##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2008
 OR
 o
    
    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 EmployerFile Number
    
    Address; and Telephone Number
    
    Identification Number1-13739
    
    UNISOURCE ENERGY CORPORATION
    
    86-0786732(An Arizona Corporation)One South Church Avenue, Suite 100Tucson, AZ 85701(520) 571-40001-5924
    
    TUCSON ELECTRIC POWER COMPANY
    
    86-0062700(An Arizona Corporation)One South Church Avenue, Suite 100Tucson, AZ 85701(520) 571-4000
 þ o
  UniSource Energy Corporation
    
    Large Accelerated Filer þ
    
    Accelerated Filer o
    
    Non-accelerated filer oSmaller Reporting Company oTucson Electric Power Company
    
    Large Accelerated Filer o
    
    Accelerated Filer o
    
    Non-accelerated filer þSmaller Reporting Company o
  UniSource Energy Corporation
    
    Yes o
    
    No þTucson Electric Power Company
    
    Yes o
    
    No þ




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Table of Contents
 Definitions
    
    
    iv
PART I Reports of Independent Registered Public Accounting Firm
    
    
    1Item 1.
 Financial Statements
    
    
    3UniSource Energy CorporationComparative
Condensed Consolidated Statements of Income
    
    
    3Comparative
Condensed Consolidated Statements of Cash Flows
    
    
    4Comparative
Condensed Consolidated Balance Sheets
    
    
    5Condensed Consolidated Statement of Changes in Stockholders Equity and
Comprehensive Income
    
    
    7Tucson Electric Power CompanyComparative
Condensed Consolidated Statements of Income
    
    
    8Comparative
Condensed Consolidated Statements of Cash Flows
    
    
    9Comparative
Condensed Consolidated Balance Sheets
    
    
    10Condensed Consolidated Statement of Changes in Stockholders Equity and
Comprehensive Income
    
    
    12Notes to Condensed Consolidated Financial Statements
    
    
    13Note 1. Nature of Operations and Basis of Accounting Presentation
    
    
    13Note 2. Regulatory Matters
    
    
    14Note 3. Debt and Credit Facilities
    
    
    17Note 4. Business Segments
    
    
    20Note 5. Accounting for Derivative Instruments and Trading Activities
    
    
    22Note 6. Income Tax Matters
    
    
    27Note 7. Commitments and Contingencies
    
    
    28Note 8. Employee Benefits Plans
    
    
    31Note 9. Share-Based Compensation Plans
    
    
    33Note 10. Fair Value Measurements
    
    
    35Note 11. UniSource Energy Earnings Per Share (EPS)
    
    
    39Note 12. New Accounting Pronouncements
    
    
    40Note 13. Supplemental Cash Flow Information
    
    
    41Note 14. Review by Independent Registered Public Accounting Firm
    
    
    42Item 2.  Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    43UniSource Energy Consolidated
    
    
    43Overview of Consolidated Business
    
    
    43Outlook and Strategies
    
    
    43Results of Operations
    
    
    45Contribution by Business Segment
    
    
    45Liquidity and Capital Resources
    
    
    46Tucson Electric Power Company
    
    
    51Results of Operations
    
    
    51Factors Affecting Results of Operations
    
    
    56Liquidity and Capital Resources
    
    
    61UNS Gas
    
    
    66Results of Operations
    
    
    66Factors Affecting Results of Operations
    
    
    68Liquidity and Capital Resources
    
    
    69UNS Electric
    
    
    71Results of Operations
    
    
    71Factors Affecting Results of Operations
    
    
    73Liquidity and Capital Resources
    
    
    74Other Non-Reportable Business Segments
    
    
    76Results of Operations
    
    
    76Critical Accounting Estimates
    
    
    77Exhibit 12(a)Exhibit 12(b)Exhibit 15Exhibit 31(a)Exhibit 31(b)Exhibit 31(c)Exhibit 31(d)Exhibit 32
   ii




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New Accounting Pronouncements
    
    
    78Safe Harbor for Forward-Looking Statements
    
    
    78Item 3.  Quantitative and Qualitative Disclosures about Market Risk
    
    
    79Item 4.  Controls and Procedures
    
    
    84PART II  OTHER INFORMATIONItem 1.  Legal Proceedings
    
    
    85Item 1A.  Risk Factors
    
    
    85Item 2.  Unregistered Sale of Equity Securities and Use of Proceeds
    
    
    85Item 5.  Other Information
    
    
    86Non-GAAP Measures
    
    
    86Ratio of Earnings to Fixed Charges
    
    
    88Item 6. Exhibits
    
    
    88Signatures
    
    
    89Exhibit Index
    
    
    90
  iii




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DEFINITIONS
  ACC
    
    Arizona Corporation Commission.AECC
    
    Arizonans for Electric Choice and Competition.AMT
    
    Alternative Minimum Tax.APS
    
    Arizona Public Service.BMGS
    
    Black Mountain Generating Station owned by UED.Btu
    
    British thermal unit(s).Capacity
    
    The ability to produce power; the most power a unit can produce or the
maximum that can be taken under a contract, measured in MWs.Citizens
    
    Citizens Communications Company.Common Stock
    
    UniSource Energys common stock, without par value.Company or UniSource Energy
    
    UniSource Energy Corporation.Cooling Degree Days
    
    An index used to measure the impact of weather on energy usage calculated by
subtracting 75 from the average of the high and daily low temperatures.DSM
    
    Demand side management.Emission 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.FAS 71
    
    Statement of Financial Accounting Standards No. 71: Accounting for
The Effects of Certain Types of Regulation.FAS 133
    
    Statement of Financial Accounting Standards No. 133: Accounting for
Derivative Instruments and Hedging Activities, as amended.FAS 143
    
    Statement of Financial Accounting Standards No. 143: Accounting for
Asset Retirement Obligations.FERC
    
    Federal Energy Regulatory Commission.Fixed CTC
    
    Competition Transition Charge of approximately $0.009 per kWh that is
included in TEPs retail rate for the purpose of recovering TEPs
$450 million TRA by December 31, 2008.Four Corners
    
    Four Corners Generating Station.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.ICRA
    
    Implementation Cost Regulatory Asset.IDBs
    
    Industrial Development Revenue Bonds.IRS
    
    Internal Revenue Service.kWh
    
    Kilowatt-hour(s).LIBOR
    
    London Interbank Offered Rate.Luna
    
    Luna Energy Facility.Mark-to-Market Adjustments
    
    Unrealized gains and losses that are recorded monthly yo reflect the market
prices at the end of each month on forward energy sales and purchase
contracts that are considered to be derivatives.Millennium
    
    Millennium Energy Holdings, Inc., a wholly-owned subsidiary of
UniSource Energy.MMBtu
    
    Million British Thermal Units.MW
    
    Megawatt(s).MWh
    
    Megawatt-hour(s).Navajo
    
    Navajo Generating Station.PGA
    
    Purchased Gas Adjuster, a retail rate mechanism designed to recover
the cost of gas purchased for retail gas customers.Pima Authority
    
    The Industrial Development Authority of the County of Pima.PPFAC
    
    Purchased Power and Fuel Adjustment Clause.
  iv




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PWMT
    
    Pinnacle West Marketing and Trading.REST
    
    Renewable Energy Standard and Tariff.RUCO
    
    Residential Utility Consumer Office.Salt River Project
    
    A public power utility serving more than 900,000 customers in Phoenix, Arizona.San Juan
    
    San Juan Generating Station.1999 Settlement Agreement
    
    TEPs 1999 Settlement Agreement approved by the ACC in November 1999 that
provided for electric retail competition and transition asset recovery.2008 Proposed Settlement
Agreement
    
    Proposed Settlement Agreement filed with the ACC in TEPs 2007/2008 rate case proceeding.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 Leases
    
    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.Springerville Unit 3
    
    Unit 3 of the Springerville Generating Station.Springerville Unit 4
    
    Unit 4 of the Springerville Generating Station.SRP
    
    Salt River Project Agricultural Improvement and Power District.Sundt
    
    H. Wilson Sundt Generating Station.Sundt Unit 4
    
    Unit 4 of the H. Wilson Sundt Generating Station.TEP
    
    Tucson Electric Power Company, the principal subsidiary of UniSource
Energy.TEP Credit Agreement
    
    Amended and Restated Credit Agreement between TEP and a syndicate of
Banks, dated as of August 11, 2006.TEP Letter of Credit Facility
    
    Letter of credit facility between TEP and a syndicate of Banks, dated as of April
30,2008.TEP Revolving Credit Facility
    
    Revolving credit facility under the TEP Credit Agreement.Therm
    
    A unit of heating value equivalent to 100,000 British thermal units (Btu).TOU
    
    Time of use.TRA
    
    Transition Recovery Asset, a $450 million regulatory asset established in TEPs
1999 Settlement Agreement to be fully recovered by December 31, 2008.Tri-State
    
    Tri-State Generation and Transmission Association.UED
    
    UniSource Energy Development Company, a wholly-owned subsidiary
of UniSource Energy, which engages in developing generation
resources and other project development services and related
activities.UES
    
    UniSource Energy Services, Inc., an intermediate holding company
established to own the operating companies (UNS Gas and UNS
Electric) which acquired the Citizens Arizona gas and electric
utility assets in 2003.UniSource Credit Agreement
    
    Amended and Restated Credit Agreement between UniSource Energy and a
syndicate of banks, dated as of August 11, 2006.UniSource Energy
    
    UniSource Energy Corporation.UNS Electric
    
    UNS Electric, Inc., a wholly-owned subsidiary of UES, which acquired
the Citizens Arizona electric utility assets in 2003.UNS Gas
    
    UNS Gas, Inc., a wholly-owned subsidiary of UES, which acquired the
Citizens Arizona gas utility assets in 2003.UNS Gas/UNS Electric Revolver
    
    Revolving credit facility under the Amended and Restated Credit
Agreement among UNS Gas and UNS Electric as borrowers, UES as
guarantor, and a syndicate of banks, dated as of August 11, 2006.
  v




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Report of Independent Registered Public Accounting Firm
 
 nine-month nine-month
    
  1




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Report of Independent Registered Public Accounting Firm
 
     
  2




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ITEM 1. FINANCIAL STATEMENTS
 UNISOURCE ENERGY CORPORATION
 
 COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
 Three Months Ended
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    
    September 30,2008
    
    
    2007
    
    
    
    
    2008
    
    
    2007(Unaudited)
    
    
    
    
    (Unaudited)-Thousands of Dollars-
    
    
    
    
    - Thousands of Dollars -(Except Per Share Amounts)
    
    
    
    
    (Except Per Share Amounts)Operating Revenues$
    321,596
    
    
    $
    320,238
    
    
    Electric Retail Sales
    
    $
    768,433
    
    
    $
    765,450(29,517
    )
    
    
    
    
    
    CTC Revenue Subject to Refund
    
    
    (44,415
    )
    
    
    292,079
    
    
    
    320,238
    
    
    Net Electric Retail Sales
    
    
    724,018
    
    
    
    765,45057,279
    
    
    
    46,225
    
    
    Electric Wholesale Sales
    
    
    187,104
    
    
    
    139,51519,739
    
    
    
    15,967
    
    
    Gas Revenue
    
    
    114,786
    
    
    
    100,92718,755
    
    
    
    15,774
    
    
    Other Revenues
    
    
    52,400
    
    
    
    39,925387,852
    
    
    
    398,204
    
    
    Total Operating Revenues
    
    
    1,078,308
    
    
    
    1,045,817Operating Expenses110,797
    
    
    
    90,135
    
    
    Fuel
    
    
    253,067
    
    
    
    223,423134,827
    
    
    
    104,428
    
    
    Purchased Energy
    
    
    356,703
    
    
    
    271,46480,365
    
    
    
    60,226
    
    
    Other Operations and Maintenance
    
    
    226,016
    
    
    
    194,34636,762
    
    
    
    34,513
    
    
    Depreciation and Amortization
    
    
    109,196
    
    
    
    103,494
    
    
    
    25,739
    
    
    Amortization of Transition Recovery Asset
    
    
    23,945
    
    
    
    59,94410,078
    
    
    
    11,555
    
    
    Taxes Other Than Income Taxes
    
    
    35,198
    
    
    
    36,208372,829
    
    
    
    326,596
    
    
    Total Operating Expenses
    
    
    1,004,125
    
    
    
    888,87915,023
    
    
    
    71,608
    
    
    Operating Income
    
    
    74,183
    
    
    
    156,938Other Income (Deductions)2,520
    
    
    
    3,756
    
    
    Interest Income
    
    
    8,724
    
    
    
    12,6561,069
    
    
    
    1,811
    
    
    Other Income
    
    
    6,267
    
    
    
    7,455(2,837
    )
    
    
    (2,291
    )
    
    Other Expense
    
    
    (5,719
    )
    
    
    (4,542
    )752
    
    
    
    3,276
    
    
    Total Other Income (Deductions)
    
    
    9,272
    
    
    
    15,569Interest Expense18,182
    
    
    
    18,468
    
    
    Long-Term Debt
    
    
    53,603
    
    
    
    54,73314,303
    
    
    
    16,112
    
    
    Interest on Capital Leases
    
    
    42,969
    
    
    
    48,390(349
    )
    
    
    1,355
    
    
    Other Interest Expense
    
    
    1,375
    
    
    
    4,767(1,304
    )
    
    
    (2,199
    )
    
    Interest Capitalized
    
    
    (4,480
    )
    
    
    (5,228
    )30,832
    
    
    
    33,736
    
    
    Total Interest Expense
    
    
    93,467
    
    
    
    102,662(15,057
    )
    
    
    41,148
    
    
    Income (Loss) before Income Taxes
    
    
    (10,012
    )
    
    
    69,845(4,018
    )
    
    
    15,731
    
    
    Income Tax Expense (Benefit)
    
    
    (1,106
    )
    
    
    27,678$
    (11,039
    )
    
    $
    25,417
    
    
    Net Income (Loss)
    
    $
    (8,906
    )
    
    $
    42,16735,677
    
    
    
    35,514
    
    
    Weighted-average Shares of Common Stock Outstanding (000)
    
    
    35,616
    
    
    
    35,469$
    (0.31
    )
    
    $
    0.72
    
    
    Basic Earnings (Loss) per Share
    
    $
    (0.25
    )
    
    $
    1.19$
    (0.31
    )
    
    $
    0.66
    
    
    Diluted Earnings (Loss) per Share
    
    $
    (0.25
    )
    
    $
    1.13$
    0.240
    
    
    $
    0.225
    
    
    Dividends Declared per Share
    
    $
    0.720
    
    
    $
    0.675
   3




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UNISOURCE ENERGY CORPORATION
 
 COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months EndedSeptember 30,2008
    
    
    2007(Unaudited)- Thousands of Dollars -Cash Flows from Operating ActivitiesCash Receipts from Electric Retail Sales
    
    $
    803,707
    
    
    $
    793,437Cash Receipts from Electric Wholesale Sales
    
    
    272,558
    
    
    
    226,429Cash Receipts from Gas Sales
    
    
    147,754
    
    
    
    135,886Cash Receipts from Operating Springerville Unit 3
    
    
    41,709
    
    
    
    28,440Interest Received
    
    
    17,069
    
    
    
    18,349Performance Deposits Receipts
    
    
    27,904
    
    
    
    7,554Sale of Excess Emission Allowances
    
    
    1,494
    
    
    
    9,987Income Tax Refunds Received
    
    
    19,626
    
    
    
    1,016Other Cash Receipts
    
    
    11,884
    
    
    
    8,529Purchased Energy Costs Paid
    
    
    (461,724
    )
    
    
    (354,410
    )Fuel Costs Paid
    
    
    (223,273
    )
    
    
    (214,098
    )Wages Paid, Net of Amounts Capitalized
    
    
    (84,543
    )
    
    
    (83,332
    )Payment of Other Operations and Maintenance Costs
    
    
    (140,773
    )
    
    
    (126,019
    )Capital Lease Interest Paid
    
    
    (43,278
    )
    
    
    (53,482
    )Taxes Paid Other than Income Taxes, Net of Amounts Capitalized
    
    
    (106,327
    )
    
    
    (102,527
    )Interest Paid, Net of Amounts Capitalized
    
    
    (50,252
    )
    
    
    (59,186
    )Income Taxes Paid
    
    
    (9,900
    )
    
    
    (20,923
    )Performance Deposit Payments
    
    
    (31,340
    )
    
    
    (7,900
    )Excess Tax Benefit from Stock Options Exercised
    
    
    (612
    )
    
    
    (443
    )Other Cash Payments
    
    
    (4,347
    )
    
    
    (3,770
    )Net Cash Flows  Operating Activities
    
    
    187,336
    
    
    
    203,537Cash Flows from Investing ActivitiesCapital Expenditures
    
    
    (255,798
    )
    
    
    (181,894
    )Deposit to Trustee for Repayment of Collateral Trust Bond
    
    
    (133,111
    )
    
    
    Proceeds from Investment in Springerville Lease Debt
    
    
    24,918
    
    
    
    27,732Proceeds from the Sale of Land
    
    
    538
    
    
    
    2,524Return of Investment from Millennium Energy Business
    
    
    839
    
    
    
    12Other Cash Receipts
    
    
    4,518
    
    
    
    1,951Investment in and Loans to Equity Investees
    
    
    (288
    )
    
    
    (632
    )Other Cash Payments
    
    
    (706
    )
    
    
    (2,864
    )Net Cash Flows  Investing Activities
    
    
    (359,090
    )
    
    
    (153,171
    )Cash Flows from Financing ActivitiesProceeds from Issuance of Long-Term Debt
    
    
    320,745
    
    
    
    Proceeds from Borrowings under Revolving Credit Facilities
    
    
    231,000
    
    
    
    160,000Payments on Borrowings under Revolving Credit Facilities
    
    
    (227,000
    )
    
    
    (159,000
    )Payments on Capital Lease Obligations
    
    
    (74,292
    )
    
    
    (71,533
    )Common Stock Dividends Paid
    
    
    (25,521
    )
    
    
    (23,829
    )Repayments of Long-Term Debt
    
    
    (74,500
    )
    
    
    (4,500
    )Payment of Debt Issue/Retirement Costs
    
    
    (3,561
    )
    
    
    (429
    )Proceeds from Stock Options Exercised
    
    
    1,910
    
    
    
    1,689Excess Tax Benefit from Stock Options Exercised
    
    
    612
    
    
    
    443Other Cash Receipts
    
    
    5,419
    
    
    
    7,228Other Cash Payments
    
    
    (2,866
    )
    
    
    (5,452
    )Net Cash Flows  Financing Activities
    
    
    151,946
    
    
    
    (95,383
    )Net Decrease in Cash and Cash Equivalents
    
    
    (19,808
    )
    
    
    (45,017
    )Cash and Cash Equivalents, Beginning of Year
    
    
    90,373
    
    
    
    104,241Cash and Cash Equivalents, End of Period
    
    $
    70,565
    
    
    $
    59,224Non-Cash Financing Activity  Repayment of Collateral Trust Bond
    
    $
    (128,300
    )
    
    $
    
    4




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UNISOURCE ENERGY CORPORATION
 
 COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)- Thousands of Dollars -ASSETSUtility PlantPlant in Service
    
    $
    3,747,588
    
    
    $
    3,565,735Utility Plant under Capital Leases
    
    
    702,337
    
    
    
    702,337Construction Work in Progress
    
    
    220,424
    
    
    
    195,105Total Utility Plant
    
    
    4,670,349
    
    
    
    4,463,177Less Accumulated Depreciation and Amortization
    
    
    (1,588,728
    )
    
    
    (1,534,424
    )Less Accumulated Amortization of Capital Lease Assets
    
    
    (540,593
    )
    
    
    (521,458
    )Total Utility Plant  Net
    
    
    2,541,028
    
    
    
    2,407,295Investments and Other PropertyInvestments in Lease Debt and Equity
    
    
    126,911
    
    
    
    152,544Other
    
    
    64,527
    
    
    
    70,677Total Investments and Other Property
    
    
    191,438
    
    
    
    223,221Current AssetsCash and Cash Equivalents
    
    
    70,565
    
    
    
    90,373Accounts Receivable  Retail and Other
    
    
    85,761
    
    
    
    67,885Accounts Receivable  Wholesale Sales
    
    
    43,214
    
    
    
    46,316Unbilled Accounts Receivable
    
    
    58,179
    
    
    
    62,101Allowance for Doubtful Accounts
    
    
    (19,090
    )
    
    
    (18,446
    )Materials and Fuel
    
    
    90,891
    
    
    
    82,433Regulatory Assets
    
    
    17,085
    
    
    
    10,262Energy Contracts  Derivative Assets
    
    
    13,993
    
    
    
    5,489Deferred Income Taxes  Current
    
    
    59,708
    
    
    
    60,055Income Tax Receivable
    
    
    12,995
    
    
    
    Interest Receivable on Capital Lease Debt Investment
    
    
    2,245
    
    
    
    6,033Interest Receivable  Other
    
    
    88
    
    
    
    3,417Other
    
    
    24,789
    
    
    
    14,322Total Current Assets
    
    
    460,423
    
    
    
    430,240Regulatory and Other AssetsIncome Taxes Recoverable Through Future Revenues
    
    
    27,102
    
    
    
    30,009Regulatory Assets  Other
    
    
    40,965
    
    
    
    37,313Energy Contracts  Derivative Assets
    
    
    6,037
    
    
    
    8,339Regulatory Assets  Transition Recovery Asset
    
    
    
    
    
    
    23,944Other Assets
    
    
    24,841
    
    
    
    25,355Total Regulatory and Other Assets
    
    
    98,945
    
    
    
    124,960Total Assets
    
    $
    3,291,834
    
    
    $
    3,185,716
  (Continued)
  5




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UNISOURCE ENERGY CORPORATION
 
 COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)- Thousands of Dollars -CAPITALIZATION AND OTHER LIABILITIESCapitalizationCommon Stock
    
    $
    706,412
    
    
    $
    702,368Accumulated Deficit
    
    
    (35,655
    )
    
    
    (628
    )Accumulated Other Comprehensive Income (Loss)
    
    
    (17,531
    )
    
    
    (11,665
    )Common Stock Equity
    
    
    653,226
    
    
    
    690,075Capital Lease Obligations
    
    
    511,422
    
    
    
    530,973Long-Term Debt
    
    
    1,314,115
    
    
    
    993,870Total Capitalization
    
    
    2,478,763
    
    
    
    2,214,918Current LiabilitiesCurrent Obligations under Capital Leases
    
    
    18,328
    
    
    
    58,599Borrowing Under Revolving Credit Facilities
    
    
    10,000
    
    
    
    10,000Current Maturities of Long-Term Debt
    
    
    6,000
    
    
    
    204,300Accounts Payable
    
    
    63,380
    
    
    
    72,003Accounts Payable  Purchased Power
    
    
    43,397
    
    
    
    50,684Interest Accrued
    
    
    25,508
    
    
    
    48,091Accrued Taxes Other than Income Taxes
    
    
    49,254
    
    
    
    36,775Accrued Employee Expenses
    
    
    21,787
    
    
    
    24,585Customer Deposits
    
    
    21,811
    
    
    
    21,425Regulatory Liabilities  Deferred CTC Revenue
    
    
    44,662
    
    
    
    Regulatory Liabilities  Over-Recovered
Purchased Energy Costs
    
    
    9,246
    
    
    
    13,084Regulatory Liabilities  Other
    
    
    6,255
    
    
    
    3,436Energy Contracts  Derivative Liabilities
    
    
    30,954
    
    
    
    3,193Other
    
    
    1,179
    
    
    
    1,506Total Current Liabilities
    
    
    351,761
    
    
    
    547,681Deferred Credits and Other LiabilitiesDeferred Income Taxes  Noncurrent
    
    
    159,509
    
    
    
    149,730Pension and Other Post-Retirement Benefits
    
    
    72,719
    
    
    
    76,407Regulatory Liabilities  Net Cost of Removal
for Interim Retirements
    
    
    121,483
    
    
    
    106,695Regulatory Liabilities  Derivatives Instruments
    
    
    
    
    
    
    6,426Regulatory Liabilities  Over-Recovered
Purchased Power Costs
    
    
    
    
    
    
    9,295Customer Advances for Construction
    
    
    31,385
    
    
    
    28,798Energy Contracts  Derivative Liabilities
    
    
    20,505
    
    
    
    4,930Other
    
    
    55,709
    
    
    
    40,836Total Deferred Credits and Other Liabilities
    
    
    461,310
    
    
    
    423,117Commitments and Contingencies (Note 7)Total Capitalization and Other Liabilities
    
    $
    3,291,834
    
    
    $
    3,185,716
  (Concluded)
  6




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##### Table of Contents



UNISOURCE ENERGY CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
 AccumulatedCommon
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    TotalShares
    
    
    Common
    
    
    Accumulated
    
    
    Comprehensive
    
    
    StockholdersIssued*
    
    
    Stock
    
    
    Deficit
    
    
    Income (Loss)
    
    
    Equity(Unaudited)- Thousands of Dollars -Balances at December 31, 2007
    
    
    35,315
    
    
    $
    702,368
    
    
    $
    (628
    )
    
    $
    (11,665
    )
    
    $
    690,075Impact of Change in Pension Plan Measurement Date
    
    
    
    
    
    
    
    
    
    
    (603
    )
    
    
    
    
    
    
    (603
    )Comprehensive Income (Loss):2008 Year-to-Date Net Loss
    
    
    
    
    
    
    
    
    
    
    (8,906
    )
    
    
    
    
    
    
    (8,906
    )Unrealized Loss on Cash Flow Hedges
(net of $3,178 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,848
    )
    
    
    (4,848
    )Reclassification of Unrealized Gain on 
Cash Flow Hedges to Net Income
(net of $578 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (882
    )
    
    
    (882
    )Employee Benefit ObligationsAmortization of net actuarial
loss and prior service credit
included in net periodic benefit
cost
(net of $89 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (136
    )
    
    
    (136
    )Total Comprehensive Income (Loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (14,772
    )Dividends Declared
    
    
    
    
    
    
    
    
    
    
    (25,518
    )
    
    
    
    
    
    
    (25,518
    )Shares Issued under Stock Compensation Plans
    
    
    22Shares Issued for Stock Options
    
    
    116
    
    
    
    1,910
    
    
    
    
    
    
    
    
    
    
    
    1,910Tax Benefit Realized from Stock Options Exercised
    
    
    
    
    
    
    612
    
    
    
    
    
    
    
    
    
    
    
    612Other
    
    
    
    
    
    
    1,522
    
    
    
    
    
    
    
    
    
    
    
    1,522Balances at September 30, 2008
    
    
    35,453
    
    
    $
    706,412
    
    
    $
    (35,655
    )
    
    $
    (17,531
    )
    
    $
    653,226
 *
    
    UniSource Energy has 75 million authorized shares of Common Stock.   7




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##### Table of Contents



TUCSON ELECTRIC POWER COMPANY
 
 COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
 Three Months Ended
    
    
    
    
    Nine Months EndedSeptember 30,
    
    
    
    
    September 30,2008
    
    
    2007
    
    
    
    
    2008
    
    
    2007(Unaudited)
    
    
    
    
    (Unaudited)- Thousands of Dollars -
    
    
    
    
    - Thousands of Dollars -Operating Revenues$
    259,913
    
    
    $
    266,466
    
    
    Electric Retail Sales
    
    $
    627,135
    
    
    $
    635,818(29,517
    )
    
    
    
    
    
    CTC Revenue Subject to Refund
    
    
    (44,415
    )
    
    
    230,396
    
    
    
    266,466
    
    
    Net Electric Retail Sales
    
    
    582,720
    
    
    
    635,81872,896
    
    
    
    46,120
    
    
    Electric Wholesale Sales
    
    
    207,791
    
    
    
    139,33720,020
    
    
    
    16,255
    
    
    Other Revenues
    
    
    55,544
    
    
    
    41,686323,312
    
    
    
    328,841
    
    
    Total Operating Revenues
    
    
    846,055
    
    
    
    816,841Operating Expenses107,228
    
    
    
    90,135
    
    
    Fuel
    
    
    247,927
    
    
    
    223,423100,418
    
    
    
    58,094
    
    
    Purchased Power
    
    
    211,194
    
    
    
    115,11168,935
    
    
    
    47,845
    
    
    Other Operations and Maintenance
    
    
    193,469
    
    
    
    159,56931,201
    
    
    
    29,392
    
    
    Depreciation and Amortization
    
    
    93,198
    
    
    
    88,033
    
    
    
    25,739
    
    
    Amortization of Transition Recovery Asset
    
    
    23,945
    
    
    
    59,9448,079
    
    
    
    9,616
    
    
    Taxes Other Than Income Taxes
    
    
    29,143
    
    
    
    30,222315,861
    
    
    
    260,821
    
    
    Total Operating Expenses
    
    
    798,876
    
    
    
    676,3027,451
    
    
    
    68,020
    
    
    Operating Income
    
    
    47,179
    
    
    
    140,539Other Income (Deductions)2,238
    
    
    
    3,092
    
    
    Interest Income
    
    
    7,704
    
    
    
    10,496927
    
    
    
    1,160
    
    
    Other Income
    
    
    4,943
    
    
    
    3,913(2,526
    )
    
    
    (2,048
    )
    
    Other Expense
    
    
    (3,255
    )
    
    
    (3,725
    )639
    
    
    
    2,204
    
    
    Total Other Income (Deductions)
    
    
    9,392
    
    
    
    10,684Interest Expense12,317
    
    
    
    12,651
    
    
    Long-Term Debt
    
    
    36,654
    
    
    
    37,76614,298
    
    
    
    16,105
    
    
    Interest on Capital Leases
    
    
    42,953
    
    
    
    48,371(457
    )
    
    
    1,062
    
    
    Other Interest Expense
    
    
    1,012
    
    
    
    4,020(1,279
    )
    
    
    (1,397
    )
    
    Interest Capitalized
    
    
    (3,632
    )
    
    
    (3,264
    )24,879
    
    
    
    28,421
    
    
    Total Interest Expense
    
    
    76,987
    
    
    
    86,893(16,789
    )
    
    
    41,803
    
    
    Income (Loss) Before Income Taxes
    
    
    (20,416
    )
    
    
    64,330(4,552
    )
    
    
    15,844
    
    
    Income Tax Expense (Benefit)
    
    
    (5,081
    )
    
    
    25,279$
    (12,237
    )
    
    $
    25,959
    
    
    Net Income (Loss)
    
    $
    (15,335
    )
    
    $
    39,051
   8




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##### Table of Contents



TUCSON ELECTRIC POWER COMPANY
 
 COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Nine Months EndedSeptember 30,2008
    
    
    2007(Unaudited)- Thousands of Dollars -Cash Flows from Operating ActivitiesCash Receipts from Electric Retail Sales
    
    $
    658,958
    
    
    $
    658,623Cash Receipts from Electric Wholesale Sales
    
    
    291,876
    
    
    
    226,429Cash Receipts from Operating Springerville Unit 3
    
    
    41,709
    
    
    
    28,440Income Tax Refunds Received
    
    
    18,028
    
    
    
    Interest Received
    
    
    15,763
    
    
    
    16,006Reimbursement of Affiliate Charges
    
    
    16,351
    
    
    
    Sale of Excess Emission Allowances
    
    
    1,494
    
    
    
    9,987Performance Deposits Receipts
    
    
    10,150
    
    
    
    Other Cash Receipts
    
    
    6,762
    
    
    
    5,888Purchased Power Costs Paid
    
    
    (287,785
    )
    
    
    (190,071
    )Fuel Costs Paid
    
    
    (218,664
    )
    
    
    (214,099
    )Payment of Other Operations and Maintenance Costs
    
    
    (135,053
    )
    
    
    (116,657
    )Wages Paid, Net of Amounts Capitalized
    
    
    (66,950
    )
    
    
    (65,818
    )Capital Lease Interest Paid
    
    
    (43,260
    )
    
    
    (53,464
    )Taxes Other than Income Taxes Paid, Net of Amounts Capitalized
    
    
    (79,006
    )
    
    
    (76,583
    )Interest Paid, Net of Amounts Capitalized
    
    
    (30,585
    )
    
    
    (39,159
    )Income Taxes Paid
    
    
    
    
    
    
    (23,609
    )Performance Deposits Payments
    
    
    (10,150
    )
    
    
    Other Cash Payments
    
    
    (3,005
    )
    
    
    (2,769
    )Net Cash Flows  Operating Activities
    
    
    186,633
    
    
    
    163,144Cash Flows from Investing ActivitiesCapital Expenditures
    
    
    (209,312
    )
    
    
    (123,352
    )Deposit to Trustee for Repayment of Collateral Trust Bond
    
    
    (133,111
    )
    
    
    Proceeds from Investment in Springerville Lease Debt
    
    
    24,918
    
    
    
    27,732Proceeds from Sale of Land
    
    
    537
    
    
    
    642Other Cash Payments
    
    
    (706
    )
    
    
    (2,444
    )Other Cash Receipts
    
    
    4,518
    
    
    
    Net Cash Flows  Investing Activities
    
    
    (313,156
    )
    
    
    (97,422
    )Cash Flows from Financing ActivitiesProceeds from Issuance of Long-Term Debt
    
    
    220,745
    
    
    
    Proceeds from Borrowings under Revolving Credit Facility
    
    
    160,000
    
    
    
    120,000Payments on Borrowings under Revolving Credit Facility
    
    
    (160,000
    )
    
    
    (134,000
    )Payments on Capital Lease Obligations
    
    
    (74,228
    )
    
    
    (71,464
    )Repayments of Long-Term Debt
    
    
    (10,000
    )
    
    
    Payment of Debt Issue/Retirement Costs
    
    
    (2,942
    )
    
    
    (415
    )Other Cash Receipts
    
    
    1,012
    
    
    
    11,206Other Cash Payments
    
    
    (1,221
    )
    
    
    (783
    )Net Cash Flows  Financing Activities
    
    
    133,366
    
    
    
    (75,456
    )Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    6,843
    
    
    
    (9,734
    )Cash and Cash Equivalents, Beginning of Year
    
    
    26,610
    
    
    
    19,711Cash and Cash Equivalents, End of Period
    
    $
    33,453
    
    
    $
    9,977Non-Cash Financing Activity  Repayment of Collateral Trust Bond
    
    $
    (128,300
    )
    
    $
    
    9




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##### Table of Contents



TUCSON ELECTRIC POWER COMPANY
 
 COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)- Thousands of Dollars -ASSETSUtility PlantPlant in Service
    
    $
    3,237,216
    
    
    $
    3,143,823Utility Plant under Capital Leases
    
    
    701,631
    
    
    
    701,631Construction Work in Progress
    
    
    198,767
    
    
    
    123,833Total Utility Plant
    
    
    4,137,614
    
    
    
    3,969,287Less Accumulated Depreciation and Amortization
    
    
    (1,541,664
    )
    
    
    (1,490,724
    )Less Accumulated Amortization of Capital Lease Assets
    
    
    (540,124
    )
    
    
    (521,057
    )Total Utility Plant  Net
    
    
    2,055,826
    
    
    
    1,957,506Investments and Other PropertyInvestments in Lease Debt and Equity
    
    
    126,911
    
    
    
    152,544Other
    
    
    31,583
    
    
    
    35,460Total Investments and Other Property
    
    
    158,494
    
    
    
    188,004Current AssetsCash and Cash Equivalents
    
    
    33,453
    
    
    
    26,610Accounts Receivable  Wholesale Sales
    
    
    43,122
    
    
    
    46,316Accounts Receivable  Retail and Other
    
    
    64,391
    
    
    
    44,431Unbilled Accounts Receivable
    
    
    43,294
    
    
    
    35,941Allowance for Doubtful Accounts
    
    
    (16,940
    )
    
    
    (16,538
    )Intercompany Accounts Receivable
    
    
    10,889
    
    
    
    8,740Income Tax Receivable
    
    
    4,772
    
    
    
    8,070Materials and Fuel Inventory
    
    
    80,220
    
    
    
    72,732Regulatory Assets
    
    
    9,401
    
    
    
    9,554Deferred Income Taxes  Current
    
    
    56,712
    
    
    
    59,157Interest Receivable on Capital Lease
    
    
    2,245
    
    
    
    6,033Interest Receivable  Current
    
    
    
    
    
    
    3,350Energy Contracts  Derivative Instruments
    
    
    13,494
    
    
    
    2,036Other
    
    
    19,584
    
    
    
    13,062Total Current Assets
    
    
    364,637
    
    
    
    319,494Regulatory and Other AssetsIncome Taxes Recoverable Through Future Revenues
    
    
    27,102
    
    
    
    30,009Regulatory Assets  Other
    
    
    32,859
    
    
    
    34,123Energy Contracts  Derivative Instruments
    
    
    4,200
    
    
    
    492Regulatory Assets  Transition Recovery Asset
    
    
    
    
    
    
    23,945Other Assets
    
    
    19,018
    
    
    
    19,463Total Regulatory and Other Assets
    
    
    83,179
    
    
    
    108,032Total Assets
    
    $
    2,662,136
    
    
    $
    2,573,036
  (Continued)
  10




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##### Table of Contents



TUCSON ELECTRIC POWER COMPANY
 
 COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)- Thousands of Dollars -CAPITALIZATION AND OTHER LIABILITIESCapitalizationCommon Stock
    
    $
    813,971
    
    
    $
    813,971Capital Stock Expense
    
    
    (6,357
    )
    
    
    (6,357
    )Accumulated Deficit
    
    
    (234,349
    )
    
    
    (218,488
    )Accumulated Other Comprehensive Income (Loss)
    
    
    (11,689
    )
    
    
    (11,777
    )Common Stock Equity
    
    
    561,576
    
    
    
    577,349Capital Lease Obligations
    
    
    511,244
    
    
    
    530,714Long-Term Debt
    
    
    903,615
    
    
    
    682,870Total Capitalization
    
    
    1,976,435
    
    
    
    1,790,933Current LiabilitiesCurrent Obligations under Capital Leases
    
    
    18,231
    
    
    
    58,502Current Maturities of Long-Term Debt
    
    
    
    
    
    
    138,300Borrowing Under Revolving Credit Facility
    
    
    10,000
    
    
    
    10,000Accounts Payable
    
    
    55,345
    
    
    
    64,664Accounts Payable  Purchased Power
    
    
    31,185
    
    
    
    22,935Intercompany Accounts Payable
    
    
    8,683
    
    
    
    4,512Interest Accrued
    
    
    22,877
    
    
    
    41,394Accrued Taxes Other than Income Taxes
    
    
    40,268
    
    
    
    28,690Accrued Employee Expenses
    
    
    19,560
    
    
    
    22,557Energy Contracts  Derivative Instruments
    
    
    16,642
    
    
    
    2,460Regulatory Liabilities  Deferred CTC Revenue
    
    
    44,662
    
    
    
    Regulatory Liabilities  Other
    
    
    5,258
    
    
    
    Other
    
    
    15,884
    
    
    
    15,533Total Current Liabilities
    
    
    288,595
    
    
    
    409,547Deferred Credits and Other LiabilitiesDeferred Income Taxes  Noncurrent
    
    
    164,254
    
    
    
    163,834Regulatory Liabilities  Net Cost of Removal for Interim Retirements
    
    
    93,444
    
    
    
    87,311Energy Contracts  Derivative Instruments
    
    
    9,166
    
    
    
    3,278Pension and Other Post-Retirement Benefits
    
    
    69,594
    
    
    
    72,755Other
    
    
    60,648
    
    
    
    45,378Total Deferred Credits and Other Liabilities
    
    
    397,106
    
    
    
    372,556Commitments and Contingencies (Note 7)Total Capitalization and Other Liabilities
    
    $
    2,662,136
    
    
    $
    2,573,036
  (Concluded)
  11




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##### Table of Contents



TUCSON ELECTRIC POWER COMPANY
 
 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
 AccumulatedCapital
    
    
    
    
    
    
    Other
    
    
    TotalCommon
    
    
    Stock
    
    
    Accumulated
    
    
    Comprehensive
    
    
    StockholdersStock
    
    
    Expense
    
    
    Deficit
    
    
    Income (Loss)
    
    
    Equity(Unaudited)- Thousands of Dollars -Balances at December 31, 2007
    
    $
    813,971
    
    
    $
    (6,357
    )
    
    $
    (218,488
    )
    
    $
    (11,777
    )
    
    $
    577,349Impact of Change in Pension Plan Measurement Date
    
    
    
    
    
    
    
    
    
    
    (526
    )
    
    
    
    
    
    
    (526
    )Comprehensive Income (Loss):2008 Year-to-Date Net Loss
    
    
    
    
    
    
    
    
    
    
    (15,335
    )
    
    
    
    
    
    
    (15,335
    )Unrealized Gain on Cash Flow Hedges
(net of $728 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,110
    
    
    
    1,110Reclassification of Unrealized Gains on
Cash Flow Hedges to Net Income
(net of $582 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (887
    )
    
    
    (887
    )Employee Benefit ObligationsAmortization of net actuarial loss and prior service
credit
included in net periodic benefit cost
(net of $89 income taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (135
    )
    
    
    (135
    )Total Comprehensive Income (Loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,247
    )Balances at September 30, 2008
    
    $
    813,971
    
    
    $
    (6,357
    )
    
    $
    (234,349
    )
    
    $
    (11,689
    )
    
    $
    561,576
   12




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  Unaudited
 
 NOTE 1. NATURE OF OPERATIONS AND BASIS OF ACCOUNTING PRESENTATION
             13




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 2. REGULATORY MATTERS
 ACCOUNTING FOR RATE REGULATION
 Accounting for the Effects of Certain
Types of Regulation
  
    
    an independent regulator sets rates;
    
    the regulator sets the rates to recover the specific costs of providing service; and
    
    the service territory lacks competitive pressures to reduce rates below the rates set
by the regulator.
 TEP RATES AND REGULATION
 TEP Rate Proceeding
  TEP Rate Proposals
  TEP 2008 Proposed Settlement Agreement
    Transition Recovery Asset and Provision for Rate Refunds
    14




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  Renewable Energy Standard Tariff (REST)
   Future Implications of Discontinuing Application of FAS 71
  UNS GAS RATES AND REGULATION
 2008 General Rate Case Filing
  Purchase Gas Adjustor (PGA) Mechanism
  (1)
    
    The PGA factor, computed monthly, is a calculation of the twelve-month rolling weighted
average gas cost, and automatically adjusts monthly, subject to limitations on how much the
price per therm may change in a twelve-month period. Effective December 2007, the ACC
increased the annual cap on the maximum increase in the PGA factor from $0.10 per therm to
$0.15 per therm in a twelve-month period.
 (2)
    
    At any time UNS Gas PGA bank balance is under-recovered, UNS Gas may request a PGA
surchargewith the goal of collecting the amount deferred from customers over a period
deemed appropriate by the ACC. When the PGA bank balance reaches an over-collected balance
of $10 million on a billed basis,
UNS Gas is required to request a PGA surcreditwith the goal of returning the over-collected
balance to customers over a period deemed appropriate by the ACC.
  15




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
    Future Implications of Discontinuing Application of FAS 71
  UNS ELECTRIC RATES AND REGULATION
 2008 Rate Order
    Purchased Power and Fuel Adjustment Clause (PPFAC)
    16




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  Purchased Power Agreement
  Renewable Energy Standard Tariff (REST)
   Future Implications of Discontinuing Application of FAS 71
  
 NOTE 3. DEBT AND CREDIT FACILITIES
 UniSource Energy Credit Agreement
    17




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 TEP Credit Agreement
  TEP Letter of Credit Facility
    TEP Long-Term Debt
 Pima A Bonds
     Pima B Bonds
    18




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
    UNS Electric Long-Term Debt
      TEP Revolving Credit Facility
  UNS Gas/UNS Electric Revolving Credit Agreement
  UNS
    
    
    UNS
    
    
    UNS
    
    
    UNSGas
    
    
    Electric
    
    
    Gas
    
    
    Electric-Millions of Dollars-September 30, 2008
    
    
    December 31, 2007Balance on the Revolver
    
    $
    
    
    
    $
    8
    
    
    $
    
    
    
    $
    26Outstanding Letters of Credit
    
    $
    
    
    
    $
    12
    
    
    $
    10
    
    
    $
    
   19




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 4. BUSINESS 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.
   Reportable Segments
    
    
    
    
    
    
    
    
    
    
    UniSourceUNS
    
    
    UNS
    
    
    
    
    
    
    Reconciling
    
    
    EnergyTEP
    
    
    Gas
    
    
    Electric
    
    
    Other
    
    
    Adjustments
    
    
    Consolidated-Millions of Dollars-Statements
of Income (Loss)Three months ended September 30, 2008:Operating Revenues  External
    
    $
    305
    
    
    $
    20
    
    
    $
    63
    
    
    $
    
    
    
    $
    
    
    
    $
    388Operating Revenues  Intersegment
    
    
    19
    
    
    
    3
    
    
    
    5
    
    
    
    7
    
    
    
    (34
    )
    
    
    Income (Loss) Before Income Taxes
    
    
    (17
    )
    
    
    (2
    )
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    (15
    )Net Income (Loss)
    
    $
    (12
    )
    
    $
    (1
    )
    
    $
    3
    
    
    $
    (1
    )
    
    $
    
    
    
    $
    (11
    )Three months ended September 30, 2007:Operating Revenues  External
    
    $
    327
    
    
    $
    17
    
    
    $
    54
    
    
    $
    
    
    
    $
    
    
    
    $
    398Operating Revenues  Intersegment
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    (5
    )
    
    
    Income (Loss) Before Income Taxes
    
    
    42
    
    
    
    (4
    )
    
    
    5
    
    
    
    (2
    )
    
    
    
    
    
    
    41Net Income (Loss)
    
    $
    26
    
    
    $
    (2
    )
    
    $
    3
    
    
    $
    (2
    )
    
    $
    
    
    
    $
    25Nine months ended September 30, 2008:Operating Revenues  External
    
    $
    817
    
    
    $
    117
    
    
    $
    144
    
    
    $
    
    
    
    $
    
    
    
    $
    1,078Operating Revenues  Intersegment
    
    
    29
    
    
    
    6
    
    
    
    7
    
    
    
    16
    
    
    
    (58
    )
    
    
    Income (Loss) Before Income Taxes
    
    
    (20
    )
    
    
    9
    
    
    
    6
    
    
    
    (5
    )
    
    
    
    
    
    
    (10
    )Net Income (Loss)
    
    $
    (15
    )
    
    $
    5
    
    
    $
    4
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    (9
    )Nine months ended September 30, 2007:Operating Revenues  External
    
    $
    812
    
    
    $
    103
    
    
    $
    131
    
    
    $
    
    
    
    $
    
    
    
    $
    1,046Operating Revenues  Intersegment
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    (17
    )
    
    
    Income (Loss) Before Income Taxes
    
    
    64
    
    
    
    2
    
    
    
    8
    
    
    
    (4
    )
    
    
    
    
    
    
    70Net Income (Loss)
    
    $
    39
    
    
    $
    1
    
    
    $
    5
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    42Balance SheetTotal Assets, September 30, 2008
    
    $
    2,662
    
    
    $
    259
    
    
    $
    271
    
    
    $
    1,045
    
    
    $
    (945
    )
    
    $
    3,292Total Assets, December 31, 2007
    
    
    2,573
    
    
    
    276
    
    
    
    226
    
    
    
    1,077
    
    
    
    (966
    )
    
    
    3,186
  20




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  Reportable Segments
    
    
    
    
    
    
    UniSource
    
    
    UniSourceUNS
    
    
    UNS
    
    
    
    
    
    
    Energy
    
    
    EnergyTEP
    
    
    Gas
    
    
    Electric
    
    
    Other
    
    
    Eliminations
    
    
    Consolidated-Millions of Dollars-Intersegment
RevenueThree months ended September 30, 2008:Wholesale Sales  TEP to UNSE
    
    $
    16
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (16
    )
    
    $
    Wholesale Sales   UNSE to TEP
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    (5
    )
    
    
    Wholesale Sales  UED to UNSE
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    (3
    )
    
    
    Gas Revenue  UNSG to UNSE
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    Other Revenue  TEP to Affiliates(1)
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    Other Revenue  MEH to TEP & UNSE(2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    (4
    )
    
    
    Other Revenue  TEP to UNSE(3)
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    Total Intersegment Revenue
    
    $
    19
    
    
    $
    3
    
    
    $
    5
    
    
    $
    7
    
    
    $
    (34
    )
    
    $
    Three months ended September 30, 2007:Other Revenue  TEP to Affiliates(1)
    
    $
    2
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (2
    )
    
    $
    Other Revenue  MEH to TEP & UNSE(2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    (3
    )
    
    
    Total Intersegment Revenue
    
    $
    2
    
    
    $
    
    
    
    $
    
    
    
    $
    3
    
    
    $
    (5
    )
    
    $
    Nine months ended September 30, 2008:Wholesale Sales  TEP to UNSE
    
    $
    22
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (22
    )
    
    $
    Wholesale Sales   UNSE to TEP
    
    
    
    
    
    
    
    
    
    
    7
    
    
    
    
    
    
    
    (7
    )
    
    
    Wholesale Sales  UED to UNSE
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    (4
    )
    
    
    Gas Revenue  UNSG to UNSE
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    Other Revenue  TEP to Affiliates(1)
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    Other Revenue  MEH to TEP & UNSE(2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    (12
    )
    
    
    Other Revenue  TEP to UNSE(3)
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    Total Intersegment Revenue
    
    $
    29
    
    
    $
    6
    
    
    $
    7
    
    
    $
    16
    
    
    $
    (58
    )
    
    $
    Nine months ended September 30, 2007:Other Revenue  TEP to Affiliates(1)
    
    $
    5
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (5
    )
    
    $
    Other Revenue  MEH to TEP & UNSE(2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    (12
    )
    
    
    Total Intersegment Revenue
    
    $
    5
    
    
    $
    
    
    
    $
    
    
    
    $
    12
    
    
    $
    (17
    )
    
    $
    
 (1)
    
    TEP provides all corporate services (finance, accounting, tax, information technology services,
etc) to UniSource Energy and its subsidiaries.(2)
    
    SES, a Millennium subsidiary, provides a supplemental workforce to TEP and UNS Electric.(3)
    
    TEP provides control area services to UNS Electric.   21




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 5. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND TRADING ACTIVITIES
 TEP INTEREST RATE SWAP
  FUEL AND POWER TRANSACTIONS
   
    
    Cash Flow Hedgesare used by TEP and UNS Gas to hedge the changes in cash flows that are
to be received or paid in connection with gas swap agreements and forward power sales.
These contracts hedge the cash flow risk associated with TEPs summer load requirements and
its forecasted excess generation and UNS Gas winter load requirement. The effective
portion of the changes in the market prices of cash flow hedges are recorded as unrealized
gains and losses in Accumulated Other Comprehensive Income (AOCI) and the ineffective
portion, if any, is recognized in earnings.TEP and UNS Gas discontinue cash flow hedge accounting prospectively, when they determine
that a contract is no longer effective in offsetting the changes in cash flows of a hedged
item. When TEP or UNS Gas discontinue cash flow hedge accounting, the gains and losses at
that time remain in AOCI and are reclassified into earnings as the underlying hedged
transaction occurs. TEP and UNS Gas continue to carry the contract at fair value and
recognize changes in fair value in current period earnings.
    
    Mark-to-Markettransactions include:
 
    
    TEP non-trading hedges, such as forward power purchase contracts indexed
to gas that did not qualify for cash flow hedge accounting treatment or did not
qualify for the normal scope exception. Unrealized gains and losses resulting from
changes in the market prices of non-trading hedges are recorded on the same line in
the income statement as the hedged transaction.
    
    TEP trading derivatives which are forward power purchase and sale
contracts entered into to reduce our exposure to energy and commodity prices.
Unrealized gains and losses resulting from changes in the market prices of trading
derivatives are recorded in the income statement in Electric Wholesale Sales.
    
    UNS Electric derivatives such as forward power purchases and gas swaps.
In December 2006, UNS Electric received authorization from the ACC to defer the
unrealized gains and losses on the balance sheet as a regulatory asset or a
regulatory liability rather than as a component of AOCI or in the income statement.
  22




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  
    
    Normal Purchase and Saletransactions are forward energy purchase and sales contracts
entered into by TEP, UNS Gas and UNS Electric to support the current load forecast and
entered into with a counterparty with load serving requirements or generating capacity.
These contracts are not required to be marked-to-market and are accounted for on an accrual
basis.
  UniSource EnergyThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Cash Flow Hedges - Unrealized Gains (Losses)Recorded to AOCI
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Forward Power Sales
    
    $
    5
    
    
    $
    1
    
    
    $
    2
    
    
    $
    Gas Price Swaps
    
    
    (44
    )
    
    
    (3
    )
    
    
    (10
    )
    
    
    (6
    )Interest Rate Swap
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    1Total Pre-Tax Unrealized Gain (Loss)
    
    $
    (40
    )
    
    $
    (3
    )
    
    $
    (8
    )
    
    $
    (5
    )After-Tax Unrealized Gain (Loss) Recorded in AOCI
    
    $
    (24
    )
    
    $
    (2
    )
    
    $
    (5
    )
    
    $
    (3
    )Unrealized (Gain) Loss Reclassified to Net Income
    
    $
    1
    
    
    $
    4
    
    
    $
    (1
    )
    
    $
    2
 TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,Cash Flow Hedges - Unrealized Gains (Losses)Recorded to AOCI
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Forward Power Sales
    
    $
    5
    
    
    $
    1
    
    
    $
    2
    
    
    $
    Gas Price Swaps
    
    
    (27
    )
    
    
    (4
    )
    
    
    
    
    
    
    (6
    )Interest Rate Swap
    
    
    (1
    )
    
    
    (1
    )
    
    
    
    
    
    
    1Total Pre-Tax Unrealized Gain (Loss)
    
    $
    (23
    )
    
    $
    (4
    )
    
    $
    2
    
    
    $
    (5
    )After-Tax Unrealized Gain (Loss) Recorded in AOCI
    
    $
    (14
    )
    
    $
    (2
    )
    
    $
    1
    
    
    $
    (3
    )Unrealized (Gain) Loss Reclassified to Net Income
    
    $
    1
    
    
    $
    4
    
    
    $
    (1
    )
    
    $
    2
    23




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  UniSource Energy and TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Recorded in Wholesale Sales:Forward Power Sales
    
    $
    28
    
    
    $
    1
    
    
    $
    13
    
    
    $
    7Forward Power Purchases
    
    
    (28
    )
    
    
    
    
    
    
    (14
    )
    
    
    (7
    )Forward Power Purchases Recorded in Purchased Energy
    
    
    1
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    Forward Gas Price Swaps Recorded in Fuel
    
    
    (7
    )
    
    
    
    
    
    
    (3
    )
    
    
    Total Pre-Tax Unrealized Gain (Loss)
    
    $
    (6
    )
    
    $
    
    
    
    $
    (5
    )
    
    $
    
  UniSource EnergyThree Months Ended
    
    
    Six Months EndedMark-to-Market Transactions - Increase (Decrease)
    
    September 30,
    
    
    September 30,Recorded in Regulatory Accounts on the Balance Sheet
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Recorded in Current Regulatory Assets  Derivatives:Gas Swaps
    
    $
    (2
    )
    
    $
    
    
    
    $
    (2
    )
    
    $
    Power Purchases
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )
    
    
    Recorded in Current Regulatory Liabilities  Derivatives:Gas Swaps
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    Power Purchases
    
    
    (25
    )
    
    
    3
    
    
    
    (3
    )
    
    
    3Recorded in
Other Regulatory Assets  Derivatives:Gas Swaps
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    (1
    )Power Purchases
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )
    
    
    Recorded in Other Regulatory Liabilities  Derivatives:Gas Swaps
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    Power Purchases
    
    
    (10
    )
    
    
    (8
    )
    
    
    (6
    )
    
    
    (2
    )Total Increase (Decrease)
    
    $
    (58
    )
    
    $
    (5
    )
    
    $
    (22
    )
    
    $
    
  24




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  UniSource EnergySeptember 30, 2008
    
    
    December 31, 2007Cash
    
    
    
    
    
    
    
    
    
    CashMark-to-Market
    
    
    Flow
    
    
    
    
    
    
    Mark-to-Market
    
    
    FlowContracts
    
    
    Hedges
    
    
    Total
    
    
    Contracts
    
    
    Hedges
    
    
    Total-Millions of Dollars-Derivative Assets  Current
    
    $
    10
    
    
    $
    4
    
    
    $
    14
    
    
    $
    4
    
    
    $
    1
    
    
    $
    5Derivative Liabilities  Current
    
    
    (22
    )
    
    
    (9
    )
    
    
    (31
    )
    
    
    (1
    )
    
    
    (2
    )
    
    
    (3
    )Net Current Derivative Assets (Liabilities)
    
    $
    (12
    )
    
    $
    (5
    )
    
    $
    (17
    )
    
    $
    3
    
    
    $
    (1
    )
    
    $
    2Derivative Assets  Noncurrent
    
    $
    6
    
    
    $
    
    
    
    $
    6
    
    
    $
    8
    
    
    $
    
    
    
    $
    8Derivative Liabilities  Noncurrent
    
    
    (12
    )
    
    
    (8
    )
    
    
    (20
    )
    
    
    (2
    )
    
    
    (3
    )
    
    
    (5
    )Net Noncurrent Derivative Assets (Liabilities)
    
    $
    (6
    )
    
    $
    (8
    )
    
    $
    (14
    )
    
    $
    6
    
    
    $
    (3
    )
    
    $
    3
 TEPSeptember 30, 2008
    
    
    December 31, 2007Cash
    
    
    
    
    
    
    
    
    
    CashMark-to-Market
    
    
    Flow
    
    
    
    
    
    
    Mark-to-Market
    
    
    FlowContracts
    
    
    Hedges
    
    
    Total
    
    
    Contracts
    
    
    Hedges
    
    
    Total-Millions of Dollars-Derivative
Assets  Current
    
    $
    10
    
    
    $
    4
    
    
    $
    14
    
    
    $
    1
    
    
    $
    1
    
    
    $
    2Derivative Liabilities  Current
    
    
    (14
    )
    
    
    (3
    )
    
    
    (17
    )
    
    
    (1
    )
    
    
    (2
    )
    
    
    (3
    )Net Current Derivative Assets (Liabilities)
    
    $
    (4
    )
    
    $
    1
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    (1
    )
    
    $
    (1
    )Derivative Assets  Noncurrent
    
    $
    4
    
    
    $
    
    
    
    $
    4
    
    
    $
    
    
    
    $
    
    
    
    $
    Derivative Liabilities  Noncurrent
    
    
    (4
    )
    
    
    (5
    )
    
    
    (9
    )
    
    
    
    
    
    
    (3
    )
    
    
    (3
    )Net Noncurrent Derivative Assets (Liabilities)
    
    $
    
    
    
    $
    (5
    )
    
    $
    (5
    )
    
    $
    
    
    
    $
    (3
    )
    
    $
    (3
    )
  Credit Risk
   25




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  UniSource Energy and TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Recorded in Wholesale Sales:Forward Power Sales
    
    $
    19
    
    
    $
    7
    
    
    $
    50
    
    
    $
    49Forward Power Purchases
    
    
    (18
    )
    
    
    (8
    )
    
    
    (50
    )
    
    
    (50
    )Total Pre-Tax Realized Gain (Loss)
    
    $
    1
    
    
    $
    (1
    )
    
    $
    
    
    
    $
    (1
    )
  UniSource Energy and TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Recorded in Wholesale Sales:Forward Power Sales
    
    $
    13
    
    
    $
    8
    
    
    $
    25
    
    
    $
    14Forward Power Purchases
    
    
    (13
    )
    
    
    (8
    )
    
    
    (25
    )
    
    
    (14
    )Total Sales and
Purchases Not Resulting
in Physical Delivery
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
  26




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 6. INCOME TAX MATTERS
 INCOME TAXES
  UniSource EnergyThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Federal Income Tax Expense (Benefit) at Statutory Rate
    
    $
    (5
    )
    
    $
    14
    
    
    $
    (3
    )
    
    $
    24State Income Tax Expense (Benefit), Net of Federal
Deduction
    
    
    (1
    )
    
    
    2
    
    
    
    (1
    )
    
    
    3San Juan Environmental Penalties
    
    
    2
    
    
    
    
    
    
    
    2
    
    
    
    State Tax Credits
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )
    
    
    Depreciation Differences (Flow Through Basis)
    
    
    1
    
    
    
    1
    
    
    
    2
    
    
    
    2Other
    
    
    
    
    
    
    (1
    )
    
    
    1
    
    
    
    (1
    )Total Federal and State Income Tax Expense (Benefit)
    
    $
    (4
    )
    
    $
    16
    
    
    $
    (1
    )
    
    $
    28
 TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Federal Income Tax Expense (Benefit) at Statutory Rate
    
    $
    (6
    )
    
    $
    14
    
    
    $
    (7
    )
    
    $
    22State Income Tax Expense (Benefit), Net of Federal
Deduction
    
    
    (1
    )
    
    
    2
    
    
    
    (1
    )
    
    
    3San Juan Environmental Penalties
    
    
    2
    
    
    
    
    
    
    
    2
    
    
    
    State Tax Credits
    
    
    (1
    )
    
    
    
    
    
    
    (2
    )
    
    
    Depreciation Differences (Flow Through Basis)
    
    
    1
    
    
    
    1
    
    
    
    2
    
    
    
    2Other
    
    
    
    
    
    
    (1
    )
    
    
    1
    
    
    
    (2
    )Total Federal and State Income Tax Expense (Benefit)
    
    $
    (5
    )
    
    $
    16
    
    
    $
    (5
    )
    
    $
    25
  27




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 UNCERTAIN TAX POSITIONS
    
 NOTE 7. COMMITMENTS AND CONTINGENCIES
 TEP COMMITMENTS
     UNS ELECTRIC COMMITMENTS
  September 30, 2008.
  28




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 UNS GAS COMMITMENTS
  TEP CONTINGENCIES
 Claims Related to Springerville Unit 3
  Regional Haze
  Claims Related to San Juan Coal Company
  Environmental Reclamation at Remote Generating Stations
 Resolution of TEP Contingencies
- Navajo Generating Station
   29




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 TEP Wholesale Accounts Receivable and Allowances
  Tucson to Nogales Transmission Line
   RESOLUTION OF TEP CONTINGENCIES  Navajo Generating Station
   GUARANTEES AND INDEMNITIES
  
    
    UES guarantee of senior unsecured notes issued by UNS Gas ($100 million) and by UNS
Electric ($100 million),
    
    UES guarantee of the $60 million UNS Gas/UNS Electric Revolver, and
    
    UniSource Energys guarantee of approximately $2 million in building lease payments for
UNS Gas.
  30




---



##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
    
 NOTE 8. EMPLOYEE BENEFIT PLANS
 PENSION BENEFIT PLANS
  OTHER POSTRETIREMENT BENEFIT PLANS
  pay-as-you-go Employers Accounting for Postretirement Benefits Other Than Pensions
  31




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 COMPONENTS OF NET PERIODIC BENEFIT COSTS
  Other PostretirementPension Benefits
    
    
    BenefitsThree Months Ended
    
    
    Three Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Components of Net Periodic Benefit CostsService Cost
    
    $
    2
    
    
    $
    2
    
    
    $
    
    
    
    $
    Interest Cost
    
    
    4
    
    
    
    3
    
    
    
    1
    
    
    
    1Expected Return on Plan Assets
    
    
    (4
    )
    
    
    (4
    )
    
    
    
    
    
    
    Prior Service Cost Amortization
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    Recognized Actuarial Loss
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Net Periodic Benefit Costs
    
    $
    3
    
    
    $
    2
    
    
    $
    1
    
    
    $
    1
 Other PostretirementPension Benefits
    
    
    BenefitsNine Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Components of Net Periodic Benefit CostsService Cost
    
    $
    6
    
    
    $
    6
    
    
    $
    1
    
    
    $
    1Interest Cost
    
    
    11
    
    
    
    9
    
    
    
    3
    
    
    
    3Expected Return on Plan Assets
    
    
    (12
    )
    
    
    (11
    )
    
    
    
    
    
    
    Prior Service Cost Amortization
    
    
    1
    
    
    
    1
    
    
    
    (1
    )
    
    
    (1
    )Recognized Actuarial Loss
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    Net Periodic Benefit Costs
    
    $
    6
    
    
    $
    7
    
    
    $
    3
    
    
    $
    3
  Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of
FAS Statements No.87, 88, 106, and 132(R
  32




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 9. SHARE-BASED COMPENSATION PLANS
  STOCK OPTIONS
    2008 Grant
    
    
    2007 GrantExpected term (years)
    
    
    6
    
    
    
    6Risk-free rate
    
    
    3.1
    %
    
    
    4.4
    %Expected volatility
    
    
    18.8
    %
    
    
    20.2
    %Expected dividend yield
    
    
    2.8
    %
    
    
    2.4
    %Weighted-average grant-date fair value of options granted
    
    $
    4.23
    
    
    $
    8.13
  33




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  Nine Months Ended September 30, 2008Total Stock OptionsOutstanding
    
    
    Non-Vested Stock OptionsWeighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    Grant Date(Shares in Thousands)
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    ValueOptions Outstanding, December 31, 2007
    
    
    1,451
    
    
    $
    21.21
    
    
    
    312
    
    
    $
    7.83Granted
    
    
    304
    
    
    $
    26.18
    
    
    
    304
    
    
    $
    4.23Exercised or Vested
    
    
    (116
    )
    
    $
    16.45
    
    
    
    (134
    )
    
    $
    7.73Options Outstanding, September 30, 2008
    
    
    1,639
    
    
    $
    22.47
    
    
    
    482
    
    
    $
    5.59Options Exercisable, September 30, 2008
    
    
    1,157
    
    
    $
    19.47Aggregate Intrinsic Value of
Options Exercised ($000s)
    
    
    
    
    
    $
    1,627
 At September 30,2008 ($000s)Aggregate Intrinsic Value for Options Outstanding
    
    $
    13,049Aggregate Intrinsic Value for Options Exercisable
    
    $
    12,135Weighted Average Remaining Contractual Life
    
    4.9 yearsWeighted Average Remaining Contractual Life of Exercisable Shares
    
   3.3 years
  Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Number of
    
    
    Remaining
    
    
    Average
    
    
    Number of
    
    
    AverageRange of
    
    Shares
    
    
    Contractual
    
    
    Exercise
    
    
    Shares
    
    
    ExerciseExercise Prices
    
    (000s)
    
    
    Life
    
    
    Price
    
    
    (000s)
    
    
    Price$11.00 - $15.56
    
    
    417
    
    
    1.4 years
    
    $
    14.12
    
    
    
    417
    
    
    $
    14.12$17.44 - $18.84
    
    
    524
    
    
    3.2 years
    
    $
    18.02
    
    
    
    524
    
    
    $
    18.02$26.18 - $37.88
    
    
    698
    
    
    8.3 years
    
    $
    30.80
    
    
    
    216
    
    
    $
    33.33
 RESTRICTED STOCK UNITS AND PERFORMANCE SHARES
 Restricted Stock Units
  
    
    February 2008  3,130 stock units at a weighted average fair value of $28.75 per share,
    
    May 2008  18,448 stock units at a weighted average fair value of $31.71 per share, and
    
    August 2008  1,400 stock units at a weighted average fair value of $32.15 per share.
   34




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 Performance Share Awards
   SHARE-BASED COMPENSATION EXPENSE
   
 NOTE 10. FAIR VALUE MEASUREMENTS
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Fair Value Measurements
  Determining the Fair Value of a Financial Asset When the Market for That Asset Is
Not Active  Fair Value Measures
  35




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 (Level 3).
 Level 1.
    
    Financial assets and liabilities whose values are based on
unadjusted quoted prices for identical assets or liabilities in
an active market (examples include active exchange-traded equity
securities and listed derivatives).
 Level 2.
    
    Financial assets and liabilities whose values are based on quoted
prices for similar assets or liabilities in active markets,
quoted prices for identical or similar assets or liabilities in
non-active markets (examples include corporate bonds, which trade
infrequently), pricing models whose inputs are observable for
substantially the full term of the asset or liabilities (examples
include most non-exchange-traded derivatives, including interest
rate swaps), and pricing models whose inputs are derived
principally from or corroborated by observable market data
through correlation or other means for substantially the full
term of the asset or liability.
 Level 3.
    
    Financial assets and liabilities whose values are based on prices
or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value
measurement. These inputs reflect managements own assumptions
about the assumptions a market participant would use in pricing
the asset or liability (examples include long-dated or complex
derivatives including certain long-dated options on gas and
power).
  UniSource EnergyQuoted Prices in
    
    
    Significant Other
    
    
    SignificantActive Markets for
    
    
    Observable
    
    
    UnobservableIdentical Assets
    
    
    Inputs
    
    
    Inputs(Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    TotalSeptember 30, 2008- Millions of Dollars -AssetsInvestments (1)
    
    $
    45
    
    
    $
    12
    
    
    $
    12
    
    
    $
    69Energy Contracts (2)
    
    
    
    
    
    
    1
    
    
    
    19
    
    
    
    20Total Assets
    
    $
    45
    
    
    $
    13
    
    
    $
    31
    
    
    $
    89LiabilitiesEnergy Contracts (2)
    
    $
    
    
    
    $
    (20
    )
    
    $
    (28
    )
    
    $
    (48
    )Deferred Compensation
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Interest Rate Swap
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (3
    )Total Liabilities
    
    
    
    
    
    
    (28
    )
    
    
    (28
    )
    
    
    (56
    )Net Total Assets and (Liabilities)
    
    $
    45
    
    
    $
    (15
    )
    
    $
    3
    
    
    $
    33
  36




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 TEPQuoted Prices in
    
    
    Significant Other
    
    
    SignificantActive Markets for
    
    
    Observable
    
    
    UnobservableIdentical Assets
    
    
    Inputs
    
    
    Inputs(Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    TotalSeptember 30, 2008- Millions of Dollars -AssetsInvestments (1)
    
    $
    20
    
    
    $
    12
    
    
    $
    
    
    
    $
    32Energy Contracts (2)
    
    
    
    
    
    
    1
    
    
    
    17
    
    
    
    18Total Assets
    
    $
    20
    
    
    $
    13
    
    
    $
    17
    
    
    $
    50LiabilitiesEnergy Contracts (2)
    
    $
    
    
    
    $
    (7
    )
    
    $
    (16
    )
    
    $
    (23
    )Deferred Compensation
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Interest Rate Swap
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (3
    )Total Liabilities
    
    
    
    
    
    
    (15
    )
    
    
    (16
    )
    
    
    (31
    )Net Total Assets and (Liabilities)
    
    $
    20
    
    
    $
    (2
    )
    
    $
    1
    
    
    $
    19
 (1)
    
    Level 1 investments are based on observable market prices and
are comprised of the fair value of
Commercial Paper and Money Market Funds. Level 2 investments comprise of amounts held in mutual
and money market funds related to deferred compensation and Supplemental Executive Retirement Plan
benefits. The valuation is based on observable market prices, not traded in active markets. Level
3 investments (UNS table only) are, in the absence of readily ascertainable market values, based on
the investment partners valuations and comprise of Millenniums equity investment in unregulated
businesses.(2)
    
    Energy contracts include gas swap agreements (Level 2), forward power purchase and sales
contracts (Level 3), and forward power purchase contracts indexed to gas (Level 3), entered into to
take advantage of favorable market conditions and reduce exposure to energy price risk.     37




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
  UniSource Energy-Millions of Dollars-Three Months EndedSeptember 30, 2008EnergyCommodityContracts
    
    
    Investments
    
    
    TotalBalance as of July 1, 2008
    
    $
    30
    
    
    $
    12
    
    
    $
    42Gains and (Losses) (realized/unrealized) Recorded to:Other Expense
    
    
    
    
    
    
    
    
    
    
    Purchased Energy
    
    
    1
    
    
    
    
    
    
    
    1AOCI
    
    
    5
    
    
    
    
    
    
    
    5Net Regulatory Liabilities
    
    
    (45
    )
    
    
    
    
    
    
    (45
    )Purchases, Issuances, and Settlements
    
    
    
    
    
    
    
    
    
    
    Balance as of September 30, 2008
    
    $
    (9
    )
    
    $
    12
    
    
    $
    3UniSource Energy-Millions of Dollars-Nine Months EndedSeptember 30, 2008EnergyCommodityContracts
    
    
    Investments
    
    
    TotalBalance as of January 1, 2008
    
    $
    10
    
    
    $
    14
    
    
    $
    24Gains and (Losses) (realized/unrealized) Recorded to:Other Expense
    
    
    
    
    
    
    (2
    )
    
    
    (2
    )Wholesale Sales
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Purchased Energy
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )AOCI
    
    
    3
    
    
    
    
    
    
    
    3Net Regulatory Liabilities
    
    
    (20
    )
    
    
    
    
    
    
    (20
    )Purchases, Issuances, and Settlements
    
    
    
    
    
    
    
    
    
    
    Balance as of September 30, 2008
    
    $
    (9
    )
    
    $
    12
    
    
    $
    3
 TEP-Millions of Dollars-Three Months
    
    
    Nine MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2008
    
    
    2008EnergyCommodity ContractsBeginning Balance
    
    $
    (5
    )
    
    $
    Gains and (Losses) (realized/unrealized) Recorded to:Wholesale Sales
    
    
    
    
    
    
    (1
    )Purchased Energy
    
    
    1
    
    
    
    (1
    )AOCI
    
    
    5
    
    
    
    3Purchases, Issuances, and Settlements
    
    
    
    
    
    
    Balance as of September 30, 2008
    
    $
    1
    
    
    $
    1
  38




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
   
 NOTE 11. UNISOURCE ENERGY EARNINGS (LOSS) PER SHARE (EPS)
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Thousands of Dollars-
    
    
    -Thousands of Dollars-Numerator:Net Income (Loss)
    
    $
    (11,039
    )
    
    $
    25,417
    
    
    $
    (8,906
    )
    
    $
    42,167Assumed Conversion of Convertible Senior Notes  reduced
interest expense (after-tax)
    
    
    
    
    
    
    1,097
    
    
    
    
    
    
    
    3,292Adjusted Numerator
    
    $
    (11,039
    )
    
    $
    26,514
    
    
    $
    (8,906
    )
    
    $
    45,459Denominator:Weighted-average Shares of Common Stock Outstanding:Common Shares Issued
    
    
    35,453
    
    
    
    35,286
    
    
    
    35,398
    
    
    
    35,250Fully Vested Deferred Stock Units
    
    
    224
    
    
    
    228
    
    
    
    218
    
    
    
    219Total Weighted-average Shares of Common Stock Outstanding
    
    
    35,677
    
    
    
    35,514
    
    
    
    35,616
    
    
    
    35,469Effect of Dilutive Securities:Convertible Senior Notes
    
    
    
    
    
    
    4,000
    
    
    
    
    
    
    
    4,000Options and Stock Issuable under Employee Benefit Plans
and the Directors Plan
    
    
    
    
    
    
    528
    
    
    
    
    
    
    
    583Total Shares
    
    
    35,677
    
    
    
    40,042
    
    
    
    35,616
    
    
    
    40,052
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-In Thousands-
    
    
    -In Thousands-Stock Options Excluded from the Diluted EPS Computation
    
    
    234
    
    
    
    234
    
    
    
    288
    
    
    
    148
  39




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 12. NEW ACCOUNTING PRONOUNCEMENTS
  
    
    FAS 161, Disclosures About Derivative Instruments and Hedging Activitiesan amendment to
FAS 133, Accounting for Derivative Instruments and Hedging Activities,issued March 2008,
requires enhanced disclosures about an entitys derivative and hedging activity.The
standard requires that the objectives for using derivative instruments be disclosed in
terms of underlying risk so that the reader understands the purpose of derivative use in
terms of the risks that the entity is intending to manage. The standard also requires
disclosure of the location in the financial statements of derivative balances as well as
the location of gains and losses incurred during the reporting period. The standard will
be applicable for fiscal years or interim periods beginning on or after November 15, 2008,
with early adoption encouraged. The Company is assessing the impact of this standard.
    
    FAS 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial
Statements,issued December 2007, will change the accounting and reporting for minority
interests, requiring such amounts to be classified as a component of equity, and will also
change the accounting for transactions with minority-interest holders. The standard will be
applicable for fiscal years beginning on or after December 15, 2008 and generally on a
prospective basis. Early adoption is prohibited and business combinations with acquisition
dates prior to the effective date will not be adjusted upon application. We do not expect
this pronouncement to have a material impact on our financial statements.
    
    FAS 141(R) Business Combinations- a replacement of FAS No. 141, issued December 2007,
requires companies to record acquisitions at fair value. FAS 141(R) changes the definition
of a business and a business combination and is generally expected to increase the number
of transactions that will need to be accounted for at fair value. The standard will be
applicable for fiscal years beginning on or after December 15, 2008 and generally on a
prospective basis. Early adoption is prohibited and business combinations with acquisition
dates prior to the effective date will not be adjusted upon application. We do not expect
this pronouncement to have a material impact on our financial statements.
    
    FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active issued October 2008, provides guidance clarifying how FAS 157 Fair
Value Measures(FAS 157) should be applied in markets that are not active. The guidance
reaffirms the notion of fair value as an exit price as of the measurement date. The FSP
emphasizes that approaches other than the market value approach to determine fair value,
such as the use of managements internal assumptions about future cash flows and
appropriately risk-adjusted discount rates, may be appropriate. The FSP, which is
effective upon issuance and applicable to prior periods for which financial statements have
not yet been issued, did not have a material impact on our financial statements.
  40




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 
 NOTE 13. SUPPLEMENTAL CASH FLOW INFORMATION
  UniSource EnergyNine Months EndedSeptember 30,2008    
    
    2007-Thousands of Dollars-Net
Income (Loss)
    
    $
    (8,906
    )
    
    $
    42,167Adjustments to Reconcile Net Income (Loss)
To Net Cash FlowsDepreciation and Amortization Expense
    
    
    109,196
    
    
    
    103,494Depreciation and Amortization Recorded to Fuel and Other O&M
Expense
    
    
    4,953
    
    
    
    5,178Amortization of Transition Recovery Asset
    
    
    23,945
    
    
    
    59,944CTC Revenue Subject to Refund
    
    
    44,415
    
    
    
    Provision for Navajo Retiree Health Care and Mine Reclamation
    
    
    10,080
    
    
    
    642Mark-to-Market Transactions
    
    
    6,413
    
    
    
    1,525Amortization of Deferred Debt-Related Costs included in
Interest Expense
    
    
    2,978
    
    
    
    2,879Provision for Bad Debts
    
    
    2,703
    
    
    
    2,333Deferred Income Taxes
    
    
    18,079
    
    
    
    24,830Pension and Postretirement Expense
    
    
    8,993
    
    
    
    10,832Pension and Postretirement Funding
    
    
    (13,044
    )
    
    
    (12,585
    )Stock Based Compensation Expense
    
    
    1,953
    
    
    
    2,372Excess Tax Benefit from Stock Option Exercises
    
    
    (612
    )
    
    
    (443
    )Impairment of Millennium Investments
    
    
    2,037
    
    
    
    Net Unrealized Loss on MEG Trading Activities
    
    
    
    
    
    
    1,165Changes in Assets and Liabilities which Provided (Used)Cash Exclusive of Changes Shown SeparatelyAccounts Receivable
    
    
    (12,911
    )
    
    
    (2,051
    )Materials and Fuel Inventory
    
    
    (8,458
    )
    
    
    (9,310
    )Over/Under Recovered Purchased Energy Cost
    
    
    (13,133
    )
    
    
    3,515Accounts Payable
    
    
    5,774
    
    
    
    (30,512
    )Interest Accrued
    
    
    (3,286
    )
    
    
    (14,271
    )Income Tax Receivable/Payable
    
    
    (13,151
    )
    
    
    (17,025
    )Taxes Other Than Income Taxes
    
    
    12,479
    
    
    
    13,670Other
    
    
    6,839
    
    
    
    15,188Net Cash Flows  Operating Activities
    
    $
    187,336
    
    
    $
    203,537
  41




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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)  Unaudited
 TEPNine Months EndedSeptember 30,2008
    
    
    2007-Thousands of Dollars-Net Income (Loss)
    
    $
    (15,335
    )
    
    $
    39,051Adjustments to Reconcile Net Income (Loss)
To Net Cash FlowsDepreciation and Amortization Expense
    
    
    93,198
    
    
    
    88,033Depreciation and Amortization Recorded to Fuel and Other O&M
Expense
    
    
    3,888
    
    
    
    4,038Amortization of Transition Recovery Asset
    
    
    23,945
    
    
    
    59,944CTC Revenue Subject to Refund
    
    
    44,415
    
    
    
    Provision for Navajo Retiree Health Care and Mine Reclamation
    
    
    10,080
    
    
    
    642Mark-to-Market Transactions
    
    
    6,372
    
    
    
    1,525Amortization of Deferred Debt-Related Costs included in
Interest Expense
    
    
    2,166
    
    
    
    2,004Provision for Bad Debts
    
    
    1,516
    
    
    
    1,197Deferred Income Taxes
    
    
    6,864
    
    
    
    15,598Pension and Postretirement Expense
    
    
    7,802
    
    
    
    9,512Pension and Postretirement Funding
    
    
    (11,600
    )
    
    
    (11,430
    )Stock Based Compensation Expense
    
    
    1,508
    
    
    
    1,847Changes in Assets and Liabilities which Provided (Used)Cash Exclusive of Changes Shown SeparatelyAccounts Receivable
    
    
    (25,233
    )
    
    
    (18,844
    )Materials and Fuel Inventory
    
    
    (7,488
    )
    
    
    (9,596
    )Accounts Payable
    
    
    19,076
    
    
    
    (13,233
    )Interest Accrued
    
    
    780
    
    
    
    (9,846
    )Income Tax Receivable/Payable
    
    
    3,298
    
    
    
    (12,022
    )Taxes Other Than Income Taxes
    
    
    11,578
    
    
    
    13,717Other
    
    
    9,803
    
    
    
    1,007Net Cash Flows  Operating Activities
    
    $
    186,633
    
    
    $
    163,144
   
 NOTE 14. REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
   42




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##### Table of Contents



ITEM 2.  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  
    
    outlook and strategies,
 
    
    operating results during the third quarter and nine months ended September 30, 2008
compared with the same periods in 2007,
 
    
    factors which affect our results and outlook,
 
    
    liquidity, capital needs, capital resources, and contractual obligations,
 
    
    dividends, and
 
    
    critical accounting estimates.
   
 UNISOURCE ENERGY CONSOLIDATED
 
 OVERVIEW OF CONSOLIDATED BUSINESS
    
 OUTLOOK AND STRATEGIES
  
    
    Obtain ACC approval of a rate increase for TEP, effective on or before January 1, 2009,
that resolves the uncertainty surrounding TEPs rates for generation service after 2008, while
providing adequate revenues to cover the rising cost of serving TEPs customers and preserving
TEPs benefits under the 1999 Settlement Agreement;
 
    
    File requests for, and obtain ACC approval of, rate increases for UNS Gas and UNS Electric
to provide adequate revenues to cover the rising cost of providing service to their customers;
  43




---



##### Table of Contents




    
    Ensure UniSource Energy continues to have adequate liquidity by maintaining sufficient
lines of credit and regularly reviewing and adjusting UniSource Energys short-term investment
strategies in response to market conditions;
 
    
    Efficiently manage our generation, transmission and distribution resources and seek ways to
control our operating expenses while maintaining and enhancing reliability, safety and
profitability;
 
    
    Diversify TEPs portfolio of generating and purchased power resources, along with programs
to expand renewable energy sources and demand side management, to meet retail energy demand
and respond to wholesale market opportunities;
 
    
    Expand UNS Electrics portfolio of generating and purchased power resources to meet retail
energy demand;
 
    
    Enhance the value of existing generation assets by working with SRP to support the
construction of Springerville Unit 4;
 
    
    Enhance the value of TEPs transmission system while continuing to provide reliable access
to generation for TEP and UNS Electrics retail customers and market access for all generating
assets;
 
    
    Continue to develop synergies between UNS Gas, UNS Electric and TEP;
 
    
    Improve UniSource Energys and TEPs ratio of common equity to total capitalization; and
 
    
    Promote economic development in our service territories.
   Economic Conditions
    44




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##### Table of Contents



Liquidity
and Capital Resources, Interest Rate Risk; Tucson Electric Power, Liquidity and Capital Resources,
Interest Rate Risk; UNS Gas, Liquidity and Capital Resources, Interest Rate Risk; and UNS Electric,
Liquidity and Capital Resources, Interest Rate Risk
 UniSource Energy Credit Agreement
 Liquidity and Capital Resources,
   
 RESULTS OF OPERATIONS
 Executive Overview
 Third Quarter of 2008 Compared with the Third Quarter of 2007
  See Tucson Electric Power Company, Results of
Operations
 Nine Months Ended September 2008 Compared with the Nine Months Ended June 2007
 See Tucson
Electric Power Company, Results of Operations
 
 CONTRIBUTION BY BUSINESS SEGMENT
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-
    
    
    -Millions of Dollars-TEP
    
    $
    (12
    )
    
    $
    26
    
    
    $
    (15
    )
    
    $
    39UNS Gas
    
    
    (1
    )
    
    
    (2
    )
    
    
    5
    
    
    
    1UNS Electric
    
    
    3
    
    
    
    3
    
    
    
    4
    
    
    
    5Other (1)
    
    
    (1
    )
    
    
    (2
    )
    
    
    (3
    )
    
    
    (3
    )Consolidated Net Income
    
    $
    (11
    )
    
    $
    25
    
    
    $
    (9
    )
    
    $
    42
 (1)
    
    Includes: UniSource Energy parent company expenses; UniSource Energy
parent company interest expense (net of tax) on the UniSource Convertible Senior Notes
and on the UniSource Credit Agreement; income and losses from UED; and income and losses
from Millennium investments.  45




---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
 UniSource Energy Consolidated Cash Flows
 Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Cash provided by (used in):Operating Activities
    
    $
    187
    
    
    $
    204Investing Activities
    
    
    (359
    )
    
    
    (153
    )Financing Activities
    
    
    152
    
    
    
    (95
    )
  Liquidity
  Borrowings
    
    
    Amount AvailableCash and Cash
    
    
    under Revolving
    
    
    under RevolvingBalances as of November 4, 2008
    
    Equivalents
    
    
    Credit Facility
    
    
    Credit Facility-Millions of Dollars-UniSource Energy stand-alone
    
    $
    3
    
    
    $
    42
    
    
    $
    28TEP
    
    
    39
    
    
    
    11
    
    
    
    139UNS Gas
    
    
    18
    
    
    
    10
    (1)
    
    
    35

(2)UNS Electric
    
    
    10
    
    
    
    20

(1)
    
    
    25

(2)Other
    
    
    7
    (3)
    
    
    
    
    
    
    Total
    
    $
    77
    
    
    $
    83
 (1)
    
    Includes $10 million of LOCs for UNS Gas and
$12 million for UNS Electric.(2)
    
    Either UNS Gas or UNS Electric may borrow up to a maximum of $45 million, but the
total combined amount borrowed cannot exceed $60 million.(3)
    
    Includes cash and cash equivalents at UED and Millennium. Short-term Investments
   46




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##### Table of Contents



Access to Revolving Credit Facilities
   Qualitative and Quantitative Disclosures about Market Risk, Credit Risk
 Executive Overview
 Operating Activities
  Investing Activities
  Financing Activities
  Liquidity Outlook
 UniSource
Energy Credit Agreement
 .
  47




---



##### Table of Contents



Tucson Electric Power, Liquidity and
Capital Resources, Financing Activities, Bond Issuances
 UNS Electric, Liquidity and
Capital Resources, Bond Issuances
 Tucson Electric Power Company,
Liquidity and Capital Resources , UNS Gas, Liquidity and Capital Resources UNS Electric,
Liquidity and Capital Resources, Other Non-Reportable Segments, Liquidity and Capital
Resources
 UniSource Energy Credit Agreement
   Interest Rate Risk
 Item 3.
Qualitative and Quantitative Disclosures about Market Risk, Credit Risk
 Convertible Senior Notes
  Guarantees and Indemnities
  
    
    UES guarantee of senior unsecured notes issued by UNS Gas ($100 million) and UNS Electric
($100 million);
 
    
    UES guarantee of the $60 million UNS Gas/UNS Electric Revolver; and
 
    
    UniSource Energys guarantee of approximately $2 million in building lease payments for UNS
Gas.
    48




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##### Table of Contents



Contractual Obligations
  UniSource Energys Contractual Obligations-Millions of Dollars-ThreeMonthsEnded
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2013Payment Due in Years
    
    December 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    andEnding December 31,
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    after
    
    
    Other
    
    
    TotalLong Term DebtPrincipal(1)
    
    $
    2
    
    
    $
    6
    
    
    $
    6
    
    
    $
    572
    
    
    $
    
    
    
    $
    745
    
    
    $
    
    
    
    $
    1,331Interest(2)
    
    
    8
    
    
    
    60
    
    
    
    61
    
    
    
    58
    
    
    
    45
    
    
    
    653
    
    
    
    
    
    
    
    885Capital Lease Obligations(3):Springerville Unit 1(4)
    
    
    
    
    
    
    30
    
    
    
    57
    
    
    
    83
    
    
    
    85
    
    
    
    231
    
    
    
    
    
    
    
    486Springerville Coal Handling
    
    
    
    
    
    
    15
    
    
    
    17
    
    
    
    19
    
    
    
    23
    
    
    
    55
    
    
    
    
    
    
    
    129Sundt Unit 4
    
    
    
    
    
    
    13
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Springerville Common
    
    
    1
    
    
    
    5
    
    
    
    5
    
    
    
    5
    
    
    
    10
    
    
    
    134
    
    
    
    
    
    
    
    160Operating Leases
    
    
    1
    
    
    
    2
    
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    8Purchase Obligations(5):Coal and Rail Transportation(6)
    
    
    22
    
    
    
    99
    
    
    
    78
    
    
    
    44
    
    
    
    37
    
    
    
    216
    
    
    
    
    
    
    
    496Purchase Power(7)
    
    
    24
    
    
    
    133
    
    
    
    52
    
    
    
    19
    
    
    
    13
    
    
    
    16
    
    
    
    
    
    
    
    257Electric Generating Turbines
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Transmission
    
    
    1
    
    
    
    5
    
    
    
    5
    
    
    
    3
    
    
    
    2
    
    
    
    7
    
    
    
    
    
    
    
    23Gas(8)
    
    
    31
    
    
    
    110
    
    
    
    119
    
    
    
    25
    
    
    
    7
    
    
    
    26
    
    
    
    
    
    
    
    318Other
Long-Term Liabilities(9):Pension
& Other Post Retirement
Obligations(10)
    
    
    2
    
    
    
    5
    
    
    
    5
    
    
    
    6
    
    
    
    6
    
    
    
    32
    
    
    
    
    
    
    
    56San
Juan Pollution Control
Equipment(11)
    
    
    17
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Acquisition
of Springerville Coal
Handling and Common
Facilities(12)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    226
    
    
    
    
    
    
    
    226Unrecognized Tax Benefits(13)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16Total Contractual Cash Obligations
    
    $
    111
    
    
    $
    502
    
    
    $
    421
    
    
    $
    835
    
    
    $
    228
    
    
    $
    2,343
    
    
    $
    16
    
    
    $
    4,456
 (1)
    
    Includes quarterly principal payments due on the term loan facility in
UniSource Energys Credit Agreement and amounts outstanding under the UniSource Energy and UNS
Electric revolving credit facilities. TEPs variable rate IDBs are backed by letters of
credit issued pursuant to TEPs Credit Agreement, which expires in August 2011, and TEPs 2008
Letter of Credit Facility, which expires in April 2011. Although the variable rate IDBs
mature between 2018 and 2029, the above maturity reflects a redemption or repurchase of such
bonds in 2011 as though the letters of credit terminate without replacement upon expiration in
2011.(2)
    
    Includes letter of credit and remarketing fees on variable rate debt.
The interest rates for variable rate debt are estimated using Eurodollar futures rates for an
approximation of LIBOR. For variable rate IDBs, a discount is applied to estimated LIBOR
based on the historical discount the IDBs have had to LIBOR. Excludes interest on revolving
credit facilities.(3)
    
    Beginning with commercial operation of Springerville Unit 3 in September 2006,
Tri-State is reimbursing TEP for various operating costs related to the common facilities on
an ongoing basis, including 14% of the Springerville Common Lease payments and 17% of the
Springerville Coal Handling Facilities Lease payments. Similar reimbursement obligations are
required after Springerville Unit 4 is constructed. TEP
remains the obligor under these capital leases. Capital Lease Obligations do not reflect any
reduction associated with this reimbursement.  49




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##### Table of Contents



(4)
    
    Annual payments under the Springerville Unit 1 lease vary in accordance with
the amortization schedules of the debt underlying the capital lease, with significantly larger
principal payments occurring in 2011 and 2012.(5)
    
    Purchase obligations reflect the minimum contractual obligation under legally
enforceable contracts with contract terms that are both fixed and determinable. The total
amount paid under these contracts depends on the quantity purchased and transported. TEP and
UES requirements are expected to be in excess of these minimums. UniSource Energy has
excluded open purchase orders expected to be fulfilled in 2009.(6)
    
    On average, TEP expects to spend $214 million annually for the purchase and
transportation of coal through 2012.(7)
    
    Includes TEP and UNS Electrics forward power purchases.(8)
    
    Amounts include TEP, UNS Gas, and UNS Electrics fixed price forward gas purchases
and firm transportation agreements. Incremental gas purchases are excluded as prices and volumes
vary. Amounts also exclude swap agreements which are marked to market on a monthly basis and do
not include any minimum payment obligation.(9)
    
    Excludes TEPs liability for final environmental reclamation at the coal mines
which supply the San Juan and Four Corners as the timing of payment has not been determined. TEP
estimates its undiscounted final reclamation liability is $45 million at these remote generating
stations with reclamation beginning in 2028. See Note 7. Also excludes asset retirement
obligations expected to occur through 2066.(10)
    
    These obligations represent TEPs expected postretirement benefit costs
to cover medical and life insurance claims as determined by the plans actuaries. TEP and UES
do not know and have not included pension contributions beyond 2008 due to the significant
impact that returns on plan assets and changes in discount rates might have on such amounts.
TEP funds the postretirement benefit plan on a pay-as-you-go basis.(11)
    
    These obligations represent TEPs share of the cost of new pollution control
equipment based on its ownership of San Juan. Under a settlement agreement signed in March
2005 with the New Mexico Environmental Department and environmental activist groups, the
co-owners of San Juan will install new technology at the generating station to reduce mercury,
particulate matter, NOx, and SO2 emissions. In addition, TEPs share of increased
operating and maintenance costs associated with the new technologies is expected to be
approximately $1 million per year over the next 10 years.(12)
    
    TEP has agreed with the owners of Springerville Units 3 and 4 that, upon
expiration of the Springerville Coal Handling Facilities and Common Leases, TEP will exercise its
fixed price purchase option under such lease and acquire the leased facilities. The fixed prices
to acquire such facilities will be $120 million in 2015, $38 million in 2017, and $68 million in
2021. Upon such acquisitions by TEP, each of the owners of Springerville Unit 3 and Unit 4 have
the obligation to purchase from TEP a 17% interest in the Springerville Coal Handling Facilities
and a 14% interest in the Springerville Common Facilities.(13)
    
    As a result of adopting FIN 48 on January 1, 2007, TEP recorded a liability for
uncertain tax positions. At September 30, 2008, TEPs liability totals $16 million. TEP is unable
to estimate when its liability for uncertain tax positions will be settled.   50




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##### Table of Contents



Dividends on Common Stock
  Dividend Amount Per ShareDeclaration Date
    
    Record Date
    
    Payment Date
    
    of Common StockFebruary 27, 2008
    
    March 10, 2008
    
    March 21, 2008
    
    $
    0.24May 1, 2008
    
    May 13, 2008
    
    May 27, 2008
    
    $
    0.24August 15, 2008
    
    August 25, 2008
    
    September 5, 2008
    
    $
    0.24
 Income Tax Position
  
 TUCSON ELECTRIC POWER COMPANY
 
 RESULTS OF OPERATIONS
  Three Months Ended September 30
  
    
    A $6 million decrease in total operating revenues due to:
 
    
    a $7 million decrease in retail revenues due to mild summer weather and a weakening
local economy;
    
    a $30 million provision for revenue subject to refund equivalent to the Fixed CTC revenue that was
collected from customers when the TRA was fully amortized in early May 2008;
    
    a $27 million increase in wholesale revenues due to increased short-term wholesale
activity and related purchased power volumes, lower retail demand resulting in an increase
in the availability of energy to sell into the wholesale market and an increase in the
market price of wholesale power. Wholesale sales volumes increased by 14% and the average
price per MWh of wholesale power sold increased by 37%; and
    
    a $4 million increase in other revenues due primarily to fees and reimbursements
received for fuel and O&M costs related to Springerville Units 3 and 4.
 
    
    An increase of $59 million in fuel and purchased power expense due to:
 
    
    a $17 million increase in fuel expense due to higher coal-related expenses, including
a $9 million provision for a settlement related to mining costs at Navajo, and a $7
million increase in unrealized losses on gas hedges;
    
    a $42 million increase in purchased power expense. Purchased power volumes increased
by 33% as a result of higher short-term wholesale sales activity, while the average price
paid per MWh increased by 30% due to higher market prices.
  51




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##### Table of Contents



Other factors impacting the comparability of third quarter 2008 results with 2007 include:
 
    
    a $21 million increase in O&M expense due to: a $7 million increase in generating plant
maintenance, due primarily to non-recurring projects at San Juan and Springerville; a $3
million increase in O&M related to Springerville Units 3 and 4, which is reimbursed to TEP by
the owners of those units and recorded in other revenues; a $3 million decrease in pre-tax
gains from the sale of excess SO2 Emission Allowances which is recorded as an offset to O&M;
increased transmission expense; and general cost pressures resulting from inflation and other
economic factors;
 
    
    a $26 million decrease in the amortization of TEPs TRA. The TRA was fully amortized in
May 2008; and
 
    
    a $4 million decrease in total interest expense resulting primarily from lower balances on
capital lease obligations.
  Nine Months Ended September 30
  
    
    A $29 million increase in total operating revenues due to:
 
    
    a $9 million decrease in retail revenues due to mild summer weather and a weakening
local economy;
    
    a $44 million provision for revenue subject to refund equivalent to the Fixed CTC revenue that was
collected from customers when the TRA was fully amortized in early May 2008;
    
    a $68 million increase in wholesale revenues due to
increased short-term wholesale
activity and related purchased power volumes, lower retail demand resulting in an increase
in the availability of energy to sell into the wholesale market and an increase in the
market price of wholesale power. Wholesale sales volumes increased 23% and the average
price per MWh of wholesale power sold increased by 21%; and
    
    a $14 million increase in other revenues due primarily to fees and reimbursements
received for fuel and O&M costs related to Springerville Units 3 and 4.
 
    
    A $121 million increase in fuel and purchased power due to:
 
    
    a $25 million increase in fuel expense due to increased coal costs, including a $9
million provision for a settlement related to mining costs at Navajo, and a 24% increase
in the average cost per kWh of
gas-fired generation due to higher natural gas prices; and
    
    a $96 million increase in purchased power expense. Purchased power volumes increased
by 32% as a result of higher wholesale sales activity and replacement power purchases
during the first and third quarters. The average price paid per MWh increased by 38% due
to higher market prices for wholesale energy.
  
    
    a $34 million increase in O&M expense due to: an $11 million increase in O&M related to
Springerville Units 3 and 4, which is reimbursed to TEP by the owners of those units and
recorded in other revenues; an increase in generation plant maintenance of $9 million; a $9
million decrease in pre-tax gains from the sale of excess SO2 Emission Allowances which is
recorded as an offset to O&M; increased transmission expense; and general cost pressures
resulting from inflation and other economic factors;
 
    
    a $5 million increase in depreciation and amortization expense due to additions to plant
in service;
 
    
    a $36 million decrease in the amortization of TEPs TRA. In May 2008, the TRA was fully
amortized; and
 
    
    a $10 million decrease in total interest expense resulting primarily from lower balances
on capital lease obligations.
  52




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##### Table of Contents



TEP kWh Sales and Revenues
 TEP
    
    Sales
    
    
    Operating RevenueThree Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Electric Retail Sales:Residential
    
    
    1,361
    
    
    
    1,436
    
    
    $
    128
    
    
    $
    135Commercial
    
    
    613
    
    
    
    620
    
    
    
    64
    
    
    
    65Industrial
    
    
    655
    
    
    
    671
    
    
    
    49
    
    
    
    49Mining
    
    
    272
    
    
    
    244
    
    
    
    14
    
    
    
    12Public Authorities
    
    
    65
    
    
    
    66
    
    
    
    5
    
    
    
    5Total Electric Retail Sales
    
    
    2,966
    
    
    
    3,037
    
    
    $
    260
    
    
    $
    266Provision
for Revenue Subject to Refund
    
    
    
    
    
    
    
    
    
    
    (30
    )
    
    
    Net Electric Retail Sales
    
    
    2,966
    
    
    
    3,037
    
    
    $
    230
    
    
    $
    266Electric Wholesale Sales Delivered:Long-term Contracts
    
    
    253
    
    
    
    272
    
    
    
    15
    
    
    
    15Other Sales
    
    
    652
    
    
    
    525
    
    
    
    54
    
    
    
    28Transmission
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    4Total Electric Wholesale Sales
    
    
    905
    
    
    
    797
    
    
    
    73
    
    
    
    47Total Electric Sales
    
    
    3,871
    
    
    
    3,834
    
    
    $
    303
    
    
    $
    313
 2008
    
    
    2007Weather Data:Cooling Degree DaysThree Months Ended September 30
    
    
    875
    
    
    
    1,01010-Year Average for the third quarter
    
    
    935
    
    
    
    942
 TEP
    
    Sales
    
    
    Operating RevenueNine Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Electric Retail Sales:Residential
    
    
    3,078
    
    
    
    3,209
    
    
    $
    281
    
    
    $
    293Commercial
    
    
    1,570
    
    
    
    1,575
    
    
    
    163
    
    
    
    164Industrial
    
    
    1,740
    
    
    
    1,798
    
    
    
    127
    
    
    
    129Mining
    
    
    815
    
    
    
    727
    
    
    
    41
    
    
    
    36Public Authorities
    
    
    193
    
    
    
    188
    
    
    
    15
    
    
    
    14Total Electric Retail Sales
    
    
    7,396
    
    
    
    7,497
    
    
    $
    627
    
    
    $
    636Provision
for Revenue Subject to Refund
    
    
    
    
    
    
    
    
    
    
    (44
    )
    
    
    Net Electric Retail Sales
    
    
    7,396
    
    
    
    7,497
    
    
    $
    583
    
    
    $
    636Electric Wholesale Sales Delivered:Long-term Contracts
    
    
    823
    
    
    
    812
    
    
    
    43
    
    
    
    42Other Sales
    
    
    2,186
    
    
    
    1,645
    
    
    
    154
    
    
    
    86Transmission
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    11Total Electric Wholesale Sales
    
    
    3,009
    
    
    
    2,457
    
    
    
    209
    
    
    
    139Total Electric Sales
    
    
    10,405
    
    
    
    9,954
    
    
    $
    792
    
    
    $
    775
 2008
    
    
    2007Weather Data:Cooling Degree DaysNine Months Ended September 30,
    
    
    1,295
    
    
    
    1,47710-Year Average for Nine Months Ended September 30,
    
    
    1,392
    
    
    
    1,383
  53




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##### Table of Contents



Mark-to-Market Adjustments
  Three Months
    
    
    Nine MonthsMark-to-Market Transactions  Unrealized Gain (Loss)
    
    Ended September 30,
    
    
    Ended September 30,Recorded in Earnings
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Dollars-Recorded in Wholesale Sales:Forward Power Sales
    
    $
    28
    
    
    $
    1
    
    
    $
    13
    
    
    $
    7Forward Power Purchases
    
    
    (28
    )
    
    
    
    
    
    
    (14
    )
    
    
    (7
    )Forward Power Purchases Recorded in Purchased Energy
    
    
    1
    
    
    
    (1
    )
    
    
    (1
    )
    
    
    Forward Gas Price Swaps Recorded in Fuel
    
    
    (7
    )
    
    
    
    
    
    
    (3
    )
    
    
    Total Pre-Tax Unrealized Gain (Loss)
    
    $
    (6
    )
    
    $
    
    
    
    $
    (5
    )
    
    $
    
 Operating Expenses
 Fuel and Purchased Power Expense
 Generation andTEP
    
    Purchased Power
    
    
    ExpenseThree Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Coal-Fired GenerationFour Corners
    
    
    213
    
    
    
    210
    
    
    $
    4
    
    
    $
    3Navajo
    
    
    351
    
    
    
    331
    
    
    
    15
    
    
    
    6San Juan
    
    
    550
    
    
    
    628
    
    
    
    12
    
    
    
    14Springerville
    
    
    1,450
    
    
    
    1,584
    
    
    
    25
    
    
    
    26Sundt Unit 4
    
    
    210
    
    
    
    197
    
    
    
    8
    
    
    
    7Total Coal-Fired Generation
    
    
    2,774
    
    
    
    2,950
    
    
    
    64
    
    
    
    56Gas-Fired GenerationLuna
    
    
    190
    
    
    
    236
    
    
    
    12
    
    
    
    10Other Gas Units
    
    
    115
    
    
    
    175
    
    
    
    14
    
    
    
    15Total Gas-Fired Generation
    
    
    305
    
    
    
    411
    
    
    
    26
    
    
    
    25Realized (Gains) / Losses on Gas Hedges
    
    
    
    
    
    
    
    
    
    
    8
    
    
    
    8Unrealized (Gains) / Losses on Gas Hedges
    
    
    
    
    
    
    
    
    
    
    7
    
    
    
    Net Gas-Fired Generation
    
    
    305
    
    
    
    411
    
    
    
    41
    
    
    
    33Solar and Other
    
    
    2
    
    
    
    1
    
    
    
    
    
    
    
    Total Generation (1)
    
    
    3,081
    
    
    
    3,362
    
    
    
    105
    
    
    
    89Total Purchased Power
    
    
    1,086
    
    
    
    818
    
    
    
    100
    
    
    
    58Total Resources
    
    
    4,167
    
    
    
    4,180
    
    
    $
    205
    
    
    $
    147Less Line Losses and Company Use
    
    
    (296
    )
    
    
    (346
    )Total Energy Sold
    
    
    3,871
    
    
    
    3,834
 (1)
    
    Fuel expense in the third quarters of 2008 and 2007 excludes $1 million related to
Springerville Unit 3; these expenses are reimbursed by Tri-State and recorded in Other Revenue. Coal Supply
   54




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##### Table of Contents



Generation andTEP
    
    Purchased Power
    
    
    ExpenseNine Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Coal-Fired GenerationFour Corners
    
    
    496
    
    
    
    510
    
    
    $
    8
    
    
    $
    9Navajo
    
    
    979
    
    
    
    948
    
    
    
    27
    
    
    
    16San Juan
    
    
    1,681
    
    
    
    1,759
    
    
    
    45
    
    
    
    42Springerville
    
    
    4,330
    
    
    
    4,388
    
    
    
    74
    
    
    
    73Sundt Unit 4
    
    
    585
    
    
    
    558
    
    
    
    21
    
    
    
    18Total Coal-Fired Generation
    
    
    8,071
    
    
    
    8,163
    
    
    
    175
    
    
    
    158Gas-Fired GenerationLuna
    
    
    543
    
    
    
    586
    
    
    
    37
    
    
    
    30Other Gas Units
    
    
    179
    
    
    
    255
    
    
    
    26
    
    
    
    24Total Gas-Fired Generation
    
    
    722
    
    
    
    841
    
    
    
    63
    
    
    
    54Realized (Gains) / Losses on Gas Hedges
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    8Unrealized (Gains) / Losses on Gas Hedges
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    Net Gas-Fired Generation
    
    
    722
    
    
    
    841
    
    
    
    69
    
    
    
    62Solar and Other
    
    
    6
    
    
    
    6
    
    
    
    
    
    
    
    Total Generation (1)
    
    
    8,799
    
    
    
    9,010
    
    
    
    244
    
    
    
    220Purchased Power
    
    
    2,341
    
    
    
    1,772
    
    
    
    211
    
    
    
    115Total Resources
    
    
    11,140
    
    
    
    10,782
    
    
    $
    455
    
    
    $
    335Less Line Losses and Company Use
    
    
    (735
    )
    
    
    (828
    )Total Energy Sold
    
    
    10,405
    
    
    
    9,954
 (1)
    
    Fuel expense in the first nine months of 2008 and 2007 excludes $4 million related
to Springerville 3; these expenses are reimbursed by Tri-State and recorded in Other Revenue. Coal Supply
 Gas-related
   55




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##### Table of Contents



Costs per kWh
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-cents per kWh-
    
    
    -cents per kWh-Coal
    
    
    2.31
    
    
    
    1.90
    
    
    
    2.17
    
    
    
    1.94Gas
    
    
    11.15
    
    
    
    8.03
    
    
    
    9.14
    
    
    
    7.37Purchased Power
    
    
    9.21
    
    
    
    7.09
    
    
    
    9.01
    
    
    
    6.49
 
 FACTORS AFFECTING RESULTS OF OPERATIONS
 TEP Rate Proceeding
  TEP Rate Proposals
  Proposed Settlement Agreement
  True-Up Revenues
   56




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##### Table of Contents




    
    Base Rate Increase.A base rate increase of approximately 6% over TEPs current retail
rate of 8.4 cents per kilowatt-hour (kWh). The proposed increase will result in an increase
in annual revenues of approximately $47 million, which would increase TEPs 2006 test year
base revenues of approximately $781 million to $828 million. The average cost of fuel and
purchased power embedded in base rates is approximately 2.9 cents per kWh.
 
    
    Ratemaking Methodology for Generation Assets.Rates for generation service, including
Springerville Unit 1 (SGS 1) and the Luna Energy Facility (Luna), will be based on a
cost-of-service methodology. For any rates in effect after 2012, all generation assets
acquired by TEP after December 31, 2006 but before December 31, 2012 shall be included in
TEPs rate base at their respective original depreciated cost, subject to subsequent review by
the ACC in future rate cases or other regulatory proceedings.
  
    
    Cost of Capital.TEPs capital structure for ratemaking purposes will be comprised of
57.5% debt and 42.5% common equity. TEPs allowed return on equity will be 10.25% and the
embedded cost of debt will be 6.38% for ratemaking purposes.
 
    
    Depreciation and Net Negative Salvage.Upon the effective date of an ACC order approving
the 2008 Proposed Settlement Agreement, TEP will implement new depreciation rates that
include: a component for net negative salvage value for all generation assets except Luna; and
new depreciation rates for distribution and general plant assets that will extend the
depreciable lives of these assets. The change in depreciation rates will result in an
increase in depreciation expense of approximately $11 million per year, based on a December
31, 2006 test year.
 
    
    Implementation Cost Recovery Asset and Coal Costs.TEPs original cost rate base will
include an Implementation Cost Recovery Asset (ICRA) of $14 million to reflect costs incurred
by TEP to transition to competition under the 1999 Settlement Agreement. For ratemaking
purposes, the ICRA will be amortized over a four-year period.
   
    
    Purchased Power and Fuel Adjustor Clause.The purchased power and fuel adjustor clause
(PPFAC) will be effective starting January 1, 2009. The PPFAC allows recovery of demand
charges and the cost of contracts for hedging fuel and purchased power costs. The PPFAC will
consist of a forward component and a true-up component.
 
    
    The forward component will be updated on April 1 of each year, starting in 2009. The
forward component will be the forecasted fuel and purchased power costs for the 12-month
period from April 1 to March 31, less the embedded base cost of fuel and purchased power of
2.9 cents per kWh. During this 12-month period, TEP will have the ability to request an
adjustment to the forward component should an extraordinary event occur that causes a
drastic change in forecasted fuel and purchased power costs.
 
    
    The true-up component will reconcile any over/under collected amounts from the
preceding 12-month period and will be credited to or recovered from customers in the
subsequent year.
    57




---



##### Table of Contents




    
    Renewable Energy and Demand-Side Management Adjustors.TEPs new rates will include the
Renewable Energy Standard Tariff (REST) adjustor mechanism approved by the ACC in April 2008.
See Renewable Energy Standard and Tariff,below. A demand-side management (DSM) adjustor
mechanism will provide initial
funding of $6 million for DSM programs. TEP will file for ACC approval to reset the DSM adjustor
rate by April 1 of each year.
 
    
    Base Rate Increase Moratorium.TEPs base rates will be frozen through December 31, 2012.
TEP will be prohibited from submitting a base rate application before June 30, 2012. The test
year to be used in TEPs next base rate application must be no earlier than December 31, 2011.
Notwithstanding the rate increase moratorium, base rates and adjustor mechanisms may be
changed in emergency conditions which are beyond TEPs control if the ACC concludes such
changes are required to protect the public interest. TEP will not be precluded from seeking
rate relief in the event of the imposition of a federal carbon tax or related federal carbon
regulations.
 
    
    1999 Settlement Agreement.All of TEPs rights and claims under the 1999 Settlement
Agreement would be waived if the proposed settlement agreement is approved by the ACC without
any significant modifications.
  True-up Revenues
  Proposed Settlement Agreement
 Renewable Energy Standard and Tariff
  FERC Proceeding
     58




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##### Table of Contents



Market Prices
  Average Market Price for Around-the-Clock Energy
    
    $/MWhQuarter ended September 30, 2008
    
    $
    69Quarter ended September 30, 2007
    
    
    55Nine months ended September 30, 2008
    
    $
    71Nine months ended September 30, 2007
    
    
    53
 Average Market Price for Natural Gas
    
    $/MMBtuQuarter ended September 30, 2008
    
    $
    8.68Quarter ended September 30, 2007
    
    
    5.47Nine months ended September 30, 2008
    
    $
    8.47Nine months ended September 30, 2007
    
    
    6.13
   Coal Supply
  Generating Plant Operating Performance
     59




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##### Table of Contents



Emission Allowances
 2 2 2 2 2
 Delivery
    
    Allowances Sold
    
    
    Pre-tax Gain-Millions-20071st Quarter
    
    
    2,500
    
    
    $
    22nd Quarter
    
    
    7,500
    
    
    
    53rd Quarter
    
    
    5,000
    
    
    
    34th Quarter
    
    
    7,000
    
    
    
    5Total 2007
    
    
    22,000
    
    
    $
    1520082nd Quarter
    
    
    4,000
    
    
    
    1Total 2008
    
    
    4,000
    
    
    $
    1
 2
 2 2
 Fair Value Measurements
 Fair Value Measurements
  Tucson Electric PowerSeptember 30, 2008- Millions of Dollars -Quoted Prices inActive Markets
    
    
    Significant Other
    
    
    Significantfor Identical
    
    
    Observable
    
    
    UnobservableAssets (Level 1)
    
    
    Inputs (Level 2)
    
    
    Inputs (Level 3)
    
    
    TotalInvestments
(1)
    
    $
    20
    
    
    $
    12
    
    
    $
    
    
    
    $
    32Energy
Contracts
(2)
    
    
    
    
    
    
    (6
    )
    
    
    1
    
    
    
    (5
    )Deferred Compensation
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Interest Rate Swap
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (3
    )Total
    
    $
    20
    
    
    $
    (2
    )
    
    $
    1
    
    
    $
    19
 (1)
    
    Level 1 investments are based on observable market prices and comprise of the fair value of
Commercial Paper and Money Market Funds. Level 2 investments comprise of amounts held in mutual
and money market funds related to deferred compensation and Supplemental Executive Retirement Plan
benefits. The valuation is based on observable market prices, not traded in active markets.(2)
    
    Energy contracts include gas swap agreements (Level 2), forward power purchase and sales
contracts (Level 3), and forward power purchase contracts indexed to gas (Level 3), entered into to
take advantage of favorable market conditions and reduce exposure to energy price risk. The
amounts include current and non-current assets and are net of current and non-current liabilities.  60




---



##### Table of Contents



Regional Haze
  
 LIQUIDITY AND CAPITAL RESOURCES
 TEP Cash Flows
   61




---



##### Table of Contents



Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Net Cash Flows  Operating Activities (GAAP)
    
    $
    187
    
    
    $
    163Amounts from Statements of Cash Flows:Less: Capital Expenditures
    
    
    (209
    )
    
    
    (123
    )Net Cash Flows after Capital Expenditures (non-GAAP)*
    
    
    (22
    )
    
    
    40Amounts from Statements of Cash Flows:Less: Retirement of Capital Lease Obligations
    
    
    (74
    )
    
    
    (71
    )Plus: Proceeds from Investment in Lease Debt
    
    
    25
    
    
    
    28Net Cash
Flows after Capital Expenditures and Required Payments on Capital Lease Obligations
(non-GAAP)*
    
    $
    (71
    )
    
    $
    (3
    )
 Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Net Cash Flows  Operating Activities (GAAP)
    
    $
    187
    
    
    $
    163Net Cash Flows  Investing Activities (GAAP)
    
    
    (313
    )
    
    
    (97
    )Net Cash Flows  Financing Activities (GAAP)
    
    
    133
    
    
    
    (75
    )Net Cash Flows after Capital Expenditures (non-GAAP)*
    
    
    (22
    )
    
    
    40Net Cash Flows after Capital Expenditures and
Required Payments on Capital Lease Obligations
(non-GAAP)*
    
    $
    (71
    )
    
    $
    (3
    )
 *
    
    Net Cash Flows after Capital Expenditures and Net Cash Flows after Required Payments, both
non-GAAP measures of liquidity, should not be considered as alternatives to Net Cash Flows -
Operating Activities, which is determined in accordance with GAAP as a measure of liquidity. We
believe that Net Cash Flows after Capital Expenditures and Net Cash Flows after Required Payments
provide useful information to investors as measures of TEPs liquidity and ability to fund capital
requirements, make required payments on capital lease obligations and pay dividends to UniSource
Energy. Bond Issuances,
 Liquidity Outlook
 Outlook and
Strategies, Economic Conditions and UniSource Energy Liquidity and Capital Resources, Liquidity,
Access to Revolving Credit Facilities
 Financing Activities, Bond Issuances
 Operating Activities
  
    
    a $36 million decrease in cash receipts from retail and wholesale electric sales, less
fuel and purchased power costs, resulting from higher coal-related fuel costs, mild
weather, general economic conditions and unplanned outages during the first quarter that
limited wholesale sales opportunities;
    
    a $13 million increase in cash receipts related to reimbursements received for the
operation of Springerville Unit 3 and 4;
  62




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##### Table of Contents




    
    income tax refunds of $18 million;
    
    an $8 million decrease in proceeds from the sale of excess SO2 emission allowances;
    
    a $19 million decrease in total interest paid due to lower capital lease obligation
balances; and
    
    a $24 million decrease in income taxes paid due to lower taxable income and payments
made last year for amended tax returns.
 Investing Activities
  Financing Activities
  
    
    proceeds of $221 million received by TEP related to the issuance of tax-exempt IDBs
through the Pima County Industrial Development Authority;
    
    a $14 million increase in net proceeds from borrowings under the TEP Revolving Credit
Facility; partially offset by
    
    $10 million of long-term debt repayments.
 TEP Credit Agreement
   Bond Issuances
    63




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##### Table of Contents



Interest Rate Risk
 Qualitative and Quantitative Disclosures about Market Risk, Interest Rate Risk
 Capital Lease Obligations
  Capital Lease Obligation BalanceLeased Asset
    
    at September 30, 2008
    
    
    Expiration-In Millions-Springerville Unit 1
    
    $
    307
    
    
    
    2015Springerville Coal Handling Facilities
    
    
    91
    
    
    
    2015Springerville Common Facilities
    
    
    106
    
    
    
    2020Sundt Unit 4
    
    
    25
    
    
    
    2011Total Capital Lease Obligations
    
    $
    529
  Investments in Springerville Lease Debt and Equity
   64




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##### Table of Contents



Lease Debt Investment BalanceLeased Asset
    
    September 30, 2008
    
    
    December 31, 2007-In Millions-Investments in Lease Debt:Springerville Unit 1
    
    $
    59
    
    
    $
    71Springerville Coal Handling Facilities
    
    
    20
    
    
    
    34Total Investment in Lease Debt
    
    $
    79
    
    
    $
    105
 Income Tax Position
 UniSource Energy, Liquidity and Capital Resources, Income Tax Position,
 Contractual Obligations
  TEPs Contractual Obligations-Millions of Dollars-ThreeMonthsEnded
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2013Payment Due in Years
    
    December
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    andEnding December 31,
    
    31, 2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    after
    
    
    Other
    
    
    TotalLong Term DebtPrincipal
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    469
    
    
    $
    
    
    
    $
    445
    
    
    $
    
    
    
    $
    914Interest
    
    
    8
    
    
    
    40
    
    
    
    41
    
    
    
    38
    
    
    
    28
    
    
    
    443
    
    
    
    
    
    
    
    598Capital Lease Obligations:Springerville Unit 1
    
    
    
    
    
    
    30
    
    
    
    57
    
    
    
    83
    
    
    
    85
    
    
    
    231
    
    
    
    
    
    
    
    486Springerville Coal Handling
    
    
    
    
    
    
    15
    
    
    
    17
    
    
    
    19
    
    
    
    23
    
    
    
    55
    
    
    
    
    
    
    
    129Sundt Unit 4
    
    
    
    
    
    
    13
    
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27Springerville Common
    
    
    1
    
    
    
    5
    
    
    
    5
    
    
    
    5
    
    
    
    10
    
    
    
    134
    
    
    
    
    
    
    
    160Operating Leases
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Purchase Obligations:Coal and Rail Transportation
    
    
    22
    
    
    
    99
    
    
    
    78
    
    
    
    44
    
    
    
    37
    
    
    
    216
    
    
    
    
    
    
    
    496Purchase Power
    
    
    9
    
    
    
    49
    
    
    
    3
    
    
    
    3
    
    
    
    3
    
    
    
    5
    
    
    
    
    
    
    
    72Transmission
    
    
    
    
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    1
    
    
    
    7
    
    
    
    
    
    
    
    14Gas
    
    
    4
    
    
    
    41
    
    
    
    74
    
    
    
    6
    
    
    
    4
    
    
    
    1
    
    
    
    
    
    
    
    130Other Long-Term Liabilities:Pension & Other Post
Retirement Obligations
    
    
    2
    
    
    
    5
    
    
    
    5
    
    
    
    6
    
    
    
    6
    
    
    
    31
    
    
    
    
    
    
    
    55San Juan Pollution Control
Equipment
    
    
    17
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35Acquisition of Springerville
Coal Handling and Common
Facilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    226
    
    
    
    
    
    
    
    226Unrecognized Tax Benefits
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16Total Contractual Cash
Obligations
    
    $
    64
    
    
    $
    318
    
    
    $
    297
    
    
    $
    675
    
    
    $
    197
    
    
    $
    1,794
    
    
    $
    16
    
    
    $
    3,361
  65




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##### Table of Contents



Dividends on Common Stock
   
 UNS GAS
 
 RESULTS OF OPERATIONS
  Sales
    
    
    RevenueThree Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Therms-
    
    
    -Millions of Dollars-Retail Therm Sales:Residential
    
    
    5
    
    
    
    5
    
    
    $
    10
    
    
    $
    9Commercial
    
    
    4
    
    
    
    4
    
    
    
    5
    
    
    
    4Industrial
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Public Authorities
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    1Total Retail Therm Sales
    
    
    10
    
    
    
    10
    
    
    
    15
    
    
    
    14Transport
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    Negotiated Sales Program (NSP)
    
    
    7
    
    
    
    3
    
    
    
    7
    
    
    
    2Total Therm Sales
    
    
    17
    
    
    
    13
    
    
    $
    23
    
    
    $
    16
 Factors Affecting Results of Operations, Rates and Regulation, Purchased Gas
Adjustment Mechanism,
 Factors Affecting Results of Operations, Rates and Regulation, Energy Cost Adjustment Mechanism,
  Three Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Gas Revenues
    
    $
    23
    
    
    $
    16Other Revenues
    
    
    1
    
    
    
    1Total Operating Revenues
    
    
    24
    
    
    
    17Purchased Gas Expense
    
    
    15
    
    
    
    10Other Operations and Maintenance Expense
    
    
    6
    
    
    
    6Depreciation and Amortization
    
    
    2
    
    
    
    2Taxes other than Income Taxes
    
    
    1
    
    
    
    1Total Other Operating Expenses
    
    
    24
    
    
    
    19Operating Income
    
    
    
    
    
    
    (2
    )Other Income
    
    
    
    
    
    
    Total Interest Expense
    
    
    2
    
    
    
    2Income Tax Expense (Benefit)
    
    
    (1
    )
    
    
    (2
    )Net Income
    
    $
    (1
    )
    
    $
    (2
    )
  66




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##### Table of Contents



Nine Months Ended September 30, 2008 Compared with the Nine Months Ended September 30, 2007
   Sales
    
    
    RevenueNine Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of Therms-
    
    
    -Millions of Dollars-Retail Therm Sales:Residential
    
    
    50
    
    
    
    48
    
    
    $
    67
    
    
    $
    62Commercial
    
    
    22
    
    
    
    21
    
    
    
    25
    
    
    
    23Industrial
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    1Public Authorities
    
    
    5
    
    
    
    4
    
    
    
    5
    
    
    
    5Total Retail Therm Sales
    
    
    78
    
    
    
    74
    
    
    
    98
    
    
    
    91Transport
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    2Negotiated Sales Program (NSP)
    
    
    21
    
    
    
    13
    
    
    
    19
    
    
    
    8Total Therm Sales
    
    
    99
    
    
    
    87
    
    
    $
    120
    
    
    $
    101
 Factors Affecting Results of Operations, Rates and Regulation, Energy Cost
Adjustment Mechanism,
  67




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##### Table of Contents



Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Gas Revenues
    
    $
    120
    
    
    $
    101Other Revenues
    
    
    2
    
    
    
    2Total Operating Revenues
    
    
    122
    
    
    
    103Purchased Gas Expense
    
    
    83
    
    
    
    69Other Operations and Maintenance Expense
    
    
    18
    
    
    
    20Depreciation and Amortization
    
    
    5
    
    
    
    6Taxes other than Income Taxes
    
    
    2
    
    
    
    2Total Other Operating Expenses
    
    
    108
    
    
    
    97Operating Income
    
    
    14
    
    
    
    6Other Income
    
    
    
    
    
    
    1Total Interest Expense
    
    
    5
    
    
    
    5Income Tax Expense (Benefit)
    
    
    4
    
    
    
    1Net Income
    
    $
    5
    
    
    $
    1
 
 FACTORS AFFECTING RESULTS OF OPERATIONS
 RATES AND REGULATION
 Energy Cost Adjustment Mechanism
     2008 General Rate Case Filing
   68




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##### Table of Contents



Test
year  12 months ended June 30, 2008
    
    Requested by UNS GasOriginal cost rate base
    
    $182 millionFair value rate base
    
    $256 millionRevenue deficiency
    
    $9.5 millionTotal rate increase (over test year revenues)
    
    6%Cost of long-term debt
    
    6.5%Cost of equity
    
    11.0%Actual capital structure
    
    50% equity / 50% debtWeighted average cost of capital
    
    8.75%Rate of return on fair value rate base
    
    6.80%
 Fair Value Measurements
 Fair Value Measurements
  UNS GasSeptember 30, 2008-Millions of Dollars-Quoted Prices inActive Markets
    
    
    Significant Other
    
    
    Significantfor Identical
    
    
    Observable
    
    
    UnobservableAssets (Level 1)
    
    
    Inputs (Level 2)
    
    
    Inputs (Level 3)
    
    
    TotalInvestments(1)
    
    $
    12
    
    
    $
    
    
    
    $
    
    
    
    $
    12Energy Contracts(2)
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    (10
    )Total
    
    $
    12
    
    
    $
    (10
    )
    
    $
    
    
    
    $
    2
 (1)
    
    Investments are based on observable market prices and comprise of the fair value of Commercial
Paper and Money Market funds.(2)
    
    Energy contracts include gas swap agreements (Level 2) entered into to take advantage of
favorable market conditions and reduce exposure to energy price risk. The amounts include current
and non-current assets and are net of current and non-current liabilities. 
 LIQUIDITY AND CAPITAL RESOURCES
 Liquidity Outlook
 Outlook and Strategies, Economic Conditions and UniSource Energy, Liquidity and Capital Resources,
Liquidity, Access to Revolving Credit Facilities
  69




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##### Table of Contents



Operating Cash Flow and Capital Expenditures
  Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Net Cash Flows  Operating Activities
    
    $
    8
    
    
    $
    19Capital Expenditures
    
    
    13
    
    
    
    18
  UNS Gas/UNS Electric Revolver
   Interest Rate Risk
 Item 3. Qualitative and
Quantitative Disclosures about Market Risk, Credit Risk
 Senior Unsecured Notes
   Contractual Obligations
   Dividends on Common Stock
 Senior Unsecured Notes
  70




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##### Table of Contents



UNS ELECTRIC
 
 RESULTS OF OPERATIONS
   Sales
    
    
    RevenueThree Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Electric Retail Sales:Residential
    
    
    300
    
    
    
    314
    
    
    $
    35
    
    
    $
    31Commercial
    
    
    183
    
    
    
    187
    
    
    
    21
    
    
    
    19Industrial
    
    
    58
    
    
    
    54
    
    
    
    6
    
    
    
    4Other
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    Total Electric Retail Sales
    
    
    542
    
    
    
    555
    
    
    $
    62
    
    
    $
    54Electric Wholesale Sales
    
    
    77
    
    
    
    1
    
    
    
    5
    
    
    
    Total Electric Sales
    
    
    619
    
    
    
    556
    
    
    $
    67
    
    
    $
    54
 Factors Affecting Results of Operations,
Rates and Regulation, General Rate Case Filing
   Three Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Retail Electric Revenues
    
    $
    62
    
    
    $
    54Wholesale Electric Revenues
    
    
    5
    
    
    
    Other Revenues
    
    
    1
    
    
    
    1Total Operating Revenues
    
    
    68
    
    
    
    55Purchased Energy Expense
    
    
    46
    
    
    
    37Fuel Expense
    
    
    4
    
    
    
    Other Operations and Maintenance Expense
    
    
    8
    
    
    
    8Depreciation and Amortization
    
    
    3
    
    
    
    3Taxes other than Income Taxes
    
    
    1
    
    
    
    1Total Other Operating Expenses
    
    
    62
    
    
    
    49Operating Income
    
    
    6
    
    
    
    6Other Income
    
    
    
    
    
    
    Total Interest Expense
    
    
    2
    
    
    
    1Income Tax Expense
    
    
    1
    
    
    
    2Net Income
    
    $
    3
    
    
    $
    3
  71




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##### Table of Contents



Nine Months Ended September 30, 2008 Compared with the Nine Months Ended September 30, 2007
   Sales
    
    
    RevenueNine Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-Millions of kWh-
    
    
    -Millions of Dollars-Electric Retail Sales:Residential
    
    
    667
    
    
    
    693
    
    
    $
    74
    
    
    $
    69Commercial
    
    
    485
    
    
    
    482
    
    
    
    53
    
    
    
    49Industrial
    
    
    162
    
    
    
    149
    
    
    
    14
    
    
    
    12Other
    
    
    2
    
    
    
    2
    
    
    
    
    
    
    
    Total Electric Retail Sales
    
    
    1,316
    
    
    
    1,326
    
    
    $
    141
    
    
    $
    130Electric Wholesale Sales
    
    
    104
    
    
    
    2
    
    
    
    8
    
    
    
    Total Electric Sales
    
    
    1,420
    
    
    
    1,328
    
    
    $
    149
    
    
    $
    130
    Nine Months Ended September 30,
    
    2008
    
    
    2007-Millions of Dollars-Electric Revenues
    
    $
    141
    
    
    $
    130Wholesale Electric Revenues
    
    
    8
    
    
    
    Other Revenues
    
    
    2
    
    
    
    1Total Operating Revenues
    
    
    151
    
    
    
    131Purchased Energy Expense
    
    
    100
    
    
    
    87Fuel Expense
    
    
    5
    
    
    
    Other Operations and Maintenance Expense
    
    
    22
    
    
    
    21Depreciation and Amortization
    
    
    10
    
    
    
    10Taxes other than Income Taxes
    
    
    3
    
    
    
    3Total Other Operating Expenses
    
    
    140
    
    
    
    121Operating Income
    
    
    11
    
    
    
    10Other Income
    
    
    
    
    
    
    2Total Interest Expense
    
    
    5
    
    
    
    4Income Tax Expense
    
    
    2
    
    
    
    3Net Income
    
    $
    4
    
    
    $
    5
  72




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##### Table of Contents



FACTORS AFFECTING RESULTS OF OPERATIONS
 Rates and Regulation
 General Rate Case Filing
  Test
year  12 months ended June 30, 2006
    
    Requested by UNS Electric
    
    2008 ACC OrderOriginal cost rate base
    
    $141 million
    
    $131 millionRevenue deficiency
    
    $8.5 million
    
    $4 millionTotal rate increase (over test year revenues)
    
    5.5%
    
    2.5%Cost of long-term debt
    
    8.2%
    
    8.2%Cost of equity
    
    11.8%
    
    10.0%Actual capital structure
    
    49% equity / 51% debt
    
    49% equity / 51% debtWeighted average cost of capital
    
    9.9%
    
    9.0%
 Purchased Power and Fuel Adjustment Clause
  2009 General Rate Case Filing
  Line Extension Policy
  Purchased Power Agreement
  Renewable Energy Standard and Tariff
  Fair Value Measurements
 Fair Value Measurements
  73




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##### Table of Contents



UNS ElectricSeptember 30, 2008- Millions of Dollars -Quoted Prices inActive Markets
    
    
    Significant Other
    
    
    Significantfor Identical
    
    
    Observable
    
    
    UnobservableAssets (Level 1)
    
    
    Inputs (Level 2)
    
    
    Inputs (Level 3)
    
    
    TotalInvestments(1)
    
    $
    7
    
    
    $
    
    
    
    
    
    
    
    $
    7Energy Contracts(2)
    
    
    
    
    
    
    (3
    )
    
    $
    (10
    )
    
    
    (13
    )Total
    
    $
    7
    
    
    $
    (3
    )
    
    $
    (10
    )
    
    $
    (6
    )
 (1)
    
    Investments are based on observable market prices and comprise of the fair value of Commercial
Paper and Money Market funds.(2)
    
    Energy contracts include gas swap agreements (Level 2),
forward power purchase contracts (Level 3), and forward power purchase contracts indexed to gas (Level 3), entered into to take advantage
of favorable market conditions and reduce exposure to energy price risk. The amounts include
current and non-current assets and are net of current and non-current liabilities.   
 LIQUIDITY AND CAPITAL RESOURCES
 Liquidity Outlook
 Outlook and Strategies, Economic
Conditions and UniSource Energy, Liquidity and Capital Resources, Liquidity, Access to Revolving
Credit Facilities
 Senior Unsecured Notes,
  74




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##### Table of Contents



Operating Cash Flow and Capital Expenditures
  Nine Months Ended September 30,

    
    2008
    
    
    2007- Millions of Dollars -Net Cash Flows  Operating Activities
    
    $
    7
    
    
    $
    19Capital Expenditures
    
    
    20
    
    
    
    31
  UNS Gas/UNS Electric Revolver
 UNS Gas, Liquidity and Capital Resources, UNS Gas/UNS Electric Revolver
  Interest Rate Risk
 Qualitative and Quantitative Disclosures about Market Risk, Credit Risk
 Senior Unsecured Notes
  short-term
  Contractual Obligations
  
    
    In 2008, UNS Electric entered into forward gas purchase agreements through August 2011.
UNS Electric estimates its minimum payments for these forward purchases to be less than $1
million for the three months ended December 31, 2008,, $6 million in 2009, $3 million in 2010,
and less than $1 million in 2011.
    
    In 2008, UNS Electric entered into forward power purchase agreements through 2010. Some of
these contracts are indexed to natural gas prices. UNS Electric estimates it minimum payments
under these contracts to be $22 million in 2009 and $11 million in 2010 based on natural gas
prices at September 30, 2008.
  75




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##### Table of Contents



Dividends on Common Stock
 Senior Unsecured Notes
 
 OTHER NON-REPORTABLE BUSINESS SEGMENTS
 
 RESULTS OF OPERATIONS
  Three Months Ended September 30,

    
    2008
    
    
    2007- Millions of Dollars -UED
    
    $
    1
    
    
    $
    Millennium Investments
    
    
    
    
    
    
    UniSource Energy Parent Company
    
    
    (2
    )
    
    
    (2
    )Total Other
    
    $
    (1
    )
    
    $
    (2
    )
 Nine Months Ended September 30,

    
    2008
    
    
    2007- Millions of Dollars -UED
    
    $
    1
    
    
    $
    Millennium Investments
    
    
    
    
    
    
    1UniSource Energy Parent Company
    
    
    (4
    )
    
    
    (4
    )Total Other
    
    $
    (3
    )
    
    $
    (3
    )
 UniSource Energy Parent Company
  UED
 UNS Electric, Factors Affecting Results of Operation,
Purchased Power Agreement
  FACTORS AFFECTING RESULTS OF OPERATIONS
 Millennium Investments
    76




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##### Table of Contents



September 30, 2008- Millions of Dollars -Quoted Prices inActive Markets
    
    
    Significant Other
    
    
    Significantfor Identical
    
    
    Observable
    
    
    UnobservableAssets (Level 1)
    
    
    Inputs (Level 2)
    
    
    Inputs (Level 3)
    
    
    TotalInvestments
    
    $
    4
    
    
    $
    
    
    
    $
    12
    
    
    $
    16
 LIQUIDITY AND CAPITAL RESOURCES
    
 CRITICAL ACCOUNTING ESTIMATES
  
    
    Accounting for Rate Regulation
    
    Accounting for Asset Retirement Obligations
    
    Pension and Other Postretirement Benefit Plan Assumptions
    
    Accounting for Derivative Instruments, Trading Activities and Hedging Activities
    
    Unbilled Revenue  TEP, UNS Gas and UNS Electric
    
    Plant Asset Depreciable Lives  TEP, UNS Gas and UNS Electric
    
    Deferred Tax Valuation
   77




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##### Table of Contents



NEW ACCOUNTING PRONOUNCEMENTS
  
    
    FAS 161, Disclosures About Derivative Instruments and Hedging Activitiesan amendment to
FAS 133, Accounting for Derivative Instruments and Hedging Activities,issued March 2008,
requires enhanced disclosures about an entitys derivative and hedging activity.The
standard requires that the objectives for using derivative instruments be disclosed in
terms of underlying risk so that the reader understands the purpose of derivative use in
terms of the risks that the entity is intending to manage. The standard also requires
disclosure of the location in the financial statements of derivative balances as well as
the location of gains and losses incurred during the reporting period. The standard will
be applicable for fiscal years or interim periods beginning on or after November 15, 2008,
with early adoption encouraged. The Company is currently assessing the impact of this
statement.
    
    FAS 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial
Statements,issued December 2007, will change the accounting and reporting for minority
interests, requiring such amounts to be classified as a component of equity, and will also
change the accounting for transactions with minority-interest holders. The standard will be
applicable for fiscal years beginning on or after December 15, 2008 on a prospective basis.
Early adoption is prohibited and business combinations with acquisition dates prior to the
effective date will not be adjusted upon application. We do not expect this pronouncement
to have a material impact on our financial statements.
    
    FAS 141(R) Business Combinations- a replacement of FAS No. 141, issued December 2007,
requires companies to record acquisitions at fair value. FAS 141(R) changes the definition
of a business and a business combination and is generally expected to increase the number
of transactions that will need to be accounted for at fair value. The standard will be
applicable for fiscal years beginning on or after December 15, 2008 and generally on a
prospective basis. Early adoption is prohibited and business combinations with acquisition
dates prior to the effective date will not be adjusted upon application. We do not expect
this pronouncement to have a material impact on our financial statements.
    
    FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active issued October 2008, provides guidance clarifying how FAS 157 Fair
Value Measures(FAS 157) should be applied in markets that are not active. The guidance
reaffirms the notion of fair value as an exit price as of the measurement date. The FSP
emphasizes that approaches other than the market value approach to determine fair value,
such as the use of managements internal assumptions about future cash flows and
appropriately risk-adjusted discount rates, may be appropriate. The FSP, which is
effective upon issuance and applicable to prior periods for which financial statements have
not yet been issued, did not have a material impact on our financial statements.
 
 SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
 Forward-looking
  78




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##### Table of Contents



1.
    
    The resolution of pending retail rate case proceedings and the resulting rate structures.2.
    
    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.3.
    
    Demand conditions in our retail service areas, including economic conditions, weather
conditions, rate structures, demographic patterns, competing energy alternatives and the
status of retail competition.4.
    
    Supply and demand conditions in wholesale energy markets, including volatility in market
prices and illiquidity in markets, are affected by a variety of factors, which 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.
    
    Changes affecting our cost of providing electric and gas service including changes in fuel
costs, generating unit operating performance, scheduled and unscheduled plant outages,
interest rates, tax laws, environmental laws, and the general rate of inflation.6.
    
    The creditworthiness of the entities with which we transact business or have transacted
business.7.
    
    Changes in accounting principles or the application of such principles to our businesses.8.
    
    Changes in the depreciable lives of our assets.9.
    
    Unanticipated changes in future liabilities relating to employee benefit plans due to changes
in market values of retirement plan assets and health care costs.10.
    
    The outcome of any ongoing or future litigation.
 
 ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Safe Harbor for
Forward-Looking Statements
 Risk Management Committee
   79




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Interest Rate Risk
   Marketable Securities Risk
  Commodity Price Risk
  TEP
 Purchases and Sales of Energy
   over-the-counter
  80




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-In Millions-
    
    
    -In Millions-Unrealized Gains (Loss)
    
    $
    5
    
    
    $
    1
    
    
    $
    2
    
    
    $
    
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-In Millions-
    
    
    -In Millions-Unrealized Gain (Loss)
    
    $
    1
    
    
    $
    
    
    
    $
    (2
    )
    
    $
    
 Natural Gas
   Nine Months Ended September 30,
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007-MWhs-

    
    
    % of Total ResourcesGas-Fired Generation
    
    
    722,000
    
    
    
    841,000
    
    
    
    6
    %
    
    
    8
    %Purchased Power
    
    
    2,341,000
    
    
    
    1,772,000
    
    
    
    21
    %
    
    
    16
    %
  81




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-In Millions-
    
    
    -In Millions-Unrealized Gain (Loss)
    
    $
    (27
    )
    
    $
    (3
    )
    
    $
    
    
    
    $
    (6
    )
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007-In Millions-
    
    
    -In Millions-Unrealized Gain (Loss)
    
    $
    (7
    )
    
    $
    
    
    
    $
    (3
    )
    
    $
    
  Unrealized Gain (Loss)
of TEPsHedging and Trading Activities- Millions of Dollars -TotalMaturity 0  6
    
    
    Maturity 6  12
    
    
    Maturity
    
    
    UnrealizedSource of Fair Value At September 30, 2008
    
    months
    
    
    months
    
    
    over 1 yr.
    
    
    Gain (Loss)Prices actively quoted
    
    $
    4
    
    
    $
    (4
    )
    
    $
    (2
    )
    
    $
    (2
    )Prices based on models and other
valuation methods
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )Total
    
    $
    4
    
    
    $
    (5
    )
    
    $
    (2
    )
    
    $
    (3
    )
 Sensitivity Analysis of Derivatives
  - Millions of Dollars -Change in Market Price As of September 30, 2008
    
    10% Increase
    
    
    10% DecreaseNon-Cash Flow HedgesForward power sales and purchase contracts
    
    $
    1
    
    
    $
    (1
    )Gas swap agreements
    
    
    2
    
    
    
    (2
    )Cash Flow HedgesForward power sales and purchase contracts
    
    $
    
    
    
    $
    Gas swap agreements
    
    
    3
    
    
    
    (3
    )
 Coal
  UNS Gas
    82




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##### Table of Contents



non-performance
  UNS Electric
      non-performance
   83




---



##### Table of Contents



Credit Risk
   non-investment
  .
  
 ITEM 4.  CONTROLS AND PROCEDURES
   84




---



##### Table of Contents



PART II  OTHER INFORMATION
 
 ITEM 1.  LEGAL PROCEEDINGS
 Note 7
of Notes to Consolidated Financial Statements, Commitments and Contingencies.
 
 ITEM 1A.  RISK FACTORS
 Form
10-K,
 Constricted credit markets may limit the ability of UniSource Energy, TEP, UNS Gas and UNS Electric
to receive funding under their respective revolving credit facilities when required which could
negatively impact liquidity.
   TEP, UNS Gas and UNS Electric may be required to post margin under their power and fuel supply
agreements which could negatively impact their liquidity.
    
 ITEM 2.  UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
   85




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##### Table of Contents



ITEM 5.  OTHER INFORMATION
 
 NON-GAAP MEASURES
 Adjusted EBITDA
   Adjusted EBITDA and Net Cash Flows  Operating Activities
 UniSource EnergyThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Adjusted EBITDA (non-GAAP)
    
    $
    55
    
    
    $
    138
    
    
    $
    221
    
    
    $
    341Net Cash Flows  Operating Activities (GAAP)
    
    
    47
    
    
    
    84
    
    
    
    187
    
    
    
    204Net Cash Flows  Investing Activities (GAAP)
    
    
    (55
    )
    
    
    (47
    )
    
    
    (359
    )
    
    
    (153
    )Net Cash Flows  Financing Activities (GAAP)
    
    $
    (25
    )
    
    $
    (74
    )
    
    $
    152
    
    
    $
    (95
    )
 TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Adjusted EBITDA (non-GAAP)
    
    $
    40
    
    
    $
    126
    
    
    $
    178
    
    
    $
    303Net Cash Flows  Operating Activities (GAAP)
    
    
    55
    
    
    
    70
    
    
    
    187
    
    
    
    163Net Cash Flows  Investing Activities (GAAP)
    
    
    (42
    )
    
    
    (25
    )
    
    
    (313
    )
    
    
    (97
    )Net Cash Flows  Financing Activities (GAAP)
    
    $
    (23
    )
    
    $
    (77
    )
    
    $
    133
    
    
    $
    (75
    )
 Reconciliation of Adjusted EBITDA to Cash Flows from Operations
 UniSource EnergyThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Adjusted EBITDA(non-GAAP) (1)
    
    $
    55
    
    
    $
    138
    
    
    $
    221
    
    
    $
    341Amounts from the Income Statements:Less: Income Taxes
    
    
    (4
    )
    
    
    16
    
    
    
    (1
    )
    
    
    28Less: Total Interest Expense
    
    
    31
    
    
    
    34
    
    
    
    93
    
    
    
    103Changes in Assets and Liabilities and Other Non-Cash Items
    
    
    19
    
    
    
    (4
    )
    
    
    58
    
    
    
    (6
    )Net Cash Flows  Operating Activities(GAAP)
    
    
    47
    
    
    
    84
    
    
    
    187
    
    
    
    204Net Cash Flows  Investing Activities(GAAP)
    
    
    (55
    )
    
    
    (47
    )
    
    
    (359
    )
    
    
    (153
    )Net Cash Flows  Financing Activities(GAAP)
    
    
    (25
    )
    
    
    (74
    )
    
    
    152
    
    
    
    (95
    )Net Increase (Decrease) in Cash and Cash Equivalents
(GAAP)
    
    $
    (33
    )
    
    $
    (37
    )
    
    $
    (20
    )
    
    $
    (44
    )
  86




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TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Adjusted EBITDA(non-GAAP) (1)
    
    $
    40
    
    
    $
    126
    
    
    $
    178
    
    
    $
    303Amounts from the Income Statements:Less: Income Taxes
    
    
    (5
    )
    
    
    16
    
    
    
    (5
    )
    
    
    25Less: Total Interest Expense
    
    
    25
    
    
    
    28
    
    
    
    77
    
    
    
    87Changes in Assets and Liabilities and Other Non-Cash Items
    
    
    35
    
    
    
    (12
    )
    
    
    81
    
    
    
    (28
    )Net Cash Flows  Operating Activities(GAAP)
    
    
    55
    
    
    
    70
    
    
    
    187
    
    
    
    163Net Cash Flows  Investing Activities(GAAP)
    
    
    (42
    )
    
    
    (25
    )
    
    
    (313
    )
    
    
    (97
    )Net Cash Flows  Financing Activities(GAAP)
    
    
    (23
    )
    
    
    (76
    )
    
    
    133
    
    
    
    (75
    )Net
Increase (Decrease) in Cash and Cash Equivalents (GAAP)
    
    $
    (10
    )
    
    $
    (31
    )
    
    $
    7
    
    
    $
    (9
    )
 (1)
    
    Adjusted EBITDA was calculated as follows: UniSource EnergyThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Net Income(GAAP)
    
    $
    (11
    )
    
    $
    25
    
    
    $
    (9
    )
    
    $
    42Amounts from the Income Statements:Plus: Income Taxes
    
    
    (4
    )
    
    
    16
    
    
    
    (1
    )
    
    
    28Total Interest Expense
    
    
    31
    
    
    
    34
    
    
    
    93
    
    
    
    103Depreciation and Amortization
    
    
    37
    
    
    
    35
    
    
    
    109
    
    
    
    103Amortization of Transition Recovery Asset
    
    
    
    
    
    
    26
    
    
    
    24
    
    
    
    60Depreciation included in Fuel and Other O&M
Expense (see Note 13 of Notes to Consolidated
Financial Statements)
    
    
    2
    
    
    
    2
    
    
    
    5
    
    
    
    5Adjusted EBITDA(non-GAAP)
    
    $
    55
    
    
    $
    138
    
    
    $
    221
    
    
    $
    341
 TEPThree Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007- Millions of Dollars -Net Income(GAAP)
    
    $
    (12
    )
    
    $
    26
    
    
    $
    (15
    )
    
    $
    39Amounts from the Income Statements:Plus: Income Taxes
    
    
    (5
    )
    
    
    16
    
    
    
    (5
    )
    
    
    25Total Interest Expense
    
    
    25
    
    
    
    28
    
    
    
    77
    
    
    
    87Depreciation and Amortization
    
    
    31
    
    
    
    29
    
    
    
    93
    
    
    
    88Amortization of Transition Recovery Asset
    
    
    
    
    
    
    26
    
    
    
    24
    
    
    
    60Depreciation included in Fuel and Other O&M
Expense (see Note 13 of Notes to Consolidated
Financial Statements)
    
    
    1
    
    
    
    1
    
    
    
    4
    
    
    
    4Adjusted EBITDA(non-GAAP)
    
    $
    40
    
    
    $
    126
    
    
    $
    178
    
    
    $
    303
 Net Debt and Total Debt and Capital Lease Obligations  TEP
   87




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##### Table of Contents



As of
    
    
    As ofSeptember 30,
    
    
    December2008
    
    
    31, 2007- Millions of Dollars -Net Debt (non-GAAP)
    
    $
    1,354
    
    
    $
    1,306Total Debt and Capital Lease Obligations (GAAP)
    
    $
    1,433
    
    
    $
    1,411
 Reconciliation of Total Debt and Capital Lease Obligations to Net Debt
 As of
    
    
    As ofSeptember 30,
    
    
    December2008
    
    
    31, 2007- Millions of Dollars -Total Debt (GAAP)
    
    $
    904
    
    
    $
    821Capital Lease Obligations
    
    
    511
    
    
    
    531Current Portion  Capital Lease Obligations
    
    
    18
    
    
    
    59Total Debt and Capital Lease Obligations(GAAP)
    
    
    1,433
    
    
    
    1,411Investment in Lease Debt
    
    
    (79
    )
    
    
    (105
    )Net Debt(non-GAAP)
    
    $
    1,354
    
    
    $
    1,306
 
 Ratio of Earnings to Fixed Charges
  9 Months Ended
    
    
    12 Months EndedSeptember 30, 2008
    
    
    September 30, 2008UniSource Energy
    
    
    0.90
    
    
    
    1.14TEP
    
    
    0.73
    
    
    
    1.03
   
 ITEM 6.  EXHIBITS
   88




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##### Table of Contents



SIGNATURES
  UNISOURCE
ENERGY CORPORATION                 
         (Registrant)Date:  November 7, 2008
    /s/ Kevin P. LarsonKevin P. LarsonSenior Vice President and Principal
Financial OfficerTUCSON
ELECTRIC POWER COMPANY                   
      (Registrant)Date:  November 7, 2008
    /s/  Kevin P. LarsonKevin P. LarsonSenior Vice President and Principal
Financial Officer  89




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##### Table of Contents



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, as amended.  90