• 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 21 20 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The gross margin, or operating revenues minus cost of energy sold and intersegment energy transfer, decreased $10.2 million or 2.7% over the prior year period. This decrease is due primarily to the rate decrease, an increase in cost of energy due to outages at Palo Verde Nuclear Generating Station (“PVNGS”) Unit 2 during the fourth quarter of 2003 for a steam-generator replacement project, and the customer transfer described above of $12.8 million. These decreases were partially offset by customer growth and lower cost of generation. Total non-fuel O&M expenses decreased $8.2 million or 5.3% over the prior year period. Energy production costs decreased $5.6 million or 4.9% primarily due to 2002 outages at the Four Corners Power Plant (“Four Corners”) and Reeves Generating Station (“Reeves”), which did not recur in 2003, for $1.3 million and $1.0 million, respectively and reduced PVNGS plant maintenance costs of $0.5 million due to increased capitalized expenditures related to the steam-generator replacement project. Customer-related expense decreased $1.8 million or 10.6% due to decreased bad debt expense as a result of continued collection efforts and the favorable outcome of a customer bankruptcy proceeding. Depreciation and amortization increased $3.8 million or 6.3% due to a higher depreciable plant base for new service delivery. In addition, lower energy production costs related to decreased decommissioning expenses of $2.7 million were mostly offset by an increase in depreciation expense of $2.2 million for the change in accounting for costs related to asset retirement obligations as required by SFAS 143 The table below sets forth the operating results for Gas (In thousands). Gas The following table shows gas revenues by customer and average customers: GAS REVENUES  (In thousands) YEAR ENDED DECEMBER 31, 2003 2002 VARIANCE Residential $ 226,799)% $ $^{176,284}$)% $ $^{50,515}$)% Commercial 72,269)% $^{53,734}$)% $^{18,535}$)% Industrial 2,820)% $^{2,872}$)% $^{(52)}$% Transportation * 18,906)% $^{17,735}$)% $^{1,171}$)% Other 37,473)% $^{26,781}$)% $^{10,692}$)% $ 358,26)% $ $^{277,406}$)% $ $^{80,861}$)% Average customers 452,328)% $^{443,396}$)% $^{8,932}$)% GAS THROUGHPUT  (Thousands of decatherms) YEAR ENDED DECEMBER 31, 2003 2002 VARIANCE Residential 27,416)% 29,627)% (2,211)% Commercial 10,810)% 12,009)% (1,199)% Industrial 485)% 749)% (264)% Transportation* 50,756)% 44,889)% 5,867)% Other 5,510)% 4,807)% 703)% 94,977)% 92,081)% 2,896)% YEAR ENDED DECEMBER 31, 2003 2002 VARIANCE OPERATING REVENUES: External customers $ 19,453)% $ $^{23,150}$)% $ $^{(3,697)}$% Intersegment revenues 32,499)% $^{31,950}$)% $^{549}$)% TOTAL REVENUES 51,952)% 55,100)% (3,148)% Less: Cost of energy 4,255)% $^{3,888}$)% $^{367}$)% GROSS MARGIN 47,697)% 51,212)% (3,515)% Energy production costs 1,051)% $^{690}$)% $^{361}$)% Transmission O&M 12,347)% $^{14,531}$)% $^{(2,184)}$% Customer related expense 19)% $^{9}$)% $^{10}$)% Administrative and general 1,610)% $^{2,216}$)% $^{(606)}$% TOTAL NON-FUEL O&M 15,027)% 17,446)% (2,419)% Corporate allocation 5,387)% $^{4,703}$)% $^{684}$)% Depreciation and amortization 10,104)% $^{8,741}$)% $^{1,363}$)% Taxes other than income taxes 2,583)% $^{2,464}$)% $^{119}$)% Income taxes 3,179)% $^{4,699}$)% $^{(1,520)}$% TOTAL NON-FUEL OPERATING EXPENSES 36,280)% 38,053)% (1,773)% OPERATING INCOME $ 11,417)% $ 13,159)% $ (1,742)% TRANSMISSION MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table shows gas throughput by customer class: $^{*}$Customer-owned gas. Operating revenues increased $80.9 million or 29.2% over the prior year period to $358.3 million, primarily because of higher natural gas prices in 2003 as compared to 2002. PNM purchases natural gas in the open market and resells it at cost of purchase to its retail gas 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 $3.2 million or 2.4% over the prior year period. This decrease is due mainly to the expiration in January 2003 of a rate rider for the recovery of certain costs of $4.1 million. The price decrease was offset by an increase in volume. Transportation throughput increased by 5.9 million decatherms, or 13.1% driven by gas pipe line extensions, increasing off-system sales. Despite customer growth of 2.0%, volume from other customers decreased 3.0 million decatherms, or 6.3% caused by warmer weather in 2003. In January 2004, the PRC approved a cost of service gas rate increase, which will improve gas earnings by approximately $22 million annually. The Company estimates that approximately two-thirds of this increase will be realized in 2004 earnings due to a delay in implementing the residential increase until April 2004.  Total non-fuel O&M expenses decreased $0.5 million or 0.9% over the prior year period. Administrative and general costs decreased $0.9 million or 30.7% primarily due to lower consulting costs of $1.0 million. Depreciation and amortization increased $1.5 million or 7.3% due to a higher depreciable plant base for new service delivery and transportation gas line extensions. Taxes other than income taxes decreased $0.8 million or 10.8% due to a decrease in property tax of $0.2 million as a result of a change in assessed values and a decrease in PRC supervision and lower inspection fees of $0.6 million. The table below sets forth the operating results for Transmission (In thousands). $^{*}$Customer-owned gas. YEAR ENDED DECEMBER 31, 2003 2002 VARIANCE OPERATING REVENUES $ 358,267)% $ $^{277,406}$)% $ $^{80,861}$)% Less: Cost of energy 228,345)% $^{144,333}$)% $^{84,012}$)% GROSS MARGIN 129,922)% $^{133,073}$)% $^{(3,151)}$% Energy production costs 1,930)% $^{1,937}$)% $^{(7)}$% Transmission and distribution O&M 29,515)% $^{29,306}$)% $^{209}$)% Customer related expense 16,832)% $^{16,607}$)% $^{225}$)% Administrative and general 2,040)% $^{2,943}$)% $^{(903)}$% TOTAL NON-FUEL O&M 50,317)% 50,793)% $^{(476)}$% Corporate allocation 40,363)% $^{33,516}$)% $^{6,847}$)% Depreciation and amortization 22,186)% $^{20,673}$)% $^{1,513}$)% Taxes other than income taxes 6,886)% $^{7,716}$)% $^{(830)}$% Income taxes (1,281)% $^{2,703}$)% $^{(3,984)}$% TOTAL NON-FUEL OPERATING EXPENSES 118,471)% 115,401)% 3,070)% OPERATING INCOME $ 11,451)% $ 17,672)% $ (6,221)%