Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2007, for PNM Resources, Inc. (PNMR) and its subsidiaries, Public Service Company of New Mexico (PNM) and Texas-New Mexico Power Company (TNMP). The Company operates as a merchant utility with regulated electric and gas services in New Mexico and Texas, alongside competitive wholesale and retail electricity operations. A significant structural change occurred on January 1, 2007, when TNMP transferred its New Mexico operations to PNM. Additionally, on June 1, 2007, PNMR contributed its Altura subsidiary (including the Twin Oaks power plant) to a new joint venture, EnergyCo, which is now accounted for using the equity method.
Key Financial Metrics (Six Months Ended June 30, 2007)
| Metric | 2007 (in millions) | 2006 (in millions) |
|---|---|---|
| Total Operating Revenues | $1,234.2 | $1,202.5 |
| Net Earnings (PNMR) | $49.9 | $42.0 |
| Net Earnings per Share (Diluted) | $0.64 | $0.61 |
| Operating Income | $101.0 | $108.6 |
| Net Cash from Operating Activities | $87.2 | $111.4 |
| Net Cash from Investing Activities | $172.5 | $(596.2) |
| Net Cash from Financing Activities | $(325.0) | $490.4 |
| Short-term Debt | $559.7 | $764.3 |
| Long-term Debt | $1,531.9 | $1,765.9 |
| Cash and Cash Equivalents | $58.1 | $123.4 |
Material Changes vs. Prior Period
- Net Earnings Increase: Net earnings increased by $7.9 million (19%) compared to the prior year. This was primarily driven by a $16.0 million non-recurring income tax benefit resulting from a settlement with the IRS regarding previously unrecognized tax benefits.
- Operating Income Decline: Despite higher revenues, operating income decreased by $7.6 million. This was due to higher coal costs, mark-to-market losses on derivative instruments, and non-recurring costs associated with the formation of EnergyCo and the impairment of Twin Oaks intangible assets.
- Segment Performance:
- PNM Electric: Operating income increased $2.6 million due to load growth and improved plant performance at PVNGS and SJGS, offset by higher coal costs.
- Wholesale: Operating income decreased $8.4 million due to mark-to-market losses and reduced marketing opportunities compared to 2006.
- First Choice: Operating income decreased $2.1 million due to cooler weather reducing sales volumes and unfavorable customer mix shifts.
- Cash Flow Volatility: Investing cash flows swung from a significant outflow in 2006 (due to the Twin Oaks acquisition) to a substantial inflow in 2007, driven by $362.3 million in cash distributions from EnergyCo.
Guidance, Outlook, and Risks
- Capital Requirements: Total capital requirements for 2007 are projected at $485.8 million, with $414.8 million for construction. Long-term projections (2007-2011) total $2.4 billion, including significant environmental upgrades at the San Juan Generating Station (SJGS) and expansion at the Afton Generating Station.
- EnergyCo Strategy: PNMR is expanding its unregulated presence through EnergyCo. Subsequent to the reporting period, EnergyCo acquired the Lyondell Power Generation Facility and announced plans to co-develop a new unit at Cedar Bayou. PNMR expects to fund these projects primarily through EnergyCo's credit facility.
- Regulatory Risks:
- Rate Cases: PNM filed a general electric rate case requesting a $68.9 million revenue increase, with hearings scheduled for October 2007. A gas rate case was approved by the NMPRC for a $9 million increase, but PNM has filed an appeal.
- Environmental Compliance: The Company faces ongoing uncertainty regarding greenhouse gas regulations, including a New Mexico order requiring utilities to factor carbon costs into resource plans. There are also pending matters regarding the Four Corners Federal Implementation Plan and Navajo Nation environmental issues.
- Legal Proceedings: Significant contingencies include the California wholesale power market refund proceedings, the FERC Gaming Partnerships Order (where PNM was dismissed but the matter remains under review), and various environmental litigation.
- Credit Ratings: Moody's changed the credit outlook for PNMR, PNM, and TNMP to "negative" from "stable" in April 2007. S&P also maintains a negative outlook.
Investor Verification Checklist
- IRS Settlement Impact: Verify the sustainability of the $16.0 million tax benefit; this was a non-recurring item that significantly boosted net earnings and distorted the effective tax rate.
- EnergyCo Cash Flows: Confirm the timing and magnitude of future cash distributions from EnergyCo, which were a primary driver of positive investing cash flow in the current period.
- Coal Cost Exposure: Assess the impact of rising coal costs on the gross margins of the regulated electric segments (PNM Electric and TNMP Electric).
- Derivative Positions: Review the net fair value of mark-to-market energy contracts, which shifted from a net asset position in late 2006 to a net liability of $4.5 million at June 30, 2007.
- Rate Case Outcomes: Monitor the NMPRC's final decision on PNM's electric rate case and the outcome of the appeal regarding the gas rate increase.
- Capital Expenditures: Track progress and cost overruns on the SJGS environmental project and Afton expansion, which represent a significant portion of future capital requirements.