Company Update

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest events reported) June 12, 2003 -------------------------- (June 12, 2003) -------------------------- 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 ------------------------------ (Former name, former address and former fiscal year, if changed since last report) Item 5. Other Events PNM Resources, Inc. and Public Service Company of New Mexico (collectively the "Company") conform their presentation of information contained in their 2002 Annual Report on Form 10-K to reflect matters previously disclosed in their First Quarter 2003 Quarterly Report on Form 10-Q. During 2002, the Company's Utility Operations business segment evolved. On January 28, 2003, the New Mexico Public Regulation Commission ("PRC") approved the Global Electric Agreement which sets a rate path through 2007. Pursuant to the Global Electric Agreement, Electric Services ("Electric") became a fully integrated retail energy supply business. As a result of that evolution, the Company's generation activities changed from a stand-alone operation to a function that became mostly integrated with the distribution energy supply business, which primarily serves to optimize the value of that business. As specified in the Global Electric Agreement, the Company's generation activities were designated to support either its rate-regulated electric retail customers or its wholesale customers. Therefore, upon review and in accordance with SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"), and as disclosed in the Company's Form 10-Q for the quarter ended March 31, 2003, the Company determined that Electric's generation and distribution components no longer meet the definition of separate operating segments for financial reporting purposes and the Company reported the financial position and results of operations of the majority of its generation and distribution activities as one segment. All prior periods have been reclassified to conform to the current presentation and include certain estimates and allocations where necessary. This current report on Form 8-K ("report") conforms the information contained in the Company's 2002 Annual Report on Form 10-K to the presentation reported in its First Quarter 2003 Form 10-Q. Accordingly, this report revises information previously reported in the Company's 2002 Annual Report on Form 10-K to reflect the following matters which have previously been disclosed in reports filed under the Securities Exchange Act of 1934. No attempt has been made in this Form 8-K to modify or update other disclosures as presented in the original Form 10-K except as required to reflect the effects of those items as described below. This report is limited to the reclassifications to reflect: o a change in business segment reporting; o a change in the reporting of trading revenues and costs; and o removal of non-GAAP financial measures from the Company's 2002 Annual Report on Form 10-K. As disclosed in the Company's Form 10-Q for the quarter ended March 31, 2003, in accordance with the consensus reached in October 2002 relating to EITF Issue No. 02-3, "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities" ("EITF 02-3") and EITF 98-10 "Accounting for Contracts Involved in Energy Trading and Risk Management Activities ("EITF 98-10"), beginning in the first quarter of 2003, the Company reclassified prior periods for those contracts previously accounted for under EITF 98-10 to conform to a net margin presentation as required by EITF 02-3. As a result, both operating revenues and cost of energy sold were reduced by approximately $74.0 million, $89.4 million and $99.7 million for the fiscal years ended December 31, 2002, 2001 and 2000, respectively. This change in presentation did not have an effect on gross margins, net income or cash flows. 2 In conjunction with filing this Report, the Company's Chief Executive Officer and the Company's Chief Financial Officer have performed the procedures necessary to evaluate the effectiveness of the Company's disclosure controls and procedures, as required by Section 302 (a) (4) (c) of the Sarbanes-Oxley Act of 2002. Based on this evaluation, the Company believes that the Company's disclosure controls and procedures to update the Company's 2002 Form 10-K as described in Item 5 of this Report, are effective in that they provide reasonable assurance that material information is made known so that it may be included in the Report. Such officers do not believe there have been significant changes in internal controls or in other factors based on their evaluation on June 5, 2003 that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. TABLE OF CONTENTS Page Updated information for the year ended December 31, 2002: THE COMPANY................................................................4 UTILITY OPERATIONS.........................................................4 WHOLESALE OPERATIONS.......................................................6 CORPORATE AND OTHER........................................................7 SOURCES OF POWER...........................................................7 FUEL AND WATER SUPPLY......................................................7 EMPLOYEES..................................................................8 SELECTED FINANCIAL DATA....................................................9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................................10 OVERVIEW.........................................................10 COMPETITIVE STRATEGY.............................................10 RESULTS OF OPERATIONS............................................11 NEW AND PROPOSED ACCOUNTING STANDARDS............................32 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...............................34 SIGNATURE................................................................109 3 THE COMPANY PNM Resources, Inc. ("Holding Company") was incorporated in the State of New Mexico on March 3, 2000. The Holding Company's principal subsidiary Public Service Company of New Mexico ("PNM") was incorporated in the State of New Mexico on May 9, 1917. This filing for PNM Resources, Inc. and Subsidiaries and PNM is presented on a combined basis. The Holding Company and PNM have their principal offices at Alvarado Square, Albuquerque, New Mexico 87158 (telephone number 505-241-2700). The Holding Company is an investor-owned holding company of energy and energy-related companies. PNM is a public utility primarily engaged in the generation, transmission, distribution, sale and marketing of electricity, and in the transmission, distribution and sale of natural gas within the State of New Mexico. 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 ease of discussion, this report may use the term "Company" when referring to PNM or when discussing matters of common applicability to the Holding Company and PNM. Upon the completion on December 31, 2001 of a one-for-one share exchange between PNM and the Holding Company, the Holding Company became the parent company of PNM. Prior to the share exchange, the Holding Company had existed as a subsidiary of PNM. The new parent company began trading on the New York Stock Exchange under the same PNM symbol beginning on December 31, 2001. As it currently operates, the Company's principal business segments are Utility Operations, Wholesale Operations ("Wholesale") and Corporate and Other. Utility Operations include Electric Services ("Electric") and Gas Services ("Gas"). Electric consists of the distribution, transmission and generation of electricity for retail electric customers in New Mexico. Gas includes the transportation and distribution of natural gas to end-users. Wholesale consists of the generation and sale of electricity into the wholesale market based on three product lines, which are long-term contracts, forward sales and short-term sales. UTILITY OPERATIONS Electric The Company provides jurisdictional retail electric service to a large area of north central New Mexico, including the City of Albuquerque ("COA") and the City of Santa Fe, and certain other areas of New Mexico. The largest retail electric customer served by the Company accounted for approximately 4.8% of the Company's total retail electric revenues for the year ended December 31, 2002. For the years 2000 through 2002, retail KWh sales have grown at a compound annual rate of approximately 2.4%. The Company's system peak demands for its retail customers and firm requirements customers in summer and winter for the last three years are shown in the following table: 4 SYSTEM PEAK DEMANDS (Megawatts) 2002 2001 2000 --------- --------- --------- Summer............................ 1,456 1,397 1,368 Winter............................ 1,297 1,294 1,211 The Company holds long-term, non-exclusive franchise agreements for its electric retail operations, expiring between May 2003 and November 2028. These franchise agreements provide the Company access to public rights-of-way for placement of the Company's electric facilities. The COA, City of Santa Fe, Town of Cochiti Lake, Bernalillo County, Luna County, Sandoval County, San Miguel County, Village of Bosque Farms, Pueblo de Cochiti and Village of Tijeras franchises have expired. The COA metropolitan area accounted for approximately 53% of the Company's 2002 total electric utility operating revenues, and no other franchise area represents more than approximately 8%. The Company continues to collect and pay franchise fees to the COA, City of Santa Fe, the Town of Cochiti Lake, Village of Bosque Farms and Village of Tijeras. The Company currently does not pay franchise fees to Bernalillo County, Luna County, Sandoval County and San Miguel County. The Company remains obligated under New Mexico state law to provide service to customers in these franchise areas even in the absence of a franchise agreement. The Company owns or leases 2,897 circuit miles of transmission lines, interconnected with other utilities in New Mexico, east and south into Texas, west into Arizona, and north into Colorado and Utah. Due to rapid load growth in the Company's service territory in recent years and the lack of transmission development, most of the capacity on this transmission system is fully committed and there is very little or no additional access available on a firm commitment basis. These factors result in physical constraints on the system and limit the ability to wheel power into the Company's service area from outside New Mexico. Gas Gas operations distributes natural gas to most of the major communities in New Mexico, including the COA and the City of Santa Fe. The COA metropolitan area accounted for approximately 44% of the total gas revenues in 2002. No single sales-service customer accounted for more than approximately 1% of the Company's therm sales in 2002. The Company holds long-term, non-exclusive franchises with varying expiration dates in all incorporated communities requiring franchise agreements except for the COA, City of Santa Fe, Aztec, Village of Bosque Farms, Town of Cochiti Lake, Los Ranchos de Albuquerque and Tatum. The Company remains obligated to serve these franchise areas pursuant to state law even in the absence of a franchise agreement. The Company's customer base includes both sales-service customers and transportation-service customers. Sales-service customers purchase natural gas and receive transportation and delivery services from the Company for which the Company receives both cost-of-gas and cost-of-service revenues. Cost-of-gas revenues collected from on-system sales-service customers are recovered in accordance with PRC regulations and represent a pass-through of the Company's cost of natural gas to the customer. Since the Company obtains its natural gas 5 supply on the open market from non-affiliated third-party producers, the Company's operating results are not affected by an increase or decrease in natural gas prices. Additionally, the Company makes occasional gas sales to off-system customers. Off-system sales deliveries generally occur at interstate pipeline interconnects with the Company's system. Transportation-service customers, who procure gas independently of the Company and contract with the Company for transportation and related services, provide the Company with cost-of-service revenues only. Transportation services are provided to gas marketers, producers and end users for delivery to locations throughout its distribution systems, as well as for delivery to interstate pipelines. The Company provided gas transportation deliveries to approximately 1,360 gas marketers, producers and end users during 2002. During 2002, approximately 49% of the Company's total gas throughput was related to transportation gas deliveries. The Company's transportation rates are unbundled, and transportation customers only pay for the service they receive. Cost-of-gas revenues, received from sales-service and off-system customers, and other PGAC-related revenues accounted for approximately 51% of the Company's total gas operating revenues in 2002. Since a major portion of the Company's load is related to heating, levels of therm sales are affected by weather. Approximately 63% of the Company's total therm sales in 2002 occurred in the months of January, February, March and December. The Company obtains its supply of natural gas primarily from sources within New Mexico by contracting with third party producers and marketers. These contracts are generally sufficient to meet the Company's peak-day demand. The Company serves certain cities which depend on El Paso Natural Gas Company or Transwestern Pipeline Company for transportation of gas supplies. Because these cities are not directly connected to the Company's transmission facilities, gas transported by these companies is the sole supply source for those cities. Such transportation is regulated by FERC. As a result of FERC Order 636, the Company's options for transporting gas to these cities and other portions of its distribution system have increased. WHOLESALE OPERATIONS The Company's Wholesale Operations consists of the generation and sale of electricity into the wholesale market based on three product lines, which are 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. 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 6 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. Power Sales All information disclosed under power sales in the 2002 Annual Report on Form 10-K remains the same except for the Wholesale strategy as discussed above. CORPORATE AND OTHER (formerly Unregulated Operations) The Holding Company incurs 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 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. SOURCES OF POWER Previously in the 2002 Annual Report on Form 10-K, the Company disclosed sources of power under its Generation and Marketing business segment. As the generation activities of the Company now support both the Electric and Wholesale business segments, this section now applies to both business segments. FUEL AND WATER SUPPLY Previously in the 2002 Annual Report on Form 10-K, the Company disclosed fuel and water supply under its Generation and Marketing business segment. As the generation activities of the Company now support both the Electric and Wholesale business segments, this section now applies to both business segments. (Intentionally left blank) 7 EMPLOYEES As of December 31, 2002, the Company had 2,656 full-time employees. The following table sets forth the number of employees by business segment as of December 31, 2002: Number ---------- Corporate (1)........................... 426 Electric Services....................... 1,613 Gas Services............................ 526 Wholesale Operations.................... 78 Corporate and Other..................... 13 ---------- Total................................ 2,656 ========== (1) These employees resided at the Holding Company at December 31, 2002. The number of employees of the Company who are represented by unions or other collective bargaining groups include (i) Electric 536; (ii) Gas 56; and (iii) Wholesale 48. (Intentionally left blank) 8 SELECTED FINANCIAL DATA The selected financial data should be read in conjunction with the consolidated financial statements, the notes to consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 2002 2001 2000 1999 1998 ------------- ------------- ------------- ------------ ------------- (In thousands except per share amounts and ratios) Total Operating Revenues............................... $1,095,009 $2,250,466 $1,511,539 $1,092,445 $1,111,343 Earnings from Continuing Operations.................... $ 64,272 $ 150,433 $ 100,946 $ 79,614 $ 95,119 Net Earnings........................................... $ 64,272 $ 150,433 $ 100,946 $ 83,155 $ 82,682 Earnings per Common Share: Continuing Operations................................ $ 1.63 $ 3.83 $ 2.54 $ 1.93 $ 2.27 Basic................................................ $ 1.63 $ 3.83 $ 2.54 $ 2.01 $ 1.97 Diluted.............................................. $ 1.61 $ 3.77 $ 2.53 $ 2.01 $ 1.95 Cash Flow Data: Net cash flows provided from operating activities.... $ 97,251 $ 327,346 $ 239,515 $ 213,045 $ 210,988 Net cash flows used in investing activities.......... $ (200,427) $ (407,014) $ (157,500) $ (55,886) $ (340,992) Net cash flows generated (used) by financing activities........................... $ 78,470 $ 385 $ (94,723) $ (98,040) $ 173,089 Total Assets........................................... $3,026,907 $2,913,788 $2,889,917 $2,723,268 $2,668,603 Long-Term Debt, including current maturities........... $ 980,092 $ 953,884 $ 953,823 $ 988,489 $1,008,614 Common Stock Data: Market price per common share at year end............ $ 23.820 $ 27.950 $ 26.813 $ 16.250 $ 20.438 Book value per common share at year end.............. $ 24.90 $ 25.87 $ 23.42 $ 21.79 $ 20.63 Average number of common shares outstanding.......... 39,118 39,118 39,487 41,038 41,774 Cash dividend declared per common share.............. $ 0.88 $ 0.80 $ 0.80 $ 1.00 $ 0.60 Return on Average Common Equity...................... 6.2 % 14.8 % 11.1 % 9.5 % 9.9 % Capitalization: Common stock equity.................................. 49.2 % 50.8 % 48.6 % 46.7 % 45.4 % Preferred stock without mandatory redemption Requirements....................................... 0.7 0.6 0.7 0.7 0.7 Long-term debt, less current maturities.............. 50.1 48.6 50.7 52.6 53.9 ------------- ------------- ------------- ------------- ------------- 100.00 % 100.00 % 100.00 % 100.00 % 100.00 % ============= ============= ============= ============= ============= (See "Comparative Operating Statistics" which appear immediately following the Consolidated Financial Statements for additional information regarding operations.) Due to the discontinuance of the natural gas trading operations of PNM's Energy Services Business Unit in 1998, certain prior year amounts have been reclassified as discontinued operations. 9 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 PNM Resources, Inc. ("Holding Company") and its Subsidiaries and Public Service Company of New Mexico ("PNM") (collectively, the "Company") is presented on a combined basis. The Holding Company assumed substantially all of the corporate activities of PNM on December 31, 2001. These activities are billed to PNM on a cost basis to the extent they are for the corporate management of PNM. In January 2002, Avistar, Inc. ("Avistar") and certain inactive subsidiaries were transferred by way of a dividend to the Holding Company pursuant to an order from the New Mexico Public Regulation Commission ("PRC"). The reader of this 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 PNM Resources, Inc. and 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 PNM Resources, Inc. and its Subsidiaries under Generally Accepted Accounting Principles ("GAAP"). Broader operational discussion references 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, distribution and sale and marketing 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. Upon the completion on December 31, 2001 of a one-for-one share exchange between PNM and the Holding Company, the Holding Company became the parent company of PNM. Prior to the share exchange, the Holding Company had existed as a subsidiary of PNM. The new parent company began trading on the New York Stock Exchange under the same PNM symbol beginning on December 31, 2001. 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, the Company may purchase 10 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. As it currently operates, the Company's principal business segments are Utility Operations, Wholesale Operations ("Wholesale") and Corporate and Other. Utility Operations include Electric Services ("Electric") and Gas Services ("Gas"). Electric consists of the distribution, transmission and generation of electricity for retail customers in New Mexico. Gas includes the transportation and distribution of natural gas to end-users. Wholesale consists of the generation and sale of electricity into the wholesale market based on three product lines which are 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. RESULTS OF OPERATIONS Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Consolidated The Company's net earnings available to common shareholders for the year ended December 31, 2002 were $63.7 million, a 57.5% decrease in net earnings from $149.8 million in 2001. This decrease primarily reflects the slowdown in the wholesale electric market, where both prices and market liquidity were significantly lower than the prior year. Despite the slowdown in the wholesale electric market, PNM's electric utility operations recorded a gross margin growth of 3.3%. This growth came from a combination of load growth and utilization of lower cost generation demonstrating the balance the regulated utility provides in the Company's "merchant utility" strategy. 11 The following discussion is based on the financial information presented in the Consolidated Financial Statements - Segment Note as updated in this Form 8-K (see Note (2)). Corporate allocations, income taxes and non-operating items are discussed only on a consolidated basis. Utility Operations The following presentation sets forth the operating results for Electric (inclusive of transmission activities) for fiscal year 2002 compared to 2001. Subsequent to filing the Form 10-Q for the quarter ended March 31, 2003, the Company changed the segment reporting for Utility Operations to disaggregate its presentation of Electric and transmission activities ("Transmission"). Based on this change, set forth below also is a presentation of the operating results for Electric (without Transmission) and for Transmission, in each case for the fiscal year 2002 compared to 2001. Electric The table below sets forth the operating results for Electric. Year Ended December 31, --------------------------------- 2002 2001 Variance -------------- -------------- ------------- (In thousands) Operating revenues............................... $570,089 $559,226 $10,863 Less: Cost of energy............................. 166,101 162,884 3,217 Energy transfer........................... (28,037) (21,999) (6,038) -------------- -------------- -------------- Gross margin..................................... 432,025 418,341 13,684 -------------- -------------- -------------- Energy production costs.......................... 116,260 121,277 (5,017) Transmission and distribution O&M................ 34,517 37,853 (3,336) Customer related expense......................... 17,480 19,388 (1,908) Administrative and general....................... 7,344 10,553 (3,209) -------------- -------------- -------------- Total non-fuel O&M............................. 175,601 189,071 (13,470) Corporate allocation............................. 56,116 59,084 (2,968) Depreciation and amortization.................... 71,210 66,680 4,530 Taxes other than income taxes.................... 20,823 18,524 2,299 Income taxes..................................... 29,605 19,230 10,375 -------------- -------------- -------------- Total non-fuel operating expenses.............. 353,355 352,589 766 -------------- -------------- -------------- Operating income................................. $78,670 $65,752 $12,918 -------------- -------------- -------------- 12 The following table shows electric revenues by customer class and average customers: Electric Revenues Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- -------------- -------------- (In thousands) Residential.............. $ 197,174 $ 187,600 $9,574 Commercial............... 247,800 242,372 5,428 Industrial............... 82,009 82,752 (743) Transmission............. 23,150 26,553 (3,403) Other.................... 19,956 19,949 7 -------------- -------------- -------------- $ 570,089 $ 559,226 $10,863 ============== ============== ============== Average customers........ 384,478 377,589 6,889 ============== ============== ============== The following table shows electric sales by customer class: Electric Sales (Megawatt hours) Year Ended December 31, -------------------------------- 2002 2001 Variance --------------- -------------- --------------- (In thousands) Residential........... 2,298,542 2,197,889 100,653 Commercial............ 3,254,576 3,213,208 41,368 Industrial............ 1,612,723 1,603,266 9,457 Other................. 240,665 240,934 (269) --------------- -------------- --------------- 7,406,506 7,255,297 151,209 =============== ============== =============== Operating revenues increased $10.9 million or 1.9% for the period to $570.1 million. Retail electricity delivery grew 2.1% to 7.4 million MWh in 2002 compared to 7.3 million MWh delivered in the prior year, resulting in increased revenues of $14.4 million year-over-year. This volume increase was the result of a weather-driven increase in consumption and continued customer growth. Year over year, customer growth was 1.8%. This increase in revenues was partially offset by a decrease of $3.4 million in revenues from third party sales of the Company's transmission capacity due to the slowdown in the wholesale market The gross margin, or operating revenues minus cost of energy sold, increased $13.7 million or 3.3%, which reflects the increased energy sales and the utilization of lower cost purchased power to serve jurisdictional needs based on a change in negotiated contract rates. Total non-fuel O&M decreased $13.5 million or 7.1%. Energy production costs decreased $5.0 million or 4.1% for the period reflecting the benefits of $2.0 million for the acceleration into 2001 of a planned outage at San Juan Generating Station ("SJGS"), decreased costs of $3.0 million for planned outages at SJGS and an adjustment of $3.1 million to prior year Palo Verde Nuclear 13 Generating Station ("PVNGS") billings from Arizona Public Service Company, the operator of PVNGS. These cost decreases were partially offset by severance costs of $1.4 million at PVNGS and Four Corners Power Plant ("Four Corners") and costs of $1.2 million for planned and unplanned outages at Four Corners. Transmission and distribution costs decreased $3.3 million or 8.8% primarily due to maintenance performed in 2001 to improve system reliability, which did not recur in 2002. Customer related expense decreased $1.9 million or 9.8% due to lower bad debt expense as a result of collection improvements and the absence of losses from the bankruptcy of a significant customer in 2001. Administrative and other costs decreased $3.2 million or 30.4% due to an adjustment of $1.4 million to prior year SJGS participant billings (the Company is the operator of SJGS and shares costs with other owners) and lower labor due to the transfer of employees from Electric to Corporate. Depreciation and amortization increased $4.5 million or 6.8% for the year due to the purchase of transmission plant assets in early 2002 and a higher depreciable base. Taxes other than income increased $2.3 million or 12.4% reflecting adjustments recorded in the prior year for favorable audit outcomes by certain tax authorities. Electric (without Transmission) The table below sets forth the operating results for Electric. Year Ended December 31, --------------------------------- 2002 2001 Variance -------------- -------------- ------------- (In thousands) Operating revenues............................... $546,939 $532,673 $14,266 Less: Cost of energy............................. 194,163 189,055 5,108 Energy transfer........................... (28,037) (21,999) (6,038) -------------- -------------- -------------- Gross margin..................................... 380,813 365,617 15,196 -------------- -------------- -------------- Energy production costs.......................... 115,570 120,353 (4,783) Distribution O&M................................. 19,986 20,712 (726) Customer related expense......................... 17,480 19,388 (1,908) Administrative and general....................... 4,995 8,398 (3,403) -------------- -------------- -------------- Total non-fuel O&M............................. 158,031 168,851 (10,820) Corporate allocation............................. 51,425 54,488 (3,063) Depreciation and amortization.................... 62,514 59,352 3,162 Taxes other than income taxes.................... 18,354 16,272 2,082 Income taxes..................................... 24,934 13,788 11,146 -------------- -------------- -------------- Total non-fuel operating expenses.............. 315,258 312,751 2,507 -------------- -------------- -------------- Operating income................................. $65,555 $52,866 $12,689 -------------- -------------- -------------- 14 The following table shows electric revenues by customer class and average customers: Electric Revenues Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- -------------- -------------- (In thousands) Residential................ $ 197,174 $ 187,600 $9,574 Commercial................. 247,800 242,372 5,428 Industrial................. 82,009 82,752 (743) Other...................... 19,956 19,949 7 -------------- -------------- -------------- $ 546,939 $ 532,673 $14,266 ============== ============== ============== Average customers.......... 384,478 377,589 6,889 ============== ============== ============== The following table shows electric sales by customer class: Electric Sales (Megawatt hours) Year Ended December 31, -------------------------------- 2002 2001 Variance --------------- -------------- --------------- (In thousands) Residential................. 2,298,542 2,197,889 100,653 Commercial.................. 3,254,576 3,213,208 41,368 Industrial.................. 1,612,723 1,603,266 9,457 Other....................... 240,665 240,934 (269) --------------- -------------- --------------- 7,406,506 7,255,297 151,209 =============== ============== =============== Operating revenues increased $14.3 million or 2.7% for the period to $546.9 million. Retail electricity delivery grew 2.1% to 7.4 million MWh in 2002 compared to 7.3 million MWh delivered in the prior year, resulting in increased revenues of $14.4 million year-over-year. This volume increase was the result of a weather-driven increase in consumption and continued customer growth. Year over year, customer growth was 1.8%. The gross margin, or operating revenues minus cost of energy sold, increased $15.2 million or 4.2%, which reflects the increased energy sales and the utilization of lower cost purchased power to serve jurisdictional needs based on a change in negotiated contract rates. Electric exclusively purchases transmission services from Transmission. These intercompany revenues and expenses are eliminated in the consolidated results. Total non-fuel O&M decreased $10.8 million or 6.4%. Energy production costs decreased $4.8 million or 4.0% for the period reflecting the benefits of $2.0 million for the acceleration into 2001 of a planned outage at SJGS, decreased costs of $3.0 million for planned outages at SJGS and an adjustment of $3.1 million to prior year Palo Verde Nuclear Generating Station ("PVNGS") billings from Arizona Public Service Company, the operator of PVNGS. These cost 15 decreases were partially offset by severance costs of $1.4 million at PVNGS and Four Corners Power Plant ("Four Corners") and costs of $1.2 million for planned and unplanned outages at Four Corners. Distribution costs decreased $0.7 million or 3.5% primarily due to maintenance performed in 2001 to improve system reliability, which did not recur in 2002. Customer related expense decreased $1.9 million or 9.8% due to lower bad debt expense as a result of collection improvements and the absence of losses from the bankruptcy of a significant customer in 2001. Administrative and other costs decreased $3.4 million or 40.5% due to an adjustment of $1.4 million to prior year SJGS participant billings and lower labor due to the transfer of employees from Electric to Corporate. Depreciation and amortization increased $3.2 million or 5.3% for the year due to a higher depreciable plant base. Taxes other than income increased $2.1 million or 12.8% reflecting adjustments recorded in the prior year for favorable audit outcomes by certain tax authorities. Transmission The table below sets forth the operating results for Transmission. Year Ended December 31, ----------------------------------- 2002 2001 Variance ---------------- ---------------- -------------- (In thousands) Operating revenues External customers............................. $23,150 $26,553 $ (3,403) Intersegment revenues.......................... 31,950 31,273 677 ---------------- ---------------- -------------- Total revenues............................... 55,100 57,826 (2,726) Cost of energy................................... 3,888 5,102 (1,214) ---------------- ---------------- -------------- Gross margin..................................... 51,212 52,724 (1,512) ---------------- ---------------- -------------- Energy production costs.......................... 690 924 (234) Transmission O&M ................................ 14,531 17,141 (2,610) Administrative and general....................... 2,349 2,155 194 ---------------- ---------------- -------------- Total non-fuel O&M............................. 17,570 20,220 (2,650) ---------------- ---------------- -------------- Corporate allocation............................. 4,691 4,596 95 Depreciation and amortization.................... 8,696 7,328 1,368 Taxes other than income taxes.................... 2,469 2,252 217 Income taxes..................................... 4,671 5,442 (771) ---------------- ---------------- -------------- Total non-fuel operating expenses.............. 38,097 39,838 (1,741) ---------------- ---------------- -------------- Operating income................................. $13,115 $12,886 $ 229 ---------------- ---------------- -------------- Operating revenues decreased $2.7 million or 4.7% and gross margin decreased $1.5 million or 2.9% primarily due to a decrease in third party sales of the Company's transmission capacity due to the slowdown in the wholesale market. Total non-fuel O&M decreased $2.7 million or 13.1%. Transmission costs decreased $2.6 million or 15.2% primarily due to maintenance performed in 2001 to improve system reliability, which did not recur in 2002. Depreciation and amortization increased $1.4 million or 18.7% for the year due to the purchase of transmission plant assets in early 2002. 16 Gas The table below sets forth the operating results for Gas. Year Ended December 31, --------------------------------- 2002 2001 Variance --------------- -------------- --------------- (In thousands) Operating revenues............................... $272,118 $385,418 $(113,300) Cost of energy................................... 139,045 251,296 (112,251) --------------- -------------- --------------- Gross margin..................................... 133,073 134,122 (1,049) --------------- -------------- --------------- Energy production costs.......................... 1,936 1,946 (10) Distribution O&M................................. 29,306 31,064 (1,758) Customer related expense......................... 16,604 19,814 (3,210) Administrative and general....................... 4,247 6,736 (2,489) --------------- -------------- --------------- Total non-fuel O&M............................. 52,093 59,560 (7,467) Corporate allocation............................. 31,316 30,908 408 Depreciation and amortization.................... 20,718 20,362 356 Taxes other than income taxes.................... 7,751 6,768 983 Income taxes..................................... 3,028 1,867 1,161 --------------- -------------- --------------- Total non-fuel operating expenses.............. 114,906 119,465 (4,559) --------------- -------------- --------------- Operating income................................. $18,167 $14,657 $ 3,510 --------------- -------------- --------------- The following table shows gas revenues by customer and average customers: Gas Revenues Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- -------------- -------------- (In thousands) Residential............. $ 172,200 $ 232,321 $(60,121) Commercial.............. 52,530 68,895 (16,365) Industrial.............. 2,872 27,519 (24,647) Transportation*......... 17,735 20,188 (2,453) Other................... 26,781 36,495 (9,714) -------------- -------------- -------------- $ 272,118 $ 385,418 $(113,300) ============== ============== ============== Average customers....... 443,396 434,591 8,805 ============== ============== ============== 17 The following table shows gas throughput by customer class: Gas Throughput Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- --------------- -------------- (Thousands of decatherms) Residential................ 29,627 27,848 1,779 Commercial................. 12,009 10,421 1,588 Industrial................. 749 3,920 (3,171) Transportation*............ 44,889 51,395 (6,506) Other...................... 4,806 4,355 451 -------------- --------------- -------------- 92,080 97,939 (5,859) ============== =============== ============== * Customer owned gas Operating revenues decreased $113.3 million or 29.4% for the period to $272.1 million, primarily because of lower natural gas prices in 2002 as compared to 2001 and a decrease in gas sales volumes of 6.0%, largely resulting from fewer purchases from Electric and Wholesale to support gas-fired generation. Despite the volume decline, customer growth was approximately 2.0%. 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 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 $1.0 million or 0.8%. This decrease is due mainly to lower consumption of gas for electric generation of $6.0 million partially offset by a 2.0% growth in customer base of $5.0 million. Gross margin is expected to decrease in 2003 due to the expiration of a rate rider in January 2003. 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. The Company's last gas rate case filing was in October 1997. Total non-fuel O&M decreased $7.5 million or 12.5%. Distribution costs decreased $1.8 million or 5.7% primarily due to maintenance performed in 2001 to improve system reliability, which did not recur in 2002. Customer related expense decreased $3.2 million or 16.2% due to lower bad debt expense because of collection improvements and the absence of losses from the bankruptcy of a significant customer in 2001. Administrative and other costs decreased $2.5 million due to lower amortization costs of $1.2 million for SFAS 106 deferred costs (which were fully amortized in 2001), and lower consulting expenses of $0.5 million in connection with cost control and process improvement initiatives in 2001 and lower legal expenses of $0.5 million for routine business matters. Taxes other than income taxes increased $1.0 million or 14.5% due to the absence of favorable audit outcomes by certain tax authorities recognized in 2001. 18 Wholesale The table below sets forth the operating results for Wholesale. Year Ended December 31, ----------------------------------- 2002 2001 Variance ---------------- -------------- ---------------- (In thousands) Operating revenues............................. $251,398 $1,304,284 $(1,052,886) Less: Cost of energy.......................... 170,110 1,020,754 (850,644) Energy Transfer..................... 28,037 21,999 6,038 ---------------- --------------- ---------------- Gross margin................................... 53,251 261,531 (208,280) ---------------- --------------- ---------------- Energy production costs........................ 31,377 29,309 2,068 Customer related expense....................... 646 821 (175) Administrative and general..................... 4,514 4,748 (234) ---------------- --------------- ---------------- Total non-fuel O&M........................... 36,537 34,878 1,659 Corporate allocation........................... 3,777 4,042 (265) Depreciation and amortization.................. 6,055 5,774 281 Taxes other than income taxes.................. 2,609 2,498 111 Income taxes................................... (4,147) 78,102 (82,249) ---------------- --------------- ---------------- Total non-fuel operating expenses............ 44,831 125,294 (80,463) ---------------- --------------- ---------------- Operating income............................... $ 8,420 $ 136,237 $ (127,817) ---------------- --------------- ---------------- The following table shows revenues by customer class: Wholesale Revenues Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- -------------- --------------- (In thousands) Long-term contracts....... $ 40,132 $ 77,250 $ (37,118) Other merchant sales...... 192,968 1,224,388 (1,031,420) Other..................... 18,298 2,646 15,652 -------------- -------------- --------------- $251,398 $1,304,284 $(1,052,886) ============== ============== =============== The following table shows sales by customer class: Wholesale Sales Year Ended December 31, -------------------------------- 2002 2001 Variance -------------- --------------- -------------- (Megawatt hours) Long-term contracts....... 844,168 1,463,031 (618,863) Other merchant sales...... 7,269,242 10,596,004 (3,326,762) -------------- --------------- -------------- 8,113,410 12,059,035 (3,945,625) ============== =============== ============== 19 Operating revenues declined $1.1 billion or 80.7% for the year to $251.4 million. This decrease in wholesale electricity sales primarily reflects the slowdown in the wholesale electric market, which resulted from steep declines in wholesale prices and market liquidity as compared to the prior year period. The significantly higher wholesale pricing in 2001 was driven by increased demand in California, a lack of generating assets to serve the market and the impact of warm weather. By contrast, 2002 has seen relatively mild weather in the West, an abundance of low cost hydropower and weak economic conditions in the region. As a result, the average price realized by the Company fell to approximately $31 per MWh in 2002 versus $108 per MWh in 2001. The low wholesale prices are expected to continue into 2003. The decline in merchant sales volumes reflect the reduction in market participants in the wholesale market caused by bankruptcy, reduced credit quality of firms in the market and firms exiting the wholesale market. There are also significant unresolved legal, political and regulatory issues that had a dampening effect on activity in the marketplace. As a result, the Company's spot market and short-term sales have declined significantly. The Company delivered wholesale (bulk) power of 8.1 million MWh of electricity for the year ended December 31, 2002, compared to 12.1 million MWh for the same period in 2001. Although other firms have exited the wholesale market or have had their access to the wholesale market limited due to concerns over credit quality, the Company remains committed to be a participant in this market place. While market liquidity is weak, the Company will focus on long-term relationships with smaller wholesale customers (small investor-owned utilities, municipal utilities and co-ops). At the same time, the Company will continue to monitor market conditions. This commitment to the wholesale market leaves the Company poised to participate in the market as liquidity returns and regulatory issues are resolved. The gross margin, or operating revenues minus cost of energy sold, decreased $208.3 million or 79.6%. Lower margins were created primarily by weak pricing, less price volatility and lower market liquidity. In addition, unexpected outages at Four Corners reduced availability of power for wholesale sales. These lower margins were partially offset by a favorable change in the mark-to-market position of the marketing portfolio of $55.3 million year-over-year ($29.5 million gain in 2002 versus $25.8 million loss in 2001). A majority of the gain in 2002 represents the reversal of previously recognized mark-to-market losses. Total non-fuel O&M increased $1.7 million or 4.8%. Energy production costs increased $2.1 million or 7.1% for the period due to costs of $4.0 million related to the future expansion of Afton Generating Station ("Afton). This cost increase was partially offset by the benefits of $0.3 million for the acceleration into 2001 of a planned outage at SJGS, decreased costs of $0.5 million for planned outages at SJGS and an adjustment of $0.5 million to prior year Palo Verde Nuclear Generating Station ("PVNGS") billings from Arizona Public Service Company, the operator of PVNGS. 20 Corporate and Other Corporate administrative and general costs, which represent costs that are driven primarily by corporate-level activities, increased $3.3 million or 3.6% for the period to $95.1 million. This increase was due to severance costs of $8.8 million resulting from a realignment of the Company's business structure (the "Realignment"), higher labor of $8.2 million resulting from a transfer of employees from operations to corporate and outside services of $2.9 million primarily related to audit and other consulting services. These increases were partially offset by lower bonus expense of $11.9 million in the current year resulting from lower earnings projections and lower costs of $4.6 million resulting from the reduction of certain unregulated activities. In accordance with EITF 94-3, Liability Recognition for Certain Employee - Termination Benefits and other Costs to Exit an Activity ("EITF 94-3"), the Company incurred a liability of $8.8 million for severance and other related costs associated with the involuntary termination of employees in connection with the realignment. As of December 31, 2002, $3.0 million of severance-related benefits were paid and charged against the liability. Consolidating Non-Operating Other Income and Deductions Other income decreased by $3.8 million or 7.3% reflecting lower year-over-year returns on investments reflecting market conditions. Other deductions decreased $54.9 million or 81.7% primarily due to charges in 2001 that did not recur in 2002. In 2001, the Company recognized charges for the write-off of an Avistar investment of $13.1 million, the write-off of non-recoverable coal mine decommissioning costs of $13.0 million, non-recoverable regulatory costs of $11.1 million, a contribution to the PNM Foundation of $5.0 million, and certain costs related to the Company's now terminated acquisition of Western Resources' electric utility operations of $18.0 million. In 2002, the Company recognized a gain from the reversal of a reserve of $2.4 million to reflect the early, successful resolution of the litigation stemming from the terminated Western Resources transaction and a charge of $4.8 million for the cancellation of a transmission line project. Income Taxes The Company's consolidated income tax expense was $33.0 million for the year ended December 31, 2002, compared to $81.1 million for the year ended December 31, 2001. The decrease was due to the impact of lower earnings and a decline in the effective tax rate. The Company's effective income tax rates for the years ended December 31, 2002 and 2001 were 33.95% and 35.02%, respectively. The decrease in the effective rate year over year was due to the reduction in earnings in 2002 without a corresponding reduction in permanent tax benefits and the recognition of certain affordable housing and research and development credits in 2002. 21 Year Ended December 31, 2001 Compared to Year Ended December 31, 2000 Consolidated The Company's net earnings available to common shareholders for the year ended December 31, 2001 were $149.8 million, a 49.3% increase over net earnings of $100.4 million in 2000. This increase reflects strong market pricing and an active wholesale electric market in the Western United States in the first half of 2001 and continuing growth in utility operations. The following discussion is based on the financial information presented in the Consolidated Financial Statements - Segment Note as updated in this Form 8-K (see Note (2)). Corporate allocations, income taxes and non-operating items are discussed only on a consolidated basis. Utility Operations The following presentation sets forth the operating results for Electric (inclusive of transmission activities) for fiscal year 2002 compared to 2001. Subsequent to filing the Form 10-Q for the quarter ended March 31, 2003, the Company changed the segment reporting for Utility Operations to disaggregate its presentation of Electric and transmission activities ("Transmission"). Based on this change, set forth below also is a presentation of the operating results for Electric (without Transmission) and for Transmission, in each case for the fiscal year 2001 compared to 2000. Electric The table below sets forth the operating results for Electric. Year Ended December 31, --------------------------------- 2001 2000 Variance --------------- -------------- -------------- (In thousands) Operating revenues............................... $559,226 $538,683 $ 20,543 Less: Cost of energy............................. 162,884 132,244 30,640 Energy transfer........................... (21,999) (22,064) 65 --------------- -------------- -------------- Gross margin..................................... 418,341 428,503 (10,162) --------------- -------------- -------------- Energy production costs.......................... 121,277 109,955 11,322 Transmission and distribution O&M................ 37,853 33,084 4,769 Customer related expense......................... 19,388 21,040 (1,652) Administrative and general....................... 10,553 9,222 1,331 --------------- -------------- -------------- Total non-fuel O&M............................. 189,071 173,301 15,770 Corporate allocation............................. 59,084 49,684 9,400 Depreciation and amortization.................... 66,680 62,457 4,223 Taxes other than income taxes.................... 18,524 18,129 395 Income taxes..................................... 19,230 34,734 (15,504) --------------- -------------- -------------- Total non-fuel operating expenses.............. 352,589 338,305 14,284 --------------- -------------- -------------- Operating income................................. $65,752 $90,198 $(24,446) --------------- -------------- -------------- 22 The following table shows electric revenues by customer class and average customers: Electric Revenues Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- -------------- -------------- (In thousands) Residential.................. $ 187,600 $ 186,133 $ 1,467 Commercial................... 242,372 238,243 4,129 Industrial................... 82,752 79,671 3,081 Transmission................. 26,553 16,855 9,698 Other........................ 19,949 17,781 2,168 -------------- -------------- -------------- $ 559,226 $ 538,683 $ 20,543 ============== ============== ============== Average customers............ 377,589 368,506 9,083 ============== ============== ============== The following table shows electric sales by customer class: Electric Sales (Megawatt hours) Year Ended December 31, -------------------------------- 2001 2000 Variance --------------- -------------- --------------- (In thousands) Residential............ 2,197,889 2,171,945 25,944 Commercial............. 3,213,208 3,133,996 79,212 Industrial............. 1,603,266 1,544,367 58,899 Other.................. 240,934 238,635 2,299 --------------- -------------- --------------- 7,255,297 7,088,943 166,354 =============== ============== =============== Operating revenues increased $20.5 million or 3.8% for the period to $559.2 million. Retail electricity delivery grew 2.3% to 7.3 million MWh in 2001 compared to 7.1 million MWh delivered in the prior year, resulting in increased revenues of $8.9 million year-over-year. This volume increase was the result of load growth from economic expansion in New Mexico. In addition, revenues from third party use of the Company's transmission system increased $9.7 million as a result of additional contracts from increased activity in the Western power market. Revenues also benefited from a $1.1 million increase in revenue from property leasing. The gross margin, or operating revenues minus cost of energy sold, decreased $10.2 million or 2.4% due to higher cost for the electricity sold to retail customers resulting from increased use of higher cost generation. In 2001, the Company experienced outages at its coal and nuclear facilities, which required it to increase its operations at Reeves Generating Station ("Reeves"), one of the Company's gas generation facilities, which has a higher cost of production. This decrease was partially offset by increased energy sales, transmission revenues and property leasing revenue. 23 Total non-fuel O&M increased $15.8 million or 9.1%. Energy production costs increased $11.3 million or 10.3% for the year. The increase is primarily due to higher maintenance costs of $6.8 million in 2001 resulting from scheduled and unscheduled outages at PVNGS, SJGS and Reeves, additional incentive bonuses of $0.4 million at SJGS, and increased operations costs of $1.0 million for generation at Reeves, one of the Company's gas generation facilities, which has a higher cost of production than the Company's coal and nuclear facilities. This increase was partially offset by lower maintenance costs of $1.1 million at Four Corners as a result of decreased outage time. A significant unscheduled outage occurred in the fall of 2001 at SJGS, which resulted in higher costs of $2.0 million in 2001. The Company took advantage of the outage to accelerate its outage scheduled for the spring of 2002. As a result, maintenance costs and the related lost market potential of the accelerated outage, was avoided in the spring of 2002. Transmission and distribution costs increased $4.8 million or 14.4% primarily due to a non-recurring increase in maintenance to improve reliability for the transmission and distribution systems. Customer related expense decreased $1.7 million or 7.9% due to lower bad debt and collection expense. By December 2000, the Company had resolved most of the problems associated with implementing its new billing system. As a result, bad debt expense was significantly lower in 2001. Administrative and general costs increased $1.3 million or 14.4% for the period due to consulting expenses focused on cost control and process improvement initiatives. Depreciation and amortization increased $4.2 million or 6.8% due to a higher depreciable plant base. Electric (without Transmission) The table below sets forth the operating results for Electric. Year Ended December 31, --------------------------------- 2001 2000 Variance --------------- -------------- -------------- (In thousands) Operating revenues............................... $532,673 $521,828 $ 10,845 Less: Cost of energy............................. 189,055 156,334 32,721 Energy transfer........................... (21,999) (22,064) 65 --------------- -------------- -------------- Gross margin..................................... 365,617 387,558 (21,941) --------------- -------------- -------------- Energy production costs.......................... 120,353 108,747 11,606 Distribution O&M................................. 20,712 18,780 1,932 Customer related expense......................... 19,388 21,040 (1,652) Administrative and general....................... 8,398 7,198 1,200 --------------- -------------- -------------- Total non-fuel O&M............................. 168,851 155,765 13,086 Corporate allocation............................. 54,488 45,973 8,515 Depreciation and amortization.................... 59,352 54,429 4,923 Taxes other than income taxes.................... 16,272 15,526 746 Income taxes..................................... 13,788 32,867 (19,079) --------------- -------------- -------------- Total non-fuel operating expenses.............. 312,751 304,560 8,191 --------------- -------------- -------------- Operating income................................. $52,866 $82,998 $(30,132) --------------- -------------- -------------- 24 The following table shows electric revenues by customer class and average customers: Electric Revenues Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- -------------- -------------- (In thousands) Residential........... $ 187,600 $ 186,133 $ 1,467 Commercial............ 242,372 238,243 4,129 Industrial............ 82,752 79,671 3,081 Other................. 19,949 17,781 2,168 -------------- -------------- -------------- $ 532,673 $ 521,828 $ 10,845 ============== ============== ============== Average customers..... 377,589 368,506 9,083 ============== ============== ============== The following table shows electric sales by customer class: Electric Sales (Megawatt hours) Year Ended December 31, -------------------------------- 2001 2000 Variance --------------- -------------- --------------- (In thousands) Residential............. 2,197,889 2,171,945 25,944 Commercial.............. 3,213,208 3,133,996 79,212 Industrial.............. 1,603,266 1,544,367 58,899 Other................... 240,934 238,635 2,299 --------------- -------------- --------------- 7,255,297 7,088,943 166,354 =============== ============== =============== Operating revenues increased $10.8 million or 2.1% for the period to $532.7 million. Retail electricity delivery grew 2.3% to 7.3 million MWh in 2001 compared to 7.1 million MWh delivered in the prior year, resulting in increased revenues of $8.9 million year-over-year. This volume increase was the result of load growth from economic expansion in New Mexico. Revenues also benefited from a $1.1 million increase in revenue from property leasing. The gross margin, or operating revenues minus cost of energy sold, decreased $21.9 million or 5.7% due to higher cost for the electricity sold to retail customers resulting from increased use of higher cost generation. In 2001, the Company experienced outages at its coal and nuclear facilities, which required it to increase its operations at Reeves, one of the Company's gas generation facilities, which has a higher cost of production. This decrease was partially offset by increased energy sales, transmission revenues and property leasing revenue. Electric exclusively purchases transmission services from Transmission. These intercompany revenues and expenses are eliminated in the consolidated results. 25 Total non-fuel O&M increased $13.1 million or 8.4%. Energy production costs increased $11.6 million or 10.7% for the year. The increase is primarily due to higher maintenance costs of $6.8 million in 2001 resulting from scheduled and unscheduled outages at PVNGS, SJGS and Reeves, additional incentive bonuses of $0.4 million at SJGS, and increased operations costs of $1.0 million for generation at Reeves, one of the Company's gas generation facilities, which has a higher cost of production than the Company's coal and nuclear facilities. This increase was partially offset by lower maintenance costs of $1.1 million at Four Corners as a result of decreased outage time. A significant unscheduled outage occurred in the fall of 2001 at SJGS, which resulted in higher costs of $2.0 million in 2001. The Company took advantage of the outage to accelerate its outage scheduled for the spring of 2002. As a result, maintenance costs and the related lost market potential of the accelerated outage, was avoided in the spring of 2002. Distribution costs increased $1.9 million or 10.3% primarily due to a non-recurring increase in maintenance to improve reliability for the transmission and distribution systems. Customer related expense decreased $1.7 million or 7.9% due to lower bad debt and collection expense. By December 2000, the Company had resolved most of the problems associated with implementing its new billing system. As a result, bad debt expense was significantly lower in 2001. Administrative and general costs increased $1.2 million or 16.7% for the period due to consulting expenses focused on cost control and process improvement initiatives. Depreciation and amortization increased $4.9 million or 9.1% due to a higher depreciable plant base. Taxes other than income taxes increased $0.7 million or 4.8% due to the settlement of the Navajo possessory interest tax on Four Corners. Transmission The table below sets forth the operating results for Transmission. Year Ended December 31, ----------------------------------- 2001 2000 Variance ---------------- ---------------- -------------- (In thousands) Operating revenues External customers............................ $26,553 $16,855 $9,698 Intersegment revenues......................... 31,273 29,138 2,135 ---------------- ---------------- -------------- Total revenues............................. 57,826 45,993 11,833 Cost of energy................................... 5,102 5,048 54 ---------------- ---------------- -------------- Gross margin..................................... 52,724 40,945 11,779 ---------------- ---------------- -------------- Energy production costs.......................... 924 1,208 (284) Transmission O&M ................................ 17,141 14,304 2,837 Administrative and general....................... 2,155 2,024 131 ---------------- ---------------- -------------- Total non-fuel O&M......................... 20,220 17,536 2,684 Corporate allocation............................. 4,596 3,711 885 Depreciation and amortization.................... 7,328 8,028 (700) Taxes other than income taxes.................... 2,252 2,603 (351) Income taxes..................................... 5,442 1,867 3,575 ---------------- ---------------- -------------- Total non-fuel operating expenses.......... 39,838 33,745 6,093 ---------------- ---------------- -------------- Operating income................................. $12,886 $ 7,200 $ 5,686 ---------------- ---------------- -------------- Operating revenues increased $11.8 million or 25.7% and gross margin increased $11.8 million or 28.8% primarily due to increased third party use of the Company's transmission system as a result of additional contracts and sales to Electric from increased activity in the Western power market. 26 Total non-fuel O&M increased $2.7 million or 15.3%. Transmission costs increased $2.8 million or 19.8% primarily due to a non-recurring increase in maintenance to improve reliability for the transmission and distribution systems. Depreciation and amortization decreased $0.7 million due to a transfer of certain plant to generation in anticipation of restructuring the electric utility industry in New Mexico. Gas The table below sets forth the operating results for Gas. Year Ended December 31, ---------------------------------- 2001 2000 Variance --------------- ---------------- --------------- (In thousands) Operating revenues............................... $385,418 $319,924 $ 65,494 Cost of energy................................... 251,296 195,334 55,962 --------------- ---------------- --------------- Gross margin..................................... 134,122 124,590 9,532 --------------- ---------------- --------------- Energy production costs.......................... 1,946 1,485 461 Distribution O&M................................. 31,064 27,206 3,858 Customer related expense......................... 19,814 19,164 650 Administrative and general....................... 6,736 3,880 2,856 --------------- ---------------- --------------- Total non-fuel O&M............................. 59,560 51,735 7,825 Corporate allocation............................. 30,908 29,405 1,503 Depreciation and amortization.................... 20,362 16,132 4,230 Taxes other than income taxes.................... 6,768 6,728 40 Income taxes..................................... 1,867 3,762 (1,895) --------------- ---------------- --------------- Total non-fuel operating expenses.............. 119,465 107,762 11,703 --------------- ---------------- --------------- Operating income................................. $14,657 $16,828 $(2,171) --------------- ---------------- --------------- The following table shows gas revenues by customer and average customers: Gas Revenues Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- -------------- -------------- (In thousands) Residential............... $ 232,321 $ 191,231 $41,090 Commercial................ 68,895 52,964 15,931 Industrial................ 27,519 24,206 3,313 Transportation*........... 20,188 14,163 6,025 Other..................... 36,495 37,360 (865) -------------- -------------- -------------- $ 385,418 $ 319,924 $65,494 ============== ============== ============== Average customers......... 434,591 434,943 (352) ============== ============== ============== 27 The following table shows gas throughput by customer class: Gas Throughput Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- --------------- -------------- (Thousands of decatherms) Residential.............. 27,848 28,810 (962) Commercial............... 10,421 9,859 562 Industrial............... 3,920 5,038 (1,118) Transportation*.......... 51,395 44,871 6,524 Other.................... 4,355 6,426 (2,071) -------------- --------------- -------------- 97,939 95,004 2,935 ============== =============== ============== *Customer-owned gas. Operating revenues increased $65.5 million or 20.5% for the period to $385.4 million. The Company purchases natural gas in the open market and resells it at cost to its distribution customers. As a result, increased gas revenues driven by increased gas costs do not impact the Company's gross margin or earnings. The revenue increase was driven primarily by a 17.6% increase in average gas prices in the first half of 2001, resulting from increased market demand. In addition, a 3.1% volume increase and a gas rate increase, which became effective October 30, 2000 contributed to the increase. The gas rate increase added $7.8 million of revenue. Transportation volume increased 14.5% or $6.0 million. This growth was primarily attributed to gas transportation customers whose increased demand was driven by the strong power market in the Western United States during the first half of 2001. Approximately $28.1 million of gas revenue in 2001 was attributable to sales to Electric and Wholesale. The gross margin, or operating revenues minus cost of energy sold, increased $9.5 million or 7.7%. This increase is due to the rate increase and higher transportation volumes. Total non-fuel O&M increased $7.8 million or 15.1%. Distribution costs increased $3.9 million or 14.2% primarily due to a non-recurring increase in maintenance to improve reliability for the transmission and distribution systems, as the Company continues to focus on improving reliability and effectiveness of its retail distribution system. Customer related expense increased $0.7 million or 3.4% due to increased labor and expenses resulting from upgrades to the call center and increased collection efforts, partially offset by decreased bad debt expense as a result of improved bad debt controls. Administrative and general costs increased $2.9 million or 73.6% due to consulting expenses incurred in connection with cost control and process improvement initiatives. Depreciation and amortization increased $4.2 million or 26.2% for the period primarily resulting from the retrofit of the distribution system to make use of new technology which inspects the integrity of the system. 28 Wholesale The table below sets forth the operating results for Wholesale. Year Ended December 31, ----------------------------------- 2001 2000 Variance --------------- --------------- --------------- (In thousands) Operating revenues............................... $1,304,284 $650,699 $653,585 Less: Cost of energy............................ 1,020,754 522,493 498,261 Energy transfer....................... 21,999 22,064 (65) --------------- --------------- --------------- Gross margin..................................... 261,531 106,142 155,389 --------------- --------------- --------------- Energy production costs.......................... 29,309 28,458 851 Customer related expense......................... 821 5,341 (4,520) Administrative and general....................... 4,748 4,537 211 --------------- --------------- --------------- Total non-fuel O&M............................. 34,878 38,336 (3,458) Corporate allocation............................. 4,042 2,917 1,125 Depreciation and amortization.................... 5,774 5,491 283 Taxes other than income taxes.................... 2,498 2,600 (102) Income taxes..................................... 78,102 15,515 62,587 --------------- --------------- --------------- Total non-fuel operating expenses.............. 125,294 64,859 60,435 --------------- --------------- --------------- Operating income................................. $ 136,237 $ 41,283 $ 94,954 --------------- --------------- --------------- The following table shows revenues by customer class: Wholesale Revenues Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- -------------- -------------- (In thousands) Long-term contracts......... $ 77,250 $ 87,731 $(10,481) Other merchant sales........ 1,224,388 556,146 668,242 Other....................... 2,646 6,822 (4,176) -------------- -------------- -------------- $1,304,284 $ 650,699 $ 653,585 ============== ============== ============== The following table shows sales by customer class: Wholesale Sales Year Ended December 31, -------------------------------- 2001 2000 Variance -------------- --------------- -------------- (Megawatt hours) Long-term contracts.......... 1,463,031 330,003 1,133,028 Other merchant sales.......... 10,596,004 10,213,725 382,279 -------------- --------------- -------------- 12,059,035 10,543,728 1,515,307 ============== =============== ============== 29 A significant increase in regional wholesale electric prices occurred in the first half of 2001 and the second half of 2000. This increase was caused by, among other things, the power supply/demand imbalance in the Western United States, a lack of generating assets to serve the market and increased natural gas prices. The high wholesale prices seen in 2001 and 2000 did not recur in 2002. At the end of the second quarter of 2001, the market experienced declining price levels. This trend continued in the last half of 2001. As a result, market liquidity - the opportunity to buy and resell power profitably in the marketplace - also declined reflecting the bankruptcy of a major market participant and limited price volatility. Operating revenues grew $653.6 million or 100.4% for the period to $1.3 billion. This increase in wholesale electricity sales primarily reflects the strong regional wholesale electric prices in the first half of 2001. The Company delivered wholesale (bulk) power of 12.1 million MWh of electricity in 2002, compared to 10.5 million MWh in the prior period. The average price realized by the Company increased to approximately $108 per MWh in 2001 compared to $62 per MWh in 2000. The gross margin, or operating revenues minus cost of energy sold, increased $155.4 million or 146.4%. The Company's margin benefits significantly from rising gas prices as most of the Company's generation portfolio is fueled by stable priced fuel sources, such as coal and uranium. As the increase in gas prices puts upward pressure on electricity prices, the profitability of the Company's stable low-cost generation increases significantly. Margin also benefited from the Company's power marketing activities. The Company buys and then resells electricity in the market generating incremental margin by taking advantage of price changes in the electricity sales market. In addition, the Company also tailors electric deliveries for its wholesale customers creating incremental margin opportunities. Generally, as market prices decline, marketing volumes rise supporting margin levels in lower price electric markets. These higher margins were partially offset by an unfavorable change in the mark-to-market position of the marketing portfolio of $21.0 million year-over-year ($25.8 million loss in 2001 versus $4.8 million loss in 2000) as the Western power market deterioration in the latter half of 2001 resulted in a reduction of the Company's merchant energy portfolio. Total non-fuel O&M decreased $3.5 million or 9.0%. Energy production costs increased $0.9 million or 3.0% for the year. The increase is primarily due to higher maintenance costs of $1.1 million in 2001 resulting from scheduled and unscheduled outages at PVNGS, SJGS and Reeves Generating Station ("Reeves"). Customer related expense decreased $4.5 million or 84.6% due to lower year-over-year Wholesale business development costs due to significant costs related to the acquisition of a long-term wholesale customer in 2000. Avistar In July 2001, the Board of Directors of Avistar decided to wind down all unregulated operations except for Avistar's Reliadigm business unit, which provides maintenance solutions and technologies to the electric power industry. Avistar had previously divested itself of its Energy Partners business unit and liquidated Axon Field Services and Pathways Integration. This divestiture was largely in response to market disruptions caused by the California energy crisis. In addition, the transfer of operation of the Sangre de Cristo Water Company to the City of Santa Fe was completed in the third quarter of 2001. All 30 remaining non-Reliadigm investments were written-off with the exception of Avistar's investment in Nth Power, an energy related venture capital fund. These write-downs reflect the significant decline in the technology market and bankruptcy of these investees. The Company recorded non-operating charges of $13.1 million to reflect these activities and the impairment of its Avistar investments. Due to the cessation of much of Avistar's historic operations, business activity declined significantly. Revenues decreased 30.8% for the period to $1.5 million. Operating losses for Avistar decreased from $4.6 million in 2000 to $4.2 million in 2001 primarily due to decreased costs as a result of the shutdown of certain operations. In January 2002, Avistar was transferred by way of a dividend to Holding Company by PNM. Corporate and Other Corporate administrative and general costs, which represent costs that are driven exclusively by corporate-level activities, increased $11.3 million or 14.0% for the period to $91.9 million. This increase was due to increased pension and post-retirement benefits expense of $9.9 million and higher legal costs of $0.8 million associated with routine business operations. Consolidating Non-Operating Other Income and Deductions Other income decreased $14.1 million for the year. In 2000, the Company recognized a gain of $13.8 million related to the settlement of a lawsuit. Other deductions increased $55.3 million for the year. In 2001, the Company recorded charges of $13.1 million to write-off certain permanently impaired Avistar investments, $13.0 million of non-recoverable coal mine decommissioning costs previously established as a regulatory asset, non-recoverable regulatory costs of $11.1 million, a donation of $5.0 million to the PNM Foundation and a charge of $18.0 million related to the Company's terminated acquisition of Western Resources. In 2000, the Company recognized gains of $4.5 million for the reversal of certain reserves associated with the resolution of two gas rate claims and $2.4 million related to the Company's hedge of certain non-qualified retirement plan trust assets. In addition, in 2000, the Company recorded charges of $12.5 million related to the Company's terminated acquisition of Western Resources. Income Taxes The Company's consolidated income tax expense was $81.1 million in the twelve months ended December 31, 2001, an increase of $6.7 million for the year. This increase was due to higher earnings in 2001. The Company's effective income tax rates for the years ended 2001 and 2000 were 35.02% and 42.41%, respectively. In 2001, the Company determined that $6.6 million of valuation allowances taken against certain income tax related regulatory assets were no longer required due to changes in the evaluation of its regulatory strategy in light of the holding company filing in May 2001. In 2000, when the allowance was established, management believed these income-tax-related regulatory assets would not be recoverable based on the probable regulatory outcome of industry restructuring in New Mexico. Currently, management fully expects to recover these costs in future rate cases, a situation that was not possible prior to the 31 delay of open access in New Mexico. Excluding the impact of the valuation reserve changes, the Company's effective income tax rates for the years ended 2001 and 2000 were 37.85% and 38.67%, respectively. The decrease in the effective rate was primarily due to the favorable tax treatment received on 2001 equity earnings from a passive investment. NEW AND PROPOSED ACCOUNTING STANDARDS 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. The rescission of EITF 98-10 requires that energy contracts which do not meet the definition of a derivative under SFAS 133 no longer be marked to market and recognized in current earnings. As a result, all contracts which were marked to market under EITF 98-10 and must now be accounted for under the accrual method should be written back to cost with any difference included as a cumulative effect of a change in accounting principle in the period of adoption. This transition provision was effective January 1, 2003. The rescission of EITF 98-10 did not have a material impact on the Company's financial condition or results of operations as all contracts previously marked to market under the definition provided in EITF 98-10 also met the definition of a derivative under SFAS 133 and are properly recorded at fair value with gains and losses recorded in earnings. The Company reviewed its energy contract portfolio to determine whether its contracts meet the definition of trading activities under EITF 02-3. As a result, the Company has reclassified those contracts previously accounted for under EITF 98-10 to a net margin basis for the fiscal years ended December 31, 2002, 2001 and 2000. The Company will not report revenues and cost of energy sold on a net margin basis on a prospective basis as a result of the application of EITF 02-3 as none of the Company's marketing activities meet the definitions of trading activities as prescribed by EITF 02-3. The following table details wholesale electric revenues as reclassified under EITF 02-3. Energy trading margin is included in Electric Operating Revenues in the Statement of Earnings: Year Ended December 31, 2002 2001 2000 ------------- -------------- -------------- (In thousands) Wholesale revenues............................. $76,226 $60,982 $80,207 Wholesale purchases (EITF 02-3 adjustment)..... (73,987) (89,351) (99,735) ------------- -------------- -------------- Energy trading margin.......................... $ 2,239 $ (28,369) $ (19,528) ============= ============== ============== 32 DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS Statements made in this filing and other documents the Company files with the SEC that relate to future events or its 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 estimates and the Company assumes no obligation to update this information. Because actual results may differ materially from those expressed or implied by the forward-looking statements, the Company cautions readers not to place undue reliance on these statements. Factors that could cause actual results to differ, and that will affect the Company's future financial condition, cash flow and operating results include 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. For a detailed discussion of the important factors that affect the Company and that could cause actual results to differ from those expressed or implied by the Company's forward-looking statements, please see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's current and future Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q and also the Company's current and future Current Reports on Form 8-K, filed with the SEC. (Intentionally left blank) 33 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX Page Management's Responsibility for Financial Statements........................34 Report of Independent Auditors (PNM Resources, Inc.)........................36 Report of Independent Auditors (Public Service Company of New Mexico).......37 Financial Statements: PNM Resources, Inc. and Subsidiaries Consolidated Statements of Earnings..................................38 Consolidated Statements of Retained Earnings.........................39 Consolidated Balance Sheets..........................................40 Consolidated Statements of Cash Flows................................42 Consolidated Statements of Capitalization............................43 Consolidated Statements of Comprehensive Income/(Loss)...............44 Public Service Company of New Mexico Consolidated Statements of Earnings..................................45 Consolidated Statements of Retained Earnings.........................46 Consolidated Balance Sheets..........................................47 Consolidated Statements of Cash Flows................................49 Consolidated Statements of Capitalization............................50 Consolidated Statements of Comprehensive Income/(Loss)...............51 Notes to Consolidated Financial Statements...............................52 Supplementary Data: Quarterly Operating Results..............................................100 Comparative Operating Statistics.........................................101 Independent Auditors' Report.............................................103 Schedule I Condensed Financial Information of Parent Company.............106 Schedule II Valuation and Qualifying Accounts............................107 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS The accompanying financial statements of PNM Resources, Inc. and its subsidiaries and Public Service Company of New Mexico and its subsidiaries, a wholly owned subsidiary of PNM Resources, Inc., have been prepared in conformity with accounting principles generally accepted in the United States of America. The integrity and objectivity of data in these financial statements and accompanying notes, including estimates and judgments related to matters not concluded by year-end, are the responsibility of management as is all other information in this Annual Report. Management devotes ongoing attention to review and appraisal of its system of internal controls. This system is designed to provide reasonable assurance, at an appropriate cost, that PNM Resources, 34 Inc.'s and Public Service Company of New Mexico's assets are protected, that transactions and events are recorded properly and that financial reports are reliable. The system is augmented by a staff of corporate auditors; careful attention to selection and development of qualified financial personnel; and programs to further timely communication and monitoring of policies, standards and delegated authorities. The Audit and Ethics Committee of the Board of Directors of PNM Resources, Inc., composed entirely of outside directors, meets regularly with financial management, the corporate auditors and the independent auditors to review the work of each. The independent auditors and corporate auditors have free access to the Committee, without management representatives present, to discuss the results of their audits and their comments on the adequacy of internal controls and the quality of financial reporting. 35 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of PNM Resources, Inc. We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of PNM Resources, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of earnings, retained earnings, comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PNM Resources, Inc. and subsidiaries as of December 31, 2002 and 2001, and results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 16 to the consolidated financial statements, the Company adopted EITF 02-3 "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities," effective January 1, 2003. As discussed in Note 2 to the consolidated financial statements, effective January 1, 2003, the Company realigned its segments for financial reporting purposes. DELOITTE & TOUCHE LLP Omaha, Nebraska February 11, 2003 (June 5, 2003, as to Notes 2 and 16, as it relates to EITF 02-3) 36 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholder of Public Service Company of New Mexico We have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Public Service Company of New Mexico and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of earnings, retained earnings, comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Public Service Company of New Mexico and subsidiaries as of December 31, 2002 and 2001, and results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 16 to the consolidated financial statements, the Company adopted EITF 02-3 "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities," effective January 1, 2003. As discussed in Note 2 to the consolidated financial statements, effective January 1, 2003, the Company realigned its segments for financial reporting purposes. DELOITTE & TOUCHE LLP Omaha, Nebraska (June 5, 2003, as to Notes 2 and 16, as it relates to EITF 02-3) 37 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS Year Ended December 31, -------------------------------------------------- 2002 2001 2000 --------------- --------------- --------------- (In thousands, except per share amounts) Operating Revenues: (notes 1 and 2) Electric................................................. $ 821,487 $ 1,863,510 $ 1,189,457 Gas...................................................... 272,118 385,418 319,924 Unregulated businesses................................... 1,404 1,538 2,158 --------------- --------------- --------------- Total operating revenues.............................. 1,095,009 2,250,466 1,511,539 --------------- --------------- --------------- Operating Expenses: Cost of energy sold...................................... 476,066 1,434,934 850,145 Administrative and general............................... 146,231 155,392 147,268 Energy production costs.................................. 149,528 152,455 139,894 Depreciation and amortization............................ 102,409 96,936 93,059 Transmission and distribution costs...................... 63,870 69,001 60,330 Taxes, other than income taxes........................... 34,244 30,302 34,405 Income taxes (note 1 and 8).............................. 20,887 88,769 53,964 --------------- --------------- --------------- Total operating expenses.............................. 993,235 2,027,789 1,379,065 --------------- --------------- --------------- Operating income...................................... 101,774 222,677 132,474 --------------- --------------- --------------- Other Income and Deductions: Other income............................................. 48,360 52,147 66,246 Other deductions......................................... (12,306) (67,257) (11,950) Income tax (expense) benefit (notes 1 and 8)............ (12,144) 7,706 (20,382) --------------- --------------- --------------- Net other income and deductions....................... 23,910 (7,404) 33,914 --------------- --------------- --------------- Earnings before interest charges...................... 125,684 215,273 166,388 --------------- --------------- --------------- Interest Charges: Interest on long-term debt (note 4)...................... 56,409 62,716 62,823 Other interest charges................................... 5,003 2,124 2,619 --------------- --------------- --------------- Net interest charges.................................. 61,412 64,840 65,442 --------------- --------------- --------------- Net Earnings............................................... 64,272 150,433 100,946 Preferred Stock Dividend Requirements...................... 586 586 586 --------------- --------------- --------------- Net Earnings Applicable to Common Stock.................... $ 63,686 $ 149,847 $ 100,360 =============== =============== =============== Net Earnings per Share of Common Stock (Basic) (note 7).... $ 1.63 $ 3.83 $ 2.54 =============== =============== =============== Net Earnings per Share of Common Stock (Diluted) (note 7).. $ 1.61 $ 3.77 $ 2.53 =============== =============== =============== Dividends Paid per Share of Common Stock................... $ 0.86 $ 0.80 $ 0.80 =============== =============== =============== The accompanying notes are an integral part of these financial statements. 38 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Year Ended December 31, -------------------------------------------------- 2002 2001 2000 --------------- --------------- --------------- (In thousands) Balance at Beginning of Year............................. $ 415,388 $ 296,843 $ 227,828 Net earnings before preferred stock dividends.......... 64,272 150,433 100,946 Dividends (note 4): Cumulative preferred stock.......................... (586) (586) (586) Common stock........................................ (34,423) (31,302) (31,345) --------------- --------------- --------------- Balance at End of Year................................... $ 444,651 $ 415,388 $ 296,843 =============== =============== =============== The accompanying notes are an integral part of these financial statements. 39 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS As of December 31, ------------------------------- 2002 2001 --------------- ------------- (In thousands) Utility Plant: (notes 1, 11 and 12) Electric plant in service................................................... $2,301,673 $2,117,947 Gas plant in service........................................................ 615,907 575,350 Common plant in service and plant held for future use....................... 79,987 45,223 --------------- ------------- 2,997,567 2,738,520 Less accumulated depreciation and amortization.............................. 1,330,376 1,251,801 --------------- ------------- 1,667,191 1,486,719 Construction work in progress............................................... 173,248 246,278 Nuclear fuel, net of accumulated amortization of $16,568 and $16,954........ 26,832 26,940 --------------- ------------- Net utility plant........................................................ 1,867,271 1,759,937 --------------- ------------- Other Property and Investments: Other investments (notes 1, 6 and 12)....................................... 442,704 552,453 Non-utility property, net of accumulated depreciation of $1,750 and $1,580.. 1,528 1,784 --------------- ------------- Total other property and investments..................................... 444,232 554,237 --------------- ------------- Current Assets: Cash and cash equivalents................................................... 3,702 28,408 Accounts receivables, net of allowance for uncollectible accounts of $15,575 and $18,025.................................................. 76,850 84,620 Unbilled revenues (note 1).................................................. 49,079 62,377 Other receivables........................................................... 47,122 51,883 Inventories (note 1)........................................................ 37,230 36,483 Regulatory assets (note 3).................................................. 24,027 10,473 Short-term investments (note 1)............................................. 79,630 45,111 Other current assets........................................................ 32,753 33,243 --------------- ------------- Total current assets..................................................... 350,393 352,598 --------------- ------------- Deferred charges: Regulatory assets (note 3).................................................. 196,283 195,367 Prepaid retirement cost (note 9)............................................ 39,665 18,273 Other deferred charges...................................................... 129,063 33,376 --------------- ------------- Total deferred charges................................................... 365,011 247,016 --------------- ------------- $3,026,907 $2,913,788 =============== ============= The accompanying notes are an integral part of these financial statements. 40 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS CAPITALIZATION AND LIABILITIES As of December 31, ------------------------------- 2002 2001 --------------- -------------- (In thousands) Capitalization: Common stockholders' equity: Common stock outstanding--39,118 shares, no par value (note 4)........... $ 624,119 $625,632 Accumulated other comprehensive loss, net of tax......................... (94,721) (28,996) Retained earnings........................................................ 444,651 415,388 --------------- -------------- Total common stockholders' equity..................................... 974,049 1,012,024 Minority interest (notes 1 and 5).......................................... 11,760 11,652 Cumulative preferred stock without mandatory redemption requirements (note 4).................................................... 12,800 12,800 Long-term debt (note 4).................................................... 980,092 953,884 --------------- -------------- Total capitalization.................................................... 1,978,701 1,990,360 --------------- -------------- Current Liabilities: Short-term debt............................................................ 150,000 35,000 Accounts payable........................................................... 97,968 76,141 Accrued interest and taxes (notes 1 and 8)................................. 46,189 72,022 Other current liabilities.................................................. 99,019 149,454 --------------- -------------- Total current liabilities............................................... 393,176 332,617 --------------- -------------- Deferred Credits: Accumulated deferred income taxes (notes 1 and 8).......................... 125,595 120,153 Accumulated deferred investment tax credits (notes 1 and 8)................ 41,583 44,714 Regulatory liabilities (note 3)............................................ 52,019 54,295 Regulatory liabilities related to accumulated deferred income tax (note 3). 14,137 14,163 Accrued post-retirement benefit cost (note 9).............................. 17,335 14,929 Other deferred credits (note 13)........................................... 404,361 342,557 --------------- -------------- Total deferred credits.................................................. 655,030 590,811 --------------- -------------- Commitments and Contingencies (note 12)...................................... - - --------------- -------------- $3,026,907 $2,913,788 =============== ============== The accompanying notes are an integral part of these financial statements. 41 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, ---------------------------------------------- 2002 2001 2000 -------------- -------------- -------------- Cash Flows From Operating Activities: (In thousands) Net earnings...................................................... $ 64, 272 $150,433 $100,946 Adjustments to reconcile net earnings to net cash flows from operating activities: Depreciation and amortization................................. 115,415 106,768 103,829 Accumulated deferred investment tax credit.................... (3,131) (3,139) (3,143) Accumulated deferred income tax............................... 47,269 (32,927) 21,215 Asset write-offs.............................................. 4,817 24,079 - Write-off Avistar investments................................. - 12,417 - Non-recurring merger costs.................................... (2,436) 17,975 6,700 Net unrealized losses on trading and investment contracts..... (29,513) 26,172 370 Wholesale credit reserve...................................... - (5,406) 8,456 Other, net.................................................... 2,083 (4,297) (330) Changes in certain assets and liabilities: Accounts receivables........................................ 10,220 92,990 (90,680) Other assets................................................ (52,655) 32,481 (32,444) Accounts payable............................................ 23,660 (137,073) 107,346 Other liabilities........................................... (82,750) 46,873 17,250 -------------- -------------- -------------- Net cash flows provided by operating activities........... 97,251 327,346 239,515 -------------- -------------- -------------- Cash Flows From Investing Activities: Utility plant additions........................................... (240,225) (264,844) (146,878) Redemption of short-term investments.............................. 76,633 - - Return of principal PVNGS lessor notes............................ 17,531 16,674 16,668 Merger acquisition costs.......................................... - (11,567) (6,700) Short-term and long-term investments.............................. - (150,000) - Other............................................................. (54,366) 2,723 (20,590) -------------- -------------- -------------- Net cash flows used for investing activities.............. (200,427) (407,014) (157,500) -------------- -------------- -------------- Cash Flows From Financing Activities: Borrowings (note 4)............................................... 115,000 35,000 - Repayments (note 4)............................................... - - (32,800) Exercise of employee stock options (note 10)...................... (2,412) (2,179) (1,232) Common stock repurchase (note 4).................................. - - (27,867) Dividends paid.................................................... (34,226) (31,876) (32,265) Other............................................................. 108 (560) (559) -------------- -------------- -------------- Net cash flows provided by (used for) financing activities 78,470 385 (94,723) -------------- -------------- -------------- Decrease in Cash and Cash Equivalents............................... (24,706) (79,283) (12,708) Beginning of Year................................................... 28,408 107,691 120,399 -------------- -------------- -------------- End of Year......................................................... $ 3,702 $ 28,408 $ 107,691 ============== ============== ============== Supplemental cash flow disclosures: Interest paid, net of capitalized interest........................ $ 53,041 $ 62,216 $ 64,045 ============== ============== ============== Income taxes paid, net............................................ $ 13,541 $ 72,146 $ 50,480 ============== ============== ============== Long-term debt assumed for transmission line...................... $ 26,152 $ - $ - ============== ============== ============== The accompanying notes are an integral part of these financial statements. 42 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CAPITALIZATION As of December 31, --------------------------------- 2002 2001 --------------- -------------- (In thousands) Common Stock Equity: Common Stock, no par value (note 4)................................... $ 624,119 $ 625,632 Accumulated other comprehensive income, net of tax.................... (94,721) (28,996) Retained earnings..................................................... 444,651 415,388 --------------- -------------- Total common stock equity......................................... 974,049 1,012,024 --------------- -------------- Minority Interest (notes 1 and 5)......................................... 11,760 11,652 --------------- -------------- Cumulative Preferred Stock: (note 4) Without mandatory redemption requirements: 1965 Series, 4.58% with a stated value of $100.00 and a current redemption price of $102.00. Outstanding shares at December 31, 2002 were 128,000................................ 12,800 12,800 --------------- -------------- Long-Term Debt: (note 4) Issue and Final Maturity First Mortgage Bonds, Pollution Control Revenue Bonds: 5.7% due 2016.................................................... 65,000 65,000 6.375% due 2022.................................................. 46,000 46,000 --------------- -------------- Total First Mortgage Bonds 111,000 111,000 --------------- -------------- Senior Unsecured Notes, Pollution Control Revenue Bonds: 6.30% due 2016................................................. 77,045 77,045 5.75% due 2022................................................. 37,300 37,300 5.80% due 2022................................................. 100,000 100,000 6.375% due 2022.................................................. 90,000 90,000 6.375% due 2023.................................................. 36,000 36,000 6.40% due 2023................................................. 100,000 100,000 6.30% due 2026................................................. 23,000 23,000 6.60% due 2029................................................. 11,500 11,500 --------------- -------------- Total Senior Unsecured Notes, Pollution Control Revenue Bonds.... 474,845 474,845 --------------- -------------- Senior Unsecured Notes: 7.10% due 2005................................................ 268,420 268,420 7.50% due 2018................................................ 100,025 100,025 EIP debt due 2003-2012............................................... 26,152 - Other, including unamortized discounts............................... (350) (406) --------------- -------------- Total long-term debt......................................... 980,092 953,884 --------------- -------------- Total Capitalization...................................................... $ 1,978,701 $ 1,990,360 =============== ============== The accompanying notes are an integral part of these financial statements. 43 PNM RESOURCES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Year Ended December 31, -------------------------------------------- 2002 2001 2000 ------------- -------------- ------------- (In thousands) Net Earnings Before Preferred Stock Dividends.......................... $ 64,272 $150,433 $100,946 ------------- -------------- ------------- Other Comprehensive Income (Loss), net of tax: Unrealized gain (loss) on securities: Unrealized holding gains arising during the period............... 1,303 70 2,508 Reclassification adjustment for losses included in net income.... (919) (526) (4,887) Minimum pension liability adjustment................................. (55,061) (28,858) - Mark-to-market adjustment for certain derivative transactions Initial implementation of SFAS 133 designated cash flow hedges... - 6,148 - Change in fair market value of designated cash flow hedges....... (10,361) 345 - Reclassification adjustment for losses included in net income.... (687) (6,148) - ------------- -------------- ------------- Total Other Comprehensive Loss......................................... (65,725) (28,969) (2,379) ------------- -------------- ------------- Total Comprehensive Income (Loss)...................................... $(1,453) $121,464 $ 98,567 ============= ============== ============= The accompanying notes are an integral part of these financial statements. 44 PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS Year Ended December 31, -------------------------------------------------- 2002 2001 2000 --------------- --------------- --------------- (In thousands, except per share amounts) Operating Revenues: (notes 1 and 2) Electric............................................ $ 821,487 $1,863,510 $1,189,457 Gas................................................. 272,118 385,418 319,924 Unregulated businesses.............................. - 1,538 2,158 --------------- --------------- --------------- Total operating revenues......................... 1,093,605 2,250,466 1,511,539 --------------- --------------- --------------- Operating Expenses: Cost of energy sold................................. 475,256 1,434,934 850,145 Administrative and general.......................... 140,500 155,392 147,268 Energy production costs............................. 149,528 152,455 139,894 Depreciation and amortization....................... 101,689 96,936 93,059 Transmission and distribution costs................. 63,870 69,001 60,330 Taxes, other than income taxes...................... 31,333 30,302 34,405 Income taxes (note 1 and 8)......................... 22,774 88,769 53,964 --------------- --------------- --------------- Total operating expenses......................... 984,950 2,027,789 1,379,065 --------------- --------------- --------------- Operating income................................. 108,655 222,677 132,474 --------------- --------------- --------------- Other Income and Deductions: Other income........................................ 40,446 52,147 66,246 Other deductions.................................... (15,059) (67,257) (11,950) Income tax (expense) benefit (notes 1 and 8)....... (10,096) 7,706 (20,382) --------------- --------------- --------------- Net other income and deductions.................. 15,291 (7,404) 33,914 --------------- --------------- --------------- Earnings before interest charges................. 123,946 215,273 166,388 --------------- --------------- --------------- Interest Charges: Interest on long-term debt (note 4)................. 56,409 62,716 62,823 Other interest charges.............................. 5,321 2,124 2,619 --------------- --------------- --------------- Net interest charges............................. 61,730 64,840 65,442 --------------- --------------- --------------- Net Earnings Before Preferred Stock Dividends......... 62,216 150,433 100,946 Preferred Stock Dividend Requirements................. 586 586 586 --------------- --------------- --------------- Net Earnings.......................................... $ 61,630 $ 149,847 $ 100,360 =============== =============== =============== See disclosures regarding Public Service Company of New Mexico and subsidiaries included in the notes to the consolidated financial statements. 45 PUBLIC SERVICE COMPANY OF NEW MEXICO AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Year Ended December 31, -------------------------------------------------- 2002 2001 2000 --------------- --------------- --------------- (In thousands) Balance at Beginning of Year......................... $288,388 $296,843 $227,828 Net earnings before preferred stock dividends...... 62,216 150,433 100,946 Dividends (note 4): Cumulative preferred stock...................... (586) (586) (586) Common stock.................................... - (31,302) (31,345) Dividends to Parent (note 4): Assets.