UniSource Energy Reports 2010 Earnings, Increases Quarterly Dividend, and Issues Earnings Guidance for 2011

UniSource Energy Corporation (NYSE: UNS) today reported 2010 net income of $111.5 million, or $2.82 per share of common stock on a fully diluted basis, compared with $104.3 million, or $2.69 per diluted share in 2009.

"Our 2010 financial results reflect the resilience of our core utility business in the face of a third consecutive year of declining retail sales at TEP,” said Paul Bonavia, UniSource Energy’s Chairman, President and CEO. "We have prudently managed our costs and continue to identify opportunities to improve the efficiency and effectiveness of our operations.”

TEP’s retail kilowatt-hour (kWh) sales in 2010 fell 0.8 percent from 2009 levels. Although the weather in TEP’s service area was hotter than normal, there were 3.5 percent fewer cooling degree days than in 2009. Sales volumes to TEP’s mining customers were strong, increasing by 1.4 percent compared with 2009. Mining activity in TEP’s service area continues to increase as the price of copper remains strong in response to robust demand.

"While we are encouraged by the sales outlook for our mining customers, we expect lingering weakness in the local economy and the implementation of additional energy efficiency programs to moderate any growth in sales to residential and business customers,” Bonavia said.

UniSource Energy’s earnings for 2011 are estimated to be in the range of $2.60 to $2.90 per diluted share. The mid-point of the range assumes consolidated base operations and maintenance (O&M) expense of $272 million and an increase in TEP’s annual kWh sales of 0.5 percent. In 2010, UniSource Energy’s consolidated base O&M expense was $265 million.

"If sales at TEP remain near current levels, the higher costs of necessary maintenance activity, combined with an increase in depreciation and interest expense, will put pressure on our earnings,” Bonavia said. TEP’s non-fuel base rates cannot be increased before 2013.

"Our operating cash flows, however, are expected to remain strong with $350 million forecasted for 2011,” Bonavia said. UniSource Energy posted operating cash flows in 2010 of $342 million, which exceeded capital expenditures of $317 million. "Our board of directors’ decision to increase the dividend signals its confidence in the company’s ability to continue its strong operating performance and maintain solid cash flows from operations.”

Common Stock Dividend

UniSource Energy’s board of directors declared a first quarter dividend for common shareholders of 42 cents per share. The dividend will be paid on March 23, 2011 to common shareholders of record as of March 11, 2011. In 2010, the company’s quarterly dividend was 39 cents per share.

The board’s decision to increase the dividend is consistent with the strategy it adopted in 2010, of continuing to increase the dividend and to reach a targeted dividend payout level of approximately 60 percent of UniSource Energy’s net income.

The declaration of dividend payments is at the board’s sole discretion and is subject to numerous factors that ordinarily affect dividend policy, including the results of UniSource Energy’s operations and its financial position as well as general economic and business conditions.

Tucson Electric Power

Retail kWh Sales

TEP’s retail kilowatt-hour (kWh) sales fell 0.8 percent in 2010 compared with 2009. Sales to residential customers decreased 0.9 percent, while kWh sales to TEP’s commercial and industrial sales declined by 1.3 percent and 1.0 percent, respectively. Sales to TEP’s mining customers increased by 1.4 percent in 2010 compared with the prior year.

During the fourth quarter of 2010, which included one of the warmest Decembers on record in Tucson, retail sales declined 0.3 percent compared with the same period last year. Although commercial, industrial, and mining customers all posted year-over-year sales increases in the fourth quarter of 2010, only residential – TEP’s most weather-sensitive customer class – consumed less electricity during the period.

Retail Revenues

Retail margin revenues decreased $5 million, or 1.0 percent, in 2010 compared with 2009. These revenues do not include a $12 million increase in customer surcharges used to fund renewable energy and energy efficiency programs or a $6 million decrease in charges to cover fuel and purchased power costs.

Long-Term Wholesale and Transmission Revenues

In 2010, the margin on long-term wholesale sales of electricity was $28 million compared with $25 million in 2009. The increase reflects higher kWh sales to the Navajo Tribal Utility Authority. Wholesale revenues from the sale of transmission services were $21 million in 2010 compared with $19 million in 2009.

Other Operating Expenses

TEP’s 2010 base O&M expense of $228 million was down $3 million, or 1.3 percent, from 2009 levels. Base O&M excludes costs directly offset by customer surcharges and third-party reimbursements. The reduction reflects the impact of cost containment efforts as well as lower generation maintenance outage expense.

Depreciation expense decreased by $10 million primarily due to new lower depreciation rates for transmission assets and lower depreciation on Unit 4 at TEP’s H. Wilson Sundt Generating Station. Those savings were partially offset by depreciation expense related to new plant additions. Amortization expense decreased $7 million due to a decline in the balance of capital lease obligations. The decreases in depreciation and amortization exclude adjustments made in 2009 related to an investment in Springerville Unit 1 lease equity.

Benefits of SGS Units 3 and 4

The December 2009 completion of SGS Unit 4 resulted in an $11 million increase in rents and fees for the operations of SGS Units 3 and 4. In 2010, rents and fees related to the operation of these Units totaled $24 million. Phoenix-based Salt River Project (SRP) owns Unit 4, while Tri-State Generation and Transmission Association leases Unit 3 from a financial owner. TEP operates all four units at the eastern Arizona plant.

Interest Expense

Total interest expense on long-term debt increased by $6 million in 2010 compared with 2009, primarily due to the January 2010 conversion of $130 million of bonds from a variable to a fixed rate.

UNS Gas

UNS Gas reported net income of $9 million in 2010 compared with $7 million in 2009. The increase resulted from a 3.7 percent increase in retail therm sales and a 2 percent non-fuel base rate increase that took effect in April 2010. Cooler weather drove heating degree days 3 percent higher than in 2009 and 3 percent higher than the 10-year average.

UNS Electric

UNS Electric reported net income of $10 million in 2010 compared with $6 million in the previous year. The increase is due primarily to a 4.1 percent increase in kWh sales, a 4 percent non-fuel base rate increase that took effect October 1, 2010 and a settlement related to previous transactions with the California Power Exchange that resulted in after-tax income of $2 million.

The increase in UNS Electric’s retail kWh sales reflects higher usage by a copper mining customer and the addition of a new industrial customer.

Millennium

Millennium recorded a $13 million net loss in 2010 compared with net income of $2 million in 2009. Millennium’s 2010 results include $3 million of income tax expense related to the write-off of deferred tax assets and an $8 million after-tax impairment loss related to its investments.

In the fourth quarter of 2010, Millennium recorded a net loss of $4 million, compared with a net loss of $1 million in the fourth quarter of 2009.

On December 31, 2010, Millennium had assets of $22 million, including a $15 million note receivable, land and buildings of $2 million, deferred tax assets of $2 million and cash of $3 million.

Seasonality of Earnings

The net income and results of operations of TEP as well as of UNS Gas and UNS Electric – operating subsidiaries of UniSource Energy Services (UES) – are seasonal in nature. TEP and UNS Electric typically record the majority of their net income during the second and third quarters when hot weather contributes to higher energy consumption. TEP’s retail prices, which include higher rates for higher levels of energy use, also shift a larger share of the company’s earnings into those periods.

Energy demand from UNS Gas customers typically peaks during the winter. Accordingly, UNS Gas records the majority of its net income during the first and fourth quarters.

(1) Includes UniSource Energy on a stand-alone basis and results from UniSource Energy Development, a wholly owned subsidiary of UniSource Energy.

UniSource Energy believes the presentation of TEP, UNS Gas, UNS Electric, and Millennium net income or loss on a per basic UniSource Energy share basis (which are non-GAAP financial measures) provides useful information to investors by disclosing the results of operations of its business segments on a basis consistent with UniSource Energy's reported earnings or losses.

Conference Call and Webcast

The company will host a conference call on Monday, February 28 at 12 p.m. EST to discuss the financial results and outlook. To participate in the call, please dial in 5 to 10 minutes prior to the start time.

The conference call can be heard live on UniSource Energy’s website. The webcast can be accessed at uns.com and will be available for replay for seven days.

In conjunction with this earnings announcement, UniSource Energy has provided detailed information on its performance during 2010 and outlook for 2011. These materials have been filed with the Securities and Exchange Commission and are also available at uns.com.

UniSource Energy is a Tucson, Arizona-based company with consolidated assets of approximately $3.8 billion. UniSource Energy's primary subsidiaries include Tucson Electric Power, which serves more than 402,000 customers in southern Arizona, and UniSource Energy Services, provider of natural gas and electric service for about 237,000 customers in northern and southern Arizona. Visit uns.com for more information about UniSource Energy and its subsidiaries.

This release contains forward-looking information that involves risks and uncertainties, including factors that could affect UniSource Energy's ability to reach the 2011 earnings guidance. These risks and uncertainties include, but are not limited to: state and federal regulatory and legislative decisions and actions; regional economic and market conditions, which could affect customer growth and energy usage; weather variations affecting energy usage; the cost of debt and equity capital and access to capital markets; the performance of the stock market and changing interest rate environment, which affect the value of the company’s pension and other postretirement benefit plan assets and the related contribution requirements and expense; unexpected increases in O&M expense; resolution of pending litigation matters; changes in accounting standards; changes in critical accounting estimates; the ongoing restructuring of the electric industry; changes to long-term contracts; the cost of fuel and power supplies; performance of TEP's generating plants; and other factors listed in UniSource Energy's Form 10-K and 10-Q filings with the Securities and Exchange Commission. The preceding factors may cause future results to differ materially from outcomes currently expected by UniSource Energy.