system, (ii) certain of the Local TEP Generating Facilities, and
(iii) Unit 2 of the Springerville Generating Station and the dedicated 345 kV
transmission line bringing energy from that unit south to Tucson. Except for
Springerville Unit 2 and the dedicated transmission line, none of the Remote TEP
Generating Facilities or high voltage transmission facilities were financed in
this manner.
TEP and Citizens must observe certain operating limitations on the use of
the facilities financed with the IDBs in order to ensure that the IDBs continue
to qualify for tax-exempt treatment(9) and that the interest expense associated
with the IDBs continues to be tax deductible to TEP and to Citizens.(10) If the
historically separate electric systems of TEP and Citizens were operated as a
single integrated and coordinated electric system, thereby enlarging TEP's and
Citizens' service area to more than two contiguous counties, TEP and the New
Utility Companies would not have future access to IDB financing on a tax-exempt
basis.(11) Moreover, the outstanding IDBs issued for the benefit of TEP
(totaling approximately $649 million in unpaid principal) and the outstanding
IDBs issued to finance facilities for the benefit of Citizens (totaling
approximately $94 million in unpaid principal) would have to be redeemed or
-------------------
(9) An explanation of these operating limitations, as applicable to Unit No. 2
of the Springerville Generating Station (which was financed by IDBs issued by
the Apache County authority), were included in the 1995 No-Action Letter, supra
note 2.
(10) See Code ss. 150(b)(4).
(11) See Rev. Rul. 83-56, 1983-1 C.B. 22.
25
defeased to their next permitted redemption date if there is to be any chance of
preserving the tax-exempt status of interest on those outstanding IDBs.(12) If
the relevant outstanding IDBs cannot be redeemed before the combined electric
systems begin to be operated as a single integrated and coordinated system, TEP
and Citizens would be denied federal income tax deductions for interest expense
associated with those IDBs until they are actually redeemed.(13) However, it
should be noted that these operating restrictions do not generally apply to the
operation of facilities that are not treated as part of a system for the "local
furnishing" of electricity. Thus, energy produced by the Remote TEP Generating
Facilities (other than Springerville Unit 2) could be transmitted over TEP's
other high-voltage transmission facilities and/or, when completed, the proposed
new 345 kV line from Tucson to Nogales, as well as transmission facilities owned
by other interconnected utilities, including but not limited to APS, Southwest
Transmission Cooperative, Salt River and Western Area Power Administration, and
delivered, subject to certain operating protocols, to either the northwestern or
southern portion of the Citizens system. In addition, during "emergency
circumstances" tax-related operating restrictions generally are suspended, and
energy may flow freely from one system to the other without violating the
"two-county" rule. Thus, even allowing for the restrictions under the
"two-county" rule, there will still be some opportunities to coordinate the
physical operations of the historic TEP and Citizens electric properties.
-------------------
(12) See Treas. Reg. ss.ss. 1.142-1(b) and 1.142-2, which might be interpreted
as providing that even timely redemption or defeasance might not be effective to
preserve the tax-exempt status of the outstanding IDBs.
(13) Code ss. 150(b)(4). Under these circumstances, the relief provisions in
Code ss. 142(f)(2)(B) and 142(f)(4) would not be available to either TEP or to
Citizens.
26
Finally, the Transaction and related financing are subject to approval by
the ACC, and the New Utility Companies will be locally managed. Thus, the
Transaction will not give rise to any of the abuses, such as ownership of
scattered utility properties, inefficient operations, lack of local management
or evasion of state regulation, that the Act, including Section 11(b)(1), was
intended to prevent. In fact, the Transaction will result in improvements in
local management and operating efficiency.
b. The Acquisition Will Serve the Public Interest by Tending Toward
----------------------------------------------------------------
the Economical and Efficient Development of an Integrated Public-
-----------------------------------------------------------------
Utility System.
--------------
Under Section 10(c)(2), the Commission must affirmatively find that the
acquisition of the New Utility Companies by UniSource Energy "will serve the
public interest by tending towards the economical and the efficient development
of an integrated public-utility system . . . ." As indicated, the existing
electric properties of TEP and the electric and gas properties of Citizens will
not, together, form a single integrated public-utility system. However, the
Commission has stated on numerous occasions that under Section 10(c)(2) an
exempt holding company may consist of more than one integrated system. See e.g.,
Union Electric Company, 45 S.E.C. 489 (1974). In essence, Section 10(c)(2)
requires that (i) each utility system within the exempt holding company system
be an integrated system and (ii) the acquisition tend toward the economical and
efficient development of an integrated system. In this case, following the
acquisition, UniSource Energy will own utility operations consisting of (1)
TEP's integrated electric utility system, which includes generation and
transmission facilities located in Arizona and New Mexico that are
interconnected with and used primarily to serve TEP's retail load in southeast
Arizona, which will be physically interconnected with the portion of Citizens'
electric system south of Tucson via a new 345 kV transmission line, (2) a
27
separate electric utility transmission and distribution system in northwest
Arizona, and (3) an integrated gas utility system serving most of northern
Arizona and Santa Cruz County south of Tucson.(14)
The economies and efficiencies expected to result from the Transaction are
sufficient to satisfy the standards of Section 10(c)(2). The Commission has
noted that economies and efficiencies that cannot be quantified should be taken
into account in this analysis, as "specific dollar forecasts of future savings
are not necessarily required; a demonstrated potential for economies will
suffice even when these are not precisely quantifiable." Centerior Energy
Corporation, 49 S.E.C. 472, 480 (1986), citing American Electric Power Company,
Inc., 46 S.E.C. 1299, 1322 (1978).
UniSource Energy has indicated in the Joint Application to the ACC
(Exhibit D-1 hereto) that it will retain substantially all of Citizens' Arizona
electric and gas utility employees. Hence, labor cost savings - typically one of
the larger components of synergy savings in utility mergers - will not be
realized to any great extent. Moreover, because Citizens has very little
generating capacity of its own, there will be little opportunity to achieve fuel
and production cost savings related to generation. Nevertheless, UniSource
Energy believes that there will be opportunities to achieve modest synergy
savings in both the operating and administrative areas. With respect to
operations matters, the acquisition will allow more efficient utilization of
fleet equipment, training facilities, transformer maintenance equipment, meter
repair facilities, automated mapping facilities and substation testing
equipment. Operational synergies will also be enhanced by the flexibility to
-------------------
(14) Although Citizens' Arizona gas utility operations are conducted through two
distinct divisions - the Northern Arizona Division and the Santa Cruz Division -
management of gas supply, engineering services, and other administrative
functions (such as billing, customer service, legal and regulatory services) for
the two divisions are performed, and will continue to be performed, on
centralized, coordinated basis.
28
dispatch electric trouble crews during certain emergency situations when not
otherwise required for TEP operations. Under the proposed Settlement, TEP is
obligated to provide a feasibility study and written plan to consolidate or, in
the alternative, coordinate the operations of the new electric utility company's
operations in Santa Cruz County with the operations of TEP at the time TEP files
its next rate case. The study shall explore means to improve operations,
efficiency and service for the Santa Cruz County customers. In determining the
feasibility of such a plan, TEP will consider the impact of consolidation on
"two-county" bond financing.
With respect to the administrative area, certain support service functions
such as legal, regulatory, human resources, auditing, environmental services and
risk management will be more effectively utilized among the UniSource Energy
operating subsidiaries given the commonality of federal, state and local agency
regulation. Also, it is expected that synergies will be obtained by spreading
the utilization of information systems over an expanded customer base with
respect to materials management, financial accounting, billing systems, call
center operations, payroll services and employee records. Finally, natural gas
procurement will benefit through the combination of purchases for both retail
consumption and electric generation. The exact nature and timing of these
synergy opportunities is still under review.
c. Compliance with Relevant State Law.
----------------------------------
Section 10(f) of the Act states that the Commission may not approve a
proposed acquisition unless it finds that the applicant has complied with all
applicable state laws. As indicated, the Transaction and related financing must
be approved by the ACC. A copy of the Joint Application filed with the ACC is
included herewith as Exhibits D-1.
29
d. The Acquisition Will Not Tend Towards Interlocking
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Relations or Concentration of Control of Public-Utility
-------------------------------------------------------
Companies that is Detrimental to the Public Interest or
-------------------------------------------------------
Interest of Investors or Consumers.
----------------------------------
(i) Interlocking Relationships. Although any
acquisition results in new links between previously unrelated companies, the
relationships that will result from the Transaction are not the types of
interlocking relationships prohibited by Section 10(b)(1), which was primarily
aimed at preventing business combinations unrelated to operational and economic
benefits to the integrated utility system. See Northeast Utilities, Inc., 50
S.E.C. 427, 443 (1990), as modified, 50 S.E.C. 511 (1990), aff'd sub nom., City
of Holyoke v. SEC, 972 F.2d 358 (D.C. Cir. 1992) (finding that interlocking
relationships are necessary to integrate the two merging entities).
(ii) Concentration of Control. Section 10(b)(1) was
intended to avoid "an excess of concentration and bigness" in the utility
industry at the expense of competition while preserving the "opportunities for
economies of scale, the elimination of duplicative facilities and activities,
the sharing of production capacity and reserves and generally more efficient
operations" afforded by certain acquisitions. See American Electric Power Co.,
Inc., 46 S.E.C. 1299, 1309 (1978). In applying Section 10(b)(1) to utility
acquisitions, the Commission must determine whether the acquisition will create
"the type of structures and combinations at which the Act was specifically
directed." See Vermont Yankee Nuclear Power Corp., 43 S.E.C. 693, 700 (1968). As
discussed below, the Transaction will not create a "huge, complex, and
irrational system," but rather will afford the opportunity to achieve economies
of scale and efficiencies which are expected to benefit investors and consumers.
American Electric Power Co., Inc., 46 S.E.C. at 1307.
30
Size. If approved, the Transaction will create a combination electric
and gas utility system having approximately 437,500 retail electric utility
customers and approximately 125,000 retail gas utility customers, all in
Arizona. On a pro forma basis, UniSource Energy and its subsidiaries will have
total assets of approximately $2.9 billion as of September 30, 2002. In Arizona,
UniSource Energy will continue to be substantially smaller than Arizona Public
Service Company (total assets of $6.6 billion as of September 30, 2002 and
approximately 875,000 electric utility customers).
Economies and Efficiencies. As previously described, the Transaction
will create opportunities for modest operating and administrative efficiencies.
Thus, the Transaction will not lead to the type of concentration of control over
utilities, unrelated to operating efficiencies, that Section 10(b)(1) was
intended to prevent.(15).
Competitive Effects. As the Commission noted in Northeast Utilities,
supra, at 445, the "antitrust ramifications of an acquisition must be considered
in light of the fact that public utilities are regulated monopolies and that
federal and state administrative agencies regulate the rates charged consumers."
UniSource Energy and Citizens intend to file the Notification and Report Forms
with the Department of Justice ("DOJ") and Federal Trade Commission ("FTC")
required by the HSR Act describing the Transaction. The proposed Transaction
cannot be consummated until the applicable waiting period expires or is
terminated.
-------------------
(15) See Section 1(b)(4) of the Act (finding that the public interest and
interests of consumers and investors are adversely affected "when the growth and
extension of holding companies bears no relation to economy of management and
operation or the integration and coordination of related operating
properties .. ..").
31
The competitive effects of the Transaction on wholesale power markets will
also be reviewed by the FERC in light of the criteria set forth in FERC Order
No. 592 (hereinafter, the "Merger Policy Statement")(16) and Order No. 642.(17)
Specifically, the FERC must consider the effects of combining TEP's and
Citizens' generation assets (horizontal market power), the effects of combining
generation and transmission assets (one aspect of vertical market power), and
the effects of combining electric and natural gas assets. As part of the joint
application filed with FERC (Exhibit D-3 hereto), UniSource Energy, Citizens and
TEP have offered expert economic testimony addressing the effect of the
Transaction on competition.(18) The Commission has held, and the courts have
agreed, that it may "watchfully defer" to FERC with respect to such matters. See
City of Holyoke v. SEC, 972 F.2d at 363-64, quoting Wisconsin's Environmental
Decade v. SEC, 882 F.2d 523, 527 (D.C. Cir. 1989).
e. The Consideration To Be Paid Is Reasonable and Bears a Fair
-----------------------------------------------------------
Relation to the Value of the Utility Assets Underlying the
----------------------------------------------------------
Securities To Be Acquired.
-------------------------
Section 10(b)(2) precludes approval of an acquisition if the consideration
to be paid in connection with the transaction, including all fees, commissions
and other remuneration, is "not reasonable or does not bear a fair relation to
the sums invested in or the earning capacity of . . . the utility assets
underlying the securities to be acquired." The Commission has found persuasive
evidence that the standards of Section 10(b)(2) are satisfied where, as here,
-------------------
(16) See Inquiry Concerning Merger Policy under the Federal Power Act: Policy
Statement, Order No. 592, III FERC Stats. & Regs. P. 31,044 (1996),
reconsideration denied, Order No. 592-A, 79 FERC P. 61,321 (1997) (codified at
18 C.F.R. ss. 2.26).
(17) See Revised Filing Requirements Under Part 33 of the Commission's
Regulations, Order No. 642, III FERC Stats. & Regs. P. 31,111 (2000), reh'g
denied, Order No. 642-A, 94 FERC P. 61,289 (2001).
(18) See the Prepared Direct Testimony and Exhibits of expert witness J. Stephen
Henderson, which is filed as "Exhibit JSH" to the FERC application (Exhibit D-3
hereto).
32
the agreed consideration for an acquisition is the result of arm's-length
negotiations between the managements of the companies involved, supported by
opinions of financial advisors. See Entergy Corporation, 51 S.E.C. at 869, 879
(1993); Southern Company, Holding Co. Act Release No. 24579 (Feb. 12, 1988).
The purchase price resulted from arm's-length negotiations and was deemed
acceptable by UniSource Energy after lengthy negotiations with Citizens and due
diligence. The new rates proposed in the Joint Application to the ACC for the
New Utility Companies, although representing a significant reduction in the
level of rates previously requested by Citizens, were designed to allow the New
Utility Companies to service the debt obligations they will incur to finance the
Transaction and provide working capital and to earn an 11.0% return on equity.
Another consideration under Section 10(b)(2) is the overall fees,
commissions and expenses to be incurred in connection with the Transaction.
UniSource Energy estimates that the fees, commissions and expenses that will be
incurred in connection with the Transaction will total approximately $5.6
million (see Item 2 - Fees, Commissions and Expenses), or approximately 2.4% of
the total consideration to be paid to Citizens for the purchased assets.
UniSource Energy believes that the estimated fees and expenses in this matter
bear a fair relation to the consideration to be paid, and further that the fees
and expenses are fair and reasonable in light of the size and complexity of the
overall Transaction. See Northeast Utilities, 50 S.E.C. 427, 441 and 446 (1990)
(noting that fees and expenses must constitute normal costs and represent a
minor part of the overall acquisition). Moreover, under the proposed Settlement,
the parties have agreed that the New Utility Companies will be allowed to
recover the anticipated transaction costs related to the transfer of the
Electric Assets and Gas Assets.
33
f. The Acquisition Will Not Unduly Complicate the Capital
------------------------------------------------------
Structure of the UniSource Energy System and Will Not Be
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Detrimental to the Public Interest, the Interest of
---------------------------------------------------
Investors or Consumers, or the Proper Functioning of the
--------------------------------------------------------
UniSource Energy System.
------------------------
Section 10(b)(3) requires the Commission to determine whether a proposed
acquisition will "unduly complicate the capital structure" or be "detrimental to
the public interest or the interest of investors or consumers or the proper
functioning" of the holding company system. The intent of these requirements is
to assure the financial soundness of the holding company system, with particular
regard to the proper balance of debt and equity.
The capital structure of the UniSource Energy system following the
Transaction will be substantially similar to the capital structures of many
existing registered holding company systems. See, e.g., American Electric Power
Co., Inc. 47 S.E.C. 215 (1980). UniSource Energy owns substantially all of the
outstanding common stock of TEP and, following the Transaction, will own,
directly or indirectly, all of the outstanding common stock of the New Utility
Companies. Hence, the Transaction itself will not create any publicly-held
minority interest in the voting securities of any public utility company. The
only voting securities of UniSource Energy that will be publicly-held following
the Transaction will be UniSource Energy's common stock. It is expected, based
on UniSource Energy's review of the current rating criteria used by the
principal nationally recognized statistical rating organizations ("NRSROs"),
that the debt incurred by the New Utility Companies (or HoldCo if the HoldCo
Structure is utilized) will have an investment grade rating by at least one
NRSRO. The Transaction will have no effect on the outstanding securities of TEP.
34
Finally, the effects, if any, of the Transaction on the capital costs and
rates of Citizens and TEP have also been addressed in the Joint Application
filed by Citizens and UniSource Energy with the ACC (Exhibit D-1 hereto).
As explained in Item 1.5 above, under the proposed Settlement filed with
the ACC, the TEP loan will have a relatively short maturity (four years) and be
secured by a pledge of 100% of the common stock of the New Utility Companies or
HoldCo (if the HoldCo Structure is used). Other terms and conditions of the
proposed Settlement will limit dividend payments by TEP to UniSource Energy and
require that a portion of the interest income on the TEP loan be used to
increase TEP's common equity capitalization ratio. In this regard, TEP has
provided financial projections to the ACC that show that the loan will not
affect TEP's stated objective of continuing to improve its equity ratio,
including using $30 million - $50 million per year for early debt retirements
and lease debt purchases, thereby enabling TEP to remain on course to gradually
deleverage its balance sheet and improve its credit ratings. Moreover, TEP's
financial integrity will continue to be protected by other limitations and
restrictions imposed under the Holding Company Order (supra note 2).
The Transaction is also not anticipated to have any negative impact on the
pro forma capitalization of UniSource Energy. UniSource Energy's consolidated
capitalization currently consists of about 18% common equity, which is below the
"traditionally acceptable 30% level." See Northeast Utilities, 50 S.E.C. at 440,
note 47. As previously described, TEP's low common equity capitalization (which
is essentially mirrored by UniSource Energy's consolidated capitalization) is
the result of TEP's financial restructuring in late 1992. Since 1992, TEP's
common equity has improved steadily, even after payment of dividends on common
stock in 1999, 2000, and 2001. Under substantially similar circumstances, the
35
Commission has permitted capital structures for registered holding companies
consisting of less than 30% common equity. See e.g., Allegheny Energy, Inc., et
al., Holding Co. Act Release No. 27579 (Oct. 17, 2002).
The Transaction itself, which, at this time, is expected to be financed in
part with the proceeds of new common stock issued by UniSource Energy, may
slightly improve UniSource Energy's consolidated equity to debt capitalization
ratio. Moreover, the targeted capitalization ratios for the New Utility
Subsidiaries, 40% common equity and 60% debt, are within acceptable industry
ranges and consistent with an investment grade rating under current NRSRO
ratings criteria.
3.3 Exemption of UniSource Energy, TEP and HoldCo under Section 3(a)(1).
-------------------------------------------------------------------
Section3(a)(1) provides that "unless and except insofar as it finds the
exemption detrimental to the public interest or the interests of investors or
consumers" the Commission shall exempt from registration any holding company and
every subsidiary thereof, if:
such holding company, and every subsidiary company thereof which
is a public-utility company from which such holding company
derives, directly, or indirectly, any material part of its
income, are predominantly intrastate in character and carry on
their business substantially in a single State in which such
holding company and every such subsidiary company thereof are
organized.
As is clear from the language of the statute, the "predominantly intrastate in
character/substantially in a single State" test is applied separately to the
holding company system as a whole and to each "material" public-utility
subsidiary.
UniSource Energy and HoldCo (if the HoldCo Structure is utilized) will each
satisfy the objective criteria for exemption under Section 3(a)(1) in this case.
UniSource Energy and TEP are both incorporated under the laws of Arizona, and
the New Utility Company(ies) and HoldCo (if the HoldCo Structure is used) will
36
also be incorporated under Arizona law. UniSource Energy derives a "material
part" of its income from TEP, its predominant public-utility subsidiary, and it
is assumed for purposes hereof that each New Utility Company will also
contribute a "material part" of UniSource Energy's income. TEP's public utility
operations are confined substantially to Arizona, and the public utility
operations of the New Utility Companies will be confined entirely to
Arizona.(19)
In determining whether a company is "predominantly intrastate in character"
and operates "substantially in a single State," the Commission has historically
considered various quantifiable factors, including gross operating revenues, net
operating revenues, net income, number of customers served, location of utility
assets, and net utility plant, in order to compare the company's out-of-state
presence with its in-state presence. See NIPSCO Industries, Inc., 53 S.E.C.
1296, 1323 (1999) ("NIPSCO"). In a recent case, the Commission observed that, in
practice, it has given the greatest deference to revenues. See C&T Enterprises,
Inc., et al., Holding Co. Act Release No. 27590 (Oct. 31, 2002).
With the exception of occasional wholesale sales of energy from the San
Juan and Four Corners Generating Stations to wholesale customers in New Mexico,
all of TEP's retail and wholesale sales of electric energy occur in Arizona or
at the Arizona border.(20) In the three-year period 2000 through 2002, not more
-------------------
(19) The state of incorporation and interstate character of business of an
applicant's non-utility subsidiaries is not considered relevant to whether a
holding company is entitled to an exemption under Section 3(a)(1). See Eastern
Gas and Fuel Associates, 30 S.E.C. 834, 848 (note 19) (1950).
(20) The Commission has previously held that, for purposes of Section 3(a)(1)
of the Act, wholesale sales of electric energy to an out-of-state buyer that are
made at the state line constitute a part of the intrastate public utility
business of the applicant. See WPL Holdings, Inc., 49 S.E.C. 761, 773 (1988),
aff'd in part and rev'd in part sub nom., Wisconsin's Environmental Decade v.
SEC, 882 F.2d 523 (D.C. Cir. 1989), reaffirmed, 50 S.E.C. 728 (1991), citing
Sierra Pacific Resources, Inc., 49 S.E.C. 735 (1988).
37
than 4% of TEP's total operating revenues were derived from wholesale sales
outside of Arizona. All of the retail and wholesale sales of electric energy and
retail sales of gas by Citizens' Arizona utility division occur in Arizona or at
the Arizona border. In NIPSCO, the Commission determined that the "predominantly
intrastate in character/substantially in a single State" standard was met where,
using a three-year historical average, 13.2% of NIPSCO's pro forma net operating
revenues were derived from out-of-state operations. This is the highest
percentage in any case in which the Commission has granted an exemption under
Section 3(a)(1) by order. TEP's three-year average of gross revenues from
electricity sales outside of Arizona is well below that limit.(21)
As indicated in Item 1 above, TEP has a fractional undivided interest in
generating units located at two sites in New Mexico (the San Juan and Four
Corners Generating Stations) representing, in the aggregate, 432 MW of its total
of 2,002 MW of owned or leased generating capacity, plus a fractional undivided
interest in two 345 kV transmission lines that are used to deliver the output
from those stations to TEP at the Arizona-New Mexico border. The generating
stations, which are operated by other co-owners, are required by TEP to serve
its retail and wholesale loads in Arizona. As shown on Exhibit E-2, the 345 kV
lines are also used to deliver power from the Springerville Generating Station,
which is in Arizona, to the Tucson area. All of TEP's other utility assets are
located in Arizona. At December 31, 2002, TEP's investment in the two plants and
-------------------
(21) In NIPSCO, the Commission attached greatest importance to net operating
revenues, rather than gross operating revenues, because of NIPSCO's status as a
combination gas and electric utility and the inherent difficulty of comparing
the relative size of gas and electric operations based on gross revenues
figures. TEP, in contrast, is an electric utility only. There is no need,
therefore, to look beyond gross operating revenues to measure the relative size
of its in-state and out-of-state utility business.
38
the portion of the 345 kV lines located outside of Arizona represented
approximately 7% of its net utility plant. In NIPSCO, the Commission granted an
exemption under Section 3(a)(1) where investment in out-of-state utility plant
represented about 13.5% of the applicant's total net utility plant.
In addition, with the exception of certain hours during its summer peaking
period, TEP does not rely upon purchases of power in the wholesale power markets
to meet its retail and long-term wholesale customer loads in Arizona. On the
contrary, the capacity of TEP's owned and leased generating resources generally
exceeds the requirements of its Arizona retail and long-term wholesale customer
loads.(22) Further, TEP also does not participate through ownership in
transmission lines that are used primarily to serve interstate wholesale
markets. As shown on Exhibit E-2, TEP's long-distance, high voltage,
transmission lines were constructed primarily to link the Remote TEP Generating
Facilities to the Tucson area.
There is also no basis for the Commission to conclude that the grant of an
exemption to UniSource Energy and HoldCo (if the HoldCo Structure is utilized)
would be "detrimental to the public interest or the interests of investors or
consumers." TEP is and the New Utility Companies will be subject to effective
state regulation by the ACC. The Transaction and related financing require ACC
approval. TEP and the New Utility Company acquiring the Electric Assets will
also be subject to ongoing regulation by the FERC.
-------------------
(22) In 2002, TEP generated 11,469,573,000 kWh of power from its owned and
leased units. Its retail electric sales, all in Arizona, totaled 8,012,418,000
kWh. TEP's total owned and leased resources (2,002 MW in 2002) was only 5.4%
greater than its peak retail customer demand (1,899 MW).
39
ITEM 4. REGULATORY APPROVALS.
--------------------
4.1 State Approvals. The Transaction, as well as certain related financing
proposals, including but not limited to TEP's loan to UniSource Energy, are
subject to approval by the ACC. A copy of the Joint Application filed by
Citizens and UniSource Energy with the ACC is filed herewith as Exhibit D-1, and
a copy of the proposed Settlement is filed herewith as Exhibit D-1(A).
4.2 Federal Approvals.
-----------------
Federal Power Act. Under Section 203 of the Federal Power Act, the FERC is
directed to approve a merger if it finds such merger consistent with the public
interest. In reviewing transactions under the standards of Section 203, the FERC
generally evaluates: whether the merger will adversely affect competition;
whether the merger will adversely affect rates; and whether the merger will
impair the effectiveness of regulation. A copy of the joint application filed by
UniSource Energy, Citizens and TEP with the FERC requesting the necessary
approvals of the Transaction under the Federal Power Act is filed herewith as
Exhibit D-3.
HSR Act. Under the HSR Act, and the rules promulgated thereunder by the
FTC, the Transaction may not be consummated until UniSource Energy and Citizens
file notifications and provide certain information to the FTC and the DOJ and
specified waiting period requirements are satisfied. Even after the HSR Act
waiting period expires or terminates, the FTC or the DOJ may later challenge the
transaction on antitrust grounds. If the Transaction is not completed within 12
months after the expiration or earlier termination of the initial HSR Act
40
waiting period, the parties would be required to submit new information under
the HSR Act and a new waiting period would begin.
Except as described above, no other state or federal commission, other than
this Commission, has jurisdiction over the Transaction.(23)
ITEM 5. PROCEDURE.
---------
UniSource Energy requests that the Commission publish a notice under
Rule 23 with respect to the filing of this Application/Declaration as soon as
practicable and issue an order approving the Application/Declaration as soon as
its rules permit after the end of the required notice period. UniSource Energy
requests that there should not be a 30-day waiting period between issuance of
the Commission's order and the date on which the order is to become effective;
waives a recommended decision by a hearing officer or other responsible officer
of the Commission; and consents to the participation by the Division of
Investment Management in the preparation of the Commission's decision and/or
order, unless the Division of Investment Management opposes the matters proposed
herein.
ITEM 6. EXHIBITS AND FINANCIAL STATEMENTS.
---------------------------------
(a) Exhibits.
A-1 Amended and Restated Articles of Incorporation of UniSource
Energy Corporation (incorporated by reference to Exhibit 2(a) to
Current Report of UniSource Energy Corporation on Form 8-A/A,
dated January 30, 1998, in File No. 1-13739).
-------------------
(23) It is expected that Citizens will also require approvals (or disclaimers)
of other state and federal agencies in order to transfer or amend certificates,
permits and licenses that it now holds.
41
A-2 Bylaws of UniSource Energy Corporation, as amended December 11,
1997 (incorporated by reference to Exhibit 2(b) to Current Report
of UniSource Energy Corporation on Form 8-A, dated December 23,
1997, in File No. 1- 13739).
A-3 Form of Restated Articles of Incorporation of New Utility
Subsidiary (to be filed by amendment).
A-4 Form of Bylaws of New Utility Subsidiary (to be filed by
amendment).
A-5 Form of Articles of Incorporation of HoldCo (to be filed by
amendment if applicable).
A-6 Form of Bylaws of HoldCo (to be filed by amendment if
applicable).
B-1 Asset Purchase Agreement, dated October 29, 2002, by and between
Citizens Communications Company, as Seller, and UniSource Energy
Corporation, as Buyer, relating to Seller's Arizona Electric
Utility Business (incorporated by reference to Exhibit 99.1 to
Current Report of UniSource Energy Corporation on Form 8-K, dated
October 31, 2002, in File No.1-13739).
B-2 Asset Purchase Agreement, dated October 29, 2002, by and between
Citizens Communications Company, as Seller, and UniSource Energy
Corporation, as Buyer, relating to Seller's Arizona gas utility
business (incorporated by reference to Exhibit 99.2 to Current
Report of UniSource Energy Corporation on Form 8-K, dated October
31, 2002, in File No.1-13739).
C None.
D-1 Joint Application of Citizens Communications Company and
UniSource Energy Corporation to the Arizona Corporation
Commission (previously filed).
D-1(A) Proposed Settlement Agreement (filed herewith).
D-2 Order of the Arizona Corporation Commission (to be filed by
amendment).
D-3 Joint Application of Citizens Communications Company, Tucson
Electric Power Company and UniSource Energy Corporation to the
Federal Energy Regulatory Commission (previously filed).
42
D-4 Order of the Federal Energy Regulatory Commission (to be filed by
amendment).
E-1 Map showing electric service territories of Tucson Electric Power
Company and Citizens Communications Company/Arizona Division
(Form SE - Required paper format filing) (previously filed).
E-2 Map showing principal electric generation and transmission
facilities of Tucson Electric Power Company. (Form SE - Required
paper format filing) (previously filed).
E-3 Map showing gas service territories of Citizens Communications
Company/Arizona Division (Form SE - Required paper format filing)
(previously filed).
F Opinion of counsel to UniSource Energy Corporation (to be filed
by amendment).
G Proposed form of Federal Register notice (previously filed).
H Statement on Form U-3A-2 pursuant to Rule 2 of UniSource Energy
Corporation for year ended December 31, 2002 (incorporated by
reference to File No. 69-293).
I Description of Non-Utility Subsidiaries of UniSource (filed
herewith).
(b) Financial Statements.
--------------------
FS-1: Consolidated Balance Sheet and Statement of Income for UniSource
Energy Corporation as of and for the year ended December 31, 2002
(incorporated by reference to the Annual Report of UniSource
Energy Corporation on Form 10-K for the year ended December 31,
2002, in File No. 1-13739).
FS-2: Intentionally left blank.
FS-3 Unaudited Pro Forma Combined Condensed Balance Sheet of UniSource
Energy Corporation (to be filed by amendment).
43
ITEM 7. INFORMATION AS TO ENVIRONMENTAL EFFECTS.
---------------------------------------
The Transaction does not involve a "major federal action" nor will it
"significantly affect the quality of the human environment" as those terms are
used in section 102(2)(C) of the National Environmental Policy Act. The
Transaction will not result in changes in the operation of UniSource Energy or
its subsidiaries that will have an impact on the environment. UniSource Energy
is not aware of any federal agency that has prepared or is preparing an
environmental impact statement with respect to the Transaction.
SIGNATURE
Pursuant to the requirements of the Public Utility Holding Company Act of
1935, as amended, the undersigned company has duly caused this amended
Application/Declaration to be signed on its behalf by the undersigned thereunto
duly authorized.
UNISOURCE ENERGY CORPORATION
By: /s/ Kevin P. Larson
---------------
Name: Kevin P. Larson
Title: Vice President, Chief Financial
Officer and Treasurer
Date: May 8, 2003