EL PASO ELECTRIC CO /TX/ - 10-Q Quarterly Report

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 March 31, 2005

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-296

El Paso Electric Company

(Exact name of registrant as specified in its charter)


Texas		74-0607870
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Stanton Tower, 100 North Stanton, El Paso, Texas		79901
(Address of principal executive offices)		(Zip Code)

(915) 543-5711

(Registrant’s telephone number, including area code)

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

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

As of April 29, 2005, there were 47,731,566 shares of the Company’s no par value common stock outstanding.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

INDEX TO FORM 10-Q


			Page No.
PART I. FINANCIAL INFORMATION

	Item 1.	Financial Statements

Consolidated Balance Sheets – March 31, 2005 and December 31, 2004			1

Consolidated Statements of Operations – Three Months and Twelve Months Ended March 31, 2005 and 2004			3

Consolidated Statements of Comprehensive Operations – Three Months and Twelve Months Ended March 31, 2005 and 2004			4

Consolidated Statements of Cash Flows – Three Months Ended March 31, 2005 and 2004			5

Notes to Consolidated Financial Statements			6

Report of Independent Registered Public Accounting Firm			17

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31

	Item 4.	Controls and Procedures	31

PART II. OTHER INFORMATION

	Item 1.	Legal Proceedings	32

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32

	Item 5.	Other Information	32

	Item 6.	Exhibits	32

(i)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

ASSETS

(In thousands)


	March 31, 2005 (Unaudited)			December 31, 2004
Utility plant:
Electric plant in service	$	1,843,882		$	1,839,924
Less accumulated depreciation and amortization		(687,400	)		(666,774	)

Net plant in service		1,156,482			1,173,150
Construction work in progress		86,970			74,853
Nuclear fuel; includes fuel in process of $980 and $7,128, respectively		71,205			69,239
Less accumulated amortization		(38,833	)		(34,195	)

Net nuclear fuel		32,372			35,044

Net utility plant		1,275,824			1,283,047

Current assets:
Cash and temporary investments		39,950			29,401
Accounts receivable, principally trade, net of allowance for doubtful accounts of $2,940 and $3,071, respectively		63,551			70,710
Accumulated deferred income taxes		7,203			6,509
Inventories, at cost		25,464			25,193
Undercollection of fuel revenues		16,760			19,302
Income taxes receivables		11,692			18,999
Prepayments and other		8,282			7,507

Total current assets		172,902			177,621

Deferred charges and other assets:
Decommissioning trust funds		89,542			89,363
Regulatory assets		17,904			18,487
Other		13,315			12,837

Total deferred charges and other assets		120,761			120,687

Total assets	$	1,569,487		$	1,581,355

See accompanying notes to consolidated financial statements.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (Continued)

CAPITALIZATION AND LIABILITIES

(In thousands except for share data)


	March 31, 2005 (Unaudited)			December 31, 2004
Capitalization:
Common stock, stated value $1 per share, 100,000,000 shares authorized, 63,016,150 and 62,665,500 shares issued, and 79,734 and 102,630 restricted shares, respectively	$	63,096		$	62,768
Capital in excess of stated value		270,766			268,771
Deferred and unearned compensation		1,713			1,127
Retained earnings		390,867			386,110
Accumulated other comprehensive loss, net of tax		(13,866	)		(10,553	)

		712,576			708,223
Treasury stock, 15,365,108 shares, at cost		(176,076	)		(176,076	)

Common stock equity		536,500			532,147
Long-term debt, net of current portion		183,555			359,362
Financing obligations, net of current portion		18,418			20,274

Total capitalization		738,473			911,783

Current liabilities:
Current portion of long-term debt and financing obligations		389,764			214,092
Accounts payable, principally trade		24,763			34,404
Taxes accrued other than federal income taxes		13,217			15,719
Interest accrued		13,200			13,609
Overcollection of fuel revenues		506			520
Other		26,263			24,726

Total current liabilities		467,713			303,070

Deferred credits and other liabilities:
Accumulated deferred income taxes		109,122			111,991
Accrued postretirement benefit liability		100,367			98,827
Asset retirement obligation		61,822			60,388
Accrued pension liability		46,323			49,055
Regulatory liabilities		15,365			15,682
Other		30,302			30,559

Total deferred credits and other liabilities		363,301			366,502


Commitments and contingencies

Total capitalization and liabilities	$	1,569,487		$	1,581,355

See accompanying notes to consolidated financial statements.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands except for share data)


	Three Months Ended March 31,						Twelve Months Ended March 31,
	2005			2004			2005			2004
Operating revenues	$	159,185		$	155,852		$	711,961		$	672,728

Energy expenses:
Fuel		44,228			39,049			199,603			172,065
Purchased and interchanged power		11,487			12,852			65,086			55,668

		55,715			51,901			264,689			227,733

Operating revenues net of energy expenses		103,470			103,951			447,272			444,995

Other operating expenses:
Other operations		41,869			41,460			173,945			169,831
Impairment loss on CIS project		—			—			—			17,576
Maintenance		8,954			9,203			44,941			42,386
Depreciation and amortization		23,570			23,179			93,763			89,318
Taxes other than income taxes		10,416			11,537			41,463			43,182

		84,809			85,379			354,112			362,293

Operating income		18,661			18,572			93,160			82,702

Other income (deductions):
Investment and interest income, net		925			271			4,058			1,981
Loss on extinguishments of debt		—			(2,106	)		(3,250	)		(2,106	)
Miscellaneous other income		—			—			227			966
Miscellaneous other deductions		(834	)		(651	)		(2,686	)		(2,161	)

		91			(2,486	)		(1,651	)		(1,320	)

Interest charges (credits):
Interest on long-term debt and financing obligations		11,983			12,673			48,478			50,977
Other interest		122			148			509			744
Capitalized interest and AFUDC		(1,086	)		(770	)		(3,743	)		(5,026	)

		11,019			12,051			45,244			46,695

Income before income taxes and extraordinary item		7,733			4,035			46,265			34,687
Income tax expense		2,976			1,121			11,053			13,494

Income before extraordinary item		4,757			2,914			35,212			21,193
Extraordinary gain on re-application of SFAS No. 71, net of tax		—			—			1,802			—

Net income	$	4,757		$	2,914		$	37,014		$	21,193

Basic earnings per share:
Income before extraordinary item	$	0.10		$	0.06		$	0.74		$	0.44
Extraordinary gain on re-application of SFAS No. 71, net of tax		—			—			0.04			—

Net income	$	0.10		$	0.06		$	0.78		$	0.44

Diluted earnings per share:
Income before extraordinary item	$	0.10		$	0.06		$	0.73		$	0.44
Extraordinary gain on re-application of SFAS No. 71, net of tax		—			—			0.04			—

Net income	$	0.10		$	0.06		$	0.77		$	0.44

Weighted average number of shares outstanding		47,405,270			47,451,300			47,415,395			47,965,274

Weighted average number of shares and dilutive potential shares outstanding		48,250,450			47,900,302			48,107,347			48,389,715

See accompanying notes to consolidated financial statements.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS

(Unaudited)

(In thousands)


	Three Months Ended March 31,						Twelve Months Ended March 31,
	2005			2004			2005			2004
Net income	$	4,757		$	2,914		$	37,014		$	21,193
Other comprehensive income (loss):
Minimum pension liability adjustment		—			—			(1,413	)		(4,234	)
Net unrealized gains (losses) on marketable securities:
Net holding gains (losses) arising during period		(1,970	)		287			(1,906	)		10,235
Reclassification adjustments for net (gains) losses included in net income		91			(233	)		(101	)		(175	)
Unrealized losses on cash flow hedges		(2,903	)		—			(2,903	)		—

Total other comprehensive income (loss) before income taxes		(4,782	)		54			(6,323	)		5,826

Income tax benefit (expense) related to items of other comprehensive income (loss):
Minimum pension liability adjustment		—			—			532			1,673
Net unrealized gains (losses) on marketable securities		376			(11	)		402			(2,310	)
Unrealized losses on cash flow hedges		1,093			—			1,093			—

Total income tax benefit (expense)		1,469			(11	)		2,027			(637	)

Other comprehensive income (loss), net of tax		(3,313	)		43			(4,296	)		5,189

Comprehensive income	$	1,444		$	2,957		$	32,718		$	26,382

See accompanying notes to consolidated financial statements.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)


	Three Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net income	$	4,757		$	2,914
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of electric plant in service		23,570			23,179
Amortization of nuclear fuel		4,700			4,302
Deferred income taxes, net		(2,152	)		(3,460	)
Loss on extinguishments of debt		—			2,106
Other amortization and accretion		2,912			2,138
Other operating activities		(33	)		6
Change in:
Accounts receivable		7,159			7,907
Inventories		(196	)		149
Net (under)/overcollection of fuel revenues		2,528			1,076
Prepayments and other		6,348			3,750
Accounts payable		(9,641	)		3,050
Taxes accrued other than federal income taxes		(2,502	)		(1,680	)
Interest accrued		(409	)		(279	)
Other current liabilities		(1,365	)		1,418
Deferred charges and credits		(2,267	)		3,507

Net cash provided by operating activities		33,409			50,083

Cash flows from investing activities:
Cash additions to utility property, plant and equipment		(19,062	)		(15,656	)
Cash additions to nuclear fuel		(1,949	)		(2,019	)
Capitalized interest and AFUDC:
Utility property, plant and equipment		(1,036	)		(711	)
Nuclear fuel		(50	)		(59	)
Decommissioning trust funds:
Purchases, including funding of $1.5 million		(5,289	)		(5,566	)
Sales and maturities		3,235			3,333
Other investing activities		1,422			(1,741	)

Net cash used for investing activities		(22,729	)		(22,419	)

Cash flows from financing activities:
Proceeds from exercise of stock options		2,713			305
Repurchases of and payments on first mortgage bonds		—			(16,370	)
Nuclear fuel financing obligations:
Proceeds		2,323			2,315
Payments		(4,284	)		(3,769	)
Other financing activities		(883	)		(223	)

Net cash used for financing activities		(131	)		(17,742	)

Net increase in cash and temporary investments		10,549			9,922
Cash and temporary investments at beginning of period		29,401			34,426

Cash and temporary investments at end of period	$	39,950		$	44,348

See accompanying notes to consolidated financial statements.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A. Principles of Preparation

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Annual Report of El Paso Electric Company on Form 10-K for the year ended December 31, 2004 (the “2004 Form 10-K”). Capitalized terms used in this report and not defined herein have the meaning ascribed for such terms in the 2004 Form 10-K. In the opinion of management of the Company, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company at March 31, 2005 and December 31, 2004; the results of its operations and comprehensive operations for the three and twelve months ended March 31, 2005 and 2004; and its cash flows for the three months ended March 31, 2005 and 2004. The results of operations and comprehensive operations and the cash flows for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for the full calendar year.

Pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in financial statements prepared in accordance with generally accepted accounting principles. Certain prior period amounts have been reclassified to conform with the current period presentation.

Stock Options. The Company has two stock-based long-term incentive plans and accounts for them under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Stock options have typically been granted with an exercise price equal to fair market value on the date of grant and, accordingly, no compensation expense is recorded by the Company. If compensation expense for the option portion of the plans had been determined based on the fair value of the option at the grant date and amortized on a straight-line basis over the vesting period, consistent with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts presented below (in thousands, except for per share data):

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


	Three Months Ended March 31,				Twelve Months Ended March 31,
	2005		2004		2005		2004
Net income, as reported	$	4,757	$	2,914	$	37,014	$	21,193
Deduct: Compensation expense, net of tax		220		229		896		915

Pro forma net income	$	4,537	$	2,685	$	36,118	$	20,278

Basic earnings per share:
As reported	$	0.10	$	0.06	$	0.78	$	0.44
Pro forma		0.10		0.06		0.76		0.42

Diluted earnings per share:
As reported		0.10		0.06		0.77		0.44
Pro forma		0.09		0.06		0.75		0.42

Unbilled Revenues. Accounts receivable include accrued unbilled revenues of $14.3 million and $18.0 million at March 31, 2005 and December 31, 2004, respectively.

Supplemental Cash Flow Disclosures (in thousands)


	Three Months Ended March 31,
	2005		2004
Cash paid for:
Interest on long-term debt and financing obligations	$	12,104	$	12,690

Non-cash financing activities:
Grants of restricted shares of common stock		19		21

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

B. Regulation

Texas Regulatory Matters

The rates and services of the Company are regulated in Texas by municipalities and by the Texas Commission. The largest municipality in the Company’s service area is the City of El Paso. The Texas Commission has exclusive appellate jurisdiction to review municipal orders and ordinances regarding rates and services within municipalities in Texas and original jurisdiction over certain other activities of the Company. The decisions of the Texas Commission are subject to judicial review.

Termination of Freeze Period. The Freeze Period expires on August 1, 2005. Thereafter, the Company will be subject to traditional cost of service regulation by the Texas cities it serves and by the Texas Commission. Its present rates will stay in effect until changed by a city or the Texas Commission. Any such change would be initiated with either a request by the Company or a regulator or customer. Any rate change order would be preceded by discovery and presentation of evidence. Any decision by a city would be subject to appellate review by the Texas Commission. The Company has no present intention to request a base rate change, and no complaints against the Company’s base rates are pending.

The end of the Freeze Period may also bring an end to the 50/50 sharing of off-system sales margins between the Company and its customers. The current fuel rule in Texas provides that such margins are to be fully credited to customers.

The Company’s ten-year franchise with the City of El Paso (“City”) expires on August 1, 2005. The franchise governs the Company’s usage of City-owned property, including the payment of franchise fees. On March 18, 2005, the Company made a presentation to the City of El Paso Public Utility Regulation Board (“PURB”) on a proposed extension of its current rate agreement. The material terms of the proposed agreement extension presented to the PURB included (i) a new 5-year base rate freeze; (ii) that there will be no change in rates if the Company’s return on equity is within a “bandwidth” of 200 basis points above or below a target return on equity of 400 basis points over the published utility bond yield average, and that the Company will have the right to initiate a rate case if earnings are below the bandwidth and will share earnings over such bandwidth equally with the City; (iii) an increase in the City franchise fee from 2% to 3%; (iv) a commitment from the Company to build its next generating plant in El Paso; (v) a commitment from the Company to spend at least 0.3% of its revenues from City customers on civic and charitable causes; (vi) a commitment from the Company to modify the percentage of its off-system sales margin that it shares with customers to 25%; and (vii) a new 30-year franchise agreement. The PURB is a public advisory board which will make a recommendation to the El Paso City Council (“City Council”) regarding the proposed agreement. The City Council is expected to make a final determination in the second or third quarter of 2005. If the agreement is approved in principle, the proposal will be set forth in a definitive agreement between the parties. The Company is unable to predict the outcome of these discussions.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fuel. Although the Company’s base rates are frozen in Texas pursuant to Texas Commission rules and the Texas Rate Stipulation, the Company can request adjustments to its fuel factor to more accurately reflect projected energy costs associated with providing electricity and seek recovery of past undercollections of fuel revenues, subject to periodic final review by the Texas Commission in fuel reconciliation proceedings.

The Company reconciled its Texas jurisdictional fuel costs for the period January 1, 1999 through December 31, 2001 in PUC Docket No. 26194, and on May 5, 2004, the Texas Commission issued its final order. At issue was the Company’s request to recover an additional $15.8 million, before interest, from its Texas customers as a surcharge due to fuel undercollections from January 1999 through December 2001. The Texas Commission disallowed approximately $4.5 million of Texas jurisdictional expenses, before interest, consisting primarily of (i) approximately $4.2 million of purchased power expenses which the Texas Commission characterized as “imputed capacity charges,” and (ii) approximately $0.3 million in fees which were deemed to be administrative costs, not recoverable as fuel. This disallowance was recorded as a reduction of fuel revenue during the fourth quarter of 2003. In Texas, capacity charges are not eligible for recovery as fuel expenses but are to be recovered through the Company’s base rates. As the Company’s base rates were frozen during the period in which the imputed capacity charges were deemed to have been incurred, the $4.2 million of imputed capacity charges were therefore permanently disallowed, and not recoverable from its Texas customers. The Texas Commission’s decision has been appealed by two parties and the Company, and the Company is unable to predict the ultimate outcome of the appeals.

On August 31, 2004, the Company filed an application to reconcile Texas jurisdictional fuel costs for the period January 1, 2002 to February 29, 2004 in PUC Docket No. 30143. The Company has incurred purchased power costs similar to those that were at issue in PUC Docket No. 26194 for this current fuel reconciliation case. The Company believes that it has accounted for its purchased power costs during the reconciliation period covered by PUC Docket No. 30143 in a manner consistent with the Texas Commission’s decision in PUC Docket No. 26194. However, the Texas Commission is currently conducting a generic rulemaking proceeding to determine a statewide policy for the appropriate pricing of capacity in purchased power contracts. There can be no assurance as to the outcome of the rulemaking and its potential impact on the Company with respect to fuel recovery in future reconciliation periods, including those in PUC Docket No. 30143. Additionally, intervenors in PUC Docket No. 30143 have filed testimony disputing as much as $44 million of the requested fuel and purchase power costs. Although the ultimate outcome of the proceeding cannot be predicted with certainty, the Company believes the amount of under/overcollection of fuel revenues recorded as of March 31, 2005 is appropriate.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

C. Common Stock

Common Stock Repurchase Program

Since the inception of the stock repurchase programs in 1999, the Company has repurchased approximately 15.3 million shares in total at an aggregate cost of $175.6 million, including commissions. Approximately 1.7 million shares remain authorized to be repurchased under the currently authorized program. No shares were repurchased during the first quarter of 2005. The Company may continue making purchases of its stock pursuant to its stock repurchase plan at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.

Reconciliation of Basic and Diluted Earnings Per Share

The reconciliation of basic and diluted earnings per share before extraordinary item is presented below:


	Three Months Ended March 31,
	2005					2004
	Income		Shares	Per Share		Income		Shares	Per Share
	(In thousands)					(In thousands)
Basic earnings per share:
Income before extraordinary item	$	4,757	47,405,270	$	0.10	$	2,914	47,451,300	$	0.06

Effect of dilutive securities:
Unvested restricted stock		—	136,923				—	23,357
Stock options		—	708,257				—	425,645

Diluted earnings per share:
Income before extraordinary item	$	4,757	48,250,450	$	0.10	$	2,914	47,900,302	$	0.06

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


	Twelve Months Ended March 31,
	2005					2004
	Income		Shares	Per Share		Income		Shares	Per Share
	(In thousands)					(In thousands)
Basic earnings per share:
Income before extraordinary item	$	35,212	47,415,395	$	0.74	$	21,193	47,965,274	$	0.44

Effect of dilutive securities:
Unvested restricted stock		—	113,324				—	56,162
Stock options		—	578,628				—	368,279

Diluted earnings per share:
Income before extraordinary item	$	35,212	48,107,347	$	0.73	$	21,193	48,389,715	$	0.44

Options excluded from the computation of diluted earnings per share because the exercise price was greater than the average market price for the periods presented are as follows:


	Three Months Ended March 31,		Twelve Months Ended March 31,
	2005	2004	2005	2004
Options excluded	—	558,745	39,158	888,952
Exercise price range	—	$13.77 - $ 15.99	$14.50 - $ 15.99	$11.88 - $ 15.99

D. Commitments, Contingencies and Uncertainties

For a full discussion of commitments and contingencies, see Note I of Notes to Consolidated Financial Statements in the 2004 Form 10-K. In addition, see Note B above and Notes B and C of Notes to Consolidated Financial Statements in the 2004 Form 10-K regarding matters related to regulation and Palo Verde, including decommissioning, spent fuel storage, disposal of low-level radioactive waste, steam generators and liability and insurance matters.

Environmental Matters

The Company is subject to regulation with respect to air, soil and water quality, solid waste disposal and other environmental matters by federal, state, tribal and local authorities. Those authorities govern current facility operations and have continuing jurisdiction over facility modifications. Failure to comply with these environmental regulatory requirements can result in actions by regulatory agencies or other authorities that might seek to impose on the Company administrative, civil, and/or criminal penalties. If the United States regulates green house gas emissions, the Company’s fossil fuel generation assets will be faced with the additional cost of monitoring, controlling and reporting these emissions. In addition, unauthorized releases of pollutants or contaminants into the environment can result in costly cleanup obligations that are subject to enforcement by the regulatory agencies. Environmental regulations can change rapidly and are often difficult to predict. While the Company strives to prepare for and implement changes necessary to

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

comply with changing environmental regulations, substantial expenditures may be required for the Company to comply with such regulations in the future.

The Company analyzes the costs of its obligations arising from environmental matters on an ongoing basis, and believes it has made adequate provision in its financial statements to meet such obligations. As a result of this analysis, the Company has a provision for environmental remediation obligations of approximately $1.3 million as of March 31, 2005, which is related to compliance with federal and state environmental standards. However, unforeseen expenses associated with compliance could have a material adverse effect on the future operations and financial condition of the Company.

The Company incurred the following expenditures during the three and twelve months ended March 31, 2005 and 2004 to comply with federal environmental statutes (in thousands):


	Three Months Ended March 31,				Twelve Months Ended March 31,
	2005		2004		2005		2004
Clean Air Act	$	220	$	210	$	772	$	1,165
Clean Water Act (1)		99		226		1,079		728

(1)	Includes $0.6 million in remediation costs for the twelve months ended March 31, 2005.

Along with many other companies, the Company received from the Texas Commission on Environmental Quality (“TCEQ”) a request for information dated October 15, 2003 in connection with environmental conditions at a facility in San Angelo, Texas that has been owned and operated by the San Angelo Electric Service Company (“SESCO”). The Company’s written response to TCEQ notes that SESCO performed repair services for certain Company electrical equipment between 1981 and 1991, prior to the Company’s bankruptcy. Although the SESCO site has not been designated as a state or federal Superfund site and the Company has not been named as a “responsible party” or a “potentially responsible party” at that site, the Company received in October 2004 an invitation to participate in site cleanup activities from a group of private companies that are conducting certain cleanup activities at the SESCO site. At this time, the Company has not agreed to participate in the cleanup of the SESCO site and is unable to predict the outcome of this matter, although the Company has no reason at present to believe that it will incur material liabilities in connection with the SESCO site.

Except as described herein, the Company is not aware of any other active investigation of its compliance with environmental requirements by the Environmental Protection Agency, the TCEQ or the New Mexico Environment Department which is expected to result in any material liability. Furthermore, except as described herein, the Company is not aware of any unresolved, potentially material liability it would face pursuant to the Comprehensive Environmental Response, Comprehensive Liability Act of 1980, also known as the Superfund law.

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

E. Litigation

The Company is a party to various legal actions. In many of these matters, the Company has excess casualty liability insurance that covers the various claims, actions and complaints. Based upon a review of these claims and applicable insurance coverage, to the extent that the Company has been able to reach a conclusion as to its ultimate liability, it believes that none of these claims will have a material adverse effect on the financial position, results of operations or cash flows of the Company.

On January 16, 2003, the Company was served with a complaint on behalf of a purported class of shareholders alleging violations of the federal securities laws (Roth v. El Paso Electric Company, et al., No. EP-03-CA-0004). The complaint was filed in the El Paso Division of the United States District Court for the Western District of Texas. The suit seeks undisclosed compensatory damages for the class as well as costs and attorneys’ fees. The lead plaintiff, Carpenters Pension Fund of Illinois, filed a consolidated amended complaint on July 2, 2003, alleging, among other things, that the Company and certain of its current and former directors and officers violated securities laws by failing to disclose that some of the Company’s revenues and income were derived from an allegedly unlawful relationship with Enron. The allegations arise out of the FERC investigation of the power markets in the western United States during 2000 and 2001, which the Company previously settled with the FERC Trial Staff and certain intervening parties. On August 15, 2003, the Company and the individual defendants filed a motion to dismiss the complaint for failure to state a claim upon which relief can be granted. On November 26, 2003, the Court denied the motion to dismiss as to the Company and three of the individual defendants and granted the motion to dismiss as to two individual defendants. On April 13, 2004, the Court granted a motion of the Company and the remaining individual defendants requesting permission to file an interlocutory appeal to the U. S. Court of Appeals for the Fifth Circuit regarding certain legal questions relating to the Court’s denial of the motion to dismiss the complaint as to those defendants. On April 27, 2004, the Court entered an order staying the district court proceedings until the Fifth Circuit completed its review. On June 7, 2004, the U. S. Court of Appeals denied the appeal which automatically lifted the stay in the district court. This matter is presently set for trial on September 19, 2005, but such date may be extended. While the Company believes the lawsuit is without merit and intends to defend itself vigorously, the parties have reached an agreement in principle to resolve this case. This settlement remains subject to the execution of a mutually acceptable settlement agreement and approval by the Court. If ultimately approved by the Court, the Company does not expect any further charge to earnings as a result of the settlement.

On May 21, 2003, the Company was served with a complaint by the Port of Seattle seeking civil damages under the Sherman Act, the Racketeer Influenced and Corrupt Organization Act, and state anti-trust laws, as well as for fraud (Port of Seattle v. Avista Corporation, et al., No. CV03-117OP). The complaint was filed in the United States District Court for the Western District of Washington. The complaint alleges that the Company, indirectly through its dealings with Enron, conspired with the other named defendants to manipulate the California energy market, which had the

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

effect of artificially inflating the price that the Port of Seattle paid for electricity. The Company, together with several other defendants, filed a motion to dismiss. On May 12, 2004, the Court granted the Company’s motion, and the suit was dismissed. The Port of Seattle has filed an appeal of the Court’s decision with the U. S. Court of Appeals for the Ninth Circuit. The parties have filed briefs and are awaiting a hearing and decision. While the Company believes that these matters are without merit, the Company is unable to predict the outcome or range of any possible loss.

On May 5, 2004, Wah Chang, a specialty metals manufacturer which operates a plant in Oregon, filed suit against the Company and other defendants in the United States District Court for the District of Oregon. (Wah Chang v. Avista Corporation, et al., No. 04-619AS). The complaint makes substantially the same allegations as were made in Port of Seattle and seeks the same types of damages. In addition, on June 7, 2004, the City of Tacoma filed suit against the Company and other defendants in the United States District Court for the Western District of Washington (City of Tacoma v. American Electric Power Service Corp., et al., C04-5325RBL). This complaint also makes substantially the same allegations as were made in Port of Seattle and seeks civil damages (including treble damages) from the Company and the other defendants for violations of certain antitrust provisions under the Sherman Act. Both of these matters were transferred to the same court that heard and dismissed the Port of Seattle lawsuit and on February 11, 2005, the Court granted the Company’s motion to dismiss both cases. Wah Chang and the City of Tacoma have both filed notices of appeal with the U.S. Court of Appeals for the Ninth Circuit. While the Company believes that these matters are without merit and intends to defend itself vigorously, the Company is unable to predict the outcome or range of possible loss.

F. Employee Benefits

Retirement Plans

The net periodic benefit cost recognized for the three and twelve months ended March 31, 2005 and 2004 is made up of the components listed below as determined using the projected unit credit actuarial cost method (in thousands):


	Three Months Ended March 31,						Twelve Months Ended March 31,
	2005			2004			2005			2004
Components of net periodic benefit cost:
Service cost	$	1,233		$	1,113		$	4,561		$	3,972
Interest cost		2,636			2,522			10,232			9,729
Expected return on plan assets		(2,215	)		(1,927	)		(8,214	)		(7,579	)
Amortization of:
Net loss		1,049			843			3,629			2,145
Prior service cost		29			5			139			21

Net periodic benefit cost	$	2,732		$	2,556		$	10,347		$	8,288

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

During the first quarter of 2005, the Company contributed $5.1 million of its projected $18.5 million for 2005 annual contribution to its retirement plans.

Other Postretirement Benefits

The net periodic benefit cost recognized for the three and twelve months ended March 31, 2005 and 2004 is made up of the components listed below (in thousands):


	Three Months Ended March 31,						Twelve Months Ended March 31,
	2005			2004			2005			2004
Components of net periodic benefit cost:
Service cost	$	1,098		$	1,159		$	3,735		$	4,095
Interest cost		1,698			1,756			5,781			6,607
Expected return on plan assets		(339	)		(315	)		(1,282	)		(1,080	)
Amortization of:
Net gain		—			—			(387	)		—
Prior service cost		(63	)		—			(314	)		—

Net periodic benefit cost	$	2,394		$	2,600		$	7,533		$	9,622

During the first quarter of 2005, the Company contributed $0.9 million of its projected $3.4 million 2005 annual contribution to its postretirement plan.

G. Franchises and Significant Customers

City of El Paso Franchise

The Company’s ten-year franchise with the City of El Paso (“City”) expires on August 1, 2005. The franchise governs the Company’s usage of City-owned property, including the payment of franchise fees. The Company is meeting with the City to discuss the Company’s franchise and rate treatment after the expiration of the Freeze Period. See Note B. The Company is unable to predict the outcome of these discussions.

Military Installations

The Company’s retail service contract with Holloman Air Force Base expires in December 2005. The Company is currently negotiating with Holloman Air Force Base and is seeking to enter into a new contract with this customer.

H. Financial Instruments

The Company has filed a shelf registration statement on Form S-3 with the SEC, which became effective on May 5, 2005. The shelf registration statement enables the Company to offer and issue

EL PASO ELECTRIC COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

debt securities, first mortgage bonds, shares of stock and certain other securities of up to $1.0 billion from time to time in one or more offerings.

During the first quarter of 2005, the Company entered into treasury rate lock agreements to hedge against potential movements in the treasury reference interest rates. These treasury rate locks expire during the second quarter of 2005. The treasury rate lock agreements meet the criteria for hedge accounting and are designated as a highly effective cash flow hedge. In accordance with cash flow hedge accounting, the Company recorded the fair value of the cash flow hedge at March 31, 2005 of $1.8 million, net of tax, as a component of accumulated other comprehensive loss. The Company will adjust the value of the hedge gain or loss until the position is closed which will occur during the second quarter of 2005. The accumulated other comprehensive gain or loss associated with the cash flow hedge will be recognized in earnings as interest expense is accrued on applicable debt obligations. In the event that the treasury rate lock agreements are not utilized in connection with the issuance of debt, any gain or loss on such agreements will be recognized immediately.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

El Paso Electric Company:

We have reviewed the condensed consolidated balance sheet of El Paso Electric Company and subsidiary as of March 31, 2005, the related condensed consolidated statements of operations and comprehensive operations for the three-month and twelve-month periods ended March 31, 2005 and 2004, and the related condensed consolidated statements of cash flows for the three-month periods ended March 31, 2005 and 2004. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of El Paso Electric Company and subsidiary as of December 31, 2004, and the related consolidated statements of operations, comprehensive operations, changes in common stock equity, and cash flows for the year then ended (not presented herein); and in our report dated March 11, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

KPMG LLP

El Paso, Texas

May 5, 2005

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information contained in this Item 2 updates, and should be read in conjunction with, the information set forth in Part II, Item 7 of the Company’s 2004 Form 10-K.

Forward-Looking Statements

Certain matters discussed in this Quarterly Report on Form 10-Q other than statements of historical information are “forward-looking statements.” The Private Securities Litigation Reform Act of 1995 has established that these statements qualify for safe harbors from liability. Forward-looking statements may include words like the Company “believes”, “anticipates”, “targets”, “expects”, “pro forma”, “estimates”, “intends” and words of similar meaning. Forward-looking statements describe the Company’s future plans, objectives, expectations or goals. Such statements address future events and conditions concerning:

•

capital expenditures,

•

earnings,

•

liquidity and capital resources,

•

litigation,

•

accounting matters,

•

possible corporate restructurings, acquisitions and dispositions,

•

compliance with debt and other restrictive covenants,

•

interest rates and dividends,

•

environmental matters,

•

nuclear operations, and

•

the overall economy of the Company’s service area.

These forward-looking statements involve known and unknown risks that may cause the Company’s actual results in future periods to differ materially from those expressed in any forward-looking statement. Factors that would cause or contribute to such differences include, but are not limited to, such things as:

•

the Company’s rates following the end of the Freeze Period and the New Mexico Stipulation,

•

loss of margins on off-system sales,

•

increased costs at Palo Verde,

•

unscheduled outages,

•

electric utility deregulation or re-regulation,

•

regulated and competitive markets,

•

ongoing municipal, state and federal activities,

•

economic and capital market conditions,

•

changes in accounting requirements and other accounting matters,

•

changing weather trends,

•

rates, cost recoveries and other regulatory matters,

•

the impact of changes and downturns in the energy industry and the market for trading wholesale electricity,

•

political, legislative, judicial and regulatory developments,

•

the impact of lawsuits filed against the Company,

•

the impact of changes in interest rates,

•

inability to refinance maturing debt,

•

changes in, and the assumptions used for, pension and other post-retirement and post-employment benefit liability calculations, as well as actual and assumed investment returns on pension plan assets,

•

the impact of changing cost and cost escalation and other assumptions on the Company’s nuclear decommissioning liability for the Palo Verde Nuclear Generating Station,

•

Texas, New Mexico and electric industry utility service reliability standards,

•

homeland security considerations,

•

coal, natural gas, oil and wholesale electricity prices, and

•

other circumstances affecting anticipated operations, sales and costs.

These lists are not all-inclusive because it is not possible to predict all factors. A discussion of some of these factors is included in this document under the headings “Risk Factors” and in the 2004 Form 10-K under the headings “Management’s Discussion and Analysis” “–Summary of Critical Accounting Policies and Estimates” and “–Liquidity and Capital Resources.” This report should be read in its entirety. No one section of this report deals with all aspects of the subject matter. Any forward-looking statement speaks only as of the date such statement was made, and the Company is not obligated to update any forward-looking statement to reflect events or circumstances after the date on which such statement was made except as required by applicable laws or regulations.

Summary of Critical Accounting Policies and Estimates

The preparation of the Company’s financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented and actual results could differ in future periods from those estimates. Critical accounting policies and estimates are both important to the portrayal of the Company’s financial condition and results of operations and which require complex, subjective judgments are more fully described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2004 Form 10-K.

Overview

The Company derives revenue principally from the sale of power to retail customers and economy sales as follows:


	Three Months Ended March 31,				Twelve Months Ended March 31,
	2005		2004		2005		2004
Retail sales	81	%	86	%	86	%	88	%
Economy sales	17		12		12		10

Revenues from the sale of electricity include fuel costs, which are passed through directly to customers, and base revenues. Base revenues refers to the Company’s revenues from the sale of

electricity excluding such fuel costs. Economy sales are wholesale sales into markets outside the Company’s service territory.

The Company’s retail base revenues percentages by customer class are presented below:


	Three Months Ended March 31,				Twelve Months Ended March 31,
	2005		2004		2005		2004
Residential	39	%	39	%	38	%	38	%
Commercial and industrial, small	36		35		37		36
Commercial and industrial, large	9		10		9		10
Sales to public authorities	16		16		16		16

Total base revenues	100	%	100	%	100	%	100	%

No retail customer accounted for more than 2% of the Company’s base revenues during such periods. In addition, sales for resale base revenues accounted for less than 1% of base revenues.

Palo Verde, which represents approximately 40% of the Company’s available net generating capacity and approximately 56% and 49% of the Company’s available energy for the three and twelve months ended March 31, 2005, respectively, is subject to performance standards in Texas. If such performance standards are not met, the Company is subject to a penalty. See Part I, “Business–Regulation–Texas Regulatory Matters–Palo Verde Performance Standards of the 2004 Form 10-K.”

Historical Results of Operations


	Three Months Ended March 31,				Twelve Months Ended March 31,
	2005		2004		2005		2004
Income before extraordinary item (in thousands)	$	4,757	$	2,914	$	35,212	$	21,193
Diluted earnings per share before extraordinary item		0.10		0.06		0.73		0.44

Income for the three months ended March 31, 2005 increased $1.8 million or $0.04 diluted earnings per share, compared to the results for the same period a year ago. This after-tax increase resulted primarily from (i) increased 2005 economy sales margins of $1.5 million; (ii) loss on extinguishments of debt of $1.3 million in the quarter ended March 31, 2004 with no comparable amount in the current quarter; (iii) a $0.7 million 2005 decrease in taxes other than income taxes; (iv) decreased 2005 insurance expenses of $0.4 million; (v) decreased 2005 outside services of $0.4 million; and (vi) a $0.4 million 2005 increase in investment and interest income. These increases were partially offset by decreased 2005 retail base revenues of $2.2 million after-tax and increased 2005 non-Palo Verde operating and maintenance expenses of $0.7 million after-tax.

Income before the extraordinary item for the twelve months ended March 31, 2005 increased $14.0 million or $0.29 diluted earnings per share, compared to the results for the same period a year ago.

This after-tax increase resulted primarily from (i) the 2003 asset impairment loss on the CIS project of $10.7 million with no comparable loss in the current period; (ii) the recording of the benefits of the IRS settlement of $6.2 million with no comparable amount in the previous period; (iii) the Texas fuel disallowance in Docket No. 26194 of $2.8 million that was recorded in 2003 with no comparable amount in the current period; (iv) increased 2005 economy sales margins of $2.0 million; (v) decreased 2005 insurance expenses of $1.8 million; (vi) decreased 2005 interest charges on long-term debt of $1.5 million; and (vii) increased 2005 investment and interest income of $1.3 million. These increases were partially offset by the following items, which are presented on an after-tax basis (i) increased 2005 pension and benefits expense of $3.9 million; (ii) decreased 2005 retail base revenues of $2.9 million; (iii) increased 2005 depreciation expense of $2.8 million; (iv) increased 2005 Palo Verde expenses of $2.2 million; and (v) increased 2005 non-Palo Verde operation and maintenance costs of $1.2 million.

Operating revenues net of energy expenses decreased $0.5 million for the three months ended March 31, 2005 compared to the same period last year primarily due to decreased retail base revenues of $3.5 million. This decrease was partially offset by increased economy sale margins and sales of $2.4 million.

Operating revenues net of energy expenses increased $2.3 million for the twelve months ended March 31, 2005 compared to the previous period primarily due to (i) the Texas fuel disallowance of $4.5 million recorded in the fourth quarter of 2003; (ii) increased 2005 economy margins and sales of $3.3 million; and (iii) $1.3 million expense related to fuel settlement agreements primarily with Enron North America, Corp. recorded in the prior period with no comparable amount in the current period. This increase was partially offset by decreased 2005 retail base revenues of $4.7 million and a $2.4 million increase in the coal reclamation liability recorded in the fourth quarter of 2004 with no comparable amount in the previous period.

Comparisons of kWh sales and operating revenues are shown below (in thousands):


					Increase (Decrease)
Quarter Ended March 31:	2005		2004		Amount			Percent
kWh sales:
Retail:
Residential		449,464		468,317		(18,853	)	(4.0	)%
Commercial and industrial, small		435,490		454,848		(19,358	)	(4.3	)
Commercial and industrial, large		267,840		303,390		(35,550	)	(11.7	)(1)
Sales to public authorities		268,046		278,904		(10,858	)	(3.9	)

Total retail sales		1,420,840		1,505,459		(84,619	)	(5.6	)

Wholesale:
Sales for resale		8,165		9,267		(1,102	)	(11.9	)
Economy sales		587,111		486,620		100,491		20.7	(2)

Total wholesale sales		595,276		495,887		99,389		20.0

Total kWh sales		2,016,116		2,001,346		14,770		0.7

Operating revenues:
Base revenues:
Retail:
Residential	$	39,235	$	40,171	$	(936	)	(2.3	)%
Commercial and industrial, small		35,364		36,101		(737	)	(2.0	)
Commercial and industrial, large		9,274		10,290		(1,016	)	(9.9	)(1)
Sales to public authorities		15,737		16,558		(821	)	(5.0	)

Total retail base revenues		99,610		103,120		(3,510	)	(3.4	)
Wholesale:
Sales for resale		325		392		(67	)	(17.1	)

Total base revenues		99,935		103,512		(3,577	)	(3.5	)

Fuel revenues		29,528		31,274		(1,746	)	(5.6	)
Economy sales		26,710		18,964		7,746		40.8	(2)
Other		3,012		2,102		910		43.3	(3)(4)

Total operating revenues	$	159,185	$	155,852	$	3,333		2.1

(1)	Primarily due to the closure or significantly reduced operations of several customers.

(2)	Primarily due to increased available generation and higher market prices.

(3)	Primarily due to increased transmission revenues.

(4)	Represents revenues with no related kWh sales.


					Increase (Decrease)
Twelve Months Ended March 31:	2005		2004		Amount			Percent
kWh sales:
Retail:
Residential		1,967,232		1,969,286		(2,054	)	(0.1	)%
Commercial and industrial, small		2,096,464		2,114,145		(17,681	)	(0.8	)
Commercial and industrial, large		1,200,875		1,235,714		(34,839	)	(2.8	)
Sales to public authorities		1,232,146		1,245,747		(13,601	)	(1.1	)

Total retail sales		6,496,717		6,564,892		(68,175	)	(1.0	)

Wholesale:
Sales for resale		39,991		67,129		(27,138	)	(40.4	)(1)
Economy sales		1,938,958		1,791,814		147,144		8.2

Total wholesale sales		1,978,949		1,858,943		120,006		6.5

Total kWh sales		8,475,666		8,423,835		51,831		0.6

Operating revenues:
Base revenues:
Retail:
Residential	$	173,816	$	174,247	$	(431	)	(0.2	)%
Commercial and industrial, small		165,023		165,830		(807	)	(0.5	)
Commercial and industrial, large		42,134		43,698		(1,564	)	(3.6	)
Sales to public authorities		71,899		73,805		(1,906	)	(2.6	)

Total retail base revenues		452,872		457,580		(4,708	)	(1.0	)
Wholesale:
Sales for resale		1,608		3,225		(1,617	)	(50.1	)(1)

Total base revenues		454,480		460,805		(6,325	)	(1.4	)

Fuel revenues		159,306		132,538		26,768		20.2	(2)
Economy sales		86,279		70,469		15,810		22.4	(3)
Other		11,896		8,916		2,980		33.4	(4)(5)

Total operating revenues	$	711,961	$	672,728	$	39,233		5.8

(1)	Primarily due to sales to the CFE in 2003 with no comparable sales in 2004.

(2)	Primarily due to an increase in recoverable fuel expenses as a result of an increase in the price and volume of natural gas burned and an increase in purchased power costs.

(3)	Primarily due to increased available generation and higher market prices.

(4)	Primarily due to increased transmission revenues.

(5)	Represents revenues with no related kWh sales.

Other operations expense increased $0.4 million for the three months ended March 31, 2005 compared to the same period last year primarily due to increased (i) pension and benefits expense of $0.7 million relating to employee bonuses accrual; (ii) increased 2005 non-Palo Verde operations expense of $0.8 million; and (iii) increased 2005 Palo Verde operations expense of $0.4 million. These increases were partially offset by decreased insurance related expenses of $0.7 million and decreased outside services of $0.7 million.

Other operations expense increased $4.1 million for the twelve months ended March 31, 2005 compared to the same period last year primarily due to (i) increased 2005 pension and benefits expense

of $6.3 million (including a $4.0 million increase in employee bonuses); (ii) increased 2005 Palo Verde operations expense of $1.7 million; and (iii) increased 2005 non-Palo Verde operations expense of $1.4 million. These increases were partially offset by (i) decreased 2005 insurance related expenses of $2.9 million; (ii) decreased 2005 customer account expense of $1.5 million; and (iii) decreased outside services of $1.2 million.

The Company abandoned a CIS project and recognized an asset impairment loss of $17.6 million in September 2003. The Company is now analyzing various options to meet its current and projected CIS needs.

Maintenance expense decreased $0.2 million for the three months ended March 31, 2005 compared to the same period last year primarily due to reduced 2005 maintenance at Palo Verde of $0.5 million partially offset by increased 2005 non-Palo Verde maintenance of $0.3 million.

Maintenance expense increased $2.6 million for the twelve months ended March 31, 2005 compared to the same period last year primarily due to increased 2005 maintenance at Palo Verde of $1.8 million and increased 2005 non-Palo Verde maintenance of $0.6 million.

Depreciation and amortization expense increased $0.4 million and $4.4 million for the three and twelve months ended March 31, 2005, respectively, compared to the same periods last year due to increases in depreciable plant balances. The twelve month increase was also due to the implementation of new depreciation rates based on a new depreciation study.

Taxes other than income taxes decreased $1.1 million and $1.7 million for the three and twelve months ended March 31, 2005, respectively, compared to the same periods last year. The decrease was primarily due to a June 2004 change in New Mexico law which changed the way the occupation street rental tax was recorded and a decrease in property tax compared to the prior period.

Other income (deductions) increased $2.6 million for the three months ended March 31, 2005 compared to the same period last year primarily due to losses on extinguishments of debt of $2.1 million recorded in 2004 with no comparable activity in 2005, and an adjustment of $0.7 million reducing interest income associated with the resolution of the Texas fuel reconciliation in PUC Docket No. 26194 recorded in 2004 with no comparable activity in 2005.

Other income (deductions) decreased $0.3 million for the twelve months ended March 31, 2005 compared to the same period last year primarily due to an increase of $1.1 million related to losses on extinguishments of debt and the receipt of $0.9 million of sales tax refunds in the prior period with no comparable activity in the current period. These decreases were partially offset by increased investment income of $1.3 million related to the decommissioning trust funds.

Interest charges (credits) decreased $1.0 million for the three months ended March 31, 2005 compared to the same period last year primarily due to (i) a $0.7 million decrease resulting from a reduction of outstanding debt as a result of open market purchases of the Company’s first mortgage bonds and (ii) increased capitalized interest of $0.3 million due to an increase in construction work in progress expenditures related to Palo Verde Units 1 and 3 steam generators.

Interest charges (credits) decreased $1.5 million for the twelve months ended March 31, 2005 compared to the same period last year primarily due to a $2.5 million decrease resulting from a reduction of outstanding debt as a result of open market purchases of the Company’s first mortgage bonds partially offset by a reduction in capitalized interest of $1.3 million as a result of transferring Palo Verde Unit 2 steam generators to plant in service.

Income tax expense increased $1.9 million for the three months ended March 31, 2005 compared to the same period last year primarily due to changes in pretax income and certain permanent differences and adjustments. Income tax expense, before the effect of an extraordinary item, decreased $2.4 million for the twelve months ended March 31, 2005 compared to the same period last year, primarily due to the $6.2 million benefit for the IRS settlement offset by changes in pretax income and certain permanent differences.

Extraordinary gain on re-application of SFAS No. 71 relates to the Company’s third quarter 2004 determination that it met the criteria necessary to re-apply SFAS No. 71 to its New Mexico jurisdiction. The decision was based on the Company’s receiving the New Mexico Commission’s approval for new rates that were based upon the Company’s cost of service and the fact that New Mexico had repealed its electric utility restructuring law. The re-application of SFAS No. 71 to the Company’s New Mexico jurisdiction resulted in the recording of a $1.8 million extraordinary gain, net of tax.

In December 2004, the FASB issued a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123 (revised) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123 (revised) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with some limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award – “the requisite service period” – typically the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. SFAS No. 123 (revised) is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after December 15, 2005. SFAS No. 123 (revised) applies to all awards granted after the required effective date and to awards modified, repurchased or cancelled after that date. Additionally, compensation cost for outstanding awards for which the requisite service has not been rendered as of the effective date shall be expensed as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated for pro forma disclosure under SFAS No. 123. Due to timing of the release of SFAS No. 123 (revised), the Company has not yet completed the analysis of the ultimate impact that this new pronouncement will have on the Company’s financial statements but does not expect this statement to have an effect materially different than the pro forma disclosures provided in Note A.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” (“FIN 47”). FIN 47 clarifies that the term “conditional” as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” which refers to a legal obligation to perform an asset retirement activity even if the timing and/or settlement are conditional on a future event that may or may not be within the control of an entity. Accordingly, the entity must record a liability for the conditional asset retirement obligation if the fair value of the obligation can be reasonably estimated. The interpretation is effective for companies no later than the end of the fiscal year ending after

December 15, 2005. The Company is evaluating the impact of FIN 47 on its consolidated financial statements.

Liquidity and Capital Resources

The Company’s principal liquidity requirements in the near-term are expected to consist of the refinancing of the Company’s pollution control bonds and its first mortgage bonds, interest payments on the Company’s indebtedness, operating and capital expenditures related to the Company’s generating facilities and transmission and distribution systems, and income and other taxes. The Company expects that, for all but the debt refinancing, cash flows from operations will be sufficient for such purposes. As of March 31, 2005, the Company had approximately $40.0 million in cash and cash equivalents, an increase of $10.6 million from the balance of $29.4 million on December 31, 2004.

Pollution control bonds of $193.1 million are subject to remarketing on August 1, 2005, and first mortgage bonds of $175.8 million are scheduled to mature in 2006. Additionally, the Company has $183.6 million of first mortgage bonds which become callable in 2006 and which may be refinanced at that time if market conditions are favorable. During the first quarter of 2005, the Company entered into treasury rate lock agreements to hedge against potential movements in the treasury reference interest rates. These treasury rate locks expire during the second quarter of 2005. Treasury rates have fallen since the Company entered into these agreements. Should treasury rates remain at these lower levels or continue to fall, a cash payment will be due when these agreements expire. Assuming treasury rates at the expiration of the hedges are the same as treasury rates as of April 29, 2005, a cash payment of $22.9 million would be due. The Company’s ability to access capital and credit markets may be adversely affected by uncertainties related to its operating results, conditions in the credit markets and debt rating agency actions.

The Company has filed a shelf registration statement on Form S-3 with the SEC which became effective on May 5, 2005. The shelf registration statement enables the Company to offer and issue debt securities, first mortgage bonds, shares of stock and certain other securities from time to time in one or more offerings of up to $1.0 billion.

On May 5, 2005, the Company announced that it has commenced a cash tender offer for any and all of its 8.90% Series D First Mortgage Bonds due February 1, 2006 and its 9.40% Series E First Mortgage Bonds due May 1, 2011, which are callable by the Company beginning on February 1, 2006 (collectively, the “Bonds”). The total outstanding principal amount of the Bonds subject to the offer is approximately $359.4 million. See Part II, Item 5, “Other Information.”

Long-term capital requirements of the Company will consist primarily of construction of electric utility plant and the payment of interest on and retirement and refinancing of debt. Utility construction expenditures will consist primarily of expanding and updating the transmission and distribution systems, addition of new generation, and the cost of capital improvements and replacements at Palo Verde and other generating facilities, including the replacement of steam generators in Palo Verde Units 1 and 3.

Utility construction expenditures reflected in the following table consist primarily of local generation (including cost of capacity to replace units to be retired), expanding and updating the transmission and distribution systems and the cost of capital improvements and replacements at Palo Verde, including the fabrication and installation of Palo Verde Units 1 and 3 steam generators.

Replacement power costs expected to be incurred during the replacement of Palo Verde steam generators are not included in construction costs. Studies indicate that the Company will need additional supply-side and demand-side resources to meet increasing load requirements on its system. As a result, the Company is currently evaluating various alternatives to meet its load requirements.

The Company’s estimated cash construction costs for 2005 through 2008 are approximately $498 million. Actual costs may vary from the construction program estimates shown. Such estimates are reviewed and updated periodically to reflect changed conditions.


By Year (1)(2) (In millions)			By Function (In millions)
2005	$	95	Production (1)(2)	$	284
2006		83	Transmission		32
2007		141	Distribution		126
2008		179	General		56

Total	$	498	Total	$	498

(1)	Does not include acquisition costs for nuclear fuel. See Part I “Energy Sources – Nuclear Fuel” in the 2004 Form 10-K.

(2)	Includes $159.6 million for local generation, $15.4 million for the Four Corners Station and $109.4 million for the Palo Verde Station.

During the twelve months ended March 31, 2005 and 2004, the Company utilized $55.5 million and $11.6 million, respectively, of regular federal tax loss carryforwards. The significant reduction in federal tax loss carryforwards during the twelve months ended March 31, 2005 was primarily related to the IRS settlement. The Company anticipates that existing federal tax loss carryforwards will be fully utilized in 2005 and the Company’s cash flow requirements are expected to include greater amounts of cash for income taxes than has existed in recent years.

The Company is continually evaluating its funding requirements related to its retirement plans, other postretirement benefit plans, and decommissioning trust funds. To date, the Company has contributed $5.1 million of its projected $18.5 million 2005 annual contribution to its retirement plans. The Company has also contributed $0.9 million of its projected $3.4 million 2005 annual contribution to its postretirement benefit plan and $1.5 million of its projected $6.2 million 2005 annual contribution to the decommissioning trust funds.

The $100 million revolving credit facility provides up to $70 million for nuclear fuel purchases. Any amounts not borrowed by the Company for nuclear fuel purchases are available for use for working capital needs. As of March 31, 2005, approximately $39.2 million had been drawn for nuclear fuel purchases. No amounts are currently outstanding on this facility for working capital needs. The revolving credit facility was renewed for a five-year term in December 2004. During the term of the agreement, the revolving credit facility may be increased to $150 million at the request of the Company.

Since inception of its deleveraging program in 1996, the Company has repurchased or retired with internally generated cash $586.5 million of first mortgage bonds. No first mortgage bonds were repurchased during the first quarter of 2005. Common stock equity as a percentage of capitalization, including current portion of long-term debt and financing obligations, was 48% as of March 31, 2005.

Since the inception of the stock repurchase programs in 1999, the Company repurchased approximately 15.3 million shares in total at an aggregate cost of $175.6 million, including commissions. No shares were repurchased during the first quarter of 2005. The Company may continue making purchases of its stock pursuant to its stock repurchase plan at open market prices and may engage in private transactions, where appropriate. The repurchased shares will be available for issuance under employee benefit and stock option plans, or may be retired.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Risk Factors

Like other companies in our industry, our consolidated financial results will be impacted by weather, the economy of our service territory, fuel prices, the performance of our customers and the decisions of regulatory agencies. Our common stock price and creditworthiness will be affected by national and international macroeconomic trends, general market conditions and the expectations of the investment community, all of which are largely beyond our control. In addition, the following statements highlight risk factors that may affect our consolidated financial condition and results of operations. These are not intended to be an exhaustive discussion of all such risks, and the statements below must be read together with factors discussed elsewhere in this document and in our other filings with the SEC.

Our Costs Could Increase if There are Problems at the Palo Verde Nuclear Generating Station

A significant percentage of our generating capacity, assets and operating expenses is attributable to Palo Verde. The Company’s 15.8% interest in each of the three Palo Verde units total approximately 600 MW of generating capacity. Palo Verde represents approximately 40% of our available net generating capacity and represented approximately 56% of our available energy for the three months ended March 31, 2005. We face the risk of additional or unanticipated costs at Palo Verde resulting from (i) increases in operation and maintenance expenses; (ii) the replacement of steam generators in Palo Verde Units 1 and 3; (iii) an extended outage of any of the Palo Verde units; (iv) increases in estimates of decommissioning costs; (v) the storage of radioactive waste, including spent nuclear fuel; (vi) insolvency of other Palo Verde Participants; and (vii) compliance with the various requirements and regulations governing commercial nuclear generating stations. At the same time, the Company’s retail base rates in Texas are effectively capped through a rate freeze ending in August 2005. As a result, the Company cannot raise its base rates in Texas prior to the expiration of the Freeze Period in the event of increases in non-fuel costs or loss of revenue. Additionally, should retail competition occur, there may be competitive pressure on the Company’s power generation rates which could reduce its profitability. The Company cannot assure that its revenues will be sufficient to recover any increased costs, including any increased costs in connection with Palo Verde or other operations, whether as a result of inflation, changes in tax laws or regulatory requirements, or other causes.

Our Retail Rates Are Subject to Change Following the Termination of our Ten-Year Rate Freeze in August 2005

Our rates in Texas, which accounted for 63% of our revenues for the three months ended March 31, 2005, have been frozen and not subject to regulatory review since August 2, 1995. The Freeze Period expires on August 1, 2005. Thereafter, we will be subject to traditional cost of service regulation by the Texas cities that we serve and the Texas Commission. There can be no assurance that we will be able to maintain our Texas rates after expiration of the Freeze Period. In addition, the end of the Freeze Period may mean that we will no longer be entitled to retain 50% of our margins from off-system sales. If a return to cost of service regulation leads to lower rates or the retention by us of less of the margin from off-system sales, there would be a material negative impact on our revenues, earnings, cash flows and financial position.

Our Franchise With the City of El Paso Expires in August 2005

El Paso is the largest city in our service area, representing 54% of our revenues for the three months ended March 31, 2005. Our ten-year franchise with the City of El Paso expires on August 1, 2005 and there can be no assurance that we will be able to negotiate a new franchise on terms that are acceptable to us.

We May Not Be Able to Pass Through All of Our Fuel Expenses to Customers

In general, through regulation, we can pass through our fuel and purchased power expenses to our customers. Nevertheless, we agreed in 2004 to a fixed fuel factor for ten percent of our retail customers in New Mexico. This subjects us to the risk of increased costs of fuel that would not be recoverable. The portion of fuel expense that is not fixed is subject to reconciliation by the Texas and New Mexico Commissions. Prior to the completion of a reconciliation, the Company records fuel transactions such that fuel revenues equal fuel expense except for the portion fixed in New Mexico. In the event that a disallowance occurs during a reconciliation proceeding, the amounts recorded for fuel and purchased power expenses could differ from the amounts allowed to be collected by us from our customers and we would incur a loss to the extent of the disallowance.

Equipment Failures and Other External Factors Can Adversely Affect Our Results

The generation and transmission of electricity require the use of expensive and complex equipment. While we have a maintenance program in place, generating plants are subject to unplanned outages because of equipment failure. We are particularly vulnerable to this due to the advanced age of several of our generating units in or near El Paso. In these events, we must acquire power from others at unpredictable costs in order to supply our customers and comply with our contractual agreements. This can increase our costs materially and prevent us from selling excess power at wholesale, thus reducing our profits. In addition, decisions or mistakes by other utilities may adversely affect our ability to use transmission lines to deliver or import power, thus subjecting us to unexpected expenses or to the cost and uncertainty of public policy initiatives. We are particularly vulnerable to this because a significant portion of our available energy (at Palo Verde and Four Corners) is located hundreds of miles from El Paso and Las Cruces and must be delivered to our customers over long distance transmission lines. These factors, as well as weather, interest rates, economic conditions, fuel prices and price volatility, are

largely beyond our control, but may have a material adverse effect on our consolidated earnings, cash flows and financial position.

Competition and Deregulation Could Result in a Loss of Customers and Increased Costs

As a result of changes in federal law, our wholesale and large retail customers already have, in varying degrees, alternate sources of economical power, including co-generation of electric power. In addition, in recent years, both New Mexico and Texas passed industry deregulation legislation requiring us to separate our transmission and distribution functions, which would remain regulated, from our power generation and energy services businesses, which would operate in a competitive market, in the future. New Mexico repealed the New Mexico Restructuring Act in April 2003, and the Company’s operations in New Mexico will remain fully regulated. On October 13, 2004, the Texas Commission approved a rule delaying retail competition in the Company’s Texas service territory. There is substantial uncertainty about both the regulatory framework and market conditions that would exist if and when retail competition is implemented in the Company’s Texas service territory, and we may incur substantial preparatory, restructuring and other costs that may not ultimately be recoverable. There can be no assurance that deregulation would not adversely affect our future operations, cash flows and financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risk due to changes in interest rates, equity prices and commodity prices. See the Company’s 2004 Form 10-K, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” for a complete discussion of the market risks faced by the Company and the Company’s market risk sensitive assets and liabilities. As of March 31, 2005, there have been no material changes in the market risks faced by the Company or the fair values of assets and liabilities disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in the Company’s 2004 Form 10-K, except as discussed below.

During the first quarter of 2005, the Company entered into treasury rate lock agreements to hedge against potential movements in the treasury reference interest rates. These treasury rate locks expire during the second quarter of 2005. The treasury rate lock agreements meet the criteria for hedge accounting and are designated as a highly effective cash flow hedge. In accordance with cash flow hedge accounting, the Company recorded the fair value of the cash flow hedge at March 31, 2005 of $1.8 million, net of tax, as a component of accumulated other comprehensive loss. The Company will adjust the value of the hedge gain or loss until the position is closed which will occur sometime during the second quarter of 2005. The accumulated other comprehensive gain or loss associated with the cash flow hedge will be recognized in earnings as interest expense is accrued on applicable debt obligations.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. During the period covered by this report, the Company’s chief executive officer and principal financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of March 31, 2005, (the “Evaluation Date”), concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures (as required by paragraph (b) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15) were adequate and designed to ensure that material information relating to the Company and the Company’s consolidated subsidiary would be made known to them by others within those entities.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting in connection with the evaluation required by paragraph (d) of the Securities Exchange Act of 1934 Rules 13a-15 or 15d-15, that occurred during the quarter ended March 31, 2005, that materially affected, or that were reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company hereby incorporates by reference the information set forth in Part I of this report under Notes B and E of Notes to Consolidated Financial Statements.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

In February 2004, the Company’s Board of Directors authorized a new stock repurchase program permitting the repurchase of up to 2 million shares of its outstanding common stock. Approximately 1.7 million shares remain authorized to be repurchased under the program. No shares were repurchased during the first quarter of 2005.

Item 5. Other Information

Sixth Supplement to General Mortgage Indenture and Deed of Trust

On May 5, 2005, the Company entered into a Sixth Supplemental Indenture to the General Mortgage Indenture and Deed of Trust dated as of February 1, 1996 between the Company and U.S. Bank National Association, as successor to State Street Bank and Trust Company, as Trustee (the “General Mortgage”), which amends the covenants and events of default contained in the First Supplemental Indenture to the General Mortgage at such time as there are no longer outstanding any of the Company’s Series D or Series E First Mortgage Bonds under the General Mortgage.

Tender Offer

On May 5, 2005, the Company announced that it has commenced a cash tender offer (the “Tender Offer”) for any and all of its 8.90% Series D First Mortgage Bonds due February 1, 2006 and its 9.40% Series E First Mortgage Bonds due May 1, 2011, which are callable by the Company beginning on February 1, 2006 (collectively, the “Bonds”). The total outstanding principal amount of the Bonds subject to the Tender Offer is approximately $359.4 million. The terms and conditions of the Tender Offer are more fully described in a Form 8-K filed by the Company on May 5, 2005.

Item 6. Exhibits

See Index to Exhibits incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


EL PASO ELECTRIC COMPANY

By:		/s/ SCOTT D. WILSON
		Scott D. Wilson
		Senior Vice President
		and Chief Financial Officer
		(Duly Authorized Officer and
		Principal Financial Officer)

Dated: May 6, 2005

EL PASO ELECTRIC COMPANY

INDEX TO EXHIBITS


Exhibit Number		Exhibit
4.01		Sixth Supplemental Indenture dated as of May 5, 2005 to General Mortgage Indenture and Deed of Trust dated as of February 1, 1996 between the Company and U.S. Bank National Association as trustee

†10.01		Form of Directors’ Restricted Stock Award Agreement between the Company and certain directors of the Company. (Identical in all material respects to Exhibit 10.07 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1999)

10.02		Eight Treasury Rate Lock agreements between the Company and Credit Suisse First Boston International

††10.03		Master Power Purchase and Sale Agreement and Transaction Agreement, dated as of July 7, 2004, between the Company and Southwestern Public Service Company

15		Letter re Unaudited Interim Financial Information

31.01		Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.01		Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

†		In lieu of non-employee director cash compensation, four agreements, dated as of January 3, 2005 and April 1, 2005, substantially identical in all material respects to this Exhibit, have been entered into with Kenneth R. Heitz; and Patricia Z. Holland-Branch directors of the Company.

††		Confidential treatment has been requested for the redacted portions of Exhibit 10.03. The copy filed herewith omits the information subject to the confidentiality request. Omissions are designated as “****.” A complete version of this Exhibit has been filed separately with the Securities and Exchange Commission.

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