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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 September 30, 2003
- 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
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Name of Registrant Title of Each Class on Which Registered
- ------------------ ------------------- ---------------------
PNM Resources, Inc. Common Stock, No Par Value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act
None.
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 November 1, 2003, 40,248,428 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:
Independent Accountants' Report........................................ 3
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
PNM Resources, Inc. and Subsidiaries
Consolidated Statements of Earnings
Three and Nine Months Ended September 30, 2003 and 2002..... 5
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002.................... 6
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and 2002............... 8
Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2003 and 2002..... 9
Public Service Company of New Mexico and Subsidiaries
Consolidated Statements of Earnings
Three and Nine Months Ended September 30, 2003 and 2002..... 10
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002.................... 11
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and 2002............... 13
Consolidated Statements of Comprehensive Income
Three and Nine Months Ended September 30, 2003 and 2002..... 14
Notes to Consolidated Financial Statements.......................... 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............. 51
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK................................................ 75
ITEM 4. CONTROLS AND PROCEDURES....................................... 82
PART II. OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS............................................. 83
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.............................. 83
Signature.............................................................. 86
2
INDEPENDENT ACCOUNTANTS' REPORT
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 September 30, 2003, and the related
consolidated statements of earnings and comprehensive income for the three-month
and nine-month periods ended September 30, 2003 and 2002, and of cash flows for
the nine-month periods ended September 30, 2003 and 2002. These interim
financial statements are the responsibility of the Company's management.
We conducted our reviews 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 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 reviews, we are not aware of any material modifications that should
be made to such consolidated interim 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.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet and
consolidated statement of capitalization (not presented herein) of PNM
Resources, Inc. and subsidiaries as of December 31, 2002, 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 February 11, 2003, (June 5, 2003, as to Notes 2 and 16) (which
report includes explanatory paragraphs referring to the realignment of segments
for financial reporting purposes and the adoption of EITF 02-3) appearing in the
Current Report on Form 8-K dated June 12, 2003, 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, 2002 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
November 5, 2003
3
INDEPENDENT ACCOUNTANTS' REPORT
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 September 30, 2003,
and the related consolidated statements of earnings and comprehensive income for
the three-month and nine-month periods ended September 30, 2003 and 2002, and of
cash flows for the nine-month periods ended September 30, 2003 and 2002. These
interim financial statements are the responsibility of the Company's management.
We conducted our reviews 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 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 reviews, we are not aware of any material modifications that should
be made to such consolidated interim 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.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, 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, 2002, 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 February 11, 2003, (June 5, 2003, as to Notes 2 and 16)
(which report includes explanatory paragraphs referring to the realignment of
segments for financial reporting purposes and the adoption of EITF 02-3)
appearing in the Current Report on Form 8-K dated June 12, 2003, 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, 2002 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
November 5, 2003
4
ITEM 1. FINANCIAL STATEMENTS
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands, except per share amounts)
Operating Revenues:
Electric....................................... $337,198 $238,096 $844,726 $636,017
Gas............................................ 47,938 36,244 268,200 189,413
Unregulated businesses......................... 25 335 137 1,252
------------ ------------ ------------ ------------
Total operating revenues..................... 385,161 274,675 1,113,063 826,682
------------ ------------ ------------ ------------
Operating Expenses:
Cost of energy sold............................ 214,416 117,899 615,685 369,887
Administrative and general..................... 38,599 38,787 113,241 106,494
Energy production costs........................ 34,217 35,238 103,826 104,411
Depreciation and amortization.................. 29,260 25,780 86,484 75,776
Transmission and distribution costs............ 15,150 15,949 46,503 47,937
Taxes, other than income taxes................. 7,439 7,077 21,945 24,589
Income taxes................................... 10,199 4,810 26,158 16,317
------------ ------------ ------------ ------------
Total operating expenses..................... 349,280 245,540 1,013,842 745,411
------------ ------------ ------------ ------------
Operating income............................. 35,881 29,135 99,221 81,271
------------ ------------ ------------ ------------
Other Income and Deductions:
Other income................................... 15,455 13,801 39,406 39,252
Other deductions............................... (18,761) (6,842) (40,693) (10,234)
Income tax expense (benefit)................... 1,193 (2,541) 468 (10,815)
------------ ------------ ------------ ------------
Net other income (deductions)................ (2,113) 4,418 (819) 18,203
------------ ------------ ------------ ------------
Income before interest charges............... 33,768 33,553 98,402 99,474
Interest Charges................................. 17,053 15,756 53,050 45,571
Preferred Stock Dividend Requirements
of Subsidiary................................. 147 147 440 440
------------ ------------ ------------ ------------
Net Earnings Before Cumulative Effect of a
Change in Accounting Principle................ 16,568 17,650 44,912 53,463
------------ ------------ ------------ ------------
Cumulative Effect of a Change in Accounting
Principle, Net of Tax of $24,524.............. - - 37,422 -
------------ ------------ ------------ ------------
Net Earnings..................................... $ 16,568 $ 17,650 $ 82,334 $ 53,463
============ ============ ============ ============
Net Earnings per Common Share:
Basic.......................................... $ 0.41 $ 0.45 $ 2.08 $ 1.37
============ ============ ============ ============
Diluted........................................ $ 0.41 $ 0.45 $ 2.06 $ 1.35
============ ============ ============ ============
Dividends Paid per Share of Common Stock......... $ 0.23 $ 0.22 $ 0.68 $ 0.64
============ ============ ============ ============
The accompanying notes are an integral part of these
financial statements.
5
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2003 2002
-------------- --------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service........................................ $2,397,862 $2,301,673
Gas plant in service............................................. 648,064 615,907
Common plant in service and plant held for future use............ 57,094 79,987
-------------- --------------
3,103,020 2,997,567
Less accumulated depreciation and amortization................... 1,341,272 1,330,376
-------------- --------------
1,761,748 1,667,191
Construction work in progress.................................... 153,613 173,248
Nuclear fuel, net of accumulated amortization of
$18,864 and $16,568.......................................... 24,507 26,832
-------------- --------------
Net utility plant.............................................. 1,939,868 1,867,271
-------------- --------------
Other Property and Investments:
Investment in lessor notes....................................... 330,798 350,479
Other investments................................................ 106,795 92,225
Non-utility property, net of accumulated depreciation of
$1,754 and $1,750............................................ 1,524 1,528
-------------- --------------
Total other property and investments........................... 439,117 444,232
-------------- --------------
Current Assets:
Cash and cash equivalents........................................ 12,338 3,702
Accounts receivables, net of allowance for uncollectible
accounts of $9,866 and $15,575............................... 56,721 46,914
Unbilled revenues................................................ 62,885 65,472
Other receivables................................................ 32,715 53,052
Inventories...................................................... 41,706 37,230
Regulatory assets................................................ 5,422 24,027
Short-term investments........................................... - 79,630
Other current assets............................................. 46,885 32,753
-------------- --------------
Total current assets........................................... 258,672 342,780
-------------- --------------
Deferred Charges:
Regulatory assets................................................ 223,025 196,283
Prepaid retirement costs......................................... 86,583 39,665
Other deferred charges........................................... 134,391 129,063
-------------- --------------
Total deferred charges......................................... 443,999 365,011
-------------- --------------
$3,081,656 $3,019,294
============== ==============
The accompanying notes are an integral part of these
financial statements.
6
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2003 2002
--------------- ---------------
(In thousands)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders' equity:
Common stock................................................... $645,585 $ 624,119
Accumulated other comprehensive loss, net of tax............... (82,760) (94,721)
Retained earnings.............................................. 508,747 444,651
--------------- ---------------
Total common stockholders' equity........................... 1,071,572 974,049
Minority interest................................................. 10,348 11,760
Cumulative preferred stock without mandatory
redemption requirements........................................ 12,800 12,800
Long-term debt.................................................... 987,296 980,092
--------------- ---------------
Total capitalization........................................ 2,082,016 1,978,701
--------------- ---------------
Current Liabilities:
Short-term debt.................................................... 132,885 150,000
Accounts payable.................................................... 50,908 90,355
Accrued interest and taxes.......................................... 68,216 46,189
Other current liabilities........................................... 77,353 99,019
--------------- ---------------
Total current liabilities................................... 329,362 385,563
--------------- ---------------
Deferred Credits:
Accumulated deferred income taxes................................... 174,524 125,595
Accumulated deferred investment tax credits......................... 39,242 41,583
Regulatory liabilities.............................................. 79,149 52,019
Regulatory liabilities related to accumulated deferred income tax... 14,137 14,137
Asset retirement obligations........................................ 44,892 -
Minimum pension liability........................................... 141,175 141,175
Accrued postretirement benefit costs................................ 18,389 17,335
Other deferred credits.............................................. 158,770 263,186
--------------- ---------------
Total deferred credits....................................... 670,278 655,030
--------------- ---------------
Commitments and contingencies (Note 5).............................. - -
--------------- ---------------
$ 3,081,656 $ 3,019,294
=============== ===============
The accompanying notes are an integral part of these
financial statements.
7
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-----------------------------
2003 2002
-------------- -------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings............................................................ $ 82,334 $ 53,463
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization...................................... 98,804 85,752
Accumulated deferred income tax...................................... 37,674 (1,511)
Transition costs write-off........................................... 16,720 -
Loss on reacquired debt.............................................. 16,576 -
Cumulative effect of a change in accounting principle................ (61,946) -
Net unrealized gains on energy and investing contracts............. (1,111) (22,107)
Changes in certain assets and liabilities:
Accounts receivables................................................ (9,807) 5,218
Unbilled revenues.................................................... 2,587 15,601
Accrued post-retirement benefit costs................................ (16,913) (21,086)
Other assets......................................................... 31,230 21,140
Accounts payable..................................................... (39,447) 11,390
Accrued interest and taxes........................................... 22,027 (12,189)
Other liabilities.................................................... (16,448) (35,100)
-------------- -------------
Net cash flows provided by operating activities.............. 162,280 100,571
-------------- -------------
Cash Flows From Investing Activities:
Utility plant additions................................................. (129,334) (166,640)
Redemption of short-term investments.................................... 80,291 45,000
Combustion turbine payments............................................. (11,136) (19,425)
Bond purchase........................................................... (6,675) -
Return of principal of PVNGS lessor notes............................... 18,360 17,531
Other................................................................... (3,607) (11,998)
-------------- -------------
Net cash flows used for investing activities................. (52,101) (135,532)
-------------- -------------
Cash Flows From Financing Activities:
Short-term borrowings (repayments), net................................. (17,115) 65,000
Long-term debt borrowings............................................... 483,882 -
Long-term debt repayments............................................... (476,572) -
Premium on long-term debt refinancing................................... (23,905) -
Refund costs of pollution control bonds................................. (31,427) -
Exercise of employee stock options...................................... (7,355) (2,909)
Dividends paid.......................................................... (27,298) (25,475)
Other................................................................... (1,753) (72)
-------------- -------------
Net cash flows (used for) provided by financing activities... (101,543) 36,544
-------------- -------------
Increase in Cash and Cash Equivalents..................................... 8,636 1,583
Beginning of Period....................................................... 3,702 28,408
-------------- -------------
End of Period............................................................. $ 12,338 $ 29,991
============== =============
Supplemental Cash Flow Disclosures:
Interest paid, net of amounts capitalized............................... $ 56,040 $ 40,145
============== =============
Income taxes paid (refunded), net....................................... $(11,648) $ 43,534
============== =============
Prepaid pension contribution of PNM Resources, Inc. common shares....... $ 28,950 $ -
============== =============
The accompanying notes are an integral part of these
financial statements.
8
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(In thousands)
Net Earnings.............................................. $16,568 $17,650 $82,334 $53,463
---------- ---------- ---------- ----------
Other Comprehensive Income (Loss)
Unrealized gain (loss) on securities:
Unrealized holding gains arising during the
period, net of tax expense of $170, $2,216,
$743 and $779....................................... 261 3,381 1,133 1,189
Reclassification adjustment for gains included
in net income, net of tax expense of $58, $32,
$381 and $311...................................... (88) (49) (582) (475)
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of designated cash
flow hedges, net of tax expense (benefit)
of $(271), $(8,495), $7,748 and $(8,718)............ (414) (12,963) 11,410 (13,303)
Reclassification adjustment for (gains) losses in
net income, net of tax expense (benefit) of
$92 and $(508)..................................... - (141) - 775
---------- ---------- ---------- ----------
Total Other Comprehensive Income (Loss)..................... (241) (9,772) 11,961 (11,814)
---------- ---------- ---------- ----------
Total Comprehensive Income.................................. $16,327 $ 7,878 $94,295 $41,649
========== ========== ========== ==========
The accompanying notes are an integral part of
these financial statements.
9
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ -------------
(In thousands, except per share amounts)
Operating Revenues:
Electric........................................... $ 337,198 $238,097 $ 844,726 $636,017
Gas................................................ 47,938 36,244 268,200 189,413
------------ ------------ ------------ -------------
Total operating revenues......................... 385,136 274,341 1,112,926 825,430
------------ ------------ ------------ -------------
Operating Expenses:
Cost of energy sold................................ 214,416 117,835 615,685 369,076
Administrative and general......................... 39,033 40,768 110,249 104,510
Energy production costs............................ 34,217 35,238 103,826 104,411
Depreciation and amortization...................... 28,803 25,541 85,287 75,294
Transmission and distribution costs................ 15,150 15,949 47,603 47,937
Taxes, other than income taxes..................... 6,707 7,529 21,955 23,610
Income taxes....................................... 10,495 8,209 27,606 20,714
------------ ------------ ------------ -------------
Total operating expenses......................... 348,821 251,069 1,012,211 745,552
------------ ------------ ------------ -------------
Operating income................................. 36,315 23,272 100,715 79,878
------------ ------------ ------------ -------------
Other Income and Deductions:
Other income....................................... 14,700 11,355 36,790 30,848
Other deductions................................... (18,713) (4,691) (38,156) (8,443)
Income tax expense (benefit)....................... 1,474 (1,986) 500 (8,870)
------------ ------------ ------------ -------------
Net other income (deductions).................... (2,539) 4,678 (866) 13,535
------------ ------------ ------------ -------------
Income before interest charges................... 33,776 27,950 99,849 93,413
Interest Charges..................................... 17,011 15,788 52,336 45,744
------------ ------------ ------------ -------------
Net Earnings Before Cumulative Effect of a
Change in Accounting Principle.................... 16,765 12,162 47,513 47,669
------------ ------------ ------------ -------------
Cumulative Effect of a Change in Accounting
Principle, Net of Tax of $24,524.................. - - 37,422 -
------------ ------------ ------------ -------------
Net Earnings Before Preferred Stock Dividends 16,765 12,162 84,935 47,669
Preferred Stock Dividend Requirements................ 147 147 440 440
------------ ------------ ------------ -------------
Net Earnings......................................... $ 16,618 $ 12,015 $ 84,495 $ 47,229
============ ============ ============ =============
The accompanying notes are an integral part of these
financial statements.
10
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2003 2002
-------------- --------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service.................................... $2,397,862 $2,301,048
Gas plant in service......................................... 648,064 615,907
Common plant in service and plant held for future use........ 18,179 18,137
-------------- --------------
3,064,105 2,935,092
Less accumulated depreciation and amortization............... 1,332,243 1,326,286
-------------- --------------
1,731,862 1,608,806
Construction work in progress................................ 144,806 159,435
Nuclear fuel, net of accumulated amortization of
$18,864 and $16,568...................................... 24,507 26,832
-------------- --------------
Net utility plant.......................................... 1,901,175 1,795,073
-------------- --------------
Other Property and Investments:
Investment in lessor notes................................... 330,798 350,479
Other investments............................................ 82,912 78,344
Non-utility property......................................... 966 966
-------------- --------------
Total other property and investments....................... 414,676 429,789
-------------- --------------
Current Assets:
Cash and cash equivalents.................................... 14,033 3,094
Accounts receivables, net of allowance for uncollectible
accounts of $9,866 and $15,575........................... 56,721 46,914
Unbilled revenues............................................ 62,885 65,472
Intercompany receivable...................................... - 4,593
Other receivables............................................ 32,444 52,783
Inventories.................................................. 41,697 37,228
Regulatory assets............................................ 5,422 24,027
Other current assets......................................... 35,156 22,872
-------------- --------------
Total current assets....................................... 248,358 256,983
-------------- --------------
Deferred Charges:
Regulatory assets............................................ 223,025 196,242
Prepaid retirement costs..................................... 86,583 39,665
Other deferred charges....................................... 134,284 129,083
-------------- --------------
Total deferred charges..................................... 443,892 364,990
-------------- --------------
$3,008,101 $2,846,835
============== ==============
The accompanying notes are an integral part of these
financial statements.
11
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2003 2002
-------------- --------------
(In thousands)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholder's equity:
Common stock.................................................... $ 195,589 $ 195,589
Additional paid-in capital...................................... 540,046 430,043
Accumulated other comprehensive loss, net of tax................ (82,791) (94,130)
Retained earnings............................................... 330,146 256,157
-------------- --------------
Total common stockholder's equity............................ 982,990 787,659
Minority interest.................................................. 10,348 11,760
Cumulative preferred stock without mandatory
redemption requirements....................................... 12,800 12,800
Long-term debt..................................................... 987,296 953,940
-------------- --------------
Total capitalization......................................... 1,993,434 1,766,159
-------------- --------------
Current Liabilities:
Short-term debt.................................................... 131,346 150,000
Intercompany debt.................................................. - 28,436
Accounts payable................................................... 47,495 88,101
Intercompany accounts payable...................................... 51,021 34,468
Accrued interest and taxes......................................... 53,338 36,450
Other current liabilities.......................................... 59,688 87,701
-------------- --------------
Total current liabilities.................................... 342,888 425,156
-------------- --------------
Deferred Credits:
Accumulated deferred income taxes.................................... 177,832 128,383
Accumulated deferred investment tax credits.......................... 39,242 41,583
Regulatory liabilities............................................... 79,149 52,019
Regulatory liabilities related to accumulated deferred income tax.... 14,137 14,137
Asset retirement obligations......................................... 44,892 -
Minimum pension liability............................................ 141,175 141,175
Accrued postretirement benefit costs................................. 18,389 17,335
Other deferred credits............................................... 156,963 260,888
-------------- --------------
Total deferred credits............................................ 671,779 655,520
-------------- --------------
Commitments and contingencies (Note 5)............................... - -
-------------- --------------
$3,008,101 $2,846,835
============== ==============
The accompanying notes are an integral part of these
financial statements.
12
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
--------------------------
2003 2002
------------- -----------
(In thousands)
Cash Flows From Operating Activities:
Net earnings........................................................... $ 84,495 $ 47,229
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization....................................... 97,602 85,143
Accumulated deferred income tax..................................... 38,351 949
Transition costs write-off.......................................... 16,720 -
Loss on reacquired debt............................................. 16,576 -
Cumulative effect of a change in accounting principle............... (61,946) -
Net unrealized gains on energy and investing contracts.............. (1,111) (22,107)
Changes in certain assets and liabilities:
Accounts receivables................................................ (9,807) 5,218
Unbilled revenues................................................... 2,587 15,601
Accrued post-retirement benefit costs............................... (16,913) (21,086)
Other assets........................................................ 33,389 2,494
Accounts payable.................................................... (40,606) 5,474
Accrued interest and taxes.......................................... 16,888 854
Other liabilities................................................... (33,219) (41,104)
------------- -----------
Net cash flows provided by operating activities 143,006 78,665
------------- -----------
Cash Flows Used for Investing Activities:
Utility plant additions................................................ (124,255) (162,813)
Combustion turbine payments............................................ (11,136) (19,425)
Eastern Interconnect Project buyout.................................... (36,925) -
Redemption of short-term investments................................... - 45,000
Return of principal of PVNGS lessor notes.............................. 18,360 17,531
Other investing........................................................ 1,696 3,361
------------- -----------
Net cash flows used for investing activities..................... (152,260) (116,346)
------------- -----------
Cash Flows Used for Financing Activities:
Short-term borrowings, net............................................ (18,654) 65,000
Long-term debt borrowings............................................. 483,882 -
Long-term debt repayments............................................. (450,420) -
Premium on long-term debt refinancing................................. (23,905) -
Refund costs of pollution control bonds............................... (31,427) -
Equity contribution from parent....................................... 110,000 -
Dividends paid........................................................ (10,946) (59,420)
Other financing....................................................... (1,634) (114)
Change in intercompany borrowings..................................... (36,703) 35,605
------------- ------------
Net cash flows provided by financing activities................. 20,193 41,071
------------- ------------
Increase in Cash and Cash Equivalents................................... 10,939 3,390
Beginning of Period..................................................... 3,094 17,028
------------- ------------
End of Period........................................................... $ 14,033 $ 20,418
============= ============
Supplemental Cash Flow Disclosures:
Interest paid, net of amounts capitalized............................ $ 55,334 $ 40,311
============= ============
Income taxes paid (refunded), net..................................... $ (5,084) $ 31,514
============= ============
The accompanying notes are an integral part of these
financial statements.
13
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ----------------------
2003 2002 2003 2002
----------- ----------- ---------- ----------
(In thousands)
Net Earnings Before Preferred Stock Dividend
Requirements.......................................... $ 16,765 $12,162 $84,935 $47,669
----------- ----------- ---------- ----------
Other Comprehensive Income (Loss)
Unrealized gain (loss) on securities:
Unrealized holding gains arising during the
period, net of tax expense of $171, $332,
$968 and $483...................................... 261 507 1,477 737
Reclassification adjustment for gains included in
net income, net of tax expense of $58, $32,
$86 and $311....................................... (88) (49) (131) (475)
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of designated cash
flow hedges, net of tax expense (benefit)
of $(271), $(7,820), $6,549 and $(8,042)........... (414) (11,932) 9,993 (12,271)
Reclassification adjustment for (gains) losses in
net income, net of tax expense (benefit) of
$92 and $(508)..................................... - (141) - 775
----------- ----------- ---------- ----------
Total Other Comprehensive Income (Loss).................... (241) (11,615) 11,339 (11,234)
----------- ----------- ---------- ----------
Total Comprehensive Income................................. $ 16,524 $ 547 $96,274 $36,435
=========== =========== ========== ==========
The accompanying notes are an integral part of
these financial statements.
14
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 ("PNM") and
Subsidiaries, (collectively, the "Company") the accompanying unaudited interim
consolidated financial statements present fairly the Company's financial
position at September 30, 2003 and December 31, 2002, the consolidated results
of its operations and comprehensive income for the three months and nine months
ended September 30, 2003 and 2002 and the consolidated statements of cash flows
for the nine months ended September 30, 2003 and 2002. These financial
statements are presented in accordance with the rules and regulations of the
United States Securities and Exchange Commission ("SEC"). Accordingly, they 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, 2002,
that are included in the Company's Annual Reports on Form 10-K for the year
ended December 31, 2002 and as updated by the Company's Current Reports on Form
8-K dated June 12, 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 PNM Resources, Inc. 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 2002 consolidated financial statements and notes
have been reclassified to conform to the 2003 financial statement presentation.
Regulatory Accounting
The Company's accounting policies conform to the provisions of Statement
of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" ("SFAS 71"). SFAS 71 requires a rate-regulated entity to
15
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
reflect the effects of regulatory decisions in its financial statements. In
accordance with SFAS 71, the Company has deferred certain costs and recorded
certain liabilities pursuant to the rate actions of the United States Federal
Energy Regulatory Commission ("FERC") and the New Mexico Public Regulation
Commission ("PRC") and its predecessor. To the extent that the Company concludes
that the recovery of a regulatory asset is no longer probable due to regulatory
treatment, the effects of competition or other factors, the amount would be
recorded as a charge to earnings in the period in which recovery is determined
to no longer be probable.
As of December 31, 1999, the Company discontinued the application of SFAS
71 to the generation portion of its business effective with the passage of the
Electric Utility Industry Restructuring Act of 1999 ("Restructuring Act") in
accordance with Statement of Financial Accounting Standards No. 101, "Accounting
for the Discontinuation of Application of the Financial Accounting Standards
Board ("FASB") FASB Statement No. 71" ("SFAS 101"). Due to the repeal of the
Restructuring Act (see Note 5 - "Commitments and Contingencies - Global Electric
Agreement"), the Company re-applied the accounting requirements of SFAS 71 to
the generation portion of its business as of January 28, 2003.
Asset Retirement Obligations ("ARO")
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"),
on January 1, 2003 and accordingly identified certain AROs that are subject to
the standard. These obligations included the decommissioning of the Company's
nuclear generation facilities and fossil fuel generation plants. The Company's
transmission and distribution facilities are also subject to SFAS 143, However,
an ARO liability for transmission and distribution assets will not be recognized
until the assets' useful life and settlement date become known and are material.
The Company did not identify any material AROs associated with the transmission
and distribution assets, because the majority of these assets have an
indeterminable useful life and settlement date.
Previously, the Company had recognized decommissioning costs for its
fossil fuel and nuclear generation facilities ratably over approved cost
recovery periods. Upon implementation of the standard, 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 has been
recognized as a cumulative effect of a change in accounting principle of $37.4
million, net of related income taxes. Additionally, certain amounts accrued for
nuclear decommissioning costs over the Company's legal AROs for its nuclear
generation facilities have been reclassified as regulatory liabilities.
The effects of adopting SFAS 143 are based on the Company's
interpretation of the standard and its determination of underlying assumptions,
such as the Company's discount rate, estimates of the future costs for
decommissioning and the timing of the removal activities to be performed. Any
changes in these assumptions underlying the required calculations may require
revisions to the estimated ARO when identified.
16
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Pro forma net income and earnings per share have not been presented for
the nine months ended September 30, 2002 or the years ended December 31, 2002,
2001 and 2000 because the pro forma application of SFAS 143 would result in pro
forma net income and earnings per share not materially different from the
amounts previously reported for those periods.
A reconciliation of the Company's asset retirement obligations is as
follows:
September 30, 2003
------------------
(In thousands)
Upon adoption at January 1, 2003....... $ 42,201
Liabilities incurred................... -
Liabilities settled.................... -
Accretion expense...................... 2,691
Revisions to estimate.................. -
--------------
$ 44,892
==============
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.
SFAS 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 its current method of accounting as described above, and
has adopted the disclosure requirements of SFAS 123 only.
(Intentionally left blank)
17
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At September 30, 2003, 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 Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
----------- ----------- ----------- ----------
Net earnings................................. $16,568 $17,650 $82,334 $53,463
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects........ (490) (1,091) (1,560) (3,302)
----------- ----------- ----------- ----------
Pro forma net earnings....................... $16,078 $16,559 $80,774 $50,161
=========== =========== =========== ==========
Earnings per share:
Basic - as reported...................... $ 0.41 $ 0.45 $ 2.08 $ 1.37
=========== =========== =========== ==========
Basic - pro forma........................ $ 0.40 $ 0.42 $ 2.04 $ 1.28
=========== =========== =========== ==========
Diluted - as reported.................... $ 0.41 $ 0.45 $ 2.06 $ 1.35
=========== =========== =========== ==========
Diluted - pro forma...................... $ 0.39 $ 0.42 $ 2.02 $ 1.27
=========== =========== =========== ==========
(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
include Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission"). These segments model the resource allocations as
mandated in the Global Electric Agreement (see Note 5 - Commitments and
Contingencies - Global Electric Agreement). Certain prior period amounts have
been reclassified to conform to the current year presentation. In addition,
Transmission was reclassified from Electric and disclosed as its own business
segment.
18
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. Customer rates
for retail electric service are set by the PRC based on the provisions of the
Global Electric Agreement.
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 distribution
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 of jurisdictional assets as well as the capacity
of the Company's wholesale unregulated fleet. Both regulated and unregulated
generation is jointly dispatched and sold exclusively for the benefit of
shareholders.
Long-term contracts include sales to firm-requirements wholesale
customers with multi-year arrangements. These contracts range from 2 to 17 years
with an average of 7.5 years. Forward sales include sales of excess generation
and 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 Statement of Financial Accounting Standards No. SFAS 133, "Accounting
for Derivative Instruments and Hedging Activites", as amended ("SFAS 133"), 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
Global Electric Agreement.
19
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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
transferred by way of a dividend to the Holding Company pursuant to an order
from the PRC.
(Intentionally left blank)
20
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the three months
ended September 30, 2003 is as follows:
Utility
-------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ------------- -------------- ------------ -----------
(In thousands)
2003:
Operating revenues:
External customers.................. $154,746 $ 47,938 $ 8,920 $ - $ 211,604
Intersegment revenues............... - - 6,447 (4,349) 2,098
Depreciation and amortization.......... 15,910 5,613 2,689 - 24,212
Interest income........................ 6,666 685 170 - 7,521
Interest charges....................... 6,023 3,566 1,724 - 11,313
Total income tax expense (benefit)..... 19,971 (3,244) 1,810 - 18,537
Operating income (loss)................ 22,262 (1,333) 4,210 - 25,139
Segment net income (loss).............. 22,296 (4,950) 2,748 - 20,094
Total assets........................... 1,302,254 444,742 254,063 - 2,001,059
Gross property additions............... 20,095 11,973 15,378 - 47,446
Corporate
Wholesale and Other Consolidated
------------- ------------- ---------------
(In thousands)
2003:
Operating revenues:
External customers.................. $ 173,532 $ 25 $385,161
Intersegment revenues............... 635 (2,733) -
Depreciation and amortization.......... 3,579 1,469 29,260
Interest income........................ 1,638 1,632 10,791
Interest charges....................... 4,191 1,549 17,053
Total income tax expense (benefit)..... 5,066 (14,597) 9,006
Operating income....................... 9,287 1,455 35,881
Segment net income (loss).............. 6,263 (9,789) 16,568
Total assets........................... 397,052 683,545 3,081,656
Gross property additions............... 3,794 5,366 56,606
21
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the three months
ended September 30, 2002 is as follows:
Utility
-------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ------------- -------------- ------------ -----------
(In thousands)
2002:
Operating revenues:
External customers.................. $ 150,670 $ 36,244 $ 5,693 $ - $ 192,607
Intersegment revenues............... - 691 8,779 (8,603) 867
Depreciation and amortization.......... 14,871 5,160 2,158 - 22,189
Interest income........................ 6,559 (60) 56 - 6,555
Interest charges....................... 7,029 3,493 1,563 - 12,085
Total income tax expense (benefit)..... 16,315 (3,505) 1,212 - 14,022
Operating income (loss)................ 19,068 (1,825) 3,457 - 20,700
Segment net income (loss).............. 16,086 (5,419) 1,813 - 12,480
Total assets........................... 1,658,113 441,370 203,862 - 2,303,345
Gross property additions............... 20,234 5,696 3,498 - 29,428
Corporate
Wholesale and Other Consolidated
------------- ------------- ---------------
(In thousands)
2002:
Operating revenues:
External customers.................... $ 81,733 $ 335 $ 274,675
Intersegment revenues................. - (867) -
Depreciation and amortization............ 2,417 1,174 25,780
Interest income.......................... 1,501 3,170 11,226
Interest charges......................... 3,768 (97) 15,756
Total income tax expense (benefit)....... 1,826 (8,497) 7,351
Operating income......................... 4,537 3,898 29,135
Segment net income....................... 1,258 3,912 17,650
Total assets............................. 371,571 232,382 2,907,298
Gross property additions................. 4,918 4,542 38,888
22
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the nine months
ended September 30, 2003 is as follows:
Utility
-------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ------------- -------------- ------------ -----------
(In thousands)
2003:
Operating revenues:
External customers.................. $ 414,881 $ 268,200 $ 15,794 $ - $ 698,875
Intersegment revenues............... - - 24,636 (24,636) -
Depreciation and amortization.......... 47,488 16,553 7,348 - 71,389
Interest income........................ 22,722 1,794 228 - 24,744
Interest charges....................... 19,375 10,355 4,803 - 34,533
Total income tax expense (benefit)..... 26,743 (263) 3,052 - 29,532
Operating income....................... 54,404 9,356 9,194 - 72,954
Cumulative effect of a change
in accounting principle, net of tax.. 25,092 - - - 25,092
Segment net income (loss).............. 65,901 (402) 4,658 - 70,157
Total assets........................... 1,302,254 444,742 254,063 - 2,001,059
Gross property additions............... 51,066 33,206 26,707 - 110,979
Corporate
Wholesale and Other Consolidated
------------- ------------- ---------------
(In thousands)
2003:
Operating revenues:
External customers................... $ 414,051 $ 137 $ 1,113,063
Intersegment revenues................ 1,535 (1,535) -
Depreciation and amortization........... 10,639 4,456 86,484
Interest income......................... 4,233 2,991 31,968
Interest charges........................ 11,352 7,165 53,050
Total income tax expense (benefit)...... 10,559 (14,401) 25,690
Operating income........................ 24,518 1,749 99,221
Cumulative effect of a change
in accounting principle, net of tax... 12,330 - 37,422
Segment net income (loss)............... 28,441 (16,264) 82,334
Total assets............................ 397,052 683,545 3,081,656
Gross property additions................ 9,176 9,179 129,334
23
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the nine months
ended September 30, 2002 is as follows:
Utility
-------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ------------- -------------- ------------ -----------
(In thousands)
2002:
Operating revenues:
External customers.................. $ 414,426 $ 189,413 $ 17,504 $ - $ 621,343
Intersegment revenues............... - 1,136 24,214 (23,684) 1,666
Depreciation and amortization.......... 44,509 15,257 6,479 - 66,245
Interest income........................ 22,567 21 70 - 22,658
Interest charges....................... 20,338 10,128 4,483 - 34,949
Total income tax expense............... 28,675 466 3,334 - 32,475
Operating income....................... 51,206 9,524 9,812 - 70,542
Segment net income..................... 43,755 711 5,090 - 49,556
Total assets........................... 1,658,113 441,370 203,862 - 2,303,345
Gross property additions............... 106,055 23,274 9,771 - 139,100
Corporate
Wholesale and Other Consolidated
------------- ------------- ---------------
(In thousands)
2002:
Operating revenues:
External customers.................. $ 204,087 $ 1,252 $ 826,682
Intersegment revenues............... - (1,666) -
Depreciation and amortization.......... 6,179 3,352 75,776
Interest income........................ 4,052 6,078 32,788
Interest charges....................... 10,903 (281) 45,571
Total income tax expense (benefit)..... (1,987) (3,356) 27,132
Operating income....................... 5,867 4,862 81,271
Segment net income (loss).............. (3,033) 6,940 53,463
Total assets........................... 371,571 232,382 2,907,298
Gross property additions............... 19,693 7,847 166,640
(3) Fair Value of Financial Instruments
GAAP defines the fair value of a financial instrument as the amount at
which the instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation. Although management uses
its best judgment in estimating the fair value of these financial instruments,
there are inherent limitations in any estimation technique. Therefore, the fair
value estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current transaction. Fair value is based on
market quotes provided by the Company's investment bankers and trust advisors.
24
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company's available-for-sale securities include assets held in trust
for its share of decommissioning costs of PVNGS and its executive retirement
program. The trusts hold equity and fixed income securities. These amounts are
included in other investments on the balance sheet. The amortized cost, gross
unrealized gains and losses and estimated fair value of investments in
available-for-sale securities are as follows:
September 30, 2003
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities.............. $ 40,237 $ 8,383 $(650) $47,970
Municipal bonds................ 18,637 1,352 (11) 19,978
U.S. Government securities..... 4,856 458 (21) 5,293
Corporate bonds................ 12 - - 12
Other investments.............. 4,697 - (9) 4,688
---------------- ---------------- --------------- ----------------
$ 68,439 $ 10,193 $(691) $77,941
================ ================ =============== ================
December 31, 2002
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities.............. $32,643 $ 4,134 $ (1,514) $35,263
Mortgage-backed securities..... 33,145 410 (93) 33,462
Corporate bonds................ 32,466 438 (19) 32,885
Municipal bonds................ 21,229 1,394 (24) 22,599
U.S. Government securities..... 12,725 702 - 13,427
Other investments.............. 14,716 - - 14,716
---------------- ---------------- --------------- ----------------
$146,924 $ 7,078 $ (1,650) $152,352
================ ================ =============== ================
(Intentionally left blank)
25
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At September 30, 2003, the available-for-sale investments held by the
Company had the following maturities:
Amortized Cost Fair Value
---------------- ----------------
(In thousands)
Within 1 year............................. $ 1,513 $ 1,503
After 1 year through 5 years.............. 2,584 2,652
After 5 years through 10 years............ 2,545 2,670
Over 10 years............................. 17,135 18,721
Equity securities......................... 40,237 47,970
Other investments......................... 4,425 4,425
---------------- ----------------
$68,439 $77,941
================ ================
The proceeds and gross realized gains and losses on the disposition of
available-for-sale investments are shown in the following table. Realized gains
and losses are determined by specific identification. The short-term investment
balance was fully redeemed in the nine months ended September 30, 2003 and
included in proceeds from sales.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -----------------------
2003 2002 2003 2002
---------- ----------- ---------- -----------
(In thousands)
Proceeds from sales........... 9,147 55,754 113,131 161,870
Gross realized gains.......... 752 317 5,508 2,226
Gross realized losses......... (532) (2,738) (3,169) (6,675)
Natural Gas Contracts
Pursuant to a 1997 order issued by the New Mexico Public Utility
Commission, the predecessor to the PRC, the Company previously entered into
swaps to hedge certain portions of natural gas supply contracts to protect the
Company's natural gas customers from the risk of adverse price fluctuations in
the natural gas market. All hedge gains and losses from swaps 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 gas options, a type of hedge, to protect its natural gas
customers from the risk of price fluctuations during the 2002-2003 heating
season. PNM expended $6.0 million to purchase options that limit the maximum
amount the Company would pay for gas during the winter heating season. The
Company recovered its actual hedging expenditures as a component of the PGAC
during the months of October 2002 through February 2003 in equal monthly
allotments of $1.2 million.
26
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
PNM purchased gas options, a type of hedge, to protect its natural gas
customers from the risk of price fluctuations during the 2003-2004 heating
season. PNM expended $9.5 million to purchase gas options that limit the maximum
amount the Company would pay for gas during the winter heating season. The
Company will recover its actual hedging expenditures as a component of the PGAC
during the months of October 2003 through February 2004 in equal monthly
allotments of $1.9 million.
Electricity Contracts
The Company's wholesale operations entered into various forward physical
contracts for the purchase and sale of electricity with the intent to optimize
its net generation position. Some of these contracts do not qualify for normal
purchase and sale designation pursuant to SFAS 133, and are marked to market as
required by SFAS 133.
For the three months ended September 30, 2003, the Company's Wholesale
Operations settled forward contracts for the sale of electricity that generated
$65.5 million of electric revenues by delivering 1.1 million megawatt hours
("MWh"). The Company purchased $59.8 million or 1.0 million MWh of electricity
to support these contractual sales and other open market sales opportunities.
For the three months ended September 30, 2002, the Company's Wholesale
Operations settled forward contracts for the sale of electricity that generated
$10.7 million of electric revenues by delivering 0.2 million MWh. The Company
purchased $19.5 million or 0.3 million MWh of electricity to support these
contractual sales and other open market sales opportunities.
For the nine months ended September 30, 2003, the Company's Wholesale
Operations settled forward contracts for the sale of electricity that generated
$125.3 million of electric revenues by delivering 2.5 million MWh. The Company
purchased $120.8 million or 2.5 million MWh of electricity to support these
contractual sales and other open market sales opportunities. For the nine months
ended September 30, 2002, the Company's Wholesale Operations settled forward
contracts for the sale of electricity that generated $31.3 million of electric
revenues by delivering 0.8 million MWh. The Company purchased $55.4 million or
1.0 million MWh of electricity to support these contractual sales and other open
market sales opportunities.
As of September 30, 2003, the Company had open contract positions to buy
$42.5 million and to sell $42.3 million of electricity. At September 30, 2003,
the Company had a gross mark-to-market gain (asset position) on these forward
contracts of $4.8 million and a gross mark-to-market loss (liability position)
of $4.6 million, with a net mark-to-market gain (asset position) of $184
thousand 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'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
27
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
accounts for these derivative financial instruments 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 September 30,
2003, the Company had open forward positions classified as normal sales of
electricity of $201.2 million and normal purchases of electricity of $124.9
million, both of which are not recorded in the financial statements.
The Company's Wholesale Operations, including both firm commitments and
other wholesale sale activities, are managed through an 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 September 30, 2003 and December 31, 2002 was $23.9
million and $18.7 million, respectively.
Forward Starting Interest Rate Swaps
PNM had $46 million of tax-exempt bonds outstanding that were callable at
a premium beginning December 15, 2002, and an additional $136 million that
became callable at a premium in August 2003. With the intention of refinancing
these bonds, PNM had hedged the entire planned refinancing by entering into five
forward starting interest rate swaps in the fourth quarter of 2001 and the first
quarter of 2002. The Company received regulatory approval to refund the
tax-exempt bonds on October 29, 2002. The refinancings were completed on May 23,
2003.
The forward starting interest rate swaps were terminated on May 13, 2003
for a cash settlement of $27.1 million. This amount has been capitalized by the
Company as a financing cost and will be amortized over the life of the bonds.
Corporate and Pension Hedge
The Company has approximately $296 million invested in domestic stocks
and approximately $35 million invested in international stocks in various trusts
for nuclear decommissioning, pension plan, executive retirement and retiree
medical benefits. The trusts for nuclear decommissioning and the executive
retirement plan are included on the balance sheet in other investments. The
Company uses financial derivatives based on the Standard & Poor's ("S&P") 500
Index to limit potential loss on these investments due to adverse market
fluctuations. The options are structured as a collar, protecting the portfolio
against losses beyond a certain amount and balancing the cost of that downside
protection by foregoing gains above a certain level. If the S&P 500 Index is
28
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
within the specified range when the option contract expires, the Company will
not be obligated to pay, nor will the Company have the right to receive cash. In
the second quarter of 2003, the Company entered into certain S&P 500 Index
contracts, which will expire on December 19, 2003 and March 19, 2004. The range
of the floor and ceiling of the collar relative to a December 31, 2002 S&P 500
Index of 880 is -3.4% for a floor and 16.7% to 21.0% for a ceiling. For the
three months and nine months ended September 30, 2003, the change in the market
value of the corporate options was not significant.
(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 for the periods ended September 30 (in thousands except per share
amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Basic:
Net Earnings before cumulative effect of a
change in accounting principle.................. $16,568 $17,650 $44,912 $53,463
Cumulative effect of a change in
accounting principle, net of tax of $24,524..... - - 37,422 -
----------- ----------- ----------- -----------
Net Earnings....................................... $16,568 $17,650 $82,334 $53,463
=========== =========== =========== ===========
Average Number of Common Shares
Outstanding..................................... 40,239 39,118 39,578 39,118
=========== =========== =========== ===========
Net Earnings per Share of Common Stock (Basic) $ 0.41 $ 0.45 $ 2.08 $ 1.37
=========== =========== =========== ===========
Earnings before cumulative effect of a
change in accounting principle.................. 0.41 0.45 1.13 1.37
Cumulative effect of a change in
accounting principle, net of tax of $0.62....... - - 0.95 -
----------- ----------- ----------- -----------
Net Earnings per Share of Common Stock (Basic) $ 0.41 $ 0.45 $ 2.08 $ 1.37
=========== =========== =========== ===========
29
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Diluted:
Net Earnings Before Cumulative Effect of a
Change in Accounting Principle.................... $16,568 $17,650 $44,912 $53,463
Cumulative Effect of a Change in
Accounting Principle, net of tax of $24,524....... - - 37,422 -
---------- ---------- ---------- ----------
Net Earnings......................................... $16,568 $17,650 $82,334 $53,463
========== ========== ========== ==========
Average Number of Common Shares
Outstanding....................................... 40,239 39,118 39,578 39,118
Dilutive Effect of Common Stock
Equivalents (a)................................... 467 207 358 366
---------- ---------- ---------- ----------
Average Common and Common
Equivalent Shares Outstanding..................... 40,706 39,325 39,936 39,484
========== ========== ========== ==========
Net Earnings per Share of Common Stock
(Diluted)......................................... $ 0.41 $ 0.45 $ 2.06 $ 1.35
========== ========== ========== ==========
Earnings Before Cumulative Effect of a
Change in Accounting Principle.................... 0.41 0.45 1.12 1.35
Cumulative Effect of a Change in
Accounting Principle, net of tax of $0.61........ - - 0.94 -
---------- ---------- ---------- ----------
Net Earnings per Share of Common Stock
(Diluted)......................................... $ 0.41 $ 0.45 $ 2.06 $ 1.35
========== ========== ========== ==========
(a) Excludes the effect of average anti-dilutive common stock
equivalents related to out-of-the-money options of 50,000 and
1,881,588 for the three months ended and 876,061 and 718,745 for
the nine months ended September 30, 2003 and 2002, respectively.
(5) 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 increases
30
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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
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.
Natural Gas Explosion
On April 25, 2001, a natural gas explosion occurred in Santa Fe, New
Mexico. The apparent cause of the explosion was a leak from a PNM gas line near
the location. The explosion destroyed a small building and injured two persons
who were working in the building. PNM's investigation indicates that the leak
was an isolated incident likely caused by a combination of corrosion and
increased pressure. PNM also cooperated with an investigation of the incident by
the PRC's Pipeline Safety Bureau (the "Bureau"), which issued its report on
March 18, 2002. The Bureau's report gave PNM notice of probable violations of
the New Mexico Pipeline Safety Act and related regulations. PNM and the Bureau
staff entered into a compliance agreement addressing the probable violations and
filed it with the PRC for approval on March 4, 2003. PNM agreed to undertake a
list of twenty-four corrective actions, including internal policy changes,
retraining employees and enhancing gas line monitoring. PNM has also agreed to
voluntarily accelerate spending on pipeline replacement by more than $10.0
million and to commit an additional $1.8 million to development and
implementation of systems to improve gas line management. The compliance
agreement was approved by the PRC on March 25, 2003. No civil penalty was
imposed. Two lawsuits against PNM by the injured persons along with several
claims for property and business interruption damages have been resolved.
31
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Global Electric Agreement
On October 10, 2002, PNM announced that it had agreed with the PRC staff,
the New Mexico Attorney General ("AG"), and other consumer groups on a Global
Electric Agreement that provided for joint support for the repeal of a majority
of the New Mexico Electric Utility Industry Restructuring Act of 1999, as
amended, ("Restructuring Act"), a fixed rate path, procedures for the Company's
participation in unregulated generating plant activities and other regulatory
issues. The rate-path is effective for services rendered September 1, 2003
through December 31, 2007. Based on the normal time frame for rate proceedings
in New Mexico of ten months, a change in rates would not happen until late 2008.
The Global Electric Agreement was approved by the PRC on January 28, 2003.
Legislation repealing the Restructuring Act and continuing the authorization for
utilities to participate in unregulated generating plant activities for a
limited time according to the Global Electric Agreement was passed by the New
Mexico Legislature and signed into law by the Governor on April 8, 2003. In the
Global Electric Agreement, PNM agreed to forego recovery of the costs incurred
in preparing to transition to a competitive retail market in New Mexico under
the repealed law. This resulted in a charge of $16.7 million, pre-tax, in the
first quarter of 2003. As a result of the repeal of the Restructuring Act, PNM
has re-applied the accounting requirements of SFAS 71 to its regulated
generation activities effective January 28, 2003, which did not have a material
effect on the Company's financial condition or results of operations.
Asset Securitization
On April 8, 2003, PNM entered into a transaction providing for the
securitization of PNM's retail electric service accounts receivable and retail
gas service accounts receivable ("AR Securitization"). The total capacity under
the AR Securitization is $90.0 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable, principally retail receivables, to a
bankruptcy remote subsidiary, PNM Receivables Corp., which in turn pledges an
undivided interest in the receivables to an unaffiliated conduit commercial
paper issuer. This transaction was previously approved by the PRC on December
17, 2002. As of September 30, 2003, the Company had borrowed $35.0 million under
the AR Securitization, which was secured by $86.6 million of accounts
receivable. PNM Receivables Corp. is consolidated in the Company's financial
statements.
Eastern Interconnection Project ("EIP") Purchase
On April 1, 2003, PNM exercised its early buyout option related to a 60%
interest in the EIP transmission line and related facilities held under lease.
Through the exercise of the early buyout option, PNM was able to retire all
$26.2 million of secured facility bonds, which were issued to finance the sale
leaseback transaction which had previously been disclosed as off balance sheet
debt in the notes to the Companies' financial statements. The Company will
continue to exclude $4.5 million of lease obligations relating to the 40%
interest that the Company does not own from the consolidated balance sheet.
32
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Financing Activities
On May 13, 2003, the Company priced $182 million of tax-exempt pollution
control bonds at a one-year interest rate of 2.75%. The bond sale closed on May
23, 2003. The bonds will need to be remarketed at the end of the one-year
interest rate period. A portion of the proceeds were used to refund the $46.0
million of pollution control bonds, which became callable on December 15, 2002.
Additionally, the remaining $136.0 million were placed in an escrow account to
be used to refund the same amount of pollution control bonds. The remaining
$136.0 million of pollution control bonds were redeemed on August 15, 2003. Both
of these issuances were previously hedged (see Note 3 - Fair Market Value of
Financial Instruments - Forward Starting Interest Rate Swaps).
The premium paid to refinance the pollution control bonds was $3.6
million. The balance of the unamortized debt issuance costs associated with the
pollution control bonds that were retired was $3.8 million. These amounts were
capitalized as loss on reacquired debt. The portion of unamortized loss on
reacquired debt associated with the FERC firm requirements customers and the
excluded plant of $1.0 million was written off in conjunction with the
refinancing of the pollution control bonds. The remaining balance will be
amortized over the life of the new bonds.
Pursuant to PRC approval, on September 9, 2003, PNM sold $300.0 million
of senior unsecured notes with a coupon of 4.40% that mature September 15, 2008.
The transaction closed on September 17, 2003 and the proceeds were used to
retire $268.4 million of long-term debt with a 7.10% interest rate that would
otherwise have matured in August 2005, pay the transaction costs, and improve
working capital. The premium paid to refinance the long-term debt was $23.9
million of which $16.6 million was charged against earnings based on prior
regulatory agreements. The remaining balance was capitalized as loss on
reacquired debt and will be amortized over the life of the new debt.
On August 27, 2003, the Company entered into an unrated private issuance
commercial paper program. The Company will periodically issue up to $50 million
in unrated commercial paper for the shorter of 120 days or the maturity of the
Company's Credit Facility. The commercial paper is unsecured and the proceeds
were used to reduce revolving credit borrowings. The Company's Credit Facility
serves as a backstop for the outstanding commercial paper. As of September 30,
2003, $30.8 million was outstanding.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without the approval of the United States Department of
Labor ("DOL") provided that the contribution does not otherwise constitute a
prohibited transaction under the Employee Retirement Income Security Act
("ERISA"). On June 11, 2003, a contribution of 1,121,495 Holding Company common
shares (approximately $28.9 million in market value) was made to the Company's
retirement plan.
33
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Shelf Registrations
On June 12, 2003, the Holding Company and PNM each filed universal shelf
registration filings with the SEC for a combination of debt and equity
securities for $500.0 million and $285.0 million, respectively. The PNM shelf
registration, when combined with a previously filed shelf, provided $500.0
million of capacity. The PNM and Holding Company shelf registrations were
declared effective June 28, 2003 and August 28, 2003, respectively. On September
9, 2003, PNM sold $300.0 million of debt under its shelf registration (see
"Financing Activities" above). As of September 30, 2003, the Holding Company and
PNM had remaining securities registered under the shelf registrations of $500.0
million and $200.0 million, respectively.
Gas Rate Case
On January 10, 2003, PNM filed a general gas rate case, requesting that
the PRC approve an increase in the service fees charged to its 441,000
natural-gas customers. PNM's proposal would have increased both the set monthly
service fee and the charge tied to monthly usage. Such fees are separate from
the cost of gas charged to customers. The monthly cost of gas charge would not
be affected by the fee increase as discussed below. The cost of service rate
increase proposed by PNM was $37.6 million, and was designed to provide PNM's
gas utility an opportunity to earn a 12% return on equity. PNM's current return
on equity from its gas business is below 3%.
On June 25, 2003, PNM, the PRC Staff, and a group of industrial
consumers filed a settlement allowing the Company a $20 million annual revenue
increase in base cost of service rates, a $1.6 million annual increase in
miscellaneous fees and charges and the recovery of $4.4 million in previously
approved costs. The agreement also allows the Company to collect interest on
uncollected regulatory assets over the collection period. The revenue increase
and interest collection combined generate approximately $22 million of revenue
and a 10.25% return on equity. The settlement rates were proposed to go into
effect for bills rendered in November 2003. On November 3, 2003 the PRC rejected
the proposed settlement. On November 7, 2003, the Company filed a request for
rehearing. In its motion for rehearing, the Company proposed two options for
consideration. Under the first option, the Company agreed to delay
implementation of the increase for residential customers until April 1, 2004.
This delay would reduce revenues that the Company would have collected over the
winter heating season by $10.8 million. Under this option new rates for other
customer classes would take effect in November. Under the second option, the
Company agreed to defer collection of the winter heating season revenues from
residential customers until April 2004. During the April 2004 through October
2004 time period, the Company would surcharge residential customers to collect
the amounts deferred. The Company then commits to contribute $5.4 million, which
would be half of the amount collected through the deferral charge, to assist the
Company's low income residential customers winter gas bills over the next three
heating seasons. The PRC granted the request for rehearing on the two proposed
options on November 13, 2003. A recommended decision is expected in December
2003. The Company is also exploring possible judicial remedies. The Company is
unable to predict the ultimate outcome of this matter.
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 water supplies to meet all the needs of the state,
including growth, is a major issue. The Company has secured sufficient water
rights in connection with the building of 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 SJGS and 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
34
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
watershed that supplies the Four Corners areas, the plants may be affected in
2004 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, 2003, and environmental approvals are in the process of
being obtained. A renewal request for 2004 is pending. PNM has also negotiated
and 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, 2003.
Discussions for a similar agreement in 2004 are underway. 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.
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 FERC
and other federal and state governmental authorities are conducting
investigations 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
By order dated June 19, 2001, in response to a complaint filed by San
Diego Gas and Electric Company ("SDG&E") and other California buyers against
sellers into the California wholesale electric market, the FERC directed one of
its administrative law judges ("ALJ") to convene a settlement conference to
address potential refunds owed by sellers into the California market. The
settlement conference, in which PNM participated, was ultimately unsuccessful,
and the ALJ recommended to the FERC that an evidentiary hearing be held to
resolve the dispute, suggesting that refunds were due. The estimated refunds,
however, were significantly lower than those demanded by California and, in most
instances, were offset by the amounts due suppliers from the Cal PX and the
California Independent System Operator ("Cal ISO"). The California parties had
demanded refunds of approximately $9 billion from power suppliers. Hearings on
the refunds were held in September 2002, and the ALJ issued the "Proposed
Findings on California Refund Liability" on December 12, 2002, in which it was
determined that the Cal ISO had, for the most part, calculated the amounts of
the refunds correctly. 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. PNM was identified as having a refund liability of
35
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
approximately $4.3 million, while being owed approximately $7 million from the
Cal ISO. Pursuant to the FERC's order, PNM filed, in conjunction with the
competitive supplier group, initial comments on January 13, 2003 to the ALJ's
preliminary findings addressing errors the Company believes the ALJ made in the
proposed findings, and filed reply comments on February 3, 2003. On March 26,
2003, the FERC issued an order substantially adopting the ALJ's findings, 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. On October 16, 2003, 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 16, 2003 Order. The
Company is unable to predict the ultimate outcome of this FERC proceeding, or
whether PNM will be directed to make any refunds as the result of the FERC
order.
In addition, prior to the December 12, 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 on March 3, 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 on March 20, 2003, denying the allegations
against it. PNM cannot predict what effect the FERC's review of this additional
evidence will have on its rulings in the refund proceeding or in other
proceedings involving wholesale electric transactions in California during the
so-called "California energy crisis".
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. On
September 24, 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 the submission of additional evidence in the case on March 3, 2003. On
June 25, 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 on July 25, 2003, which are
currently pending before the FERC. The Company is unable to predict the ultimate
outcome of this FERC proceeding, or whether PNM will be directed to make any
refunds as the result of an order by the FERC.
36
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
FERC Investigation of "Enron-Like" Trading Practices
The FERC has also 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 have been
required to submit data regarding short-term transactions in 2000-2001. PNM made
its data submission in April 2002. Subsequently, in May 2002, new Enron
documents came to light that raised additional concerns about Enron's trading
practices. In light of these new revelations, the FERC issued additional orders
in the pending investigation requiring sellers to respond to detailed questions
by admitting or denying that they had engaged in trading practices similar to
those practiced by Enron and certain other sellers, including so-called "wash"
transactions. The FERC issued supplemental requests for data submissions. In its
responses to the FERC requests, PNM denied that it had engaged in improper
activities such as those identified in Enron's documents and also denied
engaging in "wash" transactions. PNM acknowledged that it had engaged in certain
activities described in the Enron documents but asserted that its activities
were legitimate and not manipulative. Where appropriate, PNM's responses
addressed any arguable similarities between any of its wholesale activities and
those under investigation by the FERC. In August 2002, the FERC staff issued a
preliminary report on its findings, recommending that the FERC initiate formal
investigative proceedings directed at three companies and the FERC has done so.
The Company was not among the companies named. On March 26, 2003, the FERC staff
issued its final report, which addressed various types of conduct that the FERC
staff believes may have violated market monitoring protocols in the Cal ISO and
Cal PX tariffs. Based on the final report, the FERC has issued orders to certain
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. The FERC staff also recommended
that PNM and other entities be required to show cause why they should not
disgorge profits related to business dealings with Enron and the employment of
certain trading strategies deemed to be manipulative.
FERC Show Cause Orders
On June 25, 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. Entities subject to the Gaming
Practices Order will have an opportunity to respond to the allegations contained
37
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
in the order in a trial-type evidentiary proceeding before an ALJ, and to show
cause why they should not be found to have engaged in Gaming Practices in
violation of the Cal ISO and Cal PX tariffs. 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. 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 on August 25, 2003. On
September 30, 2003, the California parties filed their objection to the
dismissal of PNM from the case. PNM believes that it has not engaged in improper
conduct and intends to defend itself vigorously against these allegations. The
Company cannot predict the outcome of these 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
several entities that allegedly may have been used as market manipulation
schemes. These entities include Aquila, Inc., Constellation Power Source, Inc.,
El Paso Merchant Energy, L.P., Idaho Power Company, Koch Energy Trading, Inc.,
MIECO Inc., Morgan Stanley Capital Group, PECO Energy Company, PacifiCorp,
Powerex, Sempra Energy Trading Corporation, TransAlta Energy Marketing (U.S.)
Inc. and TransAlta Energy Marketing (California) Inc. 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. On September 2, 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. The FERC ALJ has issued a procedural schedule in the case and
on October 3, 2003, PNM filed testimony and exhibits in the case reasserting its
response previously filed. The ALJ has set a hearing in the case for April 13,
2004. PNM believes that it has not engaged in improper conduct and intends to
defend itself vigorously against these allegations.
Investigation of Anomalous Bidding Behavior and Practices in the Western Markets
On June 25, 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. On July 2, 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
38
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the investigation. On July 24, 2003, PNM submitted its response to OMOI's data
request, in which PNM provided justification of its bidding strategies during
that period. On July 25, 2003, PNM joined with other sellers in filing a request
for rehearing of the June 25, 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 investigation is currently pending and
PNM has received additional requests for information and data from OMOI. PNM is
responding to OMOI's additional questions. The Company cannot predict the
outcome of OMOI's investigation, but intends to vigorously defend itself against
any allegation of wrongdoing.
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.
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. On May 31, 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 31, 2002 order. The California Attorney General filed a request for
rehearing contesting the FERC decision. On September 23, 2002, the FERC issued
its order denying the California Attorney General's request for rehearing. The
California Attorney General has filed a petition for review in the United States
Court of Appeals for the Ninth Circuit. PNM has intervened in the Ninth Circuit
appeal and is participating as a party in that proceeding. The Ninth Circuit
held oral arguments in the case on October 9, 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
39
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 the
outcome of this matter.
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
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
On February 1, 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 filing was an administrative remedy that served as a mandatory
prerequisite to filing suit against the state for recovery of damages related to
the commandeering of the Block Forward Agreements. The Victims Claims Board
denied PNM `s claim on March 22, 2002. PNM filed a complaint against the State
of California in California state court on September 20, 2002, seeking damages
for the state's commandeering of the Block Forward Agreements and requesting
40
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 California state court stayed the proceedings through July 2003
pending resolution of certain related issues before the FERC, but recently
lifted the stay to address procedural matters in light of the delay in rulings
from the FERC on the related issues. Although the stay was lifted, the judge
delayed establishing a procedural schedule for the case pending a determination
of the Cal PX's status in the litigation. At a hearing held on October 2, 2003,
the judge held that the Cal PX could represent the interests of Cal PX
participants in the litigation. However, the judge declined to set a procedural
schedule because of his impending retirement and the anticipation that a new
judge would be appointed to preside over the hearing.
New Source Review Rules
In November 1999, the United States Department of Justice ("DOJ"), at the
request of the 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. The EPA has reached settlements with several of the
companies sued by the DOJ. 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"). That case now proceeds to
a remedy phase. By contrast, in a separate federal district court proceeding
against Duke Energy Company, 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
undertaken at its power plants was and continues to be in accordance with the
requirements of NSR and NSPS. However, by letter dated October 23, 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.
41
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The National Energy Policy Development Group released the National Energy
Policy in May 2001 which called for a review of the pending EPA enforcement
actions. As a result of that review, on June 14, 2002, the EPA announced its
intention to pursue steps to increase energy efficiency, encourage emissions
reductions and make improvements and reforms to the NSR program. The EPA
announced that, among other things, the NSR program had impeded or resulted in
the cancellation of projects that would maintain or improve reliability,
efficiency and safety of existing power plants. The EPA's June 2002 announcement
contemplated further rulemakings on NSR-related issues and expressly cautioned
that the announcement was not intended to affect pending NSR enforcement
actions. Thereafter, on December 31, 2002, the EPA promulgated certain
long-awaited revisions to the NSR rules, along with proposals to revise the RMRR
exclusion contained in the regulations. On August 27, 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 and how such challenges will be resolved cannot be predicted.
Citizen Suit Under the Clean Air Act
By letter dated January 9, 2002, counsel for the Grand Canyon Trust and
Sierra Club (collectively, "GCT") notified PNM of GCT's intent to file a
so-called "citizen suit" under the Clean Air Act, alleging that PNM and
co-owners of the SJGS violated the Clean Air Act, and the implemention of
federal and state regulations, at SJGS. Pursuant to that notification, on May
16, 2002, the GCT filed suit in federal district court in New Mexico against PNM
(but not against the other SJGS co-owners). 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 Prevention
of Significant Deterioration ("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 filed its answer in federal court on June
6, 2002, denying the material allegations in the complaint.
Both sides in the litigation filed motions for partial summary judgment
and on May 9, 2003 the court held a hearing on all pending motions. At the
conclusion of the hearing, the court denied the summary judgment motions
relating to the opacity claims, meaning that the opacity issues will go to trial
on the merits. The court took under advisement the summary judgment motions
relating to the PSD issues, but thereafter entered an order granting PNM's
motion for summary judgment on the PSD issues and dismissing that portion of the
case against PNM. A trial date on certain other preliminary liability issues has
been established to start on November 17, 2003. On October 8, 2003, the court
42
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
entered an order granting in part and denying in part GCT's motion seeking to
limit the evidence PNM could present at the November 17 trial. The court
excluded evidence PNM wished to present that certain measurement methods relied
on by GCT were not proper to measure compliance and that they unlawfully created
a more stringent standard. The court will allow PNM, however, to present
evidence that specific data relied on by GCT does not meet the standards of
other measurement methods and that the measurement methods relied on by GCT are
contradicted by other measurement methods or by other qualified scientific data.
The court will also allow evidence demonstrating the inaccuracy of the data
relied on by GCT or that particular data relied on by GCT should not be
considered evidence of a violation for other appropriate reasons. A trial on
remaining liability issues, if necessary, and also on remedy issues, if
necessary, would be scheduled at a later date. The Company believes that it has
meritorious defenses and vigorously disputes the allegations. PNM's corporate
policy continues to be to adhere to high environmental standards as evidenced by
its ISO 14000 certification. The Company is, however, unable to predict the
ultimate outcome of the matter.
Archeological Site Disturbance
The Company hired a contractor, 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. PNM has 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 has
given the Corps of Engineers notice concerning the disturbances in arroyos. The
Corps of Engineers has acknowledged the Company's notice and asked PNM to
cooperate in addressing these disturbances. The USFS verbally instructed PNM to
undertake an assessment and possible related mitigation measures with respect to
the archeological sites in question. 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. PNM has
provided Great Southwestern with notice and a demand for indemnity. Zurich
Insurance, the insurer for Great Southwestern, has denied coverage and indemnity
to PNM for this claim but has agreed to share the cost of a portion of the
investigation of this claim. A subsequent preliminary investigation into other
transmission lines that were covered by the "climb and tighten" project
indicated that there are disturbances on lands governed by other federal
agencies and Indian tribes. PNM and Great Southwestern have provided notice of
the potential disturbances to these other agencies and tribes. The Company had
been informed that the USFS and BLM had commenced a criminal investigation into
Great Southwestern's activities on this project. However, the Company received
verbal confirmation that the USFS and the BLM have decided to decline criminal
prosecution under the Archeological Resources Protection Act ("ARPA") against
43
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
PNM and Great Southwestern. The State of New Mexico requested information from
PNM concerning the location of potential disturbances on state lands. The Navajo
Nation has also requested further information concerning disturbances on Navajo
land, but has provided written declination of criminal charges under ARPA
against PNM and Great Southwestern. The Navajo Nation has indicated that it may
pursue civil damages under ARPA. PNM and Great Southwestern are seeking the
consent of BLM and the USFS to address impacted drainages under these agencies
jurisdiction. The Company is unable to predict the outcome of this matter and
cannot estimate 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 more than two years, PNM has been in
discussions with NMED concerning excess emissions reports for the period after
January 1997. During this period, NMED investigated the circumstances of these
excess emissions and whether these emissions involve any violation of applicable
permits and regulations. 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
December 31, 2003. By letter dated September 12, 2003, the NMED advised PNM that
NMED would not excuse certain of the emissions exceeding the operation permit
emission permits. The letter also stated that PNM had violated the opacity
limits in the operating permit and articulated a construction of the standards
that NMED would apply in evaluating opacity exceedances. Attached to the
September 12 letter was what was identified as a "draft" compliance order
assessing unspecified civil penalties. The September 12 letter invited PNM to
enter into discussions concerning the contents of the letter and of the draft
compliance order and PNM has advised the NMED that PNM will enter into such
discussion. The compliance order has not yet been finalized and no proceeding
against PNM has yet been commenced by NMED. PNM disagrees with the construction
of its operating permit that is contained in the September 12 letter which
represents a construction of the operating permit 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.
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. No source of gasoline contamination in the groundwater
was identified as originating from the site. However, in June 1996, PNM received
a letter from the NMED, indicating that the NMED believed that PNM was the
source of gasoline contamination in a City of Santa Fe municipal supply well and
in groundwater underlying the Santa Fe Station site. Further, the NMED letter
stated that PNM was required to proceed with interim remediation of the
44
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
contamination pursuant to the New Mexico Water Quality Control Commission
regulations. In October 1996, PNM and the NMED signed an amendment to the
Settlement Agreement concerning the groundwater contamination underlying the
site. As part of the amendment, PNM agreed to spend approximately $1.2 million
for certain costs related to sampling, monitoring and the development and
implementation of a remediation plan with respect to gasoline contamination in
the groundwater.
Pursuant to the terms of the Settlement Agreement, on October 5, 1998, a
new remediation system began operation to treat groundwater produced by the
Santa Fe well to drinking water standards for municipal distribution and
bioremediation of gasoline contamination beneath the Santa Fe Station site.
Since the reactivation of the Santa Fe well, the groundwater treatment and
bioremediation systems have resulted in a marked reduction in contaminant
concentrations at the wellhead. However, contaminant concentrations at the
property boundary remain high.
The amended Settlement Agreement did not, however, provide PNM with a
full release from potential further liability for remediation of the gasoline
contamination in the groundwater. If the NMED continued to assert that PNM was
responsible for the gasoline contamination after the specified settlement amount
was exhausted, the Settlement Agreement called for binding arbitration on the
question of whether PNM was the source of gasoline contamination. Under the
terms of the Settlement Agreement, NMED had the burden of proof to establish the
Santa Fe Generating Station as the source for the gasoline contamination.
By letter dated August 7, 2002, PNM provided written notice to the NMED
and the City of Santa Fe that PNM had satisfied its obligations with respect to
the gasoline contamination under the amended Settlement Agreement, and PNM also
stated its intention to cease operation, effective October 5, 2002, of the
wellhead and bioremediation systems, and to discontinue monitoring and reporting
with respect to gasoline contamination at the site. The NMED responded with a
written notice of determination dated August 16, 2002, stating that PNM is the
responsible party for gasoline contamination at the site and requested that PNM
refrain from cessation of operation of the remediation systems, monitoring and
reporting. In a meeting held on September 5, 2002, the NMED indicated its
intention to file a court action seeking an order invalidating the binding
arbitration provisions of the amended Settlement Agreement and a declaratory
judgment that PNM is the responsible party for the gasoline contamination at the
site. PNM is of the opinion that the data compiled indicates observed
groundwater contamination originated from off-site sources. In August 2003, PNM
elected to enter into a fifth amendment ("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.
45
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Fifth Amendment notes the continued presence of chlorinated solvents
in the groundwater under the former Santa Fe Generating Station and provides
that once the remediation standards are met, the NMED anticipates that it will
not require PNM to undertake any further investigation or remediation with
respect to chlorinated solvents. In the event that chlorinated solvent
concentrations remain at levels requiring further action, the NMED will not
require PNM to take any further action with respect to the chlorinated solvent
contamination until the NMED has reviewed any new data relating to the
chlorinated solvent contamination and undertaken a good faith investigation into
other potential sources. The NMED has acknowledged that at least a portion of
the chlorinated solvent contaminated observed beneath the Santa Fe Generating
Station site has originated from off-site sources. 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 Generating 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.
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
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 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.
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; changes in accounting
46
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
rules and standards; and external factors such as weather and water supply.
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. Moreover, Congress is currently debating
energy legislation which could affect the FERC's activities. 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 that
may call for regulatory reforms for the industry; and the resulting market
prices for electricity and natural gas. In addition, the Company has in place 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
and economic conditions.
(6) Company Realignment
On August 22, 2002, the Company was realigned because of the changes in
the electric industry and particularly, the negative impact on the Company's
earnings and growth prospects from wholesale market uncertainty. The changes
included consolidation of similar functions. A total of 85 salaried and hourly
employees were notified of their termination as part of the realignment. In
accordance with Emerging Issues Task Force 94-3 ("EITF 94-3"), "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity", the Company incurred a liability of $8.8 million for severance and
other related costs associated with the involuntary termination of employees,
which was charged to operations in the quarter ended September 30, 2002. The
Company had paid $8.0 million as of September 30, 2003 for such costs and the
balance of the liability was $0.8 million.
(Intentionally left blank)
47
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(7) Other Income and Deductions
The following table details the components of other income and deductions
for PNM Resources, Inc. and Subsidiaries:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- ---------------
(In thousands)
Other income:
Interest income............................. $10,791 $11,226 $31,968 $32,788
Miscellaneous non-operating income.......... 4,664 2,575 7,438 6,464
-------------- -------------- -------------- ---------------
15,455 13,801 39,406 39,252
============== ============== ============== ===============
Other deductions:
Loss on reacquired debt write-off........... 16,576 - 16,576 -
Transition costs write-off.................. - - 16,720 -
Miscellaneous non-operating deductions...... 2,185 6,842 7,397 10,234
-------------- -------------- -------------- ---------------
18,761 6,842 40,693 10,234
============== ============== ============== ===============
The following table details the components of other income and deductions
for PNM:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands)
Other income:
Interest income............................. $10,500 $ 8,884 $30,701 $27,072
Miscellaneous non-operating income.......... 4,200 2,471 6,089 3,776
-------------- -------------- -------------- --------------
$14,700 $ 11,355 $36,790 $30,848
============== ============== ============== ==============
Other deductions:
Loss on reacquired debt write-off........... 16,576 - 16,576 -
Transition costs write-off.................. - - 16,720 -
Miscellaneous non-operating deductions...... 2,137 4,691 4,860 8,443
-------------- -------------- -------------- --------------
$18,713 $ 4,691 $38,156 $ 8,443
============== ============== ============== ==============
(8) New and Proposed Accounting Standards
Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin ("ARB") No. 51, "Consolidated Financial Statements" ("FIN
46"). In January 2003, the Financial Accounting Standards Board ("FASB") issued
FIN 46 to address the consolidation of variable interest entities. FIN 46
applies immediately to variable interest entities created after January 31,
48
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2003, and to variable interest entities in which an enterprise obtains an
interest after that date. FIN 46 may also be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated.
Upon adoption, FIN 46 did not have a material impact on the Company's financial
condition or results of operations.
EITF 02-3 "Issues Related to Accounting for Contracts Involved in Energy
Trading and Risk Management Activities", EITF 98-10 "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities" and Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). On October 25, 2002, the EITF reached a
final consensus on EITF 02-3 that rescinds EITF 98-10 and requires that all
energy contracts held for trading purposes be presented on a net margin basis in
the statement of earnings. As a result, the Company has reclassified those
contracts previously accounted for under EITF 98-10 to a net margin basis under
EITF 02-3 for the three months and nine months ended September 30, 2002. The
Company will not report revenues and cost of energy sold on a net margin basis
on a prospective basis under EITF 02-3, as none of the Company's current
marketing activities meet the definition of trading activities as prescribed by
EITF 02-3.
The following table details wholesale electric revenues as adjusted under
EITF 02-3. Energy trading margin is included in electric operating revenues in
the Consolidated Statements of Earnings.
Three Months Nine Months
Ended Ended
September 30, September 30,
2002 2002
------------- -------------
Wholesale revenues........................... $ 18,792 $56,942
Wholesale purchases (EITF 02-3 adjustment)... (19,463) (54,895)
------------- --------------
Energy trading margin........................ $ (671) $ 2,047
============= ==============
Statement of Financial Accounting Standards No. 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). On
April 30, 2003, the Financial Accounting Standards Board ("FASB") issued SFAS
149. SFAS 149 amends SFAS 133 for derivative instruments, including certain
derivative investments embedded in other contracts and for hedging activities.
SFAS 149 also amends certain existing pronouncements. It will require contracts
with comparable characteristics to be accounted for similarly. In particular,
SFAS 149 clarifies when a contract with an initial net investment meets the
characteristics of a derivative and clarifies when a derivative that contains a
financing component will require special reporting in the statement of cash
flows. The Company must apply SFAS 149 to contracts entered into or modified
after June 30, 2003.
49
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For the companies in the wholesale power marketing industry, SFAS 149
amends previously issued guidance in Derivative Implementation Group Issue
Summaries. Specifically, the pronouncement excludes electricity contracts
subject to unplanned netting from normal designation under SFAS 133. In
addition, the pronouncement amends the definition of a capacity contract.
Electricity contracts entered into or modified after June 30, 2003 that meet the
amended definition may qualify for normal designation despite being subject to
unplanned netting.
The impact of SFAS 149 in the quarter ended September 30, 2003 was
immaterial. However, the Company historically has entered into certain forward
physical contracts for the sale and/or purchase of power as part of its
wholesale power marketing operations. These contracts have typically been
classified as "normal" pursuant to SFAS 133 and not marked-to-market. If the
Company's forward contracts that are typically designated as normal pursuant to
SFAS 133 do not meet the definition of a capacity contract pursuant to SFAS 149,
they would be marked to market which will substantially increase the number of
the Company's contracts subject to mark-to-market accounting.
Statement of Financial Accounting Standards No. 150 "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150"). On May 15, 2003, the FASB issued SFAS 150. SFAS 150
established standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. Under SFAS 150,
issuers are required to classify as liabilities a financial instrument that is
within its scope as a liability because that financial instrument embodies an
obligation of the issuer. SFAS 150 is effective for financial instruments
entered into or modified after May 31, 2003. The FASB has indefinitely deferred
the adoption of SFAS 150 in relation to limited life entities. Currently, the
Company is evaluating the impact of such financial instruments that are covered
under this statement and is unable to predict its effect on the Company's
presentation in its Consolidated Balance Sheet.
EITF Issue No. 03-11 "Reporting Realized Gains and Losses on Derivative
Instruments That Are Subject to FASB Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"), and Not "Held for
Trading Purposes" as Defined in EITF Issue No. 02-3, "Issues Involved in
Accounting for Derivative Contracts Held for Trading Purposes and Contracts
Involved in Energy Trading and Risk Management Activities". The EITF reached a
consensus that determining whether realized gains and losses on derivative
contracts not held for trading purposes should be reported on a net or gross
basis is a matter of judgment that depends on the relevant facts and
circumstances. Guidance in EITF Issue No. 99-19, "Reporting Revenue Gross as a
Principal versus Net as an Agent" and APB Opinion No. 29, "Accounting for
Nonmonetary Transactions" may be considered in making the determination. EITF
Issue No. 03-11 should be applied to derivative instruments entered into after
September 30, 2003. The Company is currently evaluating the impact of
implementing EITF Issue No. 03-11 and is unable to predict its effect on the
Company's presentation of operating results.
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. In January 2002,
Avistar and certain inactive subsidiaries were transferred by way of a dividend
to the Holding Company pursuant to an order from the PRC. 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. 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,
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 production from the
utility, as well as unregulated generation, into a competitive marketplace. As
part of its electric wholesale power operation, it 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 are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
include Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission"). Electric consists of the distribution and generation
of electricity for retail customers. 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 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 asset-backed energy
sales supported by long-term contracts and the wholesale market. The
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, including sales to retail customers. Growth will be
dependent on market development and upon 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 rationally priced asset additions.
Expansion of the Company's generating portfolio will depend upon acquiring
favorably priced assets at strategic locations and securing long-term
commitments for the purchase of power from the acquired plants.
(Intentionally left blank)
52
RESULTS OF OPERATIONS
Three Months Ended September 30, 2003
Compared to Three Months Ended September 30, 2002
Consolidated
The Company's net earnings for the three months ended September 30, 2003
were $16.6 million or $0.41 per diluted share of common stock, a 6.1% decrease
in net earnings compared to $17.7 million or $0.45 per diluted share of common
stock in 2002. This decrease primarily reflects a write-off of $16.6 million for
costs incurred to early retire long term debt, partially offset by new long-term
contract sales, improved wholesale market conditions and increased demand in the
New Mexico service territory for electricity and natural gas.
The following discussion is based on the financial information presented
in the Consolidated Financial Statements - Segment Information Note 2, in the
Notes to the Consolidated Financial Statements. Corporate allocations, income
taxes and non-operating items are discussed only on a consolidated basis.
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Three Months Ended
September 30,
--------------------------
2003 2002 Variance
------------- ----------- -----------
(In thousands)
Operating revenues: $ 154,746 $ 150,670 $ 4,076
Less: Cost of energy...................... 58,690 55,498 3,192
Intersegment energy transfer....... (8,696) (5,319) (3,377)
------------- ------------ ------------
Gross margin.............................. 104,752 100,491 4,261
------------- ------------ ------------
Energy production costs................... 26,511 27,229 (718)
Distribution O&M.......................... 5,013 4,898 115
Customer related expense.................. 3,779 4,286 (507)
Administrative and general................ 915 634 281
------------- ------------ ------------
Total non-fuel O&M...................... 36,218 37,047 (829)
Corporate allocation...................... 15,122 17,257 (2,135)
Depreciation and amortization............. 15,910 14,871 1,039
Taxes other than income taxes............. 4,599 4,358 241
Income taxes.............................. 10,641 7,890 2,751
------------- ------------ ------------
Total non-fuel operating expenses....... 82,490 81,423 1,067
------------- ------------ ------------
Operating income.......................... $ 22,262 $ 19,068 $ 3,194
------------- ------------ ------------
53
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Three Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............. $ 58,301 $ 53,213 $5,088
Commercial.............. 73,918 69,800 4,118
Industrial.............. 16,689 21,819 (5,130)
Other................... 5,838 5,838 -
------------- ------------- --------------
$154,746 $150,670 $4,076
============= ============= ==============
Average customers....... 397,489 385,468 12,021
============= ============= ==============
The following table shows electric sales by customer class:
Electric Sales
Three Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Residential........... 688,617 620,299 68,318
Commercial............ 995,470 928,250 67,220
Industrial............ 332,747 427,481 (94,734)
Other................. 76,305 80,711 (4,406)
------------- ------------- --------------
2,093,139 2,056,741 36,398
============= ============= ==============
Operating revenues increased $4.1 million or 2.7% over the prior year
period. Retail electricity delivery grew to 2.09 million MWh in 2003 compared to
2.06 million MWh delivered in the prior year, resulting in an increase in
revenues. This volume increase was the result of customer growth year-over-year
of 3.1% and warmer weather, which resulted in increased revenues of $10.5
million. This increase was partially offset by the transfer of a significant
customer from retail to wholesale electric rates in the first quarter of 2003
and the first month impact of the electric rate reduction of $1.3 million.
Without the customer transfer, volume increased 6.7% and retail electric
revenues increased $9.1 million. Beginning in September 2003, the Company
reduced its retail electric rates based on the Global Electric Agreement, which
was approved in January 2003.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, increased $4.3 million or 4.2% over the prior year
period. This increase is due mainly to customer growth in the Company's retail
electric service territory and warmer weather, partially offset by the customer
transfer.
Total non-fuel O&M expenses decreased $0.8 million or 2.2% over the prior
year period. Energy production costs decreased $0.7 million or 2.6% primarily
due to a decrease in decommissioning expense. Customer-related expense decreased
$0.5 million or 11.8% as a result of a favorable outcome of a customer
54
bankruptcy proceeding. Depreciation and amortization increased $1.0 million or
7.0% due to an increase of $0.4 million for the change in accounting for costs
related to asset retirement obligations required by SFAS 143 and a higher
depreciable plant base.
Gas
The table below sets forth the operating results for Gas.
Three Months Ended
September 30,
--------------------------
2003 2002 Variance
------------ ------------ -------------
(In thousands)
Operating revenues:
External customers.................. $47,938 $36,244 $ 11,694
Intersegment revenues............... - 691 (691)
------------ ------------ -------------
Total revenues...................... 47,938 36,935 11,003
Less: Cost of energy.................. 23,227 12,905 10,322
------------ ------------ -------------
Gross margin.......................... 24,711 24,030 681
------------ ------------ -------------
Energy production costs............... 510 486 24
Transmission and distribution O&M..... 7,299 7,313 (14)
Customer related expense.............. 4,805 4,019 786
Administrative and general............ 28 717 (689)
------------ ------------ -------------
Total non-fuel O&M.................. 12,642 12,535 107
Corporate allocation.................. 9,159 9,747 (588)
Depreciation and amortization......... 5,613 5,160 453
Taxes other than income taxes......... 1,841 1,899 (58)
Income taxes.......................... (3,211) (3,486) 275
------------ ------------ -------------
Total non-fuel operating expenses... 26,044 25,855 189
------------ ------------ -------------
Operating income (loss)............... $ (1,333) $ (1,825) $ 492
------------ ------------ -------------
The following table shows gas revenues by customer and average customers:
Gas Revenues
Three Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............. $25,852 $20,550 $ 5,302
Commercial.............. 9,281 6,249 3,032
Industrial.............. 391 348 43
Transportation*......... 5,584 4,941 643
Other................... 6,830 4,847 1,983
------------- ------------- --------------
$47,938 $36,935 $11,003
============= ============= ==============
Average customers....... 450,378 439,638 10,740
============= ============= ==============
55
The following table shows gas throughput by customer class:
Gas Throughput
Three Months Ended
September 30,
2003 2002 Variance
---------- ---------- -----------
(Thousands of decatherms)
Residential.............. 2,212 2,291 (79)
Commercial............... 1,306 1,263 43
Industrial............... 62 94 (32)
Transportation*.......... 17,613 13,753 3,860
Other.................... 955 800 155
---------- ---------- -----------
22,148 18,201 3,947
========== ========== ===========
*Customer-owned gas
Operating revenues increased $11.0 million or 29.8% over the prior year
period to $47.9 million primarily because of higher natural gas prices in 2003
as compared to 2002, customer growth of 2.4% and an increase in gas sales
volumes of 21.7%, largely resulting from gas line extensions increasing
off-system sales. PNM purchases natural gas in the open market and resells it at
that open market price to its distribution 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.
The gross margin, or operating revenues minus cost of energy sold,
increased $0.7 million or 2.8% over the prior year period. This increase is due
mainly to customer growth of 2.4% and increased off-system sales, partially
offset by the expiration in January 2003 of a rate rider for the recovery of
certain costs of $0.7 million. The Company currently believes that its gas
assets are not earning an adequate level of return. As a result, the Company
filed a request for increased rates in January 2003. For additional information
see Note 5 - "Commitments and Contingencies - Gas Rate Case" in the Notes to
Consolidated Financial Statements.
Total non-fuel O&M expenses increased $0.1 million or 0.9% over the prior
year period. Customer related expense increased $0.8 million or 19.6% due to
increased bad debt expense resulting from higher gas costs. Administrative and
general costs decreased $0.7 million or 96.1% primarily due to consulting costs
for process improvement in 2002, which did not recur in 2003. Depreciation and
amortization increased $0.5 million or 8.8% primarily due to a gas line
expansion.
56
Transmission
The table below sets forth the operating results for Transmission.
Three Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- ----------
(In thousands)
Operating revenues:
External customers.................. $ 8,920 $ 5,693 $ 3,227
Intersegment revenues............... 6,447 8,779 (2,332)
------------ ------------ -----------
Total revenues...................... 15,367 14,472 895
Less: Cost of energy.................. 1,210 841 369
------------ ------------ -----------
Gross margin.......................... 14,157 13,631 526
------------ ------------ -----------
Energy production costs............... 296 218 78
Transmission O&M...................... 2,815 3,725 (910)
Administrative and general............ 611 503 108
------------ ------------ -----------
Total non-fuel O&M.................. 3,722 4,446 (724)
Corporate allocation.................. 1,298 1,736 (438)
Depreciation and amortization......... 2,689 2,158 531
Taxes other than income taxes......... 610 594 16
Income taxes.......................... 1,628 1,240 388
------------ ------------ -----------
Total non-fuel operating expenses... 9,947 10,174 (227)
------------ ------------ -----------
Operating income...................... $ 4,210 $ 3,457 $ 753
------------ ------------ -----------
Operating revenues increased $0.9 million or 6.2% and gross margin
increased $0.5 million or 3.9% over the prior year period primarily due to
higher New Mexico retail sales.
Total non-fuel O&M expenses decreased $0.7 million or 16.3% over the
prior year period. Transmission O&M decreased $0.9 million or 24.4% primarily
due to a decrease in lease costs of $1.1 million for the EIP transmission line,
a portion of which was repurchased in April 2003.
(Intentionally left blank)
57
Wholesale
The table below sets forth the operating results for Wholesale.
Three Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- ------------
(In thousands)
Operating revenues:
External customers................. $ 173,532 $ 81,733 $ 91,799
Intersegment revenues.............. 635 - 635
------------ ------------ ------------
Total revenues..................... 174,167 81,733 92,434
Less: Cost of energy................. 138,371 58,003 80,368
Intersegment energy transfer.. 8,696 5,319 3,377
------------ ------------ ------------
Gross margin......................... 27,100 18,411 8,689
------------ ------------ ------------
Energy production costs.............. 6,900 7,305 (405)
Administrative and general........... 2,233 1,669 564
------------ ------------ ------------
Total non-fuel O&M................. 9,133 8,974 159
Corporate allocation................. 1,105 1,301 (196)
Depreciation and amortization........ 3,579 2,417 1,162
Taxes other than income taxes........ 656 677 (21)
Income taxes......................... 3,340 505 2,835
------------ ------------ ------------
Total non-fuel operating expenses.. 17,813 13,874 3,939
------------ ------------ ------------
Operating income..................... $ 9,287 $ 4,537 $ 4,750
------------ ------------ ------------
The following table shows revenues by customer class:
Wholesale Revenues
Three Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts..... $ 41,337 $12,682 $28,655
Forward sales*.......... 58,708 (671) 59,379
Short-term sales........ 74,122 69,722 4,400
------------- ------------- --------------
$174,167 $81,733 $92,434
============= ============= ==============
*Includes mark-to-market gains/(losses).
(Intentionally left blank)
58
The following table shows sales by customer class:
Wholesale Sales
Three Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Long-term contracts..... 730,536 160,947 569,589
Forward sales........... 1,063,000 - 1,063,000
Short-term sales........ 1,514,924 2,013,673 (498,749)
------------- ------------- --------------
3,308,460 2,174,620 1,133,840
============= ============= ==============
Operating revenues increased $92.4 million or 113.1% over the prior year
period to $174.2 million. This increase in wholesale electric sales primarily
reflects additional long-term contract sales and more normalized wholesale
market conditions. The Company delivered wholesale (bulk) power of 3.3 million
MWh of electricity for the three months ended September 30, 2003 compared to 2.2
million MWh for the same period in 2002. In addition, effective January 1, 2003,
the Company adopted EITF 02-3, which resulted in the reclassification of
contracts that were previously accounted for gross under EITF 98-10 to a net
margin basis. Therefore, in 2002, $19.5 million of realized purchased power
expense was netted against revenues for a net margin loss of $0.7 million. These
sales and purchases were accounted for in the forward sales market.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, increased $8.7 million or 47.2% over the prior
year period. Higher margins were created primarily by additional long-term sales
under new and existing contracts, higher market prices and improved market
liquidity. The addition of new, multi-year long-term contracts added $7.6
million. In addition, long-term contract margin increased due to the transfer of
a significant customer from retail to wholesale. Forward sales margin increased
$4.4 million reflecting higher market prices and improved market liquidity. The
average price realized by the Company on its forward sales was $58 per MWh in
2003, compared to $47 per MWh in 2002. These margin increases were partially
offset by short-term sales margin which decreased $3.3 million due to retail
growth, increased long-term sale obligations and fewer available resources
caused by increased outages. The average price on the Company's realized
short-term sales was $49 per MWh in 2003, compared to $35 per MWh in 2002.
Overall open market sales (forward and short-term sales) averaged $53 per MWh in
2003 versus $36 per MWh in 2002. The Company had a favorable change in the
unrealized mark-to-market position of the forward sales portfolio of $1.4
million year-over-year ($0.6 million gain in 2003 versus $0.8 million loss in
2002).
Total non-fuel O&M expenses increased $0.2 million or 1.8% over the prior
year period. Administrative and general increased $0.6 million or 33.8%
primarily due to increased pension and benefits expenses at PVNGS. Depreciation
and amortization increased $1.2 million or 48.1% primarily due to the addition
of Lordsburg and Afton.
59
Corporate and Other
Corporate administrative and general, which represent costs that are
driven primarily by corporate-level activities, is allocated to the business
segments and presented in the corporate allocation line item in the segment
statements. These costs decreased $0.8 million or 2.8% over the prior year
period to $26.2 million. In 2002, the Company incurred severance costs of $8.8
million resulting from a realignment of the Company's business structure, which
did not recur in 2003. This decrease was offset by increased pension and
benefits expense of $5.7 million resulting from lower prior-year returns on
pension investments and increasing healthcare costs. In addition, consulting
expenses increased $1.5 million for Sarbanes-Oxley Act compliance and other
corporate initiatives.
Consolidated
Other Income and Deductions
Other income increased by $1.7 million or 12.0% over the prior year
period due to higher quarter-over-quarter returns on investments reflecting
improved market conditions. This increase is partially offset by lower interest
income due to a decrease in the short-term investment balance. Cash from the
redemption of short-term investments was primarily used for the Company's
repayment of the EIP long-term debt, debt refinancing and repayment of
short-term debt in the second quarter 2003.
Other deductions increased $11.9 million over the prior year period
primarily due to a write-off of $16.6 million for costs related to long-term
debt refinancing, partially offset by decreased realized losses on investments
of $2.2 million.
Interest Expense
Interest expense increased $1.3 million or 8.2% over the prior year
period primarily from decreased capitalized interest of $1.0 million due to the
completion of the southern New Mexico gas-fired plant construction in 2002.
Income Taxes
The Company's consolidated income tax expense was $9.0 million for the
three months ended September 30, 2003, compared to $7.4 million for the three
months ended September 30, 2002. The Company's effective income tax rates for
the three months ended September 30, 2003 and 2002 were 35.0% and 29.2%,
respectively. The increase in the effective rate period over period was due to
the reduction in permanent tax benefits.
60
RESULTS OF OPERATIONS
Nine Months Ended September 30, 2003
Compared to Nine Months Ended September 30, 2002
Consolidated
The Company's net earnings for the nine months ended September 30, 2003
were $82.3 million or $2.06 per diluted share of common stock, a 54.0% increase
in net earnings compared to $53.5 million or $1.35 per diluted share of common
stock in 2002. This increase primarily reflects the cumulative effect of a
change in accounting principle for the adoption of SFAS 143 of $37.4 million,
net of tax and improved operating performance. This increase was partially
offset by the write-off of transition costs of $16.7 million that resulted from
the repeal of electric deregulation in New Mexico in the first quarter of 2003
and a write-off of $16.6 million for costs related to long-term debt
refinancing.
The following discussion is based on the financial information presented
in the Consolidated Financial Statements - Segment Information Note 2, in the
Notes to the Consolidated Financial Statements. Corporate allocations, income
taxes and non-operating items are discussed only on a consolidated basis.
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Nine Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- ----------
(In thousands)
Operating revenues: $ 414,881 $ 414,426 $ 455
Less: Cost of energy................... 156,470 151,850 4,620
Intersegment energy transfer.... (30,460) (22,471) (7,989)
------------ ------------ -----------
Gross margin........................... 288,871 285,047 3,824
------------ ------------ -----------
Energy production costs................ 79,388 82,115 (2,727)
Transmission and distribution O&M...... 15,170 14,976 194
Customer related expense............... 10,242 13,134 (2,892)
Administrative and general............. 3,797 3,049 748
------------ ------------ -----------
Total non-fuel O&M................... 108,597 113,274 (4,677)
Corporate allocation................... 42,019 42,189 (170)
Depreciation and amortization.......... 47,488 44,509 2,979
Taxes other than income taxes.......... 13,407 13,640 (233)
Income taxes........................... 22,956 20,229 2,727
------------ ------------ -----------
Total non-fuel operating expenses.... 234,467 233,841 626
------------ ------------ -----------
Operating income....................... $ 54,404 $ 51,206 $ 3,198
------------ ------------ -----------
61
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............. $ 156,135 $ 149,631 $6,504
Commercial.............. 192,008 187,382 4,626
Industrial.............. 51,791 62,239 (10,448)
Other................... 14,947 15,174 (227)
------------- ------------- --------------
$ 414,881 $414,426 $ 455
============= ============= ==============
Average customers....... 394,878 383,572 11,306
============= ============= ==============
The following table shows electric sales by customer class:
Electric Sales
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Residential............ 1,827,897 1,743,712 84,185
Commercial............. 2,546,486 2,462,727 83,759
Industrial............. 1,029,625 1,225,398 (195,773)
Other.................. 189,612 203,736 (14,124)
------------- ------------- --------------
5,593,620 5,635,573 (41,953)
============= ============= ==============
Operating revenues increased $0.5 million or 0.1% over the prior year
period primarily due to customer growth of 2.9%. Retail electricity delivery
declined slightly to 5.59 million MWh in 2003 compared to 5.64 million MWh
delivered in the prior year. Lower volumes were the result of the transfer of a
significant customer from retail to wholesale electric rates in the first
quarter of 2003. Without the customer transfer, volume increased 4.2% due
customer growth and warmer weather.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, increased $3.8 million or 1.3% over the prior year
period. This increase is due primarily to customer growth in the Company's
retail electric service territory and warmer weather, partially offset by the
customer transfer and the first month of the electric rate reduction.
Total non-fuel O&M expenses decreased $4.7 million or 4.1% over the prior
year period. Energy production costs decreased $2.7 million or 3.3% primarily
due to decreased decommissioning expenses of $1.8 million. Additionally, these
costs decreased due to lower plant maintenance costs of $1.0 million at Reeves
and $1.4 million at Four Corners for outages in 2002, which did not recur in
2003. This decrease was partially offset by increased costs of $2.3 million at
SJGS related to increased plant outages in 2003. Customer-related expense
62
decreased $2.9 million or 22.0% due to lower bad debt expense of $2.5 million as
a result of continued collection efforts. Administrative and general costs
increased $0.7 million or 24.5% due to increased pension and benefits costs of
$2.3 million at SJGS and PVNGS, offset by salary decreases due to the Company
realignment. Depreciation and amortization increased $3.0 million or 6.7% due to
an increase of $1.2 million for the change in accounting for costs related to
asset retirement obligations as required by SFAS 143 and a higher depreciable
plant base.
Gas
The table below sets forth the operating results for Gas.
Nine Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- ------------
(In thousands)
Operating revenues:
External customers................... $ 268,200 $ 189,413 $ 78,787
Intersegment revenues................ - 1,136 (1,136)
------------ ----------- ------------
Total revenues....................... 268,200 190,549 77,651
Less: Cost of energy................... 174,380 96,576 77,804
------------ ----------- ------------
Gross margin........................... 93,820 93,973 (153)
------------ ----------- ------------
Energy production costs................ 1,458 1,520 (62)
Transmission and distribution O&M...... 22,424 21,836 588
Customer related expense............... 12,715 12,289 426
Administrative and general............. 987 2,859 (1,872)
------------ ----------- ------------
Total non-fuel O&M................... 37,584 38,504 (920)
Corporate allocation................... 25,786 25,175 611
Depreciation and amortization.......... 16,553 15,257 1,296
Taxes other than income taxes.......... 5,196 5,909 (713)
Income taxes........................... (655) (396) (259)
------------ ----------- ------------
Total non-fuel operating expenses.... 84,464 84,449 15
------------ ----------- ------------
Operating income....................... $ 9,356 $ 9,524 $ (168)
------------ ----------- ------------
(Intentionally left blank)
63
The following table shows gas revenues by customer and average customers:
Gas Revenues
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............ $168,525 $118,274 $ 50,251
Commercial............. 54,844 36,839 18,005
Industrial............. 1,856 1,412 444
Transportation*........ 15,339 13,686 1,653
Other.................. 27,636 20,338 7,298
------------- ------------- --------------
$268,200 $190,549 $ 77,651
============= ============= ==============
Average customers...... 451,164 442,360 8,804
============= ============= ==============
*Customer-owned gas.
The following table shows gas throughput by customer class:
Gas Throughput
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(Thousands of decatherms)
Residential............ 18,069 18,791 (722)
Commercial............. 7,281 7,827 (546)
Industrial............. 318 390 (72)
Transportation*........ 42,703 35,226 7,477
Other.................. 3,924 3,904 20
------------- ------------- --------------
72,295 66,138 6,157
============= ============= ==============
*Customer-owned gas.
Operating revenues increased $77.7 million or 40.8% over the prior year
period to $268.2 million, primarily because of higher natural gas prices in 2003
as compared to 2002, customer growth of 2.0% and an increase in gas sales
volumes of 9.3%, driven by increased sales to third-party gas transportation
customers. This volume increase was partially offset by a decrease in
residential and commercial sales due to warmer weather in the first quarter of
2003. PNM purchases natural gas in the open market and resells it at cost of
purchase to its retail gas distribution 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.
The gross margin, or operating revenues minus cost of energy sold,
decreased $0.2 million or 0.2% over the prior year period. This decrease is due
mainly to an overall weather-related decline in gas volumes and the expiration
in January 2003 of a rate rider for the recovery of certain costs of $3.0
million. January 2003 was the warmest January in recorded history in New Mexico.
64
The Company currently believes that its gas assets are not earning an adequate
level of return. As a result, the Company filed a request for increased rates in
January 2003. For additional information see Note 5 - "Commitments and
Contingencies - Gas Rate Case".
Total non-fuel O&M expenses decreased $0.9 million or 2.4% over the prior
year period. Transmission and distribution O&M increased $0.6 million or 2.7%
due to an increase in transportation costs of $0.4 million and a non-recurring
2002 legal settlement of $0.2 million. Administrative and general costs
decreased $1.9 million or 65.5% primarily due to consulting costs of $0.7
million for process improvement in 2002, which did not recur in 2003 and the
resulting cost control initiatives in 2003. Depreciation and amortization
increased $1.3 million or 8.5% due to a higher depreciable plant base. Taxes
other than income taxes decreased $0.7 million or 12.1% due to a decrease in
property tax as a result of a change in assessed values and a decrease in social
security taxes.
Transmission
The table below sets forth the operating results for Transmission.
Nine Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- -----------
(In thousands)
Operating revenues:
External customers.................. $ 15,794 $ 17,504 $ (1,710)
Intersegment revenues............... 24,636 24,214 422
------------ ------------ ------------
Total revenues...................... 40,430 41,718 (1,288)
Less: Cost of energy.................. 3,640 3,054 586
------------ ------------ ------------
Gross margin.......................... 36,790 38,664 (1,874)
------------ ------------ ------------
Energy production costs............... 799 443 356
Transmission O&M...................... 9,965 11,090 (1,125)
Administrative and general............ 1,266 1,680 (414)
------------ ------------ ------------
Total non-fuel O&M.................. 12,030 13,213 (1,183)
Corporate allocation.................. 3,506 3,851 (345)
Depreciation and amortization......... 7,348 6,479 869
Taxes other than income taxes......... 1,835 1,818 17
Income taxes.......................... 2,877 3,491 (614)
------------ ------------ ------------
Total non-fuel operating expenses... 27,596 28,852 (1,256)
------------ ------------ ------------
Operating income...................... $ 9,194 $ 9,812 $ (618)
------------ ------------ ------------
Operating revenues decreased $1.3 million or 3.1% and gross margin
decreased $1.9 or 4.8% over the prior year period primarily due to lower demand
for wheeling of $2.4 million to California from Arizona as a result of lower
demand in the California market, partially offset by higher New Mexico retail
sales of $1.5 million.
Total non-fuel O&M expenses decreased $1.2 million or 9.0% over the prior
year period. Transmission O&M decreased $1.1 million or 10.1% due to a decrease
in lease costs of $2.2 million for the EIP transmission line, a portion of which
was repurchased in April 2003, partially offset by increased maintenance costs
for reliability purposes.
65
Wholesale
The table below sets forth the operating results for Wholesale.
Nine Months Ended
September 30,
-------------------------
2003 2002 Variance
------------ ----------- ------------
In thousands)
Operating revenues:
External customers................. $ 414,051 $ 204,087 $209,964
Intersegment revenues.............. 1,535 - 1,535
------------ ------------ ------------
Total revenues..................... 415,586 204,087 211,499
Less: Cost of energy................. 307,366 142,945 164,421
Intersegment energy transfer.. 30,460 22,471 7,989
------------ ------------ ------------
Gross margin......................... 77,760 38,671 39,089
------------ ------------ ------------
Energy production costs.............. 22,181 20,333 1,848
Administrative and general........... 6,277 4,212 2,065
------------ ------------ ------------
Total non-fuel O&M................. 28,458 24,545 3,913
Corporate allocation................. 2,999 3,375 (376)
Depreciation and amortization........ 10,639 6,179 4,460
Taxes other than income taxes........ 2,517 2,005 512
Income taxes......................... 8,629 (3,300) 11,929
------------ ------------ ------------
Total non-fuel operating expenses.. 53,242 32,804 20,438
------------ ------------ ------------
Operating income..................... $ 24,518 $ 5,867 $ 18,651
------------ ------------ ------------
The following table shows revenues by customer class:
Wholesale Revenues
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts.... $102,023 $45,742 $56,281
Forward sales*......... 125,656 2,047 123,609
Short-term sales....... 187,907 156,298 31,609
------------- ------------- --------------
$415,586 $204,087 $211,499
============= ============= ==============
*Includes mark-to-market gains/(losses).
66
The following table shows sales by customer class:
Wholesale Sales
Nine Months Ended
September 30,
2003 2002 Variance
------------- ------------- ---------------
(Megawatt hours)
Long-term contracts.... 1,792,653 669,100 1,123,553
Forward sales.......... 2,580,380 - 2,580,380
Short-term sales....... 4,323,668 5,623,388 (1,299,720)
------------- ------------- ---------------
8,696,701 6,292,488 2,404,213
============= ============= ===============
Operating revenues increased $211.5 million or 103.6% over the prior year
period to $415.6 million. This increase in wholesale electric sales primarily
reflects additional long-term contract sales and more normalized wholesale
market conditions. The Company delivered wholesale (bulk) power of 8.7 million
MWh of electricity for the nine months ended September 30, 2003, compared to 6.3
million MWh for the same period in 2002. In addition, effective January 1, 2003,
the Company adopted EITF 02-3 which resulted in the reclassification of
contracts that were previously accounted for under EITF 98-10 to a net margin
basis. Therefore, in 2002, $54.9 million of purchased power expense was netted
against revenues for a net margin of $2.0 million in 2002. These sales and
purchases were accounted for in the forward sales market.
The gross margin, or operating revenues minus cost of energy sold and
intersegment energy transfer, increased $39.1 million or 101.1% over the prior
year period. A higher gross margin was achieved primarily by additional
long-term sales under new and existing contracts, a return to more rational
electric commodity market prices and improving market liquidity. The addition of
long-term contracts added $25.3 million or 64.6% of the total gross margin
increase for the period. In addition, long-term contract margin increased due to
the transfer of a significant customer from retail to wholesale. Forward sales
margin increased $11.7 million or 29.9% of the total gross margin increase
reflecting the higher prices. The average price realized by the Company on its
forward sales was $49 per MWh in 2003, compared to $38 per MWh in 2002.
Short-term sales margin increased $2.1 million or 5.4% of the total gross margin
increase due to commodity price stability, partially offset by lower volume due
to retail growth, increased long-term sales contracts and fewer available
resources caused by increased outages. The average price realized by the Company
on its short-term sales was $43 per MWh in 2003, compared to $28 per MWh in
2002. Overall open market sales (forward and short-term sales) averaged $45 per
MWh in 2003 versus $29 per MWh in 2002. This increase was partially offset by
planned and unplanned outages at SJGS, which reduced availability of power for
wholesale sales, largely in the first quarter. In addition, the Company had to
buy power in the open market at higher prices to cover its contractual
obligations, which resulted in increased power costs. The Company also had a
favorable change in the unrealized mark-to-market position of the forward sales
portfolio of $1.9 million period-over-period ($3.2 million gain in 2003 versus
$1.4 million gain in 2002).
Total non-fuel O&M expenses increased $3.9 million or 15.9% over the
prior year period. Energy production costs increased $1.8 million or 9.1%
primarily due to increased costs of $2.5 million for PVNGS Unit 3 and $0.4
million at SJGS related to various planned and unplanned outages. In addition,
the new Afton and Lordsburg gas fired facilities, which became operational in
67
late 2002, incurred operating costs of $1.1 million in 2003. These increases
were partially offset by decreased decommissioning expense of $2.4 million.
Administrative and general increased $2.1 million or 49.0% primarily due to
combustion turbine storage costs of $1.0 million and increased pension and
benefits costs of $1.4 million at SJGS and PVNGS. Depreciation and amortization
increased $4.5 million or 72.2% primarily due to the addition of Lordsburg and
Afton. Taxes other than income taxes increased $0.5 million or 25.5% primarily
due to the addition of Afton and Lordsburg.
Corporate and Other
Corporate administrative and general, which represent costs that are
driven primarily by corporate-level activities, is allocated to the business
segments and is presented in the corporate allocation line item in the segment
statements. These costs increased $8.7 million or 12.6% over the prior year
period to $77.8 million. This increase was due to increased pension and benefits
expense of $12.6 million, resulting from lower prior-year returns on pension
investments and increasing healthcare costs. Labor costs increased $1.5 million
due to a transfer of employees to Corporate. Consulting expenses increased $1.7
million primarily for Sarbanes-Oxley Act compliance and other corporate
initiatives. The Company had system conversion expenses of $0.8 million for new
information system implementations. In addition, regulatory commission expenses
increased $0.6 million from environmental costs. These increases were partially
offset by non-recurring 2002 severance costs of $8.8 million due to the
realignment.
Taxes other than income taxes decreased $2.2 million over the prior year
period to a benefit of $1.0 million due to the favorable assessment of
outstanding tax issues, a decrease in property taxes as a result of a change in
assessed value and a decrease in social security taxes resulting from lower
payroll costs.
Consolidated
Other Income and Deductions
Other income increased $0.2 million or 0.4% over the prior year period
reflecting higher year-over-year returns on investments of $1.0, mostly offset
by a decrease in the short-term investment balance resulting in decreased
interest income of $0.8 million. Cash from the redemption of short-term
investments was primarily used for the Company's repayment of the EIP long-term
debt, debt refinancing, repayment of short-term debt and pension funding.
Other deductions increased $30.5 million over the prior year period
primarily due to a charge of $16.7 million in 2003 for the write-off of
transition costs due to the repeal of deregulation in New Mexico and a write-off
of $16.6 million for costs related to long-term debt refinancing. These
decreases were partially offset by decreased realized losses on investments of
$3.5 million.
Interest Expense
Interest expense increased $7.5 million or 16.4% over the prior year
period primarily due to decreased capitalized interest of $4.6 million due to
the completion of the two southern New Mexico gas-fired plants in 2002. Higher
average short term borrowing levels also contributed to the increase.
68
Income Taxes
The Company's consolidated income tax expense before the cumulative
effect of a change in accounting principle was $25.7 million for the nine months
ended September 30, 2003, compared to $27.1 million for the nine months ended
September 30, 2002. The decrease was due to the impact of lower pre-tax
earnings. The Company's effective income tax rates for the nine months ended
September 30, 2003 and 2002 were 36.2% and 33.5%, respectively. The increase in
the effective rate period over period was due to a reduction in permanent tax
benefits.
Cumulative Effect of a Change in Accounting Principle
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 $0.94 per
diluted common share, representing amounts expensed in prior years in excess of
legal obligations related to fossil-fuel and nuclear generation plants.
CRITICAL ACCOUNTING POLICIES
As of September 30, 2003, other than the adoption of SFAS No. 143, 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, 2002. The policies disclosed included the accounting for: revenue
recognition; regulatory assets and liabilities; asset impairment, pension and
other post-retirement benefits; decommissioning costs; self-insurance;
contingent liabilities; environmental issues; legal fees and risk management.
See Note 1 to the Consolidated Financial Statements for a discussion regarding
asset retirement obligations.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2003, the Company had cash and short-term investments of
$12.3 million compared to $83.3 million in cash and short-term investments at
December 31, 2002.
Cash provided by operating activities for the nine months ended September
30, 2003 was $162.3 million compared to $100.6 million for the nine months ended
September 30, 2002. This increase in cash flows was due to increased
profitability in the Company's wholesale power operations, higher gas sales
volumes and lower tax payments. The Company did not make its first quarter 2001
estimated federal income tax payment of $32.0 million until January 2002 because
of an extension granted by the IRS to taxpayers in several counties in New
Mexico as a result of wildfires in 2000. This increase in operating cash flows
was offset by a decrease in the working capital change year-over-year resulting
from higher wholesale electric prices and volume and higher gas prices in the
current year. The Company's working capital is negatively affected by the timing
difference in gas purchases and collections. The Company pays for gas in the
month following purchase. Recovery of gas costs has typically taken up to three
months. The negative effect of this mismatch in cash flows was greater in 2003
due to the increase in gas prices. The increase in accounts receivable reflects
higher wholesale electric prices in 2003.
69
Cash used for investing activities was $52.1 million in 2003 compared to
$135.5 million in 2002. Cash used in 2002 for investing activities included
construction expenditures for new generating plants of $77.3 million. Payments
for combustion turbines were $11.1 million in 2003 compared to $19.4 million in
2002. Cash used for investing activities in 2003 also included 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 $80.3 million in 2003 at the Holding Company level as compared to
$45.0 million in 2002 at PNM. 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.
Cash used for financing activities was $101.5 million in 2003 compared to
cash generated by financing activities of $36.5 million in 2002. Financing
activities in 2003 primarily consisted of the repurchase of long-term debt of
$26.1 million, costs associated with the refunding and refinancing of long-term
debt of $55.3 million and short-term debt repayments of $17.1 million. In 2002,
the Company had short-term borrowings of $65.0 million for short-term liquidity
needs.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without DOL approval, provided that the contribution does
not otherwise constitute a prohibited transaction under ERISA. On June 11, 2003,
a contribution of 1,121,495 Holding Company common shares (approximately $28.9
million in market value) was made to the Company's retirement plan.
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
eliminate capital expenditures for previously planned generation expansion until
market conditions warrant further investment. Projections for total capital
requirements for 2003 are $176 million and projections for construction
expenditures for 2003 are $156 million. Total capital requirements are projected
to be $800 million and construction expenditures are projected to be $708
million for 2003-2007. These estimates are under continuing review and subject
to on-going adjustment. This projection excludes any generation fleet expansion
capital. Such projects are subject to market opportunities and can not be
forecasted to any one time period. However, 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.
In the nine months ended September 30, 2003, 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
70
meet all of its capital requirements for the years 2003 through 2007. 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 October 31, 2003, PNM had $305 million of liquidity arrangements.
The liquidity arrangements consist of $195.0 million from an unsecured revolving
credit facility ("Credit Facility"), $90.0 million from an accounts receivable
securitization program ("AR Securitization") and $20.0 million in local lines of
credit. PNM entered into a new revolving credit facility on December 19, 2002,
which increased borrowing capacity from $150.0 million to $195.0 million. This
facility will mature December 18, 2003. PNM is currently in the process of
renewing its Credit Facility. PNM anticipates the new facility to provide
committed borrowing capacity of $300.0 million with a three-year term and
currently intends for it to be in place before the end of November 2003. There
were $50.7 million in borrowings against the Credit Facility and PNM was using
$25.0 million of the AR Securitization capacity. PNM had $49.9 of commercial
paper outstanding as of October 31, 2003. In addition, the Holding Company has
$15.0 million in local lines of credit.
On April 8, 2003, the Company entered into the AR Securitization
providing for the securitization of PNM's retail electric service accounts
receivable and retail gas services accounts receivable. The total capacity under
the AR Securitization is $90.0 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable, principally retail receivables, to a
bankruptcy remote subsidiary, PNM Receivables Corp, which in turn pledges an
undivided interest in the receivables to an unaffiliated conduit commercial
paper issuer. This transaction was previously approved by the PRC on December
17, 2002.
On April 1, 2003, PNM exercised its early buyout option related to a 60%
interest in the EIP transmission line and related facilities held under lease.
Through the exercise of the early buyout option, PNM was able to retire all
$26.2 million of secured facility bonds, which were issued to originally finance
the sale-leaseback transaction. The secured facility bonds had previously been
disclosed as off balance sheet debt in the notes to the Company's financial
statements. The Company will continue to exclude $4.5 million of lease
obligations relating to the 40% interest the Company does not own from the
consolidated balance sheet.
On June 12, 2003, the Holding Company and PNM both filed universal shelf
registration filings with the SEC for a combination of debt and equity
securities for $500.0 million and $285.0 million, respectively. The PNM shelf
registration, when combined with a previously filed shelf, provides $500.0
million of capacity. The PNM and Holding Company shelf registrations were
declared effective June 28, 2003 and August 28, 2003, respectively. On September
9, 2003, PNM sold $300.0 million of debt under its shelf registration (see
"Financing Activities" below). As of September 30, 2003, the Holding Company and
PNM had remaining securities registered under the shelf registrations of $500.0
million and $200.0 million, respectively.
On August 27, 2003, the Company entered into an unrated private issuance
commercial paper program. The Company will periodically issue up to $50.0
million in unrated commercial paper for the shorter of 120 days or the maturity
of the Company's Credit Facility. The commercial paper is unsecured and the
proceeds will be used to reduce revolving credit borrowings. The Company's
Credit Facility serves as a backstop for the outstanding commercial paper.
71
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 positive by Moody's Investor Services,
Inc. ("Moody's"), Standard and Poor's Ratings Services ("S&P") and Fitch, Inc.
("Fitch"). The Company is committed to maintaining or improving its investment
grade ratings. On June 13, 2003, S&P improved PNM's business position to a five
from its previous position of six. S&P currently rates PNM's senior unsecured
notes ("SUNs") "BBB-" and its preferred stock "BB". Moody's rates PNM's SUNs and
senior unsecured pollution control revenue bonds "Baa3" and its preferred stock
"Ba2". Fitch rates PNM's SUNs and senior unsecured pollution control revenue
bonds "BBB-" and its preferred stock "BB-." 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.
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. In
addition, the Credit Facility contains a contingent requirement that requires
72
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.
Financing Activities
Pursuant to PRC approval, on September 9, 2003, PNM sold $300.0 million
of senior unsecured notes with a coupon of 4.40% that mature September 15, 2008.
The transaction closed on September 17, 2003 and the proceeds were used to
retire $268.4 million of long-term debt that would otherwise have matured in
August 2005, pay the transaction costs, and improve working capital. All other
long-term debt of PNM matures in 2016 or later. The premium paid to refinance
the long-term debt was $23.9 million of which $16.6 million was charged against
earnings based on prior regulatory agreements. The remaining balance was
capitalized as loss on reacquired debt and will be amortized over the life of
the new debt.
On May 13, 2003, the Company priced $182.0 million of tax exempt
pollution control bonds. The bonds were priced at a one-year interest rate of
2.75%. The bond sale closed on May 23, 2003. The bonds will need to be
remarketed at the end of the one-year interest rate period. A portion of the
proceeds were used to refund the $46.0 million of pollution control bonds, which
became callable on December 15, 2002. Additionally, the remaining $136.0 million
was placed in an escrow account to be used to refund the same amount of
pollution control bonds. The remaining $136.0 million of pollution control bonds
were redeemed on August 15, 2003. Both of these issuances were previously hedged
(see Note 3 - Fair Value of Financial Instruments - Forward Starting Interest
Rate Swaps).
The Company could enter into other long-term financings 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.
73
Capital Structure
The Company's capitalization, including current maturities of long-term
debt, is shown below:
September 30, December 31,
2003 2002
------------- ------------
Common Equity....................... 51.7% 49.5%
Preferred Stock..................... 0.6 0.7
Long-term Debt...................... 47.7 49.8
------------- ------------
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 $180.3 million as of September
30, 2003 and $195.8 million as of December 31, 2002.
PNM LABOR UNION NEGOTIATIONS
PNM and the International Brotherhood of Electrical Workers ("IBEW")
Local Union 611 successfully completed negotiations for a successor collective
bargaining agreement during June 2003. The new agreement, which covers the
approximately 580 bargaining unit employees in Electric, took effect July 5,
2003 and will expire on April 30, 2005.
OTHER ISSUES FACING THE COMPANY
See Note 5 - "Commitments and Contingencies" in the Notes to Consolidated
Financial Statements.
NEW AND PROPOSED ACCOUNTING STANDARDS
See Note 8 - "New and Proposed 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 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 risk and uncertainties. The Company
assumes no obligation to update this information.
Because actual results may differ materially from expectations,
projections, estimates, goals and targets, the Company cautions readers not to
place undue reliance on these forward-looking statements. Future financial
results will be affected by a number of factors, including interest rates,
weather, fuel costs, 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 system, state and federal regulatory and legislative decisions and
actions, the outcome of legal proceedings and the performance of state, regional
and national economies.
74
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.
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 Chief Accounting Officer, 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).
75
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.
The Company's Wholesale Operations, including long-term contracts,
forward sales and short-term sales, are managed through an asset-backed
marketing strategy, whereby PNM's aggregate net open forward contract position
is covered by its forecasted excess generation capabilities. PNM is 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 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. Gains or losses are recognized when the hedged
transaction settles. Derivatives that meet the normal sales and purchases
exceptions within SFAS 133 are not marked to market but rather recorded in
results of operations when the underlying transaction settles. However, if the
Company's forward contracts that are typically designated as normal pursuant to
SFAS 133 do not meet the definition of a capacity contract pursuant to SFAS 149,
they would be marked to market which will substantially increase the number of
the Company's contracts subject to mark-to-market accounting.
(Intentionally left blank)
76
The following table shows the net fair value of mark-to-market energy
contracts included in the balance sheet:
September 30, December 31,
2003 2002
------------- ------------
(In thousands)
Mark-to-Market Energy Contracts:
Current asset................................... $ 3,681 $ 4,531
Long-term asset................................. 1,074 267
------------- ------------
Total mark-to-market assets................ 4,755 4,798
------------- ------------
Current liability............................... (3,816) (5,725)
Long-term liability............................. (755) -
------------- ------------
Total mark-to-market liabilities........... (4,571) (5,725)
------------- ------------
Net fair value of mark-to-market energy contracts.. $ 184 $ (927)
============= ============
The mark-to-market energy portfolio positions represent net assets at
September 30, 2003 and represent net liabilities at December 31, 2002 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 September 30, 2003
and December 31, 2002, PNM did not have any 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 2003 as compared to
2002.
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:
Nine Months Ended
September 30,
2003 2002
------------ ------------
(In thousands)
Sources of Fair Value Gain/(Loss)
Fair value at beginning of year............ $ (927) $(30,440)
Amount realized on contracts delivered
during period........................... (3,271) 6,220
Changes in fair value...................... 4,382 15,887
------------ ------------
Net fair value at end of period............ $ 184 $(8,333)
============ ============
Net change recorded as mark-to-market...... $ 1,111 $ 22,107
============ ============
77
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 September 30, 2003
Maturities
---------------------------------------------
Less than
1 year 1-3 Years Total
-------------- -------------- -------------
(In thousands)
$ (135) $ 319 $ 184
As of September 30, 2003, 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
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 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.
78
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 $86 thousand at September 30, 2003. 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 $3.6 million at
September 30, 2003.
The following table shows the high, average and low market risk as
measured by VAR on the Company's mark-to-market portfolio:
Three Months Ended
September 30, 2003
Period
High Average Low End
-------- --------- -------- --------
(In thousands)
Three day holding period, 99%
two-tailed confidence level......... $394 $101 $6 $ 86
One day holding period, 99%
two-tailed confidence level......... $227 $ 59 $3 $ 50
Ten day holding period, 95%
two-tailed confidence level......... $548 $141 $8 $120
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
market and credit risk. PNM's credit risk with its largest counterparty as of
September 30, 2003 was $23.9 million.
In 2001, in response to the increased credit risk and market price
volatility described above, the Company provided an allowance against revenue of
$12.0 million for anticipated losses to reflect management's estimate of the
increased market and credit risk in the wholesale power market and its impact on
2001 revenues. As of December 31, 2001, $8.9 million was transferred to the
allowance for bad debt. Based on information available at September 30, 2003,
the Company believes the total allowance for anticipated losses (exclusive of
bad debt), currently established at $2.4 million, is adequate for management's
estimate of losses from credit risk. The Company will continue to monitor the
wholesale power marketplace and adjust its estimates accordingly.
79
The following table provides information related to PNM's credit exposure
as of September 30, 2003. The Company does not hold any credit collateral as of
September 30, 2003. 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
September 30, 2003
Net
(b) Number Exposure
Net of of
Credit Counter Counter-
Risk -parties -parties
Rating (a) Exposure >10% >10%
- ------------------------------- ------------ ----------- -------------
(Dollars in thousands)
Investment grade............... $55,112 2 $31,543
Non-investment grade........... 568 -
Split rating................... 362 -
Internal ratings
Investment grade............ 3,080 -
Non-investment grade........ 15,081 1 7,768
------------ -------------
Total.................. $74,203 $39,311
============ =============
Credit reserves $2,433
============
(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.
80
Maturity of Credit Risk Exposure
As of September 30, 2003
Less than Total Net
Rating 2 Years 2-5 Years Exposure
- --------------------------- -------------- -------------- --------------
(In thousands)
Investment grade........... $47,063 $ 8,049 $55,112
Non-investment grade....... 568 568
Split rating............... 362 - 362
Internal ratings
Investment grade........ 3,080 - 3,080
Non-investment grade.... 15,081 - 15,081
-------------- -------------- --------------
Total.............. $66,154 $ 8,049 $74,203
============== ============== ==============
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 September 30, 2003 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 3.3% or $33.1 million if interest rates were to decline by 50
basis points from their levels at September 30, 2003. As of September 30, 2003,
the fair value of PNM's long-term debt was $1,004 million as compared to a
book-value of $987 million. In general, an increase in fair value would 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.
During the nine months ended September 30, 2003, PNM contributed cash of
$20.4 million and approximately $28.9 million in Holding Company common shares
for plan year 2002 and 2003 to the trust for the Company's pension plan. In
addition, the Company contributed cash of approximately $4.6 million to other
post retirement benefits for plan year 2003. The securities held by the trusts
had an estimated fair value of $530.3 million as of September 30, 2003, of which
approximately 31.2% were fixed-rate debt securities that subject the Company to
risk of loss of fair value with movements in market interest rates. If rates
were to increase by 50 basis points from their levels at September 30, 2003, the
decrease in the fair value of the securities would be 2.73% or $4.5 million. PNM
81
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 September 30, 2003. These equity
securities also expose the Company to losses in fair value. Approximately 62.3%
of the securities held by the various trusts were equity securities as of
September 30, 2003 of which 3.4% is composed of the Holding Company Stock
contributed to the pension plan. The Holding Company Stock represents a
concentrated position whose change in value may have an impact on the volatility
of the pension portfolio. The Company is currently implementing a change in the
asset allocation in the pension portfolio, which will reduce the domestic equity
exposure from 55% 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.
In 2001, the Company implemented an enhanced cash management strategy
using derivative instruments based on the S&P 100, S&P 500, and Nasdaq composite
indices. The strategy is designed to capitalize on high market volatility or
benefit from market direction. An investment manager is utilized to execute the
program. The risk related to the program is carefully managed by the RMC and has
VAR and stop-loss limits established. Trades are typically closed-out before the
end of a reporting period and within the same day of execution.
The enhanced cash management program utilizes a one-day VAR under the
variance/covariance model, with a two-tailed confidence interval of 99%. As of
September 30, 2003, the program had no open positions.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure 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. There was no change in
the Company's internal control over financial reporting that occurred during the
Company's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Santa Fe Generating Station
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Santa Fe
Generating Station".
Citizen Suit Under the Clean Air Act
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Citizen Suit
Under the Clean Air Act".
Archeological Site Disturbance
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Archeological
Site Disturbance".
California AG Threatened Litigation
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Western United
States Wholesale Power Market - California AG Threatened Litigation".
California Attorney General Complaint
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Western United
States Wholesale Power Market - California Attorney General Complaint".
California Antitrust Litigation
See "Part I - Item 1. Financial Statements - Notes to Consolidated
Financial Statements - Note 5 - Commitments and Contingencies - Western United
States Wholesale Power - California Antitrust Litigation".
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
4.7.1 Second Supplemental Indenture dated as of September 1,
2003 to Indenture dated as of August 1, 1998, between PNM
and JPMorgan Chase Bank, as Trustee.
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.
83
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.
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 July 17, 2003 pursuant to Item 5 of Form 8-K that the
Company declares quarterly common stock dividend, elects 2 new directors and
approves refinancing $300 million in long-term debt.
Report dated and furnished July 22, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Comparative Operating Statistics for the months of
April, May, June 2003 and 2002 and the year ended April, May, June 2003 and
2002.
Report dated and furnished July 30, 2003 pursuant to Item 12 of Form 8-K that
the Company issued a press release announcing its unaudited results of
operations for the three and six months ended June 2003 and 2002 and other
select financial information.
Report dated and furnished August 21, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Comparative Operating Statistics for the month of July
2003 and 2002 and the year ended July 2003 and 2002.
Report dated and filed August 22, 2003 pursuant to Item 5 of Form 8-K that the
Company plans to issue up to $300 million in new Senior Unsecured Notes ("Suns")
in September 2003.
Report dated and furnished August 22, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Comparative Operating Statistics for the months of
January, February and March 2003 and 2002 and the year ended January, February
and March 2003 and 2002.
Report dated and filed September 11, 2003 pursuant to Item 5 of Form 8-K
reporting the Company issues new debt. Lower cost debt will save the company
$5.0 million in annual interest expense.
Report dated and furnished September 15, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Comparative Operating Statistics for the month of August
2003 and 2002 and the eight months ended August 2003 and 2002.
Report dated and furnished September 18, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Senior Vice President and Chief Financial Officer John
Loyack reaffirmed the company's existing earnings guidance for 2003.
84
Report dated and filed September 23, 2003 pursuant to Item 5 of Form 8-K
reporting the Company plans to redeem $268 million in existing Senior Unsecured
Notes ("SUNs") that pay 7.10% interest.
85
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
---------------------------------------------
(Registrant)
Date: November 13, 2003 /s/ Robin A. Lumney
---------------------------------------------
Robin A. Lumney
Vice President, Controller
and Chief Accounting Officer
(Officer duly authorized to sign this report)
85