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## MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

## CONSOLIDATED 

## Other Income and Deductions 

Other income increased $4.3 million or 9.0% over the prior year period reflecting higher year-over-year returns on investments of $6.3 million, and an increase in the equity component of AFUDC of $2.6 million. These increases were offset by decreased interest income of $4.5 million due to the redemption of short-term investments early in 2003. Cash from the redemption of these investments was primarily used for the Company’s retirement of the EIP long-term debt, debt refinancing, repayment of short-term debt and pension funding (see “Liquidity” below). 

Other deductions increased $33.8 million over the prior year period primarily due to a charge of $16.7 million in 2003 for the write-off of transition costs due to the repeal of deregulation in New Mexico and a write-off of $16.6 million for costs related to long-term debt refinancing (see “Financing Activities” below). 

## Interest Expense 

Interest expense increased $4.8 million or 7.8% over the prior year period primarily due to decreased capitalized interest of $3.9 million from the completion of the Afton and Lordsburg gas-fired plants in southern New Mexico. Higher average short term borrowing levels also contributed to the increase. 

## Income Taxes 

The Company’s consolidated income tax expense before the cumulative effect of a change in accounting principle was $27.9 million for the year ended December 31, 2003, compared to $33.0 million for the prior year period. The decrease was due to the impact of lower pre-tax earnings. The Company’s effective income tax rates for the years ended December 31, 2003 and 2002 were 32.05% and 33.95%, respectively. The decrease in the effective tax rate, year-over-year, was due to an increase in permanent tax differences, resulting from AFUDC and research and development credits in 2003. 

## CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE 

Effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). The effect of the initial application of the new standard is reported as a cumulative effect of a change in accounting principle. As a result, the Company recorded income, net of income taxes, of approximately $37.4 million, or $0.93 per diluted common share, representing amounts expensed in prior years for its asset retirement obligations in excess of the actual legal obligations as established under the new accounting standard. 

In 2003, the Company changed its valuation date for its pension and post retirement benefits plans from September 30 to December 31 to better reflect the actual plan balances as of the Company’s year end balance sheet date. The effect of the change in the pension plans’ valuation date is reported as a cumulative effect of a change in accounting principle. The Company recorded additional expense, net of income taxes, of approximately $0.8 million, or $0.02 per diluted common share reflecting the effect of changing the valuation date. 

## 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 reflected 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 4.5%. This growth came from a combination of load growth and utilization of lower cost generation demonstrating the balance that the regulated utility can provide in the Company’s “merchant utility” strategy. 

The following discussion is based on the methodology that the Company’s management uses for making operating decisions and assessing performance of its various business activities. As such, these statements report operating results without regard to the effect of accounting or regulatory changes, and similar one-time items not related to normal operations. See Note 2 – “Segment Information” in the Notes to Consolidated Financial Statements for reconciliation between these results and the consolidated financial statements. 

Corporate costs, income taxes and non-operating items are discussed only on a consolidated basis and are in conformity with the presentation in the consolidated financial statements. 

## MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

## ELECTRIC 

The table below sets forth the operating results for Electric (In thousands). 

<img src='content_image/21749.jpg'>

The following table shows electric revenues by customer class and average customers (In thousands): 

<img src='content_image/21750.jpg'>

The following table shows electric sales by customer class (Megawatt hours): 

<img src='content_image/21751.jpg'>

Operating revenues increased $14.3 million or 2.7% for the period to $546.9 million. Retail electricity delivery grew 2.4% to 7.4 million MWh in 2002 compared to 7.3 million MWh delivered in the prior year, resulting in increased revenues of $14.3 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 $16.3 million or 4.5%, 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. 

