MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 26 The table below sets forth the operating results for Gas (In thousands). The following table shows gas revenues by customer and average customers (In thousands): The following table shows gas throughput by customer class (Thousands of decatherms): YEAR ENDED DECEMBER 31, 2002 2001 VARIANCE OPERATING REVENUES $ 277,406)% $ $^{371,265}$)% $ $^{(93,859)}$% Cost of energy 144,333)% $^{237,143}$)% $^{(92,810)}$% GROSS MARGIN 133,073)% 134,122)% (1,049)% Energy production costs $^{1,937}$)% $^{1,946}$)% $^{(9)}$% Distribution O&M $^{29,306}$)% $^{31,064}$)% $^{(1,758)}$% Customer related expense $^{16,607}$)% $^{19,814}$)% $^{(3,207)}$% Administrative and general $^{2,943}$)% $^{6,736}$)% $^{(3,793)}$% TOTAL NON-FUEL O&M 50,793)% 59,560)% (8,767)% Corporate allocation $^{33,516}$)% $^{30,908}$)% $^{2,608}$)% Depreciation and amortization $^{20,673}$)% $^{20,362}$)% $^{311}$)% Taxes other than income taxes $^{7,716}$)% $^{6,768}$)% $^{948}$)% Income taxes $^{2,703}$)% $^{1,867}$)% $^{836}$)% TOTAL NON-FUEL OPERATING EXPENSES 115,401)% 119,465)% (4,064)% OPERATING INCOME $ 17,672)% $ 14,657)% $ 3,015)% GAS REVENUES  YEAR ENDED DECEMBER 31, 2002 2001 VARIANCE Residential $ 176,284)% $ $^{221,409}$)% $ $^{(45,125)}$% Commercial 53,734)% $^{65,654}$)% $^{(11,920)}$% Industrial 2,872)% $^{27,519}$)% $^{(24,647)}$% Transportation * 17,735)% $^{20,188}$)% $^{(2,453)}$% Other 26,781)% $^{36,495}$)% $^{(9,714)}$% $ 277,406)% $ 371,265)% $ (93,859)% AVERAGE CUSTOMERS 443,396)% 434,591)% 8,805)% GAS THROUGHPUT  YEAR ENDED DECEMBER 31, 2002 2001 VARIANCE 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 4,807)% 4,355)% 452)% 92,081)% 97,939)% (5,858)% P N M R E S O U R C E S MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating revenues decreased $93.9 million or 25.3% for the period to $277.4 million, primarily because of lower natural gas prices in 2002 as compared to 2001. 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 $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.  Total non-fuel O&M decreased $8.8 million or 14.7%. 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 $3.8 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 $0.9 million or 14.0% due to the absence of favorable audit outcomes by certain tax authorities recognized in 2001. 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 $2.8 million or 13.7%. 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 19.3% for the year due to the purchase of transmission plant assets in early 2002. The table below sets forth the operating results for Transmission (In thousands). YEAR ENDED DECEMBER 31, 2002 2001 VARIANCE 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)% $^{17,141}$)% $^{(2,610)}$% Customer related expense 9)% $^{–}$)% $^{9}$)% Administrative and general 2,216)% $^{2,155}$)% $^{61}$)% TOTAL NON-FUEL O&M 17,446)% 20,220)% (2,774)% Corporate allocation 4,703)% $^{4,596}$)% $^{107}$)% Depreciation and amortization 8,741)% $^{7,328}$)% $^{1,413}$)% Taxes other than income taxes 2,464)% $^{2,252}$)% $^{212}$)% Income taxes 4,699)% $^{5,442}$)% $^{(743)}$% TOTAL NON-FUEL OPERATING EXPENSES 38,053)% 39,838)% (1,785)% OPERATING INCOME $ 13,159)% $ 12,886)% $ 273)% 27 • 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 $^{* }$Customer owned gas Total non-fuel O&M decreased $12.8 million or 7.6%. Energy production costs decreased $7.1 million or 5.9% 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 PVNGS billings from Arizona Public Service Company, the operator of PVNGS. These cost decreases were partially offset by 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 $2.0 million or 10.4% 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 $3.0 million or 35.6% 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. Taxes other than income increased $2.0 million or 12.2% reflecting adjustments recorded in the prior year for favorable audit outcomes by certain tax authorities. GAS TRANSMISSION