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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended DECEMBER 31, 2003

OR

For the transition period from              to             

Commission File Number: 1-8847

TNP ENTERPRISES, INC.

(Exact name of registrant as specified in its charter)

4100 International Plaza, P. O. Box 2943, Fort Worth, Texas 76113

(Address and zip code of principal executive offices)

Telephone number, including area code: 817-731-0099

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x

TNP Enterprises, Inc. has no publicly traded shares of common stock outstanding.

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $0.

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TNP ENTERPRISES INC. AND SUBSIDIARIES (TNP)

Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2003

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Statement Regarding Forward Looking Information

The discussions in this document that are not historical facts, including, but not limited to, future cash flows and the potential recovery of stranded costs are based upon current expectations. Actual results may differ materially. Among the facts that could cause the results to differ materially from expectations are the following: the ability of TNP’s subsidiaries to adapt to open market competition; the ability of First Choice Power, Inc. (First Choice) to attract and retain customers as competition moves forward; the effects of accounting pronouncements that may be issued periodically; changes in regulations affecting TNP’s businesses; decisions in connection with regulatory proceedings including Public Utility Commission of Texas (PUCT) Docket No. 29206, the stranded cost true-up proceeding of Texas-New Mexico Power Company (TNMP); insurance coverage available for claims made in litigation; general business and economic conditions; price fluctuations in the electric power and natural gas markets; collections experience; and other factors described from time to time in TNP’s reports filed with the Securities and Exchange Commission (SEC). TNP wishes to caution readers not to place undue reliance on any such forward looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made.

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PART I

Introduction

TNP was organized as a holding company in 1983 and transacts business through its subsidiaries. On April 7, 2000, pursuant to an Agreement and Plan of Merger among TNP, ST Acquisition Corp. (ST Corp) and SW Acquisition, LP (SW Acquisition), the parent of ST Corp., ST Corp. merged with and into TNP (Merger). TNP is the surviving corporation in the Merger, and is wholly owned by SW Acquisition.

TNP’s principal operations are conducted through TNMP and First Choice. TNMP is a regulated utility operating in Texas and New Mexico. In Texas, TNMP provides regulated transmission and distribution services under the provisions of the legislation that established retail competition in Texas (Senate Bill 7). In New Mexico, TNMP provides integrated electricity services that include transmitting, distributing, purchasing and selling electricity to its New Mexico customers. TNMP’s Texas and New Mexico operations are subject to traditional cost-of-service regulation. Traditional cost-of-service regulation is a method of regulation that sets rates that TNMP can charge to its electricity customers based upon its cost of providing that service. The cost of providing that service includes a return of and on the capital, which TNMP has invested and dedicated to providing electric service. TNMP’s predecessor was organized in 1925. First Choice was organized in 2000 to act as TNMP’s affiliated retail electric provider, as required by Senate Bill 7. TNMP and First Choice are wholly owned subsidiaries of TNP.

TNMP has two subsidiaries, Texas Generating Company, LP (TGC), a Texas limited partnership, and Texas Generating Company II, LLC (TGC II), a Texas limited liability company. TNMP formed TGC and TGC II as Texas corporations to finance construction of TNP One, formerly its sole generation facility. Until May 2001, TNMP owned TNP One together with TGC and TGC II. At that time, TNMP converted TGC and TGC II to their present forms and consolidated the ownership of TNP One into TGC to comply with the Senate Bill 7.

Effective January 1, 2002, Senate Bill 7 established retail competition in the Texas electricity market. Prior to January 1, 2002, TNMP operated as an integrated electric utility in Texas, generating, transmitting and distributing electricity to customers in its Texas service territory. As required by Senate Bill 7, and in accordance with a plan approved by the PUCT, TNMP separated its Texas utility operations into three components:

Upon separation, TNMP provided First Choice equity capitalization of $23 million. No other payments or considerations were exchanged between TNMP, First Choice or TGC in connection with the separation.

TNP, TNMP, and First Choice are all Texas corporations. TGC is a Texas limited partnership and TGC II is a Texas limited liability company. The executive offices of TNP, TNMP, TGC, TGC II and First Choice are located at 4100 International Plaza, P.O. Box 2943, Fort Worth, Texas 76113 and the telephone number is (817) 731-0099. TNP also has an executive office located at 2 Robbins Lane, Suite 201, Jericho, NY 11753 and the telephone number is (516) 933-3100. Unless otherwise indicated, all financial information in this report is presented on a consolidated basis.

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TNMP’s Service Areas

TNMP serves a market niche of smaller- to medium-sized communities. TNMP provides electric service, either directly or through retail electric providers, to more than 252,000 customers in 85 Texas and New Mexico municipalities and adjacent rural areas. Only three of the 85 communities in TNMP’s service territory have populations exceeding 50,000. TNMP’s service territory is organized into two operating areas: Texas and New Mexico. In most areas that TNMP serves, it is the exclusive provider of transmission and distribution services.

Texas

TNMP’s Texas territory consists of three non-contiguous areas. One portion of this territory extends from Lewisville, which is approximately 10 miles north of DFW International Airport, eastward to municipalities near the Red River, and to communities south and west of Fort Worth. A second portion of its territory includes the area along the Texas Gulf Coast between Houston and Galveston, and a third includes areas of far west Texas between Midland and El Paso. In Texas, TNMP provides transmission and distribution service, through retail electric providers, to a variety of entities, including customers engaged in the agricultural, food processing, oil and gas, petrochemical, and tourism industries.

TNMP’s Texas operations lie entirely within the Electric Reliability Council of Texas (ERCOT) region. ERCOT is the independent system operator that is responsible for maintaining reliable operations of the bulk electric power supply system in the ERCOT region, which is located entirely within Texas and serves about 85 percent of the electrical load in Texas.

New Mexico

TNMP’s New Mexico service territory includes areas in southwest and south central New Mexico. TNMP engages in the transmission, distribution, purchase and sale of electricity to residential customers and a variety of commercial and industrial entities, including customers engaged in mining and agriculture, with copper mines as the major industrial customer.

Franchises and Certificates of Public Convenience and Necessity

Texas and New Mexico laws do not require an electric utility to execute a franchise agreement with a municipality to be entitled to provide or continue to provide electrical service within the municipality. A franchise agreement does, however, document the mutually agreeable terms under which the service will be provided within a municipality. TNMP holds 81 franchises with terms ranging from 15 to 50 years, two franchises with a five-year term, and two franchises with indefinite terms from the 85 municipalities to which TNMP provides electric service. These franchises will expire on various dates from 2004 to 2039. Two Texas franchises and one New Mexico franchise, which account for 11 percent of total company revenues, are scheduled to expire in 2004. TNMP intends to negotiate and execute new or amended franchise agreements with these municipalities to be effective before the existing franchises expire. The sales within the 85 franchises currently contribute approximately 62 percent of TNMP’s total revenues. The remainder of TNMP’s revenues are earned from service provided to facilities in TNMP’s service area that lie outside the territorial jurisdiction of the municipalities with which TNMP has franchise agreements.

TNMP also holds PUCT certificates of public convenience and necessity covering all Texas areas that it serves. These certificates include terms that are customary in the public utility industry. TNMP generally has not been required to have certificates of public convenience and necessity to provide electric service in New Mexico. In both Texas and New Mexico, TNMP is the exclusive transmission and distribution provider in nearly all of the areas it serves.

First Choice’s Service Areas

First Choice had approximately 248,000 customers in Texas as of December 31, 2003. This number consists of approximately 176,000 price-to-beat customers and 72,000 customers (residential, commercial, and aggregated municipalities) acquired through competition. The price-to-beat customers are former customers of TNMP that have chosen to remain with First Choice, TNMP’s affiliated retail electric provider. First Choice focuses its competitive customer acquisition efforts in the major metropolitan areas that are open to electric choice within ERCOT, including Dallas-Fort Worth, Houston, Corpus Christi, and McAllen-Harlingen. First Choice is one of twelve retail electric providers competing for mass market customers (residential and small commercial), and one of forty retail electric providers competing for large commercial, and aggregated municipal customers. At December 31, 2003, First Choice’s gigawatt-hour (GWH) sales market share in the competitive regions of ERCOT was slightly greater than 3.2 percent.

Seasonality of Business

TNMP and First Choice experience increased sales and operating revenues during the summer months as a result of increased air conditioner usage in hot weather. In 2003 approximately 41 percent of TNP’s consolidated annual revenues were recorded in June, July, August, and September.

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Sources and Cost of Energy

First Choice assumed the energy supply activities of TNMP in Texas on January 1, 2002. The competitive market created under the provisions of Senate Bill 7 contains no provisions for the specific recovery of fuel and purchased power costs, although First Choice can request that the PUCT change the price-to-beat twice a year to recognize changes in natural gas prices. As a result, changes in the market prices of fuel and purchased power will affect First Choice’s operating results. To manage this risk, First Choice has established a strategy to mitigate the effects of changing prices.

Strategy for mitigating fluctuation in costs of energy supply. On October 28, 2003, Constellation and First Choice executed a new power supply agreement that amended the existing power supply agreement, provided for additional purchases under the existing agreement and stated the parties’ intent to execute a power supply agreement to replace the existing agreement. As a result, Constellation is the primary supplier of power for First Choice’s customers, both price-to-beat and competitive. The new Constellation agreement allows First Choice to execute a risk management policy that establishes limits upon the amount of risk that First Choice may assume. First Choice’s basic strategy is to minimize its exposure to fluctuations in market energy prices by matching fixed price sales contracts with fixed price supply. In addition, First Choice can use its ability to change the price-to-beat fuel factor to mitigate fluctuations in the cost of its price-to-beat energy supply and use various financial instruments to hedge against the risk of adverse changes in natural gas prices.

Benefits provided by new Constellation agreement. As part of the new agreement, First Choice granted a security interest in its accounts receivable to Constellation, which has provided First Choice with sufficient credit for its Texas operations. As a result, First Choice has secured supply to serve all of its forecasted commitments to existing competitive customers for 2004 at fixed prices. In addition, First Choice has secured supply to all of its forecasted commitments to price-to-beat customers for the first nine months of 2004 at fixed prices. First Choice has secured supply to serve its forecasted commitments to price-to-beat customers in the last quarter of 2004 at prices that currently vary with monthly natural gas prices. To mitigate the risk of changes to monthly natural gas prices, First Choice has the ability to file with the PUCT to change the price-to-beat twice in 2004, in the event of significant changes in natural gas prices, or use financial instruments, as discussed previously.

Risk management in 2003. During 2003, prior to amending the existing power supply agreement with Constellation, First Choice lacked sufficient credit to purchase power supply at fixed prices. As a result, First Choice purchased the majority of its power supply at prices that varied with monthly natural gas prices. First Choice mitigated the risk of changes in natural gas prices in 2003 by requesting and implementing two increases in the price-to-beat fuel factor and by purchasing natural gas call options. Purchases of 2003 natural gas call options were delayed until March 2003 due to the discovery that the initial option purchase in November 2002 had been made with an organization created by a now former First Choice employee. This delay resulted in greater First Choice exposure to higher gas prices than it would have incurred had the option coverage began as initially planned.

First Choice executed a number of contracts for competitive customers in late 2002, prior to purchasing the natural gas call options. At the time of executing the contracts, First Choice estimated that energy prices would average $35 per MWH based on gas costs of $3.99 per million British Thermal Units (MMBtu). Natural gas prices started to rise above $3.99 per MMBtu in December 2002 and monthly average prices ranged between $4.69 per MMBtu and $9.13 per MMBtu during 2003. Due to the increase in natural gas prices First Choice realized a net decrease in gross margin of $41.6 million for 2003. During 2003, the price of natural gas paid by First Choice averaged $5.43 per MMBtu.

Risk management beyond 2004. First Choice is implementing the new agreement with Constellation in three phases. Phase one began with the execution of the new power supply agreement described above on October 28, 2003. Phase one ended and phase two began in December 2003, when First Choice executed a restructured power supply agreement with Constellation to replace the previous agreement. The credit terms in place during phase one continue to apply in phase two. In particular, Constellation received a lien against billed and unbilled receivables and a variable amount of cash to cover both settlement exposure and mark-to-market exposure rather than requiring First Choice to post cash collateral for purchased power supply. However, if a dramatic change in electricity or gas forward prices creates an increase in Constellation’s credit exposure to First Choice beyond a limit based on cash and accounts receivable, First Choice will be constrained in its ability to sign up additional customers until that imbalance is corrected.

First Choice expects phase three to begin during the first half of 2004. At that time, First Choice expects to have in place a bankruptcy remote special purpose entity (SPE) that will hold all relevant customer contracts, wholesale power contracts and natural gas contracts. Constellation will receive a lien on the accounts receivable, customer contracts, cash, and equity of the SPE.

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Constellation’s security interest in First Choice receivables during phases one and two, and its liens on the SPE during phase three will provide First Choice with the credit it needs to pursue its strategy for mitigating fluctuations in the cost of its energy supply. In phase three of the Constellation agreement and beyond, First Choice expects to purchase supply to serve its commitments to competitive customers at fixed prices. For price-to-beat customers, First Choice generally expects to purchase supply at prices that vary with monthly natural gas prices, but can, at its discretion, convert those variable prices to fixed prices using various financial instruments. To the extent that changes in the price-to-beat can be requested, First Choice can use such changes to mitigate the risk of changing natural gas prices.

Load Forecasting Risks. First Choice’s load fluctuates continuously due to among other things, customer additions and losses, changes in customers’ usage, severe or unexpected weather and timing of customer switching. First Choice continually monitors and revises its load forecast to account for changing customer loads (both price-to-beat and competitive). First Choice develops short-term load forecasts to identify short-term load surpluses and shortages, and to insure that hedges are in place to cover expected sales. To the extent these short-term load forecasts identify shortages, First Choice covers shortages through short-term power purchases. First Choice may cover off-peak shortages through purchases on the ERCOT balancing market where off-peak prices are generally lower than can be contracted through short-term purchases.

The restructured power supply agreement with Constellation resulted in Constellation assuming the risks related to changes in expected customers’ usage and weather-related risks. First Choice retained the risks associated with customer attrition.

New Mexico. TNMP purchases all electricity for its New Mexico customers’ needs and energy-scheduling services under terms of a long-term wholesale power contract with Public Service Company of New Mexico (PNM). Purchases under the contract are at fixed rates to provide price stability to TNMP’s New Mexico customers. The contract extends through December 2006.

To maintain a reliable power supply for its New Mexico customers and to coordinate interconnected operations, TNMP is a member of the Western Systems Coordinating Council.

Purchased Power Costs. During 2003, TNP’s consolidated average cost per Kilowatt-Hour (KWH) of purchased power was 5.43 cents per KWH. In 2002, TNP’s consolidated average cost of purchased power was 4.05 cents per KWH.

The following table illustrates the composition of TNP’s sources of electric energy in 2003.

New Mexico Purchased Power Recovery

TNMP recovers all New Mexico purchased power costs through the fuel and purchased power adjustment clause authorized by the New Mexico Public Regulation Commission (NMPRC). The purchased power recovery factor changes monthly to reflect over-collections or under-collections of purchased power costs.

Government Regulation

TNMP is subject to various federal, state and local regulations. TNMP possesses all necessary franchises, licenses and certificates to enable it to conduct its business. Within Texas, TNMP is a rate-regulated electric transmission and distribution utility and is subject to the jurisdiction of the PUCT and certain municipalities with respect to rates and service. Within New Mexico, TNMP is subject to the jurisdiction of the NMPRC. TNMP is subject in some of its activities, including the issuance of securities and the acquisition or disposition of properties in New Mexico, to the jurisdiction of the FERC. TNMP’s transmission and distribution activities in Texas are not subject to FERC regulation, because those activities occur solely within the ERCOT system of Texas.

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In addition to regulation as a utility, TNMP’s facilities are regulated by the Environmental Protection Agency and Texas and New Mexico environmental agencies. During 2002 and 2001, TNMP incurred expenses related to air, water, and solid waste pollution abatement (including ash removal) of approximately $3.1 million and $3.8 million, respectively. Substantially all of TNMP’s environmental expenses were incurred at TNP One, which TNMP sold in October 2002.

In October, 2003, the Texas Commission on Environmental Quality (TCEQ) notified various parties including TNMP that releases of hazardous substances had been documented from a site owned and operated by a vendor with whom TNMP had a business relationship. TNMP purchased transformers from the vendor and also sent some transformers to the vendor for repair and/or disposal. TCEQ has requested that TNMP provide records and information relevant to its business relationship with the vendor, which TNMP has done. The TCEQ has not yet identified potentially responsible parties. TNMP is cooperating fully with TCEQ in the ongoing investigation of the vendor and the vendor’s site.

First Choice operates under a certificate issued by the PUCT and is subject to PUCT rules concerning various aspects of customer service and protection. The PUCT also has the authority to approve and, in limited circumstances, change the price-to-beat First Choice charges to its customers.

Employees and Executive Officers

At December 31, 2003, TNP, First Choice and TNMP had 745 employees. The employees are not represented by a union or covered by a collective bargaining agreement. Management believes relations with its employees are excellent. Executive officers of TNP are elected annually by and serve at the discretion of the board of directors.

The executive officers of TNP and the presidents of its principal operating subsidiaries are as follows:

William J. Catacosinos has been Chairman and Chief Executive Officer of TNP since the closing of the Merger in April 2000 and serves on TNMP’s board of directors. He was President of TNP from April 2000 until January 2004. Since November 1998, Dr. Catacosinos has also served as Managing Partner of Laurel Hill Capital Partners. Dr. Catacosinos was Chairman and Chief Executive Officer of Long Island Lighting Company (LILCO) from January 1984 to July 1998.

Michael E. Bray became President and Chief Operating Officer of TNP on January 19, 2004. He became a director of TNP on January 14, 2004. He became a director of TNMP and Chairman of First Choice on February 4, 2004. From July 2000 until September 2003 he was President of PPL Electric Utilities and Vice Chair of PPL Gas Utilities, electric and gas utilities based in Allentown, Pennsylvania. From April 2000 to July 2000 he was Senior Vice President of PPL Electric. From February 1999 to April 2000 he was President and Chief Executive Officer of Consolidated Edison Development, Inc., a power generation subsidiary of Consolidated Edison Company of New York, New York. From March 1997 to February 1999 he was Senior Vice President—Electric Business Unit of LILCO.

Theodore A. Babcock joined TNP upon the closing of the Merger as Chief Financial Officer. Since 1999, Mr. Babcock has been a Managing Director of Laurel Hill. From 1996 to 1998, Mr. Babcock served as Vice President and Treasurer of LILCO.

Jack V. Chambers was named Chairman, President & Chief Executive Officer of TNMP in April 2001. Prior to that time, Mr. Chambers had served as Senior Vice President & Chief Operations Officer of TNMP since October 2000. Mr. Chambers was Senior Vice President and Chief Customer Officer of TNMP from 1994 until October 2000, and Senior Vice President of TNP from April 1996 until the closing of the Merger.

Manjit S. Cheema was elected President of First Choice in August 2001 and Treasurer of TNP in May 2000. He was Senior Vice President & Chief Financial Officer of TNMP from July 1996 until August 2002. Mr. Cheema was Senior Vice President & Chief Financial Officer of TNP from May 1997 until the closing of the Merger.

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Kathleen A. Marion joined TNP upon the closing of the Merger as Corporate Secretary. Since 1999, Ms. Marion has been Executive Administrator of Laurel Hill. From 1994 to 1998, she served as Vice President of Corporate Services and Corporate Secretary of LILCO.

Other Developments

In March 2004, TNP’s Board of Directors authorized TNP’s management to engage Goldman Sachs to advise it on strategic alternatives regarding the future of its businesses.

Transmission and Distribution Facilities

TNMP’s facilities are located within its Texas and New Mexico service areas. TNMP’s Texas transmission and distribution facilities are located in three non-contiguous areas. One area extends from Lewisville, which is approximately 10 miles north of DFW International Airport, eastward to municipalities near the Red River, and to communities south and west of Fort Worth. A second area includes portions of Galveston and Brazoria counties, located along the Texas Gulf Coast between Houston and Galveston, and a third includes areas of far west Texas between Midland and El Paso, extending from the cities of Kermit and Pecos south to Fort Stockton and Sanderson. TNMP’s New Mexico transmission and distribution facilities are located in southwest and south central New Mexico, including the cities of Alamogordo, Ruidoso, Silver City, Lordsburg and surrounding communities.

Management believes that TNMP’s transmission and distribution facilities have sufficient capacity to serve existing customers adequately and that those facilities can be extended and expanded to serve customer growth for the foreseeable future. These facilities primarily consist of overhead and underground lines, substations, transformers, and meters. TNMP generally constructs its transmission and distribution facilities on easements or public rights of way and not on real property held in fee simple.

Administrative and Service Facilities

TNP’s, TNMP’s, and First Choice’s corporate headquarters are located in an office building in Fort Worth, Texas. Space in this building is leased through October 2007. TNP also has an office in Jericho, New York.

TNMP owns or leases 26 construction centers or other office facilities in Texas and New Mexico. First Choice owns or leases local offices in 20 of the Texas municipalities it serves. In addition to these facilities, TNMP owns or leases offices in 12 Texas communities that are shared with First Choice. Such sharing of facilities is allowed through a waiver granted by the PUCT.

Final Fuel Reconciliation. In January 2004, the PUCT issued its final order related to TNMP’s reconciliation of fuel and energy-related costs incurred between January 1, 2000 and December 31, 2001. The reconciliation was required under the provisions of Senate Bill 7. The PUCT’s final order disallowed $15.7 million of fuel and energy-related purchased power costs. TNMP intends to appeal portions of the final order.

Information regarding additional regulatory and legal matters is provided in Notes 2 and 12.

No matters were submitted to a vote of security holders in the fourth quarter of 2003.

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PART II

TNP has no publicly traded shares of common stock outstanding.

The following table sets forth selected financial data of TNP for 1999 through 2003.

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TEXAS-NEW MEXICO POWER COMPANY

SELECTED OPERATING STATISTICS

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FIRST CHOICE POWER, INC.

SELECTED OPERATING STATISTICS

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SIGNIFICANT EVENTS AND KNOWN TRENDS AFFECTING TNP

Competitive Conditions

First Choice Energy Supply

A discussion of the competitive position of TNP with regard to energy supply is included in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk.”

First Choice Customer Operations

As discussed in Note 2, the Texas electricity market has been open to retail competition since January 1, 2002. First Choice has addressed, and continues to address, a number of issues related to the development of retail competition.

Price-to-Beat. First Choice must offer customers that reside in TNMP’s service area, and whose loads are less than 1 megawatt a regulated price, commonly called the price-to-beat. The price-to-beat will be offered through December 31, 2006, and First Choice cannot offer those customers any other rate before the loss of 40 percent of the energy consumed by its price-to-beat customers, or January 1, 2005, whichever occurs first. In January 2004, the PUCT approved a stipulation among TNMP and other parties, which found that First Choice had lost more than 40 percent of the energy consumed by its small commercial price-to-beat customers. As a result of PUCT’s action, First Choice may offer small commercial customers who reside in TNMP’s service area rates other than the price-to-beat. First Choice remains below the 40 percent loss threshold with respect to residential price-to-beat customers. Accordingly, First Choice continues to be prohibited from offering rates other than the price-to-beat to residential customers in TNMP’s service area.

Customer Retention and Acquisition. At December 31, 2003, First Choice served approximately 176,000 customers at price-to-beat rates and approximately 72,000 customers at competitive rates. At December 31, 2002, First Choice served approximately 186,000 and 38,000 price-to-beat and competitive customers, respectively. In response to the factors discussed in Bad Debt and Delinquency, below, First Choice is not actively pursuing mass market customers. Mass market customers who choose First Choice as their retail electric provider are required to make a deposit before First Choice begins service.

Bad Debt and Delinquency. First Choice has the right to disconnect customers that reside in TNMP’s transmission and distribution service territory for nonpayment. First Choice is prohibited from disconnecting customers who reside outside TNMP’s transmission and distribution service territory for nonpayment, but may transfer such a customer to the affiliated retail electric provider of the transmission and distribution service provider that serves the transferred customer.

The structure described above limits First Choice’s collection activities, and affects both bad debt expense and the level of delinquent accounts receivable. Bad debt expense as a percentage of operating revenues for First Choice was approximately 1.9 percent for the year ended December 31, 2003, compared with 1.3 percent during 2002. On average, delinquent accounts receivable were approximately 6.0 percent of monthly operating revenue for the year ended December 31, 2003, compared with the 2002 delinquency rate of 9.7 percent. First Choice expects that its bad debt and delinquency rate will decrease during 2004 due to a number of internal and external factors that are discussed in the remainder of this section.

Switching and Billing Issues. Since retail competition began, transactions and data have not flowed between the market participants as accurately or in the volumes that ERCOT’s system was designed to accommodate. The impaired data flow limits the ability of retail electric providers to switch customers from one retailer to another, and causes billing inaccuracies at First Choice. Retail electric providers, transmission and distribution service providers and ERCOT are all working together to address these problems in order to improve the infrastructure and processes that support the competitive electric market. The efforts of the various market participants have resulted in improvements in the switching process, correcting errors that occurred shortly after the market opened and improving data flows between the market participants. First Choice expects these improvements to continue.

Under retail competition, First Choice must bill its customers using data not only from TNMP, but also from the other transmission and distribution utilities that serve First Choice’s customers. The wider range of sources providing billing data to First Choice has also contributed to billing inaccuracies since the beginning of retail competition. The frequency of these issues has decreased as First Choice and other market participants have gained experience under retail competition. However, First Choice expects it will experience some level of billing issues in the competitive market related to multiple sources of billing data.

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TNMP

TNMP provides transmission and distribution services within TNMP’s Texas service area at regulated rates to various retail electric providers that, in turn, provide retail electric service. As of December 31, 2003, 31 retail electric providers served customers that receive transmission and distribution services from TNMP. First Choice provided electric service to customers that accounted for approximately 56 percent of the energy delivered by TNMP for the year ended December 31, 2003. TNMP’s next largest customer was a non-affiliated retail electric provider that served customers that accounted for approximately 18 percent of the energy delivered by TNMP during the year ended December 31, 2003.

Senate Bill 7 provides for recovery of stranded costs, which is the difference between the regulatory value of TNMP’s investment in generation assets and the market price for energy in a competitive market. On January 22, 2004, TNMP filed its true-up proceeding with the PUCT. The PUCT assigned Docket No. 29206 to the true-up proceeding. The purpose of the true-up proceeding is to quantify and reconcile the amount of stranded costs that TNMP may recover from its transmission and distribution customers. The proceeding will examine a number of issues, including the sale of TNP One that occurred in October 2002, the final fuel reconciliation and the clawback. The issues that will be examined in the true-up proceeding are described more fully in Note 2. The schedule established for the true-up proceeding calls for a final order to be issued near the end of the second quarter of 2004

Critical Accounting Policies

The accounting policies that TNP employed in the preparation of the consolidated financial statements are discussed in Note 1. TNP is required to use estimates in order to prepare the consolidated financial statements in accordance with generally accepted accounting principles. Those estimates include accruals for estimated revenues for electricity delivered from the latest billing date to the end of the accounting period and estimated purchased power expenses incurred but not billed at the end of the accounting period. The use of these estimates is customary in the electric utility industry. Estimated revenues and purchased power expenses are adjusted to the actual amounts billed or incurred in the following month. In addition, purchased power expenses are subject to adjustment due to revisions that ERCOT may make to the metered load of First Choice during ERCOT’s settlement process. These adjustments may occur several months after the actual usage and the amounts of these adjustments can be significant.

TNP also employs certain critical accounting policies that require use of judgments and assumptions that are subject to uncertainty. The amounts reported in the consolidated financial statements that are related to those critical accounting policies could be different if either different judgments were made or different assumptions were used. Those critical accounting policies are discussed below.

Goodwill and Intangible Assets. TNP has goodwill related to the Merger that had a carrying value of $270.3 million as of December 31, 2003. As discussed in Note 10, TNP has apportioned the carrying value of the goodwill between its Regulated Transmission and Distribution segment and First Choice. As of December 31, 2003, TNP had assigned approximately $178.7 million of goodwill to the Regulated Transmission and Distribution segment and approximately $91.6 million to First Choice.

Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS 142) requires TNP to test goodwill for impairment at least annually and more frequently when indicators of impairment exist. TNP performed its annual goodwill impairment test as of December 31, 2003, and concluded that the fair value of the goodwill related to the Merger exceeded its carrying value.

To determine the fair value of the goodwill, TNP estimated the fair value of the Regulated Transmission and Distribution and First Choice segments. TNP’s estimate was based on the present value of the projected cash flows of each segment. Projected cash flows for the segments were derived from TNP’s five-year financial forecast.

The five-year forecast is subject to a number of estimates, including projections of customer growth and margins at First Choice. To the extent the assumptions are not achieved, or cannot be sustained, future assumptions may require modification, and such modifications would affect the estimates of expected cash flows contained in TNP’s annual goodwill impairment test. Accordingly, TNP’s conclusion regarding the fair value of goodwill would be affected by changes in the five-year financial forecast.

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Accounting for Derivatives – Normal Purchases and Sales. In the normal course of business, TNMP and First Choice enter into commodity contracts, which include “swing” components for additional purchases or sales of electricity, in order to meet customer requirements. In most circumstances, such contracts would be defined as derivatives under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” However, the Financial Accounting Standards Board (FASB) has defined criteria by which option-type and forward contracts for electricity could qualify for the normal purchase and sales exception provided by SFAS 133, as amended by SFAS 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities.” Based on the FASB’s guidance, the management of TNMP and First Choice has determined that their respective contracts for electricity qualify for the normal purchases and sales exception. Accordingly, TNMP and First Choice do not account for their respective electricity contracts as derivatives.

If TNMP and First Choice were required to account for their respective electricity contracts as derivatives, the fair values of the contracts would be recorded on the balance sheet as assets or liabilities. Changes in the fair values of the contracts would be recognized in earnings.

Recoverable Stranded Costs – Sale of TNP One. TNMP sold TNP One in October 2002. Based on TNMP’s true-up filing, as discussed in Note 2, the fair value of TNP One, less cost to sell, was approximately $117.6 million. The book value included in the true-up filing was approximately $425.1 million. TNMP believes that the difference between the fair value of TNP One, net of selling costs, and its book value is recoverable from TNMP’s Texas transmission and distribution customers under the provisions of Senate Bill 7.

Under the provisions of Senate Bill 7, the amount and manner of stranded cost recovery is subject to review and approval by the PUCT as part of the true-up proceeding. In addition to the sale of TNP One, other issues will affect the amount of stranded costs that TNMP will recover from its customers. Those other issues include, among others, the final fuel reconciliation, as discussed in Note 2.

Action taken by the PUCT in the true-up proceeding could affect the ultimate recovery of the amounts requested as recoverable stranded costs. PUCT action that limits the recovery of requested stranded costs could have a material impact on TNP’s and TNMP’s financial position and cash flows.

Results of Operations

2003 Compared With 2002

Overall Results

For the year ended December 31, 2003, TNP had a loss applicable to common stock of $40.3 million compared with income applicable to common stock of $13.0 million for the year ended December 31, 2002. The changes in TNP’s earnings for 2003 compared with 2002 are attributable to the factors listed below (in millions):

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Index to Financial Statements

First Choice Results

For the year ended December 31, 2003, First Choice had a net loss of $13.3 million, compared with net income of $26.0 million for the year ended December 31, 2002. The changes in First Choice’s earnings for 2003 compared with 2002 are attributable to the factors listed below (in millions):

First Choice Gross Profit

The following table summarizes the components of First Choice gross profit (in thousands).

Transmission and distribution costs are included in the “Other operating and maintenance” line of TNP’s consolidated income statement. The clawback accrual is shown on the income statement as “Accrual for payment to TNMP.” The following table summarizes the components of the change in First Choice’s gross profit for, 2003, compared with 2002 (in thousands).

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Index to Financial Statements

Gross profit for the year ended December 31, 2003, decreased $49.5 million compared with the corresponding 2002 period. The decrease resulted primarily from higher purchased power expenses, partially offset by higher revenues from both price-to-beat and competitive customers.

For the year ended December 31, 2003, revenues, net of transmission and distribution charges, from price-to-beat customers increased $31.2 million compared with the year ended December 31, 2002. The increase resulted from increases in the price-to-beat fuel factor during 2003, partially offset by losses of price-to-beat customers during 2003 in response to price increases, and milder than normal weather in the third quarter of 2003.

Revenues from competitive customers, net of transmission and distribution charges, increased $109.6 million for the year ended December 31, 2003, compared with the year ended December 31, 2002. Changes in rates accounted for $41.7 million of the increase. During 2003, First Choice charged competitive customers higher rates to offset increasing natural gas prices. The remaining $67.9 million increase reflects higher sales resulting from First Choice’s acquisition of customers in the competitive market.

Retail electric providers such as First Choice include a transmission and distribution charge in the prices they charge their customers for electric service. The transmission and distribution charge is regulated by the PUCT and is designed to allow the utility that provides transmission and distribution services within a specific service area, referred to as the transmission and distribution service provider, to recover its cost of service. For the year ended December 31, 2003, First Choice billed and incurred transmission and distribution costs related to sales to competitive customers of $103.6 million, compared with $60.1 million for the year ended December 31, 2002. As noted above, the increases reflect the acquisition of customers in the competitive market by First Choice.

Price-to-beat-related transmission and distribution revenues and costs were $103.4 million for the year ended December 31, 2003, compared with $101.6 million for the year ended December 31, 2003. The increase is primarily attributable to higher sales in the first half of 2003 compared with the first half of 2002, partially offset by losses of price-to-beat customers during 2003 in response to price increases, and lower sales due to milder than normal weather in the third quarter of 2003.

Purchased power and fuel expenses increased $203.7 million for the year ended December 31, 2003, compared with the amount incurred in the same period in 2002. Increases in the price of natural gas were primarily responsible for $140.6 million of the increase. The price increases accelerated in December 2002, and First Choice responded to the increases by seeking increases in the price-to-beat fuel factor and by purchasing natural gas hedges to mitigate the risk of increasing natural gas prices. First Choice began implementing its strategy in November 2002. An additional $67.3 million of the increase is primarily attributable to increased purchases of power to supply customers acquired by First Choice in the competitive market.

These increases were partially offset in 2003 by adjustments resulting from the resettlement of 2002 purchased power expense by ERCOT. As discussed earlier in “Competitive Conditions,” participants in the competitive market experienced impaired data flows at the beginning of competition. As a result, First Choice and other retail electric providers had difficulty determining when to transfer ownership of customers that had switched from one retail electric provider to another. In addition, the metering data that ERCOT used to determine the various retail electric providers’ electric load during 2002 was not accurate in every case. First Choice and the other market participants have been working to correct the impaired data flows and have made considerable progress. In September 2003, as a result of this corrective process, ERCOT adjusted the metered load of First Choice for the period August through December 2002. The adjustment to metered load reduced purchased power expenses by $8.5 million, resulting in a net reduction to purchased power expense of $4.2 million for the year ended December 31, 2003.

During 2003, First Choice increased its pre-tax reserve related to a provision of Senate Bill 7, commonly known as the clawback, by $3.2 million. The clawback provision requires First Choice to credit TNMP with the difference between the price-to-beat and the market price of electricity during the years 2002 and 2003. During 2002, First Choice recorded $12.7 million related to the clawback liability. Additional details of the clawback are discussed in Note 2.

Other Operating and Maintenance

For the year ended December 31, 2003, other operating and maintenance expenses increased $14.4 million compared with the same period in 2002. The increase resulted from a higher reserve for uncollectible accounts receivable of $7.4 million, and increased personnel and outside services costs in First Choice’s customer service organization of $6.1 million.

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Index to Financial Statements

TNMP Results

For the year ended December 31, 2003, TNMP had income applicable to common stock of $25.3 million compared with income applicable to common stock of $36.1 million for the twelve months ended December 31, 2002. The changes in TNMP’s earnings for 2003 compared with 2002 are attributable to the factors listed below (in millions):

TNMP Gross Profit

The following table summarizes the components of TNMP’s gross profit (in thousands).

Transmission expense is included in the “Other operating and maintenance” line of TNMP’s consolidated income statement.

The following table summarizes the components of the change in TNMP’s gross profit for the year ended December 31, 2003, compared with the same period in 2002 (in thousands).

Gross profit for the year ended December 31, 2003, decreased $23.7 million compared with the corresponding 2002 period. The decrease is attributable to the loss of revenue from the sale of TNP One output, which TNMP sold in October 2002, and a disallowance of fuel and energy-related purchased power costs that occurred in the final fuel reconciliation in Texas. The final fuel reconciliation is discussed in Note 2. In addition, 2002 gross profit included revenues from the billing of bundled rates in January 2002 that were not present in 2003.

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Although retail competition began on January 1, 2002, TNMP’s former customers were transferred to First Choice following their January 2002 meter reading. As a result, TNMP’s January 2002 revenues include charges for service rendered through January 2002 meter reading dates at prices that reflect its integrated operations prior to competition. Beginning in February 2002, TNMP’s revenues reflected rates designed to recover its cost of providing transmission and distribution service under the provisions of Senate Bill 7. Those rates are lower than the rates TNMP charged prior to the beginning of competition, and resulted in decreased gross profit in the twelve months ended December 31, 2003. The table above quantifies the impact of changing TNMP’s rates to recover its cost of providing only transmission and distribution service.

In the first quarter of 2002, TNMP sold the output of TNP One to First Choice at cost, which was 2.5 cents per kilowatt-hour (KWH). First Choice used the power to serve its customers’ load. Beginning in April 2002, TNMP sold the output of TNP One to third parties at prices that averaged 2.8 cents per KWH, until the sale of TNP One in October 2002. TNMP realized pre-tax income of $4.3 million related to third party sales for the year ended December 31, 2002.

Electric service revenues increased because TNMP provided a greater number of fee-based services to retail electric providers in the year ended December 31, 2003, compared with the same period in 2002. The fee-based services included account initiation charges, service call charges, disconnect/reconnect charges and various metering charges, among others. Some of the charges for fee-based services that TNMP provided to retail electric providers were included in the bundled rates TNMP charged its customers prior to competition.

The $3.2 million gross profit increase described as “price/sales mix and other” for the year ended December 31, 2003, compared to the corresponding 2002 period, is primarily attributable to increased revenues from commercial and industrial customers in Texas. A significant portion of those customers’ revenues are calculated based upon those customers’ highest peak demand for electricity in the twelve month period ending in the month that the customers are billed. Customers’ bills during 2003 were based upon a full twelve months of demand data, but customers’ bills during 2002 were based upon less than twelve months of demand data due to the beginning of retail competition in January 2002. As a result, some 2002 bills were lower than they normally would be, because the demand data for the summer months of 2001, during which these customers typically have their highest demand, could not be included in the calculation of the customers’ bills.

Purchased power and fuel expenses decreased $32.9 million for the year ended December 31, 2003, compared with the amount incurred in the same period in 2002. Expenses in 2002 included fuel costs of $35.5 million at TNP One, which was sold in October 2002.

Operating Expenses

For the year ended December 31, 2003, TNMP incurred operating expenses of $183.7 million, a decrease of $43.6 million from the amount incurred during the corresponding period of 2002. The primary reason for the decrease was the absence of the operating expenses related to TNP One in 2003 resulting from the sale of TNP One in October 2002. TNMP does not expect similar decreases in operating expenses in the future.

Operating expenses include purchased power and fuel, and transmission expense. Those expenses decreased $30.7 million for the year ended December 31, 2003, compared with the same periods in 2002.

The details in the changes of purchased power and fuel, and transmission expense, are discussed above in “TNMP Gross Profit.” The remaining components of the changes in operating expenses are discussed below.

Other Operating and Maintenance

Other operating and maintenance expenses decreased $11.4 million for the year ended December 31, 2003, compared with the same period in 2002. The decrease is related to operating expenses of TNP One, which was sold in October 2002 and to TNMP’s establishment of a regulatory asset related to unrecovered System Benefit Fund payments, as discussed in Note 2.

Taxes Other Than Income Taxes

Taxes other than income taxes decreased $3.3 million for the year ended December 31, 2003, compared with the corresponding 2002 period. The decrease is primarily related to ad valorem taxes on TNP One, which was sold in October 2002.

Interest Expenses

Interest expenses increased $7.1 million for the year ended December 31, 2003, compared to the same period in 2002. The increase reflects interest on the issuance of TNMP’s $250 million of 6.125 percent Senior Notes due 2008 and $3.1 million of charges associated with the termination of its interest rate swaps upon the issuance of the Senior Notes in June 2003.

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TNP Preferred Stock Dividends

Dividends on preferred stock increased $2.8 million for the year ended December 31, 2003, compared with the corresponding period in 2002. The increase is attributable to TNP paying dividends on preferred stock through the issuance of additional shares of preferred stock.

2002 Compared With 2001

Overall Results

When full retail competition began in Texas on January 1, 2002, TNMP separated its previously integrated Texas utility operations into three components. Since First Choice has assumed the activities related to the sale of electricity to retail customers in Texas, the financial statements of TNMP for 2002 and 2001 are not comparable. The following discussion will focus primarily on amounts presented in the consolidated financial statements of TNP, except as noted otherwise.

TNP had consolidated income applicable to common stock of $13.0 million for the year ended December 31, 2002, compared with a consolidated loss of $7.8 million for the year ended December 31, 2001.

The changes in TNP’s earnings for 2002 compared to 2001, are attributable to the factors listed below (in millions):

Gross Profit

The following table summarizes the components of TNP’s gross profit (in thousands).

Transmission and distribution costs and transmission expense are included in the “Other operating and maintenance” line of TNP’s consolidated income statement. The clawback accrual is shown on the income statement as “Accrual for payment to TNMP.”

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2002 Gross Profit Compared With 2001

The following table summarizes the components of the change in TNP’s gross profit for the year ended December 31, 2002, compared with the same period in 2001 (in thousands):

Gross profit for the year ended December 31, 2002, decreased $3.8 million, or 1.4 percent compared with the corresponding 2001 period. The decrease resulted from the loss of former TNMP customers to competing retail electric providers, the clawback accrual and the change in TNMP’s transmission revenue and expenses resulting from the annual PUCT allocation of transmission costs. These decreases were offset in part by higher gross profit from price-to-beat customers due primarily to lower purchased power prices and the increase in the price-to-beat fuel factor. Other factors that partially offset the gross profit decrease were the acquisition of new First Choice customers in the competitive market and the sale of the output from TNP One to third parties from April 2002 until the sale of TNP One in October 2002. During the first quarter of 2002, the output of TNP One was sold on an intercompany basis, and gross profit from the sale was eliminated in consolidation.

Purchased power and fuel expenses decreased $40.3 million for the year ended December 31, 2002, compared with the amount incurred in the same period in 2001. The decrease was caused by reduced purchases resulting from the gains and losses of customers due to competition described above and lower prices in Texas and New Mexico. The decrease was partially offset by the sale of the output from TNP One to third parties, which resulted in First Choice purchasing additional power to supply the load that was served by TNP One during 2001.

Retail electric providers such as First Choice include a transmission and distribution charge in the prices they charge their customers for electric service. The transmission and distribution charge is regulated by the PUCT and is designed to allow the utility that provides transmission and distribution services within a specific service area, referred to as the transmission and distribution service provider, to recover its cost of service. During the years ended December 31, 2002 and 2001, First Choice incurred transmission and distribution charges of $55.7 million and $0.9 million, respectively, related to non-affiliated transmission and distribution service providers.

In the fourth quarter of 2002, TNMP recorded a pre-tax reserve of $12.7 million related the clawback.

During February 2002, the PUCT implemented an updated method of allocating transmission costs within ERCOT. The updated allocation had the effect of reducing the revenue TNMP realized from providing transmission service during the year ended December 31, 2002, and increasing the payments TNMP made for using the transmission facilities of other ERCOT utilities. The updated allocation caused TNMP to incur $3.4 million of net transmission expense for the year ended December 31, 2002 compared with net transmission revenue of $6.4 million for the year ended December 31, 2001.

Operating Expenses

TNP incurred operating expenses of $574.3 million for the year ended December 31, 2002, a decrease of $1.2 million from the amount incurred during the corresponding period of 2001. Operating expenses include purchased power and fuel, transmission and distribution costs, clawback accrual and transmission expenses. Those expenses increased $32.3 million for the year ended December 31, 2002, compared with the same period in 2001. The details of the changes in those expenses are discussed above in “Gross Profit.”

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Index to Financial Statements

The remaining components of the changes in operating expenses are discussed below.

Other Operating and Maintenance

Other operating and maintenance expenses for the year ended December 31, 2002 decreased $1.5 million compared with 2001. The decrease is partially attributable to payment of $3.6 million to the System Benefit Fund mandated by Senate Bill 7 in 2001. In 2002, the costs of the System Benefit Fund are passed through to customers, and are not recorded in operating and maintenance expense. The termination of TNMP’s factoring arrangement in February 2002 contributed approximately $3.0 million to the decrease. The decreases are partially offset by increased reserves for uncollectible accounts receivable related to the beginning of competition in Texas, customer acquisition costs at First Choice and increased personnel costs in First Choice’s customer service organization.

Depreciation and Amortization

As discussed in Note 3, TNP stopped amortizing the goodwill associated with the Merger upon adoption of SFAS 142. In addition, TNP and TNMP stopped depreciating TNP One when it was reclassified to assets held for sale as of December 31, 2001. As a result, depreciation and amortization decreased $26.3 million during the year ended December 31, 2002 compared with the corresponding period of 2001.

Charge for Recovery of Stranded Plant

Effective with the start of retail competition on January 1, 2002, the earnings cap under which TNMP operated in 2001 was no longer in effect. Accordingly, TNMP is no longer required to accrue for excess earnings. During the year ended December 31, 2002, the charge for recovery of stranded plant decreased $2.1 million compared with the same period in 2001. The decrease resulted from TNMP no longer accruing for excess earnings, and from TNMP recording an adjustment to its 2001 excess earnings accrual in the first quarter of 2002.

Other Income and Deductions

Net other income and deductions decreased $7.1 million for the year ended December 31, 2002 compared with 2001. The decrease was caused by a $2.5 million pre-tax loss related to the write-off of TNP’s entire investment in a company involved in fuel cell research and development and a pre-tax gain of $3.8 million on the sale of non-utility property recorded in December 2001. In addition, TNMP recorded a pre-tax loss of $0.2 million related to a portion of the loss on the sale of TNP One that is not eligible for recovery under the stranded cost provisions of Senate Bill 7.

Interest Charges

Interest charges decreased by $9.1 million for the year ended December 31, 2002, compared with 2001. The decrease was due to lower interest rates on both TNP’s Senior Credit Facility (Senior Credit Facility) and the TNMP/First Choice Credit Facility. The decrease was partially offset by increased borrowings under the TNMP/First Choice Credit Facility that resulted primarily from the termination of the factoring arrangement in February 2002.

Cumulative Effect of Change in Accounting

Cumulative effect of change in accounting decreased $1.2 million for the year ended December 31, 2002, compared with the corresponding period in 2001. The changes reflect the charge TNMP recorded in the first quarter of 2001 to write off the balance of previously deferred major maintenance costs. Effective January 1, 2001, TNMP began charging the costs of major maintenance to expense as incurred.

Dividends on Preferred Stock

Dividends on preferred stock increased $2.5 million for the year ended December 31, 2002, compared with the same period in 2001. The increase in 2002 over 2001 reflects the payment of dividends on the preferred stock through the issuance of additional shares of preferred stock.

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Liquidity and Capital Resources

TNP Liquidity

TNP’s main sources of liquidity, and its ability to service the debt issued to finance the Merger, depend primarily on the earnings of its subsidiaries, TNMP and First Choice. TNP receives distributions of those earnings in the form of cash dividends, as well as payments from its subsidiaries under a tax sharing agreement.

Senior Credit Facility. In August 2003, TNP and the banks participating in TNP’s Senior Credit Facility agreed to increase the commitment under, and extend the maturity of, the Senior Credit Facility. As a result the Senior Credit Facility is now composed of a $112.5 million term loan that matures in December 2006. The commitment under the term loan increased $42 million and TNP used the proceeds to provide First Choice with $25 million in additional capital and replace the working capital available under the revolving portion of the Senior Credit Facility. The revolving portion of the Senior Credit Facility expired in August 2003 and had a commitment of $15 million. The extension of the maturity of the Senior Credit Facility allows TNP flexibility to coordinate the refunding of the term loan with the anticipated issuance of securitization bonds related to the recovery of stranded costs resulting from TNMP’s sale of TNP One.

The Senior Credit Facility contains various financial covenants with which TNP must comply. Due to losses during the first quarter of 2003 at First Choice resulting from high natural gas prices, and increased amounts of outstanding debt due to the termination of TNMP’s factoring agreement early in 2002, TNP did not comply with one financial covenant for the period ended March 31, 2003. In May 2003, TNP obtained a modification of that financial covenant, as well as a second covenant. Additional covenants pertaining to risk management practices were implemented with this amendment. The amendment allows TNP to meet the covenant, which was in noncompliance for the period ended March 31, 2003, and TNP expects to comply with all covenants for the periods covered by the modifications, which extend to September 30, 2004.

TNMP is required to provide notice to the NMPRC prior to paying dividends to TNP. For the year ended December 31, 2003, TNMP paid dividends of $29.4 million to TNP. For the year ended December 31, 2002, TNMP and First Choice paid dividends of $102.3 million and $15.0 million, respectively, to TNP. For the year ended December 31, 2001, TNMP paid dividends to TNP of $35.0 million.

For the year ended December 31 2003, TNMP made tax sharing payments of $15.7 million to TNP, and TNP made tax sharing payments of $1.2 million to First Choice. For the year ended December 31, 2002, First Choice made tax sharing payments to TNP of $19.5 million and TNP made tax sharing payments of $3.4 million to TNMP. For the year ended December 31, 2001, TNMP made tax sharing payments to TNP of $13.4 million.

For the year ended December 31, 2003, TNP made equity contributions of $35 million to First Choice. The Senior Credit Facility limits the amount of equity that TNP may contribute to First Choice to $25 million for years after 2003.

Management believes that dividends from its subsidiaries, payments under the tax sharing agreement, and cash on hand as a result of increasing the commitment under the Senior Credit Facility should be sufficient to meet TNP’s working capital requirements at least through the end of 2005.

For the year ended December 31, 2003, TNP’s cash flow from operations was $12.3 million higher than in the year ended December 31, 2002. The factors causing the increase in cash flow from operations are summarized in the following table (in millions).

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Index to Financial Statements

Cash flow from sales increased due to the acquisition of customers in the competitive market and increases in the price-to-beat fuel factor. As discussed in First Choice Gross Profit, purchased power expenses increased in 2003 due to rising natural gas prices and increased purchases primarily as a result of higher sales to competitive customers. Cash flow in 2002 was reduced due to the termination of TNMP’s factoring agreement in February 2002. First Choice purchased natural gas options in primarily the first half of 2003 as part of a strategy to mitigate the risk of increasing natural gas prices, as discussed in Note 4. The increased payments to suppliers are primarily attributable to increased transmission and distribution charges, which were addressed in First Choice Gross Profit. Payments for taxes other than income taxes have decreased primarily due to reduced payments for ad valorem taxes resulting from the sale of TNP One in October 2002.

TNMP and First Choice Liquidity

TNMP Liquidity. On June 10, 2003, TNMP completed the sale of $250 million of 6.125 percent Senior Notes due in 2008. The proceeds from this sale were used to repay all of TNMP’s outstanding borrowings under the TNMP/First Choice Credit Facility, which were $207 million as of June 10, 2003. As a result of the sale, TNMP has sufficient liquidity to satisfy the possibility of any known contingencies. TNMP believes that cash flow from its operations and cash on hand as a result of the issuance of the Senior Notes will be sufficient to meet its working capital requirements at least through the end of 2005, without the need for additional bank financing. TNMP’s cash balance as of December 31, 2003, was approximately $56.9 million.

Expiration of TNMP/First Choice Credit Facility and Other Developments. The TNMP/First Choice Credit Facility expired in October 2003. Prior to the issuance of the 6.125 percent Senior Notes due in 2008, TNMP used the TNMP/First Choice Credit Facility to finance its working capital requirements.

In October 2003, the NMPRC granted TNMP’s request for the authority to extend a portion of the guarantees that TNMP provides for certain power supply obligations of First Choice. The NMPRC originally granted TNMP authority to guarantee up to $75 million of First Choice obligations in December 2001, and was set to expire at the end of October 2003. TNMP agreed to a number of conditions in return for the authority to guarantee First Choice’s power supply obligations, including the following:

TNMP’s cash flow from operations for the year ended December 31, 2003 was $38.9 million higher than in the year ended December 31, 2002. Cash flow in 2002 was reduced due to the termination of TNMP’s factoring agreement in February 2002 and increased by tax benefits from the sale of TNP One. In addition, the sale of TNP One resulted in lower ad valorem tax payments in 2003 compared with the corresponding period in 2002, resulting in increased cash flows in 2003. Cash flow in 2003 was reduced by increased interest payments as a result of the issuance of the 6.125 percent Senior Notes in June 2003.

First Choice Liquidity. On October 28, 2003, First Choice and Constellation executed a new power supply agreement under which Constellation will supply First Choice the majority of its remaining power requirements through the end of 2006. As part of the agreement, First Choice has granted a security interest in its accounts receivable to Constellation, providing First Choice with sufficient credit for its Texas operations. This agreement eliminated the need for a new credit facility that First Choice had been negotiating, or the renewal of the expiring revolving credit facility.

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First Choice is implementing the new agreement with Constellation in three phases. Phase one began with the execution of the new power supply agreement described above on October 28, 2003. Phase one ended and phase two began in December 2003, when First Choice executed a restructured power supply agreement with Constellation to replace the previous agreement. The credit terms in place during phase one continue to apply in phase two. In particular, Constellation received a lien against billed and unbilled receivables and a variable amount of cash to cover both settlement exposure and mark-to-market exposure rather than requiring First Choice to post cash collateral for purchased power supply. However, if a dramatic change in electricity or gas forward prices creates an increase in Constellation’s credit exposure to First Choice beyond a limit based on cash and accounts receivable, First Choice will be constrained in its ability to sign up additional customers until that imbalance is corrected.

In phase two, Constellation assumed the risks associated with differences in expected customers’ usage, and weather-related risks, for a fixed fee above the cost of energy. First Choice retained the risks associated with customer attrition.

Phase three of the agreement begins once First Choice establishes a bankruptcy remote SPE to hold all customer contracts and wholesale power and gas contracts. Some of the provisions in phase three of the agreement are subject to PUCT approval. First Choice expects to have the SPE established during the first half of 2004. Constellation will receive a lien on accounts receivable, customer contracts, cash, and the equity of the SPE. The lien will provide First Choice with enough credit to purchase power without the need to deposit cash collateral with Constellation, and will result in Constellation releasing TNMP from its $25 million guarantee. Phase three will continue until the expiration of the agreement on December 31, 2006.

During the first two phases of the new agreement, Constellation may terminate the agreement with six months prior notice if the SPE described above is not established by the earlier of thirty days after the PUCT approves the provisions in phase three over which it has jurisdiction or September 1, 2004. First Choice may terminate the agreement upon ninety days prior notice to Constellation, for any reason.

In the event of termination, the security interest in First Choice’s accounts receivable granted to Constellation would remain in effect until First Choice’s obligations are paid in full, and until the power supply agreements with Constellation are terminated. Alternatively First Choice can provide Constellation with other acceptable collateral. Provisions of the Letter of Intent and power supply agreements that by their terms survive termination would expire on their original expiration dates.

First Choice management believes cash flow from operations and cash on hand should be sufficient to meet working capital and credit requirements at least through the expiration of the new Constellation agreement in December 2006.

Intercompany Loans. During 2002, TNMP borrowed excess cash from First Choice. During 2003, all intercompany loans were repaid. Due to cash on hand as a result of the sale of the 6.125 percent Senior Notes due in 2008 discussed in TNMP Liquidity, TNMP does not expect to have intercompany borrowings during 2004.

Pension Plans. TNP maintains a qualified defined benefit pension plan, retiree medical plan, and retiree life insurance plan that cover its subsidiaries’ eligible employees. TNMP also maintains an excess benefit plan, which provides pension benefits in excess of amounts permitted for qualified plans under U.S. tax law to affected participants of the qualified pension plan.

TNP’s retirement plan expense for the qualified pension plan, retiree medical plan, retiree life insurance plan and excess benefit plan was approximately $3.1 million, $2.0 million, and $1.9 million for 2003, 2002 and 2001, respectively.

Retirement plan expense has been calculated based upon a number of actuarial assumptions, including an expected long-term rate of return on pension plan assets of 8.5 percent for 2003 and 9.0 percent for 2002. Reducing this assumption by 50 basis points increased the 2003 retirement plan expense by approximately $0.4 million.

In developing the expected long-term rate of return assumption, TNP evaluated input from its actuary, including a review of asset class return expectations as well as long-term inflation assumptions developed by independent consultants and economists. Projected investment returns are based on equity and fixed income indices, which represent broad market expectations. Based on this input, TNP believes it is reasonable to assume that its pension plan investment strategy will generate long-term returns of at least 7.8 percent in 2004 and beyond.

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The expected long-term rate of return on pension plan assets is based on an investment strategy that allocates pension plan assets among equity, Treasury Inflation Protected Securities (TIPS), and money market assets based on a formula dependent upon the composite price/earnings ratio of the S&P 500 index and the current yield on TIPS. As of December 31, 2003, the plan’s target allocation was 10 percent equity index fund, 10 percent TIPS, and 80 percent money market fund. TNP believes that 7.8 percent is a reasonable long-term rate of return for its pension plan assets based on simulated returns of the investment strategy over the last 5, 15 and 20 years. The plan’s return on average plan assets during 2003 was approximately 4.3 percent. TNP will continue to evaluate its actuarial assumptions, including the expected rate of return, at least annually, and will make adjustments as necessary.

TNP bases its determination of retirement plan expense on a market-related valuation of assets, which reduces year-to-year volatility. The market-related valuation recognizes realized and unrealized gains or losses over a five-year period. Therefore, future asset values will be impacted as previously deferred realized and unrealized gains and losses are recognized. Recent investment gains and losses will be recognized in the market-related value of assets over the next five years.

The discount rate that TNP utilizes for determining its benefit obligations and retirement plan expense is based on a review of long-term corporate bonds. The Moody’s Aa index as of December 31st has been used to establish the discount rate. The discount rate determined on this basis decreased from 6.5 percent at December 31, 2002 to 6.0 percent at December 31, 2003.

The value of qualified pension plan assets has decreased from $88.4 million at December 31, 2002 to $85.1 million at December 31, 2003, primarily due to payments to beneficiaries. The decline in value and declining discount rates have reduced the funded status (the difference between plan assets and projected benefit obligation) for the qualified pension plan and SERP from $2.0 million at December 31, 2002 to ($0.2) million at December 31, 2003.

TNP has recognized the reduction in postretirement benefits plan liabilities due to the changes in Medicare that became law in December 2003. Recognition of the provisions of the new law reduced the accumulated benefit obligation of the postretirement benefits plan by approximately $0.4 million. TNP has not determined how the reduction in the accumulated benefit obligation will be reflected in the net postretirement benefit costs of the years 2004 and beyond. There have been no changes to estimates of either participation rates or per capita claims cost as a result of the new law. Accounting guidance on the accounting for the federal subsidy included in the new law is pending. Accordingly, authoritative guidance that may be issued in the future could require changes to the information reported here. Based on the advice of TNP’s actuary, TNP has concluded that its plan is at least actuarially equivalent to Medicare Part D.

TNP Capital Resources

As of December 31, 2003, TNP’s common equity, preferred stock and long-term debt ratios were 5.1 percent, 15.9 percent and 79 percent, respectively, compared to common equity, preferred stock and long-term debt ratios of 9.8 percent, 15.2 percent and 75.0 percent as of December 31, 2002, respectively. The changes in capital ratios reflect the issuance of additional shares of preferred stock in payment of dividends, increased borrowings under TNP’s Senior Credit Facility and the issuance of TNMP’s 6.125 percent Senior Notes due in 2008.

TNP’s capital requirements through 2008 are projected to be as follows (amounts in millions):

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Table of Contents

Index to Financial Statements

Aggregate Contractual Obligations

The table below presents the aggregate contractual obligations of TNP, TNMP and First Choice as of December 31, 2003 (amounts in millions):