10-Q 1 sec2003310q.txt FORM 10Q 3RD 2003 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------------------------------------------------------------- FORM 10-Q -------------------------------------------------------------------------------- X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 -------------------------------------------------------------------------------- Commission file number 33-42125 CHUGACH ELECTRIC ASSOCIATION, INC. Incorporated pursuant to the Laws of Alaska State -------------------------------------------------------------------------------- Internal Revenue Service - Employer Identification No. 92-0014224 5601 Minnesota Drive, Anchorage, AK 99518 (907) 563-7494 -------------------------------------------------------------------------------- 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes No X Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date. CLASS OUTSTANDING AT NOVEMBER 1, 2003 NONE NONE Page Number CAUTION REGARDING FORWARD-LOOKING STATEMENTS PART I FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) 2 Balance Sheets, September 30, 2003 and December 31, 2002 3 Statements of Revenues, Expenses and Patronage Capital, Three and Nine Months Ended September 30, 2003 and 2002 5 Statements of Cash Flows, Nine Months Ended September 30, 2003 and 2002 6 Notes to Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 1 1 Item 3. Quantitative and Qualitative Disclosures About Market Risk 2 1 Item 4. Controls and Procedures 2 2 PART II OTHER INFORMATION Item 1. Legal Proceedings 2 2 Item 2. Changes in Securities and Use of Proceeds 2 3 Item 3. Defaults Upon Senior Securities 2 3 Item 4. Submission of Matters to a Vote of Security Holders 2 3 Item 5. Other Information 2 3 Item 6. Exhibits and reports on Form 8-K 2 4 Signatures 2 5 Exhibits 2 6 CAUTION REGARDING FORWARD-LOOKING STATEMENTS Statements in this report that do not relate to historical facts, including statements relating to future plans, events or performance, are forward-looking statements that involve risks and uncertainties. Actual results, events or performance may differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date of this report and the accuracy of which is subject to inherent uncertainty. Chugach Electric Association, Inc. (Chugach) undertakes no obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances that may occur after the date of this report or the effect of those events or circumstances on any of the forward-looking statements contained in this report except as required by law. PART I FINANCIAL INFORMATION Item 1. Financial Statements The unaudited financial statements and notes to financial statements of Chugach for the quarter ended September 30, 2003, follow: CHUGACH ELECTRIC ASSOCIATION, INC. BALANCE SHEETS
(Unaudited) Assets September 30, 2003 December 31, 2002 ------ ------------------ ----------------- Utility plant: Electric plant in service $732,735,303 $730,439,297 Construction work in progress 24,377,886 20,224,302 ---------------------------------------------- 757,113,189 750,663,599 Less accumulated depreciation (290,300,411) (279,958,912) ---------------------------------------------- 466,812,778 470,704,687 Other property and investments, at cost: Nonutility property 3,550 3,550 Investments in associated organizations 10,996,796 10,963,715 ---------------------------------------------- 11,000,346 10,967,265 Current assets: Cash and cash equivalents 10,581,957 7,284,292 Cash-restricted construction funds 507,924 598,864 Special deposits 222,163 222,163 Fuel cost receivable 100,714 0 Accounts receivable, net 13,524,287 26,410,264 Materials and supplies 22,190,977 23,747,590 Prepayments 3,375,803 1,953,350 Other current assets 351,187 336,798 ---------------------------------------------- 50,855,012 60,553,321 Deferred charges 24,781,290 27,989,601 ---------------------------------------------- Total Assets $553,449,426 $570,214,874 ==============================================
CHUGACH ELECTRIC ASSOCIATION, INC. BALANCE SHEETS (Continued)
(Unaudited) Liabilities and Equities September 30, 2003 December 31, 2002 ------------------------ ------------------ ----------------- Equities and margins: Memberships $1,143,643 $1,108,243 Patronage capital 124,434,700 120,148,502 Other 6,161,732 6,221,150 -------------------------------------------------- 131,740,075 127,477,895 Long-term obligations, excluding current installments 2001 Series A Bond payable 150,000,000 150,000,000 2002 Series A Bond payable 120,000,000 120,000,000 2002 Series B Bond payable 51,100,000 55,700,000 CoBank, ACB Bonds payable 63,189,179 64,134,179 -------------------------------------------------- 384,289,179 389,834,179 Current liabilities: Short-term obligations 0 6,081,250 Current installments of long-term obligations 5,545,000 5,165,821 Accounts payable 3,622,249 7,719,974 Provision for rate refund 5,207,503 7,050,000 Consumer deposits 1,810,156 1,826,265 Fuel cost payable 0 363,862 Accrued interest 1,992,610 6,381,106 Salaries, wages and benefits 5,221,340 4,977,594 Fuel 8,659,340 7,095,402 Other current liabilities 1,664,264 2,027,938 -------------------------------------------------- 33,722,462 48,689,212 Deferred credits 3,697,710 4,213,588 -------------------------------------------------- Total Liabilities and Equities $553,449,426 $570,214,874 ================================================== See accompanying notes to financial statements
CHUGACH ELECTRIC ASSOCIATION, INC. Statement of Revenues, Expenses and Patronage Capital (Unaudited)
Three months ended September 30 Nine months ended September 30 2003 2002 2003 2002 ---- ---- ---- ---- Operating revenues: $41,163,160 $41,523,323 $133,091,838 $132,929,592 Operating expenses: Fuel 12,267,067 11,320,700 34,120,453 36,016,679 Power production 3,363,789 3,389,458 9,486,981 10,113,399 Purchased power 4,681,807 4,165,054 12,714,043 14,172,137 Transmission 1,045,137 876,754 3,159,875 2,871,203 Distribution 2,869,990 2,522,722 8,147,487 7,746,900 Consumer accounts/Information expense 1,307,796 1,478,932 4,123,234 4,373,951 Administrative, general and other 5,976,266 5,496,010 19,261,872 15,470,650 Depreciation and amortization 6,839,754 6,299,242 20,812,332 18,862,947 ------------------------------------------------------------------ Total operating expenses 38,351,606 35,548,872 111,826,277 109,627,866 Interest expense: On long-term obligations 5,845,448 6,026,315 17,590,018 20,158,954 On short-term obligations 0 70,644 11,900 229,436 Charged to construction-credit (110,826) (102,069) (212,510) (358,663) ------------------------------------------------------------------ Net interest expense 5,734,622 5,994,890 17,389,408 20,029,727 ------------------------------------------------------------------ Net operating margins (2,923,068) (20,439) 3,876,153 3,271,999 Non-operating margins: Interest income 99,950 93,200 282,033 638,401 Other 22,890 (1,827) 86,605 266,709 Property gain (loss) 30,396 3,273 101,615 (188,751) ------------------------------------------------------------------ Total non-operating margins 153,236 94,646 470,253 716,359 ------------------------------------------------------------------ Assignable margins (2,769,832) 74,207 4,346,406 3,988,358 ================================================================== Patronage capital at beginning of period 127,204,532 128,955,925 120,148,502 125,184,374 Retirement of capital credits and estate payments 0 (71,141) (60,208) (213,741) ------------------------------------------------------------------ Patronage capital at end of period $124,434,700 $128,958,991 $124,434,700 $128,958,991 ================================================================== See accompanying notes to financial statements
CHUGACH ELECTRIC ASSOCIATION, INC. Statement of Cash Flows (Unaudited)
Nine months ended September 30 2003 2002 ---- ---- Cash flows from operating activities: Assignable margins $4,346,406 $3,988,358 Adjustments to reconcile assignable margins to net cash (used in) provided by operating activities: Provision for rate refund (1,842,497) 0 Depreciation and amortization (net of deferred asset amortization) 24,813,600 18,862,947 Capitalization of interest (245,983) (401,431) Property (gains) losses (101,615) 188,751 Impairment of long-lived asset 1,846,816 0 Other 1,145 2,116 Changes in assets and liabilities: (Increase) decrease in assets: Fuel cost recovery (100,714) 3,190,691 Accounts receivable 12,885,977 6,274,830 Prepayments (1,422,453) (2,457,835) Materials and supplies 1,556,613 (1,164,824) Deferred charges, net (792,956) 1,655,610 Other (14,389) (10,546) Increase (decrease) in liabilities: Accounts payable (4,097,725) (5,641,761) Fuel payable (363,862) 0 Consumer deposits (16,109) 159,849 Accrued interest (4,388,496) (5,318,532) Deferred credits (978,206) (15,743,826) Other 1,444,009 (5,331,718) ---------------------------- Net cash (used in) provided by operating activities 32,529,561 (1,747,321) Cash flows from investing activities: Extension and replacement of plant (18,419,642) (18,218,299) Investments in associated organizations (34,226) (61,876) ---------------------------- Net cash used in investing activities (18,453,868) (18,280,175) Cash flows from financing activities: Short-term obligations (6,081,250) 0 Proceeds from long-term obligations 0 180,000,000 Prepayments of long-term obligations (5,165,821)(159,719,945) Retirement of patronage capital (60,208) (213,741) Other 529,251 (211,833) ---------------------------- Net cash (used in) provided by financing activities (10,778,028) 19,854,481 Net increase (decrease) in cash and cash equivalents 3,297,665 (173,015) Cash and cash equivalents at beginning of period 7,284,292 3,814,767 ------------------------------------------------ ---------------------------- Cash and cash equivalents at end of period $10,581,957 $3,641,752 ------------------------------------------ ============================ Supplemental disclosure of cash flow information - interest expense paid, net of amounts capitalized $17,456,325 $25,348,258 ============================ See accompanying notes to financial statements
CHUGACH ELECTRIC ASSOCIATION, INC. Notes to Financial Statements (Unaudited) 1. Presentation of Financial Information During interim periods, Chugach Electric Association, Inc. (Chugach) follows the accounting policies set forth in its audited financial statements included in Form 10-K filed with the Securities and Exchange Commission unless otherwise noted. Users of interim financial information are encouraged to refer to the footnotes contained in Chugach's Form 10-K when reviewing interim financial results. The accompanying unaudited interim financial statements reflect normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Certain reclassifications have been made to the 2002 financial statements to conform to the 2003 presentation. 2. Lines of credit Chugach maintains a line of credit of $20 million with CoBank, ACB (CoBank). The CoBank line of credit expires December 31, 2003, subject to renewal at the discretion of the parties. At September 30, 2003, there was no outstanding balance on this line of credit. In addition, Chugach has an annual line of credit of $50 million available at the National Rural Utilities Cooperative Finance Corporation (NRUCFC). At September 30, 2003, there was no outstanding balance on this line of credit. The NRUCFC line of credit expires October 15, 2007. 3. Environmental Matters Chugach discovered polychlorinated biphenyls (PCBs) in paint, caulk and grease at the Cooper Lake Hydroelectric plant during initial phases of a turbine overhaul. A Federal Energy Regulatory Commission (FERC) approved plan, prepared in consultation with the Environmental Protection Agency (EPA), was implemented to remediate the PCBs in the plant. As a condition of its approval of the license amendment for the overhaul project, FERC required Chugach to also investigate the presence of PCBs in Kenai Lake. A sampling plan was developed by us in consultation with state and federal agencies and approved by FERC. In 2000, we sampled sediments and fish collected from Kenai Lake and other waters. While low levels of PCBs were found in some sediment samples taken near the plant, no pathway from sediment to fish was established. While the levels of PCBs in fish from Kenai Lake were similar to levels found in fish from other lakes within the region, we conducted additional sampling and analysis of fish in Kenai Lake and other waters and filed our final report dated April 1, 2002, with FERC, which analyzed the results of the sampling. Based on these analyses, we concluded that no further PCB sampling and analysis in Kenai Lake was necessary. In a letter dated June 13, 2002, FERC informed us that its review of the report supported our conclusions and agreed we were not required to conduct further PCB sampling and analysis in Kenai Lake. In its recent order in our general rate case, Order U-01-108(26), the Regulatory Commission of Alaska (RCA) permitted the costs associated with the overhaul and the PCB remediation to be recovered through rates. Consequently, management believes the costs of the PCB remediation and studies will have no material impact on our financial condition or results of operations. 4. Legal Proceeding Matanuska Electric Association, Inc., v. Chugach Electric Association, Inc., Superior Court Case No. 3AN-99-8152 Civil This action is a claim for a breach of the Tripartite Agreement, which is the contract governing the parties' relationship for a 25-year period from 1989 through 2014 and governing our sale of power to Matanuska Electric Association, Inc., (MEA) during that time. MEA asserted we breached that contract by failing to provide information, by failing to properly manage our long-term debt, and by failing to bring our base rate action to a joint committee before presenting it to the RCA. The committee is defined in the power sales contract and consists of one MEA and two Chugach board members. All of MEA's claims have been dismissed. On April 29, 2002, MEA appealed to the Alaska Supreme Court the Superior Court's decisions relating to our financial management, our decision not to bring our base rate action to the joint committee before filing with the RCA, as well as the Superior's Court's award to us of attorney's fees. We cross-appealed the Superior Court's decision not to dismiss the financial management claim on jurisdictional and res judicata grounds. Oral argument was heard by the Supreme Court on April 15, 2003. Management is uncertain as to the outcome and expects a decision within six to twelve months. Chugach has certain additional litigation matters and pending claims that arise in the ordinary course of its business. In the opinion of management, no individual matter or the matters in the aggregate is likely to have a material adverse effect on our results of operations, financial condition or liquidity. 5. Critical Accounting Policies The preparation of financial statements in conformity with principles generally accepted in the United States of America requires that management apply accounting policies and make estimates and assumptions that affect results of operations and reported amounts of assets and liabilities in the financial statements. The following areas represent those that management believes are particularly important to the financial statements and that require the use of estimates and assumptions to describe matters that are inherently uncertain. FERC Accounting Chugach prepares its financial statements in accordance with principles generally accepted in the United States of America and in conformity with the FERC's uniform system of accounts. Cost Basis Regulation Chugach is subject to regulation by the RCA. The rates that are charged by Chugach to its customers are based upon cost-based regulation reviewed and approved by this regulatory commission. Under the authority of this commission, Chugach has recorded certain regulatory assets in the amount of $23.4 million as of September 30, 2003. If Chugach's rates were no longer based upon cost or there was no longer the probability of future collection in rates, these assets and liabilities would be written off against assignable margins. Financial Instruments and Hedging Chugach has previously used U.S. Treasury-based forward rate-lock agreements to hedge expected interest rates on debt. Chugach accounted for the agreements under SFAS 80 and 71 through December 31, 2000, and SFAS 133, 138, 149 and 71 subsequent to that date. Gains or losses are treated as regulatory assets or liabilities upon settlement. If Chugach's rates were no longer based upon cost or there was no longer the probability of future collection in rates, these assets and liabilities would be written off against assignable margins. Based on historical regulatory treatment on previous refinancing, management believes the establishment and recovery of Chugach's regulatory assets and liabilities is appropriate. Accounting for derivatives continues to evolve through guidance issued by the Derivatives Implementation Group (DIG) of the Financial Accounting Standards Board (FASB). To the extent that changes by the DIG modify current guidance, the accounting treatment for derivatives may change. 6. Impairment of Long-Lived Assets In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), Chugach performed an analysis of certain generation assets in the second quarter of 2003 and determined an impairment of an asset existed. As a result of this analysis, an asset was written down by $1,846,816 to its estimated salvage value. This amount is included in the nine months ended September 30, 2003 column in the Statement of Revenues, Expenses and Patronage Capital, "Administrative, general and other," category. 7. Recent Accounting Prounouncements In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Many of those instruments were previously classified as equity. Some of the provisions of this Statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with FASB's proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares depending on the nature of the relationship established between the holder and the issuer. While FASB still plans to revise that definition through an amendment to Concepts Statement 6, FASB decided to defer issuing that amendment until it has concluded its deliberations on the next phase of this project. That next phase will deal with certain compound financial instruments including puttable shares, convertible bonds, and dual-indexed financial instruments. Chugach plans to implement SFAS 150 effective January 1, 2004. Chugach has not completed evaluating the potential impact of this Statement on its financial statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Reference is made to the information contained under the caption "CAUTION REGARDING FORWARD-LOOKING STATEMENTS" at the beginning of this report. Regulatory Matters Docket U-01-108 Chugach filed a general rate case, Docket U-01-108, on July 10, 2001, based on the 2000 test year, requesting a permanent base rate increase of 6.5%, and an interim base rate increase of 4.0%. On September 5, 2001, the RCA granted a 1.6% interim demand and energy rate increase effective September 14, 2001. Chugach filed a petition for reconsideration and on October 25, 2001, the RCA revised its Interim Approval to permit Chugach to collect an interim base rate increase of 3.97%. The additional rate increase was implemented on November 1, 2001. As anticipated in Chugach's July 2001 original filing, on April 15, 2002, Chugach submitted a filing with the RCA to update certain known and measurable costs and savings that had occurred outside the 2000 Test Year. In the updated filing, Chugach reduced its base rate increase request from 6.5% to 5.7%, or approximately $0.9 million in the revenue requirement on a system basis. The revised filing also reflected an increase in depreciation expense of approximately $1.5 million due to the completion of the Beluga Unit 7 re-powering project and a reduction in annualized interest expense of $2.4 million due to Chugach's recent refinancings. In this revised filing, Chugach continued to request $11.9 million in margins. As a result of reduced interest costs, Chugach's supplemental filing would have yielded an equivalent system Times Interest Earned Ratio (TIER) of 1.47. Docket U-01-108, Order No. 26 The RCA issued Order No. 26 in Docket U-01-108 on February 6, 2003. The impact of Order 26 required the following: o Based on the final rates ordered, a refund of revenues collected in 2001 of approximately $1.1 million and in revenues collected in 2002 of approximately $6.0 million, which resulted in a net operating loss of $2 million in 2002. Under the Order, Chugach's financial performance for 2002 fell below the 1.10 level contained in the Rate Covenants in its currently effective indenture, the Amended and Restated Indenture, the CoBank Master Loan Agreement and the MBIA Insurance Corporation's (MBIA) Reimbursement and Indemnity Agreement. In accordance with the Rate Covenant in the Amended and Restated Indenture, on February 13, 2003, Chugach filed a Motion with the RCA asking the RCA to stay the effect of Order 26 until after the RCA considered Chugach's Petition for Reconsideration. On February 18, 2003, the RCA granted, in part, our motion for stay. Chugach filed the Petition for Reconsideration with the RCA on February 28, 2003. Docket U-01-108, Order No. 30 On April 15, 2003, the RCA issued Order No. 30 in Docket U-01-108, revising its earlier ruling by: o Reversing its AFUDC/IDC offset decision and agreeing with Chugach that the offset of AFUDC and IDC against long-term interest expense in the test year is not appropriate. Language in Order 30 may limit its ruling to projects commenced and concluded within the test year. o Allowing most of the legal expenses reduced or amortized from the revenue requirement to be added back. o Establishing a normalized interest rate of 3.8% on our $60 million in variable rate debt. o Clarifying that it intended to set a floating TIER of 1.64 for Distribution. o Clarifying, as requested by Chugach, that the refund cannot go below the "floor" of the rates that were in place prior to Chugach's interim increase. o Clarifying that interest expense should be allocated based on net plant. o Authorizing Chugach to use the higher interest rate existing in January and February of 2002 (before the March refinancing reduced interest expense) in calculating any refunds. In Order No. 30, the RCA also: o Declined to change its ruling continuing the split TIER. o Declined to change its ruling reducing overall TIER to 1.30 and reducing Generation and Transmission (G&T) TIER to 1.10. o Declined to change its ruling that rate case costs cannot be amortized and recovered in rates. Chugach calculates, that based on actual results through September 30 and for the remainder of the year, the budgeted revenues and expenditures, under Order 30, Chugach will have sufficient margins over interest in 2003 to comply with the requirements of the Rate Covenants in the Amended and Restated Indenture, the CoBank Master Loan Agreement and the MBIA Reimbursement Agreement. Docket U-01-108, Order No. 33 On August 26, 2003, the RCA issued Order No. 33 in Docket U-01-108, which reversed again its decision and required Chugach to offset long-term interest expense with a normalized level of AFUDC/IDC established to be $1.2 million. On August 15, 2003, the RCA issued Order No. 32 and clarified that January 31, 2003 is the date from which any refunds below the level of the previously approved rates must be computed. On August 26, 2003, the RCA issued Order No. 33 and re-reversed its decision on the ratemaking treatment of AFUDC / IDC. In this order, the RCA required Chugach to treat AFUDC / IDC as a reduction to long-term interest expense, which reduces the revenue requirement by approximately $1.2 million, excluding TIER. This treatment effectively reverts to the treatment accorded by the RCA's original decision made in Order 26 of this docket. On September 8, 2003 Chugach filed its recalculated revenue requirement in compliance with Order No. 33. The results of the calculation show a permanent system revenue requirement increase of less than $0.1 million. On November 5, 2003, the RCA issued an electronic order partially approving Chugach's compliance filing and requiring Chugach to file revised Cost of Power Adjustment (COPA) Tariffs by November 6, 2003, and indicating that upon receipt and approval of the required COPA, all tariffs would be approved with a simultaneous effective date. On September 25, 2003, Chugach filed an appeal in Superior Court of RCA Order 33 on the grounds that the RCA's treatment of AFUDC/IDC disallowed interest expense actually incurred and thus sets rates that are not just, fair and reasonable and which are constitutionally confiscatory, constituted an abuse of discretion, results in insufficient margins on the wholesale side of Chugach's business and resulted in discriminatory rates. The Superior Court has consolidated the appeals of Orders 26 and 30 with the appeal of Order 33. Docket U-01-108, Appeals Chugach has appealed the RCA's decisions in Order No. 26 to modify Chugach's generation and transmission TIER of 1.10, from the previously authorized level of 1.15 and a distribution TIER of approximately 1.6. Chugach asserts that such a disparity in TIER violates the requirements of AS 42.05.141(a)(3) and AS 42.05.391 (a) in that the resulting rates are not just, fair and reasonable and yield an unreasonable difference as to rates between Chugach's retail and wholesale customers. Chugach further asserts that the resulting rates grant an unreasonable preference or advantage to Chugach's wholesale customers by creating an unreasonable prejudice or disadvantage to its retail customers. On April 29, 2003, Chugach filed an appeal in Alaska Superior Court on two issues. In Order No. 30 of this docket, the RCA reconsidered and reversed its earlier decision and agreed with Chugach that requiring AFUDC/IDC as an offset to long-term interest expense would cause under-recovery and should, therefore, not be required. However, the specific language of the RCA's order on reconsideration limited its ruling to projects commenced and concluded within the test year. This could cause under-recovery of project costs over the life of the asset resulting in a confiscatory rate. Chugach has filed an appeal as to this portion of the RCA's decision on reconsideration in Order No. 30. On May, 13, 2003, MEA filed a cross appeal challenging the following RCA's decisions: o Allowing 3.8 percent interest rate for use in calculating the weighted cost of debt associated with its 2002 Series B (auction rate) Bonds. o Approving Chugach's treatment of AFUDC/IDC for ratemaking purposes. o Determining that the RCA did not have the jurisdiction to consider the claims of MEA regarding Chugach's alleged breach of its power sales agreement with MEA. o Concluding that the "rate locks" executed by Chugach were both a prudent financial management decision and a prudent expenditure such that Chugach could recover the cost of the rate locks through the rates paid by MEA. On July 21, 2003, the Superior Court of Alaska granted Chugach's motion for stay on condition that the excess interim rate refund be placed into an interest bearing escrow account and the revenues received from future rates, which may be subject to refund, be held in the same account. On October 3, 2003 Chugach filed for a motion to dissolve the stay that was granted by the Superior Court on July 21. Based on the results of RCA orders, subsequent to Chugach's request for stay in Superior Court, Chugach determined that removal of the stay on implementation of rates pursuant to Order 33 would increase Chugach revenues by approximately $0.7 million on an annual basis. Chugach will continue to pursue all issues raised in its appeals in Alaska Superior Court. On October 31, the superior court issued an order granting Chugach's motion to remove stay, releasing the escrow funds and ordering Chugach to pay refunds within 10 days of the order based upon the RCA's orders. On November 7, 2003, the Commission issued an electronic ruling approving Chugach's Order No. 33 compliance filing. As a result of the order, Chugach implemented revised retail and wholesale rates. The final order resulted in a system rate increase of 0.07 percent, or an increase of 3.5 percent to Chugach retail and a decrease of 7.9 percent to wholesale rates. In addition to implementing the revised rates, Chugach issued refunds on November 10, 2003, in the amount of $4.8 million to its wholesale customer classes. Chugach has requested an extension of time during which to issue refunds to its retail customers to allow it 90 days from the date of final approval by the RCA of Chugach's retail refund plan. This request was not opposed by the parties to the appeal, with MEA indicating it takes no position with respect to the request. Chugach expects to refund approximately $0.5 million to its small commercial customers, the only customer class entitled to a refund under the decision by the RCA. Impairment of Long-Lived Assets In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), Chugach performed an analysis of generation assets, in the second quarter of 2003, and determined an impairment of a certain asset existed. As a result of this analysis, an asset was written down by $1,846,816 to its estimated salvage value. This amount is included in the nine months ended September 30, 2003 column in the Statement of Revenues, Expenses and Patronage Capital, "Administrative, general and other," category. Results Of Operations Current Year Quarter Versus Prior Year Quarter Assignable margins decreased by $2.8 million for the quarter ended September 30, 2003, over the same quarter in 2002 primarily due to additional provision for rate refunds recorded in the third quarter of 2003 pending a final decision from the RCA. Operating revenues, which include sales of electric energy to retail, wholesale and economy energy customers and other miscellaneous revenues, decreased by $360.2 thousand, or 0.9%, for the quarter ended September 30, 2003, over the same quarter in 2002. The decrease in revenues was due to provision for rate refunds recorded in the third quarter of 2003, which was offset by a $759.7 thousand, or 60.0%, increase in economy energy sales to Golden Valley Electric Association (GVEA). GVEA purchased more from Chugach in the third quarter of 2003 as compared to the same quarter last year when they purchased more from another provider. The following table represents kWh sales for the quarter ended September 30: 2003 2002 ---- ---- Customer kWh kWh Retail 270,956,140 258,530,607 Wholesale 269,168,585 265,987,798 Economy Energy 48,747,730 34,830,310 ---------- ---------- Total 588,872,455 559,348,715 ================== ================= Retail demand and energy rates and wholesale demand and energy rates charged to HEA and MEA did not change in the third quarter of 2003 compared to the third quarter of 2002. The interim rate increase authorized by the RCA for all rate classes except small commercial and public street and highway lighting in November 2001 was still in affect awaiting a final order from the RCA for the 2000 Test Year rate case. Wholesale demand and energy rates charged to Seward Electric System (SES) did not change in this quarter compared to the same quarter last year. Fuel expense increased by $946.4 thousand, or 8.4%, for the quarter ended September 30, 2003, compared to the same period in 2002 due to higher fuel prices. Purchased power expense increased $516.8 thousand, or 12.4% due to higher fuel prices and additional purchases from Anchorage Municipal Light & Power (AML&P) while the Beluga units were out for maintenance. Distribution expense increased by $347.3 thousand, or 13.8%, due to a decrease in meter and transformer installation credits and additional labor associated with the transfer of a crew who's efforts concentrated on distribution projects. Administrative, general and other expense increased by $480.3 thousand, or 8.7%, due to increased insurance, labor and health and welfare costs. Depreciation and amortization expense increased by $540.5 thousand, or 8.6%, due to the implementation of new depreciation rates in accordance with the depreciation study approved by the RCA. Power production, transmission and consumer accounts/information expenses did not materially change for the three-month period ended September 30, 2003. Interest on long-term debt decreased by $180.9 thousand, or 3.0%, due to lower interest rates. Current Year to Date Versus Prior Year to Date Assignable margins increased $358.0 thousand, or 9.0% in the first nine months of 2003 compared to the same period in 2002 due to the various reasons described below. Operating revenues did not materially change for the nine-month period ended September 30, 2003. Operating revenues increased due to increased kWh sales and higher fuel prices, resulting in increased revenue collected through the fuel surcharge cost-recovery mechanism; however, that was offset by $2.9 million of additional provision for rate refunds recorded in the third quarter of 2003. The following table represents kWh sales for the nine months ended September 30: 2003 2002 ---- ---- Customer kWh kWh Retail 845,910,228 831,036,637 Wholesale 819,762,696 828,322,490 Economy Ener 166,840,860 80,537,210 ----------- ---------- Total 1,832,513,784 1,739,896,337 =================== ================== Fuel expense decreased by $1.9 million, or 5.3%, for the first nine months of 2003, compared to the same period in 2002 due to lower fuel prices. Power production expense decreased $626.4 thousand, or 6.2%, due to unplanned vacancies. Purchased power expense decreased by $1.5 million, or 10.3%, due to an outage of the Nikiski power plant as a result of a controls upgrade in the first quarter of 2003. Distribution expense increased by $400.6 thousand, or 5.2%, due to a decrease in meter and transformer installation credits and additional labor associated with an added crew. Administrative, general and other expense increased by $3.8 million, or 24.5%, for the first nine months of 2003, compared to the same period in 2002. This was due to a $1.8 million write down of an impaired asset, a $341 thousand increase in labor, a $430 thousand increase in insurance costs, a $500 thousand reclassification of the Kenai Lake PCBs study from a deferred debit to other deductions, a $627 thousand increase in allocated information services costs and the $207 thousand donation of an obsolete inventory item. Depreciation and amortization expense increased by $1.9 million, or 10.3%, due to the implementation of new depreciation rates in accordance with the depreciation study approved by the RCA. Transmission and consumer accounts/information expense did not materially change for the nine-month period ended September 30, 2003, compared to the same period in 2002. Interest on long-term debt decreased by $2.6 million, or 12.7%, due to lower interest rates. Interest charged to construction decreased by $146.2 thousand, or 40.7%, in the first nine months of 2003 compared to the same period in 2002 due to less construction activity and lower interest rates. Other interest expense decreased by $217.5 thousand, or 94.8%, during the same period in 2003 compared to the same period in 2002 due to decreased borrowing on the lines of credit in 2003. Other non-operating margins decreased by $246.1 thousand, or 34.4%, for the nine-month period ended September 30, 2003, compared to the same period in 2002, due primarily to a decrease in interest income. During the 2002 refinancing, Chugach received and invested funds that increased interest income in the prior year. Financial Condition Total assets decreased $16.8 million, or 2.9%, from December 31, 2002, to September 30, 2003. The decrease was due in part to a $3.9 million, or 0.8%, decrease in net plant, caused primarily by the increase in accumulated depreciation under new depreciation rates and plant construction completed in 2002. The decrease was also due to a $12.9 million, or 48.8%, decrease in accounts receivable caused by the payment of wholesale power invoices and the state of Alaska relocation invoices that were accrued but not paid at December 31, 2002. It was also due to a $1.6 million, or 6.6%, decrease in materials and supplies caused by the use of generation inventory items for scheduled maintenance projects. The decrease was also due to a $3.2 million, or 11.5%, decrease in deferred charges caused by the amortization of deferred projects, as well as the reclassification of the Kenai Lake PCBs study from a deferred debit to other deductions. The decrease in total assets was offset by a $3.3 million, or 45.3%, increase in cash and cash equivalents caused by the collection of relocation invoices from the State of Alaska. It was also offset by a $1.4 million, or 72.9%, increase in prepayments caused by the September 2003 property insurance renewal. Notable changes to total liabilities and equities include a $4.3 million, or 3.6%, increase in patronage capital due to the margin impact of the provision for rate refund adjustment to revenue. Fuel payable also increased by $1.6 million, or 22.0%, due to increased fuel prices and the timing of fuel invoice payments. The increases to total liabilities and equities were offset by a $363.9 thousand, or 100.0% decrease in fuel cost payable caused by the under-collection of the prior quarter's fuel cost adjustment, as well as a $5.5 million, or 1.4%, decrease in long-term obligations due to an installment payment of the 2002 Series B Bond and installment payments of CoBank 3 and CoBank 4 bonds. There was a $6.1 million, or 100.0%, decrease in short-term obligations caused by the collection of outstanding accounts receivable that was collected and used to pay off the line of credit. There was also a $4.4 million, or 68.8% decrease in accrued interest caused by lower interest rates and the semi-annual interest payment on the 2001 Series A Bonds in the third quarter. There was also a $4.1 million, or 53.1%, decrease in accounts payable due to the payment of invoices that were accrued at December 31, 2002. There was also a $1.8 million, or 26.1%, decrease in the provision for rate refund caused by an initial adjustment calculated by RCA Order 30 and by additional refund amounts that are recorded monthly. Liquidity and Capital Resources Chugach has satisfied its operational and capital cash requirements primarily through internally generated funds, an annual $50 million line of credit from NRUCFC and a $20 million line of credit with CoBank. At September 30, 2003, there was no outstanding balance under the NRUCFC or CoBank line of credit. Chugach also has a term loan facility with CoBank. Loans made under this facility are evidenced by promissory notes governed by the Master Loan Agreement, which became effective on January 22, 2003. At September 30, 2003, Chugach had the following promissory notes outstanding under this facility:
Interest rate at Principal Payment Promissory Note Principal balance September 30, 2003 Maturity Date Dates CoBank 2 $10,000,000 7.76% 2005 2005 CoBank 3 $21,086,330 2.70% 2022 2003 - 2022 CoBank 4 $23,047,849 2.70% 2022 2003 - 2022 CoBank 5 $10,000,000 2.70% 2012 2002 - 2012 Total $64,134,179
On January 22, 2003, Chugach and CoBank finalized a new Master Loan Agreement pursuant to the existing term loan facility that was converted from secured to unsecured debt and the obligations represented by the outstanding bonds held by CoBank were converted into promissory notes governed by the new Master Loan Agreement. Chugach's existing mortgage indenture was replaced in its entirety by an Amended and Restated Indenture dated April 1, 2001. All liens and security interests imposed under the indenture were terminated and all outstanding Chugach bonds (including New Bonds of 2001 Series A, 2002 Series A and 2002 Series B) became unsecured obligations governed by the terms of the Amended and Restated Indenture. Capital construction in 2003 is estimated at $31.1 million. At September 30, 2003, approximately $18.4 million had been expended. Capital improvement expenditures are expected to decrease in the upcoming fourth quarter as the construction season ends. Chugach management continues to expect that cash flows from operations and external funding sources will be sufficient to cover operational and capital funding requirements in 2003 and thereafter. Outlook Chugach reorganized its management and structure in June 2002 when the longstanding Chief Financial Officer (CFO), Evan J. Griffith, accepted the Chief Executive Officer (CEO) position. Chugach now has four senior vice-president level organizational entities: CFO (Finance and Accounting), Energy Supply, Power Delivery and Administration. A Chief of Staff position was also created and staffed by in-house senior management. We believe this structure will better facilitate the organization's ability to effectively manage future challenges. Environmental Matters Compliance with Environmental Standards Chugach's operations are subject to certain federal, state and local environmental laws that Chugach monitors to ensure compliance. The costs associated with environmental compliance are included as a component of both the operating and capital budget processes. Chugach accrues for costs associated with environmental remediation obligations when such costs are probable and reasonably estimable. Environmental Matters Chugach discovered polychlorinated biphenyls (PCBs) in paint, caulk and grease at the Cooper Lake Hydroelectric plant during initial phases of a turbine overhaul. A Federal Energy Regulatory Commission (FERC) approved plan, prepared in consultation with the Environmental Protection Agency (EPA), was implemented to remediate the PCBs in the plant. As a condition of its approval of the license amendment for the overhaul project, FERC required Chugach to also investigate the presence of PCBs in Kenai Lake. A sampling plan was developed by us in consultation with state and federal agencies and approved by FERC. In 2000, we sampled sediments and fish collected from Kenai Lake and other waters. While low levels of PCBs were found in some sediment samples taken near the plant, no pathway from sediment to fish was established. While the levels of PCBs in fish from Kenai Lake were similar to levels found in fish from other lakes within the region, we conducted additional sampling and analysis of fish in Kenai Lake and other waters and filed our final report dated April 1, 2002, with FERC, which analyzed the results of the sampling. Based on these analyses, we concluded that no further PCB sampling and analysis in Kenai Lake was necessary. In a letter dated June 13, 2002, FERC informed us that its review of the report supported our conclusions and agreed we were not required to conduct further PCB sampling and analysis in Kenai Lake. In its recent order in our general rate case, Order U-01-108(26), the RCA permitted the costs associated with the overhaul and the PCB remediation to be recovered through rates. Consequently, management believes the costs of the PCB remediation and studies will have no material impact on our financial condition or results of operations. Item 3. Quantitative and Qualitative Disclosures About Market Risk Chugach is exposed to a variety of risks, including changes in interest rates and changes in commodity prices due to repricing mechanisms inherent in gas supply contracts. In the normal course of our business, we manage our exposure to these risks as described below. Chugach does not engage in trading market risk-sensitive instruments for speculative purposes. Interest Rate Risk As of September 30, 2003, the 2002 Series B Bond carried a variable interest rate and will re-price every 28 days. CoBank 3, 4, and 5 were re-priced from 5.6% to 2.7%, on October 16, 2003, to a variable interest rate instrument that is re-priced every 30 days. All of our other outstanding long-term obligations were at fixed interest rates with varying maturity dates. The following table provides information regarding auction dates and rates in 2003 for the 2002 Series B Bonds. Auction Date Interest Rate January 29, 2003 1.40% February 26, 2003 1.35% March 26, 2003 1.32% April 23, 2003 1.33% May 21, 2003 1.30% June 18, 2003 1.18% July 16, 2003 1.10% August 13, 2003 1.10% September 10, 2003 1.12% October 8, 2003 1.12% November 5, 2003 1.12% The following table provides information regarding cash flows for principal payments on total debt by maturity date (dollars in thousands) as of September 30, 2003.
Fair Total Debt* 2003 2004 2005 2006 2007 Thereafter Total Value ----------- ---- ---- ---- ---- ---- ---------- ----- ----- Fixed rate $0 $0 $10,000 $0 $0 $270,000 $280,000 $313,414 Average interest rate 7.56% 6.39% 6.44% Variable rate $0 $5,545 $5,931 $6,326 $6,729 $85,303 $109,834 $109,834 Average interest rate -- 1.39% 1.39% 1.40% 1.41% 2.04% 1.90% * Includes current portion
Commodity Price Risk Chugach's gas contracts provide for adjustments to gas prices based on fluctuations of certain commodity prices and indices. Because purchased power costs are passed directly to our wholesale and retail customers through a fuel surcharge, fluctuations in the price paid for gas pursuant to long-term gas supply contracts do not normally impact margins. The fuel surcharge mechanism mitigates the commodity price risk related to market fluctuations in the price of purchased power. Item 4. Controls and Procedures Chugach's management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the Company's disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934) as of September 30, 2003. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in Chugach's internal controls that could significantly affect its disclosure controls and procedures since the date of the evaluation. PART II OTHER INFORMATION Item 1. Legal Proceedings Matanuska Electric Association, Inc., v. Chugach Electric Association, Inc., Superior Court Case No. 3AN-99-8152 Civil This action is a claim for a breach of the Tripartite Agreement, which is the contract governing the parties' relationship for a 25-year period from 1989 through 2014 and governing our sale of power to Matanuska Electric Association, Inc., (MEA) during that time. MEA asserted we breached that contract by failing to provide information, by failing to properly manage our long-term debt, and by failing to bring our base rate action to a joint committee before presenting it to the RCA. The committee is defined in the power sales contract and consists of one MEA and two Chugach board members. All of MEA's claims have been dismissed. On April 29, 2002, MEA appealed to the Alaska Supreme Court the Superior Court's decisions relating to our financial management, our decision not to bring our base rate action to the joint committee before filing with the RCA, as well as the Superior's Court's award to us of attorney's fees. We cross-appealed the Superior Court's decision not to dismiss the financial management claim on jurisdictional and res judicata grounds. Oral argument was heard by the Supreme Court on April 15, 2003. Management is uncertain as to the outcome and expects a decision within six to twelve months. Chugach has certain additional litigation matters and pending claims that arise in the ordinary course of its business. In the opinion of management, no individual matter or the matters in the aggregate is likely to have a material adverse effect on our results of operations, financial condition or liquidity. Item 2. Changes in Securities and Use of Proceeds Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders Not applicable Item 5. Other Information On August 8, 2003, Standard & Poor's rating service downgraded the underlying ratings on Chugach's 2001 Series A, 2002 Series A and 2002 Series B Bonds from "A Stable" rating to "A-minus Negative" rating. On October 31, 2003, Fitch Ratings downgraded the underlying ratings Chugach's 2001 Series A, 2002 Series A and 2002 Series B Bonds from "A+" to "A" rating and placed the debt on Rating Watch Negative. The rating with Moody's Investors Service has not been affected. The 2001 Series A and 2002 Series A and B Bonds are still insured by MBIA Insurance Corporation. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: No reports on Form 8-K were filed for the quarter ended September 30, 2003. Signatures Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CHUGACH ELECTRIC ASSOCIATION, INC. By: /s/Evan J. Griffith Evan J. Griffith Chief Executive Officer Date: November 14, 2003 By: /s/Michael R. Cunningham Michael R. Cunningham Chief Financial Officer Date: November 14, 2003 EXHIBITS Listed below are the exhibits, which are filed as part of this Report: Exhibit Number Description 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002