MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Retail Operations also contributed to the Company’s earnings growth with increased load growth of 3% in Electric and 2% in Gas. The Company benefited from improved efficiencies and cost cutting measures, including lower power production costs. On an operations and maintenance expense (“O&M”) per revenue unit of sale basis, the Company’s O&M costs decreased significantly from $0.0172 in 2002 to $0.0154 in 2003. The year 2003 was one of the warmest in recent New Mexico history. The warmer temperatures increased retail electric sales during the summer months but significantly reduced demand for natural gas during the colder months. Certain developments affecting the Company, and which will have a more meaningful impact on its operating results in 2004 are as follows: In 2004, the Company intends to continue its efforts to expand its wholesale business by building on existing relationships and forming new relationships with long-term contract customers. The Company expects its 2004 earnings to benefit from higher gas rates, forecasted lower fuel costs from the new SJGS underground mine and planned productivity improvements. Other factors that will be critical to achieving earnings goals in 2004 include continued stable wholesale market prices and improved plant performance. 18 The Company’s net earnings for the year ended December 31, 2003 were $95.2 million or $2.37 per diluted share of common stock, a 49.5% increase in net earnings compared to $63.7 million or $1.61 per diluted share of common stock in 2002. This increase primarily reflects the cumulative effect of a change in accounting principle for the adoption of SFAS 143 of $37.4 million, net of income taxes, and improved operating performance. This increase was partially offset by the write-off of transition costs of $16.7 million, net of income taxes, that resulted from the repeal of electric deregulation in New Mexico in the first quarter of 2003 and a write-off of $16.6 million, net of income taxes, for costs related to long-term debt refinancing. CONSOLIDATED Results of Operations YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002 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 additional information regarding these results and the consolidated financial statements.  In addition, adjustments related to EITF Issue 02-03 “Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities” and 03-11 “Reporting Realized Gains and Losses on Derivative Instruments that are subject to FASB statement No. 133 and Not Held for Trading Purposes” are excluded. These accounting pronouncements require a net presentation of trading gains and losses and realized gains and losses for certain non-trading derivatives. Management evaluates wholesale operations on a gross presentation basis due to its net-asset-backed marketing strategy and the importance it places on velocity. 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. • In the fourth quarter of 2003, the coal mine operations that supply SJGS reached commercial operation status. In addition, the mine completed on schedule its first long-wall mine change-over to a new area of the coal seam. Coal costs in 2003 were significantly lower than in 2002, and although  coal costs cannot be predicted with certainty, the Company currently estimates that coal costs will remain lower in 2004 than average 2002 levels. • On December 22, 2003, the Company entered into an agreement to provide an Arizona municipal utility with up to 35 MW of power. The ten year contract is expected to produce about $6.5 million in revenues for the Company in 2004. • On January 13, 2004, PRC approved a $22 million revenue increase for the Company’s gas utility. Increased rates for commercial customers took effect immediately, while the increase for residential customers will begin April 1, 2004. • 2 0 0 3 A n n u a l R e p o r t t o S h a r e h o l d e r s P N M R E S O U R C E S MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS UTILITY OPERATIONS Electric The table below sets forth the operating results for Electric (In thousands).  YEAR ENDED DECEMBER 31, ELECTRIC RETAIL REVENUES (In thousands) YEAR ENDED DECEMBER 31, ELECTRIC SALES  (Megawatt hours) YEAR ENDED DECEMBER 31, The following table shows electric sales by customer class: The following table shows electric revenues by customer class and average customers: 2003 2002 VARIANCE OPERATING REVENUES $ 543,850)% $ $^{546,939}$)% $ $^{(3,089)}$% Less: Cost of energy 204,610)% $^{194,138}$)% $^{10,472}$)% Intersegment energy transfer (32,474)% $^{(29,155)}$% $^{(3,319)}$% GROSS MARGIN 371,714)% 381,956)% (10,242)% Energy production costs 107,683)% $^{113,257}$)% $^{(5,574)}$% Distribution O&M 19,249)% $^{19,987}$)% $^{(738)}$% Customer related expense 15,524)% $^{17,372}$)% $^{(1,848)}$% Administrative and general 5,362)% $^{5,408}$)% $^{(46)}$% TOTAL NON-FUEL O&M 147,818)% 156,024)% (8,206)% Corporate allocation 65,071)% $^{52,878}$)% $^{12,193}$)% Depreciation and amortization 63,428)% $^{59,654}$)% $^{3,774}$)% Taxes other than income taxes 17,937)% $^{18,251}$)% $^{(314)}$% Income taxes 20,873)% $^{26,779}$)% $^{(5,906)}$% TOTAL NON-FUEL OPERATING EXPENSES 315,127)% 313,586)% 1,541)% OPERATING INCOME $ 56,587)% $ 68,370)% $ (11,783)% 2003 2002 VARIANCE Residential $ 203,710)% $ $^{197,174}$)% $ $^{6,536}$)% Commercial 252,876)% $^{247,800}$)% $^{5,076}$)% Industrial 67,388)% $^{82,009}$)% $^{(14,621)}$% Other 19,876)% $^{19,956}$)% $^{(80)}$% $ 543,850)% $ $^{546,939}$)% $ $^{(3,089)}$% AVERAGE CUSTOMERS 396,303)% $^{384,478}$)% $^{11,825}$)% 2003 2002 VARIANCE Residential 2,405,488)% $^{2,298,542}$)% $^{106,946}$)% Commercial 3,379,147)% $^{3,254,576}$)% $^{124,571}$)% Industrial 1,346,940)% $^{1,612,723}$)% $^{(265,783)}$% Other 247,255)% $^{267,070}$)% $^{(19,815)}$% 7,378,830)% $^{7,432,911}$)% $^{(54,081)}$% Operating revenues decreased $3.1 million or 0.6% over the prior year period primarily due to the transfer of a significant customer from retail to wholesale electric rates in the first quarter of 2003 and a 4% retail electric rate reduction, which became effective in September 2003. Rates will decrease again by 2.5% in September 2005 and remain at that level through 2007. The customer transfer reduced retail revenues $14.3 million. The rate reduction resulted in a decrease in revenues of approximately $6.9 million. These decreases were partially offset by average customer growth of approximately 3.1%. After adjusting 2002 MWh sales for the transfer of the significant customer from retail to wholesale for comparative purposes, retail electric MWh sales increased due to customer growth. 