TXNM

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2004, for PNM Resources, Inc. (the Holding Company) and its principal subsidiary, Public Service Company of New Mexico (PNM). The Company operates as an integrated public utility providing electricity and natural gas in New Mexico, alongside wholesale energy marketing operations in the Western United States. As of November 1, 2004, 60,441,459 shares of common stock were outstanding.

Key Financial Metrics (Nine Months Ended Sept 30, 2004)

Note: 2003 Net Earnings included a one-time cumulative effect of accounting changes totaling $36.6 million.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 9.2% year-over-year, driven primarily by a 31.4% increase in Gas revenues due to higher natural gas prices and a 14.2% increase in Wholesale revenues from higher volumes and prices.
• Earnings Decline: Net earnings decreased 15.3% to $69.0 million. This decline is largely attributable to the absence of the $36.6 million one-time gain from accounting changes (SFAS 143 and pension valuation) recorded in 2003, as well as a $10.1 million write-off of transition costs in 2003 related to the repeal of New Mexico's electric deregulation.
• Cost Management: Interest expense decreased 28.1% to $38.2 million due to debt refinancing and lower borrowing levels. Depreciation and amortization decreased 14.0% due to regulatory rate adjustments and the full amortization of the billing system.
• Segment Performance:
  • Electric: Operating income decreased slightly due to a retail rate reduction effective September 2003 and cooler weather reducing demand.
  • Gas: Operating income increased significantly due to a PRC-approved rate increase and customer growth.
  • Wholesale: Operating income decreased due to lower short-term sales margins and unplanned outages, despite higher sales volumes.

Outlook, Risks, and Unusual Items

• Proposed Acquisition: On July 24, 2004, the Company agreed to acquire TNP Enterprises, Inc. for approximately $189 million in stock and cash. The transaction is expected to close in Q2 2005, subject to regulatory approvals (PRC, PUCT, FERC, SEC). The combined entity would serve over 500,000 customers.
• Regulatory Risks: The Company faces a retail electric rate freeze through 2007 and a 2.5% rate reduction effective September 2005. Future earnings depend on cost control and wholesale market performance.
• Legal and Environmental Contingencies:
  • California Energy Crisis: The Company is involved in FERC refund proceedings and antitrust litigation regarding wholesale power sales in California. A $1.0 million settlement was reached with the FERC regarding "parking and lending" transactions, though broader refund liabilities remain uncertain.
  • Environmental: Ongoing litigation regarding opacity violations at the San Juan Generating Station (SJGS) and potential New Source Review (NSR) compliance costs.
• Market Risk: The Company utilizes a net asset-backed strategy for wholesale operations. As of September 30, 2004, the Value at Risk (VAR) for the wholesale portfolio was $13.2 million.

Investor Verification Checklist

• TNP Acquisition Status: Verify the progress of regulatory approvals required for the TNP acquisition and the final financing structure.
• California Refund Liability: Monitor the outcome of FERC proceedings regarding the California energy crisis refunds, as the final liability amount remains uncertain.
• Rate Freeze Impact: Assess the Company's ability to maintain margins under the retail electric rate freeze through 2007 and the scheduled 2005 rate reduction.
• Wholesale Margin Volatility: Review the impact of weather and market prices on short-term wholesale margins, which are highly variable.
• Environmental Compliance: Track the resolution of the SJGS opacity litigation and any potential capital expenditures required for NSR compliance.