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UNS Energy Corp 10-Q 2010
Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2010
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 Employer
File Number   Address; and Telephone Number   Identification Number
         
1-13739   UNISOURCE ENERGY CORPORATION   86-0786732
    (An Arizona Corporation)    
    One South Church Avenue, Suite 100    
    Tucson, AZ 85701    
    (520) 571-4000    
         
1-5924   TUCSON ELECTRIC POWER COMPANY   86-0062700
    (An Arizona Corporation)    
    One South Church Avenue, Suite 100    
    Tucson, AZ 85701    
    (520) 571-4000    
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
         
UniSource Energy Corporation
  Yes þ   No o
Tucson Electric Power Company (1)
  Yes o   No þ
     
(1)   Tucson Electric Power Company is not required to file reports under the Exchange Act. However, Tucson Electric Power Company has filed all Exchange Act reports for the preceding 12 months.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
         
UniSource Energy Corporation
  Yes þ   No o
Tucson Electric Power Company
  Yes o   No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
UniSource Energy Corporation   Large Accelerated Filer þ
Smaller Reporting Company o
  Accelerated Filer o   Non-accelerated filer o
Tucson Electric Power Company   Large Accelerated Filer o
Smaller Reporting Company o
  Accelerated Filer o   Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
         
UniSource Energy Corporation
  Yes o   No þ
Tucson Electric Power Company
  Yes o   No þ
At October 15, 2010, 36,431,763 shares of UniSource Energy Corporation Common Stock, no par value (the only class of Common Stock), were outstanding. At October 15, 2010, 32,139,434 shares of Tucson Electric Power Company’s common stock, no par value, were outstanding, all of which were held by UniSource Energy Corporation.
This combined Form 10-Q is separately filed by UniSource Energy Corporation and Tucson Electric Power Company. Information contained in this document relating to Tucson Electric Power Company is filed by UniSource Energy Corporation and separately by Tucson Electric Power Company on its own behalf. Tucson Electric Power Company makes no representation as to information relating to UniSource Energy Corporation or its subsidiaries, except as it may relate to Tucson Electric Power Company.
 
 

 

 


Table of Contents

Table of Contents
         
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PART II – OTHER INFORMATION
 
       
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 Exhibit 12(a)
 Exhibit 12(b)
 Exhibit 15
 Exhibit 31(a)
 Exhibit 31(b)
 Exhibit 31(c)
 Exhibit 31(d)
 Exhibit 32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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Table of Contents

DEFINITIONS
The abbreviations and acronyms used in the 2010 third quarter report on Form 10-Q are defined below:
     
2008 TEP Rate Order
  A rate order issued by the ACC resulting in a new retail rate structure for TEP, effective December 1, 2008.
ACC
  Arizona Corporation Commission.
AMT
  Alternative Minimum Tax.
APS
  Arizona Public Service Company.
BART
  Best Available Retrofit Technology
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.
Common Stock
  UniSource Energy’s common stock, without par value.
Company
  UniSource Energy Corporation.
Cooling Degree Days
  An index used to measure the impact of weather on energy usage calculated by subtracting 75 from the average of the high and low daily temperatures.
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.
EPA
  Environmental Protection Agency.
FERC
  Federal Energy Regulatory Commission.
Four Corners
  Four Corners Generating Station.
GBtu
  Billion British Thermal Units.
IRS
  Internal Revenue Service.
kWh
  Kilowatt-hour(s).
LIBOR
  London Interbank Offered Rate.
Luna
  Luna Energy Facility.
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.
O&M
  Operations and Maintenance Expense.
PGA
  Purchased Gas Adjuster, a retail rate mechanism designed to recover the cost of gas purchased for retail gas customers.
PPFAC
  Purchased Power and Fuel Adjustment Clause.
RES
  Renewable Energy Standard.
Salt River Project
  A public power utility serving more than 900,000 customers in Phoenix, Arizona.
San Juan
  San Juan Generating Station.
SCR
  Selective Catalytic Reduction
Springerville
  Springerville Generating Station.
Springerville Common
Facilities
  Facilities at Springerville used in common with Springerville Unit 1 and Springerville Unit 2.

 

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Table of Contents

     
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. Expires on August 11, 2011.
TEP Revolving Credit Facility
  Revolving credit facility under the TEP Credit Agreement. Expires on August 11, 2011.
TEP Term Loan
  $30 million term loan agreement dated as of March 1, 2010. Matures on September 1, 2011.
Therm
  A unit of heating value equivalent to 100,000 British thermal units (Btu).
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.
UED Credit Agreement
  Credit agreement between UED and a syndicate of banks, dated as of March 26, 2009, guaranteed by UniSource Energy. Expires on March 24, 2012.
UES
  UniSource Energy Services, Inc., an intermediate holding company established to own the operating companies (UNS Gas and UNS Electric).
UniSource Credit Agreement
  Amended and Restated Credit Agreement between UniSource Energy and a syndicate of banks, dated as of August 11, 2006. Expires on August 11, 2011.
UniSource Energy
  UniSource Energy Corporation.
UNS Electric
  UNS Electric, Inc., a wholly-owned subsidiary of UES.
UNS Gas
  UNS Gas, Inc., a wholly-owned subsidiary of UES.
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. Expires on August 11, 2011.

 


Table of Contents

Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
UniSource Energy Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of UniSource Energy Corporation and its subsidiaries (the “Company”) as of September 30, 2010, and the related condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2010 and 2009, the condensed consolidated statement of changes in stockholders’ equity and comprehensive income for the nine-month period ended September 30, 2010 and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2010 and 2009. These interim financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2009, and the related consolidated statements of income, of cash flows, of capitalization, and of changes in stockholders’ equity and comprehensive income for the year then ended (not presented herein), and in our report dated February 25, 2010, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2009, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
     
/s/ PricewaterhouseCoopers LLP
   
 
PricewaterhouseCoopers LLP
   
Phoenix, Arizona
   
October 27, 2010
   

 

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Table of Contents

Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholder of
Tucson Electric Power Company:
We have reviewed the accompanying condensed consolidated balance sheet of Tucson Electric Power Company and its subsidiaries (the “Company”) as of September 30, 2010, and the related condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2010 and 2009, the condensed consolidated statement of changes in stockholder’s equity and comprehensive income for the nine-month period ended September 30, 2010, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2010 and 2009. These interim financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2009, and the related consolidated statements of income, of cash flows, of capitalization, and of changes in stockholder’s equity and comprehensive income for the year then ended (not present herein), and in our report dated February 25, 2010, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2009, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
     
/s/ PricewaterhouseCoopers LLP
   
 
PricewaterhouseCoopers LLP
   
Phoenix, Arizona
   
October 27, 2010
   

 

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Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS
UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                 
Three Months Ended         Nine Months Ended  
September 30,         September 30,  
2010     2009         2010     2009  
(Unaudited)         (Unaudited)  
-Thousands of Dollars-         -Thousands of Dollars-  
(Except Per Share Amounts)         (Except Per Share Amounts)  
               
Operating Revenues
               
$ 360,028     $ 348,938    
Electric Retail Sales
  $ 824,714     $ 817,490  
  36,776       28,785    
Electric Wholesale Sales
    100,094       92,031  
           
California Power Exchange (CPX) Provision for Wholesale Refunds
    (2,970 )      
  16,140       16,226    
Gas Revenue
    96,598       99,189  
  25,824       20,290    
Other Revenues
    76,053       55,169  
           
 
           
  438,768       414,239    
Total Operating Revenues
    1,094,489       1,063,879  
           
 
           
               
 
               
               
Operating Expenses
               
  90,493       99,895    
Fuel
    220,187       223,758  
  93,889       76,207    
Purchased Energy
    241,151       217,121  
  3,380       2,356    
Transmission
    8,688       7,607  
  (12,373 )     (15,403 )  
Decrease to Reflect PPFAC/PGA Recovery
    (35,335 )     (5,083 )
           
 
           
  175,389       163,055    
Total Fuel and Purchased Energy
    434,691       443,403  
  88,936       79,549    
Other Operations and Maintenance
    258,979       243,432  
  32,450       35,246    
Depreciation
    95,773       109,601  
  7,177       8,433    
Amortization
    20,797       22,280  
  11,334       11,098    
Taxes Other Than Income Taxes
    35,559       35,915  
           
 
           
  315,286       297,381    
Total Operating Expenses
    845,799       854,631  
           
 
           
  123,482       116,858    
Operating Income
    248,690       209,248  
           
 
           
               
 
               
               
Other Income (Deductions)
               
  2,011       2,609    
Interest Income
    5,891       9,530  
  1,362       1,899    
Other Income
    8,499       16,284  
  (1,621 )     (812 )  
Other Expense
    (8,524 )     (2,040 )
           
 
           
  1,752       3,696    
Total Other Income (Deductions)
    5,866       23,774  
           
 
           
               
 
               
               
Interest Expense
               
  15,928       14,317    
Long-Term Debt
    46,984       43,680  
  11,616       12,504    
Capital Leases
    35,124       36,762  
  (1,726 )     544    
Other Interest Expense, Net of Interest Capitalized
    (1,213 )     631  
           
 
           
  25,818       27,365    
Total Interest Expense
    80,895       81,073  
           
 
           
               
 
               
  99,416       93,189    
Income Before Income Taxes
    173,661       151,949  
  44,533       35,543    
Income Tax Expense
    73,266       58,110  
           
 
           
               
 
               
$ 54,883     $ 57,646    
Net Income
  $ 100,395     $ 93,839  
           
 
           
               
 
               
  36,533       35,928    
Weighted-Average Shares of Common Stock Outstanding (000)
    36,321       35,829  
           
 
           
               
 
               
$ 1.50     $ 1.60    
Basic Earnings per Share
  $ 2.76     $ 2.62  
           
 
           
               
 
               
$ 1.36     $ 1.45    
Diluted Earnings per Share
  $ 2.53     $ 2.40  
           
 
           
               
 
               
$ 0.39     $ 0.29    
Dividends Declared per Share
  $ 1.17     $ 0.87  
           
 
           
See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
    (Unaudited)  
    -Thousands of Dollars-  
Cash Flows from Operating Activities
               
Cash Receipts from Electric Retail Sales
  $ 848,308     $ 858,056  
Cash Receipts from Electric Wholesale Sales
    138,236       135,006  
Cash Receipts from Gas Sales
    124,922       130,765  
Cash Receipts from Operating Springerville Units 3 & 4
    67,593       51,399  
Interest Received
    9,029       12,997  
Income Tax Refunds Received
    174       16,961  
Performance Deposits Received
    16,200       27,720  
Other Cash Receipts
    15,989       10,086  
Purchased Energy Costs Paid
    (288,035 )     (257,414 )
Fuel Costs Paid
    (182,703 )     (227,304 )
Payment of Other Operations and Maintenance Costs
    (177,261 )     (177,101 )
Taxes Other Than Income Taxes Paid, Net of Amounts Capitalized
    (106,701 )     (110,271 )
Wages Paid, Net of Amounts Capitalized
    (94,490 )     (94,217 )
Interest Paid, Net of Amounts Capitalized
    (49,751 )     (48,312 )
Capital Lease Interest Paid
    (37,106 )     (38,050 )
Performance Deposit Payments
    (17,200 )     (21,010 )
Income Taxes Paid
    (11,246 )      
Excess Tax Benefit from Stock Options Exercised
    (1,796 )     (1,929 )
Other Cash Payments
    (4,870 )     (5,084 )
 
           
Net Cash Flows — Operating Activities
    249,292       262,298  
 
           
 
               
Cash Flows from Investing Activities
               
Capital Expenditures
    (200,183 )     (236,913 )
Purchase of Sundt Unit 4 Lease Asset
    (51,389 )      
Purchase of Springerville Lease Debt
          (31,375 )
Prepayment Deposit on UED Debt
    (3,188 )     (2,069 )
Other Cash Payments
    (820 )     (866 )
Return of Investment in Springerville Lease Debt
    25,615       12,736  
Customer Advance Reimbursement from Citizens
    1,254        
Return of Investment from Millennium Energy Businesses
    423       5,000  
Insurance Proceeds for Replacement Assets
    1,041       4,928  
Other Cash Receipts
    356       322  
 
           
Net Cash Flows — Investing Activities
    (226,891 )     (248,237 )
 
           
 
               
Cash Flows from Financing Activities
               
Proceeds from Borrowings Under Revolving Credit Facilities
    231,000       158,000  
Proceeds from Issuance of Long-Term Debt
    39,570        
Proceeds from Issuance of Short-Term Debt
          30,000  
Proceeds from Stock Options Exercised
    8,896       2,021  
Excess Tax Benefit from Stock Options Exercised
    1,796       1,929  
Other Cash Receipts
    6,981       4,517  
Repayments of Borrowings Under Revolving Credit Facilities
    (199,000 )     (140,000 )
Payments of Capital Lease Obligations
    (55,970 )     (24,157 )
Common Stock Dividends Paid
    (42,326 )     (31,037 )
Repayment of Long-Term Debt
    (19,445 )     (4,500 )
Payment of Debt Issue/Retirement Costs
    (2,099 )     (963 )
Other Cash Payments
    (1,827 )     (1,957 )
 
           
Net Cash Flows — Financing Activities
    (32,424 )     (6,147 )
 
           
 
               
Net (Decrease) Increase in Cash and Cash Equivalents
    (10,023 )     7,914  
Cash and Cash Equivalents, Beginning of Year
    76,922       55,172  
 
           
Cash and Cash Equivalents, End of Period
  $ 66,899     $ 63,086  
 
           
See Note 16 for supplemental cash flow information.
See Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2010     2009  
    (Unaudited)  
    - Thousands of Dollars -  
ASSETS
               
Utility Plant
               
Plant in Service
  $ 4,412,776     $ 4,147,268  
Utility Plant under Capital Leases
    583,374       720,628  
Construction Work in Progress
    178,642       144,551  
 
           
Total Utility Plant
    5,174,792       5,012,447  
Less Accumulated Depreciation and Amortization
    (1,804,302 )     (1,652,296 )
Less Accumulated Amortization of Capital Lease Assets
    (456,829 )     (574,437 )
 
           
Total Utility Plant — Net
    2,913,661       2,785,714  
 
           
 
               
Investments and Other Property
               
Investments in Lease Debt and Equity
    104,118       132,168  
Other
    55,939       60,239  
 
           
Total Investments and Other Property
    160,057       192,407  
 
           
 
               
Current Assets
               
Cash and Cash Equivalents
    66,899       76,922  
Accounts Receivable — Customer
    110,014       80,191  
Unbilled Accounts Receivable
    56,967       53,361  
Allowance for Doubtful Accounts
    (6,257 )     (5,977 )
Fuel Inventory
    38,951       48,159  
Materials and Supplies
    65,150       68,633  
Derivative Instruments
    6,440       2,653  
Regulatory Assets — Current
    62,138       41,772  
Deferred Income Taxes — Current
    54,705       52,355  
Investments in Lease Debt
    1,473        
Other
    29,888       28,236  
 
           
Total Current Assets
    486,368       446,305  
 
           
 
               
Regulatory and Other Assets
               
Regulatory Assets — Noncurrent
    184,097       147,325  
Derivative Instruments
    9,467       4,498  
Other Assets
    24,618       24,993  
 
           
Total Regulatory and Other Assets
    218,182       176,816  
 
           
 
               
Total Assets
  $ 3,778,268     $ 3,601,242  
 
           
See Notes to Condensed Consolidated Financial Statements.
(Continued)

 

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UNISOURCE ENERGY CORPORATION
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2010     2009  
    (Unaudited)  
    - Thousands of Dollars -  
CAPITALIZATION AND OTHER LIABILITIES
               
Capitalization
               
Common Stock Equity
  $ 816,533     $ 750,865  
Capital Lease Obligations
    426,881       488,349  
Long-Term Debt
    899,464       1,307,795  
 
           
Total Capitalization
    2,142,878       2,547,009  
 
           
 
               
Current Liabilities
               
Current Obligations Under Capital Leases
    60,375       40,441  
Borrowing Under Revolving Credit Facility
    84,000       35,000  
Current Maturities of Long-Term Debt
    420,100       12,195  
Accounts Payable — Trade
    102,363       98,990  
Interest Accrued
    23,327       41,396  
Accrued Taxes Other than Income Taxes
    55,553       36,698  
Accrued Employee Expenses
    26,270       27,545  
Customer Deposits
    28,590       25,978  
Regulatory Liabilities — Current
    64,880       42,229  
Derivative Instruments
    35,864       21,186  
Other
    16,497       4,038  
 
           
Total Current Liabilities
    917,819       385,696  
 
           
 
               
Deferred Credits and Other Liabilities
               
Deferred Income Taxes — Noncurrent
    290,772       227,199  
Regulatory Liabilities — Noncurrent
    195,755       211,891  
Derivative Instruments
    32,132       19,489  
Pension and Other Postretirement Benefits
    114,093       123,476  
Other
    84,819       86,482  
 
           
Total Deferred Credits and Other Liabilities
    717,571       668,537  
 
           
 
               
Commitments and Contingencies (Note 6)
               
 
               
Total Capitalization and Other Liabilities
  $ 3,778,268     $ 3,601,242  
 
           
See Notes to Condensed Consolidated Financial Statements.
(Concluded)

 

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UNISOURCE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
                                         
                            Accumulated        
    Common                     Other        
    Shares     Common     Accumulated     Comprehensive        
    Outstanding*     Stock     Earnings     Loss     Total  
    (Unaudited)  
    -Thousands of Dollars-  
 
                                       
Balances at December 31, 2009
    35,851     $ 696,206     $ 60,461     $ (5,802 )   $ 750,865  
 
                                     
 
                                       
Comprehensive Income:
                                       
2010 Year-to-Date Net Income
                    100,395               100,395  
 
                                       
Unrealized Loss on Cash Flow Hedges
(net of $4,950 income taxes)
                            (7,550 )     (7,550 )
 
                                       
Reclassification of Unrealized Losses on Cash Flow Hedges to Net Income
(net of $1,530 income taxes)
                            2,334       2,334  
 
                                       
Employee Benefit Obligations
                                       
Amortization of SERP Net Prior Service Cost Included in Net Periodic Benefit Cost
(net of $102 income taxes)
                            156       156  
 
                                     
 
                                       
Total Comprehensive Income
                                    95,335  
 
                                       
Dividends Declared
                    (42,646 )             (42,646 )
Shares Issued under Deferred Compensation Plans
    18       587                       587  
Shares Issued under Stock Compensation Plans -
(net of shares redeemed for taxes)
    508       8,507                       8,507  
Tax Benefit Realized from Share-Based Compensation Plans
            1,796                       1,796  
Other Share-Based Compensation
            2,089                       2,089  
 
                             
 
                                       
Balances at September 30, 2010
    36,377     $ 709,185     $ 118,210     $ (10,862 )   $ 816,533  
 
                             
     
*   UniSource Energy has 75 million authorized shares of Common Stock.
See Notes to Condensed Consolidated Financial Statements.

 

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TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                 
Three Months Ended         Nine Months Ended  
September 30,         September 30,  
2010     2009         2010     2009  
(Unaudited)         (Unaudited)  
-Thousands of Dollars-         -Thousands of Dollars-  
               
Operating Revenues
               
$ 300,348     $ 297,418    
Electric Retail Sales
  $ 685,322     $ 675,190  
  26,669       38,018    
Electric Wholesale Sales
    94,694       107,762  
           
California Power Exchange (CPX) Provision for Wholesale Refunds
    (2,970 )      
  27,559       21,753    
Other Revenues
    81,066       59,055  
           
 
           
  354,576       357,189    
Total Operating Revenues
    858,112       842,007  
           
 
           
               
 
               
               
Operating Expenses
               
  85,793       92,330    
Fuel
    210,838       208,808  
  47,909       52,999    
Purchased Power
    103,766       112,416  
  972       632    
Transmission
    2,818       2,439  
  (13,362 )     (12,895 )  
Decrease to Reflect PPFAC Recovery
    (24,098 )     (16,898 )
           
 
           
  121,312       133,066    
Total Fuel and Purchased Energy
    293,324       306,765  
  76,277       69,232    
Other Operations and Maintenance
    224,441       213,069  
  25,190       28,073    
Depreciation
    74,143       88,605  
  8,153       9,646    
Amortization
    23,963       25,934  
  9,271       9,117    
Taxes Other Than Income Taxes
    29,049       29,413  
           
 
           
  240,203       249,134    
Total Operating Expenses
    644,920       663,786  
           
 
           
  114,373       108,055    
Operating Income
    213,192       178,221  
           
 
           
               
 
               
               
Other Income (Deductions)
               
  1,725       2,367    
Interest Income
    5,111       9,176  
  2,014       1,686    
Other Income
    4,347       9,671  
  (826 )     (702 )  
Other Expense
    (2,425 )     (1,616 )
           
 
           
  2,913       3,351    
Total Other Income (Deductions)
    7,033       17,231  
           
 
           
               
 
               
               
Interest Expense
               
  10,223       8,829    
Long-Term Debt
    30,255       27,232  
  11,614       12,502    
Capital Leases
    35,118       36,753  
  (1,683 )     159    
Other Interest Expense, Net of Interest Capitalized
    (1,641 )     (289 )
           
 
           
  20,154       21,490    
Total Interest Expense
    63,732       63,696  
           
 
           
               
 
               
  97,132       89,916    
Income Before Income Taxes
    156,493       131,756  
  38,139       34,639    
Income Tax Expense
    59,514       50,527  
           
 
           
               
 
               
$ 58,993     $ 55,277    
Net Income
  $ 96,979     $ 81,229  
           
 
           
See Notes to Condensed Consolidated Financial Statements.

 

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TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 
    Nine Months Ended  
    September 30,  
    2010     2009  
    (Unaudited)  
    -Thousands of Dollars-  
Cash Flows from Operating Activities
               
Cash Receipts from Electric Retail Sales
  $ 704,027     $ 701,988  
Cash Receipts from Electric Wholesale Sales
    140,207       152,897  
Cash Receipts from Operating Springerville Units 3 & 4
    67,593       51,399  
Reimbursement of Affiliate Charges
    13,781       19,625  
Interest Received
    8,986       12,759  
Performance Deposits Received
    5,040       6,073  
Income Tax Refunds Received
    3,369       10,423  
Other Cash Receipts
    8,270       11,774  
Fuel Costs Paid
    (173,796 )     (212,389 )
Payment of Other Operations and Maintenance Costs
    (166,487 )     (167,919 )
Purchased Power Costs Paid
    (143,793 )     (141,700 )
Capital Lease Interest Paid
    (37,099 )     (38,042 )
Wages Paid, Net of Amounts Capitalized
    (76,637 )     (75,162 )
Taxes Other Than Income Taxes Paid, Net of Amounts Capitalized
    (88,390 )     (81,716 )
Interest Paid, Net of Amounts Capitalized
    (28,841 )     (27,260 )
Perfomance Deposit Payments
    (5,040 )     (13,750 )
Income Taxes Paid
    (14,865 )     (8,636 )
Other Cash Payments
    (2,487 )     (2,890 )
 
           
Net Cash Flows — Operating Activities
    213,838       197,474  
 
           
 
               
Cash Flows from Investing Activities
               
Capital Expenditures
    (166,338 )     (194,777 )
Purchase of Sundt Unit 4 Lease Asset
    (51,389 )      
Purchase of Springerville Lease Debt
          (31,375 )
Other Cash Payments
    (1 )     (409 )
Return of Investment in Springerville Lease Debt
    25,615       12,736  
Insurance Proceeds for Replacement Assets
    1,041       4,928  
Other Cash Receipts
    347        
 
           
Net Cash Flows — Investing Activities
    (190,725 )     (208,897 )
 
           
 
               
Cash Flows from Financing Activities
               
Proceeds from Borrowings Under Revolving Credit Facility
    177,000       126,000  
Proceeds from Issuance of Long-Term Debt
    30,000        
Equity Investment from UniSource Energy
    15,000       30,000  
Other Cash Receipts
    1,831       2,246  
Repayments of Borrowings Under Revolving Credit Facility
    (157,000 )     (111,000 )
Payments of Capital Lease Obligations
    (55,889 )     (24,091 )
Dividends Paid to UniSource Energy
    (30,000 )     (30,000 )
Payment of Debt Issue/Retirement Costs
    (1,505 )     (24 )
Other Cash Payments
    (1,177 )     (1,282 )
 
           
Net Cash Flows — Financing Activities
    (21,740 )     (8,151 )
 
           
 
               
Net Increase (Decrease) in Cash and Cash Equivalents
    1,373       (19,574 )
Cash and Cash Equivalents, Beginning of Year
    22,418       33,275  
 
           
Cash and Cash Equivalents, End of Period
  $ 23,791     $ 13,701  
 
           
See Note 16 for supplemental cash flow information.
See Notes to Condensed Consolidated Financial Statements.

 

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TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2010     2009  
    (Unaudited)  
    - Thousands of Dollars -  
ASSETS
               
Utility Plant
               
Plant in Service
  $ 3,826,705     $ 3,584,308  
Utility Plant under Capital Leases
    582,669       719,922  
Construction Work in Progress
    138,884       113,390  
 
           
Total Utility Plant
    4,548,258       4,417,620  
Less Accumulated Depreciation and Amortization
    (1,717,762 )     (1,582,442 )
Less Accumulated Amortization of Capital Lease Assets
    (456,177 )     (573,853 )
 
           
Total Utility Plant — Net
    2,374,319       2,261,325  
 
           
 
               
Investments and Other Property
               
Investments in Lease Debt and Equity
    104,118       132,168  
Other
    33,143       31,813  
 
           
Total Investments and Other Property
    137,261       163,981  
 
           
 
               
Current Assets
               
Cash and Cash Equivalents
    23,791       22,418  
Accounts Receivable — Customer
    92,197       62,508  
Unbilled Accounts Receivable
    45,758       32,368  
Allowance for Doubtful Accounts
    (4,285 )     (3,806 )
Accounts Receivable — Due from Affiliates
    3,344       5,218  
Fuel Inventory
    38,941       48,149  
Materials and Supplies
    54,031       56,712  
Derivative Instruments
    2,596       5,043  
Regulatory Assets — Current
    33,983       27,026  
Deferred Income Taxes — Current
    55,323       50,789  
Investments in Lease Debt
    1,473        
Other
    21,390       24,362  
 
           
Total Current Assets
    368,542       330,787  
 
           
 
               
Regulatory and Other Assets
               
Regulatory Assets — Noncurrent
    170,287       137,147  
Derivative Instruments
    1,971       1,075  
Other Assets
    20,477       19,984  
 
           
Total Regulatory and Other Assets
    192,735       158,206  
 
           
 
               
Total Assets
  $ 3,072,857     $ 2,914,299  
 
           
See Notes to Condensed Consolidated Financial Statements.
(Continued)

 

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TUCSON ELECTRIC POWER COMPANY
COMPARATIVE CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2010     2009  
    (Unaudited)  
    - Thousands of Dollars -  
CAPITALIZATION AND OTHER LIABILITIES
               
Capitalization
               
Common Stock Equity
  $ 720,063     $ 643,144  
Capital Lease Obligations
    426,881       488,311  
Long-Term Debt
    575,015       903,615  
 
           
Total Capitalization
    1,721,959       2,035,070  
 
           
 
               
Current Liabilities
               
Current Maturities of Long-Term Debt
    358,600        
Current Obligations Under Capital Leases
    60,309       40,332  
Borrowing Under Revolving Credit Facility
    55,000       35,000  
Accounts Payable — Trade
    81,291       71,328  
Accounts Payable — Due to Affiliates
    3,068       3,694  
Interest Accrued
    20,954       33,970  
Accrued Taxes Other than Income Taxes
    46,176       28,404  
Accrued Employee Expenses
    23,129       24,409  
Customer Deposits
    20,138       18,125  
Derivative Instruments
    8,188       9,434  
Regulatory Liabilities — Current
    57,042       26,639  
Other
    5,199       1,445  
 
           
Total Current Liabilities
    739,094       292,780  
 
           
 
               
Deferred Credits and Other Liabilities
               
Deferred Income Taxes — Noncurrent
    268,385       217,316  
Regulatory Liabilities — Noncurrent
    161,555       179,478  
Derivative Instruments
    15,362       11,195  
Pension and Other Postretirement Benefits
    108,437       116,991  
Other
    58,065       61,469  
 
           
Total Deferred Credits and Other Liabilities
    611,804       586,449  
 
           
 
               
Commitments and Contingencies (Note 6)
               
 
               
Total Capitalization and Other Liabilities
  $ 3,072,857     $ 2,914,299  
 
           
See Notes to Condensed Consolidated Financial Statements.
(Concluded)

 

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TUCSON ELECTRIC POWER COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER’S EQUITY AND COMPREHENSIVE INCOME
                                         
                            Accumulated        
            Capital             Other        
    Common     Stock     Accumulated     Comprehensive        
    Stock     Expense     Deficit     Loss     Total  
    (Unaudited)  
    - Thousands of Dollars -  
 
                                       
Balances at December 31, 2009
  $ 843,971     $ (6,357 )   $ (188,668 )   $ (5,802 )   $ 643,144  
 
                                     
 
                                       
Comprehensive Income:
                                       
2010 Year-to-Date Net Income
                    96,979               96,979  
 
                                       
Unrealized Loss on Cash Flow Hedges
(net of $4,950 income taxes)
                            (7,550 )     (7,550 )
 
                                       
Reclassification of Unrealized Losses on Cash Flow Hedges to Net Income
(net of $1,530 income taxes)
                            2,334       2,334  
 
                                       
Employee Benefit Obligations
                                       
Amortization of SERP Net Prior Service Cost Included in Net Periodic Benefit Cost
(net of $102 income taxes)
                            156       156  
 
                                     
 
                                       
Total Comprehensive Income
                                    91,919  
 
                                       
Capital Contribution from UniSource Energy
    15,000                               15,000  
 
                                       
Dividends Paid
                    (30,000 )             (30,000 )
 
                             
 
                                       
Balances at September 30, 2010
  $ 858,971     $ (6,357 )   $ (121,689 )   $ (10,862 )   $ 720,063  
 
                             
See Notes to Condensed Consolidated Financial Statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — Unaudited
NOTE 1. NATURE OF OPERATIONS AND BASIS OF ACCOUNTING PRESENTATION
UniSource Energy Corporation (UniSource Energy) is a holding company that has no significant operations of its own. Operations are conducted by UniSource Energy’s subsidiaries, each of which is a separate legal entity with its own assets and liabilities. UniSource Energy owns the common stock of Tucson Electric Power Company (TEP), UniSource Energy Services, Inc. (UES), Millennium Energy Holdings, Inc. (Millennium) and UniSource Energy Development Company (UED).
TEP, a regulated public utility, is UniSource Energy’s largest operating subsidiary and represented approximately 81% of UniSource Energy’s assets as of September 30, 2010. TEP generates, transmits and distributes electricity to approximately 402,000 retail electric customers in a 1,155 square mile area in Southern Arizona. TEP also sells electricity to other utilities and power marketing entities primarily located in the Western U.S. In addition, TEP operates Springerville Unit 3 on behalf of Tri-State Generation and Transmission Association, Inc. (Tri-State) and, Springerville Unit 4 on behalf of Salt River Project Agricultural Improvement and Power District (SRP).
UES holds the common stock of UNS Gas, Inc. (UNS Gas) and UNS Electric, Inc. (UNS Electric). UNS Gas is a gas distribution company with 145,000 retail customers in Mohave, Yavapai, Coconino, and Navajo counties in Northern Arizona, as well as Santa Cruz county in Southeast Arizona. UNS Electric is an electric transmission and distribution company with approximately 91,000 retail customers in Mohave and Santa Cruz counties. UED owns the Black Mountain Generating Station (BMGS), a natural gas-fired combustion turbine in Northern Arizona that, through a power sale agreement, provides electricity to UNS Electric.
Millennium holds investments in unregulated businesses that represent less than 1% of UniSource Energy’s assets as of September 30, 2010. Millennium is in the process of exiting its remaining investments which may yield gains or losses. At September 30, 2010, Millennium’s key assets include: a $15 million note receivable related to the 2009 sale of Sabinas, $7 million of investments related to various energy technology projects and $3 million in cash. See Note 13 for additional information.
References to “we” and “our” are to UniSource Energy and its subsidiaries, collectively.
The accompanying quarterly financial statements of UniSource Energy and TEP are unaudited but reflect all normal recurring accruals and other adjustments which we believe are necessary for a fair presentation of the results for the interim periods presented. These financial statements are presented in accordance with the Securities and Exchange Commission’s (SEC) interim reporting requirements which do not include all the disclosures required by accounting principles generally accepted in the United States of America (GAAP) for audited annual financial statements. The year-end condensed balance sheet data was derived from audited financial statements, but does not include disclosures required by GAAP for audited annual financial statements. This quarterly report should be reviewed in conjunction with UniSource Energy and TEP’s 2009 Annual Report on Form 10-K, and quarterly reports on Form 10-Q for the quarters ended March 31 and June 30, 2010.
Weather, among other factors, causes seasonal fluctuations in TEP, UNS Gas and UNS Electric’s sales; therefore, quarterly results are not indicative of annual operating results.
In an effort to more closely match GAAP taxonomies in extensible business reporting language, more commonly known as XBRL, UniSource Energy and TEP made the following balance sheet presentation changes from previously issued financial statements to conform to the current presentation:
    Accounts Receivable — Retail and Other, and Accounts Receivable Wholesale are no longer shown separately, but, instead are reported as Accounts Receivable — Customer or Accounts Receivable — Non-customers reported in Other Assets;
    Separately report Fuel Inventory which was previously combined with Materials Inventory;
    Rather than being shown separately, all regulatory balances are reported in either Regulatory Assets — Current, Regulatory Assets — Noncurrent, Regulatory Liabilities — Current, or Regulatory Liabilities — Noncurrent;
    Combined Accounts Payable and Accounts Payable — Purchased Power to report in the aggregate as Accounts Payable — Trade; and
    Customer Advances for Construction are no longer shown separately; but, instead, are reported as Other within Deferred Credits and Other Liabilities.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 2. REGULATORY MATTERS
ACCOUNTING FOR RATE REGULATION
The Arizona Corporation Commission (ACC) and the Federal Energy Regulatory Commission (FERC) regulate portions of TEP, UNS Gas, and UNS Electric (the three utilities) utility accounting practices and rates. The ACC has authority over certain rates charged to retail customers, the issuance of securities, and transactions with affiliated parties. The FERC regulates rates for wholesale power sales and interstate transmission services.
TEP RATES AND REGULATION
The following table summarizes TEP’s regulatory assets and liabilities:
                 
    September 30,     December 31,  
    2010     2009  
    -Millions of Dollars-  
Regulatory Assets — Current
               
Property Tax Deferrals
  $ 17     $ 16  
Derivative Instruments
    6       4  
Deregulation Costs
    4       4  
Demand Side Management (DSM) Assets
    4        
Other Current Regulatory Assets
    3       3  
 
           
Total Regulatory Assets — Current
    34       27  
 
           
 
               
Regulatory Assets — Noncurrent
               
Pension and Other Postretirement Benefits
    78       80  
Income Taxes Recoverable through Future Revenues
    18       18  
Final Mine Reclamation Costs
    10       9  
PPFAC — Under-Recovered Purchased Energy Costs
    44        
PPFAC — Over-Recovered Purchased Energy Costs, Fixed CTC Revenue to be Refunded
    (3 )      
San Juan Coal Contract Amendment
    6       7  
Retiree Health Care Costs
    6       6  
Unamortized Loss on Reacquired Debt
    5       4  
Deregulation Costs
    4       7  
Derivative Instruments
    2       5  
Other Regulatory Assets
          1  
 
           
Total Regulatory Assets — Noncurrent
    170       137  
 
           
 
               
Regulatory Liabilities — Current
               
PPFAC — Over-Recovered Purchased Energy Costs, Fixed CTC Revenue to be Refunded Within the Next 12 Months
    (35 )     (9 )
Renewable Energy Standards (RES) Tariff
    (20 )     (17 )
Other Current Regulatory Liabilities
    (2 )     (1 )
 
           
Total Regulatory Liabilities — Current
    (57 )     (27 )
 
           
 
               
Regulatory Liabilities — Noncurrent
               
Net Cost of Removal for Interim Retirements
    (160 )     (162 )
Derivative Instruments
    (2 )      
PPFAC — Under-Recovered Purchased Energy Costs
          20  
PPFAC — Over-Recovered Purchased Energy Costs, Fixed CTC Revenue to be Refunded
          (37 )
 
           
Total Regulatory Liabilities — Noncurrent
    (162 )     (179 )
 
           
Total Net Regulatory Assets (Liabilities)
  $ (15 )   $ (42 )
 
           

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
TEP Purchased Power and Fuel Adjustment Clause (PPFAC)
TEP is allowed recovery of fuel, transmission, and purchased power costs, including demand charges and the prudent costs of contracts for hedging fuel and purchased power costs. The PPFAC mechanism provides for the annual adjustment of retail rates to reflect variations in retail fuel and purchased power costs from the base power supply rate currently included in base rates of approximately 2.9 cents per kWh. The current PPFAC rate of 0.09 cents per kWh, effective April 2010, includes a forward component credit of (0.08) cents and a true-up component of 0.17 cents. TEP offsets the forward and true-up components of the PPFAC with Fixed Competition Transition Charge (CTC) revenue to be refunded, resulting in a PPFAC charge of zero to customers until the CTC is fully credited. For the year ended March 2010, TEP had a PPFAC rate of 0.18 cents per kWh. TEP had no PPFAC rate in the first quarter of 2009.
The following table shows the changes in the deferred purchased energy regulatory asset (liability) and the impacts on revenue and expense for the nine months ended September 30, 2010:
                                 
                    Nine Months Ended  
    Balance at     September 30, 2010  
    September 30,     December 31,     Impact on     Impact on  
    2010     2009     Revenue     Expense  
    -Millions of Dollars-  
Fixed CTC Revenue to be Refunded Within the Next 12 Months; Included in Regulatory Liabilities — Current
  $ (35 )   $ (9 )   $ (26 )   $  
 
                           
 
                               
Under-Recovered Purchased Energy Costs — Regulatory Basis As Billed to Customers
  $ 57     $ 29               28  
 
                               
Reduction in Under-Recovered Purchased Energy Costs — As Estimated in Accrued Unbilled Revenues
    (13 )     (9 )             (4 )
Fixed CTC Revenue to be Refunded
    (3 )     (37 )     34          
 
                       
Total Included in Regulatory Assets (Liabilities) — Noncurrent
  $ 41     $ (17 )                
 
                           
 
                               
Increase in Retail Revenue to reflect Amortization of Fixed CTC Revenue
                  $ 8          
 
                             
 
                               
Decrease in Fuel and Purchased Energy Expense to reflect PPFAC Recovery
                          $ 24  
 
                             
For the nine months ended September 2009, the increase in Retail Revenue to reflect Amortization of Fixed CTC Revenue was $8 million and the decrease in Fuel and Purchased Energy Expense to reflect PPFAC Recovery was $17 million.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
UNS GAS RATES AND REGULATION
UNS Gas has the following Regulatory Assets and Liabilities:
                 
    September 30,     December 31,  
    2010     2009  
    -Millions of Dollars-  
Current Assets
               
Derivative Instruments
  $ 10     $ 5  
Other Regulatory Assets
               
Pension Obligations
    2       2  
Derivative Instruments
    3       3  
Other Regulatory Assets
    1       1  
Regulatory Liabilities
               
PGA — Over-Recovered Purchased Energy Costs
    (7 )     (10 )
Net Cost of Removal for Interim Retirements
    (22 )     (21 )
 
           
Total Net Regulatory Assets (Liabilities)
  $ (13 )   $ (20 )
 
           
2008 General Rate Case Filing
In November 2008, UNS Gas filed a general rate case (on a cost of service basis) with the ACC requesting a total rate increase of 6% to cover a revenue deficiency of $10 million. Effective April 2010, the ACC approved a rate increase of 2% ($3 million), including an 8% return on original cost rate base. The rate increase is intended to cover the costs of providing service.
Purchased Gas Adjuster (PGA) Mechanism
UNS Gas’ retail rates include a PGA mechanism intended to address the volatility of natural gas prices and allow UNS Gas to recover its actual commodity costs, including transportation, through a price adjuster. All purchased gas commodity costs, including transportation, increase the PGA bank, a balancing account. UNS Gas recovers these costs or returns amounts over-collected from/to ratepayers through a PGA mechanism which is reset monthly and for 2010 ranged from 75.83 cents per therm to 72.33 cents per therm. In 2009, the PGA rate ranged from 88.70 cents per therm to 76.56 cents per therm. In October 2009, the ACC approved an 8 cent per therm PGA surcredit, effective November 2009 through October 2010. Effective November 2010, UNS Gas will not have a PGA surcredit or surcharge until Over-Recovered Purchased Energy Costs exceed predetermined thresholds. See table above for the balance of Over-Recovered Purchased Energy Costs.
UNS ELECTRIC RATES AND REGULATION
UNS Electric’s regulatory assets and liabilities were as follows:
                 
    September 30,     December 31,  
    2010     2009  
    -Millions of Dollars-  
Current Regulatory Assets
               
Derivative Instruments
  $ 14     $ 9  
PPFAC — Under-Recovered Purchased Power Costs
    3        
Other Regulatory Assets
               
Derivative Instruments
    6       2  
Pension Assets
    2       2  
Other
          1  
Current Regulatory Liabilities
               
PPFAC — Over-Recovered Purchased Power Costs
          (5 )
Other Regulatory Liabilities
               
Net Cost of Removal for Interim Retirements
    (13 )     (12 )
 
           
Total Net Regulatory Assets (Liabilities)
  $ 12     $ (3 )
 
           

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
2009 General Rate Case Filing
In April 2009, UNS Electric filed a general rate case with the ACC (on a cost of service basis) requesting a rate increase of 7% to cover a revenue deficiency of $14 million. In September 2010, the ACC approved a rate increase of 4% ($7 million), including an 8% return on original cost rate base, effective October 1, 2010. The rate increase is intended to cover the costs of providing service. The ACC approved new depreciation rates effective October 1, 2010, resulting in an expected $1 million annual reduction of depreciation expense.
The ACC rate order also authorized the purchase by UNS Electric of BMGS from UED at its net book value of approximately $62 million. Upon purchase of this facility, subject to FERC approval, BMGS will be placed into rate base through a revenue-neutral rate reclassification of approximately 0.7 cents per kWh from base power supply rate to the non-fuel base rate.
UNS Electric Purchased Power and Fuel Adjustment Clause (PPFAC)
The PPFAC allows recovery of fuel and purchased power costs, including demand charges and the prudent costs of contracts for hedging fuel and purchased power costs. In April 2010, UNS Electric filed an annual PPFAC recommendation with the ACC to have a (0.28) cent PPFAC surcredit for twelve months. This includes a forward component credit of (0.42) cents and a true-up component of 0.14 cents. The surcredit was effective starting June 2010. In September 2010, as part of the general rate case the ACC updated and approved a 0.08 cent PPFAC surcharge and a base power supply rate of approximately 6.77 cents per kWh which includes an updated forward component credit of (0.06) cents and a true-up component of 0.14 cents. The surcharge is effective October 2010 through May 2011.
RES and DSM
The ACC allows TEP and UNS Electric to include a RES tariff on customer bills to recover qualified expenditures related to renewable energy projects. TEP and UNS Electric are required to file a five-year implementation plan with the ACC, and annually seek approval for the upcoming year’s RES funding amount. For 2010, the ACC approved collections through the RES tariff of $32 million for TEP and $8 million for UNS Electric. In 2010, the ACC approved annual collections through the DSM tariffs of $14 million for TEP, $2 million for UNS Electric and $1 million for UNS Gas.
In May 2010, the ACC approved a funding mechanism for approximately $14 million of TEP owned renewable energy projects. The mechanism allows TEP to use RES funds to recover operating costs, depreciation, property taxes and provide TEP with a return on its investment until these costs could be recovered as part of TEP’s base rates. TEP expects these projects to be completed by the end of 2010 and cost recovery of the investment to begin through the RES tariff in January 2011.
In July 2010, TEP filed its 2011 RES implementation plan with the ACC. The plan includes a proposal for TEP to invest $28 million in TEP owned solar projects per year. These company-owned solar projects would be installed between 2011 and 2014. The plan allows TEP to use RES funds to recover operating costs, depreciation, property taxes and provides TEP with a return on its investment until these costs could be recovered as part of TEP’s base rates.
In September 2010, the ACC approved a proposal for UNS Electric to invest approximately $5 million in UNS Electric owned solar projects per year between 2011 and 2014. The plan allows UNS Electric to use RES funds to recover operating costs, depreciation, property taxes and provides UNS Electric with a return on its investment until these costs could be recovered as part of UNS Electric’s base rates.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
Renewable Energy Purchase Power Agreements
In 2009, TEP entered into three 20-year long-term purchase power agreements with companies developing renewable energy generation facilities. The ACC approved the agreements in April 2010. The facilities are expected to begin commercial operation during 2011 or 2012. TEP is required to purchase the full output of each facility for 20 years. Expected capacities range from 1.4 MW to 25 MW. TEP is only obligated to pay for actual energy delivered. There are no minimum payment obligations under these contracts. TEP is authorized to recover a portion of the cost of renewable energy through the PPFAC with the balance of costs recoverable through the RES tariff.
In 2010, TEP entered into similar long-term renewable energy contracts for approximately 96 MW of solar energy, 50 MW of wind energy and 2.2 MW of landfill gas. The ACC approved these agreements in August 2010. These facilities are also expected to begin commercial operation during 2011 and 2012.
In 2009, UNS Electric entered into a 20-year long-term purchase power agreement with a company developing a renewable energy generation facility. The agreement received ACC approval in April 2010. The facility is expected to begin commercial operation in 2011. UNS Electric is required to purchase the full output of the facility for 20 years. The facility has an expected minimum capacity of 7 MW. UNS Electric is only obligated to pay for actual energy delivered. There is no minimum payment obligation under this contract. UNS Electric is authorized to recover a portion of the cost of renewable energy through the PPFAC with the balance of cost recovery through the RES surcharge.
NOTE 3. BUSINESS SEGMENTS
Based on the way we organize our operations and evaluate performance, we have three reportable segments:
  (1)   TEP, a vertically integrated electric utility business, UniSource Energy’s largest subsidiary;
  (2)   UNS Gas, a regulated gas distribution utility business; and
  (3)   UNS Electric, a regulated electric distribution utility business.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
The UniSource Energy and UES holding companies, Millennium, and UED are included in Other. Reconciling adjustments consist of the elimination of intersegment revenues which were due to the following transactions and are eliminated in consolidation:
                                 
    Reportable Segments        
            UNS     UNS        
    TEP     Gas     Electric     Other  
    -Millions of Dollars-  
Intersegment Revenue
                               
Three Months Ended September 30, 2010
                               
Wholesale Sales — TEP to UNS Electric
  $ 2     $     $     $  
Wholesale Sales — UNS Electric to TEP
                1        
Wholesale Sales — UED to UNS Electric
                      3  
Gas Revenue — UNS Gas to UNS Electric
          2              
Other Revenue — TEP to Affiliates(1)
    2                    
Other Revenue — Millennium to TEP, UNS Electric, & UNS Gas(2)
                      5  
Other Revenue — TEP to UNS Electric(3)
    1                    
 
                       
Total Intersegment Revenue
  $ 5     $ 2     $ 1     $ 8  
 
                       
 
                               
Three Months Ended September 30, 2009
                               
Wholesale Sales — TEP to UNS Electric
  $ 9     $     $     $  
Wholesale Sales — UNS Electric to TEP
                1        
Wholesale Sales — UED to UNS Electric
                      3  
Gas Revenue — UNS Gas to UNS Electric
          2              
Other Revenue — TEP to Affiliates(1)
    2                    
Other Revenue — Millennium to TEP, UNS Electric, & UNS Gas(2)
                      4  
Other Revenue — TEP to UNS Electric(3)
    1                    
 
                       
Total Intersegment Revenue
  $ 12     $ 2     $ 1     $ 7  
 
                       
 
                               
Nine Months Ended September 30, 2010
                               
Wholesale Sales — TEP to UNS Electric
  $ 15     $     $     $  
Wholesale Sales — UNS Electric to TEP
                2        
Wholesale Sales — UED to UNS Electric
                      8  
Gas Revenue — UNS Gas to UNS Electric
          4              
Other Revenue — TEP to Affiliates(1)
    6                    
Other Revenue — Millennium to TEP, UNS Electric, & UNS Gas(2)
                      13  
Other Revenue — TEP to UNS Electric(3)
    2                    
 
                       
Total Intersegment Revenue
  $ 23     $ 4     $ 2     $ 21  
 
                       

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
                                 
    Reportable Segments        
            UNS     UNS        
    TEP     Gas     Electric     Other  
    -Millions of Dollars-  
Nine Months Ended September 30, 2009
                               
Wholesale Sales — TEP to UNS Electric
  $ 16     $     $     $  
Wholesale Sales — UNS Electric to TEP
                3        
Wholesale Sales — UED to UNS Electric
                      9  
Gas Revenue – UNS Gas to UNS Electric
          4              
Other Revenue – TEP to Affiliates(1)
    6                    
Other Revenue – Millennium to TEP, UNS Electric, & UNS Gas(2)
                      12  
Other Revenue – TEP to UNS Electric(3)
    2                    
 
                       
Total Intersegment Revenue
  $ 24     $ 4     $ 3     $ 21  
 
                       
     
(1)   TEP provides corporate services (finance, accounting, tax, information technology services, etc.) to UniSource Energy and its subsidiaries.
 
(2)   Millennium provides supplemental workforce and meter reading services to TEP, UNS Electric and UNS Gas.
 
(3)   TEP provides control area services to UNS Electric.
Other significant reconciling adjustments include the elimination of investments in subsidiaries held by UniSource Energy and reclassifications of deferred tax assets and liabilities.
We disclose selected financial data for our reportable segments in the following table:
                                                 
    Reportable Segments                     UniSource  
            UNS     UNS             Reconciling     Energy  
    TEP     Gas     Electric     Other     Adjustments     Consolidated  
    -Millions of Dollars-  
Income Statement
                                               
Three Months Ended September 30, 2010:
                                               
Operating Revenues — External
  $ 350     $ 17     $ 72     $     $     $ 439  
Operating Revenues — Intersegment
    5       2       1       8       (16 )      
Income (Loss) Before Income Taxes
    97       (2 )     5       (1 )           99  
Net Income (Loss)
    59       (1 )     3       (6 )           55  
 
                                               
Three Months Ended September 30, 2009:
                                               
Operating Revenues — External
  $ 345     $ 17     $ 52     $     $     $ 414  
Operating Revenues — Intersegment
    12       2       1       7       (22 )      
Income (Loss) Before Income Taxes
    90       (2 )     6       (1 )           93  
Net Income (Loss)
    55       (1 )     4                   58  
 
                                               
Nine Months Ended September 30, 2010:
                                               
Operating Revenues — External
  $ 835     $ 99     $ 160     $     $     $ 1,094  
Operating Revenues — Intersegment
    23       4       2       21       (50 )      
Income (Loss) Before Income Taxes
    156       9       13       (4 )           174  
Net Income (Loss)
    97       5       8       (10 )           100  
 
                                               
Nine Months Ended September 30, 2009:
                                               
Operating Revenues — External
  $ 818     $ 102     $ 144     $     $     $ 1,064  
Operating Revenues — Intersegment
    24       4       3       21       (52 )      
Income Before Income Taxes
    132       6       9       4       1       152  
Net Income
    81       4       6       3             94  
The details of the reconciling adjustments are disclosed in the Intersegment Revenue table above.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 4. DEBT, CREDIT FACILITIES AND CAPITAL LEASE OBLIGATIONS
UNISOURCE ENERGY CREDIT AGREEMENT
UniSource Energy had the following balances outstanding under the UniSource Credit Agreement:
                                                 
    Current     Long-             Current     Long-        
    Liabilities     Term Debt     Total     Liabilities     Term Debt     Total  
    -Millions of Dollars-  
    September 30, 2010     December 31, 2009  
Revolver
  $ 29     $     $ 29     $     $ 31     $ 31  
 
                                               
Term Loan
    5             5       6       3       9  
On October 15, 2010, UniSource Energy had $30 million in borrowings outstanding under its revolving credit facility.
TEP SUNDT UNIT 4 CAPITAL LEASE PURCHASE
In January 2010, TEP entered into a commitment to purchase 100% of the equity interest in Sundt Unit 4 from the owner participants for $52 million, resulting in an increase in capital lease assets and the capital lease obligation. In March 2010, TEP paid the owner participants $52 million reducing the capital lease obligation. In April 2010, TEP paid the final outstanding Sundt Unit 4 lease obligation of $5 million to terminate the lease and reclassified the capital lease asset and the related leasehold improvements to plant in service. TEP is depreciating the asset over its best estimate of remaining plant life at the time of purchase which is twenty-five years.
TEP CREDIT AGREEMENT
At September 30, 2010, TEP had $55 million in borrowings outstanding and less than $1 million in letters of credit issued under its revolving credit agreement. The letters of credit were issued to provide credit enhancements for energy purchase contracts and hedging activities. As of December 31, 2009, TEP had $35 million in borrowings outstanding and $1 million in letters of credit issued under its revolving credit facility. On October 15, 2010, TEP had less than $1 million in letters of credit issued under its revolving credit facility, and no outstanding borrowings. The revolving loan balances are included in Current Liabilities in the UniSource Energy and TEP balance sheets.
The TEP Credit Agreement also consists of a $341 million LOC facility which supports $329 million of tax-exempt variable rate Industrial Development Revenue Bonds (IDBs) which are included in Current Maturities of Long-Term Debt in the UniSource Energy and TEP balance sheets, as the LOCs supporting the IDBs mature in August 2011. TEP is in the process of refinancing this credit facility and expects the transaction to be completed by the end of 2010.
TEP DEBT
2010 Pima Series A Bonds Issuance
In October 2010, the Pima Authority issued $100 million of its 2010 Series A tax-exempt IDBs for TEP’s benefit. The 2010 Pima Series A IDBs are unsecured, bear interest at a rate of 5.25%, mature in October 2040, and are callable at par on or after October 1, 2020. Net of an underwriting discount, $99 million of proceeds were deposited in a construction fund with the bond trustee. The proceeds were applied to the construction of certain of TEP’s transmission and distribution facilities used to provide electric service in Pima County. TEP drew down $74 million of the proceeds from the construction fund at closing, with the remaining $25 million expected to be drawn down by the end of the first quarter of 2011.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
TEP Term Loan Borrowing
In March 2010, TEP entered into an 18-month, $30 million term loan facility secured by $30 million of TEP mortgage bonds which is included in Current Maturities of Long-Term Debt in the UniSource Energy and TEP balance sheets. In October 2010, TEP repaid the term loan.
2008 Pima B Bonds Interest Conversion
In January 2010, TEP converted the interest on the $130 million of 2008 Pima B Bonds from a variable rate to a fixed rate. The Pima B Bonds were reoffered in January 2010, with a term rate of 5.75% through maturity on September 2029. Interest is payable semi-annually beginning June 1, 2010. The bonds are callable at par beginning January 2015. Accordingly, the associated letter of credit which supported the 2008 variable rate Pima B Bonds was terminated on January 12, 2010, and the TEP mortgage bonds which collateralized the letter of credit were canceled. TEP capitalized $1 million of costs related to the transaction that will amortize as interest expense through September 2029.
UNS GAS/UNS ELECTRIC REVOLVING CREDIT AGREEMENT
UNS Electric had $18 million and $11 million in outstanding letters of credit under the UNS Gas/UNS Electric Revolver as of September 30, 2010 and December 31, 2009, respectively, which are not shown on the balance sheet. As of October 15, 2010, UNS Electric had $18 million of outstanding letters of credit under the UNS Gas/UNS Electric Revolver.
UED BORROWINGS
In February 2010, UED amended its senior secured term loan facility to extend the termination date by two years to March 2012, and to increase borrowings by $9 million bringing the outstanding balance to $35 million. UED capitalized less than $1 million in costs related to the transaction. As of September 30, 2010, UED owed $32 million under the UED Credit Agreement.
OTHER
As of September 30, 2010, UniSource Energy and its subsidiaries were in compliance with the terms of their respective loan and credit agreements.
NOTE 5. INCOME TAXES
EFFECTIVE TAX RATE
For the quarter ended September 30, 2010, UniSource Energy’s effective tax rate of 45% differed from the federal rate of 35% primarily due to state income taxes, the impact of the domestic production activities deduction, and deferred tax asset write-offs and valuation allowance adjustments. For the quarter ended September 30, 2009 UniSource Energy’s effective tax rate of 38% differed from the federal rate of 35% primarily due to state income taxes and the impact of the domestic production activities deduction.
For the quarters ended September 30, 2010, and September 30, 2009, TEP’s effective tax rate of 39% differed from the federal rate of 35%, primarily due to state income taxes and the impact of the domestic production activities deduction.
In estimating the annual effective tax rate for 2010, UniSource Energy and TEP included a $3 million tax benefit for the domestic production activities deduction as of June 30, 2010. On September 27, 2010, the President signed the Small Business Jobs Act which extended bonus depreciation on capital investments. As a result of the reduction in taxable income from the increase in depreciation, UniSource Energy and TEP have reduced the estimated tax benefit of the domestic production activities deduction to $1 million as of September 30, 2010.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
The 2010 annual effective tax rate for UniSource Energy and TEP includes a $1 million tax benefit for a Federal Energy Credit. The credit is contingent on the construction of solar facilities being completed by December 31, 2010. The construction of the facilities is expected to be complete by year end.
DEFERRED TAX ASSETS
The following table summarizes UniSource Energy’s deferred tax assets relating to Millennium.
                                         
                                    Income Tax  
                                    Expense for  
    Deferred     Valuation     Deferred     Valuation     the Quarter  
    Tax Asset     Allowance     Tax Asset     Allowance     Ended  
    June 30,     June 30,     September 30,     September 30,     September 30,  
    2010     2010     2010     2010     2010  
    -Millions of Dollars-  
Realized Capital Losses
  $ 5     $ (3 )   $ 5     $ (3 )   $  
Unrealized Capital Losses
    2             3       (3 )     3  
Unrealized Ordinary Losses
    1             1              
Investment in Subsidiary
    3                         3  
 
                             
Total
  $ 11     $ (3 )   $ 9     $ (6 )   $ 6  
 
                             
       
                                    Income Tax  
                                    Expense for  
    Deferred     Valuation     Deferred     Valuation     the Nine Months  
    Tax Asset     Allowance     Tax Asset     Allowance     Ended  
    December 31,     December 31,     September 30,     September 30,     September 30,  
    2009     2009     2010     2010     2010  
    -Millions of Dollars-  
Realized Capital Losses
  $     $     $ 5     $ (3 )   $ 1  
Unrealized Capital Losses
    5             3       (3 )     3  
Unrealized Ordinary Losses
                1              
Investment in Subsidiary
    3                         3  
 
                             
Total
  $ 8     $     $ 9     $ (6 )   $ 7  
 
                             
UniSource Energy and TEP had no valuation allowances in 2009.
Capital Losses
Corporate capital losses can reduce taxable income if there are offsetting capital gains during the current year, the 3-year carryback period, or the 5-year carryforward period. If the capital losses remain unused after the 5-year carryforward period, they expire. Management expects to use $2 million of the capital loss deferred tax asset during the 3-year carryback period. The remaining capital loss deferred tax asset of $6 million will be carried forward to future years to offset any future capital gains. This amount has been fully offset by a valuation allowance at September 30, 2010 because management does not believe it is more likely than not the Company will generate future capital gains prior to the expiration date of the loss carryforward.
Unrealized Ordinary Losses
Based upon the Company’s current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the benefit of its ordinary loss deferred tax asset.
Investment in Subsidiary
For the quarter ended September 30, 2010, UniSource Energy recorded a $3 million out-of-period income tax expense. The out-of-period expense related to the write-off of a previously recorded deferred tax asset associated with the excess of tax over book basis difference in a consolidated Millennium investment. Management concluded that this out-of-period adjustment was not material to the current and prior period financial statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
UNCERTAIN TAX POSITIONS
As a result of the expiration of the statue of limitations for the 2005 and 2006 tax years, UniSource Energy and TEP recorded a $2 million reduction to interest expense relating to uncertain tax positions during the quarter ended September 30, 2010.
NOTE 6. COMMITMENTS AND CONTINGENCIES
TEP COMMITMENTS
Firm Purchase Commitments
In 2010, TEP entered into new long-term, forward purchase power commitments in addition to those reported in our 2009 Annual Report on Form 10-K. These contracts will settle in June 2011 through September 2011 with prices that are indexed to natural gas prices. TEP’s estimated minimum payment obligation for these purchases is $15 million based on projected market prices as of September 30, 2010.
UNS ELECTRIC COMMITMENTS
In 2010, UNS Electric entered into forward power purchase agreements through December 2012. UNS Electric estimates its minimum payments for these forward purchases to be $25 million in 2011 and $7 million in 2012. Certain of these purchased power contracts are at a fixed price per MWh and others are indexed to natural gas prices. For indexed contracts, commitments are based on projected market prices as of September 30, 2010.
UNS GAS COMMITMENTS
In 2010, UNS Gas entered into forward gas purchase agreements through May 2015. UNS Gas estimates its minimum payments for these forward purchases to be $4 million in 2011 and 2012, $2 million in 2013 and less than $1 million in each of 2014 and 2015.
UNISOURCE ENERGY COMMITMENTS
In 2009, UniSource Energy purchased land to construct a new headquarters building in downtown Tucson. In April 2010, UniSource Energy signed a design-build contract committing to a payment of $26 million for the first and second phases of the construction project of which $18 million remained an outstanding commitment at September 30, 2010. We expect to spend a total of $75 million on the building including furniture, fixtures and equipment. UniSource Energy expects the building to be completed and in service by November 2011.
RENEWABLE ENERGY PURCHASE POWER AGREEMENTS AND PROJECTS
TEP and UNS Electric entered into various forward power purchase agreements with developing renewable energy generation facilities to meet compliance requirements under the RES tariff. The facilities are expected to begin commercial operation in 2011. Additionally, TEP entered into contracts to develop TEP owned renewable energy projects for $14 million of which $6 million remained an outstanding commitment at September 30, 2010. See Note 2 for additional information on RES related contracts.
TEP CONTINGENCIES
El Paso Electric Transmission
In 2006, El Paso filed a complaint with the FERC claiming that TEP must request service under El Paso’s Open Access Transmission Tariff (OATT) in order to transmit power from Luna to TEP’s system. TEP filed a counter complaint stating that TEP has existing rights under a 1982 Tucson-El Paso Transmission Agreement and, therefore, is not required to pay for transmission service under El Paso’s OATT. In November 2008, the FERC issued an order supporting TEP’s position.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
In December 2008, pending resolution, El Paso refunded to TEP $10 million paid for transmission service from Luna to TEP’s system during the period 2006 to 2008 and interest of $1 million. TEP is not currently paying or accruing for transmission service under El Paso’s OATT.
In July 2010, the FERC issued an order denying El Paso’s request for rehearing of FERC’s November 2008 order. In July, El Paso filed an appeal in the United States Court of Appeals for the District of Columbia Circuit. TEP intervened in the appeal proceeding. TEP has not recognized income as a result of the July 2010 FERC decision.
If El Paso were to prevail in its appeal, TEP would be required to pay for transmission service under El Paso’s OATT from October 2008 through the date of the decision. For the period October 2008 to September 30, 2010, this additional transmission expense would approximate $8 million. However, under the PPFAC mechanism, TEP would be allowed to recover $7 million of this additional transmission expense from its retail customers.
In December 2008, TEP filed a complaint in the United States Federal District Court against El Paso seeking a $2 million reimbursement from El Paso for transmission charges paid by TEP to Public Service Company of New Mexico (PNM) for transmission service in an attempt to mitigate TEP’s damages before FERC issued its decision in November 2008. In September 2009, the District Court denied El Paso’s motion to dismiss TEP’s complaint and stayed the proceeding pending a final resolution of the FERC proceedings and any appeal.
TEP cannot predict the timing or outcome of these lawsuits.
Claims Related to Navajo Generating Station
In June 1999, the Navajo Nation filed suit against Salt River Project (SRP), several Peabody Coal Company entities including Peabody Western Coal Company (Peabody), the coal supplier to Navajo Generating Station (Navajo), Southern California Edison Company, and other defendants in the U.S. District Court for the District of Columbia (D.C. Lawsuit). Although TEP is not a named defendant in the D.C. Lawsuit, TEP owns 7.5% of Navajo Units 1, 2 and 3. The D.C. Lawsuit alleges, among other things, that the defendants obtained a favorable coal royalty rate on the lease agreements under which Peabody mines coal by improperly influencing the outcome of a federal administrative process pursuant to which the royalty rate was to be adjusted. The suit seeks $600 million in damages, treble damages, punitive damages of not less than $1 billion, and the ejection of defendants from all possessory interests and Navajo Tribal lands arising out of the primary coal lease.
In July 2001, the District Court dismissed all claims against SRP. In March 2008, the District Court lifted a stay that had been in place since October 2004 and referred pending discovery related motions to a magistrate judge. In January 2010, the District Court extended the discovery deadline and set other procedural deadlines at various dates between March 2010 and February 2011. In April 2010, the Navajo Nation filed a Second Amended Complaint. In September 2010, the case was referred to the District Court’s mediation program to assist with settlement negotiations.
In 2004, Peabody filed a complaint in the Circuit Court for the City of St. Louis, Missouri against the participants at Navajo, including TEP, for reimbursement of royalties and other costs arising out of the D.C. Lawsuit. In July 2008, the parties entered into a joint stipulation of dismissal of these claims which was approved by the Circuit Court. TEP cannot predict whether the lawsuit will be refiled based upon the final outcome of the D.C. Lawsuit.
Claims Related to San Juan Generating Station
In April 2010, the Sierra Club filed a citizens suit under the Resource Conservation and Recovery Act (RCRA) and the Surface Mine Control and Reclamation Act (SMCRA) in the U.S. District Court for the District of New Mexico against PNM, as operator of San Juan, PNM parent PNM Resources, Inc. (PNMR), San Juan Coal Company (SJCC), which operates the San Juan mine that supplies coal to San Juan, and SJCC’s parent BHP Minerals International Inc. (BHP). The Sierra Club alleges in the suit that certain activities at San Juan and the San Juan mine associated with the treatment, storage and disposal of coal and coal combustion residuals (CCRs), primarily coal ash, are causing imminent and substantial harm to the environment, including ground and surface water in the region, and that placement of CCRs at the mine constitute “open dumping” in violation of RCRA. The RCRA claims are asserted against PNM, PNMR, SJCC and BHP. The suit also includes claims under SMCRA which are directed only against SJCC and BHP. The suit seeks the following relief: an injunction requiring the parties to undertake certain mitigation measures with respect to the placement of CCRs at the mine or to cease placement of CCRs at the mine; the imposition of civil penalties; and, attorney’s fees and costs. On July 10, 2010, the Sierra Club filed an amended complaint that corrected some technical deficiencies in its original complaint. The factual allegations remained the same. The parties have agreed to and the court has entered a stay of the action on August 27, 2010 to allow the parties to try to address Sierra Club’s concerns. If the parties are unable to settle the matter, PNM plans an aggressive defense of the RCRA claims in the suit. TEP owns 50% of San Juan Units 1 and 2, which represents approximately 20% of the total generation capacity of the entire San Juan Generation Station, and is liable for its share of any resulting liabilities. TEP cannot predict the outcome of this matter at this time.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
SJCC, the coal supplier to San Juan, through leases with the federal government and the State of New Mexico, owns coal interests with respect to an underground mine that supplies coal to San Juan. Certain gas producers have oil and gas leases with the federal government, the State of New Mexico and private parties in the area of the underground mine. These gas producers allege that SJCC’s underground coal mining operations have or will interfere with their gas production and will reduce the amount of natural gas that they would otherwise be entitled to recover. SJCC has compensated certain gas producers for any remaining gas production from a well when it was determined that mining activity was close enough to warrant shutting down the well. These settlements, however, do not resolve all potential claims by gas producers in the underground mine area. TEP owns 50% of San Juan Units 1 and 2, which represents approximately 20% of the total generation capacity of the entire San Juan Generation Station, and is liable for its share of any resulting liabilities. TEP cannot estimate the impact of any future claims by these gas producers on the cost of coal at San Juan.
Regional Haze Rules
The EPA’s regional haze rules require emission controls known as Best Available Retrofit Technology (BART) for certain industrial facilities emitting air pollutants that reduce visibility. The rules call for all states to establish goals and emission reduction strategies for improving visibility in national parks and wilderness areas and to submit a state implementation plan to the EPA.
San Juan
In June 2010, the New Mexico Environment Department (NMED) filed its proposed regional haze state implementation plan with the New Mexico Environmental Improvement Board. The plan proposes that the BART for nitrogen oxides at San Juan is a technology known as “selective catalytic reduction” (SCR) plus “sorbent injection.” PNM, the operator at San Juan, previously analyzed SCR and concluded it was not the BART and intends to vigorously challenge the NMED’s proposal.
TEP’s share of installing SCRs with sorbent injection is estimated to be $171 million. This estimate is based on PNM’s 2007 analysis of the cost of installation of SCR technology and more recent estimates of the cost of installing sorbent injection. Adding these technologies to San Juan would also increase operating costs at the generating station. Once the EPA approves an implementation plan for New Mexico, the San Juan participants would have five years to achieve compliance.
Four Corners Generating Station (Four Corners)
In October 2010, EPA issued a proposed federal implementation plan (FIP) for BART at the Four Corners. The proposed FIP, if approved, would require the installation of SCRs on units 1 though 5 and baghouses on units 1 through 3. TEP has a 7% interest in units 4 and 5. TEP’s estimated share of the installation cost for SCRs for units 4 and 5 is approximately $38 million. Once the EPA finalizes the BART rule for Four Corners, the Four Corners participants would have five years to achieve compliance.
TEP cannot predict the ultimate outcome of these matters.
Mine Closure Reclamation at Generating Stations Not Operated by TEP
TEP currently pays on-going reclamation costs related to the coal mines which supply the generating stations in which TEP has an ownership interest but does not operate. It is probable that TEP will have to pay a portion of final reclamation costs upon closure of these mines. TEP’s share of the reclamation costs at the expiration dates of the coal supply agreements in 2016 through 2019 approximates $26 million. TEP recognizes this liability over the remaining terms of the coal supply agreements and had recorded liabilities of $10 million at September 30, 2010 and December 31, 2009.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
Amounts recorded for final reclamation are subject to various assumptions, such as estimating the costs of reclamation, when final reclamation will occur, and the credit-adjusted risk-free interest rate to be used to discount future liabilities. As these assumptions change, TEP will prospectively adjust the expense amounts for final reclamation over the remaining coal supply agreement term. TEP does not believe that recognition of its final reclamation obligations will be material to TEP in any single year because recognition occurs over the remaining terms of its coal supply agreements.
TEP’s PPFAC allows TEP to pass-through most fuel costs, including final reclamation costs, to customers. Therefore, TEP classifies these costs as a regulatory asset. TEP will increase the regulatory asset and the reclamation liability over the remaining life of the coal supply agreements on an accrual basis, and will recover the regulatory asset through the PPFAC as final mine reclamation costs are paid to the coal suppliers.
California Energy Market Issues
In March 2010, TEP and the California Attorney General, California Public Utilities Commission and various private entities (collectively California Parties) reached a settlement in principal of all remaining claims against TEP related to TEP’s transactions in the Western energy markets including the California Power Exchange and the California Independent System Operator during the California energy crisis of 2000 and 2001. As a result of the settlement with the California Parties, TEP recognized an additional liability of $4 million in March 2010, bringing TEP’s gross liability related to these claims to $6 million.
In April 2010, TEP and the California Parties entered into a written settlement agreement that FERC approved in June 2010, and TEP paid the liability in July 2010. Also, in association with the California Parties settlement, in March 2010, TEP recorded a receivable from SRP for approximately $1 million, that has since been settled, related to a long-term power sale agreement between TEP and SRP. The net $3 million is shown as California Power Exchange (CPX) Provision for Wholesale Refunds on TEP’s income statement. In addition, in March 2010, UNS Electric reached a related settlement with Arizona Public Service Company (APS) and recorded Other Income of $3 million that has since been received in cash. The settlements described above offset and had no impact on UniSource Energy’s consolidated results in the first three quarters of 2010.
Tucson to Nogales Transmission Line
TEP and UNS Electric are parties to a project development agreement for the joint construction of an approximately 60-mile transmission line from Tucson to Nogales, Arizona. UNS Electric’s participation in this project was initiated in response to an order by the ACC to improve reliability to UNS Electric’s retail customers in Nogales, Arizona.
In 2002, the ACC approved the location and construction of the proposed 345-kV line along a route identified as the Western Corridor route subject to a number of conditions, including obtaining all required permits from state and federal agencies. The U.S. Forest Service subsequently identified a preference for a route identified as the Central Corridor route in the final Environmental Impact Statement for the project. TEP is considering options for the project including potential new routes. If a decision is made to pursue an alternative route, approvals will be needed from the ACC, the Department of Energy, U.S. Forest Service, Bureau of Land Management, and the International Boundary and Water Commission. As of September 30, 2010, TEP had capitalized $11 million related to the project, including $2 million of land and land rights. If TEP does not receive the required approvals or abandons the project, TEP believes cost recovery is probable for prudent and reasonably incurred costs related to the project as a consequence of the ACC’s requirement for a second transmission line serving the Nogales, Arizona area.
GUARANTEES
In the normal course of business, UniSource Energy and certain subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of certain subsidiaries. We enter into these agreements primarily to support or enhance the creditworthiness of a subsidiary on a stand-alone basis. The most significant of these guarantees are:
    UES’ guarantee of $100 million senior unsecured notes issued by UNS Gas and $100 million senior unsecured notes issued by UNS Electric;
    UES’ guarantee of the $60 million UNS Gas/UNS Electric Revolver;

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
    UniSource Energy’s guarantee of approximately $2 million in building lease payments for UNS Gas; and
    UniSource Energy’s guarantee of the $32 million of outstanding loans under the UED Credit Agreement.
To the extent liabilities exist under these contracts, the liabilities are included in our consolidated balance sheets.
We believe that the likelihood UniSource Energy or UES would be required to perform or otherwise incur any significant losses associated with any of these guarantees is remote.
In March 2010, TEP purchased 100% of the equity interest in Sundt Unit 4. TEP indemnified the seller of Sundt Unit 4 from any sales, use, transfer or similar taxes or fees due relating to the purchase. The terms of the indemnification do not include a limit on potential future payments; however, TEP believes that the parties to the agreement have abided by all tax laws and TEP does not have any additional tax obligations. TEP has not made any payments under the terms of this indemnification to date.
NOTE 7. FAIR VALUE OF FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE
The fair value of a financial instrument is the market price that would be received to sell an asset or transfer a liability at the measurement date. We use the following methods and assumptions for estimating the fair value of our financial instruments:
  The carrying amounts of our current assets and liabilities, including Current Maturities of Long-Term Debt, term loans, and amounts outstanding under our credit agreements, approximate their fair value due to the short-term nature of these instruments; with the exception of $50 million of UNS Gas Senior Unsecured Notes with a make-whole provision on a call premium that have a fair value of $52 million. These items have been excluded from the table below.
  Investments in Lease Debt and Equity: TEP calculated the present value of remaining cash flows at the balance sheet date using current market rates for instruments with similar characteristics with respect to credit rating and time-to-maturity. We also incorporated the impact of counterparty credit risk using market credit default swap data.
  Fixed Rate Long-Term Debt: UniSource Energy and TEP used quoted market prices, where available, or calculated the present value of remaining cash flows at the balance sheet date using current market rates for bonds with similar characteristics with respect to credit rating and time-to-maturity. We also incorporate the impact of our own credit risk using a credit default swap rate when determining the fair value of fixed rate long-term debt.
The use of different estimation methods and/or market assumptions may yield different estimated fair value amounts. The amounts recorded in the balance sheet (carrying value) and the estimated fair values of our financial instruments included the following:
                                 
    September 30,     December 31,  
    2010     2009  
    Carrying     Fair     Carrying     Fair  
    Value     Value     Value     Value  
    -Millions of Dollars-  
Assets:
                               
TEP Investment in Lease Debt and Equity
  $ 106     $ 113     $ 132     $ 140  
Millennium Note Receivable
    15       15       15       15  
Liabilities:
                               
Fixed Rate Long-Term Debt
                               
TEP
    575       477       445       336  
UniSource Energy
    875       809       795       693  
Variable Rate Long-Term Debt
                               
UniSource Energy and TEP
                459       452  

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 8. EMPLOYEE BENEFIT PLANS
PENSION BENEFIT PLANS
The three utilities maintain noncontributory, defined benefit pension plans for substantially all regular employees and certain affiliate employees. Benefits are based on years of service and the employee’s average compensation. The three utilities fund the plans by contributing at least the minimum amount required under Internal Revenue Service regulations.
We recognize the underfunded status of our defined benefit pension plans as a liability on our consolidated balance sheets. The underfunded status is measured as the difference between the fair value of the plan’s assets and the projected benefit obligation for pension plans. We recognize a regulatory asset to the extent these future costs are probable of recovery in rates.
Additionally, we provide supplemental retirement benefits to certain employees whose benefits are limited by Internal Revenue Service benefit or compensation limitations. Changes in Supplemental Executive Retirement Plan (SERP) benefit obligations are recognized as a component of accumulated other comprehensive income (AOCI).
OTHER POSTRETIREMENT BENEFIT PLANS
TEP provides limited health care and life insurance benefits for retirees. All regular employees may become eligible for these benefits if they reach retirement age while working for TEP or an affiliate. UNS Gas and UNS Electric provide postretirement medical benefits for current retirees. UNS Gas and UNS Electric active employees do not participate in the postretirement medical plan.
COMPONENTS OF NET PERIODIC BENEFIT COST
The components of UniSource Energy’s net periodic benefit cost are as follows:
                                 
                    Other Postretirement  
    Pension Benefits     Benefits  
    Three Months Ended     Three Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    -Millions of Dollars-  
Components of Net Periodic Benefit Cost
                               
Service Cost
  $ 2     $ 2     $     $  
Interest Cost
    4       4       1       1  
Expected Return on Plan Assets
    (3 )     (3 )            
Amortization of Net Loss
    1       2              
 
                       
Net Periodic Benefit Cost
  $ 4     $ 5     $ 1     $ 1  
 
                       

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
The table above includes pension benefit costs of less than $0.5 million and other postretirement benefit costs of less than $0.1 million for UNS Gas and UNS Electric.
                                 
                    Other Postretirement  
    Pension Benefits     Benefits  
    Nine Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    -Millions of Dollars-  
Components of Net Periodic Benefit Cost
                               
Service Cost
  $ 6     $ 6     $ 2     $ 2  
Interest Cost
    11       11       3       3  
Expected Return on Plan Assets
    (10 )     (8 )            
Amortization of Prior Service Cost
                (1 )     (1 )
Amortization of Net Loss
    4       5              
 
                       
Net Periodic Benefit Cost
  $ 11     $ 14     $ 4     $ 4  
 
                       
The table above includes pension benefit costs of $1 million and other postretirement benefit costs of less than $0.1 million for UNS Gas and UNS Electric.
NOTE 9. SHARE-BASED COMPENSATION PLANS
RESTRICTED STOCK UNITS AND PERFORMANCE SHARES
Restricted Stock Units
In May 2010, the Compensation Committee of the UniSource Energy Board of Directors granted 15,620 restricted stock units to non-employee directors at a grant date fair value of $31.69 per share. The restricted stock units vest in one year or immediately upon death, disability, or retirement. Compensation expense equal to the fair value on the grant date is recognized over the vesting period. Fully vested but undistributed stock unit awards accrue dividend equivalent stock units based on the fair value of common shares on the date the dividend is paid. In the January following the year the person is no longer a Director, Common Stock shares will be issued for the vested stock units.
Performance Shares
In February 2010, the Compensation Committee of the UniSource Energy Board of Directors granted 93,720 performance share awards (targeted shares) to Officers. 50% of the performance share awards had a grant date fair value, based on a Monte Carlo simulation, of $31.26 per share and will be paid out in shares of UniSource Energy Common Stock based on targeted, cumulative UniSource Energy Total Shareholder Return during the performance period of January 1, 2010 through December 31, 2012, compared to the Total Shareholder Return over the same period of an industry or peer group. The remaining 50% had a grant date fair value of $30.52 per share and will be paid out in shares of UniSource Energy Common Stock based on cumulative net income for the 3-year period ended December 31, 2012. The performance shares vest based on goal attainment upon completion of the performance period; any unearned awards are forfeited. Performance shares are eligible for dividend equivalents during the performance period.
SHARE-BASED COMPENSATION EXPENSE
UniSource Energy and TEP recorded share-based compensation expense, net of amounts capitalized of $1 million, for each of the three months ended September 30, 2010 and 2009 and $2 million for each of the nine months ended September 30, 2010 and 2009.
At September 30, 2010, the total unrecognized compensation cost related to non-vested share-based compensation was $4 million, which will be recorded as compensation expense over the remaining vesting periods through December 2012. The total number of shares awarded but not yet issued, including target performance based shares, under the share-based compensation plans at September 30, 2010, was 1 million.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 10. FAIR VALUE MEASUREMENTS
The following tables set forth, by level within the fair value hierarchy, UniSource Energy and TEP’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2010, and December 31, 2009. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. There were no transfers between Levels 1, 2 or 3 for either reporting period.
                                 
    UniSource Energy  
    Quoted Prices in     Significant Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
    September 30, 2010  
    - Millions of Dollars -  
Assets
                               
Cash Equivalents (1)
  $ 34     $     $     $ 34  
Rabbi Trust Investments to support the Deferred Compensation and SERP Plans (2)
          15             15  
Equity Investments (3)
                1       1  
Collateral Posted (4)
          3             3  
Energy Contracts (5)
                16       16  
 
                       
Total Assets
    34       18       17       69  
 
                       
 
                               
Liabilities
                               
Energy Contracts (5)
          (25 )     (30 )     (55 )
Interest Rate Swaps (6)
          (13 )           (13 )
 
                       
Total Liabilities
          (38 )     (30 )     (68 )
 
                       
Net Total Assets and (Liabilities)
  $ 34     $ (20 )   $ (13 )   $ 1  
 
                       

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
                                 
    UniSource Energy  
    Quoted Prices in     Significant Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
    December 31, 2009  
    - Millions of Dollars -  
Assets
                               
Cash Equivalents (1)
  $ 51     $     $     $ 51  
Rabbi Trust Investments to support the Deferred Compensation and SERP Plans (2)
          14             14  
Equity Investments (3)
                6       6  
Collateral Posted (4)
          2             2  
Energy Contracts (5)
          1       6       7  
 
                       
Total Assets
    51       17       12       80  
 
                       
 
                               
Liabilities
                               
Energy Contracts (5)
          (16 )     (19 )     (35 )
Interest Rate Swaps (6)
          (6 )           (6 )
 
                       
Total Liabilities
          (22 )     (19 )     (41 )
 
                       
Net Total Assets and (Liabilities)
  $ 51     $ (5 )   $ (7 )   $ 39  
 
                       
                                 
    TEP  
    Quoted Prices in     Significant Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
    September 30, 2010  
    - Millions of Dollars -  
Assets
                               
Cash Equivalents (1)
  $ 10     $     $     $ 10  
Rabbi Trust Investments to support the Deferred Compensation and SERP Plans (2)
          15             15  
Energy Contracts (5)
                5       5  
 
                       
Total Assets
    10       15       5       30  
 
                       
 
                               
Liabilities
                               
Energy Contracts (5)
          (8 )     (3 )     (11 )
Interest Rate Swaps (6)
          (13 )           (13 )
 
                       
Total Liabilities
          (21 )     (3 )     (24 )
 
                       
Net Total Assets and (Liabilities)
  $ 10     $ (6 )   $ 2     $ 6  
 
                       

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
                                 
    TEP  
    Quoted Prices in     Significant Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
    December 31, 2009  
    - Millions of Dollars -  
Assets
                               
Cash Equivalents (1)
  $ 8     $     $     $ 8  
Rabbi Trust Investments to support the Deferred Compensation and SERP Plans (2)
          14             14  
Energy Contracts (5)
          1       5       6  
 
                       
Total Assets
    8       15       5       28  
 
                       
 
                               
Liabilities
                               
Energy Contracts (5)
          (5 )     (9 )     (14 )
Interest Rate Swaps (6)
          (6 )           (6 )
 
                       
Total Liabilities
          (11 )     (9 )     (20 )
 
                       
Net Total Assets and (Liabilities)
  $ 8     $ 4     $ (4 )   $ 8  
 
                       
     
(1)   Cash Equivalents are based on observable market prices and are comprised of the fair value of commercial paper, money market funds and certificates of deposit.
 
(2)   Rabbi Trust Investments consist of amounts held in mutual and money market funds related to deferred compensation and SERP benefits. The valuation is based on quoted prices, traded in active markets. These investments are included in Investments and Other Property – Other in the UniSource Energy and TEP balance sheets.
 
(3)   Equity Investments are, in the absence of readily ascertainable market values, based on the investment partner’s valuations and comprise Millennium’s equity investments in unregulated businesses. These investments are included in Investments and Other Property – Other in the UniSource Energy balance sheet.
 
(4)   Collateral provided for energy contracts with counterparties to reduce credit risk exposure. Collateral posted is included in Current Assets – Other in the UniSource Energy balance sheet.
 
(5)   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 reduce exposure to energy price risk. These contracts are included in Derivative Instruments in the UniSource Energy and TEP balance sheets. The valuation techniques are described below. See Note 17 for additional information.
 
(6)   Interest Rate Swaps are valued based on the 6-month LIBOR index or the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap index. These interest rate swaps are included in Derivative Instruments in the UniSource Energy and TEP balance sheets.
Energy Contracts
The three utilities primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Where observable inputs are available for substantially the full term of the asset or liability, such as gas swap derivatives valued using New York Mercantile Exchange (NYMEX) pricing, adjusted for basis differences, the instrument is categorized in Level 2.
Derivatives valued using an aggregate pricing service or published prices that represent a consensus reporting of multiple brokers are categorized in Level 3. For both power and gas prices, TEP and UNS Electric obtain quotes from brokers, major market participants, exchanges or industry publications as well as its own price experience from active transactions in the market. TEP and UNS Electric primarily use one set of quotations each for power and for gas, and then use the other sources as validation of those prices. The broker providing quotes for power prices states that the market information provided is indicative only, but believes it to be reflective of market conditions as of the time and date indicated. In addition, energy derivatives include contracts where published prices are not readily available. These include contracts for delivery periods during non-standard time blocks, contracts for delivery during only a few months of a given year when prices are quoted only for the annual average, or contracts for delivery at illiquid delivery points. In these cases, TEP and UNS Electric apply certain management assumptions to value such contracts. These assumptions include applying percentage multipliers to value non-standard time blocks, applying historical price curve relationships to calendar year quotes, and including adjustments for transmission and line losses to value contracts at illiquid delivery points. We also consider the impact of counterparty credit risk using current and historical default and recovery rates as well as our own credit risk using market credit default swap data. TEP and UNS Electric review these assumptions on a quarterly basis.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
The fair value of TEP’s purchase power call option is estimated using an internal pricing model which includes assumptions about market risks such as liquidity, volatility, and contract valuation. This model also considers credit and non-performance risk. UniSource Energy and TEP’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.
The following tables set forth a reconciliation of changes in the fair value of assets and liabilities classified as Level 3 in the fair value hierarchy:
                                 
    Three Months Ended  
    September 30, 2010  
    - Millions of Dollars -  
    UniSource Energy     TEP  
    Energy     Equity             Energy  
    Contracts     Investments     Total     Contracts  
Balance, as of July 1, 2010
  $ (11 )   $ 1     $ (10 )   $ 2  
Gains and (Losses) (Realized/Unrealized) Recorded to:
                               
Net Regulatory Assets-Derivative Instruments
    (3 )           (3 )      
Other Comprehensive Income
                       
Other Expense
                       
 
                       
Balance, as of September 30, 2010
  $ (14 )   $ 1     $ (13 )   $ 2  
 
                       
 
                               
Total gains (losses) attributable to the change in unrealized gains or losses relating to assets/liabilities still held at the end of the period
  $ (6 )   $     $ (6 )   $ 1  
 
                       
                                 
    Nine Months Ended  
    September 30, 2010  
    - Millions of Dollars -  
    UniSource Energy     TEP  
    Energy     Equity             Energy  
    Contracts     Investments     Total     Contracts  
Balance, as of January 1, 2010
  $ (13 )   $ 6     $ (7 )   $ (4 )
Gains and (Losses) (Realized/Unrealized) Recorded to:
                               
Net Regulatory Assets-Derivative Instruments
    1             1       8  
Other Comprehensive Income
    (2 )           (2 )     (2 )
Other Expense
          (5 )     (5 )      
 
                       
Balance, as of September 30, 2010
  $ (14 )   $ 1     $ (13 )   $ 2  
 
                       
 
                               
Total gains (losses) attributable to the change in unrealized gains or losses relating to assets/liabilities still held at the end of the period
  $ (7 )   $     $ (7 )   $ 6  
 
                       
Gains and losses on energy contracts include the reclassification of realized gains and losses on the settlement of derivative contracts.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 11. UNISOURCE ENERGY EARNINGS PER SHARE (EPS)
We compute basic EPS by dividing Net Income by the weighted-average number of common shares outstanding during the period. Except when the effect would be anti-dilutive, the diluted EPS calculation includes the impact of shares that could be issued upon exercise of outstanding stock options, contingently issuable shares under equity-based awards or common shares that would result from the conversion of convertible notes. The numerator in calculating diluted earnings per share is Net Income adjusted for the interest on convertible notes (net of tax) that would not be paid if the notes were converted to common shares.
The following table shows the effects of potentially dilutive Common Stock on the weighted-average number of shares:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    -Thousands of Dollars-  
Numerator:
                               
Net Income
  $ 54,883     $ 57,646     $ 100,395     $ 93,839  
Income from Assumed Conversion of Convertible Senior Notes
    1,097       1,097       3,292       3,292  
 
                       
Adjusted Numerator
  $ 55,980     $ 58,743     $ 103,687     $ 97,131  
 
                       
 
                               
    - Thousands of Shares -
Denominator:
                               
Weighted-average Shares of Common Stock Outstanding:
                               
Common Shares Issued
    36,308       35,722       36,107       35,623  
Fully Vested Deferred Stock Units
    132       100       120       102  
Participating Securities
    93       106       94       104  
 
                       
Total Weighted-average Shares of Common Stock Outstanding-Basic
    36,533       35,928       36,321       35,829  
Effect of Dilutive Securities:
                               
Convertible Senior Notes
    4,192       4,101       4,166       4,086  
Options and Stock Issuable under Employee Benefit Plans and the Directors’ Plan
    416       507       436       491  
 
                       
Total Shares — Diluted
    41,141       40,536       40,923       40,406  
 
                       
The following table shows the number of stock options to purchase shares of Common Stock excluded from the computation of diluted EPS because the stock option’s exercise price was greater than the average market price of the Common Stock:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
            -In Thousands-          
 
 
Stock Options Excluded from the Diluted EPS Computation
    218       395       227       395  
 
                       
NOTE 12. STOCKHOLDERS’ EQUITY
In August 2010, UniSource Energy declared a third quarter dividend to shareholders of 39 cents per share of UniSource Energy Common Stock. The dividend, totaling approximately $14 million, was paid in September 2010. For the nine-month period ended September 30, 2010, dividends of $1.17 per share or $42 million were paid to common shareholders. In August 2009, UniSource Energy declared a third quarter dividend to shareholders of 29 cents per share of UniSource Energy Common Stock. The dividend, totaling approximately $10 million, was paid in September 2009. For the nine-month period ended September 30, 2009, dividends of 87 cents per share or $31 million were paid to common shareholders.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
Dividends and Capital Contribution
UniSource Energy contributed capital to TEP of $15 million in March 2010 and $30 million in March 2009.
Millennium paid dividends which represented return of capital distributions to UniSource Energy of $2 million in March 2010, and $4 million in January 2010. UED paid dividends to UniSource Energy of $9 million in February 2010, $4 million of which represented a return of capital distribution. In April 2010, UNS Gas paid dividends of $10 million to UniSource Energy. In August 2010, TEP paid dividends of $30 million to UniSource Energy.
NOTE 13. MILLENNIUM INVESTMENTS
In the third quarter of 2010, Millennium recorded a pre-tax impairment loss on a cost method investment of $1 million. This was a result of a new valuation and a change in the ownership percentage following a capital infusion by new investors.
In the second quarter of 2010, UniSource Energy wrote off an investment held by Millennium. The underlying investment related to a proposed Liquefied Natural Gas project which no longer appears viable. To recognize the impairment at June 30, 2010, we recorded a pre-tax loss of $5 million. The loss is reflected in Other Expense on the UniSource Energy income pre-tax statement. Millennium has no further investment obligation related to this investment.
In the first quarter of 2010, Millennium sold a wholly-owned subsidiary. Millennium received cash of less than $1 million, and recorded less than $1 million of pre-tax gain included in Other Income on UniSource Energy’s income statement.
In the second quarter of 2009, Millennium finalized a sale of its 50% equity interest in Carboelectrica Sabinas, S. de R.L. de C.V. (Sabinas), a Mexican limited liability company. Millennium received an upfront payment of $5 million in January 2009 and a $15 million, three-year, 6%, secured note receivable from Minerales de Monclova, S.A. de C.V. (Mimosa). Principal on the note is due at maturity; interest on the note is due annually on December 31. The $15 million note is included in Investments and Other Property – Other on UniSource Energy’s balance sheet. Millennium recorded a $6 million pre-tax gain on the sale included in Other Income on UniSource Energy’s income statement.
See Note 5 for tax information related to Millennium’s investments.
NOTE 14. TRANSMISSION ASSETS DEPRECIATION
During the fourth quarter of 2009, TEP performed an analysis of the service life and net salvage parameters of its transmission assets. As a result, new depreciation rates were implemented effective January 1, 2010. The new rates effectively extend the expected remaining service lives of TEP’s transmission assets, resulting in a reduction of related depreciation expense of $10 million for the nine months ended September 30, 2010 compared to September 30, 2009.
NOTE 15. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The following recently issued accounting standards are not yet reflected in UniSource Energy and TEP financial statements:
    The FASB issued authoritative guidance for multiple deliverable revenue arrangements that provides another alternative for determining the selling price of deliverables and eliminates the residual method of allocating consideration. In addition, this pronouncement requires expanded qualitative and quantitative disclosures and is effective for revenue arrangements entered into after January 1, 2011. We are evaluating the impact of this pronouncement.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
    The FASB issued amendments that require some new disclosures and clarify some existing disclosure requirements about fair value measurements. Disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, are effective for interim and annual reporting periods beginning January 1, 2011. We will incorporate these new disclosures in our March 31, 2011 financial statements.
NOTE 16. SUPPLEMENTAL CASH FLOW INFORMATION
A reconciliation of Net Income to Net Cash Flows — Operating Activities follows:
                 
    UniSource Energy  
    Nine Months Ended  
    September 30,  
    2010     2009  
    -Thousands of Dollars-  
 
               
Net Income
  $ 100,395     $ 93,839  
 
               
Adjustments to Reconcile Net Income To Net Cash Flows from Operating Activities
               
Depreciation Expense
    95,773       109,601  
Amortization Expense
    20,797       22,280  
Depreciation and Amortization Recorded to Fuel and Other O&M Expense
    4,025       3,667  
Amortization of Deferred Debt-Related Costs Included in Interest Expense
    2,672       3,170  
Provision for Bad Debts
    2,881       2,537  
Deferred Income Taxes
    58,970       52,849  
Deferred Tax Valuation Allowance
    5,702        
Pension and Postretirement Expense
    14,626       17,987  
Pension and Postretirement Funding
    (20,927 )     (23,275 )
Share-Based Compensation Expense
    2,102       2,120  
Excess Tax Benefit from Stock Options Exercised
    (1,796 )     (1,929 )
CTC Revenue Refunded
    (8,152 )     (9,040 )
Decrease to Reflect PPFAC/PGA Recovery
    (35,335 )     (5,083 )
Loss/(Gain) on Millennium’s Investments
    5,208       (5,979 )
Changes in Assets and Liabilities which Provided (Used)
               
Cash Exclusive of Changes Shown Separately
               
Accounts Receivable
    (35,783 )     (6,655 )
Materials and Fuel Inventory
    12,691       (32,020 )
Other Regulatory Assets
    (4,897 )     434  
Accounts Payable
    6,851       (6,617 )
Interest Accrued
    (3,633 )     (4,621 )
Income Taxes
    8,911       19,478  
Accrued Taxes Other than Income Taxes
    18,855       14,381  
Other Regulatory Liabilities
    2,774       18,929  
Other
    (3,418 )     (3,755 )
 
           
Net Cash Flows – Operating Activities
  $ 249,292     $ 262,298  
 
           

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
                 
    TEP  
    Nine Months Ended  
    September 30,  
    2010     2009  
    -Thousands of Dollars-  
 
               
Net Income
  $ 96,979     $ 81,229  
 
               
Adjustments to Reconcile Net Income To Net Cash Flows from Operating Activities
               
Depreciation Expense
    74,143       88,605  
Amortization Expense
    23,963       25,934  
Depreciation and Amortization Recorded to Fuel and Other O&M Expense
    2,837       2,546  
Amortization of Deferred Debt-Related Costs Included in Interest Expense
    1,534       1,882  
Provision for Bad Debts
    1,961       1,626  
Deferred Income Taxes
    49,984       42,350  
Pension and Postretirement Expense
    12,979       16,262  
Pension and Postretirement Funding
    (19,174 )     (21,793 )
Share-Based Compensation Expense
    1,628       1,619  
CTC Revenue Refunded
    (8,152 )     (9,040 )
Decrease to Reflect PPFAC Recovery
    (24,098 )     (16,898 )
Changes in Assets and Liabilities which Provided (Used)
               
Cash Exclusive of Changes Shown Separately
               
Accounts Receivable
    (44,561 )     (28,695 )
Materials and Fuel Inventory
    11,889       (31,146 )
Other Regulatory Assets
    (4,566 )     461  
Accounts Payable
    13,792       5,394  
Interest Accrued
    1,420       488  
Income Taxes
    1,950       3,242  
Accrued Taxes Other than Income Taxes
    17,772       15,213  
Other Regulatory Liabilities
    2,684       17,411  
Other
    (1,126 )     784  
 
           
Net Cash Flows – Operating Activities
  $ 213,838     $ 197,474  
 
           

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
NOTE 17. ACCOUNTING FOR DERIVATIVE INSTRUMENTS, TRADING ACTIVITIES AND HEDGING ACTIVITIES
RISKS AND OVERVIEW
The three utilities are exposed to energy price risk associated with their gas and purchased power requirements, volumetric risk associated with their seasonal load and operational risk associated with their power plants, transmission and transportation systems. The energy price risk is mitigated through the PPFAC and PGA mechanisms which provide an adjustment to the three utilities’ retail rates to recover the actual costs of purchased power, gas, transmission and transportation. The three utilities further reduce their energy price risk through a variety of derivative and non-derivative instruments. The objectives for entering into such contracts include: creating price stability for the three utilities; ensuring the three utilities can meet their load and reserve requirements; and reducing the three utilities’ exposure to price volatility that may result in delayed recovery under the PPFAC or PGA. While current procurement methodologies allow the three utilities to recover electric and gas procurement costs from customers, future regulatory structures could change, potentially impacting the recoverability of electric and gas procurement costs. See Note 2 for further information regarding regulatory matters.
We consider the effect of counterparty credit risk in determining the fair value of derivative instruments that are in a net asset position, after incorporating collateral posted by counterparties, and allocating the credit risk adjustment to individual contracts. We also consider the impact of our own credit risk, after considering collateral posted, on instruments that are in a net liability position and allocating the credit risk adjustment to all individual contracts.
Although TEP’s gains and losses on trading activities are recorded on a net basis in the income statement, we report the related cash receipts and cash payments separately in the statement of cash flows. We present cash collateral and derivative assets and liabilities, associated with the same counterparty, separately in our financial statements and we bifurcate all derivatives into their current and long-term portions on the balance sheet.
CASH FLOW HEDGES
TEP hedges the cash flow risk associated with unfavorable changes in the variable interest rates related to LIBOR on the Springerville Common Facilities Lease. In addition, TEP hedges the cash flow risk associated with a six-year power supply agreement using a six-year power purchase swap agreement. TEP accounts for cash flow hedges as follows:
    The effective portion of the changes in the fair value of TEP’s interest rate swaps and TEP’s six-year power purchase swap agreement are recorded in AOCI and the ineffective portion, if any, is recognized in earnings.
    When TEP determines a contract is no longer effective in offsetting the changes in cash flow of a hedged item, TEP recognizes the changes in fair value in earnings. The gains and losses at that time remain in AOCI and are reclassified into earnings as the underlying hedged transaction occurs.
We formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivatives have been and are expected to remain highly effective in offsetting changes in the cash flows of hedged items. We discontinue hedge accounting when: (1) the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur; or (4) we determine that designating the derivative as a hedging instrument is no longer appropriate.
MARK-TO-MARKET
  TEP
 
    TEP non-trading hedges, such as forward power purchase contracts indexed to gas, short-term forward power sales contracts, or call and put options (gas collars), that were not designated as cash flow hedges or did not qualify for the normal scope exception, are considered mark-to-market transactions. TEP hedges a portion of its monthly natural gas exposure for plant fuel, gas-indexed purchased power and spot market purchases with fixed price contracts for a maximum of three years. Unrealized gains and losses are recorded as either a regulatory asset or regulatory liability only to the extent they qualify for recovery under the PPFAC mechanism.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
    TEP enters into certain energy-related derivatives for trading purposes which are forward power purchase and sale contracts entered into purely to profit from market price changes. As unrealized gains and losses resulting from changes in the market prices of trading derivatives are not recoverable in the PPFAC, unrealized gains and losses are recorded in the income statement in Electric Wholesale Sales. The net trading activities represent a very small portion (less than 1%) of TEP’s revenue from wholesale sales.
 
  UNS Electric
 
    UNS Electric enters into derivatives, such as fixed price forward power purchases, natural gas-indexed forward power purchase contracts, call and put options (gas collars) or financial gas swaps, to hedge a portion of its purchased power exposure. These contracts are considered mark-to-market transactions. As UNS Electric’s PPFAC mechanism permits recovery of the prudent costs of hedging transactions, unrealized gains and losses resulting from changes in the market prices of such contracts are recorded as either regulatory assets or regulatory liabilities.
 
  UNS Gas
 
    UNS Gas enters into derivatives, such as forward gas purchases and financial gas swaps to ensure supply, create price stability and reduce exposure to natural gas price volatility that may result in delayed recovery under the PGA. Unrealized gains and losses are recorded as either a regulatory asset or regulatory liability, as the UNS Gas PGA mechanism permits the recovery of the prudent cost of hedging contracts.
NORMAL PURCHASE AND NORMAL SALE
TEP and UNS Electric enter into forward energy purchase and sales contracts, including call options, to support the current load forecast. When these contracts are entered into with counterparties that have generating capacity or load serving requirements, these contracts are not required to be marked to market and are accounted for on an accrual basis. UNS Gas enters into forward gas purchases, based on forecasted needs, with counterparties that can supply its physical requirements. These contracts meet the normal purchase scope exception and are not required to be marked to market. On an ongoing basis, we evaluate our counterparties for non-performance risk to ensure such risk does not impact our ability to obtain the normal scope exception.
FINANCIAL IMPACT OF DERIVATIVES
Cash Flow Hedges
At September 30, 2010 and December 31, 2009, UniSource Energy and TEP had liabilities related to their cash flow hedges of $15 million and $7 million, respectively. UniSource Energy and TEP had net after-tax unrealized losses on derivative activities reported in AOCI of $3 million for the three months ended September 30, 2010 and $2 million for the three months ended September 30, 2009. UniSource Energy and TEP had net after-tax unrealized losses on derivative activities reported in AOCI of $8 million for the nine months ended September 30, 2010 and less than $1 million for the nine months ended September 30, 2009.
Regulatory Treatment of Commodity Derivatives
UniSource Energy and TEP report unrealized gains and losses on energy contracts that are recoverable through the PPFAC or PGA on the balance sheet as a regulatory asset or a regulatory liability rather than as a component of AOCI or in the income statement. For the three months ended September 30, 2010, UniSource Energy recorded net increases to regulatory assets of $6 million and TEP recorded net decreases to regulatory assets of $1 million. UniSource Energy and TEP recorded net decreases of $33 million and $19 million, respectively for the three months ended September 30, 2009. For the nine months ended September 30, 2010, UniSource Energy recorded net increases to regulatory assets of $10 million and TEP recorded net decreases to regulatory assets of $4 million. UniSource Energy and TEP recorded net decreases to regulatory assets of $23 million and $11 million, respectively for the nine months ended September 30, 2009.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) — Unaudited
At September 30, 2010, UniSource Energy and TEP had liabilities of $53 million and $8 million, respectively, and assets of $16 million and $5 million, respectively, related to their energy derivatives that will be recovered through the PPFAC or PGA. At December 31, 2009, UniSource Energy and TEP had liabilities of $34 million and $9 million, respectively, and assets of $7 million and $2 million, respectively, related to their energy derivatives that will be recovered through the PPFAC or PGA.
Realized gains and losses on settled gas swaps are fully recovered through the PPFAC or PGA. For the three months ended September 30, 2010, UniSource Energy and TEP realized losses of $8 million and $5 million, respectively, and $27 million and $21 million, respectively, for the three months ended September 30, 2009. For the nine months ended September 30, 2010, UniSource Energy and TEP realized losses of $17 million and $8 million, respectively, and $46 million and $29 million, respectively, for the nine months ended September 30, 2009.
At September 30, 2010, TEP had contracts that will settle through the third quarter of 2015; UNS Electric had contracts that will settle through the fourth quarter of 2013; and UNS Gas had contracts that will settle through the third quarter of 2013.
Other Commodity Derivatives
UniSource Energy and TEP record realized and unrealized gains and losses on other energy contracts on a net basis in Wholesale Sales. For each three and nine month period ended September 30, 2010 and 2009, net realized and unrealized gains and losses were less than $1 million. At September 30, 2010, TEP had no other energy contracts outstanding. At December 31, 2009, TEP had assets of $4 million and liabilities of $4 million related to other energy contracts. TEP’s other energy contracts were with an affiliated counterparty; therefore, related assets and liabilities were eliminated in the UniSource Energy financial statements.
The settlement of forward power purchase and sales contracts that did not result in physical delivery were as follows:
                                 
    UniSource Energy and TEP  
    Three Months     Nine Months  
    Ended September 30,     Ended September 30,  
    2010     2009     2010     2009  
    -Millions of Dollars-  
Recorded in Wholesale Sales:
                               
Forward Power Sales
  $ 19     $ 8     $ 25     $ 20  
Forward Power Purchases
    (25 )     (7 )     (32 )     (18 )
 
                       
Total Sales and Purchases Not Resulting in Physical Delivery
  $ (6 )   $ 1     $ (7 )   $ 2  
 
                       
DERIVATIVE VOLUMES
At September 30, 2010, UniSource Energy and TEP had gas swaps totaling 14,833 GBtu and 6,397 GBtu, respectively, and power contracts totaling 4,646 GWh and 1,246 GWh, respectively, which were accounted for as derivatives. At December 31, 2009, UniSource Energy and TEP had gas swaps totaling 13,321 GBtu and 5,658 GBtu, respectively, and power contracts totaling 3,859 GWh and 1,247 GWh, respectively, which were accounted for as derivatives.
CREDIT RISK ADJUSTMENT
When the fair value of our derivative contracts is reflected as an asset, the counterparty owes us and this creates credit risk. We minimize our credit risk by: (1) entering into transactions with high-quality counterparties, (2) limiting our exposure to each counterparty, (3) monitoring the financial condition of the counterparties and (4) requiring collateral in accordance with the counterparty master agreements. Using a combination of market credit default swap data and historical recovery rates for bonds, we consider the impact of counterparty creditworthiness in determining the fair value of our derivatives as well as its possible effect on continued qualification for cash flow hedge accounting. At September 30, 2010, and at December 31, 2009, the impact of counterparty credit risk on the fair value of derivative asset contracts was less than $1 million.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Concluded) — Unaudited
We also consider the impact of our own credit risk on instruments that are in a net liability position, after deducting collateral posted, using market credit default swap data and allocating the credit risk adjustment to all individual contracts in a net liability position. At September 30, 2010, and at December 31, 2009, the impact of our own credit risk was less than $1 million.
CONCENTRATION OF CREDIT RISK
The use of contractual arrangements to manage the risks associated with changes in energy commodity prices creates credit risk exposure resulting from the possibility of non-performance by counterparties pursuant to the terms of their contractual obligations. The three utilities enter into contracts for the physical delivery of energy and gas which contain remedies in the event of non-performance by the supply counterparties. In addition, volatile energy prices can create significant credit exposure from energy market receivables and mark-to-market valuations.
The three utilities have contractual agreements for their energy procurement and hedging activities that contain certain provisions that require each company to post collateral under certain circumstances. These circumstances include: exposures in excess of unsecured credit limits provided to TEP, UNS Gas or UNS Electric; credit rating downgrades; or a failure to meet certain financial ratios. In the event that such credit events were to occur, the three utilities would have to provide certain credit enhancements in the form of cash or letters of credit to fully collateralize their exposure to these counterparties.
The following table shows the sum of the fair value of all derivative instruments under contracts with credit-risk related contingent features that are in a net liability position at September 30, 2010. It also shows cash collateral and letters of credit posted, and additional collateral to be posted if credit-risk related contingent features were triggered.
                                 
                            UniSource  
    TEP     UNS Gas     UNS Electric     Energy  
    September 30, 2010  
    -Millions of Dollars-  
Net Liability Position
  $ 30     $ 22     $ 29     $ 81  
Cash Collateral Posted
          3             3  
Letters of Credit
    1             18       19  
Additional Collateral to Post if Contingent Features Triggered
    30       19       15       64  
As of September 30, 2010, TEP had $20 million of credit exposure to other counterparties’ creditworthiness related to its wholesale marketing and gas hedging activities, and UNS Electric had $3 million related to its supply and hedging contracts. TEP had five counterparties which individually comprise greater than 10% of the total credit exposure and UNS Electric had one. At September 30, 2010, UNS Gas had immaterial exposure to other counterparties’ creditworthiness.
NOTE 18. REVIEW BY INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The UniSource Energy and TEP condensed consolidated financial statements as of September 30, 2010 and for the three and nine months ended September 30, 2010 and 2009, have been reviewed by PricewaterhouseCoopers LLP, an independent registered public accounting firm. Their reports (dated October 27, 2010) are included on pages 1 and 2. The reports of PricewaterhouseCoopers LLP state that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their reports on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (the Act) for their reports on the unaudited financial information because neither of those reports is a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

 

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ITEM 2. — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis explains the results of operations, the general financial condition, and the outlook for UniSource Energy and its three primary business segments and includes the following:
  outlook and strategies;
  operating results during the third quarter and nine-months ended September 30, 2010 compared with the same periods in 2009;
  factors which affect our results and outlook;
  liquidity, capital needs, capital resources, and contractual obligations;
  dividends; and
  critical accounting estimates.
Management’s Discussion and Analysis should be read in conjunction with UniSource Energy and TEP’s 2009 Annual Report on Form 10-K and with the Comparative Condensed Consolidated Financial Statements, beginning on page 3, which present the results of operations for the three and nine-months ended September 30, 2010 and 2009. Management’s Discussion and Analysis explains the differences between periods for specific line items of the Comparative Condensed Consolidated Financial Statements.
References in this report to “we” and “our” are to UniSource Energy and its subsidiaries, collectively.
UNISOURCE ENERGY CONSOLIDATED
OVERVIEW OF CONSOLIDATED BUSINESS
UniSource Energy is a holding company that has no significant operations of its own. Operations are conducted by UniSource Energy’s subsidiaries, each of which is a separate legal entity with its own assets and liabilities. UniSource Energy owns all of the outstanding common stock of Tucson Electric Power Company (TEP), UniSource Energy Services, Inc. (UES), UniSource Energy Development Company (UED) and Millennium Energy Holdings, Inc. (Millennium). We conduct our business in three primary business segments — TEP, UNS Gas, Inc. (UNS Gas) and UNS Electric, Inc. (UNS Electric).
TEP, an electric utility, provides electric service to the community of Tucson, Arizona. UES, through its two operating subsidiaries, UNS Gas and UNS Electric, provides gas and electric service to 30 communities in Northern and Southern Arizona.
UED developed and owns the Black Mountain Generating Station (BMGS), a natural gas-fired combustion turbine in Northern Arizona that, through a power sales agreement, provides energy to UNS Electric.
Millennium has existing investments in unregulated businesses that represent less than 1% of UniSource Energy’s total assets as of September 30, 2010; no new investments are planned in Millennium.
UniSource Energy was incorporated in the State of Arizona in 1995 and obtained regulatory approval to form a holding company in 1997. In 1998, TEP and UniSource Energy exchanged shares of stock resulting in TEP becoming a subsidiary of UniSource Energy.
OUTLOOK AND STRATEGIES
Our financial prospects and outlook for the next few years will be affected by many factors including: the 2008 TEP Rate Order that freezes base rates through 2012, the recent national and regional economic downturn, the financial market disruptions and volatility, potential regulations impacting greenhouse gas emissions and other regulatory factors. Our plans and strategies include the following:
  Focus on the core utility businesses including: operational excellence; investing in utility rate base; customer satisfaction; community presence; and achieving constructive regulatory outcomes.

 

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  Expand TEP and UNS Electric’s portfolio of renewable energy resources and programs to meet Arizona’s renewable energy standards while creating ownership opportunities for renewable energy projects that benefit customers, shareholders and the communities we serve.
  Develop strategic responses to energy efficiency requirements that protect the financial stability of our utility businesses and provide benefits to our customers.
  Expand TEP and UNS Electric’s transmission system to meet increasing loads and provide access to renewable energy resources.
  Develop strategic responses to new environmental regulation and potential new legislation, including limitations on carbon emissions. We are evaluating TEP’s existing mix of generation resources and defining steps to achieve environmental objectives that provide an appropriate return on investment and are consistent with earnings growth.
  Refinance expiring credit facilities and maturing long-term debt at UniSource Energy, TEP, UNS Gas and UNS Electric before the obligations expire or mature in August 2011.
RESULTS OF OPERATIONS
Executive Overview
Seasonality of Utility Operations
The net income and results of operations of UniSource Energy’s utility businesses are seasonal in nature. TEP and UNS Electric are summer-peaking utilities and historically have recorded a majority of their net income during the second and third quarters, when hot weather drives increases in energy consumption. Energy demand from UNS Gas customers typically peaks during the winter, and that company records the majority of its net income during the first and fourth quarters.
Third Quarter of 2010 Compared with the Third Quarter of 2009
UniSource Energy reported net income of $55 million in the third quarter of 2010 compared with $58 million in the third quarter of 2009. Factors that affected earnings in the third quarter of 2010 compared with the same period in 2009 include:
    A $6 million after-tax loss recorded at Millennium related to the write-off of deferred taxes and the impairment of investments; partially offset by
    Lower depreciation and amortization expense at TEP; and
    Operating benefits related to Springerville Unit 4.
Nine Months Ended September 30, 2010 Compared with the Nine Months Ended September 30, 2009
UniSource Energy reported net income of $100 million in the first nine months of 2010 compared with $94 million in the same period last year. Factors that contributed to the increase in UniSource Energy’s net income in the first nine months of 2010 occurred primarily at TEP. These include:
    Lower depreciation and amortization expense at TEP;
    Operating benefits related to Springerville Unit 4;
    The sale of transmission capacity by TEP to the owner of Springerville Unit 4 during the first three months of 2010; and
    Lower base O&M expense due to fewer planned maintenance outages and lower pension expense; partially offset by:
    A decrease in retail margin revenues caused by weather, weak economic conditions and the implementation of energy efficiency measures; and
    Lower other income related to items recorded in the first nine months of 2009 including: interest income related to an income tax refund; and a gain recognized on company owned life insurance.

 

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Factors that offset the increase in TEP’s net income include:
    A $9 million after-tax loss at Millennium related to the write-off of deferred taxes and the impairment of investments in the first nine months of 2010; and
    A $4 million after-tax gain related to the sale of an investment by Millennium in the first nine months of 2009.
See Tucson Electric Power, Results of Operations below for more information.
Operations and Maintenance Expense
The table below summarizes the items included in UniSource Energy’s O&M expense.
                                 
    Three Months     Nine Months  
    Ended Sept. 30,     Ended Sept. 30,  
    2010     2009     2010     2009  
    -Millions of Dollars-     -Millions of Dollars-  
TEP Base O&M
  $ 53     $ 53     $ 163     $ 174  
UNS Gas Base O&M
    6       6       18       18  
UNS Electric Base O&M
    5       5       15       14  
Consolidating Adjustments and Other (1)
    (2 )     (2 )     (6 )     (5 )
 
                       
UniSource Energy Base O&M
    62       62       190       201  
Reimbursed Expenses Related to Springerville Units 3 and 4
    14       12       41       29  
Expenses Related to Customer-Funded Renewable Energy and DSM Programs(2)
    13       6       28       13  
 
                       
Total UniSource Energy O&M
  $ 89     $ 80     $ 259     $ 243  
 
                       
     
(1)   Includes Millennium, UED and parent company O&M, and inter-company eliminations.
 
(2)   Corresponding amounts are charged to customers and are recorded in electric retail revenues.
CONTRIBUTION BY BUSINESS SEGMENT
The table below shows the contributions to our consolidated after-tax earnings by our three business segments, as well as Other Net Income (Loss).
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2010     2009     2010     2009  
    -Millions of Dollars-     -Millions of Dollars-  
TEP
  $ 59     $ 55     $ 97     $ 81  
UNS Gas
    (1 )     (1 )     5       4  
UNS Electric
    3       4       8       6  
Other (1)
    (6 )           (10 )     3  
 
                       
Consolidated Net Income
  $ 55     $ 58     $ 100     $ 94  
 
                       
     
(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 Millennium investments and UED.

 

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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The primary source of liquidity for UniSource Energy, the parent company, is dividends from its subsidiaries, primarily TEP. Also, under UniSource Energy’s tax sharing agreement, subsidiaries make income tax payments to UniSource Energy, which makes payments on behalf of the consolidated group to taxing authorities. The table below provides a summary of the liquidity position of UniSource Energy on a stand-alone basis and for each of its segments.
                         
            Borrowings     Amount Available  
    Cash and Cash     under Revolving     under Revolving  
Balances at October 15, 2010   Equivalents     Credit Facility(1)     Credit Facility  
    -Millions of Dollars-  
UniSource Energy stand-alone
  $ 2     $ 30     $ 40  
TEP
    42       1       149  
UNS Gas
    25             45 (2)
UNS Electric
    15       18       27 (2)
Other
    7 (3)     N/A       N/A  
 
                 
Total
  $ 91                  
 
                     
     
(1)   Includes letters of credit issued under revolving credit facilities.
 
(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
We have a short-term investment policy which governs the investment of excess cash balances by UniSource Energy and its subsidiaries. This policy is reviewed periodically in response to market conditions to adjust, if necessary, the maturities and concentrations by investment type and issuer in the investment portfolio. As of September 30, 2010, UniSource Energy’s short-term investments consisted of highly-rated and liquid money market funds, certificates of deposit and commercial paper. These short-term investments are classified as Cash and Cash Equivalents on the Balance Sheet.
Access to Revolving Credit Facilities
UniSource Energy, TEP, UNS Gas and UNS Electric are each party to a revolving credit agreement with a group of lenders, which is available to be used for working capital purposes. Each of these agreements is a committed facility and expires in August 2011. The TEP Credit Agreement and UNS Gas/UNS Electric Revolver may be used for revolving borrowings, as well as to issue letters of credit. TEP, UNS Gas and UNS Electric each issue letters of credit from time to time to provide credit enhancement to counterparties for their power or gas procurement and hedging activities. The UniSource Credit Agreement may be used only for revolver borrowings.
UniSource Energy and its subsidiaries believe that they have sufficient liquidity under their revolving credit facilities to meet their short-term working capital needs and to provide credit enhancement as may be required under their respective energy procurement and hedging agreements. See Item 3. Quantitative and Qualitative Disclosures about Market Risk, Credit Risk, below.

 

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Refinancings
UniSource Energy and its subsidiaries have $621 million of credit facilities, which include revolvers that expire in August 2011. We are in the process of refinancing the UniSource Energy, TEP, UNS Gas and UNS Electric credit facilities and expect the transactions to be completed by the end of 2010. Based on current market conditions, the associated interest rate spreads are expected to increase approximately 150 to 175 basis points over current levels.
Also in August 2011, UNS Gas has $50 million of unsecured notes that mature. We intend to refinance the $50 million prior to its maturity.
See: UniSource Energy Credit Agreement, below; Tucson Electric Power, Liquidity and Capital Resources, TEP Credit Agreement, below; and UNS Gas, Liquidity and Capital Resources, UNS Gas/UNS Electric Revolver, below for more information.
Executive Overview — UniSource Energy Consolidated Cash Flows
                 
Nine Months Ended September 30,   2010     2009  
    -Millions of Dollars-  
Cash provided by (used in):
               
Operating Activities
  $ 249     $ 262  
Investing Activities
    (227 )     (248 )
Financing Activities
    (32 )     (6 )
Operating Activities
In the first nine months of 2010, net cash flows from operating activities were $13 million lower than the same period last year due to: an $8 million increase in total taxes paid in the first nine months of 2010 compared with the same period last year; a $4 million decrease in interest received in the first nine months of 2010 due in part to lower balances of investments in lease debt by TEP; and $17 million of income tax refunds received in 2009; partially offset by a $16 million increase in proceeds from the operation of Springerville Units 3 and 4.
Investing Activities
Net cash flows used for investing activities decreased by $21 million in the first nine months of 2010 compared with the same period last year. The decrease resulted primarily from a $13 million increase in lease debt principal received and a $4 million decrease in insurance proceeds in the first nine months of 2010 compared with the same period last year and activities that took place in the first nine months of 2009 including: a $31 million investment in lease debt; and $5 million in proceeds from the sale of an interest in a Millennium investment.
Capital Expenditures
In the first nine months of 2010, UniSource Energy’s capital expenditures, including the purchase of Sundt Unit 4 by TEP, were $252 million, a $15 million increase compared with the first nine months of 2009. Excluding TEP’s purchase of Sundt Unit 4, UniSource Energy’s capital expenditures were $37 million below the first nine months of 2009 due primarily to a decline in customer growth in our utility service areas resulting from regional economic weakness. The purchase of Sundt Unit 4 is included in our estimated capital expenditures for 2010.

 

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    Actual     Actual              
    Year-to-Date     Year-to-Date     Estimate     Actual  
    Sept. 30, 2010     Sept. 30, 2009     Full Year 2010     Full Year 2009  
    -Millions of Dollars-     -Millions of Dollars-  
TEP
  $ 218     $ 195     $ 276     $ 235  
UNS Gas
    7       11       12       14  
UNS Electric
    17       23       24       28  
Other
    10       8       16       10  
 
                       
UniSource Energy Consolidated
  $ 252     $ 237     $ 328     $ 287  
 
                       
Financing Activities
Net cash flows used for financing activities were $26 million higher in the first nine months of 2010 compared with the same period last year due primarily to: a $32 million increase in payments on TEP’s capital lease obligations; an $11 million increase in dividends paid to shareholders; and a $7 million decrease in debt proceeds, net of debt repayments and issuances or retirement costs. Those activities were partially offset by an increase in revolving credit facility borrowings of $14 million, net of repayments, and a $7 million increase in proceeds from exercised stock options.
UniSource Energy Credit Agreement
The UniSource Credit Agreement, which expires in August 2011, consists of a $30 million amortizing term loan facility and a $70 million revolving credit facility. Principal payments of $1.5 million on the outstanding term loan are due quarterly, with the balance due at maturity. At September 30, 2010, there was $5 million outstanding under the term loan facility and $29 million outstanding under the UniSource Energy revolving credit facility at a weighted average interest rate of 1.51%. We have the option of paying interest on the term loan and on borrowings under the revolving credit facility at adjusted LIBOR plus 1.25% or the sum of the greater of the federal funds rate plus 0.5% or the agent bank’s reference rate and 0.25%.
The UniSource Credit Agreement restricts additional indebtedness, liens, mergers, sales of assets, and certain investments and acquisitions. We must also meet: (1) a minimum cash flow to debt service coverage ratio for UniSource Energy on a standalone basis and (2) a maximum leverage ratio on a consolidated basis. We may pay dividends if, after giving effect to the dividend payment, we have more than $15 million of unrestricted cash and unused revolving credit.
As of September 30, 2010, we were in compliance with the terms of the UniSource Credit Agreement.
If an event of default occurs, the UniSource Credit Agreement may become immediately due and payable. An event of default includes failure to make required payments under the UniSource Credit Agreement, failure of UniSource Energy or certain subsidiaries to make payments or default on debt greater than $20 million, or certain bankruptcy events at UniSource Energy or certain subsidiaries. For information about refinancing the UniSource Credit Agreement see UniSource Energy Consolidated, Liquidity and Capital Resources, Liquidity, above.
Interest Rate Risk
UniSource Energy is subject to interest rate risk resulting from changes in interest rates on its borrowings under the revolving credit facility. The interest rate on revolving credit borrowings is variable. If LIBOR and other benchmark interest rates increase, UniSource Energy would be required to pay higher rates of interest on borrowings under its revolving credit facility. See Item 3. Quantitative and Qualitative Disclosures about Market Risk, Credit Risk, below.
Convertible Senior Notes
UniSource Energy has outstanding $150 million of 4.50% Convertible Senior Notes due 2035. Each $1,000 of Convertible Senior Notes is convertible into 27.95 shares of our Common Stock at any time, representing a conversion price of $35.78 per share of our Common Stock, subject to adjustments. The closing price of UniSource Energy’s Common Stock was $34.27 on October 15, 2010.

 

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Guarantees
In the normal course of business, UniSource Energy and certain subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of certain subsidiaries. We enter into these agreements primarily to support or enhance the creditworthiness of a subsidiary on a stand-alone basis. The most significant of these guarantees at September 30, 2010 were:
  UES’ guarantee of $100 million senior unsecured notes issued by UNS Gas and $100 million senior unsecured notes issued by UNS Electric;
  UES’ guarantee of the $60 million UNS Gas/UNS Electric Revolver;
  UniSource Energy’s guarantee of approximately $2 million in building lease payments for UNS Gas; and
  UniSource Energy’s guarantee of the $32 million of outstanding loans under the UED Credit Agreement.
To the extent liabilities exist under the contracts subject to these guarantees, such liabilities are included in the consolidated balance sheets.
We believe that the likelihood that UniSource Energy or UES would be required to perform or otherwise incur any significant losses associated with any of these guarantees is remote.
In March 2010, TEP purchased 100% of the equity interest in Sundt Unit 4. TEP indemnified the seller of Sundt Unit 4 from any sales, use, transfer or similar taxes or fees due relating to the purchase. The terms of the indemnification do not include a limit on potential future payments; however, TEP believes that the parties to the agreement have abided by all tax laws and TEP does not have any additional tax obligations. TEP has not made any payments under the terms of this indemnification to date.
Contractual Obligations
There have been no significant changes in our contractual obligations or other commercial commitments from those reported in our 2009 Annual Report on Form 10-K, other than the following entered into in 2010:
                                                         
                                            2015        
Payment Due in Years                                           and        
Ending December 31,   2010     2011     2012     2013     2014     after     Total  
    - Millions of Dollars -  
Long-Term Debt(1)
  $ 32     $ 6     $ 24     $     $     $     $ 62  
Purchase Obligations:
                                                       
Fuel
          4       4       2                   10  
Purchased Power
          40       7                         47  
Building Commitments
    14       4                               18  
Solar Installation Commitments
    4       2                               6  
 
                                         
Total Additional Contractual Cash Obligations
  $ 50     $ 56     $ 35     $ 2     $     $     $ 143  
 
                                         
     
(1)   In February 2010, UED amended the UED Credit Agreement to extend the termination date by two years to March 2012 and to increase borrowings by $9 million. In March 2010, TEP entered into an 18-month, $30 million term loan facility. TEP repaid the term loan in October 2010.

 

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Dividends on Common Stock
The following table shows the dividends declared to UniSource Energy shareholders for 2010:
                 
            Dividend Amount Per Share  
Declaration Date   Record Date   Payment Date   of Common Stock  
February 12, 2010
  February 23, 2010   March 8, 2010   $ 0.39  
May 5, 2010
  May 17, 2010   June 4, 2010   $ 0.39  
August 5, 2010
  August 19, 2010   September 2, 2010   $ 0.39  
Income Tax Position
At September 30, 2010, UniSource Energy had federal AMT credit carryforwards of $41 million, including $24 million for TEP, which do not expire. UniSource Energy has a capital loss carryforward of $8 million which expires on December 31, 2015. As of September 30, 2010, a $3 million valuation allowance has been recorded against the deferred tax asset. See Financial Statements Note 5. Income Taxes, for more information.
TUCSON ELECTRIC POWER COMPANY
RESULTS OF OPERATIONS
Executive Summary
The financial condition and results of operations of TEP are currently the principal factors affecting the financial condition and results of operations of UniSource Energy on an annual basis. The following discussion relates to TEP’s utility operations, unless otherwise noted.
TEP recorded net income of $59 million in the third quarter of 2010 compared with net income of $55 million in the same period in 2009. The improvement is due primarily to: a decrease in depreciation and amortization expense due to lower depreciation rates on TEP’s transmission assets; lower capital lease amortization resulting from a decline in outstanding capital lease obligations; and benefits related to Springerville Unit 4, which began commercial operations in December 2009.
Third Quarter of 2010 Compared with the Third Quarter of 2009
The following factors contributed to the increase in TEP’s net income:
    A $3 million decrease in depreciation expense due to lower depreciation rates on TEP’s transmission assets, a lengthened depreciation period for leasehold improvements at Sundt Unit 4, partially offset by depreciation related to an increase in plant-in-service;
    a $1 million decrease in amortization expense related to lower capital lease amortization; and
    $3 million of pre-tax benefit recognized by TEP related to Springerville Unit 4 for operating fees and contributions toward common facility costs received from the owner of Springerville Unit 4. Springerville Unit 4 started commercial operation in December 2009.
These factors were partially offset by:
    a $1 million decrease in total retail margin revenues due primarily to a 5% decrease in cooling degree days compared with the same period last year.

 

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Nine Months Ended September 30, 2010 Compared with the Nine Months Ended September 30, 2009
The following factors contributed to the increase in TEP’s net income:
    An $11 million decrease in base O&M expense, which excludes costs directly offset by customer surcharges for renewable energy and demand side management programs and third party reimbursements, resulting primarily from lower generating plant maintenance expense and a $3 million decrease in pension and post retirement medical expense. See Operations and Maintenance Expense, below;
    $9 million of pre-tax benefits recognized by TEP related to Springerville Unit 4 for operating fees and contributions toward common facility costs received from the owner of Springerville Unit 4. Springerville Unit 4 started commercial operation in December 2009;
    a $7 million decrease in depreciation expense due to lower depreciation rates on TEP’s transmission assets and a lengthened depreciation period for leasehold improvements at Sundt Unit 4, partially offset by depreciation related to an increase in plant-in-service. The decrease excludes a $7 million adjustment that increased depreciation expense in the second quarter of 2009, related to a change in accounting for TEP’s investment in Springerville Unit 1 lease equity;
    a $5 million decrease in amortization expense due to a decline in the balance of capital lease obligations. The decrease excludes a $3 million adjustment that decreased amortization expense made in the second quarter of 2009, related to a change in accounting for TEP’s investment in Springerville Unit 1 lease equity;
    a $3 million increase in wholesale transmission revenues as TEP temporarily provided transmission capacity for Springerville Unit 4 during the first quarter of 2010; and
    a $1 million increase in long-term wholesale margin revenues due primarily to an increase in sales volumes to one of TEP’s long-term wholesale customers.
These factors were partially offset by:
    a $5 million decrease in total retail margin revenues. Weather, the implementation of energy efficiency measures and weak economic conditions contributed to a 1% decrease in kWh sales compared with the first nine months of 2009. Cooling degree days during the first nine months of 2010 were 5% below the same period last year;
    a $7 million decrease in total other income due in part to interest related to an income tax refund received in the second quarter of last year and a decline in gains recognized on company owned life insurance. The decrease excludes a $3 million adjustment that increased other income in the second quarter of 2009, related to a change in accounting for TEP’s investment in Springerville Unit 1 lease equity; and
    a $3 million provision for wholesale refunds in the first quarter of 2010 resulting from the settlement of disputes related to wholesale sales to the California Power Exchange in 2000 and 2001.

 

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Retail Sales and Revenues
                                 
                    Increase (Decrease)  
Three Months Ended September 30,   2010     2009     Amount     Percent*  
Energy Sales, kWh (in millions)
                               
Electric Retail Sales:
                               
Residential
    1,445       1,453       (8 )     (0.6 %)
Commercial
    612       619       (7 )     (1.1 %)
Industrial
    630       628       2       0.3 %
Mining
    274       269       5       2.0 %
Public Authorities
    65       67       (2 )     (2.3 %)
 
                       
Total Electric Retail Sales
    3,026       3,036       (10 )     (0.3 %)
 
                       
 
                               
Retail Margin Revenues (in millions):
                               
Residential
  $ 97     $ 97     $       (0.7 %)
Commercial
    51       52       (1 )     (0.9 %)
Industrial
    29       29             (1.7 %)
Mining
    8       8             4.7 %
Public Authorities
    3       3             (1.2 %)
 
                       
Total Retail Margin Revenues
  $ 188     $ 189     $ (1 )     (0.7 %)
Retail Fuel Revenues
    100       103       (3 )     (2.7 %)
RES & DSM Revenues
    12       5       7     NM  
 
                       
Total Retail Revenues
  $ 300     $ 297     $ 3       1.0 %
 
                       
 
                               
Avg. Retail Margin Rate (cents / kWh):
                               
Residential
    6.67       6.67             (0.1 %)
Commercial
    8.35       8.34       0.01       0.2 %
Industrial
    4.57       4.67       (0.10 )     (2.0 %)
Mining
    2.95       2.87       0.08       2.7 %
Public Authorities
    5.25       5.19       0.06       1.2 %
 
                       
Avg. Retail Margin Rate
    6.20       6.23       (0.03 )     (0.4 %)
Avg. PPFAC Rate
    3.33       3.41       (0.08 )     (2.4 %)
Avg. RES & DSM Rate
    0.39       0.16       0.23     NM  
 
                       
Total Avg. Retail Rate
    9.92       9.80       0.12       1.3 %
 
                       
                                 
    2010     2009                  
Weather Data:
                               
Cooling Degree Days
                               
Three Months Ended September 30,
    1,096       1,155       (59 )     (5.1 %)
10-Year Average
    978       970              
     
*   Percent change calculated on un-rounded data; may not correspond to data shown in table.
Residential
Residential kWh sales were 0.6% lower in the third quarter of 2010, resulting in a decrease in residential margin revenues of less than $1 million. The decline in residential kWh sales can be attributed primarily to a 5.1% decrease in cooling degree days compared with the third quarter of 2009.
Commercial
Commercial kWh sales decreased by 1.1% compared with the third quarter of 2009. A decline in cooling degree days and weak economic conditions contributed to the sales decline. The lower sales volumes led to a decline in commercial margin revenues of $1 million.

 

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Industrial
Industrial kWh sales increased by 0.3% compared with the third quarter of 2009. Margin revenues from industrial customers in the third quarter of 2010 decreased slightly compared with the same period last year due to changing usage patterns which reduced demand charges.
Mining
Higher copper prices led to increased mining activity and a 2.0% increase in sales volumes in the third quarter of 2010 compared with the same period last year. Margin revenues from mining customers in the third quarter of 2010 rose slightly compared with the same period last year due to changing usage patterns which increased demand charges.
Wholesale Sales and Revenues
                                 
                    Increase (Decrease)  
Three Months Ended September 30,   2010     2009     Amount     Percent*  
Long-Term Wholesale Contracts
                               
kWh Sales (Millions)
    224       126       98       77.8 %
Revenues (Millions)
  $ 14     $ 10     $ 4       33.2 %
     
*   Percent change calculated on un-rounded data; may not correspond to data shown in table.
Long-Term Wholesale and Transmission Revenues
Revenues from long-term wholesale contracts increased by $4 million compared with the third quarter of 2009, due primarily to an increase in kWh sales to SRP, which nearly doubled compared with the third quarter of 2009.
Short-Term Wholesale and Trading Revenues
In the third quarters of 2010 and 2009, TEP’s short-term wholesale and trading revenues were $15 million and $22 million, respectively. All of the revenues from short-term wholesale sales and 10% of the profits from wholesale trading activity are credited to fuel and purchased power costs eligible for recovery in the PPFAC.

 

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Retail Sales and Revenues
                                 
                    Increase (Decrease)  
Nine Months Ended September 30,   2010     2009     Amount     Percent*  
Energy Sales, kWh (in millions)
                               
Electric Retail Sales:
                               
Residential
    3,109       3,129       (20 )     (0.6 %)
Commercial
    1,516       1,545       (29 )     (1.9 %)
Industrial
    1,639       1,667       (28 )     (1.6 %)
Mining
    807       793       14       1.7 %
Public Authorities
    178       188       (10 )     (5.5 %)
 
                       
Total Electric Retail Sales
    7,249       7,322       (73 )     (1.0 %)
 
                       
 
                               
Retail Margin Revenues (in millions):
                               
Residential
  $ 203     $ 204     $ (1 )     (0.6 %)
Commercial
    124        125       (1 )     (0.9 %)
Industrial
    74       77       (3 )     (4.4 %)
Mining
    23       23             2.8 %
Public Authorities
    9       9             (3.7 %)