--------------------------------------------------------------------------------
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

         (Mark One)
            [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended June 30, 2005

                                       OR
            [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
              For the transition period from __________ to _______.

  Commission      Registrant; State of Incorporation;      IRS Employer
  File Number     Address; and Telephone Number            Identification Number
  -----------     -----------------------------            ---------------------

  1-13739         UNISOURCE ENERGY CORPORATION             86-0786732
                  (An Arizona Corporation)
                  One South Church Avenue, Suite 100
                  Tucson, AZ  85701
                  (520) 571-4000

  1-5924          TUCSON ELECTRIC POWER COMPANY            86-0062700
                  (An Arizona Corporation)
                  One South Church Avenue, Suite 100
                  Tucson, AZ  85701
                  (520) 571-4000

     Indicate by check mark whether each registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes   X    No
                                               -----     -----

     Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

     UniSource Energy Corporation      Yes   X    No
                                           -----     -----
     Tucson Electric Power Company     Yes        No   X
                                           -----     -----

     At August 4, 2005, 34,706,932 shares of UniSource Energy Corporation Common
Stock, no par value (the only class of Common Stock), were outstanding.

     At August 4, 2005, 32,139,555 shares of Tucson Electric Power Company's
common stock, no par value, were outstanding, of which 32,139,434 shares were
held by UniSource Energy Corporation.


--------------------------------------------------------------------------------

This combined Form 10-Q is separately filed by UniSource Energy Corporation and
Tucson Electric Power Company. Information contained in this document relating
to Tucson Electric Power Company is filed by UniSource Energy Corporation and
separately by Tucson Electric Power Company on its own behalf. Tucson Electric
Power Company makes no representation as to information relating to UniSource
Energy Corporation or its subsidiaries, except as it may relate to Tucson
Electric Power Company.


<PAGE>


TABLE OF 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        6
  Tucson Electric Power Company
    Comparative Condensed Consolidated Statements of Income                    7
    Comparative Condensed Consolidated Statements of Cash Flows                8
    Comparative Condensed Consolidated Balance Sheets                          9
    Condensed Consolidated Statement of Changes in Stockholders' Equity       10
  Notes to Condensed Consolidated Financial Statements                        11
  Note 1.   Nature of Operations, Basis of Accounting Presentation
            and Equity-Based Compensation                                     11
  Note 2.   Regulatory Matters                                                13
  Note 3.   Debt and Credit Facilities                                        15
  Note 4.   Business Segments                                                 17
  Note 5.   Accounting for Derivative Instruments and Trading Activities      18
  Note 6.   Commitments and Contingencies                                     21
  Note 7.   TEP Wholesale Accounts Receivable and Allowances                  23
  Note 8.   UniSource Energy Earnings Per Share (EPS)                         23
  Note 9.   Employee Benefits Plans                                           23
  Note 10.  Share-Based Compensation Plans                                    25
  Note 11.  Income and Other Taxes                                            26
  Note 12.  New Accounting Pronouncements                                     27
  Note 13.  Supplemental Cash Flow Information                                28
  Note 14.  Subsequent Event                                                  29
  Note 15.  Review by Independent Registered Public Accounting Firm           29

Item 2. - Management's Discussion and Analysis of Financial
          Condition and Results of Operations                                 30
  UniSource Energy Consolidated                                               30
    Results of Operations                                                     31
    Contribution by Business Segment                                          33
    Liquidity and Capital Resources                                           33
  Tucson Electric Power Company                                               37
    Results of Operations                                                     37
    Factors Affecting Results of Operations                                   41
    Liquidity and Capital Resources                                           45
  UNS Gas                                                                     49
    Results of Operations                                                     49
    Factors Affecting Results of Operations                                   51
    Liquidity and Capital Resources                                           51
  UNS Electric                                                                53
    Results of Operations                                                     53
    Factors Affecting Results of Operations                                   54
    Liquidity and Capital Resources                                           55
  Global Solar Energy, Inc.                                                   56
    Results of Operations                                                     56
  Other                                                                       56
    Results of Operations                                                     56
  Critical Accounting Estimates                                               58
  New Accounting Pronouncements                                               64


                                       ii
<PAGE>


  Safe Harbor for Forward-Looking Statements                                  65

Item 3. - Quantitative and Qualitative Disclosures about Market Risk          66

Item 4. - Controls and Procedures                                             68

     PART II - OTHER INFORMATION

Item 1. - Legal Proceedings                                                   69

Item 4. - Submission of Matters to a Vote of Security Holders                 70

Item 5. - Other Information                                                   70
  Non-GAAP Measures                                                           70
  Ratio of Earnings to Fixed Charges                                          73
  SEC Reports Available on UniSource Energy's Website                         73

Item 6. Exhibits                                                              73

Signatures                                                                    74

Exhibit Index                                                                 75


                                      iii
<PAGE>


                                   DEFINITIONS

The abbreviations and acronyms used in the 2005 Second Quarter 10-Q are defined
below:

--------------------------------------------------------------------------------

1941 Mortgage.................. TEP's Indenture, dated as of April 1, 1941, of
                                  TEP to JPMorgan Chase Bank, successor trustee,
                                  as supplemented and amended, which was
                                  satisfied and discharged on June 10, 2005.
1992 Mortgage.................. TEP's Indenture of Mortgage and Deed of Trust,
                                  dated as of December 1, 1992, of TEP to The
                                  Bank of New York, successor trustee, as
                                  supplemented.
ACC............................ Arizona Corporation Commission.
ACC Holding Company Order...... The order approved by the ACC in November 1997
                                  allowing TEP to form a holding company.
AHMSA.......................... Altos Hornos de Mexico, S.A. de C.V. AHMSA owns
                                  50% of Sabinas.
AMT............................ Alternative Minimum Tax.
APS............................ Arizona Public Service Company.
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.
CISO........................... California Independent System Operator.
Citizens....................... Citizens Communications Company.
Collateral Trust Bonds......... Bonds issued under the Indenture of Trust, dated
                                  as of August 1, 1998, of TEP to The Bank of
                                  New York, successor trustee.
Common Stock................... UniSource Energy's common stock, without par
                                  value.
Company or UniSource Energy.... UniSource Energy Corporation.
Convertible Senior Notes....... UniSource Energy's 4.50% Convertible Senior
                                  Notes due March 1, 2035.
Emissions Allowance(s)......... An allowance issued by the Environmental
                                  Protection Agency 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.
ESP............................ Energy Service Provider.
Express Line................... 345-kV circuit connecting Springerville Unit 2
                                  to the Tucson 138-kV system.
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.
Four Corners................... Four Corners Generating Station.
Global Solar................... Global Solar Energy, Inc., a company that
                                  develops and manufactures thin-film
                                  photovoltaic cells. Millennium owns 99% of
                                  Global Solar.
Haddington..................... Haddington Energy Partners II, LP, a limited
                                  partnership that funds energy-related
                                  investments.
Heating Degree Days............ An index used to measure the impact of weather
                                  on energy usage calculated by subtracting the
                                  average of the high and low daily temperatures
                                  from 65.
IDBs........................... Industrial development revenue or pollution
                                  control revenue bonds.
IPS............................ Infinite Power Solutions, Inc., a company that
                                  develops thin-film batteries.
IRS............................ Internal Revenue Service.
ISO............................ Independent System Operator.
ITC............................ Investment Tax Credit.
kWh............................ Kilowatt-hour(s).
kV............................. Kilovolt(s).
LIBOR.......................... London Interbank Offered Rate.
LOC............................ Letter of Credit.


                                       iv
<PAGE>


Luna........................... Luna Energy Facility.
MEG............................ Millennium Environmental Group, Inc., a
                                  wholly-owned subsidiary of Millennium, which
                                  manages and trades emissions allowances, coal,
                                  and related financial instruments.
MicroSat....................... MicroSat Systems, Inc. is a company formed to
                                  develop and commercialize small-scale
                                  satellites. Millennium currently owns 35%.
Millennium..................... Millennium Energy Holdings, Inc., a wholly-owned
                                  subsidiary of UniSource Energy.
Mimosa......................... Minerales de Monclova, S.A. de C.V., an owner of
                                  coal and associated gas reserves and a
                                  supplier of metallurgical coal to the steel
                                  industry and thermal coal to the Mexican
                                  electricity commission. Sabinas owns 19.5% of
                                  Mimosa.
MMBtus......................... 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.
PGA............................ Purchased Gas Adjustor, a retail rate mechanism
                                  designed to recover the cost of gas purchased
                                  for retail gas customers.
PNM............................ Public Service Company of New Mexico, a
                                  subsidiary of PNMR.
PNMR........................... PNM Resources, Inc.
Powertrusion................... POWERTRUSION International, Inc., a company
                                  owned 77% by Millennium, which manufactures
                                  lightweight utility poles.
PPFAC.......................... Purchased Power and Fuel Adjustment Clause.
PWCC........................... Pinnacle West Capital Corporation.
Repurchased Bonds.............. $221 million of fixed-rate tax-exempt bonds that
                                  TEP purchased from  bondholders on May 11,
                                  2005.
RTO............................ Regional Transmission Organization.
Rules.......................... Retail Electric Competition Rules.
Sabinas........................ Carboelectrica Sabinas, S. de R.L. de C.V., a
                                  Mexican limited liability company.  Millennium
                                  owns 50% of Sabinas.
Saguaro Utility................ An Arizona limited partnership, whose general
                                  partner was Sage Mountain, L.L.C. and whose
                                  limited partners included investment funds
                                  affiliated with Kohlberg Kravis Roberts & Co.,
                                  L.P., J.P. Morgan Partners, L.L.C. and
                                  Wachovia Capital Partners.
San Carlos..................... San Carlos Resources Inc., a wholly-owned
                                  subsidiary of TEP.
San Juan....................... San Juan Generating Station.
Sempra......................... Sempra Energy Trading Company.
SCE Exchange................... A power exchange agreement between TEP and
                                  Southern California Edison Company (SCE).
SES............................ Southwest Energy Solutions, Inc., a wholly-owned
                                  subsidiary of Millennium.
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.
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 Lease..... Leveraged lease arrangement 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.
SRP............................ Salt River Project Agricultural Improvement and
                                  Power District.
Sundt.......................... H. Wilson Sundt Generating Station (formerly
                                  known as the Irvington Generating Station).


                                       v
<PAGE>


Sundt Lease.................... The leveraged lease arrangement relating to
                                  Sundt Unit 4.
SWG............................ Southwest Gas Corporation.
TEP............................ Tucson Electric Power Company, the principal
                                  subsidiary of UniSource Energy.
TEP Credit Agreement........... Credit Agreement between TEP and a syndicate
                                  of banks, dated as of May 4, 2005.
TEP Revolving Credit Facility.. $60 million revolving credit facility entered
                                  into under the TEP Credit Agreement, dated as
                                  of May 4, 2005, between a syndicate of banks
                                  and TEP.
Therm.......................... A unit of heating value equivalent to 100,000
                                  British thermal units (Btu).
Tri-State...................... Tri-State Generation and Transmission
                                  Association.
TruePricing.................... TruePricing, Inc., a start-up company
                                  established to market energy related products.
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.
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. UES is wholly owned
                                  by UniSource Energy.
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..... Credit Agreement between UniSource Energy and a
                                  syndicate of banks, dated as of April 15,
                                  2005.
UniSource Energy............... UniSource Energy Corporation.
UNS Electric................... UNS Electric, Inc., a wholly-owned subsidiary of
                                  UES, which acquired the Citizens Arizona
                                  electric utility assets.
UNS Gas........................ UNS Gas, Inc., a wholly-owned subsidiary of UES,
                                  which acquired the Citizens Arizona gas
                                  utility assets.
UNS Gas/UNS Electric Revolver.. A $40 million revolving credit facility entered
                                  into by UNS Gas and UNS Electric on April 15,
                                  2005.
Valencia....................... Valencia power plant owned by UNS Electric.
WestConnect.................... The proposed for-profit RTO in which TEP is a
                                  participant.


                                       vi
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
UniSource Energy Corporation:

We have reviewed the accompanying condensed consolidated balance sheet of
UniSource Energy Corporation and its subsidiaries (the Company) as of June 30,
2005, and the related condensed consolidated statements of income for each of
the three-month and six-month periods ended June 30, 2005 and 2004 and the
condensed consolidated statement of cash flows for the six-month periods ended
June 30, 2005 and 2004 and the condensed consolidated statement of changes in
stockholders' equity for the six-month period ended June 30, 2005. These interim
financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated interim financial statements
for them to be in conformity with accounting principles generally accepted in
the United States of America.

We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet as of December 31, 2004, and the related consolidated statements of
income, of cash flows and of changes in stockholders' equity for the year then
ended, management's assessment of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2004 and the effectiveness
of the Company's internal control over financial reporting as of December 31,
2004; and in our report dated March 16, 2005, we expressed unqualified opinions
thereon. The consolidated financial statements and management's assessment of
the effectiveness of internal control over financial reporting referred to above
are not presented herein. In our opinion, the information set forth in the
accompanying consolidated balance sheet information as of June 30, 2005, is
fairly stated in all material respects in relation to the consolidated balance
sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
------------------------------

PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
August 8, 2005


                                       1
<PAGE>


             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Tucson Electric Power Company:

We have reviewed the accompanying condensed consolidated balance sheet of Tucson
Electric Power Company (the Company) as of June 30, 2005, and the related
condensed consolidated statements of income for each of the three-month and
six-month periods ended June 30, 2005 and 2004 and the condensed consolidated
statement of cash flows for the six-month periods ended June 30, 2005 and 2004
and the condensed consolidated statement of changes in stockholders' equity for
the six-month period ended June 30, 2005. These interim financial statements are
the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated interim financial statements
for them to be in conformity with accounting principles generally accepted in
the United States of America.

We previously audited in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet as of
December 31, 2004, and the related consolidated statements of income, of cash
flows, and of changes in stockholders' equity for the year then ended (not
presented herein), and in our report dated March 16, 2005 we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance sheet
information as of June 30, 2005, is fairly stated in all material respects in
relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
------------------------------

PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
August 8, 2005


                                       2
<PAGE>


                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
      Three Months Ended                                                                         Six Months Ended
           June 30,                                                                                  June 30,
      2005           2004                                                                       2005           2004
         (UNAUDITED)                                                                                (UNAUDITED)
----------------------------------------------------------------------------------------------------------------------
     -Thousands of Dollars-                                                                   - Thousands of Dollars -
   <S>             <C>        <C>                                                            <C>            <C>
                               OPERATING REVENUES
   $ 231,785       $224,056      Electric Retail Sales                                       $ 403,375      $ 398,419
      37,871         42,189      Electric Wholesale Sales                                       77,051         83,889
      26,058         20,212      Gas Revenue                                                    72,607         69,013
       4,878          3,624      Other Revenues                                                  8,488          8,844
----------------------------------------------------------------------------------------------------------------------
     300,592        290,081        TOTAL OPERATING REVENUES                                    561,521        560,165
----------------------------------------------------------------------------------------------------------------------

                               OPERATING EXPENSES
      55,863         55,340      Fuel                                                          103,154        102,789
      68,897         55,586      Purchased Energy                                              133,304        115,088
      61,248         56,410      Other Operations and Maintenance                              122,740        119,989
      33,344         36,560      Depreciation and Amortization                                  68,168         71,696
      14,136         12,003      Amortization of Transition Recovery Asset                      23,623         20,600
      12,510         12,611      Taxes Other Than Income Taxes                                  26,009         25,722
----------------------------------------------------------------------------------------------------------------------
     245,998        228,510        TOTAL OPERATING EXPENSES                                    476,998        455,884
----------------------------------------------------------------------------------------------------------------------
      54,594         61,571          OPERATING INCOME                                           84,523        104,281
----------------------------------------------------------------------------------------------------------------------

                               OTHER INCOME (DEDUCTIONS)
       5,076          5,013      Interest Income                                                10,037          9,882
       1,649          1,338      Other Income                                                    2,803          7,941
        (998)        (3,698)     Other Expense                                                  (2,242)        (2,602)
----------------------------------------------------------------------------------------------------------------------
       5,727          2,653        TOTAL OTHER INCOME (DEDUCTIONS)                              10,598         15,221
----------------------------------------------------------------------------------------------------------------------

                               INTEREST EXPENSE
      19,744         20,032      Long-Term Debt                                                 40,096         41,515
      19,401         20,065      Interest on Capital Leases                                     39,147         40,109
       5,427              -      Loss on Reacquired Debt                                         5,427          1,635
        (897)          (329)     Other Interest Expense, Net of Amounts Capitalized               (886)          (543)
----------------------------------------------------------------------------------------------------------------------
      43,675         39,768        TOTAL INTEREST EXPENSE                                       83,784         82,716
----------------------------------------------------------------------------------------------------------------------

      16,646         24,456    INCOME BEFORE INCOME TAXES                                       11,337         36,786
       7,178         11,655      Income Tax Expense                                              5,652         17,564
----------------------------------------------------------------------------------------------------------------------

     $ 9,468       $ 12,801    NET INCOME                                                      $ 5,685       $ 19,222
======================================================================================================================

      34,807         34,392    WEIGHTED-AVERAGE SHARES OF COMMON STOCK OUTSTANDING (000)        34,721         34,288
======================================================================================================================

       $0.27          $0.37    BASIC EARNINGS PER SHARE                                          $0.16          $0.56
======================================================================================================================

       $0.27          $0.37    DILUTED EARNINGS PER SHARE                                        $0.16          $0.55
======================================================================================================================

       $0.19          $0.16    DIVIDENDS PAID PER SHARE                                          $0.38          $0.32
======================================================================================================================
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       3


<PAGE>


UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                              Six Months Ended
                                                                                  June 30,
                                                                            2005             2004
                                                                                (UNAUDITED)
-----------------------------------------------------------------------------------------------------
                                                                           - Thousands of Dollars -
<S>                                                                    <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Cash Receipts from Electric Retail Sales                            $    417,057      $   409,934
   Cash Receipts from Electric Wholesale Sales                              104,229          108,665
   Cash Receipts from Gas Sales                                              95,382           90,056
   MEG Cash Receipts from Trading Activity                                   61,640           73,405
   Interest Received                                                         11,239           11,042
   Income Tax Refunds Received                                                1,484              286
   Performance Deposits                                                       7,193            1,456
   Deposit - Second Mortgage Indenture                                            -           17,040
   Other Cash Receipts                                                        5,401            9,585
   Fuel Costs Paid                                                          (99,108)         (92,935)
   Purchased Energy Costs Paid                                             (160,582)        (132,762)
   Wages Paid, Net of Amounts Capitalized                                   (52,908)         (48,973)
   Payment of Other Operations and Maintenance Costs                        (78,961)         (69,215)
   MEG Cash Payments for Trading Activity                                   (63,943)         (73,096)
   Capital Lease Interest Paid                                              (39,744)         (41,576)
   Taxes Paid, Net of Amounts Capitalized                                   (69,929)         (70,589)
   Interest Paid, Net of Amounts Capitalized                                (39,132)         (38,821)
   Income Taxes Paid                                                         (5,689)          (8,152)
   Other Cash Payments                                                       (2,309)          (4,114)
-----------------------------------------------------------------------------------------------------
NET CASH FLOWS - OPERATING ACTIVITIES                                        91,320          141,236
-----------------------------------------------------------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Capital Expenditures                                                     (90,067)         (70,588)
   Proceeds from Investment in Springerville Lease Debt and Equity            8,251            8,054
   Return of Investment from Millennium Energy Business                         299            9,714
   Other Cash Receipts                                                        8,094              515
   Payments for Investment in Springerville Lease Debt and Equity                 -           (4,499)
   Investment in and Loans to Equity Investees                               (1,150)            (424)
-----------------------------------------------------------------------------------------------------
NET CASH FLOWS - INVESTING ACTIVITIES                                       (74,573)         (57,228)
-----------------------------------------------------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Proceeds from Issuance of Long-Term Debt                                 240,000                -
   Repayments of Long-Term Debt                                            (283,016)          (1,232)
   Payments on Capital Lease Obligations                                    (48,600)         (43,641)
   Proceeds from Borrowings under Revolving Credit Facility                  40,000           20,000
   Payments on Borrowings under Revolving Credit Facility                         -          (20,000)
   Proceeds from Stock Options Exercised                                      7,104            6,261
   Other Cash Receipts                                                        5,452            4,629
   Payment of Debt Issue/Retirement Costs                                   (10,621)          (9,190)
   Common Stock Dividends Paid                                              (14,823)         (10,909)
   Other Cash Payments                                                       (3,032)          (1,927)
-----------------------------------------------------------------------------------------------------
NET CASH FLOWS - FINANCING ACTIVITIES                                       (67,536)         (56,009)
-----------------------------------------------------------------------------------------------------

Net (Decrease) Increase in Cash and Cash Equivalents                        (50,789)          27,999
Cash and Cash Equivalents, Beginning of Year                                154,028          101,266
-----------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                                  $ 103,239        $ 129,265
=====================================================================================================
</TABLE>

See Note 13 for supplemental cash flow information.

See Notes to Condensed Consolidated Financial Statements.


                                       4


<PAGE>


UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                    June 30,        December 31,
                                                                      2005             2004
                                                                            (UNAUDITED)
-------------------------------------------------------------------------------------------------
                                                                       - Thousands of Dollars -
<S>                                                                 <C>             <C>
ASSETS
UTILITY PLANT
  Plant in Service                                                  $ 3,098,523      $ 3,033,405
  Utility Plant under Capital Leases                                    723,901          723,901
  Construction Work in Progress                                         140,058          116,161
-------------------------------------------------------------------------------------------------
    TOTAL UTILITY PLANT                                               3,962,482        3,873,467
  Less Accumulated Depreciation and Amortization                     (1,396,432)      (1,348,017)
  Less Accumulated Amortization of Capital Lease Assets                (458,335)        (444,313)
-------------------------------------------------------------------------------------------------
    TOTAL UTILITY PLANT - NET                                         2,107,715        2,081,137
-------------------------------------------------------------------------------------------------

INVESTMENTS AND OTHER PROPERTY
  Investments in Lease Debt and Equity                                  162,169          170,893
  Other                                                                  81,969           85,035
-------------------------------------------------------------------------------------------------
    TOTAL INVESTMENTS AND OTHER PROPERTY                                244,138          255,928
-------------------------------------------------------------------------------------------------

CURRENT ASSETS
  Cash and Cash Equivalents                                             103,239          154,028
  Trade Accounts Receivable                                             102,878          107,694
  Unbilled Accounts Receivable                                           54,472           55,350
  Allowance for Doubtful Accounts                                       (16,724)         (16,492)
  Materials and Fuel Inventory                                           68,482           62,225
  Trading Assets                                                         15,717           70,958
  Current Regulatory Assets                                              10,006            9,653
  Deferred Income Taxes - Current                                        21,478           24,055
  Interest Receivable - Current                                          10,209           10,475
  Other                                                                  17,047           26,751
-------------------------------------------------------------------------------------------------
    TOTAL CURRENT ASSETS                                                386,804          504,697
-------------------------------------------------------------------------------------------------

REGULATORY AND OTHER ASSETS
  Transition Recovery Asset                                             200,405          224,029
  Income Taxes Recoverable Through Future Revenues                       42,280           44,624
  Other Regulatory Assets                                                22,816           15,823
  Other Assets                                                           54,656           49,280
-------------------------------------------------------------------------------------------------
    TOTAL REGULATORY AND OTHER ASSETS                                   320,157          333,756
-------------------------------------------------------------------------------------------------

TOTAL ASSETS                                                        $ 3,058,814      $ 3,175,518
=================================================================================================

CAPITALIZATION AND OTHER LIABILITIES
CAPITALIZATION
  Common Stock Equity                                                 $ 583,886        $ 580,718
  Capital Lease Obligations                                             660,437          701,931
  Long-Term Debt                                                      1,214,920        1,257,595
-------------------------------------------------------------------------------------------------
    TOTAL CAPITALIZATION                                              2,459,243        2,540,244
-------------------------------------------------------------------------------------------------

CURRENT LIABILITIES
  Current Obligations under Capital Leases                               56,136           53,694
  Current Maturities of Long-Term Debt                                    5,000            1,725
  Borrowings Under Revolving Credit Facility                             40,000                -
  Accounts Payable                                                       67,021           95,276
  Interest Accrued                                                       47,612           60,679
  Trading Liabilities                                                    14,902           65,022
  Taxes Accrued                                                          35,101           53,192
  Accrued Employee Expenses                                              15,061           19,216
  Customer Deposits                                                      14,947           14,794
  Other                                                                   6,611            4,556
-------------------------------------------------------------------------------------------------
    TOTAL CURRENT LIABILITIES                                           302,391          368,154
-------------------------------------------------------------------------------------------------

DEFERRED CREDITS AND OTHER LIABILITIES
  Deferred Income Taxes - Noncurrent                                    117,347          101,753
  Regulatory Liability - Net Cost of Removal for Interim Retirements     75,398           69,585
  Other                                                                 104,435           95,782
-------------------------------------------------------------------------------------------------
    TOTAL DEFERRED CREDITS AND OTHER LIABILITIES                        297,180          267,120
-------------------------------------------------------------------------------------------------

COMMITMENTS AND CONTINGENCIES (NOTE 6)
-------------------------------------------------------------------------------------------------

TOTAL CAPITALIZATION AND OTHER LIABILITIES                          $ 3,058,814      $ 3,175,518
=================================================================================================
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       5


UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                                    Accumulated
                                                      Common                       Accumulated         Other             Total
                                                      Shares        Common          Earnings       Comprehensive      Stockholders'
                                                   Outstanding*     Stock           (Deficit)      Income (Loss)         Equity
------------------------------------------------------------------------------------------------------------------------------------
                                                                                   (UNAUDITED)
                                                                                 - In Thousands -
<S>                                                   <C>          <C>              <C>             <C>                <C>
BALANCES AT DECEMBER 31, 2004                         34,255       $ 677,119        $ (85,666)      $ (10,735)         $ 580,718
------------------------------------------------------------------------------------------------------------------------------------

Comprehensive Income:
  2005 Year-to-Date Net Income                             -               -            5,685               -              5,685
  Unrealized Gain on Cash Flow Hedges
    (net of $2,078 income tax expense)                     -               -                -           3,170              3,170
  Reclassification of Realized Gain on
    Cash Flow Hedges to Net Income
    (net of $363 income tax expense)                       -               -                -            (554)              (554)
                                                                                                                      --------------
Total Comprehensive Income                                                                                                 8,301
                                                                                                                      --------------

  Dividends Declared                                                       -          (13,116)              -            (13,116)
  Shares Issued under Stock Compensation Plans            37               -                -               -                  -
  Shares Distributed by Deferred Compensation Trust        -               1                -               -                  1
  Shares Issued for Stock Options                        367           7,779                -               -              7,779
  Other                                                    -             203                -               -                203
------------------------------------------------------------------------------------------------------------------------------------

BALANCES AT JUNE 30, 2005                             34,659       $ 685,102        $ (93,097)       $ (8,119)         $ 583,886
====================================================================================================================================
<FN>
* UniSource Energy has 75 million authorized shares of common stock.
</FN>
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       6


TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
    Three Months Ended                                                                           Six Months Ended
         June 30,                                                                                    June 30,
  2005             2004                                                                        2005            2004
       (UNAUDITED)                                                                                  (UNAUDITED)
-------------------------------------------------------------------------------------------------------------------------
 - Thousands of Dollars -                                                                     - Thousands of Dollars -
 <S>             <C>          <C>                                                           <C>              <C>
                            OPERATING REVENUES
 $195,470        $188,908     Electric Retail Sales                                         $ 335,676        $ 332,084
   37,802          42,121     Electric Wholesale Sales                                         76,930           83,770
    3,607           2,713     Other Revenues                                                    6,179            4,862
-----------------------------------------------------------------------------------------------------------------------
  236,879         233,742       TOTAL OPERATING REVENUES                                      418,785          420,716
-----------------------------------------------------------------------------------------------------------------------

                            OPERATING EXPENSES
   55,863          55,340     Fuel                                                            103,154          102,789
   27,190          19,087     Purchased Power                                                  40,051           25,339
   47,213          42,576     Other Operations and Maintenance                                 95,190           90,405
   27,934          32,025     Depreciation and Amortization                                    57,954           62,438
   14,136          12,003     Amortization of Transition Recovery Asset                        23,623           20,600
   10,418          10,442     Taxes Other Than Income Taxes                                    21,567           21,188
-----------------------------------------------------------------------------------------------------------------------
  182,754         171,473       TOTAL OPERATING EXPENSES                                      341,539          322,759
-----------------------------------------------------------------------------------------------------------------------
   54,125          62,269         OPERATING INCOME                                             77,246           97,957
-----------------------------------------------------------------------------------------------------------------------

                            OTHER INCOME (DEDUCTIONS)
    4,903           5,000     Interest Income                                                   9,719            9,861
        -           2,319     Interest Income - Note Receivable from UniSource Energy           1,684            4,639
    1,142             623     Other Income                                                      1,798            1,185
     (676)           (357)    Other Expense                                                      (999)            (691)
-----------------------------------------------------------------------------------------------------------------------
    5,369           7,585       TOTAL OTHER INCOME (DEDUCTIONS)                                12,202           14,994
-----------------------------------------------------------------------------------------------------------------------

                            INTEREST EXPENSE
   14,458          17,257     Long-Term Debt                                                   31,437           36,003
   19,392          20,049     Interest on Capital Leases                                       39,129           40,086
    5,427               -     Loss on Reacquired Debt                                           5,427            1,635
     (882)           (310)    Other Interest Expense, Net of Amounts Capitalized                 (792)            (499)
-----------------------------------------------------------------------------------------------------------------------
   38,395          36,996       TOTAL INTEREST EXPENSE                                         75,201           77,225
-----------------------------------------------------------------------------------------------------------------------

   21,099          32,858   INCOME BEFORE INCOME TAXES                                         14,247           35,726
    8,951          14,841     Income Tax Expense                                                6,789           16,915
-----------------------------------------------------------------------------------------------------------------------
 $ 12,148        $ 18,017   NET INCOME                                                        $ 7,458         $ 18,811
=======================================================================================================================
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       7


TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                 Six Months Ended
                                                                                    June 30,
                                                                              2005               2004
                                                                                   (UNAUDITED)
----------------------------------------------------------------------------------------------------------
                                                                              - Thousands of Dollars -
<S>                                                                        <C>                <C>
CASH FLOWS FROM OPERATING ACTIVITIES
   Cash Receipts from Electric Retail Sales                                $ 345,352          $ 340,603
   Cash Receipts from Electric Wholesale Sales                               104,165            108,528
   Interest Received                                                          21,919             10,568
   Deposit - Second Mortgage Indenture                                             -             17,040
   Income Taxes Refunds Received                                                 713                286
   Other Cash Receipts                                                         1,831              4,575
   Fuel Costs Paid                                                           (99,108)           (92,935)
   Purchased Power Costs Paid                                                (59,609)           (43,047)
   Wages Paid, Net of Amounts Capitalized                                    (41,486)           (36,799)
   Payment of Other Operations and Maintenance Costs                         (66,325)           (53,443)
   Capital Lease Interest Paid                                               (39,726)           (41,572)
   Taxes Paid, Net of Amounts Capitalized                                    (50,148)           (48,618)
   Interest Paid, Net of Amounts Capitalized                                 (33,948)           (33,611)
   Income Taxes Paid                                                          (8,000)           (10,002)
   Other Cash Payments                                                        (1,797)            (2,980)
----------------------------------------------------------------------------------------------------------
NET CASH FLOWS - OPERATING ACTIVITIES                                         73,833            118,593
----------------------------------------------------------------------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES
   Capital Expenditures                                                      (67,523)           (52,676)
   Proceeds from Investment in Springerville Lease Debt and Equity             8,251              8,054
   Payments for Investment in Springerville Lease Debt and Equity                  -             (4,499)
   Other Cash Receipts                                                         6,708                  -
----------------------------------------------------------------------------------------------------------
NET CASH FLOWS - INVESTING ACTIVITIES                                        (52,564)           (49,121)
----------------------------------------------------------------------------------------------------------

CASH FLOWS FROM FINANCING ACTIVITIES
   Equity Investment from UniSource Energy                                   110,000                  -
   Proceeds from Repayment of UniSource Energy Note                           95,393                  -
   Repayments of Long-Term Debt                                             (281,766)            (1,225)
   Payments on Capital Lease Obligations                                     (48,560)           (43,599)
   Proceeds from Borrowings under Revolving Credit Facility                   40,000             20,000
   Payments on Borrowings under Revolving Credit Facility                          -            (20,000)
   Other Cash Receipts                                                         9,289              8,417
   Payment of Debt Issue/Retirement Costs                                     (5,203)            (8,814)
   Dividends Paid to UniSource Energy                                              -             (7,000)
   Other Cash Payments                                                        (7,284)            (1,079)
----------------------------------------------------------------------------------------------------------
NET CASH FLOWS - FINANCING ACTIVITIES                                        (88,131)           (53,300)
----------------------------------------------------------------------------------------------------------

Net (Decrease) Increase in Cash and Cash Equivalents                         (66,862)            16,172
Cash and Cash Equivalents, Beginning of Year                                 113,207             65,262
----------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD                                    $ 46,345           $ 81,434
==========================================================================================================
</TABLE>

See Note 13 for supplemental cash flow information.

See Notes to Condensed Consolidated Financial Statements.


                                       8


TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                       June 30,       December 31,
                                                                         2005            2004
                                                                              (UNAUDITED)
---------------------------------------------------------------------------------------------------
                                                                         - Thousands of Dollars -
<S>                                                                    <C>             <C>
ASSETS
UTILITY PLANT
  Plant in Service                                                     $ 2,810,585     $ 2,771,665
  Utility Plant under Capital Leases                                       723,195         723,195
  Construction Work in Progress                                            123,968          94,336
---------------------------------------------------------------------------------------------------
    TOTAL UTILITY PLANT                                                  3,657,748       3,589,196
  Less Accumulated Depreciation and Amortization                        (1,370,468)     (1,328,228)
  Less Accumulated Amortization of Capital Lease Assets                   (458,162)       (444,186)
---------------------------------------------------------------------------------------------------
    TOTAL UTILITY PLANT - NET                                            1,829,118       1,816,782
---------------------------------------------------------------------------------------------------

INVESTMENTS AND OTHER PROPERTY
  Investments in Lease Debt and Equity                                     162,169         170,893
  Other                                                                     24,145          23,393
---------------------------------------------------------------------------------------------------
    TOTAL INVESTMENTS AND OTHER PROPERTY                                   186,314         194,286
---------------------------------------------------------------------------------------------------

NOTE RECEIVABLE FROM UNISOURCE ENERGY                                            -          79,462
---------------------------------------------------------------------------------------------------

CURRENT ASSETS
  Cash and Cash Equivalents                                                 46,345         113,207
  Trade Accounts Receivable                                                 82,555          72,042
  Unbilled Accounts Receivable                                              41,740          33,179
  Allowance for Doubtful Accounts                                          (14,452)        (14,166)
  Intercompany Accounts Receivable                                           6,186          10,111
  Materials and Fuel Inventory                                              55,275          51,207
  Current Regulatory Assets                                                 10,006           9,653
  Income Taxes Receivable                                                    1,227               -
  Deferred Income Taxes - Current                                           20,821          24,157
  Interest Receivable - Current                                             10,192          10,475
  Other                                                                     13,823          18,330
---------------------------------------------------------------------------------------------------
    TOTAL CURRENT ASSETS                                                   273,718         328,195
---------------------------------------------------------------------------------------------------

REGULATORY AND OTHER ASSETS
  Transition Recovery Asset                                                200,405         224,029
  Income Taxes Recoverable Through Future Revenues                          42,280          44,624
  Other Regulatory Assets                                                   20,455          13,684
  Other Assets                                                              39,821          41,106
---------------------------------------------------------------------------------------------------
    TOTAL REGULATORY AND OTHER ASSETS                                      302,961         323,443
---------------------------------------------------------------------------------------------------

TOTAL ASSETS                                                           $ 2,592,111     $ 2,742,168
===================================================================================================

CAPITALIZATION AND OTHER LIABILITIES
CAPITALIZATION
  Common Stock Equity                                                    $ 562,235       $ 414,510
  Capital Lease Obligations                                                659,955         701,405
  Long-Term Debt                                                           821,170       1,097,595
---------------------------------------------------------------------------------------------------
    TOTAL CAPITALIZATION                                                 2,043,360       2,213,510
---------------------------------------------------------------------------------------------------

CURRENT LIABILITIES
  Current Obligations under Capital Leases                                  56,051          53,611
  Current Maturities of Long-Term Debt                                           -           1,725
  Borrowings Under Revolving Credit Facility                                40,000               -
  Accounts Payable                                                          43,241          46,377
  Intercompany Accounts Payable                                             10,839          20,026
  Interest Accrued                                                          40,545          56,514
  Taxes Accrued                                                             29,329          44,938
  Accrued Employee Expenses                                                 13,082          17,594
  Other                                                                     11,844           9,592
---------------------------------------------------------------------------------------------------
    TOTAL CURRENT LIABILITIES                                              244,931         250,377
---------------------------------------------------------------------------------------------------

DEFERRED CREDITS AND OTHER LIABILITIES
  Deferred Income Taxes - Noncurrent                                       144,421         129,842
  Regulatory Liability - Net Cost of Removal for Interim Retirements        72,513          67,485
  Other                                                                     86,886          80,954
---------------------------------------------------------------------------------------------------
    TOTAL DEFERRED CREDITS AND OTHER LIABILITIES                           303,820         278,281
---------------------------------------------------------------------------------------------------

COMMITMENTS AND CONTINGENCIES (NOTE 6)
---------------------------------------------------------------------------------------------------

TOTAL CAPITALIZATION AND OTHER LIABILITIES                             $ 2,592,111     $ 2,742,168
===================================================================================================
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       9


TUCSON ELECTRIC POWER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                                   Accumulated
                                                                  Capital          Accumulated        Other          Total
                                                   Common          Stock           Earnings       Comprehensive   Stockholders'
                                                   Stock          Expense          (Deficit)      Income (Loss)      Equity
-------------------------------------------------------------------------------------------------------------------------------
                                                                                  (UNAUDITED)
                                                                            - Thousands of Dollars -
<S>                                                <C>              <C>            <C>              <C>              <C>
BALANCES AT DECEMBER 31, 2004                      $ 658,254        $ (6,357)      $ (226,652)      $ (10,735)       $ 414,510
-------------------------------------------------------------------------------------------------------------------------------

Comprehensive Income:
   2005 Year-to-Date Net Income                            -               -            7,458               -            7,458
   Unrealized Gain on Cash Flow Hedges
     (net of $2,078 income tax expense)                    -               -                -           3,170            3,170
   Reclassification of Realized Gain on
     Cash Flow Hedges to Net Income
     (net of $363 income tax expense)                      -               -                -            (554)            (554)
                                                                                                                  -------------
Total Comprehensive Income                                                                                              10,074
                                                                                                                  -------------
   Equity Contribution from UniSource Energy          25,261               -                -               -           25,261
   Capital Contribution from UniSource Energy        112,390               -                -               -          112,390
-------------------------------------------------------------------------------------------------------------------------------

BALANCES AT JUNE 30, 2005                          $ 795,905        $ (6,357)      $ (219,194)       $ (8,119)       $ 562,235
===============================================================================================================================
</TABLE>

See Notes to Condensed Consolidated Financial Statements.


                                       10


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

NOTE 1. NATURE OF OPERATIONS, BASIS OF ACCOUNTING PRESENTATION AND EQUITY-BASED
COMPENSATION

     UniSource Energy Corporation (UniSource Energy) is an exempt holding
company under the Public Utility Holding Company Act of 1935. UniSource Energy
has no significant operations of its own, but owns substantially all of the
common stock of Tucson Electric Power Company (TEP) and all of the common stock
of UniSource Energy Services, Inc. (UES), Millennium Energy Holdings, Inc.
(Millennium) and UniSource Energy Development Company (UED).

     TEP, a regulated public utility incorporated in Arizona since 1963, is
UniSource Energy's largest operating subsidiary and represented approximately
85% of UniSource Energy's assets as of June 30, 2005. TEP generates, transmits
and distributes electricity. TEP serves approximately 380,000 retail electric
customers in a 1,155 square mile area in Southern Arizona. TEP also sells
electricity to other utilities and power marketing entities primarily located in
the western U.S.

     UES holds the common stock of UNS Gas, Inc. (UNS Gas) and UNS Electric,
Inc. (UNS Electric). UES has no significant operations of its own. UNS Gas is a
gas distribution company serving approximately 135,900 retail customers in
Mohave, Yavapai, Coconino, and Navajo Counties in northern Arizona, as well as
Santa Cruz County in southeast Arizona. UNS Electric is an electric transmission
and distribution company serving approximately 87,500 retail customers in Mohave
and Santa Cruz counties.

     Millennium invests in unregulated businesses, including Global Solar Energy
(Global Solar), a developer and manufacturer of thin-film photovoltaic cells and
modules. UED engages in developing generating resources and other project
development activities, including facilitating the expansion of the
Springerville Generating Station, but has no significant operations.

     We conduct our business in four primary business segments - TEP's Electric
Utility segment, UNS Gas, UNS Electric and Global Solar.

     References to "we" and "our" are to UniSource Energy and its subsidiaries,
collectively.

     The accompanying quarterly financial statements of UniSource Energy and TEP
are unaudited but reflect all normal recurring accruals and other adjustments
which we believe are necessary for a fair presentation of the results for the
interim periods presented. These financial statements are presented in
accordance with the Securities and Exchange Commission's (SEC) interim reporting
requirements which do not include all the disclosures required by accounting
principles generally accepted in the United States of America (GAAP) for audited
annual financial statements. The year-end condensed balance sheet data was
derived from audited financial statements, but does not include disclosures
required by GAAP for audited annual financial statements. This quarterly report
should be reviewed in conjunction with UniSource Energy and TEP's 2004 Annual
Report on Form 10-K.

     Weather, among other factors, causes seasonal fluctuations in TEP, UNS Gas
and UNS Electric's sales; therefore, quarterly results are not indicative of
annual operating results. UniSource Energy and TEP have made minor
reclassifications to the prior year financial statements for comparative
purposes. These reclassifications had no effect on net income.

  DEPRECIATION

     During the second quarter 2005, a study requested by the participants in
the San Juan Generating Station (San Juan) was completed which indicated San
Juan's economic useful life had changed from previous estimates. As a result of
the study and other analysis performed, TEP lengthened the estimated useful life
of San Juan from 40 to 60 years beginning April 1, 2005. TEP's depreciation
expense for the three months ended June 30, 2005, decreased approximately $2
million. Annual depreciation expense is expected to decrease by $6 million or $3
million for the remainder of 2005.

     During the second quarter of 2005, it was determined that depreciation of
certain UNS Gas and UNS Electric assets had been overstated in prior periods. An
adjustment was recorded in June 2005 which reduced UNS' Other Operations and
Maintenance Expense by $1 million.


                                       11
<PAGE>


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

  EQUITY-BASED COMPENSATION

     UniSource Energy has two equity-based compensation plans, the 1994 Outside
Director Stock Option Plan (Directors' Plan) and the 1994 Omnibus Stock and
Incentive Plan (Omnibus Plan). See Note 10. We adopted Statement of Financial
Accounting Standards No. 123(R), Share Based Payment (FAS 123(R)) effective
January 1, 2005. The adoption of FAS 123(R) did not have a significant impact on
our financial statements because stock options issued under UniSource Energy's
Omnibus Plan vested upon the shareholder vote to approve the proposed
acquisition of UniSource Energy, see UniSource Energy's 2004 Annual Report on
Form 10-K, Note 17 in Notes to Consolidated Financial Statements - Stock-Based
Compensation. After February 4, 2004, no new awards can be granted under the
Omnibus Plan. Prior to January 1, 2005, we accounted for those plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25), and related interpretations.

     All our stock options granted under the Omnibus Plan were granted with an
exercise price equal to the market value of the stock at the date of the grant.
Accordingly, under the provisions of APB 25, no compensation expense was
recorded for these awards. However, compensation expense was recognized for
restricted stock, stock unit and performance share awards over the
performance/vesting period.

     The following table illustrates the effect on UniSource Energy's net income
and earnings per share and TEP's net income as if we had applied the fair value
recognition provisions of FAS 123(R) to all equity-based employee compensation
awards for the three and six months ended June 30, 2004:

UNISOURCE ENERGY:
----------------
<TABLE>
<CAPTION>
                                                               Three Months Ended            Six Months Ended
                                                                    June 30,                     June 30,
                                                                      2004                         2004
------------------------------------------------------------- --------------------------- ------------------------
                                                                            -Thousands of Dollars-
                                                                            (except per share data)
<S>                                                                   <C>                          <C>
Net Income - As Reported                                               $   12,801                  $  19,222
Add: Equity-based compensation expense included in reported
   net income, net of related tax effects                                      66                      1,309
Deduct: Total equity-based employee compensation expense
   determined under fair value based method for all awards,
   net of related tax effects                                                 (74)                    (2,072)
------------------------------------------------------------- --------------------------- ------------------------
Pro Forma Net Income                                                   $   12,793                  $  18,459
============================================================= =========================== ========================
Basic Earnings per Share:
  As Reported                                                               $0.37                      $0.56
  Pro Forma                                                                 $0.37                      $0.54
============================================================= =========================== ========================
Diluted Earnings per Share:
  As Reported                                                               $0.37                      $0.55
  Pro Forma                                                                 $0.36                      $0.53
============================================================= =========================== ========================
</TABLE>

TEP:
----
<TABLE>
<CAPTION>
                                                                 Three Months Ended           Six Months Ended
                                                                      June 30,                     June 30,
                                                                        2004                         2004
------------------------------------------------------------- --------------------------- ------------------------
                                                                             -Thousands of Dollars-
<S>                                                                    <C>                         <C>
Net Income - As Reported                                               $  18,017                   $  18,811
Add: Equity-based compensation expense included in reported
   net income, net of related tax effects                                     57                       1,176
Deduct: Total equity-based employee compensation expense
   determined under fair value based method for all awards,
   net of related tax effects                                                (64)                     (1,925)
------------------------------------------------------------- --------------------------- ------------------------
Pro Forma Net Income                                                   $  18,010                   $  18,062
============================================================= =========================== ========================
</TABLE>


                                       12
<PAGE>


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


     The fair value of each stock option grant is estimated on the date of grant
using the Black-Scholes option-pricing model. There were no stock options
granted during the six months ended June 30, 2004. For the 21,222 options
granted under the Directors' Plan in 2003, the following weighted average
assumptions were used:

     <TABLE>
     <CAPTION>
     <S>                                                         <C>
     Expected life (years)                                       6
     Interest rate                                               3.34%
     Volatility                                                 23.74%
     Dividend yield                                              3.55%
     Weighted-average grant-date fair value of options
       granted during the period                                $3.16
     -------------------------------------------------------------------
     </TABLE>

NOTE 2. REGULATORY MATTERS
--------------------------

  REGULATORY ACCOUNTING

     TEP, UNS Gas and UNS Electric generally use the same accounting policies
and practices used by unregulated companies for financial reporting under GAAP.
However, sometimes these principles, such as Statement of Financial Accounting
Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS
71), require special accounting treatment for regulated companies to show the
effect of regulation. For example, in setting TEP, UNS Gas and UNS Electric's
retail rates, the Arizona Corporation Commission (ACC) may not allow TEP, UNS
Gas or UNS Electric to currently charge their customers to recover certain
expenses, but instead may require that these expenses be charged to customers in
the future. In this situation, FAS 71 requires that TEP, UNS Gas and UNS
Electric defer these items and show them as regulatory assets on the balance
sheet until TEP, UNS Gas and UNS Electric are allowed to charge their customers.
TEP, UNS Gas and UNS Electric then amortize these items as expense to the income
statement as these charges are recovered from customers. Similarly, certain
revenue items may be deferred as regulatory liabilities, which are also
eventually amortized to the income statement as rates to customers are reduced.

     The conditions a regulated company must satisfy to apply the accounting
policies and practices of FAS 71 include:

     o    an independent regulator sets rates;
     o    the regulator sets the rates to recover specific costs of delivering
          service; and
     o    the service territory lacks competitive pressures to reduce rates
          below the rates set by the regulator.

   IMPLICATIONS OF DISCONTINUING APPLICATION OF FAS 71

     TEP

     Upon approval by the ACC of a settlement agreement (Settlement Agreement)
in November 1999, TEP discontinued application of FAS 71 for its generation
operations. TEP continues to apply FAS 71 to its cost-based rate regulated
operations, which include the transmission and distribution portions of its
business.

     TEP's transmission and distribution regulatory assets, net of regulatory
liabilities, totaled $201 million at June 30, 2005. Regulatory assets of $30
million are not presently included in rate base and consequently are not earning
a return on investment. These regulatory assets are being recovered through the
cost of service or are authorized to be collected in future base rates. TEP's
transmission and distribution regulatory assets, net of regulatory liabilities,
totaled $225 million at December 31, 2004.

     TEP regularly assesses whether it can continue to apply FAS 71 to its
cost-based rate regulated operations. If TEP stopped applying FAS 71 to these
operations, it would write off the related balances of its regulatory assets as
an expense and its regulatory liabilities as income on its income statement.
Based on the regulatory asset balances, net of regulatory liabilities, at June
30, 2005, if TEP had stopped applying FAS 71 to its remaining cost-based rate
regulated operations, it would have recorded an extraordinary after-tax loss of
$121 million. While regulatory orders and market conditions may affect cash
flows, TEP's cash flows would not be affected if it stopped applying FAS 71
unless a regulatory order limited its ability to recover the cost of its
regulatory assets.


                                       13
<PAGE>


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

     UNS GAS AND UNS ELECTRIC

     UNS Gas and UNS Electric's regulatory liabilities exceed their regulatory
assets by $6 million at June 30, 2005. At December 31, 2004, UNS Gas and UNS
Electric' regulatory assets, net of regulatory liabilities, totaled $4 million.
UNS Gas and UNS Electric's regulatory assets and liabilities are included in
rates and consequently are earning a return. If UNS Gas and UNS Electric stopped
applying FAS 71 to their regulated operations, they would write off the related
balances of their regulatory assets as an expense and would write off their
regulatory liabilities as income on their income statements. Based on the
regulatory asset and liability balances, if UNS Gas and UNS Electric had stopped
applying FAS 71 to their regulated operations, they would have recorded an
extraordinary after-tax gain of $3 million at June 30, 2005. UNS Gas and UNS
Electric's cash flows would not be affected if they stopped applying FAS 71
unless a regulatory order limited their ability to recover the cost of their
regulatory assets.

RECENT REGULATORY ACTION

     TEP

     Given recent court action, the ACC may revise its Rules and rate
methodologies prior to the expiration in 2008 of the Settlement Agreement. A new
structure could replace that established pursuant to the Settlement Agreement
prior to January 2009.

     In an effort to resolve the uncertainty surrounding the methodology that
will be applied to determine TEP's rates for generation service after the
Competition Transition Charges (CTCs) expire, TEP filed a motion with the ACC on
May 4, 2005 requesting that the ACC issue an order declaring its position
regarding the rate treatment that will be afforded to TEP's generation assets
after 2008.

     The motion states TEP's preference for the ACC to adhere to the Settlement
Agreement and continue to authorize TEP to charge market-based rates for
generation services after December 31, 2008. The motion also states that, if the
ACC intends to rescind TEP's authorization to charge market-based rates for its
generation services, that change will have immediate consequences for the
Settlement Agreement, the 2004 general rate case information filing and future
TEP rate cases. Accordingly, TEP requested that the ACC clarify its intentions
in this regard. In addition, TEP requested that a procedural conference be held
in the 2004 rate review proceedings to discuss the status of that case pending
the issuance of an order in response to TEP's motion.

     In May 2005, a number of participants in TEP's rate proceedings, including
the Staff of the ACC, filed responses to TEP's motion. Those responses reflect
differing interpretations of the Settlement Agreement which established TEP's
existing rate structure and generation service rates, and the effect of the 2002
Track A order which eliminated the requirement that TEP transfer its generation
assets to a subsidiary and the future of electric competition in Arizona. A
number of these responses dispute TEP's assertion that the existing rate
structure contemplates market-based rates for generation services after December
31, 2008.

     On June 1, 2005, TEP filed a reply in support of its motion. The reply
stated that the differences of opinion expressed in the various responses filed
underscore the need for the ACC to clarify how it will determine TEP's rates for
generation services after December 31, 2008. TEP's reply also stated that,
although it would prefer that the ACC continue to authorize TEP to charge
market-based rates for generation services after December 31, 2008, it is
concerned that its customers will be subject to a significant rate increase in
2009.

     TEP believes that any actions by the ACC should not deny TEP the economic
benefits of the Settlement Agreement, and accordingly analyzed how the
Settlement Agreement can be modified so as to: (i) preserve the intent of the
parties; (ii) avoid a significant rate increase in 2009; (iii) mitigate a
negative financial impact on TEP; and (iv) provide all interested parties with
certainty in the near future about TEP's post-2008 rate structure.

     TEP's reply suggests that these goals can be accomplished through a
modification to the Settlement Agreement which includes the following concepts:
(i) an extension of the existing rate freeze at current rates; (ii) retention of
the current CTC amortization schedule; (iii) a commitment not to seek rate
treatment for certain TEP generation assets; and (iv) implementation of a
mechanism to protect TEP from extreme fuel market volatility after December 31,
2008. TEP intends to discuss its proposal with the parties to the Settlement
Agreement and ACC staff and, thereafter, enter into formal negotiations to seek
to modify the Settlement Agreement.


                                       14
<PAGE>


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

     On June 10, 2005 and on July 11, 2005, the ALJ issued procedural orders
related to TEP's 2004 rate review. The procedural orders took no action on TEP's
May 4, 2005 motion, however suggested a more appropriate procedure was for TEP
to file a motion to reopen the record approving the Settlement Agreement. On
July 25, 2005, TEP informed the ALJ that it will file a motion by September 12,
2005, seeking to amend the decision approving the Settlement Agreement to
address TEP's concerns about how rates will be set after December 31, 2008.

     UNS GAS

     In March 2005, the ACC approved a PGA surcharge of $0.03 per therm
beginning April 11, 2005 and lasting until the excess gas purchase costs are
fully recovered. Based on current and projected gas prices and the rates
currently in effect, we expect the PGA balance to increase. Given these gas
price projections and expected pipeline transportation cost increases, UNS Gas
may be required to request an increase in this surcharge. The under recovered
gas purchase costs of $2.1 million as of June 30, 2005, are recorded in Other
Regulatory Assets on UniSource Energy's balance sheet.

NOTE 3. DEBT AND CREDIT FACILITIES
----------------------------------

     Long-term debt matures more than one year from the date of the financial
statements.

  UNISOURCE ENERGY DEBT

     CONVERTIBLE SENIOR NOTES

     In March 2005, UniSource Energy issued $150 million of 4.50% Convertible
Senior Notes due 2035 in a private placement. The Convertible Senior Notes are
unsecured and are not guaranteed by TEP or any other UniSource Energy
subsidiary. Each $1,000 of Convertible Senior Notes is convertible into 26.6667
shares of our Common Stock at any time. This represents a conversion price of
approximately $37.50 per share of our Common Stock, which is subject to
adjustment in certain circumstances.

     On March 1, 2005, UniSource Energy used $106 million of the net proceeds
from the sale of the Convertible Senior Notes to repay its $95 million
promissory note to TEP plus accrued interest of $11 million. TEP used these
funds, along with borrowings under its revolving credit facility to repurchase
and redeem $225 million of fixed rate tax-exempt borrowings. See TEP Debt - Bond
Repurchase and Redemptions, below.

     UNISOURCE CREDIT AGREEMENT

     On April 15, 2005, UniSource Energy entered into a $105 million five-year
credit agreement with a group of lenders (UniSource Credit Agreement) which
expires on April 15, 2010. The UniSource Credit Agreement includes a $90 million
term loan facility and a $15 million revolving credit facility. Quarterly
principal payments of $1.25 million are due beginning June 30, 2005, with the
balance due at maturity.

     As of June 30, 2005, UniSource Energy borrowed $89 million under the term
loan facility at an interest rate of 5.2%. As of June 30, 2005, there were no
borrowings outstanding under the revolving credit facility.

     We pay interest on the term loan and on borrowings under the revolving
credit facility at LIBOR plus 1.75% or the agent bank's reference rate plus
0.75%. If after June 30, 2005, TEP cannot pay 100% of its current year net
income as dividends due to regulatory restrictions, interest rates would
increase by 0.25%. We paid a commitment fee of 0.50% on the unused portion of
the term loan until it was fully drawn at June 29, 2005, and pay a commitment
fee of 0.50% on the unused portion of the revolving credit facility.

     The UniSource Credit Agreement restricts additional indebtedness, liens,
mergers, sales of assets and investments and acquisitions. We must also meet:
(1) a minimum cash flow to interest coverage ratio for UniSource Energy on a
standalone basis and (2) a maximum leverage ratio on a consolidated basis. We
may pay dividends, if after giving effect to the dividend payments, we have more
than $15 million of unrestricted cash and unused revolving credit. As of June
30, 2005, we were in compliance with the terms of the UniSource Credit
Agreement.


                                       15
<PAGE>


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

     If an event of default occurs, the UniSource Credit Agreement may become
immediately due and payable. An event of default includes failure to make
required payments under the UniSource Credit Agreement, failure of UniSource
Energy or certain subsidiaries to make payments or default on debt greater than
$20 million, or certain bankruptcy events at UniSource Energy or certain
subsidiaries.

     INTER-COMPANY NOTE AND CAPITAL CONTRIBUTION FROM UNISOURCE ENERGY

     In January 2005, UNS Gas established a short-term inter-company promissory
note to UniSource Energy that allows UNS Gas to borrow up to $10 million for
general corporate purposes.

     In May 2005, UniSource Energy made a $110 million capital contribution to
TEP.

   TEP DEBT

     BOND REPURCHASE AND REDEMPTIONS

     TEP made a sinking fund payment of $1 million on its 6.1% 1941 Mortgage
IDBs in January 2005.

     In March 2005, TEP redeemed at par the remaining $31 million of its 6.1%
1941 Mortgage IDBs, which were due in 2008, as well as the remaining $21 million
of its 7.5% 1941 Mortgage IDBs, which were due in 2006. TEP recorded expense of
$0.1 million for debt costs that were capitalized and being amortized through
2008. On June 10, 2005, TEP satisfied and discharged the 1941 Mortgage.

     In May 2005, TEP purchased $147 million of its 1997 Pima Series B and $74
million of its 1997 Pima Series C fixed-rate tax-exempt bonds (Repurchased
Bonds) at a price of $101.50 per $100 principal amount and redeemed at par the
remaining $4 million of bonds outstanding under those series. TEP does not
currently plan on canceling the Repurchased Bonds which will remain outstanding
under their respective indentures; however, the Repurchased Bonds will not be
presented in our financial statements. TEP recognized a loss of approximately $3
million on the Repurchased Bonds associated with the generation portion of its
business. In addition, TEP capitalized approximately $3 million of costs for
Repurchased Bonds associated with its regulated operations and will amortize the
cost over the remaining life of the bonds. TEP may choose to cancel or resell
the Repurchased Bonds to third parties in the future.

     As a result of the capital contribution, inter-company note repayment and
the bond purchases and redemptions, TEP's ratio of equity to total
capitalization (excluding capital leases) improved to 40.6% as of June 30, 2005,
which meets an ACC requirement and allows TEP to dividend up to 100% of its
current year net income to UniSource Energy. Management believes it will be able
to maintain a 40% ratio of equity to total capitalization (excluding capital
leases) through the remainder of 2005.

     TEP CREDIT AGREEMENT

     In May 2005, TEP entered into a new $401 million Credit Agreement (TEP
Credit Agreement) to replace its previous $401 million credit agreement. The TEP
Credit Agreement includes a $60 million revolving credit facility and a $341
million letter of credit facility to support $329 million of tax-exempt variable
rate bonds. The TEP Credit Agreement expires May 4, 2010 and is secured by $401
million of Mortgage Bonds.

     The TEP Credit Agreement restricts additional indebtedness, liens, sale of
assets and sale-leasebacks agreements. The TEP Credit Agreement also requires
TEP to meet a minimum cash coverage ratio and a maximum leverage ratio. If TEP
complies with the terms of the TEP Credit Agreement, TEP may pay dividends to
UniSource Energy. Certain regulatory actions may cause a decrease in the amount
that may be borrowed. As of June 30, 2005, TEP was in compliance with the terms
of the TEP Credit Agreement.

     If an event of default occurs, the TEP Credit Agreement may become
immediately due and payable. An event of default includes failure to make
required payments under the TEP Credit Agreement; change in control, as defined;
failure of TEP or certain subsidiaries to make payments or default on debt
greater than $20 million; or certain bankruptcy events at TEP or certain
subsidiaries.

     Interest rates and fees under the TEP Credit Agreement are based on a
pricing grid tied to TEP's credit ratings. Letter of credit fees are 0.875% per
annum and amounts drawn under a letter of credit would bear interest at LIBOR


                                       16
<PAGE>


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

plus 0.875% per annum. TEP pays interest on borrowings under the revolving
credit facility at LIBOR plus 0.875% or at the agent bank's reference rate. TEP
also pays a commitment fee of 0.20% on the unused portion of the revolving
credit facility. In May 2005, TEP expensed $3 million for debt costs related to
the previous credit agreement that were capitalized and being amortized through
2009. Fees of $5 million associated with the TEP Credit Agreement are being
amortized through May 2010.

     As of June 30, 2005, TEP had $40 million outstanding under the revolving
credit facility component of the TEP Credit Agreement at an interest rate of
4.9%. TEP repaid $30 million of these amounts in July 2005.

   UNS GAS/UNS ELECTRIC REVOLVER

     In April 2005, UNS Gas and UNS Electric entered into a $40 million
three-year unsecured revolving credit agreement due April 15, 2008 with a group
of lenders (the UNS Gas/UNS Electric Revolver). Either borrower may borrow up to
a maximum of $30 million; however, the total combined amount borrowed cannot
exceed $40 million.

     UNS Gas is only liable for UNS Gas' borrowings, and similarly, UNS Electric
is only liable for UNS Electric's borrowings under the UNS Gas/UNS Electric
Revolver. UES guarantees the obligations of both UNS Gas and UNS Electric.

     The borrowers pay interest at LIBOR plus 1.50% or at the agent bank's
reference rate plus 0.50%. UNS Gas and UNS Electric also pay a commitment fee of
0.45% on the unused portion of the revolving credit facility.

     The UNS Gas/UNS Electric Revolver contains restrictions on additional
indebtedness, liens, mergers and sales of assets. The UNS Gas/UNS Electric
Revolver also contains a maximum leverage ratio and a minimum cash flow to
interest coverage ratio for each borrower. As of June 30, 2005, UNS Gas and UNS
Electric were each in compliance with the terms of the UNS Gas/UNS Electric
Revolver.

     If an event of default occurs, the UNS Gas/UNS Electric Revolver may become
immediately due and payable. An event of default includes failure to make
required payments under the UNS Gas/UNS Electric Revolver; certain change in
control transactions, certain bankruptcy events of UNS Gas or UNS Electric, or
failure of UES, UNS Gas or UNS Electric to make payments or default on debt
greater than $4 million.

     As of June 30, 2005, UNS Gas and UNS Electric had no borrowings outstanding
under the UNS Gas/UNS Electric Revolver.


NOTE 4. BUSINESS SEGMENTS
--------------------------

     Based on the way we organize our operations and evaluate performance, we
have four reportable segments:

     (1)  TEP, a vertically integrated electric utility business, is UniSource
          Energy's largest subsidiary.
     (2)  UNS Gas is a regulated gas distribution utility business.
     (3)  UNS Electric is a regulated electric distribution utility business.
     (4)  Global Solar, a developer and manufacturer of light-weight thin-film
          photovoltaic cells and panels, is the largest investment held by
          Millennium.

     The UniSource Energy, UES and Millennium holding companies, UED, and
several other subsidiaries and equity investments, which are not considered
reportable segments, are included in All Other. Through affiliates, Millennium
holds investments in several unregulated energy and emerging technology
companies. UED, a wholly-owned subsidiary of UniSource Energy, developed
generating resources and performed other project development activities,
including the expansion of the Springerville Generating Station.

     Significant reconciling adjustments consist of the elimination of
inter-company activity and balances. Other Millennium subsidiaries recorded
revenue from transactions with TEP of $3 million and $6 million during the
three-month and six-month periods ended June 30, 2005 and $6 million and $8
million during the three-month and six-month periods ended June 30, 2004. TEP's
related expense is reported in Other Operations and Maintenance expense on its
income statement. Millennium's revenue and TEP's related expense are eliminated
in UniSource Energy consolidation. Other significant reconciling adjustments
include the elimination of investments in subsidiaries held by UniSource Energy,
the inter-company note between UniSource Energy and TEP, the related interest


                                       17
<PAGE>


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

income and expense on the note and reclassifications of deferred tax assets and
liabilities. The inter-company note between UniSource Energy and TEP was repaid
on March 1, 2005. See Note 3.

     We disclose selected financial data for our reportable segments in the
following table:


<TABLE>
<CAPTION>
                                                        REPORTABLE SEGMENTS
                                              -----------------------------------------                                UNISOURCE
                                                            UNS        UNS     GLOBAL       ALL       RECONCILING        ENERGY
                                                 TEP        GAS     ELECTRIC    SOLAR      OTHER      ADJUSTMENTS     CONSOLIDATED
--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------
INCOME STATEMENT                                                              -Millions of Dollars-
----------------
<S>                                            <C>        <C>       <C>         <C>      <C>            <C>            <C>
THREE MONTHS ENDED JUNE 30, 2005:
   Operating Revenues - External               $   236    $   27    $    37     $   1    $     -        $     -        $     301
   Operating Revenues - Intersegment                 1         -          -         -          3             (4)               -
   Income (Loss) Before Income Taxes                21         -          2        (3)        (3)             -               17
   Net Income (Loss)                                12         -          1        (2)        (2)             -                9
--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------

--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------
THREE MONTHS ENDED JUNE 30, 2004:
   Operating Revenues - External               $   234    $   21    $    35     $   -    $     -        $     -        $     290
   Operating Revenues - Intersegment                 -         -          -         2          4             (6)               -
   Income (Loss) Before Income Taxes                33        (2)         3        (2)        (8)             -               24
   Net Income (Loss)                                18        (1)         1        (1)        (4)             -               13
--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------

--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------
SIX MONTHS ENDED JUNE 30, 2005:
   Operating Revenues - External               $   418    $   74    $    68     $   2    $     -        $     -        $     562
   Operating Revenues - Intersegment                 1         -          -         -          6             (7)               -
   Income (Loss) Before Income Taxes                14         7          2        (5)        (7)             -               11
   Net Income (Loss)                                 7         4          1        (3)        (3)             -                6
--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------

--------------------------------------------- ---------- --------- ----------- -------- ------------ -------------- ----------------
SIX MONTHS ENDED JUNE 30, 2004:
   Operating Revenues - External               $   420    $   70    $    67     $   1    $     2        $     -        $     560
   Operating Revenues - Intersegment                 1         -          -         2          6             (9)               -
   Income (Loss) Before Income Taxes                36         6          3        (4)        (4)             -               37
   Net Income (Loss)                                19         3          2        (2)        (3)             -               19
--------------------------------------------- --------- ---------- ---------- -------- ------------ --------------- --------------

--------------------------------------------- --------- ---------- ---------- -------- ------------ --------------- --------------
BALANCE SHEET
   Total Assets, June 30, 2005                 $ 2,592    $  199    $   145     $  21    $   950        $  (848)       $   3,059
   Total Assets, December 31, 2004               2,742       201        135        21        930           (853)           3,176
--------------------------------------------- --------- ---------- ---------- -------- ------------ --------------- --------------

</TABLE>


NOTE 5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND TRADING ACTIVITIES
--------------------------------------------------------------------

     TEP enters into forward contracts to purchase or sell a specified amount of
capacity or energy at a specified price over a given period of time, typically
for one month, three months, or one year, within established limits to take
advantage of favorable market opportunities. In general, TEP enters into forward
purchase contracts when market conditions provide the opportunity to purchase
energy for its load at prices that are below the marginal cost of its supply
resources or to supplement its own resources (e.g., during plant outages and
summer peaking periods). TEP enters into forward sales contracts when it
forecasts that it has excess supply and the market price of energy exceeds its
marginal cost. The majority of TEP's forward contracts are considered to be
normal purchases and sales and, therefore, are not required to be marked to
market. However, some of the forward contracts are considered to be derivatives,
which TEP marks to market by recording unrealized gains and losses and adjusting
the related assets and liabilities on a monthly basis to reflect the market
prices at the end of the month.

     TEP has a natural gas supply agreement under which it purchases all of its
gas requirements at spot market prices from Southwest Gas Corporation (SWG). TEP
also has agreements to purchase power that are priced using spot market gas
prices. These contracts meet the definition of normal purchases and are not
required to be marked to market. During 2004 and early 2005, in an effort to
minimize price risk on these purchases, TEP entered into commodity price swap
agreements under which TEP purchases gas at fixed prices and simultaneously
sells gas at spot market prices. The spot market price in the swap agreements is
tied to the same index as the purchases under the SWG and purchased power
contracts. These swap agreements, which expire during the summer months through


                                       18
<PAGE>


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

2007, were entered into with the goal of locking in fixed prices on at least 45%
and not more than 80% of TEP's expected summer monthly gas risk prior to
entering into the month. TEP's swap agreements are derivatives required to be
marked to market on a monthly basis; however, since the agreements satisfy the
requirements for cash flow hedge accounting, the unrealized gains and losses are
recorded in Other Comprehensive Income, a component of Common Stock Equity,
rather than being reflected in the income statement. As the gains and losses on
these cash flow hedges are realized, a reclassification adjustment is recorded
in Other Comprehensive Income for realized gains and losses that are included in
Net Income.

     TEP manages the risk of counterparty default by performing financial credit
reviews, setting limits, monitoring exposures, requiring collateral when needed,
and using a standardized agreement which allows for the netting of current
period exposures to and from a single counterparty.

     UNS Gas has a natural gas supply agreement under which it purchases
substantially all of its gas requirements at market prices from BP Energy
Company (BP). However, the contract allows UNS Gas to lock in fixed prices on a
portion of its gas purchases by entering into fixed price forward contracts with
BP at various times during the year. This enables UNS Gas to provide more stable
prices to its customers. These purchases are made up to three years in advance
with the goal of locking in fixed prices on at least 45% and not more than 80%
of expected monthly gas consumption. These forward contracts, as well as the
main gas supply contract, meet the definition of normal purchases and therefore
are not required to be marked to market.

     UNS Electric does not currently have any contracts that are required to be
marked to market.

     Millennium Environmental Group, Inc. (MEG), a wholly-owned subsidiary of
Millennium, enters into swap agreements, options and forward contracts relating
to Emissions Allowances and coal. MEG marks its trading contracts to market by
recording unrealized gains and losses and adjusting the related assets and
liabilities on a monthly basis to reflect the market prices at the end of the
month.

     MEG is in the process of winding down its activities and will not engage in
any new activities after 2005.

     The market prices used to determine fair values for TEP and MEG's
derivative instruments are estimated based on various factors including broker
quotes, exchange prices, over the counter prices and time value.

     TEP and MEG's derivative activities are reported as follows:

<TABLE>
<CAPTION>
                                                                      INCOME STATEMENT LINE
                                             ------------------------------------------------------------------------
                                                      NET UNREALIZED GAINS                  NET REALIZED GAINS
                                                          AND LOSSES                           AND LOSSES
-------------------------------------------- -------------------------------------- ---------------------------------
<S>                                          <C>                                    <C>
TEP Forward Sales Contracts                  Electric Wholesale Sales               Electric Wholesale Sales
TEP Forward Purchase Contracts               Purchased Power                        Purchased Power
TEP Commodity Price Swaps                    Other Comprehensive Income             Fuel Expense
                                             (Balance Sheet)
MEG Trading Activities                       Other Operating Revenues               Other Operating Revenues
-------------------------------------------- -------------------------------------- ---------------------------------

</TABLE>

     Although MEG's realized gains and losses on trading activities are reported
net on UniSource Energy's income statement, the related cash receipts and cash
payments are reported separately on UniSource Energy's statement of cash flows.

     The net pre-tax gains and losses from TEP and MEG's derivative activities
for the three months ended and six months ended June 30, 2005 and 2004, were as
follows:


                                       19
<PAGE>


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

<TABLE>
<CAPTION>
                                                                                     Three Months Ended
                                                                                          June 30,
                                                                             -----------------------------------
                                                                                   2005              2004
---------------------------------------------------------------------------- ------------------ ----------------
                                                                                   -Millions of Dollars-
TEP:
<S>                                                                               <C>               <C>
   Net Unrealized Loss on Forward Purchase Contracts                              $  (1)            $   -
   Net Unrealized Loss on Commodity Price Swaps                                      (1)                1
   Net Realized Gain on Commodity Price Swaps                                         1                 -
MEG:
   Net Loss from Trading Activities                                                  (1)                -
---------------------------------------------------------------------------- ------------------ ----------------

</TABLE>

<TABLE>
<CAPTION>
                                                                                      Six Months Ended
                                                                                          June 30,
                                                                             -----------------------------------
                                                                                   2005              2004
---------------------------------------------------------------------------- ------------------ ----------------
                                                                                   -Millions of Dollars-
TEP:
<S>                                                                               <C>               <C>
   Net Unrealized (Loss) Gain on Forward Sales Contracts                          $  (1)            $   1
   Net Unrealized Gain on Commodity Price Swaps                                       4                 2
   Net Realized Gain on Commodity Price Swaps                                         1                 -
MEG:
   Net Loss from Trading Activities                                                  (1)                -
---------------------------------------------------------------------------- ------------------ ----------------

</TABLE>

     TEP and MEG's derivative assets and liabilities are reported as follows:

<TABLE>
<CAPTION>
                                                                                      BALANCE SHEET LINE
                                                                     -----------------------------------------------------
                                                                              ASSETS                  LIABILITIES
-------------------------------------------------------------------- ------------------------- ---------------------------
<S>                                                                  <C>                       <C>
TEP - Current                                                        Other Current Assets      Other Current Liabilities
TEP - Noncurrent                                                     Other Assets              Other Liabilities
MEG - Current (including Emissions Allowance Inventory)              Trading Assets            Trading Liabilities
MEG - Noncurrent                                                     Other Assets              Other Liabilities
-------------------------------------------------------------------- ------------------------- ---------------------------
</TABLE>


     The fair value of TEP and MEG's derivative assets and liabilities were as
follows:

<TABLE>
<CAPTION>
                                                                         June 30,              December 31,
                                                                           2005                    2004
----------------------------------------------------------------- ----------------------- ------------------------
                                                                               -Millions of Dollars-
TEP:
<S>                                                                      <C>                    <C>
   Derivative Assets - Current                                           $   3                  $   2
   Derivative Assets - Noncurrent                                            4                      1
MEG:
   Trading Assets - Current                                                 12                     71
   Trading Assets - Noncurrent                                               6                      6
   Trading Liabilities - Current                                           (14)                   (65)
----------------------------------------------------------------- ----------------------- ------------------------

</TABLE>
     The settlement of forward purchase and sales contracts that do not result
in physical delivery are recorded net as a component of Electric Wholesale Sales
in TEP's income statement. For the three months ended June 30, 2005, $4 million
in sales were netted against $4 million in purchases. For the six months ended
June 30, 2005, $9 million in sales were netted against $8 million in purchases
and for the six months ended June 30, 2004, $2 million in sales were netted
against $2 million in purchases.


                                       20
<PAGE>


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

NOTE 6. COMMITMENTS AND CONTINGENCIES
-------------------------------------

   TEP CONTINGENCIES

     LITIGATION AND CLAIMS RELATED TO SAN JUAN GENERATING STATION

     Public Service Company of New Mexico (PNM), operator of San Juan, and the
coal supplier to San Juan have been participating in sessions sponsored by the
Environmental Protection Agency (EPA) to consider rulemaking for the disposal of
coal combustion products due to claims by third parties that San Juan has
contaminated water resources in the region as a result of disposing of fly ash
in the surface mine pits adjacent to the generating station. In November 2004, a
contractor for the EPA released a non-binding preliminary determination that any
contamination at San Juan cannot be conclusively attributed to the disposal of
fly ash; however, the EPA has not made a final determination. TEP owns 50% of
San Juan Units 1 and 2, which equates to 19.8% of the total San Juan Generating
Station. TEP does not believe that this issue will have a material adverse
impact on TEP or its operations.

     LITIGATION AND CLAIMS RELATED TO NAVAJO GENERATING STATION

     On October 15, 2004, Peabody Western Coal Company (Peabody), the coal
supplier to the Navajo Generating Station, filed a complaint in the Circuit
Court for the City of St. Louis, Missouri against the participants at Navajo,
including TEP, for reimbursement of royalties and other costs and breach of the
coal supply agreement. The case was removed to Federal District Court Eastern
District of Missouri on February 10, 2005. Peabody subsequently filed a motion
to remand to superior court. Because TEP owns 7.5% of the Navajo Generating
Station, its share of the current claimed damages would be approximately $35
million. TEP believes these claims are without merit and intends to continue to
contest them.

     POSTRETIREMENT AND PENSION BENEFIT COSTS AT NAVAJO GENERATING STATION

     In 1996, Peabody filed a lawsuit in Maricopa County Superior Court against
the participants at Navajo Generating Station, including TEP, for postretirement
benefit costs payable to the coal supplier's employees under the coal supply
agreements. The Navajo participants and Peabody have agreed to stay the
discovery process in this litigation until August 31, 2005 to allow the parties
additional time to negotiate a potential settlement. To the extent that amounts
become estimable and payment probable, TEP will record a liability for
additional postretirement benefit costs at the Navajo Generating Station. TEP
does not expect any settlement to be material to TEP.

     TEP has previously settled claims for postretirement benefit costs with the
coal suppliers at Springerville Generating Station and Four Corners Generating
Station. The cost of postretirement benefits is included in the cost of coal to
San Juan.

     ENVIRONMENTAL RECLAMATION AT REMOTE GENERATING STATIONS

     TEP currently pays on-going reclamation costs related to the coal mines
which supply the remote generating stations, and it is probable that TEP will
have to pay a portion of final reclamation costs upon mine closure. When a
reasonable estimate of final reclamation costs is available, the liability is
recognized as a cost of coal over the remaining term of the respective coal
supply agreement. TEP estimates its undiscounted final reclamation liability to
be $42 million, and the present value of TEP's liability for final reclamation
approximates $12 million at the expiration dates of the coal supply agreements.
At June 30, 2005 and December 31, 2004, TEP had recorded $1 million of its
post-term reclamation liability, which is included in Other Liabilities in the
balance sheets.

     Amounts recorded for final reclamation are subject to various assumptions
and determinations, such as estimating the costs of reclamation, estimating when
final reclamation will occur, and the credit-adjusted risk-free interest rate to
be used to discount future liabilities. Changes that may arise over time with
regard to these assumptions and determinations will change amounts recorded in
the future as expense for post-term reclamation. TEP does not believe that
recognition of its final reclamation obligations will be material to TEP in any
single year since recognition occurs over the remaining lives of its coal supply
agreements.


                                       21
<PAGE>


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

   RESOLUTION OF SPRINGERVILLE GENERATING STATION COMPLAINT

     Environmental activist groups have expressed concerns regarding the
construction of any new units at the Springerville Generating Station. In
January 2003, environmental activist groups appealed an ACC Order affirming the
ACC's approval of the expansion at the Springerville Generating Station to the
Superior Court of the State of Arizona. On October 22, 2003, the Superior Court
affirmed the ACC's issuance of the Certificate of Environmental Compatibility
for Springerville Generating Station. The environmental activist groups appealed
the Superior Court decision on December 30, 2003 and filed an amended notice of
appeal on January 2, 2004 with the Arizona Court of Appeals. In February 2005,
the Arizona Court of Appeals upheld the lower court's ruling affirming the ACC's
approval of the expansion at Springerville Generating Station. In February 2005,
the Grand Canyon Trust (GCT), one of the environmental activist groups with this
appeal, and TEP reached a settlement under which the GCT will drop all claims
against TEP regarding Springerville Generating Station. TEP will implement new
emission limits at Units 1 and 2 by January 1, 2006. The Supreme Court of
Arizona denied the other environmental activist group's petition for review on
June 28, 2005.

   MILLENNIUM CONTINGENCY - NATIONS ENERGY

     In September 2001, Nations Energy Corporation (Nations Energy) sold its
equity interest in a power project to a subsidiary of Mirant Corporation
(Mirant). Nations Energy received $5 million in cash and an $11 million note
receivable from Mirant. The note was recorded at its net present value of $8
million. As of June 30, 2005, Nations Energy's receivable from Mirant is
approximately $9 million. The first payment of $2 million on the receivable was
received in June 2004 and the second payment of $4 million was received in July
2005. The remaining payment of $5 million is expected to be received in July
2006. Nations Energy expects to collect the note in its entirety.

   MILLENNIUM COMMITMENT

      In April 2005, Millennium committed to fund $3 million to Battco, Inc., a
company formed to carry on the business of IPS.

   GUARANTEES AND INDEMNITIES

     In the normal course of business, UniSource Energy and certain subsidiaries
enter into various agreements providing financial or performance assurance to
third parties on behalf of certain subsidiaries. We enter into these agreements
primarily to support or enhance the creditworthiness of a subsidiary on a
stand-alone basis. The most significant of these guarantees are:

         o    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,
         o    UES' guarantee of a $40 million unsecured revolving credit
              agreement for UNS Gas and UNS Electric,
         o    UniSource Energy's guarantee of approximately $8 million in
              natural gas transportation and supply payments in addition to
              building and equipment lease payments for UNS Gas, UNS Electric,
              and subsidiaries of Millennium, and
         o    Millennium's guarantee of approximately $3 million in
              commodity-related payments for MEG and building lease payments
              for a subsidiary.

     In addition, UniSource Energy and its subsidiaries have indemnified the
purchasers of interests in certain investments from additional taxes due for
years prior to the sale of such investments. The terms of the indemnifications
provide for no limitation on potential future payments; however, we believe that
we have abided by all tax laws and paid all tax obligations. We have not made
any payments under the terms of these indemnifications to date.

     We believe that the likelihood UniSource Energy, UES, or Millennium would
be required to perform or otherwise incur any significant losses associated with
any of these guarantees or indemnities is remote.


                                       22
<PAGE>


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

NOTE 7. TEP WHOLESALE ACCOUNTS RECEIVABLE AND ALLOWANCES
--------------------------------------------------------

     TEP's Accounts Receivable from Electric Wholesale Sales, included in Trade
Accounts Receivable on the balance sheet, totaled $21 million at June 30, 2005
and $22 million at December 31, 2004, net of allowances. TEP's Allowance for
Doubtful Accounts on the balance sheet includes $13 million at June 30, 2005 and
$13 million at December 31, 2004 related to sales to the California Power
Exchange (CPX) and the California Independent System Operator (CISO) in 2001 and
2000. Excluding the receivables from the CPX and the CISO, substantially all of
the June 30, 2005 and the December 31, 2004 wholesale receivable balances have
been collected as of the date of this filing.

     In May 2004, the FERC issued two separate orders addressing numerous issues
in the refund calculation and the fuel cost allowance calculation (an offset to
the refund obligation). Based on these new orders, TEP increased its reserve for
sales to the CPX and the CISO by $3 million by recording a reduction of
wholesale revenues.

     There are several other outstanding legal issues, complaints and lawsuits
concerning the California energy crisis related to the FERC, wholesale power
suppliers, Southern California Edison Company, Pacific Gas and Electric Company,
the CPX and the CISO. We cannot predict the outcome of these issues or lawsuits.
We believe, however, that TEP is adequately reserved for its transactions with
the CPX and the CISO.

NOTE 8. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
-------------------------------------------------

     Basic EPS is computed by dividing net income (loss) by the weighted average
number of common shares outstanding during the period. Except when the effect
would be anti-dilutive, the diluted EPS calculation includes the impact of
shares that could be issued upon exercise of outstanding stock options,
contingently issuable shares under equity-based awards or common shares that
would result from the conversion of convertible notes. The numerator in
calculating diluted earnings per share is net income (loss) adjusted for the
interest on convertible notes (net of tax) that would not be paid if the notes
were converted to common shares.

     The following table shows the effects of potential dilutive common stock on
the weighted average number of shares:

<TABLE>
<CAPTION>
                                                                          Three Months Ended         Six Months Ended
                                                                               June 30,                  June 30,
                                                                           2005         2004        2005         2004
---------------------------------------------------------------------- ------------ ------------ ------------ ------------
                                                                           - In Thousands -          - In Thousands -
Denominator:
<S>                                                                      <C>            <C>         <C>          <C>
 Weighted-average Shares of Common Stock Outstanding                     34,807         34,392      34,721       34,288
 Effect of Dilutive Securities:
  Convertible Senior Notes                                                 4,000             -           -            -
  Options and Stock Issuable under Employee Benefit Plans
     and the Directors' Plan                                                  698          663         722          683
---------------------------------------------------------------------- ------------ ------------ ------------ ------------
Total Shares                                                             39,505         35,055     35,443        34,971
====================================================================== ============ ============ ============ ============

</TABLE>

     Dilutive shares for the six months ended June 30, 2005 exclude 3,063
average incremental common shares related to options, contingently issuable
shares and Convertible Senior Notes because they are antidilutive.


NOTE 9. EMPLOYEE BENEFITS PLANS
-------------------------------

   PENSION BENEFIT PLANS

     TEP, UNS Gas and UNS Electric maintain noncontributory, defined benefit
pension plans for substantially all regular employees and certain affiliate
employees. Benefits are based on years of service and the employee's average
compensation. TEP, UNS Gas and UNS Electric fund the plans by contributing at
least the minimum amount required under Internal Revenue Service regulations.
Additionally, we provide supplemental retirement benefits to certain employees
whose benefits are limited by Internal Revenue Service benefit or compensation
limitations.


                                       23
<PAGE>


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

OTHER POSTRETIREMENT BENEFIT PLANS

     TEP provides limited health care and life insurance benefits for retirees.
All regular employees may become eligible for these benefits if they reach
retirement age while working for TEP or an affiliate. UNS Gas and UNS Electric
provide postretirement medical benefits for current retirees and a small group
of active employees. The majority of UNS Gas and UNS Electric employees do not
participate in the postretirement medical plan.

     The ACC allows TEP, UNS Gas and UNS Electric to recover postretirement
costs through rates only as benefit payments are made to or on behalf of
retirees. The postretirement benefits are currently funded entirely on a
pay-as-you-go basis. Under current accounting guidance, TEP, UNS Gas and UNS
Electric cannot record a regulatory asset for the excess of expense calculated
per Statement of Financial Accounting Standards No. 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions, over actual benefit payments.

   COMPONENTS OF NET PERIODIC BENEFIT COST

     The components of net periodic benefit costs are as follows:

<TABLE>
<CAPTION>
                                                                                 OTHER POSTRETIREMENT
                                                         PENSION BENEFITS              BENEFITS
                                                    -----------------------------------------------------
                                                        Three Months Ended        Three Months Ended
                                                             June 30,                  June 30,
                                                         2005         2004         2005         2004
---------------------------------------------------------------------------------------------------------
                                                                    -Millions of Dollars -

COMPONENTS OF NET PERIODIC BENEFIT COST
<S>                                                    <C>          <C>          <C>          <C>
   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 (Gain) Loss                           1            -           -             -
---------------------------------------------------------------------------------------------------------
      NET PERIODIC BENEFIT COST                        $      3     $      2     $     2      $      2
=========================================================================================================

</TABLE>

<TABLE>
<CAPTION>
                                                                                 OTHER POSTRETIREMENT
                                                         PENSION BENEFITS              BENEFITS
                                                    -----------------------------------------------------
                                                         Six Months Ended          Six Months Ended
                                                             June 30,                  June 30,
                                                         2005         2004        2005          2004
---------------------------------------------------------------------------------------------------------
                                                                   -Millions of Dollars -

COMPONENTS OF NET PERIODIC BENEFIT COST
<S>                                                    <C>          <C>          <C>          <C>
   Service Cost                                        $      3     $      3     $     1      $      1
   Interest Cost                                              6            5           2             2
   Expected Return on Plan Assets                            (6)          (5)          -             -
   Prior Service Cost Amortization                            1            1          (1)           (1)
   Recognized Actuarial (Gain) Loss                           2            -           1             1
---------------------------------------------------------------------------------------------------------
      NET PERIODIC BENEFIT COST                        $      6     $      4     $     3      $      3
=========================================================================================================

</TABLE>


                                       24
<PAGE>


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

NOTE 10. SHARE-BASED COMPENSATION PLANS
---------------------------------------

     UniSource Energy has issued equity-based compensation awards under the
Directors' Plan and the Omnibus Plan. After February 4, 2004, no new awards can
be granted under the Omnibus Plan. Effective January 1, 2005, we adopted the
accounting for our share-based plans. Prior to January 1, 2005, we accounted for
those plans under the recognition and measurement principles of APB 25. See Note
1.

     At June 30, 2004, we had stock options, stock units and restricted stock
grants outstanding as discussed below.

   STOCK OPTIONS

     There were no stock options granted during the six months ended June 30,
2005 and June 30, 2004. Director stock option awards granted in 2003 vest over
three years, become exercisable in one-third increments on each anniversary date
of the grant and expire on the tenth anniversary of the grant.

     A summary of the stock option activity of the Directors' Plan and Omnibus
Plan is as follows:

<TABLE>
<CAPTION>
                                                          Six Months Ended June 30,
                                                    2005                              2004
--------------------------------------------------------------------------------------------------------
                                                          WEIGHTED                          Weighted
                                                           AVERAGE                          Average
                                                          EXERCISE                          Exercise
                                           SHARES           PRICE            Shares          Price
--------------------------------------------------------------------------------------------------------
Options Outstanding,
<S>                                       <C>               <C>              <C>             <C>
  Beginning of Period                     2,076,055         $ 16.19          2,478,551       $  16.04
   Granted                                        -               -                  -             -
   Exercised                               (366,409)        $ 16.12           (360,166)      $  15.12
   Forfeited                                 (7,198)        $ 18.08             (2,613)      $  13.86
                                      -----------------                  ----------------
Options Outstanding,
  End of Period                           1,702,448         $16.20           2,115,772       $  16.20
                                      =================                  ================
Options Exercisable,
  End of Period                           1,694,976         $16.19           2,092,169       $  16.18

Weighted Average Remaining Contractual Life at June 30, 2005:                            5.24 years
--------------------------------------------------------------------------------------------------------

</TABLE>

     Stock options awarded on January 1, 2002 accrue dividend equivalents that
are paid in cash on the earlier of the date of exercise of the underlying option
or the date the option expires. Compensation expense is recognized as dividends
are declared. We recorded compensation expense of less than $0.2 million for
each of the three and six-month periods ended June 30, 2005 and 2004.

   RESTRICTED STOCK AND STOCK UNITS

     There were no restricted stock awards granted during each of the three
months ended June 30, 2005 and 2004. For the three months ended March 31, 2005
and 2004, we granted restricted stock awards to directors totaling 6,528 shares
and 6,480 shares, respectively. The grant date fair value of the shares was
$24.51 per share in 2005 and $24.68 per share in 2004. Directors may elect to
receive stock units in lieu of restricted shares. The restricted shares or stock
units become 100% vested on the third anniversary of the grant date.
Compensation expense equal to the fair market value on the date of the award is
recognized over the vesting period. We recorded compensation expense of less
than $0.1 million for each of the three and six-month periods ended June 30,
2005 and 2004.

     There were no new stock unit awards granted under the Omnibus Plan during
each of the six months ended June 30, 2005 and 2004. All stock unit awards
previously issued under the Omnibus Plan had fully vested as of March 6, 2004.
We recognized compensation expense related to earlier awards of less than $0.1
million in the first quarter of 2004.


                                       25
<PAGE>


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

     Fully vested but undistributed stock unit awards accrue dividend equivalent
stock units based on the fair market value of common shares on the date the
dividend is paid. Compensation expense is recognized when dividends are
declared. We recorded compensation expense of less than $0.1 million for each of
the three and six-month periods ended June 30, 2005 and 2004.

   PERFORMANCE SHARES

     In May 2003, the Board of Directors approved a grant of performance shares
to key employees under the Omnibus Plan. The shares were to be awarded at the
end of a three-year performance period based on goal attainment. The grant date
fair value was $17.84 per share. Compensation expense was initially recorded
over the performance period based on the anticipated number and market value of
shares to be awarded. As a result of the shareholder vote to approve the
proposed merger, 53,566 performance shares vested and were distributed in March,
2004. See the 2004 Annual Report on Form 10-K, Note 17 of Notes to Consolidated
Financial Statements - Stock-Based Compensation Plans. Compensation expense of
$2 million was recorded for the three months ended March 31, 2004, for this
award.

NOTE 11. INCOME AND OTHER TAXES
--------------------------------

   INCOME TAXES

     The differences between the income tax expense and the amount obtained by
multiplying pre-tax income by the U.S. statutory federal income tax rate of 35%
are as follows:

<TABLE>
<CAPTION>
                                                                                  UNISOURCE ENERGY
                                                             ------------------------------------------------------------
                                                                 Three Months Ended              Six Months Ended
                                                                      June 30,                       June 30,
                                                                 2005          2004            2005            2004
-------------------------------------------------------------------------------------------------------------------------
                                                                             -Thousands of Dollars -

<S>                                                             <C>          <C>             <C>             <C>
FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE                    $  5,826     $    8,560      $    3,968      $   12,875
   State Income Tax Expense, Net of Federal Deduction                766          1,125             522           1,692
   Depreciation Differences (Flow Through Basis)                     736            789           1,416           1,578
   Tax Credits                                                      (130)          (129)           (261)           (258)
   Other                                                             (20)         1,310               7           1,677
-------------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL AND STATE INCOME TAX EXPENSE                      $  7,178     $   11,655      $    5,652      $   17,564
=========================================================================================================================

</TABLE>

<TABLE>
<CAPTION>
                                                                                         TEP
                                                             ------------------------------------------------------------
                                                                 Three Months Ended              Six Months Ended
                                                                      June 30,                       June 30,
                                                                 2005          2004            2005            2004
-------------------------------------------------------------------------------------------------------------------------
                                                                             -Thousands of Dollars -

<S>                                                             <C>          <C>             <C>             <C>
FEDERAL INCOME TAX EXPENSE AT STATUTORY RATE                    $  7,385     $   11,500      $    4,986      $   12,504
   State Income Tax Expense, Net of Federal Deduction                971          1,511             655           1,643
   Depreciation Differences (Flow Through Basis)                     736            789           1,416           1,578
   Tax Credits                                                      (130)          (129)           (261)           (258)
   Other                                                             (11)         1,170              (7)          1,448
-------------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL AND STATE INCOME TAX EXPENSE                      $  8,951     $   14,841      $    6,789      $   16,915
=========================================================================================================================

</TABLE>

     The total Federal and State Income Tax Expense in the table above is
included in UniSource Energy and TEP's income statements.


                                       26
<PAGE>


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

   OTHER TAXES

     TEP, UNS Gas and UNS Electric act as conduits or collection agents for
excise tax (sales tax) as well as franchise fees and regulatory assessments.
They record liabilities payable to governmental agencies when they bill their
customers for these amounts. Neither the amounts billed nor payable are
reflected in the income statement.


NOTE 12. NEW ACCOUNTING PRONOUNCEMENTS
--------------------------------------

     The FASB recently issued the following Statements of Financial Accounting
Standards (FAS), FASB Interpretations (FIN), and FASB Staff Positions (FSP):

     o    FIN 47, Accounting for Conditional Asset Retirement Obligations,
          issued March 2005, provides guidance for a legal obligation to perform
          an asset retirement activity in which the timing and (or) method of
          settlement are conditional on a future event that may or may not be
          within the control of the entity. The obligation to perform the asset
          retirement activity is unconditional even though uncertainty exists
          about the timing and (or) method of settlement. FIN 47 requires a
          liability be recognized for the fair value of a conditional asset
          retirement obligation if the fair value can be reasonably estimated.
          FIN 47 is required to be applied by December 31, 2005. We are
          evaluating the impact on our financial position and results of
          operations of the adoption of FIN 47.

     o    FSP FIN 46(R)-5, Implicit Variable Interests under FASB Interpretation
          No. 46 (revised December 2003), Consolidation of Variable Interest
          Entities, issued March 2005, addresses whether a reporting enterprise
          should consider whether it holds an implicit variable interest in a
          variable interest entity (VIE) or potential VIE when specific
          conditions exist. The guidance in FSP FIN 46(R)-5 was effective April
          1, 2005, and did not have a significant impact on our financial
          statements.

     o    FAS 151, Inventory Costs, issued November 2004, is an amendment of
          Accounting Research Bulletin (ARB) No. 43, Chapter 4, Inventory
          Pricing. FAS 151 clarifies that abnormal amounts of idle facility
          expense, freight, handling costs, and wasted materials (spoilage)
          should be recognized as current-period charges. FAS 151 also requires
          the allocation of fixed production overheads to inventory based on the
          normal capacity of the production facilities. FAS 151 is effective for
          inventory costs incurred during fiscal years beginning after June 15,
          2005. The adoption of FAS 151 is not expected to have a significant
          impact on our financial statements.

     o    FAS 153, Exchanges of Nonmonetary Assets, issued December 2004,
          requires nonmonetary exchanges be accounted for at fair value,
          recognizing any gains or losses, if their fair value is determinable
          within reasonable limits and the transaction has commercial substance.
          A nonmonetary exchange has commercial substance if future cash flows
          of the entity are expected to change significantly as a result of the
          exchange. FAS 153 is effective for nonmonetary asset exchange
          transactions occurring in fiscal periods beginning after June 15,
          2005. The adoption of FAS 153 is not expected to have a significant
          impact on our financial statements.

     o    FAS 154, Accounting Changes and Error Corrections, issued May 2005,
          provides guidance on the accounting for and reporting of accounting
          changes and error corrections. FAS 154 requires retrospective
          application to prior periods for a voluntary change in accounting
          principle, unless it is impracticable to do so. FAS 154 also provides
          guidance related to the reporting of a change in accounting estimate,
          a change in reporting entity and the correction of an error. FAS 154
          is effective for accounting changes and corrections of errors made in
          fiscal years beginning after December 15, 2005. The adoption of FAS
          154 is not expected to have a significant impact on our financial
          statements.

     o    FSP FAS 109-1, Application of FASB Statement No. 109, Accounting for
          Income Taxes, to the Tax Deduction on Qualified Production Activities
          Provided by the American Jobs Creation Act of 2004, issued in December
          2004, provides guidance on the application of FAS 109 to the provision
          within the American Jobs Creation Act of 2004 that provides a tax
          deduction, beginning in 2005, on qualified production activities,
          including a company's electric generation activities. Under FSP FAS
          109-1, recognition of the tax deduction on qualified production
          activities is ordinarily reported in the year it is earned. FSP FAS
          109-1 did not have an impact on our financial statements in the first
          six months of 2005. We are evaluating the impact of FSP FAS 109-1 on
          our financial position and results of operations for the remainder of
          the year.

     In June 2004, the EITF published Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides application guidance on impairment of


                                       27
<PAGE>


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

securities accounted for under FAS 115, Accounting for Certain Investments in
Debt and Equity Securities, and cost method investments and requires certain
quantitative and qualitative disclosures for securities that are impaired at the
balance sheet date but for which an other-than-temporary impairment has not been
recognized. The disclosure requirements are effective for reporting periods
ending after December 31, 2003. The FASB issued FSP EITF Issue 03-1-1, Effective
Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments in
September 2004 delaying the effective date of the application guidance on
impairment of securities until the final issuance of FSP EITF Issue 03-1-a. As
of August 4, 2005, a final FSP EITF Issue 03-1-a has not been issued. The
adoption of EITF 03-1 is not expected to have a significant impact on our
financial statements.


NOTE 13. SUPPLEMENTAL CASH FLOW INFORMATION
-------------------------------------------

     A reconciliation of net income to net cash flows from operating activities
follows:

<TABLE>
<CAPTION>
                                                                                        UNISOURCE ENERGY
                                                                                 --------------------------------
                                                                                        Six Months Ended
                                                                                            June 30,
                                                                                      2005             2004
-------------------------------------------------------------------------------- ---------------- ---------------
                                                                                     -Thousands of Dollars-
<S>                                                                                 <C>            <C>
NET INCOME                                                                          $   5,685      $    19,222

ADJUSTMENTS TO RECONCILE NET INCOME
  TO NET CASH FLOWS
     Depreciation and Amortization Expense                                             68,168           71,696
     Depreciation Recorded to Fuel and Other O&M Expense                                2,765            3,098
     Amortization of Transition Recovery Asset                                         23,623           20,600
     Net Unrealized Loss (Gain) on TEP Forward Electric Sales                           1,088             (780)
     Net Unrealized Gain on MEG Trading Activities                                     (7,143)          (1,689)
     Amortization of Deferred Debt-Related Costs included in Interest Expense           2,004            1,660
     Loss on Reacquired Debt                                                            5,427            1,635
     Provision for Bad Debts                                                            1,372            1,734
     Deferred Income Taxes                                                             10,587            3,200
     Loss (Gain) from Equity Method Entities                                              687           (5,418)
     Other                                                                             14,302           17,956
     Changes in Assets and Liabilities which Provided (Used)
       Cash Exclusive of Changes Shown Separately
         Accounts Receivable                                                            3,000          (16,979)
         Materials and Fuel Inventory                                                  (6,257)            (255)
         Accounts Payable                                                             (28,093)           6,037
         Interest Accrued                                                              (3,767)          (2,182)
         Taxes Accrued                                                                (18,447)          15,281
         Other Current Assets                                                          69,515          (39,263)
         Other Current Liabilities                                                    (53,196)          45,683
-------------------------------------------------------------------------------- ---------------- ---------------
NET CASH FLOWS - OPERATING ACTIVITIES                                               $  91,320      $   141,236
================================================================================ ================ ===============

</TABLE>

                                       28
<PAGE>


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

<TABLE>
<CAPTION>
                                                                                               TEP
                                                                                 --------------------------------
                                                                                        Six Months Ended
                                                                                            June 30,
                                                                                      2005             2004
-------------------------------------------------------------------------------- ---------------- ---------------
                                                                                     -Thousands of Dollars-
<S>                                                                                <C>              <C>
NET INCOME                                                                         $     7,458      $   18,811

ADJUSTMENTS TO RECONCILE NET INCOME
  TO NET CASH FLOWS
     Depreciation and Amortization Expense                                              57,954          62,438
     Depreciation Recorded to Fuel and Other O&M Expense                                 3,180           3,098
     Amortization of Transition Recovery Asset                                          23,623          20,600
     Net Unrealized Loss (Gain) on TEP Forward Electric Sales                            1,088            (780)
     Amortization of Deferred Debt-Related Costs included in Interest Expense            1,823           1,506
     Loss on Reacquired Debt                                                             5,427           1,635
     Provision for Bad Debts                                                             1,052             813
     Deferred Income Taxes                                                              10,328           7,686
     Gains from Equity Method Entities                                                     (45)            (62)
     Interest on Note Receivable from UniSource Energy                                  (1,684)         (4,639)
     Other                                                                              11,953          21,361
     Changes in Assets and Liabilities which Provided (Used)
       Cash Exclusive of Changes Shown Separately
         Accounts Receivable                                                           (17,748)        (23,162)
         Materials and Fuel Inventory                                                   (4,068)          1,469
         Accounts Payable                                                              (12,438)          5,872
         Interest Accrued                                                               (6,668)         (1,983)
         Interest Received from UniSource Energy                                        11,013               -
         Income Tax Receivable                                                          (1,227)              -
         Taxes Accrued                                                                 (15,965)          5,605
         Other Current Assets                                                            1,951          (1,105)
         Other Current Liabilities                                                      (3,174)           (570)
-------------------------------------------------------------------------------- ---------------- ---------------
NET CASH FLOWS - OPERATING ACTIVITIES                                              $    73,833      $  118,593
================================================================================ ================ ===============

</TABLE>


NOTE 14. SUBSEQUENT EVENT
-------------------------

     In July 2005, Millennium received $4 million as a return of its investment
in Carboelectrica Sabinas, S. de R.L. de C.V., (Sabinas) a Mexican limited
liability company. As a result of the $4 million payment, the book value of the
investment in Sabinas was reduced to approximately $14 million. Millennium owns
50% of Sabinas.


NOTE 15. REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
----------------------------------------------------------------

     With respect to the unaudited condensed consolidated financial information
of UniSource Energy and TEP for the three-month and six-month periods ended June
30, 2005 and 2004, PricewaterhouseCoopers LLP reported that they have applied
limited procedures in accordance with professional standards for a review of
such information. However, their separate report dated August 8, 2005, appearing
herein states that they did not audit and they do not express an opinion on that
unaudited condensed consolidated financial information. Accordingly, the degree
of reliance on their report on such information should be restricted in light of
the limited nature of the review procedures applied. PricewaterhouseCoopers LLP
is not subject to the liability provisions of Section 11 of the Securities Act
of 1933 (the Act) for their report on the unaudited condensed consolidated
financial information because that report is not a "report" or a "part" of a
registration statement prepared or certified by PricewaterhouseCoopers LLP
within the meaning of Sections 7 and 11 of the Act.


                                       29
<PAGE>


ITEM 2.- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS
--------------------------------------------------------------------------------

     Management's Discussion and Analysis explains the results of operations,
the general financial condition, and the outlook for UniSource Energy and its
four primary business segments and includes the following:

     o    outlook and strategies,
     o    operating results during the second quarter and first six months of
          2005 compared with the same periods in 2004,
     o    factors which affect our results and outlook,
     o    liquidity, capital needs, capital resources, and contractual
          obligations,
     o    dividends, and
     o    critical accounting estimates.

     Management's Discussion and Analysis should be read in conjunction with
UniSource Energy and TEP's 2004 Annual Report on Form 10-K and with the
Condensed Consolidated Financial Statements, beginning on page 2, which present
the results of operations for the three and six months ended June 30, 2005, and
2004. Management's Discussion and Analysis explains the differences between
periods for specific line items of the Condensed Consolidated Financial
Statements.

     References in this report to "we" and "our" are to UniSource Energy and its
subsidiaries, collectively.


                          UNISOURCE ENERGY CONSOLIDATED

OVERVIEW OF CONSOLIDATED BUSINESS

     UniSource Energy is a holding company that has no significant operations of
its own. Operations are conducted by UniSource Energy's subsidiaries, each of
which is a separate legal entity with its own assets and liabilities. UniSource
Energy owns substantially all of the outstanding common stock of TEP, and all of
the outstanding common stock of UniSource Energy Services, Inc. (UES),
Millennium Energy Holdings, Inc. (Millennium), and UniSource Energy Development
Company (UED).

     TEP, an electric utility, has provided electric service to the community of
Tucson, Arizona, for over 100 years. UES began operations in August 2003. UES,
through its two operating subsidiaries, UNS Gas, Inc. (UNS Gas) and UNS
Electric, Inc. (UNS Electric), provides gas and electric service to 30
communities in northern and southern Arizona. Millennium invests in unregulated
businesses, including Global Solar Energy, Inc. (Global Solar), a developer and
manufacturer of thin-film photovoltaic cells and modules. UED engages in
developing generating resources and other project development activities,
including facilitating the expansion of the Springerville Generating Station,
but has no significant operations. We conduct our business in four primary
business segments - TEP's Electric Utility segment, UNS Gas, UNS Electric and
Global Solar.

     UniSource Energy was incorporated in the State of Arizona on March 8, 1995,
and obtained regulatory approval to form a holding company in November 1997. On
January 1, 1998, TEP and UniSource Energy exchanged shares of stock resulting in
TEP becoming a subsidiary of UniSource Energy. Following the share exchange, TEP
transferred the stock of its subsidiary Millennium to UniSource Energy.

OUTLOOK AND STRATEGIES
----------------------

     OPERATING PLANS AND STRATEGIES

     Our financial prospects and outlook for the next few years will be affected
by many competitive, regulatory and economic factors. Our plans and strategies
include the following:

     o    Continue to integrate UES' businesses with UniSource Energy's other
          businesses.

     o    Oversee the construction of Springerville Unit 3 and continue to
          enhance the value of existing assets by working with Salt River
          Project to facilitate the development of Springerville Unit 4.


                                       30
<PAGE>


     o    Reduce UniSource Energy's debt, using some of our excess cash flows.

     o    Enhance the value of TEP's transmission system while continuing to
          provide reliable access to generation for TEP and UES' retail
          customers and market access for all generating assets.

     o    Promote economic development in our service territories.

     o    Efficiently manage our generation, transmission and distribution
          resources and look for ways to control our operating expenses while
          maintaining and enhancing reliability and profitability.

     o    Expand TEP's and UNS Electric's portfolio of generating and purchased
          power resources to meet growing retail energy demand.

     o    Increase production and sales of Global Solar's thin-film photovoltaic
          cells and seek additional investors, or sell all or part of
          Millennium's interest, or a combination of both.

     o    Manage the exit of our other Millennium investments to maximize their
          value to shareholders.

     To accomplish our goals, during 2005 we expect to spend the following
amounts on capital expenditures:

<TABLE>
<CAPTION>
                       Actual Year-to-Date         Estimate
                          June 30, 2005         Full Year 2005
-------------------- ------------------------ --------------------
                                -Millions of Dollars-
<S>                           <C>                      <C>
TEP                           $68                      $153
UNS Gas                        13                        23
UNS Electric                    9                        34
-------------------- ------------------------ --------------------

</TABLE>

     While we believe that our plans and strategies will continue to have a
positive impact on our financial prospects and position, we recognize that we
continue to be highly leveraged, and as a result, our access to the capital
markets may be limited or more expensive than for less leveraged companies.

RESULTS OF OPERATIONS
---------------------

   THREE MONTHS ENDED JUNE 30, 2005 COMPARED WITH THE THREE MONTHS ENDED
   JUNE 30, 2004

     UniSource Energy recorded net income of $9 million, or 27 cents per average
basic share of Common Stock, in the second quarter of 2005, compared with net
income of $13 million, or 37 cents per average basic share of Common Stock, in
the same period of 2004. The following factors contributed to the decline:

     2005 included:

     o    a $6 million decrease in TEP's gross margin (the sum of retail and
          wholesale electric revenues less fuel and purchased power expense) due
          to the following:

          -    an $8 million increase in purchased power expense due to higher
               replacement power costs resulting from planned coal plant
               maintenance outages and lost energy from the expiration of the
               Southern California Edison (SCE) Exchange in May 2005; and

          -    a $4 million decline in wholesale revenues due to increased
               retail demand and the lower availability of excess power to sell
               into the wholesale market; partially offset by

          -    a $6 million increase in retail revenues due to warmer weather
               and a 2% increase in TEP's customer base.

     o    a $5 million increase in other operations and maintenance (O&M)
          expense primarily due to planned outages at TEP's coal-fired plants;
          and

     o    a $4 million increase in total interest expense due to: expenses
          associated with fees written off for TEP's old Credit Agreement when
          it entered a new Credit Agreement in May 2005; the repurchase and
          redemption of $225 million of TEP debt in May 2005; and interest
          expense at UniSource Energy


                                       31
<PAGE>


          stand-alone, related to convertible notes issued in March 2005 and the
          UniSource Energy Credit Agreement, entered into in April 2005; and

     o    a $3 million decline in depreciation and amortization related to the
          extension of useful lives of certain generating assets at TEP in July
          2004 and April 2005; and

     o    a $3 million increase in other income due to lower expenses related to
          MEH investments.

     2004 included:

     o    a net loss of $1 million at UNS Gas.


   SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH THE SIX MONTHS ENDED
   JUNE 30, 2004

     UniSource Energy recorded net income of $6 million, or 16 cents per average
basic share of Common Stock, in the six months ended June 30, 2005, compared
with net income of $19 million, or 56 cents per average basic share of Common
Stock, in the same period of 2004. The following factors contributed to the
decline:

     2005 included:

     o    an $18 million decrease in TEP's gross margin (the sum of retail and
          wholesale electric revenues less fuel and purchased power expense) due
          to the following:

          -    a $15 million increase in purchased power expense due to higher
               replacement power costs resulting from planned coal plant
               maintenance outages and lost energy from the expiration of the
               SCE Exchange in May 2005; and

          -    a $7 million decline in wholesale revenues due to increased
               retail demand and the lower availability of excess power to sell
               into the wholesale market; partially offset by

          -    a $4 million increase in retail revenues due to warm weather
               during the second quarter and a 2% increase in TEP's customer
               base.

     o    a $3 million increase in other O&M expense due to higher maintenance
          costs at TEP's coal-fired plants;

     o    a $4 million decline in depreciation and amortization primarily
          related to the extension of useful lives of certain generating assets
          at TEP in July 2004 and April 2005; and

     o    net income of $4 million at UNS Gas in the first six months of 2005
          compared with net income of $3 million in the same period last year.

     2004 included:

     o    a $3 million after-tax gain at MEH from its investment in Haddington.


                                       32
<PAGE>


   CONTRIBUTION BY BUSINESS SEGMENT

     The table below shows the contributions to our consolidated after-tax
earnings by our four business segments.

<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED JUNE 30,           SIX MONTHS ENDED
                                                                                    JUNE 30,
                                              2005           2004            2005             2004
----------------------------------------- ----------------------------- ----------------------------------
                                             -Millions of Dollars-            -Millions of Dollars-
BUSINESS SEGMENT
<S>                                             <C>            <C>            <C>             <C>
   TEP                                          $   12         $   18         $    7          $   19
   UNS Gas                                           -             (1)             4               3
   UNS Electric                                      1              1              1               2
   Global Solar                                     (2)            (1)            (3)             (2)
   Other (1)                                        (2)            (4)            (3)             (3)
----------------------------------------- -------------- -------------- --------------- ------------------
       Consolidated Net Income                  $    9         $   13         $    6          $   19
========================================= ============== ============== =============== ==================

</TABLE>

(1)  Includes: UniSource Energy parent company expenses, including in
2005, interest expense (net of tax) on the UniSource Energy Convertible
Senior Notes, the UniSource Energy Credit Agreement, and on the note
payable from UniSource Energy to TEP; and in 2004 includes costs
associated with the proposed acquisition of UniSource Energy by Saguaro;
income and losses from other Millennium investments; and income and
losses from UED.


LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

<TABLE>
<CAPTION>
     UNISOURCE ENERGY CONSOLIDATED CASH FLOWS

        SIX MONTHS ENDED JUNE 30,                    2005              2004
                                                      -Millions of Dollars-
        --------------------------------------- ---------------- ---------------
        Cash provided by (used in):
<S>                                                  <C>              <C>
           Operating Activities                      $   91           $  141
           Investing Activities                         (75)             (57)
           Financing Activities                         (67)             (56)
        --------------------------------------- ---------------- ---------------
        Net Increase (Decrease) in Cash              $  (51)          $   28
        ======================================= ================ ===============

</TABLE>

     UniSource Energy's consolidated cash flows are provided primarily from
retail and wholesale energy sales at TEP, UNS Gas and UNS Electric, net of the
related payments for fuel and purchased power. Generally, cash from operations
is lowest in the first quarter and highest in the third quarter due to TEP's
summer peaking load.

     We use our available cash primarily to:

     o    finance capital expenditures at TEP, UNS Gas and UNS Electric;

     o    pay dividends to shareholders; and

     o    reduce leverage by repaying or repurchasing debt and investing in
          lease debt.

     The primary source of liquidity for UniSource Energy, the parent company,
is dividends it receives from its subsidiaries, primarily TEP. Under our tax
sharing agreement, our subsidiaries make income tax payments to UniSource
Energy, which makes payments on behalf of the consolidated group.

     As of August 4, 2005, cash and cash equivalents available to UniSource
Energy was approximately $113 million.

     OPERATING ACTIVITIES

     In the first six months of 2005, net cash flows from operating activities
decreased by $50 million compared with the same period in 2004. The following
factors contributed to the decrease:


                                       33
<PAGE>


     2005 included:

     o    an $8 million increase in cash receipts from electric and gas sales;
          offset by

          -    a $6 million increase in fuel costs paid and a $28 million
               increase in purchased power costs paid due to planned outages at
               Springerville Unit 2 and San Juan Unit 2 and higher natural gas
               prices;

     o    a $10 million increase in payments for O&M costs related to the
          planned outages at TEP's plants;

     o    a $4 million increase in wages paid due to a greater number of
          employees, rising wage levels and higher incentive compensation; and

     o    a $4 million decrease in total taxes paid, net of income tax refunds
          received, due to a smaller final tax payment related to prior year
          consolidated income tax returns.

     2004 included:

     o    $17 million received by TEP related to the return to TEP of a deposit
          for its 1992 Mortgage; and

     o    $4 million in other cash receipts related to the sale of an investment
          by a Millennium subsidiary.

     INVESTING ACTIVITIES

     Net cash used for investing activities was $17 million higher in the first
six months of 2005 compared with the same period in 2004, primarily due to the
following factors:

     2005 included:

     o    a $19 million increase in capital expenditures due primarily to a
          planned maintenance outage at Springerville and TEP's share of the
          construction costs of the Luna Energy Facility; and

     o    other cash receipts of $8 million due primarily to the redemption of a
          $5 million certificate of deposit at TEP.

     2004 included:

     o    $10 million received as a return on an MEH investment in Haddington
          and a payment received on a note receivable held by Nations Energy;
          and

     o    a $4 million purchase of Springerville lease debt.


         FINANCING ACTIVITIES

     Net cash flows used for financing activities were $12 million higher in the
first six months of 2005 compared with the same period in 2004. The following
factors contributed to the change:

     2005 included:

     o    proceeds of $240 million related to UniSource Energy's issuance of
          $150 million of Convertible Senior Notes and borrowings of $90 million
          under its term loan;

     o    borrowings under TEP's revolving credit facility of $40 million;

     o    $282 million increase in repayments on long-term debt related to TEP's
          early redemption of $53 million of First Mortgage Bonds in the first
          three months of 2005, the repurchase and redemption of $225 million of
          fixed-rate tax exempt debt in May 2005 and a $1 million principal
          payment on the UniSource Energy term loan;

     o    a $5 million increase in TEP's payments on capital lease obligations;
          and


                                       34
<PAGE>


     o    a $4 million increase in dividends paid to UniSource Energy
          shareholders.

     As a result of the activities described above, our consolidated cash and
cash equivalents decreased to $103 million at June 30, 2005, from $154 million
at December 31, 2004. We invest cash balances in high-grade money market
securities with an emphasis on preserving the principal amounts invested.

     At August 4, 2005, our consolidated cash balance, including cash
equivalents, was approximately $113 million.

     We believe that we will continue to have sufficient cash flow to cover our
capital needs, as well as required debt payments and dividends to shareholders.
In the event that we experience lower cash from operations in 2005, the Company
will use its revolving credit facilities to fund its cash needs.

     Convertible Senior Notes
     ------------------------

     In March 2005, UniSource Energy issued $150 million of 4.50% Convertible
Senior Notes due 2035 in a private placement. The Convertible Senior Notes are
unsecured and are not guaranteed by TEP or any other UniSource Energy
subsidiary. Each $1,000 of Convertible Senior Notes is convertible into 26.6667
shares of our Common Stock at any time, representing a conversion price of
approximately $37.50 per share of our Common Stock, subject to adjustment in
certain circumstances.

     We will pay interest on the Convertible Senior Notes semi-annually,
beginning on September 1, 2005.

     UniSource Credit Agreement
     --------------------------

     In April 2005, UniSource Energy entered into a $105 million five-year
credit agreement with a group of lenders (UniSource Credit Agreement) which
expires on April 15, 2010. The UniSource Credit Agreement includes a $90 million
term loan facility and a $15 million revolving credit facility. Quarterly
principal payments of $1.25 million are due beginning June 30, 2005, with the
balance due at maturity.

     We borrowed $80 million under the $90 million term loan on May 10, 2005,
and the remaining $10 million on June 29, 2005. We made the required $1.25
million principal payment on June 30, 2005, leaving an outstanding balance on
the term loan of $88.75 million.

     We pay interest on the term loan and on borrowings under the revolving
credit facility at LIBOR plus 1.75% or the agent bank's reference rate plus
0.75%. We paid a commitment fee of 0.50% on the unused portion of the term loan
until it was fully drawn at June 29, 2005, and pay a commitment fee of 0.50% on
the unused portion of the revolving credit facility.

     The UniSource Credit Agreement restricts additional indebtedness, liens,
mergers, sales of assets, and investments and acquisitions. We must also meet:
(1) a minimum cash flow to interest coverage ratio for UniSource Energy on a
standalone basis and (2) a maximum leverage ratio on a consolidated basis. We
may pay dividends, if after giving effect to the dividend payment, we have more
than $15 million of unrestricted cash and unused revolving credit. As of June
30, 2005, we were in compliance with the terms of the UniSource Credit
Agreement.

     If an event of default occurs, the UniSource Credit Agreement may become
immediately due and payable. An event of default includes failure to make
required payments under the UniSource Credit Agreement, failure of UniSource
Energy or certain subsidiaries to make payments or default on debt greater than
$20 million, or certain bankruptcy events at UniSource Energy or certain
subsidiaries.

     We expect that we may borrow from time to time under the revolving credit
facility to meet temporary cash needs. As of June 30, 2005, we had no borrowings
outstanding under the revolving credit facility.

     Use of Proceeds
     ---------------

     On March 1, 2005, we received $146 million of net proceeds from the sale of
the Convertible Senior Notes, which was used as follows:

     o    to repay our $95 million promissory note to TEP plus accrued interest
          of $11 million on March 1, 2005;


                                       35
<PAGE>


     o    to make a capital contribution of $6 million to UNS Gas and a capital
          contribution of $4 million to UNS Electric on March 10, 2005; and

     o    to make a capital contribution of $110 million to TEP on May 10, 2005,
          using the remaining $30 million from the sale of the notes, along with
          $80 million of proceeds from the term loan.

     TEP used the proceeds from the capital contribution, the inter-company note
repayment (described above), along with borrowings under its revolving credit
facility to repurchase and redeem $225 million of fixed-rate tax-exempt debt
obligations. See, Tucson Electric Power, Bond Repurchases and Redemptions, and
Tucson Electric Power Company, Liquidity and Capital Resources, Dividends on
Common Stock, below.

     GUARANTEES AND INDEMNITIES

     In the normal course of business, UniSource Energy and certain subsidiaries
enter into various agreements providing financial or performance assurance to
third parties on behalf of certain subsidiaries. We enter into these agreements
primarily to support or enhance the creditworthiness of a subsidiary on a
stand-alone basis. The most significant of these guarantees at June 30, 2005
are:

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

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

     -    UniSource Energy's guarantee of approximately $8 million in natural
          gas and supply payments and building lease payments for UNS Gas and
          UNS Electric and subsidiaries of Millennium; and

     -    Millennium's guarantee of approximately $3 million in
          commodity-related payments for MEG and building lease payments for a
          subsidiary.

     To the extent liabilities exist under the contracts subject to these
guarantees, such liabilities are included in the consolidated balance sheets.

     In addition, UniSource Energy and its subsidiaries have indemnified the
purchasers of interests in certain investments from additional taxes due for
years prior to the sale. The terms of the indemnifications provide for no
limitation on potential future payments; however, we believe that we have abided
by all tax laws and paid all tax obligations. We have not made any payments
under the terms of these indemnifications to date.

     We believe that the likelihood that UniSource Energy or TEP would be
required to perform or otherwise incur any significant losses associated with
any of these guarantees is remote.

   CONTRACTUAL OBLIGATIONS

     There are no significant changes in our contractual obligations or other
commercial commitments from those reported in our 2004 Annual Report on Form
10-K, other than: the UniSource Energy Credit Agreement (described above); the
repayment of debt obligations at TEP and the termination of TEP's 1941 Mortgage,
described below; and the UNS Gas/UNS Electric Credit Agreement, described below.

   DIVIDENDS ON COMMON STOCK

     The following table shows the dividends declared to UniSource Energy
shareholders for 2005.

<TABLE>
<CAPTION>
                                                                                               DIVIDEND AMOUNT
     DECLARATION DATE             RECORD DATE                PAYMENT DATE                 PER SHARE OF COMMON STOCK
--------------------------- ------------------------- ---------------------------- -----------------------------------------
<S>                         <C>                       <C>                                           <C>
 February 4, 2005           February 15, 2005         March 8, 2005                                 $0.19
 May 6, 2005                May 18, 2005              June 10, 2005                                  0.19

</TABLE>


                                       36
<PAGE>


   INCOME TAX POSITION

     At June 30, 2005, UniSource Energy and TEP had, for federal and state
income tax filing purposes, the following carryforward amounts:

<TABLE>
<CAPTION>
                                        UNISOURCE ENERGY                            TEP
                                      Amount            Expiring            Amount            Expiring
------------------------------ ---------------------- ------------- ----------------------- -------------
                               -Millions of Dollars-      Year      -Millions of Dollars-       Year
<S>                                    <C>             <C>                   <C>             <C>
NET OPERATING LOSSES                   $ 18            2021-2022             $ -                 -
INVESTMENT TAX CREDIT                     5            2004-2024               5             2004-2024
AMT CREDIT                              100               -                   92                 -
------------------------------ ---------------------- ------------- ----------------------- -------------

</TABLE>

     The $18 million in NOL carryforwards is subject to limitation due to a
reorganization of certain Millennium entities in December 2002. The future use
of these losses is dependant upon the generation of sufficient future taxable
income at the separate company level. See Critical Accounting Estimates,
Deferred Tax Valuation - TEP and Millennium, below.

                          TUCSON ELECTRIC POWER COMPANY

RESULTS OF OPERATIONS
---------------------

     The financial condition and results of operations of TEP are currently the
principal factors affecting the financial condition and results of operations of
UniSource Energy on an annual basis. The following discussion relates to TEP's
utility operations, unless otherwise noted.

<TABLE>
<CAPTION>
                                                         SALES                 OPERATING REVENUE
THREE MONTHS ENDED JUNE 30,                       2005           2004         2005          2004
                                                   -Millions of kWh-         -Millions of Dollars-
--------------------------------------------- -------------- ------------- ------------ --------------
ELECTRIC RETAIL SALES:
<S>                                                 <C>           <C>        <C>          <C>
  Residential                                         908           826      $   84       $    81
  Commercial                                          498           478          52            51
  Industrial                                          596           603          44            43
  Mining                                              224           205          10             9
  Public Authorities                                   66            66           5             5
--------------------------------------------- -------------- ------------- ------------ --------------
TOTAL ELECTRIC RETAIL SALES                         2,292         2,178      $ 195          $ 189
--------------------------------------------- -------------- ------------- ------------ --------------
ELECTRIC WHOLESALE SALES DELIVERED:
  Long-term Contracts                                 277           282        12              13
  Other Sales                                         477           654        24              27
  Transmission                                          -             -          2              2
  Net Unrealized Gain (Loss) on Forward
     Sales of Energy                                    -             -          -             -
--------------------------------------------- -------------- ------------- ------------ --------------
TOTAL ELECTRIC WHOLESALE SALES                        754           936         38             42
--------------------------------------------- -------------- ------------- ------------ --------------
         TOTAL ELECTRIC SALES                       3,046         3,114      $ 233        $   231
============================================= ============== ============= ============ ==============

WEATHER DATA:                                        2005            2004
   COOLING DEGREE DAYS
   Three Months Ended June 30,                        454           402
   10-Year Average                                    434           418
   % Over / (Under) Prior Year                        13%          (15%)
   % Over / (Under) 10-Year Average                    5%           (4%)
   HEATING DEGREE DAYS
   Three Months Ended June 30,                         31            57
   10-Year Average                                     72            80
   % Over / (Under) Prior Year                       (46%)         (19%)
   % Over / (Under) 10-Year Average                 (132%)         (29%)
--------------------------------------------- -------------- ------------- ------------ --------------

</TABLE>


                                       37
<PAGE>


     Total revenues from kWh sales to retail customers increased by $6 million,
or 3%, in the second quarter of 2005 compared with the same period last year.
Residential kWh sales increased 10% and commercial kWh sales increased 4%,
benefiting from warmer weather and customer growth. Cooling degree days were 13%
higher than last year and 5% above the 10-year average. The total number of
retail customers as of June 30, 2005 was 379,964, up 2.4% from a year ago. The
average price of copper during the second quarter of 2005 was $1.53 per pound,
or 24% higher than the average price in the same period last year, leading to
increased mining activity and a 9% increase in kWh sales to TEP's mining
customers; revenues from TEP's mining customers increased $1 million. Total
retail kWh sales increased by 5% in the second quarter of 2005 compared with the
same period last year.

     Wholesale revenues decreased $4 million, or 10%, in the second quarter of
2005 compared with the second quarter of 2004. Wholesale sales opportunities
were limited in the second quarter of 2005 due to higher retail energy demand
and planned outages at the San Juan and Four Corners Generating Stations. The
average wholesale market price of energy was $45 per MWh in the second quarter
of 2005, compared with $44 per MWh in the comparable period in 2004. See Factors
Affecting Results of Operations, Western Energy Markets, Market Prices, below.

<TABLE>
<CAPTION>
                                                         SALES                 OPERATING REVENUE
SIX MONTHS ENDED JUNE 30,                         2005           2004         2005          2004
                                                   -Millions of kWh-         -Millions of Dollars-
--------------------------------------------- -------------- ------------- ------------ --------------
ELECTRIC RETAIL SALES:
<S>                                                 <C>           <C>         <C>         <C>
  Residential                                       1,558         1,544       $ 140       $   139
  Commercial                                          849           836          88            87
  Industrial                                        1,108         1,093          79            79
  Mining                                              444           398          21            18
  Public Authorities                                  110           116           8             9
--------------------------------------------- -------------- ------------- ------------ --------------
TOTAL ELECTRIC RETAIL SALES                         4,069         3,987       $ 336         $ 332
--------------------------------------------- -------------- ------------- ------------ --------------
ELECTRIC WHOLESALE SALES DELIVERED:
  Long-term Contracts                                 585           628           27           28
  Other Sales                                         930         1,197           47           52
  Transmission                                          -             -            4            4
  Net Unrealized Gain (Loss) on Forward
     Sales of Energy                                    -             -          (1)           -
--------------------------------------------- -------------- ------------- ------------ --------------
TOTAL ELECTRIC WHOLESALE SALES                      1,515         1,825      $     77      $   84
--------------------------------------------- -------------- ------------- ------------ --------------
         TOTAL ELECTRIC SALES                       5,584         5,812      $   413      $   416
============================================= ============== ============= ============ ==============

WEATHER DATA:                                        2005            2004
   COOLING DEGREE DAYS
   Six Months Ended June 30,                          454           407
   10-Year Average                                    434           418
   % Over / (Under) Prior Year                        12%          (14%)
   % Over / (Under) 10-Year Average                    9%           (3%)
   HEATING DEGREE DAYS
   Six Months Ended June 30,                          805           934
   10-Year Average                                    880           876
   % Over / (Under) Prior Year                       (14%)          24%
   % Over / (Under) 10-Year Average                   (9%)           7%
--------------------------------------------- -------------- ------------- ------------ --------------

</TABLE>

     Total revenues from kWh sales to retail customers increased by $4 million,
or 1%, in the first six months of 2005 compared with the same period last year.
Mild winter weather during the first quarter was offset by customer growth and
warmer weather during the second quarter. Residential kWh sales increased 1% and
commercial kWh sales increased 2% during the first six months of 2004. The
average price of copper in the first six months of 2005 was $1.50 per pound, or
22% higher than the average price in first six months of 2004, leading to
increased mining activity and a 12% increase in kWh sales to TEP's mining
customers; revenues from TEP's mining customers increased $3 million. Total
retail kWh sales increased by 2% in the first six months of 2005 compared with
the same period last year.

     Wholesale revenues decreased $7 million, or 8%, in the first six months of
2005 compared with the same period in 2004. Planned outages at TEP's
Springerville Unit 2 and San Juan Unit 2 limited wholesale sales


                                       38
<PAGE>


opportunities. The average wholesale market price of energy was $45 per MWh in
the first six months 2005, compared with $42 per MWh in the comparable period in
2004. See Factors Affecting Results of Operations, Western Energy Markets,
Market Prices, below.

   OPERATING EXPENSES

     FUEL AND PURCHASED POWER EXPENSE

     TEP's fuel and purchased power expense, and energy resources for the second
quarters of 2005 and 2004 are shown in the table below.

<TABLE>
<CAPTION>
                                                           GENERATION                 EXPENSE
THREE MONTHS ENDED JUNE 30,                            2005        2004         2005          2004
                                                       -Millions of kWh-      -Millions of Dollars-
---------------------------------------------------- ----------------------- -------------------------

<S>                                                      <C>       <C>        <C>           <C>
Coal-Fired Generation                                    2,767     2,910      $  48         $    47
Gas-Fired Generation                                        89        98          8               8
---------------------------------------------------- --------- ------------- ------------ -------------
Total Generation                                         2,856     3,008         56              55
Purchased Power                                            416       328         27              19
---------------------------------------------------- --------- ------------- ------------ -------------
Total Resources                                          3,272     3,336       $  83        $    74
                                                                             ============ =============
Less Line Losses, Company Use and Other                    226       222
---------------------------------------------------- --------- -------------
Total Energy Sold                                        3,046     3,114
==================================================== ========= =============

</TABLE>

     Total fuel expense at TEP's generating plants was $56 million in the second
quarter of 2005, up $1 million from the same period last year, despite lower
generating output. Coal-fired generation declined 143,000 MWh, or 5%, compared
with the second quarter of 2004 due to maintenance outages at San Juan Unit 2,
Four Corners Unit 5, as well as some minor unplanned outages at TEP's other coal
plants. Gas-fired generation decreased by 9,000 MWh, however gas-related fuel
expense was unchanged due to higher natural gas prices.

     Purchased power expense increased $8 million compared with the second
quarter of 2004, due to an increase of 27%, or 88,000 MWh, in power purchases to
replace energy lost from coal plant outages and the expiration of the SCE
Exchange. In addition, the average wholesale market price for power increased 2%
compared with the second quarter of 2004. The SCE Exchange expired in May 2005.
The agreement required SCE to provide 110 MW of firm system capacity to TEP
during the summer months (May through September) and for TEP to return to SCE in
the winter months (November through February) the same amount of energy that TEP
received during the preceding summer. See Factors Affecting Results of
Operations, Western Energy Markets, Market Prices, below.

<TABLE>
<CAPTION>
                                                           GENERATION                 EXPENSE
SIX MONTHS ENDED JUNE 30,                              2005        2004         2005          2004
                                                       -Millions of kWh-      -Millions of Dollars-
---------------------------------------------------- ----------------------- -------------------------

<S>                                                      <C>       <C>         <C>          <C>
Coal-Fired Generation                                    5,172     5,673       $  90        $    94
Gas-Fired Generation                                       145       110          13              9
---------------------------------------------------- --------- ------------- ------------ -------------
Total Generation                                         5,317     5,783         103            103
Purchased Power                                            681       424          40             25
---------------------------------------------------- --------- ------------- ------------ -------------
Total Resources                                          5,998     6,207       $ 143        $   128
                                                                             ============ =============
Less Line Losses, Company Use and Other                    414       395
---------------------------------------------------- --------- -------------
Total Energy Sold                                        5,584     5,812
==================================================== ========= =============

</TABLE>

     During the first six months of 2005, planned outages at TEP's 380-megawatt
coal-fired Springerville Unit 2 facility, San Juan Unit 2 and Four Corners Unit
5, the expiration of the SCE Exchange and minor unplanned outages at some of
TEP's coal-fired generating units led to higher gas-related fuel costs and
higher purchased power expenses. Total fuel expense at TEP's generating plants
was unchanged in the first six months of 2005, compared to the same period last
year. Lower coal-fired generation costs were offset by an increase in
gas-related fuel expense of $4 million, due to the higher use of TEP's gas-fired
generating resources as well as higher commodity prices for gas. The average
price per MMBtu of gas at the Permian basin was 12% higher than in the first six
months of 2004.


                                       39
<PAGE>


     Purchased power expense increased $15 million compared with the first six
months of 2004, due to an increase of 61%, or 257,000 MWh, in power purchases to
replace energy lost from coal plant outages and the SCE Exchange. In addition,
the average wholesale market price for power was 7% higher compared with the
first six months of 2004. See Factors Affecting Results of Operations, Western
Energy Markets, Market Prices, below.

     The table below shows the average cost per kWh for TEP's generating plants
by fuel type.

<TABLE>
<CAPTION>

                          THREE MONTHS                 SIX MONTHS
                         ENDED JUNE 30,              ENDED JUNE 30,
                        2005         2004         2005          2004
                         -cents per kWh-            -cents per kWh-
     --------------- ------------------------- --------------------------
<S>                     <C>          <C>          <C>           <C>
     Coal               1.73         1.76         1.75          1.65
     Gas                9.01         9.16         8.89          8.05
     All fuels          1.96         1.84         1.94          1.78
     --------------- ------------ ------------ ------------ -------------

</TABLE>

     OTHER OPERATING EXPENSES

     Other O&M expense increased $5 million in the second quarter of 2005,
compared with the same period last year; and increased $5 million in the first
six months of 2005 compared with the first six months of 2004, primarily due to
the plant outages described above. During the first six months of 2005, TEP
recorded a gain of $3 million on the sale of excess SO2 emissions allowances.

     Depreciation and amortization decreased $4 million in the second quarter of
2005, compared with the second quarter of 2004 primarily due to the extension of
useful lives of certain generating assets at TEP in July 2004 and April 2005.

     Amortization of the Transition Recovery Asset (TRA) increased $2 million in
the second quarter of 2005 and $3 million in the first six months of 2005.
Amortization of the TRA is the result of the Settlement Agreement with the ACC,
which changed the accounting method for TEP's generation operations. This item
reflects the recovery, through 2008, of transition recovery assets which were
previously regulatory assets of the generation business. The amount of
amortization is a function of the TRA balance and total kWh consumption by TEP's
distribution customers.

     The table below shows estimated annual TRA amortization and unamortized TRA
year-end balances for 2005 through 2008.

<TABLE>
<CAPTION>
                                  FUTURE ESTIMATED           UNAMORTIZED
                                  TRA AMORTIZATION           TRA BALANCE
                                              -Millions of Dollars-
     ----------------------- ---------------------------- -------------------
<S>  <C>                               <C>                    <C>
     2005                              $  55                  $  169
     2006                                 64                     105
     2007                                 73                      32
     2008                                 32                       -
     ----------------------- ---------------------------- -------------------

</TABLE>

     OTHER INCOME (DEDUCTIONS)

     In the second quarter and first six months of 2004, TEP's Income Statement
included inter-company Interest Income of $2 million and $5 million,
respectively. This represented Interest Income on a promissory note TEP received
from UniSource Energy in exchange for the transfer to UniSource Energy of its
stock in Millennium in 1998. UniSource Energy repaid the inter-company
promissory note on March 1, 2005. On UniSource Energy's Consolidated Statement
of Income, this Interest Income, as well as UniSource Energy's related interest
expense, was eliminated as an inter-company transaction. See Liquidity and
Capital Resources, TEP Cash Flows, Inter-Company Note from UniSource Energy,
below.

     INTEREST EXPENSE

     Total interest expense increased by $1 million, or 4%, in the second
quarter of 2005. In May 2005, TEP entered into a new credit agreement. Upon
entering the new agreement, TEP expensed $2 million of unamortized


                                       40
<PAGE>


issuance costs associated with the prior credit agreement. Also in May 2005, TEP
repurchased and redeemed $225 million of debt and recorded a loss of $3 million
related to this transaction. For the second quarter of 2005, the $5 million of
expenses related to these two transactions was partially offset by the lower
rates under TEP's new credit agreement and the interest savings related to the
$225 million of debt that was redeemed and repurchased. In the first six months
of 2005, total interest expense decreased $2 million, or 3%, compared with the
same period last year.

     INCOME TAX EXPENSE

     Income tax expense decreased $6 million in the second quarter of 2005
compared with the same period in 2004, due to lower pre-tax income. In the first
six months of 2005, income tax expense decreased $10 million compared with the
same period in 2004, due to lower pre-tax income.

FACTORS AFFECTING RESULTS OF OPERATIONS
---------------------------------------

   COMPETITION

     The electric utility industry has undergone significant regulatory change
in the last few years designed to encourage competition in the sale of
electricity and related services. However, the experience in California with
deregulation has caused many states, including Arizona, to re-examine the
viability of retail electric deregulation.

     As of January 1, 2001, all of TEP's retail customers are eligible to choose
an alternate energy service provider (ESP). Certain portions of the ACC's rules
that enabled ESPs to compete in the retail market were invalidated by a recent
Arizona Court of Appeals decision described below. Currently none of TEP's
retail customers are receiving service from ESPs.

     TEP has met all conditions required by the ACC to facilitate electric
retail competition, including ACC approval of TEP's direct access tariffs. ESPs
must meet certain conditions before electricity can be sold competitively in
TEP's service territory. Examples of these conditions include ACC certification
of ESPs, and execution by ESPs of, and compliance with, direct access service
agreements with TEP.

     In January 2005, an Arizona Court of Appeals decision became final in which
the Court held invalid certain portions of the ACC rules on retail competition
and related market pricing. Based on this decision, we expect that the ACC will
address the competition rules in an administrative proceeding. We cannot predict
what changes, if any, the ACC will make to the competition rules. See Rates,
Recent Motion Filed with ACC, below.

     TEP competes against gas service suppliers and others that provide energy
services. Other forms of energy technologies may provide competition to TEP's
services in the future, but to date, are not financially viable alternatives for
its retail customers. Self-generation by TEP's large industrial customers could
also provide competition for TEP's services in the future, but has not had a
significant impact to date.

     In the wholesale market, TEP competes with other utilities, power marketers
and independent power producers in the sale of electric capacity and energy.


   RATES

     TEP'S SETTLEMENT AGREEMENT AND RETAIL ELECTRIC COMPETITION RULES

     In September 1999, the ACC approved the Retail Electric Competition Rules
(Rules) that provided a framework for the introduction of retail electric
competition in Arizona. In November 1999, the ACC approved the Settlement
Agreement between TEP and certain customer groups related to the implementation
of retail electric competition in Arizona.

     The Rules and the Settlement Agreement established:

     o    a period, 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;
     o    the recovery through rates during the transition period of $450
          million of stranded generation costs through a fixed competitive
          transition charge (fixed CTC);
     o    capped rates for TEP retail customers through 2008;
     o    an ACC interim review of TEP retail rates in 2004;


                                       41
<PAGE>


     o    unbundling of electric services with separate rates or prices for
          generation, transmission, distribution, metering, meter reading,
          billing and collection, and ancillary services;
     o    a process for ESPs to become licensed by the ACC to sell generation
          services at market prices to TEP retail customers;
     o    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);
     o    transmission and distribution services would remain subject to
          regulation on a cost of service basis; and
     o    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
     ----------------------------------

     On June 1, 2004, as required by the Settlement Agreement, TEP filed general
rate case information with the ACC. TEP's filing does not propose any change in
retail rates, and under the terms of the Settlement Agreement, no rate case
filed by TEP through 2008 may result in a net rate increase. However, absent the
restriction on raising rates, TEP believes that the data in its filing would
justify an increase in retail rates of 16%.

     The general rate case information uses a historical test year ended
December 31, 2003 and establishes, based on TEP's standard offer service, that
TEP is experiencing a revenue deficiency of $111 million. The rate case
information includes, among other things, Springerville Unit 1 costs and other
generation costs including fuel costs in excess of those recovered through
existing rates. The proposed weighted cost of capital for the test year ended
December 31, 2003 is 8.78%, including an 11.5% return on equity (increased from
10.67% currently authorized). The rate case information uses a hypothetical 40%
equity capitalization (excluding capital lease obligations) rather than the
hypothetical 37.5% equity capitalization used in TEP's last general rate case.
As a result of the debt repurchases and redemptions made during the second
quarter of 2005, TEP's actual equity capitalization at June 30, 2005 improved to
40.6%.

     On June 24, 2005, intervenor testimony in TEP's 2004 rate review was due
and several intervenors filed their respective testimony. None of the intervenor
testimony filed proposed any increase or decrease to TEP's rates; all
intervenors recommended that TEP's rates remained unchanged. On July 11, 2005,
an ACC administrative law judge (ALJ) issued a procedural order suspending the
remaining testimony filing deadlines and hearing in the 2004 rate review. The
order indicated that the ALJ will evaluate the parties' positions and the need
for further proceedings.

     Despite TEP's position that it has a revenue deficiency and the intervenor
testimony recommending no change in rates, the ACC could conclude during this
2004 rate review process that TEP should decrease rates; any such determination
would be strongly opposed by TEP.

     Transition
     ----------

     The Settlement Agreement provides that TEP's fixed CTC will expire when
TEP's $450 million transition asset is fully amortized and recovered or on
December 31, 2008, whichever is earlier. Based on current projections of retail
sales, the TRA is expected to be fully amortized by mid-2008. The Settlement
Agreement also specifies that TEP's floating competitive transition charge
(floating CTC) will expire on December 31, 2008. This charge, which moves
inversely to changes in market-based generation services rates, presently
appears as a credit on retail customer bills. Based on current forward pricing
in the wholesale energy markets, TEP anticipates that the floating CTC will
continue to appear as a credit on retail customer bills through 2008. After the
expiration of the floating CTC, TEP's rates for generation services should be
market based.

     Absent any other change to TEP's retail rate structure, including continued
inability to recover actual costs, TEP estimates that the expiration of the
fixed CTC in 2008 (which has provided revenues, on average of .93 cents per kWh
sold, or approximately $80 million annually) would result in an average decrease
in revenues from retail rates of approximately 12% relative to revenues from
current retail rates. However, absent any other change except the expiration of
the fixed CTC, the expiration in 2008 of the floating CTC would result in
market-based generation services rates which would, based on current pricing in
the wholesale energy markets, produce a retail rate increase in January 2009 of
approximately 10-15% relative to current retail rates.

     We are operating pursuant to the Settlement Agreement. However, we cannot
predict the future rate methodologies for TEP which the ACC could authorize,
including whether the ACC will permit or require market-based rates for
generation services, reinstate cost of service ratemaking for all or a portion
of TEP's generation


                                       42
<PAGE>


services or require an alternate methodology to determine rates for TEP's
generation services. Under any circumstances, TEP will seek appropriate recovery
and return on its investment in assets used to serve its customers.

     In the event that the ACC reinstates cost of service ratemaking for TEP's
generation services and does not allow other factors that have changed in the
intervening years to be considered, significant retail rate decreases could
occur. TEP expects that, in establishing future rates, TEP and the ACC will
review the entirety of the retail rate structure rather than focusing solely on
any one of the elements noted above. Although TEP is unable to predict the type
and level of future retail rates, TEP believes that the 2004 general rate case
information filed with the ACC evidences that there have been a number of
factors that have changed since the Settlement Agreement was approved that
justify increasing or maintaining retail rates at current levels.

     Recent Motion Filed with ACC
     ----------------------------

     Given the recent court action described above, the ACC may revise its Rules
and rate methodologies prior to the expiration in 2008 of the Settlement
Agreement. A new structure could replace that established pursuant to the
Settlement Agreement prior to January 2009.

     In an effort to resolve the uncertainty surrounding the methodology that
will be applied to determine TEP's rates for generation service after the
current CTCs expire, TEP filed a motion with the ACC on May 4, 2005 requesting
that the ACC issue an order declaring its position regarding the rate treatment
that will be afforded to TEP's generation assets after 2008.

     The motion states TEP's preference for the ACC to adhere to the Settlement
Agreement and continue to authorize TEP to charge market-based rates for
generation services after December 31, 2008. The motion also states that, if the
ACC intends to rescind TEP's authorization to charge market-based rates for its
generation services, that change will have immediate consequences for the
Settlement Agreement, the 2004 general rate case information filing and future
TEP rate cases. Accordingly, TEP requested that the ACC clarify its intentions
in this regard. In addition, TEP requested that a procedural conference be held
in the 2004 rate review proceedings to discuss the status of that case pending
the issuance of an order in response to TEP's motion.

     In May 2005, a number of participants in TEP's rate proceedings, including
the Staff of the ACC, filed responses to TEP's motion. Those responses reflect
differing interpretations of the Settlement Agreement which established TEP's
existing rate structure and generation service rates, and the effect of the 2002
Track A order which eliminated the requirement that TEP transfer its generation
assets to a subsidiary and the future of electric competition in Arizona. A
number of these responses dispute TEP's assertion that the existing rate
structure contemplates market-based rates for generation services after December
31, 2008.

     On June 1, 2005, TEP filed a reply in support of its motion. The reply
stated that the differences of opinion expressed in the various responses filed
underscore the need for the ACC to clarify how it will determine TEP's rates for
generation services after December 31, 2008. TEP's reply also stated that,
although it would prefer that the ACC continue to authorize TEP to charge
market-based rates for generation services after December 31, 2008, it is
concerned that its customers will be subject to a significant rate increase in
2009.

     TEP believes that any actions by the ACC should not deny TEP the economic
benefits of the Settlement Agreement, and accordingly analyzed how the
Settlement Agreement can be modified so as to: (i) preserve the intent of the
parties; (ii) avoid a significant rate increase in 2009; (iii) mitigate a
negative financial impact on TEP; and (iv) provide all interested parties with
certainty in the near future about TEP's post-2008 rate structure.

     TEP's reply suggests that these goals can be accomplished through a
modification to the Settlement Agreement which includes the following concepts:
(i) an extension of the existing rate freeze at current rates; (ii) retention of
the current CTC amortization schedule; (iii) a commitment not to seek rate
treatment for certain TEP generation assets; and (iv) implementation of a
mechanism to protect TEP from extreme fuel market volatility after December 31,
2008. TEP intends to discuss its proposal with the parties to the Settlement
Agreement and ACC staff and, thereafter, enter into formal negotiations to seek
to modify the Settlement Agreement.

     On June 10, 2005 and on July 11, 2005, the ALJ issued procedural orders
related to TEP's 2004 rate review. The procedural orders took no action on TEP's
May 4, 2005 motion, however suggested a more appropriate procedure was for TEP
to file a motion to reopen the record approving the Settlement Agreement. On
July 25, 2005, TEP informed the ALJ that it will file a motion by September 12,
2005, seeking to amend the

                                       43
<PAGE>


decision approving the Settlement Agreement to address TEP's concerns about how
rates will be set after December 31, 2008.

   WESTERN ENERGY MARKETS

     As a participant in the western U.S. wholesale power markets, TEP is
directly and indirectly affected by changes in market conditions and market
participants. TEP competes with other utilities, power marketers and independent
power producers in the sale of electric capacity and energy at market-based
rates in the wholesale market.

     As of June 30, 2005, electric generating capacity in Arizona has grown to
approximately 25,000 MW; an increase of nearly 60% since 2001. A majority of the
growth over the last three years is the result of 16 new or upgraded gas-fired
generating units with a combined capacity of approximately 9,200 MW.

     MARKET PRICES

     The average market price for around-the-clock energy based on the Dow Jones
Palo Verde Index increased in the second quarter 2005, as did the average price
for natural gas based on the Permian Index. Average market prices for
around-the-clock energy began to rise in 2003 and have continued to increase
during 2004 and the first six months of 2005 primarily due to high natural gas
prices. As a result of all of these factors, TEP's natural gas and purchased
power expenses were higher in the first six months of 2005 than the same period
in 2004. Energy prices remain at these high levels to date; however, we cannot
predict whether these higher prices will continue, or whether changes in various
factors that influence demand and supply will cause prices to fall during 2005.

<TABLE>
<CAPTION>
     AVERAGE MARKET PRICE FOR AROUND-THE-CLOCK ENERGY                $/MWH
     ---------------------------------------------------------- ----------------
          <S>                                                        <C>
          Quarter ended June 30, 2005                                $ 45
          Quarter ended June 30, 2004                                  44

          Six Months Ended June 30, 2005                             $ 45
          Six Months Ended June 30, 2004                               42
     ---------------------------------------------------------- ----------------

     AVERAGE MARKET PRICE FOR NATURAL GAS                           $/MMBTU
     ---------------------------------------------------------- ----------------
          Quarter ended June 30, 2005                               $6.10
          Quarter ended June 30, 2004                                5.39

          Six Months Ended June 30, 2005                           $ 5.83
          Six Months Ended June 30, 2004                             5.21
     ---------------------------------------------------------- ----------------

</TABLE>

     In addition to energy from its coal-fired facilities, TEP typically uses
purchased power, supplemented by generation from its gas-fired units, to meet
the summer peak demands of its retail customers and to meet local reliability
needs. Some of these purchased power contracts are price indexed to natural gas
prices. Short-term and spot power purchase prices are also closely correlated to
natural gas prices. Due to its increasing seasonal gas and purchased power
usage, TEP hedges a portion of its total natural gas exposure from plant fuel
and gas-indexed purchased power with fixed price contracts for a maximum of
three years. TEP currently has approximately 60% of this exposure hedged for the
remaining portion (July through October) of the summer peak period of 2005 at a
weighted average price of $5.88 per MMBtu. TEP purchases its remaining gas fuel
needs and purchased power in the spot and short-term markets.

     We expect the market price and demand for capacity and energy to continue
to be influenced by factors including:

     o    weather;
     o    continued population growth in the western U.S.;
     o    economic conditions in the western U.S.;
     o    availability of generating capacity throughout the western U.S.;
     o    the extent of electric utility industry restructuring in Arizona,
          California and other western states;
     o    the effect of FERC regulation of wholesale energy markets;
     o    the availability and price of natural gas;
     o    availability of hydropower;


                                       44
<PAGE>


     o    transmission constraints; and
     o    environmental regulations and the cost of compliance.

     WATER SUPPLY

     Drought conditions in northern New Mexico and Colorado, combined with
increased water usage in Arizona, Nevada and southern California, have caused
water levels to significantly recede at Lake Powell, which supplies operating
water for the Navajo Generating Station. The decision was made in the second
quarter of 2005 to lower the water intakes in Lake Powell, which will help
minimize the exposure of water loss to the plant due to continuing drought
conditions. TEP's share of the expected total cost is approximately $2 million
based on its 7.5% ownership interest in Navajo Units 1, 2, and 3 (168 MW
capacity).

     TEP does not believe that its operations will be materially affected by
this drought.

     EMISSIONS ALLOWANCES

     TEP has SO2 Emissions Allowances in excess of what is required to operate
its generating units. The excess results primarily from a higher removal rate of
SO2 emissions at Springerville Units 1 and 2 following recent upgrades to
environmental plant components and related changes to plant operations. From
time to time, TEP will sell a portion of its excess Emissions Allowances. In the
first six months of 2005, TEP sold 5,000 SO2 Emissions Allowances, recognizing a
gain of $3 million. As of June 30, 2005, TEP has sold forward 2,500, 10,000 and
7,500 SO2 Emissions Allowances for settlement in 2005 (third quarter), 2006 and
2007, respectively.


LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

    TEP CASH FLOWS

     TEP's capital requirements consist primarily of capital expenditures and
optional and mandatory redemptions of long-term debt and capital lease
obligations. Cash flow from operations typically is the lowest in the first
quarter and highest in the third quarter due to TEP's summer peaking load.

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,                                             2005           2004
                                                                     -Millions of Dollars-
---------------------------------------------------------------- --------------- --------------
<S>                                                                  <C>              <C>
Net Cash Flows - Operating Activities                                $  74            $  119
   Capital Expenditures                                                (68)              (53)
---------------------------------------------------------------- --------------- --------------
          Net Cash Flows after Capital Expenditures*                     6                66
---------------------------------------------------------------- --------------- --------------
   Debt Maturities                                                       -                (1)
   Retirement of Capital Lease Obligations                             (49)              (44)
   Proceeds from Investment in Springerville
      Lease Debt and Equity                                              8                 8
---------------------------------------------------------------- --------------- --------------
Net Cash Flows Available after Required Payments*                    $ (35)             $ 29
================================================================ =============== ==============

* We believe that Net Cash Flows after Capital Expenditures and Net Cash Flows
Available After Required Payments, which are non-GAAP financial measures,
provide useful information to investors as measures of liquidity and our ability
to meet our capital requirements and mandatory redemptions of debt and capital
lease obligations.

</TABLE>

     During 2005, TEP expects to generate sufficient internal cash flows to fund
its operating activities, construction expenditures, required debt maturities,
and to pay dividends to UniSource Energy. However, TEP's cash flows may vary due
to changes in wholesale revenues, changes in short-term interest rates, and
other factors. TEP currently has $50 million available under its Revolving
Credit Facility which it may borrow if cash flows fall short of expectations or
if monthly cash requirements temporarily exceed available cash balances. As of
June 30, 2005, TEP had $40 million outstanding under its Revolving Credit
Facility, of which $30 million was repaid in July 2005. See UniSource Energy,
Liquidity and Capital Resources, UniSource Energy Credit Agreement, Use of
Proceeds, above, and Bond Issuances and Redemptions, below.


                                       45
<PAGE>


     OPERATING ACTIVITIES

     In the first six months of 2005, net cash flows from operating activities
declined by $45 million compared with the same period in 2004. The following
factors contributed to the decrease:


     2005 included:

     o    a $5 million increase in cash receipts from electric retail sales was
          offset by a $4 million decrease in cash receipts from wholesale sales
          due to the lower availability of excess power to sell into the
          wholesale market;

     o    a $23 million increase in fuel and purchased power costs paid, due to
          higher replacement power costs resulting from planned coal plant
          maintenance outages, lost energy from the expiration of the SCE
          Exchange in May 2005 and higher gas-related fuel costs.

     o    a $13 million increase in payments for O&M costs related to the
          planned outage at Springerville Unit 2 and maintenance costs at the
          San Juan Generating Station; O&M costs include $3 million in cash
          receipts from the sale of SO2 Emissions Allowances;

     o    a $5 million increase in wages paid due to a greater number of
          employees, rising wage levels and higher incentive compensation;

     o    an $11 million increase in interest received, due primarily to
          interest received from UniSource Energy when it repaid its $95 million
          inter-company loan to TEP; and

     o    a $2 million decrease in total interest paid due to lower capital
          lease obligation balances, lower long-term debt balances and lower
          annual fees under TEP's Credit Agreement that was entered into in May
          2005.

     2004 included:

     o    the return of a $17 million deposit related to TEP's second mortgage
          indenture.

     INVESTING ACTIVITIES

     Net cash used for investing activities was $3 million higher in the first
six months of 2005 compared with the same period in 2004, due to the following:

         2005 included:

     o    a $15 million increase in capital expenditures related to a planned
          maintenance outage at Springerville and TEP's share of the
          construction costs of the Luna Energy Facility; and

     o    other cash receipts of $7 million related to proceeds received from
          the redemption of a certificate of deposit and the sale of land by a
          TEP subsidiary.

     2004 included:

     o    the use of $4 million to invest in Springerville lease debt.

     FINANCING ACTIVITIES

     Net cash used for financing activities was $35 million higher in the first
six months of 2005 compared with the same period in 2004. The following factors
contributed to the increase:

     2005 included:


                                       46
<PAGE>


     o    a $281 million increase in repayments on long-term debt related to
          TEP's early redemption of $53 million of First Mortgage Bonds in the
          first three months of 2005, and the repurchase and redemption of $225
          million of fixed-rate tax exempt debt in May 2005;

     o    a $6 million increase in other financing costs related to
          reimbursement of merger expenses paid by UniSource Energy on behalf of
          TEP;

     o    a $5 million increase in scheduled payments made on capital lease
          obligations;

     o    a capital contribution of $110 million from UniSource Energy;

     o    the receipt of $95 million from UniSource Energy as a repayment for an
          inter-company loan;

     o    $40 million borrowed under TEP's revolving credit facility; and

     o    a $4 million decrease in debt issuance/retirement costs.

     2004 included:

     o    $7 million of dividends paid to UniSource Energy.

     At June 30, 2005, there were $40 million of outstanding borrowings under
TEP's revolving credit facility. TEP repaid $30 million of these amounts in July
2005. As of August 4, 2005, cash and cash equivalents available to TEP was
approximately $42 million.

     Capital Contribution from UniSource Energy
     ------------------------------------------

     On May 10, 2005, UniSource Energy made a $110 million capital contribution
to TEP. TEP used the proceeds during May 2005 to redeem or repurchase certain of
its existing debt through tender offers and redemptions. See Bond Issuance and
Redemptions, below.

     Bond Repurchases and Redemptions
     --------------------------------

     TEP made a sinking fund payment of $1 million on its 6.1% 1941 Mortgage
IDBs in January 2005. In March 2005, TEP redeemed at par the remaining $31
million of its 6.1% 1941 Mortgage IDBs due in 2008, as well as the remaining
$21 million of its 7.5% 1941 Mortgage IDBs due in 2006.

     On May 11, 2005, TEP purchased $147 million of its 1997 Pima Series B and
$74 million of its 1997 Pima Series C fixed-rate tax-exempt bonds (Repurchased
Bonds) at a price of $101.50 per $100 principal amount. On May 18, 2005, TEP
redeemed at par the remaining $4 million of bonds outstanding under those
series. TEP does not currently plan on canceling the Repurchased Bonds, which
will remain outstanding under their respective indentures; however, the
Repurchased Bonds will not be presented in our financial statements. TEP may
choose to resell the Repurchased Bonds to third parties or cancel them in the
future.

     As a result of the capital contribution, inter-company note repayment, and
the bond repurchases and redemptions, TEP's ratio of equity to total
capitalization (excluding capital leases) improved to 40.6% as of June 30, 2005,
which allows TEP to dividend up to 100% of its current year net income to
UniSource Energy.


                                       47
<PAGE>


     Capital Lease Obligations
     -------------------------

     At June 30, 2005, TEP had $716 million of total capital lease obligations
on its balance sheet. The table below provides a summary of the outstanding
lease amounts.

<TABLE>
<CAPTION>
                                                             BALANCE AT
     LEASED ASSET                                          JUNE 30, 2005              EXPIRATION
     ----------------------------------------------- --------------------------- ---------------------
                                                          - In Millions -
     <S>                                                       <C>                       <C>
     Springerville Unit 1                                      $432                      2014
     Springerville Coal Handling Facilities                     126                      2015
     Springerville Common Facilities                            104                      2020
     Sundt Unit 4                                                54                      2011
     Other Leases                                                 -                      2006
     ----------------------------------------------- ---------------------------
     Total Capital Lease Obligations                           $716
     =============================================== ===========================

</TABLE>

     Except for TEP's 13% equity interest in the Springerville Coal Handling
Facilities, TEP will not own these assets at the expiration of the leases. TEP
may renew the leases or purchase the leased assets at such time. The renewal and
purchase options for Springerville Unit 1 and Sundt Unit 4 are generally for
fair market value as determined at that time, while the purchase price option is
fixed for the Springerville Coal Handing Facilities and Common Facilities.

     TEP Credit Agreement
     --------------------

     On May 4, 2005, TEP entered into a new $401 million Credit Agreement (TEP
Credit Agreement) to replace its previous $401 million credit agreement. The TEP
Credit Agreement includes a $60 million revolving credit facility and a $341
million letter of credit facility to support $329 million of tax-exempt variable
rate bonds. The TEP Credit Agreement expires May 4, 2010 and is secured by $401
million of Mortgage Bonds.

     The TEP Credit Agreement restricts additional indebtedness, liens, sale of
assets and sale-leasebacks agreements. The TEP Credit Agreement also requires
TEP to meet a minimum cash coverage ratio and a maximum leverage ratio. If TEP
complies with the terms of the TEP Credit Agreement, TEP may pay dividends to
UniSource Energy. Certain regulatory actions may cause a decrease in the amount
that may be borrowed. As of June 30, 2005, TEP was in compliance with the terms
of the TEP Credit Agreement.

     If an event of default occurs, the TEP Credit Agreement may become
immediately due and payable. An event of default includes failure to make
required payments under the TEP Credit Agreement; change in control, as defined;
failure of TEP or certain subsidiaries to make payments or default on debt
greater than $20 million; or certain bankruptcy events at TEP or certain
subsidiaries.

     Interest rates and fees under the TEP Credit Agreement are based on a
pricing grid tied to TEP's credit ratings. Letter of credit fees are 0.875% per
annum and amounts drawn under a letter of credit would bear interest at LIBOR
plus 0.875% per annum. TEP pays interest on borrowings under the revolving
credit facility at LIBOR plus 0.875% or at the agent bank's reference rate. TEP
also pays a commitment fee of 0.20% on the unused portion of the revolving
credit facility.

     As of June 30, 2005, TEP had $40 million outstanding under its Revolving
Credit Facility. On May 10, 2005, TEP borrowed $25 million under its Revolving
Credit Facility in connection with the redemption of $225 million of fixed-rate
tax-exempt debt. TEP borrowed an additional $15 million on June 30, 2005, to
help pay its semi-annual capital lease obligations. At August 4, 2005, TEP had
$10 million outstanding under its revolving credit facility. See UniSource
Energy, Liquidity and Capital Resources, UniSource Energy Credit Agreement, Use
of Proceeds, above, and Bond Repurchases and Redemptions, above.

     Mortgage Indentures
     -------------------

     On June 10, 2005, TEP terminated its 1941 Mortgage (formerly known as its
First Mortgage). TEP's remaining mortgage is its 1992 Mortgage (formerly known
as its Second Mortgage).

     TEP's Credit Agreement limits the amount of mortgage bonds that may be
outstanding to no more than $650 million. At June 30, 2005, TEP had a total of
$539 million in outstanding mortgage bonds. Although the


                                       48
<PAGE>


1992 Mortgage would allow TEP to issue additional bonds, the limit imposed by
the TEP Credit Agreement is more restrictive and is currently the governing
limitation.

   CONTRACTUAL OBLIGATIONS

     There have been no significant changes in TEP's contractual obligations or
other commercial commitments from those reported in TEP's 2004 Annual Report on
Form 10-K, other than those reported above in Bond Repurchases and Redemption,
TEP Credit Agreement and Mortgage Indentures.

   DIVIDENDS ON COMMON STOCK

     TEP can pay dividends if it maintains compliance with the TEP Credit
Agreement and certain financial covenants. As of June 30, 2005, TEP was in
compliance with the terms of the TEP Credit Agreement.

     The ACC Holding Company Order, as modified by the UES Settlement Agreement,
restricted the amount of dividends that TEP may pay to UniSource Energy. Until
TEP's ratio of common equity to total capitalization (excluding capital lease
obligations) equaled 40%, TEP could not pay dividends in excess of 75% of its
net income. As of June 30, 2005, TEP's ratio of common equity to total
capitalization (excluding capital lease obligations) was 40.6%.

     The Federal Power Act states that dividends shall not be paid out of funds
properly included in capital accounts. Although the terms of the Federal Power
Act are unclear, we believe that there is a reasonable basis to pay dividends
from current year earnings.


                                     UNS GAS

RESULTS OF OPERATIONS
---------------------

     SECOND QUARTER 2005 RESULTS

     UNS Gas reported net income of less than $1 million in the second quarter
of 2005, compared with a net loss of $1 million in the second quarter of 2004.

     As of June 30, 2005, UNS Gas had approximately 135,870 retail customers, a
4% increase from last year. The table below shows UNS Gas' therm sales and
revenues for the second quarters of 2005 and 2004.

<TABLE>
<CAPTION>
                                                                    SALES                          REVENUE
     THREE MONTHS ENDED JUNE 30,                             2005             2004              2005           2004
     ------------------------------------------- ---------------------------------- --------------------------------
                                                          - Millions of Therms -          - Millions of Dollars -
     RETAIL THERM SALES:
        <S>                                           <C>                <C>              <C>             <C>
        Residential                                    11                8                $ 13            $ 11
        Commercial                                      6                4                   6               4
        Industrial                                      1                1                   1               1
        Public Authorities                              1                1                   1               1
     ------------------------------------------- ----------------- ---------------- ----------------- --------------
     TOTAL RETAIL THERM SALES                          19               14                  21              17
        Transport                                       -                -                   1               1
        Negotiated Sales Program (NSP)                  7                4                   4               2
     ------------------------------------------- ----------------- ---------------- ----------------- --------------
     TOTAL THERM SALES                                 26               18                $ 26            $ 20
     =========================================== ================= ================ ================= ==============

</TABLE>

     Retail therm sales were 36% higher in the second quarter of 2005 compared
with the same period last year due to customer growth and cooler weather. Retail
revenues increased $4 million compared with the second quarter of 2004.

     Through a Negotiated Sales Program (NSP) approved by the ACC, UNS Gas
supplies natural gas to some of its large transportation customers.
Approximately one half of the margin earned on these NSP sales is retained by
UNS Gas, while the remainder benefits retail customers through a credit to the
Purchased Gas


                                       49
<PAGE>


Adjustor (PGA) mechanism which reduces the gas commodity price. See Factors
Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment
Mechanism, below.

     The table below provides summary financial information for UNS Gas.

<TABLE>
<CAPTION>
     THREE MONTHS ENDED JUNE 30,                                 2005      2004
     -------------------------------------------------------- ---------------------------
                                                              - Millions of Dollars -
<S>                                                            <C>         <C>
     Gas Revenues                                              $ 26        $  20
     Other Revenues                                               1            1
     -------------------------------------------------------- ------------ --------------
          Total Operating Revenues                               27           21
     -------------------------------------------------------- ------------ --------------
     Purchased Gas Expense                                       17           16
     Other Operations and Maintenance Expense                     5            3
     Depreciation and Amortization                                2            1
     Taxes other than Income Taxes                                1            1
     -------------------------------------------------------- ------------ --------------
          Total Other Operating Expenses                         25           21
     -------------------------------------------------------- ------------ --------------

               Operating Income                                   2            -
     -------------------------------------------------------- ------------ --------------

     Total Interest Expense                                       2            2
     Income Tax Expense (Benefit)                                 -           (1)
     -------------------------------------------------------- ------------ --------------
                NET INCOME                                    $   -        $  (1)
     ======================================================== ============ ==============

</TABLE>

     YEAR-TO-DATE JUNE 30, 2005 RESULTS

     UNS Gas reported net income of $4 million in the first six months of 2005,
compared with $3 million in the same period last year.

     The table below shows UNS Gas' therm sales and revenues for the first six
months ended June 30, 2005 and 2004.

<TABLE>
<CAPTION>
                                                                    SALES                          REVENUE
     SIX MONTHS ENDED JUNE 30,                               2005             2004              2005           2004
     ------------------------------------------- ---------------------------------- --------------------------------
                                                          - Millions of Therms -          - Millions of Dollars -
     RETAIL THERM SALES:
<S>                                                     <C>              <C>              <C>             <C>
        Residential                                     41               39               $ 44            $ 43
        Commercial                                      16               15                 15              14
        Industrial                                       2                2                  1               1
        Public Authorities                               4                4                  3               4
     ------------------------------------------- ----------------- ---------------- ----------------- --------------
     TOTAL RETAIL THERM SALES                           63               60                 63              62
        Transport                                        -                -                  2               1
        Negotiated Sales Program (NSP)                  12               11                  8               6
     ------------------------------------------- ----------------- ---------------- ----------------- --------------
     TOTAL THERM SALES                                  75               71               $ 73            $ 69
     =========================================== ================= ================ ================= ==============

</TABLE>

     Retail therm sales were 6% higher in the first six months of 2005 compared
with the same period last year due primarily to customer growth. Retail revenues
increased $1 million in the first six months of 2005.


                                       50
<PAGE>


     The table below provides summary financial information for UNS Gas.

<TABLE>
<CAPTION>
                SIX MONTHS ENDED JUNE 30,                                     2005             2004
                -------------------------------------------------------- ---------------------------
                                                                          - Millions of Dollars -
<S>                                                                         <C>           <C>
                Gas Revenues                                                $ 73          $ 69
                Other Revenues                                                 1             1
                -------------------------------------------------------- ------------ --------------
                     Total Operating Revenues                                 74            70
                -------------------------------------------------------- ------------ --------------
                Purchased Gas Expense                                         48            45
                Other Operations and Maintenance Expense                      11            11
                Depreciation and Amortization                                  3             3
                Taxes other than Income Taxes                                  2             2
                -------------------------------------------------------- ------------ --------------
                     Total Other Operating Expenses                           64            61
                -------------------------------------------------------- ------------ --------------

                          Operating Income                                    10             9
                -------------------------------------------------------- ------------ --------------

                Total Interest Expense                                         3             3
                Income Tax Expense                                             3             3
                -------------------------------------------------------- ------------ --------------
                           NET INCOME                                        $ 4           $ 3
                ======================================================== ============ ==============

</TABLE>

FACTORS AFFECTING RESULTS OF OPERATIONS
---------------------------------------

   RATES AND REGULATION

     ENERGY COST ADJUSTMENT MECHANISM

     UNS Gas' retail rates include a PGA mechanism intended to address the
volatility of natural gas prices and allows UNS Gas to recover its costs through
a price adjustor. The PGA charge changes monthly based on an ACC approved
mechanism that compares the twelve-month rolling average gas cost to the base
cost of gas, subject to limitations on how much the price per therm may change
in a twelve month period. The difference between the actual cost of UNS Gas' gas
supplies and transportation contracts and that currently allowed by the ACC are
deferred and recovered or repaid through the PGA mechanism. When under or over
recovery trigger points are met, UNS Gas may request a PGA surcharge or
surcredit with the goal of collecting or returning the amount deferred from or
to customers over a twelve month period.

     In January 2005, UNS Gas requested the ACC approve a PGA surcharge of $0.06
per therm beginning April 1, 2005 and removed one year later, to recover its
excess gas purchase costs. The previous PGA surcharge of $0.1155 per therm took
effect October 1, 2003 and ended November 1, 2004. On March 31, 2005, the ACC
approved a PGA surcharge of $0.03 per therm beginning April 11, 2005 until the
excess gas purchase costs are fully recovered. Based on current and projected
gas prices and the rates currently in effect, we expect the PGA balance to
increase. Given the gas price projections and expected pipeline transportation
cost increases, UNS Gas may be required to request an increase in this
surcharge.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

     UNS Gas' capital requirements consist primarily of capital expenditures. In
the first six months of 2005, capital expenditures were $13 million. During
2005, UNS Gas expects to generate sufficient internal cash flows to fund its
operating activities and a portion of its construction expenditures. UNS Gas
will meet its remaining cash needs through a combination of capital
contributions from UniSource Energy and borrowings under a revolving credit
facility that was established in April 2005. See UNS Gas/UNS Electric Revolver,
below.

     In January 2005, UNS Gas established a short-term inter-company promissory
note to UniSource Energy, by which it may borrow up to $10 million for general
corporate purposes. On March 10, 2005, UniSource Energy contributed an
additional $6 million in capital to UNS Gas. UNS Gas used the proceeds of this
contribution to repay the $6 million outstanding on the inter-company promissory
note.


                                       51
<PAGE>


     The table below provides summary information for operating cash flow and
capital expenditures for the first six months of 2005 and 2004.

<TABLE>
<CAPTION>
     SIX MONTHS ENDED JUNE 30,                         2005            2004
     -------------------------------------------- ------------------------------
                                                     - Millions of Dollars -
<S>                                                     <C>            <C>
     Net Cash Flows - Operating Activities              $14            $ 20
     Capital Expenditures                                13               9
     -------------------------------------------- ---------------- -------------

</TABLE>

     UNS Gas/UNS Electric Revolver
     -----------------------------

     In April 2005, UNS Gas and UNS Electric entered into a $40 million
three-year unsecured revolving credit agreement due April 15, 2008, with a group
of lenders (the UNS Gas/UNS Electric Revolver). Either borrower may borrow up to
a maximum of $30 million; however, the total combined amount borrowed cannot
exceed $40 million. UNS Gas and UNS Electric intend to use the proceeds of any
loans or letters of credit for general corporate purposes.

     UNS Gas is only liable for UNS Gas' borrowings, and similarly, UNS Electric
is only liable for UNS Electric's borrowings under the UNS Electric/UNS Gas
Revolver. UES guarantees the obligations of both UNS Gas and UNS Electric.

     The borrowers pay interest at LIBOR plus 1.50% or at the agent bank's
reference rate plus 0.50%. UNS Gas and UNS Electric also pay a commitment fee of
0.45% on the unused portion of the revolving credit facility.

     The UNS Gas/UNS Electric Revolver contains restrictions on additional
indebtedness, liens, mergers and sales of assets. The UNS Gas/UNS Electric
Revolver also contains a maximum leverage ratio and a minimum cash flow to
interest coverage ratio for each borrower. As of June 30, 2005, UNS Gas and UNS
Electric were each in compliance with the terms of the UNS Gas/UNS Electric
Revolver.

     If an event of default occurs, the UNS Gas/UNS Electric Revolver may become
immediately due and payable. An event of default includes failure to make
required payments under the UNS Gas/UNS Electric Revolver; certain change in
control transactions, certain bankruptcy events of UNS Gas or UNS Electric, or
failure of UES, UNS Gas or UNS Electric to make payments or default on debt
greater than $4 million.

     UNS Gas and UNS Electric expect to draw upon the UNS Gas/UNS Electric
Revolver from time to time for seasonal working capital purposes and to fund a
portion of capital expenditures. As of June 30, 2005, UNS Gas and UNS Electric
had no borrowings outstanding under the UNS Gas/UNS Electric Revolver.

     Senior Unsecured Notes
     ----------------------

     UNS Gas has $100 million of senior unsecured notes outstanding that are
guaranteed by UES. The note purchase agreement for UNS Gas restricts
transactions with affiliates, mergers, liens, restricted payments, and
incurrence of indebtedness, and also contains a minimum net worth test. As of
June 30, 2005, UNS Gas was in compliance with the terms of its note purchase
agreement.

     UNS Gas must meet a leverage test and an interest coverage test in order to
issue additional debt or pay dividends. However, UNS Gas may, without meeting
these tests, refinance existing debt and incur up to $7 million in short-term
debt.


   DIVIDENDS ON COMMON STOCK

     The ACC limits dividend payments by UNS Gas to 75% of earnings, until the
ratio of UNS Gas' common equity to total capitalization reaches 40%. In March
2005, UniSource Energy made a capital contribution of $6 million to UNS Gas. At
June 30, 2005, the ratio of common equity to total capitalization for UNS Gas
was 41%.

     The note purchase agreement for UNS Gas contains restrictions on dividends.
UNS Gas may pay dividends so long as (a) no default or event of default exists
and (b) it could incur additional debt under the debt incurrence test. See
Senior Unsecured Notes, above. It is unlikely, however, that UNS Gas will pay
dividends in the next five years due to expected cash requirements for capital
expenditures.


                                       52
<PAGE>


                                  UNS ELECTRIC

RESULTS OF OPERATIONS
---------------------

     SECOND QUARTER 2005 RESULTS

     UNS Electric reported net income of $1 million in the second quarters of
2005 and 2004. Similar to TEP's operations, we expect UNS Electric's operations
to be seasonal in nature, with peak energy demand occurring in the summer
months.

     As of June 30, 2005, UNS Electric had approximately 87,461 retail
customers, a 5% increase from last year. The table below shows UNS Electric's
kWh sales and revenues for the second quarters of 2005 and 2004.

<TABLE>
<CAPTION>
                                                             SALES                               REVENUE
     THREE MONTHS ENDED JUNE 30,                    2005               2004               2005             2004
     ---------------------------------------- ------------------------------------- ----------------------------------
                                                      - Millions of kWh -                - Millions of Dollars -
     ELECTRIC RETAIL SALES:
<S>                                                <C>                  <C>              <C>              <C>
        Residential                                170                  140              $  17            $   15
        Commercial                                 156                  159                 16                16
        Industrial                                  45                   58                  3                 4
        Other                                        1                    1                  -                 -
     ---------------------------------------- ----------------- ------------------- ---------------- -----------------
     TOTAL ELECTRIC RETAIL SALES                   372                  358              $  36            $   35
     ======================================== ================= =================== ================ =================

</TABLE>

     Retail kWh sales 4% higher in the second quarter of 2005 compared with the
same period last year due to customer growth and warm weather.

     The table below provides summary financial information for UNS Electric.

<TABLE>
<CAPTION>
     THREE MONTHS ENDED JUNE 30,                                   2005             2004
     -------------------------------------------------------- ---------------------------
                                                               - Millions of Dollars -
<S>                                                               <C>             <C>
     Electric Revenues                                            $ 37            $ 35
     Other Revenues                                                  -               -
     -------------------------------------------------------- ------------ --------------
          Total Operating Revenues                                  37              35
     -------------------------------------------------------- ------------ --------------
     Purchased Energy Expense                                       24              24
     Other Operations and Maintenance Expense                        6               5
     Depreciation and Amortization                                   3               2
     Taxes other than Income Taxes                                   1               1
     -------------------------------------------------------- ------------ --------------
          Total Other Operating Expenses                            34              32
     -------------------------------------------------------- ------------ --------------

               Operating Income                                      3               3
     -------------------------------------------------------- ------------ --------------

     Total Interest Expense                                          1               1
     Income Tax Expense                                              1               1
     -------------------------------------------------------- ------------ --------------
                NET INCOME                                         $ 1            $  1
     ======================================================== ============ ==============

</TABLE>

     YEAR-TO-DATE JUNE 30, 2005 RESULTS

     UNS Electric reported net income of $1 million in the first six months of
2005, compared with net income of $2 million in the same period last year. The
table below shows UNS Electric's kWh sales and revenues for the six months ended
June 30, 2005 and 2004.


                                       53
<PAGE>


<TABLE>
<CAPTION>
                                                             SALES                               REVENUE
     SIX MONTHS ENDED JUNE 30,                      2005               2004               2005             2004
     ---------------------------------------- ------------------------------------- ----------------------------------
                                                      - Millions of kWh -                - Millions of Dollars -
     ELECTRIC RETAIL SALES:
<S>                                                <C>                  <C>         <C>                   <C>
        Residential                                321                  292         $  33                 $  30
        Commercial                                 278                  280            29                    29
        Industrial                                  87                  101             6                     7
        Other                                        2                    2             -                     -
     ---------------------------------------- ----------------- ------------------- ---------------- -----------------
     TOTAL ELECTRIC RETAIL SALES                   688                  675         $  68                 $  66
     ======================================== ================= =================== ================ =================

</TABLE>

     Retail kWh sales increased 2% in the first six months of 2005 compared with
the same period last year, due primarily to customer growth.

     The table below provides summary financial information for UNS Electric.

<TABLE>
<CAPTION>
     SIX MONTHS ENDED JUNE 30,                             2005             2004
     ------------------------------------------------ --------------------------
                                                       - Millions of Dollars -
<S>                                                      <C>             <C>
     Electric Revenues                                   $  68           $  66
     Other Revenues                                          -               1
     ------------------------------------------------ ------------ -------------
          Total Operating Revenues                          68              67
     ------------------------------------------------ ------------ -------------
     Purchased Energy Expense                               45              45
     Other Operations and Maintenance Expense               12              11
     Depreciation and Amortization                           5               4
     Taxes other than Income Taxes                           2               1
     ------------------------------------------------ ------------ -------------
          Total Other Operating Expenses                    64              61
     ------------------------------------------------ ------------ -------------

               Operating Income                              4               6
     ------------------------------------------------ ------------ -------------

     Total Interest Expense                                  2               2
     Income Tax Expense                                      1               2
     ------------------------------------------------ ------------ -------------
                NET INCOME                                $ 1            $   2
     ================================================ ============ =============

</TABLE>


FACTORS AFFECTING RESULTS OF OPERATIONS
---------------------------------------

   COMPETITION

     As required by the ACC order approving UniSource Energy's acquisition of
the Citizens' Arizona gas and electric assets, on November 3, 2003, UNS Electric
filed with the ACC a plan to open its service territories to retail competition
by December 31, 2003. The plan addresses all aspects of implementation. It
includes UNS Electric's unbundled distribution tariffs for both standard offer
customers and customers that choose competitive retail access, as well as Direct
Access and Settlement Fee schedules. UNS Electric's direct access rates for both
transmission and ancillary services will be based upon its FERC Open Access
Transmission Tariff. The plan is subject to review and approval by the ACC. As a
result of the court decisions concerning the ACC's Retail Electric Competition
Rules, we are unable to predict when and how the ACC will address this plan. See
Tucson Electric Power Company, Factors Affecting Results of Operations,
Competition, above for information regarding the recent Arizona Court of Appeals
decision.

   RATES AND REGULATION

     ENERGY COST ADJUSTMENT MECHANISM

     UNS Electric's retail rates include a Purchased Power and Fuel Adjustor
Clause (PPFAC), which allows for a separate surcharge or surcredit to the base
rate for delivered purchased power to collect or return under or


                                       54
<PAGE>


over recovery of costs. The ACC has approved a PPFAC surcharge of $0.01825 per
kWh to recover the cost of the current full-requirements power supply agreement
with PWCC.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

     UNS Electric's capital requirements consist primarily of capital
expenditures. In the first six months of 2005, capital expenditures were $9
million.

     To improve the reliability of service in Santa Cruz County, UNS Electric
plans to build a 20 MW gas-fired combustion turbine as well as upgrade its
existing 115 kV line. The turbine should be in place by mid-2006, helping to
improve reliability while the approval and permitting process for the 345 kV
Tucson to Nogales transmission line continues. UNS Electric expects its capital
expenditures for the second half of 2005 to increase by approximately $8 million
related to the turbine.

     During 2005, UNS Electric expects to generate sufficient internal cash
flows to fund its operating activities and a portion of its construction
expenditures. UNS Electric will meet its remaining cash needs through a
combination of capital contributions from UniSource Energy and borrowings under
a revolving credit facility that was established in April 2005.

     On March 10, 2005, UniSource Energy contributed an additional $4 million of
capital to UNS Electric.


     The table below provides summary information for operating cash flow and
capital expenditures for the first quarters of 2005 and 2004.

<TABLE>
<CAPTION>
     SIX MONTHS ENDED JUNE 30,                                 2005            2004
     ---------------------------------------------------- -------------------------------
                                                             - Millions of Dollars -
<S>                                                             <C>             <C>
     Net Cash Flows - Operating Activities                      $9              $ 8
     Capital Expenditures                                        9                9
     ---------------------------------------------------- ---------------- --------------

</TABLE>


     UNS Gas/UNS Electric Revolver
     -----------------------------

     See UNS Gas, Liquidity and Capital Resources, UNS Gas/UNS Electric Revolver
above for description of UNS Electric's unsecured revolving credit agreement.

     Senior Unsecured Notes
     ----------------------

     UNS Electric has $60 million of senior unsecured notes outstanding that are
guaranteed by UES. The note purchase agreement for UNS Electric restricts
transactions with affiliates, mergers, liens, restricted payments, and
incurrence of indebtedness and also contains a minimum net worth test. As of
June 30, 2005, UNS Electric was in compliance with the terms of its note
purchase agreement.

     UNS Electric must meet a leverage test and an interest coverage test to
issue additional debt or to pay dividends. However, UNS Electric may, without
meeting these tests, refinance existing debt and incur up to $5 million in
short-term debt.


   DIVIDENDS ON COMMON STOCK

     The ACC limits dividend payments by UNS Electric to 75% of earnings, until
the ratio of common equity to total capitalization reaches 40%. In March 2005,
UniSource Energy made a capital contribution of $4 million to UNS Electric. At
June 30, 2005, the ratio of common equity to total capitalization for UNS
Electric was 43%.

     The note purchase agreement for UNS Electric contains restrictions on
dividends. UNS Electric may pay dividends so long as (a) no default or event of
default exists and (b) it could incur additional debt under the debt incurrence
test. See Senior Unsecured Notes, above. It is unlikely, however, that UNS
Electric will pay dividends in the next five years due to expected cash
requirements for capital expenditures.


                                       55
<PAGE>


                            GLOBAL SOLAR ENERGY, INC.

RESULTS OF OPERATIONS
---------------------

     UniSource Energy accounts for Global Solar under the consolidation method
and recognizes 100% of Global Solar's losses. Global Solar recognizes expense
when funding is used for research, development and administrative costs. The
table below provides a breakdown of the net losses recorded by Global Solar:

<TABLE>
<CAPTION>
   THREE MONTHS ENDED JUNE 30,                                         2005           2004
   --------------------------------------------------------------- -------------- -------------
                                                                     - Millions of Dollars -
   Global Solar
      <S>                                                            <C>            <C>
      Operating Revenues                                             $   1          $   2
      Research & Development Contract Expenses & Losses                 (1)            (1)
      Depreciation & Amortization Expense                               (1)            (1)
      Administrative & Other Costs                                      (2)            (2)
      Income Tax Benefits                                                1              1
   --------------------------------------------------------------- -------------- -------------
   Total Global Solar Net Loss                                       $  (2)         $  (1)
   =============================================================== ============== =============

   SIX MONTHS ENDED JUNE 30,                                           2005           2004
   --------------------------------------------------------------- -------------- -------------
                                                                     - Millions of Dollars -
   Global Solar
      Operating Revenues                                             $   2          $   3
      Research & Development Contract Expenses & Losses                 (1)            (2)
      Depreciation & Amortization Expense                               (2)            (1)
      Administrative & Other Costs                                      (4)            (4)
      Income Tax Benefits                                                2              2
   --------------------------------------------------------------- -------------- -------------
   Total Global Solar Net Loss                                       $  (3)         $  (2)
   =============================================================== ============== =============

</TABLE>

     GLOBAL SOLAR COMMITMENTS

     UniSource Energy intends to cease additional funding of Global Solar. To
that end, Millennium plans to seek additional investors for Global Solar, or
sell all or part of its interest, or a combination of both, to preserve the
value of Global Solar. We anticipate that any operating and capital funding
required to maintain Global Solar in the interim will be provided only out of
existing Millennium cash or cash returns from other Millennium investments. We
believe such cash and returns will be adequate for that purpose and to fund
Millennium's remaining commitments to Global Solar. In February 2005, Millennium
was authorized to fund up to an additional $5 million for capital expenditures
and operations at Global Solar. Millennium funded $3 million of this commitment
during the first six months of 2005. Global Solar has $1 million in commitments
to incur future expenses related to government contracts.


                                      OTHER

RESULTS OF OPERATIONS
---------------------

     Other non-reportable segments consist of UniSource Energy parent company
expenses, which includes interest expense (net of tax) related to the UniSource
Energy Convertible Senior Notes, the UniSource Credit Agreement, a note payable
from UniSource Energy to TEP; income and losses from Millennium investments
other than Global Solar, and income and losses from UED. The note payable from
UniSource Energy to TEP was repaid in March 2005.


                                       56
<PAGE>


     The table below summarizes the income and losses for the Other
non-reportable segments:

<TABLE>
<CAPTION>
   THREE MONTHS ENDED JUNE 30,                                                              2005            2004
   ------------------------------------------------------------------------------------ -------------- ---------------
                                                                                           - Millions of Dollars -

<S>                                                                                         <C>           <C>
   Other Millennium Investments                                                             $   -         $    (2)
   UniSource Energy Development Company                                                         -              (1)
   UniSource Energy Parent Company                                                             (2)             (1)
   ------------------------------------------------------------------------------------ -------------- ---------------
        Total Other                                                                         $  (2)        $    (4)
   ==================================================================================== ============== ===============

   SIX MONTHS ENDED JUNE 30,                                                                2005            2004
   ------------------------------------------------------------------------------------ -------------- ---------------
                                                                                           - Millions of Dollars -

   Other Millennium Investments                                                             $  (1)        $     1
   UniSource Energy Development Company                                                         -              (1)
   UniSource Energy Parent Company                                                             (2)             (3)
   ------------------------------------------------------------------------------------ -------------- ---------------
        Total Other                                                                         $  (3)        $    (3)
   ==================================================================================== ============== ===============

</TABLE>

     OTHER MILLENNIUM INVESTMENTS

     Millennium accounts for its investments under the consolidation method and
the equity method. In some cases, Millennium is an investment's sole provider of
funding. When this is the case, Millennium recognizes 100% of an investment's
losses, because as sole provider of funds it bears all of the financial risk. To
the extent that an investment becomes profitable and Millennium has recognized
losses in excess of its percentage ownership, Millennium will recognize 100% of
an investment's net income until Millennium's recognized losses equal its
ownership percentage of losses.

     Results from Other Millennium Investments for the three months ended June
30, 2005 include after-tax losses of less than $1 million each from several of
Millennium's other investments.

     Results from Other Millennium Investments for the three months ended June
30, 2004 include after-tax gains of $3 million from Haddington and $1 million
from MicroSat. These gains were partially offset by after-tax losses of less
than $1 million each from several of Millennium's other investments.

     CONSOLIDATED MILLENNIUM INVESTMENTS AND COMMITMENTS

     In 2004, Millennium funded $1.5 million and Dow Corning Enterprises, Inc.
(DCEI) funded $1 million in debt commitments to Infinite Power Solutions, Inc.
(IPS).

     In April 2005, Millennium and DCEI entered into a transaction with third
parties that included the formation of a new Delaware corporation, Battco, Inc.
(Battco), intended to carry on the current business of IPS. As its contribution
to the transaction, IPS transferred substantially all of its assets to Battco in
exchange for five million shares of Battco common stock. The transaction also
provides that Millennium and some of the third parties will contribute a
combined total of approximately $9 million to a subsequent Battco $25 million
preferred stock offering with the remainder coming from outside investors.
Millennium committed to fund $3.3 million of the $9 million, of which $1 million
has already been funded as a secured convertible loan to be converted to shares
of Battco preferred stock at the close of the $25 million financing.

     MEG is in the process of winding down its activities and does not expect to
engage in any new activities after 2005. Millennium is in the process of selling
its remaining interest in Nations Energy Corporation (Nations Energy).
Millennium's remaining commitments for other Millennium investments are $4
million to Haddington and $3 million to Valley Ventures.

     In July 2005, Millennium received $4 million as a return of its investment
in Carboelectrica Sabinas, S. de R.L. de C.V., (Sabinas) a Mexican limited
liability company. As a result of the $4 million payment the book value of the
investment in Sabinas was reduced to approximately $14 million. Millennium owns
50% of Sabinas.


                                       57
<PAGE>


     Also in July 2005, Millennium received a $4 million payment on a note
receivable from a subsidiary of Mirant Corporation. We expect to receive the
remaining payment of $5 million in July 2006.

     It is our intention for UniSource Energy to cease making capital
contributions to Millennium. We anticipate that the funding required to fund
Millennium's remaining commitments will be provided only out of existing
Millennium cash or cash returns from Millennium investments. We believe such
cash and returns will be adequate to fund Millennium's remaining commitments.


CRITICAL ACCOUNTING ESTIMATES
-----------------------------

     In preparing financial statements under Generally Accepted Accounting
Principles (GAAP), management exercises judgment in the selection and
application of accounting principles, including making estimates and
assumptions. UniSource Energy and TEP consider Critical Accounting Estimates to
be those that could result in materially different financial statement results
if our assumptions regarding application of accounting principles were
different. UniSource Energy and TEP describe their Critical Accounting Estimates
below. Other significant accounting policies and recently issued accounting
standards are discussed in the 2004 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

     TEP, UNS Gas and UNS Electric generally use the same accounting policies
and practices used by unregulated companies for financial reporting under GAAP.
However, sometimes these principles, such as the Financial Accounting Standards
Board's (FASB) Statement of Financial Accounting Standards No. 71, Accounting
for the Effects of Certain Types of Regulation (FAS 71), require special
accounting treatment for regulated companies to show the effect of regulation.
For example, in setting TEP, UNS Gas and UNS Electric's retail rates, the ACC
may not allow TEP, UNS Gas or UNS Electric to currently charge their customers
to recover certain expenses, but instead may require that these expenses be
charged to customers in the future. In this situation, FAS 71 requires that TEP,
UNS Gas and UNS Electric defer these items and show them as regulatory assets on
the balance sheet until TEP, UNS Gas and UNS Electric are allowed to charge
their customers. TEP, UNS Gas and UNS Electric then amortize these items as
expense to the income statement as these charges are recovered from customers.
Similarly, certain revenue items may be deferred as regulatory liabilities,
which are also eventually amortized to the income statement as rates to
customers are reduced.

     The conditions a regulated company must satisfy to apply the accounting
policies and practices of FAS 71 include:

     o    an independent regulator sets rates;

     o    the regulator sets the rates to recover specific costs of delivering
          service; and

     o    the service territory lacks competitive pressures to reduce rates
          below the rates set by the regulator.

     TEP

     In November 1999, upon approval by the ACC of the Settlement Agreement
relating to recovery of TEP's transition costs and standard retail rates, TEP
discontinued application of FAS 71 to its generation operations. TEP's
transmission and distribution regulatory assets, net of regulatory liabilities,
totaled $201 million at June 30, 2005, $30 million of which is not presently
included in the rate base and consequently is not earning a return on
investment. These regulatory assets are being recovered through the cost of
service or are authorized to be collected in future base rates. TEP's
transmission and distribution regulatory assets, net of regulatory liabilities,
totaled $225 million at December 31, 2004.

     TEP continues to apply FAS 71 to its regulated operations, which include
the transmission and distribution portions of its business. TEP regularly
assesses whether it can continue to apply FAS 71 to these operations. If TEP
stopped applying FAS 71 to its remaining regulated operations, it would write
off the related balances of its regulatory assets as an expense and its
regulatory liabilities as income on its income statement. Based on the
regulatory asset balances, net of regulatory liabilities, at June 30, 2005, if
TEP had stopped applying FAS 71 to its remaining cost-based regulated
operations, it would have recorded an extraordinary after-tax loss of
approximately $121 million. While regulatory orders and market conditions may
affect cash flows, TEP's cash flows would not be affected if it stopped applying
FAS 71 unless a regulatory order limited its ability to recover the cost of its
regulatory assets.


                                       58
<PAGE>


     UNS GAS AND UNS ELECTRIC

     UNS Gas and UNS Electric's regulatory liabilities, net of regulatory
assets, collectively totaled $6 million at June 30, 2005 and $4 million at
December 31, 2004. UNS Gas and UNS Electric's regulatory assets and liabilities
are included in rate base and consequently are earning a return on investment.
If UNS Gas and UNS Electric stopped applying FAS 71 to their regulated
operations, they would write off the related balances of regulatory assets as an
expense and regulatory liabilities as income on their income statements. Based
on the balances of regulatory liabilities and assets at June 30, 2005, if UNS
Gas and UNS Electric had stopped applying FAS 71 to their regulated operations,
they would have collectively recorded an extraordinary after-tax gain of $3
million. UNS Gas and UNS Electric's cash flows would not be affected if they
stopped applying FAS 71 unless a regulatory order limited their ability to
recover the cost of their regulatory assets.

     ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS

     FAS 143, issued by the FASB in June 2001, requires entities to record the
fair value of a liability for a legal obligation to retire an asset in the
period in which the liability is incurred. A legal obligation is a liability
that a party is required to settle as a result of an existing or enacted law,
statute, ordinance or contract. When the liability is initially recorded, the
entity should capitalize a cost by increasing the carrying amount of the related
long-lived asset. Over time, the liability is adjusted to its present value by
recognizing accretion expense as an operating expense in the income statement
each period, and the capitalized cost is depreciated over the useful life of the
related asset. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss if the actual costs
differ from the recorded amount.

     TEP

     Prior to adopting FAS 143, costs for final removal of all owned generation
facilities were accrued as an additional component of depreciation expense.
Under FAS 143, only the costs to remove an asset with legally binding retirement
obligations will be accrued over time through accretion of the asset retirement
obligation and depreciation of the capitalized asset retirement cost.

     TEP has identified legal obligations to retire generation plant assets
specified in land leases for its jointly-owned Navajo and Four Corners
Generating Stations. The land on which these stations reside is leased from the
Navajo Nation. The provisions of the leases require the lessees to remove the
facilities upon request of the Navajo Nation at the expiration of the leases.
TEP also has certain environmental obligations at the San Juan Generating
Station. TEP has estimated that its share of the cost to remove the Navajo and
Four Corners facilities and settle the San Juan environmental obligations will
be approximately $38 million at the date of retirement. No other legal
obligations to retire generation plant assets were identified.

     On November 12, 2004, TEP, Phelps Dodge Energy Services, LLC and PNM
Resources, Inc. each purchased from Duke Energy North America, LLC a one-third
interest in a limited liability company which owns the partially constructed
natural gas-fired Luna Energy Facility (Luna) in southern New Mexico. Luna is
designed as a 570-MW combined cycle plant and is expected to be operational by
the summer of 2006. The new owners assumed asset retirement obligations to
remove certain piping and evaporation ponds and to restore the ground to its
original condition. TEP has estimated its share to settle the obligations will
be approximately $2 million at the date of retirement.

     TEP has various transmission and distribution lines that operate under land
leases and rights of way that contain end dates and restorative clauses. TEP
operates its transmission and distribution lines as if they will be operated in
perpetuity and would continue to be used or sold without land remediation. As a
result, TEP is not recognizing the costs of final removal of the transmission
and distribution lines in the financial statements. As of June 30, 2005, TEP had
accrued $73 million for the net cost of removal for the interim retirements from
its transmission, distribution and general plant. As of December 31, 2004, TEP
had accrued $67 million for these removal costs. The amount is recorded as a
regulatory liability.

     Amounts recorded under FAS 143 are subject to various assumptions and
determinations, such as determining whether a legal obligation exists to remove
assets, estimating the fair value of the costs of removal, estimating when final
removal will occur, and the credit-adjusted risk-free interest rates to be used
to discount future liabilities. Changes that may arise over time with regard to
these assumptions and determinations will change amounts recorded in the future
as expense for asset retirement obligations.


                                       59
<PAGE>


     If TEP retires any asset at the end of its useful life, without a legal
obligation to do so, it will record retirement costs at that time as incurred or
accrued. TEP does not believe that the adoption of FAS 143 will result in any
change in retail rates since all matters relating to the rate-making treatment
of TEP's generating assets have been determined pursuant to the Settlement
Agreement.

     UES

     UES has various transmission and distribution lines that operate under land
leases and rights of way that contain end dates and restorative clauses. UES
operates its transmission and distribution lines as if they will be operated in
perpetuity and would continue to be used or sold without land remediation. As a
result, UES is not recognizing the cost of final removal of the transmission and
distribution lines in the financial statements. UES had accrued $3 million as of
June 30, 2005 and $2 million as of December 31, 2004, for the net cost of
removal for interim retirements from its transmission, distribution and general
plant. The amount is recorded as a regulatory liability.

     PENSION AND OTHER POST RETIREMENT BENEFIT PLAN ASSUMPTIONS

     We record plan assets, obligations, and expenses related to pension and
other postretirement benefit plans based on actuarial valuations. These
valuations include key assumptions on discount rates, expected returns on plan
assets, compensation increases and health care cost trend rates. These actuarial
assumptions are reviewed annually and modified as appropriate. The effect of
modifications is generally recorded or amortized over future periods. We believe
that the assumptions used in recording obligations under the plans are
reasonable based on prior experience, market conditions and the advice of plan
actuaries.

     TEP

     TEP discounted its future pension plan obligations at December 31, 2004
using rates of 6.1% for its Salaried and Union Plans and 6.0% for its Excess
Benefit Plan. The discount rate used at December 31, 2003 was 6.25% for all
plans. TEP discounted its other postretirement plan obligations using a rate of
5.9% at December 31, 2004, compared with 5.5% at December 31, 2003. TEP
determines the discount rate annually based on the rates currently available on
high-quality, long-term bonds. TEP looks to bonds that receive one of the two
highest ratings given by a recognized rating agency whose future cash flows
match the timing and amount of expected future benefit payments.

     The pension liability and future pension expense both increase as the
discount rate is reduced. A decrease in the discount rate results in an increase
in the Projected Benefit Obligation (PBO) and the service cost component of
pension expense. Additionally, the recognized actuarial loss is significantly
impacted by a reduction in the discount rate. Since the PBO increases with the
decrease in discount rate, the obligation is that much larger than would
normally occur due to normal growth of the plan. This leads to an actuarial loss
(or a greater actuarial loss than would occur in the absence of the discount
rate change), which is amortized over future periods leading to a greater
expense. The resulting change in the interest cost component of pension expense
is dependent on the effect that the change in the discount rate has on the PBO
and will vary based on employee demographics. The effect of the lower rate used
to calculate the interest cost is offset to some degree by a larger obligation.
The relative magnitude of these two changes determines whether interest cost
will increase or decrease. For TEP's pension plans, a 25 basis point decrease in
the discount rate would increase the accumulated benefit obligation (ABO) by
approximately $5 million and the related plan expense for 2005 by approximately
$1 million. A similar increase in the discount rate would decrease the ABO by
approximately $5 million and the related plan expense for 2005 by approximately
$1 million. For TEP's plan for other postretirement benefits, a 25 basis point
change in the discount rate would increase or decrease the accumulated
postretirement benefit obligation (APBO) by approximately $2 million. A 25 basis
point change in the discount rate would not have a significant impact on the
related plan expense for 2005.

     TEP calculates the market-related value of plan assets using the fair value
of plan assets on the measurement date. TEP assumed that its plans' assets would
generate a long-term rate of return of 8.5% at December 31, 2004 and 8.75% at
December 31, 2003. In establishing its assumption as to the expected return on
plan assets, TEP reviews the plans' asset allocation and develops return
assumptions for each asset class based on advice from an investment consultant
and the plans' actuary that includes both historical performance analysis and
forward looking views of the financial markets. Pension expense increases as the
expected rate of return on plan assets decreases. A 25 basis point change in the
expected return on plan assets would not have a significant impact on pension
expense for 2005.


                                       60
<PAGE>


     TEP used an initial health care cost trend rate of 11.0% in valuing its
postretirement benefit obligation at December 31, 2004. This rate reflects both
market conditions and the plan's experience. Assumed health care cost trend
rates have a significant effect on the amounts reported for health care plans. A
1% increase in assumed health care cost trend rates would increase the
postretirement benefit obligation by approximately $5 million and the related
plan expense by approximately $1 million. A similar decrease in assumed health
care cost trend rates would decrease the postretirement benefit obligation by
approximately $4 million and the related plan expense by less than $1 million.

     TEP recorded a minimum pension liability in Other Comprehensive Income of
approximately $20 million at December 31, 2004, compared with $3 million at
December 31, 2003. This increase resulted primarily from changes in actuarial
assumptions including revised retirements rates, updated mortality rates and a
reduction in the assumed discount rate.

     Based on the above assumptions, TEP will record pension expense of
approximately $10 million and other postretirement benefit expense of $7 million
ratably throughout 2005. TEP will make required pension plan contributions of $6
million in 2005. TEP's other postretirement benefit plan is not funded. TEP
expects to make benefit payments to retirees under the postretirement benefit
plan of approximately $3 million in 2005.

     UNS GAS AND UNS ELECTRIC

     Concurrent with the acquisition of the Arizona gas and electric system
assets from Citizens on August 11, 2003, UES established a pension plan for
substantially all employees of UNS Gas and UNS Electric. UES did not assume the
pension obligation for employees' years of service with Citizens.

     UES discounted its future pension plan obligations using a rate of 6.1% at
December 31, 2004 and 6.25% at December 31, 2003. For UES' pension plan, a 25
basis point change in the discount rate would have minimal effect on either the
ABO or the related pension expense. UES recorded a minimum pension liability and
an offsetting Intangible Asset of less than $1 million at December 31, 2004 and
approximately $1 million at December 31, 2003. UES will record pension expense
of $1 million in 2005. UES will make a pension plan contribution of $1 million
in 2005.

     On the acquisition date, UES assumed the obligation to provide
postretirement benefits for a small population of former Citizens employees,
both active and retired. The plan is not funded. UES discounted its other
postretirement plan obligations using a rate of 5.9% at December 31, 2004,
compared with 5.5% at December 31, 2003. Postretirement medical benefit expenses
are insignificant to UES' operations.

ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES

     A derivative financial instrument or other contract derives its value from
another investment or designated benchmark. TEP enters into forward contracts to
purchase or sell a specified amount of capacity or energy at a specified price
over a given period of time, typically for one month, three months, or one year,
within established limits to take advantage of favorable market opportunities.
In general, TEP enters into forward purchase contracts when market conditions
provide the opportunity to purchase energy for its load at prices that are below
the marginal cost of its supply resources or to supplement its own resources
(e.g., during plant outages and summer peaking periods). TEP enters into forward
sales contracts when it forecasts that it has excess supply and the market price
of energy exceeds its marginal cost. The majority of TEP's forward contracts are
considered to be normal purchases and sales and, therefore, are not required to
be marked to market. However, some of these forward contracts are considered to
be derivatives, which TEP marks to market by recording unrealized gains and
losses and adjusting the related assets and liabilities on a monthly basis to
reflect the market prices at the end of the month.

     TEP has a natural gas supply agreement under which it purchases all of its
gas requirements at spot market prices from Southwest Gas Corporation (SWG). TEP
also has agreements to purchase power that are priced using spot market gas
prices. These contracts meet the definition of normal purchases and are not
required to be marked to market. During 2004 and early 2005, in an effort to
minimize price risk on these purchases, TEP entered into commodity price swap
agreements under which TEP purchases gas at fixed prices and simultaneously
sells gas at spot market prices. The spot market price in the swap agreements is
tied to the same index as the purchases under the SWG and purchased power
contracts. These swap agreements, which expire during the summer months through
2008, were entered into with the goal of locking in fixed prices on at least 45%
and not more than 80% of TEP's expected summer monthly gas risk prior to
entering into the month. The swap agreements are marked to market on a monthly
basis; however, since the agreements satisfy the requirements for


                                       61
<PAGE>


cash flow hedge accounting, the unrealized gains and losses are recorded in
Other Comprehensive Income, a component of Common Stock Equity, rather than
being reflected in the income statement. As the gains and losses on these cash
flow hedges are realized, a reclassification adjustment is recorded in Other
Comprehensive Income for realized gains and losses that are included in Net
Income.

     TEP manages the risk of counterparty default by performing financial credit
reviews, setting limits, monitoring exposures, requiring collateral when needed,
and using a standardized agreement which allows for the netting of current
period exposures to and from a single counterparty.

     UNS Gas and UNS Electric do not currently have any contracts that are
required to be marked to market. UNS Gas does have a natural gas supply and
management agreement under which it purchases substantially all of its gas
requirements at market prices from BP Energy Company (BP). However, the contract
terms allow UNS Gas to lock in fixed prices on a portion of its gas purchases by
entering into fixed price forward contracts with BP at various times during the
year. This enables UNS Gas to provide more stable prices to its customers. These
purchases are made up to three years in advance with the goal of locking in
fixed prices on at least 45% and not more than 80% of the expected monthly gas
consumption prior to entering into the month. These forward contracts, as well
as the main gas supply contract, meet the definition of normal purchases and
therefore are not required to be marked to market.

     MEG, a wholly-owned subsidiary of Millennium, enters into swap agreements,
options and forward contracts relating to Emissions Allowances and coal. MEG
marks its trading contracts to market by recording unrealized gains and losses
and adjusting the related assets and liabilities on a monthly basis to reflect
the market prices at the end of the month. In accordance with UniSource Energy's
intention to cease making capital contributions to Millennium, Millennium has
significantly reduced the holdings and activity of MEG. MEG is in the process of
winding down its activities and will not engage in any new activities after
2005.

     The market prices used to determine fair values for TEP and MEG's
derivative instruments at June 30, 2005 are estimated based on various factors
including broker quotes, exchange prices, over the counter prices and time
value. For TEP's forward power contracts, a 10% decrease in market prices would
result in a decrease in unrealized losses of less than $1 million, while a 10%
increase in market prices would result in an increase in unrealized losses of
less than $1 million. For TEP's gas swap agreements, a 10% decrease in market
prices would result in a $4 million decrease in unrealized gains reported in
Other Comprehensive Income, while a 10% increase in market prices would result
in a $4 million increase in unrealized gains reported in Other Comprehensive
Income. For MEG's remaining trading contracts, a 10% decrease in market prices
or a 10% increase in market prices would be immaterial.

     Because of the complexity of derivatives, the FASB established a
Derivatives Implementation Group (DIG). To date, the DIG has issued more than
100 interpretations to provide guidance in applying Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (FAS 133). As the DIG or the FASB continues to issue interpretations,
TEP, UNS Gas and UNS Electric may change the conclusions they have reached and,
as a result, the accounting treatment and financial statement impact could
change in the future.

     See Market Risks - Commodity Price Risk in Item 3.

   UNBILLED REVENUE - TEP, UNS GAS AND UNS ELECTRIC

     TEP's, UNS Gas's and UNS Electric's retail revenues include an estimate of
MWhs/therms delivered but unbilled at the end of each period. Unbilled revenues
are dependent upon a number of factors that require management's judgment
including estimates of retail sales and customer usage patterns. The unbilled
revenue is estimated by comparing the estimated MWhs/therms delivered to the
MWhs/therms billed to TEP, UNS Gas and UNS Electric retail customers. The excess
of estimated MWhs/therms delivered over MWhs/therms billed is then allocated to
the retail customer classes based on estimated usage by each customer class.
TEP, UNS Gas and UNS Electric then record revenue for each customer class based
on the various bill rates for each customer class. Due to the seasonal
fluctuations of TEP's actual load, the unbilled revenue amount increases during
the spring and summer months and decreases during the fall and winter months.
The unbilled revenue amount for UNS Gas sales increases during the fall and
winter months and decreases during the spring and summer months, whereas, the
unbilled revenue amount for UNS Electric sales increases during the spring and
summer months and decreases during the fall and winter months.


                                       62
<PAGE>


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

     We calculate depreciation expense based on our estimate of the useful lives
of our plant assets. The estimated useful lives, and resulting depreciation
rates used to calculate depreciation expense for the transmission and
distribution businesses of TEP, UNS Gas and UNS Electric have been approved by
the ACC in prior rate decisions. Depreciation rates for transmission and
distribution cannot be changed without ACC approval.

     The estimated remaining useful lives of TEP's generating facilities are
based on management's best estimate of the economic life of the units. These
estimates are based on engineering estimates, economic analysis, and statistical
analysis of TEP's past experience in maintaining the stations. For 2004,
depreciation expense related to generation assets was $35 million, and our
generation assets are currently depreciated over periods ranging from 23 to 70
years from the original in-service dates.

     During the first quarter of 2004, TEP engaged an independent third party to
review the economic estimated useful lives of its owned generating assets in
Springerville, Arizona. TEP then hired a different independent third party to
perform a depreciation study for its generation assets, taking into
consideration the newly determined economic useful life for the Springerville
assets, and changes in generation plant life information used by the operators
and other participants of the joint power plants in which TEP participates. As a
result of these analyses, TEP lengthened the useful lives of various generation
assets for periods ranging from 11 to 22 years in July 2004. Consequently,
depreciation rates and the corresponding depreciation expense have been revised
prospectively to reflect the life extensions. The annual impact of these changes
in depreciation rates is a reduction in depreciation expense of $9 million.
During the second quarter of 2005, a study requested by the participants in the
San Juan Generating Station was completed which indicated San Juan's economic
useful life had changed from previous estimates. As a result of the study and
other analysis performed, TEP lengthened the estimated useful life of San Juan
from 40 to 60 years beginning April 1, 2005. TEP's depreciation expense for the
three months ended June 30, 2005, decreased $2 million. Annual depreciation
expense is expected to decrease by $6 million or $3 million for the remainder of
2005.

   DEFERRED TAX VALUATION - TEP AND MILLENNIUM

     We record deferred tax liabilities for amounts that will increase income
taxes on future tax returns. We record deferred tax assets for amounts that
could be used to reduce income taxes on future tax returns. We record a
valuation allowance, or reserve, for the deferred tax asset amount that we may
not be able to use on future tax returns. We estimate the valuation allowance
based on our interpretation of the tax rules, prior tax audits, tax planning
strategies, scheduled reversal of deferred tax liabilities, and projected future
taxable income.

     At June 30, 2005 and December 31, 2004, UniSource Energy and TEP had a
valuation allowance of $8 million relating to net operating loss (NOL) and
investment tax credit (ITC) carryforward amounts.

     Of the $8 million valuation allowance balance at June 30, 2005 and December
31, 2004, $7 million relates to losses generated by the Millennium entities. In
the future, if UniSource Energy and the Millennium entities determine that all
or a portion of the losses may be used on tax returns, then UniSource Energy and
the Millennium entities would reduce the valuation allowance and recognize a tax
benefit of up to $7 million. The primary factor that could cause the Millennium
entities to recognize a tax benefit would be a change in expected future taxable
income.

     The remaining $1 million of valuation allowance balance at June 30, 2005
and December 31, 2004, relates to ITC carryforwards at TEP which may not be
utilized on tax returns prior to their expiration. If in the future UniSource
Energy and TEP determine that it is probable that TEP will not use all or a
portion of additional ITC carryforward amounts, then UniSource Energy and TEP
would record additional valuation allowance and recognize tax expense. The
primary factor that could cause TEP to record additional valuation allowance
would be a change in expected future taxable income.

     As of June 30, 2005 and December 31, 2004, UniSource Energy's deferred
income tax assets include $15 million and $14 million, respectively, related to
unregulated investment losses of Millennium. As of June 30, 2005 and December
31, 2004, TEP's deferred income tax assets include $1 million related to TEP's
unregulated investment losses. These losses have not been reflected on UniSource
Energy's consolidated income tax returns. If UniSource Energy is unable to
recognize such losses through its consolidated income tax return in the
foreseeable future, UniSource Energy and TEP would be required to write off
these deferred tax assets. Millennium intends to restructure its ownership in
two of these investments, Infinite Power Solutions (IPS) and


                                       63
<PAGE>


Corporacion Panama de Energia S.A. (Copesa), in 2005. As a result of these
actions, UniSource Energy expects to liquidate IPS for tax purposes and dispose
of its stock interest in Copesa, both resulting in taxable losses that will be
reflected on UniSource Energy's consolidated income tax return. If these
actions, or other actions resulting in the recognition of the losses for tax
purposes, do not occur, UniSource Energy would be required to eliminate the
deferred tax assets and recognize additional tax expense of $9 million.

NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------

     The FASB recently issued the following Statements of Financial Accounting
Standards (FAS), FASB Interpretations (FIN), and FASB Staff Positions (FSP):

     o    FIN 47, Accounting for Conditional Asset Retirement Obligations,
          issued March 2005, provides guidance for a legal obligation to perform
          an asset retirement activity in which the timing and (or) method of
          settlement are conditional on a future event that may or may not be
          within the control of the entity. The obligation to perform the asset
          retirement activity is unconditional even though uncertainty exists
          about the timing and (or) method of settlement. FIN 47 requires a
          liability be recognized for the fair value of a conditional asset
          retirement obligation if the fair value can be reasonably estimated.
          FIN 47 is required to be applied by December 31, 2005. We are
          evaluating the impact on our financial position and results of
          operations of the adoption of FIN 47.

     o    FSP FIN 46(R)-5, Implicit Variable Interests under FASB Interpretation
          No. 46 (revised December 2003), Consolidation of Variable Interest
          Entities, issued March 2005, addresses whether a reporting enterprise
          should consider whether it holds an implicit variable interest in a
          variable interest entity (VIE) or potential VIE when specific
          conditions exist. The guidance in FSP FIN 46(R)-5 was effective April
          1, 2005, and did not have a significant impact on our financial
          statements.

     o    FAS 151, Inventory Costs, issued November 2004, is an amendment of
          Accounting Research Bulletin (ARB) No. 43, Chapter 4, Inventory
          Pricing. FAS 151 clarifies that abnormal amounts of idle facility
          expense, freight, handling costs, and wasted materials (spoilage)
          should be recognized as current-period charges. FAS 151 also requires
          the allocation of fixed production overheads to inventory based on the
          normal capacity of the production facilities. FAS 151 is effective for
          inventory costs incurred during fiscal years beginning after June 15,
          2005. The adoption of FAS 151 is not expected to have a significant
          impact on our financial statements.

     o    FAS 153, Exchanges of Nonmonetary Assets, issued December 2004,
          requires nonmonetary exchanges be accounted for at fair value,
          recognizing any gains or losses, if their fair value is determinable
          within reasonable limits and the transaction has commercial substance.
          A nonmonetary exchange has commercial substance if future cash flows
          of the entity are expected to change significantly as a result of the
          exchange. FAS 153 is effective for nonmonetary asset exchange
          transactions occurring in fiscal periods beginning after June 15,
          2005. The adoption of FAS 153 is not expected to have a significant
          impact on our financial statements.

     o    FAS 154, Accounting Changes and Error Corrections, issued May 2005,
          provides guidance on the accounting for and reporting of accounting
          changes and error corrections. FAS 154 requires retrospective
          application to prior periods' for a voluntary change in accounting
          principle, unless it is impracticable to do so. FAS 154 also provides
          guidance related to the reporting of a change in accounting estimate,
          a change in reporting entity and the correction of an error. FAS 154
          is effective for accounting changes and corrections of errors made in
          fiscal years beginning after December 15, 2005. The adoption of FAS
          154 is not expected to have a significant impact on our financial
          statements.

     o    FSP FAS 109-1, Application of FASB Statement No. 109, Accounting for
          Income Taxes, to the Tax Deduction on Qualified Production Activities
          Provided by the American Jobs Creation Act of 2004, issued in December
          2004, provides guidance on the application of FAS 109 to the provision
          within the American Jobs Creation Act of 2004 that provides a tax
          deduction, beginning in 2005, on qualified production activities,
          including a company's electric generation activities. Under FSP FAS
          109-1, recognition of the tax deduction on qualified production
          activities is ordinarily reported in the year it is earned. FSP FAS
          109-1 did not have a significant impact on our financial statements in
          the first six months of 2005. We are evaluating the impact of FSP FAS
          109-1 on our financial position and results of operations for the
          remainder of the year.

     In June 2004, the EITF published Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides application guidance on impairment of securities
accounted for under FAS 115, Accounting for Certain Investments in Debt and
Equity Securities, and cost method investments and requires certain quantitative
and qualitative disclosures for securities that are impaired at the balance
sheet date but for which an other-than-temporary impairment has not been
recognized. The disclosure requirements are effective for reporting periods
ending after December 31, 2003. The FASB


                                       64
<PAGE>


issued FSP EITF Issue 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue
No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments in September 2004 delaying the effective date of the
application guidance on impairment of securities until the final issuance of FSP
EITF Issue 03-1-a. As of August 4, 2005, a final FSP EITF Issue 03-1-a has not
been issued. The adoption of EITF 03-1 is not expected to have a significant
impact on our financial statements.

SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
------------------------------------------

     This Quarterly Report on Form 10-Q contains forward-looking statements as
defined by the Private Securities Litigation Reform Act of 1995. UniSource
Energy and TEP are including the following cautionary statements to make
applicable and take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 for any forward-looking statements made
by or for UniSource Energy or TEP in this Quarterly Report on Form 10-Q.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance and underlying assumptions and
other statements that are not statements of historical facts. Forward-looking
statements may be identified by the use of words such as "anticipates",
"estimates", "expects", "intends", "plans", "predicts", "projects", and similar
expressions. From time to time, we may publish or otherwise make available
forward-looking statements of this nature. All such forward-looking statements,
whether written or oral, and whether made by or on behalf of UniSource Energy or
TEP, are expressly qualified by these cautionary statements and any other
cautionary statements which may accompany the forward-looking statements. In
addition, UniSource Energy and TEP disclaim any obligation to update any
forward-looking statements to reflect events or circumstances after the date of
this report.

     Forward-looking statements involve risks and uncertainties, which could
cause actual results or outcomes to differ materially from those expressed in
the forward-looking statements. We express our expectations, beliefs and
projections in good faith and believe them to have a reasonable basis. However,
we make no assurances that management's expectations, beliefs or projections
will be achieved or accomplished. We have identified the following important
factors that could cause actual results to differ materially from those
discussed in our forward-looking statements. These may be in addition to other
factors and matters discussed in other parts of this report:

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

     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.   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.

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

     6.   Changes affecting our cost of providing electrical 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.

     8.   Changes affecting the cost of competing energy alternatives, including
          changes in available generating technologies and changes 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.  Market conditions and technological changes affecting our unregulated
          businesses.


                                       65
<PAGE>


     12.  Unanticipated changes in future liabilities relating to employee
          benefit plans due to changes in market values of retirement plan
          assets and health care costs.

     13.  The outcome of any ongoing or future litigation.

     14.  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.


ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
--------------------------------------------------------------------

     The information contained in this Item updates, and should be read in
conjunction with, information included in Part II, Item 7A in UniSource Energy
and TEP's Annual Report on Form 10-K for the year ended December 31, 2004, in
addition to the interim condensed consolidated financial statements and
accompanying notes presented in Items 1 and 2 of this Form 10-Q.

     We are exposed to various forms of market risk. Changes in interest rates,
returns on marketable securities, and changes in commodity prices may affect our
future financial results. The market risks resulting from changes in interest
rates and returns on marketable securities have not changed materially from the
market risks reported in the 2004 Annual Report on Form 10-K. For additional
information concerning risk factors, including market risks, see Safe Harbor for
Forward-Looking Statements, above.

     RISK MANAGEMENT COMMITTEE

     We have a Risk Management Committee responsible for the oversight of
commodity price risk and credit risk related to the wholesale energy marketing
activities of TEP, the emissions and coal trading activities of MEG, and the
fuel and power procurement activities at TEP and UES. Our Risk Management
Committee, which meets on a quarterly basis and as needed, consists of officers
from the finance, accounting, legal, wholesale marketing, transmission and
distribution operations, and the generation operations departments of UniSource
Energy. To limit TEP's, UES' and MEG's exposure to commodity price risk, the
Risk Management Committee sets trading and hedging policies and limits, which
are reviewed frequently to respond to constantly changing market conditions. To
limit TEP's, UES' and MEG's exposure to credit risk, the Risk Management
Committee reviews counterparty credit exposure, as well as credit policies and
limits.

     COMMODITY PRICE RISK

     We are exposed to commodity price risk primarily relating to changes in the
market price of electricity, natural gas, coal and Emissions Allowances.

     TEP

     To manage its exposure to energy price risk, TEP enters into forward
contracts to buy or sell energy at a specified price and future delivery period.
Generally, TEP commits to future sales based on expected excess generating
capability, forward prices and generation costs, using a diversified market
approach to provide a balance between long-term, mid-term and spot energy sales.
TEP generally enters into forward purchases during its summer peaking period to
ensure it can meet its load and reserve requirements and account for other
contracts and resource contingencies. TEP also enters into limited forward
purchases and sales to optimize its resource portfolio and take advantage of
locational differences in price. These positions are managed on both a
volumetric and dollar basis and are closely monitored using risk management
policies and procedures overseen by the Risk Management Committee. For example,
the risk management policies provide that TEP should not take a short position
in the third quarter and must have owned generation backing up all forward sales
positions at the time the sale is made. TEP's risk management policies also
restrict entering into forward positions with maturities extending beyond the
end of the next calendar year except for approved hedging purposes.

     The majority of TEP's forward contracts are considered to be "normal
purchases and sales" of electric energy and are not considered to be derivatives
under FAS 133. TEP records revenues on its "normal sales" and expenses on its
"normal purchases" in the period in which the energy is delivered. From time to
time, however, TEP enters into forward contracts that meet the definition of a
derivative under FAS 133. When TEP has derivative forward contracts, it marks
them to market on a daily basis using actively quoted prices obtained from
brokers for power traded over-the-counter at Palo Verde and at other
southwestern U.S. trading hubs. TEP believes that these broker quotations used
to calculate the mark-to-market values represent accurate measures of


                                       66
<PAGE>


the fair values of TEP's positions, because of the short-term nature of TEP's
positions, as limited by risk management policies, and the liquidity in the
short-term market. As of June 30, 2005, all of TEP's derivative forward
contracts were for settlement within 6 months. To adjust the value of its
derivative forward contracts to fair value on its income statement, TEP recorded
net unrealized gains of less than $1 million on its income statements for the
three month periods ended June 30, 2005 and 2004, respectively.

     TEP is also subject to commodity price risk from changes in the price of
natural gas. In addition to energy from its coal-fired facilities, TEP typically
uses purchased power, supplemented by generation from its gas-fired units, to
meet the summer peak demands of its retail customers and to meet local
reliability needs. Some of these purchased power contracts are price indexed to
natural gas prices. Short-term and spot power purchase prices are also closely
correlated to natural gas prices. Due to its increasing seasonal gas and
purchased power usage, TEP hedges a portion of its total natural gas exposure
from plant fuel, gas-indexed purchase power and spot market purchases with fixed
price contracts for a maximum of three years. TEP purchases its remaining gas
fuel needs and purchased power in the spot and short-term markets.

     In the first six months of 2005, the average price of natural gas was $5.83
per MMBtu, or 12% higher than the same period in 2004. TEP's generation output
fueled by natural gas was approximately 145,000 MWh, or 2% of total generation
and purchased power in the first six months of 2005. During the first six months
of 2005, TEP purchased a total of 681,000 MWh of energy, or 11% of total
generation and purchased power.

     In January 2005, TEP entered into a purchased power agreement with Panda
Gila River. TEP will purchase 50 MW of firm on-peak energy during June through
September 2005.

     TEP entered into two purchased power agreements in 2003 for the period 2003
through 2006. During 2004, and through the first six months of 2005, TEP
purchased approximately 175,000 and 75,000 MWh, respectively under these
contracts. Energy prices under these agreements are adjusted for changes in the
price of natural gas.

     UES

     UES is also subject to commodity price risk, primarily from the changes in
the price of natural gas purchased for its UNS Gas customers. This risk is
mitigated through the PGA mechanism in UNS Gas' retail rates which provides an
adjustment to recover the actual costs of gas and transportation. UNS Gas
further reduces this risk by purchasing forward fixed price contracts for a
portion of its projected gas needs under its Price Stabilization Plan. UNS Gas
purchases between 45% and 80% of its estimated gas needs in this manner.

     UNS Electric is not exposed to commodity price risk for its purchase of
electricity as it has a fixed price full-requirements supply agreement with PWCC
through May 2008.

     MEG

     During the fourth quarter of 2001, MEG began managing and trading Emissions
Allowances, coal and related instruments. We manage the market risk of this line
of business by setting notional limits by product, as well as limits to the
potential change in fair market value under a 33% change in price or volatility.
We closely monitor MEG's trading activities, which include swap agreements,
options and forward contracts, using risk management policies and procedures
overseen by the Risk Management Committee. MEG marks its trading positions to
market on a daily basis using actively quoted prices obtained from brokers and
options pricing models for positions that extend through 2007. As of June 30,
2005 and December 31, 2004, the fair value of MEG's trading assets combined with
Emissions Allowances it holds in escrow was $18 million and $77 million,
respectively. The fair value of MEG's trading liabilities was $14 million at
June 30, 2005 and $65 million at December 31, 2004. For the six months ended
June 30, 2005, MEG reflected a $7 million unrealized gain and $7 million
realized loss on its income statement, compared with an unrealized gain of $2
million and a realized loss of $2 million for the six months ended June 30,
2004.


                                       67
<PAGE>


     MEG is in the process of winding down its activities and does not expect to
engage in any new activities after 2005.

<TABLE>
<CAPTION>
                                                              Unrealized Gain (Loss) of MEG's Trading Activities
                                                                            - Millions of Dollars -
                                                      Maturity 0 - 6    Maturity 6 - 12   Maturity over        Total
Source of Fair Value At June 30, 2005                     months            months            1 yr.       Unrealized Gain
                                                                                                               (Loss)
---------------------------------------------------- ----------------- ------------------ --------------- -----------------
<S>                                                      <C>              <C>               <C>             <C>
Prices actively quoted                                   $    4           $     -           $    -          $      4
Prices based on models and other valuation methods            -                 -                6                 6
---------------------------------------------------- ----------------- ------------------ --------------- -----------------
Total                                                    $    4           $     -           $    6          $     10
==================================================== ================= ================== =============== =================

</TABLE>

     CREDIT RISK

     UniSource Energy is exposed to credit risk in its energy-related marketing
and trading activities related to potential nonperformance by counterparties. We
manage the risk of counterparty default by performing financial credit reviews,
setting limits monitoring exposures, requiring collateral when needed, and using
a standard agreement which allows for the netting of current period exposures to
and from a single counterparty.

     We calculate counterparty credit exposure by adding any outstanding
receivable (net of amounts payable if a netting agreement exists) to the
mark-to-market value of any forward contracts. As of June 30, 2005, TEP's total
credit exposure related to its wholesale marketing activities was approximately
$14 million and MEG's total credit exposure related to its trading activities
was $6 million. TEP and MEG's credit exposure is diversified across
approximately 23 counterparties. Approximately $1 million of exposure is to
non-investment grade companies.

     UniSource Energy is also exposed to credit risk related to the sale of
assets owned by Nations Energy Corporation (Nations Energy). In September 2001,
Nations Energy sold its equity interest in a power project to a subsidiary of
Mirant Corporation (Mirant). Nations Energy received $5 million in cash and an
$11 million note receivable from Mirant. The note was recorded at its net
present value of $8 million. As of June 30, 2005, Nations Energy's receivable
from Mirant is approximately $9 million. The first payment of $2 million on the
receivable was received in June 2004 and the second payment of $4 million was
received in July 2005. The remaining payment of $5 million is expected to be
received in July 2006. Nations Energy expects to collect the note in its
entirety.



ITEM 4. - CONTROLS AND PROCEDURES
--------------------------------------------------------------------------------

     UniSource Energy and TEP have disclosure controls and procedures to ensure
that material information recorded, processed, summarized and reported in their
filings with the SEC is accurate and reported on a timely basis. Management of
UniSource Energy and TEP, with the participation of the principal executive
officer and principal financial officer of UniSource Energy and TEP, have
evaluated these disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)
as of June 30, 2005. Based on such evaluation, the principal executive officer
and principal financial officer of UniSource Energy and TEP have concluded that
such disclosure controls and procedures were, as of such date, effective at
ensuring that material information is recorded, processed, summarized and
reported accurately and within the time periods specified by the SEC's rules and
forms.

     During the fiscal quarter ended June 30, 2005, there have not been any
changes in UniSource Energy or TEP's internal controls over financial reporting
that have materially affected, or are reasonably likely to materially affect,
these controls.


                                       68
<PAGE>


                           PART II - OTHER INFORMATION

ITEM 1. - LEGAL PROCEEDINGS
--------------------------------------------------------------------------------

     See Item 7. - Management's Discussion and Analysis of Financial Condition
and Results of Operations, Tucson Electric Power Company, Factors Affecting
Operations, for litigation related to ACC orders and retail competition.

     We discuss other legal proceedings in Note 6 of Notes to Condensed
Consolidated Financial Statements.

     CROSS-COMPLAINTS IN WHOLESALE ELECTRICITY ANTITRUST CASES I AND II

     In late 2000, various California municipalities and citizens filed suits
against Duke Energy Trading and Marketing, L.L.C., Reliant Energy Services, Inc.
and other large suppliers of wholesale electricity alleging that Duke, Reliant,
and the other large suppliers violated antitrust laws by colluding to effect the
price of electricity in the California wholesale electricity market. These
actions were subsequently consolidated in San Diego Superior Court in March 2002
as Wholesale Electricity Antitrust Cases I and II.

     Duke and Reliant responded by filing cross-complaints against TEP and
numerous other wholesale electricity market participants in April 2002. The
cross complaints allege that cross-defendants sold power in significant amounts
at prices the antitrust plaintiffs allege were excessive, and as participants in
power sales, cross-defendants are equally liable for plaintiffs alleged damages.
The entire action was removed to the United States District Court for the
Southern District of California in May 2002. The antitrust plaintiffs responded
to the removal by filing a motion for remand, and on December 13, 2002, the
District Court remanded the case back to state court.

     Duke and Reliant appealed the District Court's remand order and requested
that the order be stayed pending resolution of their appeal. On December 8,
2004, the Ninth Circuit affirmed the District Court's remand and similarly
denied a subsequent petition for rehearing and motion to recall the mandate. The
case has now been remanded to the state court and TEP filed a demurrer to the
cross-complaints.

     TEP believes these claims are without merit and intends to vigorously
contest them.

     CITY OF TACOMA

     On June 7, 2004, the City of Tacoma, Washington filed a lawsuit (City of
Tacoma v. American Electric Power Services Corporation, et al. (U.S. District
Ct. W. D. Wash.)) against TEP and various other electricity generators and
marketers alleging that the defendants violated antitrust laws by colluding to
effect the price of electricity in the Pacific Northwest from May 2000 through
2001. These claims are similar to those alleged in the antitrust cases against
TEP and other wholesale electricity market participants described above in
Cross-Complaints in Wholesale Electricity Antitrust Cases I and II. On September
14, 2004, the case was transferred to the United States District Court for the
Southern District of California. TEP along with other defendants filed a joint
motion to dismiss and the motion was granted on February 11, 2005. The City of
Tacoma appealed the dismissal to the Ninth Circuit and the appeal is now
pending.

     TEP believes these claims are without merit and intends to vigorously
contest them.


                                       69
<PAGE>


ITEM 4. - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
--------------------------------------------------------------------------------

     UniSource Energy conducted its annual meeting of shareholders on May 6,
2005. At that meeting, the shareholders of UniSource Energy elected members of
the Board of Directors.

     The total votes were as follows:

<TABLE>
<CAPTION>
             NOMINEE                         VOTES FOR                          WITHHELD
     ------------------------------ ------------------------------- -----------------------------------
<S>                                          <C>                                <C>
     Lawrence J. Aldrich                     29,967,903                         2,919,085
     Larry W. Bickle                         29,963,818                         2,923,170
     Elizabeth T. Bilby                      32,553,164                           333,824
     Harold W. Burlingame                    32,634,297                           252,691
     John L. Carter                          32,629,874                           257,114
     Robert A. Elliott                       32,630,222                           256,766
     Kenneth Handy                           32,637,771                           249,217
     Warren Y. Jobe                          32,474,261                           412,727
     James S. Pignatelli                     32,653,098                           233,890
     ----------------------------- ------------------------------- -----------------------------------

</TABLE>



ITEM 5. - OTHER INFORMATION
--------------------------------------------------------------------------------

NON-GAAP MEASURES

     ADJUSTED EBITDA
     ---------------

     Adjusted EBITDA represents EBITDA excluding the cumulative effect of
accounting change which is a non-cash item. EBITDA is earnings before interest,
taxes, depreciation and amortization. Adjusted EBITDA is presented here as a
measure of liquidity because it can be used as an indication of a company's
ability to incur and service debt and is commonly used as an analytical
indicator in our industry. Adjusted EBITDA measures presented may not be
comparable to similarly titled measures used by other companies. Adjusted EBITDA
is not a measurement presented in accordance with United States generally
accepted accounting principles (GAAP), and we do not intend Adjusted EBITDA to
represent cash flows from operations as defined by GAAP. Adjusted EBITDA should
not be considered to be an alternative to cash flows from operations or any
other items calculated in accordance with GAAP or an indicator of our operating
performance.

     UniSource Energy and TEP view Adjusted EBITDA, a non-GAAP financial
measure, as a liquidity measure. The most directly comparable GAAP measure to
Adjusted EBITDA is Net Cash Flows from Operating Activities.

ADJUSTED EBITDA AND NET CASH FLOWS FROM OPERATING ACTIVITIES

<TABLE>
<CAPTION>
                                                                                        UNISOURCE ENERGY
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
----------------------------------------------------------------- ------------------------------ ------------------------------
UNISOURCE ENERGY                                                       2005           2004           2005            2004
                                                                                    - Millions of Dollars -

<S>                                                                   <C>            <C>            <C>            <C>
  Adjusted EBITDA                                                     $  108         $   115        $   191        $   216
  Net Cash Flows from Operating Activities                            $   51         $    97        $    91        $   141

</TABLE>


                                       70
<PAGE>


<TABLE>
<CAPTION>
                                                                                              TEP
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
----------------------------------------------------------------- ------------------------------ ------------------------------
TEP                                                                    2005           2004           2005            2004
                                                                                    - Millions of Dollars -

<S>                                                                   <C>            <C>            <C>            <C>
  Adjusted EBITDA                                                     $  102         $   115        $   174        $   199
  Net Cash Flows from Operating Activities                            $   37         $    83        $    74        $   119

RECONCILIATION OF ADJUSTED EBITDA TO CASH FLOWS FROM OPERATIONS


                                                                                        UNISOURCE ENERGY
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
----------------------------------------------------------------- ------------------------------ ------------------------------
                                                                       2005           2004           2005            2004
                                                                                    - Millions of Dollars -
ADJUSTED EBITDA (1)                                                   $  108          $  115         $  191         $  216
Amounts from the Income Statements:
  Less:  Income Taxes                                                      7              12              6             18
  Less:  Total Interest Expense                                           44              40             84             83
Changes in Assets and Liabilities and
   Other Non-Cash Items                                                   (6)             34            (10)            26
----------------------------------------------------------------- --------------- -------------- -------------- ---------------
NET CASH FLOWS FROM OPERATING ACTIVITIES                              $   51          $   97         $   91         $  141
================================================================= =============== ============== ============== ===============

                                                                                              TEP
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
----------------------------------------------------------------- ------------------------------ ------------------------------
                                                                       2005           2004           2005            2004
                                                                                    - Millions of Dollars -
ADJUSTED EBITDA (1)                                                   $  102          $  115         $  174         $  199
Amounts from the Income Statements:
  Less:  Income Taxes                                                      9              15              7             17
  Less:  Total Interest Expense                                           38              37             75             77
Changes in Assets and Liabilities and
   Other Non-Cash Items                                                  (18)             20            (18)            14
----------------------------------------------------------------- --------------- -------------- -------------- ---------------
NET CASH FLOWS FROM OPERATING ACTIVITIES                              $   37          $   83         $   74         $  119
================================================================= =============== ============== ============== ===============

</TABLE>


                                       71
<PAGE>


(1) ADJUSTED EBITDA WAS CALCULATED AS FOLLOWS:


<TABLE>
<CAPTION>
                                                                                        UNISOURCE ENERGY
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
                                                                  ------------------------------ ------------------------------
                                                                       2005           2004           2005            2004
                                                                                    - Millions of Dollars -
<S>                                                                   <C>             <C>            <C>            <C>
NET INCOME                                                            $    9          $   13         $    6         $   19
Amounts from the Income Statements:
Plus:  Income Taxes                                                        7              12              6             18
Plus:  Total Interest Expense                                             44              40             84             83
Plus:  Depreciation and Amortization                                      33              37             68             72
Plus:  Amortization of Transition Recovery Asset                          14              12             24             21
Plus:  Depreciation included in Fuel and Other O&M
          Expense (see Note 13 of Notes to Consolidated
          Financial Statements)                                            1               1              3              3
----------------------------------------------------------------- --------------- -------------- -------------- ---------------
ADJUSTED EBITDA                                                       $  108          $  115         $  191         $  216
================================================================= =============== ============== ============== ===============


                                                                                              TEP
                                                                  -------------------------------------------------------------
                                                                       THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                             JUNE 30,                       JUNE 30,
                                                                  ------------------------------ ------------------------------
                                                                       2005           2004           2005            2004
                                                                                    - Millions of Dollars -
NET INCOME                                                            $   12          $   18         $    7         $   19
Amounts from the Income Statements:
Plus:  Income Taxes                                                        9              15              7             17
Plus:  Total Interest Expense                                             38              37             75             77
Plus:  Depreciation and Amortization                                      28              32             58             62
Plus:  Amortization of Transition Recovery Asset                          14              12             24             21
Plus:  Depreciation included in Fuel and Other O&M
          Expense (see Note 13 of Notes to Consolidated
          Financial Statements)                                            1               1              3              3
----------------------------------------------------------------- --------------- -------------- -------------- ---------------
ADJUSTED EBITDA                                                       $  102          $  115         $  174         $  199
================================================================= =============== ============== ============== ===============

</TABLE>


NET DEBT AND TOTAL DEBT AND CAPITAL LEASE OBLIGATIONS - TEP
-----------------------------------------------------------

     Net Debt represents the current and non-current portions of TEP's long-term
debt and capital lease obligations less investment in lease debt. We have
subtracted investment in lease debt because it represents TEP's ownership of the
debt component of its own capital lease obligations. Net Debt measures presented
may not be comparable to similarly titled measures used by other companies. Net
Debt is not a measurement presented in accordance with GAAP and we do not intend
Net Debt to represent debt as defined by GAAP. You should not consider Net Debt
to be an alternative to debt or any other items calculated in accordance with
GAAP.

<TABLE>
<CAPTION>
                                                       AS OF             AS OF
                                                   JUNE 30, 2005   DECEMBER 31, 2004
-------------------------------------------------- -------------- -------------------
                                                        - Millions of Dollars -
<S>                                                  <C>               <C>
Net Debt                                             $  1,375          $  1,684
Total Debt and Capital Lease Obligations             $  1,537          $  1,855
-------------------------------------------------- -------------- -------------------

</TABLE>


                                       72
<PAGE>


RECONCILIATION OF TOTAL DEBT AND CAPITAL LEASE OBLIGATIONS TO NET DEBT

<TABLE>
<CAPTION>
                                                               AS OF             AS OF
                                                           JUNE 30, 2005   DECEMBER 31, 2004
---------------------------------------------------------- -------------- -------------------
                                                                - Millions of Dollars -
<S>                                                          <C>               <C>
Long-Term Debt                                               $    821          $  1,098
Current Portion - Long-Term Debt                                    -                 2
---------------------------------------------------------- -------------- -------------------
  TOTAL DEBT                                                      821             1,100
---------------------------------------------------------- -------------- -------------------

Capital Lease Obligations                                         660               701
Current Portion - Capital Lease Obligations                        56                54
---------------------------------------------------------- -------------- -------------------
TOTAL DEBT AND CAPITAL LEASE OBLIGATIONS                        1,537             1,855
---------------------------------------------------------- -------------- -------------------

Investment in Lease Debt                                         (162)             (171)
---------------------------------------------------------- -------------- -------------------
NET DEBT                                                     $  1,375          $  1,684
========================================================== ============== ===================

</TABLE>

RATIO OF EARNINGS TO FIXED CHARGES
----------------------------------

     The following table reflects the ratio of earnings to fixed charges for
UniSource Energy and TEP:

<TABLE>
<CAPTION>
                                             6 Months Ended          12 Months Ended
                                              June 30, 2005           June 30, 2005
----------------------------------------- ---------------------- -------------------------
<S>                                               <C>                      <C>
UniSource Energy                                  1.15                     1.32

TEP                                               1.20                     1.39

</TABLE>


SEC REPORTS AVAILABLE ON UNISOURCE ENERGY'S WEBSITE
---------------------------------------------------

     UniSource Energy and TEP make available their annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments
to those reports as soon as reasonably practicable after they electronically
file them with, or furnish them to, the SEC. These reports are available free of
charge through UniSource Energy's website address:
http://www.unisourceenergy.com. A link from UniSource Energy's website to these
SEC reports is accessible as follows: At the UniSource Energy main page, select
Investor Relations from the menu shown at the top of the page; next select SEC
filings from the menu shown on the Investor Relations page.

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

     The SEC also maintains an Internet site that contains reports, proxy and
information statements, and other information regarding issuers that file
electronically with the SEC. The SEC website address is http://www.sec.gov.
Interested parties may also read and copy any materials UniSource Energy or TEP
file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW,
Washington, DC 20549. Information on the operation of the Public Reference Room
is available by calling the SEC at 1-800-SEC-0030.


ITEM 6. - EXHIBITS
--------------------------------------------------------------------------------

     See Exhibit Index.


                                       73
<PAGE>


                                   SIGNATURES


     Pursuant to the requirements of the Securities Exchange Act of 1934, each
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. The signature for each undersigned
company shall be deemed to relate only to matters having reference to such
company or its subsidiaries.


                                             UNISOURCE ENERGY CORPORATION
                                             ----------------------------
                                                     (Registrant)


Date:  August 9, 2005                        /s/      Kevin P. Larson
                                             -----------------------------------
                                                      Kevin P. Larson
                                                Vice President and Principal
                                                      Financial Officer



                                             TUCSON ELECTRIC POWER COMPANY
                                             -----------------------------
                                                     (Registrant)


Date:  August 9, 2005                        /s/      Kevin P. Larson
                                             -----------------------------------
                                                      Kevin P. Larson
                                                Vice President and Principal
                                                      Financial Officer


                                       74
<PAGE>


                                  EXHIBIT INDEX
                                  -------------


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).


*Pursuant to Item 601(b)(32)(ii) of Regulation S-K, this certificate is not
being filed for purposes of Section 18 of the Securities Exchange Act of 1934.


                                       75