Required

1. What are Johnsons options regarding how he might respond to the issues raised by Relzo?

2. Items 1 and 3 deal specifically with revenue and expense recognition in the income statement. What principles and guidelines govern when and how each of these items should be recorded?

3. Relzo raises issues with the consistent application of accounting methods (item 4) and the consistent classification of certain line items (item 5). Do you think it is within the rights of a company to vary accounting methods and reclassify certain line items?

Pitt Financial Corporation 1607 Lower 5th Avenue New York, NY 15003 February 23, 2017 Mr. Ward Johnson Chief Financial Officer Lone Star Power, Inc. 230 Lone Star Way McCullian, Texas 78324 Dear Mr. Johnson: I write this letter with some trepidation as it is usually not my style to openly question a company's financial report- ing practices. My job, as you well know, is to objectively analyze a company through its public communications and to then state my conclusion regarding the merits of an investing strategy. I have followed your company for nearly five years and am increasingly concerned that your reported financial results do not reflect the actual underlying performance of your firm. Much of my concern comes from what was communicated through your company's most recent 10-K filing and from what I know to be trends in your business. Unfortunately, there were numerous areas of unnecessary ambiguity in your latest report. Below are six specific examples I bring to your attention. These examples are chosen because they capture each of six items I find important in firms' financial reporting policies: (1) revenue recognition across periods, (2) consistent application of accounting policies, (3) cost allocation across periods, (4) classification of reported line items, (5) supplemental interpretive guidance from management, and (6) interim voluntary disclosures. I think you can understand that my reports are more favorable toward companies that meet a high standard of reporting on these dimensions, if for no other reason than I do not have to discount for significant uncertainties In your most recent 10-K your company's revenue recognition policy is described as "revenue is recog- nized based upon services rendered to customers during each accounting period." This is quite generic, 1. of course, and I believe there are trends in your business that warrant elaboration. a. From your own segment disclosure, your Business Sales Division represents a large share of opera- tions. Past conversations I have had with your staff reveal that a large chunk of the contracts in this division represent equipment sales, with the remainder ongoing service revenue contracted at the time of sale. This most recent quarter, conveniently, you have met your projected revenue growth of 4% for this segment, but I also note that accounts receivable have risen 25% over this time. I was hoping the MD&A would have provided some elaboration, but it merely listed these percentage changes. b. I know from conversations with some of your customers that in December there were significant discounts given for their prompt signing of a contract. Was there indeed a push-through of January 2017 contracts to boost 2016 revenue? I believe that in some cases the equipment portion of a contract with both an ongoing service com- ponent and an equipment sale was just a mere "pass-through sale" of the equipment (.e., the equip- ment was delivered and installed by the third-party vendor of that equipment). How does Lone Star c. recognize revenue for pass-through equipment sales? 2. Your MD&A states that $52 million of assets were impaired during 2015 due to a lower than expected utility rate increase during 2014. Since these losses had such a material impact on operations, why didn't the company issue a press release or 8-K disclosure describing this event in a more timely fashion? In addition, what circumstances might have led to the impairment a full year after the rate effects were known? 3. Your accounting policy for marketing and promotions indicates these costs are "expensed as incurred. Incurred costs for these items are further provided by year as $25 million, S45 million, and $20 million for 2016, 2015, and 2014, respectively. I find it odd that for the year 2015 there was the spike in both expenses and cash outlays without much of a noticeable change in your promotional policies. I can find no evidence of these items being treated as prepaid assets. Are these amounts related to the large impairments taken in 2015? Do managers at the unit level have the ability to choose their own accounting policies? In the telecommu- nications industry, for instance, AT&T uses a group method, where the depreciation rate for a specific asset group is based on the average useful life for all assets in that group. This would avoid the unintended con- sequence of department managers manipulating profits by extending useful lives and decelerating depre- ciation charges. From prior conversations, I believe that when Lone Star acquires other companies it does not convert the acquired assets to a method consistent with existing assets. You recently merged with Texas Light and Gas. In a review of their financial statements just prior to the merger, I noticed they used 4. different depreciation methods and lives than did Lone Star for similar assets. Now what is happening? 5. In response to a direct question during Lone Star's conference call, your CEO indicated that as of 2016 your company is now classifying all contract acquisition costs as an operating expense, as opposed to a net against top-line revenue. The argument made was that this would be consistent with industry disclo- sure practice. Why was this fact not addressed in your 10-K when revenue growth comparisons were made from 2015 to 2016? 6. During 2016 "net regulatory assets" increased by $75 million, the largest annual increase in the company's history. Since your operations were unaffected by acts of nature during 2016, and I know of no efficiency programs put into place during the year, how does one know that this asset growth is not the mere deferral of costs to a future period? I am scheduled to issue a report on your company by March 1. I hope by then you can find the time to address my questions. Sincerely, Marianne C. Relzo PFC Senior Vice President Pitt Financial Corporation 1607 Lower 5th Avenue New York, NY 15003 February 23, 2017 Mr. Ward Johnson Chief Financial Officer Lone Star Power, Inc. 230 Lone Star Way McCullian, Texas 78324 Dear Mr. Johnson: I write this letter with some trepidation as it is usually not my style to openly question a company's financial report- ing practices. My job, as you well know, is to objectively analyze a company through its public communications and to then state my conclusion regarding the merits of an investing strategy. I have followed your company for nearly five years and am increasingly concerned that your reported financial results do not reflect the actual underlying performance of your firm. Much of my concern comes from what was communicated through your company's most recent 10-K filing and from what I know to be trends in your business. Unfortunately, there were numerous areas of unnecessary ambiguity in your latest report. Below are six specific examples I bring to your attention. These examples are chosen because they capture each of six items I find important in firms' financial reporting policies: (1) revenue recognition across periods, (2) consistent application of accounting policies, (3) cost allocation across periods, (4) classification of reported line items, (5) supplemental interpretive guidance from management, and (6) interim voluntary disclosures. I think you can understand that my reports are more favorable toward companies that meet a high standard of reporting on these dimensions, if for no other reason than I do not have to discount for significant uncertainties In your most recent 10-K your company's revenue recognition policy is described as "revenue is recog- nized based upon services rendered to customers during each accounting period." This is quite generic, 1. of course, and I believe there are trends in your business that warrant elaboration. a. From your own segment disclosure, your Business Sales Division represents a large share of opera- tions. Past conversations I have had with your staff reveal that a large chunk of the contracts in this division represent equipment sales, with the remainder ongoing service revenue contracted at the time of sale. This most recent quarter, conveniently, you have met your projected revenue growth of 4% for this segment, but I also note that accounts receivable have risen 25% over this time. I was hoping the MD&A would have provided some elaboration, but it merely listed these percentage changes. b. I know from conversations with some of your customers that in December there were significant discounts given for their prompt signing of a contract. Was there indeed a push-through of January 2017 contracts to boost 2016 revenue? I believe that in some cases the equipment portion of a contract with both an ongoing service com- ponent and an equipment sale was just a mere "pass-through sale" of the equipment (.e., the equip- ment was delivered and installed by the third-party vendor of that equipment). How does Lone Star c. recognize revenue for pass-through equipment sales? 2. Your MD&A states that $52 million of assets were impaired during 2015 due to a lower than expected utility rate increase during 2014. Since these losses had such a material impact on operations, why didn't the company issue a press release or 8-K disclosure describing this event in a more timely fashion? In addition, what circumstances might have led to the impairment a full year after the rate effects were known? 3. Your accounting policy for marketing and promotions indicates these costs are "expensed as incurred. Incurred costs for these items are further provided by year as $25 million, S45 million, and $20 million for 2016, 2015, and 2014, respectively. I find it odd that for the year 2015 there was the spike in both expenses and cash outlays without much of a noticeable change in your promotional policies. I can find no evidence of these items being treated as prepaid assets. Are these amounts related to the large impairments taken in 2015? Do managers at the unit level have the ability to choose their own accounting policies? In the telecommu- nications industry, for instance, AT&T uses a group method, where the depreciation rate for a specific asset group is based on the average useful life for all assets in that group. This would avoid the unintended con- sequence of department managers manipulating profits by extending useful lives and decelerating depre- ciation charges. From prior conversations, I believe that when Lone Star acquires other companies it does not convert the acquired assets to a method consistent with existing assets. You recently merged with Texas Light and Gas. In a review of their financial statements just prior to the merger, I noticed they used 4. different depreciation methods and lives than did Lone Star for similar assets. Now what is happening? 5. In response to a direct question during Lone Star's conference call, your CEO indicated that as of 2016 your company is now classifying all contract acquisition costs as an operating expense, as opposed to a net against top-line revenue. The argument made was that this would be consistent with industry disclo- sure practice. Why was this fact not addressed in your 10-K when revenue growth comparisons were made from 2015 to 2016? 6. During 2016 "net regulatory assets" increased by $75 million, the largest annual increase in the company's history. Since your operations were unaffected by acts of nature during 2016, and I know of no efficiency programs put into place during the year, how does one know that this asset growth is not the mere deferral of costs to a future period? I am scheduled to issue a report on your company by March 1. I hope by then you can find the time to address my questions. Sincerely, Marianne C. Relzo PFC Senior Vice President