NATURE OF OPERATIONS AND FINANCIAL STATEMENT PRESENTATION

Tucson Electric Power Company (TEP) is a regulated utility that generates, transmits and distributes electricity to approximately 415,000 retail electric customers in a 1,155 square mile area in southeastern Arizona. TEP also sells electricity to other utilities and power marketing entities, located primarily in the western United States. In addition, TEP operates Springerville Generating Station (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). TEP is a wholly owned subsidiary of UNS Energy Corporation (UNS Energy), a utility services holding company. UNS Energy is an indirect wholly owned subsidiary of Fortis Inc. (Fortis), which is a leader in the North American electric and gas utility business.

FORTIS ACQUISITION OF UNS ENERGY

On December 11, 2013, UNS Energy, the parent of TEP, announced that it had entered into an Agreement and Plan of Merger (Merger) to be acquired by Fortis for $60.25 per share of UNS Energy common stock in cash. The acquisition contemplated by this agreement was completed effective August 15, 2014.

Prior to completion of the Merger, UNS Energy obtained the approval of its shareholders, the Federal Energy Regulatory Commission (FERC), and the Arizona Corporation Commission (ACC). The ACC's approval was subject to certain stipulations, including, but not limited to, the following:


•	TEP will provide credits on retail customers' bills totaling $19 million over five years: approximately $6 million in year one and $3 million annually in years two through five. The monthly bill credits will be applied each year from October through March effective October 1, 2014;


•	TEP, along with UNS Energy and its other affiliated subsidiaries, will adopt certain ring-fencing and corporate governance provisions;


•	Dividends paid from TEP to UNS Energy cannot exceed 60 percent of TEP's annual net income for a period of five years or until such time that TEP's equity capitalization reaches 50 percent of total capital. The ratios used to determine the dividend restrictions will be calculated each calendar year and reported to the ACC annually beginning on April 1, 2016; and


•	Fortis making an equity investment totaling $220 million to UNS Energy and its regulated subsidiaries, including TEP. Following the close of the Merger, Fortis exceeded the investment requirement by contributing $37 million to UNS Energy on August 15, 2014 and $200 million to UNS Energy on October 10, 2014. On October 10, 2014, UNS Energy contributed $175 million of the investment to TEP.

As a result of the Merger being completed, TEP recorded approximately $15 million through August 2014 as its allocated share of merger-related expenses, in addition to the customer bill credits discussed above. Merger-related expenses include investment banker fees, legal expenses, and accelerated expenses for certain share-based compensation awards.

SHARE-BASED COMPENSATION EXPENSE

Completion of the Merger resulted in accelerated vesting and expense recognition of all outstanding non-vested UNS Energy share-based awards that would otherwise have been recognized over remaining vesting periods through February 2017. TEP recognized approximately $2 million of expense in the third quarter of 2014 due to the accelerated vesting of the awards. TEP recorded total share-based compensation expense of $4 million for the three months ended September 30, 2014 and $1 million for the three months ended September 30, 2013. For the nine months ended September 30, 2014 and 2013, TEP recorded $5 million and $3 million of share-based compensation expense, respectively. In August 2014, UNS Energy settled all outstanding share-based compensation awards in cash.

BASIS OF PRESENTATION

We prepared our condensed consolidated financial statements according to generally accepted accounting principles in the United States of America (GAAP) and the Securities and Exchange Commission's (SEC) interim reporting requirements. These condensed consolidated financial statements exclude some information and footnotes required by GAAP and the SEC for annual financial statement reporting. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes in our 2013 Annual Report on Form 10-K.

The condensed consolidated financial statements are unaudited, but, in management's opinion, include all recurring adjustments necessary for a fair presentation of the results for the interim periods presented. Because weather and other factors cause seasonal fluctuations in sales, our quarterly results are not indicative of annual operating results.

TEP did not reflect the impacts of acquisition accounting in its financial statements. All adjustments of assets and liabilities to fair value and the resultant goodwill associated with the Merger were recorded by FortisUS Inc., a wholly owned subsidiary of Fortis.

As a result of the Fortis Merger, TEP has elected to change its method of reporting cash flows from the direct to the indirect method to conform to the presentation method elected by Fortis. Certain amounts from prior periods have been reclassified to conform to the current period presentation.

REVISION OF PRIOR PERIOD BALANCE SHEETS

TEP revised its December 31, 2013 balance sheet to correct an error in the classification of capital lease obligations and related deferred income taxes. The correction increased current capital lease obligations and decreased noncurrent capital lease obligations by $18 million and increased current deferred tax assets and noncurrent deferred tax liabilities by $7 million. We do not believe the misclassification was material to the previously issued financial statements.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

In 2014, we adopted accounting guidance that:

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requires an entity to recognize and disclose in the financial statements its obligation from a joint and several liability arrangement as the sum of the amount the entity agreed with its co-obligors that it will pay and any additional amount the entity expects to pay on behalf of its co-obligors. The adoption of this guidance did not have a material impact on our disclosures, financial condition, results of operations, or cash flows.

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impacts the financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Although adoption and prospective application of this guidance impacted how such items are classified on our balance sheets, such change was not material. Additionally, there were no material changes in our results of operations or cash flows.