TXNM

Business Context and Reporting Period

This Form 10-Q is a combined quarterly report for PNM Resources, Inc. (PNMR), Public Service Company of New Mexico (PNM), and Texas-New Mexico Power Company (TNMP) for the period ended June 30, 2010. PNMR operates regulated electric utilities in New Mexico and Texas, an unregulated retail electric provider (First Choice) in Texas, and holds a 50% equity interest in Optim Energy, an independent power producer. The company sold its natural gas operations (PNM Gas) in January 2009, which are reported as discontinued operations.

Key Financial Metrics (Six Months Ended June 30, 2010)

Material Changes vs. Prior Period

• Discontinued Operations Impact: The significant decrease in total Net Earnings Attributable to PNMR ($14.4M vs $87.5M) is primarily due to the absence of a $73.2 million gain on the sale of PNM Gas recognized in the first half of 2009. There were no discontinued operations in 2010.
• Continuing Operations Growth: Earnings from continuing operations attributable to PNMR increased slightly to $14.4 million from $14.2 million in the prior year period. This improvement was driven by rate increases implemented by PNM and TNMP and lower fuel costs, partially offset by mark-to-market losses on derivatives at First Choice and equity losses from Optim Energy.
• Segment Performance:
  • PNM Electric: Earnings increased significantly ($13.1M to $13.1M) due to rate increases and lower fuel costs, offset by a $26.6 million regulatory disallowance recorded in 2009 related to SO2 allowance sales.
  • First Choice: Earnings declined ($23.0M to $9.1M) due to $18.5 million in mark-to-market losses on unrealized economic hedges and lower customer volumes.
  • Optim Energy: Equity in net earnings improved (loss of $6.0M to loss of $8.2M) as Optim Energy focused on debt reduction and optimizing assets in a depressed market.
• Cash Flow: Operating cash flow turned positive ($76.2M) compared to a negative outflow ($34.4M) in 2009, largely due to net income tax refunds of $63.4 million in 2010 versus payments in 2009.

Guidance, Outlook, and Risks

• Regulatory Proceedings: PNM filed a general rate case in June 2010 requesting a $165.2 million increase (22% for PNM North, 20% for PNM South) effective April 2011. The New Mexico Public Regulation Commission (NMPRC) initially deemed the filing incomplete but PNM has supplemented the application. The outcome remains uncertain.
• Environmental Compliance: Significant risks exist regarding the EPA's Regional Haze rule and Best Available Retrofit Technology (BART) determinations for the San Juan Generating Station (SJGS) and Four Corners. NMED proposed SCR technology for SJGS, which PNM estimates could cost $750 million for the station (PNM share ~$347M). PNM is challenging this determination.
• Climate Change: The company faces potential costs from federal or state greenhouse gas (GHG) regulations. PNM is actively pursuing renewable energy projects to meet New Mexico's Renewable Portfolio Standard.
• Liquidity: The company maintains $678.0 million in remaining availability under revolving credit facilities as of July 29, 2010. Moody's revised the outlook to stable for PNMR, PNM, and TNMP in March 2010.
• Optim Energy: Optim Energy is focused on utilizing cash flow to reduce debt. PNMR and its partner have committed to additional equity contributions to support debt reduction.

Key Facts for Investor Verification

• Rate Case Status: Verify the NMPRC's final decision on PNM's 2010 rate case application and the timeline for implementation of the requested $165.2 million increase.
• Environmental Costs: Monitor the outcome of the BART determination for SJGS and Four Corners, as mandated controls could require hundreds of millions in capital expenditures.
• Derivative Exposure: Review the impact of mark-to-market accounting on First Choice's earnings, as unrealized losses on economic hedges significantly reduced reported income in 2010.
• Debt Refinancing: Track the company's ability to refinance debt maturing in 2011 and 2012, particularly given the reduction in credit facility capacity following the Lehman Brothers bankruptcy.
• Optim Energy Viability: Assess Optim Energy's ability to generate positive cash flow in the current depressed power and gas markets to avoid further equity calls from PNMR.