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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission Name of Registrants, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
- ----------- -------------------------------------------- ------------------
333-32170 PNM Resources, Inc. 85-0468296
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
1-6986 Public Service Company of New Mexico 85-0019030
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
Indicate by check mark whether the registrants (1) have filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrants are accelerated filers
(as defined in Rule 12b-2 of the Exchange Act). Yes X No
----- -----
As of July 30, 2004, 60,421,857 shares of common stock, no par value per
share, of PNM Resources, Inc. were outstanding.
PNM RESOURCES, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION:
Report of Independent Registered Public Accounting Firm................. 3
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
PNM Resources, Inc. and Subsidiaries
Consolidated Statements of Earnings
Three and Six Months Ended June 30, 2004 and 2003............ 5
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003.......................... 6
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2004 and 2003...................... 8
Consolidated Statements of Comprehensive Income
Three and Six Months Ended June 30, 2004 and 2003............ 10
Public Service Company of New Mexico and Subsidiaries
Consolidated Statements of Earnings
Three and Six Months Ended June 30, 2004 and 2003............ 11
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003.......................... 12
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2004 and 2003...................... 14
Consolidated Statements of Comprehensive Income
Three and Six Months Ended June 30, 2004 and 2003............ 16
Notes to Consolidated Financial Statements........................... 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............... 51
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK................................................. 77
ITEM 4. CONTROLS AND PROCEDURES........................................ 84
PART II. OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS.............................................. 84
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................... 85
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 86
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 86
Signature............................................................... 88
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of PNM Resources, Inc.
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of PNM Resources,
Inc. and subsidiaries (the "Company") as of June 30, 2004, and the related
consolidated statements of earnings, and comprehensive income for the
three-month and six-month periods ended June 30, 2004 and 2003, and of cash
flows for the six-month periods ended June 30, 2004 and 2003. These interim
consolidated financial statements are the responsibility of the Company's
management.
We conducted our reviews in accordance with 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 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 reviews, we are not aware of any material modifications that should
be made to such interim consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the consolidated interim financial statements, the
Company adopted Statement of Financial Accounting Standards No. 143, Accounting
for Asset Retirement Obligations, effective January 1, 2003. Also, as discussed
in Note 1 to the consolidated interim financial statements, during 2003, the
Company changed the actuarial valuation measurement date for the pension plan
and other post-retirement benefit plans from September 30 to December 31.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet and
consolidated statement of capitalization (not presented herein) of PNM
Resources, Inc. and subsidiaries as of December 31, 2003, and the related
consolidated statements of earnings, retained earnings, comprehensive income
(loss), and cash flows for the year then ended (not presented herein); and in
our report dated March 8, 2004 (which report includes explanatory paragraphs
referring to the adoption of Statement of Financial Accounting Standards No.
143, Accounting for Asset Retirement Obligations, effective January 1, 2003 and
the change in actuarial valuation measurement date for the pension plan and
other postretirement benefit plans from September 30 to December 31) we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying consolidated balance
sheet as of December 31, 2003 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/s/ Deloitte & Touche LLP
San Francisco, California
August 4, 2004
3
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Public Service Company of New Mexico
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of Public Service
Company of New Mexico and subsidiaries (the "Company") as of June 30, 2004, and
the related consolidated statements of earnings, and comprehensive income for
the three-month and six-month periods ended June 30, 2004 and 2003, and of cash
flows for the six-month periods ended June 30, 2004 and 2003. These interim
consolidated financial statements are the responsibility of the Company's
management.
We conducted our reviews in accordance with 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 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 reviews, we are not aware of any material modifications that should
be made to such interim consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the consolidated interim financial statements, the
Company adopted Statement of Financial Accounting Standards No. 143, Accounting
for Asset Retirement Obligations, effective January 1, 2003. Also, as discussed
in Note 1 to the consolidated interim financial statements, during 2003, the
Company changed the actuarial valuation measurement date for the pension plan
and other post-retirement benefit plans from September 30 to December 31.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet and
consolidated statement of capitalization (not presented herein) of Public
Service Company of New Mexico and subsidiaries as of December 31, 2003, and the
related consolidated statements of earnings, retained earnings, comprehensive
income (loss), and cash flows for the year then ended (not presented herein);
and in our report dated March 8, 2004, (which report includes explanatory
paragraphs referring to the adoption of Statement of Financial Accounting
Standards No. 143, Accounting for Asset Retirement Obligations, effective
January 1, 2003 and the change in actuarial valuation measurement date for the
pension plan and other postretirement benefit plans from September 30 to
December 31) we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 2003 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
/s/ Deloitte & Touche LLP
San Francisco, California
August 4, 2004
4
ITEM 1. FINANCIAL STATEMENTS
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
(In thousands, except per share amounts)
Operating Revenues:
Electric................................... $284,599 $266,150 $552,127 $507,528
Gas........................................ 80,886 59,520 256,760 203,706
Other...................................... 128 52 379 112
-------------- -------------- -------------- --------------
Total operating revenues................. 365,613 325,722 809,266 711,346
-------------- -------------- -------------- --------------
Operating Expenses:
Cost of energy sold........................ 208,737 160,846 478,504 384,713
Administrative and general................. 42,575 42,600 82,949 74,642
Energy production costs.................... 36,688 34,515 74,242 69,609
Depreciation and amortization.............. 26,431 28,850 52,568 57,224
Transmission and distribution costs........ 14,150 15,194 29,642 31,353
Taxes, other than income taxes............. 8,262 6,720 17,746 14,506
Income taxes............................... 6,506 7,083 17,817 15,959
-------------- -------------- -------------- --------------
Total operating expenses................. 343,349 295,808 753,468 648,006
-------------- -------------- -------------- --------------
Operating income......................... 22,264 29,914 55,798 63,340
-------------- -------------- -------------- --------------
Other Income and Deductions:
Other income............................... 10,590 12,745 22,178 23,951
Other deductions........................... (614) (4,020) (3,986) (21,932)
Income tax expense......................... (3,190) (3,132) (6,186) (725)
-------------- -------------- -------------- --------------
Net other income and deductions.......... 6,786 5,593 12,006 1,294
Interest Charges............................. 12,055 17,764 25,884 35,997
Preferred Stock Dividend Requirements
of Subsidiary............................. 146 147 293 293
-------------- -------------- -------------- --------------
Net Earnings Before Cumulative Effect of
Changes in Accounting Principles.......... 16,849 17,596 41,627 28,344
Cumulative Effect of Changes in Accounting
Principles, Net of Tax of $23,999......... - - - 36,621
-------------- -------------- -------------- --------------
Net Earnings................................. $ 16,849 $ 17,596 $ 41,627 $ 64,965
============== ============== ============== ==============
Net Earnings per Common Share:
Basic...................................... $ 0.28 $ 0.30 $ 0.69 $ 1.10
============== ============== ============== ==============
Diluted.................................... $ 0.28 $ 0.30 $ 0.68 $ 1.09
============== ============== ============== ==============
Dividends Paid per Common Share.............. $ 0.16 $ 0.15 $ 0.31 $ 0.30
============== ============== ============== ==============
The accompanying notes are an integral part of these
financial statements.
5
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------------ -----------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service......................................... $2,420,781 $2,419,162
Gas plant in service.............................................. 633,552 630,949
Common plant in service and plant held for future use............. 55,971 48,735
------------------ -----------------
3,110,304 3,098,846
Less accumulated depreciation and amortization.................... 1,107,814 1,063,645
------------------ -----------------
2,002,490 2,035,201
Construction work in progress..................................... 172,456 133,317
Nuclear fuel, net of accumulated amortization of
$16,032 and $15,995........................................... 25,511 25,917
------------------ -----------------
Net utility plant............................................... 2,200,457 2,194,435
------------------ -----------------
Other Property and Investments:
Investment in lessor notes........................................ 319,080 330,339
Other investments................................................. 123,499 114,273
Non-utility property, net of accumulated depreciation of
$1,782 and $1,755............................................. 1,428 1,455
------------------ -----------------
Total other property and investments............................ 444,007 446,067
------------------ -----------------
Current Assets:
Cash and cash equivalents......................................... 5,646 12,694
Accounts receivables, net of allowance for uncollectible
accounts of $9,284 and $9,284................................. 52,888 68,258
Unbilled revenues................................................. 70,555 82,899
Other receivables................................................. 53,196 47,042
Inventories....................................................... 38,866 40,799
Regulatory assets................................................. 3,863 15,436
Other current assets.............................................. 52,292 38,835
------------------ -----------------
Total current assets............................................ 277,306 305,963
------------------ -----------------
Deferred Charges:
Regulatory assets................................................. 211,093 215,416
Prepaid benefit costs............................................. 85,814 85,782
Other deferred charges............................................ 127,409 130,966
------------------ -----------------
Total deferred charges.......................................... 424,316 432,164
------------------ -----------------
$3,346,086 $3,378,629
================== =================
The accompanying notes are an integral part of these
financial statements.
6
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------------ ------------------
CAPITALIZATION AND LIABILITIES (In thousands)
Capitalization:
Common Stockholders' Equity:
Common stock.............................................. $ 640,739 $ 647,722
Accumulated other comprehensive loss, net of tax.......... (69,867) (73,487)
Retained earnings......................................... 525,364 503,069
------------------ ------------------
Total common stockholders' equity...................... 1,096,236 1,077,304
Cumulative preferred stock without mandatory
redemption requirements................................. 12,800 12,800
Long-term debt, less current maturities...................... 985,346 987,210
------------------ ------------------
Total capitalization................................... 2,094,382 2,077,314
------------------ ------------------
Current Liabilities:
Short-term debt............................................... 62,476 125,918
Accounts payable............................................... 63,239 86,155
Accrued interest and taxes..................................... 51,687 23,477
Other current liabilities...................................... 112,040 110,031
------------------ ------------------
Total current liabilities.............................. 289,442 345,581
------------------ ------------------
Deferred Credits:
Accumulated deferred income taxes.............................. 256,681 250,098
Accumulated deferred investment tax credits.................... 36,911 38,462
Regulatory liabilities......................................... 316,953 316,384
Asset retirement obligations................................... 48,393 46,416
Minimum pension liability...................................... 128,825 128,825
Accrued post-retirement benefit costs.......................... 20,347 20,638
Other deferred credits......................................... 154,152 154,911
------------------ ------------------
Total deferred credits.................................. 962,262 955,734
------------------ ------------------
$3,346,086 $3,378,629
================== ==================
The accompanying notes are an integral part of these
financial statements.
7
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-------------------------------
2004 2003
-------------- --------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings............................................................. $ 41,627 $64,965
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization......................................... 67,095 70,604
Allowance for equity funds used during construction................... (318) (760)
Accumulated deferred income tax....................................... 2,473 22,644
Transition costs write-off............................................ - 16,720
Cumulative effect of a change in accounting principle................. - (60,620)
Net unrealized gains on marketing contracts and investments........... (4,557) (4,167)
Changes in certain assets and liabilities:
Accounts receivable................................................... 15,369 (9,128)
Unbilled revenues..................................................... 12,344 9,189
Accrued post-retirement benefit costs................................. (323) (19,440)
Other assets.......................................................... 3,713 1,580
Accounts payable...................................................... (24,987) (48,144)
Accrued interest and taxes............................................ 28,211 25,586
Other liabilities..................................................... (8,159) (8,693)
-------------- --------------
Net cash flows from operating activities............................ 132,488 60,336
-------------- --------------
Cash Flows From Investing Activities:
Utility plant additions.................................................. (55,611) (67,519)
Nuclear fuel additions................................................... (4,600) (4,035)
Utility plant additions related to allowance for borrowed funds used
during construction and capitalized interest.......................... (1,519) (418)
Combustion turbine payments.............................................. - (11,136)
Redemption of available-for-sale investments............................. - 80,291
Redemption of other investments.......................................... 10,031 -
Bond purchase............................................................ - (6,675)
Return of principal of PVNGS lessor notes................................ 10,274 9,406
Other investing.......................................................... (6,991) (4,604)
-------------- --------------
Net cash flows from investing activities............................ (48,416) (4,690)
-------------- --------------
8
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-------------------------------
2004 2003
-------------- --------------
(In thousands)
Cash Flows From Financing Activities:
Short-term borrowings (repayment), net............................. (63,442) 24,134
Long-term borrowings............................................... - 182,000
Long-term debt repayments.......................................... - (208,152)
Refund costs of pollution control bonds............................ - (31,427)
Exercise of employee stock options................................. (7,444) (5,032)
Dividends paid..................................................... (19,216) (17,902)
Other financing.................................................... (1,018) (330)
-------------- --------------
Net cash flows from financing activities...................... (91,120) (56,709)
-------------- --------------
Decrease in Cash and Cash Equivalents................................ (7,048) (1,063)
Beginning of Period.................................................. 12,694 3,702
-------------- --------------
End of Period........................................................ 5,646 2,639
============== ==============
Supplemental Cash Flow Disclosures:
Interest paid, net of capitalized interest......................... $ 23,555 $ 36,522
============== ==============
Income taxes (refunded), net....................................... $ (5,508) $(10,657)
============== ==============
Pension contribution of PNM Resources, Inc. common shares.......... $ - $ 28,950
============== ==============
The accompanying notes are an integral part of these
financial statements.
9
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(In thousands)
Net Earnings.......................................... $ 16,849 $ 17,596 $ 41,627 $ 64,965
------------ ------------ ------------ ------------
Other Comprehensive Income, net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) during
the period, net of tax of $(48), $(952),
$(326) and $(572).............................. 74 1,452 497 873
Reclassification adjustment for amounts
included in net income, net of tax of $257,
$19, $435 and $324............................. (392) (29) (664) (494)
Minimum pension liability adjustment,
net of tax of $(12)............................. - - 19 -
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of designated
cash flow hedges, net of tax of $(1,342),
$(8,540), $(2,678), and $(7,748)................ 2,048 13,031 4,087 11,823
Reclassification adjustment for amounts in
net income, net of tax of $(430) and $209....... 657 - (319) -
------------ ------------ ------------ ------------
Total Other Comprehensive Income...................... 2,387 14,454 3,620 12,202
------------ ------------ ------------ ------------
Total Comprehensive Income............................ $ 19,236 $ 32,050 $ 45,247 $ 77,167
============ ============ ============ ============
The accompanying notes are an integral part of
these financial statements.
10
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- ---------------
(In thousands, except per share amounts)
Operating Revenues:
Electric................................... $284,599 $266,150 $552,127 $507,528
Gas........................................ 80,886 59,520 256,760 203,706
-------------- -------------- -------------- ---------------
Total operating revenues................. 365,485 325,670 808,887 711,234
-------------- -------------- -------------- ---------------
Operating Expenses:
Cost of energy sold........................ 208,734 160,846 478,431 384,713
Administrative and general................. 44,985 38,457 84,019 71,216
Energy production costs.................... 36,688 34,515 74,242 69,609
Depreciation and amortization.............. 25,824 28,551 51,440 56,484
Transmission and distribution costs........ 14,150 15,194 29,642 32,453
Taxes, other than income taxes............. 7,719 6,547 16,282 15,248
Income taxes............................... 5,706 8,910 18,021 17,111
-------------- -------------- -------------- ---------------
Total operating expenses................. 343,806 293,020 752,077 646,834
-------------- -------------- -------------- ---------------
Operating income......................... 21,679 32,650 56,810 64,400
-------------- -------------- -------------- ---------------
Other Income and Deductions:
Other income............................... 10,519 11,597 21,785 22,090
Other deductions........................... (274) (962) (1,591) (19,443)
Income tax expense......................... (3,296) (3,888) (6,978) (974)
-------------- -------------- -------------- ---------------
Net other income and deductions.......... 6,949 6,747 13,216 1,673
Interest Charges............................. 12,691 17,738 26,585 35,325
-------------- -------------- -------------- ---------------
Net Earnings Before Cumulative Effect of
Changes in Accounting Principles.......... 15,937 21,659 43,441 30,748
Cumulative Effect of Changes in Accounting
Principles, Net of Tax of $23,999......... - - - 36,621
-------------- -------------- -------------- ---------------
Net Earnings................................. 15,937 21,659 43,441 67,369
Preferred Stock Dividend Requirements........ 146 147 293 293
-------------- -------------- -------------- ---------------
Net Earnings Available for Common........... $ 15,791 $ 21,512 $ 43,148 $ 67,076
============== ============== ============== ===============
The accompanying notes are an integral part of these
financial statements.
11
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------------ -----------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service...................................... $2,420,781 $ 2,419,162
Gas plant in service........................................... 633,552 630,949
Common plant in service and plant held for future use.......... 12,310 10,997
------------------ -----------------
3,066,643 3,061,108
Less accumulated depreciation and amortization................. 1,099,209 1,055,251
------------------ -----------------
1,967,434 2,005,857
Construction work in progress.................................. 165,073 120,340
Nuclear fuel, net of accumulated amortization of
$16,032 and $15,995........................................ 25,511 25,917
------------------ -----------------
Net utility plant............................................ 2,158,018 2,152,114
------------------ -----------------
Other Property and Investments:
Investment in lessor notes.................................... 319,080 330,339
Other investments.............................................. 109,901 91,273
Non-utility property........................................... 966 966
------------------ -----------------
Total other property and investments......................... 429,947 422,578
------------------ -----------------
Current Assets:
Cash and cash equivalents...................................... 4,989 11,607
Accounts receivables, net of allowance for uncollectible
accounts of $9,284 and $9,284.............................. 52,888 68,258
Unbilled revenues.............................................. 70,555 82,899
Other receivables.............................................. 51,147 45,814
Notes receivable from parent................................... 7,500 -
Inventories.................................................... 38,850 40,791
Regulatory assets.............................................. 3,863 15,436
Other current assets........................................... 47,418 28,089
------------------ -----------------
Total current assets......................................... 277,210 292,894
------------------ -----------------
Deferred Charges:
Regulatory assets.............................................. 211,093 215,416
Prepaid benefit costs.......................................... 85,814 85,782
Other deferred charges......................................... 126,457 130,520
------------------ -----------------
Total current assets......................................... 423,364 431,718
------------------ -----------------
$3,288,539 $ 3,299,304
================== =================
The accompanying notes are an integral part of these
financial statements.
12
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------------ ------------------
CAPITALIZATION AND LIABILITIES (In thousands)
Capitalization:
Common Stockholder's Equity:
Common stock.............................................. $ 195,589 $ 195,589
Additional paid-in capital................................ 556,608 556,608
Accumulated other comprehensive (loss), net of tax........ (69,867) (73,487)
Retained earnings......................................... 345,737 302,589
------------------ ------------------
Total common stockholder's equity...................... 1,028,067 981,299
Cumulative preferred stock without mandatory
redemption requirements................................. 12,800 12,800
Long-term debt, less current maturities...................... 986,648 987,210
------------------ ------------------
Total capitalization................................... 2,027,515 1,981,309
------------------ ------------------
Current Liabilities:
Short-term debt.............................................. 62,500 124,900
Accounts payable............................................. 64,757 78,313
Accounts payable to parent................................... 56,504 73,571
Accrued interest and taxes................................... 34,137 8,879
Other current liabilities.................................... 89,409 83,823
------------------ ------------------
Total current liabilities.............................. 307,307 369,486
------------------ ------------------
Deferred Credits:
Accumulated deferred income taxes.............................. 252,865 246,282
Accumulated deferred investment tax credits.................... 36,911 38,462
Regulatory liabilities......................................... 316,953 316,384
Asset retirement obligation.................................... 48,393 46,416
Minimum pension liability...................................... 128,825 128,825
Accrued post-retirement benefit costs.......................... 20,347 20,638
Other deferred credits......................................... 149,423 151,502
------------------ ------------------
Total deferred credits...................................... 953,717 948,509
------------------ ------------------
$ 3,288,539 $ 3,299,304
================== ==================
The accompanying notes are an integral part of these
financial statements.
13
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------------------
2004 2003
-------------- --------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings available for common......................................... $43,148 $67,076
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization.......................................... 65,941 69,176
Allowance for equity funds used during construction.................... (307) (760)
Accumulated deferred income tax........................................ 2,473 22,644
Transition costs write-off............................................. - 16,720
Cumulative effect of a change in accounting principle.................. - (60,620)
Net unrealized losses on marketing contracts and investments........... (4,557) (4,167)
Changes in certain assets and liabilities:
Accounts receivable.................................................... 15,369 (9,128)
Unbilled revenues...................................................... 12,344 9,189
Accrued post-retirement benefit costs.................................. (323) (19,440)
Other assets........................................................... 9,208 4,581
Accounts payable....................................................... (15,628) (44,607)
Accrued interest and taxes............................................. 25,259 21,113
Other liabilities...................................................... (5,492) (17,077)
-------------- --------------
Net cash flows from operating activities............................. 147,435 54,700
-------------- --------------
Cash Flows From Investing Activities:
Utility plant additions................................................... (54,527) (63,628)
Nuclear fuel additions.................................................... (4,600) (4,035)
Utility plant additions related to allowance for borrowed funds used
during construction and capitalized interest........................... (1,371) (418)
Combustion turbine payments............................................... - (11,136)
Eastern Interconnect Project buyout....................................... - (37,388)
Purchase of bond investments.............................................. (12,247) -
Return of principal of PVNGS lessor notes................................. 10,274 9,406
Other investing........................................................... (4,145) 670
-------------- --------------
Net cash flows from investing activities............................. (66,616) (106,529)
-------------- --------------
14
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------------------
2004 2003
-------------- --------------
(In thousands)
Cash Flows From Financing Activities:
Short-term borrowings (repayments), net............................ (62,400) 22,090
Long-term debt borrowings.......................................... - 182,000
Long-term debt repayments.......................................... - (182,000)
Refund costs of pollution control bonds............................ - (31,427)
Equity contribution from parent.................................... - 110,000
Dividends paid..................................................... (293) (293)
Other financing.................................................... (177) (327)
Change in intercompany accounts.................................... (24,567) (47,146)
-------------- --------------
Net cash flows from financing activities...................... (87,437) 52,897
-------------- --------------
Increase (decrease) in Cash and Cash Equivalents................... (6,618) 1,068
Beginning of Period................................................ 11,607 3,094
-------------- --------------
End of Period...................................................... $ 4,989 $ 4,162
============== ==============
Supplemental Cash Flow Disclosures:
Interest paid, net of capital interest............................. $25,272 $35,858
============== ==============
Income taxes (refunded), net....................................... $ (2,749) $ (4,092)
============== ==============
The accompanying notes are an integral part of these
financial statements.
15
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -------------------------
2004 2003 2004 2003
----------- ----------- ------------- -----------
(In thousands)
Net Earnings Available for Common.......................... $ 15,791 $ 21,512 $ 43,148 $ 67,076
----------- ----------- ------------- -----------
Other Comprehensive Income, net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) during the
period, net of tax of $(48), $(826), $(326)
and $(797) ........................................ 74 1,260 497 1,216
Reclassification adjustment for amounts
included in net income, net of tax of $257, $19,
$435 and $28....................................... (392) (29) (664) (43)
Minimum pension liability adjustment,
net of tax of $(12)................................ - - 19 -
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of designated cash
flow hedges, net of tax of $(1,342), $(7,611),
$(2,678) and $(6,820).............................. 2,048 11,614 4,087 10,407
Reclassification adjustment for amounts in net
income, net of tax benefit of $(430), and $209..... 657 - (319) -
----------- ----------- ------------- -----------
Total Other Comprehensive Income........................... 2,387 12,845 3,620 11,580
----------- ----------- ------------- -----------
Total Comprehensive Income................................. $ 18,178 $ 34,357 $ 46,768 $ 78,656
=========== =========== ============= ===========
The accompanying notes are an integral part of
these financial statements.
16
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Accounting Policies and Responsibility for Financial Statements
In the opinion of the management of PNM Resources, Inc. (the "Holding
Company") and Subsidiaries and Public Service Company of New Mexico and
Subsidiaries ("PNM") (collectively, the "Company") the accompanying unaudited
interim consolidated financial statements reflect all normal and recurring
accruals and adjustments which are necessary to present fairly the Company's
financial position at June 30, 2004 and December 31, 2003, the consolidated
results of its operations and comprehensive income for the three and six months
ended June 30, 2004 and 2003 and the consolidated statements of cash flows for
the six months ended June 30, 2004 and 2003. These consolidated financial
statements are unaudited, and certain information and note disclosures normally
included in the Company's annual consolidated financial statements have been
condensed or omitted, as permitted under the applicable rules and regulations.
Readers of these financial statements should refer to the Company's audited
consolidated financial statements and notes thereto for the year ended December
31, 2003, that are included in the Company's Annual Reports on Form 10-K for the
year ended December 31, 2003. The results of operations presented in the
accompanying financial statements are not necessarily representative of
operations for an entire year.
Presentation
The Notes to Consolidated Financial Statements of the Company are
presented on a combined basis. The business of PNM constitutes substantially all
of the business of the Holding Company and Subsidiaries. Therefore, the
financial results and results of operations of PNM are virtually identical to
the consolidated results of the Holding Company and all its subsidiaries. For
discussion purposes, this report will use the term "Company" when discussing
matters of common applicability to the Holding Company and PNM. Readers of the
Notes to Consolidated Financial Statements should assume that the information
presented applies to the consolidated results of operations and financial
position of both the Holding Company and its subsidiaries and PNM, except where
the context or references clearly indicate otherwise. Discussions regarding
specific contractual obligations generally reference the company that is legally
obligated. In the case of contractual obligations of PNM, these obligations are
consolidated with the Holding Company and its subsidiaries under generally
accepted accounting principles ("GAAP"). Broader operational discussions refer
to the Company.
Certain amounts in the 2003 consolidated financial statements and notes
have been reclassified to conform to the 2004 financial statement presentation.
Decommissioning Costs
Accounting for decommissioning costs for nuclear and fossil-fuel
generation involves significant estimates related to costs to be incurred many
years in the future after plant closure. Changes in these estimates could
significantly impact the Company's financial position, results of operation and
cash flows. The Company owns and leases nuclear and fossil-fuel facilities that
are within and outside of its retail service areas. The Company adopted the
17
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
accounting requirements of Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("SFAS 143") on January 1, 2003.
Under SFAS 143, the Company is only required to recognize and measure
decommissioning liabilities for tangible long-lived assets for which a legal
obligation exists. Adoption of the statement changed the Company's method of
accounting for both nuclear generation decommissioning and fossil fuel
generation decommissioning. Nuclear decommissioning costs are based on
site-specific estimates of the costs for removing all radioactive and other
structures at the site. PVNGS Unit 3 is currently excluded from the Company's
retail rates base while Units 1 and 2 are included in the Company's retail
rates. The Company collects a provision for ultimate decommissioning of Units 1
and 2 in its rates and recognizes a corresponding expense and liability for
these amounts. The Company believes that it will continue to be able to collect
for its legal asset retirement obligations for nuclear and fossil-fuel
generation activities included in the ratemaking process.
Upon implementation of SFAS 143 in 2003 the net difference between the
amounts determined to represent legal AROs under SFAS 143 and the Company's
previous method of accounting for decommissioning costs was recognized as a
cumulative effect of a change in accounting principle, increasing earnings by
$37.4 million, net of related income tax expense of $24.5 million.
Pension and Other Post-retirement Benefits
In 2003, the Company changed the actuarial valuation measurement date for
the pension plan and other post-retirement benefits from September 30 to
December 31 to better reflect the actual pension balances as of the Company's
balance sheet dates and recognized a cumulative effect of a change in accounting
principle decreasing earnings by $0.8 million, net of income tax benefit of $0.5
million.
Stock Options
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the exercise price of the granted stock option.
Restricted stock is recorded as compensation cost over the requisite vesting
periods based on the market value on the date of grant.
Statement of Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS 123") established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based
employee compensation plans. The Company has elected to retain the intrinsic
value method of accounting as described above, and has adopted the disclosure
requirements of SFAS 123 only.
18
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At June 30, 2004, the Company had three stock-based employee compensation
plans. Options continue to be granted under only two of these plans. Had
compensation expense for the Company's stock options been recognized based on
the fair value on the grant date under the methodology prescribed by SFAS 123,
the effect on the Company's pro forma net earnings and pro forma earnings per
share would be as follows (in thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------------- -------------- ------------- -------------
Net earnings................................... $16,849 $17,596 $41,627 $64,965
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects.......... (741) (567) (1,407) (1,078)
------------- -------------- ------------- -------------
Pro forma net earnings......................... $16,108 $17,029 $40,220 $63,887
============= ============== ============= =============
Earnings per share:
Basic - as reported........................ $ 0.28 $ 0.30 $ 0.69 $ 1.10
============= ============== ============= =============
Basic - pro forma.......................... $ 0.27 $ 0.29 $ 0.67 $ 1.09
============= ============== ============= =============
Diluted - as reported...................... $ 0.28 $ 0.30 $ 0.68 $ 1.09
============= ============== ============= =============
Diluted - pro forma........................ $ 0.26 $ 0.29 $ 0.66 $ 1.08
============= ============== ============= =============
(2) Segment Information
The Holding Company is an investor-owned holding company of energy and
energy related businesses. Its principal subsidiary, PNM, is an integrated
public utility primarily engaged in the generation, transmission and
distribution of electricity; transmission, distribution and sale of natural gas
within the State of New Mexico; and the sale and marketing of electricity in the
Western United States. In addition, the Holding Company provides energy and
technology related services through its wholly-owned subsidiary, Avistar Inc.
("Avistar").
As it currently operates, the Company's principal business segments,
whose operating results are regularly reviewed by the Company's management, are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
includes Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission").
The following segment presentation is based on the methodology that the
Company's management uses for making operating decisions and assessing
performance of its various business activities. As such, the following
presentation reports operating results with regard to the effect of accounting
or regulatory changes and similar one-time items not related to normal
operations in the Corporate and Other segment.
19
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In addition, adjustments related to Emerging Issues Task Force ("EITF")
Issue 03-11 "Reporting Realized Gains and Losses on Derivative Instruments That
Are Subject to FASB Statement No. 133 and Not Held for Trading Purposes" are
included in Corporate and Other. These accounting pronouncements require a net
presentation of realized gains and loss for certain non-trading derivatives.
Management evaluates wholesale operations on a gross presentation basis due to
its net asset-backed marketing strategy and the importance the strategy places
on the Company's ability to repurchase and remarket previously sold capacity.
The Company has publicly referred to this as "velocity".
UTILITY OPERATIONS
Electric
Electric consists of the distribution and generation of electricity for
retail electric customers in New Mexico. The Company provides retail electric
service to a large area of north central New Mexico, including the cities of
Albuquerque and Santa Fe, and certain other areas of New Mexico. Current
customer rates for retail electric service are set by the New Mexico Public
Regulation Commission ("PRC") based on the provisions of an electric rate
agreement approved in January 2003.
Gas
Gas distributes natural gas to most of the major communities in New
Mexico, including two of New Mexico's three largest metropolitan areas,
Albuquerque and Santa Fe. The Company's customer base includes both
sales-service customers and transportation-service customers. PNM purchases
natural gas in the open market and resells it at cost to its sales- service
customers. As a result, increases or decreases in gas revenues resulting from
wholesale gas price fluctuations do not impact the Company's consolidated gross
margin or earnings.
Transmission
The Company owns or leases transmission lines, interconnected with other
utilities in New Mexico and south and east into Texas, west into Arizona, and
north into Colorado and Utah. Transmission revenues consist of sales to third
parties as well as to Electric and Wholesale.
WHOLESALE OPERATIONS
Wholesale consists of the generation and sale of electricity into the
wholesale market based on three product lines that include long-term contracts,
forward sales and short-term sales. The source of these sales is supply created
by selling the unused capacity and energy of jurisdictional assets, the capacity
and energy of the Company's plants excluded from retail rates, and purchased
power. Both regulated and unregulated generation is jointly dispatched in order
20
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
to improve reliability, provide the most economical power to retail customers
and maximize profits on any wholesale transactions.
Long-term contracts include sales to wholesale customers with multi-year
arrangements. These contracts range from 1 to 17 years with an average of 6.7
years. Forward sales include third party purchases in the forward market that
range from 1 month to 3 years. These transactions do not qualify as normal sales
and purchases as defined in SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities", as amended, and thus are generally marked to market.
Short-term sales generally include spot market, hour ahead, day ahead and week
ahead contracts with terms of 30 days or less. Also included in short-term sales
are sales of any excess generation not required to fulfill PNM's retail load and
contractual commitments. Short-term sales also cover the revenue credit to
retail customers as specified in the most recent electric rate agreement.
CORPORATE AND OTHER
The Holding Company performs substantially all of the corporate
activities of PNM. These activities are billed to PNM on a cost basis to the
extent they are for the corporate management of PNM and are allocated to the
operating segments. The Holding Company's wholly-owned subsidiary, Avistar, was
formed in August 1999 as a New Mexico corporation and is currently engaged in
certain unregulated and non-utility businesses. In January 2002, Avistar was
dividended to the Holding Company pursuant to an order from the PRC. This
segment also includes the reconciling items discussed above.
(Intentionally left blank)
21
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the three months
ended June 30, 2004 is as follows:
Utility
------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------ ------------- --------------- ------------ ----------
(In thousands)
2004:
Operating revenues:
External customers.................. $ 130,695 $ 80,886 $ 4,420 $ - $ 216,001
Intersegment revenues............... - - 7,992 (7,992) -
Depreciation and amortization.......... 13,983 4,738 2,706 - 21,427
Interest income........................ 6,821 219 312 - 7,352
Interest charges....................... 7,219 2,737 1,459 - 11,415
Total income tax expense (benefit)..... 5,775 (1,257) 448 - 4,966
Operating income....................... 11,869 697 1,909 - 14,475
Segment net earnings (loss)............ 8,811 (1,915) 685 - 7,581
Total assets........................... 1,439,950 503,446 293,419 - 2,236,815
Gross property additions............... 17,822 7,787 4,577 - 30,186
Corporate
Wholesale and Other Consolidated
------------ ------------- ---------------
(In thousands)
2004:
Operating revenues:
External customers.................. $ 158,894 $ (9,282) (a) $ 365,613
Intersegment revenues............... - - -
Depreciation and amortization.......... 3,754 1,250 26,431
Interest income........................ 1,350 142 8,844
Interest charges....................... 3,392 (2,752) 12,055
Total income tax expense............... 3,900 830 9,696
Operating income (loss)................ 8,356 (567) 22,264
Segment net earnings................... 5,951 3,317 16,849
Total assets........................... 422,410 686,861 3,346,086
Gross property additions............... 2,049 944 33,179
(a) Includes EITF 03-11 impact, under which wholesale revenues and the
associated cost of energy of $9.4 million are reclassified to a net
margin basis in accordance with GAAP.
(Intentionally left blank)
22
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the three months
ended June 30, 2003 is as follows:
Utility
--------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------ ------------- --------------- ------------ ------------
(In thousands)
2003:
Operating revenues:
External customers................ $ 131,091 $ 59,520 $ 2,317 $ - $192,928
Intersegment revenues............. - - 10,554 (7,777) 2,777
Depreciation and amortization........ 15,843 5,498 2,337 - 23,678
Interest income...................... 8,601 332 74 - 9,007
Interest charges..................... 6,705 3,413 1,669 - 11,787
Total income tax expense (benefit)... 6,846 (2,342) 559 - 5,063
Operating income (loss).............. 13,263 (290) 2,500 - 15,473
Segment net earnings (loss).......... 13,479 (3,496) 868 - 10,851
Total assets at December 31, 2003.... 1,429,291 509,111 275,301 - 2,213,703
Gross property additions............. 12,584 14,013 6,483 - 33,080
Corporate
Wholesale and Other Consolidated
------------- ------------- ---------------
(In thousands)
2003:
Operating revenues:
External customers................. $ 132,742 $ 52 $ 325,722
Intersegment revenues.............. 900 (3,677) -
Depreciation and amortization......... 3,569 1,603 28,850
Interest income....................... 1,145 325 10,477
Interest charges...................... 3,613 2,364 17,764
Total income tax expense.............. 4,932 220 10,215
Operating income...................... 10,420 4,021 29,914
Segment net earnings (loss)........... 8,090 (1,345) 17,596
Total assets at December 31, 2003..... 425,372 739,554 3,378,629
Gross property additions.............. 1,646 2,738 37,464
(Intentionally left blank)
23
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the six months
ended June 30, 2004 is as follows:
Utility
-----------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- -------------- ---------------- -------------- ----------
(In thousands)
2004:
Operating revenues:
External customers................ $ 260,731 $ 256,760 $ 8,834 $ - $ 526,325
Intersegment revenues............. - - 15,888 (15,888) -
Depreciation and amortization........ 27,953 9,467 5,414 - 42,834
Interest income...................... 13,662 1,158 418 - 15,238
Interest charges..................... 14,447 5,476 2,936 - 22,859
Total income tax expense............. 12,876 4,900 1,135 - 18,911
Operating income..................... 25,740 12,303 4,352 - 42,395
Segment net earnings................. 19,647 7,478 1,732 - 28,857
Total assets......................... 1,439,950 503,446 293,419 - 2,236,815
Gross property additions............. 31,456 14,028 8,849 - 54,333
Corporate
Wholesale and Other Consolidated
------------- ------------- -----------------
(In thousands)
2004:
Operating revenues:
External customers................ $ 292,666 $ (9,725) (a) $ 809,266
Intersegment revenues............. - - -
Depreciation and amortization........ 7,508 2,226 52,568
Interest income...................... 2,738 789 18,765
Interest charges..................... 6,786 (3,761) 25,884
Total income tax expense (benefit)... 6,924 (1,832) 24,003
Operating income (loss).............. 15,264 (1,861) 55,798
Segment net earnings................. 10,566 2,204 41,627
Total assets......................... 422,410 686,861 3,346,086
Gross property additions............. 4,848 2,867 62,048
(a) Includes EITF 03-11 impact, under which wholesale revenues and the
associated cost of energy of $10.1 million are reclassified to a net
margin basis in accordance with GAAP.
(Intentionally left blank)
24
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the six months
ended June 30, 2003 is as follows:
Utility
---------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- -------------- --------------- ------------- ----------
(In thousands)
2003:
Operating revenues:
External customers................ $ 257,296 $ 203,706 $ 6,874 $ - $ 467,876
Intersegment revenues............. - - 18,189 (15,412) 2,777
Depreciation and amortization........ 31,578 10,940 4,659 - 47,177
Interest income...................... 16,056 1,109 58 - 17,223
Interest charges..................... 13,352 6,789 3,079 - 23,220
Total income tax expense............. 15,208 2,105 1,028 - 18,341
Operating income..................... 28,569 9,400 4,652 - 42,621
Segment net earnings................. 26,239 3,290 1,583 - 31,112
Total assets at December 31, 2003.... 1,429,291 509,111 275,301 - 2,213,703
Gross property additions............. 30,972 21,234 11,330 - 63,536
Corporate
Wholesale and Other Consolidated
------------- -------------- ---------------
(In thousands)
2003:
Operating revenues:
External customers................ $ 243,358 $ 112 $711,346
Intersegment revenues............. 900 (3,677) -
Depreciation and amortization........ 7,060 2,987 57,224
Interest income...................... 2,595 1,359 21,177
Interest charges..................... 7,161 5,616 35,997
Total income tax expense (benefit)... 6,122 (7,779) (a) 16,684
Operating income..................... 15,064 5,655 63,340
Segment net earnings (loss).......... 9,905 (12,673) (a) 28,344
Total assets at December 31, 2003.... 425,372 739,554 3,378,629
Gross property additions............. 5,382 3,814 72,732
(a) Includes $10.1 million write-off of transition costs, net of tax
benefit of $6.6 million, due to the repeal of deregulation in New
Mexico.
(3) Fair Value of Financial Instruments
Retail Natural Gas Contracts
Pursuant to a 1997 order issued by the New Mexico Public Utility
Commission, the predecessor to the PRC, the Company is authorized to hedge
certain portions of natural gas supply contracts to protect the Company's
25
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
natural gas customers from the risk of adverse price fluctuations in the natural
gas market. All hedge gains and losses are recoverable through the Company's
purchased gas adjustment clause ("PGAC") if deemed prudently incurred by the
PRC. As a result, earnings are not affected by gains or losses generated by
these instruments.
PNM purchased $5.7 million of natural gas options in the first six months
of 2004 to protect its natural gas customers from the risk of rising prices
during the 2004-2005 heating season. In total, PNM plans to expend approximately
$10.0 million in 2004 to purchase gas options that essentially cap the amount
the Company would pay for each volume of gas subject to the options during the
winter heating season. PNM expects to recover its option premiums as a component
of the PGAC during the months of October 2004 through February 2005.
Wholesale Electricity Contracts
The Company's Wholesale Operations have entered into various forward
physical contracts for the purchase and sale of electricity with the intent to
optimize its net generation position. These contracts, which are derivatives, do
not qualify for normal purchase and sale designation pursuant to GAAP, and are
marked to market.
For the three months ended June 30, 2004, the Company's Wholesale
Operations settled derivative forward contracts for the sale of electricity that
generated $45.5 million of electric revenues by delivering 0.9 million megawatt
hours ("MWh"). The Company settled derivative forward contracts for the purchase
of electricity of $43.5 million or 0.9 million MWh to support these contractual
sales and other open market sales opportunities. For the three months ended June
30, 2003, the Company's Wholesale Operations settled derivative forward
contracts for the sale of electricity that generated $37.5 million of electric
revenues by delivering 0.9 million MWh. The Company settled derivative forward
contracts for the purchase of electricity of $38.6 million or 0.9 million MWh to
support these contractual sales and other open market sales opportunities.
For the six months ended June 30, 2004, the Company's Wholesale
Operations settled derivative forward contracts for the sale of electricity that
generated $72.5 million of electric revenues by delivering 1.6 million MWh. The
Company settled derivative forward contracts for the purchase of electricity of
$68.2 million or 1.5 million MWh to support these contractual sales and other
open market sales opportunities. For the six months ended June 30, 2003, the
Company's Wholesale Operations settled derivative forward contracts for the sale
of electricity that generated $59.8 million of electric revenues by delivering
1.4 million MWh. The Company settled derivative forward contracts for the
purchase of electricity of $61.0 million or 1.5 million MWh to support these
contractual sales and other open market sales opportunities.
As of June 30, 2004, the Company had open derivative forward contract
positions to buy $71.3 million and to sell $82.6 million of electricity. At June
30, 2004, the Company had a gross mark-to-market gain (asset position) on these
derivative forward contracts of $12.4 million and a gross mark-to-market loss
(liability position) of $7.7 million, with a net mark-to-market gain (asset
position) of $4.7 million recorded in other assets and liabilities. The change
in mark-to-market valuation is recognized in earnings each period and is
recorded in operating revenues.
26
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company's Wholesale Operations also entered into forward physical
contracts for the sale of the Company's electric capacity in excess of its
retail and wholesale firm requirement needs, including reserves. In addition,
the Company entered into forward physical contracts for the purchase of retail
needs, including reserves, when resource shortfalls exist. The Company generally
accounts for these as normal sales and purchases as defined by SFAS 133, as
amended. From time to time the Company makes forward purchases to serve its
retail needs when the cost of purchased power is less than the incremental cost
of its generation. At June 30, 2004, the Company had open forward positions
classified as normal sales of electricity of $187.4 million and normal purchases
of electricity of $90.6 million, which will be reflected in the financial
statements upon physical delivery.
The Company's Wholesale Operations, including both firm commitments and
other wholesale sale activities, are managed through a net asset-backed
strategy, whereby the Company's aggregate net open position is covered by its
own excess generation capabilities. The Company is exposed to market risk if its
generation capabilities were disrupted or if its retail load requirements were
greater than anticipated. If the Company were required to cover all or a portion
of its net open contract position, it would have to meet its commitments through
market purchases.
The Company is exposed to credit risk in the event of non-performance or
non-payment by counterparties of its financial and physical derivative
instruments. The Company uses a credit management process to assess and monitor
the financial conditions of counterparties. The Company's credit risk with its
largest counterparty as of June 30, 2004 and December 31, 2003 was $28.3 million
and $23.5 million, respectively.
Wholesale Gas Contracts
Beginning in the second quarter, the Company's Wholesale Operations have
entered into various forward physical contracts for the purchase of gas with the
intent to optimize its net generation position. These contracts, which are
derivatives, do not qualify for normal purchase and sale designation pursuant to
GAAP, and are marked to market. For the three months ended June 30, 2004, the
Company's Wholesale Operations settled derivative forward contracts for the sale
of gas that generated $6.1 million of revenues and settled derivative forward
contracts for the purchase of gas of $5.4 million.
As of June 30, 2004, the Company had open derivative forward contract
positions to buy $31.9 million and to sell $33.3 million of gas. At June 30,
2004, the Company had a gross mark-to-market gain (asset position) on these
derivative forward contracts of $0.9 million and a gross mark-to-market loss
(liability position) of $0.6 million, with a net mark-to-market gain (asset
position) of $0.3 million recorded in other current assets and liabilities,
respectively. The change in mark-to-market valuation is recognized in earnings
each period and is recorded in operating revenues. The Company expects to settle
these open derivative forward contract positions by September 2004.
27
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(4) Earnings Per Share
In accordance with SFAS No. 128, "Earnings per Share" ("SFAS 128"), dual
presentation of basic and diluted earnings per share has been presented in the
Consolidated Statements of Earnings. The following reconciliation illustrates
the impact on the share amounts of potential common shares and the earnings per
share amounts (in thousands except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------- ------------- -------------
Basic:
Net Earnings Before Cumulative Effect of
Changes in Accounting Principles................. $16,849 $17,596 $41,627 $28,344
Cumulative Effect of Changes in
Accounting Principles, net of tax of $23,999..... - - - 36,621
------------ ------------- ------------- -------------
Net Earnings........................................ $16,849 $17,596 $41,627 $64,965
============ ============= ============= =============
Average Number of Common Shares
Outstanding...................................... 60,404 59,046 60,396 58,863
============ ============= ============= =============
Net Earnings per Share of Common Stock
(Basic).......................................... $ 0.28 $ 0.30 $ 0.69 $ 1.10
============ ============= ============= =============
Earnings Before Cumulative Effect of
Changes in Accounting Principles................. 0.28 0.30 0.69 0.48
Cumulative Effect of Changes in
Accounting Principles............................ - - - 0.62
------------ ------------- ------------- -------------
Net Earnings per Share of Common Stock
(Basic).......................................... $ 0.28 $ 0.30 $ 0.69 $ 1.10
============ ============= ============= =============
(Intentionally left blank)
28
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------- ------------- -------------
Diluted:
Net Earnings Before Cumulative Effect of
Changes in Accounting Principles................ $16,849 $17,596 $41,627 $28,344
Cumulative Effect of Changes in
Accounting Principles, net of tax of $23,999.... - - - 36,621
------------ ------------- ------------- -------------
Net Earnings....................................... $16,849 $17,596 $41,627 $64,965
============ ============= ============= =============
Average Number of Common Shares
Outstanding..................................... 60,404 59,046 60,396 58,863
Dilutive Effect of Common Stock
Equivalents (a)................................. 755 586 797 491
------------ ------------- ------------- -------------
Average Common and Common
Equivalent Shares............................... 61,159 59,632 61,193 59,354
============ ============= ============= =============
Net Earnings per Share of Common Stock
(Diluted)....................................... $ 0.28 $ 0.30 $ 0.68 $ 1.09
============ ============= ============= =============
Earnings Before Cumulative Effect of
Changes in Accounting Principles................ 0.28 0.30 0.68 0.48
Cumulative Effect of Changes in
Accounting Principles........................... - - - 0.61
------------ ------------- ------------- -------------
Net Earnings per Share of Common Stock
(Diluted)....................................... $ 0.28 $ 0.30 $ 0.68 $ 1.09
============ ============= ============= =============
(a) Excludes the effect of average anti-dilutive common stock
equivalents related to out-of-the-money options of 798,900 and
1,318,022 for the three months ended and 635,481 and 2,829,980 for
the six months ended June 30, 2004 and 2003, respectively.
(5) Capitalization
Stock Split
On May 18, 2004, the Company's Board of Directors approved a 3-for-2
stock split that took place on June 11, 2004 for shareholders of record on June
1, 2004. The split increased the number of outstanding common shares by
20,134,648 shares, from 40,269,296 to 60,403,944. All references in the
accompanying consolidated financial statements to numbers of shares outstanding
and per share amounts have been restated to reflect the stock split.
29
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Debt
On April 1, 2004, PNM repriced $146.0 million of tax exempt pollution
control bonds, with a previous interest rate of 2.75%. The new interest rate is
2.10% for a term of 2 years. These bonds will reprice next on April 1, 2006.
On April 23, 2004, PNM entered into a rated commercial paper program. PNM
may issue up to $300 million in commercial paper for up to 365 days. The
commercial paper is unsecured and the proceeds were used to retire borrowings
under the previous unrated commercial paper program, retirement of other
short-term borrowings and other short-term cash management needs. PNM's Credit
Facility serves as a backstop for the outstanding commercial paper.
On April 29, 2004, the Holding Company entered into three fixed to
floating interest rate swaps with an aggregate notional principal amount of $150
million. Under these swaps, the Holding Company receives a 4.40% fixed interest
payment on the notional principal amount on a semi-annual basis and pays a
floating rate equal to the six month London Interbank Offered Rate ("LIBOR")
plus 58.15 basis points (0.58%) on the notional amount through September 15,
2008. The initial floating rate is approximately 1.91% and will be reset every
six months. The floating rate will first be reset on September 15, 2004. The
swap is accounted for as a fair-value hedge with a fair-market value (liability
position) of approximately $1.3 million as of June 30, 2004.
(6) Pension and Other Post-Retirement Benefit Plans
The Company and its subsidiaries maintain a qualified defined benefit
pension plan ("Pension Plan"), medical and dental benefits to eligible retirees
("Other Post-Retirement Benefits"), and an Executive Retirement Plan. The
following table shows the net periodic benefit cost or income of the Company's
Pension Plan, Other Post-Retirement Benefit Plans, and the Executive Retirement
Plan:
Three Months Ended June 30,
Other Post- Executive
Pension Plan Retirement Benefits Retirement Program
--------------------- ------------------- ---------------------
2004 2003 2004 2003 2004 2003
---------- ---------- --------- --------- ---------- ----------
(In thousands)
Components of Net Periodic
Benefit Cost/(Income)
Service cost....................... $ 1,085 $ 1,297 $ 601 $ 771 $ 25 $ 20
Interest cost...................... 7,340 7,023 1,826 1,960 310 308
Expected return on assets.......... (9,843) (8,777) (1,232) (1,148) - -
Transition obligation.............. - - 455 455 - -
Prior service cost amortization.... 79 79 (1,050) (648) 38 37
Net loss amortization.............. 1,158 977 1,234 1,031 33 22
----------- ---------- --------- --------- --------- ----------
Net Periodic Benefit Cost/(Income)... $ (181) $ 599 $ 1,834 $ 2,421 $406 $387
=========== ========== ========= ========= ========= ==========
30
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended June 30,
Other Post- Executive
Pension Plan Retirement Benefits Retirement Program
--------------------- ------------------- ---------------------
2004 2003 2004 2003 2004 2003
---------- ---------- --------- --------- ---------- ----------
(In thousands)
Components of Net Periodic
Benefit Cost/(Income)
Service cost....................... $2,170 $ 2,594 $1,202 $1,542 $ 51 $ 40
Interest cost...................... 14,680 14,045 3,652 3,920 620 616
Expected return on assets.......... (19,686) (17,554) (2,464) (2,296) - -
Transition obligation.............. - - 909 909 - -
Prior service cost amortization.... 158 158 (2,099) (1,296) 75 75
Net loss amortization.............. 2,315 1,955 2,468 2,062 66 44
---------- ---------- --------- ---------- --------- ----------
Net Periodic Benefit Cost/(Income)... $ (363) $ 1,198 $3,668 $ 4,841 $ 812 $ 775
========== ========== ========= ========== ========= ==========
For the six months ended June 30, 2004, the Company contributed $3.1
million to trusts for the Other Post-Retirement Benefits. The Company expects to
contribute an additional $3.1 million in the second half of 2004.
(7) Commitments and Contingencies
PVNGS Liability and Insurance Matters
The Palo Verde Nuclear Generating Station ("PVNGS") participants have
financial protection for public liability resulting from nuclear energy hazards
to the full limit of liability under federal law. This potential liability is
covered by primary liability insurance provided by commercial insurance carriers
in the amount of $300.0 million and the balance by an industry-wide
retrospective assessment program. If losses at any nuclear power plant covered
by the programs exceed the primary liability insurance limit, the Company could
be assessed retrospective adjustments. Effective August 20, 2003, the maximum
assessment per reactor under the program for each nuclear incident increased
from approximately $88 million to approximately $101 million. The retrospective
assessment is subject to an annual limit of $10.0 million per reactor per
incident. Based upon the Company's 10.2% interest in the three PVNGS units, the
Company's maximum potential assessment per incident for all three units is
approximately $31 million, with an annual payment limitation of approximately $3
million per incident. If the funds provided by this retrospective assessment
program prove to be insufficient, Congress could impose revenue-raising measures
on the nuclear industry to pay claims.
Possible Price-Anderson Act Changes
Versions of comprehensive energy bills proposed for adoption by Congress
contain provisions that would amend Federal Law (the "Price-Anderson Act")
addressing public liability from nuclear energy hazards in ways that would
increase the annual limit on retrospective assessments (see "PVNGS Liability and
Insurance Matters" above) from $10 million to $15 million per reactor per
31
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
incident with the Company's annual exposure per incident increasing from $3
million to $4.5 million.
The Company believes that such changes in applicable law, if enacted,
would not result in a "deemed loss event" being declared by the equity investors
in respect of the Company's sale and leaseback transactions of PVNGS Units 1 and
2.
Water Supply
Because of New Mexico's arid climate and current drought conditions,
there is a growing concern in New Mexico about the use of water for power
plants. The availability of sufficient water supplies to meet all the needs of
the state, including growth, is a major issue. The Company has secured water
rights in connection with the Afton and Lordsburg plants and water availability
does not appear to be an issue for these plants at this time.
The Four Corners region, in which San Juan Generating Station ("SJGS")
and Four Corners Power Plant ("Four Corners") are located, has been experiencing
drought conditions that may affect the water supply for the Company's generation
plants. If adequate precipitation is not received in the watershed that supplies
the Four Corners areas, the plants may be affected in 2005 and the future. The
United States Bureau of Reclamation ("USBR") has approved a supplemental
contract for 8,300 acre feet per year for a one-year term ending December 31,
2004. Environmental approvals have been obtained for the supplemental contract.
PNM has also signed a voluntary shortage sharing agreement with tribes and other
water users in the San Juan Basin for a one-year term ending December 31, 2004.
Environmental approvals for that agreement have been obtained. A similar
agreement was entered into in 2003. Although PNM does not believe that its
operations will be materially affected by the drought conditions at this time,
it cannot forecast the weather situation or its ramifications, or how
regulations and legislation may impact PNM's situation in the future, should the
drought continue.
Dugan Production Corporation Litigation
In July 2002, Dugan Production Corp. filed a lawsuit in the County of San
Juan, New Mexico, against the San Juan Coal Company ("SJCC"). In September 2002,
the SJCC removed the lawsuit to the United States District Court for the
District of New Mexico. The lawsuit sought to enjoin the underground mining of
coal from a portion of the land that is to be used for the underground mine. The
plaintiff also sought monetary damages.
The SJCC, through leases with the federal government and the State of New
Mexico, owns coal interests with respect to the underground mine. The plaintiff,
through leases with the federal government, the State of New Mexico and certain
private parties, claims to own certain oil and gas interests in portions of the
land that is to be used for the underground mine. SJCC has entered into a
settlement with the plaintiff and the United States Bureau of Land Management
which was signed on April 1, 2004. The settlement will not have a material
adverse impact on the Company or its operations. As part of the settlement, a
joint motion to dismiss was granted on April 19, 2004.
32
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Richardson Matter
Another gas leaseholder, Richardson Operating Company ("Richardson"), has
leases in the area of the underground coal mine described above and has asserted
claims against SJCC. The Company understands that discussions with Richardson
are ongoing, although no formal litigation has been filed. The Company is unable
to predict the outcome of this matter.
Western United States Wholesale Power Market
Various circumstances, including electric power supply shortages, weather
conditions, gas supply costs, transmission constraints, and alleged market
manipulation by certain sellers, resulted in the well-publicized "California
energy crisis" and in the bankruptcy filings of the California Power Exchange
("Cal PX") and of Pacific Gas and Electric Company ("PG&E"). However, since the
third quarter of 2001, conditions in the Western wholesale power market have
changed substantially because of regulatory actions, conservation measures, the
construction of additional generation, a decline in natural gas prices relative
to levels reached during the California energy crisis and regional economic
conditions.
As a result of the foregoing conditions in the Western market, the
Federal Energy Regulatory Commission ("FERC") and other federal and state
governmental authorities initiated investigations, litigation and other
proceedings relevant to the Company and other sellers. The more significant of
these in relation to the Company are summarized below.
California Refund Proceeding
San Diego Gas and Electric Company ("SDG&E") and other California buyers
have filed a complaint with the FERC against sellers into the California
wholesale electric market. Hearings were held in September 2002, and the
administrative law judge ("ALJ") issued the "Proposed Findings on California
Refund Liability" in December 2002, in which it was determined that the
California Independent System Operator ("Cal ISO") had, for the most part,
correctly calculated the amounts of the potential refunds owed by sellers. The
ALJ identified what were termed "ballpark" figures for the amount of refunds due
under the order in an appendix to the proposed findings document. Pursuant to
the FERC's order, PNM filed, in conjunction with the competitive supplier group,
initial comments in January 2003 to the ALJ's preliminary findings addressing
errors the Company believes the ALJ made in the proposed findings, and filed
reply comments in February 2003.
Prior to the December 2002 ALJ decision, the Ninth Circuit Court of
Appeals ordered the FERC to allow the parties in the case to provide additional
evidence regarding alleged market manipulation by sellers. Several California
parties submitted additional evidence in March 2003 to support their position
that virtually all market participants, including PNM, either engaged in
specific market manipulation strategies or facilitated such strategies. PNM
maintains that it did not engage in improper wholesale activities, and filed
reply evidence in March 2003, denying the allegations against it.
33
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In March 2003, the FERC issued an order substantially adopting the ALJ's
findings in his December 2002 decision, but requiring a change to the formula
used to calculate refunds. The FERC raised concerns that the indices for
California gas prices, a major element in the formula, had been subject to
potential manipulation and were unverifiable. The effect of this change, which
is not yet final, would be to increase PNM's refund liability. In October 2003,
the FERC issued its order on rehearing in which it affirmed its decision to
change the gas price indices used to calculate the refund amounts. This has the
effect of increasing the Company's amount of refund. The precise amounts,
however, will not be certain until the Cal ISO and Cal PX recalculate refund
amounts which FERC required that they do as soon as possible, but no later than
five months after its October 2003 Order. The Cal ISO previously advised FERC
that it would not complete the recalculation of the refund amounts until August
2004, however, current estimates are that the Cal ISO will not complete its
analysis prior to December 2004. On June 30, 2004, the FERC hosted a settlement
conference in which the California parties proposed a settlement template for
the California refund proceedings. The Company is currently evaluating the
template provided in the settlement conference and is unable to predict whether
settlement will be reached, or the ultimate outcome of this FERC proceeding, or
whether PNM will be ultimately directed to make any refunds as the result of the
FERC order.
Pacific Northwest Refund Proceeding
In addition to the California refund proceedings, Puget Sound Energy,
Inc. filed a complaint at the FERC alleging that spot market prices in the
Pacific Northwest wholesale electric market were unjust and unreasonable. In
September 2001, the ALJ issued a recommended decision and declined to order
refunds associated with wholesale electric sales in the Pacific Northwest. In a
ruling similar to the one issued in the California refund proceeding, the FERC
allowed additional discovery to take place and the submission of additional
evidence in the case in March 2003. In June 2003, the FERC issued an order
terminating the proceeding and adopting the ALJ's recommendation that no refunds
should be ordered. Several parties in the proceeding filed requests for
rehearing and in November 2003, FERC denied rehearing and reaffirmed its prior
ruling that refunds were not appropriate for spot market sales in the Pacific
Northwest during the first half of 2001. In November 2003, the Port of Seattle
filed an appeal of FERC's order denying rehearing in the Ninth Circuit Court of
Appeals. As a participant in the proceedings before FERC, the Company is also
participating in the appeal proceedings. The Company is unable to predict the
ultimate outcome of this appeal, or whether PNM will ultimately be directed to
make any refunds.
FERC Show Cause Orders
The FERC initiated a market manipulation investigation, partially in
response to the bankruptcy filing of the Enron Corporation ("Enron") and to
allegations that Enron may have engaged in manipulation of portions of the
Western wholesale power market. In connection with that investigation, all
sellers into Western electric and gas markets were required to submit data
regarding short-term transactions in 2000-2001. In March 2003, the FERC staff
issued its final report, which addressed various types of conduct that the FERC
staff believed may have violated market monitoring protocols in the Cal ISO and
Cal PX tariffs. Based on the final report, the FERC issued orders to certain
34
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
companies, including Enron, requiring them to show cause why the FERC should not
revoke their authorizations to sell electricity at market-based rates. In
addition, the FERC staff recommended that the FERC issue orders requiring
certain entities to show cause why they should not be required to disgorge
profits associated with conduct deemed to violate the Cal ISO and Cal PX
tariffs, or be subject to other remedial action.
In June 2003, the FERC issued two separate orders to show cause against
PNM and over sixty other companies. In the first order (the "Gaming Practices
Order"), the FERC asserted that certain entities, including PNM, appeared to
have participated in activities that constitute gaming and/or anomalous market
behavior in violation of the Cal ISO and Cal PX tariffs during the period
January 1, 2000 to June 20, 2001. Specifically, PNM is alleged to have engaged
in a practice termed "False Import," which FERC defined as the practice of
exporting power generated by California and then reimported into California in
order to avoid price caps on in-California generation. These allegations are
based primarily on an initial Cal ISO report and the additional evidentiary
submission by California parties. The Cal ISO was ordered to submit additional
information on which the entities subject to the Show Cause Order should
respond. For PNM, the potential disgorgement for alleged "False Import"
transactions covers the period May 1, 2000 to October 1, 2000. After review of
the additional Cal ISO data and consultation with PNM, the FERC trial staff
filed a motion to dismiss PNM from the case in August 2003. In September 2003,
the California parties filed their objection to the dismissal of PNM from the
case. In January 2004, the FERC issued an order granting trial staff's motion to
dismiss PNM from the Gaming Practices docket on grounds that FERC staff's
investigation did not reveal that PNM engaged in the practice of "False Import."
As a result, the Company has been dismissed from the Gaming Practices
proceedings.
In the second order to show cause (the "Gaming Partnerships Order"), the
FERC asserts that certain entities, including PNM, acted in concert with Enron
and other market participants to engage in activities that constitute gaming
and/or anomalous market behavior in violation of the Cal ISO and Cal PX tariffs
during the period January 1, 2000 to June 20, 2001. Specifically, PNM is alleged
to have entered into "partnerships, alliances or other arrangements" with
thirteen of its customers that allegedly may have been used as market
manipulation schemes. The precise basis for certain of the FERC's allegations is
not clear from the Gaming Partnerships Order, although it appears that most
arise out of PNM's provision of "parking and lending" services to the identified
companies. The potential remedies include disgorgement of unjust profits, as
well as non-monetary remedies such as revocation of a seller's market-based rate
authority.
In September 2003, PNM filed its responses to the Gaming Partnerships
Order indicating that it did not engage in the alleged "partnerships, alliances
or other arrangements" with the alleged parties. In October 2003, PNM filed
testimony and exhibits in the case reasserting its response previously filed. In
January 2004, the FERC issued an order granting FERC staff's motion to dismiss
seven of the thirteen PNM customers on grounds that there was no evidence to
conclude that these companies used their commercial relationship with PNM to
game the California ISO and PX markets. On February 27, 2004, the FERC staff and
the California parties filed their testimony. The FERC staff did not identify
any improper conduct by PNM. In March 2004, FERC approved the settlements
35
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
entered into by two of the thirteen PNM customers and dismissed another of PNM's
customers from the proceeding. Of the three remaining PNM customers in the
docket, the FERC staff has entered into settlement agreements with two of them.
The California parties allege that PNM provided false information regarding
parking transactions that allowed other parties to game the California market.
PNM believes that it has not engaged in improper conduct and intends to defend
itself vigorously against these allegations. In May 2004, the Chief ALJ issued
an order suspending the procedural schedule in the docket pursuant to the
California parties' request to enable the parties to engage in settlement
discussions of all matters related to the "California energy crisis." PNM
continues to have discussions with the FERC staff regarding possible dismissal
of the charges against PNM and attended the June 30, 2004 settlement conference
(see "California Refund Proceeding" above). The Company is unable to predict
whether settlement will be reached or the outcome of this matter.
Investigation of Anomalous Bidding Behavior and Practices in the Western Markets
In June 2003, the FERC issued an order finding that certain bids into the
Cal ISO and Cal PX markets during the period May 1 through October 1, 2000
appear to have been excessive, in violation of the prohibitions against
anomalous market behavior in the market monitoring protocols of the Cal ISO and
Cal PX tariffs. The order directed the FERC's Office of Market Oversight and
Investigation ("OMOI") to conduct a further investigation into bids in excess of
$250 per MW during that period. In July 2003, PNM received a data request from
OMOI to all sellers into the Cal ISO and Cal PX markets that submitted bids in
excess of $250 per MW to the Cal ISO and Cal PX during the period covered by the
investigation. In July 2003, PNM submitted its response to OMOI's data request,
in which PNM provided justification of its bidding strategies during that
period. In July 2003, PNM joined with other sellers in filing a request for
rehearing of the June 2003 order, challenging the FERC's determination that bids
above $250 per MW into the Cal ISO and Cal PX markets during the period May 1
through October 1, 2000 were prima facie excessive or in violation of the Cal
ISO and Cal PX tariffs. The request for hearing is currently pending before the
FERC. PNM has received supplemental requests for information and data from OMOI,
to which PNM responded. In May 2004, PNM received a letter from the director of
OMOI indicating that, pursuant to OMOI's review of the information PNM provided
during the investigation, the investigation into PNM's bidding practices was
terminated. The Company does not anticipate any additional action by FERC OMOI
related to this investigation into PNM's bidding practices.
California Power Exchange and Pacific Gas and Electric Bankruptcies
In January and February 2001, Southern California Edison ("SCE") and
PG&E, major purchasers of power from the Cal PX and Cal ISO, defaulted on
payments due to Cal PX for power purchased from the Cal PX in 2000. These
defaults caused the Cal PX to seek bankruptcy protection. PG&E subsequently also
sought bankruptcy protection. PNM has filed its proofs of claims in the Cal PX
and PG&E bankruptcy proceedings. Amounts due to PNM from the Cal PX or Cal ISO
for power sold to them in 2000 and 2001 total approximately $7 million. The
Company has provided allowances for the total amount due from the Cal PX and Cal
ISO. Both the PG&E and CalPX bankruptcy cases have confirmed plans of
36
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
reorganization in which the claims of various creditors have been specially
classified and are waiting a final determination by FERC before the claims are
actually paid. The PG&E bankruptcy case has an escrow account and the CalPX
bankruptcy has established a settlement account, both of which are awaiting
setting the level of claims and a determination of the allocation of funds by
FERC.
California Attorney General Complaint
In March 2002, the California Attorney General filed a complaint with the
FERC against numerous sellers regarding prices for wholesale electric sales into
the Cal ISO and Cal PX and to the California Department of Water Resources ("Cal
DWR"). PNM was among the sellers identified in this complaint and filed its
answer and motion to intervene. In its answer, PNM defended its pricing and
challenged the theory of liability underlying the California Attorney General's
complaint. In May 2002, the FERC entered an order denying the California
Attorney General's request to initiate a refund proceeding, but directed
sellers, including PNM, to comply with additional reporting requirements with
regard to certain wholesale power transactions. PNM has made filings required by
the May 2002 order. The California Attorney General filed a petition for review
in the United States Court of Appeals for the Ninth Circuit. PNM intervened in
the Ninth Circuit appeal and is participating as a party in that proceeding. The
Ninth Circuit held oral arguments in the case in October 2003. The Company
cannot predict the outcome of this appeal. As addressed below, the California
Attorney General has also threatened litigation against PNM in state court in
California based on similar allegations.
California Attorney General Threatened Litigation
The California Attorney General has filed several lawsuits in California
state court against certain power marketers for alleged unfair trade practices
involving overcharges for electricity. In April 2002, the California Attorney
General notified PNM of his intention to file a complaint in California state
court against PNM concerning PNM's alleged failure to file rates for wholesale
electricity sold in California and for allegedly charging unjust and
unreasonable rates in the California markets. The letter invited PNM to contact
the California Attorney General's office before the complaint was filed, and PNM
has met several times with representatives of the California Attorney General's
office. Further discussions are contemplated. To date, a lawsuit has not been
filed by the California Attorney General and the Company cannot predict if a
lawsuit will be filed or the outcome of any such lawsuit.
California Antitrust Litigation
Several class action lawsuits have been filed in California state courts
against electric generators and marketers, alleging that the defendants violated
the law by manipulating the market to grossly inflate electricity prices. Named
defendants in these lawsuits include Duke Energy Corporation ("Duke") and
related entities along with other named sellers into the California market and
numerous other "unidentified defendants." Certain of these lawsuits were
consolidated for hearing in state court in San Diego, California. In May 2002,
the Duke defendants served a cross-claim on PNM. Duke also cross-claimed against
37
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
many of the other sellers into California. Duke asked for declaratory relief and
for indemnification for any damages that might ultimately be imposed on Duke.
Several defendants removed the case to federal court in California. The federal
judge has entered an order remanding the matter to state court, but the effect
of that ruling has been stayed pending appeal. PNM has joined with other
cross-defendants in motions to dismiss the cross-claim. The Company believes it
has meritorious defenses but cannot predict the outcome of this matter.
Block Forward Agreement Litigation
In February 2002, PNM was served with a declaratory relief complaint
filed by the State of California in California state court. The state's
declaratory relief complaint seeks a determination that the state is not liable
for its commandeering of certain energy contracts known as "Block Forward
Agreements". The Block Forward Agreements were a form of futures contracts for
the purchase of electricity at below-market prices and served as security for
payment by PG&E and SCE for their electricity purchases through the Cal PX. When
PG&E and SCE defaulted on payment obligations incurred through the Cal PX, the
Cal PX moved to liquidate the Block Forward Agreements to satisfy in part the
obligations owed by PG&E and SCE. Before the Cal PX could liquidate the Block
Forward Agreements, California commandeered them for its own purposes. In March
2001, PNM and other similarly situated sellers of electricity through the Cal PX
filed claims for damages with the California state Victims Compensation and
Government Claims Board ("Victims Claims Board") on the theory that the state,
by commandeering the Block Forward Agreements, had deprived them of security to
which they were entitled under the terms of the Cal PX's tariff. The Victims
Claims Board denied PNM `s claim in March 2002. PNM filed a complaint against
the State of California in California state court in September 2002, seeking
damages for the state's commandeering of the Block Forward Agreements and
requesting judicial coordination with the state's declaratory relief action
filed in February 2002 on the basis that the two actions raise essentially the
same issues. The judge delayed establishing a procedural schedule for the case
pending a determination of the Cal PX's status in the litigation. The judge has
since held that the Cal PX could represent the interests of Cal PX participants
in the litigation. In March 2004, both the Cal PX and the State of California
filed demurrers against each other's actions, alleging each other's actions
failed to a state cause of action and that the issues raised in the other's case
were identical to the issues raised in their own cases. In a hearing held in
April 2004, the judge determined not to rule on the demurrers until the specific
market participants named in the declaratory action proceeding affirmatively
determined whether they would agree to be bound by any judgment reached in the
Cal PX complaint action. As a result of the judge's order issued in May 2004,
the various parties in the case were presented with a proposed stipulation under
which the sellers would agree that the Cal PX would represent their interest in
the proceedings, the sellers would agree to be bound by any judgment in the
case, the sellers would dismiss their complaints against the State of
California, and in turn, the State of California would dismiss its
cross-complaints against the sellers, and the Cal PX would amend its complaint
to indicate that it is bringing the lawsuit on behalf of the sellers. The
Company will agree to the stipulation. The Company cannot predict the outcome of
the litigation involving the Cal PX and the State of California, or whether the
Company will be awarded any damages as a result of the litigation.
38
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Wholesale Power Marketing Antitrust Suit
On June 14, 2004, PNM received notice that PNM has been included in a
list of fifty-six (56) defendants that have been sued by the City of Tacoma
Department of Public Utilities ("Tacoma") in federal district court in the State
of Washington. PNM has been listed in a class of defendants referred to as the
"Trading Defendants", who allegedly engaged in buying, selling and marketing
power in California and other locations in the Western United States. The
complaint alleges the Trading Defendants acted in concert among themselves and
with "Non-Defendant Trading Co-Conspirators" that were engaged in conduct that
amounted to "market manipulations"; which the complaint defines as a pattern of
activities that had the purpose and effect of creating the impressions that the
demand for power was higher, the supply of power was lower, or both, than was in
fact the case. The complaint identifies specific conduct that allegedly amounts
to "market manipulations", including the submission of false information and
misrepresentation regarding load schedules, bids, power supply, transmission
congestion, source and destination of energy, the supply and provision of energy
and ancillary services. The complaint alleges the activities of the Trading
Defendants, along with "Generator Defendants", who are defined as generators who
generated power for sale into California and other Western markets, and the
co-conspirators, resulted in substantially increased prices for energy in the
Pacific Northwest spot market in excess of what otherwise would have been the
price absent such unlawful acts, in violation of antitrust laws. The complaint
asserts damages in excess of $175 million from the multiple defendants. The
Company cannot predict the outcome of this litigation but intends to vigorously
defend itself.
New Source Review Rules
In November 1999, the United States Department of Justice ("DOJ"), at the
request of the United States Environmental Protection Agency ("EPA"), filed
complaints against seven companies, alleging that the companies over the past 25
years had made modifications to their plants in violation of the New Source
Review ("NSR") requirements and in some cases the New Source Performance
Standard ("NSPS") regulations, which could result in the requirement to make
costly environmental additions to older power plants. Whether or not the EPA
will ultimately prevail is uncertain at this time. In August 2003, in one of the
pending enforcement cases against Ohio Edison Company, a federal district judge
in Ohio ruled in favor of the EPA and against Ohio Edison. The judge accepted
the legal theories advanced by the government and in particular found that
eleven construction projects undertaken by the utility in that case between 1984
and 1998 were "modifications" of the plants within the meaning of the Clean Air
Act, not "routine maintenance, repair or replacement" ("RMRR"). By contrast, in
a separate federal district court proceeding against Duke, the court has made
certain rulings in summary judgment motions that appeared to potentially
validate elements of the industry position. If the EPA prevails in the position
advanced in the pending litigation, PNM may be required to make significant
capital expenditures, which could have a material adverse effect on the
Company's financial position and results of operations.
No complaint has been filed against PNM by the EPA, and the Company
believes that all of the routine maintenance, repair, and replacement work
39
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
undertaken at its power plants was and continues to be in accordance with the
requirements of NSR and NSPS. However, in October 2000, the New Mexico
Environmental Department ("NMED") made an information request of PNM, advising
PNM that the NMED was in the process of assisting the EPA in the EPA's
nationwide effort "of verifying that changes made at the country's utilities
have not inadvertently triggered a modification under the Clean Air Act's
Prevention of Significant Deterioration ("PSD") policies." PNM has responded to
the NMED information request. In late June 2002, PNM received another
information request from the NMED for a list of capital projects budgeted or
completed in 2001 or 2002. PNM has responded to the additional NMED information
request.
In December 2002, the EPA promulgated certain long-awaited revisions to
the NSR rules, along with proposals to revise the RMRR exclusion contained in
the regulations. In August 2003, the EPA issued its rule regarding RMRR. The new
RMRR rule clarifies what constitutes RMRR of damaged or worn equipment, subject
to safeguards to assure consistency with the Clean Air Act. It provides that
replacements of equipment are routine only if the new equipment is (i) identical
or functionally equivalent to the equipment being replaced; (ii) does not cost
more than 20% of the replacement value of the unit of which the equipment is a
part; (iii) does not change the basic design parameters of the unit; and (iv)
does not cause the unit to exceed any of its permitted emissions limits. Legal
challenges to the RMRR rule have been filed by several states; other states have
intervened in support of the rule. How such challenges will ultimately be
resolved cannot be predicted but an appellate court order has stayed the effect
of the RMRR rule pending the outcome of the litigation. The Company is unable to
determine the impact of this matter.
Citizen Suit Under the Clean Air Act
Following required notification, the Grand Canyon Trust and the Sierra
Club (collectively "GCT") filed a so-called "citizen suit" in federal district
court in New Mexico against PNM (but not against the other SJGS co-owners) in
May 2002. The suit alleged two violations of the Clean Air Act and related
regulations and permits. First, GCT argued that the plant has violated, and is
currently in violation of, the federal PSD rules, as well as the corresponding
provisions of the New Mexico Administrative Code, at SJGS Units 3 and 4. Second,
GCT alleged that the plant has "regularly violated" the 20% opacity limit
contained in SJGS's operating permit and set forth in federal and state
regulations at Units 1, 3 and 4. The lawsuit seeks penalties as well as
injunctive and declaratory relief. PNM denied the material allegations in the
complaint.
Both sides in the litigation filed motions for partial summary judgment
and the court entered an order granting PNM's motion for summary judgment on the
PSD issues, dismissing that portion of the case against PNM. A trial on certain
preliminary liability issues on the opacity claims was held in November 2003. At
this trial, the plaintiffs presented their case and PNM presented certain
defenses, including that the measurement methods relied on by GCT are
contradicted by other measurement methods or by other qualified scientific data.
On February 2, 2004 the court entered a Memorandum Opinion on PNM's general
defenses. The Memorandum Opinion rejected PNM's arguments concerning the proper
method for determining opacity compliance, but allowed PNM to present evidence
40
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
in the next part of the liability trial addressing and defending against
liability for specific alleged opacity violations. A status conference was held
on March 5, 2004. The court advised that the next phase of the liability trial
would likely be scheduled in August or September 2004. A trial on remedy issues,
if necessary, would be scheduled at a later date. Pursuant to court order, PNM
submitted a settlement offer to plaintiffs on May 28, 2004 to which the
plaintiffs responded on June 11, 2004. A settlement conference mediated by a
federal magistrate judge was held on July 1, 2004 but did not result in
settlement. A further settlement conference will likely take place in November.
At the direction of the court, the parties conferred about streamlining the next
phase of the trial. The parties agreed to a stipulation which was adopted by the
court on May 26, 2004. Under the terms of the stipulation, the parties agreed to
forego a subsequent liability phase of trial on approximately 42,000 opacity
exceedances which were therefore found to be violations. Of those 42,000
violations, approximately 30,000 are attributed to condensed water vapor. The
litigation will now proceed to the remedy phase where the Company will present
its case that the violations were not of such a nature as to require large
penalties or injunctive relief. The Company is unable to predict the ultimate
outcome of the matter.
On April 29, 2004, the Company received notice from GCT of intent to file
another suit against SJGS for violations of the Clean Air Act and related
regulations and permits. The notice alleges continuing violations of the opacity
limit in the operating permit since May 16, 2002, the date of filing the
original suit and the last day allowed by the Court for determining violations
in the original suit. In addition the notice alleges failure to operate
consistent with good air pollution control practices by burning coal with ash
content in excess of boiler and emission control equipment design capacity and
operating SJGS as a "load following" facility when it was designed as a "base
load" power plant. Further, the notice alleges continuing violations for failure
to submit true, accurate and complete compliance certifications since at least
1998 by not disclosing opacity and particulate matter violations. The notice
alleges that PNM claimed water vapor as the cause of many violations of the
opacity limit when it had no evidence to support the claim and that its Excess
Emission Forms and quarterly reports for the last five years also assert excuses
for opacity violations that are invalid. Finally, the notice alleges that PNM
has not timely filed Excess Emission Forms for many deviations. The Company
believes that it has meritorious defenses and will vigorously dispute the
allegations. The Company cannot predict the ultimate outcome of the matter.
Archeological Site Disturbance
The Company hired Great Southwestern Construction, Inc. ("Great
Southwestern"), to conduct certain "climb and tighten" activities on a number of
electric transmission lines in New Mexico between July 2001 and December 2001.
Those lines traverse a combination of federal, state, tribal and private
properties in New Mexico. In late May 2002, the U.S. Forest Service ("USFS")
notified PNM that apparent disturbances to archeological sites had been
discovered in and around the rights-of-way for PNM's transmission lines in the
Carson National Forest in New Mexico. Great Southwestern had performed "climb
and tighten" activities on those transmission lines.
41
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
PNM confirmed the existence of the disturbances, as well as disturbances
associated with certain arroyos that may raise issues under section 404 of the
Clean Water Act. PNM contracted for an archeological assessment and a proposed
remediation plan with respect to the disturbances and has provided the
assessment to the USFS and the federal Bureau of Land Management ("BLM"). The
Santa Fe Forest issued a notice of non-compliance to PNM for alleged
non-compliance with the terms and conditions of PNM's special use authorization
relating to maintenance of PNM's power lines on USFS land.
By letter dated March 22, 2004, the Navajo Nation Historic Preservation
Department ("NNHPD") indicated that it would not pursue either criminal or civil
damages under the Archeological Resources Protection Act and proposed a
stipulation to address disturbances on Navajo Nation Land. PNM and Great
Southwestern entered into a letter agreement, dated June 7, 2004, with the NNHPD
for a survey of potential impacts on Navajo Nation land. If disturbed cultural
resources are encountered, appropriate treatment plans will be implemented.
Under the terms of the June 7, 2004 letter agreement, the NNHPD agreed to
release all claims against PNM and Great Southwestern for any impacts on Navajo
Nation land arising from the "climb and tighten" project. The Company is unable
to predict the outcome of this matter and cannot with any certainty the
potential impact on the Company's operations.
Excess Emissions Reports
As required by law, whenever there are excess emissions from SJGS, due to
such causes as start-up, shutdown, upset, breakdown or certain other conditions,
PNM makes filings with the NMED. For some three years, PNM has been in
discussions with NMED concerning excess emissions reports for the period after
January 1997. PNM and NMED have entered into several agreements tolling the
running of the statute of limitations in order to allow NMED to complete its
review of these filings. The present tolling agreement expires October 1, 2004.
By letter dated September 12, 2003, the NMED has advised PNM that it would not
excuse certain of the emissions exceeding the operating permit; that PNM had
violated the opacity limits in the operating permit and set out a construction
of the standards that NMED would apply in evaluating opacity exceedances. PNM
and NMED have entered into discussions concerning these matters and a draft
compliance order. PNM has responded to a number of requests by the NMED for
additional information. The compliance order has not been finalized and no
proceeding against PNM has yet been commenced by NMED. PNM disagrees with NMED's
construction of its operating permit, which is a construction never previously
advanced by NMED. PNM is unable to predict the outcome of this matter and cannot
estimate the potential impact on the Company's operations.
42
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Santa Fe Generating Station
PNM and the NMED conducted investigations of the gasoline and chlorinated
solvent groundwater contamination detected beneath PNM's former Santa Fe
Generating Station ("Santa Fe Station") site to determine the source of the
contamination pursuant to a 1992 Settlement Agreement ("Settlement Agreement")
between PNM and the NMED.
PNM is of the opinion that the data compiled indicates observed
groundwater contamination originated from off-site sources. However, in August
2003, PNM elected to enter into a fifth amendment to the Settlement Agreement
with the NMED to avoid a prolonged legal dispute whereby PNM agreed to install
additional remediation facilities consisting of an additional extraction well
and two additional monitoring wells to address remaining gasoline contamination
in the groundwater at and in the vicinity of the site. PNM will continue to
operate the remediation facilities until the groundwater is cleaned up to
applicable federal standards or until such time as the NMED determines that
additional remediation is not required, whichever is earlier. The City of Santa
Fe, the NMED and PNM entered into an amended Memorandum of Understanding
relating to the continued operation of the Santa Fe Well and the remediation
facilities called for under the latest Amended Settlement Agreement.
In September 2003, PNM was verbally informed that the Superfund Oversight
Section of the NMED is conducting an investigation into the chlorinated solvent
contamination at the former Santa Fe Station site, including other possible
sources for the chlorinated solvents in the groundwater. The NMED states that it
expects to have the results of its investigation complete by September of 2004.
Natural Gas Royalties Qui Tam Litigation
In 1999, a complaint was served on the Company alleging violations of
the False Claims Act by PNM and its subsidiaries, Gathering Company and
Processing Company (collectively, the "Company" for purposes of this
discussion), by purportedly failing to properly measure natural gas from Federal
and tribal properties in New Mexico, and consequently, underpaying royalties
owed to the Federal government. A private relator is pursuing the lawsuit. The
complaint was served after the United States Department of Justice declined to
intervene to pursue the lawsuit. The complaint seeks actual damages, treble
damages, costs and attorneys fees, among other relief.
Currently the parties are engaged in discovery on the issue of whether
the relator meets the requirements for bringing a claim under the False Claims
Act. The Company expects to participate with other defendants in a motion to
dismiss on the ground that the relator does not meet those requirements.
The Company is vigorously defending this lawsuit and is unable to
estimate the potential liability, if any, or to predict the ultimate outcome of
this lawsuit.
43
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Asbestos Cases
The Company was named in 2003 as one of a number of defendants in 21
personal injury lawsuits relating to alleged exposure to asbestos. All of these
cases involve claims of individuals, or their descendents, who worked for
contractors building, or working at, Company power plants. Some of the claims
relate to construction activities during the 1950's and 1960's, while other
claims generally allege exposure during the last 30 years. The Company has never
manufactured, sold or distributed products containing asbestos. All of these
cases involve multiple defendants. Three of the cases against PNM have been
dismissed. The Company was insured by a number of different insurance policies
during the time period at issue in these cases. The Company intends to
vigorously defend against these lawsuits. Although the Company is unable to
fully predict the outcome of this litigation, the Company believes that these
legal proceedings will not have a material impact on the financial condition of
the Company.
San Angelo Electric Service Company ("SESCO") Matter
In October 2003, the Texas Commission on Environmental Quality ("TCEQ")
requested information from PNM concerning any involvement that PNM had with the
SESCO of San Angelo, Texas. PNM is informed that the TCEQ is conducting a site
investigation of a SESCO facility in San Angelo, Texas pursuant to the Texas
Solid Waste Act and that the SESCO site has been referred to the Superfund Site
Discovery and Assessment Program. The primary concern appears to be
polychlorinated biphenyls ("PCBs"). The TCEQ is conducting the site
investigation to determine what remediation activities are required at the SESCO
site and to identify potentially responsible parties ("PRPs"). In January 2004,
PNM submitted its preliminary response to the TCEQ request for information. The
response states that PNM previously had a "requirements" contract with SESCO for
the repair of electric transformers. It appears that a number of transformers
were sent to SESCO for repair. In addition, it appears that PNM sold a number of
retired transformers to SESCO. An informational meeting took place in Austin,
Texas on April 8, 2004 where the status of the SESCO site and the possible
establishment of a PRP Committee was discussed. PNM is still investigating its
role in the matter, and is unable to predict the outcome at this time.
Public Utility Holding Company Act of 1935 (PUHCA)
Since its formation as a holding company, PNM Resources, Inc. has claimed
the intrastate exemption from registration under PUHCA, including its most
recent filing in February 2004. As the Holding Company disclosed in its most
recent Annual Report on Form 10-K, an order issued by the SEC late last year
denied the exemption to Enron based on the interstate activities of its utility
subsidiary, Portland General Electric. This order called into question the
continuing availability of the intrastate exemption for companies with a certain
level of interstate utility activities. In discussions with the Office of Public
Utility Regulation of the SEC regarding its filing earlier this year, the
Holding Company was informed that the SEC views the existing interstate
activities of PNM to be significant enough to require registration based on the
Enron decision. The Company is preparing to register, seeking the appropriate
44
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
authorizations under PUHCA coincident with registration. This process will
likely take several months and the Company expects completion near year end. The
Company intends to maintain its current claim of exemption in the interim. Other
than some reorganizing of its corporate service functions the Company does not
anticipate that registration will affect its operations. Other utility
subsidiaries of registered holding companies successfully operate in New Mexico
subject to the regulatory requirements of both PUHCA and the PRC. The regulatory
conditions imposed upon the formation of the Holding Company are equivalent to
those imposed by the PRC on utilities of registered companies.
On June 14, 2004, the New Mexico Attorney General ("Attorney General")
filed a petition for Investigation with the PRC seeking an investigation into
the circumstances involving PNM that led to the decision of the SEC Staff to
require PNM Resources, Inc. to become a registered holding company. The Attorney
General seeks to determine the impact of registration on PNM and its customers
and whether any of the conditions in the order authorizing the formation of the
holding company need to be changed or the order otherwise reconsidered. In
previous correspondence with the PRC, PNM suggested that this issue be placed as
an item on the PRC's working session agenda so that PNM could provide further
explanations and information as needed. On June 24, 2004, PNM filed a response
to the Attorney General's petition in which PNM indicated that the PRC's
jurisdiction over PNM will not be diminished as a result of PNM Resources'
registration as a holding company under PUHCA, and that previous conditions
placed on PNM will continue to apply. PNM expressed its willingness to respond
to any questions or issues surrounding PNM Resources' registration under PUHCA,
and expressed its belief that this could best be done in a collaborative
process, once again offering to make a presentation at one of the PRC's working
sessions to address any questions or concerns. The Company cannot predict the
ultimate outcome of the Attorney General's petition but does not believe that it
will result in any material adverse effect on the Company.
Coal Combustion Waste Disposal
SJCC currently disposes of fly ash from SJGS in the surface mine pits
adjacent to the plant. PNM and SJCC have been participating in various sessions
sponsored by EPA to consider rulemaking for the disposal of coal combustion
products, including disposal of fly ash from SJGS. The rulemaking would be
pursuant to the Bevill Amendment of RCRA. Pursuant to that Act, EPA has also
listed SJGS as a potential damage case for review within the rulemaking process
due to claims by third parties that the plant and mine have contaminated water
resources in the region. PNM and SJCC vigorously deny these allegations. EPA
apparently is in the process of investigating the claims. PNM cannot predict the
outcome of this matter but does not believe currently that it will have a
material adverse impact on the Company or its operations.
Other
There are various claims and lawsuits pending against the Company. The
Company is also subject to federal, state and local environmental laws and
regulations, and is currently participating in the investigation and remediation
of numerous sites. In addition, the Company periodically enters into financial
45
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
commitments in connection with its business operations. It is not possible at
this time for the Company to determine fully the effect of all litigation and
other legal proceedings on its consolidated financial statements. However, the
Company has recorded a liability where the litigation effects can be estimated
and where an outcome is considered probable. The Company does not expect that
any known lawsuits, environmental costs and commitments will have a material
adverse effect on its financial condition or results of operations, although the
outcome of litigation, investigations and other legal proceedings is inherently
uncertain.
The Company is involved in various legal proceedings in the normal course
of its business. The associated legal costs for these legal matters are accrued
when incurred. It is also the Company's policy to accrue for legal costs
expected to be incurred in connection with Statement of Financial Accounting
Standards No. 5 "Accounting for Contingencies" ("SFAS 5") legal matters when it
is probable that a SFAS 5 liability has been incurred and the amount of expected
legal costs to be incurred is reasonably estimable. These estimates include
costs for external counsel professional fees.
Risks and Uncertainties
The Company's future results may be affected by various factors outside
of its control, including: changes in regional economic conditions; the outcome
of labor negotiations with unionized employees; fluctuations in fuel, purchased
power and gas prices; the actions of utility regulatory commissions; changes in
law and environmental regulations; the success of its planned generation
expansion; the cost and outcome of litigation and other legal proceedings and
investigations; the performance of generation facilities and transmission
systems; changes in accounting rules and standards; and external factors such as
weather and water supply; and risks and uncertainties associated with the
Holding Company's pending acquisition of TNP, such as risks and uncertainties
relating to the receipt of regulatory approvals for the proposed acquisition,
the risks that the businesses will not be integrated successfully, the risk that
the benefits of the transaction will not be fully realized or will take longer
to realize than expected, disruption from the transaction making it more
difficult to maintain relationships with customers, employees, suppliers or
other third parties, and conditions in the financial markets relevant to the
proposed acquisition. Because of pending federal regulatory reforms, the public
utility industry is undergoing a fundamental change. New Mexico has repealed the
Electric Utility Industry Restructuring Act of 1999 and therefore has abandoned
its plans to transform the industry from one of vertically-integrated monopolies
to one with deregulated, competitive generation. However, the FERC has proposed
a "Standard Market Design" ("SMD") to establish rules for a market-based
approach for wholesale transactions over the transmission grid. The FERC's
efforts have been opposed by a number of states, primarily in the West and in
the Southeast in transmission market, because of concern that the SMD does not
adequately take into account regional differences. Energy legislation, which
could affect the FERC's activities, remains under consideration in Congress. In
an attempt to ease concerns, on April 28, 2003, the FERC issued a White Paper on
"Wholesale Power Market Platform" describing changes it intended to make to its
SMD proposed rules. The Company's future results will be impacted by the form of
the FERC rules, if adopted; the costs of complying with rules and legislation
46
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
that may call for regulatory reforms for the industry; and the resulting market
prices for electricity and natural gas. In addition, the Company is subject to a
2.5% retail electric rate reduction effective September 2005 and a retail
electric rate freeze through 2007 so that the Company's financial results will
depend on its ability to control costs and grow revenues, and the implications
of uncontrollable factors such as weather, water supply, litigation, economic
conditions and the other factors described above.
(8) Other Income and Deductions
The following table details the components of other income and deductions
for PNM Resources, Inc. and Subsidiaries:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- ---------------
(In thousands)
Other income:
Interest income.............................. $8,844 $10,477 $18,765 $21,177
Miscellaneous non-operating income........... 1,746 2,268 3,413 2,774
-------------- -------------- -------------- ---------------
$10,590 $12,745 $22,178 $23,951
============== ============== ============== ===============
Other deductions:
Transition costs write-off................... $ - $ - $ - $16,720
Miscellaneous non-operating deductions....... 614 4,020 3,986 5,212
-------------- -------------- -------------- ---------------
$ 614 $4,020 $ 3,986 $21,932
============== ============== ============== ===============
The following table details the components of other income and deductions
for PNM:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- ---------------
(In thousands)
Other income:
Interest income.............................. $8,744 $10,084 $18,516 $20,201
Miscellaneous non-operating income........... 1,775 1,513 3,269 1,889
-------------- -------------- -------------- ---------------
$10,519 $11,597 $21,785 $22,090
============== ============== ============== ===============
Other deductions:
Transition costs write-off................... $ - $ - $ - $16,720
Miscellaneous non-operating deductions....... 274 962 1,591 2,723
-------------- -------------- -------------- ---------------
$ 274 $ 962 $1,591 $19,443
============== ============== ============== ===============
47
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(9) Variable Interests Entities
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities"
(Revised December 2003) ("FIN 46R") became effective January 1, 2004 for those
entities considered to be special purpose entities, and March 31, 2004 for
others. FIN46R expands the requirement of a business enterprise to consolidate
an entity beyond the concept of a controlling interest. Under FIN46R, a business
enterprise will consolidate an entity if that entity is a variable interest
entity, the business enterprise is the primary beneficiary of the entity and the
entity's risks are not effectively dispersed among all parties involved. A
variable interest entity has certain characteristics that effectively
demonstrate that the equity investor does not have economic substance, bear the
risks and receive the rewards of the entity or direct the entity's activities.
The interpretation requires that an enterprise review all its variable interests
and determine if consolidation is appropriate.
Under the model for consolidation promulgated by FIN 46R, a power
purchase agreement ("PPA") may qualify as a variable interest if its terms
expose the purchaser to variability in supply or operating costs and the
contract is for a significant portion of the entity's generating capacity. The
Company evaluated its PPAs under the provisions of FIN46R and determined that
one purchase contract entered into prior to December 31, 2003 qualifies as a
variable interest. The Company was unable to obtain the necessary information to
determine if consolidation was necessary despite efforts including a formal
written request to the operator of the entity supplying power under the PPA. The
operator cited legal and competitive reasons for refusing to provide the
information.
This variable interest PPA is a contract to purchase 132 MW of capacity
and energy for 25 years expiring in June 2020. The contract contains a fixed
capacity charge and operations and maintenance ("O&M") charge and a variable
energy charge that subjects the Company to the changes in the cost of fuel and
O&M. For the six months ended June 30, 2004, the capacity and O&M charge was
$2.5 million and the energy charges were $0.3 million, unchanged from the prior
year period. The contract is for the full output of a specific gas generating
plant and is currently accounted for as an operating lease by the Company. Under
this contract the Company is exposed to changes in the costs to produce energy
and operate the plant.
The Company also has interests in other variable interest entities
created before January 31, 2003, for which the Company is not the primary
beneficiary. These arrangements include the Holding Company's investment in a
limited partnership and PNM's two leases with special-purpose entities. The
aggregate maximum loss exposure at June 30, 2004, that the Company could be
required to record in its income statement as a result of these arrangements
totals approximately $7.9 million. The creditors of these variable interest
entities do not have recourse to the general credit of the Company in excess of
the aggregate maximum loss exposure.
48
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(10) New Accounting Standards
FASB Staff Position No. 106-2 "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003 ("the Act")" ("FSP 106-2"). The Act introduces a prescription drug benefit
under Medicare ("Medicare Part D") as well as a federal subsidy to sponsors of
retiree health care benefit plans that provide a benefit that is at least
actuarially equivalent to Medicare Part D. Under FSP 106-1 the Company elected
to defer financial recognition of the Act until the FASB issued further
guidance. FSP 106-2 provides authoritative guidance on the accounting for the
federal subsidy and specifies the disclosure requirements for employers who have
adopted FSP 106-2. Guidance of FSP 106-2 supercedes FSP 106-1 and applies only
to the sponsor of a single-employer defined benefit postretirement health care
plan for which (1) the employer's prescription drug benefits are "actuarially
equivalent" to Medicare Part D, thus qualifying for the subsidy and (2) the
expected subsidy will offset or reduce the employer's share of the cost of the
underlying postretirement prescription drug coverage on which the subsidy is
based. FSP 106-2 is effective for the quarter beginning after June 30, 2004. On
July 19, 2004, the Company's board of directors approved a resolution adopting
Medicare Part D legislation for its retiree healthcare plan. The effect of this
change will be to reduce expense by $1.1 million for the period July 1, 2004
through December 31, 2004.
(11) Subsequent Events
Proposed TNP Enterprises, Inc. Acquisition
On July 24, 2004, the Holding Company executed a definitive agreement
to acquire all the outstanding common shares of TNP Enterprises, Inc. ("TNP")
for approximately $189 million, comprised of equal amounts of the Holding
Company's common stock and cash. Under the agreement, the Holding Company will
also assume approximately $835 million of TNP's net debt and senior redeemable
cumulative preferred stock.
TNP is a privately owned holding company for Texas-New Mexico Power
Company ("TNMP") and First Choice Power ("First Choice"). TNMP provides electric
service to 85 cities and more than 252,000 customers in Texas and New Mexico.
Its affiliate, First Choice, is a retail electric provider with more than
230,000 customers in Texas.
The combined company will have consolidated revenues of over $2.3
billion and serve a number of growing communities, including Albuquerque, Santa
Fe, and Alamogordo in New Mexico, as well as suburban areas around Dallas-Fort
Worth, Houston, and Galveston in Texas. Through First Choice, the Holding
Company will also serve customers in communities throughout the Electric
Reliability Council of Texas (ERCOT) region.
Under the terms of the agreement, TNP's common shareholders will
receive approximately $189 million in consideration, consisting of approximately
4.7 million newly issued Holding Company common shares and the remainder being
paid in cash, subject to closing adjustments. The existing indebtedness and
49
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
preferred securities at TNP will be retired. All debt at TNMP will remain
outstanding.
Based on the number of common shares outstanding on a fully diluted
basis and taking into account additional equity issuances, following the
transaction, the Holding Company's shareholders would own 94% of the combined
company's common equity, and TNP's shareholders would own approximately 6%.
In order to fund the acquisition and to deleverage TNP, the Holding
Company expects to issue approximately $250 million of common equity,
approximately $200 million of equity linked securities, and approximately $100
million of long-term debt. Of the total $450 million of common equity and equity
linked securities, approximately $95 million of common stock will be issued to
TNP's shareholders, and the Holding Company has executed a letter of intent with
an existing shareholder to purchase $100 million in equity linked securities.
The remainder of the financing will be placed in the public markets at or near
closing.
The transaction is subject to customary closing conditions and
regulatory approvals, including the New Mexico Public Regulation Commission, the
Public Utility Commission of Texas, the U.S. Securities and Exchange Commission
(under the Public Utility Holding Company Act of 1935), the Federal Energy
Regulatory Commission, and antitrust review under the Hart-Scott-Rodino Act. No
shareholder approval is required. Given the straightforward nature of the
transaction, the Holding Company anticipates obtaining the necessary regulatory
approvals in 9 to 12 months.
Debt Repricing
On July 1, 2004, PNM repriced $36.0 million of tax-exempt pollution
control bonds, with a previous term and interest rate of 1 year and 2.75%,
respectively. The new interest rate is 4.0% for a term of 5 years. These bonds
will reprice next on July 1, 2009.
(Intentionally left blank)
50
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Holding Company and its subsidiaries and PNM and
its subsidiaries is presented on a combined basis. The Holding Company performs
substantially all of the corporate activities of PNM. These activities are
billed to PNM on a cost basis to the extent they are for the corporate
management of PNM and are allocated to the operating segments. The business of
PNM constitutes substantially all of the business of the Company. Therefore, the
results of operations of PNM are virtually identical to the consolidated results
of the Holding Company and all its subsidiaries. For discussion purposes, this
report will use the term "Company" when discussing matters of common
applicability to the Holding Company and Subsidiaries and PNM and Subsidiaries.
Readers of Management's Discussion and Analysis of Financial Condition and
Results of Operations should assume that the information presented applies to
consolidated results of operations of both the Holding Company and its
subsidiaries and PNM and its subsidiaries, except where the context or
references clearly indicate otherwise. Discussions regarding specific
contractual obligations generally reference the company that is legally
obligated. In the case of contractual obligations of PNM, these obligations are
consolidated with the Holding Company and its subsidiaries under GAAP. Broader
operational discussions refer to the Company.
The following is management's assessment of the Company's financial
condition and the significant factors affecting the results of operations. This
discussion should be read in conjunction with the Company's consolidated
financial statements and related notes. Trends and contingencies of a material
nature are discussed to the extent known.
OVERVIEW
The Holding Company is an investor-owned holding company of energy and
energy related companies. Its principal subsidiary, PNM, is an integrated public
utility primarily engaged in the generation, transmission and distribution of
electricity; transmission, distribution and sale of natural gas within the State
of New Mexico; and the sale and marketing of electricity in the Western United
States.
COMPETITIVE STRATEGY
The Company is positioned as a "merchant utility," primarily operating as
a regulated energy service provider. The Company is also engaged in the sale and
marketing of electricity in the competitive energy marketplace. As a utility,
PNM has an obligation to serve its customers under the jurisdiction of the PRC.
As a wholesale electricity provider, PNM markets excess power from the utility,
as well as unregulated generation, into a competitive marketplace. As part of
its electric wholesale power operation, the Company purchases wholesale
electricity in the open market for future resale or to provide energy to retail
customers in New Mexico when the Company's generation assets cannot satisfy
demand. The wholesale operations utilize an asset-backed strategy, whereby the
Company's aggregate net open position for the sale of electricity is covered by
the Company's forecasted excess generation capabilities.
51
As it currently operates, the Company's principal business segments,
whose operating results are regularly reviewed by the Company's management, are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
includes Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission"). Electric consists of the distribution and generation
of electricity for retail electric customers in New Mexico. Gas includes the
transportation and distribution of natural gas to end-users. Transmission
consists of the transmission of electricity to third parties as well as to
Electric and Wholesale. Wholesale consists of the generation and sale of
electricity into the wholesale market based on three product lines, which
include long-term contracts, forward sales and short-term sales.
The Utility Operations strategy is directed at supplying reasonably
priced and reliable energy to retail customers through customer-driven
operational excellence, high quality customer service, cost efficient processes,
and improved overall organizational performance.
The Wholesale Operations strategy calls for increased net asset-backed
energy sales supported by long-term contracts and the wholesale market, whereby
the Company's aggregate net open forward electric sales position, including
short term sales, forward sales and long-term contracts, is covered by its
forecasted excess generation capacity. The net asset-backed sales are actively
monitored by management by the use of stringent risk management policies. The
Company's future growth plans call for approximately 75% of its new generation
portfolio to be committed through long-term contracts as required by the most
recent electric rate agreement. Growth will be dependent on market development
and on the Company's ability to generate funds for the Company's future
expansion. Although the current economic environment has led the Company to
scale back its expansion plans, the Company will continue to operate in the
wholesale market and seek reasonably priced asset additions. Expansion of the
Company's generating portfolio will depend on the Company's ability to acquire
favorably priced assets at strategic locations and to secure long-term
commitments for the purchase of power from the acquired plants.
On July 24, 2004, the Holding Company entered into an agreement to
acquire TNP (see Note 11 in the Notes to Consolidated Financial Statements). The
Holding Company believes its combination with TNP provides a number of strategic
benefits. Specifically, this acquisition:
o Is consistent with the Holding Company's strategic plan of
disciplined growth, which is to balance stable and predictable
revenue streams with growth opportunities. This move will expand
the Holding Company's electric customer base by more than 76%.
o Expands the Holding Company's electric retail territory in the
growing Southwest, providing it marketplace diversity and less
exposure to customer usage patterns.
o Provides additional growth opportunities by establishing a platform
in the competitive electric market in Texas.
o Provides significant stable, low-risk revenue and cash flow from
TNMP's utility operations.
o Allows the Holding Company and TNP to take advantage of their
utilities' overlapping and contiguous gas and electric service
territories in New Mexico to drive operating efficiencies.
52
OVERALL OUTLOOK
The Company experienced continued earnings growth in the six months ended
June 30, 2004 compared to the same period in 2003, excluding certain items that
occurred in 2003 for the cumulative effect of an accounting change (see
"Cumulative Effect of Changes in Accounting Principles" below) and the write-off
of transition costs related to the repeal of electric deregulation in New Mexico
in 2003 (see "Consolidated - Other Income and Deductions" below). This growth
was primarily due to the addition of new long-term power contracts, coupled with
customer growth in the Company's Utility Operations, significantly lower
interest costs and a normal winter season in New Mexico during the 2004 period.
The first quarter of 2003 was one of the warmest in recent history. The volume
gains made in the Company's Utility Operations and a gas rate increase more than
offset a retail electric rate reduction that took effect in September 2003.
Wholesale Operations was the biggest contributor to the Company's
earnings growth in 2004. The Company continued to grow its wholesale sales by
adding long-term contracts to support its Wholesale Operations. In addition,
increased liquidity in the marketplace and more favorable pricing allowed the
Company to improve its velocity, the Company's ability to repurchase and resell
previously sold capacity, from 1.77 in 2003 to 1.98 in 2004.
Retail Operations also contributed to the Company's earnings growth with
increased load growth of 3.2% in Electric and a 1.9% customer growth in Gas. The
Company also benefited from lower fuel costs for coal-fired generation and a
normal winter heating season in 2004, which increased both its retail electric
and gas gross margin. These improvements were partially offset by scheduled
outages and unplanned outages at PVNGS, SJGS and Four Corners and the associated
increases in purchase power costs.
Other significant developments affecting the Company included:
o On January 13, 2004, the PRC approved a $22 million revenue
increase for the Company's gas utility. Increased rates for
commercial and industrial customers took effect immediately, while
the increase for residential customers began April 1, 2004.
o On February 27, 2004, Standard & Poor's raised both the Holding
Company and PNM's corporate credit rating to `BBB', with a stable
outlook.
o On March 10, 2004, Moody's Investors Service upgraded the rating on
debt securities of PNM to Baa2, with a stable outlook.
o On April 23, 2004, the Company entered into a rated commercial
paper program (see "Financing Activities" below).
o On April 29, 2004, the Company entered into three fixed to floating
interest rate swaps (see "Financing Activities" below).
o On June 15, 2004, PNM expanded its long-term power sales with a 10
MW contract to the city of Mesa, Arizona which the Company
anticipates will increase 2004 revenues by $1.6 million.
o On July 24, 2004, the Holding Company entered into an agreement to
acquire TNP (see Note 11 in the Notes to Consolidated Financial
Statements).
In 2004, the Company intends to continue its efforts to expand its
wholesale business by building on existing relationships and forming new
relationships with long-term contract customers. The Company expects its 2004
53
earnings to benefit from higher wholesale power prices and the new cost of
service gas rates approved by the PRC, forecasted lower fuel costs from the new
SJGS underground mine, significantly lower interest costs and planned
productivity improvements. Other factors that will be critical to achieving
earnings goals in 2004 include continued stable wholesale market prices and
improved plant performance, particularly in light of the retail electric rate
freeze continuing through 2007.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2004
Compared to Three Months Ended June 30, 2003
Consolidated
The Company's net earnings available to common shareholders for the three
months ended June 30, 2004 were $16.8 million or $0.28 per diluted share of
common stock, a 4.3% decrease in net earnings compared to $17.6 million or $0.30
per diluted share of common stock in 2003. This decrease primarily reflects the
utilization of higher cost electric purchases resulting from less available
lower cost generation due to planned and unplanned outages at the Company's
generation plants. This decrease is partially offset by new long-term contract
sales, increased demand in the New Mexico service territory for electricity and
natural gas and lower interest costs.
The following discussion is based on the methodology that the Company's
management uses for making operating decisions and assessing performance of its
various business activities. As such, these segments report operating results
with regard to the effect of accounting or regulatory changes, and similar
one-time items not related to normal operations within the Corporate and Other
segment. See Note 2 - "Segment Information" in the Notes to Consolidated
Financial Statements for additional information regarding these results and the
consolidated financial statements.
In addition, adjustments related to EITF Issue 03-11 "Reporting Realized
Gains and Losses on Derivative Instruments That Are Subject to FASB Statement
No. 133 and Not Held for Trading Purposes" are excluded. This accounting
pronouncement requires a net presentation of realized gains and losses for
certain non-trading derivatives. Management evaluates wholesale operations on a
gross presentation basis due to its net-asset-backed marketing strategy and the
importance it places on velocity.
Corporate costs, income taxes and non-operating items are discussed only
on a consolidated basis and are in conformity with the presentation in the
consolidated financial statements.
(Intentionally left blank)
54
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Three Months Ended
June 30,
----------------------------------
2004 2003 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:........................ $130,695 $ 131,091 $ (396)
Less: Cost of energy....................... 51,883 50,006 1,877
Energy transfer..................... (10,924) (11,654) 730
---------------- --------------- --------------
Gross margin............................... 89,736 92,739 (3,003)
---------------- --------------- --------------
Energy production costs.................... 29,121 25,427 3,694
Distribution O&M........................... 4,805 4,903 (98)
Customer related expense................... 4,539 4,184 355
Administrative and general................. 1,581 1,851 (270)
---------------- --------------- --------------
Total non-fuel O&M....................... 40,046 36,365 3,681
Corporate allocation....................... 16,435 19,373 (2,938)
Depreciation and amortization.............. 13,983 15,843 (1,860)
Taxes other than income taxes.............. 4,355 3,598 757
Income taxes............................... 3,048 4,297 (1,249)
---------------- --------------- --------------
Total non-fuel operating expenses........ 77,867 79,476 (1,609)
---------------- --------------- --------------
Operating income........................... $11,869 $ 13,263 $(1,394)
---------------- --------------- --------------
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Residential................ $46,821 $46,582 $ 239
Commercial................. 63,114 63,273 (159)
Industrial................. 15,373 16,351 (978)
Other...................... 5,387 4,885 502
------------- ------------- --------------
$130,695 $131,091 $ (396)
============= ============= ==============
Average customers.......... 405,325 394,617 10,708
============= ============= ==============
55
The following table shows electric sales by customer class:
Electric Sales
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Megawatt hours)
Residential............. 567,825 543,195 24,630
Commercial.............. 862,490 834,103 28,387
Industrial.............. 318,633 325,243 (6,610)
Other................... 65,038 63,130 1,908
------------- ------------- --------------
1,813,986 1,765,671 48,315
============= ============= ==============
Operating revenues decreased $0.4 million or 0.3% over the prior year
period. This revenue decrease was primarily due to a retail electric rate
decrease of $5.1 million. The Company reduced its retail electric rates based on
an electric rate agreement, which took effect in the third quarter of 2003. This
revenue decrease was mostly offset by retail electricity sales which grew to
1.81 million MWh in 2004 compared to 1.77 million MWh sold in the prior year,
resulting in an increase in revenues of $3.9 million. This volume increase was
the result of load growth year-over-year of 2.8%. Under the rate freeze
applicable to the Company, retail electric rates will be reduced by a further
2.5% effective September 2005 and will be frozen at that level through December
31, 2007 at which time the Company or others can request a review of the
Company's rates.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, decreased $3.0 million or 3.2% over the prior year
period. This decrease is due to the rate decrease and additional costs of $1.5
million related to the amortization of certain coal mine reclamation costs as
agreed to in the current electric rate agreement, offset by load growth in the
Company's retail electric service territory. The average cost of generation and
purchased power on a per unit basis increased slightly year over year. Lower
fuel costs at SJGS were mostly offset by higher purchased power costs due to
outages at PVNGS in June 2004.
Total non-fuel O&M expenses increased $3.7 million or 10.1% over the
prior year period. Energy production costs increased $3.7 million or 14.5%
primarily due to increased maintenance costs for increased planned and unplanned
outages at SJGS and PVNGS in 2004. Depreciation and amortization decreased $1.9
million or 11.7%. Lower electric depreciation rates for 2004 based on a new
five-year depreciation study and the full amortization of the Company's customer
billing system at the end of 2003 reduced depreciation $1.7 million. Taxes other
than income increased $0.8 million primarily due to a property obsolescence
settlement in 2003, which did not recur in 2004 and increased property tax
rates.
(Intentionally left blank)
56
Gas
The table below sets forth the operating results for Gas.
Three Months Ended
June 30,
--------------------------------
2004 2003 Variance
--------------- -------------- ---------------
(In thousands)
Operating revenues:........................ $80,886 $59,520 $21,366
Less: Cost of energy....................... 51,650 31,786 19,864
--------------- -------------- ---------------
Gross margin............................... 29,236 27,734 1,502
--------------- -------------- ---------------
Energy production costs.................... 480 438 42
Transmission and distribution O&M.......... 6,807 7,145 (338)
Customer related expense................... 4,729 4,062 667
Administrative and general................. 1,388 924 464
--------------- -------------- ---------------
Total non-fuel O&M....................... 13,404 12,569 835
Corporate allocation....................... 9,868 11,069 (1,201)
Depreciation and amortization.............. 4,738 5,498 (760)
Taxes other than income taxes.............. 1,867 1,314 553
Income taxes............................... (1,338) (2,426) 1,088
--------------- -------------- ---------------
Total non-fuel operating expenses........ 28,539 28,024 515
--------------- -------------- ---------------
Operating income (loss).................... $ 697 $ (290) $ 987
--------------- -------------- ---------------
The following table shows gas revenues by customer class and average
customers:
Gas Revenues
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Residential............... $39,053 $33,882 $5,171
Commercial................ 12,796 11,470 1,326
Industrial................ 622 434 188
Transportation*........... 3,639 6,010 (2,371)
Other..................... 24,776 7,724 17,052
------------- ------------- --------------
$80,886 $59,520 $21,366
============= ============= ==============
Average customers......... 459,398 450,948 8,450
============= ============= ==============
57
The following table shows gas throughput by customer class:
Gas Throughput
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Thousands of decatherms)
Residential............... 3,334 3,651 (317)
Commercial................ 1,455 1,641 (186)
Industrial................ 88 70 18
Transportation*........... 13,014 16,455 (3,441)
Other..................... 4,077 1,026 3,051
------------- ------------- --------------
21,968 22,843 (875)
============= ============= ==============
*Customer-owned gas
Operating revenues increased $21.4 million or 35.9% over the prior year
period primarily because of higher natural gas prices in 2004 as compared to
2003 and an increase in gas sales volumes of 3.8%, resulting from customer
growth of 1.9%, which increased revenues $0.4 million. This revenue increase was
partially offset by a decrease in off-system gas transportation sales of $2.4
million due to lower price differences between the San Juan and Permian basins.
The Company has a major pipeline between the basins and can realize revenue
opportunities when pricing in the basins differ.
The Company purchases natural gas in the open market and resells it at
that open market price to its sales-service customers. As a result, increases or
decreases in gas revenues driven by gas costs do not impact the Company's
consolidated gross margin or earnings. In addition, revenues grew $3.3 million
due to a cost of service rate increase granted by the PRC in January 2004. The
PRC approved a rate increase, which will improve gas earnings by approximately
$22 million annually. The Company estimates that approximately two-thirds of
this increase will be realized in 2004 earnings due to a delay in implementing
the residential increase until April 2004.
The gross margin, or operating revenues minus cost of energy sold,
increased $1.5 million or 5.4% over the prior year period. This increase is due
mainly to customer growth and the PRC approved rate increase, partially offset
by a decrease in off-system transportation sales as described above.
Total non-fuel O&M expenses increased $0.8 million or 6.6% over the prior
year period. Customer related expense increased $0.7 million or 16.4% primarily
due to the recovery of bad debt costs in 2003, which did not recur in 2004.
Administrative and general costs increased $0.5 million primarily due to a
reduction of capitalized costs resulting from capital activity in 2003 for two
new pipelines, which did not recur in 2004. Depreciation and amortization
decreased $0.8 million or 13.8% due to the Company's customer billing system
being fully amortized at the end of 2003. Taxes other than income increased $0.6
million primarily due to increased property tax rates.
58
Transmission
The table below sets forth the operating results for Transmission.
Three Months Ended
June 30,
----------------------------------
2004 2003 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:
External customers...................... $ 4,420 $ 2,317 $ 2,103
Intersegment revenues................... 7,992 10,554 (2,562)
---------------- --------------- --------------
Total revenues.......................... 12,412 12,871 (459)
Less: Cost of energy...................... 1,885 1,183 702
---------------- --------------- --------------
Gross margin.............................. 10,527 11,688 (1,161)
---------------- --------------- --------------
Energy production costs................... 147 241 (94)
Transmission O&M.......................... 2,527 3,136 (609)
Administrative and general................ 862 581 281
---------------- --------------- --------------
Total non-fuel O&M...................... 3,536 3,958 (422)
Corporate allocation...................... 1,463 1,762 (299)
Depreciation and amortization............. 2,706 2,337 369
Taxes other than income taxes............. 620 586 34
Income taxes.............................. 294 545 (251)
---------------- --------------- --------------
Total non-fuel operating expenses....... 8,619 9,188 (569)
---------------- --------------- --------------
Operating income.......................... $ 1,908 $ 2,500 $ (592)
---------------- --------------- --------------
Gross margin decreased $1.2 million or 9.9% compared to the prior year
period primarily due to increased transmission costs for Afton and lower third
party sales of available transmission. Cost of energy represents purchased
transmission to support transmission offerings.
Total non-fuel O&M expenses decreased $0.4 million or 10.7% over the
prior year period as a result of lower transmission O&M, which decreased $0.6
million or 19.4% primarily due to an increase in costs for line repairs in 2003
for reliability purposes, which did not recur in 2004.
(Intentionally left blank)
59
Wholesale
The table below sets forth the operating results for Wholesale.
Three Months Ended
June 30,
-----------------------------------
2004 2003 Variance
---------------- --------------- --------------
(In thousands)
Operating revenues:
External customers...................... $ 158,894 $ 132,742 $26,152
Intersegment revenues................... - 900 (900)
---------------- ---------------- --------------
Total revenues.......................... 158,894 133,642 25,252
Less: Cost of energy...................... 120,717 89,327 31,390
Energy transfer.................... 10,924 11,652 (728)
---------------- ---------------- --------------
Gross margin.............................. 27,253 32,663 (5,410)
---------------- ---------------- --------------
Energy production costs................... 6,940 8,409 (1,469)
Transmission and distribution O&M......... 13 10 3
Customer related expense.................. 469 114 355
Administrative and general................ 2,415 2,192 223
---------------- ---------------- --------------
Total non-fuel O&M...................... 9,837 10,725 (888)
Corporate allocation...................... 1,176 2,439 (1,263)
Depreciation and amortization............. 3,754 3,569 185
Taxes other than income taxes............. 876 1,050 (174)
Income taxes.............................. 3,254 4,460 (1,206)
---------------- ---------------- --------------
Total non-fuel operating expenses....... 18,897 22,243 (3,346)
---------------- ---------------- --------------
Operating income.......................... $ 8,356 $ 10,420 $ (2,064)
---------------- ---------------- --------------
The following table shows revenues by customer class:
Wholesale Revenues
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts*...... $40,214 $34,507 $5,707
Forward sales*............ 48,045 44,010 4,035
Short-term sales.......... 70,635 55,125 15,510
------------- ------------- --------------
$158,894 $133,642 $25,252
============= ============= ==============
*Includes mark-to-market gains/(losses).
(Intentionally left blank)
60
The following table shows sales by customer class:
Wholesale Sales
Three Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Megawatt hours)
Long-term contracts....... 718,389 560,672 157,717
Forward sales............. 930,800 929,300 1,500
Short-term sales.......... 1,599,519 1,377,886 221,633
------------- ------------- --------------
3,248,708 2,867,858 380,850
============= ============= ==============
Operating revenues increased $25.3 million or 18.9% over the prior year
period. This increase in wholesale electric sales primarily reflects additional
long-term contract sales and wholesale electric price improvements. In the
second quarter of 2004, new long-term contracts added 150,303 MWhs, or $7.4
million in revenues. These contracts support the Company's long-term growth
plans and net asset-backed strategy, as described above. In addition, the
Company's forward and short-term sales increased $19.5 million or 19.7% compared
to the second quarter of 2003. As market liquidity increased in the current
quarter compared to the earlier year period, the Company was able to increase
transaction volumes and take advantage of higher market prices. Accordingly, the
Company's velocity ratio increased from 1.78 to 2.06 or 15.7% compared to the
second quarter of 2003 due to the increase in prices. The Company sold wholesale
(bulk) power of 3.3 million MWh of electricity for the three months ended June
30, 2004 compared to 2.9 million MWh for the same period in 2003.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, decreased $5.4 million or 16.6% over the prior
year period. Long-term contracts margin increased $2.6 million primarily due to
additional long-term sales under new contracts. Forward sales margin decreased
$2.8 million primarily reflecting higher purchase prices, partially offset by
higher market prices. Short-term sales margin decreased $5.1 million primarily
due to the dilutive effect of less available lower cost generation resulting
from planned and unplanned outages at the Company's facilities and higher
purchase volumes, partially offset by higher sales volumes and higher market
prices. The average price on the Company's realized forward and short-term sales
was $46 per MWh in 2004, compared to $41 per MWh in 2003. The Company had an
unfavorable change in the unrealized mark-to-market position of $2.9 million
period over period ($1.0 million gain in 2004 versus $3.9 million gain in 2003).
In addition, the long-term margin increase included $3.0 million from sales of
pollution credits and a reduction of purchased power of $2.3 million for
renewable energy credits.
As discussed above, adjustments of $9.4 million for the three months
ended June 30, 2004 related to EITF Issue 03-11, which requires a net
presentation of trading gains and losses and realized gains and losses for
certain non-trading derivatives, are included in Corporate and Other in the
Company's segment presentation. Management evaluates wholesale operations on a
gross presentation basis due to its net asset-backed marketing strategy.
Total non-fuel O&M decreased $0.9 million or 8.3% over the prior year
period. Energy production costs decreased $1.5 million or 17.5% primarily due to
61
planned outages at PVNGS Unit 3 in 2003, which did not recur in 2004, partially
offset by planned and unplanned outages at SJGS and PVNGS Units 1 and 2.
Corporate and Other
Corporate administrative and general expenses, which represent costs that
are driven primarily by corporate-level activities, are allocated to the
business segments and presented in the corporate allocation line item in the
segment statements. These costs decreased $2.1 million or 7.5% over the prior
year period to $25.9 million. The decrease in these costs was due to a net
decrease in pension and benefit costs of $0.8 million due to decreased
pension/retirement expense of $2.2 million, resulting from higher returns on
pension plan assets and lower retiree medical costs partially offset by
increased 401(k) plan and health insurance costs of $1.4 million. In addition,
computer maintenance costs decreased $0.5 million and labor decreased $0.7
million due to costs associated with a short-term incentive based compensation
plan.
Consolidated
Other Income and Deductions
Other income decreased $2.2 million or 16.9% over the prior year period
due to lower quarter-over-quarter returns on investments.
Other deductions decreased $3.4 million or 84.7% over the prior year
period. In 2003, the Company had a write-off of $1.0 million for costs related
to long-term debt refunding, which did not recur in 2004. In addition, the
Company recognized amortization of $0.4 million of debt re-financing costs and
recognized a decrease in short-term cash investment losses of $1.6 million in
2004.
Interest Expense
Interest expense decreased $5.7 million or 32.1% over the prior year
period primarily due to refinancing of senior unsecured notes and pollution
control bonds, which decreased interest costs $4.1 million, as well as lower
interest costs of $0.9 million on short-term debt resulting from lower interest
rates and lower short-term borrowings. In addition, allowance for funds used
during construction ("AFUDC") and capitalized interest increased $0.5 million in
2004 compared to 2003, reducing interest expense further.
Income Taxes
The Company's consolidated income tax expense decreased $0.5 million from
$10.2 million for the three months ended June 30, 2003 to $9.7 million for the
period ended June 30, 2004. The Company's effective income tax rates for the
three months ended June 30, 2004 and 2003 were 36.33% and 36.54%, respectively.
The decrease in the effective tax rate was due to an increase in permanent tax
differences.
62
RESULTS OF OPERATIONS
Six Months Ended June 30, 2004
Compared to Six Months Ended June 30, 2003
Consolidated
The Company's net earnings for the six months ended June 30, 2004 were
$41.6 million or $0.68 per diluted share of common stock, a 35.9% decrease in
net earnings compared to $65.0 million or $1.09 per diluted share of common
stock in 2003. This decrease primarily resulted from items that occurred in 2003
that did not recur in 2004. In 2003, the Company recognized, as an addition to
net income, the cumulative effect of changes in accounting principles for the
adoption of Statement of Financial Accounting Standards No. 143, "Accounting for
Asset Retirement Obligations," ("SFAS 143") and the change in the pension
actuarial valuation measurement date of $36.6 million, net of income taxes, or
$0.61 per diluted share of common stock, partially offset by the write-off of
transition costs of $10.7 million, net of income taxes, or $0.17 per diluted
share of common stock that resulted from the repeal of electric deregulation in
New Mexico in 2003.
The following discussion is based on the methodology that the Company's
management uses for making operating decisions and assessing performance of its
various business activities. As such, these segments report operating results
with regard to the effect of accounting or regulatory changes, and similar
one-time items not related to normal operations within the Corporate and Other
segment. See Note 2 - "Segment Information" in the Notes to Consolidated
Financial Statements for additional information regarding these results and the
consolidated financial statements.
In addition, adjustments related to EITF Issue 03-11 "Reporting Realized
Gains and Losses on Derivative Instruments That Are Subject to FASB Statement
No. 133 and Not Held for Trading Purposes" are excluded. This accounting
pronouncement requires a net presentation of realized gains and losses for
certain non-trading derivatives. Management evaluates wholesale operations on a
gross presentation basis due to its net-asset-backed marketing strategy and the
importance it places on velocity.
Corporate costs, income taxes and non-operating items are discussed only
on a consolidated basis and are in conformity with the presentation in the
consolidated financial statements.
(Intentionally left blank)
63
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Six Months Ended
June 30,
----------------------------------
2004 2003 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:........................ $ 260,731 $ 257,296 $ 3,435
Less: Cost of energy....................... 103,520 99,181 4,339
Energy transfer..................... (24,337) (24,034) (303)
---------------- --------------- --------------
Gross margin............................... 181,548 182,149 (601)
---------------- --------------- --------------
Energy production costs.................... 58,642 52,877 5,765
Transmission and distribution O&M.......... 10,007 10,157 (150)
Customer related expense................... 8,642 6,463 2,179
Administrative and general................. 1,646 2,045 (399)
---------------- --------------- --------------
Total non-fuel O&M....................... 78,937 71,542 7,395
Corporate allocation....................... 32,336 31,681 655
Depreciation and amortization.............. 27,953 31,578 (3,625)
Taxes other than income taxes.............. 9,181 8,808 373
Income taxes............................... 7,401 9,971 (2,570)
---------------- --------------- --------------
Total non-fuel operating expenses........ 155,808 153,580 2,228
---------------- --------------- --------------
Operating income........................... $ 25,740 $ 28,569 $ (2,829)
---------------- --------------- --------------
(Intentionally left blank)
64
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Residential............. $100,953 $97,590 $ 3,363
Commercial.............. 119,865 118,334 1,531
Industrial.............. 30,260 32,263 (2,003)
Other................... 9,653 9,109 544
------------- ------------- --------------
$260,731 $257,296 $ 3,435
============= ============= ==============
Average customers....... 404,285 393,573 10,712
============= ============= ==============
The following table shows electric sales by customer class:
Electric Sales
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Megawatt hours)
Residential............ 1,223,309 1,136,055 87,254
Commercial............. 1,639,332 1,554,240 85,092
Industrial............. 629,308 642,650 (13,342)
Other.................. 115,727 113,307 2,420
------------- ------------- --------------
3,607,676 3,446,252 161,424
============= ============= ==============
Operating revenues increased $3.4 million or 1.3% over the prior year
period. Retail electricity sales grew to 3.6 million MWh in 2004 compared to 3.4
million MWh sold in the prior year. This volume increase was the result of load
growth year-over-year of 3.2%, resulting in an increase in revenues of $12.6
million and a normal winter heating season in 2004, which increased revenues
$1.6 million. This revenue increase was partially offset by a retail electric
rate decrease of $10.5 million. The Company reduced its retail electric rates
based on an electric rate agreement, which took effect in the third quarter of
2003.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, decreased $0.6 million or 0.3% over the prior year
period. This decrease is due mainly to the rate decrease and additional costs of
$3.0 million related to the amortization of certain coal mine reclamation costs
as agreed to in the current electric rate agreement, partially offset by load
growth in the Company's retail electric service territory. The average cost of
generation and purchased power on a per unit basis increased year over year.
Higher purchased power costs due to outages at PVNGS and SJGS were, partially
offset by lower fuel costs at SJGS.
Total non-fuel O&M expenses increased $7.4 million or 10.3% over the
prior year period. Energy production costs increased $5.8 million or 10.9%
primarily due to increased maintenance costs of $5.4 million for increased
65
planned and unplanned outages in 2004. Customer-related expense increased $2.2
million or 33.7% as a result of favorable collection outcomes in 2003. Overall
collection trends remained stable from year to year but did not show
improvements as in past years. Depreciation and amortization decreased $3.6
million or 11.5%. Lower electric depreciation rates for 2004 based on a new
five-year depreciation study and the full amortization of the Company's customer
billing system at the end of 2003 reduced depreciation $3.5 million.
Gas
The table below sets forth the operating results for Gas.
Six Months Ended
June 30,
--------------------------------
2004 2003 Variance
--------------- -------------- ---------------
(In thousands)
Operating revenues:
External customers.......................... $256,760 $203,706 $53,054
Less: Cost of energy........................ 180,798 134,597 46,201
--------------- -------------- ---------------
Gross margin................................ 75,962 69,109 6,853
--------------- -------------- ---------------
Energy production costs..................... 1,013 948 65
Transmission and distribution O&M........... 14,392 15,125 (733)
Customer related expense.................... 8,865 7,850 1,015
Administrative and general.................. 1,957 1,019 938
--------------- -------------- ---------------
Total non-fuel O&M........................ 26,227 24,942 1,285
Corporate allocation........................ 19,466 18,760 706
Depreciation and amortization............... 9,467 10,940 (1,473)
Taxes other than income taxes............... 4,025 3,355 670
Income taxes................................ 4,474 1,712 2,762
--------------- -------------- ---------------
Total non-fuel operating expenses......... 63,659 59,709 3,950
--------------- -------------- ---------------
Operating income............................ $ 12,303 $ 9,400 2,903
--------------- -------------- ---------------
(Intentionally left blank)
66
The following table shows gas revenues by customer and average customers:
Gas Revenues
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Residential............. $154,791 $130,282 $ 24,509
Commercial.............. 48,952 41,398 7,554
Industrial.............. 1,290 1,465 (175)
Transportation*......... 7,943 9,755 (1,812)
Other................... 43,784 20,806 22,978
------------- ------------- --------------
$256,760 $203,706 $ 53,054
============= ============= ==============
Average customers....... 460,263 451,558 8,705
============= ============= ==============
*Customer-owned gas.
The following table shows gas throughput by customer class:
Gas Throughput
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Thousands of decatherms)
Residential............. 17,348 15,857 1,491
Commercial.............. 6,273 5,975 298
Industrial.............. 192 256 (64)
Transportation*......... 20,734 25,090 (4,356)
Other................... 7,135 2,969 4,166
------------- ------------- --------------
51,682 50,147 1,535
============= ============= ==============
*Customer-owned gas.
Operating revenues increased $53.1 million or 26.0% over the prior year
period primarily because of higher natural gas prices in 2004 as compared to
2003 and an increase in gas sales volumes of 3.1%, resulting from customer
growth of 1.9%, which increased revenues $2.7 million and a normal winter
heating season in 2004, which increased revenues $1.6 million. These revenue
increases were partially offset by a decrease in off-system transportation sales
of $2.8 million due to lower price differences between the San Juan and Permian
basins.
The Company purchases natural gas in the open market and resells it at
that open market price to its sales-service customers. As a result, increases or
decreases in gas revenues driven by gas costs do not impact the Company's
consolidated gross margin or earnings. In addition, revenues grew $4.4 million
due to a cost of service rate increase granted by the PRC in January 2004. The
PRC approved a rate increase, which will improve gas earnings by approximately
67
$22 million annually. The Company estimates that approximately two-thirds of
this increase will be realized in 2004 earnings due to a delay in implementing
the residential increase until April 2004.
The gross margin, or operating revenues minus cost of energy sold,
increased $6.9 million or 9.9% over the prior year period. This increase is due
mainly to customer growth, a normal winter heating season during the first
quarter 2004 compared to the prior year period and the PRC approved rate
increase, partially offset by a decrease in off-system transportation sales as
described above.
Total non-fuel O&M expenses increased $1.3 million or 5.2% over the prior
year period. Customer related expense increased $1.0 million or 12.9% primarily
due to the recovery of bad debt costs in 2003. Administrative and general costs
increased $0.9 million due to decreased capital costs resulting from capital
activity in 2003 for two new pipelines, which did not recur in 2004 costs.
Depreciation and amortization decreased $1.5 million or 13.5% due to the
Company's customer billing system being fully amortized at the end of 2003.
Taxes other than income increased $0.7 million or 20.0% primarily due to
increased property tax rates.
Transmission
The table below sets forth the operating results for Transmission.
Six Months Ended
June 30,
----------------------------------
2004 2003 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:
External customers...................... $ 8,834 $ 6,874 $ 1,960
Intersegment revenues................... 15,888 18,189 (2,301)
---------------- --------------- --------------
Total revenues.......................... 24,722 25,063 (341)
Less: Cost of energy...................... 3,241 2,430 811
---------------- --------------- --------------
Gross margin.............................. 21,481 22,633 (1,152)
---------------- --------------- --------------
Energy production costs................... 449 503 (54)
Transmission O&M.......................... 5,218 7,150 (1,932)
Administrative and general................ 982 655 327
---------------- --------------- --------------
Total non-fuel O&M...................... 6,649 8,308 (1,659)
Corporate allocation...................... 2,862 2,758 104
Depreciation and amortization............. 5,414 4,659 755
Taxes other than income taxes............. 1,276 1,225 51
Income taxes.............................. 928 1,031 (103)
---------------- --------------- --------------
Total non-fuel operating expenses....... 17,129 17,981 (852)
---------------- --------------- --------------
Operating income.......................... $ 4,352 $ 4,652 $ (300)
---------------- --------------- --------------
Gross margin decreased $1.2 million or 5.1% compared to the prior year
period primarily due to lower demand and increased transmission costs for Afton.
Cost of energy represents purchased transmission to support transmission
offerings.
Total non-fuel O&M expenses decreased $1.7 million or 20.0% over the
prior year period as a result of lower transmission O&M, which decreased $1.9
million or 27.0% primarily due to a decrease in operating lease costs of $1.1
68
million for a transmission line, a portion of which was purchased in April 2003
and accelerated line repair costs of $0.9 million in 2003, which did not recur
in 2004.
Wholesale
The table below sets forth the operating results for Wholesale.
Six Months Ended
June 30,
-----------------------------------
2004 2003 Variance
---------------- --------------- --------------
(In thousands)
Operating revenues:
External customers....................... $ 292,666 $ 243,358 $49,308
Intersegment revenue..................... - 900 (900)
---------------- ---------------- --------------
Total revenues........................... 292,666 244,258 48,408
Less: Cost of energy....................... 216,864 167,594 49,270
Energy transfer..................... 24,337 24,034 303
---------------- ---------------- --------------
Gross margin............................... 51,465 52,630 (1,165)
---------------- ---------------- --------------
Energy production costs.................... 14,138 15,281 (1,143)
Transmission and distribution O&M.......... 26 20 6
Customer related expense................... 888 249 639
Administrative and general................. 3,978 4,611 (633)
---------------- ---------------- --------------
Total non-fuel O&M....................... 19,030 20,161 (1,131)
Corporate allocation....................... 2,308 3,305 (997)
Depreciation and amortization.............. 7,508 7,060 448
Taxes other than income taxes.............. 1,799 1,861 (62)
Income taxes............................... 5,556 5,179 377
---------------- ---------------- --------------
Total non-fuel operating expenses........ 36,201 37,566 (1,365)
---------------- ---------------- --------------
Operating income........................... $ 15,264 $ 15,064 $ 200
---------------- ---------------- --------------
The following table shows revenues by customer class:
Wholesale Revenues
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts*........ $77,759 $62,625 $15,134
Forward sales*.............. 76,006 66,948 9,058
Short-term sales............ 138,901 113,785 25,116
------------- ------------- --------------
$292,666 $243,358 $49,308
============= ============= ==============
*Includes mark-to-market gains/(losses).
69
The following table shows sales by customer class:
Wholesale Sales
Six Months Ended
June 30,
2004 2003 Variance
------------- ------------- --------------
(Megawatt hours)
Long-term contracts......... 1,432,810 1,116,345 316,465
Forward sales............... 1,553,960 1,517,380 36,580
Short-term sales............ 3,243,204 2,808,744 434,460
------------- ------------- --------------
6,229,974 5,442,469 787,505
============= ============= ==============
Operating revenues increased $48.4 million or 19.8% over the prior year
period. This increase in wholesale electric sales primarily reflects additional
long-term contract sales and wholesale electric price improvements. In the six
months ended June 30, 2004, new long-term contracts added 284,623 MWhs, or $13.4
million in revenues. These contracts support the Company's long-term growth
plans and net asset-backed strategy, as described above. In addition, the
Company's forward and short-term sales increased $34.2 million or 10.9% compared
to the prior year period. As market liquidity increased in the current quarter
compared to the earlier year period, the Company was able to increase
transaction volumes and take advantage of higher market prices. Accordingly, the
Company's velocity ratio increased from 1.77 to 1.98 or 11.9%. The Company sold
wholesale (bulk) power of 6.2 million MWh of electricity for the six months
ended June 30, 2004 compared to 5.4 million MWh for the same period in 2003.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, decreased $1.2 million or 2.2% over the prior year
period. Long-term contracts margin increased $5.1 million primarily due to
additional long-term sales under new and existing contracts. Forward sales
margin decreased $0.9 million reflecting higher purchase prices, partially
offset by higher market prices. Short-term sales margin decreased $5.4 million
primarily due to the dilutive effect of less available lower cost generation
resulting from unplanned outages at the Company's facilities and higher purchase
volumes, partially offset by higher sales volumes and higher market prices. The
average price on the Company's realized forward and short-term sales was $44 per
MWh in 2004, compared to $41 per MWh in 2003. The Company had an unfavorable
change in the unrealized mark-to-market position of $0.3 million period over
period ($2.3 million gain in 2004 versus $2.6 million gain in 2003). In
addition, the long-term margin increase included $3.0 million from sales of
pollution credits and a reduction of purchased power of $2.3 million for
renewable energy credits.
As discussed above, adjustments of $10.1 million for the six months ended
June 30, 2004 related to EITF Issue 03-11, which requires a net presentation of
realized gains and losses for certain non-trading derivatives, are included in
Corporate and Other in the Company's segment presentation. Management evaluates
wholesale operations on a gross presentation basis due to its net asset-backed
marketing strategy.
Total non-fuel O&M decreased $1.1 million or 5.6% over the prior year
period. Energy production costs decreased $1.1 million or 7.5% primarily due to
planned outages at PVNGS Unit 3 in 2003, which did not recur in 2004, partially
70
offset by planned and unplanned outages at PVNGS Units 1 and 2, SJGS and Four
Corners. Customer related expense increased $0.6 million primarily due to
increased incentive bonus costs. Administrative and general decreased $0.6
million or 13.7% primarily due to transportation costs of $0.8 million
recognized in 2003 for turbines that will be utilized in future construction for
wholesale plant growth, which did not recur in 2004.
Corporate and Other
Corporate administrative and general expenses, which represent costs that
are driven primarily by corporate-level activities, are allocated to the
business segments and presented in the corporate allocation line item in the
segment statements. These costs increased $4.2 million or 8.3% over the prior
year period to $54.6 million. The increase in these costs was due to a net
increase in pension and benefit costs of $0.5 million due to increased 401(k)
plan and health insurance costs of $3.8 million, partially offset by decreased
pension/retirement expense of $3.3 million, resulting from higher returns on
pension plan assets and lower retiree medical costs. In addition, computer
maintenance costs increased $0.7 million, outside service costs increased $0.5
million for Sarbanes-Oxley compliance and labor increased $1.6 million due to
costs associated with short-term and long-term incentive based compensation
plans.
Taxes other than income increased $2.2 million primarily due to the
favorable assessment of outstanding tax issues in 2003, which did not recur in
2004 and a decrease in social security taxes.
Consolidated
Other Income and Deductions
Other income decreased $1.8 million or 7.4% primarily due to lower
year-over-year returns on investments.
Other deductions decreased $17.9 million or 81.8% over the prior year
period. In 2003, the Company had write-offs of transition costs of $16.7 million
due to the repeal of deregulation in New Mexico and $1.0 million for costs
related to long-term debt refunding. In addition, the Company recognized losses
of $0.7 million on short-term cash investments in 2004.
Interest Expense
Interest expense decreased $10.1 million or 28.1% over the prior year
period primarily due to refinancing of senior unsecured notes and pollution
control bonds, which decreased interest costs $7.3 million, as well as lower
interest costs of $1.4 million on short-term debt resulting from lower interest
rates and lower short-term borrowings. In addition, allowance for funds used
during construction ("AFUDC") and capitalized interest increased $0.6 million in
2004 compared to 2003, reducing interest expense further.
Income Taxes
The Company's consolidated income tax expense was $24.0 million for the
six months ended June 30, 2004, compared to $16.7 million for the six months
ended June 30, 2003. The increase was due to the impact of higher pre-tax
71
earnings. The Company's effective income tax rates for the six months ended June
30, 2004 and 2003 were 36.41% and 36.81%, respectively.
Cumulative Effects of Changes in Accounting Principles
Effective January 1, 2003, the Company adopted SFAS 143. The effect of
the initial application of the new standard is reported as a cumulative effect
of a change in accounting principle. As a result, the Company recorded
additional earnings, net of taxes, of approximately $37.4 million, or $0.63 per
diluted common share, representing amounts expensed in prior years in excess of
legal obligations related to fossil-fuel and nuclear generation plants.
In 2003, the Company changed the actuarial valuation measurement date for
the pension plan and other post-retirement benefits from September 30 to
December 31 to better reflect the actual pension balances as of the Company's
balance sheet dates and recognized a cumulative effect of a change in accounting
principle decreasing earnings by $0.8 million, net of taxes, or $0.02 per
diluted common share.
CRITICAL ACCOUNTING POLICIES
As of June 30, 2004, there have been no significant changes with regard
to the critical accounting policies disclosed in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003. The policies disclosed included
the accounting for: revenue recognition; regulatory assets and liabilities;
asset impairment; pension plan; self-insurance; contingent liabilities and
environmental issues.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004, the Company had cash and short-term investments of $5.6
million compared to $12.7 million in cash and short-term investments at December
31, 2003.
Cash provided by operating activities for the six months ended June 30,
2004 was $132.5 million compared to $60.3 million for the six months ended June
30, 2003. This increase in cash flows was due to increased sales in the
Company's wholesale power operations and gas operations as well as lower
interest costs. Contributing to this increase was a stabilization of accounts
receivable levels in 2004 as increased demand for wholesale energy has remained
constant with 2003 levels. In addition, the Company contributed $3.1 million in
2004 compared to $20.0 million in 2003 to the trusts for the Company's pension
and other post-retirement benefits.
Cash used for investing activities was $48.4 million in 2004 compared to
$4.7 million in 2003. Cash used in 2004 was primarily for construction
expenditures. In 2003, in addition to construction expenditures, cash used for
investing activities included payments for combustion turbines of $11.1 million
and the repurchase of the Company's EIP bonds in the open market for $6.7
million. The cash used for investing activities in 2003 was largely offset by
the redemption of short-term investments of $80.2 million in 2003 at the Holding
Company level. These redemptions were primarily used for the Company's repayment
of the EIP long-term debt, repayment of short-term debt, debt refinancing and
pension funding.
72
Cash used for financing activities was $91.1 million in 2004 compared to
$56.7 million in 2003. Financing activities in 2004 primarily consisted of the
repurchase of short-term repayments of $63.4 million. Financing activities in
2003 primarily consisted of the repurchase of long-term debt of $26.1 million
and costs associated with the refunding of long-term debt of $31.4 million. This
decrease in cash flows was partially offset by short-term borrowings of $24.1
million in 2003.
Capital Requirements
Total capital requirements include construction expenditures as well as
other major capital requirements and cash dividend requirements for both common
and preferred stock. The main focus of the Company's current construction
program is upgrading generation systems, upgrading and expanding the electric
and gas transmission and distribution systems and purchasing nuclear fuel. To
preserve a strong financial position, the Company announced in 2002 its plans to
delay capital expenditures for previously planned generation expansion.
Projections for total capital requirements for 2004 are $172 million and
projections for construction expenditures for 2004 are $154 million. Total
capital requirements are projected to be $804 million and construction
expenditures are projected to be $707 million for 2004-2008. These estimates are
under continuing review and subject to on-going adjustment, and do not include
expenditures for the proposed acquisition of TNP (see Note 11 in the Notes to
Consolidated Financial Statements). The Company continues to look for
appropriately priced generation acquisition and expansion opportunities to
support retail electric load growth, the continued expansion of its long-term
contract business and to supplement its natural transmission position in the
Southwest and West.
At June 30, 2004, the Company analyzed three turbines, which are
currently in storage, with a combined carrying value of approximately $79.1
million. These assets were intended for planned build-outs that have been
delayed or canceled. Based on the Company's various plans to make these turbines
operational, the Company concluded that it will fully recover its investment.
The Company expects to begin construction utilizing these assets over the next
several years. If the Company were unable to realize these plans, the Company
would be forced to recognize a loss with respect to the carrying value of these
assets depending on prevailing market conditions. The Company will continue to
analyze the turbines for impairment in accordance with SFAS 144.
In the six months ended June 30, 2004, the Company utilized cash
generated from operations and cash on hand, as well as its liquidity
arrangements, to cover its construction commitments. The Company anticipates
that internal cash generation and current debt capacity will be sufficient to
meet all of its capital requirements for the years 2004 through 2008. To cover
the difference in the amounts and timing of cash generation and cash
requirements, the Company intends to use short-term borrowings under its current
and future liquidity arrangements.
Liquidity
As of July 30, 2004, PNM had $413.5 million of liquidity arrangements.
The liquidity arrangements consist of $300 million from an unsecured revolving
credit facility ("Credit Facility"), $90 million from an accounts receivable
securitization program ("AR Securitization") and $23.5 million in local lines of
credit. As of July 30, 2004, there were no borrowings against the Credit
Facility, the AR Securitization capacity or the local lines of credit. PNM had
73
$50.5 million of commercial paper outstanding as of July 30, 2004. In addition,
the Holding Company has $15.0 million in local lines of credit, all of which
were unused at July 30, 2004.
On April 23, 2004, PNM entered into a new rated commercial paper program
for up to $300 million. PNM will use borrowings under the new program to repay
borrowings under the previous unrated program, to retire other short-term
borrowings and for other short-term cash management needs. As of July 30, 2004,
PNM had no borrowings outstanding under its old unrated program.
The Company's ability, if required, to access the capital markets at a
reasonable cost and to provide for other capital needs is largely dependent upon
its ability to earn a fair return on equity, its results of operations, its
credit ratings, obtaining required regulatory approvals and financial and
wholesale market conditions. Financing flexibility is enhanced by providing a
high percentage of total capital requirements from internal sources and having
the ability, if necessary, to issue long-term securities and to obtain
short-term credit.
PNM's credit outlook is considered stable by Moody's Investor Services,
Inc. ("Moody's") and Standard and Poor's Ratings Services ("S&P"). The Company
is committed to maintaining or improving its investment grade ratings. As of
June 30, 2004, S&P rated PNM's business position as six, its senior unsecured
notes ("SUNs") as "BBB" with a stable outlook and its preferred stock as "BB+".
S&P assigned PNM a new business position on June 2, 2004, as part of its
industry wide reassessment. No changes were made to the Company's rating or
outlook. As of June 30, 2004, Moody's rated PNM's SUNs, senior unsecured
pollution control revenue bonds as "Baa2" and its preferred stock as "Ba1". On
April 12, 2004, S&P assigned its `A-2' corporate credit and short-term debt
ratings to PNM's new commercial paper program. On April 23, 2004, Moody's
assigned its `P-2' corporate credit and short-term debt ratings to PNM's new
commercial paper program.
In July, both Moody's and S&P affirmed the Company's ratings. The Company
anticipates maintaining its current ratings after the acquisition of TNP is
consummated, which is currently anticipated to occur in 2005 (see Note 11 in the
Notes to the Consolidated Financial Statements), although no assurance can be
given in this regard. Investors are cautioned that a security rating is not a
recommendation to buy, sell or hold securities, that it is subject to revision
or withdrawal at any time by the assigning rating organization, and that each
rating should be evaluated independently of any other rating.
It is currently anticipated that the Holding Company's Board of Directors
will maintain the current dividend policy of paying out 50% to 60% of regulated
earnings until its next annual evaluation of dividend policy. The Holding
Company's dividend has increased, on average, more than 4.4% over the last three
years, with the current annual common stock dividend at $0.64 per share. The
Holding Company's Board generally considers the Company's dividend policy on an
annual basis in February.
Commitments and Contractual Obligations
The Company enters into contracts that require payment of cash over
specified periods, based on specified minimum quantities and prices. For an
in-depth discussion of the Company's commitments and contractual obligations,
see "Commitments and Contractual Obligations " in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Company's Form
74
10-K for the year ended December 31, 2003. As of June 30, 2004, there have been
no material changes to the Company's commitments and contractual obligations.
Contingent Provisions of Certain Obligations
The Holding Company and PNM have a number of debt obligations and other
contractual commitments that contain contingent provisions. Some of these, if
triggered, could affect the liquidity of the Company. The Holding Company or PNM
could be required to provide security, immediately pay outstanding obligations
or be prevented from drawing on unused capacity under certain credit agreements
if the contingent requirements were to be triggered. The most significant
consequences resulting from these contingent requirements are detailed in the
discussion below.
PNM's master purchase agreement for the procurement of gas for its retail
customers contains a contingent requirement that could require PNM to provide
security for its gas purchase obligations if the seller were to reasonably
believe that PNM was unable to fulfill its payment obligations under the
agreement.
The master agreement for the sale of electricity in the Western Systems
Power Pool ("WSPP") contains a contingent requirement that could require PNM to
provide security if its debt were to fall below investment grade rating. The
WSPP agreement also contains a contingent requirement, commonly called a
material adverse change ("MAC") provision, which could require PNM to provide
security if a material adverse change in its financial condition or operations
were to occur.
PNM's committed Credit Facility contains a "ratings trigger," for pricing
purposes only. If PNM is downgraded or upgraded by the ratings agencies, the
result would be an increase or decrease in interest cost, respectively. PNM's
committed Credit Facility contains a MAC provision, which, if triggered, could
prevent PNM from drawing on its unused capacity under the Credit Facility. On
April 16, 2004, the Company amended the MAC provision of the credit agreement to
allow drawing to repay commercial paper. In addition, the Credit Facility
contains a contingent requirement that requires PNM to maintain a
debt-to-capital ratio, inclusive of off-balance sheet debt, of less than 65% as
well as maintenance of an earnings before interest, taxes, depreciation and
amortization ("EBITDA")/interest coverage ratio of three times. If PNM's
debt-to-capital ratio, inclusive of off-balance sheet debt, were to exceed 65%
or its interest coverage ratio falls below 3.0, PNM could be required to repay
all borrowings under the Credit Facility, be prevented from drawing on the
unused capacity under the Credit Facility, and be required to provide security
for all outstanding letters of credit issued under the Credit Facility.
If a contingent requirement were to be triggered under the Credit
Facility resulting in an acceleration of the outstanding loans under the Credit
Facility, a cross-default provision in the PVNGS leases could occur if the
accelerated amount is not paid. If a cross-default provision is triggered, the
lessors have the ability to accelerate their rights under the leases, including
acceleration of all future lease payments.
75
Financing Activities
On April 1, 2004, PNM repriced $146.0 million of tax-exempt pollution
control bonds, with a previous interest rate of 2.75%. The new interest rate is
2.10% for a term of 2 years. These bonds will reprice next on April 1, 2006.
On April 23, 2004, PNM entered into a rated commercial paper program. The
Company may issue up to $300 million in commercial paper for up to 365 days. The
commercial paper is unsecured and the proceeds were used to retire borrowings
under the previous unrated commercial paper program, retirement of other
short-term borrowings and other short-term cash management needs. PNM's Credit
Facility serves as a backstop for the outstanding commercial paper.
On April 29, 2004, the Holding Company entered into three fixed to
floating interest rate swaps. The notional principal amount is $150 million. The
Company will receive a 4.40% fixed interest payment on a semi-annual basis and
pay 6 month LIBOR plus 58.15 basis points through September 15, 2008. The
initial floating rate is approximately 1.91% and will be reset each September 15
and March 15.
On July 1, 2004, PNM repriced $36 million of tax-exempt pollution control
bonds, with a previous term and interest rate of 1 year and 2.75%, respectively.
The new interest rate is 4.00% for a term of 5 years. These bonds will reprice
next on July 1, 2009.
Depending on its future business strategy, capital needs and market
conditions, the Company could enter into additional long-term financings in the
future for the purpose of strengthening its balance sheet, funding growth and
reducing its cost of capital. The Company continues to evaluate its investment
and debt retirement options to optimize its financing strategy and earnings
potential. No additional first mortgage bonds may be issued under PNM's
mortgage. The amount of SUNs that may be issued is not limited by the SUNs
indenture. However, debt-to-capital requirements in certain of PNM's financial
instruments and regulatory agreements would ultimately limit the amount of
additional debt PNM would issue.
Capital Structure
The Company's capitalization, including current maturities of long-term
debt, at June 30, 2004 and December 31, 2003 is shown below:
June 30, December 31,
2004 2003
------------ ------------
Common Equity....................... 52.4% 51.9%
Preferred Stock..................... 0.6 0.6
Long-term Debt...................... 47.0 47.5
------------ ------------
Total Capitalization*............ 100.0% 100.0%
============ ============
* Total capitalization does not include as debt the present value of
PNM's operating lease obligations for PVNGS Units 1 and 2, EIP and
the Delta operating lease, which was $177.7 million as of June 30,
2004 and $179.4 million as of December 31, 2003.
76
OTHER ISSUES FACING THE COMPANY
See Note 7 - "Commitments and Contingencies" in the Notes to Consolidated
Financial Statements.
NEW ACCOUNTING STANDARDS
See Note 10 - "New Accounting Standards" in the Notes to Consolidated
Financial Statements.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Statements made in this filing that relate to future events or the
Company's expectations, projections, estimates, intentions, goals, targets and
strategies, both with respect to the Company and with respect to the proposed
acquisition of TNP, are made pursuant to the Private Securities Litigation
Reform Act of 1995. Readers are cautioned that all forward-looking statements
are based upon current expectations and are subject to risks and uncertainties.
The Company assumes no obligation to update this information.
Because actual results may differ materially from those expressed or
implied by these forward-looking statements, the Company cautions readers not to
place undue reliance on these forward-looking statements. Future financial and
operating results and cash flow will be affected by a number of factors,
including risks and uncertainties relating to the receipt of regulatory
approvals for the proposed acquisition of TNP, the risks that the businesses
will not be integrated successfully, the risk that the benefits of the
transaction will not be fully realized or will take longer to realize than
expected, disruption from the transaction making it more difficult to maintain
relationships with customers, employees, suppliers or other third parties,
conditions in the financial markets relevant to the proposed acquisition,
interest rates, weather, water supply, fuel costs, seasonality and other changes
in supply and demand in the market for electric power, wholesale power prices,
market liquidity, the competitive environment in the electric and natural gas
industries, the performance of generating units and transmission systems, state
and federal regulatory and legislative decisions and actions, the recoverability
of regulatory assets, the cost and outcome of legal proceedings and labor
negotiations with union employees, changes in applicable accounting principles
and the performance of state, regional and national economies. See also Item 3
below for information about the risks associated with the Company's use of
derivative financial instruments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company uses derivative financial instruments to manage risk as it
relates to changes in natural gas and electric prices, changes in interest rates
and, historically, adverse market changes for investments held by the Company's
various trusts. Additionally, the Company uses derivative instruments based on
certain financial composite indices as part of its enhanced cash management
program. The Company also uses certain derivative instruments for wholesale
power marketing transactions in order to take advantage of favorable price
movements and market timing activities in the wholesale power markets. The
following additional information is provided.
77
Risk Management
The Company controls the scope of its various forms of risk through a
comprehensive set of policies and procedures and oversight by senior level
management and the Holding Company Board of Directors. The Board's Finance
Committee sets the risk limit parameters. The Risk Management Committee ("RMC"),
comprised of corporate and business segment officers and other managers,
oversees all of the activities, which include commodity price, credit, equity,
interest rate and business risks. The RMC has oversight for the ongoing
evaluation of the adequacy of the risk control organization and policies. The
Company has a risk control organization, headed by the Director of Financial
Risk Management ("Risk Manager"), which is assigned responsibility for
establishing and enforcing the policies, procedures and limits and evaluating
the risks inherent in proposed transactions, on an enterprise-wide basis.
The RMC's responsibilities specifically include: establishment of a
general policy regarding risk exposure levels and activities in each of the
business segments; recommendation of the types of instruments permitted;
authority to establish a general policy regarding counterparty exposure and
limits; authorization and delegation of transaction limits; review and approval
of controls and procedures; review and approval of models and assumptions used
to calculate mark-to-market and risk exposure; authority to approve and open
brokerage and counterparty accounts; review of hedging and risk activities; and
quarterly reporting to the Finance Committee and the Board of Directors on these
activities.
The RMC also proposes Value at Risk ("VAR") limits to the Finance
Committee. The Finance Committee ultimately sets the aggregate VAR limits.
It is the responsibility of each business segment to create its own
control procedures and policies within the parameters established by the Finance
Committee. The RMC reviews and approves these policies, which are created with
the assistance of the Corporate Controller, Director of Internal Audit and the
Risk Manager. Each business segment's policies address the following controls:
authorized risk exposure limits; authorized instruments and markets; authorized
personnel; policies on segregation of duties; policies on mark-to-market
accounting; responsibilities for deal capture; confirmation procedures;
responsibilities for reporting results; statement on the role of derivative
transactions; and limits on individual transaction size (nominal value).
To the extent an open position exists, fluctuating commodity prices can
impact financial results and financial position, either favorably or
unfavorably. As a result, the Company cannot predict with certainty the impact
that its risk management decisions may have on its businesses, operating results
or financial position.
Commodity Risk
Marketing and procurement of energy often involves market risks
associated with managing energy commodities and establishing open positions in
the energy markets, primarily on a short-term basis. These risks fall into three
different categories: price and volume volatility, credit risk of counterparties
and adequacy of the control environment. PNM routinely enters into forward
contracts and options to hedge purchase and sale commitments, fuel requirements
and to enhance returns and minimize the risk of market fluctuations on the
Wholesale Operations.
78
The Company's Wholesale Operations, including long-term contracts,
forward sales and short-term sales, are managed through a net asset-backed
marketing strategy, whereby PNM's aggregate net open forward contract position
is covered by its forecasted excess generation capabilities. PNM would be
exposed to market risk if its generation capabilities were disrupted or if its
retail load requirements were greater than anticipated. If PNM were required to
cover all or a portion of its net open contract position, it would have to meet
its commitments through market purchases.
Under the derivative accounting rules and the related accounting rules
for energy contracts, the Company accounts for its various financial derivative
instruments for the purchase and sale of energy differently based on
management's intent when entering into the contract. Energy contracts which meet
the definition of a derivative under SFAS 133 and do not qualify for a normal
purchase or sale designation are recorded on the balance sheet at fair market
value at each period end. The changes in fair market value of these contracts
are recognized in earnings unless specific hedge accounting criteria are met.
Should an energy transaction qualify as a hedge under SFAS 133, fair market
value changes from year to year are recognized on the balance sheet with a
corresponding charge to other comprehensive income to the extent it is
effective. Gains or losses on these transactions are recognized when the hedged
transaction settles. Derivatives that meet the normal sales and purchases
exceptions within SFAS 133 as amended, are not marked to market but rather are
recorded in results of operations when the underlying transaction settles.
The following table shows the net fair value of mark-to-market energy
contracts included in the balance sheet:
June 30, December 31,
2004 2003
------------- --------------
(In thousands)
Mark-to-Market Energy Contracts:
Current asset........................................ $10,672 $ 2,098
Long-term asset...................................... 2,470 1,359
------------- -------------
Total mark-to-market assets..................... 13,142 3,457
------------- -------------
Current liability.................................... (6,943) (1,941)
Long-term liability.................................. (1,209) (1,083)
------------- -------------
Total mark-to-market liabilities................ (8,152) (3,024)
------------- -------------
Net fair value of mark-to-market energy contracts...... $4,990 $ 433
============= =============
The mark-to-market energy portfolio positions represent net assets at
June 30, 2004 and December 31, 2003 after netting all applicable open purchase
and sale contracts.
The market prices used to value PNM's mark-to-market energy portfolio are
based on closing exchange prices and broker quotations. As of June 30, 2004 and
December 31, 2003, PNM did not have any material outstanding contracts that were
valued using methods other than quoted prices. The Company did not change its
methods for valuing its mark-to-market energy portfolio in 2004 as compared to
2003.
79
The following table provides detail of changes in the Company's
mark-to-market energy portfolio net asset or liability balance sheet position
from one period to the next:
Six Months Ended
June 30,
2004 2003
------------- -------------
(In thousands)
Sources of Fair Value Gain/(Loss)
Fair value at beginning of year............. $ 433 $ (927)
Amount realized on contracts delivered
during period............................ 1,714 299
Changes in fair value....................... 2,843 3,868
------------- -------------
Net fair value at end of period............. $ 4,990 $ 3,240
============= =============
Net change recorded as mark-to-market....... $ 4,557 $ 4,167
============= =============
The following table provides the maturity of the net assets/(liabilities)
of the Company, giving an indication of when these mark-to-market amounts will
settle and generate/(use) cash. The following values were determined using
broker quotes:
Fair Value at June 30, 2004
Maturities
----------------- --- ------------------------------ -- -------------
Less than
1 year 1-3 Years 4 Years + Total
----------------- ------------- ------------- -------------
(In thousands)
$3,711 $869 $410 $4,990
As of June 30, 2004, a decrease in market pricing of PNM's mark-to-market
energy portfolio by 10% would have resulted in a decrease in net earnings of
less than 1%. Conversely, an increase in market pricing of this portfolio by 10%
would have resulted in an increase in net earnings of less than 1%.
The Company assesses the risk of these long-term contracts and wholesale
sales activities using the VAR method to maintain the Company's total exposure
within management-prescribed limits. The Company utilizes the
variance/covariance model of VAR, which is a probabilistic model that measures
the risk of loss to earnings in market sensitive instruments. The
variance/covariance model relies on statistical relationships to analyze how
changes in different markets can affect a portfolio of instruments with
different characteristics and market exposure. VAR models are relatively
sophisticated. The quantitative risk information, however, is limited by the
parameters established in creating the model. The instruments being evaluated
may trigger a potential loss in excess of calculated amounts if changes in
commodity prices exceed the confidence level of the model used. The VAR
methodology employs the following critical parameters: volatility estimates,
market values of open positions, appropriate market-oriented holding periods and
seasonally adjusted correlation estimates. The Company's portfolio VAR
calculation considers the Company's forward position for the preceding eighteen
80
months. The mark-to-market VAR is calculated through the contract periods. The
Company uses a holding period of three days as the estimate of the length of
time that will be needed to liquidate the positions. The volatility and the
correlation estimates measure the impact of adverse price movements both at an
individual position level as well as at the total portfolio level. The
two-tailed confidence level established is 99%. For example, if VAR is
calculated at $10.0 million, it is estimated at a 99% confidence level that if
prices move against PNM's positions, the Company's pre-tax gain or loss in
liquidating the portfolio would not exceed $10.0 million in the three days that
it would take to liquidate the portfolio.
The Company's VAR is regularly monitored by the Company's RMC. The RMC
has put in place procedures designed to ensure that increases in VAR are
reviewed and, if deemed necessary, acted upon to reduce exposures. The VAR
represents an estimate of the potential gains or losses that could be recognized
on PNM's wholesale power marketing portfolios given current volatility in the
market, and is not necessarily indicative of actual results that may occur,
since actual future gains and losses will differ from those estimated. Actual
gains and losses may differ due to actual fluctuations in market rates,
operating exposures, and the timing thereof, as well as changes to PNM's
wholesale power marketing portfolios during the year.
The Company accounts for the sale of electric generation in excess of its
retail needs or the purchase of power for retail needs as normal purchases and
sales under SFAS 133. Transactions that do not meet the normal purchase or sale
exception or the definition of a hedge under SFAS 133 are accounted for as
energy marketing contracts and comprise PNM's mark-to-market portfolio. The VAR
for the mark-to-market portfolio was $481 thousand at June 30, 2004. The Company
also calculates a portfolio VAR for the preceding 18 months, which in addition
to its mark-to-market portfolio includes all contracts designated as normal
sales and purchases, hedges, and its estimated excess generation assets. This
excess is determined using average peak forecasts for the respective block of
power in the forward market. The Company's portfolio VAR was $17.0 million at
June 30, 2004.
The following table shows the high, average and low market risk as
measured by VAR on the Company's mark-to-market portfolio:
Six Months Ended
June 30, 2004
Period
High Average Low End
---------- ------------ ------------ -----------
(In thousands)
Three day holding period, 99%
two-tailed confidence level......... $206 $ 93 $ - $112
One day holding period, 99%
two-tailed confidence level......... $119 $ 53 $ - $ 65
Ten day holding period, 95%
two-tailed confidence level......... $287 $129 $ - $156
Credit Risk
PNM is exposed to credit losses in the event of non-performance or
non-payment by counterparties. The Company uses a credit management process to
assess and monitor the financial conditions of counterparties. Credit exposure
is also regularly monitored by the RMC. The Company provides for losses due to
81
market and credit risk. PNM's credit risk with its largest counterparty as of
June 30, 2004 was $28.3 million.
The following table provides information related to PNM's credit exposure
as of June 30, 2004. The Company does not hold any credit collateral as of June
30, 2004. The table further delineates that exposure by the credit worthiness
(credit rating) of the counterparties and provides guidance as to the
concentration of credit risk to individual counterparties PNM may have. Also
provided is an indication of the maturity of a company's credit risk by credit
ratings of the counterparties.
Schedule of Wholesale Operations Credit Risk Exposure
June 30, 2004
(b) Number Net
Net of Exposure of
Credit Counter- Counter-
Risk parties parties
Rating (a) Exposure >10% >10%
- -------------------------------- ------------- ------------ -------------
(In thousands)
Investment grade................ $58,557 3 $41,756
Non-investment grade............ 24 -
Split rating.................... 44 -
Internal ratings
Investment grade............. 69 -
Non-investment grade......... 5,201 -
------------- -------------
Total................... $63,895 $41,756
============= =============
(a) Rating - Included in "Investment Grade" are counterparties with a minimum
S&P rating of BBB- or Moody's rating of Baa3. If the counterparty has
provided a guarantee by a higher rated entity (e.g., its parent),
determination is based on the rating of its guarantor. The "Internal
Ratings - Investment Grade" includes those counterparties that are
internally rated as investment grade in accordance with the guidelines
established in the Company's credit policy.
(b) The Net Credit Risk Exposure is the net credit exposure to PNM from its
Wholesale Operations. This includes long-term contracts, forward sales
and short-term sales. The exposure captures the net amounts due to PNM
from receivables/payables for realized transactions, delivered and
unbilled revenues, and mark-to-market gains/losses (pursuant to contract
terms). Exposures are offset according to legally enforceable netting
arrangements and reduced by credit collateral. Credit collateral includes
cash deposits, letters of credit and performance bonds received from
counterparties. Amounts are presented before those reserves that are
determined on a portfolio basis.
82
Maturity of Credit Risk Exposure
As of June 30, 2004
Exposure
Before
Less than Credit
Rating 2 Years 2-5 Years Collateral
- ----------------------------- -------------- -------------- --------------
(In thousands)
Investment grade............. $58,449 $108 $58,557
Non-investment grade......... 24 - 24
Split rating................. 44 - 44
Internal ratings
Investment grade.......... 69 - 69
Non-investment grade...... 5,201 - 5,201
-------------- -------------- --------------
Total................ $63,787 $108 $63,895
============== ============== ==============
Natural Gas Supply Contracts
PNM hedges certain portions of natural gas supply contracts in order to
protect its retail customers from adverse price fluctuations in the natural gas
market. The financial impact of all hedge gains and losses, including the
related costs of the program, is recoverable through the purchased gas
adjustment clause. As a result, earnings are not affected by gains and losses
generated by these instruments.
Interest Rate Risk
As of June 30, 2004 the Company had liquidated its investment portfolio
of fixed-rate government obligations and corporate securities.
PNM has long-term debt which subjects it to the risk of loss associated
with movements in market interest rates. The majority of the Company's long-term
debt is fixed-rate debt, and therefore, does not expose the Company's earnings
to a major risk of loss due to adverse changes in market interest rates.
However, the fair value of all long-term debt instruments would increase by
approximately 3.35% or $34.3 million if interest rates were to decline by 50
basis points from their levels at June 30, 2004. As of June 30, 2004, the fair
value of PNM's long-term debt was $1,024 million as compared to a book value of
$987 million. In general, an increase in fair value could impact earnings and
cash flows if PNM were to re-acquire all or a portion of its debt instruments in
the open market prior to their maturity.
In April 2004, the Holding Company entered into three fixed-to-floating
interest rate swaps with an aggregate notional value of $150 million. The
purpose of these swaps is to synthetically increase the amount of floating rate
debt in the Company's capital structure in order to reduce repricing risk
associated with fixed rate debt.
During the six months ended June 30, 2004, PNM contributed cash of $3.1
million to external trusts for other post-retirement benefits for plan year
2004. The securities held by the trusts had an estimated fair value of $574.5
million as of June 30, 2004, of which approximately 27.6% were fixed-rate debt
securities that subject the Company to risk of loss of fair value with movements
83
in market interest rates. If rates were to increase by 50 basis points from
their levels at June 30, 2004, the decrease in the fair value of the securities
would be 2.8% or $4.4 million. PNM does not currently recover or return through
rates any losses or gains on these securities; therefore, the Company is at risk
for shortfalls in its funding of its obligations due to investment losses. The
Company does not believe that long-term market returns over the period of
funding will be less than required for the Company to meet its obligations.
However, this belief is based on assumptions about future returns that are
inherently uncertain.
Equity Market Risk
PNM contributes to trusts established to fund its share of the
decommissioning costs of PVNGS and pension and other post-retirement benefits.
The trusts hold certain equity securities as of June 30, 2004. These equity
securities also expose the Company to losses in fair value. Approximately 59.2%
of the securities held by the various trusts were equity securities as of June
30, 2004. The Company is currently implementing a change in the asset allocation
in the pension portfolio, which will reduce the domestic equity exposure from
55.0% to 47.5%. Similar to the debt securities held for funding decommissioning
and certain pension and other post-retirement costs, PNM does not recover or
earn a return through rates on any losses or gains on these equity securities.
ITEM 4. CONTROLS AND PROCEDURES
The Company's principal executive officer and principal financial officer
have concluded that the Company's disclosure controls and procedures, based on
their evaluation of these disclosure controls and procedures, as of the end of
the period covered by this report, are effective to ensure that material
information relating to the Company, including its consolidated subsidiaries,
was made known to them by others within those entities, particularly during the
period in which the periodic reports are being prepared.
In May 2004, the Company completed its conversion to a new accounting
system. In connection with the system conversion, internal controls and
procedures have been modified to reflect the new system environment; however,
the Company's overall financial reporting controls have not changed
significantly. The Company's management has reviewed the effectiveness of the
design of the new internal controls and procedures in the new system environment
and believes they are appropriate.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Santa Fe Generating Station ("Santa Fe Station")
See Note 7 - "Commitments and Contingencies - Santa Fe Generating
Station" in the Notes to Consolidated Financial Statements.
84
Natural Gas Royalties Qui Tam Litigation
See Note 7 - "Commitments and Contingencies - Natural Gas Royalties Qui
Tam Litigation" in the Notes to Consolidated Financial Statements.
Citizen Suit Under the Clean Air Act
See Note 7 - "Commitments and Contingencies - Citizen Suit Under the
Clean Air Act" in the Notes to Consolidated Financial Statements.
California Attorney General Complaint
See Note 7 - "Commitments and Contingencies - Western United States
Wholesale Power Market - California Attorney General Complaint" in the Notes to
Consolidated Financial Statements.
California Antitrust Litigation
See Note 7 - "Commitments and Contingencies - Western United States
Wholesale Power Market - California Antitrust Litigation" in the Notes to
Consolidated Financial Statements.
Excess Emissions Report
See Note 7 - "Commitments and Contingencies - Excess Emissions Report" in
the Notes to Consolidated Financial Statements.
San Angelo Electric Service Company ("SESCO") Matter
See Note 7 - "Commitments and Contingencies - San Angelo Electric Service
Company ("SESCO") Matter" in the Notes to Consolidated Financial Statements.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On June 11, 2004, the Company effected a 3-for-2 stock split with respect
to its common stock. See Note 5 -"Capitalization - Stock Split" in the Notes to
Consolidated Financial Statements.
(Intentionally left blank)
85
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Annual Meeting
The annual meeting of shareholders was held on May 18, 2004. The matters
voted on at the meeting and the results were as follows:
The election of the following nominees to serve as directors as follows:
Votes
Against
Director Votes For Or Withheld
-------- --------- -----------
Terms expiring in 2007 (Class "C" Directors):
Bonnie S. Reitz 36,221,906 229,741
Jeffry E. Sterba 34,583,494 1,868,153
Joan B. Woodard 36,231,565 220,082
Term expiring in 2005 (Class "A" Director):
Adelmo E. Archuleta 35,893,046 558,601
The approval of the selection by the Company's board of directors of
Deloitte & Touche LLP as independent auditors for the fiscal year ending
December 31, 2004, was voted on, as follows:
Votes
Against
Votes For Or Withheld Abstentions
--------- ----------- -----------
34,034,751 2,349,423 67,473
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
2.0 Stock Purchase Agreement, dated as of July 24, 2004 by and
between PNM Resources, Inc. and SW Acquisition, L.P.
(incorporated by reference to Exhibit 2.0 to the Company's
Current Report on Form 8-K dated July 28, 2004).
15.1 Letter Re: Unaudited Interim Financial Information for PNM
Resources, Inc. and Subsidiaries.
15.2 Letter Re: Unaudited Interim Financial Information for
Public Service Company of New Mexico.
31.1 Chief Executive Officer Certification Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
86
32.1 Chief Executive Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
b. Reports on Form 8-K:
Report dated and filed May 19, 2004 pursuant to Item 5 of Form 8-K reporting
that the Company announces a 3-for-2 stock split of its common stock ("Stock
Split") and the quarterly stock dividend approved by its Board of Directors.
87
Signature
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
PNM RESOURCES, INC. AND
PUBLIC SERVICE COMPANY OF NEW MEXICO
---------------------------------------------
(Registrants)
Date: August 5, 2004 /s/ Thomas G. Sategna
---------------------------------------------
Thomas G. Sategna
Vice President and Corporate Controller
(Officer duly authorized to sign this report)
88