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Table of Contents
 
 
Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
(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, 2002
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                         to                                         
 
Commission file number 0-296
 
El Paso Electric Company
(Exact name of registrant as specified in its charter)
 
Texas
     
74-0607870
(State or other jurisdiction of incorporation or organization)
     
(I.R.S. Employer Identification No.)
Stanton Tower, 100 North Stanton, El Paso, Texas
     
79901
(Address of principal executive offices)
     
(Zip Code)
 
(915) 543-5711
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has 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 registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  x    NO  ¨
 
As of August 8, 2002 there were 49,945,432 shares of the Company’s no par value common stock outstanding.
 

Table of Contents
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
INDEX TO FORM 10-Q
      
Page No.
PART I.     FINANCIAL INFORMATION
       
Item 1.     Financial Statements
       
    
1
    
3
    
5
    
6
    
7
    
15
    
16
    
25
PART II.     OTHER INFORMATION
       
Item 1.     Legal Proceedings
     
26
    
26
    
26

i

Table of Contents
 
PART I.    FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS
(In thousands)
   
June 30,
2002
(Unaudited)
   
December 31,
2001
Utility plant:
              
Electric plant in service
   
$
1,713,301
   
$
1,708,908
Less accumulated depreciation and amortization
   
 
512,836
   
 
472,297
    
  
Net plant in service
   
 
1,200,465
   
 
1,236,611
Construction work in progress
   
 
113,246
   
 
86,802
Nuclear fuel; includes fuel in process of $9,440 and $11,356, respectively
   
 
73,634
   
 
74,004
Less accumulated amortization
   
 
33,851
   
 
33,177
    
  
Net nuclear fuel
   
 
39,783
   
 
40,827
    
  
Net utility plant
   
 
1,353,494
   
 
1,364,240
    
  
Current assets:
              
Cash and temporary investments
   
 
31,818
   
 
27,994
Accounts receivable, principally trade, net of allowance for doubtful accounts of $3,281
and $3,525, respectively
   
 
76,769
   
 
75,025
Accumulated deferred income taxes
   
 
42,646
   
 
39,299
Inventories, at cost
   
 
24,568
   
 
24,356
Undercollection of fuel revenues
   
 
20,765
   
 
26,797
Prepayments and other
   
 
8,331
   
 
9,741
    
  
Total current assets
   
 
204,897
   
 
203,212
    
  
Deferred charges and other assets:
              
Decommissioning trust funds
   
 
59,498
   
 
60,901
Other
   
 
15,895
   
 
16,086
    
  
Total deferred charges and other assets
   
 
75,393
   
 
76,987
    
  
Total assets
   
$
1,633,784
   
$
1,644,439
    
  
 
See accompanying notes to consolidated financial statements.

1

Table of Contents
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Continued)
 
CAPITALIZATION AND LIABILITIES
(In thousands except for share data)
   
June 30,
2002
(Unaudited)
     
December 31,
2001
  
Capitalization:
                  
Common stock, stated value $1 per share, 100,000,000 shares authorized, 62,384,827 and 61,982,963 shares issued, and 223,256 and 267,334 restricted shares, respectively
   
$
62,608
 
   
$
62,250
 
Capital in excess of stated value
   
 
260,735
 
   
 
257,891
 
Unearned compensation – restricted stock awards
   
 
(2,391
)
   
 
(2,041
)
Retained earnings
   
 
283,944
 
   
 
265,775
 
Accumulated other comprehensive income, net of tax
   
 
(1,417
)
   
 
752
 
    
  
    
 
603,479
 
   
 
584,627
 
Treasury stock, 12,442,937 and 11,991,637 shares, respectively; at cost
   
 
(140,885
)
   
 
(134,434
)
    
  
Common stock equity
   
 
462,594
 
   
 
450,193
 
Long-term debt, net of current portion
   
 
588,711
 
   
 
590,925
 
Financing obligations, net of current portion
   
 
27,207
 
   
 
28,440
 
    
  
Total capitalization
   
 
1,078,512
 
   
 
1,069,558
 
    
  
Current liabilities:
                  
Current portion of long-term debt and financing obligations
   
 
60,587
 
   
 
90,355
 
Accounts payable, principally trade
   
 
25,582
 
   
 
24,626
 
Taxes accrued other than federal income taxes
   
 
15,395
 
   
 
16,713
 
Interest accrued
   
 
15,892
 
   
 
16,860
 
Overcollection of fuel revenues
   
 
1,758
 
   
 
3,265
 
Other
   
 
17,313
 
   
 
15,942
 
    
  
Total current liabilities
   
 
136,527
 
   
 
167,761
 
    
  
Deferred credits and other liabilities:
                  
Decommissioning liability
   
 
141,742
 
   
 
137,614
 
Accrued postretirement benefit liability
   
 
86,756
 
   
 
84,974
 
Accumulated deferred income taxes
   
 
123,280
 
   
 
116,850
 
Accrued pension liability
   
 
30,506
 
   
 
30,694
 
Other
   
 
36,461
 
   
 
36,988
 
    
  
Total deferred credits and other liabilities
   
 
418,745
 
   
 
407,120
 
    
  
Commitments and contingencies
                  
Total capitalization and liabilities
   
$
1,633,784
 
   
$
1,644,439
 
    
  
See accompanying notes to consolidated financial statements.

2

Table of Contents
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except for share data)
 
    
Three Months Ended
June 30,
     
Six Months Ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
  
Electric utility operating revenues
   
$
179,917
 
   
$
203,127
 
   
$
327,524
 
   
$
394,517
 
    
  
  
  
Energy expenses:
                                    
Fuel
   
 
35,241
 
   
 
53,207
 
   
 
62,398
 
   
 
102,659
 
Purchased and interchanged power
   
 
29,890
 
   
 
34,537
 
   
 
45,225
 
   
 
51,148
 
    
  
  
  
    
 
65,131
 
   
 
87,744
 
   
 
107,623
 
   
 
153,807
 
    
  
  
  
Electric utility operating revenues net of energy expenses
   
 
114,786
 
   
 
115,383
 
   
 
219,901
 
   
 
240,710
 
    
  
  
  
Energy services operations:
                                    
Operating revenues
   
 
1,105
 
   
 
496
 
   
 
2,695
 
   
 
1,985
 
Operating expenses
   
 
1,433
 
   
 
1,220
 
   
 
3,152
 
   
 
3,113
 
    
  
  
  
    
 
(328
)
   
 
(724
)
   
 
(457
)
   
 
(1,128
)
    
  
  
  
Other electric utility operating expenses:
                                    
Other operations
   
 
34,371
 
   
 
31,687
 
   
 
67,020
 
   
 
64,692
 
Maintenance
   
 
10,967
 
   
 
13,899
 
   
 
22,484
 
   
 
25,181
 
Depreciation and amortization
   
 
22,443
 
   
 
22,246
 
   
 
45,009
 
   
 
44,399
 
Taxes other than income taxes
   
 
11,229
 
   
 
10,812
 
   
 
22,416
 
   
 
21,539
 
    
  
  
  
    
 
79,010
 
   
 
78,644
 
   
 
156,929
 
   
 
155,811
 
    
  
  
  
Operating income
   
 
35,448
 
   
 
36,015
 
   
 
62,515
 
   
 
83,771
 
    
  
  
  
Other income (deductions):
                                    
Investment income (loss), net
   
 
(286
)
   
 
1,706
 
   
 
177
 
   
 
2,607
 
Other, net
   
 
(586
)
   
 
(613
)
   
 
(934
)
   
 
(1,253
)
    
  
  
  
    
 
(872
)
   
 
1,093
 
   
 
(757
)
   
 
1,354
 
    
  
  
  
Income before interest charges
   
 
34,576
 
   
 
37,108
 
   
 
61,758
 
   
 
85,125
 
    
  
  
  
Interest charges (credits):
                                    
Interest on long-term debt and financing obligations
   
 
13,727
 
   
 
16,025
 
   
 
27,884
 
   
 
32,694
 
Other interest
   
 
2,202
 
   
 
1,995
 
   
 
4,377
 
   
 
3,985
 
Interest capitalized
   
 
(1,585
)
   
 
(1,255
)
   
 
(2,959
)
   
 
(2,296
)
    
  
  
  
    
 
14,344
 
   
 
16,765
 
   
 
29,302
 
   
 
34,383
 
    
  
  
  
Income before income taxes and extraordinary item
   
 
20,232
 
   
 
20,343
 
   
 
32,456
 
   
 
50,742
 
Income tax expense
   
 
7,853
 
   
 
8,077
 
   
 
12,202
 
   
 
19,878
 
    
  
  
  
Income before extraordinary item
   
 
12,379
 
   
 
12,266
 
   
 
20,254
 
   
 
30,864
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
61
 
   
 
161
 
   
 
2,085
 
   
 
161
 
    
  
  
  
Net income
   
$
12,318
 
   
$
12,105
 
   
$
18,169
 
   
$
30,703
 
    
  
  
  
Basic earnings per share:
                                    
Income before extraordinary item
   
$
0.25
 
   
$
0.24
 
   
$
0.40
 
   
$
0.60
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
—  
 
   
 
—  
 
   
 
0.04
 
   
 
—  
 
    
  
  
  
Net income
   
$
0.25
 
   
$
0.24
 
   
$
0.36
 
   
$
0.60
 
    
  
  
  
Diluted earnings per share:
                                    
Income before extraordinary item
   
$
0.24
 
   
$
0.23
 
   
$
0.40
 
   
$
0.59
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
—  
 
   
 
—  
 
   
 
0.04
 
   
 
—  
 
    
  
  
  
Net income
   
$
0.24
 
   
$
0.23
 
   
$
0.36
 
   
$
0.59
 
    
  
  
  
Weighted average number of common shares outstanding
   
 
50,092,213
 
   
 
51,333,726
 
   
 
50,044,473
 
   
 
51,175,732
 
    
  
  
  
Weighted average number of common shares and dilutive potential common shares outstanding
   
 
50,652,666
 
   
 
52,314,337
 
   
 
50,642,442
 
   
 
52,152,625
 
    
  
  
  
 
See accompanying notes to consolidated financial statements.

3

Table of Contents
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except for share data)
    
Twelve Months Ended
June 30,
  
    
2002
     
2001
  
Electric utility operating revenues
   
$
687,531
 
   
$
783,721
 
    
  
Energy expenses:
                  
Fuel
   
 
145,188
 
   
 
200,532
 
Purchased and interchanged power
   
 
79,664
 
   
 
92,812
 
    
  
    
 
224,852
 
   
 
293,344
 
    
  
Electric utility operating revenues net of energy expenses
   
 
462,679
 
   
 
490,377
 
    
  
Energy services operations:
                  
Operating revenues
   
 
15,891
 
   
 
4,921
 
Operating expenses
   
 
15,975
 
   
 
7,004
 
    
  
    
 
(84
)
   
 
(2,083
)
    
  
Other electric utility operating expenses:
                  
Other operations
   
 
138,208
 
   
 
132,015
 
Maintenance
   
 
43,312
 
   
 
47,531
 
Depreciation and amortization
   
 
90,072
 
   
 
88,879
 
Taxes other than income taxes
   
 
44,657
 
   
 
42,702
 
    
  
    
 
316,249
 
   
 
311,127
 
    
  
Operating income
   
 
146,346
 
   
 
177,167
 
    
  
Other income (deductions):
                  
Investment income, net
   
 
23
 
   
 
4,344
 
Other, net
   
 
(1,257
)
   
 
(1,891
)
    
  
    
 
(1,234
)
   
 
2,453
 
    
  
Income before interest charges
   
 
145,112
 
   
 
179,620
 
    
  
Interest charges (credits):
                  
Interest on long-term debt
   
 
58,092
 
   
 
66,380
 
Other interest
   
 
8,390
 
   
 
7,787
 
Interest capitalized
   
 
(5,386
)
   
 
(4,220
)
    
  
    
 
61,096
 
   
 
69,947
 
    
  
Income before income taxes and extraordinary item
   
 
84,016
 
   
 
109,673
 
Income tax expense
   
 
28,748
 
   
 
42,369
 
    
  
Income before extraordinary item
   
 
55,268
 
   
 
67,304
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
4,143
 
   
 
1,384
 
    
  
Net income
   
$
51,125
 
   
$
65,920
 
    
  
Basic earnings per share:
                  
Income before extraordinary item
   
$
1.10
 
   
$
1.29
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
0.08
 
   
 
0.03
 
    
  
Net income
   
$
1.02
 
   
$
1.26
 
    
  
Diluted earnings per share:
                  
Income before extraordinary item
   
$
1.08
 
   
$
1.26
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
0.08
 
   
 
0.02
 
    
  
Net income
   
$
1.00
 
   
$
1.24
 
    
  
Weighted average number of common shares outstanding
   
 
50,320,969
 
   
 
52,366,103
 
    
  
Weighted average number of common shares and dilutive potential common shares outstanding
   
 
51,032,717
 
   
 
53,331,686
 
    
  
 
See accompanying notes to consolidated financial statements.

4

Table of Contents
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(Unaudited)
(In thousands)
    
Three Months
Ended
June 30,
     
Six Months
Ended
June 30,
     
Twelve Months
Ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
     
2002
     
2001
  
Net income
   
$
12,318
 
   
$
12,105
 
   
$
18,169
 
   
$
30,703
 
   
$
51,125
 
   
$
65,920
 
Other comprehensive income (loss):
                                                      
Minimum pension liability adjustment
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
(824
)
   
 
—  
 
Net unrealized gains (losses) on marketable securities:
                                                      
Net holding gains (losses) arising during period
   
 
(4,856
)
   
 
1,586
 
   
 
(4,815
)
   
 
(2,934
)
   
 
(7,401
)
   
 
(5,591
)
Reclassification adjustments for net losses included in net income
   
 
1,071
 
   
 
198
 
   
 
1,425
 
   
 
580
 
   
 
3,935
 
   
 
1,115
 
    
  
  
  
  
  
    
 
(3,785
)
   
 
1,784
 
   
 
(3,390
)
   
 
(2,354
)
   
 
(4,290
)
   
 
(4,476
)
    
  
  
  
  
  
Income tax benefit (expense) related to items of other comprehensive income (loss):
                                                      
Minimum pension liability adjustment
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
289
 
   
 
—  
 
Net unrealized gains (losses) on marketable securities
   
 
1,325
 
   
 
(624
)
   
 
1,221
 
   
 
824
 
   
 
1,212
 
   
 
1,567
 
    
  
  
  
  
  
    
 
1,325
 
   
 
(624
)
   
 
1,221
 
   
 
824
 
   
 
1,501
 
   
 
1,567
 
    
  
  
  
  
  
Other comprehensive income (loss), net of tax
   
 
(2,460
)
   
 
1,160
 
   
 
(2,169
)
   
 
(1,530
)
   
 
(2,789
)
   
 
(2,909
)
    
  
  
  
  
  
Comprehensive income
   
$
9,858
 
   
$
13,265
 
   
$
16,000
 
   
$
29,173
 
   
$
48,336
 
   
$
63,011
 
    
  
  
  
  
  
 
See accompanying notes to consolidated financial statements.

5

Table of Contents
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
    
Six Months Ended
June 30,
  
    
2002
     
2001
  
Cash flows from operating activities:
                  
Net income
   
$
18,169
 
   
$
30,703
 
Adjustments to reconcile net income to net cash provided by operating activities:
                  
Depreciation and amortization of electric plant in service
   
 
45,009
 
   
 
44,399
 
Amortization of nuclear fuel
   
 
8,770
 
   
 
8,107
 
Deferred income taxes, net
   
 
5,341
 
   
 
18,486
 
Extraordinary loss on extinguishments of debt, net of income tax benefit
   
 
2,085
 
   
 
161
 
Amortization and accretion of interest costs
   
 
4,923
 
   
 
4,742
 
Other operating activities
   
 
2,562
 
   
 
914
 
Change in:
                  
Accounts receivable
   
 
(1,744
)
   
 
2,196
 
Inventories
   
 
(212
)
   
 
258
 
Net under/overcollection of fuel revenues
   
 
4,525
 
   
 
(10,628
)
Prepayments and other
   
 
1,410
 
   
 
4,578
 
Accounts payable
   
 
956
 
   
 
(6,653
)
Taxes accrued other than federal income taxes
   
 
(1,318
)
   
 
(3,275
)
Interest accrued
   
 
(968
)
   
 
1,691
 
Other current liabilities
   
 
1,371
 
   
 
977
 
Deferred charges and credits
   
 
384
 
   
 
3,540
 
    
  
Net cash provided by operating activities
   
 
91,263
 
   
 
100,196
 
    
  
Cash flows from investing activities:
                  
Cash additions to utility property, plant and equipment
   
 
(32,316
)
   
 
(35,927
)
Cash additions to nuclear fuel
   
 
(7,545
)
   
 
(7,075
)
Interest capitalized:
                  
Utility property, plant and equipment
   
 
(2,779
)
   
 
(1,995
)
Nuclear fuel
   
 
(180
)
   
 
(301
)
Investment in decommissioning trust fund
   
 
(3,046
)
   
 
(2,558
)
Other investing activities
   
 
312
 
   
 
1,118
 
    
  
Net cash used for investing activities
   
 
(45,554
)
   
 
(46,738
)
    
  
Cash flows from financing activities:
                  
Proceeds from exercise of stock options
   
 
2,006
 
   
 
4,869
 
Purchases of treasury stock
   
 
(6,451
)
   
 
(8,285
)
Repurchases of and payments on long-term debt
   
 
(36,396
)
   
 
(41,083
)
Nuclear fuel financing obligations:
                  
Proceeds
   
 
8,906
 
   
 
8,498
 
Payments
   
 
(8,868
)
   
 
(9,663
)
Other financing activities
   
 
(1,082
)
   
 
(456
)
    
  
Net cash used for financing activities
   
 
(41,885
)
   
 
(46,120
)
    
  
Net increase in cash and temporary investments
   
 
3,824
 
   
 
7,338
 
Cash and temporary investments at beginning of period
   
 
27,994
 
   
 
11,344
 
    
  
Cash and temporary investments at end of period
   
$
31,818
 
   
$
18,682
 
    
  
 
See accompanying notes to consolidated financial statements.

6

Table of Contents
 
EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)
 
A.    Principles of Preparation
 
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Annual Report of El Paso Electric Company on Form 10-K for the year ended December 31, 2001 (the “2001 Form 10-K”). Capitalized terms used in this report and not defined herein have the meaning ascribed for such terms in the 2001 Form 10-K. In the opinion of management of the Company, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company at June 30, 2002 and December 31, 2001; the results of its operations for the three, six and twelve months ended June 30, 2002 and 2001; and its cash flows for the six months ended June 30, 2002 and 2001. The results of operations for the three and six months ended June 30, 2002 and the cash flows for the six months ended June 30, 2002 are not necessarily indicative of the results to be expected for the full calendar year.
 
Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in financial statements prepared in accordance with generally accepted accounting principles. Certain prior period amounts have been reclassified to conform with the current period presentation.
 
At January 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” SFAS No. 142, “Goodwill and Other Intangible Assets” and SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” The implementation of these standards did not have an impact on the Company’s financial position or results of operations.
 
Supplemental Cash Flow Disclosures (in thousands)
 
    
Six Months Ended June 30,
    
2002
   
2001
Cash paid for:
              
Interest on long-term debt and financing obligations
   
$
28,979
   
$
30,103
Other interest
   
 
9
   
 
12
Income taxes
   
 
7,203
   
 
3,550
Non-cash investing and financing activities:
              
Grants of restricted shares of common stock
   
 
1,531
   
 
1,779
Remeasurements of employee stock options
   
 
240
   
 
—  

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

 
B.    Regulation
 
For a full discussion of the Company’s regulatory matters, see Note B of Notes to Consolidated Financial Statements in the 2001 Form 10-K.
 
Federal Regulatory Matters
 
Federal Energy Regulatory Commission.    The Company is subject to regulation by FERC in certain matters, including rates for wholesale power sales, transmission of electric power and the issuance of securities. FERC is currently conducting an investigation into potential manipulation of prices for electricity in the western United States during 2000 and 2001. As part of its inquiry, FERC issued a data request concerning various trading strategies of sellers of wholesale electricity and/or ancillary services in the Western Systems Coordinating Council during 2000-2001. The Company was one of over 150 entities that received this request and, on May 22, 2002, responded by providing the FERC with information related to various trading strategies identified in two memoranda relating to Enron Power Marketing, Inc. (“EPMI”). On June 4, 2002, the FERC issued an order to show cause, in essence indicating the Company’s market based rate authority was jeopardized as a result of FERC’s determination that the May 22, 2002 response was inadequate. In order to remedy the stated inadequacy, the Company retained outside counsel and conducted an exhaustive review of all data in its possession and control. On June 14, 2002, the Company provided a supplemental response to the FERC. On July 29, 2002, the Company received a letter from the FERC informing it that the supplemental response satisfied the concerns raised by the June 4, 2002 show cause letter. The Company has voluntarily undertaken the obligation to continue to provide the FERC with any additional data which may be responsive to the FERC’s inquiry.
 
Widespread disclosures and publicity concerning transactions in the nation’s power markets during 2000-2001 have prompted other regulatory entities to commence investigations and seek documents and data from a large number of electric utilities, power marketing firms and other market participants. In addition to the FERC inquiry described above, the Company has received an informal request from the SEC for documents concerning “so called ‘wash,’ ‘round trip,’ ‘credit wash,’ or ‘sell/buyback’ type transactions.” On July 11, 2002, the Company received a subpoena from the Commodities Futures Trading Commission (“CFTC”) requesting documents. The subpoena appears to be similar in scope to the SEC’s request. These requests appear to be substantially narrower in scope than FERC’s and the Company is in the process of seeking clarifications from the SEC and CFTC staffs with the intention of responding in a full and timely manner.
 
Texas Regulatory Matters
 
Deregulation.    The Texas Restructuring Law requires most electric utilities to legally separate their power generation business from their transmission and distribution business by January 1, 2002. In January 2002, competition was instituted in most parts of Texas. Nonetheless, the Texas Restructuring Law specifically recognizes the benefits the Company bargained for in its Texas Rate Stipulation and Texas Settlement Agreement, exempting the Company’s Texas service area from retail competition and preserving rates at their current levels until the end of the Freeze Period. At the end of the Freeze Period, the Company will generally be subject to the provisions of the law, including the institution of

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

retail competition and at that time will be permitted to recover nuclear decommissioning costs through a non-bypassable customer charge in its distribution rates, but will have no further claim for recovery of stranded costs. Stranded costs are the positive difference, if any, between the book value of electric generating assets, including long-term purchase power contracts, and the market value of those assets.
 
Fuel.    Although the Company’s base rates are frozen in Texas, pursuant to Texas Commission rules and the Texas Rate Stipulation, the Company can request adjustments to its fuel factor to more accurately reflect projected energy costs associated with the provision of electricity as well as seek recovery of past undercollections of fuel revenues.
 
In October 2001, the Texas Commission approved a unanimous settlement agreement (the “Texas Fuel Settlement”) between the Company and the parties which had intervened, including the City of El Paso, which increased the Texas fuel factor by $0.00308 per kWh. This factor was implemented on an interim basis in April 2001. The Texas Fuel Settlement also provides for the surcharge of underrecovered fuel costs as of December 31, 2000 of approximately $15.0 million plus interest over an 18-month period. The fuel surcharge was implemented on an interim basis beginning with the first billing cycle in June 2001.
 
On July 1, 2002, the Company filed a petition with the Texas Commission to reconcile the Company’s fuel and purchased power expenses and associated revenues for the three-year period January 1, 1999 through December 31, 2001. This filing was made pursuant to the Texas Commission rules, which require companies to submit a fuel reconciliation at least every three years. Among other things, the Company’s petition provided (i) a reconciliation of the Company’s Texas jurisdictional eligible fuel costs for the period of $277.0 million and fuel factor revenues of $268.9 million; (ii) Palo Verde performance rewards of $21.6 million, including interest, for achieving a capacity factor of 89.8% and (iii) a request for authority to continue to collect the current interim fuel surcharge after November 2002 in order to recover its underrecovered fuel expense. The Company has previously agreed to contribute 50% of the Palo Verde performance rewards to fund programs for bill payment assistance and demand side management programs for commercial customers in the Texas service territory. The Texas Commission staff, local regulatory authorities such as the City of El Paso and customers are entitled to intervene in a fuel reconciliation proceeding and to challenge the prudence of fuel and purchased power expenses. Under the Texas Fuel Settlement, the Texas Commission has deemed the $21.6 million Palo Verde performance reward to be reconciled. The Company anticipates that it will take nine to twelve months to process its petition and receive a final order from the Texas Commission.
 
New Mexico Regulatory Matters
 
Deregulation.    In March 2001, the New Mexico Legislature amended the New Mexico Restructuring Law to postpone deregulation in New Mexico until January 1, 2007, and to prohibit the separation of a utility’s transmission and distribution activities from its existing generation activities prior to September 1, 2005. The amended New Mexico Restructuring Law allows the utility, until corporate separation occurs, to participate in unregulated generation activities if the generation is not intended to serve New Mexico retail customers.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

 
The amended New Mexico Restructuring Law prohibiting the separation of the Company’s generation activities from its transmission and distribution activities prior to September 1, 2005 may conflict with the Texas Restructuring Law requiring separation of those activities after the expiration of the Freeze Period in August 2005. The Company anticipates that it will make its filing before the New Mexico Commission in late 2004 requesting a solution to this potential conflict and approval to separate the Company’s generation activities from its transmission and distribution activities to allow the Company to restructure at the earliest time allowable.
 
Fuel.     The New Mexico Settlement Agreement entered into in October 1998 eliminated the then existing fuel factor of $0.01949 per kWh incorporating it into frozen base rates. Accordingly, the Company was required to absorb any increases in fuel and purchased power expenses related to its New Mexico retail customers until new rates were implemented subsequent to the end of the rate freeze on April 30, 2001. The average fuel and purchased power expenses incurred for New Mexico jurisdictional customers exceeded this fuel factor by a substantial amount. Therefore, on April 23, 2001, the Company filed a petition with the New Mexico Commission proposing a settlement that would implement a new incremental fixed fuel factor, while leaving the existing $0.01949 fuel factor as part of the still frozen base rates, and reinstate for a two-year period a fuel adjustment clause in lieu of a base rate increase (the “New Mexico Fuel Factor Agreement”). The New Mexico Commission entered its final order on January 8, 2002, setting an incremental fixed fuel factor of $0.01501 per kWh.
 
Due to the decrease in gas prices since mid-2001, on February 12, 2002, the Company filed a petition with the New Mexico Commission for an incremental fuel factor decrease to $0.00420 per kWh. The New Mexico Commission issued an order approving that decrease on February 19, 2002. This new incremental fuel factor was implemented as of March 6, 2002.
 
Sales for Resale
 
The Company and the CFE have signed a contract whereby the Company sold up to 100 MW and 150 MW of non-firm power to CFE during the months of June and July 2002, respectively.
 
C.    Common Stock
 
Common Stock Repurchase Program
 
The Company’s Board of Directors has previously approved three stock repurchase programs allowing the Company to purchase up to fifteen million of its outstanding shares of common stock. As of June 30, 2002, the Company had repurchased 12,372,629 shares of common stock under these programs for approximately $140.4 million, including commissions. Repurchased shares are available for issuance under employee benefit and stock option plans, or may be retired.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

 
Reconciliation of Basic and Diluted Earnings Per Share
 
The reconciliation of basic and diluted earnings per share before extraordinary item is presented below:
 
    
Three Months Ended June 30,
    
2002
   
2001
    
Income
   
Shares
   
Per
Share
   
Income
   
Shares
   
Per
Share
    
(In thousands)
             
(In thousands)
          
Basic earnings per share:
                                      
Income before extraordinary item
   
$
12,379
   
50,092,213
   
$
0.25
   
$
12,266
   
51,333,726
   
$
0.24
                
              
Effect of dilutive securities:
                                      
Unvested restricted stock
   
 
—  
   
68,389
          
 
—  
   
56,143
       
Stock options
   
 
—  
   
492,064
          
 
—  
   
924,468
       
    
  
         
  
      
Diluted earnings per share:
                                      
Income before extraordinary item
   
$
12,379
   
50,652,666
   
$
0.24
   
$
12,266
   
52,314,337
   
$
0.24
    
  
  
  
  
  
 
    
Six Months Ended June 30,
    
2002
   
2001
    
Income
   
Shares
   
Per
Share
   
Income
   
Shares
   
Per
Share
    
(In thousands)
             
(In thousands)
          
Basic earnings per share:
                                      
Income before extraordinary item
   
$
20,254
   
50,044,473
   
$
0.40
   
$
30,864
   
51,175,732
   
$
0.60
                
              
Effect of dilutive securities:
                                      
Unvested restricted stock
   
 
—  
   
55,845
          
 
—  
   
40,497
       
Stock options
   
 
—  
   
542,124
          
 
—  
   
936,396
       
    
  
         
  
      
Diluted earnings per share:
                                      
Income before extraordinary item
   
$
20,254
   
50,642,442
   
$
0.40
   
$
30,864
   
52,152,625
   
$
0.59
    
  
  
  
  
  
 
    
Twelve Months Ended June 30,
    
2002
   
2001
    
Income
   
Shares
   
Per
Share
   
Income
   
Shares
   
Per
Share
    
(In thousands)
             
(In thousands)
          
Basic earnings per share:
                                      
Income before extraordinary item
   
$
55,268
   
50,320,969
   
$
1.10
   
$
67,304
   
52,366,103
   
$
1.29
                
              
Effect of dilutive securities:
                                      
Unvested restricted stock
   
 
—  
   
74,100
          
 
—  
   
58,146
       
Stock options
   
 
—  
   
637,648
          
 
—  
   
907,437
       
    
  
         
  
      
Diluted earnings per share:
                                      
Income before extraordinary item
   
$
55,268
   
51,032,717
   
$
1.08
   
$
67,304
   
53,331,686
   
$
1.26
    
  
  
  
  
  

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

 
Options excluded from the computation of diluted earnings per share because the exercise price was greater than the average market price for the periods presented are as follows:
 
    
Three Months
Ended June 30,
   
Six Months
Ended June 30,
   
Twelve Months
Ended June 30,
    
2002
   
2001
   
2002
   
2001
   
2002
   
2001
Options
   
150,760
   
150,000
   
152,979
   
305,048
   
252,979
   
                        305,048
Exercise price range
   
$14.95-$15.65
   
$14.95
   
$14.60-$15.99
   
$12.60-$14.95
   
$14.00-$15.99
   
$12.60-$14.95
 
D.    Commitments, Contingencies and Uncertainties
 
For a full discussion of commitments and contingencies, including environmental matters related to the Company, see Note H of Notes to Consolidated Financial Statements in the 2001 Form 10-K. In addition, see Note C of Notes to Consolidated Financial Statements in the 2001 Form 10-K regarding matters related to Palo Verde, including decommissioning, spent fuel storage, disposal of low-level radioactive waste and liability and insurance matters.
 
Power Contracts
 
The Company has not entered into any new financially significant open contracts or power exchange agreements other than those discussed in the Company’s 2001 Form 10-K.
 
Environmental Matters
 
The Company is subject to regulation with respect to air, soil and water quality, solid waste disposal and other environmental matters by federal, state, tribal and local authorities. Those authorities govern current facility operations and exercise continuing jurisdiction over facility modifications. Environmental regulations can change rapidly and are difficult to predict. Substantial expenditures may be required to comply with these regulations. The Company analyzes the costs of its obligations arising from environmental matters on an ongoing basis, and management believes it has made adequate provision in its financial statements to meet such obligations. Currently, the Company has provision for environmental remediation obligations of approximately $0.2 million. However, unforeseen expenses associated with compliance could have a material adverse effect on the future operations and financial condition of the Company.

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

The following are expenditures incurred by the Company for the three, six and twelve months ended June 30, 2002 and 2001 for complying with federal environmental statutes (in thousands):
 
    
Three Months
Ended June 30,
   
Six Months
Ended June 30,
   
Twelve Months
Ended June 30,
    
2002
   
2001
   
2002
   
2001
   
2002
   
2001
Clean Air Act
   
$
84
   
$
166
   
$
414
   
$
235
   
$
897
   
$
688
Federal Clean Water Act
   
 
40
   
 
60
   
 
123
   
 
98
   
 
306
   
 
608
 
The Company is not under any environmental investigation by the Environmental Protection Agency, the Texas Natural Resources Conservation Commission or the New Mexico Environment Department. In addition, the Company has not been named as a Potentially Responsible Party pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980.
 
Customer Information System
 
In July 2002, the Company suspended work on its Customer Information System (“CIS”) project to perform an assessment of the project and of alternatives to completion of the project. As of June 30, 2002, the Company has capitalized or committed to incur $15.3 million on the CIS project. If, as a result of this assessment, any portion of the amounts that have been capitalized to date to implement a new CIS system are deemed impaired, the Company would recognize an impairment charge against income in the period they are identified and the effect on the Company’s financial results could be material. Management expects to complete its assessment by the fourth quarter of 2002.
 
MiraSol Warranty Obligations
 
MiraSol is an energy services subsidiary which offered a variety of services to reduce energy use and/or lower energy costs. MiraSol was not a power marketer. On July 19, 2002, all marketing activities of MiraSol ceased. MiraSol remains a going concern devoted to satisfaction of current contracts and warranty and service obligations on previously installed projects. Management of MiraSol is undertaking an assessment of all projects for potential warranty obligations. At this time, MiraSol is unable to quantify its probable loss exposure on warranty claims, if any, and therefore has not recorded a warranty liability in its financial statements. MiraSol has received a claim from a large customer attempting to enforce warranty provisions on a $5.6 million generator project. The Company believes that any warranty claim will be absorbed by subcontractors. If it is determined at a future date that MiraSol has an obligation to this or any other customer, and MiraSol, its subcontractors or any other third party contributions are insufficient to honor the warranty obligations, the Company intends to honor the warranty obligations after making any appropriate regulatory filings. Since inception MiraSol had recorded total revenues of $27.0 million for projects performed for customers, of which $8.9 million have been identified as potentially having warranty claims.

13

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EL PASO ELECTRIC COMPANY AND SUBSIDIARY
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(Unaudited)

 
E.    Litigation
 
The Company is a party to various claims, legal actions and complaints. In many of these matters, the Company has excess casualty liability insurance that covers the various claims, actions and complaints. Based upon a review of these claims and applicable insurance coverage, the Company believes that none of these claims will have a material adverse effect on the financial position, results of operations and cash flows of the Company.
 
F.    Subsequent Event
 
On August 1, 2002, the Company issued two series of pollution control bonds in the amounts of $37.1 million and $33.3 million. These bonds were issued with a fixed interest rate of 6.25% and 6.375%, respectively. These interest rates are fixed until August 1, 2005 which is the date the bonds are due to be remarketed. This issuance replaces two series of bonds which were subject to remarketing as of July 31, 2002. As a result, the bonds which were outstanding as of June 30, 2002 are presented as non-current in the consolidated balance sheet as of June 30, 2002.

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Independent Accountants’ Review Report
 
The Shareholders and the Board of Directors
El Paso Electric Company:
 
We have reviewed the accompanying condensed consolidated balance sheet of El Paso Electric Company and subsidiary (the Company) as of June 30, 2002, the related condensed consolidated statements of operations and comprehensive operations for the three, six and twelve months ended June 30, 2002 and 2001, and the related condensed consolidated statements of cash flows for the six months ended June 30, 2002 and 2001. These condensed consolidated financial statements are the responsibility of the Company’s management.
 
We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, 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 review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
 
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of El Paso Electric Company and subsidiary as of December 31, 2001, and the related consolidated statements of operations, comprehensive operations, changes in common stock equity and cash flows for the year then ended (not presented herein); and in our report dated March 11, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2001 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
 
KPMG LLP
 
El Paso, Texas
August 1, 2002

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The information contained in this Item 2 updates, and should be read in conjunction with, the information set forth in Part II, Item 7 of the Company’s 2001 Form 10-K.
 
Statements in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, as well as other oral and written forward-looking statements made by or on behalf of the Company from time to time, including statements contained in the Company’s filings with the Securities and Exchange Commission and its reports to shareholders, involve known and unknown risks and other factors which may cause the Company’s actual results in future periods to differ materially from those expressed in any forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to: (i) increased prices for fuel and purchased power; (ii) the possibility that regulators may not permit the Company to pass through all such increased costs to customers; (iii) fluctuations in wholesale margins due to uncertainty in the wholesale power market; (iv) unanticipated increased costs associated with scheduled and unscheduled outages; (v) the cost of replacing steam generators and other unexpected costs at Palo Verde and (vi) other factors discussed below under the headings “Summary of Critical Accounting Policies and Estimates,” “Overview” and “Liquidity and Capital Resources.” The Company’s filings are available from the Securities and Exchange Commission or may be obtained upon request from the Company. Any such forward-looking statement is qualified by reference to these risks and factors. The Company cautions that these risks and factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company except as required by law.
 
Summary of Critical Accounting Policies and Estimates
 
The preparation of the Company’s financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented and actual results could differ from those estimates. Critical accounting policies and estimates, which are both important to the portrayal of the Company’s financial condition and results of operations and which require complex, subjective judgments are more fully described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2001 Form 10-K.

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Overview
 
El Paso Electric Company is an electric utility that serves retail customers in west Texas and southern New Mexico and wholesale customers in Texas, New Mexico and Mexico. The Company owns or has substantial ownership interests in six electrical generating facilities providing it with a total capacity of approximately 1,500 MW. The Company’s energy sources consist of nuclear fuel, natural gas, coal, purchased power and wind. The Company owns or has significant ownership interests in four major 345 kV transmission lines and three 500 kV lines to provide power from Palo Verde and Four Corners, and owns the distribution network within its retail service territory. The Company is subject to regulation by the Texas and New Mexico Commissions and, with respect to wholesale power sales, transmission of electric power and the issuance of securities, by the FERC.
 
The Company faces a number of risks and challenges that could negatively impact its operations and financial results. The most significant of these risks and challenges arise from the deregulation of the electric utility industry, the possibility of increased costs, especially from Palo Verde, and the Company’s relatively high level of debt.
 
The electric utility industry in general and the Company in particular are facing significant challenges and increased competition as a result of changes in federal provisions relating to third-party transmission services and independent power production, as well as changes in state laws and regulatory provisions relating to wholesale and retail service. In 1999, both Texas and New Mexico passed industry deregulation legislation requiring the Company to separate its transmission and distribution functions, which will remain regulated, from its power generation and energy services businesses, which will operate in a competitive market in the future. New Mexico subsequently amended its deregulation law to delay the implementation date. While the Company is not subject to deregulation in Texas and New Mexico until 2005 and 2007, respectively, the potential effects of competition in the power generation and energy services markets remain important to the Company. There can be no assurance that the deregulation of the power generation market will not adversely affect the future operations, cash flows and financial condition of the Company.
 
The changing regulatory environment and the advent of unregulated power production have created a substantial risk that the Company will lose important customers. The Company’s wholesale and large retail customers already have, in varying degrees, additional alternate sources of economical power, including co-generation of electric power. Historically, the Company has lost certain large retail customers to self generation and/or co-generation and seen reductions in wholesale sales due to new sources of generation. Duke Energy recently began constructing a generation plant in Deming, New Mexico which is scheduled to be complete by 2004. Public Service Company of New Mexico is near completion of a generation plant outside Las Cruces, New Mexico. If the Company loses a significant portion of its retail customer base or wholesale sales, the Company may not be able to replace such revenues through either the addition of new customers or an increase in rates to remaining customers.
 
Another risk to the Company is potential increased costs, including the risk of additional or unanticipated costs at Palo Verde resulting from (i) increases in operation and maintenance expenses; (ii) the replacement of steam generators; (iii) an extended outage of any of the Palo Verde units; (iv) increases in estimates of decommissioning costs; (v) the storage of radioactive waste, including spent nuclear fuel; (vi) insolvency of other Palo Verde Participants and (vii) compliance with the various requirements and regulations governing commercial nuclear generating stations. At the same time, the

17

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Company’s retail base rates in Texas are effectively capped through a rate freeze ending in August 2005. Additionally, upon initiation of competition, there will be competitive pressure on the Company’s power generation rates which could reduce its profitability. The Company also cannot assure that its revenues will be sufficient to recover any increased costs, including any increased costs in connection with Palo Verde or other operations, whether as a result of inflation, changes in tax laws or regulatory requirements, or other causes.
 
The Company is subject to regulation by FERC in certain matters, including rates for wholesale power sales, transmission of electric power and the issuance of securities. FERC is currently conducting an investigation into potential manipulation of prices for electricity in the western United States during 2000 and 2001. As part of its inquiry, FERC issued a data request concerning various trading strategies of sellers of wholesale electricity and/or ancillary services in the Western Systems Coordinating Council during 2000-2001. The Company was one of over 150 entities that received this request and, on May 22, 2002, responded by providing the FERC with information related to various trading strategies identified in two memoranda relating to Enron Power Marketing, Inc. (“EPMI”). On June 4, 2002, the FERC issued an order to show cause, in essence indicating the Company’s market based rate authority was jeopardized as a result of FERC’s determination that the May 22, 2002 response was inadequate. In order to remedy the stated inadequacy, the Company retained outside counsel and conducted an exhaustive review of all data in its possession and control. On June 14, 2002, the Company provided a supplemental response to the FERC. On July 29, 2002, the Company received a letter from the FERC informing it that the supplemental response satisfied the concerns raised by the June 4, 2002 show cause letter. The Company has voluntarily undertaken the obligation to continue to provide the FERC with any additional data which may be responsive to the FERC’s inquiry.
 
Widespread disclosures and publicity concerning transactions in the nation’s power markets during 2000-2001 have prompted other regulatory entities to commence investigations and seek documents and data from a large number of electric utilities, power marketing firms and other market participants. In addition to the FERC inquiry described above, the Company has received an informal request from the SEC for documents concerning “so called ‘wash,’ ‘round trip,’ ‘credit wash,’ or ‘sell/buyback’ type transactions.” On July 11, 2002, the Company received a subpoena from the Commodities Futures Trading Commission (“CFTC”) requesting documents. The subpoena appears to be similar in scope to the SEC’s request. These requests appear to be substantially narrower in scope than FERC’s and the Company is in the process of seeking clarifications from the SEC and CFTC staffs with the intention of responding in a full and timely manner.
 
The Company has identified two matters that could potentially have a material negative impact on its financial statements. The first relates to cessation of marketing at MiraSol, an energy services subsidiary which offered a variety of services to reduce energy use and/or lower energy costs effective July 19, 2002. MiraSol was not a power marketer. MiraSol remains a going concern devoted to satisfaction of current contracts and warranty and service obligations on previously installed projects. Management of MiraSol is undertaking an assessment of all projects for potential warranty obligations. At this time, MiraSol is unable to quantify its probable loss exposure on warranty claims, if any, and therefore has not recorded a warranty liability in its financial statements. MiraSol has received a claim from a large customer attempting to enforce warranty provisions on a $5.6 million generator project. The Company believes that any warranty claim will be absorbed by subcontractors. If it is determined at a future date that MiraSol has an obligation to this or any other customer, and MiraSol, its subcontractors or any other third party contributions are insufficient to honor the warranty obligations, the Company intends to honor the warranty obligations after making any appropriate regulatory filings.

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Since inception MiraSol had recorded total revenues of $27.0 million for projects performed for customers, of which $8.9 million have been identified as potentially having warranty claims.
 
Second, in July 2002, the Company suspended work on its CIS project to perform an assessment of the project and of alternatives to completion of the project. As of June 30, 2002, the Company has capitalized or committed to incur $15.3 million on the CIS project. If, as a result of this assessment, any portion of the amounts that have been capitalized to date to implement a new CIS system are deemed impaired, the Company would recognize an impairment charge against income in the period they are identified and the effect on the Company’s financial results could be material. Management expects to complete its assessment by the fourth quarter of 2002.
 
Liquidity and Capital Resources
 
The Company’s principal liquidity requirements in the near-term are expected to consist of interest and principal payments on the Company’s indebtedness and capital expenditures related to the Company’s generating facilities and transmission and distribution systems. The Company expects that cash flows from operations and refinancing of long-term debt will be sufficient for such purposes.
 
Long-term capital requirements of the Company will consist primarily of construction of electric utility plant and payment of interest on and retirement of debt. Utility construction expenditures will consist primarily of expanding and updating the transmission and distribution systems, possible addition of new generation and the cost of capital improvements and replacements at Palo Verde and other generating facilities, including the replacement of the Palo Verde steam generators.
 
During the twelve months ended June 30, 2002 and 2001, the Company utilized $120.1 million and $113.8 million, respectively, of federal tax loss carryforwards. The Company anticipates that existing federal tax loss carryforwards will be fully utilized in 2003 and after that date the Company’s cash flow requirements are expected to include greater amounts of cash for income taxes than has existed in recent years.
 
As of June 30, 2002, cash and temporary investments totaled $31.8 million, an increase of $3.8 million from the December 31, 2001 balance of $28.0 million. The Company also has a $100 million revolving credit facility, which provides up to $70 million for nuclear fuel purchases. Any amounts not borrowed for nuclear fuel purchases may be borrowed by the Company for working capital needs. In January 2002, the revolving credit facility was renewed for a three-year term. At June 30, 2002, approximately $48.3 million had been drawn for nuclear fuel purchases. No amounts are currently outstanding on this facility for working capital needs.
 
The Company has a relatively high debt to capitalization ratio and significant debt service obligations. Due to the Texas Rate Stipulation, the Texas Settlement Agreement, and competitive pressures, the Company does not expect to be able to raise its base rates in Texas in the event of increases in non-fuel costs or loss of revenues. Accordingly, as described below, debt reduction continues to be a high priority for the Company in order to gain additional financial flexibility to address the evolving competitive market.
 
The Company has significantly reduced its long-term debt since its emergence from bankruptcy in 1996. From June 1, 1996 through August 8, 2002, the Company repurchased and repaid approximately $511.1 million of first mortgage bonds, including the repurchase of approximately $2.7 million of first mortgage bonds during the second quarter of 2002, with internally generated cash as part of a

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deleveraging program. The Company also anticipates redeeming the remaining $39.4 million of Series C First Mortgage Bonds at their maturity in February 2003 with internally generated cash. Common stock equity as a percentage of capitalization, including current portion of long-term debt and financing obligations, has increased from 19% at June 30, 1996 to 41% at June 30, 2002.
 
On August 1, 2002, the Company issued two series of pollution control bonds in the amounts of $37.1 million and $33.3 million. These bonds were issued with a fixed interest rate of 6.25% and 6.375%, respectively. These interest rates are fixed until August 1, 2005 which is the date the bonds are due to be remarketed. This issuance replaces two series of bonds which were subject to remarketing as of July 31, 2002. As a result, the bonds which were outstanding as of June 30, 2002 are presented as non-current in the consolidated balance sheet as of June 30, 2002.
 
The Company continues to believe that the orderly reduction of debt with a goal of achieving a capital structure that is more typical in the electric utility industry is a significant component of long-term shareholder value creation. Accordingly, the Company will regularly evaluate market conditions and, when appropriate, use a portion of its available cash to reduce its fixed obligations through open market purchases of first mortgage bonds.
 
The degree to which the Company is leveraged could have important consequences on the Company’s liquidity, including (i) the Company’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate or other purposes could be limited in the future and (ii) the Company’s higher than average leverage may place the Company at a competitive disadvantage by limiting its financial flexibility to respond to the demands of the competitive market and make it more vulnerable to adverse economic or business changes.
 
The Company’s Board of Directors previously approved three stock repurchase programs allowing the Company to purchase up to fifteen million of its outstanding shares of common stock. As of August 8, 2002, the Company had repurchased 12,591,929 shares of common stock under these programs for approximately $143.2 million, including commissions. The Company expects to continue to make purchases primarily in the open market at prevailing prices and will also engage in private transactions, as appropriate. Any repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.
 
Historical Results of Operations
 
    
Three Months
Ended June 30,
   
Six Months
Ended June 30,
   
Twelve Months
Ended June 30,
    
2002
   
2001
   
2002
   
2001
   
2002
   
2001
Net income
                                          
(in millions)
   
$
12.3
   
$
12.1
   
$
18.2
   
$
30.7
   
$
51.1
   
$
65.9
Diluted earnings per share
   
 
0.24
   
 
0.23
   
 
0.36
   
 
0.59
   
 
1.00
   
 
1.24

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Electric utility operating revenues net of energy expenses decreased $0.6 million, $20.9 million and $27.7 million for the three, six and twelve months ended June 30, 2002, respectively, compared to the same periods last year, primarily due to decreased economy sales margins due to significant lower wholesale prices in the western United States power markets. These decreases were partially offset by the recovery of energy expenses in New Mexico beginning in July 2001 that were not recovered in the prior periods and by retail sales growth in the Company’s west Texas and southern New Mexico retail service territory.
 
The Company and the CFE have signed a contract whereby the Company sold up to 100 MW and 150 MW of non-firm power to CFE during the months of June and July 2002, respectively.
 
Comparisons of kWh sales and electric utility operating revenues are shown below (in thousands):
 
              
Increase (Decrease)
  
Three Months Ended June 30:
   
2002
   
2001
   
Amount
     
Percent
  
Electric kWh sales:
                              
Retail
   
 
1,621,205
   
 
1,522,014
   
 
99,191
 
   
6.5
%(1)
Sales for resale
   
 
257,428
   
 
383,502
   
 
(126,074
)
   
(32.9
)(2)
Economy sales
   
 
499,053
   
 
273,893
   
 
225,160
 
   
82.2
(3)
    
  
  
      
Total
   
 
2,377,686
   
 
2,179,409
   
 
198,277
 
   
9.1
 
    
  
  
      
Operating revenues:
                              
Base revenues:
                              
Retail
   
$
112,237
   
$
106,205
   
$
6,032
 
   
5.7
%(1)
Sales for resale
   
 
8,703
   
 
14,063
   
 
(5,360
)
   
(38.1
)(4)
    
  
  
      
Total base revenues
   
 
120,940
   
 
120,268
   
 
672
 
   
0.6
 
Fuel revenues
   
 
44,119
   
 
53,092
   
 
(8,973
)
   
(16.9
)(5)
Economy sales
   
 
13,209
   
 
27,228
   
 
(14,019
)
   
(51.5
)(6)
Other (7)
   
 
1,649
   
 
2,539
   
 
(890
)
   
(35.1
)(8)
    
  
  
      
Total operating revenues
   
$
179,917
   
$
203,127
   
$
(23,210
)
   
(11.4
)
    
  
  
      
 
              
Increase (Decrease)
  
Six Months Ended June 30:
   
2002
   
2001
   
Amount
     
Percent
  
Electric kWh sales:
                              
Retail
   
 
3,008,392
   
 
2,964,661
   
 
43,731
 
   
1.5
%
Sales for resale
   
 
605,913
   
 
705,922
   
 
(100,009
)
   
(14.2
)(2)
Economy sales
   
 
612,219
   
 
628,852
   
 
(16,633
)
   
(2.6
)
    
  
  
      
Total
   
 
4,226,524
   
 
4,299,435
   
 
(72,911
)
   
(1.7
)
    
  
  
      
Operating revenues:
                              
Base revenues:
                              
Retail
   
$
210,703
   
$
206,514
   
$
4,189
 
   
2.0
%
Sales for resale
   
 
20,672
   
 
23,387
   
 
(2,715
)
   
(11.6
)(4)
    
  
  
      
Total base revenues
   
 
231,375
   
 
229,901
   
 
1,474
 
   
0.6
 
Fuel revenues
   
 
76,595
   
 
84,577
   
 
(7,982
)
   
(9.4
)(5)
Economy sales
   
 
15,982
   
 
74,730
   
 
(58,748
)
   
(78.6
)(6)
Other (7)
   
 
3,572
   
 
5,309
   
 
(1,737
)
   
(32.7
)(8)
    
  
  
      
Total operating revenues
   
$
327,524
   
$
394,517
   
$
(66,993
)
   
(17.0
)
    
  
  
      

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Increase (Decrease)
  
Twelve Months Ended June 30:
   
2002
   
2001
   
Amount
     
Percent
  
Electric kWh sales:
                              
Retail
   
 
6,262,203
   
 
6,196,396
   
 
65,807
 
   
1.1
%
Sales for resale
   
 
1,360,374
   
 
1,421,023
   
 
(60,649
)
   
(4.3
)
Economy sales
   
 
913,281
   
 
1,446,725
   
 
(533,444
)
   
(36.9
)(6)
    
  
  
      
Total
   
 
8,535,858
   
 
9,064,144
   
 
(528,286
)
   
(5.8
)
    
  
  
      
Operating revenues:
                              
Base revenues:
                              
Retail
   
$
439,465
   
$
434,389
   
$
5,076
 
   
1.2
%
Sales for resale
   
 
50,164
   
 
48,314
   
 
1,850
 
   
3.8
(9)
    
  
  
      
Total base revenues
   
 
489,629
   
 
482,703
   
 
6,926
 
   
1.4
 
Fuel revenues
   
 
156,354
   
 
158,875
   
 
(2,521
)
   
(1.6
)
Economy sales
   
 
33,704
   
 
129,861
   
 
(96,157
)
   
(74.0
)(6)
Other (7)
   
 
7,844
   
 
12,283
   
 
(4,439
)
   
(36.1
)(10)
    
  
  
      
Total operating revenues
   
$
687,531
   
$
783,722
   
$
(96,191
)
   
(12.3
)
    
  
  
      
(1)
 
Primarily due to increased kWh sales to commercial and industrial customers and residential customers in Texas.
(2)
 
Primarily due to the expiration of a wholesale power contract with IID on April 30, 2002, partially offset by increased kWh sales to TNP.
(3)
 
Primarily due to increased available power as a result of the expiration of a wholesale power contract with IID and increased sales at Palo Verde due to transmission constraints.
(4)
 
Primarily due to the expiration of a wholesale power contract with IID on April 30, 2002 and decreased sales to CFE. These decreases were partially offset by increased demand charges to TNP.
(5)
 
Primarily due to decreased energy expenses that are passed through directly to Texas jurisdictional customers and certain wholesale customers partially offset by energy expenses that are now passed through to New Mexico jurisdictional customers with no comparable pass through last year.
(6)
 
Primarily due to a weaker power market in 2002 compared to the previous year.
(7)
 
Represents revenues with no related kWh sales.
(8)
 
Primarily due to decreased transmission sales.
(9)
 
Primarily due to increased demand charges from TNP and increased sales to CFE. These increases were partially offset by the expiration of a wholesale power contract with IID on April 30, 2002.
(10)
 
Primarily due to margins on swaps entered into with a large power marketer in 2000 in order to lock in a fixed price on certain power purchases with no comparable amount in the current period.

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Table of Contents
 
Other electric utility operations expense increased $2.7 million and $2.3 million for the three and six months ended June 30, 2002, respectively, compared to the same periods last year. These increases were primarily due to (i) increased OPEB costs resulting from a change in discount rate and escalation assumptions for medical costs; (ii) a reserve for a potential refund of transmission expenses and (iii) a litigation settlement. The increase for the six month period was partially offset by a decrease in customer accounts expense due to recording a reserve for a large customer in 2001 with no comparable amount in the current period.
 
Other electric utility operations expense increased $6.2 million for the twelve months ended June 30, 2002 compared to the same period last year. This increase was primarily due to (i) increased OPEB costs resulting from a change in discount rate and escalation assumptions for medical costs; (ii) litigation settlements and (iii) increased professional fees related to regulatory matters. These increases were partially offset by decreased expenses related to outside services for consulting and corporate restructuring.
 
Electric utility maintenance expense decreased $2.9 million, $2.7 million and $4.2 million for the three, six and twelve month periods ended June 30, 2002, respectively, compared to the same periods last year. The decrease was primarily due to scheduled maintenance outages in the prior periods and decreased costs related to a jointly owned transmission line operated by another utility.
 
Depreciation and amortization expense increased $0.2 million, $0.6 million and $1.2 million for the three, six and twelve months ended June 30, 2002, respectively, compared to the same periods last year primarily due to an increase in the depreciable plant balances.
 
Taxes other than income taxes remained relatively unchanged for the three months ended June 30, 2002, compared to the same period last year. Taxes other than income taxes increased $0.9 million and $2.0 million for the six and twelve months ended June 30, 2002, respectively, compared to the same periods last year primarily due to increases in Texas revenue related taxes. These increases were partially offset by a decrease in Arizona property taxes as a result of Arizona House Bill 2324 phasing in a decrease in assessed values beginning in 2001.
 
Other income (deductions) decreased $2.0 million, $2.1 million and $3.7 million for the three, six and twelve months ended June 30, 2002, respectively, compared to the same periods last year primarily due to a decrease of $2.0 million, $2.4 million and $4.3 million, respectively, in investment and interest income related to the decommissioning trust fund, the undercollection of Texas fuel revenues and cash investments.
 
Interest charges decreased $2.4 million, $5.1 million and $8.9 million for the three, six and twelve months ended June 30, 2002, respectively, compared to the same period last year primarily due to (i) a reduction in outstanding debt as a result of open market purchases and the maturity of certain of the Company’s first mortgage bonds; (ii) increased capitalized interest related to construction work in progress and (iii) decreased interest rates.
 
Income tax expense, excluding the tax effect of the extraordinary item, did not change significantly for the three months ended June 30, 2002 compared to the same period last year. Income tax expense, excluding the tax effect of the extraordinary item, decreased $7.7 million and $13.6 million for the six and twelve months ended June 30, 2002, respectively, compared to the same periods last year primarily due to changes in pretax income and certain permanent differences and adjustments including (i) a reduction to the Company’s estimate of contingent federal tax liability based upon discussions and

23

Table of Contents
agreed issues with taxing authorities related to the IRS examination of the Company’s 1996 through 1998 tax returns and (ii) deductions taken for abandoned transition costs.
 
Extraordinary loss on extinguishments of debt, net of income tax benefit, represents the payment of premiums on debt extinguishments and the recognition of unamortized issuance expenses on that debt.
 
The FASB has continued to issue additional guidance on SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities,” including providing revised guidance on FASB Derivatives Implementation Group (the “DIG”) Issue C15 “Scope Exceptions: Normal Purchases and Normal Sales Exception for Option-Type Contracts and Forward Contracts in Electricity” on December 28, 2001. This revised guidance, which became effective on April 1, 2002, has not had a significant impact on the Company’s consolidated financial statements.
 
In July 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). SFAS No. 143 provides accounting guidance for retirement obligations, for which there is a legal obligation to settle, associated with tangible long-lived assets. SFAS No. 143 requires that asset retirement costs be capitalized as part of the cost of the related long-lived asset and such costs should be allocated to expense by using a systematic and rational method. SFAS No. 143 requires the initial measurement of the asset retirement obligation liability to be recorded at fair value and the use of an allocation approach for subsequent changes in the measurement of the liability. Upon adoption of SFAS No. 143, an entity will use a cumulative-effect adjustment to recognize transition amounts for any existing asset retirement obligation liability, asset retirement costs and accumulated depreciation net of amounts already provided in the financial statements for asset retirement costs under existing accounting policies. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. Management has not yet quantified the impact of adopting SFAS No. 143 on the Company’s consolidated financial statements.
 
Additionally, in April 2002, the FASB issued SFAS No. 145 “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections”. SFAS No. 145 rescinds SFAS No. 4 “Reporting Gains and Losses from Extinguishment of Debt” which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effects. Upon adoption of SFAS No. 145, gains and losses from the extinguishment of debt will not be classified as an extraordinary item unless the debt extinguishment meets the unusual in nature and infrequent of occurrence criteria in APB Opinion No. 30 “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (“APB No. 30”). SFAS No. 145 will be effective for fiscal years beginning after May 15, 2002 with early adoption encouraged. Upon adoption, enterprises must reclassify prior period items that do not meet the extraordinary item classification criteria of APB No. 30. The Company has determined that all previously reported extraordinary items related to debt extinguishments will be included as a component of income before extraordinary item.

24

Table of Contents
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
 
The Company is exposed to market risk due to changes in interest rates, equity prices and commodity prices. See the Company’s 2001 Form 10-K, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” for a complete discussion of the market risks faced by the Company and the Company’s market risk sensitive assets and liabilities. As of June 30, 2002, there have been no material changes in the market risks faced by the Company or the fair values of assets and liabilities disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in the Company’s 2001 Form 10-K.

25

Table of Contents
 
PART II. OTHER INFORMATION
 
Item 1.    Legal Proceedings
 
The Company hereby incorporates by reference the information set forth in Part I of this report under Note E of Notes to Consolidated Financial Statements.
 
Item 4.    Submission of Matters to a Vote of Security Holders
 
The annual meeting of shareholders of the Company was held May 9, 2002. The total number of common shares outstanding was 50,288,779, of which 45,126,614 were represented in person or by proxy. The following directors were elected to hold office for a three-year term expiring at the annual meeting of shareholders of the Company to be held in 2005:
 
Director
  
Votes For
   
Votes Withheld
James Haines
  
44,039,704
   
1,086,910
Gary R. Hedrick
  
44,763,266
   
   363,348
Kenneth R. Heitz
  
44,764,545
   
   362,069
Michael K. Parks
  
44,713,752
   
   412,862
Eric B. Siegel
  
44,764,582
   
   362,032
 
The following director was elected to hold office for a one-year term expiring at the annual meeting of shareholders of the Company to be held in 2003:
 
Director
  
Votes For
  
Votes Withheld
James W. Harris
  
44,764,603
  
   362,011
 
In addition to the individuals set forth above, the following individuals continued as directors following the meeting: Wilson K. Cadman, James A. Cardwell, James W. Cicconi, George W. Edwards, Jr., Ramiro Guzman, Patricia Z. Holland-Branch, Stephen Wertheimer, and Charles A. Yamarone.
 
Item 6.    Exhibits and Reports on Form 8-K
 
(a)    Exhibits: See Index to Exhibits incorporated herein by reference.
 
(b)    Reports on Form 8-K:
 
Date of Reports
   
Item Numbers
   
Financial Statements
Required to be Filed
July 15, 2002
   
9
   
None

26

Table of Contents
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
EL PASO ELECTRIC COMPANY
By:
  
/s/    TERRY BASSHAM        
   
Terry Bassham
Executive Vice President,
Chief Financial and
Administrative Officer
(Duly Authorized Officer and
Principal Financial Officer)
 
Dated: August 12, 2002
 

27

Table of Contents
 
EL PASO ELECTRIC COMPANY
 
INDEX TO EXHIBITS
 
Exhibit
Number
   
Exhibit
†10.07
   
Form of Directors’ Restricted Stock Award Agreement between the Company and certain directors of the Company. (Identical in all material respects to Exhibit 10.07 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1999)
††10.08
   
Form of Directors’ Stock Option Agreements between the Company and certain directors of the Company. (Identical in all material respects to Exhibit 99.17 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997)
10.09
   
Interconnection Agreement date as of May 23, 2002 between the Company and Public Service Company of New Mexico.
    15     
   
Letter re Unaudited Interim Financial Information
 
†
 
In lieu of non-employee director compensation, three agreements, dated as of July 1, 2002, substantially identical in all material respects to this Exhibit, have been entered into with Kenneth Heitz; Patricia Z. Holland-Branch; and Charles A. Yamarone; directors of the Company.
 
††
 
In lieu of non-employee director compensation, two agreements, dated as of July 1, 2002, substantially identical in all material respects to this Exhibit, have been entered into with Wilson Cadman and Kenneth Heitz; directors of the Company.