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**FORM      10-Q**

**QUARTERLY      REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**                                   THE SECURITIES EXCHANGE ACT OF 1934**

**TRANSITION      REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**                                   THE SECURITIES EXCHANGE ACT OF 1934**

|   | CommissionFile                Number | Registrant;                State of Incorporation;Address;                and Telephone Number                                                                                                                                                    | IRS                EmployerIdentification                Number |
|--------|--------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|
|   |                                 |                                                                                                                                                                                                                                              |                                                            |
|   | 1-13739                              | **UNISOURCE                ENERGY CORPORATION**(An                Arizona                Corporation)One                South                Church Avenue, Suite 100Tucson,                AZ                85701(520)                571-4000  | 86-0786732                                                      |
|   |                                 |                                                                                                                                                                                                                                              |                                                            |
|   | 1-5924                               | **TUCSON                ELECTRIC POWER COMPANY**(An                Arizona                Corporation)One                South                Church Avenue, Suite 100Tucson,                AZ                85701(520)                571-4000 | 86-0062700                                                      |

|   | Indicate                by                check mark whether the registrant is a large accelerated filer, an                accelerated filer or a                non-accelerated |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | UniSource                  Energy Corporation                                                                                                                                        | Large                  Accelerated Filer X  Accelerated Filer__ Non-accelerated                  filer__ |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------|
|   | Tucson                  Electric Power Company                                                                                                                                       | Large                  Accelerated Filer__ Accelerated Filer__ Non-accelerated filer                  X       |
|   |                                                                                                                                                                                 |                                                                                                               |   |   |
|   | Indicate                  by                  check mark whether the registrant is a shell company (as defined                  in Rule                  12b-2 of the Exchange Act). |
|   | UniSource                  Energy Corporation                                                                                                                                        | Yes                                                                                                                | No                  X |   |
|   | Tucson                  Electric Power Company                                                                                                                                       | Yes                                                                                                                | No                  X |   |

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**Tableof      Contents**

| Definitions                                                                                                                         | iv                                                                                                                                                    |
|-------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| **--PART                I --**                                                                                                      |
|                                                                                                                                |                                                                                                                                                  |
| Reports                of Independent Registered Public Accounting                Firm                                              | 1                                                                                                                                                     |
|                                                                                                                                |                                                                                                                                                  |
| Item                1. - Financial Statements                                                                                       | 3                                                                                                                                                     |
|                                                                                                                                | UniSource                Energy Corporation                                                                                                           |   |
|                                                                                                                                | Comparative                Condensed Consolidated Statements of Income                                                                                | 3 |
|                                                                                                                                | Comparative                Condensed Consolidated Statements of                Cash Flows                                                             | 4 |
|                                                                                                                                | Comparative                Condensed Consolidated Balance                Sheets                                                                       | 5 |
|                                                                                                                                | Condensed                Consolidated Statement of Changes in                Stockholders’ Equity and Comprehensive                Income  | 7  |
|                                                                                                                                | Tucson                Electric Power Company                                                                                                          |   |
|                                                                                                                                | Comparative                Condensed Consolidated Statements of Income                                                                                | 8 |
|                                                                                                                                | Comparative                Condensed Consolidated Statements of                Cash Flows                                                             | 9 |
|                                                                                                                                | Comparative                Condensed Consolidated Balance                Sheets                                                                       | 10 |
|                                                                                                                                | Condensed                Consolidated Statement of Changes in                Stockholder’s Equity and Comprehensive                Income       | 12 |
|                                                                                                                                | Notes                to Condensed Consolidated Financial                Statements                                                                    | 13 |
|                                                                                                                                | Note                1. Nature of Operations and Basis of Accounting                Presentation                                                       | 13 |
|                                                                                                                                | Note                2. Regulatory Matters                                                                                                             | 13 |
|                                                                                                                                | Note                3. Debt and Capital Leases                                                                                                        | 19 |
|                                                                                                                                | Note                4. Business Segments                                                                                                              | 21 |
|                                                                                                                                | Note                5. Accounting for Derivative Instruments and Trading                Activities                                                    | 22 |
|                                                                                                                                | Note                6. Commitments and Contingencies                                                                                                  | 25 |
|                                                                                                                                | Note                7. Discontinued Operations - Sale of Global                Solar                                                                  | 27 |
|                                                                                                                                | Note                8. TEP Wholesale Accounts Receivable and                Allowances                                                                | 28 |
|                                                                                                                                | Note                9. UniSource Energy Earnings Per Share                (EPS)                                                                       | 28 |
|                                                                                                                                | Note                10. Employee Benefits Plans                                                                                                       | 29 |
|                                                                                                                                | Note                11. Share-Based Compensation Plans                                                                                                | 30 |
|                                                                                                                                | Note                12. Income and Other Taxes                                                                                                        | 33 |
|                                                                                                                                | Note                13. Utility Plant and Jointly-Owned                Facilities                                                                     | 34 |
|                                                                                                                                | Note                14. New Accounting Pronouncements                                                                                                 | 34 |
|                                                                                                                                | Note                15. Supplemental Cash Flow Information                                                                                            | 36 |
|                                                                                                                                | Note                16. Review of Independent Registered Public Accounting                Firm                                                        | 37 |
|                                                                                                                                |                                                                                                                                                  |
| Item                2. - Management’s Discussion and Analysis of Financial Condition                and Results of Operations | 38                                                                                                                                                    |
|                                                                                                                                | UniSource                Energy Consolidated                                                                                                          | 38 |
|                                                                                                                                | Overview                of Consolidated Business                                                                                                      | 38 |
|                                                                                                                                | Outlook                and Strategies                                                                                                                 | 38 |
|                                                                                                                                | Results                of Operations                                                                                                                  | 39 |
|                                                                                                                                | Contribution                by Business                Segment                                                                                        | 40 |
|                                                                                                                                | Liquidity                and Capital Resources                                                                                                        | 42 |
|                                                                                                                                | Tucson                Electric Power Company                                                                                                          | 48 |
|                                                                                                                                | Results                of Operations                                                                                                                  | 48 |
|                                                                                                                                | Factors                Affecting Results of                Operations                                                                                 | 53 |
|                                                                                                                                | Liquidity                and Capital Resources                                                                                                        | 58 |
|                                                                                                                                | UNS                Gas                                                                                                                                | 64 |
|                                                                                                                                | Results                of Operations                                                                                                                  | 64 |
|                                                                                                                                | Factors                Affecting Results of                Operations                                                                                 | 65 |
|                                                                                                                                | Liquidity                and Capital                Resources                                                                                         | 67 |
|                                                                                                                                | UNS                Electric                                                                                                                           | 68 |
|                                                                                                                                | Results                of Operations                                                                                                                  | 69 |
|                                                                                                                                | Factors                Affecting Results of                Operations                                                                                 | 70 |

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|                                                                                                              | Liquidity                and Capital                Resources                           | 70 |
|-------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|----|
|                                                                                                              | Other                                                                                   | 72 |
|                                                                                                              | Results                of Operations                                                    | 72 |
|                                                                                                              | Critical                Accounting Estimates                                            | 73 |
|                                                                                                              | New                Accounting Pronouncements                                            | 80 |
|                                                                                                              | Safe                Harbor for Forward-Looking                Statements                | 81 |
|                                                                                                              |                                                                                    |
| Item                3. - Quantitative and Qualitative Disclosures about                Market                Risk | 82                                                                                      |
|                                                                                                              |                                                                                    |
| Item                4. - Controls and Procedures                                                                  | 86                                                                                      |
|                                                                                                              |                                                                                    |
| PART                II - OTHER INFORMATION                                                                        |
|                                                                                                              |
| Item                1. - Legal Proceedings                                                                        | 87                                                                                      |
|                                                                                                              |                                                                                    |
| Item                1A - Risk Factors                                                                             | 88                                                                                      |
|                                                                                                              |                                                                                    |
| Item                5. - Other Information                                                                        | 88                                                                                      |
|                                                                                                              | Non-GAAP                Measures                                                        | 88 |
|                                                                                                              | Ratio                of Earnings to Fixed Charges                                       | 91 |
|                                                                                                              | SEC                Reports Available on UniSource Energy’s                Website | 91 |
|                                                                                                              |                                                                                    |
| Item                6. Exhibits                                                                                   | 91                                                                                      |
|                                                                                                              |                                                                                    |
| Signatures                                                                                                        | 92                                                                                      |
|                                                                                                              |                                                                                    |
| Exhibit                Index                                                                                      | 93                                                                                      |

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**DEFINITIONS**

| 1992                  Mortgage                                | TEP’s                  Indenture of Mortgage and Deed of Trust, dated as of December 1,                  1992, to                  the Bank of New York, successor trustee, as                  supplemented.                                                        |
|---------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1992                  Mortgage                  Bonds         | Bonds                  issued                  under the 1992 Mortgage.                                                                                                                                                                                                    |
| ACC                                                           | Arizona                  Corporation Commission.                                                                                                                                                                                                                           |
| ACC                  Holding                  Company Order   | The                  order                  approved by the ACC in November 1997 allowing TEP to form a holding                  company.                                                                                                                                  |
| AMT                                                           | Alternative                  Minimum Tax.                                                                                                                                                                                                                                  |
| Btu                                                           | British                  thermal unit(s).                                                                                                                                                                                                                                  |
| Capacity                                                      | The                  ability                  to produce power; the most power a unit can produce or the maximum                  that                  can be taken under a contract; measured in MWs.                                                                    |
| Citizens                                                      | Citizens                  Communications Company.                                                                                                                                                                                                                          |
| Common                  Stock                                 | UniSource                  Energy’s common stock, without par value.                                                                                                                                                                                                 |
| Company                  or                  UniSource Energy | UniSource                  Energy Corporation.                                                                                                                                                                                                                             |
| Cooling                  Degree Days                          | An                  index used                  to measure the impact of weather on energy usage calculated by                  subtracting                  75 from the average of the high and low daily                  temperatures.                                  |
| Emission                  Allowance(s)                        | An                  allowance                  issued by the EPA which  permits                  emission of one ton of sulfur dioxide or one ton of nitrogen oxide.                  These                  allowances can be bought and sold.                       |
| Energy                                                        | The                  amount of                  power produced over a given period of time; measured  in                  MWh.                                                                                                                                        |
| EPA                                                           | Environmental                  Protection Agency.                                                                                                                                                                                                                          |
| ESP                                                           | Energy                  Service Provider.                                                                                                                                                                                                                                  |
| FAS                  71                                       | Statement                  of                  Financial Accounting Standards No. 71: Accounting for the Effects                  of                  Certain Types of Regulation.                                                                                         |
| FAS                  133                                      | Statement                  of                  Financial Accounting Standards No. 133: Accounting for Derivative                  Instruments and Hedging Activities, as amended.                                                                                          |
| FAS                  143                                      | Statement                  of                  Financial Accounting Standards No. 143: Accounting for Asset Retirement                  Obligations.                                                                                                                       |
| FERC                                                          | Federal                  Energy Regulatory Commission.                                                                                                                                                                                                                     |
| Fixed                  CTC                                    | Competitive                  Transition Charge representing $0.009 that is included in TEP’s average                  retail rate of $0.083 per kWh.                                                                                                                 |
| Four                  Corners                                 | Four                  Corners                  Generating Station.                                                                                                                                                                                                         |
| Global                  Solar                                 | Global                  Solar                  Energy, Inc., a company that develops and manufactures thin-film                  photovoltaic cells. Millennium sold its interest in Global Solar                  in March                  2006.                         |
| Haddington                                                    | Haddington                  Energy Partners II, LP, a limited partnership that funds energy-related                  investments.                                                                                                                                          |
| IPS                                                           | Infinite                  Power Solutions, Inc., a company that develops thin-film batteries.                  Millennium owns 8.9% of IPS.                                                                                                                                |
| IRS                                                           | Internal                  Revenue Service.                                                                                                                                                                                                                                 |
| kWh                                                           | Kilowatt-hour(s).                                                                                                                                                                                                                                                          |
| kV                                                            | Kilovolt(s).                                                                                                                                                                                                                                                               |
| LIBOR                                                         | London                  Interbank Offered Rate.                                                                                                                                                                                                                            |
| Luna                                                          | Luna                  Energy                  Facility.                                                                                                                                                                                                                    |
| Mark-to-Market                  Adjustments                   | Forward                  energy sales and purchase contracts that are considered to be derivatives                  are adjusted monthly by recording unrealized gains and losses to                  reflect                  the market prices at the end of each month. |
| MEG                                                           | Millennium                  Environment Group, Inc., a wholly-owned subsidiary of Millennium,                  which                  manages and trades emission allowances and related financial                  instruments.                                           |
| MicroSat                                                      | MicroSat                  Systems, Inc., a company formed to develop and commercialize small-scale                  satellites. Millennium sold its investment in MicroSat in January                  2006.                                                               |

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| Millennium                                                      | Millennium                  Energy Holdings, Inc., a wholly-owned subsidiary of UniSource                  Energy.                                                                                                                                                                                                                                        |
|-----------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| MMBtu                                                           | Million                  British Thermal Units.                                                                                                                                                                                                                                                                                                           |
| MW                                                              | Megawatt(s).                                                                                                                                                                                                                                                                                                                                              |
| MWh                                                             | Megawatt-hour(s).                                                                                                                                                                                                                                                                                                                                         |
| Navajo                                                          | Navajo                  Generating Station.                                                                                                                                                                                                                                                                                                               |
| NOL                                                             | Net                  Operating                  Loss carryback or carryforward for income tax purposes.                                                                                                                                                                                                                                                   |
| Phelps                  Dodge                  Decision         | An                  Arizona                  Court of Appeals decision issued in 2005 that invalidated portions                  of the                  ACC’s Retail Electric Competition Rules.                                                                                                                                                   |
| PGA                                                             | Purchased                  Gas                  Adjuster, a retail rate mechanism designed to recover the cost                  of gas                  purchased for retail gas customers.                                                                                                                                                               |
| PPFAC                                                           | Purchased                  Power and Fuel Adjustment Clause.                                                                                                                                                                                                                                                                                              |
| PWCC                                                            | Pinnacle                  West                  Capital Corporation.                                                                                                                                                                                                                                                                                      |
| Rules                                                           | Retail                  Electric Competition Rules.                                                                                                                                                                                                                                                                                                       |
| San                  Juan                                       | San                  Juan                  Generating Station.                                                                                                                                                                                                                                                                                            |
| Settlement                  Agreement                           | TEP’s                  Settlement Agreement approved by the ACC in November 1999 that                  provided                  for electric retail competition and transition asset                  recovery.                                                                                                                                    |
| Springerville                                                   | Springerville                  Generating Station.                                                                                                                                                                                                                                                                                                        |
| Springerville                  Coal Handling Facilities Leases  | Leveraged                  lease arrangements relating to the coal handling facilities serving                  Springerville.                                                                                                                                                                                                                            |
| Springerville                  Common Facilities                | Facilities                  at                  Springerville used in common with Springerville Unit 1 and Springerville                  Unit 2 and partly by Springerville Unit 3.                                                                                                                                                                      |
| Springerville                  Common Facilities Leases         | Leveraged                  lease arrangements relating to an undivided one-half interest in                  certain                  Springerville Common Facilities.                                                                                                                                                                                    |
| Springerville                  Unit 1                           | Unit                  1 of the                  Springerville Generating Station.                                                                                                                                                                                                                                                                         |
| Springerville                  Unit 1 Leases                    | Leveraged                  lease arrangements relating to Springerville Unit 1 and an undivided                  one-half interest in certain Springerville Common                  Facilities.                                                                                                                                                           |
| Springerville                  Unit 2                           | Unit                  2 of the                  Springerville Generating Station.                                                                                                                                                                                                                                                                         |
| Springerville                  Unit 3                           | Unit                  3 of the                  Springerville Generating Station.                                                                                                                                                                                                                                                                         |
| SRP                                                             | Salt                  River                  Project Agricultural Improvement and Power District.                                                                                                                                                                                                                                                         |
| Sundt                                                           | H.                  Wilson                  Sundt Generating Station (formerly known as the Irvington Generating                  Station).                                                                                                                                                                                                               |
| SWG                                                             | Southwest                  Gas                  Corporation.                                                                                                                                                                                                                                                                                              |
| TEP                                                             | Tucson                  Electric Power Company, the principal subsidiary of UniSource                  Energy.                                                                                                                                                                                                                                            |
| TEP                  Credit                  Agreement          | Amended                  and                  Restated Credit Agreement between TEP and a syndicate of banks,                  dated as                  of August 11, 2006.                                                                                                                                                                              |
| TEP                  Guarantee                  Home Program    | The                  TEP Home                  Guarantee Program provides incentives to new home builders to construct                  homes that meet the highest construction and energy-efficient standards                  available.                                                                                                               |
| TEP                  Revolving                  Credit Facility | Revolving                  credit facility under the TEP Credit Agreement.                                                                                                                                                                                                                                                                                |
| Therm                                                           | A                  unit of                  heating value equivalent to 100,000 British thermal units                  (Btu).                                                                                                                                                                                                                             |
| Track                  A                                        | An                  order                  issued by the ACC in 2002 which granted a waiver from the requirement                  in                  TEP’s Settlement Agreement that TEP transfer its generating assets                  to a                  subsidiary.                                                                         |
| Track                  B                                        | An                  order                  issued by the ACC in 2003 which defined a competitive bidding process                  TEP                  must use to obtain capacity and energy requirements beyond what                  is                  supplied by TEP’s existing resources for the period 2003 through                  2006. |
| Tri-State                                                       | Tri-State                  Generation and Transmission Association.                                                                                                                                                                                                                                                                                       |
| UED                                                             | UniSource                  Energy Development Company, a wholly-owned subsidiary of UniSource                  Energy,                  which engages in developing generation resources and other project                  development services and related                  activities.                                                                 |

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| UES                                                             | UniSource                  Energy Services, Inc., an intermediate holding company established                  to own                  the operating companies (UNS Gas and UNS Electric) which acquired                  the                  Citizens’ Arizona gas and electric utility assets in                  2003. |
|-----------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| UES                  Settlement Agreement                       | An                  agreement                  with the ACC Staff dated April 1, 2003, addressing rate case and                  financing                  issues in the acquisition by UniSource Energy of Citizens’ Arizona gas and                  electric assets.                                                   |
| UniSource                  Credit Agreement                     | Amended                  and                  Restated Credit Agreement between UniSource Energy and a syndicate                  of                  banks, dated as of August 11, 2006.                                                                                                                                        |
| UniSource                  Energy                               | UniSource                  Energy Corporation.                                                                                                                                                                                                                                                                                   |
| UNS                  Electric                                   | UNS                  Electric,                  Inc., a wholly-owned subsidiary of UES, which acquired the Citizens                  Arizona electric utility assets in 2003.                                                                                                                                                    |
| UNS                  Gas                                        | UNS                  Gas,                  Inc., a wholly-owned subsidiary of UES, which acquired the Citizens                  Arizona gas utility assets in 2003.                                                                                                                                                              |
| UNS                  Gas/UNS                  Electric Revolver | Revolving                  credit facility under the Amended and Restated Credit Agreement                  among UNS                  Gas and UNS Electric as borrowers, and UES as guarantor, and a                  syndicate                  of banks, dated as of August 11, 2006.                                         |
| Valencia                                                        | Valencia                  power plant owned by UNS Electric.                                                                                                                                                                                                                                                                     |

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**Reportof      Independent Registered Public Accounting Firm**

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**Report      of      Independent Registered Public Accounting Firm **

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|  PARTI                    - FINANCIAL INFORMATION                                                                        |
|-------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **ITEM1.                    FINANCIAL STATEMENTS**                                                                            |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **UNISOURCEENERGY                    CORPORATION**                                                                            |
| **COMPARATIVECONDENSED                    CONSOLIDATED STATEMENTS OF                    INCOME**                              |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| Three                    Months                    Ended                                                                      |   |   |   | Nine                    Months                    Ended |
| September                    30,                                                                                              |   |   |   | September                    30, |
| **2006**                                                                                                                      |   | **2005** |   |   |   | **2006** |   | **2005** |
| **(Unaudited)**                                                                                                               |   |   |   | **(Unaudited)** |
| -Thousands                    of                    Dollars- (Except                    Per                    Share Amounts) |   |   | -Thousands                    of                    Dollars- (Except                    Per Share Amounts) |
|                                                                                                                          |   |   |   | **Operating                    Revenues** |   |   |   |   |
| **$                    298,641**                                                                                              |   | $                    296,003 |   |                      Electric Retail Sales |   | **$                    728,697** |   | $                    699,378 |
| **46,488**                                                                                                                    |   | 30,830 |   |                      Electric Wholesale Sales |   | **137,790** |   | 107,881 |
| **20,615**                                                                                                                    |   | 16,231 |   |  Gas                    Revenue |   | **109,150** |   | 88,838 |
| **9,896**                                                                                                                     |   | 3,934 |   |  Other                    Revenues |   | **23,352** |   | 10,866 |
| **375,640**                                                                                                                   |   | 346,998 |   | **                       Total Operating Revenues** |   | **998,989** |   | 906,963 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                                                                                          |   |   |   | **Operating                    Expenses** |   |   |   |   |
| **78,301**                                                                                                                    |   | 66,510 |   |                      Fuel |   | **197,660** |   | 169,664 |
| **91,327**                                                                                                                    |   | 105,982 |   |                      Purchased Energy |   | **250,417** |   | 239,286 |
| **59,856**                                                                                                                    |   | 49,048 |   |  Other                    Operations and Maintenance |   | **175,406** |   | 166,964 |
| **33,330**                                                                                                                    |   | 33,136 |   |                      Depreciation and Amortization |   | **96,767** |   | 99,800 |
| **21,959**                                                                                                                    |   | 20,242 |   |                      Amortization of Transition Recovery Asset |   | **51,080** |   | 43,865 |
| **10,232**                                                                                                                    |   | 10,248 |   |  Taxes                    Other Than Income Taxes |   | **35,145** |   | 36,037 |
| **295,005**                                                                                                                   |   | 285,166 |   | **                       Total Operating Expenses** |   | **806,475** |   | 755,616 |
| **80,635**                                                                                                                    |   | 61,832 |   | **                         Operating Income** |   | **192,514** |   | 151,347 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                                                                                          |   |   |   | **Other                    Income (Deductions)** |   |   |   |   |
| **4,582**                                                                                                                     |   | 4,657 |   |                      Interest Income |   | **14,651** |   | 14,694 |
| **1,814**                                                                                                                     |   | 3,261 |   |  Other                    Income |   | **5,436** |   | 6,064 |
| **(206)**                                                                                                                     |   | (25) |   |  Other                    Expense |   | **(1,181)** |   | (2,267) |
| **6,190**                                                                                                                     |   | 7,893 |   | **                       Total Other Income (Deductions)** |   | **18,906** |   | 18,491 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                                                                                          |   |   |   | **Interest                    Expense** |   |   |   |   |
| **18,855**                                                                                                                    |   | 18,002 |   |                      Long-Term Debt |   | **56,747** |   | 58,098 |
| **17,974**                                                                                                                    |   | 20,078 |   |                      Interest on Capital Leases |   | **55,047** |   | 59,225 |
| **1,080**                                                                                                                     |   | - |   |  Loss                    on Extinguishment of Debt |   | **1,080** |   | 5,261 |
| **4,303**                                                                                                                     |   | 833 |   |  Other                    Interest Expense |   | **6,876** |   | 2,502 |
| **(1,304)**                                                                                                                   |   | (845) |   |                      Interest Capitalized |   | **(4,652)** |   | (3,234) |
| **40,908**                                                                                                                    |   | 38,068 |   | **                       Total Interest Expense** |   | **115,098** |   | 121,852 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **45,917**                                                                                                                    |   | 31,657 |   | **Income                    from Continuing Operations before Income Taxes** |   | **96,322** |   | 47,986 |
| **17,714**                                                                                                                    |   | 11,856 |   |  Income                    Tax Expense |   | **38,630** |   | 19,483 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **28,203**                                                                                                                    |   | 19,801 |   | **Income                    from Continuing Operations** |   | **57,692** |   | 28,503 |
| **-**                                                                                                                         |   | (1,404) |   | **Discontinued                    Operations - Net of Tax** |   | **(2,669)** |   | (4,421) |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **$                    28,203**                                                                                               |   | $                    18,397 |   | **Net                    Income** |   | **$                    55,023** |   | $                    24,082 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **35,308**                                                                                                                    |   | 34,863 |   | **Weighted-average                    Shares of Common Stock Outstanding (000)** |   | **35,223** |   | 34,734 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                                                                                          |   |   |   | **Basic                    Earnings (Loss) per Share** |   |   |   |   |
| **$                    0.80**                                                                                                 |   | $                    0.57 |   | **                     Income from Continuing Operations** |   | **$                    1.64** |   | $                    0.82 |
| **-**                                                                                                                         |   | (0.04) |   | **                     Discontinued Operations - Net of Tax** |   | **(0.08)** |   | (0.13) |
| **$                    0.80**                                                                                                 |   | $                    0.53 |   | **                     Net Income** |   | **$                    1.56** |   | $                    0.69 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
|                                                                                                                          |   |   |   | **Diluted                    Earnings (Loss) per Share** |   |   |   |   |
| **$                    0.73**                                                                                                 |   | $                    0.53 |   | **                     Income from Continuing Operations** |   | **$                    1.53** |   | $                    0.80 |
| **-**                                                                                                                         |   | (0.04) |   | **                     Discontinued Operations - Net of Tax** |   | **      (0.07)** |   | (0.12) |
| **$                    0.73**                                                                                                 |   | $                    0.49 |   | **                     Net Income** |   | **$                    1.46** |   | $                    0.68 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| **$                    0.21**                                                                                                 |   | $                    0.19 |   | **Dividends                    Declared per Share** |   | **$                    0.63** |   | $                    0.57 |
|                                                                                                                          |   |   |   |   |   |   |   |   |
| See                    Notes to                    Condensed Consolidated Financial                    Statements.            |

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| **UNISOURCE                    ENERGY CORPORATION**                                                  |
|------------------------------------------------------------------------------------------------------|
| **COMPARATIVECONDENSED                    CONSOLIDATED STATEMENTS OF                    CASH FLOWS** |

|                                                                                                                          |   | Nine                      Months                      Ended      |         |
|-------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------|--------------|
|                                                                                                                          |   | September                      30,                               |         |
|                                                                                                                          |   | **2006**                                                         |         | **2005** |   |
|                                                                                                                          |   | **(Unaudited)**                                                  |         |
|                                                                                                                          |   | -Thousands                      of                      Dollars- |         |
| **Cash                      Flows from Operating Activities**                                                                 |   |                                                             |         |   |   |
|     Cash                      Receipts from Electric Retail Sales                                         |   | **$**                                                            | **759,535**  |   | $ | 730,791 |   |
|                          Cash Receipts from Electric Wholesale Sales                                           |   |                                                             | **180,832**  |   |   | 156,408 |   |
|                          Cash Receipts from Gas Sales                                                          |   |                                                             | **139,334**  |   |   | 115,484 |   |
|                          MEG Cash Receipts from Trading Activity                                               |   |                                                             | **194**      |   |   | 62,414 |   |
|                          Interest Received                                                                     |   |                                                             | **21,345**   |   |   | 22,400 |   |
|                          Performance Deposits                                                                  |   |                                                             | **5,666**    |   |   | 14,506 |   |
|                          Sale of Excess Emission Allowances                                                    |   |                                                             | **7,081**    |   |   | 9,242 |   |
|                          Income Tax Refunds Received                                                           |   |                                                             | **553**      |   |   | 1,484 |   |
|                          Other Cash Receipts                                                                   |   |                                                             | **8,531**    |   |   | 5,495 |   |
|                          Fuel Costs Paid                                                                       |   |                                                             | **(184,417** | **)** |   | (172,852 | ) |
|                          Purchased Energy Costs Paid                                                           |   |                                                             | **(288,399** | **)** |   | (276,583 | ) |
|                          Wages Paid, Net of Amounts Capitalized                                                |   |                                                             | **(77,429**  | **)** |   | (71,731 | ) |
|                          Payment of Other Operations and Maintenance Costs                                     |   |                                                             | **(107,754** | **)** |   | (111,419 | ) |
|                          MEG Cash Payments for Trading Activity                                                |   |                                                             | **(812**     | **)** |   | (73,899 | ) |
|                          Capital Lease Interest Paid                                                           |   |                                                             | **(62,780**  | **)** |   | (67,693 | ) |
|                          Taxes Paid, Net of Amounts Capitalized                                                |   |                                                             | **(98,886**  | **)** |   | (94,729 | ) |
|                          Interest Paid, Net of Amounts Capitalized                                             |   |                                                             | **(58,504**  | **)** |   | (62,833 | ) |
|                          Income Taxes and Related Interest Paid                                                |   |                                                             | **(40,220**  | **)** |   | (5,777 | ) |
|                          Excess Tax Benefit from Stock Option Exercises                                        |   |                                                             | **(1,106**   | **)** |   | (1,945 | ) |
|                          Net Cash Used by Operating Activities of Discontinued                      Operations |   |                                                             | **(2,710**   | **)** |   | (4,789 | ) |
|                          Other Cash Payments                                                                   |   |                                                             | **(2,763**   | **)** |   | (3,556 | ) |
| **Net                      Cash Flows – Operating Activities**                                                          |   |                                                             | **197,291**  |   |   | 170,418 |   |
|                                                                                                                          |   |                                                             |         |   |   |   |   |
| **Cash                      Flows from Investing Activities**                                                                 |   |                                                             |         |   |   |   |   |
|                          Capital Expenditures                                                                  |   |                                                             | **(158,755** | **)** |   | (139,445 | ) |
|                          Payments for Investment in Lease Equity                                               |   |                                                             | **(48,025**  | **)** |   | - |   |
|                          Sale of Subsidiary                                                                    |   |                                                             | **16,000**   |   |   | - |   |
|                          Proceeds from Investment in Lease Debt                                                |   |                                                             | **22,158**   |   |   | 13,646 |   |
|                          Return of Investment from Millennium                                                  |   |                                                             | **4,743**    |   |   | 8,978 |   |
|                          Proceeds from Sale of Land                                                            |   |                                                             | **-**        |   |   | 2,255 |   |
|                          Other Cash Receipts                                                                   |   |                                                             | **2,178**    |   |   | 6,542 |   |
|                          Investment in and Loans to Equity Investees                                           |   |                                                             | **(4,518**   | **)** |   | (4,270 | ) |
|                          Net Cash Used by Investing Activities of Discontinued                      Operations |   |                                                             | **(46**      | **)** |   | (53 | ) |
|                          Other Cash Payments                                                                   |   |                                                             | **(1,487**   | **)** |   | - |   |
| **Net                      Cash Flows - Investing Activities**                                                                |   |                                                             | **(167,752** | **)** |   | (112,347 | ) |
|                                                                                                                          |   |                                                             |         |   |   |   |   |
| **Cash                      Flows from Financing Activities**                                                                 |   |                                                             |         |   |   |   |   |
|                          Proceeds from Borrowings under Revolving Credit Facilities                            |   |                                                             | **155,000**  |   |   | 40,000 |   |
|                          Payments on Borrowings under Revolving Credit Facilities                              |   |                                                             | **(119,000** | **)** |   | (40,000 | ) |
|                          Proceeds from Issuance of Long-Term Debt                                              |   |                                                             | **30,000**   |   |   | 240,000 |   |
|                          Repayments of Long-Term Debt                                                          |   |                                                             | **(88,000**  | **)** |   | (284,266 | ) |
|                          Payments on Capital Lease Obligations                                                 |   |                                                             | **(61,175**  | **)** |   | (52,665 | ) |
|                          Common Stock Dividends Paid                                                           |   |                                                             | **(14,715**  | **)** |   | (13,108 | ) |
|                          Proceeds from Stock Options Exercised                                                 |   |                                                             | **3,682**    |   |   | 7,286 |   |
|                          Other Cash Receipts                                                                   |   |                                                             | **9,886**    |   |   | 8,982 |   |
|                          Payment of Debt Issue/Retirement Costs                                                |   |                                                             | **(1,898**   | **)** |   | (12,417 | ) |
|                          Excess Tax Benefit from Stock Option Exercises                                        |   |                                                             | **1,106**    |   |   | 1,945 |   |
|                          Other Cash Payments                                                                   |   |                                                             | **(3,851**   | **)** |   | (4,566 | ) |
| **Net                      Cash Flows - Financing Activities**                                                                |   |                                                             | **(88,965**  | **)** |   | (108,809 | ) |
|                                                                                                                          |   |                                                             |         |   |   |   |   |
| Net                      Decrease                      in Cash and Cash Equivalents                                           |   |                                                             | **(59,426**  | **)** |   | (50,738 | ) |
| Cash                      and Cash                      Equivalents, Beginning of Year                                        |   |                                                             | **144,679**  |   |   | 154,028 |   |
| **Cash                      and Cash Equivalents, End of Period**                                                             |   | **$**                                                            | **85,253**   |   | $ | 103,290 |   |
|                                                                                                                          |   |                                                             |         |   |   |   |   |
| See                      Note 15                      for supplemental cash flow information.                                 |   |                                                             |         |   |   |   |   |
|                                                                                                                          |   |                                                             |         |   |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial Statements.                           |   |                                                             |         |   |   |   |   |

----

Table              of Contents

| **UNISOURCE                      ENERGY CORPORATION**                                               |   |                                                                             |           |     |   |
|-----------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|----------------|----------|--------|
| **COMPARATIVECONDENSED                      CONSOLIDATED BALANCE                      SHEETS**      |   |                                                                             |           |     |   |
|                                                                                                |   |                                                                             |           |     |   |
|                                                                                                |   | September                      30,   December                      31, |           |
|                                                                                                |   | **2006**                                                                         |           | **2005** |   |
|                                                                                                |   | **(Unaudited)**                                                                  |           |
| **ASSETS**                                                                                          |   | -                      Thousands                      of Dollars -               |           |
| **Utility                      Plant**                                                              |   |                                                                             |           |     |   |
|  Plant                      in Service                                                         |   | **$**                                                                            | **3,367,406**  |     | $      | 3,167,900 |   |
|                        Utility Plant under Capital Leases                                      |   |                                                                             | **705,609**    |     |   | 723,900 |   |
|                        Construction Work in Progress                                           |   |                                                                             | **98,241**     |     |   | 160,186 |   |
| **                         Total Utility Plant**                                     |   |                                                                             | **4,171,256**  |     |   | 4,051,986 |   |
|  Less                      Accumulated Depreciation and Amortization                           |   |                                                                             | **(1,467,475** | **)**    |   | (1,408,158 | ) |
|  Less                      Accumulated Amortization of Capital Lease Assets                    |   |                                                                             | **(492,838**   | **)**    |   | (472,367 | ) |
| **                         Total Utility Plant - Net**                               |   |                                                                             | **2,210,943**  |     |   | 2,171,461 |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| **Investments                      and Other Property**                                             |   |                                                                             |           |     |   |   |   |
|                        Investments in Lease Debt and Equity                                    |   |                                                                             | **181,459**    |     |   | 156,301 |   |
|                        Noncurrent Assets of Subsidiary Held for Sale                           |   |                                                                             | **-**          |     |   | 13,065 |   |
|                        Other                                                                   |   |                                                                             | **66,261**     |     |   | 58,468 |   |
| **                         Total Investments and Other Property**                    |   |                                                                             | **247,720**    |     |   | 227,834 |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| **Current                      Assets**                                                             |   |                                                                             |           |     |   |   |   |
|  Cash                      and Cash Equivalents                                                |   |                                                                             | **85,253**     |     |   | 144,679 |   |
|  Trade                      Accounts Receivable                                                |   |                                                                             | **124,825**    |     |   | 99,338 |   |
|                        Unbilled Accounts Receivable                                            |   |                                                                             | **51,921**     |     |   | 53,920 |   |
|                        Allowance for Doubtful Accounts                                         |   |                                                                             | **(16,186**    | **)**    |   | (15,037 | ) |
|                        Materials and Fuel Inventory                                            |   |                                                                             | **69,931**     |     |   | 65,716 |   |
|                        Trading Assets                                                          |   |                                                                             | **25,257**     |     |   | 36,418 |   |
|                        Current Regulatory Assets                                               |   |                                                                             | **10,299**     |     |   | 15,563 |   |
|                        Deferred Income Taxes - Current                                         |   |                                                                             | **14,647**     |     |   | 9,104 |   |
|                        Interest Receivable - Current                                           |   |                                                                             | **3,898**      |     |   | 9,830 |   |
|                        Current Assets of Subsidiary Held for Sale                              |   |                                                                             | **-**          |     |   | 16,639 |   |
|                        Other                                                                   |   |                                                                             | **13,855**     |     |   | 17,717 |   |
| **                         Total Current Assets**                                    |   |                                                                             | **383,700**    |     |   | 453,887 |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| **Regulatory                      and Other Assets**                                                |   |                                                                             |           |     |   |   |   |
|                        Transition Recovery Asset                                               |   |                                                                             | **116,531**    |     |   | 167,611 |   |
|  Income                      Taxes Recoverable Through Future Revenues                         |   |                                                                             | **37,092**     |     |   | 39,936 |   |
|  Other                      Regulatory Assets                                                  |   |                                                                             | **20,568**     |     |   | 20,944 |   |
|  Other                      Assets                                                             |   |                                                                             | **46,164**     |     |   | 57,254 |   |
| **                         Total Regulatory and Other Assets**                       |   |                                                                             | **220,355**    |     |   | 285,745 |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| **Total                      Assets**                                                               |   | **$**                                                                            | **3,062,718**  |     | $      | 3,138,927 |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial Statements. |   |                                                                             |           |     |   |   |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |
| **(Comparative                      Condensed Consolidated Balance Sheets Continued)**              |   |
|                                                                                                |   |                                                                             |           |     |   |   |   |

----

Table              of Contents

| **UNISOURCE                      ENERGY CORPORATION**                                                               |   |                                                                     |          |                              |   |
|---------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------|---------------|-----------------------------------|--------|
| **COMPARATIVE                      CONDENSED CONSOLIDATED BALANCE SHEETS**                                          |   |                                                                     |          |                              |   |
|                                                                                                                |   |                                                                     |          |                              |   |
|                                                                                                                |   | September                      30,                                       |          | December                      31, |   |
|                                                                                                                |   | **2006**                                                                 |          | **2005**                          |   |
|                                                                                                                |   | **(Unaudited)**                                                          |          |
| **CAPITALIZATION                      AND OTHER LIABILITIES**                                                       |   |  -                      Thousands                      of Dollars - |          |
| **Capitalization**                                                                                                  |   |                                                                     |          |                              |   |
|  Common                      Stock                                                                             |   | **$**                                                                    | **695,589**   |                              | $      | 689,185 |   |
|                        Accumulated Deficit                                                                     |   |                                                                     | **(32,929**   | **)**                             |   | (65,861 | ) |
|                        Accumulated Other Comprehensive Loss                                                    |   |                                                                     | **(11,997**   | **)**                             |   | (6,583 | ) |
|  Common                      Stock Equity                                                                      |   |                                                                     | **650,663**   |                              |   | 616,741 |   |
|                        Capital Lease Obligations                                                               |   |                                                                     | **586,728**   |                              |   | 665,737 |   |
|                        Long-Term Debt                                                                          |   |                                                                     | **1,177,420** |                              |   | 1,212,420 |   |
| **                         Total Capitalization**                                                    |   |                                                                     | **2,414,811** |                              |   | 2,494,898 |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| **Current                      Liabilities**                                                                        |   |                                                                     |          |                              |   |   |   |
|                        Current Obligations under Capital Leases                                                |   |                                                                     | **59,089**    |                              |   | 48,804 |   |
|                        Borrowing Under Revolving Credit Facilities                                             |   |                                                                     | **17,000**    |                              |   | 5,000 |   |
|                        Current Maturities of Long-Term Debt                                                    |   |                                                                     | **6,000**     |                              |   | 5,000 |   |
|                        Accounts Payable                                                                        |   |                                                                     | **74,747**    |                              |   | 98,085 |   |
|  Income                      Taxes Payable                                                                     |   |                                                                     | **19,333**    |                              |   | 29,826 |   |
|                        Interest Accrued                                                                        |   |                                                                     | **29,453**    |                              |   | 57,386 |   |
|                        Trading Liabilities                                                                     |   |                                                                     | **16,341**    |                              |   | 27,300 |   |
|  Taxes                      Accrued                                                                            |   |                                                                     | **47,492**    |                              |   | 34,978 |   |
|                        Accrued Employee Expenses                                                               |   |                                                                     | **17,237**    |                              |   | 16,052 |   |
|                        Customer Deposits                                                                       |   |                                                                     | **18,335**    |                              |   | 15,463 |   |
|                        Current Liabilities of Subsidiary Held for Sale                                         |   |                                                                     | **-**         |                              |   | 2,206 |   |
|  Other                                                                                                         |   |                                                                     | **19,812**    |                              |   | 3,933 |   |
| **                         Total Current Liabilities**                                               |   |                                                                     | **324,839**   |                              |   | 344,033 |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| **Deferred                      Credits and Other Liabilities**                                                     |   |                                                                     |          |                              |   |   |   |
|                        Deferred Income Taxes - Noncurrent                                                      |   |                                                                     | **107,065**   |                              |   | 106,820 |   |
|                        Regulatory Liability - Net Cost of Removal for Interim                      Retirements |   |                                                                     | **84,806**    |                              |   | 78,535 |   |
|                        Other                                                                                   |   |                                                                     | **131,197**   |                              |   | 114,641 |   |
| **                         Total Deferred Credits and Other Liabilities**                            |   |                                                                     | **323,068**   |                              |   | 299,996 |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| **Commitments                      and Contingencies (Note 6)**                                                     |   |                                                                     |          |                              |   |   |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| **Total                      Capitalization and Other Liabilities**                                                 |   | **$**                                                                    | **3,062,718** |                              | $      | 3,138,927 |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial Statements.                 |   |                                                                     |          |                              |   |   |   |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |
| **(Comparative                      Condensed Consolidated Balance Sheets                      Concluded)**         |
|                                                                                                                |   |                                                                     |          |                              |   |   |   |

----

Table              of Contents

| **UNISOURCE                      ENERGY CORPORATION**                                                                                     |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **CONDENSEDCONSOLIDATED                      STATEMENT OF CHANGES                      IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME** |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   | Accumulated |   |   |   |
|                                                                                                                                      |   | Common |   |   |   |   |   | Other |   | Total |   |
|                                                                                                                                      |   | Shares |   | Common |   | Accumulated |   | Comprehensive |   | Stockholders' |   |
|                                                                                                                                      |   | Issued* |   | Stock |   | Deficit |   | Loss |   | Equity |   |
|                                                                                                                                      |   | **(Unaudited)** |   |
|                                                                                                                                      |   | -                      Thousands                      of Dollars - |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                      at December 31, 2005**                                                                                    |   |   | 34,874 |   | $ | 689,185 |   | $ | (65,861 | ) | $ | (6,583 | ) | $ | 616,741 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Comprehensive                      Income:                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                      Income                                                                                                           |   |   | - |   |   | - |   |   | 55,023 |   |   | - |   |   | 55,023 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|  Unrealized                    Loss                    on Cash Flow Hedges                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (net                      of $3,814 income taxes)                                                                                         |   |   | - |   |   | - |   |   | - |   |   | (5,818 | ) |   | (5,818 | ) |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|  Reclassification                    of Net Unrealized Gains and                                                                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                      on Cash Flow Hedges to Net Income                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (net                      of $265 income taxes)                                                                                           |   |   | - |   |   | - |   |   | - |   |   | 404 |   |   | 404 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                      Comprehensive Income                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 49,609 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Dividends                      Declared                                                                                                   |   |   | - |   |   | - |   |   | (22,091 | ) |   | - |   |   | (22,091 | ) |
| Shares                      Issued                      under Stock Compensation Plans                                                    |   |   | 11 |   |   | - |   |   | - |   |   | - |   |   | - |   |
| Shares                      Issued                      for Stock Options                                                                 |   |   | 237 |   |   | 3,679 |   |   | - |   |   | - |   |   | 3,679 |   |
| Tax                      Benefit                      Realized from Stock Options Exercised                                               |   |   | - |   |   | 1,106 |   |   | - |   |   | - |   |   | 1,106 |   |
| Other                                                                                                                                     |   |   | - |   |   | 1,619 |   |   | - |   |   | - |   |   | 1,619 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                      at September 30, 2006**                                                                                   |   |   | **35,122** |   | **$** | **695,589** |   | **$** | **(32,929** | **)** | **$** | **(11,997** | **)** | **$** | **650,663** |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *                      UniSource                      Energy has 75 million authorized shares of common                      stock.       |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial                      Statements.                  |

----

Table              of Contents

| **TUCSONELECTRIC                      POWER COMPANY**                                                                    |
|--------------------------------------------------------------------------------------------------------------------------|
| **COMPARATIVECONDENSED                      CONSOLIDATED STATEMENTS OF                      INCOME**                     |
|                                                                                                                     |   |   |   |   |   |   |   |   |
| Three                      Months                      Ended                                                             |   |   |   | Nine                      Months                      Ended |
| September                      30,                                                                                       |   |   |   | September                      30, |
| **2006**                                                                                                                 |   | **2005** |   |   |   | **2006** |   | **2005** |
| **(Unaudited)**                                                                                                          |   |   |   | **(Unaudited)** |
| -                      Thousands                      of Dollars -                                                       |   |   |   | -                      Thousands                      of Dollars - |
|                                                                                                                     |   |   |   | **Operating                      Revenues** |   |   |   |   |
| **$                      248,188**                                                                                       |   | $                      248,454 |   |                        Electric Retail Sales |   | **$                      605,215** |   | $                      584,130 |
| **46,425**                                                                                                               |   | 30,771 |   |                        Electric Wholesale Sales |   | **137,601** |   | 107,701 |
| **9,352**                                                                                                                |   | 3,009 |   |  Other                      Revenues |   | **22,124** |   | 9,188 |
| **303,965**                                                                                                              |   | 282,234 |   | **                         Total Operating Revenues** |   | **764,940** |   | 701,019 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
|                                                                                                                     |   |   |   | **Operating                      Expenses** |   |   |   |   |
| **78,302**                                                                                                               |   | 66,510 |   |                        Fuel |   | **197,660** |   | 169,664 |
| **41,884**                                                                                                               |   | 63,293 |   |                        Purchased Power |   | **87,888** |   | 103,344 |
| **47,337**                                                                                                               |   | 35,629 |   |  Other                      Operations and Maintenance |   | **139,331** |   | 130,819 |
| **28,772**                                                                                                               |   | 28,949 |   |                        Depreciation and Amortization |   | **83,504** |   | 86,903 |
| **21,959**                                                                                                               |   | 20,242 |   |                        Amortization of Transition Recovery Asset |   | **51,080** |   | 43,865 |
| **8,218**                                                                                                                |   | 8,737 |   |  Taxes                      Other Than Income Taxes |   | **29,058** |   | 30,304 |
| **226,472**                                                                                                              |   | 223,360 |   | **                         Total Operating Expenses** |   | **588,521** |   | 564,899 |
| **77,493**                                                                                                               |   | 58,874 |   | **                           Operating Income** |   | **176,419** |   | 136,120 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
|                                                                                                                     |   |   |   | **Other                      Income (Deductions)** |   |   |   |   |
| **3,864**                                                                                                                |   | 4,396 |   |                        Interest Income |   | **12,454** |   | 14,115 |
| **-**                                                                                                                    |   | - |   |                        Interest Income - Note Receivable from   UniSource                      Energy |   | **-** |   |  1,684 |
| **1,644**                                                                                                                |   | 1,729 |   |  Other                      Income |   | **4,018** |   | 3,527 |
| **(247)**                                                                                                                |   | (339) |   |  Other                      Expense |   | **(1,031)** |   | (1,338) |
| **5,261**                                                                                                                |   | 5,786 |   | **                         Total Other Income (Deductions)** |   | **15,441** |   | 17,988 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
|                                                                                                                     |   |   |   | **Interest                      Expense** |   |   |   |   |
| **12,965**                                                                                                               |   | 12,128 |   |                        Long-Term Debt |   | **38,669** |   | 43,565 |
| **17,960**                                                                                                               |   | 20,070 |   |                        Interest on Capital Leases |   | **55,024** |   | 59,199 |
| **685**                                                                                                                  |   | - |   |  Loss                      on Extinguishment of Debt |   | **685** |   | 5,261 |
| **3,986**                                                                                                                |   | 790 |   |  Other                      Interest Expense |   | **5,852** |   | 2,173 |
| **(1,197)**                                                                                                              |   | (902) |   |                        Interest Capitalized |   | **(3,958)** |   | (2,911) |
| **34,399**                                                                                                               |   | 32,086 |   | **                         Total Interest Expense** |   | **96,272** |   | 107,287 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
|                                                                                                                     |   |   |   |   |   |   |   |   |
| **48,355**                                                                                                               |   | 32,574 |   | **Income                      Before Income Taxes** |   | **95,588** |   | 46,821 |
| **18,754**                                                                                                               |   | 12,210 |   |  Income                      Tax Expense |   | **38,180** |   | 18,999 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
| **$                      29,601**                                                                                        |   | $                      20,364 |   | **Net                      Income** |   | **$                      57,408** |   | $                      27,822 |
|                                                                                                                     |   |   |   |   |   |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial                      Statements. |

----

Table              of Contents

| **TUCSON                      ELECTRIC POWER COMPANY**                                                   |   |   |                                                              |   |   |     |   |
|----------------------------------------------------------------------------------------------------------|--------|--------|-------------------------------------------------------------------|--------|--------|----------|--------|
| **COMPARATIVECONDENSED                      CONSOLIDATED STATEMENTS OF                      CASH FLOWS** |   |   |                                                              |   |   |     |   |
|                                                                                                     |   |   |  Nine                      Months                      Ended |   |
|                                                                                                          |   |   | September                      30,                                |   |
|                                                                                                     |   |   | **2006**                                                          |   |   | **2005** |   |
|                                                                                                     |   |   | **(Unaudited)**                                                   |   |
|                                                                                                     |   |   | -Thousands                      of                      Dollars-  |   |
| **Cash                      Flows from Operating Activities**                                            |   |   |                                                              |   |   |     |   |
|                           Cash Receipts from Electric Retail Sales                   |   | **$**  | **632,986**                                                       |   | $      | 610,581  |   |
|                           Cash Receipts from Electric Wholesale Sales                |   |   | **180,832**                                                       |   |   | 156,344  |   |
|                           Interest Received                                          |   |   | **18,446**                                                        |   |   | 20,653   |   |
|                           Interest Received - UniSource                              |   |   | -                                                                 |   |   | 11,013   |   |
|                           Sale of Excess Emission Allowances                         |   |   | **7,081**                                                         |   |   | 9,242    |   |
|                           Other Cash Receipts                                        |   |   | **6,852**                                                         |   |   | 2,567    |   |
|                           Income Taxes Refunds Received                              |   |   | **-**                                                             |   |   | 713      |   |
|                           Fuel Costs Paid                                            |   |   | **(184,359**                                                      | **)**  |   | (172,852 | )      |
|                           Purchased Power Costs Paid                                 |   |   | **(129,453**                                                      | **)**  |   | (133,476 | )      |
|                           Wages Paid, Net of Amounts Capitalized                     |   |   | **(60,488**                                                       | **)**  |   | (57,691  | )      |
|                           Payment of Other Operations and Maintenance Costs          |   |   | **(95,570**                                                       | **)**  |   | (95,299  | )      |
|                           Capital Lease Interest Paid                                |   |   | **(62,758**                                                       | **)**  |   | (67,667  | )      |
|                           Taxes Paid, Net of Amounts Capitalized                     |   |   | **(72,958**                                                       | **)**  |   | (69,415  | )      |
|                           Interest Paid, Net of Amounts Capitalized                  |   |   | **(36,706**                                                       | **)**  |   | (48,054  | )      |
|                           Income Taxes and Related Interest Paid                     |   |   | **(58,714**                                                       | **)**  |   | (18,400  | )      |
|                           Other Cash Payments                                        |   |   | **(1,690**                                                        | **)**  |   | (2,648   | )      |
| **Net                      Cash Flows – Operating Activities**                                     |   |   | **143,501**                                                       |   |   | 145,611  |   |
|                                                                                                     |   |   |                                                              |   |   |     |   |
| **Cash                      Flows from Investing Activities**                                            |   |   |                                                              |   |   |     |   |
|                           Capital Expenditures                                       |   |   | **(111,463**                                                      | **)**  |   | (103,922 | )      |
|                           Payments for Investment in Lease Equity                    |   |   | **(48,025**                                                       | **)**  |   | -        |   |
|                           Proceeds from Investment in Lease Debt                     |   |   | **22,158**                                                        |   |   | 13,646   |   |
|                           Other Cash Payments                                        |   |   | **(1,004**                                                        | **)**  |   | -        |   |
|                           Other Cash Receipts                                        |   |   | **-**                                                             |   |   | 7,305    |   |
| **Net                      Cash Flows - Investing Activities**                                           |   |   | **(138,334**                                                      | **)**  |   | (82,971  | )      |
|                                                                                                     |   |   |                                                              |   |   |     |   |
| **Cash                      Flows from Financing Activities**                                            |   |   |                                                              |   |   |     |   |
|                           Proceeds from Borrowings under Revolving Credit Facility   |   |   | **105,000**                                                       |   |   | 40,000   |   |
|                           Payments on Borrowings under Revolving Credit Facility     |   |   | **(100,000**                                                      | **)**  |   | (40,000  | )      |
|                           Payments on Capital Lease Obligations                      |   |   | **(61,111**                                                       | **)**  |   | (52,605  | )      |
|                           Equity Investment from UniSource Energy                    |   |   | -                                                                 |   |   | 110,000  |   |
|                           Proceeds from Repayment of UniSource Energy Note           |   |   | -                                                                 |   |   | 95,393   |   |
|                           Repayments of Long-Term Debt                               |   |   | -                                                                 |   |   | (281,766 | )      |
|                           Other Cash Receipts                                        |   |   | **13,368**                                                        |   |   | 15,128   |   |
|                           Payment of Debt Issue/Retirement Costs                     |   |   | **(1,439**                                                        | **)**  |   | (5,233   | )      |
|                           Dividends Paid to UniSource Energy                         |   |   | **-**                                                             |   |   | (15,000  | )      |
|                           Other Cash Payments                                        |   |   | **(863**                                                          | **)**  |   | (7,864   | )      |
| **Net                      Cash Flows - Financing Activities**                                           |   |   | **(45,045**                                                       | **)**  |   | (141,947 | )      |
|                                                                                                     |   |   |                                                              |   |   |     |   |
| Net                      Decrease                      in Cash and Cash Equivalents                      |   |   | **(39,878**                                                       | **)**  |   | (79,307  | )      |
| Cash                      and Cash                      Equivalents, Beginning of Year                   |   |   | **53,433**                                                        |   |   | 113,207  |   |
| **Cash                      and Cash Equivalents, End of Period**                                        |   | **$**  | **13,555**                                                        |   | $      | 33,900   |   |
|                                                                                                     |   |   |                                                              |   |   |     |   |
| See                      Note 15                      for supplemental cash flow information.            |   |   |                                                              |   |   |     |   |
|                                                                                                     |   |   |                                                              |   |   |     |   |
| See                      Notes to                      Condensed Consolidated Financial Statements.      |   |   |                                                              |   |   |     |   |

----

Table              of Contents

| **TUCSON                      ELECTRIC POWER COMPANY**                                              |   |                                                |           |                              |   |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------|----------------|-----------------------------------|--------|
| **COMPARATIVECONDENSED                      CONSOLIDATED BALANCE                      SHEETS**      |   |                                                |           |                              |   |
|                                                                                                |   |                                                |           |                              |   |
|                                                                                                |   | September                      30,                  |           | December                      31, |   |
|                                                                                                |   | **2006**                                            |           | **2005**                          |   |
|                                                                                                |   | **(Unaudited)**                                     |           |
| **ASSETS**                                                                                          |   |  -                      Thousands of Dollars - |
| **Utility                      Plant**                                                              |   |                                                |           |                              |   |   |   |
|  Plant                      in Service                                                         |   | **$**                                               | **3,007,151**  |                              | $      | 2,861,511 |   |
|                        Utility Plant under Capital Leases                                      |   |                                                | **704,904**    |                              |   | 723,195 |   |
|                        Construction Work in Progress                                           |   |                                                | **78,640**     |                              |   | 132,427 |   |
| **                         Total Utility Plant**                                     |   |                                                | **3,790,695**  |                              |   | 3,717,133 |   |
|  Less                      Accumulated Depreciation and Amortization                           |   |                                                | **(1,425,769** | **)**                             |   | (1,378,362 | ) |
|  Less                      Accumulated Amortization of Capital Lease Assets                    |   |                                                | **(492,551**   | **)**                             |   | (472,149 | ) |
| **                         Total Utility Plant - Net**                               |   |                                                | **1,872,375**  |                              |   | 1,866,622 |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| **Investments                      and Other Property**                                             |   |                                                |           |                              |   |   |   |
|                        Investments in Lease Debt and Equity                                    |   |                                                | **181,458**    |                              |   | 156,301 |   |
|                        Other                                                                   |   |                                                | **30,137**     |                              |   | 27,013 |   |
| **                         Total Investments and Other Property**                    |   |                                                | **211,595**    |                              |   | 183,314 |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| **Current                      Assets**                                                             |   |                                                |           |                              |   |   |   |
|  Cash                      and Cash Equivalents                                                |   |                                                | **13,555**     |                              |   | 53,433 |   |
|  Trade                      Accounts Receivable                                                |   |                                                | **105,978**    |                              |   | 78,487 |   |
|                        Unbilled Accounts Receivable                                            |   |                                                | **37,981**     |                              |   | 29,658 |   |
|                        Allowance for Doubtful Accounts                                         |   |                                                | **(15,629**    | **)**                             |   | (14,528 | ) |
|                        Intercompany Accounts Receivable                                        |   |                                                | **9,441**      |                              |   | 5,807 |   |
|  Income                      Taxes Receivable                                                  |   |                                                | **4,413**      |                              |   | - |   |
|                        Materials and Fuel Inventory                                            |   |                                                | **60,622**     |                              |   | 57,815 |   |
|                        Current Regulatory Assets                                               |   |                                                | **10,299**     |                              |   | 9,663 |   |
|                        Deferred Income Taxes - Current                                         |   |                                                | **13,896**     |                              |   | 10,684 |   |
|                        Interest Receivable - Current                                           |   |                                                | **3,898**      |                              |   | 9,747 |   |
|                        Trading Assets                                                          |   |                                                | **16,444**     |                              |   | 12,338 |   |
|                        Other                                                                   |   |                                                | **11,906**     |                              |   | 10,240 |   |
| **                         Total Current Assets**                                    |   |                                                | **272,804**    |                              |   | 263,344 |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| **Regulatory                      and Other Assets**                                                |   |                                                |           |                              |   |   |   |
|                        Transition Recovery Asset                                               |   |                                                | **116,531**    |                              |   | 167,611 |   |
|  Income                      Taxes Recoverable Through Future Revenues                         |   |                                                | **37,092**     |                              |   | 39,936 |   |
|  Other                      Regulatory Assets                                                  |   |                                                | **20,182**     |                              |   | 20,634 |   |
|  Other                      Assets                                                             |   |                                                | **30,312**     |                              |   | 34,582 |   |
| **                         Total Regulatory and Other Assets**                       |   |                                                | **204,117**    |                              |   | 262,763 |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| **Total                      Assets**                                                               |   | **$**                                               | **2,560,891**  |                              | $      | 2,576,043 |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial Statements. |   |                                                |           |                              |   |   |   |
|                                                                                                |   |                                                |           |                              |   |   |   |
| **(Comparative                      Condensed Consolidated Balance Sheets Continued)**              |   |
|                                                                                                |   |                                                |           |                              |   |   |   |

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Table              of Contents

| **TUCSON                      ELECTRIC POWER COMPANY**                                                              |   |                               |                                                                     |                              |   |   |      |   |
|---------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------------------------------------------------------------------------|-----------------------------------|--------|--------|-----------|--------|
| **COMPARATIVE                      CONDENSED CONSOLIDATED BALANCE SHEETS**                                          |   |                               |                                                                     |                              |   |   |      |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
|                                                                                                                |   | September                      30, |                                                                     | December                      31, |
|                                                                                                                |   |                               | **2006**                                                                 |                              |   |   | **2005**  |   |
|                                                                                                                |   |                               | **(Unaudited)**                                                     |                              |
| **CAPITALIZATION                    AND OTHER LIABILITIES**                                                         |   |                               | -                      Thousands of                      Dollars -  |                              |
| **Capitalization**                                                                                                  |   |                               |                                                                     |                              |   |   |      |   |
|  Common                      Stock                                                                             |   | **$**                              | **795,971**                                                              |                              |   | $      | 795,971   |   |
|                        Capital Stock Expense                                                                   |   |                               | **(6,357**                                                               | **)**                             |   |   | (6,357    | )      |
|                        Accumulated Deficit                                                                     |   |                               | **(166,977**                                                             | **)**                             |   |   | (224,385  | )      |
|                        Accumulated Other Comprehensive Loss                                                    |   |                               | **(12,403**                                                              | **)**                             |   |   | (6,583    | )      |
|  Common                      Stock Equity                                                                      |   |                               | **610,234**                                                              |                              |   |   | 558,646   |   |
|                        Capital Lease Obligations                                                               |   |                               | **586,357**                                                              |                              |   |   | 665,299   |   |
|                        Long-Term Debt                                                                          |   |                               | **821,170**                                                              |                              |   |   | 821,170   |   |
| **                         Total Capitalization**                                                    |   |                               | **2,017,761**                                                            |                              |   |   | 2,045,115 |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
| **Current                      Liabilities**                                                                        |   |                               |                                                                     |                              |   |   |      |   |
|                        Current Obligations under Capital Leases                                                |   |                               | **58,999**                                                               |                              |   |   | 48,718    |   |
|                        Borrowing Under Revolving Credit Facility                                               |   |                               | **5,000**                                                                |                              |   |   | -         |   |
|                        Accounts Payable                                                                        |   |                               | **55,764**                                                               |                              |   |   | 62,974    |   |
|                        Intercompany Accounts Payable                                                           |   |                               | **9,536**                                                                |                              |   |   | 9,362     |   |
|  Income                      Taxes Payable                                                                     |   |                               | **-**                                                                    |                              |   |   | 17,111    |   |
|                        Interest Accrued                                                                        |   |                               | **26,958**                                                               |                              |   |   | 50,230    |   |
|  Taxes                      Accrued                                                                            |   |                               | **39,399**                                                               |                              |   |   | 27,260    |   |
|                        Accrued Employee Expenses                                                               |   |                               | **15,204**                                                               |                              |   |   | 14,585    |   |
|                        Trading Liabilities                                                                     |   |                               | **10,439**                                                               |                              |   |   | 2,923     |   |
|  Other                                                                                                         |   |                               | **13,902**                                                               |                              |   |   | 10,687    |   |
| **                         Total Current Liabilities**                                               |   |                               | **235,201**                                                              |                              |   |   | 243,850   |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
| **Deferred                      Credits and Other Liabilities**                                                     |   |                               |                                                                     |                              |   |   |      |   |
|                        Deferred Income Taxes - Noncurrent                                                      |   |                               | **130,219**                                                              |                              |   |   | 119,895   |   |
|                        Regulatory Liability - Net Cost of Removal for Interim                      Retirements |   |                               | **79,753**                                                               |                              |   |   | 74,825    |   |
|                        Other                                                                                   |   |                               | **97,957**                                                               |                              |   |   | 92,358    |   |
| **                         Total Deferred Credits and Other Liabilities**                            |   |                               | **307,929**                                                              |                              |   |   | 287,078   |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
| **Commitments                      and Contingencies (Note 6)**                                                     |   |                               |                                                                     |                              |   |   |      |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
| **Total                      Capitalization and Other Liabilities**                                                 |   | **$**                              | **2,560,891**                                                            |                              |   | $      | 2,576,043 |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
| See                      Notes to                      Condensed Consolidated Financial Statements.                 |   |                               |                                                                     |                              |   |   |      |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |
|  **(Comparative                      Condensed Consolidated Balance Sheets Concluded)**                        |   |
|                                                                                                                |   |                               |                                                                     |                              |   |   |      |   |

----

Table              of Contents

| **TUCSON                      ELECTRIC POWER COMPANY**                                                                                    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **CONDENSEDCONSOLIDATED                      STATEMENT OF CHANGES                      IN STOCKHOLDER'S EQUITY AND COMPREHENSIVE INCOME** |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   | Accumulated |   |   |   |
|                                                                                                                                      |   |   |   | Capital |   |   |   | Other |   | Total |   |
|                                                                                                                                      |   | Common |   | Stock |   | Accumulated |   | Comprehensive |   | Stockholder's |   |
|                                                                                                                                      |   | Stock |   | Expense |   | Deficit |   | Loss |   | Equity |   |
|                                                                                                                                      |   |  **(Unaudited)** |   |
|                                                                                                                                      |   |  -                      Thousands                      of Dollars - |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                      at December 31, 2005**                                                                                    |   | $ | 795,971 |   | $ | (6,357 | ) | $ | (224,385 | ) | $ | (6,583 | ) | $ | 558,646 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Comprehensive                      Income:                                                                                                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                      Income                                                                                                           |   |   | - |   |   | - |   |   | 57,408 |   |   | - |   |   | 57,408 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized                      Loss on Cash Flow Hedges                                                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (net                      of                      $4,081income taxes)                                                                |   |   | - |   |   | - |   |   | - |   |   | (6,224 | ) |   | (6,224 | ) |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Reclassification                      of Net Unrealized Gains and                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Losses                      on                      Cash Flow Hedges to Net Income                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (net                      of $265                      income taxes)                                                                 |   |   | - |   |   | - |   |   | - |   |   | 404 |   |   | 404 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                      Comprehensive Income                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 51,588 |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balances                      at September 30, 2006**                                                                                   |   | **$** | **795,971** |   | **$** | **(6,357** | **)** | **$** | **(166,977** | **)** | **$** | **(12,403** | **)** | **$** | **610,234** |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| See                      Notes to                      Condensed Consolidated Financial Statements.                                       |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

----

Table              of Contents

----

Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL              STATEMENTS**

**NOTE1.          NATURE OF OPERATIONS AND BASIS OF ACCOUNTING          PRESENTATION**

UniSource

**NOTE2.          REGULATORY MATTERS**

**REGULATORY          ACCOUNTING**

*Accounting          for          the Effects of Certain Types of Regulation*

----

Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|   | · | an                    independent regulator sets rates; |
|--------|--------|---------------------------------------------------------|

|   | · | the                    regulator                    sets the rates to recover specific costs of delivering service;                    and |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | the                    service                    territory lacks competitive pressures to reduce rates below the                    rates set                    by the regulator. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**IMPLICATIONS          OF DISCONTINUING APPLICATION OF FAS 71**

**    TEP**

**UNS          Gas and          UNS Electric**

**RECENT          REGULATORY ACTION **

**    TEP**

**    Settlement          Agreement**

----

Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|   | · | a                    period from                    November 1999 through 2008 for TEP to transition its generation                    assets                    from a cost of service based rate structure to a market, or competitive,                    rate structure; |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | the                    recovery                    through rates during the transition period of $450 million of                    stranded                    generation costs through a fixed competitive transition charge                    (Fixed                    CTC); |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | capped                    rates                    for TEP retail customers through                    2008; |
|--------|--------|--------------------------------------------------------------------------------------------------------------|

|   | · | an                    ACC                    interim review of TEP retail rates in                    2004; |
|--------|--------|-------------------------------------------------------------------------------------------------------------|

|   | · | unbundling                    of                    electric services with separate rates or prices for generation,                    transmission, distribution, metering, meter reading, billing                    and                    collection, and ancillary services; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | a                    process for                    ESPs to become licensed by the ACC to sell generation services                    at market                    prices to TEP retail customers; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | access                    for                    TEP retail customers to buy market priced generation services                    from ESPs                    beginning in 2000 (currently, no TEP customers are purchasing                    generation                    services from ESPs); |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | transmission                    and distribution services would remain subject to regulation                    on a cost of                    service basis; and |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | beginning                    in                    2009, TEP’s generation would be market-based and its retail customers                    would pay the market rate for generation                    services. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**2004          General Rate Case Information**

**ACC          Order          to Review the Settlement Agreement**

**TEP          Testimony**

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**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|   | · | A                    cap would                    be set such that no customer class would realize an initial rate                    increase                    in excess of 12%. The phase-in period would begin in 2009, last                    approximately four years and then be fully                    market-based; |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | TEP’s                    current                    rates would remain frozen through the end of 2008;                    and |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Implementation                    of the new DSM, RES and TOU programs and                    tariffs. |
|--------|--------|--------------------------------------------------------------------------------------------------------|

|   | · | A                    new                    regulatory asset of $850 million to be included in rate base                    will be                    created to compensate TEP for the financial impacts and costs                    incurred in                    performing under the Settlement                    Agreement; |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | An                    energy                    cost adjustment clause (ECAC) to recover energy costs associated                    with                    serving the incremental retail load above that filed in its                    cost-of-service test year; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | Immediate                    filing of a cost-of-service rate case in                    2007; |
|--------|--------|------------------------------------------------------------------------------------------------|

|   | · | Implementation                    of the new DSM, RES and TOU programs and tariffs;                    and |
|--------|--------|------------------------------------------------------------------------------------------------------------|

|   | · | Restore                    exclusivity of TEP’s certificate of convenience and                    necessity. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------|

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**Procedural          Schedule**

|                                                                              | **Date**                                                |
|-----------------------------------------------------------------------------------|---------------------------------------------------------|
| ACC                    staff and                    intervenor testimony          | January                    8,                    2007   |
| TEP                    rebuttal                    testimony                      | January                    29,                    2007  |
| ACC                    staff and                    intervenor rebuttal testimony | February                    8,                    2007  |
| TEP                    rejoinder                    testimony                     | February                    15,                    2007 |
| Hearings                    before ALJ                                            | February                    20,                    2007 |

**Renewable          Energy Standard and Tariff**

**UNS          Gas**

**Energy          Cost          Adjustment Mechanism**

*General          Rate          Case Filing*

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

| **Surcharge                    Amount****Per                    Therm** |  **Period                    In Effect**                       |
|-------------------------------------------------------------------------|---------------------------------------------------------------------|
| $0.15                                                                   | November                    2005                    - February 2006 |
| $0.25                                                                   | March                    2006 -                    April 2006       |
| $0.30                                                                   | May                    2006 -                    June 2006          |
| $0.35                                                                   | July                    2006 -                    September 2006    |
| $0.25                                                                   | October                    2006                    - November 2006  |
| $0.20                                                                   | December                    2006                    - February 2007 |
| $0.25                                                                   | March                    2007 -                    April 2007       |

**General          Rate Case Filing**

| Test                    year                                                        | Year                    ended                    December 31, 2005 |
|-------------------------------------------------------------------------------------|--------------------------------------------------------------------|
| Original                    cost                    rate base                       | $162                    million                                    |
| Revenue                    deficiency                                               | $10                    million                                     |
| Total                    rate                    increase (over test year revenues) | 7%                                                                 |
| Cost                    of                    debt                                  | 6.60%                                                              |
| Cost                    of                    equity                                | 11.00%                                                             |
| Hypothetical                    capital structure                                   | 50%                    equity /                    50% debt        |
| Weighted                    average cost of capital                                 | 8.80%                                                              |

| **Filing**                                                                          | **Date**                                               |
|-------------------------------------------------------------------------------------|--------------------------------------------------------|
| ACC                    Staff                    & intervenor testimony          | February                    9,                    2007 |
| UNS                    Gas                    rebuttal testimony                    | March                    9,                    2007    |
| ACC                    Staff                    & intervenor rebuttal testimony | March                    30,                    2007   |
| UNS                    Gas                    rejoinder testimony                   | April                    6,                    2007    |
| Hearing                    before ALJ                                               | April                    16,                    2007   |

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**NOTE3.          DEBT AND CAPITAL LEASES**

**SPRINGERVILLE          UNIT 1 LEASE EQUITY**

**SPRINGERVILLE          COMMON FACILITIES LEASES**

**UNISOURCE          ENERGY CREDIT AGREEMENT**

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Table                of Contents

**NOTES                TO                CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                (CONTINUED)**

**TEP          CREDIT          AGREEMENT**

**UNS          GAS/UNS          ELECTRIC REVOLVER**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**NOTE4.          BUSINESS SEGMENTS**

* *

|                                                                                                                                                                |   | **Reportable                        Segments**                      |   |           |   |                                    |   | **Unisource**    |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------|----------------|--------|-----------------------------------------|--------|------------------|--------|
|                                                                                                                                                                |   |  **TEP**                                                       |   | **UNS****Gas** |   | **UNS                        Electric** |   | **All****Other** |   | **Reconciling                        Adjustments** |   | **Energy                        Consolidated** |   |
| **Income                        Statement**                                                                                                                         |   | -Millions                        of                        Dollars- |
| **Three                        months ended September 30, 2006:**                                                                                                   |   |                                                                |   |           |   |                                    |   |             |   |   |   |   |   |
| Operating                        Revenues - External                                                                                                                |   | $                                                                   | 304    |           | $      | 21                                      |   | $                | 51     |   | $ | - |   | $ | - |   | **$** | **376** |   |
| Operating                        Revenues - Intersegment                                                                                                            |   |                                                                | -      |           |   | -                                       |   |             | -      |   |   | 4 |   |   | (4 | ) |   | **-** |   |
| Income                        (Loss)                        from Continuing  Operations                        Before Income                        Taxes |   |                                                                | 48     |           |   | (3                                      | )      |             | 4      |   |   | (3 | ) |   | - |   |   | **46** |   |
| Net                        Income                        (Loss)                                                                                                     |   |                                                                | 30     |           |   | (2                                      | )      |             | 2      |   |   | (2 | ) |   | - |   |   | **28** |   |
|                                                                                                                                                                |   |                                                                |   |           |   |                                    |   |             |   |   |   |   |   |   |   |   |   |   |   |
| **Three                        months ended September 30, 2005:**                                                                                                   |   |                                                                |   |           |   |                                    |   |             |   |   |   |   |   |   |   |   |   |   |   |
| Operating                        Revenues - External                                                                                                                |   | $                                                                   | 281    |           | $      | 17                                      |   | $                | 48     |   | $ | 1 |   | $ | - |   | **$** | **347** |   |
| Operating                        Revenues - Intersegment                                                                                                            |   |                                                                | 1      |           |   | -                                       |   |             | -      |   |   | 3 |   |   | (4 | ) |   | **-** |   |
| Income                        (Loss)                        from Continuing  Operations                        Before Income                        Taxes |   |                                                                | 33     |           |   | (3                                      | )      |             | 4      |   |   | (2 | ) |   | - |   |   | **32** |   |
| Discontinued                        Operations - Net of Tax                                                                                                         |   |                                                                | -      |           |   | -                                       |   |             | -      |   |   | (1 | ) |   | - |   |   | **(1** | **)** |
| Net                        Income                        (Loss)                                                                                                     |   |                                                                | 20     |           |   | (2                                      | )      |             | 2      |   |   | (2 | ) |   | - |   |   | **18** |   |

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**NOTES                    TO                    CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                    (CONTINUED)**

|                                                                                                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| **Nine                        months ended September 30, 2006:**                                                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          Operating Revenues - External                                                                                   |   | $      | 763    |   | $      | 111    |   | $      | 125    |   | $      | -      |   | $ | - |   | **$** | **999** |   |
|                          Operating Revenues - Intersegment                                                                               |   |   | 2      |   |   | -      |   |   | -      |   |   | 11     |   |   | (13 | ) |   | **-** |   |
|  Income                        (Loss) from Continuing     Operations                        Before Income Taxes |   |   | 96     |   |   | 3      |   |   | 7      |   |   | (10    | )      |   | - |   |   | **96** |   |
|                          Discontinued Operations - Net of Tax                                                                            |   |   | -      |   |   | -      |   |   | -      |   |   | (3     | )      |   | - |   |   | **(3** | **)** |
|  Net                        Income (Loss)                                                                                                |   |   | 57     |   |   | 2      |   |   | 4      |   |   | (8     | )      |   | - |   |   | **55** |   |

|                                                                                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| **Nine                      months ended September 30, 2005:**                                                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                        Operating Revenues - External                                                                                       |   | $      | 699    |   | $      | 91     |   | $      | 116    |   | $      | 1      |   | $ | - |   | **$** | **907** |   |
|                        Operating Revenues - Intersegment                                                                                   |   |   | 2      |   |   | -      |   |   | -      |   |   | 9      |   |   | (11 | ) |   | **-** |   |
|   Income                      (Loss) from Continuing     Operations                      Before Income Taxes |   |   | 47     |   |   | 4      |   |   | 6      |   |   | (9     | )      |   | - |   |   | **48** |   |
|                        Discontinued Operations - Net of Tax                                                                                |   |   | -      |   |   | -      |   |   | -      |   |   | (4     | )      |   | - |   |   | **(4** | **)** |
|  Net                      Income (Loss)                                                                                                    |   |   | 28     |   |   | 2      |   |   | 4      |   |   | (10    | )      |   | - |   |   | **24** |   |
|                                                                                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Balance                      Sheet**                                                                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|  Total                      Assets, September 30, 2006                                                                                     |   | $      | 2,561  |   | $      | 227    |   | $      | 186    |   | $      | 1,028  |   | $ | (939 | ) | **$** | **3,063** |   |
|  Total                      Assets, December 31, 2005                                                                                      |   |   | 2,575  |   |   | 233    |   |   | 161    |   |   | 1,044  |   |   | (874 | ) |   | **3,139** |   |

**NOTE5.          ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND TRADING          ACTIVITIES**

** **
**TEP          INTEREST RATE SWAP**

**TEP          FUEL          AND POWER TRANSACTIONS**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|                                                                                                                                                                                                        |   | Three                        Months                        Ended    |   | Nine                        Months                        Ended |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|
|                                                                                                                                                                                                        |   | September                        30,                                |   | September                        30,                            |   |
|                                                                                                                                                                                                        |   | **2006**                                                            |   | **2005**                                                        |   | **2006** |   | **2005** |   |
|                                                                                                                                                                                                        |   | -Millions                        of                        Dollars- |   |
| Net                        Unrealized Gain (Loss) on Forward Power Sales -  Derivative                        Contracts                                                                           |   | **$**                                                               | **6**  |                                                            | $      | (9 | ) | **$** | **7** |   | $ | (10 | ) |
| Net                        Unrealized (Loss) Gain on Forward Power Purchases                        -  Derivative                        Contracts                                                |   |                                                                | **(5** | **)**                                                           |   | 1 |   |   | **(6** | **)** |   | 1 |   |
|     Pre-Tax                        Unrealized Gain (Loss) on Derivative      Contracts                        Recorded in                        Earnings |   | **$**                                                               | **1**  |                                                            | $      | (8 | ) | **$** | **1** |   | $ | (9 | ) |
|                                                                                                                                                                                                        |   |                                                                |   |                                                            |   |   |   |   |   |   |   |   |   |
| Net                        Unrealized Gain (Loss) on Forward Power Sales -  Cash                        Flow                        Hedges                                                        |   | **$**                                                               | **6**  |                                                            | $      | (3 | ) | **$** | **7** |   | $ | (3 | ) |
| Net                        Unrealized (Loss) Gain on Gas Price Swaps -  Cash                        Flow                        Hedges                                                            |   |                                                                | **(1** | **)**                                                           |   | 7 |   |   | **(15** | **)** |   | 7 |   |
|     Pre-Tax                        Unrealized Gain (Loss) on Cash Flow Hedges                                                                                                           |   | **$**                                                               | **5**  |                                                            | $      | 4 |   | **$** | **(8** | **)** | $ | 4 |   |
|                                                                                                                                                                                                        |   |                                                                |   |                                                            |   |   |   |   |   |   |   |   |   |
| After                        Tax                        Unrealized Gain (Loss) on Cash Flow Hedges  Recorded                        in                        OCI                                 |   | **$**                                                               | **3**  |                                                            | $      | 2 |   | **$** | **(5** | **)** | $ | 2 |   |

|                                                                   |   | September                    30,                            |   | December                    31,         |   |
|------------------------------------------------------------------------|--------|-------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                   |   | **2006**                                                    |   | **2005**                                |   |
|                                                                   |   | **Derivative                    Contracts**                 |   | **Cash                    Flow Hedges** |   | **Derivative                    Contracts** |   | **Cash                    Flow Hedges** |   |
|                                                                   |   | -Millions                    of                    Dollars- |   |
|                      Derivative Assets - Current                  |   | **$**                                                       | **9**  |                                    | **$**  | **7** |   | $ | 2 |   | $ | 10 |   |
|                      Derivative Liabilities - Current             |   |                                                        | **(9** | **)**                                   |   | **(2** | **)** |   | (2 | ) |   | (1 | ) |
|                        Net Current Derivative Assets    |   | **$**                                                       | **-**  |                                    | **$**  | **5** |   | $ | - |   | $ | 9 |   |
|                                                                   |   |                                                        |   |                                    |   |   |   |   |   |   |   |   |   |
|                      Derivative Assets - Noncurrent               |   | **$**                                                       | **-**  |                                    | **$**  | **1** |   | $ | - |   | $ | 4 |   |
|                      Derivative Liabilities - Noncurrent          |   |                                                        | **-**  |                                    |   | **(1** | **)** |   | - |   |   | (1 | ) |
|                        Net Noncurrent Derivative Assets |   | **$**                                                       | **-**  |                                    | **$**  | **-** |   | $ | - |   | $ | 3 |   |

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**UNS          GAS          SUPPLY TRANSACTIONS**

**UNS          ELECTRIC POWER SUPPLY TRANSACTIONS**

|                                                             |   |                                        |   |                                    |   |
|------------------------------------------------------------------|--------|---------------------------------------------|--------|-----------------------------------------|--------|
|                                                             |   | September                    30,            |   | December                    31,         |   |
|                                                             |   | **2006**                                    |   | **2005**                                |   |
|                                                             |   | **Derivative                    Contracts** |   | **Cash                    Flow Hedges** |   | **Derivative                    Contracts** |   | **Cash                    Flow Hedges** |   |
| Derivative                    Assets - Noncurrent                |   | **$**                                       | **1**  |                                    | **$**  | **1** |   | $ | - |   | $ | - |   |
| Derivative                    Liabilities - Noncurrent           |   |                                        | **(2** | **)**                                   |   | **-** |   |   | - |   |   | - |   |
|                       Net Noncurrent Derivative Assets |   | **$**                                       | **(1** | **)**                                   | **$**  | **1** |   | $ | - |   | $ | - |   |

**MEG          TRADING          TRANSACTIONS**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|                                                                                            |   | September                      30,                              |   | December                      31, |   |
|-------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                            |   | **2006**                                                        |   | **2005**                          |   |
|                                                                                            |   | -Millions                      of                      Dollars- |   |
| MEG:                                                                                            |   |                                                            |   |                              |   |
|   Trading                      Assets - Current                                       |   | **$**                                                           | **9**  |                              | $      | 24 |   |
|   Trading                      Liabilities -                      Current             |   |                                                            | **(6** | **)**                             |   | (24 | ) |
|     Net                      Current                      Trading Assets    |   | **$**                                                           | **3**  |                              | $      | - |   |
|                                                                                            |   |                                                            |   |                              |   |   |   |
|   Trading                      Assets - Noncurrent                                    |   | **$**                                                           | **5**  |                              | $      | 14 |   |
|   Trading                      Liabilities -                      Noncurrent          |   |                                                            | **-**  |                              |   | (1 | ) |
|     Net                      Noncurrent                      Trading Assets |   | **$**                                                           | **5**  |                              | $      | 13 |   |

**NOTE6.          COMMITMENTS AND CONTINGENCIES**

**TEP          COMMITMENTS**

**Power          Purchase from Springerville Unit 3**

**TEP          Guarantee Home Program**

**UNS          ELECTRIC COMMITMENTS**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**UED          COMMITMENTS**

**TEP          CONTINGENCIES**

**Litigation          and Claims Related to San Juan Generating Station**

**Claims          Related to San Juan Coal Company**

**Litigation          and Claims Related to Navajo Generating Station**

**Postretirement          and Pension Benefit Costs at Navajo Generating Station**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**Environmental          Reclamation at Remote Generating Stations**

**GUARANTEES          AND INDEMNITIES**

|   | · | UES’                    guarantee of $160 million of aggregate principal amount of senior                    unsecured notes issued by UNS Gas and UNS Electric to purchase                    the                    Citizens Arizona gas and electric utility                    assets, |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | UES’                    guarantee of a $40 million unsecured revolving credit agreement                    for UNS                    Gas and UNS Electric, and |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | UniSource                    Energy’s guarantee of approximately $5 million in natural gas                    transportation and supply payments in addition to building lease                    payments                    for UNS Gas and UNS Electric. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**NOTE7.          DISCONTINUED OPERATIONS - SALE OF GLOBAL          SOLAR**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|                                                                                            |   | Three                      Months                      Ended          |     | Nine                      Months                      Ended |   |
|-------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|----------|-------------------------------------------------------------|--------|
|                                                                                            |   | September                      30,                                    |     | September                      30,                          |   |
|                                                                                            |   |                                                                  | **2006** |                                                        |   | **2005** |   |   | **2006** |   |   | **2005** |   |
|                                                                                            |   | -Millions                      of                      Dollars-  |
| Revenues                      from                      Discontinued Operations                 |   | **$**                                                                 | **-**    |                                                        | $      | 2 |   | **$** | **1** |   | $ | 4 |   |
|                                                                                            |   |                                                                  |     |                                                        |   |   |   |   |   |   |   |   |   |
| Loss                      from                      Discontinued Operations                     |   | **$**                                                                 | **-**    |                                                        | $      | (2 | ) | **$** | **(4** | **)** | $ | (7 | ) |
| Loss                      on Sale                      of Discontinued Operations               |   |                                                                  | **-**    |                                                        |   | - |   |   | **(1** | **)** |   | - |   |
| Loss                      from                      Discontinued Operations Before Income Taxes |   |                                                                  | **-**    |                                                        |   | (2 | ) |   | **(5** | **)** |   | (7 | ) |
| Income                      Tax                      Benefit                                    |   |                                                                  | **-**    |                                                        |   | (1 | ) |   | **(2** | **)** |   | (3 | ) |
| Discontinued                      Operations - Net of Tax                                       |   | **$**                                                                 | **-**    |                                                        | $      | (1 | ) | **$** | **(3** | **)** | $ | (4 | ) |

**NOTE8.          TEP **
**WHOLESALE          ACCOUNTS RECEIVABLE AND ALLOWANCES**

**NOTE9.          UNISOURCE ENERGY EARNINGS PER SHARE          (EPS)**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|                                                                                                                    |   | Three                    Months                    Ended |       | Nine                    Months                    Ended |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------|------------|---------------------------------------------------------|--------|
|                                                                                                                    |   | September                    30,                         |       | September                    30,                        |   |
|                                                                                                                    |   | **2006**                                                 |       | **2005**                                                |   | **2006** |   | **2005** |   |
|                                                                                                                    |   | -                    In                    Thousands -   |       | -                    In                    Thousands -  |   |
| Numerator:                                                                                                              |   |                                                     |       |                                                    |   |   |   |   |   |
|  Net                    Income                                                                                     |   | **$**                                                    | **28,203** |                                                    | $      | 18,397 |   | **$** | **55,023** |   | $ | 24,082 |   |
|  Income                    from Assumed Conversion of Convertible   Senior                    Notes |   |                                                     | **1,097**  |                                                    |   | 1,097 |   |   | **3,292** |   |   | - |   |
| Adjusted                    Numerator                                                                                   |   | **$**                                                    | **29,300** |                                                    | $      | 19,494 |   | **$** | **58,315** |   | $ | 24,082 |   |

|                                                                                                                                                                                                              |   |   |       |   |   |   |   |   |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|------------|--------|--------|--------|--------|--------|------------|
| Denominator:                                                                                                                                                                                                      |   |   |       |   |   |   |   |   |       |
|                      Weighted-average Shares of Common Stock                     Outstanding:                                                                                                           |   |   |       |   |   |   |   |   |       |
|                          Common Shares Issued                                                                                                                                            |   |   | **35,108** |   |   | 34,666 |   |   | **35,028** |   |   | 34,539 |   |
|                          Fully Vested Deferred Stock Units                                                                                                                               |   |   | **200**    |   |   | 197    |   |   | **195**    |   |   | 195 |   |
|                              Total Weighted-average Shares of Common                             Stock Outstanding |   |   | **35,308** |   |   | 34,863 |   |   | **35,223** |   |   | 34,734 |   |
|  Effect                    of Dilutive Securities:                                                                                                                                                           |   |   |       |   |   |   |   |   |       |   |   |   |   |
|                      Convertible Senior Notes                                                                                                                                                                |   |   | **4,000**  |   |   | 4,000  |   |   | **4,000**  |   |   | - |   |
|                      Options and Stock Issuable under Employee      Benefit                    Plans and                    the                    Directors’ Plan  |   |   | **609**    |   |   | 709    |   |   | **592**    |   |   | 718 |   |
| Total                    Shares                                                                                                                                                                                   |   |   | **39,917** |   |   | 39,572 |   |   | **39,815** |   |   | 35,452 |   |

**NOTE10.          EMPLOYEE BENEFITS PLANS**

**PENSION          BENEFIT PLANS**

**OTHER          POSTRETIREMENT BENEFIT PLANS**

*Employers’          Accounting for Postretirement Benefits Other Than Pensions*

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**COMPONENTS          OF NET PERIODIC BENEFIT COST**

|                                                                  |   |  **Pension                    Benefits**            |   | **Other                    Postretirement****Benefits**      |   |
|-----------------------------------------------------------------------|--------|----------------------------------------------------------|--------|--------------------------------------------------------------|--------|
|                                                                  |   | Three                    Months                    Ended |   | Three                    Months                    Ended     |   |
|                                                                  |   | September                    30,                         |   | September                    30,                             |   |
|                                                                  |   | **2006**                                                 |   | **2005**                                                     |   | **2006** |   | **2005** |   |
|                                                                  |   |                                                     |   | -Millions                    of                    Dollars - |   |   |   |
|                                                                  |   |                                                     |   |                                                         |   |   |   |   |   |
| **Components                    of Net Periodic Benefit Cost**        |   |                                                     |   |                                                         |   |   |   |   |   |
| Service                    Cost                                       |   | **$**                                                    | **2**  |                                                         | $      | 2 |   | **$** | **1** |   | $ | 1 |   |
|                        Interest Cost                   |   |                                                     | **3**  |                                                         |   | 2 |   |   | **1** |   |   | 1 |   |
|                        Expected Return on Plan Assets  |   |                                                     | **(3** | **)**                                                        |   | (3 | ) |   | **-** |   |   | - |   |
|                        Prior Service Cost Amortization |   |                                                     | **-**  |                                                         |   | 1 |   |   | **-** |   |   | - |   |
|                        Recognized Actuarial Loss       |   |                                                     | **-**  |                                                         |   | - |   |   | **-** |   |   | 1 |   |
| **Net                    Periodic Benefit Cost**                      |   | **$**                                                    | **2**  |                                                         | $      | 2 |   | **$** | **2** |   | $ | 3 |   |

|                                                                  |   |  **Pension                    Benefits**           |    | **Other                    Postretirement****Benefits**      |   |
|-----------------------------------------------------------------------|--------|---------------------------------------------------------|---------|--------------------------------------------------------------|--------|
|                                                                  |   | Nine                    Months                    Ended |    | Nine                    Months                    Ended      |   |
|                                                                  |   | September                    30,                        |    | September                    30,                             |   |
|                                                                  |   | **2006**                                                |    | **2005**                                                     |   | **2006** |   | **2005** |   |
|                                                                  |   |                                                    |    | -Millions                    of                    Dollars - |   |   |   |
|                                                                  |   |                                                    |    |                                                         |   |   |   |   |   |
| **Components                    of Net Periodic Benefit Cost**        |   |                                                    |    |                                                         |   |   |   |   |   |
| Service                    Cost                                       |   | **$**                                                   | **6**   |                                                         | $      | 5 |   | **$** | **2** |   | $ | 2 |   |
|                        Interest Cost                   |   |                                                    | **9**   |                                                         |   | 8 |   |   | **3** |   |   | 3 |   |
|                        Expected Return on Plan Assets  |   |                                                    | **(10** | **)**                                                        |   | (9 | ) |   | **-** |   |   | - |   |
|                        Prior Service Cost Amortization |   |                                                    | **1**   |                                                         |   | 2 |   |   | **(1** | **)** |   | (1 | ) |
|                        Recognized Actuarial Loss       |   |                                                    | **2**   |                                                         |   | 2 |   |   | **1** |   |   | 2 |   |
| **Net                    Periodic Benefit Cost**                      |   | **$**                                                   | **8**   |                                                         | $      | 8 |   | **$** | **5** |   | $ | 6 |   |

**NOTE11.          SHARE-BASED COMPENSATION          PLANS**

**STOCK          OPTIONS**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

*Topic          14:          Share-Based Payment*

|                                                                                                                                |   | 2006   |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|                                                                                                                                |   |   |   |
| Expected                    term                    (years)                                                                         |   |   | 6      |   |
| Risk-free                    rate                                                                                                   |   |   | 4.97   | % |
| Expected                    volatility                                                                                              |   |   | 22.57  | % |
| Expected                    dividend yield                                                                                          |   |   | 2.45   | % |
| Weighted-average                    grant-date fair value of options                       granted during the period |   | $      | 7.38   |   |

|                                                                                  |   | Nine                    Months                    Ended September 30, |          |
|---------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|---------------|
|                                                                                  |   | **2006**                                                              |          | **2005** |   |
|                                                                                  |   |                                                                  |          | **Weighted** |   |   |   | Weighted |   |
|                                                                                  |   |                                                                  |          | **Average** |   |   |   | Average |   |
|                                                                                  |   |                                                                  |          | **Exercise** |   |   |   | Exercise |   |
|                                                                                  |   | **Shares**                                                            |          | **Price** |   | Shares |   | Price |   |
| Options                    Outstanding,                                               |   |                                                                  |          |   |   |   |   |   |   |
| Beginning                    of                    Period                             |   |                                                                  | **1,537,041** |   | **$** | **16.75** |   |   | 2,076,055 |   | $ | 16.19 |   |
| Granted                                                                               |   |                                                                  | **187,640**   |   | **$** | **30.55** |   |   | 50,000 |   | $ | 33.55 |   |
| Exercised                                                                             |   |                                                                  | **(237,002**  | **)** | **$** | **15.53** |   |   | (377,443 | ) | $ | 16.11 |   |
| Forfeited                                                                             |   |                                                                  | **(2,252**    | **)** | **$** | **14.23** |   |   | (7,198 | ) | $ | 18.08 |   |
| Options                    Outstanding, End of Period                                 |   |                                                                  | **1,485,427** |   | **$** | **18.69** |   |   | 1,741,414 |   | $ | 16.70 |   |
| Options                    Exercisable, End of Period                                 |   |                                                                  | **1,264,454** |   | **$** | **16.54** |   |   | 1,683,942 |   | $ | 16.20 |   |
|                                                                                  |   |                                                                  |          |
| Weighted                    Average Remaining Contractual Life at September 30, 2006: |   | 5.08                    years                                         |          |

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**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|                                                  | **Options                    Outstanding** | **Options                    Exercisable**                         |
|-------------------------------------------------------|--------------------------------------------|--------------------------------------------------------------------|
| **Range                    of Exercise Prices**       | **Number                    of Shares**    | **Weighted-Average                    Remaining Contractual Life** |  **Weighted-Average                    Exercise Price** | **Number                    of Shares** | **Weighted-Average                    Exercise Price** |
| $11.00                    -                    $15.56 | 572,095                                    | 3.1                    years                                       | $14.30 | 572,095 | $14.30 |
| $16.78                    -                    $18.84 | 675,692                                    | 5.2                    years                                       | $18.02 | 675,692 | $18.02 |
| $30.55                    -                    $33.55 | 237,640                                    | 9.5                    years                                       | $31.18 | 16,667 | $33.55 |

**RESTRICTED          STOCK AND STOCK UNITS**

**PERFORMANCE          SHARES**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**NOTE12.          INCOME AND OTHER TAXES**

**INCOME          TAXES**

|                                                                        |   | **UniSource                    Energy**                  |       |
|-----------------------------------------------------------------------------|--------|----------------------------------------------------------|------------|
|                                                                        |   | Three                    Months                    Ended |       | Nine                    Months                    Ended |   |
|                                                                        |   | September                    30,                         |       | September                    30, |   |
|                                                                        |   | **2006**                                                 |       | **2005** |   | **2006** |   | **2005** |   |
|                                                                        |   |                                                     |       | -Thousands                    of                    Dollars - |   |   |   |
|                                                                        |   |                                                     |       |   |   |   |   |   |   |
| **Federal                    Income Tax Expense at Statutory Rate**         |   | **$**                                                    | **16,071** |   | $ | 10,267 |   | **$** | **33,713** |   | $ | 14,235 |   |
|  State                    Income Tax Expense, Net of Federal Deduction |   |                                                     | **2,112**  |   |   | 1,350 |   |   | **4,430** |   |   | 1,871 |   |
|                      Depreciation Differences (Flow Through Basis)     |   |                                                     | **662**    |   |   | 708 |   |   | **1,987** |   |   | 2,124 |   |
|                      Amortization of Excess Deferred Income Tax        |   |                                                     | **(90**    | **)** |   | - |   |   | **(270** | **)** |   | - |   |
|  Tax                    Credits                                        |   |                                                     | **(127**   | **)** |   | (205 | ) |   | **(381** | **)** |   | (466 | ) |
|                      Valuation Allowance                               |   |                                                     | **(120**   | **)** |   | (1,000 | ) |   | **(120** | **)** |   | (1,000 | ) |
|                      Other                                             |   |                                                     | **(794**   | **)** |   | (184 | ) |   | **(729** | **)** |   | (176 | ) |
| **Total                    Federal and State Income Tax Expense**           |   | **$**                                                    | **17,714** |   | $ | 10,936 |   | **$** | **38,630** |   | $ | 16,588 |   |

|                                                                        |   | **TEP**                                                  |       |
|-----------------------------------------------------------------------------|--------|----------------------------------------------------------|------------|
|                                                                        |   | Three                    Months                    Ended |       | Nine                    Months                    Ended |   |
|                                                                        |   | September                    30,                         |       | September                    30, |   |
|                                                                        |   | **2006**                                                 |       | **2005** |   | **2006** |   | **2005** |   |
|                                                                        |   |                                                     |       | -Thousands                    of                    Dollars - |   |   |   |
|                                                                        |   |                                                     |       |   |   |   |   |   |   |
| **Federal                    Income Tax Expense at Statutory Rate**         |   | **$**                                                    | **16,924** |   | $ | 11,401 |   | **$** | **33,456** |   | $ | 16,387 |   |
|  State                    Income Tax Expense, Net of Federal Deduction |   |                                                     | **2,224**  |   |   | 1,499 |   |   | **4,396** |   |   | 2,153 |   |
|                      Depreciation Differences (Flow Through Basis)     |   |                                                     | **662**    |   |   | 708 |   |   | **1,987** |   |   | 2,124 |   |
|                      Amortization of Excess Deferred Income Tax        |   |                                                     | **(90**    | **)** |   | - |   |   | **(270** | **)** |   | - |   |
|  Tax                    Credits                                        |   |                                                     | **(127**   | **)** |   | (205 | ) |   | **(381** | **)** |   | (466 | ) |
|                      Valuation Allowance                               |   |                                                     | **(120**   | **)** |   | (1,000 | ) |   | **(120** | **)** |   | (1,000 | ) |
|                      Other                                             |   |                                                     | **(719**   | **)** |   | (193 | ) |   | **(888** | **)** |   | (199 | ) |
| **Total                    Federal and State Income Tax Expense**           |   | **$**                                                    | **18,754** |   | $ | 12,210 |   | **$** | **38,180** |   | $ | 18,999 |   |

**OTHER          TAX          MATTERS**

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Table              of Contents

**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

**OTHER          TAXES**

**NOTE13.          UTILITY PLANT AND JOINTLY-OWNED          FACILITIES**

|                                                                                                                     |   |                                                        |   |                           |   |                                |   |                                                       |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------|--------|--------------------------------|--------|-------------------------------------|--------|------------------------------------------------------------|--------|
|                                                                                                                     |   | **TEP**                                                     |   | **UNS                    Gas** |   | **UNS                    Electric** |   | ** UniSource                    Energy Consolidated** |   |
| **As                    of                    September 30, 2006**                                                       |   | T&D                                                     |   | Gen*                           |   | Total                    Plant      |   | Total                    Plant                             |   | Total                    Plant |   | AllOther |   | TEP                    Gen* |   | Total                    Plant |   |
|                                                                                                                     |   | -Millions                    of                    Dollars- |   |
| Gross                    Plant                    in Service                                                             |   | $                                                           | 1,713  |                           | $      | 1,294                               |   | $                                                          | 3,007  |   | $ | 196 |   | $ | 164 |   | $ | 2,073 |   | $ | 1,294 |   | $ | 3,367 |   |
| Less                    Accumulated  Depreciation                    and                     Amortization |   |                                                        | 859    |                           |   | 567                                 |   |                                                       | 1,426  |   |   | 14 |   |   | 27 |   |   | 900 |   |   | 567 |   |   | 1,467 |   |
| Net                    Plant in                    Service                                                               |   | $                                                           | 854    |                           | $      | 727                                 |   | $                                                          | 1,581  |   | $ | 182 |   | $ | 137 |   | $ | 1,173 |   | $ | 727 |   | $ | 1,900 |   |
|                                                                                                                     |   |                                                        |   |                           |   |                                |   |                                                       |   |

|                                                                                                                |   |                                                              |    |           |   |   |                |   |                                                          |
|---------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------|---------|----------------|--------|--------|---------------------|--------|---------------------------------------------------------------|
|                                                                                                                     |   | **TEP**                                                      |    | **UNS****Gas** |   |   | **UNS****Electric** |   | ** UniSource                    Energy****Consolidated** |
| **As                    of                    December 31, 2005**                                                   |   |                                                              | T&D |           |   | Gen*   |                |   | Total                    Plant                                |   |   | Total                    Plant |   |   | Total                    Plant |   |   | AllOther |   |   | TEPGen* |   |   | Total                    Plant |   |
|                                                                                                                |   | -Millions                    of                    Dollars-  |
| Gross                    Plant                    in Service                                                        |   | $                                                                 | 1,629   |           | $      | 1,233  |                | $      | 2,862                                                         |   | $ | 180 |   | $ | 126 |   | $ | 1,935 |   | $ | 1,233 |   | $ | 3,168 |   |
| Less                    Accumulated                     Depreciation and                     Amortization |   |                                                              | 817     |           |   | 561    |                |   | 1,378                                                         |   |   | 10 |   |   | 20 |   |   | 847 |   |   | 561 |   |   | 1,408 |   |
| Net                    Plant in                    Service                                                          |   | $                                                                 | 812     |           | $      | 672    |                | $      | 1,484                                                         |   | $ | 170 |   | $ | 106 |   | $ | 1,088 |   | $ | 672 |   | $ | 1,760 |   |

**NOTE14.          NEW ACCOUNTING PRONOUNCEMENTS**

|   | · | Emerging                    Issues Task Force Issue 06-3 (EITF 06-3), *How                    Taxes                    Collected from Customers and Remitted to Governmental Authorities                    Should                    Be Presented in the Income Statement (that Is, Gross versus Net                    Presentation)*,                    ratified                    June 2006, requires disclosure of a company’s accounting policy decision                    to present taxes on either a gross (included in revenues and                    costs) or a                    net (excluded from revenues) basis. Additionally, a company must                    disclose                    the amounts of any taxes reported on a gross basis in interim                    and |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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**NOTES              TO              CONDENSED CONSOLIDATED FINANCIAL STATEMENTS              (CONTINUED)**

|   |   | annual                        financial statements. EITF 06-3 is effective for interim                        and annual                        reporting periods beginning after December 15, 2006. See                        Note                        12. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | FIN                    48,                    *Accounting                    for Uncertainty in Income Taxes - an interpretation of FAS                    109*,                    issued July                    2006, prescribes a recognition threshold and measurement attribute                    for the                    financial statement recognition and measurement of a tax position                    taken in                    a tax return. We must determine whether it is “more-likely-than-not” that                    a tax position will be sustained upon examination, including                    resolution of                    any related appeals or litigation processes, based on the technical                    merits                    of the position. Once it is determined that a position meets                    the                    more-likely-than-not recognition threshold, the position is measured                    to                    determine the amount of benefit to recognize in the financial                    statements.                    Additionally, FIN 48 requires disclosure of a rollforward of                    total                    unrecognized tax benefits.  We do not believe the adoption of FIN 48                    will have a material effect on our financial position or results                    of                    operations. FIN 48 is effective for fiscal years beginning after                    December                    15, 2006. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | FAS                    157,                    *Fair                    Value Measurement*, issued                    September 2006, defines fair value, establishes a framework for                    measuring                    fair value, and expands disclosures about fair value measurements.                     This Statement clarifies that the exchange price is the price                    in the                    principal market in which the reporting entity would transact                    for the                    asset or liability.  We are required to disclose inputs used to                    develop fair value measurements and the effect of any of our                    assumptions                    on earnings or changes in net assets for the period.  FAS 157 is                    effective for financial statements issued for fiscal years beginning                    after                    November 15, 2007, and interim periods within those fiscal years.  We                    will incorporate these additional disclosure requirements in                    our financial                    statements for the quarter ended March 31,                    2008. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | FSP                    AUG-AIR-1, *Accounting                    for Planned Major Maintenance Activities*,                    issued                    September 2006, prohibits the use of the accrue-in-advance method                    of                    accounting for planned major maintenance activities effective                    in fiscal                    years beginning after December 15, 2006.  As we do not accrue planned                    major maintenance activities in advance, we anticipate no impact                    on our                    financial statements from the adoption of this                    FSP. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | · | FAS                    158,                    *Employers’                    Accounting for Defined Benefit Pension and Other Postretirement                    Plans*,                    issued                    September 2006, requires recognition of the overfunded or underfunded                    status of a defined benefit postretirement plan measured as the                    difference                    between the fair value of the plans assets and benefit obligation.                    For a                    pension plan, the benefit obligation would be the projected benefit                    obligation; for any other postretirement benefit plans, the benefit                    obligation would be the accumulated postretirement benefit obligation.                    An                    overfunded status would result in the recognition of an asset                    and an                    underfunded status would result in the recognition of a liability.                    The                    adjustment required to recognize an asset or liability upon adoption                    of                    this statement would result in an expense or benefit to Other                    Comprehensive Income. FAS 158 is effective for fiscal years ending                    after                    December 15, 2006. We are evaluating the impact of FAS 158 on                    our                    financial condition and results of operations. Based on our benefit                    obligations and fair value of plan assets as of December 31,                    2005, the                    adoption of FAS 158 could result in the recognition of an additional                    liability and a corresponding charge to Other Comprehensive Income                    in the                    range of $24 million to $38 million, subject to various assumptions,                    such                    as the discount rate. If TEP’s regulated operations and UNS Gas and UNS                    Electric qualify for regulatory accounting treatment, any additional                    liability recognized would be offset by a regulatory asset, rather                    than                    Other Comprehensive Income. However, FAS 158 would not have a                    material                    effect on our results of                    operations. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   |   | In                    the third                    quarter of 2006, the Pension Protection Act of 2006 was signed                    into law,                    which will be effective January 1, 2008. The new law will affect                    the                    manner in which many companies, including UniSource Energy and                    TEP,                    administer their pension plans. The legislation will require                    companies to                    increase the amount by which they fund their pension plans, increase                    premiums to the Pension Benefit Guaranty Corporation for defined                    benefit                    plans, amend plan documents and provide additional disclosures                    in                    regulatory filings and to plan participants. We are currently                    assessing                    the impact it may have on our financial                    statements. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table                of Contents

**NOTES                TO                CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                (CONTINUED)**

**NOTE15.          SUPPLEMENTAL CASH FLOW          INFORMATION**

|                                                                                                           |   | **UniSource                    Energy**                                                 |        |
|----------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------|-------------|
|                                                                                                           |   | Nine                    Months                    EndedSeptember                    30, |        |
|                                                                                                           |   | **2006**                                                                                |        | **2005** |   |
|                                                                                                           |   | -Thousands                    of                    Dollars-                            |        |
|                                                                                                           |   |                                                                                    |        |   |   |
| **Net                    Income**                                                                              |   | **$**                                                                                   | **55,023**  |   | $ | 24,082 |   |
| **Adjustments                    to Reconcile Net Income**                                                     |   |                                                                                    |        |   |   |   |   |
| **To                    Net Cash Flows**                                                                       |   |                                                                                    |        |   |   |   |   |
| Discontinued                    Operations - Net of Tax                                                        |   |                                                                                    | **2,669**   |   |   | 4,421 |   |
| Depreciation                    and Amortization Expense                                                       |   |                                                                                    | **96,767**  |   |   | 99,800 |   |
| Depreciation                    Recorded to Fuel and Other O&M Expense                                     |   |                                                                                    | **5,760**   |   |   | 4,576 |   |
| Amortization                    of Transition Recovery Asset                                                   |   |                                                                                    | **51,080**  |   |   | 43,865 |   |
| Net                    Unrealized (Gain) Loss on Forward Electric Sales                                        |   |                                                                                    | **(7,321**  | **)** |   | 10,066 |   |
| Net                    Unrealized Loss (Gain) on Forward Electric Purchases                                    |   |                                                                                    | **6,950**   |   |   | (779 | ) |
| Net                    Unrealized Loss (Gain) on MEG Trading Activities                                        |   |                                                                                    | **3,056**   |   |   | (5,413 | ) |
| Amortization                    of Deferred Debt-Related Costs included in Interest                    Expense |   |                                                                                    | **3,509**   |   |   | 3,502 |   |
| Loss                    on                    Extinguishment of Debt                                           |   |                                                                                    | **1,080**   |   |   | 5,261 |   |
| Provision                    for                    Bad Debts                                                  |   |                                                                                    | **2,635**   |   |   | 2,140 |   |
| Deferred                    Income Taxes                                                                       |   |                                                                                    | **13,328**  |   |   | 16,684 |   |
| (Income)                    Loss                    from Equity Method Entities                                |   |                                                                                    | **(309**    | **)** |   | 109 |   |
| Excess                    Tax                    Benefit from Stock Option Exercises                           |   |                                                                                    | **(1,106**  | **)** |   | (1,945 | ) |
| Other                                                                                                          |   |                                                                                    | **7,391**   |   |   | (2,065 | ) |
| Changes                    in                    Assets and Liabilities which Provided (Used)                  |   |                                                                                    |        |   |   |   |   |
| Cash                    Exclusive of Changes Shown Separately                                                  |   |                                                                                    |        |   |   |   |   |
| Accounts                    Receivable                                                                         |   |                                                                                    | **(26,821** | **)** |   | (6,752 | ) |
| Materials                    and                    Fuel Inventory                                             |   |                                                                                    | **(4,215**  | **)** |   | (10,547 | ) |
| Accounts                    Payable                                                                            |   |                                                                                    | **(22,846** | **)** |   | (25,454 | ) |
| Income                    Taxes                    Payable                                                     |   |                                                                                    | **(10,493** | **)** |   | (3,445 | ) |
| Interest                    Accrued                                                                            |   |                                                                                    | **(17,192** | **)** |   | (18,952 | ) |
| Taxes                    Accrued                                                                               |   |                                                                                    | **12,514**  |   |   | 12,887 |   |
| Other                    Current                    Assets                                                     |   |                                                                                    | **27,269**  |   |   | 84,284 |   |
| Other                    Current                    Liabilities                                                |   |                                                                                    | **1,273**   |   |   | (61,118 | ) |
| Net                    Cash Used                    by Operating Activities of Discontinued Operations         |   |                                                                                    | **(2,710**  | **)** |   | (4,789 | ) |
| **Net                    Cash Flows - Operating Activities**                                                   |   | **$**                                                                                   | **197,291** |   | $ | 170,418 |   |

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Table              of Contents

**NOTES                TO                CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                (CONCLUDED)**

|                                                                                                           |   | **TEP**                                                      |        |
|----------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------|-------------|
|                                                                                                           |   | Nine                    Months                    Ended      |        |
|                                                                                                           |   | September                    30,                             |        |
|                                                                                                           |   | **2006**                                                     |        | **2005** |   |
|                                                                                                           |   | -Thousands                    of                    Dollars- |        |
|                                                                                                           |   |                                                         |        |   |   |
| **Net                    Income**                                                                              |   | **$**                                                        | **57,408**  |   | $ | 27,822 |   |
| **Adjustments                    to Reconcile Net Income**                                                     |   |                                                         |        |   |   |   |   |
| To                    Net Cash                    Flows                                                        |   |                                                         |        |   |   |   |   |
| Depreciation                    and Amortization Expense                                                       |   |                                                         | **83,504**  |   |   | 86,903 |   |
| Depreciation                    Recorded to Fuel and Other O&M Expense                                     |   |                                                         | **4,812**   |   |   | 4,763 |   |
| Amortization                    of Transition Recovery Asset                                                   |   |                                                         | **51,080**  |   |   | 43,865 |   |
| Net                    Unrealized (Gain) Loss on TEP Forward Electric Sales                                    |   |                                                         | **(7,322**  | **)** |   | 10,066 |   |
| Net                    Unrealized Loss (Gain) on TEP Forward Electric Purchases                                |   |                                                         | **6,368**   |   |   | (779 | ) |
| Amortization                    of Deferred Debt-Related Costs included in Interest                    Expense |   |                                                         | **2,560**   |   |   | 2,775 |   |
| Loss                    on                    Extinguishment of Debt                                           |   |                                                         | **685**     |   |   | 5,261 |   |
| Provision                    for                    Bad Debts                                                  |   |                                                         | **1,373**   |   |   | 1,645 |   |
| Deferred                    Income Taxes                                                                       |   |                                                         | **13,771**  |   |   | 19,466 |   |
| Income                    from                    Equity Method Entities                                       |   |                                                         | **(276**    | **)** |   | (281 | ) |
| Interest                    on                    Note Receivable from UniSource Energy                        |   |                                                         | **-**       |   |   | (1,684 | ) |
| Other                                                                                                          |   |                                                         | **7,634**   |   |   | 2,969 |   |
| Changes                    in                    Assets and Liabilities which Provided (Used)                  |   |                                                         |        |   |   |   |   |
| Cash                    Exclusive of Changes Shown Separately                                                  |   |                                                         |        |   |   |   |   |
| Accounts                    Receivable                                                                         |   |                                                         | **(47,913** | **)** |   | (30,885 | ) |
| Materials                    and                    Fuel Inventory                                             |   |                                                         | **(2,807**  | **)** |   | (8,701 | ) |
| Accounts                    Payable                                                                            |   |                                                         | **(13,087** | **)** |   | (11,811 | ) |
| Interest                    Accrued                                                                            |   |                                                         | **(12,531** | **)** |   | (17,612 | ) |
| Interest                    Received from UniSource Energy                                                     |   |                                                         | **-**       |   |   | 11,013 |   |
| Income                    Taxes                    Receivable                                                  |   |                                                         | **(4,413**  | **)** |   | - |   |
| Income                    Taxes                    Payable                                                     |   |                                                         | **(17,111** | **)** |   | (15,946 | ) |
| Taxes                    Accrued                                                                               |   |                                                         | **12,139**  |   |   | 12,908 |   |
| Other                    Current                    Assets                                                     |   |                                                         | **3,547**   |   |   | 7,423 |   |
| Other                    Current                    Liabilities                                                |   |                                                         | **4,080**   |   |   | (3,569 | ) |
| **Net                    Cash Flows - Operating Activities**                                                   |   | **$**                                                        | **143,501** |   | $ | 145,611 |   |

**NOTE16.          REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING          FIRM**

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Table              of Contents

| **ITEM2.                - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL                CONDITION AND RESULTS OF                OPERATIONS** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | outlook                and                strategies, |
|----------------------------------------------------|-------------------------------------------------------|

| ·                    | operating                results during the third quarter and first nine months of 2006 compared                with the same periods in 2005, |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | factors                which                affect our results and outlook, |
|----------------------------------------------------|-----------------------------------------------------------------------------|

| ·                    | liquidity,                capital needs, capital resources, and contractual                obligations, |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------|

| ·                    | dividends,                and |
|----------------------------------------------------|-------------------------------|

| ·                    | critical                accounting estimates. |
|----------------------------------------------------|-----------------------------------------------|

**UNISOURCEENERGY      CONSOLIDATED**

**OVERVIEWOF      CONSOLIDATED      BUSINESS**

**OUTLOOKAND      STRATEGIES**

**Operating      Plans and Strategies **

| ·                    | Efficiently                manage our generation, transmission and distribution resources and                look                for ways to control our operating expenses while maintaining and                enhancing                reliability and profitability; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Expand                TEP’s                and UNS Electric’s portfolio of generating and purchased power resources                to meet growing retail energy                demand; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·                    | Resolve                the                uncertainty surrounding TEP’s rates for generation service after 2008,                while preserving TEP’s benefits under the Settlement                Agreement; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Receive                ACC                approval of rate increases for UNS Gas and UNS Electric to provide                adequate revenues to cover the rising cost of providing service to                their                customers; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Enhance                the                value of existing generation assets by working with Salt River Project                to                support the construction of Springerville Unit                4; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Enhance                the                value of TEP’s transmission system while continuing to provide reliable                access to generation for TEP and UNS Electric’s retail customers and                market access for all generating                assets; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Continue                to                integrate UNS Gas and UNS Electric with UniSource Energy’s other                businesses; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Reduce                debt;                and |
|----------------------------------------------------|------------------------------------------------|

| ·                    | Promote                economic development in our service territories.** ** |
|----------------------------------------------------|-----------------------------------------------------------------------------------|

|                                         |   | Actual                Year-to-Date September                30,                2006 |   | EstimateFull                Year                2006 |   |
|----------------------------------------------|--------|-------------------------------------------------------------------------------------|--------|------------------------------------------------------|--------|
|                                         |   | -Millions                of                Dollars-                                 |   |
| TEP                                          |   | $                                                                                   | 111    |                                                 | $      | 175 |   |
| UNS                Gas                       |   |                                                                                | 19     |                                                 |   | 26 |   |
| UNS                Electric                  |   |                                                                                | 29     |                                                 |   | 39 |   |
| Other                                        |   |                                                                                | -      |                                                 |   | 10 |   |
| UniSource                Energy Consolidated |   | $                                                                                   | 159    |                                                 | $      | 250 |   |

**RESULTSOF      OPERATIONS**

**Executive      Overview**

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Table          of Contents

**CONTRIBUTIONBY      BUSINESS      SEGMENT**

|                                                                                  |   | **Three                Months Ended****September                30,** | **Nine                Months Ended****September                30,** |
|----------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|----------------------------------------------------------------------|
|                                                                             |   |                                                                  | **2006**                                                             |   |   | **2005** |   |   | **2006** |   |   | **2005** |   |
|                                                                             |   | -Millions                of                Dollars-                   | -Millions                of Dollars-                                 |
| TEP                                                                              |   | $                                                                     | 30                                                                   |   | $ | 20 |   | $ | 57 |   | $ | 28 |   |
| UNS                Gas                                                           |   |                                                                  | (2                                                                   | ) |   | (2 | ) |   | 2 |   |   | 2 |   |
| UNS                Electric                                                      |   |                                                                  | 2                                                                    |   |   | 2 |   |   | 4 |   |   | 4 |   |
| Other                (1)                                                         |   |                                                                  | (2                                                                   | ) |   | - |   |   | (5 | ) |   | (5 | ) |
| Consolidated                Net Income from Continuing                Operations |   | $                                                                     | 28                                                                   |   | $ | 20 |   | $ | 58 |   | $ | 29 |   |
| Discontinued                Operations (2)                                       |   |                                                                  | -                                                                    |   |   | (2 | ) |   | (3 | ) |   | (5 | ) |
| Consolidated                Net Income                                           |   | $                                                                     | 28                                                                   |   | $ | 18 |   | $ | 55 |   | $ | 24 |   |

**Three      Months Ended September 30, 2006 Compared with the Three Months Ended September      30, 2005**

| ·                    | a                $31 million                increase in TEP’s gross margin (total operating revenues less fuel and                purchased power expense) due to the                following: |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $16 million                increase in wholesale revenues due primarily to a $15 million change                in                mark-to-market adjustments to recognize unrealized gains on forward                wholesale sales. Lower market prices for power offset a 21% increase                in                wholesale MWhs sold. See -*TEP                Results of Operations*,                below for                detail; and |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $12 million                increase in fuel expense for TEP’s generating plants due to the higher use                and availability of TEP’s coal plants, as well as gas-related fuel expense                related to Luna; offset by |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $21 million                decrease in purchased power expense due to the higher availability                of                TEP’s coal-fired plants and output from Luna. Purchased power expense                also                reflects a $6 million change in mark-to-market adjustments to recognize                unrealized losses on forward purchases of energy. See - *TEP                Results of Operations*,                below for                detail; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | an                $11                million increase in other operations and maintenance (O&M) expense due                primarily to higher operating costs at TEP’s generating plants. O&M                also includes pre-tax gains of $3 million and $4 million, respectively,                in                the third quarters of 2006 and 2005, related to the sale of excess                Emission Allowances by TEP; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·                    | a                $3 million                contribution related to the operation of Tri-State’s Springerville Unit 3.                The reimbursement of O&M, fuel expenses and operating fees paid by                Tri-State are recorded in other revenue and the associated costs                are                recorded in fuel and O&M. Transmission revenues related to                Springerville Unit 3 are recorded in wholesale                revenues; |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $3 million                increase in total interest expense due to the payment of interest                to the                IRS related to a notice of a proposed adjustment to previously filed                tax                returns and the write off of fees related to amending the credit                agreements for UniSource Energy, TEP, UNS Gas and UNS Electric;                and |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $2 million                increase in the amortization of TEP’s Transition Recovery Asset                (TRA). |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $16 million                increase in retail sales due to warmer weather and 3% increase in                TEP’s                customer base compared with the third quarter of                2004; |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $14 million                reduction in TEP’s gross margin due to replacement power costs and lost                wholesale sales opportunities resulting from a 26-day unplanned outage                at                TEP’s 380 MW Springerville Unit 2;                and |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                net                unrealized loss of $8 million related to mark-to-market adjustments                on                forward sales and purchases of energy. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Nine      Months      Ended September 30, 2006 Compared with the Nine Months Ended September 30,      2005**

| ·                    | a                $51 million                increase in TEP’s gross margin (total operating revenues less fuel and                purchased power expense) due to the                following: |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $21 million                increase in retail revenues due to warm weather during the second                quarter                and customer growth; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $30 million                increase in wholesale revenues resulting from a $17 million increase                in                unrealized gains related to mark-to-market adjustments on forward                sales                and higher wholesale sales resulting from increased excess capacity                at                TEP’s coal-fired generating plants;                and |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $15 million                decrease in purchased power expense due to fewer coal plant outages                and                the availability of Luna to offset some of TEP’s wholesale purchases                during summer peak periods. Purchased power expense also reflects                a $7                million increase in unrealized losses due to mark-to-market adjustments                on                forward purchases of energy; offset                by |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $28 million                increase in fuel expense for TEP’s generating plants resulting from the                higher use and availability of TEP’s coal plants, as well as gas-related                fuel expense related to Luna; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | an                $8 million                increase in O&M expense due primarily to higher operating costs                associated with Luna. O&M also includes pre-tax gains of $7 million in                the first nine months of 2006 and 2005, related to the sale of excess                Emission Allowances by TEP; |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $3 million                contribution related to Tri-State’s Springerville Unit 3. The                reimbursement of O&M, fuel expenses and operating fees paid by                Tri-State are recorded in other revenue and the associated costs                are                recorded in fuel and O&M. Transmission revenues related to                Springerville Unit 3 are recorded in wholesale                revenues; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·       | a                $3 million                decline in depreciation and amortization due primarily to the extension                of                useful lives of certain generating assets at TEP in April 2005; |
|--------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $7 million                increase in the amortization of TEP’s TRA;                and |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------|

| ·                    | a                $7 million                decrease in total interest expense due primarily to lower interest                on                long-term debt and capital lease debt, which was partially offset                by                interest paid to the IRS related to a notice of a proposed adjustment                to                previously filed tax returns and fees incurred in the third quarter                of                2006 related to amending the credit agreements at UniSource Energy,                TEP,                UNS Gas and UNS Electric. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**LIQUIDITYAND      CAPITAL RESOURCES**

**UNISOURCE      ENERGY CONSOLIDATED CASH FLOWS**

| **Nine                Months Ended September 30,**        |   | **2006**                                            |   | **2005** |   |
|-----------------------------------------------------------|--------|-----------------------------------------------------|--------|----------|--------|
|                                                      |   | -Millions                of                Dollars- |
| Cash                provided                by (used in): |   |                                                |   |     |   |   |   |
| Operating                Activities                       |   | $                                                   | 197    |     | $      | 170 |   |
| Investing                Activities                       |   |                                                | (168   | )        |   | (112 | ) |
| Financing                Activities                       |   |                                                | (89    | )        |   | (109 | ) |

| ·                    | fund                capital                expenditures at TEP, UNS Gas and UNS                Electric; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------|

| ·                    | pay                dividends                to shareholders; and |
|----------------------------------------------------|------------------------------------------------------------------|

| ·                    | reduce                leverage. |
|----------------------------------------------------|---------------------------------|

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Table          of Contents

|   **Balances                As of****October                31, 2006** |   |   **Cash                and Cash Equivalents** |                           |  **Borrowings****under                Revolving****Credit                Facility** |   |  **Amount                Available under Revolving Credit Facility** |   |
|----------------------------------------------------------------------------------|--------|----------------------------------------------------------|--------------------------------|------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------|--------|
|                                                                             |   | -Millions                of                Dollars-      |                           |
| UniSource                Energy stand-alone                                      |   | $                                                        | 1                    |                                                                                     | $      | 20                                                                        |   | $ | 50                   |   |
| TEP                                                                              |   |                                                     | 22                   |                                                                                     |   | -                                                                         |   |   | 60                (1 | ) |
| UNS                Gas                                                           |   |                                                     | 20                   |                                                                                     |   | -                                                                         |   |   | 26                (2 | ) |
| UNS                Electric                                                      |   |                                                     | 5                    |                                                                                     |   | 14                                                                        |   |   | 16                (2 | ) |
| Other                                                                            |   |                                                     | 34                (3           | )                                                                                        |   | NA                                                                        |   |   | NA                   |   |
| Total                                                                            |   | $                                                        | 82                   |                                                                                     |   |                                                                      |   |   |   |   |

*Tucson      Electric      Power, Liquidity and Capital Resources, TEP Credit Agreement.*

*UNS      Gas,      Liquidity and Capital Resources, UNS Gas/UNS Electric Credit*
*Agreement,*
*UNS      Electric,      Liquidity and Capital Resources, UNS Gas/UNS Electric Credit Agreement,*

**Executive      Overview**

**Operating      Activities**

| ·                    | a                $29 million                increase in cash receipts from retail electric sales due primarily                to                customer growth at TEP and UNS                Electric; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $24 million                increase in cash receipts from UNS Gas’ retail sales due to the Purchased                Gas Adjustor (PGA) surcharge adjustments that took effect in November                2005                and customer growth; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $24 million                increase in cash receipts from wholesale electric sales due to the                higher                amount of excess output from TEP’s coal-fired generating plants and                increased wholesale trading activity; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $12 million                increase in fuel costs paid due to the higher availability and use                of                TEP’s coal-fired generating plants, as well as the availability of                Luna; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $12 million                increase in purchased energy costs due to higher sales at UNS Electric                and                UNS Gas; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $4 million                decrease in payments for O&M costs. O&M costs were higher in the                first nine months of 2005 due to outages at TEP’s coal                plants; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·                    | a                $9 million                decrease in total interest costs paid due to lower amounts of outstanding                long-term debt and capital lease obligations;                and |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $34 million                increase in income taxes paid due to a $24 million payment made to                the IRS                related to a notice of a proposed adjustment to previously filed                tax                returns and a $10 million increase to federal and state extension                and                estimated tax payments. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | $11                million                of net cash payments related to MEG trading                activity. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------|

**Investing      Activities**

| ·                    | a                $19 million                increase in capital expenditures related to TEP’s share of the                construction costs of Luna, growth and |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP’s                purchase of a 14% equity interest in the Springerville Unit 1 Lease,                which                represents approximately 53 MW of                capacity; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | $16                million                of proceeds from the sale of Global                Solar; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------|

| ·                    | a                $9 million                increase in proceeds from investment in Springerville Lease Debt;                and |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $4 million                decline in proceeds received from the return on Millennium                investments. |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------|

**Financing      Activities**

| ·                    | a                $36 million                increase in net proceeds from borrowings under revolving credit                facilities; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | an                $11                million decline in debt issuance and retirement                costs; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------|

| ·                    | $30                million                of proceeds from the issuance of long-term                debt; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------|

| ·                    | $88                million                used for long-term debt repayments; |
|----------------------------------------------------|-------------------------------------------------------------------------------|

| ·                    | a                $9 million                increase in TEP’s scheduled payments on capital lease                obligations; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $4 million                decrease in proceeds from the exercise of stock options; and |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------|

| ·                    | a                $2 million                increase in dividends paid to UniSource Energy                shareholders. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------|

| ·                    | $240                million                of proceeds related to debt issuances at UniSource Energy; offset                by |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------|

| ·                    | $284                million                used to repay long-term debt at TEP and UniSource Energy;                and |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|

| ·                    | $12                million                used for debt issuance and retirement                costs. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------|

----

Table          of Contents

**GUARANTEES      AND INDEMNITIES**

| ·                    | UES’                guarantee of $160 million of senior unsecured notes issued by UNS                Gas and                UNS Electric to purchase the Arizona gas and electric system assets                of                Citizens Communication Company (Citizens); |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | UES’                guarantee of a $40 million revolving credit facility available to                UNS Gas                and UNS Electric; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·                    | UniSource                Energy’s guarantee of approximately $5 million in natural gas and supply                payments and building lease payments for UNS Gas, UNS Electric and                a                subsidiary of Millennium. |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Note      3 of Notes      to Condensed Consolidated Financial Statements*

**CONTRACTUAL      OBLIGATIONS**

| ·                    | In                October                2006, UED purchased two electric generating turbines for $17 million.                UED                paid $2 million at the date of purchase and will pay the balance                over the                next six months. The turbines will be part of a 90 MW power project                to be                constructed in Kingman, Arizona in UNS Electric’s service area.                Construction is expected to begin during the third quarter of 2007                with an                estimated completion date of May 2008. Including the purchase of                the                turbines, the entire project is expected to cost $60                million. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                September                2006, UNS Electric entered into a 25 MW power supply agreement for                the                period June 2008 through May 2009. The                contract                is based on a fixed price and will cost UNS Electric approximately                $14                million for the year. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                September                2006, UNS Electric entered into a 25 MW power supply agreement for                the                period June 2008 through May 2011. The                contract                is indexed to natural gas prices. UNS Electric’s minimum expected annual                payment under this contract is $16 million based on natural gas prices                as                of September 30, 2006. |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP’s                purchased power agreement with Tri-State for 100 MW of system capacity                became effective September 1, 2006. This contract allows Tri-State                to                reduce the contract capacity in increments of 25 MW with 90 days’ notice.                To date, TEP has received no such notice. If Tri-State does not give                notice to reduce capacity, the minimum capacity payments will be                $10                million for 2006, $31 million annually in 2007 through 2010, and                $21                million in 2011. |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP                provides                incentives to new home builders to construct TEP Guarantee Homes                that meet                the highest construction and energy-efficiency standards available.                TEP’s                builder incentive commitment totaled $2 million at September 30,                2006. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                June 2006,                TEP refinanced variable rate notes underlying the Springerville Common                Facilities Leases. A portion of the rent payable by TEP pursuant                to the                Springerville Common Facilities Leases is determined by the amount                of                interest payable on the variable rate lease debt. The notes were                amended                to provide that interest will be payable at LIBOR plus 1.5% for the                next                three years with the spread over LIBOR increasing every three years                thereafter to 2% by June 2018. Prior to the refinancing, the interest                rate                was LIBOR plus 4%. TEP                estimates                its obligation using a forward LIBOR curve. At September 30, 2006,                TEP’s                expected payments under the Springerville Common Facilities Leases                total:                $7 million in 2006; $6 million in 2007; $6 million in 2008; $6 million                in                2009; $6 million in 2010; $6 million in 2011; and $145 million thereafter.                TEP’s obligation does not include the impact of the 2006 interest rate                swap. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                June 2006,                TEP purchased a 14% equity ownership interest in the Springerville                Unit 1                Leases. As a result, TEP amended the Springerville Unit 1 Lease related                to                such undivided interest to reduce TEP’s rent |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

Table          of Contents

|    | payable                to                equal the scheduled amount of principal and interest payable on the                debt                issued by the owner trustee. At September 30, 2006, TEP’s expected                payments under the Springerville Unit 1 Leases total: $85 million                in 2006;                $83 million in 2007; $82 million in 2008; $30 million in 2009; $57                million                in 2010; $83 million in 2011; and $317 million                thereafter. |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                May 2006,                UNS Electric entered into a 25 MW power supply agreement for the                period                June 2008 through December 2013. The                25 MW                consists of 10 MW at a fixed price with the remaining 15 MW price                indexed                to natural gas prices. UNS Electric’s minimum expected annual payment                under this contract is $10 million based on natural gas prices at                September 30, 2006. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP                entered                into operating leases in the first quarter 2006 for equipment at                Springerville totaling $2 million over three                years. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Under                a                settlement agreement signed in March 2005 with the New Mexico                Environmental Department and environmental activist groups, the co-owners                of San Juan will install new technology at the generating station                to                reduce mercury, particulate matter, NOx, and SO2 emissions.                TEP’s share of the cost of new pollution control equipment based on its                ownership of San Juan has increase from $30 million over the next                three                years to $16 million in 2007, $39 million in 2008, and $7 million                in 2009                as a result of higher commodity prices, construction, and engineering                costs. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**DIVIDENDS      ON COMMON STOCK**

|  **Declaration                Date**        |  **Record                Date**             |  **Payment                Date**          | **Dividend                Amount****Per                Share of Common Stock** |
|--------------------------------------------------|--------------------------------------------------|------------------------------------------------|--------------------------------------------------------------------------------|
| February                10,                2006  | February                21,                2006  | March                15,                2006   | $0.21                                                                          |
| May                5,                2006        | May                17,                2006       | June                9,                2006     | $0.21                                                                          |
| September                14,                2006 | September                25,                2006 | October                10,                2006 | $0.21                                                                          |

**INCOME      TAX      MATTERS**

----

Table          of Contents

**TUCSONELECTRIC      POWER COMPANY**

**RESULTSOF      OPERATIONS**

|                                                                 |   | **Sales**                                       | **Operating                Revenue** |
|----------------------------------------------------------------------|--------|-------------------------------------------------|--------------------------------------|
| **Three                Months Ended Sept. 30,**                      |   |                                            | **2006**                             |   |   | **2005** |   |   | **2006** |   |   | **2005** |   |
|                                                                 |   | -Millions                of                kWh- | -Millions                of Dollars- |
| **Electric                Retail Sales:**                            |   |                                            |                                 |   |   |   |   |   |   |   |   |   |   |
| Residential                                                          |   |                                            | 1,297                                |   |   | 1,326 |   | $ | 122 |   | $ | 125 |   |
| Commercial                                                           |   |                                            | 583                                  |   |   | 574 |   |   | 61 |   |   | 60 |   |
| Industrial                                                           |   |                                            | 657                                  |   |   | 669 |   |   | 49 |   |   | 49 |   |
| Mining                                                               |   |                                            | 236                                  |   |   | 190 |   |   | 11 |   |   | 9 |   |
| Public                Authorities                                    |   |                                            | 65                                   |   |   | 70 |   |   | 5 |   |   | 5 |   |
| **Total                Electric Retail Sales**                       |   |                                            | 2,838                                |   |   | 2,829 |   | $ | 248 |   | $ | 248 |   |
| **Electric                Wholesale Sales Delivered:**               |   |                                            |                                 |   |   |   |   |   |   |   |   |   |   |
| Long-term                Contracts                                   |   |                                            | 255                                  |   |   | 286 |   |   | 13 |   |   | 14 |   |
| Other                Sales                                           |   |                                            | 543                                  |   |   | 374 |   |   | 24 |   |   | 24 |   |
| Transmission                                                         |   |                                            | -                                    |   |   | - |   |   | 3 |   |   | 2 |   |
| Net                Unrealized Gain (Loss) on Forward Sales of Energy |   |                                            | -                                    |   |   | - |   |   | 6 |   |   | (9 | ) |
| **Total                Electric Wholesale Sales**                    |   |                                            | 798                                  |   |   | 660 |   |   | 46 |   |   | 31 |   |
| **Total                Electric Sales**                              |   |                                            | 3,636                                |   |   | 3,489 |   | $ | 294 |   | $ | 279 |   |
|                                                                 |   |                                            |                                 |   |   |   |   |   |   |   |   |   |   |
| **Weather                Data:**                                     |   |                                            | **2006**                             |   |   | **2005** |   |   |   |   |   |   |   |
| **Cooling                Degree Days**                               |   |                                            |                                 |   |   |   |   |   |   |   |   |   |   |
| Three                Months                Ended Sept. 30,           |   |                                            | 795                                  |   |   | 1,023 |   |   |   |   |   |   |   |
| 10-Year                Average                                       |   |                                            | 943                                  |   |   | 949 |   |   |   |   |   |   |   |

*Factors      Affecting Results of Operations, Western Energy Markets, Market Prices,*

----

Table          of Contents

|                                                                 |   | **Sales**                        | **Operating                Revenue** |
|----------------------------------------------------------------------|--------|----------------------------------|--------------------------------------|
| **Nine                Months Ended Sept. 30,**                       |   |                             | **2006**                             |   |   | **2005** |   |   | **2006** |   |   | **2005** |   |
|                                                                 |   | -Millions                of kWh- | -Millions                of Dollars- |
| **Electric                Retail Sales:**                            |   |                             |                                 |   |   |   |   |   |   |   |   |   |   |
| Residential                                                          |   |                             | 3,008                                |   |   | 2,883 |   | $ | 275 |   | $ | 264 |   |
| Commercial                                                           |   |                             | 1,498                                |   |   | 1,423 |   |   | 156 |   |   | 148 |   |
| Industrial                                                           |   |                             | 1,751                                |   |   | 1,777 |   |   | 127 |   |   | 129 |   |
| Mining                                                               |   |                             | 688                                  |   |   | 634 |   |   | 33 |   |   | 30 |   |
| Public                Authorities                                    |   |                             | 195                                  |   |   | 180 |   |   | 14 |   |   | 13 |   |
| **Total                Electric Retail Sales**                       |   |                             | 7,140                                |   |   | 6,897 |   | $ | 605 |   | $ | 584 |   |
| **Electric                Wholesale Sales Delivered:**               |   |                             |                                 |   |   |   |   |   |   |   |   |   |   |
| Long-term                Contracts                                   |   |                             | 792                                  |   |   | 871 |   |   | 39 |   |   | 41 |   |
| Other                Sales                                           |   |                             | 1,679                                |   |   | 1,304 |   |   | 86 |   |   | 71 |   |
| Transmission                                                         |   |                             | -                                    |   |   | - |   |   | 6 |   |   | 6 |   |
| Net                Unrealized Gain (Loss) on Forward Sales of Energy |   |                             | -                                    |   |   | - |   |   | 7 |   |   | (10 | ) |
| **Total                Electric Wholesale Sales**                    |   |                             | 2,471                                |   |   | 2,175 |   |   | 138 |   |   | 108 |   |
| **Total                Electric Sales**                              |   |                             | 9,611                                |   |   | 9,072 |   | $ | 743 |   | $ | 692 |   |
|                                                                 |   |                             |                                 |   |   |   |   |   |   |   |   |   |   |
| **Weather                Data:**                                     |   |                             | **2006**                             |   |   | **2005** |   |   |   |   |   |   |   |
| **Cooling                Degree Days**                               |   |                             |                                 |   |   |   |   |   |   |   |   |   |   |
| Nine                Months                Ended Sept. 30,            |   |                             | 1,338                                |   |   | 1,477 |   |   |   |   |   |   |   |
| 10-Year                Average                                       |   |                             | 1,377                                |   |   | 1,384 |   |   |   |   |   |   |   |

*Factors      Affecting Results of Operations, Western Energy Markets, Market Prices,*

**Mark-to-Market      Adjustments on Trading Activity**

|                                                                                              | **Three                Months Ended****September                30,** | **Nine                Months Ended****September                30,** |
|---------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------|----------------------------------------------------------------------|
|                                                                                                   | **2006**                                                              | **2005**                                                             | **2006** | **2005** |
|                                                                                              | -Millions                of                Dollars-                   | -Millions                of                Dollars-                  |
| Net                Unrealized Gain (Loss) onForward                Sales                of Energy |  $6                                                              |                      $(9)                   |                      $7 |                      $(10) |
| Net                Unrealized (Loss) Gain onForward                Purchases of Energy            |                        (5)         |                       1                |                       (6) |                        1 |
| Net                Unrealized Gain (Loss)                                                         |                      $1                      |                      $(8)                   |                      $1 |                      $(9) |

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Table          of Contents

**OPERATING      EXPENSES**

**Fuel      and      Purchased Power Expense**

|                                                                                                                                                                                                                                               |   | **Generation                and****Purchased                Power** |                                 |  **Expense** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------------------------------------|-------------------|--------|
| **Three                Months Ended September 30,**                                                                                                                                                                                                |   | **2006**                                                            |                                 | **2005**          |   | **2006** |   | **2005** |   |
|                                                                                                                                                                                                                                               |   | -Millions                of                kWh-                     | -Millions                of Dollars- |
| Coal-Fired                Generation                                                                                                                                                                                                               |   |                                                                |                                 |              |   |   |   |   |   |   |   |   |   |
|  Four                Corners                                                                                                                                                                                                                  |   |                                                                | 209                                  |              |   | 207 |   | $ | 3 |   | $ | 3 |   |
|                  Navajo                                                                                                                                                                                                                       |   |                                                                | 352                                  |              |   | 352 |   |   | 5 |   |   | 5 |   |
|  San                Juan                                                                                                                                                                                                                      |   |                                                                | 681                                  |              |   | 658 |   |   | 15 |   |   | 14 |   |
|                  Springerville                                                                                                                                                                                                                |   |                                                                | 1,569                                |              |   | 1,387 |   |   | 26 |   |   | 23 |   |
|  Sundt                4                                                                                                                                                                                                                       |   |                                                                | 191                                  |              |   | 219 |   |   | 5 |   |   | 4 |   |
| Total                Coal-Fired Generation                                                                                                                                                                                                         |   |                                                                | 3,002                                |              |   | 2,823 |   |   | 54 |   |   | 49 |   |
| Gas-Fired                Generation                                                                                                                                                                                                                |   |                                                                |                                 |              |   |   |   |   |   |   |   |   |   |
| Luna                                                                                                                                                                                                                                               |   |                                                                | 175                                  |              |   | - |   |   | 9 |   |   | - |   |
| Other                Gas                Units                                                                                                                                                                                                      |   |                                                                | 152                                  |              |   | 191 |   |   | 14 |   |   | 18 |   |
| Total                Gas-Fired Generation                                                                                                                                                                                                          |   |                                                                | 327                                  |              |   | 191 |   |   | 23 |   |   | 18 |   |
| Solar                and                Other                                                                                                                                                                                                      |   |                                                                | 2                                    |              |   | 3 |   |   | - |   |   | - |   |
| Total                Generation (1)                                                                                                                                                                                                                |   |                                                                | 3,331                                |              |   | 3,017 |   |   | 77 |   |   | 67 |   |
| Purchased                Power                                                                                                                                                                                                                     |   |                                                                | 614                                  |              |   | 761 |   |   | 37 |   |   | 64 |   |
| Net                Unrealized (Gain) Loss on Forward                 Purchases of Energy                                                                                                                                                      |   |                                                                | -                                    |              |   | - |   |   | 5 |   |   | (1 | ) |
| Total                Purchased Power                                                                                                                                                                                                               |   |                                                                | 614                                  |              |   | 761 |   |   | 42 |   |   | 63 |   |
| Total                Resources                                                                                                                                                                                                                     |   |                                                                | 3,945                                |              |   | 3,778 |   | $ | 119 |   | $ | 130 |   |
| Less                Line                Losses and Company Use                                                                                                                                                                                     |   |                                                                | (309                                 | )                 |   | (289 | ) |   |   |   |   |   |   |
| Total                Energy                Sold                                                                                                                                                                                                    |   |                                                                | 3,636                                |              |   | 3,489 |   |   |   |   |   |   |   |
|  (1)                Fuel                expense                in 2006 excludes $1 million related to Springerville 3; these expenses                are                reimbursed by Tri-State and recorded in Other                Revenue. |

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Table          of Contents

|                                                                                                                                                                                                                                               |   | **Generation                and****Purchased                Power** |   |  **Expense**                                   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------|--------|-----------------------------------------------------|--------|
| **Nine                Months Ended September 30,**                                                                                                                                                                                                 |   | **2006**                                                            |   | **2005**                                            |   | **2006** |   | **2005** |   |
|                                                                                                                                                                                                                                                    |   | -Millions                of                kWh-                     |   | -Millions                of                Dollars- |   |
| Coal-Fired                Generation                                                                                                                                                                                                               |   |                                                                |   |                                                |   |   |   |   |   |   |   |   |   |
| Four                Corners                                                                                                                                                                                                                        |   |                                                                | 612    |                                                |   | 588 |   | $ | 9 |   | $ | 8 |   |
| Navajo                                                                                                                                                                                                                                             |   |                                                                | 931    |                                                |   | 894 |   |   | 13 |   |   | 11 |   |
| San                Juan                                                                                                                                                                                                                            |   |                                                                | 1,939  |                                                |   | 1,863 |   |   | 44 |   |   | 40 |   |
| Springerville                                                                                                                                                                                                                                      |   |                                                                | 4,297  |                                                |   | 4,053 |   |   | 71 |   |   | 68 |   |
| Sundt                4                                                                                                                                                                                                                             |   |                                                                | 470    |                                                |   | 596 |   |   | 11 |   |   | 12 |   |
| Total                Coal-Fired Generation                                                                                                                                                                                                         |   |                                                                | 8,249  |                                                |   | 7,994 |   |   | 148 |   |   | 139 |   |
| Gas-Fired                Generation                                                                                                                                                                                                                |   |                                                                |   |                                                |   |   |   |   |   |   |   |   |   |
| Luna                                                                                                                                                                                                                                               |   |                                                                | 400    |                                                |   | - |   |   | 18 |   |   | - |   |
| Other                Gas                Units                                                                                                                                                                                                      |   |                                                                | 278    |                                                |   | 337 |   |   | 25 |   |   | 31 |   |
| Total                Gas-Fired Generation                                                                                                                                                                                                          |   |                                                                | 678    |                                                |   | 337 |   |   | 43 |   |   | 31 |   |
| Solar                and                Other                                                                                                                                                                                                      |   |                                                                | 7      |                                                |   | 6 |   |   | - |   |   | - |   |
| Total                Generation (1)                                                                                                                                                                                                                |   |                                                                | 8,934  |                                                |   | 8,337 |   |   | 191 |   |   | 170 |   |
| Purchased                Power                                                                                                                                                                                                                     |   |                                                                | 1,411  |                                                |   | 1,443 |   |   | 82 |   |   | 104 |   |
| Net                Unrealized (Gain) Loss on Forward                 Purchases of Energy                                                                                                                                                      |   |                                                                | -      |                                                |   | - |   |   | 6 |   |   | (1 | ) |
| Total                Purchased Power                                                                                                                                                                                                               |   |                                                                | 1,411  |                                                |   | 1,443 |   |   | 88 |   |   | 103 |   |
| Total                Resources                                                                                                                                                                                                                     |   |                                                                | 10,345 |                                                |   | 9,780 |   | $ | 279 |   | $ | 273 |   |
| Less                Line                Losses and Company Use                                                                                                                                                                                     |   |                                                                | (734   | )                                                   |   | (708 | ) |   |   |   |   |   |   |
| Total                Energy                Sold                                                                                                                                                                                                    |   |                                                                | 9,611  |                                                |   | 9,072 |   |   |   |   |   |   |   |
|  (1)                Fuel                expense                in 2006 excludes $7 million related to Springerville 3; these expenses                are                reimbursed by Tri-State and recorded in Other                Revenue. |

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Table          of Contents

|                           | **Three                Months Ended****September                30,** | **Nine                Months****Ended                September 30,** |
|--------------------------------|-----------------------------------------------------------------------|----------------------------------------------------------------------|
|                           | **2006**                                                              | **2005**                                                             | **2006** | **2005** |
|                           | -cents                per                kWh-                         | -cents                per                kWh-                        |
| Coal                           | 1.80                                                                  | 1.74                                                                 | 1.79 | 1.74 |
| Gas*                           |                  7.12*                                           | 9.42                                                                 |                  6.60* | 9.20 |
| All                fuels       | 2.31                                                                  | 2.22                                                                 | 2.14 | 2.04 |
| Purchased                Power | 6.84                                                                  | 8.28                                                                 | 6.24 | 7.14 |

**Other      Operating Expenses**

*Factors      Affecting Results of Operations, Emission Allowances, *

|   | **Estimated**                                       | **Unamortized**                                 |
|--------|-----------------------------------------------------|-------------------------------------------------|
|   | **TRA                Amortization**                 | **TRA                Balance**                  |
|   | -Millions                of                Dollars- |
| 2006   | $                66                                 | $                102                            |
| 2007   |                   76                      |                    26            |
| 2008   |                   26                      |                      - |

**Other      Income (Deductions)**

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Table          of Contents

**Interest      Expense**

**Income      Tax      Expense**

**FACTORSAFFECTING      RESULTS OF      OPERATIONS**

**COMPETITION**

*Rates*
*ACC      Order to      Review the Settlement Agreement, *

**RATES**

**Settlement      Agreement **

| ·                    | a                period from                November 1999 through 2008 for TEP to transition its generation assets                from a cost of service based rate structure to a market, or competitive,                rate structure; |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | the                recovery                through rates during the transition period of $450 million of stranded                generation costs through a fixed competitive transition charge (Fixed                CTC); |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | capped                rates                for TEP retail customers through                2008; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------|

| ·                    | an                ACC                interim review of TEP retail rates in                2004; |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------|

| ·                    | unbundling                of                electric services with separate rates or prices for generation,                transmission, distribution, metering, meter reading, billing and                collection, and ancillary services; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                process for                ESPs to become licensed by the ACC to sell generation services at                market                prices to TEP retail customers; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| ·                    | access                for                TEP retail customers to buy market priced generation services from                ESPs                beginning in 2000 (currently, no TEP customers are purchasing generation                services from ESPs); |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | transmission                and distribution services would remain subject to regulation on a                cost of                service basis; and |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | beginning                in                2009, TEP’s generation would be market-based and its retail customers                would pay the market rate for generation                services. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**2004      General Rate Case Information**

**ACC      Order      to Review the Settlement Agreement**

*Competition*

**TEP      Testimony**

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Table          of Contents

| ·                    | A                cap would                be set such that no customer class would realize an initial rate                increase                in excess of 12%. The phase-in period would begin in 2009, last                approximately four years and then be fully                market-based; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP’s                current                rates would remain frozen through the end of 2008;                and |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|

| ·                    | Implementation                of the new DSM, RES and TOU programs and                tariffs. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------|

| ·                    | A                new                regulatory asset of $850 million to be included in rate base will                be                created to compensate TEP for the financial impacts and costs incurred                in                performing under the Settlement                Agreement; |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | An                energy                cost adjustment clause (ECAC) to recover energy costs associated                with                serving the incremental retail load above that filed in its                cost-of-service test year; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Immediate                filing of a cost-of-service rate case in                2007; |
|----------------------------------------------------|----------------------------------------------------------------------------------------|

| ·                    | Implementation                of the new DSM, RES and TOU programs and tariffs;                and |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------|

| ·                    | Restore                exclusivity of TEP’s certificate of convenience and necessity. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------|

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Table          of Contents

**Procedural      Schedule**

|                                                                      | **Date**                                        |
|---------------------------------------------------------------------------|-------------------------------------------------|
| ACC                staff and                intervenor testimony          | January                8,                2007   |
| TEP                rebuttal                testimony                      | January                29,                2007  |
| ACC                staff and                intervenor rebuttal testimony | February                8,                2007  |
| TEP                rejoinder                testimony                     | February                15,                2007 |
| Hearings                before ALJ                                        | February                20,                2007 |

**RENEWABLE      ENERGY STANDARD AND TARIFF**

**WESTERN      ENERGY MARKETS**

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Table          of Contents

**Market      Prices**

| **Average                Market Price for Around-the-Clock Energy** | **$/MWh**                                                 |
|---------------------------------------------------------------------|-----------------------------------------------------------|
| Quarter                ended                September 30, 2006      | $55          |
| Quarter                ended                September 30, 2005      | 68                     |
|                                                                |                                                      |
| Nine                months                ended September 30, 2006  | $50               |
| Nine                months                ended September 30, 2005  | 53                          |
|                                                                |                                                      |
| **Average                Market Price for Natural Gas**             | **$/MMBtu**                                               |
| Quarter                ended                September 30, 2006      | $5.93                                 |
| Quarter                ended                September 30, 2005      | 7.36                                            |
|                                                                |                                                      |
| Nine                months                ended September 30, 2006  | $6.21                                      |
| Nine                months                ended September 30, 2005  | 6.34                                            |

| ·                    | availability                and price of natural gas; |
|----------------------------------------------------|-------------------------------------------------------|

| ·                    | weather; |
|----------------------------------------------------|----------|

| ·                    | continued                population growth in the western                U.S.; |
|----------------------------------------------------|--------------------------------------------------------------------------------|

| ·                    | economic                conditions in the western U.S.; |
|----------------------------------------------------|---------------------------------------------------------|

| ·                    | availability                of generating capacity throughout the western                U.S.; |
|----------------------------------------------------|------------------------------------------------------------------------------------------------|

| ·                    | the                extent of                electric utility industry restructuring in Arizona, California and                other                western states; |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | the                effect of                FERC regulation of wholesale energy                markets; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------|

| ·                    | availability                of hydropower; |
|----------------------------------------------------|--------------------------------------------|

| ·                    | transmission                constraints; and |
|----------------------------------------------------|----------------------------------------------|

| ·                    | environmental                regulations and the cost of                compliance. |
|----------------------------------------------------|-------------------------------------------------------------------------------------|

**COAL      SUPPLY**

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Table          of Contents

**EMISSION      ALLOWANCES**

|  **Delivery**                               |  **Allowances                Sold** | **Pre-tax                Gain**** (millions)** |
|--------------------------------------------------|------------------------------------------|-----------------------------------------------------|
| 2005                                             | 15,000                                   | $13                                                 |
| 2006                                             |                                     |                                                |
|                  1st                Quarter |   2,500                        | 2                                                   |
|                  2nd                Quarter |   2,500                        | 2                                                   |
|                  3rd                Quarter |                  5,000              | 3                                                   |
| 2007                                             | 10,000                                   | 8                                                   |

**SPRINGERVILLE      UNITS 3 AND 4 **

**LIQUIDITYAND      CAPITAL RESOURCES**

**TEP      CASH      FLOWS**

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Table          of Contents

| **Nine                Months Ended September 30,**                                                                                                                            |   |                                 | **2006** |   |   | **2005** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|----------|--------|--------|----------|--------|
|                                                                                                                                                                          |   | -Millions                of Dollars- |
| Net                Cash                Flows - Operating Activities (GAAP)                                                                                                    |   | $                                    | 144      |   | $      | 146      |   |
| Amounts                from                Statements of Cash Flows:                                                                                                          |   |                                 |     |   |   |     |   |
| Less:                Capital                Expenditures                                                                                                                      |   |                                 | (111     | )      |   | (104     | )      |
| Net                Cash                Flows after Capital Expenditures (non-GAAP)*                                                                                           |   |                                 | 33       |   |   | 42       |   |
| Amounts                from                Statements of Cash Flows:                                                                                                          |   |                                 |     |   |   |     |   |
| Less:                Retirement of Capital Lease Obligations                                                                                                                  |   |                                 | (61      | )      |   | (53      | )      |
| Plus:                Proceeds from Investment in Lease Debt                                                                                                                   |   |                                 | 22       |   |   | 14       |   |
| Net                Cash                Flows after Capital Expenditures and Required Payments on Debt and                Capital                Lease Obligations (non-GAAP)* |   | $                                    | (6       | )      | $      | 3        |   |

| **Nine                Months Ended September 30,**                                                                                                                           |   |                                 | **2006** |   |   | **2005** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|----------|--------|--------|----------|--------|
|                                                                                                                                                                         |   | -Millions                of Dollars- |
| Net                Cash                Flows - Operating Activities (GAAP)                                                                                                   |   | $                                    | 144      |   | $      | 146      |   |
| Net                Cash                Flows - Investing Activities (GAAP)                                                                                                   |   |                                 | (138     | )      |   | (83      | )      |
| Net                Cash                Flows - Financing Activities (GAAP)                                                                                                   |   |                                 | (45      | )      |   | (142     | )      |
| Net                Cash                Flows after Capital Expenditures (non-GAAP)                                                                                           |   |                                 | 33       |   |   | 42       |   |
| Net                Cash                Flows after Capital Expenditures and Required Payments on Debt and                Capital                Lease Obligations (non-GAAP) |   |                                 | (6       | )      |   | 3        |   |

**Operating      Activities**

| ·                    | a                $39 million                increase in cash receipts from electric retail and wholesale sales,                net of                fuel and purchased energy costs, due primarily to retail customer                growth,                higher availability of excess power to sell into the wholesale market;                and                the availability of Luna to offset some of TEP’s purchased power                requirements; and |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $16 million                decrease in total interest paid due to lower capital lease obligation                balances, lower long-term debt balances and lower annual fees under                the                TEP credit agreement that was entered into in May 2005; offset by: |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $40 million                increase in income taxes due to a $24 million payment made to the                IRS                related to a notice of a proposed adjustment to previously filed                tax                returns and an increase in federal and state extension and estimated                tax                payments; |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $3 million                increase in wages paid; and |
|----------------------------------------------------|------------------------------------------------------------------------|

| ·                    | a                $2 million                decline in proceeds from the sale excess emission                allowances. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

**:**

| ·                    | $11                million                of interest received from UniSource Energy related to an inter-company                note repaid in the first quarter of                2005. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Investing      Activities**

| ·                    | a                $9 million                increase in proceeds from investments in Springerville Lease Debt;                offset                by |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | an                $8 million                increase in capital expenditures related to TEP’s share of the                construction costs of Luna and growth and maintenance                  of TEP’s electric system; and |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP’s                purchase of a 14% equity interest in Springerville Unit 1 Lease,                which                represents approximately 53 MW of                capacity. |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Financing      Activities**

| ·                    | a                $5 million                increase in net proceeds from borrowings under the TEP Revolving                Credit                Facility; offset by |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | a                $9 million                increase in scheduled payments made on capital lease obligations. |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------|

| ·                    | a                $110                million equity investment by UniSource Energy; and |
|----------------------------------------------------|-----------------------------------------------------------------------------------------|

| ·                    | proceeds                of                $95 million from UniSource Energy as a repayment for an inter-company                loan; offset by |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | the                use of                $282 million to repay long-term                debt; |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------|

| ·                    | $15                million                of dividends paid to UniSource Energy;                and |
|----------------------------------------------------|-----------------------------------------------------------------------------------------------------|

| ·                    | $5                million                for debt issuance and retirement                costs. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------|

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Table          of Contents

|  **Leased                Asset**                         |   | **Capital                Lease****Obligation                Balance****at                September 30, 2006** |                                |  **Expiration** |   |
|---------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------|-------------------------------------|----------------------|--------|
|                                                          |   |                                                                                                          | -                In Millions -      |                 |   |  |   |
| Springerville                Unit 1                           |   |                                                                                                          | $381                                |                 |   | 2015 |   |
| Springerville                Coal Handling Facilities         |   |                                                                                                          |  112                           |                 |   | 2015 |   |
| Springerville                Common Facilities                |   |                                                                                                          |  105                           |                 |   | 2020 |   |
| Sundt                Unit                4                    |   |                                                                                                          |   46                      |                 |   | 2011 |   |
| Other                Leases                                   |   |                                                                                                          |                    1 |                 |   | 2008 |   |
| Total                Capital                Lease Obligations |   |                                                                                                          | $645                                |                 |   |   |   |

|                                                                             | **Lease                Debt Investment Balance** |
|----------------------------------------------------------------------------------|--------------------------------------------------|
| **Leased                Asset**                                                  | **September                30, 2006**            | **December                31, 2005** |
|                                                                             | -                In Millions                -    |
| Investments                in Lease Debt:                                        |                                             |   |
|   Springerville                Unit                1                   | $                81                              | $                91 |
|   Springerville                Coal Handling                Facilities | 52                                               | 65 |
| Total                Investment in Lease Debt                                    | $133                                             | $156 |

----

Table          of Contents

**INCOME      TAX      MATTERS**

*UniSource      Energy, Liquidity and Capital Resources, Income Tax Matters, Internal Revenue      Service Matters,*

**CONTRACTUAL      OBLIGATIONS**

| ·                    | TEP’s                purchased power agreement with Tri-State for 100 MW of system capacity                became effective September 1, 2006. This contract allows Tri-State                to                reduce the contract capacity in increments of 25 MW with 90 days                notice.                To date, TEP has received no such notice. If Tri-State does not give                notice to reduce capacity, the minimum capacity payments will be                $10                million for 2006, $31 million annually in 2007 through 2010, and                $21                million in 2011. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | TEP                provides                incentives to new home builders to construct TEP Guarantee Homes                that meet                the highest construction and energy-efficiency standards available.                TEP’s                builder incentive commitment totaled $2 million at September 30,                2006. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                June 2006,                TEP refinanced variable rate notes underlying the Springerville Common                Facilities Leases. A portion of the rent payable by TEP pursuant                to the                Springerville Common Facilities Leases is determined by the amount                of                interest payable on the variable rate lease debt. The notes were                amended                to provide that interest will be payable at LIBOR plus 1.5% for the                next                three years with the spread over LIBOR increasing every three years                thereafter to 2% by June 2018. Prior to the refinancing, the interest                rate                was LIBOR plus 4%. TEP estimates its obligation using a forward LIBOR                curve. At September 30, 2006, TEP’s expected payments under the                Springerville Common Facilities Leases total: $7 million in 2006;                $6 |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

|   | million                  in                  2007; $6 million in 2008; $6 million in 2009; $6 million in 2010;                  $6                  million in 2011; and $145 million thereafter. TEP’s obligation does not                  include the impact of the 2006 interest rate                  swap. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                      | In                  June 2006,                  TEP purchased a 14% equity ownership interest in the Springerville                  Unit 1                  Leases. As a result, TEP amended the Springerville Unit 1 Lease                  related to                  such interest to reduce TEP’s rent payable to equal the scheduled amount                  of principal and interest payable on the debt issued by the owner                  trustee.                  At September 30, 2006, TEP’s expected payments under the Springerville                  Unit 1 Leases total: $85 million in 2006; $83 million in 2007;                  $82 million                  in 2008; $30 million in 2009; $57 million in 2010; $83 million                  in 2011;                  and $317 million thereafter. |
|------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                  ** ** | TEP                entered                into operating leases in the first quarter 2006 for equipment at                Springerville totaling $2 million over three                years. |
|--------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | Under                a                settlement agreement signed in March 2005 with the New Mexico                Environmental Department and environmental activist groups, the co-owners                of San Juan will install new technology at the generating station                to                reduce mercury, particulate matter, NOx, and SO2 emissions.                TEP’s share of the cost of new pollution control equipment based on its                ownership of San Juan has increase from $30 million over the next                three                years to $16 million in 2007, $39 million in 2008, and $7 million                in 2009                as a result of higher commodity prices, construction, and engineering                costs. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**DIVIDENDS      ON COMMON STOCK**

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Table          of Contents

**UNSGAS**

**RESULTSOF      OPERATIONS**

**Three      Months Ended September 30, 2006 Compared with the Three Months Ended September      30, 2005**

|                                                                     | **Sales**                                                | **Revenue**                                               |
|--------------------------------------------------------------------------|----------------------------------------------------------|-----------------------------------------------------------|
| **Three                Months Ended September 30,**                      | **2006**                                                 | **2005**                                                  | **  2006** | **2005** |
|                                                                          |                    - Millions of Therms - |                    - Millions of Dollars - |
| **Retail                Therm Sales:**                                   |                                                     |                                                      |   |   |
|   Residential                                                  | 6                                                        | 5                                                         | $10 | $ 8 |
|   Commercial                                                   | 4                                                        | 4                                                         | 6 | 4 |
|   Industrial                                                   | 1                                                        | 1                                                         | 1 | 1 |
|   Public                Authorities                            | -                                                        | -                                                         | 1 | - |
| **Total                Retail Therm Sales**                              | 11                                                       | 10                                                        | 18 | 13 |
|   Transport                                                    | -                                                        | -                                                         | 1 | - |
|   Negotiated                Sales Program                (NSP) | 3                                                        | 4                                                         | 2 | 3 |
| **Total                Therm Sales**                                     | 14                                                       | 14                                                        | $21 | $16 |

*Factors      Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment      Mechanism,*

*Factors      Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment      Mechanism,*

| **Three                Months Ended September 30,**                       | **                      2006**                | **                      2005**         |
|---------------------------------------------------------------------------|-----------------------------------------------------------------------------|----------------------------------------------------------------------|
|                                                                      |                       - Millions of Dollars - |
| Gas                Revenues                                               | $                21                                                         | $                16                                                  |
| Other                Revenues                                             | -                                                                           | 1                                                                    |
|    Total                Operating                Revenues  | 21                                                                          | 17                                                                   |
| Purchased                Gas                Expense                       | 14                                                                          | 10                                                                   |
| Other                Operations and Maintenance Expense                   | 6                                                                           | 6                                                                    |
| Depreciation                and Amortization                              | 1                                                                           | 1                                                                    |
| Taxes                other                than Income Taxes               | 1                                                                           | 1                                                                    |
|    Total                Operating                Expenses  | 22                                                                          | 18                                                                   |
|                                                                      |                                                                        |                                                                 |
|        Operating                Income |                     (1)                                 |                     (1)                          |
|                                                                      |                                                                        |                                                                 |
| Total                Interest Expense                                     | 2                                                                           | 2                                                                    |
| Income                Tax                Expense (Benefit)                |                       (1)                     |                     (1)                          |
| **       Net                Income**   |                        $ (2)             |         $                (2) |

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**Nine      Months      Ended September 30, 2006 Compared with the Nine Months Ended September 30,      2005**

|                                                                     | **                    Sales**              | **                    Revenue**             |
|--------------------------------------------------------------------------|----------------------------------------------------------------|-----------------------------------------------------------------|
| **Nine                Months Ended September 30,**                       | **                    2006**               | **                    2005**                | **                    2006** | **                    2005** |
|                                                                     |                     - Millions of Therms - |                     - Millions of Dollars - |
| **Retail                Therm Sales:**                                   |                                                           |                                                            |   |   |
|   Residential                                                  | 45                                                             | 46                                                              | $ 65 | $51 |
|   Commercial                                                   | 20                                                             | 20                                                              | 26 | 19 |
|   Industrial                                                   | 2                                                              | 2                                                               | 2 | 2 |
|   Public                Authorities                            | 5                                                              | 5                                                               | 5 | 4 |
| **Total                Retail Therm Sales**                              | 72                                                             | 73                                                              | 98 | 76 |
|   Transport                                                    | -                                                              | -                                                               | 2 | 2 |
|   Negotiated                Sales Program                (NSP) | 13                                                             | 16                                                              | 9 | 11 |
| **Total                Therm Sales**                                     | 85                                                             | 89                                                              | $109 | $89 |

*Factors      Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment      Mechanism,*

| **Nine                Months Ended September 30,**                        | **                       2006**                | **                       2005** |
|---------------------------------------------------------------------------|-----------------------------------------------------------------------------------|--------------------------------------------------------------------|
|                                                                      |                        - Millions of Dollars - |
| Gas                Revenues                                               | $                109                                                              | $89                                                                |
| Other                Revenues                                             | 2                                                                                 | 2                                                                  |
|    Total                Operating                Revenues  | 111                                                                               | 91                                                                 |
| Purchased                Gas                Expense                       | 78                                                                                | 58                                                                 |
| Other                Operations and Maintenance Expense                   | 18                                                                                | 18                                                                 |
| Depreciation                and Amortization                              | 5                                                                                 | 5                                                                  |
| Taxes                other                than Income Taxes               | 2                                                                                 | 2                                                                  |
|    Total                Operating                Expenses  | 103                                                                               | 83                                                                 |
|                                                                      |                                                                              |                                                               |
|        Operating                Income |                     8                                         |                     8                          |
|                                                                      |                                                                              |                                                               |
| Total                Interest Expense                                     | 5                                                                                 | 5                                                                  |
| Income                Tax                Expense (Benefit)                | 1                                                                                 |                     1                          |
| **       Net                Income**   |       $                  2                     |                        $ 2 |

**FACTORSAFFECTING      RESULTS OF OPERATIONS**

**RATES      AND      REGULATION**

**Energy      Cost      Adjustment Mechanism**

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Table          of Contents

*General      Rate      Case Filing*

| **Surcharge                Amount****Per                Therm** |  **Period                In Effect         ** |
|-----------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
| $0.15                                                           | November                2005                - February 2006                                     |
| $0.25                                                           | March                2006 -                April 2006                                           |
| $0.30                                                           | May                2006 -                June 2006                                              |
| $0.35                                                           | July                2006 -                September 2006                                        |
| $0.25                                                           | October                2006                - November 2006                                      |
| $0.20                                                           | December                2006                - February 2007                                     |
| $0.25                                                           | March                2007 -                April 2007                                           |

**General      Rate Case Filing **

|                                                                        |                                                       |
|-----------------------------------------------------------------------------|------------------------------------------------------------|
| Test                year                                                    | Year                ended                December 31, 2005 |
| Original                cost                rate base                       | $162                million                                |
| Revenue                deficiency                                           | $10                million                                 |
| Total                rate                increase (over test year revenues) | 7%                                                         |
| Cost                of                debt                                  | 6.60%                                                      |
| Cost                of                equity                                | 11.00%                                                     |
| Hypothetical                capital structure                               | 50%                equity /                50% debt        |
| Weighted                average cost of capital                             | 8.80%                                                      |

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Table          of Contents

| **Filing**                                                                  | **Date**                                       |
|-----------------------------------------------------------------------------|------------------------------------------------|
| ACC                Staff                & intervenor testimony          | February                9,                2007 |
| UNS                Gas                rebuttal testimony                    | March                9,                2007    |
| ACC                Staff                & intervenor rebuttal testimony | March                30,                2007   |
| UNS                Gas                rejoinder testimony                   | April                6,                2007    |
| Hearing                before ALJ                                           | April                16,                2007   |

**LIQUIDITYAND      CAPITAL      RESOURCES**

| **Nine                months Ended September 30,**                  | **2006**                                              | **2005**                 |
|---------------------------------------------------------------------|-------------------------------------------------------|--------------------------|
|                                                                | -                Millions of                Dollars - |
| Net                Cash                Flows - Operating Activities | $26                                                   | $15                      |
| Capital                Expenditures                                 |                  19                              |                  18 |

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Table          of Contents

**INCOME      TAX      MATTERS**

*UniSource      Energy, Liquidity and Capital Resources, Income Tax Matters, Internal Revenue      Service Matters,*

** **
**DIVIDENDS      ON COMMON STOCK **

*Senior      Unsecured Notes*

**UNSELECTRIC**

**RESULTSOF      OPERATIONS**

**Three      Months Ended September 30, 2006 Compared with the Three Months Ended September      30, 2005**

|                                                  | **                       Sales**                  | **                    Revenue**             |
|-------------------------------------------------------|----------------------------------------------------------------------------|-------------------------------------------------------|
| **Three                  Months Ended September 30,** | **                          2006** | **                   2005**                      | **                     2006** | **                   2005** |
|                                                  |                        - Millions of kWh -        |                     - Millions of Dollars - |
| **Electric                  Retail Sales:**           |                                                                       |                                                  |   |   |
|   Residential                               | 293                                                                        | 274                                                   | $29 | $27 |
|   Commercial                                | 178                                                                        | 175                                                   | 17 | 17 |
|   Industrial                                | 50                                                                         | 47                                                    | 4 | 4 |
|   Other                                     | 1                                                                          | 1                                                     | - | - |
| **Total                  Electric Retail Sales**      | 522                                                                        | 497                                                   | $50 | $48 |

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| **Three                Months Ended September 30,**                | **                        2006**                | **                        2005**       |
|--------------------------------------------------------------------|-----------------------------------------------------------------------------------------|--------------------------------------------------------------------------------|
|                                                               |                         - Millions of Dollars - |
| Electric                Revenues                                   | $                 50                                                               | $48                                                                            |
| Other                Revenues                                      | 1                                                                                       | -                                                                              |
|   Total                Operating                Revenues | 51                                                                                      | 48                                                                             |
| Purchased                Energy Expense                            | 34                                                                                      | 33                                                                             |
| Unrealized                Loss on Forward Purchases                |                       1                                   | -                                                                              |
| Total                Purchased Energy Expense                      | 35                                                                                      | 33                                                                             |
| Other                Operations and Maintenance Expense            | 7                                                                                       | 7                                                                              |
| Depreciation                and Amortization                       | 3                                                                                       | 2                                                                              |
| Taxes                other                than Income Taxes        | 1                                                                                       | 1                                                                              |
|   Total                Operating                Expenses | 46                                                                                      | 43                                                                             |
|     Operating                Income            |                       5                                   |                       5                          |
| Total                Interest Expense                              | 1                                                                                       | 1                                                                              |
| Income                Tax                Expense                   | 2                                                                                       |                       2                          |
| **  Net                Income**                          |        $                   2               |           $                2 |

**Nine      Months      Ended September 30, 2006 Compared with the Nine Months Ended September 30,      2005**

|                                                 | **                      Sales**                        | **                    Revenue**             |
|------------------------------------------------------|----------------------------------------------------------------------------|-------------------------------------------------------|
| **Nine                  Months Ended September 30,** | **                          2006** | **                   2005**                      | **                     2006** | **                    2005** |
|                                                 |                       - Millions of kWh -              |                     - Millions of Dollars - |
| **Electric                  Retail Sales:**          |                                                                       |                                                  |   |   |
|   Residential                              | 650                                                                        | 595                                                   | $                  65 | $                  60 |
|   Commercial                               | 472                                                                        | 453                                                   | 47 | 45 |
|   Industrial                               | 145                                                                        | 135                                                   | 11 | 10 |
|   Other                                    | 2                                                                          | 2                                                     | - | - |
| **Total                  Electric Retail Sales**     | 1,269                                                                      | 1,185                                                 | $123 | $115 |

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| **Nine                Months Ended September 30,**                 | **                        2006**                | **                        2005** |
|--------------------------------------------------------------------|-----------------------------------------------------------------------------------------|--------------------------------------------------------------------------|
|                                                               |                         - Millions of Dollars - |
| Electric                Revenues                                   | $                123                                                                    | $115                                                                     |
| Other                Revenues                                      | 2                                                                                       | 1                                                                        |
|   Total                Operating                Revenues | 125                                                                                     | 116                                                                      |
| Purchased                Energy Expense                            | 83                                                                                      | 78                                                                       |
| Unrealized                Loss on Forward Purchases                |                       1                                   | -                                                                        |
| Total                Purchased Energy Expense                      | 84                                                                                      | 78                                                                       |
| Other                Operations and Maintenance Expense            | 19                                                                                      | 18                                                                       |
| Depreciation                and Amortization                       | 8                                                                                       | 7                                                                        |
| Taxes                other                than Income Taxes        | 3                                                                                       | 3                                                                        |
|   Total                Operating                Expenses | 114                                                                                     | 106                                                                      |
|     Operating                Income            |                      11                                        |                     10                               |
| Total                Interest Expense                              | 4                                                                                       |       4                                    |
| Income                Tax                Expense                   | 3                                                                                       |                      2                          |
| **  Net                Income**                          |     $                  4                                  |                       $   4 |

**FACTORSAFFECTING      RESULTS OF      OPERATIONS**

**COMPETITION**

*Tucson      Electric      Power Company, Factors Affecting Results of Operations,      Competition,*

**RATES      AND      REGULATION**

**Energy      Cost      Adjustment Mechanism**

**General      Rate Case Filing**

**LIQUIDITYAND      CAPITAL      RESOURCES**

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| **Nine                Months Ended September 30,**                  | **2006**                                              | **2005**                 |
|---------------------------------------------------------------------|-------------------------------------------------------|--------------------------|
|                                                                | -                Millions of                Dollars - |
| Net                Cash                Flows - Operating Activities | $                 9                              | $                13      |
| Capital                Expenditures                                 |                  29                              |                  17 |

*UNS      Gas,      Liquidity and Capital Resources, UNS Gas/UNS Electric Revolver*

**INCOME      TAX      MATTERS**

*UniSource      Energy, Liquidity and Capital Resources, Income Tax Matters, Internal Revenue      Service Matters,*

**DIVIDENDS      ON COMMON STOCK **

*Senior      Unsecured Notes*

----

Table          of Contents

**OTHER**

**RESULTSOF      OPERATIONS**

| **Three                Months Ended September 30,** | **2006**                                              | **2005**                                          |
|-----------------------------------------------------|-------------------------------------------------------|---------------------------------------------------|
|                                                | -                Millions of                Dollars - |
| Millennium                Investments               |                   $   -      |                   $  1             |
| UniSource                Energy Parent Company      |                      (2)     |                      (1) |
|    Total                Other        |                   $                (2)      |                   $   -       |

| **Nine                Months Ended September 30,** | **2006**                                              | **2005**                                    |
|----------------------------------------------------|-------------------------------------------------------|---------------------------------------------|
|                                               | -                Millions of                Dollars - |
| Millennium                Investments              |                   $   -      |                  $   -       |
| UniSource                Energy Parent Company     |       (5)               |                     (5) |
|    Total                Other       |                   $ (5)                |                  $                (5)  |

**UniSource      Energy Parent Company**

**UED**

**Millennium      Investments**

**FACTORS      AFFECTING RESULTS OF OPERATIONS**

**Millennium      Investments **

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Table          of Contents

**LIQUIDITY      AND CAPITAL RESOURCES**

**CRITICALACCOUNTING      ESTIMATES**

*2005      Annual      Report on Form 10-K, Note 1 of Notes to Consolidated Financial Statements -      Nature of Operations and Summary of Significant Accounting      Estimates.*

**ACCOUNTING      FOR RATE REGULATION**

*Accounting      for      the Effects of Certain Types of Regulation*

| ·                    | an                independent regulator sets rates; |
|----------------------------------------------------|-----------------------------------------------------|

| ·                    | the                regulator                sets the rates to recover specific costs of delivering service;                and |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------|

| ·                    | the                service                territory lacks competitive pressures to reduce rates below the rates                set                by the regulator. |
|----------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**TEP**

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**UNS      Gas and      UNS Electric**

**ACCOUNTING      FOR ASSET RETIREMENT OBLIGATIONS **

*Accounting      for      Asset Retirement Obligations*

**TEP**

*Accounting      for      Conditional Asset Retirement Obligations*

----

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*      Tucson      Electric Power Company, Factors Affecting Results of Operations, Rates,      Settlement Agreement, *
*.*

**UNS      Gas and      UNS Electric**

**PENSION      AND      OTHER POST RETIREMENT BENEFIT PLAN ASSUMPTIONS**

----

Table          of Contents

*Employers’      Accounting for Defined Benefit Pension and Other Postretirement      Plans*

**TEP**

----

Table          of Contents

**UNS      Gas and      UNS Electric**

**ACCOUNTING      FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING      ACTIVITIES**

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Table          of Contents

*Accounting      for      Derivative Instruments and Hedging Activities*

*Market      Risks -      Interest Rate Risk *
*Commodity      Price      Risk *

**UNBILLED      REVENUE - TEP, UNS GAS AND UNS ELECTRIC**

**PLANT      ASSET      DEPRECIABLE LIVES - TEP, UNS GAS AND UNS ELECTRIC**

**DEFERRED      TAX VALUATION - TEP AND MILLENNIUM **

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Table          of Contents

*Notes      To      Condensed Consolidated Financial Statements*

**NEWACCOUNTING      PRONOUNCEMENTS**

| ·*      * | Emerging                Issues Task Force Issue 06-3 (EITF 06-3), *How                Taxes                Collected from Customers and Remitted to Governmental Authorities                Should                Be Presented in the Income Statement (that Is, Gross versus Net                Presentation)*,                ratified                June 2006, requires disclosure of a company’s accounting policy decision                to present taxes on either a gross (included in revenues and costs)                or a                net (excluded from revenues) basis. Additionally, a company must                disclose                the amounts of any taxes reported on a gross basis in interim and                annual                financial statements. EITF 06-3 is effective for interim and annual                reporting periods beginning after December 15, 2006. See *Note                12*of                *Notes                to                Condensed Consolidated Financial Statements*. |
|----------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | FIN                48,                *Accounting                for Uncertainty in Income Taxes - an interpretation of FAS                109*,                issued July                2006, prescribes a recognition threshold and measurement attribute                for the                financial statement recognition and measurement of a tax position                taken in                a tax return. We must determine whether it is “more-likely-than-not” that                a tax position will be sustained upon examination, including resolution                of                any related appeals or litigation processes, based on the technical                merits                of the position. Once it is determined that a position meets the                more-likely-than-not recognition threshold, the position is measured                to                determine the amount of benefit to recognize in the financial statements.                Additionally, FIN 48 requires disclosure of a rollforward of total                unrecognized tax benefits.  We do not believe the adoption of FIN 48                will have a material effect on our financial position or results                of                operations. FIN 48 is effective for fiscal years beginning after                December                15, 2006. |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | FAS                157,                *Fair                Value Measurement*, issued                September 2006, defines fair value, establishes a framework for measuring                fair value, and expands disclosures about fair value measurements.                 This Statement clarifies that the exchange price is the price in                the                principal market where the reporting entity would transact for the                asset                or liability.  We are required to disclose inputs used to develop                fair value measurements and the effect of any of our assumptions                on                earnings or changes in net assets for the period.  FAS 157 is                effective for financial statements issued for fiscal years beginning                after                November 15, 2007, and interim periods within those fiscal years.  We                will incorporate these additional disclosure requirements in our                financial                statements for the quarter ended March 31,                2008. |
|----------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | FSP                AUG-AIR-1, *Accounting                for Planned Major Maintenance Activities*,                issued                September 2006, prohibits the use of the accrue-in-advance method                of                accounting for planned major maintenance activities effective in                fiscal                years beginning after December 15, 2006.  As we do not accrue planned                major maintenance activities in advance, we anticipate no impact                on our                financial statements from the adoption of this                FSP. |
|----------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·                    | In                September                2006, the FASB issued FAS 158, *Employers’                Accounting for Defined Benefit Pension and Other Postretirement                Plans*.                FAS 158                requires recognition of the overfunded or underfunded status of a                defined                benefit postretirement plan measured as the difference between the                fair                value of the plans’ assets and benefit obligation. For a pension plan, the                benefit obligation would be the projected benefit obligation; for                any                other postretirement benefit plans, the benefit obligation would                be the                accumulated postretirement benefit obligation. An overfunded status                would                result in the recognition of an asset and an underfunded status would                result in the recognition of a liability. The adjustment required                to                recognize an asset or liability upon adoption of this statement would                result in an expense or benefit to Other Comprehensive Income. FAS                158 is                effective for fiscal years ending after December 15, 2006. We are                evaluating the impact of FAS 158 on our financial condition and results                of                operations. Based on our benefit                obligations |
|----------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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|   | and                  fair                  value of plan assets as of December 31, 2005, the adoption of FAS                  158                  could result in the recognition of an additional liability and                  a                  corresponding charge to Other Comprehensive Income in the range                  of $24                  million to $38 million, subject to various assumptions, such as                  the                  discount rate. If TEP’s regulated operations and UNS Gas and UNS Electric                  qualify for regulatory accounting treatment, any additional liability                  recognized would be offset by a regulatory asset, rather than Other                  Comprehensive Income. FAS 158 would not have a material effect                  on our                  results of operations. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**SAFEHARBOR      FOR FORWARD-LOOKING      STATEMENTS**

| 1.    | Supply                and                demand conditions in wholesale energy markets, including volatility                in                market prices and illiquidity in markets, which are affected by a                variety                of factors. These factors include the availability of generating                capacity                in the western U.S., including hydroelectric resources, weather,                natural                gas prices, the extent of utility restructuring in various states,                transmission constraints, environmental regulations and cost of                compliance, FERC regulation of wholesale energy markets, and economic                conditions in the western U.S. |
|----------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 2.                 | Effects                of                competition in retail and wholesale energy                markets. |
|------------------------------|-------------------------------------------------------------------------------------------------------------|

| 3.                 | Changes                in                economic conditions, demographic patterns and weather conditions                in our                retail service areas. |
|------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 4.                 | Effects                of                restructuring initiatives in the electric industry and other                energy-related industries. |
|------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|

| 5.                 | The                creditworthiness of the entities with which we transact business                or have                transacted business. |
|------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|

| 6.                 | Changes                affecting our cost of providing electric and gas service including                changes                in fuel costs, generating unit operating performance, scheduled and                unscheduled plant outages, interest rates, tax laws, environmental                laws                and the general rate of inflation. |
|------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 7.                 | Changes                in                governmental policies and regulatory actions with respect to financing                and                rate structures. |
|------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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Table          of Contents

| 8.                 | Changes                affecting the cost of competing energy alternatives, including changes                in                available generating technologies and in the cost of natural                gas. |
|------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 9.                 | Changes                in                accounting principles or the application of such principles to our                businesses. |
|------------------------------|----------------------------------------------------------------------------------------------------------------------------------------|

| 10.                 | Changes                in                the depreciable lives of our assets. |
|-------------------------------|-------------------------------------------------------------------------------|

| 11.                 | Unanticipated                changes in funding requirements, future liabilities and recorded                expenses                relating to employee benefit plans due to changes in market values                of                retirement plan assets and health care costs, changes in accounting                requirements of the FASB and new                legislation. |
|-------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| 12.                 | The                outcome                of any ongoing or future                litigation. |
|-------------------------------|-----------------------------------------------------------------------------------------------|

| 13.                 | Ability                to                obtain financing through debt and/or equity issuance, which can be                affected by various factors, including interest rate fluctuations                and                capital market conditions. |
|-------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**ITEM3.      - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET      RISK**

**MARKET      RISKS**

*Safe      Harbor for      Forward-Looking Statements*

**Risk      Management Committee**

**Commodity      Price Risk**

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Table          of Contents

**TEP**

|                                    | Three                  Months                  EndedSeptember 30, | Nine                  Months                  EndedSeptember                  30, |
|-----------------------------------------|-------------------------------------------------------------------|-----------------------------------------------------------------------------------|
|                                    | 2006                                                              | 2005                                                                              | 2006 | 2005 |
|                                    | -In                  Millions-                                    | -In                  Millions-                                                    |
| Unrealized                  Gain (Loss) | $                   6                                        |                          $ (3)                 | $                   7 |                          $ (3) |

|                                    | Three                  Months                  EndedSeptember 30, | Nine                  Months                  EndedSeptember                  30, |
|-----------------------------------------|-------------------------------------------------------------------|-----------------------------------------------------------------------------------|
|                                    | 2006                                                              | 2005                                                                              | 2006 | 2005 |
|                                    | -In                  Millions-                                    | -In                  Millions-                                                    |
| Unrealized                  Gain (Loss) |                    $  1                                 |                          $ (8)                 |  $                   1 |                          $ (9) |

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Table          of Contents

| **Nine                  Months Ended September 30,** | ** 2006**                                                                    | **2005**                                               | **2006**                               | **2005**                                     |
|------------------------------------------------------|-----------------------------------------------------------------------------------|--------------------------------------------------------|----------------------------------------|----------------------------------------------|
|                                                 | -Thousands                  of                  MWh-                              | %                  of Total                  Resources |
| Gas-Fired                  Generation                |                             678 |                     337                      |                      6% |                       3% |
| Purchased                  Power                     |                          1,411                 | 1,443                                                  |                    14%            |                     15%            |

|                                    | Three                  Months                  EndedSeptember 30, | Nine                  Months                  EndedSeptember                  30, |
|-----------------------------------------|-------------------------------------------------------------------|-----------------------------------------------------------------------------------|
|                                    | 2006                                                              | 2005                                                                              | 2006 | 2005 |
|                                    | -In                  Millions-                                    | -In                  Millions-                                                    |
| Unrealized                  (Loss) Gain | $ (1)                                                        |    $                   7                                      | $                  (15) |    $                   7 |

**UNS      Gas**

**UNS      Electric**

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**MEG**

|                                                                             | Unrealized                Gain (Loss) of MEG’s Trading Activities |
|----------------------------------------------------------------------------------|-------------------------------------------------------------------------|
|                                                                             | -                Millions of                Dollars -                   |
|  Source                of                Fair Value At September 30, 2006   | Maturity                0 -                6months                      | Maturity                6 -                12months | Maturityover                1                yr. | Total                UnrealizedGain (Loss) |
| Prices                actively quoted                                            | $4                                                       | $                -    |                    $2 |                  $6 |
| Prices                based                on models and other valuation methods | -                                                                  | - |                      3 |                    3 |
| Total                                                                            | $4                                                       | $                -    |                    $5 |                  $9 |

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Table          of Contents

**Credit      Risk**

**Interest      Rate Risk**

| **ITEM4.              - CONTROLS AND              PROCEDURES**  |
|----------------------------------------------------------------------|

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Table          of Contents

**PARTII      - OTHER INFORMATION**

| **ITEM1.                - LEGAL                PROCEEDINGS**  |
|--------------------------------------------------------------------|

*Note      6      of*
*Notes      to      Consolidated Financial Statements, Commitments and      Contingencies.*

**Cross-Complaints      in Wholesale Electricity Antitrust Cases I and II**

**City      of      Tacoma**

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Table          of Contents

| **ITEM1A.                - RISK                FACTORS**  |
|----------------------------------------------------------------|

| **ITEM5.                - OTHER                INFORMATION**  |
|--------------------------------------------------------------------|

**NON-GAAP      MEASURES**

**Adjusted      EBITDA**

**Adjusted      EBITDA and Net Cash Flows - Operating Activities**

|                                                                       | **UniSource                Energy**                   |
|----------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                       | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                       | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                       | -                Millions of                Dollars - |
| Adjusted                EBITDA (non-GAAP)                                  | $144                                                  | $124 | $                366 | $                318 |
| Net                Cash                Flows - Operating Activities (GAAP) | $                 72                             | $                 81 | $                197 | $                170 |
| Net                Cash                Flows - Investing Activities (GAAP) | $                (34)                                 | $                (38) | $(167) | $(112) |
| Net                Cash                Flows - Financing Activities (GAAP) | $                (88)                                 | $                (43) | $                 (89) | $(109) |

|                                                                       | **TEP**                                               |
|----------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                       | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                       | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                       | -                Millions of                Dollars - |
| Adjusted                EBITDA (non-GAAP)                                  | $136                                                  | $115 | $                331 | $                290 |
| Net                Cash                Flows - Operating Activities (GAAP) | $                 45                             | $                 72 | $                143 | $                146 |
| Net                Cash                Flows - Investing Activities (GAAP) | $                (18)                                 | $                (30) | $(138) | $                 (83) |
| Net                Cash                Flows - Financing Activities (GAAP) | $                (63)                                 | $                (54) | $                 (45) | $(142) |

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**Reconciliation      of Adjusted EBITDA to Cash Flows from Operations**

|                                                                                     | **UniSource                Energy**                   |
|------------------------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                                     | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                                     | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                                     | -                Millions of                Dollars - |
| **Adjusted                EBITDA**(non-GAAP)** ****(1)**** **                  | $144                                                  | $124 | $366 | $318 |
| Amounts                from                the Income Statements:                        |                                                  |   |   |   |
|   Less:                Income Taxes                                            |                   18                        |                   12 |                   39 |                   19 |
|   Less:                Total Interest                Expense                   |                   41                        |                   38 |  115 |  122 |
| Changes                in                Assets and Liabilities and Other Non-Cash Items |                  (13)                            |                     7 |                  (15) |                   (7) |
| **Net                Cash Flows - Operating Activities**(GAAP)** **                 | **                  72**                    | **                  81** | ** 197** | ** 170** |
| **Net                Cash Flows - Investing Activities**(GAAP)                           | **                 (34)**                        | **                 (38)** | **(167)** | **(112)** |
| **Net                Cash Flows - Financing Activities**(GAAP)                           | **                 (88)**                        | **                 (43)** | **                 (89)** | **(109)** |
| **Net                Decrease in Cash and Cash Equivalents**(GAAP)                       | **$****(50)**                                         | **$  ****-** | **$****(59)** | **$****(51)** |

|                                                                                     | **TEP**                                               |
|------------------------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                                     | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                                     | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                                     | -                Millions of                Dollars - |
| **Adjusted                EBITDA**(non-GAAP)** ****(1)**** **                  | $136                                                  | $115 | $331 | $290 |
| Amounts                from                the Income Statements:                        |                                                  |   |   |   |
|   Less:                Income                Taxes                             |                   19                        |                   12 |                   38 |                   19 |
|   Less:                Total Interest                Expense                   |                   34                        |                   32 |                   96 |  107 |
| Changes                in                Assets and Liabilities and Other Non-Cash Items |                  (38)                            |                     1 |                  (54) |  (18) |
| **Net                Cash Flows - Operating Activities**(GAAP)** **                 | **                  45**                    | **                  72** | ** 143** | ** 146** |
| **Net                Cash Flows - Investing Activities**(GAAP)                           | **                 (18)**                        | **                 (30)** | **(138)** | ** (83)** |
| **Net                Cash Flows - Financing Activities**(GAAP)                           | **                 (63)**                        | **                 (54)** | **                 (45)** | **(142)** |
| **Net                Decrease in Cash and Cash Equivalents**(GAAP)                       | **$****(36)**                                         | **$****(12)** | **$****(40)** | **$****(79)** |

**(1)**

**      Adjusted      EBITDA was calculated as follows:**

|                                                                                                          | **UniSource                Energy**                   |
|---------------------------------------------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                                                          | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                                                          | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                                                          | -                Millions of                Dollars - |
| **Net                Income**(GAAP)                                                                           | $                28                                   |  $                18 |  $ 55 | $                24 |
| Amounts                from                the Income Statements:                                             |                                                  |   |   |   |
|   Less:                Discontinued                Operations - Net of Tax                          |                     -             |                    (1) |                    (3) |                   (4) |
|   Plus:                Income                Taxes                                                  |    18                                  |                   12 |                   39 |                   19 |
|      Total                Interest Expense                                           |    41                                  |                   38 |  115 |  122 |
|     Depreciation                and Amortization                                          |    33                                  |                   33 |                   97 |  100 |
|     Amortization                of Transition Recovery Asset                              |    22                                  |                   20 |    51 |                   44 |
|     Depreciation                included in Fuel and Other O&M                        |                                                  |   |   |   |
|                         Expense (see Note 15 of Notes to Consolidated |                                                  |   |   |   |
|                         Financial Statements)                         |                     2             |                     2 |                     6 |                     5 |
| **Adjusted                EBITDA**(non-GAAP)                                                                  | **$144**                                              | **$124** | **$****366** | **$****318** |

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|                                                                                              | **TEP**                                               |
|---------------------------------------------------------------------------------------------------|-------------------------------------------------------|
|                                                                                              | **Three                Months Ended September 30,**   | **Nine                Months Ended September 30,** |
|                                                                                              | **2006**                                              | **2005** | **2006** | **2005** |
|                                                                                              | -                Millions of                Dollars - |
| **Net                Income**(GAAP)                                                               | $                30                                   | $                20 | $                57 | $                28 |
| Amounts                from                the Income Statements:                                 |                                                  |   |   |   |
|   Plus:                Income                Taxes                                      |                   19                        |                   12 |                   38 |                   19 |
|    Total                Interest                Expense                            |                   34                        |                   32 |                   96 |  107 |
|    Depreciation                and                Amortization                     |                   29                        |                   29 |                   84 |                   87 |
|    Amortization                of                Transition Recovery Asset         |                   22                        |                   20 |                   51 |                   44 |
|    Depreciation                included                in Fuel and Other O&M   |                                                  |   |   |   |
|                       Expense (see Note 15 of Notes to Consolidated |                                                  |   |   |   |
|                       Financial Statements)                         |                     2             |                     2 |                     5 |                     5 |
| **Adjusted                EBITDA**(non-GAAP)                                                      | **$****136**                                          | **$****115** | **$****331** | **$****290** |

**Net      Debt      and Total Debt and Capital Lease Obligations - TEP**

|                                                                          | **As                of** **September                30, 2006** | **As                of****December                31, 2005** |
|-------------------------------------------------------------------------------|---------------------------------------------------------------------|--------------------------------------------------------------|
|                                                                          | -                Millions of                Dollars -               |
| Net                Debt                (non-GAAP)                             |   $1,333                                                  | $1,379                                                       |
| Total                Debt                and Capital Lease Obligations (GAAP) |   $1,466                                                  | $1,535                                                       |

**Reconciliation      of Total Debt and Capital Lease Obligations to Net Debt**

|                                                              | **As                of** **September                30, 2006** | **As                of****December                31, 2005**         |
|-------------------------------------------------------------------|---------------------------------------------------------------------|----------------------------------------------------------------------|
|                                                              | -                Millions of                Dollars -               |
| **Total                Debt (GAAP)**                              |  $                   821                        |       $                  821 |
|                                                              |                                                                |                                                                 |
| Capital                Lease                Obligations           |                       586             |                  665                                            |
| Current                Portion - Capital Lease Obligations        |                         59  |                    49                                 |
| **Total                Debt and Capital Lease Obligations**(GAAP) |                    1,466                             | 1,535                                                                |
|                                                              |                                                                |                                                                 |
| Investment                in                Lease Debt            |                      (133)                 |  (156)                                                          |
| **Net                Debt**(non-GAAP)                             |  $                1,333                                        |                      $ 1,379                |

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**Ratioof      Earnings to Fixed Charges**

|                            | **9                Months Ended**        | **12                Months Ended**       |
|---------------------------------|------------------------------------------|------------------------------------------|
|                            | **September                30,****2006** | **September                30,****2006** |
| UniSource                Energy | 1.81                                     | 1.86                                     |
|                            |                                     |                                     |
| TEP                             | 1.96                                     | 1.99                                     |

**SECReports      Available on UniSource Energy’s      Website**

*Information      contained at UniSource Energy’s website is not part of any report filed with the      SEC by UniSource Energy or TEP.*

| **ITEM                6. -                EXHIBITS **  |
|------------------------------------------------------------------|

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**SIGNATURES**

|                                          |   | UNISOURCE                  ENERGY CORPORATION(Registrant)                                                                                      |
|-----------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| Date:                   November 3, 2006 | /s/    | Kevin                  P.                  Larson                                                                                                        |
|                                          |   | Kevin                  P.                  LarsonSenior                  Vice                  President and PrincipalFinancial                  Officr  |
|                                          |   |                                                                                                                                           |
|                                          |   | TUCSON                  ELECTRIC POWER COMPANY(Registrant)                                                                                     |
| Date:                   November 3, 2006 | /s/    | Kevin                  P.                  Larson                                                                                                        |
|                                          |   | Kevin                  P.                  LarsonSenior                  Vice                  President and PrincipalFinancial                  Officer |

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**EXHIBITINDEX**

| 4      | --     | Amendment                No. 1 to Amended and Restated Credit                Agreement, dated September 1, 2006, among TEP, the Lenders, the                Issuing Banks, Union Bank of California N.A., as Administrative Agent,                and                Wells Fargo Bank, National Association and ABN Amro Bank N.V., as                New                Issuing Banks. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 12(a)  | --     | Computation                of Ratio of Earnings to Fixed Charges -                UniSource Energy.                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 12(b)  | --     | Computation                of Ratio of Earnings to Fixed Charges -                TEP.                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 15     | --     | Letter                regarding unaudited interim financial                information.                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31(a)  | --     | Certification                Pursuant to Section 302 of the                Sarbanes-Oxley Act - UniSource Energy, by James S. Pignatelli.                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31(b)  | --     | Certification                Pursuant to Section 302 of the                Sarbanes-Oxley Act - UniSource Energy, by Kevin P. Larson.                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31(c)  | --     | Certification                Pursuant to Section 302 of the                Sarbanes-Oxley Act - TEP, by James S. Pignatelli.                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| 31(d)  | --     | Certification                Pursuant to Section 302 of the                Sarbanes-Oxley Act - TEP, by Kevin P. Larson.                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                    |
| *32    | --     | Statements                of Corporate Officers (pursuant to Section                906 of the Sarbanes-Oxley Act of 2002).                                                                                                                                                                                                                                                             |

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