1 Letter to the Governor 2 Report of the Commission 4 Report of the Executive Director 5 Operations and Environments 6 Historical Energy Sales 7 Management’s Discussion and Analysis 17 Report of the Independent Accountants 18 Financial Statements 22 Notes to Financial Statements We understand that the policies we pursue today have a real impact on the welfare of Arizona. That’s why every decision we make is with an eye on long-term results. December 1, 2007 The Honorable Janet A. Napolitano Governor of Arizona State Capitol Ninth Floor, West Wing Phoenix, AZ 85007 Dear Governor: On behalf of the Commissioners and staff, I submit the Arizona Power Authority’s 49th Annual Report. This report details the Authority’s operational and financial activities for the fiscal year ending June 30, 2007. It also highlights the Authority’s efforts in administering Arizona’s hydroelectric power entitlement generated at Hoover Dam and Powerplant. The Colorado River system continues to experience a severe drought cycle with the lowest eight-year average water flows in 100 years of record keeping. Due to the prolonged drought conditions, impounded water in Lake Mead continues to decrease, thereby reducing the amount of hydroelectric generation available to Arizona. As of July 2007, storage in Lake Mead was 49% of its capacity, down 6% from 2006. Nevertheless, the State’s water and power entitlements, although at reduced levels of electric generation, are still available for the State’s use. The Authority maintains its aggressive and active involvement in federal and state efforts to mitigate the drought’s impact. The Authority is also continuing to investigate opportunities for development of various renewable electric power generating resources to provide our customers with more diverse generation, reducing their dependency on fossil-fuel energy resources. These resources, if developed, would supplement the hydro resource and provide clean energy for Arizona. Sincerely, John I. Hudson, LT GEN, USMC (Ret.) Chairman –1– Report of the Commission With the prolonged drought cycle of the Colorado River system, it is increasingly important for the Arizona Power Authority to manage its federal allocation prudently. Critical decisions must be made in concert with the other Hoover hydro power allottees to assure the maximum efficiency and cost effective management of this valuable resource. The continual interaction of the Authority with the federal agencies responsible for the generation and transmission of this key Arizona resource is our primary obligation and commitment. “The past cannot be changed. The future is yet in your power.” - Hugh White (1773 - 1840) Lt. General John I. Hudson USMC ( Ret.), Chairman First appointed to the Arizona Power Authority Commission in March 2000, John I. Hudson was elected Chairman in January 2006 with his current term expiring in 2012. A retired Lieutenant General in the U.S. Marine Corps where he served for 37 years, John Hudson is a member of the Board of Directors of the Yuma Regional Medical Center. In addition, he is a member and past chairman of the Greater Yuma Port Authority Board of Directors, a founding Director of the Foothills Bank of Yuma, and past president of Yuma’s 78-CRIME Board of Directors. Dalton H. Cole, Vice-Chairman Appointed to the Commission in January 2002 for a term to run until 2008, Dalton Cole was elected to be the Vice-Chairman in January 2006. Dalton Cole is a retired businessman and farmer. A past member of the Central Arizona Water Conservation District Board, Mr. Cole co-founded and chaired the HoHoKam Irrigation District. He also served on the board of Electrical District No. 2 in Pinal County for 18 years and is a past chairman. In addition, Mr. Cole is a past chairman of the State Board of Directors for Community Colleges. He has served on the Ground Water Management Committee for Pinal County, as well as advisory committees to the Arizona Legislature regarding water and power issues. –2– Delbert R. Lewis First appointed to the Arizona Power Authority Commission in April 2003, Delbert Lewis has been reappointed for a six-year term ending in January 2010. Delbert Lewis is one of the founders of KTVK Channel 3 and the CEO of MAC America Communications, Inc. His past and present civic affiliations include the Arizona Broadcasters Association, Metropolitan Phoenix Broadcasters, Phoenix Chamber of Commerce, Samaritan Health Services, Greater Phoenix Leadership, the National Conference, Maricopa County Sports Authority and Orpheum Theatre Foundation. Now farming 4,000 acres of farmland near Florence, Arizona, Delbert Lewis and his wife, Sharron, are nationally recognized for their financial support and commitment to education and community service. Richard S. Walden Appointed to the Commission in 1984 and re-appointed through his present term expiring in 2010, Richard Walden is the President and CEO of Farmers Investment Co., a family-owned, pecan growing and processing company headquartered in Sahuarita, Arizona. He is a member of the Board of the International Tree Nut Council and in that capacity serves as the chairman of the Committee for Nutrition and Education associated with the Nutrition and Education Foundation. He is also a former member of the Advisory Council on Small Business and Agriculture for the Federal Reserve Bank of San Francisco and a member of the Board of the National Pecan Shellers Association. Michael C. Francis Starting his tenure on the Commission in 1999, Mr. Francis was selected Chairman in April 2003 and re-elected to this position in 2005. His current term expires in January 2008. Michael Francis is a partner in Santa Lucia Farms, producer of over 3.7 million garden rose bushes annually. He is also a member of the American Rose Society. Additionally, he owns and operates Francis Insurance Agency, which insures Arizona and California farmers. Michael Francis is a Board of Directors member of M&I Bank, Arizona Region. “Advice is judged by results, not by intentions.” - Cicero, Roman author, orator, & politician (106 BC - 43 BC) –3– Report of the Executive Director Optimizing performance at every level To ensure we are delivering the best possible outcomes for our Arizona customers and the state as a whole, the Arizona Power Authority continually seeks ways to enhance efficiency and overall performance. This begins with refining our strategy for maximizing the impact of Arizona’s Hoover Power allotment, and extends to streamlining our internal, day-to-day operations at the Authority. Hydro power is especially well-suited to responding to peaking power needs. By simply opening the wicket gates at Hoover, more power can be generated almost instantaneously to meet increasing loads. This makes Hoover Power unique when compared to other forms of power generation which are less responsive. Typically, our agricultural customers don’t require such a rapid response. Their needs are scheduled and more predictable. To make the best use of Arizona’s Hoover Power, the Authority has entered into an agreement that provides for the best use of Hoover Power to meet the power needs of Arizona. This agreement benefits everyone involved. The Authority receives payment for Hoover’s scheduling flexibility, which helps reduce operating costs, while the state as a whole benefits from lower pollution and operating costs. Consumers, of course, are the ultimate beneficiaries because they receive the instantaneous power they expect when they flip on a switch, plus lower cost and less pollution. This generation optimization agreement helps reduce pollution that would otherwise be generated by the gas- or coal-fired plants that would have been required to ramp up to meet rising loads. In this way, the Authority is helping to ensure Arizona makes the most of its Hoover Power allotment. –4– As drought conditions continue in the western United States, the water levels in Lake Mead, the largest manmade lake and reservoir in the U.S., have reached historically low levels, at just 49% of capacity. The challenge at Hoover Dam and the Arizona Power Authority is to utilize the water available to maximum efficiency. Optimizing software as well as upgrades in the physical plant at Hoover makes this possible. The Authority recognizes that for Arizonians, every dollar counts. That’s why we are working closely with the State’s congressional delegation in Washington to craft legislation that will open the way for lowering the cost of high voltage transmission. Such legislation would save the people of Arizona approximately $60 million. This would be achieved by allowing the Authority to purchase transmission capacity from the Western Area Power Administration (Western) in advance. This lump sum payment would then be used to pay down Western’s debt. Financing for this payment would be attained at considerably lower interest rates than Western’s original loan, creating a significant savings. The Authority is optimizing its internal operations as well. Staff assignments are being fine-tuned to take advantage of our peoples’ strengths. We have also rewritten many accounting and billing programs to make them much more user-friendly, efficient, and minimize the amount of labor-intensive input required. The Authority is also enhancing its communications processes. Reports to our Commissioners have been re-designed to make them easier to understand, supporting clearer, more informed decision making. In addition, the Authority is maintaining close communications with our sister state agencies, as well as the Governor’s Office. These direct channels of communication are essential to supporting the clear decisions regarding energy in Arizona. From how Hoover Power is distributed to the efficiency of our own internal operation, the Authority is committed to optimizing our performance. In this way, we can ensure we continue to support Arizona’s growth and the best interest of its citizens. “Change is the law of life. And those who look only to the past or present are certain to miss the future.” - John F. Kennedy (1917 - 1963) Operations and Environments As a severe drought cycle continues in the Colorado River system, with the lowest eight-year average water flows in 100 years of record keeping, impounded water in Lake Mead has decreased, reducing further the amount of hydroelectric generation available. As of July 2007, storage in Lake Mead was 49% of its capacity, down 6% from 2006. To increase Hoover generation capabilities at lower lake levels, Hoover Dam personnel completed two generating unit overhauls and two unit wicket gates re-stroking during the 2006/2007 maintenance cycle. This increased the total plant capacity by approximately 27 megawatts at lake levels below 1145 feet. A two-unit overhaul was proposed for the 2007/2008 maintenance period. APA and other Hoover customers recommended an alternate approach which resulted in Hoover personnel adopting a new plan including re-stroking and redesigning the unit Pressure Relief Valve (PRV) connection, thereby improving unit capacity and PRV operating characteristics while reducing future maintenance costs of the PRVs. With the re-stroking of three units and the overhaul of one unit, substantial improvements are expected--an estimated additional 31 megawatts at lake levels below 1145 feet. Environmentally, the voluntary Lower Colorado River Multi-Species Conservation Program is actively pursuing the work plan established by the steering committee. Proposed federal legislation that would codify the LCRMSCP in law has been introduced and committee hearings have been conducted. Passage of the legislation will be addressed after the Congress reconvenes in 2008. “You cannot escape the responsibility of tomorrow by evading it today.” - Abraham Lincoln (1809 - 1865) –5 4– Schedule of Capacity and Energy Sales Year Ending June 30, 2007 July 1, 2006 thru June 30, 2007 Average Billing Demand (kW) Energy Delivered (kWh) Sale of Hydro Power Aguila Irrigation District Avra Valley Irrigation & Drainage District Buckeye Water Conservation District Central Arizona Water Conservation District Chandler Heights Citrus Irrigation District Cortaro-Marana Irrigation District Electrical District No. 2, Pinal Electrical District No. 3, Pinal Electrical District No. 4, Pinal Electrical District No. 5, Pinal Electrical District No. 5, Maricopa Electrical District No. 6, Pinal Electrical District No. 7, Maricopa Electrical District No. 8, Maricopa Harquahala Valley Power District Maricopa County Municipal Water District No. 1 McMullen Valley Water Conserv. & Drainage Dist. Ocotillo Water Conservation District Queen Creek Irrigation District Roosevelt Irrigation District Roosevelt Water Conservation District Salt River Project San Tan Irrigation District Silverbell Irrigation & Drainage District Tonopah Irrigation District Wellton-Mohawk Irrigation & Drainage District City of Page City of Safford Town of Thatcher Town of Wickenburg Ak-Chin Indian Community Arizona Electric Power Cooperative Arizona Public Service Company Citizens Utilities Company City of Mesa Tohono O’odham Utilities Authority San Carlos Project Tucson Electric Power Company 3,363 578 1,869 118,556 682 2,121 14,883 32,277 12,886 9,846 280 3,850 5,345 14,646 1,726 6,359 4,821 1,769 471 2,687 1,875 28,458 378 568 1,061 2,135 283 1,281 851 675 0 0 0 0 0 0 0 0 10,995,000 1,623,000 8,926,000 149,823,000 2,964,000 18,573,000 56,109,000 52,697,000 55,066,000 44,474,000 1,046,000 17,887,000 22,088,000 51,577,000 7,349,000 28,738,000 16,903,000 7,415,000 1,657,000 14,255,000 8,451,000 100,917,000 1,504,000 4,204,000 4,703,000 8,401,000 837,000 1,937,000 1,097,000 2,191,000 0 0 0 0 0 0 0 0 Total Hydro Power Sales 276,582 704,407,000 Total Net Prior Year Adjustment (FY07 Accrual) Total Supplemental Power Sales Sales ($) $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 257,381 40,075 184,882 5,504,671 63,036 337,338 1,246,899 1,661,619 1,178,717 935,966 23,306 374,399 478,419 1,174,477 157,245 603,969 386,310 159,280 38,052 286,625 180,102 2,293,503 32,783 78,284 99,456 184,059 20,561 64,218 39,728 51,700 - $18,137,058 $(1,289,933) 528,296 Other Electric Services Income** 45,421,000 $6,034,405 $5,419,452 $28,300,982 * Total Power Income * Any Difference between Total Electric Sales and Operating Revenue is due to post-closing reconciliation of estimate to actuals between the Authority and Western Area Power Administration. ** Includes Administrative fees, facilities charges, late charges, and Scheduling Entity revenue. –6– Management’s Discussion and Analysis Using This Annual Report The following is a discussion and analysis of the Arizona Power Authority’s (“Authority”) financial performance for the fiscal years ended June 30, 2007 and 2006. This discussion is designed to: This annual report consists of a series of financial statements. The Statements of Net Assets, the Statements of Revenues, Expenses and Changes in Net Assets and the Statements of Cash Flows (on pages 18-21) provide information about the activities of the Authority as a whole and present a longer-term view of the Authority’s finances. The Authority is a body, corporate and politic, of the State of Arizona and is a special-purpose government entity engaged only in business-type activities. Accordingly, the financial statements presented in this Annual Report are the required basic financial statements in accordance with the provisions of Governmental Accounting Standards Board Statement No. 34, Basic Financial Statements – and Management’s Discussion and Analysis – for State and Local Governments. (a) assist the reader in focusing on significant financial issues, (b) provide an overview of the Authority’s financial activity, and (c) identify changes in the Authority’s financial position. The Management’s Discussion and Analysis (“MD&A”) focuses on the 2007 and 2006 fiscal years’ activities, resulting changes and known facts, and should be read in conjunction with the Authority’s annual report for the years ended June 30, 2007 and 2006. This MD&A is an introduction to the basic financial statements of the Authority, which are comprised of two components. (1) Fund Financial Statements (2) Notes to the Financial Statements Authority Highlights Transmission Agreement – On January 24, 2003, the Authority and the Western Area Power Administration (“Western”) entered into an agreement for the Advancement of Funds for Transmission Services. The Authority had an existing agreement with Western that provided for the delivery of power and energy. The agreement provides for the Authority to advance funds to Western on a monthly basis to fund operations, maintenance and replacement costs associated with Western’s transmission services. For the years ended June 30, 2007 and 2006, the Authority advanced a net prepaid deposit of $182,360, which is included in the Statements of Net Assets. This contract gives Western greater flexibility and allows them to work more effectively with the Authority and other customers. The Fund Financial Statements begin on page 10 and provide detailed information about the individual funds. A fund is a fiscal and accounting entity with a selfbalancing set of accounts that the Authority uses to keep track of specific sources of revenues and disbursements for specific purposes. The Authority’s funds are treated as proprietary and are independent of each other. Most of the Authority’s financial dealings are with contracts outside of state government. A separate fund is not maintained for government activities. The Authority does not act as a fiduciary. –7– Contributions Revenues During fiscal years 2007 and 2006, the Authority contributed $60,000 via the Arizona Power Authority Scholarship Program. The following schools each received $20,000: Arizona State University, The University of Arizona, and Northern Arizona University. Increase/Decrease in Commission Approved Power Rates State statute requires the rates be set at levels to recover the cost of supplying service. In addition, contracts between the Authority and its customers provide specific details regarding rate determination. The Arizona Power Authority Commission is solely responsible for periodically adjusting rates, as appropriate. Effects of Drought on Hoover Energy The Colorado River Basin has been experiencing severe drought conditions for the past eight years. This has resulted in a reduction in Lake Mead’s storage and the power production at Hoover Dam. In response to customer requests, the Authority continues to purchase supplemental power to offset the reduced energy production at Hoover. The supplemental power costs are significantly higher than Hoover rates and are passed directly to the requesting customers. These supplemental revenues and costs are reflected on the Authority’s books, resulting in higher revenue and purchased power costs. Market Impacts on Investment Income Favorable market conditions during fiscal year 2007 resulted in an increase in interest rates, yielding greater investment income for the year. Economic Drought Condition Although the drought condition in the Colorado River Basin continues, increased efficiency improvements at Hoover Dam have helped to offset the decreases resulting from reduced water levels. Arizona State Treasurer-Held Investment Write-off Expenses The Authority is statutorily required to invest funds through the Arizona State Treasurer (“Treasurer”), who has sole investment decision-making authority. In November 2002, the Authority was advised that one of the Treasurer’s chosen investments managed by National Century Financial Enterprises was under investigation for fraud. In December 2002, the Authority was informed that the Treasurer was vitiating the investment in question, thereby reducing the value to zero. Since that time, litigation was initiated and continues. There is no guarantee that the litigation will result in the recovery of the Authority’s funds, which total $227,224. Therefore, the Authority wrote off the lost investment amount as of June 30, 2003. As of June 30, 2007, a total of $118,569 has been recovered. $29,784 was received in fiscal year 2007 and is presented as Other Income. There were no changes during this fiscal year; however, individual programs may be added or deleted to meet changing Authority needs. Introduction of New Programs Increase/Decrease in Authorized Personnel Changes in the Authority’s services may result in increasing/decreasing authorized staffing. Fiscal year 2007 staffing costs (salary and related benefits) represent 3.12% of the Authority’s operating costs. For fiscal year 2006, staffing costs represent 2.60% of the Authority’s operating costs. Salary Structure The ability to attract and retain competent personnel requires the Authority to provide a competitive salary structure, which is reviewed annually, and is within State guidelines. During fiscal year 2007, the Authority was at full staff, as opposed to 2006 when several staff positions remained open for a portion of the year. –8– Financial Highlights • The Authority’s 2007 net assets increased by $531,355, or 16.02%, due mainly to increased rates that resulted in increased retained earnings. • The Authority’s 2006 net assets increased by $561,639, or 20.4%, due mainly to increased rates. • The Authority’s 2007 operating revenues increased by $1,972,386, or 7.49%, due to an increase in rates. The accrual for the fiscal year 2007 customer refunds has been included in the Operating Revenue number. • The Authority’s 2006 operating revenues decreased by $143,839, or 0.5%, due to accrual of fiscal year 2006 customer refunds. Statements Of Net Assets There are three normal transactions that will affect the comparability of the Statements of Net Assets summary presentation: Net Results of Activities Which will impact (increase/decrease) current assets and undesignated net assets. Principal Payment on Debt Which will reduce current assets and reduce long-term debt. Reduction of Capital Assets through Depreciation Which will reduce capital assets and investment in capital assets, net of debt. –9– Condensed Statements of Net Assets Business Type Activities June 30 2007 2006 Diff $ Diff% $ 14,327,162 $ 13,774,025 $ 553,137 4.0% 46,500,896 49,307,084 (2,806,188) (5.7%) 200,159 235,769 (35,610) (15.1%) 61,028,217 63,316,878 (2,288,661) (3.6%) 7,492,262 7,077,825 414,437 5.9% Long-term (bonds payable,net) 49,687,469 52,921,922 (3,234,453) (6.1%) Total liabilities 57,179,731 59,999,747 (2,820,016) (4.7%) 200,159 235,769 (35,610) (15.1%) 3,648,327 3,081,362 566,965 18.4% 3,848,486 3,317,131 531,355 16.0% $ 61,028,217 $ 63,316,878 $ (2,288,661) (3.6%) Current assets Long-Term assets Capital assets, net Total assets Current liabilities Net assets Invested in capital assets Unrestricted Total net assets Total liabilities and net assets Fiscal Year 2007 Condensed Statements of Net Assets Discussion Current Assets Increased due to an increase in prepaid purchased power, increased accounts receivable, and an increase in the Debt Service cash account. Long-Term Assets Decreased because of a payment of principal for the current year debt service for the Uprating Program. Capital Assets, Net Decreased because of normal depreciation/attrition of capital assets. Current Liabilities Increased due to an increase in amounts owed for purchased power pursuant to power contracts with the Western Area Power Administration as of June 30, 2007 and an increase in current Debt Service payable. Long-Term Liabilities Decreased due to a pay down of the bond principal. See further explanation on page 12. Net Assets Are explained on page 13. – 10 – Condensed Statements of Net Assets Business Type Activities June 30 2006 2005 Diff $ Diff% $ 13,774,025 $ 11,558,522 $ 2,215,503 19.2% 49,307,084 52,113,652 (2,806,568) (5.4%) 235,769 211,786 23,983 11.3% 63,316,878 63,883,960 (567,082) (0.9%) 7,077,825 5,261,291 1,816,534 34.5% Long-term (bonds payable,net) 52,921,922 55,867,177 (2,945,255) (5.3%) Total liabilities 59,999,747 61,128,468 (1,128,721) (1.8%) 235,769 211,786 23,983 11.3% 3,081,362 2,543,706 537,656 21.1% 3,317,131 2,755,492 561,639 20.4% $ 63,316,878 $ 63,883,960 $ (567,082) (0.9%) Current assets Long-Term assets Capital assets, net Total assets Current liabilities Net assets Invested in capital assets Unrestricted Total net assets Total liabilities and net assets Fiscal Year 2006 Condensed Statements of Net Assets Discussion Current Assets Increased due to an increase in prepaid purchased power, increased accounts receivable, and an increase in the Debt Service cash account. Long-Term Assets Decreased because of a payment of principal for the current year Uprating Program. Capital Assets, Net Increased due to the investment in the new parking lot for the office building. Current Liabilities Increased due to an increase in amounts owed pursuant to power contracts at June 30, 2006 and an accrual for fiscal year 2006 customer refunds. Long-Term Liabilities Decreased due to a pay down of the bond principal. See further explanation on page 12. Net Assets Are explained on page 13 – 11 – Debt Outstanding Capital Assests As of fiscal year end, the Authority had $200,159 invested in a variety of capital assets, as reflected in the following schedule, which represents a net decrease (additions less retirements and depreciation) of $(35,610), or (15.1)%, during fiscal year 2007 and a net increase of $23,983, or 11.3%, during fiscal year 2006. June 30 Transmission Plant Distribution Plant General plant - office Invested in capital assests, end of year 2007 2006 $ 24,413 $ 27,464 23,032 31,757 152,714 176,548 $ 200,159 $ 235,769 The following reconciliation summarizes the change in Capital Assets for the years ended June 30, 2007 and 2006, which is presented in detail in Note 3: June 30 2007 2006 $ 235,769 $ 211,786 Additions 3,084 64,248 Disposals - - (38,694) (40,265) $ 200,159 $ 235,769 Beginning Balance Depreciation Ending Balance – 12 – As of June 30, 2007, the Authority had $52,135,000 in debt outstanding, compared to $54,960,000 in the prior year, as a result of a principal payment of $2,825,000, which was paid on October 1, 2006. As of June 30, 2006, the Authority had $54,960,000 in debt outstanding, compared to $57,520,000 in the prior year, as a result of a principal payment of $2,560,000, which was paid on October 1, 2005. These payments were scheduled principal payments during the year. Also see Note 5 to the Financial Statements for a detailed summary of debt activity during the year. Liquidity Pursuant to Arizona Revised Statutes (A.R.S.) Section 30-124, the Commission of the Authority shall establish electric rates to include such price components as are necessary to maintain the Authority, to provide and maintain reasonable working capital and depreciation and other necessary and proper reserves. Components that are necessary to maintain the Authority include employee payroll, occupancy costs, cost of purchases or construction of generation and transmission services, and any cost factors chargeable to the cost of providing service as the Commission deems necessary or advisable to establish and maintain the financial integrity of the Authority. Contracts for sale of electric power to the Authority’s customers include rates which may be modified upon 24-hour notice when such action is necessary in the sole judgment of the Commission in order to achieve the purposes of A.R.S. Section 30-124. The Commission, on a monthly basis, reviews the financial status of the Authority, including expenses and revenues and the adequacy of the rates to maintain the Authority’s financial integrity. During fiscal year 2006, the Commission raised rates 15% effective February 1, 2006 in response to reduced energy generation and other business conditions. No rate changes were effected during fiscal year 2007. Statements of Revenues, Expenses, and Changes in Net Assets There are three normal transactions that will affect the comparability of the Statements of Changes in the Net Assets summary presentation: Operating Revenues which increase/decrease as a result of economic conditions and power usage. Operating Expenses which increase/decrease as a result of purchased power costs, transmission costs, and operating costs. Other Income (Deductions) which increase/decrease as a result of investment market conditions. Statements of Revenues, Expenses, and Changes in Net Assets Business Type Activities June 30 2007 2006 Diff $ Diff% $ 28,300,982 $ 26,328,596 $ 1,972,386 7.5% Purchased power 21,359,826 19,404,200 1,955,626 10.1% Western credits (5,523,334) (5,167,368) (355,966) 6.9% Amortization of Hoover Uprating Program costs 5,523,334 5,167,368 355,966 6.9% Transmission and distribution 5,303,199 5,258,886 44,313 0.8% Administrative and general 1,481,035 1,405,247 75,788 5.4% Depreciation 38,694 40,265 (1,571) (3.9%) Other 87,088 109,518 (22,430) (20.5%) 28,269,842 26,218,116 2,051,726 7.8% 31,140 110,480 (79,340) 71.8% (2,724,425) (2,862,363) 137,938 (4.8%) 2,273,992 2,347,319 (73,327) (3.1%) Amortization 114,453 120,255 (5,802) (4.8%) Interest income 794,593 750,465 44,128 5.9% 41,602 95,483 (53,881) (56.4%) Total other (deductions) income 500,215 451,159 49,056 10.9% Change in net assets 531,355 561,639 (30,284) (5.4%) Net assets, beginning of year 3,317,131 2,755,492 561,639 20.4% $ 3,848,486 $ 3,317,131 $ 531,355 16.0% Operating revenues Operating expenses Total operating expenses Operating income (loss) Other (deductions) income Interest expense Deferred interest expense Other, net Net assets, end of year – 13 – Other Income Interest Income $156,051 0.53% $794,593 2.72% Supplemental Power Sales/Admin Charges $6,053,857 20.70% 2007 Revenues Hoover Power Sales $22,247,125 76.05% Transmission & Distribution $5,303,199 18.47% Hoover Power Purchased $15,325,421 53.36% Net Interest Expense $450,433 1.57% Administrative & General $1,481,035 5.16% Depreciation Other Costs $38,694 0.13% $87,088 0.30% 2007 Expenses Supplemental Power Purchased $6,034,405 21.01% Fiscal Year 2007 Changes in Net Assets Discussion Net Assets increased overall because of the following: • Operating Revenues increased due to an increase in rates. • Total Operating Expenses increased due to an increase in purchase power expenses. • Western Credits increased because of changes in debt payments and associated costs related to the Uprating Program. • Amortization of the Uprating Program increased because of the increase in the amortization of long-term bond costs. • Administrative and General expenses increased due to staffing and related expenses, resulting from all staff positions being filled for the entire year in fiscal year 2007, as opposed to fiscal year 2006 when several positions remained unfilled for a portion of the year. • Depreciation decreased due to the normal attrition of capital assets. • Other expenses decreased due to a reduction in expenditures for special projects, such as the Colorado River Legal Defense Fund. – 14 – Statements of Revenues, Expenses, and Changes in Net Assets There are three normal transactions that will affect the comparability of the Statements of Changes in the Net Assets summary presentation: Operating Revenues which increase/decrease as a result of economic conditions and power usage. Operating Expenses which increase/decrease as a result of purchased power costs, transmission costs, and operating costs. Other Income (Deductions) which increase/decrease as a result of investment market conditions. Statements of Revenues, Expenses, and Changes in Net Assets Business Type Activities June 30 2006 2005 Diff $ Diff% $ 26,328,596 $ 26,472,435 $ (143,839) (0.5%) Purchased power 19,404,200 20,805,429 (1,401,229) (6.7%) Western credits (5,167,368) (5,119,484) (47,884) 0.9% Amortization of Hoover Uprating Program costs 5,167,368 5,119,484 47,884 0.9% Transmission and distribution 5,258,886 5,256,841 2,045 0.0% Administrative and general 1,405,247 1,348,146 57,101 4.2% 40,265 41,024 (759) (1.9%) 109,518 70,837 38,681 54.6% 26,218,116 27,522,277 (1,304,161) (4.7%) 110,480 (1,049,842) 1,160,322 110.5% (2,862,363) (2,990,812) 128,449 (4.3%) 2,347,319 2,520,052 (172,733) (6.9%) Amortization 120,255 124,304 (4,049) (3.3%) Interest income 750,465 596,597 153,868 25.8% 95,483 25,894 69,589 268.7% Total other (deductions) income 451,159 276,035 175,124 63.4% Change in net assets 561,639 (773,807) 1.335,446 172.6% Net assets, beginning of year 2,755,492 3,529,299 (773,807) (21.9%) $ 3,317,131 $ 2,755,492 $ 561,639 20.4% Operating revenues Operating expenses Depreciation Other Total operating expenses Operating income (loss) Other (deductions) income Interest expense Deferred interest expense Other, net Net assets, end of year – 15 – Other Income Interest Income $ 215,738 0.79% $ 750,465 2.75% Supplemental Power Sales/Admin Charges $ 6,013,328 22.03% 2006 Revenues Hoover Power Sales $ 20,315,268 74.43% Transmission & Distribution $ 5,258,886 19.67% Net Interest Expense Hoover Power Purchased $ 515,044 1.93% $ 13,453, 282 50.32% Administrative & General $ 1,405,247 5.26% Depreciation Other Costs $ 40,265 0.15% $ 109,518 0.41% 2006 Expenses Supplemental Power Purchased $ 5,950,918 22.26% Fiscal Year 2006 Changes in Net Assets Discussion Net Assets increased overall because of the following: • Operating Revenues decreased due to the accrual of fiscal year 2006 customer refunds. • Total Operating Expenses decreased due to a decrease in purchased power. • Western Credits increased because of changes in debt payments and associated costs related to the Uprating Program. • Amortization of the Uprating Program increased because of the increase in the amortization of long-term bond costs. • Administrative and General expenses increased due to Lower Colorado River Multi-Species Conservation Program (MSCP) expenses. • Depreciation decreased due to the normal attrition of capital assets. • Other expenses increased due to the initiation of special expenses, such as the Colorado River Legal Defense Fund and National Renewable Energy Laboratory (NREL) – 16 – – 17 – Financial Highlights Statements of Net Assets June 30, 2007 and 2006 APA General Fund Hoover Uprating Fund Total 2007 2006 2007 2006 2007 2006 $ 3,514,101 $ 3,517,969 $ 1,741,630 $ 2,457,591 $ 5,255,731 $ 5,975,560 - - 3,105,380 2,818,376 3,105,380 2,818,376 purchases 834,828 598,577 2,392,037 2,349,602 3,226,865 2,948,179 Interest receivable 24,592 20,331 88,753 128,733 113,345 149,064 298,163 170,063 - - 298,163 170,063 - - 2,327,678 1,712,783 2,327,678 1,712,783 4,671,684 4,306,940 9,655,478 9,467,085 14,327,162 13,774,025 200,159 235,769 - - 200,159 235,769 Investments Held by Trustee - Long Term - - 6,546,641 6,546,569 6,546,641 6,546,569 Advances for Hoover Uprating Program, net - - 39,771,895 42,578,155 39,771,895 42,578,155 Prepaid transmission 182,360 182,360 - - 182,360 182,360 Total assets $ 5,054,203 $ 4,725,069 $ 55,974,014 $ 58,591,809 $ 61,028,217 $ 63,316,878 $ 8,173 $ 15,440 $ 120,956 $ 96,239 $ 129,129 $ 111,679 - - 1,289,933 1,504,693 1,289,933 1,504,693 Power contracts payable 833,207 593,456 1,447,713 1,335,405 2,280,920 1,928,861 Accrued interest payable - - 672,280 707,592 672,280 707,592 Bonds payable - - 3,120,000 2,825,000 3,120,000 2,825,000 841,380 608,896 6,650,882 6,468,929 7,492,262 7,077,825 Bonds payable - - 49,015,000 52,135,000 49,015,000 52,135,000 Premium (discounts) on bonds payable - - 672,469 786,922 672,469 786,922 Bonds payable, net - - 49,687,469 52,921,922 49,687,469 52,921,922 841,380 608,896 56,338,351 59,390,851 57,179,731 59,999,747 200,159 235,769 - - 200,159 235,769 4,012,664 3,880,404 ( 364,337 ) ( 799,042 ) 3,648,327 3,081,362 4,212,823 4,116,173 ( 364,337 ) ( 799,042 ) 3,848,486 3,317,131 $ 5,054,203 $ 4,725,069 $ 61,028,217 $ 63,316,878 Assets Current Assets Cash and cash equivalents Investments held by Trustee - Short Term Accounts receivable, customer power Other assets Prepaid purchased power Total current assets Capital assets, net Liabilities Current liabilities Accounts payable and other Customer refunds Total current liabilities Total liabilities Net Assets Invested in capital assets Unrestricted Total net assets Total liabilities and net assets $ 55,974,014 $ 58,591,809 *the accompanying notes are an integral part of these financial statements – 18 – Statements of Revenues, Expenses and Changes in Net Assets June 30, 2007 and 2006 APA General Fund Hoover Uprating Fund Total 2007 2006 2007 2006 2007 2006 $ 6,053,857 $ 6,013,328 $ 22,247,125 $ 20,315,268 $ 28,300,982 $ 26,328,596 6,034,405 5,950,918 15,325,421 13,453,282 21,359,826 19,404,200 - - ( 5,523,334 ) ( 5,167,368 ) ( 5,523,334 ) ( 5,167,368 ) - - 5,523,334 5,167,368 5,523,334 5,167,368 9,842 324 5,293,357 5,258,562 5,303,199 5,258,886 Administrative and general 19,839 70,558 1,461,196 1,334,689 1,481,035 1,405,247 Depreciation 38,694 40,265 - - 38,694 40,265 Other 61,433 82,899 25,655 26,619 87,088 109,518 6,164,213 6,144,964 22,105,629 20,073,152 28,269,842 26,218,116 141,496 242,116 31,140 110,480 Operating Revenues Operating Expenses Purchased power Western credits Amortization of Hoover Uprating Program costs Transmission and distribution Total operating expenses Operating income (loss) (110,356 ) (131,636 ) Other (deductions) income Interest expense - - ( 2,724,425 ) ( 2,862,363 ) ( 2,724,425) ( 2,862,363) Deferred interest expense - - 2,273,992 2,347,319 2,273,992 2,347,319 Amortization - - 114,453 120,255 114,453 120,255 177,172 131,356 617,421 619,109 794,593 750,465 29,834 67,927 11,768 27,556 41,602 95,483 207,006 199,283 293,209 251,876 500,215 451,159 96,650 67,647 434,705 493,992 531,355 561,639 4,116,173 4,048,526 ( 799,042 ) (1,293,034 ) 3,317,131 2,755,492 $ 4,212,823 $ 4,116,173 ( 364,337 ) ( 799,042 ) $ 3,848,486 $ 3,317,131 Interest income Other Total other (deductions) income Changes in net assets Net assets, beginning of year Net assets, end of year *the accompanying notes are an integral part of these financial statements – 19 – Statements of Cash Flows June 30, 2007 and 2006 APA General Fund Hoover Uprating Fund Total 2007 2006 2007 2006 2007 2006 $ 5,689,508 $ 5,759,578 $ 22,204,691 $ 21,651,791 $ 27,894,199 $ 27,411,369 Cash flows from operating activites Cash received from customers Cash payments to suppliers for goods ( 5,893,034 ) or services Cash payments to employees for services Net cash (used in) provided by operating activities Cash flows from capital and related ( 203,526 ) ( 5,991,416 ) ( 231,838 ) ( 22,089,056 ) ( 20,512,553) ( 27,982,090 ) ( 26,503,969 ) ( 709,205 ) ( 603,132) (709,205 ) ( 603,132 ) ( 593,570 ) 536,106 (797,096 ) 304,268 financing activities Interest payments on bonds payable - - ( 2,759,738 ) ( 2,894,363 ) ( 2,759,738 ) (2,894,363) Payments on bonds payable - - ( 2,825,000 ) ( 2,560,000 ) ( 2,825,000 ) ( 2,560,000 ) ( 3,083 ) (64,248 ) ( 443,082 ) ( 233,594 ) Acquisition of capital assets ( 3,083 ) ( 64,248 ) Other costs relating to Hoover Uprating Program - - Reduction in advances for Hoover Uprating Program - - Net cash (used in) provided by capital and related financing activities Cash flows from investing activities (443,082 ) 5,523,334 ( 233,594 ) 5,167,368 5,523,334 5,167,368 ( 64,248 ) (504,486 ) ( 520,589 ) (507,569) ( 584,837 ) 202,741 194,429 669,170 640,895 871,911 835,324 Purchase on investments - - ( 5,979,348 ) (7,467,429 ) (5,979,348) (7,467,429 ) Proceeds from sale and maturities of investments - - 5,692,273 7,295,443 5,692,273 7,295,443 202,741 194,429 382,095 468,909 584,836 663,338 (101,657 ) ( 715,961 ) 484,426 (719,829) 382,769 Interest on investments Net cash provided by (used in) investing activities Net change in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year ( 3,083 ) ( 3,868 ) 3,517,969 3,619,626 2,457,591 1,973,165 5,975,560 5,592,791 $ 3,514,101 3,517,969 $ 1,741,630 $ 2,457,591 $ 5,255,731 5,975,560 *the accompanying notes are an integral part of these financial statements – 20 – Statements of Cash Flows (continued) June 30, 2007 and 2006 APA General Fund 2007 Hoover Uprating Fund 2006 Total 2007 2006 2007 2006 $ 141,496 $ 242,116 $ 31,140 $ 110,480 Reconciliation of operating income (loss) to net cash provided by (used in) operating activities Operating income (loss) $ ( 110,356 ) $(131,636 ) Adjustments to reconcile operating income (loss) to net cash provided by (used in) operating activities Depreciation Loss on disposal of capital asset 38,694 40,265 - - 38,694 40,265 - - - - - - Changes in assets and liabilities (increase) decrease in accounts receivable ( 236,251) ( 134,389 ) ( 42,435) (168,170) (278,686 ) ( 302,559 ) (increase) decrease in other assets ( 128,097) ( 119,361 ) - - (128,097 ) ( 119,361 ) ( 614,895) (1,008,091) (614,895 ) (1,008,091 ) 24,717 (16,681) (increase) decrease in prepaid purchase power (increase) decrease in accounts payable and other (increase) decrease in customer refunds (increase) decrease in power contracts payable Total adjustments Net cash provided by (used in) operating activities ( 7,267) ( 18,200 ) ( 34,881 ) 17,450 ( 214,761 ) - - ( 214,761) 1,504,693 239,751 131,483 112,308 (17,761) 352,059 113,722 ( 93,170) (100,202 ) ( 735,066 ) 293,990 ( 828,236 ) 193,788 $ ( 203,526) $ ( 231,838 ) $ ( 593,570 ) $ 536,106 $ ( 797,096 ) 1,504,693 $ 304,268 Supplemental schedule of noncash capital and related financing activities Deferred interest expense Supplemental schedule of cash paid for interest $- $- $ 2,273,992 $ 2,347,319 $ 2,273,992 $ 2,347,319 - - 2,759,738 2,894,363 2,759,738 2,894,363 *the accompanying notes are an integral part of these financial statements – 21 – Notes to Financial Statements 1. Description of Business and Summary of Significant Accounting Policies Description of Business The Arizona Power Authority (the “Authority”) is a body, corporate and politic, without taxing power, established by the Arizona Legislature on May 27, 1944 by the Power Authority Act. Under the Power Authority Act, the Authority is directed to obtain electric power developed from the mainstream of the Colorado River and sell such power to certain qualified purchasers. The Power Authority Act provides that the Authority must be a self-supporting agency and prohibits the Authority from incurring any obligation, which would be binding upon the State of Arizona. The Authority supplies capacity and energy on a wholesale basis to certain power purchasers in the State of Arizona. The Authority’s primary source of power and energy is the Hoover Power Plant at Hoover Dam, located approximately 25 miles from Las Vegas, Nevada. Hoover power is produced by the Boulder Canyon Project hydropower plant owned by the Bureau of Reclamation. Hoover Dam is the highest and third largest concrete dam in the United States of America. Hoover Dam was dedicated in 1935 and the first generator of the Hoover Power Plant was in full operation in October 1936 and has been in continuous operation since. Power and energy from the Hoover Power Plant is transmitted to load centers in Arizona, California and Nevada. The Authority first contracted for Arizona’s share of Hoover power in 1952 and has continuously provided power and energy to its customers since that time. The Authority is governed by a commission of five members appointed by the Governor and approved by the State Senate (the “Commission”). The term of office for each member is six years and the members select a chairman and vice-chairman from among its membership for two-year terms. Pursuant to Arizona law, the Commission serves as the Authority’s regulatory body with the exclusive authority to establish electric prices. The Authority is required to follow certain procedures, pertaining to public notice requirements and public meetings, before implementing changes in electric price schedules. in the Statements of Net Assets. The Statements of Revenues, Expenses and Changes in Net Assets present increases (revenues) and decreases (expenses) in total net assets. The Authority’s reported total net assets are segregated into invested in capital assets and unrestricted components. Basis of Accounting Basis of Accounting refers to the time at which revenues and expenses are recognized in the accounts and reported in the financial statements, regardless of the measurement focus applied. The accrual basis of accounting is used by the Authority whereby revenues are recognized in the accounting period in which they are earned and become measurable, and expenses are recognized when incurred. The accompanying financial statements are presented in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying financial statements have been prepared in accordance with the reporting model defined by Governmental Accounting Standards Board (“GASB”) Statement No. 34, Basic Financial Statements - and Management’s Discussion and Analysis - for State and Local Governments, as amended by GASB Statement No. 37, Basic Financial Statements and Management’s Discussion and Analysis - for State and Local Governments: Omnibus - an Amendment of GASB Statements No. 21 and No. 34, and GASB Statement No. 38, Certain Financial Statement Note Disclosures. Accounting Standards GASB Statement No. 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, requires that governments’ proprietary activities apply all GASB pronouncements as well as pronouncements issued on or before November 30, 1989, unless those pronouncements conflict with or contradict GASB pronouncements, Financial Accounting Standards Board (“FASB”) Statements and Interpretations, Accounting Principles Board Opinions and Accounting Research Bulletins. Governments are given the option whether or not to apply all FASB Statements and Interpretations issued after November 30, 1989, except for those that conflict with or contradict GASB pronouncements. The Authority has elected not to implement FASB Statements and Interpretations issued after November 30, 1989. Measurement Focus The Authority’s funds are accounted for on a flow of economic resources measurement focus. All assets and liabilities (whether current or noncurrent) associated with their activity are included – 22 – New Accounting Pronouncements In September 2006, the GASB published Statement No. 48 (“GASB No. 48”), Sales and Pledges of Receivables and Future Revenues and Intra-Entity Transfers of Assets and Future Revenues. This Statement establishes accounting and financial reporting standards for transactions in which a government receives, or is entitled to, resources in exchange for future cash flows generated by collecting specific receivables or specific future revenues. It also contains provisions that apply to certain situations in which a government does not receive resources but, nevertheless, pledges or commits future cash flows generated by collecting specific future revenues. This Statement is effective for financial statements for periods beginning after December 15, 2006. The impact of GASB No. 48 is currently being evaluated by the Authority. Revenue Recognition The Authority recognizes revenue when power is delivered to the customers. Cash and Cash Equivalents The Authority treats short-term temporary cash investments with original maturities, when purchased, of three months or less as cash equivalents. All cash and cash equivalent balances are maintained by the State of Arizona Treasurer within the Local Government Investment Pool (“LGIP”). The LGIP is not registered with the Securities and Exchange Commission and investments are not subject to custodial credit risk. The State Board of Investment conducts monthly reviews of investment activity and performance. LGIP amounts are carried at fair value. Participant shares are purchased and sold based on the Net Asset Value (“NAV”) of the shares. The NAV is determined by dividing the fair value of the portfolio by the total shares outstanding. Capital Assets and Depreciation Capital assets are stated at original cost less accumulated depreciation. Depreciation is provided on the straight-line method based on the estimated useful lives of the property items, which range from 3 to 20 years. The costs of additions and replacements are capitalized. Repairs and maintenance are charged to expense as incurred. Retirements, sales and disposals are recorded by removing the cost and accumulated depreciation from the asset and accumulated depreciation accounts with any resulting gain or loss reflected in Other within the Statements of Revenues, Expenses and Changes in Net Assets. Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the fair value is less than the carrying amount of the asset, a loss is recognized for the difference. Advances for Hoover Uprating Program Proceeds from bonds payable were advanced by the Authority for uprating the Hoover Power Plant and are recorded as advances. Such advances, including debt issue costs, plus net interest expense incurred by the Authority are reimbursed in the form of credits on the monthly power bills rendered by the Western Area Power Administration of the Department of Energy (“Western”). These credits will be issued over the 30-year life of the bonds. Substantially all advances, net interest expense and other related costs on the bonds are charged to the Uprating Program as amounts to be recovered from future credits. These amounts are included in the Amortization of Hoover Uprating Program Costs in the Statement of Revenues, Expenses and Changes in Net Assets. Operating Revenues Operating revenues are derived from the sale of power to customers or from other contractual agreements. Operating revenues include $5,400,000 received each year from Salt River Project for scheduling entity services during the years ended June 30, 2007 and 2006. The revenues are the result of an agreement between the Authority and the Salt River Project which will yield $5,400,000 annual revenues to the Authority thereby reducing the overall revenue requirements to be paid by the Authority’s customers through power rates. The agreement will expire on September 30, 2011. Application of Net Assets to Expenses Incurred The Authority applies unrestricted, undesignated net assets to expenses incurred. To the extent undesignated net assets are unavailable, unrestricted, designated net assets will be applied to expenses incurred. – 23 – Customer Credits The Authority operates on a nonprofit basis and reduces charges to its customers through credits on power bills or checks to customers, for any revenues in excess of expenses after the close of the operating year. Likewise, the Authority bills its customers for any deficit in revenues versus expenses incurred during the operating year. an advancement of funds procedure whereby prospective nonfederal purchasers of the uprated Hoover capacity and associated energy contribute to the financing of the Uprating Program. The Uprating Program was determined to be complete in September 1995. The Authority financed a portion of the total Uprating Program by issuing bonds. During the year ended June 30, 2007, the accrued amount to be refunded to the customers was $1,289,933. The Hoover Uprating Fund accounts for advances by the Authority in connection with the Uprating Program. Effective June 1, 1987, the Authority executed new power contracts with Western and its customers which expire in 2017. The revenues and expenditures applicable to the sale and transmission of power and energy received by the Authority from Western under these contracts are accounted for in the Hoover Uprating Fund. Income Taxes APA General Fund Refunds of $1,504,693 and $297,405 were paid to the customers during the years ended June 30, 2007 and 2006, respectively. The Authority’s operations other than those applicable to the Hoover Uprating Fund are accounted for in the APA General Fund. The purchase of supplemental power and the sale and transmission of such power to the Authority’s customers comprise the majority of this fund’s activity. The Authority is exempt from federal and Arizona state income taxes. Accordingly, no provision for income taxes has been recorded for the Authority in the accompanying financial statements. Use of Estimates 3. Capital Assets, net The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Capital assets, net, of the APA General Fund at June 30, 2007 and 2006 were as follows: 2007 2006 $ 319,565 $ 319,565 Distribution plant 227,518 227,518 General plant 779,965 777,076 1,327,048 1,324,159 (1,126,889) (1,088,390) $ 200,159 $ 235,769 Transmission plant Geographic and Product Concentration The Authority’s revenues are derived from the sale of electrical power and services to water districts, electrical and irrigation districts, and cities, which represent contracted customers in the state of Arizona. The Hoover Uprating Fund is used to purchase electric power solely from Western. The Authority’s APA General Fund is used to purchase electric power from various providers. 2. Fund Accounting Hoover Uprating Fund Less: Accumilated depreciation Capital assets, net The Authority had additions of $3,084 and $64,248 for the years ended June 30, 2007 and 2006, respectively. The Authority had disposals of $195 and $13,980 for the years ended June 30, 2007 and 2006, respectively. The transmission and distribution plant is comprised of a substation and related equipment. Purchased power is delivered over transmission facilities owned by Western. The Hoover Power Plant Act of 1984 (“Hoover Act”) authorized the U.S. government to increase the capacity of existing generating equipment at the Hoover Dam Power Plant (“Uprating Program”). Instead of appropriating further federal funds for the Uprating Program, Congress implemented – 24 – 4. Advances for Hoover Uprating Program Advances for the Hoover Uprating Program were reimbursed by Western through credits on the Authority’s power bills in the amount of $5,523,334 and $5,167,368 for the years ended June 30, 2007 and 2006, respectively. Credits were received for the upraters’ portion of principal and interest expense on the bonds and other costs associated with the Hoover Uprating Program. 5. Bonds Payable Bonds payable consists of the following: June 30, 2006 Bond payable current $ 2,825,000 Bond payable long-term Total bonds payable Increases Reductions Transfers June 30, 2007 $ $ (2,825,000) $ 3,120,000 $ 3,120,000 - 52,135,000 $ 54,960,000 ( 3,120,000 ) $ - $ (2,825,000) $ - 49,015,000 $ 52,135,000 In prior years, the Authority defeased various issues of bonds by purchasing U.S. government securities which were deposited in an irrevocable trust with an escrow agent to provide for future debt service until the call dates. As a result, those bonds are considered to be defeased and the corresponding liability has been removed from the Hoover Uprating Fund. Accordingly, the trust account assets and related liabilities are not included in the Authority’s financial statements. The Authority’s outstanding bonds, totaling $52,135,000, bear interest ranging from 5.00% to 5.25%, are due from fiscal year 2007 through 2018, and are secured by the pledged property, as defined by the Resolution, which includes the proceeds from the sale of the bonds, rights and interest in various contracts and revenues. The Authority amortizes the bond premium (discount) using the effective interest method. Principal and interest amounts due over the next five fiscal years ending June 30 and thereafter are as follows: Principal Interest 2008 $ 3,120,000 $ 2,611,113 2009 3,450,000 2,446,863 2010 3,815,000 2,265,238 Crossover Refunding On September 12, 2001, the Authority issued $57,520,000 of Special Obligation Crossover Refunding Bonds. Proceeds from the sale of the 2,064,363 4,220,000 2011 bonds along with a fund contribution by the Authority were held in an 1,844,238 4,585,000 2012 escrow trust account invested in government securities until October 1, 5,284,258 26,725,000 2013-2017 2003 (the “Crossover Date”) when a crossover refunding took place. The crossover refunding resulted in $57,520,000 of Special Obligation 163,275 6,220,000 2018 Crossover Refunding Bonds being exchanged for 2001 Series Power Resource Revenue Refunding Bonds of the same principal amount, maturity date and interest rates as the crossover bonds. The Authority called the $62,630,000 of the 1993 Series Power Resource Revenue Refunding Bonds maturing on and after October 1, 2005. The proceeds in the government securities escrow trust account, together with the income realized from investment of trust assets served as collateral for the Special Obligation Crossover Bonds and paid the debt service on those bonds until the Crossover Date. The Special Obligation Crossover Bonds were payable solely from the amounts in the escrow trust account and were not payable from any other source. – 25 – As a result of the crossover refunding transaction on October 1, 2003, the 2001 Series Bonds are reflected as obligations of the Authority at June 30, 2007 and the called portion of the 1993 Series Bonds are no longer outstanding and cease to be entitled to any lien on the revenues pledged to payment of those bonds. Instead, the revenue stream originally pledged to secure the called portion of the 1993 Series Bonds “crossed over” to pay debt service on the 2001 Series Bonds on October 1, 2003. The 2001 Series Bonds bear interest at a rate of 5.00% and 5.25% payable on April 1 and October 1, respectively, of each year, commencing April 1, 2004 and maturing in 2017. In addition, the Authority recognized an economic gain (difference between the present value of the old and new debt service payments) of $2,095,648. The crossover refunding also resulted in the recognition of a deferred amount of $2,411,956 that has been reflected as a decrease in bonds payable and which will be amortized using the effective interest method as a component of interest expense over the life of the refunded bonds. The Authority amortized $245,460 and $257,883 for the years ended June 30, 2007 and 2006, respectively, resulting in a net deferred amount of $1,442,179 and $1,687,639 in the Statement of Net Assets, respectively. The Authority also recognized a premium of $3,536,652 on the crossover refunding which has been reflected as an increase in bonds payable and which will be amortized using the effective interest method. The Authority amortized $359,917 and $378,138 for the years ended June 30, 2007 and 2006, respectively, resulting in a net premium of bonds payable of $2,114,644 and $2,474,561 in the Statement of Net Assets, respectively. 6. Commitments and Contingencies The Lower Colorado Multi-Species Conservation Program (“MSCP”) is a cooperative effort between Federal and non-federal entities that will create more than 8,100 acres of riparian, marsh and backwater habitat for 31 species of fish, birds, mammals and plants. The program became effective on April 4, 2005 and expires April 30, 2055. As a party to this Agreement, the Arizona Power Authority’s financial obligation is approximately $119,000 per year (in 2003 dollars, adjusted annually for inflation). For the years ended June 30, 2007 and 2006, the Authority paid $133,518 and $128,877, respectively. The Authority is involved in various claims arising in the ordinary course of business, none of which, in the – 26 – opinion of management, if determined adversely against the Authority, will have a material adverse effect on the business financial condition or results of operations of the Authority. 7. Investments Held by Trustee As of June 30, 2007 and 2006, investments are collateralized with securities held by the Authority’s trustee. The fair value of the investment securities at June 30 is as follows: Repurchase agreement U.S. government securities Total investments held by Trustee 2007 2006 $ 6,546,641 $ 6,546,569 3,105,380 2,818,376 $ 9,652,021 $ 9,364,945 On October 2, 2006, the Authority entered into a repurchase and custody agreement with MBIA Investment Management Corporation (“IMC”) wherein the Authority agreed to effect a series of repurchase transactions with IMC, in investments allowable under the bond resolution agreements and state law, with a fixed earnings rate of 5.00%. The securities are held in trust by The Bank of New York. If at any time the aggregate market value of all purchased securities is less than the amount required under the repurchase and custody agreement (calculated using a percentage of 104%), the Authority may require IMC to transfer additional securities so the aggregate market value of all securities will equal or exceed such requirement. At June 30, 2007, the aggregate market value of all purchased securities exceeded the amount required under the repurchase and custody agreement. 8. Retirement Plan The Authority contributes to the retirement plan described below. Benefits are established by state statute and generally provide retirement, death, long-term disability, survivor, and health insurance premium benefits. The Arizona State Retirement System (the “Plan” or “ASRS”) administers a cost-sharing multiple-employer defined benefit pension plan that covers permanent, full-time employees of the Authority. The ASRS is governed by the Arizona State Retirement System Board according to the provisions of ARS Title 38, Chapter 5, Article 2. The ASRS issues a publicly available financial report that includes its financial statements and required supplementary information. By actuarial computation, employee member and Authority contributions to the Plan were fixed at 9.10% (8.60% retirement and 0.50% long-term disability) and 8.25% (7.75% retirement and 0.50% long-term disability) of their compensation for the years ended June 30, 2007 and 2006, respectively, with the contributions made through payroll deductions. Employee contributions vest immediately. Total contributions to the Plan for the years ended June 30, 2007 and 2006 by the Authority’s covered employees were $64,180 and $45,864, respectively. Matching employer member contributions were actuarially determined and fixed at the same rate as employee member contributions for the years ended June 30, 2007 and 2006. In the event the Plan’s actuary determines that additional contributions are needed in order to amortize an unfunded accrued liability, every employer member will be required to contribute the revised contribution percentage which is established by the Arizona State Legislature. All full-time employees of the Authority are required to become members of the Plan. The Authority’s total payroll for employees covered by this Plan for the years ended June 30, 2007 and 2006 was $709,205 and $603,132, respectively. Contributions to the Plan by the Authority for its covered employees vest over five years. All required employer contributions are made to the Plan by the end of each month. – 27 – 9. Additional Benefits In addition to the pension benefits described above, ASRS offers health care benefits to retired and disabled members who are no longer eligible for health care benefits through their former member employer’s group health plan. Retired is defined as actively receiving an annuity benefit and disabled is defined as receiving a long-term disability (“LTD”) benefit through the LTD program administered by ASRS. A premium benefit is applied to the member’s health insurance cost. The following chart illustrates the maximum amount of the monthly available benefit supplement for eligible members and their dependents: Member Years of Credited Service Member & Dependent(s) Percent of Premium Benefit Not Medicare Eligible Medicare Eligible Not Medicare Eligible Medicare Eligible 5.0-5.9 50% $ 75.00 $ 50.00 $ 130.00 $ 85.00 6.0-6.9 60% 90.00 60.00 156.00 102.00 7.0-7.9 70% 105.00 70.00 182.00 119.00 8.0-8.9 80% 120.00 80.00 208.00 136.00 9.0-9.9 90% 135.00 90.00 234.00 153.00 10.0+ 100% 150.00 100.00 260.00 170.00 10. Purchased Power, Sales and Transmission Commitments The Authority is party to Firm Electric Service and Transmission Service Contracts with terms expiring September 30, 2017. This requires the Authority to pay approximately 19% of Western’s revenue requirements each operating year until the contract expires. During the years ended June 30, 2007 and 2006, the Authority paid $15,325,421 and $13,453,282, respectively, for purchased power under this contract. The Authority is obligated to pay these costs under the contract even in the unlikely event that no power is supplied. The Authority also has a contract with Western for transmission services. During the years ended June 30, 2007 and 2006, the Authority paid $5,293,357 and $5,258,562, respectively, for transmission costs to Western. On January 24, 2003, the Authority entered into the Advancement of Funds for Transmission Services contract with Western. The contract provides for the Authority to advance funds to Western on a monthly basis to fund operations, maintenance and replacement costs associated with Western’s transmission services. The advanced funds are then applied to the subsequent month’s transmission invoice. As of June 30, 2007 and 2006, the Authority recognized a prepaid deposit of $182,360 that is refundable upon termination of the contract. The Authority has sales contracts with all customers. Under these contracts, customers are obligated to pay for their percentage allocation if any Hoover power is delivered or made available for delivery. These sales contracts expire September 30, 2017, but some can be terminated by the Authority on June 1, 2007 or thereafter. The Authority also has contracts with Salt River Project for the purchase and transmission of power to the Authority’s customers. Under the transmission contract, the Authority must pay an annual transmission fee of $63,898 until September 30, 2017. The Authority has a power contract with SRP in which supplemental power purchases can be made by the Authority on behalf of its customers. There are no minimum quantities that the Authority is required to purchase. This agreement is applicable when supplemental power is necessary, during such times of low production of Hoover energy, and during summer months when customers require higher levels of energy. During the years ended June 30, 2007 and 2006, the Authority paid $6,034,405 and $5,950,918, respectively, for purchased power under this contract for its customers. – 28 – Debt Service Coverage Ratio NET INCOME $ 434,705 Add: Interest Expense Amortization Depreciation Western Credits Credits to Customers for Prior Years $ 2,724,425 $ 245,460 $ 25,655 $ 5,523,334 $ 1,289,933 Total Additions $ 10,243,512 Deduct: Deferred Interest Expenses Premium Amortization Total Deductions (2,273,992) $ (359,913) $ (2,633,905) Income available for debt service $ 7,609,607 Debt Service $ 5,770,676 Debt service Coverage ratio 1.32 Note: Interest expense, depreciation expense and amortization of Uprating Costs are not expenses under the Bond Resolution. Debt Service is the total of Principal and Interest Expense accrued between July 1, 2006 and June 30, 2007.