To: Editors, News Directors

Date: April 30, 2004

For: Immediate Release

Staff Testimony Filed in UniSource’s Bid to Change Ownership Structure
Staff: Insufficient Protections to Ensure Safe, Reliable Utility Service

PHOENIX – Staff from the Arizona Corporation Commission filed testimony in the UniSource Energy Corporation Reorganization docket today. UniSource is the parent company of Tucson Electric Power and UniSource Energy Services. These two subsidiaries are regulated by the Arizona Corporation Commission and provide electric or natural gas utility service to 550,000 customers in Arizona.

To help familiarize you with key issues related to this case, the Commission has prepared the following Question & Answer document.

What has transpired up to this point?

UniSource filed an application on December 29, 2003 to be acquired by Saguaro Utility Group. The application from the company indicates that Saguaro Utility Group’s general partner is Sage Mountain LLC, an Arizona company managed and owned by Frederick Rentschler, former president and CEO of Armour-Dial, Beatrice Companies and Northwest Airlines. The group’s limited partners are investment funds affiliated with Kohlberg Kravis Roberts & Company, J.P. Morgan Partners and Wachovia Capital Partners, according to UniSource documents.

The case has been assigned to an administrative law judge. The judge has approved the involvement of certain groups such as the Residential Utility Consumer Office (RUCO), the Arizona Utility Investors Association (AUIA) and others. Collectively, these groups and individuals are called "intervenors" and have been granted the legal status to file testimony and cross-examine witnesses during the case.

Staff, intervenors and UniSource have participated in a "discovery period" during which specific documents that could be meaningful to the case are requested.

Commission staff members and an outside expert with experience in utility mergers and acquisitions have conducted an analysis of the structure of the transaction and the policy implications of the reorganization.

What is the procedural significance of staff’s testimony?

Staff’s testimony represents the first response to the reorganization plan. It also represents the first opportunity to see what Staff’s litigation position will be as we progress toward the June 21, 2004 hearing.

Will the Commission make a decision at the June 21 hearing?

No. The hearing will be presided over by an administrative law judge. She will hear testimony from each of the parties, ask questions and listen to the cross-examination of the expert witnesses. The process is comparable to a judge presiding over a court case. After the hearing and any briefing cycle that the judge requests, she will review the transcripts and testimony and draft a Recommended Opinion and Order (ROO). The Commissioners make the final decision at a future, public Open Meeting.

Will the Commissioners attend the hearing?

Schedules permitting, the Commissioners are expected to attend all or portions of the hearings.

What were the primary focus areas/issues for Staff’s testimony?

Staff’s testimony focuses on two key issues: the structure of the organization and the resulting risk exposure presented to the two regulated utilities.

Staff has concluded that the proposed transaction is not in the public interest. Although the transaction provides immediate benefit to the new investors, existing shareholders and senior management of UniSource, the transaction introduces a new level of risk to the regulated utilities, according to Staff. Staff concludes that the buyout, as proposed, could impair the financial status of the regulated utility.

UniSource, already heavily burdened by debt, could be forced to take on new and greater debts, according to the testimony. If the parent company is debt-laden and the utility subsidiary is still delivering steady cash flow, Staff contends that the parent could look to Tucson Electric Power as a "cash cow" and seek to draw profits from it.

Leveraged buyouts, Staff contends, typically result in major pressure to cut costs. The transaction contains no enforceable protections against reductions that would be inappropriate to maintaining safe, reliable and adequate electric service.

Absent specific commitments to protect utility customers in the future, Staff does not believe the deal should be consummated.

The Staff’s testimony also cites concerns over the acquiring partners’ ability or experience in managing the day-to-day operations of a regulated utility. The ownership structure could hamper the ability of local management to address routine management functions and timely respond to the concerns of the Commission. UniSource’s application and testimony also fails to adequately address what would happen if the group takes on a new general partner.

Other concerns addressed in Staff’s testimony include:

• As proposed, the transaction does not provide strict limits on the ability of the partnership to make additional unrelated investments without Commission approval.
• The transaction does not contain agreements not to transfer without prior approval of the Commission, ownership of the entity that forms the general partner or not to transfer the interest of the limited partners. In effect, the people and players could change without Commission review.
• The proposal fails to address potential conflicts of interest due to particular business activities of the limited partners. The transaction does not contain clear limits on and regular reporting of affiliate transactions.
• The deal lacks firm commitments regarding Commission access to books and records and also lacks firm commitments regarding issues such as community support or headquarters location.

Does the ACC Staff’s testimony give any suggestions of how to remedy their concerns?

Yes. John Antonuk, an expert witness with experience in mergers, acquisitions and leveraged buyouts, outlines several potential "fixes" in his testimony. The company could come forward with remedies and assurances that adequately address the above concerns and others outlined in the testimony.

On the issue of protecting the assets and equity of the regulated utilities, Antonuk indicated that the transaction could be "ring fenced" to protect utility customers. Ring fencing is the financial equivalent of putting up a firewall between the holding company and one or more of its subsidiaries. Ring fencing would ensure that once TEP’s equity reaches 40 percent, it could not be diminished in any way.

What happens next?

In a procedural order dated February 6, 2004, UniSource is directed to submit testimony in response to Staff and/or intervenor testimony by May 25, 2004. The staff and intervenors will make one more filing on June 11, 2004 in response to UniSource’s rebuttal testimony. You can view the procedural orders and other important documents, including Staff’s testimony online at http://www.cc.state.az.us/utility/electric/uecr.htm.

I’m not a party or intervenor. Is there a way I can comment on the case?

The Commission is planning a series of public comment sessions and will be making stops in Lake Havasu City, Kingman, Prescott, Nogales and Tucson. Final details are being worked out. A separate news release announcing the dates, times and locations will be issued shortly. Public comment may also be submitted by mail or on-line. In addition, on the day of the hearing, the administrative law judge will allow time for public comment.

Public Comment by Mail

If you cannot attend the hearing or public comment sessions, the Commission encourages the timely submission of written comments. Submit comments to the Docket Control Center and they will be distributed to all registered parties or intervenors. Be sure to reference the docket numbers to ensure that your comments are properly catalogued and referenced.

Arizona Corporation Commission
Docket Control Center
1200 West Washington
Phoenix, AZ 85007

Docket Number: E-04230A-03-0933

Electronic Public Comment

You may also comment through the Commission’s "Can We Help You" page on the Utilities Division website. Be sure to include the docket number listed above. For instructions on filing electronic public comment, click on http://www.cc.state.az.us/utility/cons/index.htm.

When might the Commission rule on this case?

UniSource has expressed a desire to have the Commission rule on its application by the end of August 2004. There are still several important dates and procedural steps so it is too soon to tell whether that time frame is realistic.