TXNM

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2006, 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 operations in New Mexico and Texas, alongside unregulated wholesale power marketing and retail electricity sales through First Choice. A significant event during the period was the acquisition of the Twin Oaks coal-fired power plant on April 18, 2006, for $480 million.

Key Financial Metrics (Nine Months Ended Sept 30, 2006)

Note: Short-term debt increased significantly due to a $480 million bridge loan for the Twin Oaks acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated operating revenues increased 29.5% year-over-year, driven primarily by the inclusion of Twin Oaks operations and First Choice results (acquired in 2005) for a full nine-month period.
• Earnings Increase: Net earnings rose 42.9% to $86.5 million. This was largely due to the Twin Oaks acquisition and improved wholesale margins, partially offset by plant outages at the Palo Verde Nuclear Generating Station (PVNGS) and rate reductions in New Mexico.
• Cost of Energy: Cost of energy sold increased to $1.10 billion (from $848.5 million in 2005) due to higher purchased power costs and the addition of Twin Oaks fuel costs.
• Interest Charges: Interest charges surged to $105.2 million (from $64.5 million) due to the bridge loan for Twin Oaks and debt associated with the TNP acquisition.
• Investing Activities: Cash used for investing activities jumped to $651.6 million, primarily reflecting the $481 million cash outflow for the Twin Oaks business acquisition and utility plant additions.

Guidance, Outlook, and Risks

• Outlook: Management expects to request an increase in PNM electric rates effective January 1, 2008. The Company anticipates that internal cash generation and current debt capacity will be sufficient to meet capital requirements through 2010.
• Strategic Initiatives: PNMR and Cascade (Bill Gates' investment vehicle) agreed to form a new unregulated energy company, "EnergyCo," pending regulatory and financing conditions. Construction of the Luna combined-cycle plant was completed and is operational.
• Operational Risks:
  • PVNGS Outages: Extended outages at PVNGS Unit 1 reduced gross margin by an estimated $22.3 million for the nine-month period. Unit 1 experienced recurring issues with pressurizer heaters and control rod indicators in late 2006.
  • Regulatory Matters: Pending outcomes include the PUCT's final order on TNMP's stranded cost true-up (approved Nov 2, 2006), California refund proceedings, and FERC investigations into market power.
  • Commodity Risk: The Company utilizes derivatives to manage price risk. A 10% decrease in market pricing of mark-to-market energy transactions would result in a net earnings decrease of less than 1%.
• Unusual Items: The adoption of SFAS 123R (Share-Based Payment) resulted in a $6.6 million stock-based compensation expense for the nine months ended Sept 30, 2006, compared to zero in the prior year.

Investor Verification Checklist

• Twin Oaks Integration: Verify the operational performance and integration costs of the newly acquired Twin Oaks plant, which contributed $17.5 million to net earnings year-to-date.
• PVNGS Reliability: Monitor the status of PVNGS Unit 1 and Unit 2, as outages significantly impact wholesale sales and require costly power purchases.
• Debt Refinancing: Confirm the permanent financing strategy for the $480 million Twin Oaks bridge loan, which must be repaid by April 2007.
• Regulatory Approvals: Track the status of the proposed "EnergyCo" joint venture and the FERC approval for the transfer of TNMP's New Mexico assets to PNM (effective Jan 1, 2007).
• California Litigation: Assess the potential financial impact of ongoing California refund proceedings and antitrust litigation, where outcomes remain uncertain.