UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
- OR -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission Name of Registrants, State of Incorporation, I.R.S. Employer
File Number Address and Telephone Number Identification No.
- ----------- -------------------------------------------- ------------------
333-32170 PNM Resources, Inc. 85-0468296
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
1-6986 Public Service Company of New Mexico 85-0019030
(A New Mexico Corporation)
Alvarado Square
Albuquerque, New Mexico 87158
(505) 241-2700
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Name of Registrant Title of Each Class on Which Registered
- ------------------ ------------------- -----------------------
PNM Resources, Inc. Common Stock, No Par Value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act
None.
Indicate by check mark whether the registrants (1) have filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
------ ------
Indicate by check mark whether the registrants are accelerated
filers (as defined in Rule 12b-2 of the Exchange Act). Yes X No
------ -----
As of August 1, 2003, 40,239,294 shares of common stock, no par value
per share, of PNM Resources, Inc. were outstanding.
PNM RESOURCES, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION:
Independent Accountants Report..................................... 3
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
PNM Resources, Inc.
Consolidated Statements of Earnings
Three and Six Months Ended June 30, 2003 and 2002....... 5
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002..................... 6
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002................. 8
Consolidated Statements of Comprehensive Income
Three and Six Months Ended June 30, 2003 and 2002....... 9
Public Service Company of New Mexico
Consolidated Statements of Earnings
Three and Six Months Ended June 30, 2003 and 2002....... 10
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002..................... 11
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002................. 13
Consolidated Statements of Comprehensive Income
Three and Six Months Ended June 30, 2003 and 2002....... 14
Notes to Consolidated Financial Statements...................... 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK............................................ 71
ITEM 4. CONTROLS AND PROCEDURES................................... 78
PART II. OTHER INFORMATION:
ITEM 1. LEGAL PROCEEDINGS......................................... 79
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................. 81
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....... 81
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................... 82
Signature.......................................................... 84
2
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of PNM Resources, Inc.
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of PNM Resources,
Inc. and subsidiaries (the Company) as of June 30, 2003, and the related
consolidated statements of earnings and comprehensive income for the three-month
and six-month periods ended June 30, 2003 and 2002, and of cash flows for the
six-month periods ended June 30, 2003 and 2002. These interim financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with
auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the consolidated interim financial statements, the
Company adopted Statement of Financial Accounting Standards No. 143, "Accounting
for Asset Retirement Obligations," effective January 1, 2003.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet and
consolidated statement of capitalization (not presented herein) of PNM
Resources, Inc. and subsidiaries as of December 31, 2002, and the related
consolidated statements of earnings, retained earnings, comprehensive income
(loss), and cash flows for the year then ended (not presented herein); and in
our report dated February 11, 2003, (June 5, 2003, as to Notes 2 and 16) (and
includes explanatory paragraphs referring to the realignment of segments for
financial reporting purposes and the adoption of EITF 02-3) appearing in the
Current Report on Form 8-K dated June 12, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
August 4, 2003
3
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders of
Public Service Company of New Mexico
Albuquerque, New Mexico
We have reviewed the accompanying consolidated balance sheet of Public Service
Company of New Mexico and subsidiaries (the Company) as of June 30, 2003, and
the related consolidated statements of earnings and comprehensive income for the
three-month and six-month periods ended June 30, 2003 and 2002, and of cash
flows for the six-month periods ended June 30, 2003 and 2002. These interim
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures and
making inquiries of persons responsible for financial and accounting matters. It
is substantially less in scope than an audit conducted in accordance with
auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the consolidated interim financial statements, the
Company adopted Statement of Financial Accounting Standards No. 143, "Accounting
for Asset Retirement Obligations," effective January 1, 2003.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet and
consolidated statement of capitalization (not presented herein) of Public
Service Company of New Mexico and subsidiaries as of December 31, 2002, and the
related consolidated statements of earnings, retained earnings, comprehensive
income (loss), and cash flows for the year then ended (not presented herein);
and in our report dated February 11, 2003, (June 5, 2003, as to Notes 2 and 16)
(and includes explanatory paragraphs referring to the realignment of segments
for financial reporting purposes and the adoption of EITF 02-3) appearing in the
Current Report on Form 8-K dated June 12, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 2002 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Omaha, Nebraska
August 4, 2003
4
ITEM 1. FINANCIAL STATEMENTS
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands, except per share amounts)
Operating Revenues:
Electric................................. $266,150 $206,136 $507,528 $397,920
Gas...................................... 74,009 43,968 220,262 153,169
Unregulated businesses................... 52 85 112 917
-------------- -------------- -------------- --------------
Total operating revenues............... 340,211 250,189 727,902 552,006
-------------- -------------- -------------- --------------
Operating Expenses:
Cost of energy sold...................... 175,335 108,382 401,269 251,987
Administrative and general............... 42,600 36,319 74,642 67,707
Energy production costs.................. 34,515 34,202 69,609 69,173
Depreciation and amortization............ 28,850 25,217 57,224 49,996
Transmission and distribution costs...... 15,194 15,451 31,353 31,988
Taxes, other than income taxes........... 6,720 9,028 14,506 17,512
Income taxes............................. 7,083 2,141 15,959 11,507
-------------- -------------- -------------- --------------
Total operating expenses............... 310,297 230,740 664,562 499,870
-------------- -------------- -------------- --------------
Operating income....................... 29,914 19,449 63,340 52,136
-------------- -------------- -------------- --------------
Other Income and Deductions:
Other income............................. 12,745 11,724 23,951 25,451
Other deductions......................... (4,020) (1,895) (21,932) (3,392)
Income tax expense....................... (3,132) (3,432) (725) (8,274)
-------------- -------------- -------------- --------------
Net other income and deductions........ 5,593 6,397 1,294 13,785
-------------- -------------- -------------- --------------
Income before interest charges......... 35,507 25,846 64,634 65,921
Interest Charges........................... 17,764 14,689 35,997 29,815
-------------- -------------- -------------- --------------
Net Earnings from Operations............... 17,743 11,157 28,637 36,106
-------------- -------------- -------------- --------------
Cumulative Effect of a Change in Accounting
Principle, Net of Tax of $24,524........ - - 37,422 -
-------------- -------------- -------------- --------------
Net Earnings............................... 17,743 11,157 66,059 36,106
Preferred Stock Dividend Requirements...... 147 147 293 293
-------------- -------------- -------------- --------------
Net Earnings Applicable to Common Stock.... $ 17,596 $ 11,010 $ 65,766 $ 35,813
============== ============== ============== ==============
Net Earnings per Common Share:
Basic.................................... $ 0.45 $ 0.28 $ 1.68 $ 0.92
============== ============== ============== ==============
Diluted.................................. $ 0.44 $ 0.28 $ 1.66 $ 0.90
============== ============== ============== ==============
Dividends Paid per Share of Common Stock... $ 0.23 $ 0.22 $ 0.45 $ 0.42
============== ============== ============== ==============
The accompanying notes are an integral part of these
financial statements.
5
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
------------------ -----------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service..................................... $2,385,534 $2,301,673
Gas plant in service.......................................... 627,980 615,907
Common plant in service and plant held for future use......... 63,088 79,987
------------------ -----------------
3,076,602 2,997,567
Less accumulated depreciation and amortization................ 1,335,298 1,330,376
------------------ -----------------
1,741,304 1,667,191
Construction work in progress................................. 158,568 173,248
Nuclear fuel, net of accumulated amortization of
$16,195 and $16,568....................................... 25,176 26,832
------------------ -----------------
Net utility plant........................................... 1,925,048 1,867,271
------------------ -----------------
Other Property and Investments:
Other investments............................................. 446,109 442,704
Non-utility property, net of accumulated depreciation of
$1,835 and $1,750......................................... 1,443 1,528
------------------ -----------------
Total other property and investments........................ 447,552 444,232
------------------ -----------------
Current Assets:
Cash and cash equivalents..................................... 2,639 3,702
Accounts receivables, net of allowance for uncollectible
accounts of $12,275 and $15,575........................... 56,042 46,914
Unbilled revenues............................................. 56,283 65,472
Other receivables............................................. 46,093 53,052
Inventories................................................... 37,730 37,230
Regulatory assets............................................. 5,194 24,027
Short-term investments........................................ - 79,630
Other current assets.......................................... 67,564 32,753
------------------ -----------------
Total current assets........................................ 271,545 342,780
------------------ -----------------
Deferred Charges:
Regulatory assets............................................. 215,713 196,283
Prepaid retirement costs...................................... 86,876 39,665
Other deferred charges........................................ 137,088 129,063
------------------ -----------------
Total deferred charges...................................... 439,677 365,011
------------------ -----------------
$3,083,822 $3,019,294
================== =================
The accompanying notes are an integral part of these
financial statements.
6
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
------------------ ------------------
(In thousands)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholders' equity:
Common stock.................................................... $648,036 $ 624,119
Accumulated other comprehensive loss, net of tax................ (82,519) (94,721)
Retained earnings............................................... 501,416 444,651
------------------ ------------------
Total common stockholders' equity............................ 1,066,933 974,049
Minority interest.................................................. 11,437 11,760
Cumulative preferred stock without mandatory
redemption requirements....................................... 12,800 12,800
Long-term debt..................................................... 953,934 980,092
------------------ ------------------
Total capitalization......................................... 2,045,104 1,978,701
------------------ ------------------
Current Liabilities:
Short-term debt..................................................... 174,134 150,000
Accounts payable..................................................... 42,211 90,355
Accrued interest and taxes........................................... 71,775 46,189
Other current liabilities............................................ 95,397 99,019
------------------ ------------------
Total current liabilities.................................... 383,517 385,563
------------------ ------------------
Deferred Credits:
Accumulated deferred income taxes.................................... 158,942 125,595
Accumulated deferred investment tax credits.......................... 40,022 41,583
Regulatory liabilities............................................... 78,728 52,019
Regulatory liabilities related to accumulated deferred income tax.... 14,137 14,137
Asset retirement obligations......................................... 43,995 -
Minimum pension liability............................................ 141,175 141,175
Accrued postretirement benefit costs................................. 16,156 17,335
Other deferred credits............................................... 162,046 263,186
------------------ ------------------
Total deferred credits........................................ 655,201 655,030
------------------ ------------------
$ 3,083,822 $ 3,019,294
================== ==================
The accompanying notes are an integral part of these
financial statements.
7
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
----------------------------------
2003 2002
--------------- ---------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings............................................................ $ 66,059 $ 36,106
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization...................................... 65,448 56,470
Accumulated deferred income tax...................................... 23,169 (3,885)
Transition costs write-off........................................... 16,720 -
Cumulative effect of a change in accounting principle................ (61,946) -
Net unrealized gains on trading and investing contracts............ (4,167) (16,131)
Changes in certain assets and liabilities:
Accounts receivables................................................ (9,128) 11,455
Unbilled revenues.................................................... 9,189 18,483
Accrued post-retirement benefit costs................................ (19,440) (20,678)
Other assets......................................................... 6,736 11,773
Accounts payable..................................................... (48,144) (2,753)
Accrued interest and taxes........................................... 25,586 (17,569)
Other liabilities.................................................... (8,986) (12,880)
--------------- ---------------
Net cash flows provided by operating activities.............. 61,096 60,391
--------------- ---------------
Cash Flows From Investing Activities:
Utility plant additions................................................. (72,732) (127,752)
Redemption of short-term investments.................................... 80,291 45,000
Combustion turbine payments............................................. (11,136) (13,935)
Bond purchase........................................................... (6,675) -
Return of principal of PVNGS lessor notes............................... 9,406 8,996
Other................................................................... (4,604) (452)
--------------- ---------------
Net cash flows used for investing activities................. (5,450) (88,143)
--------------- ---------------
Cash Flows From Financing Activities:
Short-term borrowings, net.............................................. 24,134 65,000
Long-term borrowings.................................................... 182,000 -
Long-term debt repayments............................................... (208,152) -
Refund costs of pollution control bonds................................. (31,427) -
Exercise of employee stock options...................................... (5,032) (3,312)
Dividends paid.......................................................... (17,902) (16,723)
Other................................................................... (330) 581
--------------- ---------------
Net cash flows (used for) provided by financing activities... (56,709) 45,546
--------------- ---------------
Increase (decrease) in Cash and Cash Equivalents.......................... (1,063) 17,794
Beginning of Period....................................................... 3,702 28,408
--------------- ---------------
End of Period............................................................. $ 2,639 $ 46,202
=============== ===============
Supplemental Cash Flow Disclosures:
Interest paid, net of amounts capitalized............................... $ 36,522 $ 24,919
=============== ===============
Income taxes paid (refunded), net....................................... $ (10,657) $ 41,784
=============== ===============
Prepaid pension contribution of PNM Resources, Inc. common shares....... $ 28,950 $ -
=============== ===============
The accompanying notes are an integral part of these
financial statements.
8
PNM RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands)
Net Earnings Before Preferred
Stock Dividends................................ $ 17,743 $11,157 $66,059 $36,106
------------ ------------ ------------ ------------
Other Comprehensive Income (Loss),
net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses)
arising during the period.................. 1,452 (3,765) 873 (2,192)
Reclassification adjustment for
(gains) losses included in net income...... (29) (246) (494) (427)
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of
designated cash flow hedges................. 13,031 (1,036) 11,823 (196)
Reclassification adjustment for
(gains) losses in net income............... - 430 - 773
------------ ------------ ------------ ------------
Total Other Comprehensive Income (Loss)............. 14,454 (4,617) 12,202 (2,042)
------------ ------------ ------------ ------------
Total Comprehensive Income.......................... $32,197 $ 6,540 $78,261 $34,064
============ ============ ============ ============
The accompanying notes are an integral part of
these financial statements.
9
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- ---------------
(In thousands, except per share amounts)
Operating Revenues:
Electric................................... $266,150 $206,136 $507,528 $397,920
Gas........................................ 74,009 43,968 220,262 153,169
-------------- -------------- -------------- ---------------
Total operating revenues................. 340,159 250,104 727,790 551,089
-------------- -------------- -------------- ---------------
Operating Expenses:
Cost of energy sold........................ 175,335 108,382 401,269 251,987
Administrative and general................. 38,457 35,847 71,216 62,996
Energy production costs.................... 34,515 34,202 69,609 69,173
Depreciation and amortization.............. 28,551 24,980 56,484 49,753
Transmission and distribution costs........ 15,194 15,451 32,453 31,988
Taxes, other than income taxes............. 6,547 8,045 15,248 16,081
Income taxes............................... 8,910 2,733 17,111 12,505
-------------- -------------- -------------- ---------------
Total operating expenses................. 307,509 229,640 663,390 494,483
-------------- -------------- -------------- ---------------
Operating income......................... 32,650 20,464 64,400 56,606
-------------- -------------- -------------- ---------------
Other Income and Deductions:
Other income............................... 11,597 9,128 22,090 19,493
Other deductions........................... (962) (1,626) (19,443) (3,752)
Income tax expense......................... (3,888) (2,511) (974) (6,884)
-------------- -------------- -------------- ---------------
Net other income and deductions.......... 6,747 4,991 1,673 8,857
-------------- -------------- -------------- ---------------
Income before interest charges........... 39,397 25,455 66,073 65,463
Interest Charges............................. 17,738 14,802 35,325 29,956
-------------- -------------- -------------- ---------------
Net Earnings from Operations................. 21,659 10,653 30,748 35,507
-------------- -------------- -------------- ---------------
Cumulative Effect of a Change in Accounting
Principle, Net of Tax of $24,524.......... - - 37,422 -
-------------- -------------- -------------- ---------------
Net Earnings Before Preferred Stock Dividends 21,659 10,653 68,170 35,507
Preferred Stock Dividend Requirements........ 147 147 293 293
-------------- -------------- -------------- ---------------
Net Earnings................................. $ 21,512 $ 10,506 $ 67,877 $ 35,214
============== ============== ============== ===============
The accompanying notes are an integral part of these
financial statements.
10
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
------------------ -----------------
(In thousands)
ASSETS
Utility Plant:
Electric plant in service.................................... $2,385,534 $2,301,048
Gas plant in service......................................... 627,980 615,907
Common plant in service and plant held for future use........ 28,519 18,137
------------------ -----------------
3,042,033 2,935,092
Less accumulated depreciation and amortization............... 1,326,725 1,326,286
------------------ -----------------
1,715,308 1,608,806
Construction work in progress................................ 147,241 159,435
Nuclear fuel, net of accumulated amortization of
$16,195 and $16,568...................................... 25,176 26,832
------------------ -----------------
Net utility plant.......................................... 1,887,725 1,795,073
------------------ -----------------
Other Property and Investments:
Other investments............................................ 422,255 428,823
Non-utility property......................................... 966 966
------------------ -----------------
Total other property and investments....................... 423,221 429,789
------------------ -----------------
Current Assets:
Cash and cash equivalents.................................... 4,162 3,094
Accounts receivables, net of allowance for uncollectible
accounts of $12,275 and $15,575.......................... 56,042 46,914
Unbilled revenues............................................ 56,283 65,472
Intercompany receivable...................................... - 4,593
Other receivables............................................ 45,027 52,783
Inventories.................................................. 37,726 37,228
Regulatory assets............................................ 5,194 24,027
Other current assets......................................... 56,062 22,872
------------------ -----------------
Total current assets....................................... 260,496 256,983
------------------ -----------------
Deferred Charges:
Regulatory assets............................................ 215,713 196,242
Prepaid retirement costs..................................... 86,876 39,665
Other deferred charges....................................... 136,384 129,083
------------------ -----------------
Total deferred charges..................................... 438,973 364,990
------------------ -----------------
$3,010,415 $2,846,835
================== =================
The accompanying notes are an integral part of these
financial statements.
11
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
------------------ ------------------
(In thousands)
CAPITALIZATION AND LIABILITIES
Capitalization:
Common stockholder's equity:
Common stock................................................. $ 195,588 $ 195,589
Additional paid-in capital................................... 540,046 430,043
Accumulated other comprehensive loss, net of tax............. (82,550) (94,130)
Retained earnings............................................ 313,528 256,157
------------------ ------------------
Total common stockholders' equity......................... 966,612 787,659
Minority interest............................................... 11,437 11,760
Cumulative preferred stock without mandatory
redemption requirements.................................... 12,800 12,800
Long-term debt.................................................. 953,934 953,940
------------------ ------------------
Total capitalization...................................... 1,944,783 1,766,159
------------------ ------------------
Current Liabilities:
Short-term debt................................................. 172,090 150,000
Intercompany debt............................................... - 28,436
Accounts payable................................................ 43,494 88,101
Intercompany accounts payable................................... 40,578 34,468
Accrued interest and taxes...................................... 57,563 36,450
Other current liabilities....................................... 96,210 87,701
------------------ ------------------
Total current liabilities................................. 409,935 425,156
------------------ ------------------
Deferred Credits:
Accumulated deferred income taxes................................. 162,250 128,383
Accumulated deferred investment tax credits....................... 40,022 41,583
Regulatory liabilities............................................ 78,728 52,019
Regulatory liabilities related to accumulated deferred income tax. 14,137 14,137
Asset retirement obligations...................................... 43,995 -
Minimum pension liability......................................... 141,175 141,175
Accrued postretirement benefit costs.............................. 16,156 17,335
Other deferred credits............................................ 159,234 260,888
------------------ ------------------
Total deferred credits......................................... 655,697 655,520
------------------ ------------------
$3,010,415 $2,846,835
================== ==================
The accompanying notes are an integral part of these
financial statements.
12
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
----------------------------------
2003 2002
-------------- ---------------
(In thousands)
Cash Flows From Operating Activities:
Net earnings...................................................... $ 68,170 $ 35,507
Adjustments to reconcile net earnings to net cash flows
from operating activities:
Depreciation and amortization.................................. 64,020 56,142
Accumulated deferred income tax................................ 23,169 (1,887)
Transition costs write-off..................................... 16,720 -
Cumulative effect of a change in accounting principle.......... (61,946) -
Net unrealized gains on trading and investing contracts........ (4,167) (16,131)
Changes in certain assets and liabilities:
Accounts receivables........................................... (9,128) 11,455
Unbilled revenues.............................................. 9,189 18,483
Accrued post-retirement benefit costs.......................... (19,440) (20,679)
Other assets................................................... 9,737 (7,674)
Accounts payable............................................... (44,607) (2,544)
Accrued interest and taxes..................................... 21,113 (7,755)
Other liabilities.............................................. (17,370) (17,930)
-------------- ---------------
Net cash flows provided by operating activities........ 55,460 46,987
-------------- ---------------
Cash Flows Used for Investing Activities:
Utility plant additions........................................... (68,841) (124,446)
Combustine turbine payments....................................... (11,136) (13,935)
Eastern Interconnect Project buyout............................... (37,388) -
Redemption of short-term investments.............................. - 45,000
Return of principal of PVNGS lessor notes......................... 9,406 8,996
Other investing................................................... 670 704
-------------- ---------------
Net cash flows used for investing activities................ (107,289) (83,681)
-------------- ---------------
Cash Flows Used for Financing Activities:
Short-term borrowings, net........................................ 22,090 65,000
Long-term debt borrowings......................................... 182,000 -
Long-term debt repayments......................................... (182,000) -
Refund costs of pollution control bonds........................... (31,427) -
Equity contribution from parent................................... 110,000 -
Dividends paid.................................................... (293) (59,273)
Other financing................................................... (327) 432
Change in intercompany debt....................................... (47,146) 30,385
-------------- ---------------
Net cash flows provided by financing activities............. 52,897 36,544
-------------- ---------------
Increase (decrease) in Cash and Cash Equivalents.................... 1,068 (150)
Beginning of Period................................................. 3,094 17,028
-------------- ---------------
End of Period....................................................... $ 4,162 $ 16,878
============== ===============
Supplemental Cash Flow Disclosures:
Interest paid, net of amounts capitalized......................... $ 35,858 $ 26,246
============== ===============
Income taxes paid (refunded), net ................................ $ (4,092) $ 31,514
============== ===============
The accompanying notes are an integral part of these
financial statements.
13
PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands)
Net Earnings Before Preferred
Stock Dividends................................ $ 21,659 $ 10,653 $ 68,170 $ 35,507
------------ ------------ ------------ ------------
Other Comprehensive Income (Loss),
net of tax:
Unrealized gain (loss) on securities:
Unrealized holding gains (losses)
arising during the period................... 1,260 (903) 1,216 231
Reclassification adjustment for
(gains) losses included in net income....... (29) (246) (43) (427)
Mark-to-market adjustment for certain
derivative transactions:
Change in fair market value of
designated cash flow hedges................. 11,614 (1,036) 10,407 (196)
Reclassification adjustment for
(gains) losses in net income................ - 430 - 773
------------ ------------ ------------ ------------
Total Other Comprehensive Income (Loss)............. 12,845 (1,755) 11,580 381
------------ ------------ ------------ ------------
Total Comprehensive Income.......................... $ 34,504 $ 8,898 $ 79,750 $35,888
============ ============ ============ ============
The accompanying notes are an integral part of
these financial statements.
14
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Accounting Policies and Responsibility for Financial Statements
In the opinion of the management of PNM Resources, Inc. (the "Holding
Company") and Subsidiaries and Public Service Company of New Mexico ("PNM") and
Subsidiaries, (collectively, the "Company") the accompanying interim
consolidated financial statements present fairly the Company's financial
position at June 30, 2003 and December 31, 2002, the consolidated results of its
operations and comprehensive income for the three months and six months ended
June 30, 2003 and 2002 and the consolidated statements of cash flows for the six
months ended June 30, 2003 and 2002. These statements are presented in
accordance with the rules and regulations of the United States Securities and
Exchange Commission ("SEC"). Accordingly, they are unaudited, and certain
information and footnote disclosures normally included in the Company's annual
consolidated financial statements have been condensed or omitted, as permitted
under the applicable rules and regulations. Readers of these financial
statements should refer to the Company's audited consolidated financial
statements and notes thereto for the year ended December 31, 2002, that are
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002 and as updated by the Company's Current Report on Form 8-K dated June
12, 2003. The results of operations presented in the accompanying financial
statements are not necessarily representative of operations for an entire year.
Presentation
The Notes to Consolidated Financial Statements of the Company are
presented on a combined basis. The business of PNM constitutes substantially all
of the business of PNM Resources, Inc. and Subsidiaries. Therefore, the
financial results and results of operations of PNM are virtually identical to
the consolidated results of the Holding Company and all its subsidiaries. For
discussion purposes, this report will use the term "Company" when discussing
matters of common applicability to the Holding Company and PNM. Readers of the
Notes to Consolidated Financial Statements should assume that the information
presented applies to the consolidated results of operations and financial
position of both the Holding Company and its subsidiaries and PNM, except where
the context or references clearly indicate otherwise. Discussions regarding
specific contractual obligations generally reference the company that is legally
obligated. In the case of contractual obligations of PNM, these obligations are
consolidated with the Holding Company and its subsidiaries under generally
accepted accounting principles ("GAAP"). Broader operational discussions refer
to the Company.
Certain amounts in the 2002 consolidated financial statements and notes
have been reclassified to conform to the 2003 financial statement presentation.
Regulatory Accounting
The Company's accounting policies conform to the provisions of Statement
of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" ("SFAS 71"). SFAS 71 requires a rate-regulated entity to
reflect the effects of regulatory decisions in its financial statements. In
15
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
accordance with SFAS 71, the Company has deferred certain costs and recorded
certain liabilities pursuant to the rate actions of the Federal Energy
Regulatory Commission ("FERC") and the New Mexico Public Regulation Commission
("PRC") and its predecessor. To the extent that the Company concludes that the
recovery of a regulatory asset is no longer probable due to regulatory
treatment, the effects of competition or other factors, the amount would be
recorded as a charge to earnings in the period in which recovery is determined
to no longer be probable.
As of December 31, 1999, the Company discontinued the application of SFAS
71 for the generation portion of its business effective with the passage of the
Electric Utility Industry Restructuring Act of 1999 ("Restructuring Act") in
accordance with Statement of Financial Accounting Standards No. 101, "Accounting
for the Discontinuation of Application of the Financial Accounting Standards
Board ("FASB") FASB Statement No. 71" ("SFAS 101"). As a result of the repeal of
the Restructuring Act (see Note 5 - "Commitments and Contingencies - Global
Electric Agreement"), the Company re-applied the accounting requirements of SFAS
71 to the generation portion of its business as of January 28, 2003.
Asset Retirement Obligations ("ARO")
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 143 "Accounting for Asset Retirement Obligations" ("SFAS 143") on
January 1, 2003 and accordingly identified certain AROs that are subject to the
standard. These obligations included the decommissioning of the Company's
nuclear generation facilities and fossil fuel generation plants. The Company's
transmission and distribution facilities are also subject to the standard;
however, the majority of these assets have an indeterminable useful life and
settlement date. As such, an ARO liability for transmission and distribution
assets would not be recognized until this information becomes known and is
material. The Company did not identify any material AROs associated with the
transmission and distribution assets.
Previously, the Company had recognized decommissioning costs for its
fossil fuel and nuclear generation facilities ratably over approved cost
recovery periods. Upon implementation of the standard, the net difference
between the amounts determined to represent legal AROs under SFAS 143 and the
Company's previous method of accounting for decommissioning costs has been
recognized as a cumulative effect of a change in accounting principle, net of
related income taxes. Additionally, certain amounts accrued for nuclear
decommissioning costs over the Company's legal AROs for its nuclear generation
facilities have been reclassified as regulatory liabilities.
The effects of adopting the new standard are based on the Company's
interpretation of the standard and determination of underlying assumptions, such
as the Company's discount rate, estimates of the future costs for
decommissioning and the timing of the removal activities to be performed. Any
changes in these assumptions underlying the required calculations may require
revisions to the estimated ARO when identified.
16
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table shows the pro forma effect on the Company's earnings
had the Company adopted SFAS 143 at the beginning of each respective period. The
pro forma amounts below are based on current information and assumptions, which
are reflected in the consolidated statement of earnings. The following table is
presented for comparative purposes.
Six Months
Ended Year Ended
June 30, December 31
2002 2002 2001 2000
-------------- -------------- --------------- -------------
(In thousands)
Net earnings before cumulative effect of a
change in accounting principle................ $36,106 $64,272 $150,433 $100,946
Cumulative effect of a change in accounting
principle..................................... 32,771 37,422 32,771 28,059
-------------- -------------- --------------- -------------
Net earnings..................................... 68,877 101,694 183,204 129,005
Preferred stock dividend requirements............ 293 586 586 586
-------------- -------------- --------------- -------------
Net earnings applicable to common stock.......... $68,584 $101,108 $182,618 $128,419
============== ============== =============== =============
Earnings per share:
Basic earnings per share before cumulative
effect of a change in accounting principle.... $ 0.92 $ 1.63 $ 3.83 $ 2.54
Cumulative effect of a change in accounting
principle..................................... 0.84 0.95 0.84 0.71
-------------- -------------- --------------- -------------
Basic earnings per share......................... $ 1.76 $ 2.58 $ 4.67 $ 3.25
============== ============== =============== =============
Diluted earnings per share before cumulative
effect of a change in accounting principle.... $ 0.90 $ 1.61 $ 3.77 $ 2.53
============== ============== =============== =============
Diluted earnings per share after cumulative
effect of a change in accounting principle.... $ 1.73 $ 2.56 $ 4.60 $ 3.23
============== ============== =============== =============
Asset retirement obligation liability............ $42,201 $38,235
============== ===============
(Intentionally left blank)
17
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A reconciliation of the Company's asset retirement obligations is as
follows:
June 30, 2003
--------------
(In thousands)
Upon adoption at January 1, 2003....... $42,201
Liabilities incurred................... -
Liabilities settled.................... -
Accretion expense...................... 1,794
Revisions to estimate.................. -
--------------
$43,995
==============
Stock Options
The Company accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Compensation cost for stock options,
if any, is measured as the excess of the quoted market price of the Company's
stock at the date of grant over the exercise price of the granted stock option.
Restricted stock is recorded as compensation cost over the requisite vesting
periods based on the market value on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),
established accounting and disclosure requirements using a fair-value-based
method of accounting for stock-based employee compensation plans. The Company
has elected to retain its current method of accounting as described above, and
has adopted the disclosure requirements of SFAS 123 only.
(Intentionally left blank)
18
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At June 30, 2003, the Company had three stock-based employee compensation
plans. Options continue to be granted under only two of these plans. Had
compensation expense for the Company's stock options been recognized based on
the fair value on the grant date under the methodology prescribed by SFAS 123,
the effect on the Company's pro forma net earnings and pro forma earnings per
share would be as follows (in thousands, except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------------- ------------- ------------- ------------
Net earnings: (available for common
stock)................................... $17,596 $11,010 $65,766 $35,813
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects....... (565) (1,105) (1,070) (2,211)
------------- ------------- ------------- ------------
Pro forma net earnings...................... $17,031 $9,905 $64,696 $33,602
============= ============= ============= ============
Earnings per share:
Basic - as reported..................... $ 0.45 $ 0.28 $ 1.68 $ 0.92
============= ============= ============= ============
Basic - pro forma....................... $ 0.43 $ 0.25 $ 1.65 $ 0.86
============= ============= ============= ============
Diluted - as reported................... $ 0.44 $ 0.28 $ 1.66 $ 0.90
============= ============= ============= ============
Diluted - pro forma..................... $ 0.43 $ 0.25 $ 1.64 $ 0.85
============= ============= ============= ============
(2) Segment Information
The Holding Company is an investor-owned holding company of energy and
energy related businesses. Its principal subsidiary, PNM, is an integrated
public utility primarily engaged in the generation, transmission and
distribution of electricity; transmission, distribution and sale of natural gas
within the State of New Mexico and the sale and marketing of electricity in the
Western United States. In addition, the Holding Company provides energy and
technology related services through its wholly-owned subsidiary, Avistar Inc.
("Avistar").
As it currently operates, the Company's principal business segments are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
include Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission") . These segments model the resource allocations as
mandated in the Global Electric Agreement (see Note 5 - Commitments and
Contingencies - Global Electric Agreement). Certain prior period amounts have
been reclassified to conform to the current year presentation. In addition,
Transmission was reclassified from Electric and disclosed as its own business
segment.
19
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
UTILITY OPERATIONS
Electric
Electric consists of the distribution and generation of electricity for
retail electric customers in New Mexico. The Company provides retail electric
service to a large area of north central New Mexico, including the cities of
Albuquerque and Santa Fe, and certain other areas of New Mexico. Customer rates
for retail electric service are set by the PRC based on the provisions of the
Global Electric Agreement.
Gas
Gas distributes natural gas to most of the major communities in New
Mexico, including New Mexico's two largest metropolitan areas, Albuquerque and
Santa Fe. The Company's customer base includes both sales-service customers and
transportation-service customers. PNM purchases natural gas in the open market
and resells it at cost to its distribution customers. As a result, increases or
decreases in gas revenues resulting from wholesale gas price fluctuations do not
impact the Company's consolidated gross margin or earnings.
Transmission
The Company owns or leases transmission lines, interconnected with other
utilities in New Mexico and south and east into Texas, west into Arizona, and
north into Colorado and Utah. Transmission revenues consist of sales to third
parties as well as to Electric and Wholesale.
WHOLESALE OPERATIONS
Wholesale consists of the generation and sale of electricity into the
wholesale market based on three product lines that include long-term contracts,
forward sales and short-term sales. Long-term contracts include sales to
firm-requirements wholesale customers with multi-year arrangements. These
contracts range from 2 to 17 years with an average of 7.5 years. Forward sales
include sales of excess generation and third party purchases in the forward
market that range from 1 month to 3 years. These transactions do not qualify as
normal sales and purchases as defined in SFAS 133 and as a result, are generally
marked to market. Short-term sales generally include spot market, hour ahead,
day ahead and week ahead contracts with terms of 30 days or less. Also included
are sales of any excess generation not required to fulfill PNM's retail load and
contractual commitments. Short-term sales also cover the revenue credit to
retail customers as specified in the Global Electric Agreement.
CORPORATE AND OTHER
The Holding Company performs substantially all of the corporate
activities of PNM. These activities are billed to PNM on a cost basis to the
extent they are for the corporate management of PNM and are allocated to the
operating segments. The Holding Company's wholly-owned subsidiary, Avistar, was
20
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
formed in August 1999 as a New Mexico corporation and is currently engaged in
certain unregulated and non-utility businesses. In January 2002, Avistar was
transferred by way of a dividend to the Holding Company pursuant to an order
from the PRC.
Summarized financial information by business segment for the three months
ended June 30, 2003 is as follows:
Utility
------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ----------- ------------- ------------ ------------
(In thousands)
2003:
Operating revenues:
External customers................ $131,091 $ 74,009 $ 2,317 $ - $ 207,417
Intersegment revenues............. - - 10,554 (7,777) 2,777
Depreciation and amortization........ 15,843 5,498 2,337 - 23,678
Interest income...................... 8,132 332 58 - 8,522
Interest charges..................... 6,905 3,654 1,041 - 11,600
Total income tax expense (benefit)... 7,381 (1,431) 1,063 - 7,013
Operating income..................... 16,482 1,293 2,636 - 20,411
Segment net income (loss)............ 15,299 (2,185) 1,625 - 14,739
Total assets......................... 1,313,108 438,828 243,232 - 1,995,168
Gross property additions............. 12,584 14,013 6,483 - 33,080
Corporate
Wholesale and Other Consolidated
------------- ----------- ------------
(In thousands)
2003:
Operating revenues:
External customers................ $ 132,742 $ 52 $ 340,211
Intersegment revenues............. 900 (3,677) -
Depreciation and amortization........ 3,569 1,603 28,850
Interest income...................... 1,313 642 10,477
Interest charges..................... 5,968 196 17,764
Total income tax expense (benefit)... 4,423 (1,221) 10,215
Operating income (loss).............. 12,436 (2,933) 29,914
Segment net income (loss)............ 7,529 (4,525) 17,743
Total assets......................... 404,184 684,470 3,083,822
Gross property additions............. 1,646 2,738 37,464
21
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the three months
ended June 30, 2002 is as follows:
Utility
------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ----------- ------------- ------------ ------------
(In thousands)
2002:
Operating revenues:
External customers............... $ 134,412 $ 43,968 $ 5,912 $ - $ 184,292
Intersegment revenues............ - 445 7,798 (7,444) 799
Depreciation and amortization....... 14,752 5,035 2,199 - 21,986
Interest income..................... 7,843 (7) 8 - 7,844
Interest charges.................... 7,024 3,317 937 - 11,278
Total income tax expense (benefit).. 5,940 (1,316) 1,282 - 5,906
Operating income (loss)............. 15,899 (94) 2,978 - 18,783
Segment net income (loss)........... 13,513 (1,936) 1,984 - 13,561
Total assets........................ 1,712,744 449,695 197,928 - 2,360,367
Gross property additions............ 47,234 11,035 3,272 - 61,541
Corporate
Wholesale and Other Consolidated
------------- ----------- ------------
(In thousands)
2002:
Operating revenues:
External customers............... $ 65,812 $ 85 $ 250,189
Intersegment revenues............ - (799) -
Depreciation and amortization....... 1,906 1,325 25,217
Interest income..................... 1,273 613 9,730
Interest charges.................... 6,100 (2,689) 14,689
Total income tax expense (benefit).. (2,892) 2,559 5,573
Operating income (loss)............. 1,676 (1,010) 19,449
Segment net income (loss)........... (3,626) 1,222 11,157
Total assets........................ 314,998 264,484 2,939,849
Gross property additions............ 8,845 1,829 72,215
22
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the six months
ended June 30, 2003 is as follows:
Utility
------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ----------- ------------- ------------ ------------
(In thousands)
2003:
Operating revenues:
External customers................. $ 260,135 $ 220,262 $ 6,874 $ - $ 487,271
Intersegment revenues.............. - - 18,189 (15,412) 2,777
Depreciation and amortization......... 31,578 10,940 4,659 - 47,177
Interest income....................... 16,056 1,109 58 - 17,223
Interest charges...................... 13,352 6,789 3,079 - 23,220
Total income tax expense.............. 6,772 2,981 1,242 - 10,995
Operating income...................... 32,143 10,689 4,984 - 47,816
Cumulative effect of a change
in accounting principle, net of tax. 25,093 - - - 25,093
Segment net income.................... 43,605 4,548 1,910 - 50,063
Total assets.......................... 1,313,108 438,828 243,232 - 1,995,168
Gross property additions.............. 30,972 21,234 11,330 - 63,536
Corporate
Wholesale and Other Consolidated
------------- ----------- ------------
(In thousands)
2003:
Operating revenues:
External customers................. $ 240,519 $ 112 $ 727,902
Intersegment revenues.............. 900 (3,677) -
Depreciation and amortization......... 7,060 2,987 57,224
Interest income....................... 2,595 1,359 21,177
Interest charges...................... 7,161 5,616 35,997
Total income tax expense.............. 5,493 196 16,684
Operating income...................... 15,231 293 63,340
Cumulative effect of a change
in accounting principle, net of tax. 12,329 - 37,422
Segment net income (loss)............. 22,178 (6,182) 66,059
Total assets.......................... 404,184 684,470 3,083,822
Gross property additions.............. 16,518 3,814 83,868
23
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Summarized financial information by business segment for the six months
ended June 30, 2002 is as follows:
Utility
------------------------------------------------------------------
Electric Gas Transmission Eliminations Total
------------- ----------- ------------- ------------ ------------
(In thousands)
2002:
Operating revenues:
External customers............... $ 263,756 $ 153,169 $ 11,810 $ - $ 428,735
Intersegment revenues............ - 445 15,435 (15,081) 799
Depreciation and amortization....... 29,638 10,097 4,321 - 44,056
Interest income..................... 16,008 81 14 - 16,103
Interest charges.................... 13,309 6,635 2,920 - 22,864
Total income tax expense............ 12,360 3,971 2,122 - 18,453
Operating income.................... 32,138 11,349 6,355 - 49,842
Segment net income.................. 27,669 6,130 3,277 - 37,076
Total assets........................ 1,712,744 449,695 197,928 - 2,360,367
Gross property additions............ 97,805 17,578 6,273 - 121,656
Corporate
Wholesale and Other Consolidated
------------- ----------- ------------
(In thousands)
002:
Operating revenues:
External customers................ $ 122,354 $ 917 $ 552,006
Intersegment revenues............. - (799) -
Depreciation and amortization........ 3,762 2,178 49,996
Interest income...................... 2,551 2,908 21,562
Interest charges..................... 7,135 (184) 29,815
Total income tax expense (benefit)... (3,813) 5,141 19,781
Operating income..................... 1,330 964 52,136
Segment net income (loss)............ (4,291) 3,321 36,106
Total assets......................... 314,998 264,484 2,939,849
Gross property additions............. 16,726 3,305 141,687
(3) Fair Value of Financial Instruments
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation. Although management uses its best
judgment in estimating the fair value of these financial instruments, there are
inherent limitations in any estimation technique. Therefore, the fair value
estimates presented herein are not necessarily indicative of the amounts that
the Company could realize in a current transaction. Fair value is based on
market quotes provided by the Company's investment bankers and trust advisors.
24
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company's available-for-sale securities include assets held in trust
for its share of decommissioning costs of PVNGS and its executive retirement
program. The trusts hold equity and fixed income securities. These amounts are
included in other investments on the balance sheet. The amortized cost, gross
unrealized gain and losses and estimated fair value of investments in
available-for-sale securities are as follows:
June 30, 2003
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities............... $ 42,146 $6,920 $(999) $48,067
Municipal bonds................. 18,555 1,548 (1) 20,102
U.S. Government securities...... 5,703 618 (18) 6,303
Corporate bonds................. 11 1 - 12
Other investments............... 1,678 - (3) 1,675
---------------- ---------------- --------------- ----------------
$ 68,093 $9,087 $(1,021) $76,159
================ ================ =============== ================
December 31, 2002
--------------------------------------------------------------------
Amortized Cost Unrealized Unrealized Fair Value
Gains Losses
---------------- ---------------- --------------- ----------------
(In thousands)
Available-for-sale:
Equity securities............... $32,643 $4,134 $ (1,514) $ 35,263
Mortgage-backed securities...... 33,145 410 (93) 33,462
Corporate bonds................. 32,466 438 (19) 32,885
Municipal bonds................. 21,229 1,394 (24) 22,599
U.S. Government securities...... 12,725 702 - 13,427
Other investments............... 14,716 - - 14,716
---------------- ---------------- --------------- ----------------
$146,924 $7,078 $ (1,650) $152,352
================ ================ =============== ================
(Intentionally left blank)
25
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
At June 30, 2003, the available-for-sale investments held by the Company
had the following maturities:
Amortized Cost Fair Value
---------------- ----------------
(In thousands)
Within 1 year............................. $ 2,053 $ 2,067
After 1 year through 5 years.............. 2,169 2,258
After 5 years through 10 years............ 3,138 3,311
Over 10 years............................. 17,180 19,049
Equity securities......................... 42,146 48,067
Other investments......................... 1,407 1,407
---------------- ----------------
$68,093 $76,159
================ ================
The proceeds and gross realized gains and losses on the disposition of
available-for-sale investments are shown in the following table. Realized gains
and losses are determined by specific identification. The short-term investment
balance was fully redeemed in the six months ended June 30, 2003 and included in
proceeds from sale.
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ----------------
(In thousands)
Proceeds from sales......... 17,140 51,096 103,984 106,116
Gross realized gains........ 2,939 627 4,756 1,909
Gross realized losses....... (1,016) (1,420) (2,637) (3,937)
Natural Gas Contracts
Pursuant to a 1997 order issued by the New Mexico Public Utility
Commission, the predecessor to the PRC, the Company previously entered into
swaps to hedge certain portions of natural gas supply contracts in order to
protect the Company's natural gas customers from the risk of adverse price
fluctuations in the natural gas market. The financial impact of all hedge gains
and losses from swaps is recoverable through the Company's purchased gas
adjustment clause ("PGAC") if deemed prudently incurred by the PRC. As a result,
earnings are not affected by gains or losses generated by these instruments.
PNM purchased gas options, a type of hedge, to protect its natural gas
customers from the risk of price fluctuations during the 2002-2003 heating
season. PNM expended $6.0 million to purchase options that limit the maximum
amount the Company would pay for gas during the winter heating season. The
Company recovered its actual hedging expenditures as a component of the PGAC
during the months of October 2002 through February 2003 in equal monthly
allotments of $1.2 million.
26
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Electricity Contracts
The Company's wholesale operations entered into various forward physical
contracts for the purchase and sale of electricity with the intent to optimize
its net generation position. These contracts do not qualify for normal purchase
and sale designation pursuant to Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133")
and are marked to market as required by SFAS 133. For the six months ended June
30, 2003, the Company's Wholesale Operations settled forward contracts for the
sale of electricity that generated $59.8 million of electric revenues by
delivering 1.4 million MWh. The Company purchased $61.0 million or 1.5 million
MWh of electricity to support these contractual sales and other open market
sales opportunities. For the six months ended June 30, 2002, the Company's
Wholesale Operations settled forward contracts for the sale of electricity that
generated $20.6 million of electric revenues by delivering 0.6 million MWh. The
Company purchased $35.9 million or 0.7 million MWh of electricity to support
these contractual sales and other open market sales opportunities.
As of June 30, 2003, the Company had open contract positions to buy $78.1
million and to sell $80.3 million of electricity. At June 30, 2003, the Company
had a gross mark-to-market gain (asset position) on these forward contracts of
$17.9 million and gross mark-to-market loss (liability position) of $14.7
million, with net mark-to-market gain (asset position) of $3.2 million recorded
in other current assets and liabilities, respectively. The change in
mark-to-market valuation is recognized in earnings each period and is recorded
in operating revenues.
The Company's Wholesale Operations also entered into forward physical
contracts for the sale of the Company's electric capacity in excess of its
retail and wholesale firm requirement needs, including reserves. In addition,
the Company entered into forward physical contracts for the purchase of retail
needs, including reserves, when resource shortfalls exist. The Company generally
accounts for these derivative financial instruments as normal sales and
purchases as defined by SFAS 133, as amended. From time to time the Company
makes forward purchases to serve its retail needs when the cost of purchased
power is less than the incremental cost of its generation. At June 30, 2003, the
Company had open forward positions classified as normal sales of electricity of
$203.2 million and normal purchases of electricity of $138.3 million, which are
not recorded on the financial statements.
The Company's Wholesale Operations, including both firm commitments and
other wholesale sale activities, are managed through an asset-backed strategy,
whereby the Company's aggregate net open position is covered by its own excess
generation capabilities. The Company is exposed to market risk if its generation
capabilities were disrupted or if its retail load requirements were greater than
anticipated. If the Company were required to cover all or a portion of its net
open contract position, it would have to meet its commitments through market
purchases.
The Company is exposed to credit risk in the event of non-performance or
non-payment by counterparties of its financial and physical derivative
instruments. The Company uses a credit management process to assess and monitor
the financial conditions of counterparties. The Company's credit risk with its
largest counterparty as of June 30, 2003 and December 31, 2002 was $30.4 million
and $18.7 million, respectively.
27
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Forward Starting Interest Rate Swaps
PNM had $46 million of tax-exempt bonds outstanding that were callable at
a premium beginning December 15, 2002, and an additional $136 million that
become callable at a premium in August 2003. PNM intended to refinance these
bonds and had hedged the entire planned refinancing. The Company received
regulatory approval to refund the tax-exempt bonds on October 29, 2002. In order
to take advantage of low interest rates, PNM entered into five forward starting
interest rate swaps in the fourth quarter of 2001 and the first quarter of 2002.
The refinancings were completed on May 23, 2003.
The forward starting swaps were terminated on May 13, 2003 for a cash
settlement of $27.1 million. This amount has been capitalized by the Company as
a financing cost and will be amortized over the life of the bonds.
Corporate and Pension Hedge
The Company has approximately $318 million invested in domestic stocks
and approximately $32 million invested in international stocks in various trusts
for nuclear decommissioning, pension plan, executive retirement and retiree
medical benefits. The Company uses financial derivatives based on the Standard &
Poor's ("S&P") 500 Index to limit potential loss on these investments due to
adverse market fluctuations. The options are structured as a collar, protecting
the portfolio against losses beyond a certain amount and balancing the cost of
that downside protection by foregoing gains above a certain level. If the S&P
500 Index is within the specified range when the option contract expires, the
Company will not be obligated to pay, nor will the Company have the right to
receive cash. During the three months ended June 30, 2003, the Company entered
into certain S&P 500 Index contracts, which will expire on December 19, 2003 and
March 19, 2004. The range of the floor and ceiling of the collar relative to a
December 31, 2002 S&P 500 index of 880 is -3.4% for a floor and 16.7% to 21.0%
for a ceiling. For the three months and six months ended June 30, 2003, the
change in the market value of its corporate options was immaterial.
(Intentionally left blank)
28
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(4) Earnings Per Share
In accordance with SFAS No. 128, "Earnings per Share" ("SFAS 128"), dual
presentation of basic and diluted earnings per share has been presented in the
Consolidated Statements of Earnings. The following reconciliation illustrates
the impact on the share amounts of potential common shares and the earnings per
share amounts for June 30 (in thousands except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------- ------------- -------------
Basic:
Net Earnings from Operations...................... $17,743 $11,157 $28,637 $36,106
Cumulative effect of a change in
accounting principle, net of tax of $24,524.... - - 37,422 -
------------ ------------- ------------- -------------
Net Earnings...................................... 17,743 11,157 66,059 36,106
Preferred Stock Dividend Requirements............. 147 147 293 293
------------ ------------- ------------- -------------
Net Earnings Applicable to Common Stock........... $17,596 $11,010 $65,766 $35,813
============ ============= ============= =============
Average Number of Common Shares
Outstanding.................................... 39,364 39,118 39,242 39,118
============ ============= ============= =============
Net Earnings per Share of Common Stock $ 0.45 $ 0.28 $ 1.68 $ 0.92
============ ============= ============= =============
Earnings from operations.......................... 0.45 0.28 0.73 0.92
Cumulative effect of a change in
accounting principle........................... - - 0.95 -
------------ ------------- ------------- -------------
Net earnings per share of common stock (basic) $ 0.45 $ 0.28 $ 1.68 $ 0.92
============ ============= ============= =============
(Intentionally left blank)
29
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------- ------------- -------------
Diluted:
Net Earnings from Operations...................... $17,743 $11,157 $28,637 $36,106
Cumulative effect of a change in
accounting principle, net of tax of $24,524.... - - 37,422 -
------------ ------------- ------------- -------------
Net Earnings...................................... 17,743 11,157 66,059 36,106
Preferred Stock Dividend Requirements............. 147 147 293 293
------------ ------------- ------------- -------------
Net Earnings Applicable to Common Stock........... $17,596 $11,010 $65,766 $35,813
============ ============= ============= =============
Average Number of Common Shares
Outstanding.................................... 39,364 39,118 39,242 39,118
Dilutive effect of common stock
equivalents (a)................................ 390 468 327 494
------------ ------------- ------------- -------------
Average common and common
equivalent shares outstanding.................. 39,754 39,586 39,569 39,612
============ ============= ============= =============
Net Earnings per Share of Common Stock
(Diluted)...................................... $ 0.44 $ 0.28 $ 1.66 $ 0.90
============ ============= ============= =============
Earnings from operations.......................... 0.44 0.28 0.71 0.90
Cumulative effect of a change in
accounting principle........................... - - 0.95 -
------------ ------------- ------------- -------------
Net earnings per share of common stock
(diluted)...................................... $ 0.44 $ 0.28 $ 1.66 $0.90
============ ============= ============= =============
(a) Excludes the effect of average anti-dilutive common stock
equivalents related to out-of-the-money options of 878,681 and
33,462 for the three months ended and 1,886,653 and 23,785 for the
six months ended June 30, 2003 and 2002, respectively.
(5) Commitments and Contingencies
PVNGS Liability and Insurance Matters
The PVNGS participants have financial protection for public liability
resulting from nuclear energy hazards to the full limit of liability under
federal law. This potential liability is covered by primary liability insurance
provided by commercial insurance carriers in the amount of $300 million and the
balance by an industry-wide retrospective assessment program. If losses at any
nuclear power plant covered by the programs exceed the primary liability
insurance limit, the Company could be assessed retrospective adjustments.
Effective August 20, 2003 the maximum assessment per reactor under the program
30
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
for each nuclear incident increases from approximately $88 million to
approximately $101 million. The retrospective assessment is subject to an annual
limit of $10 million per reactor per incident. Based upon the Company's 10.2%
interest in the three PVNGS units, the Company's maximum potential assessment
per incident for all three units is approximately $31 million, with an annual
payment limitation of approximately $3 million per incident. If the funds
provided by this retrospective assessment program prove to be insufficient,
Congress could impose revenue-raising measures on the nuclear industry to pay
claims.
Natural Gas Explosion
On April 25, 2001, a natural gas explosion occurred in Santa Fe, New
Mexico. The apparent cause of the explosion was a leak from a PNM gas line near
the location. The explosion destroyed a small building and injured two persons
who were working in the building. PNM's investigation indicates that the leak
was an isolated incident likely caused by a combination of corrosion and
increased pressure. PNM also cooperated with an investigation of the incident by
the PRC's Pipeline Safety Bureau (the "Bureau"), which issued its report on
March 18, 2002. The Bureau's report gave PNM notice of probable violations of
the New Mexico Pipeline Safety Act and related regulations. PNM and the Bureau
staff entered into a compliance agreement addressing the probable violations and
filed it with the PRC for approval on March 4, 2003. PNM agreed to undertake a
list of twenty-four corrective actions, including internal policy changes,
retraining employees and enhancing gas line monitoring. PNM has also agreed to
voluntarily accelerate spending on pipeline replacement by more than $10.0
million and to commit an additional $1.8 million to development and
implementation of systems to improve gas line management. The compliance
agreement was approved by the PRC on March 25, 2003. No civil penalty was
imposed. Two lawsuits against PNM by the injured persons along with several
claims for property and business interruption damages have been resolved.
Global Electric Agreement
On October 10, 2002, PNM announced that it had agreed with the PRC staff,
the New Mexico Attorney General ("AG"), and other consumer groups on a Global
Electric Agreement that provided for joint support for the repeal of a majority
of the New Mexico Utility Industry Restructuring Act of 1999, as amended,
("Restructuring Act"), a fixed rate path, procedures for the Company's
participation in wholesale plant activities and other regulatory issues. The
rate-path is effective for services rendered September 1, 2003 through December
31, 2007. Based on the normal time frame for rate proceedings in New Mexico of
ten months, a change in rates would not happen until late 2008. The Global
Electric Agreement was approved by the PRC on January 28, 2003. Legislation
repealing the Restructuring Act and continuing the authorization for utilities
to participate in wholesale plant activities for a limited time according to the
Global Electric Agreement was passed by the New Mexico Legislature and signed
into law by the Governor on April 8, 2003. In the Global Electric Agreement, PNM
agreed to forego recovery of the costs incurred in preparing to transition to a
competitive retail market in New Mexico under the repealed law. This resulted in
a charge of $16.7 million, pre-tax, in the first quarter of 2003. As a result of
31
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the repeal of the Restructuring Act, PNM has re-applied the accounting
requirements of SFAS 71 to its regulated generation activities effective January
28, 2003, which did not have a material effect on the Company's financial
condition or results of operations.
Asset Securitization
On April 8, 2003, PNM entered into a transaction providing for the
securitization of PNM's retail electric service accounts receivable and retail
gas service accounts receivable ("AR Securitization"). The total capacity under
the AR Securitization is $90 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable to a bankruptcy remote subsidiary, PNM
Receivables Corp., which in turn pledges an undivided interest in the
receivables to an unaffiliated conduit commercial paper issuer. This transaction
was previously approved by the PRC on December 17, 2002. As of June 30, 2003,
the Company had borrowed $64.6 million under the AR Securitization, which was
secured by $78.5 million of accounts receivable. PNM Receivables Corp. is
consolidated in the results of PNM Resources, Inc. and Subsidiaries and Public
Service Company of New Mexico and Subsidiaries.
Eastern Interconnection Project ("EIP") Purchase
On April 1, 2003, PNM exercised its early buyout option related to a 60%
interest in the EIP transmission line and related facilities held under lease.
Through the exercise of the early buyout option, PNM was able to retire all
$26.2 million of secured facility bonds , which were issued to finance the sale
leaseback transaction which had previously been disclosed as off balance sheet
debt in the notes to the Companies' financial statements. The Company will
continue to exclude $4.6 million of lease obligations relating to the 40%
interest the Company does not own from the consolidated balance sheet.
Debt Refinance
On May 13, 2003, the Company priced $182 million of tax-exempt pollution
control bonds at a one-year interest rate of 2.75%. The bond sale closed on May
23, 2003. The bonds will need to be remarketed at the end of the one-year
interest rate period. A portion of the proceeds were used to refund the $46
million of pollution control bonds, which became callable on December 15, 2002.
Additionally, the remaining $136 million have been placed in an escrow account
to be used to refund the same amount of pollution control bonds. The redemption
notice for the remaining $136 million of pollution control bonds was issued and
the bonds have been called for redemption on August 15, 2003. Both of these
issuances were previously hedged (see Note 3 - Fair Market Value of Financial
Instruments - Forward Interest Rate Swaps).
The premium paid to refinance the pollution control bonds was $3.6
million. The balance of the unamortized debt issuance costs associated with the
pollution control bonds that were retired was $3.8 million. These amounts were
capitalized as loss on reacquired debt. The portion of unamortized loss on
reacquired debt associated with the FERC firm requirements customers and the
excluded plant of $1.0 million was written off in conjunction with the
32
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
refinancing of the pollution control bonds. The remaining balance will be
amortized over the life of the new bonds.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without Department of Labor approval, provided that the
contribution does not otherwise constitute a prohibited transaction under
Employee Retirement Income Security Act ("ERISA"). On June 11, 2003, a
contribution of 1,121,495 PNM Resources common shares (approximately $28.9
million in market value) was made to the Company's retirement plan.
Shelf Registrations
On June 12, 2003, the Holding Company and PNM both filed universal shelf
registration filings with the SEC for a combination of debt and equity
securities for $500 million and $285 million, respectively. The PNM shelf
registration, when combined with a previously filed shelf, provides $500 million
of capacity. The PNM shelf registration was declared effective June 28, 2003.
The Holding Company has not asked the SEC to declare its shelf registration
effective as of the date of this filing.
Other
There are various claims and lawsuits pending against the Company. The
Company is also subject to federal, state and local environmental laws and
regulations, and is currently participating in the investigation and remediation
of numerous sites. In addition, the Company periodically enters into financial
commitments in connection with its business operations. It is not possible at
this time for the Company to determine fully the effect of all litigation on its
consolidated financial statements. However, the Company has recorded a liability
where the litigation effects can be estimated and where an outcome is considered
probable. The Company does not expect that any known lawsuits, environmental
costs and commitments will have a material adverse effect on its financial
condition or results of operations.
The Company is involved in various legal proceedings in the normal course
of business. The associated legal costs for these legal matters are accrued when
incurred. It is also the Company's policy to accrue for legal costs expected to
be incurred in connection with Statement of Financial Accounting Standards No. 5
"Accounting for Contingencies" ("SFAS 5") legal matters when it is probable that
a SFAS 5 liability has been incurred and the amount of expected legal costs to
be incurred is reasonably estimable. These estimates include costs for external
counsel professional fees.
33
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Risks and Uncertainties
The Company's future results may be affected by changes in regional
economic conditions; the outcome of labor negotiations with unionized employees;
fluctuations in fuel, purchased power and gas prices; the actions of utility
regulatory commissions; changes in law and environmental regulations; the
success of its planned generation expansion; and external factors such as
weather and water supply. Because of pending federal regulatory reforms, the
public utility industry is undergoing a fundamental change. New Mexico has
repealed the Electric Utility Industry Restructuring Act of 1999 and therefore
has abandoned its plans to transform the industry from one of
vertically-integrated monopolies to one with deregulated, competitive
generation. However, the FERC has proposed a "Standard Market Design" ("SMD") to
establish rules for a market-based approach for wholesale transactions over the
transmission grid. The FERC's efforts have been opposed by a number of states,
primarily in the West and in the Southeast in transmission market, because of
concern that the SMD does not adequately take into account regional differences.
Congress is currently debating energy legislation which could affect the FERC's
activities. In an attempt to ease concerns, on April 28, 2003, the FERC issued a
White Paper on "Wholesale Power Market Platform" describing changes it intended
to make to its SMD proposed rules. The Company's future results will be impacted
by the form the FERC rules take, if adopted; the costs of complying with rules
and legislation that may call for regulatory reforms for the industry; and the
resulting market prices for electricity and natural gas. In addition, the
Company has in place a retail electric rate freeze through 2007 so that the
Company's financial results will depend on its ability to control costs and grow
revenues, and the implications of uncontrollable factors such as weather, water
supply, litigation, and economic conditions.
(6) Company Realignment
On August 22, 2002, the Company was realigned due to the changes in the
electric industry and particularly, the negative impact on the Company's
earnings and growth prospects from wholesale market uncertainty. The changes
included consolidation of similar functions. A total of 85 salaried and hourly
employees were notified of their termination as part of the realignment. In
accordance with Emerging Issues Task Force 94-3 ("EITF 94-3"), "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity", the Company incurred a liability of $8.8 million for severance and
other related costs associated with the involuntary termination of employees,
which was charged to operations in the quarter ended September 30, 2002. The
Company had paid $7.6 million as of June 30, 2003 for such costs and the balance
of the liability was $1.2 million.
34
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(7) Other Income and Deductions
The following table details the components of other income and deductions
for PNM Resources, Inc. and Subsidiaries:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
2003 2002 2003 2002
------------- -------------- -------------- ---------------
(In thousands)
Other income:
Interest income............................. $10,477 $9,730 $21,177 $21,562
Miscellaneous non-operating income.......... 2,268 1,994 2,774 3,889
------------- -------------- -------------- ---------------
$12,745 $11,724 $23,951 $25,451
============= ============== ============== ===============
Other deductions:
Transition costs write-off.................. - - 16,720 -
Miscellaneous non-operating deductions...... 4,020 1,895 5,212 3,392
------------- -------------- -------------- ---------------
$4,020 $1,895 $21,932 $3,392
============= ============== ============== ===============
The following table details the components of other income and deductions
for PNM:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
2003 2002 2003 2002
------------- -------------- -------------- ---------------
(In thousands)
Other income:
Interest income............................. $10,084 $8,177 $20,201 $18,188
Miscellaneous non-operating income.......... 1,513 951 1,889 1,305
------------- -------------- -------------- ---------------
$11,597 $9,128 $22,090 $19,493
============= ============== ============== ===============
Other deductions:
Transition costs write-off.................. - - 16,720 -
Miscellaneous non-operating deductions...... 962 1,626 2,723 3,752
------------- -------------- -------------- ---------------
$ 962 $1,626 $19,443 $3,752
============= ============== ============== ===============
(8) New and Proposed Accounting Standards
Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin (ARB) No. 51, "Consolidated Financial Statements" ("FIN 46").
In January 2003, the Financial Accounting Standards Board ("FASB") issued FIN 46
to address the consolidation of variable interest entities. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date and may be applied prospectively with a cumulative-effect adjustment as of
the date on which it is first applied or by restating previously issued
financial statements for one or more years with a cumulative-effect adjustment
35
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
as of the beginning of the first year restated. As of July 1, 2003, FIN 46 did
not have a material impact on the Company's financial condition or results of
operations.
EITF 02-3 "Issues Related to Accounting for Contracts Involved in Energy
Trading and Risk Management Activities", EITF 98-10 "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities" and Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). On October 25, 2002, the EITF reached a
final consensus on EITF 02-3 that rescinds EITF 98-10 and requires that all
energy contracts held for trading purposes be presented on a net margin basis in
the statement of earnings. As a result, the Company has reclassified those
contracts previously accounted for under EITF 98-10 to a net margin basis under
EITF 02-3 for the three months and six months ended June 30, 2002. The Company
will not report revenues and cost of energy sold on a net margin basis on a
prospective basis because of the application of EITF 02-3, as none of the
Company's current marketing activities meet the definition of trading activities
as prescribed by EITF 02-3.
The following table details wholesale electric revenues as adjusted under
EITF 02-3. Energy trading margin is included in electric operating revenues in
the Statements of Earnings.
Three Months Six Months
Ended Ended
June 30, 2002 June 30, 2002
--------------- ----------------
Wholesale revenues.......................... $ 20,408 $38,150
Wholesale purchases (EITF 02-3 adjustment).. (18,944) (35,432)
------------- ------------
Energy trading margin....................... $ 1,464 $ 2,718
============= ============
Statement of Financial Accounting Standards No. 149 "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"). On
April 30, 2003, the Financial Accounting Standards Board ("FASB") issued SFAS
149. SFAS 149 amends SFAS 133 for derivative instruments, including certain
derivative investments embedded in other contracts and for hedging activities.
SFAS 149 also amends certain existing pronouncements. It will require contracts
with comparable characteristics to be accounted for similarly. In particular,
SFAS 149 clarifies when a contract with an initial net investment meets the
characteristics of a derivative and clarifies when a derivative that contains a
financing component will require special reporting in the statement of cash
flows. The Company must apply SFAS 149 to contracts entered into or modified
after June 30, 2003.
For the companies in the wholesale power marketing industry, SFAS 149
amends previously issued guidance in Derivative Implementation Group Issue
Summaries. Specifically, the pronouncement excludes electricity contracts
subject to unplanned netting from normal designation under SFAS 133. In
addition, the pronouncement amends the definition of a capacity contract.
Electricity contracts entered into or modified after June 30, 2003 that meet the
36
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
amended definition may qualify for normal designation despite being subject to
unplanned netting. The Company is currently evaluating the impact of adopting
the requirements of SFAS 149 and is unable to determine if SFAS 149 will have a
material effect on the Company's financial statements. If the Company's forward
contracts that are typically designated as normal pursuant to SFAS 133 do not
meet the definition of a capacity contract pursuant to SFAS 149, they may be
marked-to-market which will substantially increase the number of the Company's
contracts subject to mark-to-market accounting.
Statement of Financial Accounting Standards No. 150 "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150"). On May 15, 2003, the FASB issued SFAS 150. This statement
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. It requires
that issuers classify as liabilities a financial instrument that is within its
scope as a liability because that financial instrument embodies an obligation of
the issuer. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period after June 15, 2003. Currently, the Company does not
possess any such financial instruments that are covered under this statement.
EITF 01-8 "Determining Whether an Arrangement Contains a Lease." EITF
01-8 provides guidance on how to determine whether an arrangement contains a
lease that is within the scope of Statement of Financial Accounting Standards
No. 13, "Accounting for Leases" ("SFAS 13"). The guidance is based on whether
the arrangement conveys to the purchaser (lessee) the right to use a specific
asset. A consensus was reached on the accounting for substantial services
provided by the lessor in these arrangements in which these services are not
executory costs as the term is used in SFAS 13. Guidance is also provided as to
when an arrangement should be reassessed to determine whether it contains a
lease and how to account for these subsequent changes in lease classification.
EITF 01-8 should be applied to arrangements agreed to, committed to, modified,
or acquired in business combinations initiated in the next reporting period
beginning after May 28, 2003. The Company does not expect EITF 01-8 to have a
significant impact on its consolidated financial statements.
EITF 02-9 "Accounting for Changes That Result in a Transferor Regaining
Control of Financial Assets Sold." EITF 02-9 addresses how to apply the
accounting requirements of paragraph 55 of Statement of Financial Accounting
Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("SFAS 140"), with respect to beneficial
interests held by the transferor and loans that do not meet the definition of a
security, including whether the transferor should recognize a gain or loss when
the provisions of paragraph 55 are applied. Paragraph 55 of SFAS No. 140
requires a transferor to recognize in its financial statements assets previously
accounted for appropriately as having been sold when one or more of the
conditions regarding control of the assets are no longer met. EITF 02-9 should
be applied to events occurring after April 2, 2003. The Company does not expect
EITF 02-9 to have a significant impact on its consolidated financial statements.
37
PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(9) Subsequent Events
Employee Stock Purchase Plan ("ESPP")
The ESPP, which allows eligible employees to purchase shares of PNM
Resources common stock ("Stock") at a discount, became effective on July 1,
2003. Employees can contribute from 1% to 10% of their pay each pay period
towards purchases. The ESPP is organized into two six-month offering periods
that run from January 1 through June 30 and from July 1 through December 31.
Within each offering period, there are two purchase periods and two purchase
dates. The purchase periods run from January 1 through March 31, April 1 through
June 30, July 1 through September 30 and October 1 through December 31. The
purchase dates are March 31, June 30, September 30 and December 31. At the end
of each purchase period, the accumulated contributions are used to purchase full
and fractional shares of stock at the discounted purchase price. The discounted
purchase price is 85% of the lower of fair market value of the Stock on the two
different days each offering period: the first day of the offering period; or
the relevant purchase date. Employees cannot purchase more than $25,000 of stock
each calendar year. As of July 1, 2003, 347 employees elected to participate in
the ESPP. The total amount to be contributed each purchase period is
approximately $0.2 million.
Long-term Debt
As of June 30, 2003, PNM had $268.4 million of long-term debt that
matures in August 2005. All other long-term debt of PNM matures in 2016 or
later. On June 30, 2003, PNM filed for approval with the PRC to issue up to $300
million of new long term debt maturing in 2008, 2010, 2013 or some combination
thereof. Proceeds would be used to retire the $268.4 million maturing in August
2005. The Company filed a conditional notice of redemption on the $268.4 million
of long-term debt on July 21, 2003. A hearing on the matter was held July 29,
2003. The PRC approved the issuance of new long-term debt on August 5, 2003.
38
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Holding Company and its subsidiaries and PNM is
presented on a combined basis. The Holding Company performs substantially all of
the corporate activities of PNM. These activities are billed to PNM on a cost
basis to the extent they are for the corporate management of PNM and are
allocated to the operating segments. In January 2002, Avistar and certain
inactive subsidiaries were transferred by way of a dividend to the Holding
Company pursuant to an order from the PRC. The business of PNM constitutes
substantially all of the business of the Company. Therefore, the financial
results and results of operations of PNM are virtually identical to the
consolidated results of the Holding Company and all its subsidiaries. For
discussion purposes, this report will use the term "Company" when discussing
matters of common applicability to the Holding Company and Subsidiaries and PNM.
Readers of Management's Discussion and Analysis of Financial Condition and
Results of Operations should assume that the information presented applies to
consolidated results of operations and financial position of both the Holding
Company and its subsidiaries and PNM, except where the context or references
clearly indicate otherwise. Discussions regarding specific contractual
obligations generally reference the company that is legally obligated. In the
case of contractual obligations of PNM, these obligations are consolidated with
the Holding Company and its subsidiaries under GAAP. Broader operational
discussions refer to the Company.
The following is management's assessment of the Company's financial
condition and the significant factors affecting the results of operations. This
discussion should be read in conjunction with the Company's consolidated
financial statements and related notes. Trends and contingencies of a material
nature are discussed to the extent known and considered relevant.
OVERVIEW
The Holding Company is an investor-owned holding company of energy and
energy related companies. Its principal subsidiary, PNM, is an integrated public
utility primarily engaged in the generation, transmission and distribution of
electricity; transmission, distribution and sale of natural gas within the State
of New Mexico; and the sale and marketing of electricity in the Western United
States.
COMPETITIVE STRATEGY
The Company is positioned as a "merchant utility," primarily operating as
a regulated energy service provider. The Company is also engaged in the sale and
marketing of electricity in the competitive energy market place. As a utility,
PNM has an obligation to serve its customers under the jurisdiction of the PRC.
As a wholesale electricity provider, PNM markets excess production from the
utility, as well as unregulated generation, into a competitive marketplace. As
part of its electric wholesale power operation, it purchases wholesale
electricity in the open market for future resale or to provide energy to retail
customers in New Mexico when the Company's generation assets cannot satisfy
demand. The wholesale operations utilize an asset-backed strategy, whereby the
Company's aggregate net open position for the sale of electricity is covered by
the Company's forecasted excess generation capabilities.
39
As it currently operates, the Company's principal business segments are
Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations
include Electric Services ("Electric"), Gas Services ("Gas") and Transmission
Services ("Transmission"). Electric consists of the distribution and generation
of electricity for retail customers. Wholesale consists of the generation and
sale of electricity into the wholesale market based on three product lines that
include long-term contracts, forward sales and short-term sales.
The Utility Operations strategy is directed at supplying reasonably
priced and reliable energy to retail customers through customer-driven
operational excellence, high quality customer service, cost efficient processes,
and improved overall organizational performance.
The Wholesale Operations strategy calls for increased asset-backed energy
sales supported by long-term contracts and the wholesale market. The
asset-backed sales are actively monitored by management by the use of stringent
risk management policies. The Company's future growth plans call for
approximately 75% of its new generation portfolio to be committed through
long-term contracts, including sales to retail customers. Growth will be
dependent on market development and upon the Company's ability to generate funds
for the Company's future expansion. Although the current economic environment
has led the Company to scale back its expansion plans, the Company will continue
to operate in the wholesale market and seek rationally priced asset additions.
Expansion of the Company's generating portfolio will depend upon acquiring
favorably priced assets at strategic locations and securing long-term
commitments for the purchase of power from the acquired plants.
(Intentionally left blank)
40
RESULTS OF OPERATIONS
Three Months Ended June 30, 2003
Compared to Three Months Ended June 30, 2002
Consolidated
The Company's net earnings available to common shareholders for the three
months ended June 30, 2003 were $17.6 million or $0.44 per diluted share of
common stock, a 59.8% increase in net earnings compared to $11.0 million or
$0.28 per diluted share of common stock in 2002. This increase primarily
reflects new long-term contract sales, improved wholesale market conditions and
increased demand in the New Mexico service territory for electricity and natural
gas.
The following discussion is based on the financial information presented
in the Consolidated Financial Statements - Segment Information Note 2, in the
Notes to the Consolidated Financial Statements. Corporate allocations, income
taxes and non-operating items are discussed only on a consolidated basis.
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Three Months Ended
June 30,
----------------------------------
2003 2002 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:..................... $ 131,091 $ 134,412 $(3,321)
Less: Cost of energy.................... 50,006 49,733 273
Energy transfer.................. (11,654) (8,526) (3,128)
---------------- --------------- --------------
Gross margin............................ 92,739 93,205 (466)
---------------- --------------- --------------
Energy production costs................. 25,427 26,899 (1,472)
Distribution O&M........................ 4,903 5,145 (242)
Customer related expense................ 4,184 4,938 (754)
Administrative and general.............. 2,175 2,391 (216)
---------------- --------------- --------------
Total non-fuel O&M.................... 36,689 39,373 (2,684)
Corporate allocation.................... 13,850 12,761 1,089
Depreciation and amortization........... 15,843 14,752 1,091
Taxes other than income taxes........... 3,598 4,605 (1,007)
Income taxes............................ 6,277 5,815 462
---------------- --------------- --------------
Total non-fuel operating expenses..... 76,257 77,306 (1,049)
---------------- --------------- --------------
Operating income........................ $ 16,482 $ 15,899 $ 583
---------------- --------------- --------------
41
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential................ $46,871 $45,696 $1,175
Commercial................. 62,984 62,577 407
Industrial................. 16,351 20,792 (4,441)
Other...................... 4,885 5,347 (462)
------------- ------------- --------------
$131,091 $134,412 $ (3,321)
============= ============= ==============
Average customers.......... 394,679 383,589 11,090
============= ============= ==============
The following table shows electric sales by customer class:
Electric Sales
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Residential............... 547,145 534,417 12,728
Commercial................ 830,153 823,218 6,935
Industrial................ 325,243 405,571 (80,328)
Other..................... 56,783 62,491 (5,708)
------------- ------------- --------------
1,759,324 1,825,697 (66,373)
============= ============= ==============
Operating revenues decreased $3.3 million or 2.5% for the period. Retail
electricity delivery declined to 1.76 million MWh in 2003 compared to 1.83
million MWh delivered in the prior year, resulting in the decrease in revenues.
This volume decrease was the result of the reclassification of a significant
customer from retail to wholesale electric rates in the first quarter of 2003,
partially offset by customer growth year-over-year of 2.9%. Without the customer
reclassification, volume increased 1.3% and retail electric revenues increased
$1.4 million.
The gross margin, or operating revenues minus cost of energy sold,
decreased $0.5 million or 0.5%. This decrease is due mainly to the customer
reclassification, partially offset by customer growth in the Company's retail
electric service territory.
Total non-fuel O&M expenses decreased $2.7 million or 6.8%. Energy
production costs decreased $1.5 million or 5.5% primarily due to plant
maintenance schedules. As a result of the maintenance schedule timing,
maintenance costs decreased $0.7 million at Reeves Generating Station ("Reeves")
and $0.9 million at Palo Verde Nuclear Generating Station (`PVNGS") Unit 2 for
outages in 2002, which did not recur in 2003. Customer-related expense decreased
$0.8 million or 15.3% due to lower salaries and outside services due to the
Company realignment (see Note 6 "Company Realignment") and lower bad debt
42
expense of $0.3 million as a result of collection improvements. Depreciation and
amortization increased $1.1 million or 7.4% due to an increase of $0.3 million
for the change in accounting for costs related to asset retirement obligations,
as required by SFAS 143, and a higher depreciable plant base. Taxes other than
income taxes decreased $1.0 million or 21.9% due to a decrease in property tax
as a result of a change in assessed value and a decrease in social security
taxes.
Gas
The table below sets forth the operating results for Gas.
Three Months Ended
June 30,
--------------------------------
2003 2002 Variance
--------------- -------------- ---------------
(In thousands)
Operating revenues:
External customers.................... $74,009 $43,968 $ 30,041
Intersegment revenues................. - 445 (445)
--------------- -------------- ---------------
Total revenues........................ 74,009 44,413 29,596
Less: Cost of energy.................... 46,275 18,922 27,353
--------------- -------------- ---------------
Gross margin............................ 27,734 25,491 2,243
--------------- -------------- ---------------
Energy production costs................. 438 503 (65)
Transmission and distribution O&M....... 7,145 6,592 553
Customer related expense................ 4,062 4,281 (219)
Administrative and general.............. 924 1,568 (644)
--------------- -------------- ---------------
Total non-fuel O&M.................... 12,569 12,944 (375)
Corporate allocation.................... 8,607 7,875 732
Depreciation and amortization........... 5,498 5,035 463
Taxes other than income taxes........... 1,314 1,967 (653)
Income taxes............................ (1,547) (2,236) 689
--------------- -------------- ---------------
Total non-fuel operating expenses..... 26,441 25,585 856
--------------- -------------- ---------------
Operating income (loss)................. $ 1,293 $ (94) $ 1,387
--------------- -------------- ---------------
The following table shows gas revenues by customer and average customers:
Gas Revenues
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............... $44,699 $25,612 $19,087
Commercial................ 15,142 8,191 6,951
Industrial................ 434 415 19
Transportation*........... 6,010 5,134 876
Other..................... 7,724 5,061 2,663
------------- ------------- --------------
$74,009 $44,413 $29,596
============= ============= ==============
Average customers......... 451,079 443,514 7,565
============= ============= ==============
43
The following table shows gas throughput by customer class:
Gas Throughput
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Thousands of decatherms)
Residential............... 3,651 2,984 667
Commercial................ 1,641 1,594 47
Industrial................ 70 124 (54)
Transportation*........... 16,455 14,076 2,379
Other..................... 1,026 1,114 (88)
------------- ------------- --------------
22,843 19,892 2,951
============= ============= ==============
*Customer-owned gas
Operating revenues increased $29.6 million or 66.6% for the period to
$74.0 million, primarily because of higher natural gas prices in 2003 as
compared to 2002, customer growth of 1.7% and an increase in gas sales volumes
of 14.8%, largely resulting from cooler weather in April 2003. PNM purchases
natural gas in the open market and resells it at that open market price to its
distribution customers. As a result, increases or decreases in gas revenues
driven by gas costs do not impact the Company's consolidated gross margin or
earnings.
The gross margin, or operating revenues minus cost of energy sold,
increased $2.2 million or 8.8%. This increase is due mainly to a weather-related
increase in gas volumes, partially offset by the expiration in January 2003 of a
rate rider for the recovery of certain costs of $0.6 million. The Company
currently believes that gas assets are not earning an adequate level of return.
As a result, the Company filed a request for increased rates in January 2003. In
June 2003, the Company agreed to a negotiated settlement. If approved by the
PRC, the agreement will increase gas revenues by $21.6 million annually. The
agreement also allows the Company to collect interest on uncollected regulatory
assets over the collection period. The revenue increase and interest collection
combined generate approximately $22 million of pre-tax value. An order from the
PRC is not expected until September 2003 with new rates going into effect in
October 2003.
Total non-fuel O&M expenses decreased $0.4 million or 2.9%. Transmission
and distribution O&M increased $0.6 million or 8.4% due to an increase in leak
surveys of $0.3 million for safety purposes and a 2002 legal settlement of $0.3
million. Administrative and general costs decreased $0.6 million or 41.1%
primarily due to lower costs resulting from increased capital activity and cost
control initiatives. Depreciation and amortization increased $0.5 million or
9.2% due to a higher depreciable plant base. Taxes other than income taxes
decreased $0.7 million or 33.2% due to a decrease in property tax as a result of
a change in assessed value and a decrease in social security taxes.
44
Transmission
The table below sets forth the operating results for Transmission.
Three Months Ended
June 30,
----------------------------------
2003 2002 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:
External customers..................... $ 2,317 $ 5,912 $ (3,595)
Intersegment revenues.................. 10,554 7,798 2,756
---------------- --------------- --------------
Total revenues......................... 12,871 13,710 (839)
Less: Cost of energy..................... 1,183 1,021 162
---------------- --------------- --------------
Gross margin............................. 11,688 12,689 (1,001)
---------------- --------------- --------------
Energy production costs.................. 241 (4) 245
Transmission O&M......................... 3,136 3,705 (569)
Administrative and general............... 581 669 (88)
---------------- --------------- --------------
Total non-fuel O&M..................... 3,958 4,370 (412)
Corporate allocation..................... 1,127 1,200 (73)
Depreciation and amortization............ 2,337 2,199 138
Taxes other than income taxes............ 586 604 (18)
Income taxes............................. 1,044 1,338 (294)
---------------- --------------- --------------
Total non-fuel operating expenses...... 9,052 9,711 (659)
---------------- --------------- --------------
Operating income......................... 2,636 2,978 $ (342)
---------------- --------------- --------------
Operating revenues decreased $0.8 million or 6.1% and gross margin
decreased $1.0 million or 7.9% for the period. Transmission revenues decreased
primarily due to lower demand for wheeling to California from Arizona as a
result of lower demand in the California market.
Total non-fuel O&M expenses decreased $0.4 million or 9.4%. Transmission
O&M decreased $0.6 million or 15.4% primarily due to a decrease in lease costs
of $1.1 million for the EIP transmission line, a portion of which was
repurchased in April 2003. This decrease was partially offset by higher
maintenance costs incurred for reliability improvement purposes.
45
Wholesale
The table below sets forth the operating results for Wholesale.
Three Months Ended
June 30,
-----------------------------------
2003 2002 Variance
---------------- --------------- --------------
(In thousands)
Operating revenues:
External customers.................... $ 132,742 $65,812 $66,930
Intersegment revenues................. 900 - 900
---------------- ---------------- --------------
Total revenues........................ 133,642 65,812 67,830
Less: Cost of energy.................... 89,327 46,936 42,391
Energy transfer.................. 11,652 8,526 3,126
---------------- ---------------- --------------
Gross margin............................ 32,663 10,350 22,313
---------------- ---------------- --------------
Energy production costs................. 8,409 6,804 1,605
Administrative and general.............. 1,994 1,316 678
---------------- ---------------- --------------
Total non-fuel O&M.................... 10,403 8,120 2,283
Corporate allocation.................... 965 918 47
Depreciation and amortization........... 3,569 1,906 1,663
Taxes other than income taxes........... 1,050 630 420
Income taxes............................ 4,240 (2,900) 7,140
---------------- ---------------- --------------
Total non-fuel operating expenses..... 20,227 8,674 11,553
---------------- ---------------- --------------
Operating income........................ $ 12,436 $ 1,676 $ 10,760
---------------- ---------------- --------------
The following table shows revenues by customer class:
Wholesale Revenues
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts....... $34,507 $16,045 $18,462
Forward sales*............ 44,010 1,464 42,546
Short-term sales.......... 55,125 48,303 6,822
------------- ------------- --------------
$133,642 $65,812 $67,830
============= ============= ==============
*Includes mark-to-market gains/(losses).
(Intentionally left blank)
46
The following table shows sales by customer class:
Wholesale Sales
Three Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Long-term contracts....... 560,672 227,000 333,672
Forward sales............. 955,180 - 955,180
Short-term sales.......... 1,352,006 1,771,569 (419,563)
------------- ------------- --------------
2,867,858 1,998,569 869,289
============= ============= ==============
Operating revenues increased $67.8 million or 103.1% for the period to
$133.6 million. This increase in wholesale electric sales primarily reflects new
long-term contract sales and improved wholesale market conditions. The Company
delivered wholesale (bulk) power of 2.9 million MWh of electricity for the three
months ended June 30, 2003 compared to 2.0 million MWh for the same period in
2002. In addition, effective January 1, 2003, the Company adopted EITF 02-3,
which resulted in the reclassification of contracts that were previously
accounted for under EITF 98-10 to a net margin basis. Therefore, in 2002, $18.9
million of realized purchased power expense was netted against revenues for a
net margin of $1.5 million. These sales and purchases were accounted for in the
forward sales market.
The gross margin, or operating revenues minus cost of energy sold,
increased $22.3 million or 215.6%. Higher margins were created primarily by new
long-term sales contracts, higher market prices and improved market liquidity.
The addition of new, multi-year long-term contracts added $12.7 million or 57.0%
of the total gross margin increase for the quarter. In addition, long-term
contract margin increased due to the transfer of a significant customer from
retail to wholesale. Forward sales margin increased $6.4 million or 28.8% of the
total gross margin increase reflecting a return to more rational price markets
and improved market liquidity. The average price realized by the Company on its
forward sales was $42 per MWh in 2003, compared to $35 per MWh in 2002.
Short-term sales margin increased $3.2 million or 14.2% of the total gross
margin increase due to the commodity price stabilization, partially offset by
lower volume due to resources being used for increased long-term sale
obligations. The average price on the Company's realized short-term sales was
$40 per MWh in 2003, compared to $27 per MWh in 2002. This increase was
partially offset by planned and unplanned outages at SJGS and PVNGS, which
reduced availability of power for wholesale sales. Overall open market sales
(forward and short-term sales) averaged $41 per MWh in 2003 versus $28 per MWh
in 2002. Unplanned outages were within the Company's expected ranges for the
second quarter 2003. The Company had a favorable change in the unrealized
mark-to-market position of the forward sales portfolio of $2.9 million
year-over-year ($3.9 million gain in 2003 versus $1.0 million gain in 2002).
Total non-fuel O&M expenses increased $2.3 million or 28.1%. Energy
production costs increased $1.6 million or 23.6% primarily due to costs of $2.5
million related to a PVNGS Unit 3 planned outage in 2003. In addition, the new
Afton and Lordsburg gas fired facilities, which became operational in late 2002,
incurred operating costs of $0.4 million in 2003. Administrative and general
increased $0.7 million or 51.5% primarily due to combustion turbine storage
47
costs of $0.6 million. Depreciation and amortization increased $1.7 million or
87.3% primarily due to the addition of Lordsburg and Afton and an increase of
$0.4 million for the change in accounting for costs related to asset retirement
obligations as required by SFAS 143.
Corporate and Other
Corporate administrative and general, which represent costs that are
driven primarily by corporate-level activities, is allocated to the business
segments and presented in the corporate allocation line item in the segment
statements. These costs increased $7.7 million or 36.6% for the period to $28.6
million. Lower prior-year returns on pension investments and increasing
healthcare costs were two critical drivers. Bonus accruals were also higher
because of higher year-over-year earnings, while environmental costs increased
$0.5 million for routine clean-up matters.
Taxes other than income taxes decreased $1.0 million or 85.8% to $0.2
million due to a decrease in property taxes as a result of a change in assessed
value and a decrease in social security tax.
Consolidated
Other Income and Deductions
Other income increased by $1.0 million or 8.7% due to higher
quarter-over-quarter returns on investments reflecting improved market
conditions. This increase is partially offset by lower interest income due to a
decrease in the short-term investment balance. Cash from the redemption of
short-term investments was primarily used for the Company's repayment of the EIP
long-term debt, debt refinancing and repayment of short-term debt.
Other deductions increased $2.1 million or 112.1% primarily due to a
write-off of $1.0 million for costs related to long-term debt refunding.
Interest Expense
Interest expense increased $3.1 million or 20.9% primarily due to
increased short-term borrowings and by decreased capitalized interest of $2.3
million due to the completion of the southern New Mexico gas-fired plant
construction.
Income Taxes
The Company's consolidated income tax expense before the cumulative
effect of a change in accounting principle was $10.2 million for the three
months ended June 30, 2003, compared to $5.6 million for the three months ended
June 30, 2002. The increase was due to the impact of higher pre-tax earnings.
The Company's effective income tax rates for the three months ended June 30,
2003 and 2002 were 36.54% and 33.31%, respectively. The increase in the
effective rate period over period was due to the reduction in permanent tax
benefits.
48
RESULTS OF OPERATIONS
Six Months Ended June 30, 2003
Compared to Six Months Ended June 30, 2002
Consolidated
The Company's net earnings available to common shareholders for the six
months ended June 30, 2003 were $65.8 million or $1.66 per diluted share of
common stock, an 83.6% increase in net earnings compared to $35.8 million or
$0.90 per diluted share of common stock in 2002. This increase primarily
reflects the cumulative effect of a change in accounting principle for the
adoption of SFAS 143 of $37.4 million, net of tax and improved operating
performance. This increase was partially offset by the write-off of transition
costs of $16.7 million that resulted from the repeal of electric deregulation in
New Mexico in the first quarter of 2003.
The following discussion is based on the financial information presented
in the Consolidated Financial Statements - Segment Information Note 2, in the
Notes to the Consolidated Financial Statements. Corporate allocations, income
taxes and non-operating items are discussed only on a consolidated basis.
Utility Operations
Electric
The table below sets forth the operating results for Electric.
Six Months Ended
June 30,
----------------------------------
2003 2002 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:...................... $ 260,135 $ 263,756 $(3,621)
Less: Cost of energy..................... 97,780 96,352 1,428
Energy transfer................... (21,765) (17,152) (4,613)
---------------- --------------- --------------
Gross margin............................. 184,120 184,556 (436)
---------------- --------------- --------------
Energy production costs.................. 52,877 54,886 (2,009)
Transmission and distribution O&M........ 10,157 10,078 79
Customer related expense................. 6,463 8,848 (2,385)
Administrative and general............... 2,882 2,415 467
---------------- --------------- --------------
Total non-fuel O&M..................... 72,379 76,227 (3,848)
Corporate allocation..................... 26,897 24,932 1,965
Depreciation and amortization............ 31,578 29,638 1,940
Taxes other than income taxes............ 8,808 9,282 (474)
Income taxes............................. 12,315 12,339 (24)
---------------- --------------- --------------
Total non-fuel operating expenses...... 151,977 152,418 (441)
---------------- --------------- --------------
Operating income......................... $ 32,143 $ 32,138 $ 5
---------------- --------------- --------------
49
The following table shows electric revenues by customer class and average
customers:
Electric Retail Revenues
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential................ $97,834 $96,418 $1,416
Commercial................. 118,090 117,582 508
Industrial................. 35,102 40,420 (5,318)
Other...................... 9,109 9,336 (227)
------------- ------------- --------------
$260,135 $263,756 $ (3,621)
============= ============= ==============
Average customers.......... 393,635 382,625 11,010
============= ============= ==============
The following table shows electric sales by customer class:
Electric Sales
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Residential............... 1,139,280 1,123,413 15,867
Commercial................ 1,551,015 1,534,477 16,538
Industrial................ 696,878 797,917 (101,039)
Other..................... 99,669 109,365 (9,696)
------------- ------------- --------------
3,486,842 3,565,172 (78,330)
============= ============= ==============
Operating revenues decreased $3.6 million or 1.4% for the period. Retail
electricity delivery declined slightly to 3.5 million MWh in 2003 compared to
3.6 million MWh delivered in the prior year, resulting in decreased revenues.
Lower volumes were the result of the reclassification of a significant customer
from retail to wholesale electric rates in the first quarter of 2003, which was
almost completely offset by customer growth of 2.9%. Without the customer
reclassification, volume increased 2.8%.
The gross margin, or operating revenues minus cost of energy sold,
decreased $0.4 million or 0.2%. This decrease is due to the customer
reclassification, offset by customer growth in the Company's retail electric
service territory.
Total non-fuel O&M expenses decreased $3.8 million or 5.0%. Energy
production costs decreased $2.0 million or 3.7% primarily due to lower plant
maintenance costs. Contributing to this decrease were decreased costs of $1.0
million at Reeves, $1.8 million at Four Corners and $1.9 million at PVNGS Unit 2
primarily for outages in 2002, which did not recur in 2003. This decrease was
partially offset by increased costs of $2.4 million at SJGS related to increased
plant outages in 2003. Customer-related expense decreased $2.4 million or 27.0%
due to lower bad debt expense of $1.9 million as a result of continued
collection improvements and lower salaries and outside services due to the
Company realignment. Depreciation and amortization increased $1.9 million or
6.5% due to an increase of $0.7 million for the change in accounting for costs
related to asset retirement obligations as required by SFAS 143 and a higher
depreciable plant base. Taxes other than income taxes decreased $0.5 million or
5.1% due to a decrease in property tax as a result of a change in assessed value
and a decrease in social security taxes.
Gas
The table below sets forth the operating results for Gas.
Six Months Ended
June 30,
--------------------------------
2003 2002 Variance
--------------- -------------- ---------------
(In thousands)
Operating revenues:
External customers..................... $220,262 $153,169 $ 67,093
Intersegment revenues.................. - 445 (445)
--------------- -------------- ---------------
Total revenues......................... 220,262 153,614 66,648
Less: Cost of energy..................... 151,153 83,671 67,482
--------------- -------------- ---------------
Gross margin............................. 69,109 69,943 (834)
--------------- -------------- ---------------
Energy production costs.................. 948 1,034 (86)
Transmission and distribution O&M........ 15,125 14,523 602
Customer related expense................. 7,850 8,270 (420)
Administrative and general............... 1,019 2,142 (1,123)
--------------- -------------- ---------------
Total non-fuel O&M..................... 24,942 25,969 (1,027)
Corporate allocation..................... 16,627 15,428 1,199
Depreciation and amortization............ 10,940 10,097 843
Taxes other than income taxes............ 3,355 4,010 (655)
Income taxes............................. 2,556 3,090 (534)
--------------- -------------- ---------------
Total non-fuel operating expenses...... 58,420 58,594 (174)
--------------- -------------- ---------------
Operating income......................... $ 10,689 $ 11,349 $ (660)
--------------- -------------- ---------------
(Intentionally left blank)
51
The following table shows gas revenues by customer and average customers:
Gas Revenues
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Residential............... $142,673 $97,724 $44,949
Commercial................ 45,563 30,590 14,973
Industrial................ 1,465 1,064 401
Transportation*........... 9,755 8,745 1,010
Other..................... 20,806 15,491 5,315
------------- ------------- --------------
$220,262 $153,614 $66,648
============= ============= ==============
Average customers......... 451,688 443,720 7,968
============= ============= ==============
*Customer-owned gas.
The following table shows gas throughput by customer class:
Gas Throughput
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Thousands of decatherms)
Residential............... 15,857 16,500 (643)
Commercial................ 5,975 6,564 (589)
Industrial................ 256 296 (40)
Transportation*........... 25,090 21,473 3,617
Other..................... 2,969 3,104 (135)
------------- ------------- --------------
50,147 47,937 2,210
============= ============= ==============
*Customer-owned gas.
Operating revenues increased $66.6 million or 43.4% for the period to
$220.3 million, primarily because of higher natural gas prices in 2003 as
compared to 2002, customer growth of 1.8% and an increase in gas sales volumes
of 4.6%, driven by increased sales to third-party gas transportation customers.
This increase was partially offset by a decrease in residential and commercial
sales due to warmer weather in the first quarter of 2003. PNM purchases natural
gas in the open market and resells it at cost of purchase to its retail gas
distribution customers. As a result, increases or decreases in gas revenues
driven by gas costs do not impact the Company's consolidated gross margin or
earnings.
The gross margin, or operating revenues minus cost of energy sold,
decreased $0.8 million or 1.2%. This decrease is due mainly to an overall
weather-related decline in gas volumes and the expiration in January 2003 of a
rate rider for the recovery of certain costs of $2.1 million. January 2003 was
52
the warmest January in recorded history in New Mexico. The Company currently
believes that gas assets are not earning an adequate level of return. As a
result, the Company filed a request for increased rates in January 2003. In June
2003, the Company agreed to a negotiated settlement. If approved by the PRC, the
agreement will increase revenues by $21.6 million and operating income by
approximately $22 million, annually. An order is not expected until September
2003.
Total non-fuel O&M expenses decreased $1.0 million or 4.0%. Transmission
and distribution O&M increased $0.6 million or 4.1% due to an increase in leak
surveys of $0.3 million for safety purposes and a 2002 legal settlement of $0.3
million. Administrative and general costs decreased $1.1 million or 52.4%
primarily due to cost control initiatives. Depreciation and amortization
increased $0.8 million or 8.3% due to a higher depreciable plant base. Taxes
other than income taxes decreased $0.7 million or 16.3% due to a decrease in
property tax as a result of a change in assessed values and a decrease in social
security taxes.
Transmission
The table below sets forth the operating results for Transmission.
Six Months Ended
June 30,
----------------------------------
2003 2002 Variance
----------------- -------------- --------------
(In thousands)
Operating revenues:
External customers...................... $ 6,874 $ 11,810 $ (4,936)
Intersegment revenues................... 18,189 15,435 2,754
---------------- --------------- --------------
Total revenues.......................... 25,063 27,245 (2,182)
Less: Cost of energy...................... 2,430 2,213 217
---------------- --------------- --------------
Gross margin.............................. 22,633 25,032 (2,399)
---------------- --------------- --------------
Energy production costs................... 503 225 278
Transmission O&M.......................... 7,150 7,365 (215)
Administrative and general................ 655 1,177 (522)
---------------- --------------- --------------
Total non-fuel O&M...................... 8,308 8,767 (459)
Corporate allocation...................... 2,208 2,115 93
Depreciation and amortization............. 4,659 4,321 338
Taxes other than income taxes............. 1,225 1,223 2
Income taxes.............................. 1,249 2,251 (1,002)
---------------- --------------- --------------
Total non-fuel operating expenses....... 17,649 18,677 (1,028)
---------------- --------------- --------------
Operating income.......................... $ 4,984 $ 6,355 $ (1,371)
---------------- --------------- --------------
Operating revenues decreased $2.2 million or 8.0% and gross margin
decreased $2.4 or 9.6% for the period. Transmission revenues decreased primarily
due to lower demand for wheeling to California from Arizona as a result of lower
demand in the California market.
Total non-fuel O&M expenses decreased $0.5 million or 5.2%. Transmission
O&M decreased only slightly as a decrease in lease costs of $1.1 million for the
EIP transmission line, a portion of which was repurchased in April 2003, was
mostly offset by increased maintenance costs for reliability purposes.
53
Wholesale
The table below sets forth the operating results for Wholesale.
Six Months Ended
June 30,
-----------------------------------
2003 2002 Variance
---------------- --------------- --------------
(In thousands)
Operating revenues:
External customers..................... $ 240,519 $ 122,354 $118,165
Intersegment revenue................... 900 - 900
---------------- ---------------- --------------
Total revenues......................... 241,419 122,354 119,065
Less: Cost of energy..................... 168,995 84,942 84,053
Energy transfer................... 21,764 17,152 4,612
---------------- ---------------- --------------
Gross margin............................. 50,660 20,260 30,400
---------------- ---------------- --------------
Energy production costs.................. 15,281 13,028 2,253
Administrative and general............... 4,044 2,543 1,501
---------------- ---------------- --------------
Total non-fuel O&M..................... 19,325 15,571 3,754
Corporate allocation..................... 1,894 2,074 (180)
Depreciation and amortization............ 7,060 3,762 3,298
Taxes other than income taxes............ 1,861 1,328 533
Income taxes............................. 5,289 (3,805) 9,094
---------------- ---------------- --------------
Total non-fuel operating expenses...... 35,429 18,930 16,499
---------------- ---------------- --------------
Operating income......................... $ 15,231 $ 1,330 $ 13,901
---------------- ---------------- --------------
The following table shows revenues by customer class:
Wholesale Revenues
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(In thousands)
Long-term contracts....... $60,686 $33,060 $27,626
Forward sales*............ 66,948 2,718 64,230
Short-term sales.......... 113,785 86,576 27,209
------------- ------------- --------------
$241,419 $122,354 $119,065
============= ============= ==============
*Includes mark-to-market gains/(losses).
(Intentionally left blank)
54
The following table shows sales by customer class:
Wholesale Sales
Six Months Ended
June 30,
2003 2002 Variance
------------- ------------- --------------
(Megawatt hours)
Long-term contracts....... 1,062,117 508,153 553,964
Forward sales............. 1,517,380 - 1,517,380
Short-term sales.......... 2,808,744 3,609,715 (800,971)
------------- ------------- --------------
5,388,241 4,117,868 1,270,373
============= ============= ==============
Operating revenues increased $119.1 million or 97.3% for the period to
$241.4 million. This increase in wholesale electric sales primarily reflects new
long-term contract sales, improved wholesale market conditions for open market
sales (forward and short-term sales) and the impact of the adoption of EITF 02-3
on 2002 wholesale revenues. The Company delivered wholesale (bulk) power of 5.4
million MWh of electricity for the six months ended June 30, 2003, compared to
4.2 million MWh for the same period in 2002. In addition, effective January 1,
2003, the Company adopted EITF 02-3 which resulted in the reclassification of
contracts that were previously accounted for under EITF 98-10 to a net margin
basis for the six months ended June 30, 2002. Therefore, in 2002, $35.4 million
of purchased power expense was netted against revenues for a net margin of $2.7
million in 2002. These sales and purchases were accounted for in the forward
sales market.
The gross margin, or operating revenues minus cost of energy sold,
increased $30.4 million or 150.0%. A higher gross margin was achieved primarily
by new long-term sales contracts, a return to more rational electric commodity
market prices and improving market liquidity. The addition of long-term
contracts added $17.7 million or 58.3% of the total gross margin increase for
the period. In addition, long-term contract margin increased due to the transfer
of a significant customer from retail to wholesale. Forward sales margin
increased $7.3 million or 24.0% of the total gross margin increase reflecting
the higher prices and improved market liquidity. The average price realized by
the Company on its forward sales was $42 per MWh in 2003, compared to $35 per
MWh in 2002. Short-term sales margin increased $5.4 million or 17.7% of the
total gross margin increase due to commodity price stability, partially offset
by lower volume due to resources being used to service new long-term sales
contracts. The average price realized by the Company on its short-term sales was
$40 per MWh in 2003, compared to $24 per MWh in 2002. Overall open market sales
(forward and short-term sales) averaged $41 per MWh in 2003 versus $26 per MWh
in 2002. This increase was partially offset by planned and unplanned outages at
SJGS, which reduced availability of power for wholesale sales, largely in the
first quarter. In addition, the Company had to buy power in the open market at
higher prices to cover its contractual obligations, which resulted in increased
power costs. The Company also had a favorable change in the unrealized
mark-to-market position of the forward sales portfolio of $0.4 million
period-over-period ($2.6 million gain in 2003 versus $2.2 million gain in 2002).
Total non-fuel O&M expenses increased $3.8 million or 24.1%. Energy
production costs increased $2.3 million or 17.3% primarily due to increased
costs of $2.5 million for PVNGS Unit 3 and $0.4 million at SJGS related to
various planned and unplanned outages. In addition, the new Afton and Lordsburg
55
gas fired facilities, which became operational in late 2002, incurred operating
costs of $0.8 million in 2003. These increases were partially offset by
decreased decommissioning expense of $1.7 million resulting from the change in
accounting for costs related to asset retirement obligations as required by SFAS
143. Administrative and general increased $1.5 million or 59.0% primarily due to
combustion turbine storage costs of $1.2 million. Depreciation and amortization
increased $3.3 million or 87.7% primarily due to the addition of Lordsburg and
Afton and an increase of $0.8 million for the change in accounting for costs
related to asset retirement obligations as required by SFAS 143. Taxes other
than income taxes increased $0.5 million or 40.1% primarily due to the addition
of Afton and Lordsburg.
Corporate and Other
Corporate administrative and general, which represent costs that are
driven primarily by corporate-level activities, is allocated to the business
segments and is presented in the corporate allocation line item in the segment
statements. These costs increased $9.5 million or 22.5% for the period to $51.6
million. This increase was due to increased pension and benefits expense of $6.4
million, resulting from lower prior-year returns on pension investments and
increasing healthcare costs. Bonus accruals were also higher due to higher
year-over-year earnings, while environmental costs increased $0.5 million for
routine clean-up matters.
Taxes other than income taxes decreased $2.4 million or 144.5% to income
of $0.7 million due to the favorable assessment of outstanding tax issues, a
decrease in property taxes as a result of a change in assessed value and a
decrease in social security taxes.
Consolidated
Other Income and Deductions
Other income decreased by $1.5 million or 5.9% reflecting lower
year-over-year returns on investments and a decrease in the short-term
investment balance. Cash from the redemption of short-term investments was
primarily used for the Company's repayment of the EIP long-term debt, debt
refinancing, repayment of short-term debt and pension funding.
Other deductions increased $18.5 million primarily due to a charge of
$16.7 million in 2003 for the write-off of transition costs previously
capitalized in anticipation of deregulation in New Mexico and a write-off of
$1.0 million for costs related to long-term debt refunding.
Interest Expense
Interest expense increased $6.2 million or 20.7% primarily due to
increased short-term borrowings and by decreased capitalized interest of $3.9
million due to the completion of the two southern New Mexico gas-fired plants in
2002.
Income Taxes
The Company's consolidated income tax expense before the cumulative
effect of a change in accounting principle was $16.7 million for the six months
ended June 30, 2003, compared to $19.8 million for the six months ended June 30,
2002. The decrease was due to the impact of lower pre-tax earnings. The
56
Company's effective income tax rates for the six months ended June 30, 2003 and
2002 were 36.81% and 35.39%, respectively. The increase in the effective rate
period over period was due to the reduction in permanent tax benefits.
Cumulative Effect of a Change in Accounting Principle
Effective January 1, 2003, the Company adopted SFAS 143. The effect of
the initial application of the new standard is reported as a cumulative effect
of a change in accounting principle. As a result, the Company recorded
additional earnings, net of taxes, of approximately $37.4 million, or $0.95 per
diluted common share, representing amounts expensed in prior years in excess of
legal obligations related to fossil-fuel and nuclear generation plants.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, the Company had cash and short-term investments of $2.6
million compared to $83.3 million in cash and short-term investments at December
31, 2002.
Cash provided by operating activities for the six months ended June 30,
2003 was $61.1 million compared to $60.4 million for the six months ended June
30, 2002. This increase in cash flows was due to lower tax payments. The Company
did not make its first quarter 2001 estimated federal income tax payment of
$32.0 million until January 2002 because of an extension granted by the IRS to
taxpayers in several counties in New Mexico as a result of wildfires in 2000.
This increase in operating cash flows was offset by a decrease in the working
capital change year-over-year resulting from higher wholesale electric prices
and volume and higher gas prices in the current year. The Company's working
capital is negatively affected by the timing difference in gas purchases and
collections. The Company pays for gas in the month following purchase. Recovery
of gas costs can range up to three months. The negative effect to cash flow of
payments and collections increased year-over-year due to the increase in gas
prices. In addition, a large portion of the Company's forward and short-term
wholesale sales is generated later in the second quarter. This accounts for the
increase in accounts receivables. These amounts should be fully collected early
in the third quarter.
Cash used for investing activities was $5.5 million in 2003 compared to
$88.1 million in 2002. Payments for combustion turbines were $11.1 million in
2003 compared to $13.9 million in 2002. In addition, cash used for investing
activities in 2003 included the repurchase of the Company's EIP bonds in the
open market for $6.7 million. Cash used in 2002 for investing activities
includes construction expenditures for new generating plants of $82.6 million.
The cash used for investing activities in 2003 was largely offset by the
redemption of short-term investments of $80.2 million in 2003 at the Holding
Company level as compared to $45.0 million in 2002 at PNM. These redemptions
were primarily used for the Company's repayment of the EIP long-term debt,
repayment of short-term debt, debt refinancing and pension funding.
Cash used for financing activities was $56.7 million in 2003 compared to
cash generated by financing activities of $45.5 million in 2002. Financing
activities in 2003 primarily consisted of the repurchase of long-term debt of
$26.1 million and costs associated with the refunding of long-term debt of $31.4
million. This decrease in cash flows was partially offset by short-term
borrowings of $24.1 million in 2003. Short-term borrowings in 2002 were $65.0
million. Borrowings were greater in 2002 due to short-term liquidity needs.
Pension and Other Post-Retirement Benefits
On May 13, 2003, the board of directors approved the use of Holding
Company stock in the funding of the Company's defined benefit pension plan as
57
well as its retiree medical trust. Corporate plan sponsors may make
contributions of common stock to their defined benefit plans of up to 10% of the
value of the portfolio without Department of Labor approval, provided that the
contribution does not otherwise constitute a prohibited transaction under ERISA.
On June 11, 2003, a contribution of 1,121,495 Holding Company common shares
(approximately $28.9 million in market value) was made to the Company's
retirement plan.
Capital Requirements
Total capital requirements include construction expenditures as well as
other major capital requirements and cash dividend requirements for both common
and preferred stock. The main focus of the Company's current construction
program is upgrading generation systems, upgrading and expanding the electric
and gas transmission and distribution systems and purchasing nuclear fuel. To
preserve a strong financial position, the Company announced in 2002 its plans to
eliminate capital expenditures for previously planned generation expansion until
market conditions warrant further investment. Projections for total capital
requirements for 2003 are $176 million and projections for construction
expenditures for 2003 are $156 million. For 2003-2007 projections, total capital
requirements are $800 million and construction expenditures are $708 million.
These estimates are under continuing review and subject to on-going adjustment.
This projection excludes any generation fleet expansion capital. Such projects
are subject to market opportunities and can not be forecasted to any one time
period. However, the Company continues to look for appropriately priced
generation acquisition and expansion opportunities to support jurisdictional
load growth, the continued expansion of its long-term contract business and to
supplement its natural transmission position in the Southwest and West.
In the six months ended June 30, 2003, the Company utilized cash
generated from operations and cash on hand, as well as its liquidity
arrangements, to cover its construction commitments. The Company anticipates
that internal cash generation and current debt capacity will be sufficient to
meet all of its capital requirements for the years 2003 through 2007. To cover
the difference in the amounts and timing of cash generation and cash
requirements, the Company intends to use short-term borrowings under its current
and future liquidity arrangements.
Liquidity
As of August 1, 2003, PNM had $305 million of liquidity arrangements. The
liquidity arrangements consist of $195 million from an unsecured revolving
credit facility ("Credit Facility"), $90 million from an accounts receivable
securitization program ("AR Securitization") and $20 million in local lines of
credit. PNM entered into a new revolving credit facility on December 19, 2002,
which increased borrowing capacity from $150 million to $195 million. This
facility will mature December 18, 2003. There were $114.8 million in borrowings
against the Credit Facility and PNM was using $64.6 million of the AR
Securitization capacity as of August 1, 2003. In addition, the Holding Company
has $15 million in local lines of credit.
On April 8, 2003, the Company entered into the AR Securitization
providing for the securitization of PNM's retail electric service accounts
receivable and retail gas services accounts receivable. The total capacity under
the AR Securitization is $90 million. Under the AR Securitization, PNM will
periodically sell its accounts receivable to a bankruptcy remote subsidiary, PNM
58
Receivables Corp, which in turn pledges an undivided interest in the receivables
to an unaffiliated conduit commercial paper issuer. This transaction was
previously approved by the PRC on December 17, 2002. As of August 1, 2003, the
Company had borrowed $64.6 million under the AR Securitization.
On April 1, 2003, PNM exercised its early buyout option related to a 60%
interest in the EIP transmission line and related facilities held under lease.
Through the exercise of the early buyout option, PNM was able to retire all
$26.2 million of secured facility bonds, which were issued to originally finance
the sale leaseback transaction which had previously been disclosed as off
balance sheet debt in the notes to the Company's financial statements. The
Company will continue to exclude $4.6 million of lease obligations relating to
the 40% interest the Company does not own from the consolidated balance sheet.
On June 12, 2003, the Holding Company and PNM both filed universal shelf
registration filings with the SEC for a combination of debt and equity
securities for $500 million and $285 million, respectively. The PNM shelf
registration, when combined with a previously filed shelf, provides $500 million
of capacity. The PNM shelf registration was declared effective June 28, 2003.
The Holding Company has not asked the SEC to declare its shelf registration
effective as of the date of this filing.
The Company's ability, if required, to access the capital markets at a
reasonable cost and to provide for other capital needs is largely dependent upon
its ability to earn a fair return on equity, its results of operations, its
credit ratings, obtaining required regulatory approvals and financial and
wholesale market conditions. Financing flexibility is enhanced by providing a
high percentage of total capital requirements from internal sources and having
the ability, if necessary, to issue long-term securities and to obtain
short-term credit.
PNM's credit outlook is considered positive by Moody's Investor Services,
Inc. ("Moody's"), Standard and Poor's Ratings Services ("S&P") and Fitch, Inc.
("Fitch"). The Company is committed to maintaining or improving its investment
grade ratings. On June 13, 2003, S&P improved PNM's business position to a five
(5) from its previous position of six (6). S&P currently rates PNM's senior
unsecured notes ("SUNs") "BBB-" and its preferred stock "BB". Moody's rates
PNM's SUNs and senior unsecured pollution control revenue bonds "Baa3" and its
preferred stock "Ba1". Fitch rates PNM's SUNs and senior unsecured pollution
control revenue bonds "BBB-" and its preferred stock "BB-." Investors are
cautioned that a security rating is not a recommendation to buy, sell or hold
securities, that it is subject to revision or withdrawal at any time by the
assigning rating organization, and that each rating should be evaluated
independently of any other rating.
Contingent Provisions of Certain Obligations
The Holding Company and PNM have a number of debt obligations and other
contractual commitments that contain contingent provisions. Some of these, if
triggered, could affect the liquidity of the Company. The Holding Company or PNM
could be required to provide security, immediately pay outstanding obligations
or be prevented from drawing on unused capacity under certain credit agreements
if the contingent requirements were to be triggered. The most significant
consequences resulting from these contingent requirements are detailed in the
discussion below.
59
PNM's master purchase agreement for the procurement of gas for its retail
customers contains a contingent requirement that could require PNM to provide
security for its gas purchase obligations if the seller were to reasonably
believe that PNM was unable to fulfill its payment obligations under the
agreement.
The master agreement for the sale of electricity in the Western Systems
Power Pool ("WSPP") contains a contingent requirement that could require PNM to
provide security if its debt were to fall below investment grade rating. The
WSPP agreement also contains a contingent requirement, commonly called a
material adverse change ("MAC") provision, which could require PNM to provide
security if a material adverse change in its financial condition or operations
were to occur.
PNM's committed Credit Facility contains a "ratings trigger." If PNM is
downgraded or upgraded by the ratings agencies, the result would be an increase
or decrease in interest cost, respectively. PNM's committed Credit Facility
contains a MAC provision which, if triggered, could prevent PNM from drawing on
its unused capacity under the Credit Facility. In addition, the Credit Facility
contains a contingent requirement that requires PNM to maintain a
debt-to-capital ratio, inclusive of off-balance sheet debt, of less than 65% as
well as maintenance of an earnings before interest, taxes, depreciation and
amortization ("EBITDA")/interest coverage ratio of three times. If PNM's
debt-to-capital ratio, inclusive of off-balance sheet debt, were to exceed 65%
or its interest coverage ratio falls below 3.0, PNM could be required to repay
all borrowings under the Credit Facility, be prevented from drawing on the
unused capacity under the Credit Facility, and be required to provide security
for all outstanding letters of credit issued under the Credit Facility.
If a contingent requirement were to be triggered under the Credit
Facility resulting in an acceleration of the outstanding loans under the Credit
Facility, a cross-default provision in the PVNGS leases could occur if the
accelerated amount is not paid. If a cross-default provision is triggered, the
lessors have the ability to accelerate their rights under the leases, including
acceleration of all future lease payments.
Planned Financing Activities
As of June 30, 2003, PNM had $268.4 million of long-term debt that
matures in August 2005. All other long-term debt of PNM matures in 2016 or
later. On June 30, 2003, PNM filed for approval with the PRC to issue up to $300
million of new long term debt maturing in 2008, 2010, 2013 or some combination
thereof. Proceeds would be used to retire the $268.4 million maturing in August
2005. The Company filed a conditional notice of redemption on the $268.4 million
of long-term debt on July 21, 2003. A hearing on the matter was held July 29,
2003. The PRC approved the issuance of new long-term debt on August 5, 2003.
This communication shall not constitute an offer to sell or the solicitation of
an offer to buy nor shall there be any sale of these securities in any state in
which such offer, solicitation or sale would be unlawful prior to registration
or qualification under the securities laws of any such state.
On May 13, 2003, the Company priced $182 million of tax exempt pollution
control bonds. The bonds were priced at a one-year interest rate of 2.75%. The
bond sale closed on May 23, 2003. The bonds will need to be remarketed at the
end of the one-year interest rate period. A portion of the proceeds were used to
refund the $46 million of pollution control bonds, which became callable on
December 15, 2002. Additionally, the remaining $136 million was placed in an
60
escrow account to be used to refund the same amount of pollution control bonds.
The redemption notice for the remaining $136 million of pollution control bonds
was issued and the bonds have been called for redemption on August 15, 2003.
Both of these issuances were previously hedged (see Note 3 - Fair Value of
Financial Instruments - Forward Starting Interest Rate Swaps).
By the end of August 2003, the Company plans to enter into an unrated
private issuance commercial paper program. The Company will periodically issue
up to $50 million in unrated commercial paper for up to 120 day periods. The
commercial paper is unsecured and the proceeds will be used to reduce revolving
credit borrowings. Borrowings under the plan are expected to bear interest at a
rate 20 to 40 basis points below the Company's revolving credit facility.
The Company could enter into other long-term financings for the purpose
of strengthening its balance sheet, funding growth and reducing its cost of
capital. The Company continues to evaluate its investment and debt retirement
options to optimize its financing strategy and earnings potential. No additional
first mortgage bonds may be issued under PNM's mortgage. The amount of SUNs that
may be issued is not limited by the SUNs indenture. However, debt-to-capital
requirements in certain of PNM's financial instruments and regulatory agreements
would ultimately limit the amount of additional debt PNM would issue.
Capital Structure
The Company's capitalization, including current maturities of long-term
debt, at June 30, 2003 and December 31, 2002 is shown below:
June 30, December 31,
2003 2002
------------------ -----------------
Common Equity................. 52.5% 49.5%
Preferred Stock............... 0.6 0.7
Long-term Debt................ 46.9 49.8
------------------ -----------------
Total Capitalization*...... 100.0% 100.0%
================== =================
* Total capitalization does not include as debt the present value of
PNM's operating lease obligations for PVNGS Units 1 and 2, EIP and
the Delta operating lease which was $181 million as of June 30, 2003
and $196 million as of December 31, 2002.
OTHER ISSUES FACING THE COMPANY
RESTRUCTURING THE ELECTRIC UTILITY INDUSTRY
State
In April 1999, the Restructuring Act was enacted into law. The
Restructuring Act would have opened the state's electric power market to
customer choice. On October 10, 2002, PNM announced that it had agreed with the
PRC Staff, the AG, and other consumer groups on a Global Electric Agreement that
provided for joint support to repeal a majority of the Restructuring Act a
five-year rate path, procedures for the Company's participation in wholesale
61
plant activities and other regulatory issues. The Global Electric Agreement was
approved by the PRC on January 28, 2003. Legislation repealing the Restructuring
Act and continuing the authorization for utilities to participate in wholesale
plant activities for a limited time was passed by the New Mexico Legislature and
signed into law by the Governor on April 8, 2003. In the Global Electric
Agreement, PNM agreed to forego recovery of the costs incurred in preparing to
transition to a competitive retail market in New Mexico under the repealed law.
This resulted in a charge of $16.7 million, pre-tax, in the first quarter of
2003. As a result of the repeal of the Restructuring Act, PNM has re-applied the
accounting requirements of SFAS 71 to its regulated generation activities
effective January 28, 2003, which did not have a material effect on the
Company's financial condition or results of operations.
GAS RATE CASE
On January 10, 2003, PNM filed a general gas rate case, which asked the
PRC to approve an increase in the service fees charged to its 441,000
natural-gas customers. The proposal would have increased both the set monthly
service fee and the charge tied to monthly usage. Those fees are separate from
the cost of gas charged to customers. The monthly cost of gas charge would not
be affected by the fee increase as discussed below. The cost of service rate
increase proposed by PNM was $37.6 million, and was designed to provide PNM's
gas utility an opportunity to earn a 12% return on equity. PNM's current return
on equity from its gas business is below 3%.
On June 25, 2003, PNM, the PRC Staff, and a group of industrial consumers
filed a settlement, which would allow the Company a $20 million annual revenue
increase in base cost of service rates, a $1.6 million annual increase in
miscellaneous fees and charges and the recovery of $4.4 million in previously
approved costs. The settlement rates are proposed to go into effect for bills
rendered in November 2003. The settlement rates would provide PNM's gas utility
with an opportunity to earn 10.25% return on equity. The settlement is opposed
only by the United States Executive Agencies. A hearing was held and concluded
in July 2003. An order is not expected until September 2003.
WATER SUPPLY
There is a growing concern in New Mexico about the use of water for power
plants, due to the state's arid climate and current drought conditions. The
availability of sufficient water supplies to meet all the needs of the state,
including growth, is a major issue. An interim committee of the legislature
refused to support legislation mandating the use of dry cooling technology.
Legislation requiring a water conservation plan as part of an application for
siting generation plants of a certain size was considered, but defeated, in the
2003 session. In building the Afton and Lordsburg plants, the Company has
secured sufficient water rights.
The Four Corners region, in which SJGS and Four Corners are located, has
been experiencing drought conditions that may affect the water supply for the
plants in 2003, as well as later years, if adequate moisture is not received in
the watershed that supplies the area. United States Bureau of Reclamation
("USBR") is working to assess the adequacy of the water supply under PNM's USBR
contract for 16,200 acre feet ("A.F.") per year of water that supplies SJGS.
Additionally, various stakeholders in the San Juan Basin, including the New
Mexico State Engineer, are evaluating what water rights might be affected by the
drought conditions, including water rights pursuant to the New Mexico state
permit that provide 8,000 A.F. per year of water to SJGS and approximately
62
28,000 A.F. per year of water for Four Corners. In April 2003, a supplemental
water supply contract was negotiated between PNM and the Jicarilla Apache Nation
for 8,300 A.F. per year to assist SJGS in meeting its water requirement even if
there is a water shortage. USBR has approved a supplemental contract for 8,300
A.F. per year for a one-year term and environmental approvals have been
obtained. PNM has also negotiated and signed a voluntary shortage sharing
agreement with tribes and other water users in the San Juan Basin for a one-year
term. Additionally, PNM does not believe that its operations will be materially
affected at this time. However, PNM cannot forecast the weather situation and
its ramifications with any degree of certainty or how regulators and legislators
may impact PNM's situation in the future, should the drought continue.
WESTERN UNITED STATES WHOLESALE POWER MARKET
Various circumstances, including electric power supply shortages, weather
conditions, gas supply costs, transmission constraints, and alleged market
manipulation by certain sellers, resulted in the well-publicized "California
energy crisis" and in the bankruptcy filings of the California Power Exchange
("Cal PX") and of Pacific Gas and Electric Company ("PG&E"), although the
turmoil in the Western markets was not limited to California. However, since the
third quarter of 2001, conditions in the Western wholesale power market have
changed substantially as the result of regulatory actions, moderate weather
conditions, conservation measures, the construction of additional generation and
a decline in natural gas prices relative to levels reached during the California
energy crisis, as well as the lingering slowdown in the regional economy.
As a result of the foregoing conditions in the Western market, the FERC
and other federal and state governmental authorities are conducting
investigations and other proceedings relevant to the Company and other sellers.
The more significant of these in relation to the Company are summarized below.
California Refund Proceeding
By order dated June 19, 2001, in response to a complaint filed by San
Diego Gas and Electric Company ("SDG&E") and other California buyers against
sellers into the California wholesale electric market, the FERC directed one of
its administrative law judges ("ALJ") to convene a settlement conference to
address potential refunds owed by sellers into the California market. The
settlement conference, in which PNM participated, was ultimately unsuccessful,
and the ALJ recommended to the FERC that an evidentiary hearing be held to
resolve the dispute, suggesting that refunds were due; however, the estimated
refunds were significantly lower than those demanded by California, and in most
instances, were offset by the amounts due suppliers from the Cal PX and the
California Independent System Operator ("Cal ISO"). The California parties had
demanded refunds of approximately $9 billion from power suppliers. Hearings on
the refunds were held in September 2002, and the ALJ issued his Proposed
Findings on California Refund Liability on December 12, 2002, in which he
determined that the Cal ISO had, for the most part, calculated the amounts of
the refunds correctly. In his appendix identifying the amounts of the refunds,
he identified what he termed "ballpark" figures for the amount of refunds due
under his order. PNM was identified as having a refund liability of
approximately $4.3 million, while being owed approximately $7 million from the
Cal ISO. Pursuant to the FERC's order, PNM filed, in conjunction with the
competitive supplier group, initial comments on January 13, 2003 to the ALJ's
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preliminary findings addressing errors the Company believes the ALJ made in his
proposed findings and reply comments on February 3, 2003. On March 26, 2003, the
FERC issued an order largely adopting the ALJ's findings, but requiring a change
to the formula used to calculate refunds, based upon concerns that the indices
for California gas prices, a major element in the formula, had been subject to
potential manipulation and were unverifiable. The effect of this change which is
not yet final, would be to increase the Company's refund liability, although the
precise amount will not be known with certainty until the Cal ISO and Cal PX
recalculate refund amounts after the FERC has acted upon requests for rehearing
that have been filed by the parties.
In addition, prior to the December 12, 2002 ALJ decision, the Ninth
Circuit Court of Appeals ordered the FERC to allow the parties in the case to
provide additional evidence in the case concerning allegations of market
manipulation by sellers. Several California parties submitted additional
evidence on March 3, 2003, which they argue supports their position that
virtually all market participants either engaged in specific market manipulation
strategies or facilitated such strategies, including PNM. PNM maintains that it
did not engage in improper wholesale activities, and filed reply evidence on
March 20, 2003 denying the allegations against it. PNM cannot predict what
effect the FERC's review of this additional evidence will have on its rulings in
the refund proceeding or the determination of specific refund amounts. The
Company is unable to predict the ultimate outcome of this FERC proceeding, or
whether PNM will be directed to make any refunds as the result of a FERC order.
Pacific Northwest Refund Proceeding
In addition to the California refund proceedings, Puget Sound Energy,
Inc. ("Puget Sound") filed a complaint at the FERC alleging that spot market
prices in the Pacific Northwest wholesale electric market were unjust and
unreasonable. On September 24, 2001, the ALJ issued a recommended decision and
declined to order refunds associated with wholesale electric sales in the
Pacific Northwest. On June 25, 2003, the FERC issued an order terminating the
proceeding and adopting the ALJ's recommendation that no refunds should be
ordered. The Commission's order is subject to potential requests for rehearing,
and therefore is not yet final. The Company is unable to predict the ultimate
outcome of this FERC proceeding, or whether PNM will be directed to make any
refunds as the result of an order by the FERC.
FERC Investigation of "Enron-Like" Trading Practices
The FERC has also initiated a market manipulation investigation,
partially in response to the bankruptcy filing of the Enron Corporation
("Enron") and to allegations that Enron may have engaged in manipulation of
portions of the Western wholesale power market. In connection with that
investigation, all FERC jurisdictional and non-jurisdictional sellers into
Western electric and gas markets have been required to submit data regarding
short-term transactions in 2000-2001. PNM made its data submission in April
2002. Subsequently, in May 2002, new Enron documents came to light that raised
additional concerns about Enron's trading practices. In light of these new
revelations, the FERC issued additional orders in the pending investigation
requiring sellers to respond to detailed questions by admitting or denying that
they had engaged in trading practices similar to those practiced by Enron and
certain other sellers, including so-called "wash" transactions. The FERC issued
supplemental requests for data submissions. In its responses to the FERC
requests, PNM denied that it had engaged in improper activities such as those
identified in Enron's documents and also denied engaging in "wash" transactions.
64
PNM admitted engaging in certain activities described in the memos that were not
improper. Where appropriate, PNM's responses addressed any arguable similarities
between any of its wholesale activities and those under investigation by the
FERC. In August 2002, the FERC staff issued a preliminary report on its
findings, recommending that the FERC initiate formal investigative proceedings
directed at three companies and the FERC has done so. The Company was not among
the companies named. On March 26, 2003, the FERC staff issued its final report,
which addressed various types of conduct that the FERC staff believes may have
violated market monitoring protocols in the Cal ISO and Cal PX tariffs. Based on
the final report, the FERC has issued orders to certain companies, including
Enron, requiring them to show cause why the FERC should not revoke their
authorizations to sell electricity at market-based rates. In addition, the FERC
staff recommended that the FERC issue orders requiring certain entities to show
cause why they should not be required to disgorge profits associated with
conduct deemed to violate the Cal ISO and Cal PX tariffs, or be subject to other
remedial action. The FERC Staff also recommended that PNM and other entities be
required to show cause why they should not disgorge profits related to business
dealings with Enron and Enron's employment of certain trading strategies deemed
to be manipulative.
FERC Show Cause Orders
On June 25, 2003, the FERC issued two separate show cause orders against
PNM and numerous other entities. In the first (the "Gaming Practices Order"),
the FERC asserts that certain entities, including PNM, appear to have
participated in activities that constitute gaming and/or anomalous market
behavior in violation of the Cal ISO and Cal PX tariffs during the period
January 1, 2000 to June 20, 2001. Specifically, PNM is alleged to have engaged
in a practice denominated "False Import," in which power was exported from
California and then reimported into California in order to avoid price caps on
in-California generation. These allegations are based primarily on a Cal ISO
report, the basis for which has not yet been fully disclosed. Entities subject
to the Gaming Practices Order will have an opportunity to respond to the
allegations contained in the order in a trial-type evidentiary proceeding before
an ALJ, and to show cause why they should not be found to have engaged in Gaming
Practices in violation of the Cal ISO and Cal PX tariffs. The potential remedies
include disgorgement of unjust profits, as well as non-monetary remedies such as
revocation of a seller's market-based rate authority. For PNM, the potential
disgorgement for alleged "False Import" transactions covers the period May 1,
2000 to October 1, 2000. PNM has not yet had an opportunity to respond to the
allegations contained in the Gaming Practices Order, but believes that it has
not engaged in improper conduct and intends to defend itself vigorously against
these allegations.
In the second show cause order (the "Gaming Partnerships Order"), the
FERC asserts that certain entities, including PNM, acted in concert with Enron
and other market participants to engage in activities that constitute gaming
and/or anomalous market behavior in violation of the Cal ISO and Cal PX tariffs
during the period January 1, 2000 to June 20, 2001. Specifically, PNM is alleged
to have entered into "partnerships, alliances or other arrangements" with
several entities that allegedly may have been used as market manipulation
schemes. These entities include Aquila, Inc., Constellation Power Source, Inc.,
El Paso Merchant Energy, L.P., Idaho Power Company, Koch Energy Trading, Inc.,
MIECO Inc., Morgan Stanley Capital Group, PECO Energy Company, PacifiCorp,
Powerex, Sempra Energy Trading Corporation, TransAlta Energy Marketing (U.S.)
65
Inc. and TransAlta Energy Marketing (California) Inc. The precise basis for
certain of the FERC's allegations is not clear from the Gaming Partnerships
Order, although it appears that most arise out of PNM's provision of "parking
and lending" services to the identified companies. Entities subject to the
Gaming Partnerships Order will have an opportunity to respond to the allegations
contained in the order in a trial-type evidentiary proceeding before an ALJ, and
to show cause why they should not be found to have engaged in Gaming Practices
in violation of the Cal ISO and Cal PX tariffs. The potential remedies include
disgorgement of unjust profits, as well as non-monetary remedies such as
revocation of a seller's market-based rate authority. PNM has not yet had an
opportunity to respond to the allegations contained in the Gaming Partnerships
Order, but believes that it has not engaged in improper conduct and intends to
defend itself vigorously against these allegations. The Company cannot predict
the outcome of these proceedings.
Investigation of Anomalous Bidding Behavior and Practices in the Western Markets
On June 25, 2003, the FERC issued an order finding that certain bids into
the Cal ISO and Cal PX markets during the period May 1 through October 1, 2000
appear to have been excessive, in violation of the prohibitions against
anomalous market behavior in the market monitoring protocols of the Cal ISO and
Cal PX tariffs. The order directed the FERC's Office of Market Oversight and
Investigation ("OMOI") to conduct a further investigation into bids in excess of
$250 per MW during that period. On July 2, 2003, PNM received a data request
from OMOI to all sellers into the Cal ISO and Cal PX markets that submitted bids
in excess of $250 per MW to the Cal ISO and Cal PX during the period covered by
the investigation. On July 24, 2003, PNM submitted its response to OMOI's data
request, in which PNM provided justification of its bidding strategies during
that period. On July 25, 2003, PNM joined with other sellers in filing a request
for rehearing of the June 25, 2003 order, challenging the determination made by
FERC that it is appropriate to treat bids above $250 per MW into the Cal ISO and
Cal PX markets during the period May 1 through October 1, 2000 to be prima facie
excessive or in violation of the Cal ISO and Cal PX tariffs.
California Power Exchange and Pacific Gas and Electric Bankruptcies
In January and February 2001, SCE and PG&E, major purchasers of power
from the Cal PX and Cal ISO, defaulted on payments due to Cal PX for power
purchased from the Cal PX in 2000. These defaults caused the Cal PX to seek
bankruptcy protection. PG&E subsequently also sought bankruptcy protection. PNM
has filed its proofs of claims in the Cal PX and PG&E bankruptcy proceedings.
Amounts due PNM from the Cal PX or Cal ISO for power sold to them in 2000 and
2001 total approximately $7 million. The Company has provided allowances for the
total amount due from the Cal PX and Cal ISO.
California Attorney General Complaint
In March 2002, the California Attorney General filed a complaint with the
FERC against numerous sellers regarding prices for wholesale electric sales into
the Cal ISO and Cal PX and to the California Department of Water Resources ("Cal
DWR"). PNM was among the sellers identified in this complaint and filed its
answer and motion to intervene. In its answer, PNM defended its pricing and
challenged the theory of liability underlying the California Attorney General's
complaint. On May 31, 2002, the FERC entered an order denying the California
Attorney General's request to initiate a refund proceeding, but directed
sellers, including PNM, to comply with additional reporting requirements with
66
regard to certain wholesale power transactions. PNM has made filings required by
the May 31, 2002 order. The California Attorney General filed a request for
rehearing contesting the FERC decision. On September 23, 2002, the FERC issued
its order denying the California Attorney General's request for rehearing. The
California Attorney General has filed a petition for review in the United States
Court of Appeals for the Ninth Circuit. PNM has intervened in the Ninth Circuit
appeal and is participating as a party in that proceeding. The Company cannot
predict the outcome of this appeal. As addressed below, the California Attorney
General has also threatened litigation against PNM in state court in California
based on similar allegations.
California Attorney General Threatened Litigation
The California Attorney General has filed several lawsuits in California
state court against certain power marketers for alleged unfair trade practices
involving alleged overcharges for electricity. In April 2002, the California
Attorney General notified PNM of his intention to file a complaint in California
state court against PNM concerning PNM's alleged failure to file rates for
wholesale electricity sold in California and for allegedly charging unjust and
unreasonable rates in the California markets. The letter invited PNM to contact
the California Attorney General's office before the complaint was filed, and PNM
has met several times with representatives of the California Attorney General's
office. Further discussions are contemplated. To date, a lawsuit has not been
filed by the California Attorney General and the Company cannot predict the
outcome of this matter.
California Antitrust Litigation
Several class action lawsuits have been filed in California state courts
against electric generators and marketers, alleging that the defendants violated
the law by manipulating the market to grossly inflate electricity prices. Named
defendants in these lawsuits include Duke Energy Corporation ("Duke") and
related entities along with other named sellers into the California market and
numerous other "unidentified defendants." Certain of these lawsuits were
consolidated for hearing in state court in San Diego. In May 2002, the Duke
defendants in the foregoing state court litigation served a cross-claim on PNM.
Duke also cross-claimed against many of the other sellers into California. Duke
asked for declaratory relief and for indemnification for any damages that might
ultimately be imposed on Duke. Several defendants removed the case to federal
court. The federal judge has entered an order remanding the matter to state
court, but the effect of that ruling has been stayed pending appeal. PNM has
joined with other cross-defendants in motions to dismiss the cross-claim. The
Company believes it has meritorious defenses but cannot predict the outcome of
this matter.
Block Forward Agreement Litigation
On February 1, 2002, PNM was served with a declaratory relief complaint
filed by the State of California in California state court. The state's
declaratory relief complaint seeks a determination that the state is not liable
for its commandeering of certain energy contracts known as "Block Forward
Agreements". The Block Forward Agreements were a form of futures contracts for
the purchase of electricity at below-market prices and served as security for
payment by PG&E and SCE for their electricity purchases through the Cal PX. When
PG&E and SCE defaulted on payment obligations incurred through the Cal PX, the
Cal PX moved to liquidate the Block Forward Agreements to satisfy in part the
obligations owed by PG&E and SCE. Before the Cal PX could liquidate the Block
67
Forward Agreements, California commandeered them for its own purposes. In March
2001, PNM and other similarly situated sellers of electricity through the Cal PX
filed claims for damages with the California state Victims Compensation and
Government Claims Board ("Victims Claims Board") on the theory that the state,
by commandeering the Block Forward Agreements, had deprived them of security to
which they were entitled under the terms of the Cal PX's tariff. The Victims
Claims Board filing was an administrative remedy that served as a mandatory
prerequisite to filing suit against the state for recovery of damages related to
the commandeering of the Block Forward Agreements. The Victims Claims Board
denied PNM `s claim on March 22, 2002. PNM filed a complaint against the State
of California in California state court on September 20, 2002 seeking damages
for the state's commandeering of the Block Forward Agreements and requesting
judicial coordination with the state's declaratory relief action filed in
February 2002 on the basis that the two actions raise essentially the same
issues. The California state court has stayed the proceedings through July 2003
pending resolution of certain related issues before the FERC, but recently
lifted the stay to address procedural matters in light of the delay in rulings
from the FERC on the related issues.
NEW SOURCE REVIEW RULES
In November 1999, the Department of Justice at the request of the
Environmental Protection Agency ("EPA") filed complaints against seven companies
alleging the companies over the past 25 years had made modifications to their
plants in violation of the New Source Review ("NSR") requirements and in some
cases the New Source Performance Standard ("NSPS") regulations, which could
result in the requirement to make costly environmental additions to older power
plants. Whether or not the EPA will ultimately prevail is uncertain at this
time. The EPA has reached settlements with several of the companies sued by the
Justice Department. In addition, on August 7, 2003, in one of the pending
enforcement cases against Ohio Edison Company, a federal district judge in Ohio
ruled in favor of the EPA and against Ohio Edison. The judge accepted the legal
theories advanced by the government and in particular found that eleven
construction projects undertaken by the utility in that case between 1984 and
1998 were "modifications" of the plants within the meaning of the Clean Air Act,
not "routine maintenance, repair or replacement." That case now proceeds to a
remedy phase.
No complaint has been filed against PNM by the EPA, and the Company
believes that all of the routine maintenance, repair, and replacement work
undertaken at its power plants was and continues to be in accordance with the
requirements of NSR and NSPS. However, by letter dated October 23, 2000, the New
Mexico Environmental Department ("NMED") made an information request of PNM,
advising PNM that the NMED was in the process of assisting the EPA in the EPA's
nationwide effort "of verifying that changes made at the country's utilities
have not inadvertently triggered a modification under the Clean Air Act's
Prevention of Significant Determination ("PSD") policies." PNM has responded to
the NMED information request. In late June 2002, PNM received another
information request from the NMED for a list of capital projects budgeted or
completed in 2001 or 2002. PNM has responded to this additional NMED information
request.
The National Energy Policy released in May 2001 by the National Energy
Policy Development Group called for a review of the pending EPA enforcement
actions. As a result of that review, on June 14, 2002, the EPA announced its
intention to pursue steps to increase energy efficiency, encourage emissions
reductions and make improvements and reforms to the NSR program. The EPA
68
announced that, among other things, the NSR program had impeded or resulted in
the cancellation of projects that would maintain or improve reliability,
efficiency and safety of existing power plants. The EPA's June 2002 announcement
contemplated further rulemakings on NSR-related issues and expressly cautioned
that the announcement was not intended to affect pending NSR enforcement
actions. Thereafter, on December 31, 2002, the EPA promulgated certain
long-awaited revisions to the NSR rules, along with proposals to revise the
routine maintenance, repair and replacement exclusion contained in the
regulations. There is no specific timetable for these revisions and the ultimate
resolution of NSR-related issues raised by the enforcement actions remains
unclear. If the EPA prevails in the position advanced in the pending litigation,
the Company may be required to make significant capital expenditures, which
could have a material adverse effect on the Company's financial position and
results of operations.
Citizen Suit Under the Clean Air Act
By letter dated January 9, 2002, counsel for the Grand Canyon Trust and
Sierra Club (collectively, "GCT") notified PNM of GCT's intent to file a
so-called "citizen suit" under the Clean Air Act, alleging that PNM and
co-owners of the SJGS violated the Clean Air Act, and the implemention of
federal and state regulations, at SJGS. Pursuant to that notification, on May
16, 2002, the GCT filed suit in federal district court in New Mexico against PNM
(but not against the other SJGS co-owners). The suit alleges two violations of
the Clean Air Act and related regulations and permits. First, GCT argues that
the plant has violated, and is currently in violation of, the federal Prevention
of Significant Deterioration ("PSD") rules, as well as the corresponding
provisions of the New Mexico Administrative Code, at SJGS Units 3 and 4. Second,
GCT alleges that the plant has "regularly violated" the 20% opacity limit
contained in SJGS's operating permit and set forth in federal and state
regulations at Units 1, 3 and 4. The lawsuit seeks penalties as well as
injunctive and declaratory relief. PNM filed its answer in federal court on June
6, 2002, denying the material allegations in the complaint. Both sides in the
litigation filed motions for partial summary judgment and on May 9, 2003 the
court held a hearing on all pending motions. At the conclusion of the hearing,
the court denied the summary judgment motions relating to the opacity claims,
meaning that the opacity issues will go to trial on the merits. The court took
under advisement the summary judgment motions relating to the PSD issues, but
indicated that a ruling on those issues would be forthcoming prior to trial. A
trial date has been established in early September 2003. Based on its
investigation to date, the Company firmly believes that the allegations are
without merit and PNM vigorously disputes the allegations. PNM has always
adhered to and continues to adhere to high environmental standards as evidenced
by its ISO 14000 certification. The Company is, however, unable to predict the
ultimate outcome of the matter.
LANDOWNER ENVIRONMENTAL CLAIMS
In March 2002, a lawsuit was filed in New Mexico state court by a
landowner owning property in the vicinity of SJGS, against PNM and San Juan Coal
Company ("SJCC"). The complaint sought $20 million in damages, plus pre-judgment
interest and punitive damages, based on allegations related to the alleged
discharge of pollutants into an arroyo near the plant, including damage to the
plaintiff's livestock. PNM denied the allegations of wrongdoing. After the court
entered an order compelling the plaintiff to answer PNM's discovery requests,
the plaintiff filed a motion to dismiss his lawsuit without prejudice. The court
has entered an order dismissing the complaint without prejudice and conditioning
69
any attempt by the plaintiff to refile the litigation on the plaintiff's
compliance with the PNM discovery requests.
ARCHEOLOGICAL SITE DISTURBANCE
The Company hired a contractor, Great Southwestern Construction, Inc.
("Great Southwestern"), to conduct certain "climb and tighten" activities on a
number of electric transmission lines in New Mexico between July 2001 and
December 2001. Those lines traverse a mix of federal, state, tribal and private
properties in New Mexico. In late May 2002, the U.S. Forest Service ("USFS")
notified PNM that apparent disturbances to archeological sites had been
discovered in and around the rights-of-way for PNM's transmission lines in the
Carson National Forest in New Mexico. Great Southwestern performed "climb and
tighten" activities on those transmission lines. PNM has confirmed the existence
of the disturbances, as well as disturbances associated with certain arroyos
that may raise issues under section 404 of the Clean Water Act. PNM has given
the Corps of Engineers notice concerning the disturbances in arroyos. The Corps
of Engineers has acknowledged the Company's notice and asked PNM to cooperate in
addressing these disturbances. The USFS verbally instructed PNM to undertake an
assessment and possible related mitigation measures with respect to the
archeological sites in question. PNM contracted for an archeological assessment
and a proposed remediation plan with respect to the disturbances and has
provided the assessment to the USFS and the federal Bureau of Land Management
("BLM"). The Santa Fe Forest issued a notice of non-compliance to PNM for
alleged non-compliance with the terms and conditions of PNM's special use
authorization relating to maintenance of PNM's power lines on USFS land. The
Santa Fe Forest also issued PNM a bill for collection in the amount of
$38,047.45 to be escrowed to cover the costs of USFS oversight of any required
damage assessment and mitigation efforts. PNM has provided Great Southwestern
with notice and a demand for indemnity. Zurich Insurance, the insurer for Great
Southwestern, has denied coverage and indemnity to PNM for this claim but has
indicated a willingness to share the cost of investigation of this claim. A
subsequent preliminary investigation into other transmission lines that were
covered by the "climb and tighten" project indicated that there are disturbances
on lands governed by other federal agencies and Indian tribes. PNM and Great
Southwestern have provided notice of the potential disturbances to these other
agencies and tribes. The Company had been informed that the USFS and BLM had
commenced a criminal investigation into Great Southwestern's activities on this
project. However, the Company received verbal confirmation that the USFS and the
BLM have decided to decline criminal prosecution under the Archeological
Resources Act against Southwestern. The State of New Mexico requested
information from PNM concerning the location of potential disturbances on state
lands. The Navajo Nation has also requested further information concerning
disturbances on Navajo land. PNM and Great Southwestern are seeking the consent
of BLM and the USFS to address impacted drainages under these agencies
jurisdiction. The Company is unable to predict the outcome of this matter and
cannot estimate with any certainty the potential impact on the Company's
operations.
PNM LABOR UNION NEGOTIATIONS
PNM and the International Brotherhood of Electrical Workers ("IBEW")
Local Union 611 successfully completed negotiations for a successor collective
bargaining agreement during June 2003. The new agreement, which covers the
approximately 580 bargaining unit employees in Electric, took effect July 5,
2003 and will expire on April 30, 2005.
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NEW AND PROPOSED ACCOUNTING STANDARDS
See Note 8 - New and Proposed Accounting Standards in the Notes to
Consolidated Financial Statements.
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Statements made in this filing that relate to future events or the
Company's expectations, projections estimates, intentions, goals, targets and
strategies are made pursuant to the Private Securities Litigation Reform Act of
1995. Readers are cautioned that all forward-looking statements are based upon
current expectations and are subject to risk and uncertainties. The Company
assumes no obligation to update this information.
Because actual results may differ materially from expectations, the
Company cautions readers not to place undue reliance on these statements. Future
financial results will be affected by a number of factors, including interest
rates, weather, fuel costs, changes in supply and demand in the market for
electric power, wholesale power prices, market liquidity, the competitive
environment in the electric and natural gas industries, the performance of
generating units and transmission system, state and federal regulatory and
legislative decisions and actions, the outcome of legal proceedings and the
performance of state, regional and national economies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company uses derivative financial instruments to manage risk as it
relates to changes in natural gas and electric prices, changes in interest rates
and, historically, adverse market changes for investments held by the Company's
various trusts. Additionally, the Company uses derivative instruments based on
certain financial composite indices as part of its enhanced cash management
program. The Company also uses certain derivative instruments for wholesale
power marketing transactions in order to take advantage of favorable price
movements and market timing activities in the wholesale power markets. The
following additional information is provided.
Risk Management
The Company controls the scope of its various forms of risk through a
comprehensive set of policies and procedures and oversight by senior level
management and the Holding Company Board of Directors. The Board's Finance
Committee sets the risk limit parameters. The Risk Management Committee ("RMC"),
comprised of corporate and business segment officers and other managers,
oversees all of the activities, which include commodity price, credit, equity,
interest rate and business risks. The RMC has oversight for the ongoing
evaluation of the adequacy of the risk control organization and policies. The
Company has a risk control organization, headed by the Director of Financial
Risk Management ("Risk Manager"), which is assigned responsibility for
establishing and enforcing the policies, procedures and limits and evaluating
the risks inherent in proposed transactions, on an enterprise-wide basis.
The RMC's responsibilities specifically include: establishment of a
general policy regarding risk exposure levels and activities in each of the
business segments; recommendation of the types of instruments permitted;
71
authority to establish a general policy regarding counterparty exposure and
limits; authorization and delegation of transaction limits; review and approval
of controls and procedures; review and approval of models and assumptions used
to calculate mark-to-market and risk exposure; authority to approve and open
brokerage and counterparty accounts; review of hedging and risk activities; and
quarterly reporting to the Finance Committee and the Board of Directors on these
activities.
The RMC also proposes Value at Risk ("VAR") limits to the Finance
Committee. The Finance Committee ultimately sets the aggregate VAR limits.
It is the responsibility of each business segment to create its own
control procedures and policies within the parameters established by the Finance
Committee. The RMC reviews and approves these policies, which are created with
the assistance of the Chief Accounting Officer, Director of Internal Audit and
the Risk Manager. Each business segment's policies address the following
controls: authorized risk exposure limits; authorized instruments and markets;
authorized personnel; policies on segregation of duties; policies on
mark-to-market accounting; responsibilities for deal capture; confirmation
procedures; responsibilities for reporting results; statement on the role of
derivative transactions; and limits on individual transaction size (nominal
value).
To the extent an open position exists, fluctuating commodity prices can
impact financial results and financial position, either favorably or
unfavorably. As a result, the Company cannot predict with precision the impact
that its risk management decisions may have on its businesses, operating results
or financial position.
Commodity Risk
Marketing and procurement of energy often involves market risks
associated with managing energy commodities and establishing open positions in
the energy markets, primarily on a short-term basis. These risks fall into three
different categories: price and volume volatility, credit risk of counterparties
and adequacy of the control environment. PNM routinely enters into forward
contracts and options to hedge purchase and sale commitments, fuel requirements
and to enhance returns and minimize the risk of market fluctuations on the
Wholesale Operations.
The Company's Wholesale Operations, including long-term contracts,
forward sales and short-term sales, are managed through an asset-backed
marketing strategy, whereby PNM's aggregate net open forward contract position
is covered by its forecasted excess generation capabilities. PNM is exposed to
market risk if its generation capabilities were disrupted or if its retail load
requirements were greater than anticipated. If PNM were required to cover all or
a portion of its net open contract position, it would have to meet its
commitments through market purchases.
Under the derivative accounting rules and the related accounting rules
for energy contracts, the Company accounts for its various financial derivative
instruments for the purchase and sale of energy differently based on
management's intent when entering into the contract. Energy contracts which meet
the definition of a derivative under SFAS 133 and do not qualify for a normal
purchase or sale designation are recorded on the balance sheet at fair market
value at each period end. The changes in fair market value are recognized in
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earnings unless specific hedge accounting criteria are met. Should an energy
transaction qualify as a hedge under SFAS 133, fair market value changes from
year to year are recognized on the balance sheet with a corresponding charge to
other comprehensive income. Gains or losses are recognized when the hedged
transaction settles. Derivatives that meet the normal sales and purchases
exceptions within SFAS 133 are not marked to market but rather recorded in
results of operations when the underlying transaction settles.
The following table shows the net fair value of mark-to-market energy
contracts included in the balance sheet:
June 30, December 31,
2003 2002
--------------- ------------------
(In thousands)
Mark-to-Market Energy Contracts:
Current asset..................................... $16,079 $ 4,531
Long-term asset................................... 1,839 267
------------- -------------
Total mark-to-market assets.................. 17,918 4,798
------------- -------------
Current liability................................. (13,755) (5,725)
Long-term liability............................... (923) -
------------- -------------
Total mark-to-market liabilities............. (14,678) (5,725)
------------- -------------
Net fair value of mark-to-market energy contracts... $ 3,240 $ (927)
============= =============
The mark-to-market energy portfolio positions represent net assets at
June 30, 2003 and represent net liabilities at December 31, 2002 after netting
all open purchase and sale contracts.
The market prices used to value PNM's mark-to-market energy portfolio are
based on closing exchange prices and broker quotations. As of June 30, 2003 and
December 31, 2002, PNM did not have any outstanding contracts that were valued
using methods other than quoted prices. The Company did not change its methods
for valuing its mark-to-market energy portfolio in 2003 as compared to 2002.
The following table provides detail of changes in the Company's
mark-to-market energy portfolio net asset or liability balance sheet position
from one period to the next:
Six Months Ended
June 30,
2003 2002
--------------- -------------
(In thousands)
Sources of Fair Value Gain/(Loss)
Fair value at beginning of year.............. $ (927) $(30,440)
Amount realized on contracts delivered
during period............................. 299 5,609
Changes in fair value........................ 3,868 10,522
--------------- -------------
Net fair value at end of period.............. $ 3,240 $(14,309)
=============== =============
Net change recorded as mark-to-market........ $ 4,167 $ 16,131
=============== =============
73
The following table provides the maturity of the net assets/(liabilities)
of the Company, giving an indication of when these mark-to-market amounts will
settle and generate/(use) cash. The following values were determined using
broker quotes:
Fair Value at June 30, 2003
Maturities
---------------------------------------------------------
Less than
1 year 1-3 Years Total
------------------- --------------- -----------------
(In thousands)
$2,324 $ 916 $3,240
As of June 30, 2003, a decrease in market pricing of PNM's mark-to-market
energy portfolio by 10% would have resulted in a decrease in net earnings of
less than 1%. Conversely, an increase in market pricing of this portfolio by 10%
would have resulted in an increase in net earnings of less than 1%.
The Company assesses the risk of these long-term contracts and wholesale
sales activities using the VAR method to maintain the Company's total exposure
within management-prescribed limits. The Company utilizes the
variance/covariance model of VAR, which is a probabilistic model that measures
the risk of loss to earnings in market sensitive instruments. The
variance/covariance model relies on statistical relationships to analyze how
changes in different markets can affect a portfolio of instruments with
different characteristics and market exposure. VAR models are relatively
sophisticated; however, the quantitative risk information is limited by the
parameters established in creating the model. The instruments being evaluated
may trigger a potential loss in excess of calculated amounts if changes in
commodity prices exceed the confidence level of the model used. The VAR
methodology employs the following critical parameters: volatility estimates,
market values of open positions, appropriate market-oriented holding periods and
seasonally adjusted correlation estimates. The Company's portfolio VAR
calculation considers the Company's forward position for the preceding eighteen
months. The mark-to-market VAR is calculated through the contract periods. The
Company uses a holding period of three days as the estimate of the length of
time that will be needed to liquidate the positions. The volatility and the
correlation estimates measure the impact of adverse price movements both at an
individual position level as well as at the total portfolio level. The
two-tailed confidence level established is 99%. For example, if VAR is
calculated at $10 million, it is estimated at a 99% confidence level that if
prices move against PNM's positions, the Company's pre-tax gain or loss in
liquidating the portfolio would not exceed $10 million in the three days that it
would take to liquidate the portfolio.
The Company's VAR is regularly monitored by the Company's RMC. The RMC
has put in place procedures to ensure that increases in VAR are reviewed and, if
deemed necessary, acted upon to reduce exposures. The VAR represents an estimate
of the potential gains or losses that could be recognized on PNM's wholesale
power marketing portfolios given current volatility in the market, and is not
necessarily indicative of actual results that may occur, since actual future
gains and losses will differ from those estimated. Actual gains and losses may
differ due to actual fluctuations in market rates, operating exposures, and the
timing thereof, as well as changes to PNM's wholesale power marketing portfolios
during the year.
74
The Company accounts for the sale of electric generation in excess of its
retail needs or the purchase of power for retail needs as normal purchases and
sales under SFAS 133. Transactions that do not meet the normal purchase or sale
exception or the definition of a hedge under SFAS 133 are accounted for as
energy marketing contracts and comprise PNM's mark-to-market portfolio. The VAR
for the mark-to-market portfolio was $108 thousand at June 30, 2003. The Company
also calculates a portfolio VAR for the preceding 18 months, which in addition
to its mark-to-market portfolio includes all contracts designated as normal
sales and purchases, hedges, and its estimated excess generation assets. This
excess is determined using average peak forecasts for the respective block of
power in the forward market. The Company's portfolio VAR was $8.7 million at
June 30, 2003.
The following table shows the high, average and low market risk as
measured by VAR on the Company's mark-to-market portfolio:
Three Months Ended
June 30, 2003
Period
High Average Low End
---------- ------------ ------------ -----------
(In thousands)
Three day holding period, 99%
two-tailed confidence level..... $352 $118 $1 $108
One day holding period, 99%
two-tailed confidence level..... $203 $ 68 $1 $ 62
Ten day holding period, 95%
two-tailed confidence level..... $490 $164 $2 $151
Credit Risk
PNM is exposed to credit losses in the event of non-performance or
non-payment by counterparties. The Company uses a credit management process to
assess and monitor the financial conditions of counterparties. Credit exposure
is also regularly monitored by the RMC. The Company provides for losses due to
market and credit risk. PNM's credit risk with its largest counterparty as of
June 30, 2003 was $30.4 million.
In 2001, in response to the increased credit risk and market price
volatility described above, the Company provided an allowance against revenue of
$12.0 million for anticipated losses to reflect management's estimate of the
increased market and credit risk in the wholesale power market and its impact on
2001 revenues. As of December 31, 2001, $8.9 million was transferred to the
allowance for bad debt. Based on information available at June 30, 2003, the
Company believes the total allowance for anticipated losses (exclusive of bad
debt), currently established at $2.4 million, is adequate for management's
estimate of losses from credit risk. The Company will continue to monitor the
wholesale power marketplace and adjust its estimates accordingly.
75
The following table provides information related to PNM's credit
exposure, net of collateral as of June 30, 2003. It further delineates that
exposure by the credit worthiness (credit rating) of the counterparties and
provides guidance as to the concentration of credit risk to individual
counterparties PNM may have. Also provided is an indication of the maturity of a
company's credit risk by credit ratings of the counterparties.
Schedule of Wholesale Operations Credit Risk Exposure
June 30, 2003
Net
Exposure Number Exposure
Before of of
Credit Credit Counter Counter
Collateral Collateral Net Exposure -parties -parties
Rating (a) (b) (c) >10% >10%
- --------------------------- -------------- -------------- ------------- ------------ --------------
(Dollars in thousands)
Investment grade........... $56,850 $ - $56,850 2 $36,594
Non-investment grade 1,917 - 1,917 -
Split rating............... 870 - 870
Internal ratings
Investment grade........ 425 - 425 -
Non-investment
grade................. 17,357 - 17,357 1 7,413
-------------- -------------- ------------- --------------
Total.............. $77,419 $ - $77,419 $44,007
============== ============== ============= ==============
Credit reserves $2,433
=============
(a) Rating - Included in "Investment Grade" are counterparties with a minimum
Standard & Poor's rating of BBB- or Moody's rating of Baa3. If the
counterparty has provided a guarantee by a higher rated entity (e.g., its
parent), determination is based on the rating of its guarantor. The
"Internal Ratings - Investment Grade" includes those counterparties that
are internally rated as investment grade in accordance with the
guidelines established in the Company's credit policy.
(b) The Exposure Before Credit Collateral is the net credit exposure to PNM
from its Wholesale Operations. This includes long-term contracts, forward
sales and short-term sales. The exposure captures the net amounts due to
PNM from receivables/payables for realized transactions, delivered and
unbilled revenues, and mark-to-market gains/losses (pursuant to contract
terms). Exposures are offset according to legally enforceable netting
arrangements. Amounts are presented before those reserves that are
determined on a portfolio basis.
(c) The Credit Collateral reflects the face amount of cash deposits, letters
of credit and performance bonds received from counterparties.
76
Maturity of Credit Risk Exposure
As of June 30, 2003
Exposure
Before
Less than Credit
Rating 2 Years 2-5 Years Collateral
- --------------------------- -------------- -------------- --------------
(In thousands)
Investment grade........... $40,473 $16,377 $56,850
Non-investment grade 1,917 1,917
Split rating............... 870 - 870
Internal ratings
Investment grade........ 425 - 425
Non-investment
grade................. 17,357 - 17,357
-------------- -------------- --------------
Total.............. $61,042 $16,377 $77,419
============== ============== ==============
Natural Gas Supply Contracts
PNM hedges certain portions of natural gas supply contracts in order to
protect its retail customers from adverse price fluctuations in the natural gas
market. The financial impact of all hedge gains and losses, including the
related costs of the program, is recoverable through the purchased gas
adjustment clause. As a result, earnings are not affected by gains and losses
generated by these instruments.
Interest Rate Risk
As of June 30, 2003 the Company has liquidated its investment portfolio
of fixed-rate government obligations and corporate securities.
PNM has long-term debt which subjects it to the risk of loss associated
with movements in market interest rates. The majority of the Company's long-term
debt is fixed-rate debt, and therefore, does not expose the Company's earnings
to a major risk of loss due to adverse changes in market interest rates.
However, the fair value of all long-term debt instruments would increase by
approximately 2.95% or $29.7 million if interest rates were to decline by 50
basis points from their levels at June 30, 2003. As of June 30, 2003, the fair
value of PNM's long-term debt was $1,008 million as compared to a book-value of
$954 million. In general, an increase in fair value would impact earnings and
cash flows if PNM were to re-acquire all or a portion of its debt instruments in
the open market prior to their maturity.
During the six months ended June 30, 2003, PNM contributed cash of $20
million and approximately $28.9 million in Holding Company common shares for
plan year 2002 and 2003 to the trust for the Company's pension plan. In
addition, the Company contributed cash of approximately $3.1 million to other
post retirement benefits for plan year 2003. The securities held by the trusts
had an estimated fair value of $520.9 million as of June 30, 2003, of which
approximately 26% were fixed-rate debt securities that subject the Company to
risk of loss of fair value with movements in market interest rates. If rates
were to increase by 50 basis points from their levels at June 30, 2003, the
decrease in the fair value of the securities would be 3.43% or $4.6 million. PNM
77
does not currently recover or return through rates any losses or gains on these
securities; therefore, the Company is at risk for shortfalls in its funding of
its obligations due to investment losses. However, the Company does not believe
that long-term market returns over the period of funding will be less than
required for the Company to meet its obligations.
Equity Market Risk
PNM contributes to trusts established to fund its share of the
decommissioning costs of PVNGS and pension and other post-retirement benefits.
The trusts hold certain equity securities as of June 30, 2003. These equity
securities also expose the Company to losses in fair value. Approximately 67% of
the securities held by the various trusts were equity securities as of June 30,
2003 of which 5.6% is composed of the Holding Company Stock contributed to the
pension plan. The Holding Company Stock represents a concentrated position whose
change in value may have an impact on the volatility of the pension portfolio.
Similar to the debt securities held for funding decommissioning and certain
pension and other post-retirement costs, PNM does not recover or earn a return
through rates on any losses or gains on these equity securities.
In 2001, the Company implemented an enhanced cash management strategy
using derivative instruments based on the S&P 100, S&P 500, and Nasdaq composite
indices. The strategy is designed to capitalize on high market volatility or
benefit from market direction. An investment manager is utilized to execute the
program. The program is carefully managed by the RMC and has VAR and stop-loss
limits established. Trades are typically closed-out before the end of a
reporting period and within the same day of execution.
The enhanced cash management program utilizes a one-day VAR under the
variance/covariance model, with a two-tailed confidence interval of 99%. As of
June 30, 2003, the program had no open positions.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
The Company's principal executive officer and principal financial officer
have concluded that the Company's disclosure controls and procedures, based on
their evaluation as of the end of the period covered by this report, of these
disclosure controls and procedures, are effective to ensure that material
information relating to the Company, including its consolidated subsidiaries,
was made known to them by others within those entities, particularly during the
period in which the periodic reports are being prepared. There was no change in
the Company's internal control over financial reporting that occurred during the
Company's most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
78
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Santa Fe Generating Station ("Santa Fe Station")
PNM and the NMED conducted investigations of the gasoline and chlorinated
solvent groundwater contamination detected beneath PNM's former Santa Fe Station
site to determine the source of the contamination pursuant to a 1992 Settlement
Agreement ("Settlement Agreement") between PNM and the NMED. No source of
gasoline contamination in the groundwater was identified as originating from the
site. However, in June 1996, PNM received a letter from the NMED, indicating
that the NMED believed PNM is the source of gasoline contamination in a City of
Santa Fe municipal supply well and in groundwater underlying the Santa Fe
Station site. Further, the NMED letter stated that PNM was required to proceed
with interim remediation of the contamination pursuant to the New Mexico Water
Quality Control Commission regulations. In October 1996, PNM and the NMED signed
an amendment to the Settlement Agreement concerning the groundwater
contamination underlying the site. As part of the amendment, PNM agreed to spend
approximately $1.2 million for certain costs related to sampling, monitoring and
the development and implementation of a remediation plan with respect to
gasoline contamination in the groundwater.
The amended Settlement Agreement does not, however, provide PNM with a
full release from potential further liability for remediation of the gasoline
contamination in the groundwater. After PNM has expended the settlement amount,
if the NMED can establish through binding arbitration that the Santa Fe Station
is the source of the contamination, PNM could be required to perform further
remediation that is determined to be necessary. PNM continues to dispute any
contention that the Santa Fe Station is the source of the gasoline contamination
in the groundwater and believes that insufficient data exists to identify the
source(s) of the groundwater contamination. PNM's aquifer characterization and
groundwater quality reports compiled from 1996 through 2002 strongly suggest
groundwater contamination has been drawn under the site by the pumping of the
Santa Fe supply well. PNM and the NMED, with the cooperation of the City of
Santa Fe, jointly selected a 3 to 4 year remediation plan proposed by a
remediation contractor. The City of Santa Fe, PNM and the NMED entered into a
memorandum of understanding concerning the selected remediation plan and the
operation of the municipal well adjacent to the Santa Fe Station site in
connection with carrying out the plan. On October 5, 1998, a new system began
operation to treat groundwater produced by the Santa Fe well to drinking water
standards for municipal distribution and bioremediation of gasoline
contamination beneath the Santa Fe Station site. Since the reactivation of the
Santa Fe well, the groundwater treatment and bioremediation systems have
resulted in a marked reduction in contaminant concentrations at the wellhead.
However, contaminant concentrations at the property boundary remain high.
By letter dated August 7, 2002, PNM provided written notice to the NMED
and the City of Santa Fe that PNM had satisfied its obligations with respect to
the gasoline contamination under the amended Settlement Agreement, and PNM also
stated its intention to cease operation, effective October 5, 2002, of the
wellhead and bioremediation systems, and to discontinue monitoring and reporting
with respect to gasoline contamination at the site. The NMED responded with a
written notice of determination dated August 16, 2002, stating that PNM is the
responsible party for gasoline contamination at the site and requested that PNM
79
refrain from cessation of operation of the remediation systems, monitoring and
reporting. In a meeting held on September 5, 2002, the NMED indicated its
intention to file a court action seeking an order invalidating the binding
arbitration provisions of the amended Settlement Agreement and a declaratory
judgment that PNM is the responsible party for the gasoline contamination at the
site. PNM, the NMED and the City of Santa Fe have engaged in extensive
settlement discussions. As part of the negotiations, PNM agreed to continue
operation of the wellhead remediation system through October 1, 2004. The NMED
and PNM have reached a tentative settlement agreement whereby under the terms of
the proposed settlement, PNM will install additional remediation facilities
consisting of an additional extraction well and at least two additional
monitoring wells, to address remaining gasoline contamination in the groundwater
at and in the vicinity of the site. PNM will continue to operate the remediation
facilities until the groundwater is cleaned up to applicable federal standards
or until such time as the NMED determines that additional remediation is not
required, whichever is earlier. The settlement is conditioned upon final
agreement of an amendment to the existing settlement agreement and a
modification of the existing memorandum of agreement with the City of Santa Fe
for continued operation of the Santa Fe Well.
Citizen Suit Under the Clean Air Act
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Citizen Suit Under the Clean Air Act".
Landowner Environmental Claims
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Landowner Environmental Claims".
Archeological Site Disturbance
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Archeological Site Disturbance".
California AG Threatened Litigation
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Western United States Wholesale Power
Market - California AG Threatened Litigation".
California Attorney General Complaint
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Other Issues Facing the Company - Western
United States Wholesale Power Market - California Attorney General Complaint".
California Antitrust Litigation
See "Part I - Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Other Issues Facing the Company - Western
United States Wholesale Power - California Antitrust Litigation".
80
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In June 2003, the Holding Company contributed 1,121,495 shares of Holding
Company Common Stock to the trust for the Company's defined benefit pension
plan, in reliance on the exemption afforded by Section 4(2) under the Securities
Act of 1933, as amended. No cash proceeds were received by the Holding Company
in connection with this contribution.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Annual Meeting
The annual meeting of shareholders was held on May 13, 2003. The matters
voted on at the meeting and the results were as follows:
The election of the following nominees to serve as directors as follows:
Votes
Against
Director Votes For Or Withheld
-------- --------- -----------
Terms expiring in 2006:
Robert G. Armstrong 29,767,076 6,035,149
Manuel T. Pacheco 29,485,406 6,316,819
Robert M. Price 35,433,778 368,447
Term expiring in 2005:
Julie A. Dobson 29,588,299 6,213,926
As reported in the Definitive 14A Proxy Statement filed April 4, 2003 the
name of each director whose term of office as director continues after the
meeting is as follows:
R. Martin Chavez Joyce A. Godwin Paul F. Roth Bonnie S. Reitz Theodore F.
Patlovich Jeffry E. Sterba
The approval of the Employee Stock Purchase Plan as follows:
Votes
Against
Votes For Or Withheld Abstentions
--------- ----------- -----------
34,723,522 928,750 149,953
81
The approval of the selection by the Company's board of directors of
Deloitte & Touche LLP as independent auditors for the fiscal year ending
December 31, 2003, was voted on, as follows:
Votes
Against
Votes For Or Withheld Abstentions
--------- ----------- -----------
29,632,027 6,096,225 73,973
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits:
4.6.2 Fourth Supplemental Indenture, dated as of May 1, 2003, to
Indenture, dated as of March 11, 1998, between PNM and
JPMorgan Chase Bank (formerly The Chase Manhattan Bank).
4.6.3 Fifth Supplemental Indenture, dated as of May 1, 2003, to
Indenture, dated as of March 11, 1998, between PNM and
JPMorgan Chase Bank.
4.6.4 Sixth Supplemental Indenture, dated as of May 1, 2003, to
Indenture, dated as of March 11, 1998, between PNM and
JPMorgan Chase Bank.
10.89 Receivables Sale Agreement, dated as of April 8, 2003,
between PNM Receivables Corp., as buyer and PNM as
originator.
10.90 Receivables Purchase Agreement, dated as of April 8, 2003,
among PNM Receivables Corp, as seller, PNM, as servicer,
EagleFunding Capital Corporation, as conduit investor,
Fleet National Bank, as an alternate investor and Fleet
Securities, Inc., as managing agent and deal agent.
12.1 PNM Resources, Inc. and Subsidiaries Ratio of Earnings
to Fixed Charges.
12.2 PNM Resources, Inc. and Subsidiaries Ratio of Earnings
to Combined Fixed Charges and Preferred Stock Dividends.
12.3 Public Service Company of New Mexico and Subsidiaries
Ratio of Earnings to Fixed Charges.
12.4 Public Service Company of New Mexico and Subsidiaries
Ratio of Earnings to Combined Fixed Charges and Preferred
Stock Dividends.
15.1 Letter Re: Unaudited Interim Financial Information for
PNM Resources, Inc. and Subsidiaries.
15.2 Letter Re: Unaudited Interim Financial Information for
Public Service Company of New Mexico.
31.1 Chief Executive Officer Certification Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer Certification Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
82
b. Reports on Form 8-K:
Report dated and filed May 29, 2003 pursuant to Item 5 of Form 8-K that the
Company refinanced $182 million in long-term debt.
Report dated and filed June 12, 2003 pursuant to Items 5 and 7 of Form 8-K that
the Company conformed its presentation of information contained in its 2002
Annual Report on Form 10-K to reflect matters previously disclosed in its First
Quarter 2003 Quarterly Report on Form 10-Q.
Report dated and furnished June 26, 2003 pursuant to Item 9 of Form 8-K that the
Company's utility unit agrees to settle gas rate case.
Report dated and filed July 17, 2003 pursuant to Item 5 of Form 8-K that the
Company declares quarterly common stock dividend, elects 2 new directors and
approves refinancing $300 million in long-term debt.
Report dated and furnished July 22, 2003 pursuant to Item 9 of Form 8-K
reporting the Company's Comparative Operating Statistics for the months of
April, May, June 2003 and 2002 and the year ended April, May, June 2003 and
2002.
Report dated and furnished July 30, 2003 pursuant to Item 12 of Form 8-K that
the Company issued a press release announcing its unaudited results of
operations for the three and six months ended June 2003 and 2002 and other
select financial information.
83
Signature
- ---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
PNM RESOURCES, INC. AND
PUBLIC SERVICE COMPANY OF NEW MEXICO
-----------------------------------------------
(Registrant)
Date: August 11, 2003 /s/ Robin A. Lumney
-----------------------------------------------
Robin A. Lumney
Vice President, Controller
and Chief Accounting Officer
(Officer duly authorized to sign this report)
84