ML17303A552

Public Svc Co of New Mexico,1986 Annual Rept.

ML17303A552
Person / Time
Site:	Palo Verde
Issue date:	12/31/1986
From:	GEIST J D PUBLIC SERVICE CO. OF NEW MEXICO
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ML17303A547	List: ML17303A546 ML17303A548 ML17303A552
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About PMM ublic Service Company of New Mexico is a combined utility with diversified inter-ests.The total population of the area served by one or more of the Compa-ny's utility services is approximately 960,000, or 65 percent of the state'population.

In addition to electric and gas services, the Company also:~provides water utility services to the City of Santa Fe, through the Sangre de Cristo Water Company;and~owns and operates mining and diver-sified capital companies.

In diversifying, we seek to improve our earnings while also strengthening the economy of our utility service areas.Our primary service territories are in New Mexico-"The Land of Enchant-ment"-one of the most magnificent regions on earth.In this report, we would like to share this land in which we live, work, and grow.New Mexico is a land of vast horizons, and we look forward to our future with confidence and excitement.

WW Annual meeting of shareholders The annual meeting of stockholders of Public Service Company of New Mexico will be held at the Kimo Theatre,423 Central Avenue, N.W., Albuquerque, New Mexico, on Tues-day, June 23, 1987, at 9:30 a.m.Stock-holders are urged to attend;however, whether or not attending, proxies should be mailed to the Company.A proxy statement and form of proxy will be mailed to stockholders on or about May 11, 1987.$4.23'3.36$2.16 S2.46 Earnings Per Share of Common Stock Dollsrs 5$3.11$3.30$3.29~On the cover: (top to bottom)Falcon Ridge, Arizona;Meadows Resources, Inc.~San Juan Generating Station, New Mexico;Electric Opera.tions.~Dogie Canyon Compressor Station, New Mexico;Gas Operations.

~De.Na-Zin/Gateway Coal Mine, New Mexico;Sunbelt Mining Company, Inc.'76'77'78'79'80'81'82'83'84'85'86 Includes sale ol retained economic interest in coal leases which contributed

$.90 and$.73 per share, respectively in 1981 and 1983.

GNfhcOCtNMh Chairman's Letter Corporate Office Initiates Strategic Policy Electric Utility Faces Capacity, Competition, and Regulatory Challenges Gas Utility Operates in a More Competitive Environment Diversified Capital Group Invests for Future Natural Resources Unit Improves Operations An Expression of Thanks A Good Place to do Business-A Good Place to Live"New Mexican" Means Unique Art Born from the Inspiration of a Land and its People Financial Data and Consolidated Financial Statements Stockholder Information Directors and Officers 10 14 16 18 20 22 24 26 48 49 Public Service Company of New Mexico and Subsidiaries QhimiLfhS 1986 1985%Change Operating revenues Operating expenses Net earnings Return on average common equity Earnings per common share Dividends paid per common share Book value per common share at year-end$$$$697,995,000

$689,982,000 1.2$517,519,000

$504,868,000 2.5$151,005,000

$146,310,000 3.2 12 8%13 2%(3 0)3.29$3.30 (0.3)2.92$2.89 1.0 26.51$25.73 3.0 Utility construction expenditures

$200,031,000

$261,931,000 (23.6)NB8lW Total kilowatt-hour sales 6,727)530,000 7,437,062,000 (9.5)Decatherm sales 52,520,000 55,161,000" (4.8)'Includes other contracted energy sales of 1,625,217,000 kWhr and 2 200,952,000 kWhr in 1986 and 1985, respectively.

• • From the acquisition date, January 28,1985.

To the stockholders:

n 1986 we achieved some solid financial results in a difficult environment.

Net earnings applicable to common stock were$132.8 million, or$3.29 per share, compared with$122.4 mil-llion, or$3.30 per share in 1985.Non-".cash earnings related to construction l and"inventoried" generating capa-i;city contributed 43 percent of our'otal earnings.A series of tax bene-fits, which are not expected to recur at the same high level in future years, contributed

$1.03 earnings per share.The Board of Directors maintained our quarterly dividend on common shares, but did not increase it, for the first time in 15 years.The difficulties we faced: A sustained slump in the mining and oil and gas industries has slowed economic growth in New Mexico.In 1986 our uranium mining cus-tomers used only 14 percent of the electricity they used seven years ago-and only three percent of their projected peak usage.Coal mining customers used only 40 percent of projected peak.The depression in New Mexico's oil and gas fields was felt throughout the state, even in Albuquerque

-the state's major business center and our major service area.In Albuquerque, the electronics industry-hit by international compe-tition-has not expanded as projected.

In fact, our electric utility's largest retail customer added in the last six years has been our own Meadows Resources'iberboard plant in Las Vegas, New Mexico.Result: uncommitted capacity The result is that PNM-as do many other utilities-has more generating capacity than our customers can use.Generating plants, especially nuclear, require years to plan and build.But the present economy has disproved past forecasts.

The regional wholesale power market has been little better.Many utilities have uncommitted capacity.Wet years in the West yielded cheap hydroelectric power.Low oil and gas prices led to reactivating oil-and gas-fired power plants.We also faced regulatory setbacks.Our most recent request for higher electric rates resulted in a$4.5 mil-lion revenue reduction.

Proposed accounting rule changes, involving national accounting standards, may adversely affect the viability of our ratemaking method called"inventory of capacity".

The New Mexico Public Service Commission has scheduled a proceeding to obtain proposals for alternatives to the inventory methodology.

We had to fight a biased Palo Verde construction audit.The regulatory effort to audit our interest in Palo Verde resurfaced in a new investiga-tion by the Public Service Commis-sion.We continue to work toward an equitable regulatory solution regard-ing recovery of our investment.

Regional initiatives and the business environment

~Our electric utility cut$10 million in operations and maintenance costs.~We have reduced the cost of our gas by one-third.

~We werc the first-in-the-nation to sell and lease back an interest in a nu-clear plant.In 1985 and 1986, we com-pleted the sale and leasebacks of our interests in Palo Verde Units 1 and 2.~Meadows Resources'nvestments in New Mexico businesses have started to build utility loads.But today's challenges require even greater efforts.In earlier reports and meetings I have discussed the far-reaching changes under way in the utility industry.Two observations make these changes clearer.First: Changes in the natural gas industry: Wellhead prices deregulated, interstate pipelines opened, contract carriage, gas companies divided into production

-pipeline-distribution companies, mergers as stronger companies absorbed the weak.At Gas Company we'e experi-enced some of these changes.And we feel they foreshadow similar change in the electric industry.Second: As chairman of the Edison Electric Institute (the national asso-ciation of investor-owned electric utilities), I'e watched our industry's transformation in a broader frame-work: The unwillingness of regulators to continue to enforce major terins of the"regulatory compact" between utility suppliers and customers.

The growth of energy alternatives.

The impact of international competition-on utilities directly and through their customers.

Agenda for tomorrow This rapidly changing environment calls for bold initiatives.

There are no easy solutions.

And so, with your support, we con-tinue to pursue new strategies.

Our business objectives include: r becoming one of the lowest-cost providers in our region through cost control, regulatory acceptance and innovative financing;

~becoming a holding company and thereafter restructuring our utilities;

~expanding our non-utility investments in telecommunications manufacturing, financial services, and real estate;~a new, stronger commitment to business development in New Mex-ico and the Southwest.

~With the new state administration in Santa Fe, we are pursuing a program to exchange the old regulatory risks for new competitive opportunities.

PNM will take action to resolve outstanding regulatory issues and form the holding company approved by our stockholders last May.Among other benefits, this will provide greater flexibility for our investment and mining companies.

Thereafter, the utility subsidiary would divide its utility operations into separate entities to respond to market trends-for example, an elec-tric distribution entity and an electric generation and transmission entity.This could allow more effective com-petition in the new marketplace.

Each separate utility entity would take action to lower its costs.This would make our utility services more competitive and boost local business Jerry D.Geist Chairman and President Pubtic Service Company of New Mexico development.

One alternative which we are studying is the formation of a limited partnership which would conduct the electric distribution busi-ness of PNM.The Chinese sign for crisis is a combination of the signs for"dan-ger" and"opportunity".

We are con-scious of current dangers.But we look forward with confidence and excitement to your company's future opportunities.

Sincerely, Jerry D.Geist Chairman and President March 4, 1987 Corporaie office iniiiaies siraiegic policy Each Owner Paitcipant CIST:Siim5 Palo Verde Units 1 and 2 Sale and Leaseback 1iansaction Loan (2)Trustees Totaf Sales Price (1)Title to Palo Verde Lease to Pafo Verde Lease Payments (5)Debt Service(6)

~In 1985 and 1986, PNM sold its interests in Palo Verde Units 1 and 2 (and certain common facilities) to several investors (box shown as Each Owner Participant).

The total sales price was$900 minion (1), of which approximately

$714 million was foaned (2)to the participants by First PV Funding Corp..a corporation organized solely to provide debt financing for the partici.pants;the participants invested$186 million as First PV Funding Corp.PNM Bond os(4)Issu Bond Proceed s Bondhorders equity (3).First PV Funding Corp.obtained per.manent financing for the loans by issuing long term lease obligation bonds (4).Simultaneous with the sale.the Company leased back the Units for a basic term of about 29 years at a rental of approximately

$84 milbon per year (5).Under the leases, PNM's rental payments are used first to service the lease obligation bonds (6).with the remainder going to the participants (7).orking with the Com-pany's four business units, the corpo-rate office's business and financial planners, public policy advisors, tax analysts, and corporate policy and communication advisors develop specific plans and policies for consid-eration by the Corporation's senior management and Board of Directors.

Adopted programs are put into action by the business units them-selves assisted as required by the corporate office's financial manage-ment, investor services, and govern-ment affairs staff.The corporate office's major activities in 1986 were the nuclear facility sale/Ieasebacks of our inter-est in Klo Verde Units 1 and 2, the

~tteft)Al Robison, senior vice president and chief financial officer (at right), and Lloyd Williams, managing director of Kidder, Peabody ft Co., a major PNM underwriter, during dosing activities of a sale and leaseback transaction.

PNM was the first corporation in the nation to sell and lease back a nuclear generating plant.The Company sold for$900 miltion and leased.back its entire interest in Palo Verde Units 1 and 2.//cost-cutting retirement of high-inter-est bonds and redemption of high dividend preferred stock, the effort to secure regulatory approval for hold-ing company organization, and the Dinch Power Project.Holding company plan is key to new era Shareholders approved the holding company plan in May 1986.How-ever, the New Mexico Public Service Commission denied our plan, claim-ing that the new structure would make it more difficult to review and regulate transactions between utility and nonutility operations.

We appealed the Commission's decision to the New Mexico Supreme Court.The new holding company struc-~(above)J.B."Bud" Mulcock, Jr.~senior vice president of corporate affairs and secretary, helps make the strategic decisions for PNM.Mr.Mulcock is also responsible for the Company's stockholder services, investor refations, and other public affairs activities.

ture, if implemented, would increase the Company's financial flexibility and more distinctly separate utility and nonutility operations.

The holding company plan is not unique.More than 20 utilities have reorganized as holding companies in the last decade.Dinch partnership would export energy Economic and demographic fore-casts for the 1990s indicate there will be electric generating capacity short-ages in the Southwest and Pacific Coast regions.The proposed Dinch Power Project would respond to that need.Proposed as a joint venture with the Navajo Nation and several other major corporations, Dinch would export New Mexico's abundant coal resources in the form of electricity.

The project would include a coal-fired electric generating plant on Navajo land in northwestern New Mexico.The site is near coal resources controlled by PNM's Sun-belt Mining Company and others.These resources would provide the plant's coal.The Dinch project would also include the construction of a 500 kV transmission line to carry electricity to wholesale customers.

The U.S.Congress included a provision in the new tax law which will preserve an investment tax credit until 1995 for construction of the Dinch project.Other participants in the Dinch project include the Navajo Nation, Bechtel Power Corporation, and Combustion Engineering, Inc.The corporate office has committed to continue funding a portion of the Dinch study.Neither we nor the other participants would begin construction until agreements have been signed with utilities or other buyers to buy a significant portion of Dinch power.

Eleciric uiiliiy faces capaciiy.compeiiiion.

and regulaiory challenges.

ERR~RtstsIllitrtr Ns'Wool peg I llllg)~4Ž~~

4~')~(above)Atop Palo Verde's Unit 3 reactor vessel, technicians inspect the unit during its pre.opera.

tional phase.Unit 3 first generated non nucfear powered electricity November 1986 as part of an important test of the unit's turbine and generator.

a (below)Martha McDonald, vice president of human resources and support services, and Dwayne Pruitt, equipment operator and union steward, discuss safety issues at an Albuquer-que maintenance and service center.From centers like this one.transmission and distribu.tion lines and facilities are constructed and maintained, 3~(above)John Bundrant, president and chief operating officer of electric operations, visits the Indian Pueblo Cultural Center in support of the electric utility's Customer Success program.Business growth teams provided advice on the Center's energy usage and marketing and management functions.

0 D C3 Major Southwestern Electric System Map All Lines 230 kV and Higher PNM or Joint Ownership Proposed Others Proposed Leased or Corporate Venture Proposed~(above)Palo Verde Units 1 and 2 began commercial service in January and September 1986.In October, Unit 2 set a new record for United States nudear plants, generating 987,300 megawatt hours.Upon comptetion of Unit 3.the electric utility's share of Palo Verde's capacity will be 390 MW.0 Generation b, Switching Station 0 Cities and Towns 0~CALIF.oo+craana ARIZ.0 V~a,.<0 0'~c 0 NM.our service area is higher than the national average, but remains lower than previously experienced and forecasted.

This is largely the result of a sharp decline in industrial loads, primarily the mining industry and delayed operation of the microchip industry, and less dramatic growth in the"sunbelt" e began as an electric, gas, and ice utility.Today, electric sales account for 65 percent of total operating revenues.The electric utility as an energy marketer As output increases from Palo Verde Nuclear Generating Station, the importance of sales to other utili-ties also increases.

With Unit 2's operation, our off-system sales to San Diego Gas&Electric Company increased from 106 MW to 236 MW.Off-system energy sales to other utilities represented 33.5 percent of the Company's total kilowatt-hour sales.Our sales to other utilities in 1986 decreased because of our system's relative cost and transmission access limitations.

In response, we are striv-ing to lower costs as well as develop new markets in our service areas, in the Southwest, and in adjoining regions.Projected New Mexico retail elec-tric sales growth of about 3 percent in Changing market realities require new regulatory policies As competition becomes a stronger force in our industry, the role of regulation must change.The new realities we face include: (a)lower than forecasted growth in our region and primary service areas leading in the short-term to regional overcapacity in generation;(b)the need for transmission facilities able to serve distant markets;(c)aggressive energy pricing;and, (d)the need for innovation and information in bulk-power system lMleeiing ihe cosi compeiiiion challenge

~(above)Cathleen Andrasovsky, shift supervisor of San Juan Generating Station's water opera.tions analysis laboratory, monitors water quality in the plant's boilers and cooling towers.~(left)As acid rain increasingty becomes an issue of national concern, we can point with pride to the coal fired San Juan Generating Station.San Juan's pollution control facilities reduce air pollutants to levels more stringent than those considered as effective acid rain control elsewhere in the nation.r~(below)Service should be customer.conve-nient!Our innovative"PNM Catalog" offers services, facts, and ideas to retail electric cus-tomers.Throughout 1986, we established neighborhood customer service offices, incfud.ing one in an Albuquerque supermarket (right).lr>>I'C i,ll oe h~(top)Several 500 kV lines emanate from Palo Verde, connecting to distant markets.To further improve our access to those markets we are exploring options for acquiring additional trans-mission facilities.

t4 Tlat rlu~ggo I I iMll4(err rQVKI Gas utility operates in a more competitive environment 4 x 1 wrw~IN<@@"'o years ago PNM acquired Gas Company of New Mexico, the largest natural gas utility in the state an'd the supplier for most state residents.

'We buy natural gas from many independent producers through gas gathering operations and from pipeline companies, process that gas for home and business use, and sell it to retail customers in Albuquerque and most of New Mexico.Abundant supplies nationwide have forced change in the natural gas industry, at least for the near-term.

Some of our responses to competition at the wellhead, city-gate, and burner tip took place in 1986.More are planned in 1987.But Gas Company's transition from a traditional gas utility to a more competitive service company requires:~greater sensitivity by regulators to the changing marketplace; a more flexible gas supplies;a improved interstate pipeline arrangements; and,~improved marketing flexibility.

lVlarket-sensitive regulation ls needed now Federal and state regulations now promote"contract carriage" of gas owned by others.Under contract carriage, a consumer buys natural gas directly from suppliers and arranges for transportation and delivery by a carrier such as Gas Company.As an example, some customers now buy gas on the"spot-market" at a price lower than our system supply price.Their assurance of supply is limited to days or months.But these customers still expect our system supply to be available as back-up at no extra cost.As a result, Gas Com-pany has a supply of gas, previously contracted for with producers, that it is now unable to sell to another cus-tomer.We believe the state should allow separate rates for this back-up service or relieve us from the obliga-tion to contract for and hold reserves for carriage customers.

We also believe it is important to the Company, its owners, and cus-~(top)It's a fong journey by pipe from the gas well to the customer, The Dogie Canyon Con.pressor Station-19 miles from the nearest paved road-is home to six gas utility employees and their families.This and similar stations increase a pipeline's pressure to transport gas to distant distribulion systems and interstate markets.~(above)John Ackerman, president of Gas Company of New Mexico (right), and Buster Orbison, manager of gas purchasing, met throughout the year to discuss the progress made in renegotiating gas contracts with well.owners.Between December 1984 and Decem.ber 1986, our customers saw their cost of gas dedine 33 percent as a result of the utility's efforts and lower market prices.~(right)Larry Thompson, electronics technician, maintains Albuquerque's city-gate.

City.gates mark the transition from the gas utTiity's transmis.sion system to ils distribution system.10 4 t+El>l l~~.o.a~~~~~~4li~4'~~~~.~~

lMlarkei characierisiics of gas are analyzed from gaihering io end user tI.lllllllllll i%~%~%%%~%%~ia~%~%%~%~%~raa~%~%~%~%~le~%~%%~%~%~%~%~%%%~%~%~%~e A%~%~'%V A%%A%%%%%%~%%%~%~%%%~%%~%%%~%~%%%%%~'%%~%%%~%%%%%%%~%~%%%%'%~%%%%6 I%%%~~%%%%~%jointly to improve their sales, and, as a result, improve our sales.To encourage customers to stay on our system, our gas must be competi-tively priced.We began developing a computer model of our entire gas supply system that will help assure that we have the right quantity of gas available at the best price at all times.By matching the characteristics and costs of our supply contracts with the characteristics and price expectations of our customers'emands, we can reduce our customers'ost of gas.12%(Wr ms Gas Delivered by Customer Class'988 35 rttr 20 err 25 e4r 1986 40%19 re D Residential 0 Sales tor Resale D Commercial D Transportation

&Brokerage D Other Retail D Industrial

'Indurres is%car%orms sorrl by Gas company oner~trsnpoonrecr ior orrrers by Gas Company rrnrrer corcrars carrriage.

~(above)sales to industrial customers in 1986 have decreased signifcantly, white a nevi customer dass-transportation and brokerage is emerging,~(above)D.A."Zan" James, vice president of marketing, rates, and regulatory affairs of Gas Company (center), and Brian Jetfries.manager ot marketing tor gas gathering company (righl), discuss final details of an off.system gas sale with Dan Gibson, vice president of tuel resources, of San Francisco.headquaaered Pacific Gas and Electric Company.Off.system gas sales are an increasingly important market outlet, tomers for rates to be instituted for franchise residential and commercial customers who do not have these choices, and other rates for those larger customers willing to risk service inter-ruption in exchange for a lower rate.Gathering provides our supply During 1986, we concentrated on stabilizing both supply and demand for our natural gas.We renegotiated many contracts with natural gas well-owners.

In doing so, we improved the character-istics of our gathering operations especially our mix of long-term, short-term, and"spot-market" pur-chases.This helps to assure us an ample supply at competitive prices.We are also working to improve our communication with gas well-owners.

Our publication,"GCNM Pipeline," is one of those efforts.We work Processing is required before gas is shipped to markets We became an operator of a gas processing company in 1986.Proc-essing removes liquid by-products like butane and propane before put-ting natural gas into pipelines.

The liquid by-products are sold to others.Pipellnes:

connections to retail and interstate customers We are seeking better ways of using our pipeline assets.One option is to secure interstate transportation paths to the out-of-state marketplace using other companies'ipelines.

Another option is transporting gas belonging to others through our pipe-lines in addition to our New Mexico customers'as.

In the meantime, new trends in regulation and competition have dra-matically changed our markets.(See charts at left.)Distribution:

improving service to individuals We recognize the importance of serving the needs of individual customers and in 1986 we made major changes to improve service to customers.

For example, our surveys indicated that many customers found us diffi-cult to reach.We responded by installing a new computer-based telecommunications system and increasing the size of our customer service staff.

To Northwestern Markets To Midwestern Markets To Western Markets To Texas and Gulf Coast Markets~A computerized telephone system and a larger staff make us more responsive to customers.

Diana Morris, customer consultant manager, discusses a caller's concern viith a member of her staff (top).Peggy Pierce retrieves a tape recording of customer calls for use in evaluating an employee's telephone skills (above).Regional Gas Utility System Map Gas Company of New Mexico System~Gas Company Gathering Wellfield Area~Gathering Company Wefffield Area~Other Transmission National Pipeline Interconnection Area 13 Diversified capital group invesis for future-.5C~N4 aks~eff r,1 e&i r gellis Y7).e)rtr', I=.h;~l4%nf%'(above)Falcon Ridge, near Phoenix, is a new development of Bellamah Community Develop-ment.a Meadows investment.

Falcon Ridge is Bellamah's 30th project.Real estate is one of Meadows'hree areas of investment emphasis.~(left)Jim Jennings, president and chief execu-tive officer of Meadows (right), and Bill Hunt, chairman of the board, president, and chief executive officer, of Alliance Telecommunications Corporation, a Meadows investment, at an Alliance manufacturing plant in Atlanta, Alliance manufactures radio paging and voice messag-ing equipment.

14 phoeHx~0 Chtoatto O ouincy0 asup Oerher rants oo Raton-Los Atarnos o Santa Fe ruR~ua'tp ttttsa Les Cruces oe Otahcona Cttr oattas Wonh Houstrw o Dlverslf led Capital Investment Locations o Telecommunlcatlons Manufacturing

~Financial Services o Real Estate Development o Fiberboard Plant~Venture CapItal eostonoo Staintord O A stew W<~errr hrough Meadows Resources, Inc., we manage nonutility invest-ments, primarily in three industries offering long-term growth and profit potential:

~telecommunications manufacturing;

~financial services;and,~real estate development.

During our first year in telecom-munications, we acquired interests in several companies.

These companies generated more than$50 million of sales in 1986, giving Meadows an international presence in a special-ized market of designing, manufac-turing, and marketing equipment for radio, cellular, voice storage and forwarding, and paging uses.Our desire is to provide to a common customer group components from the phone line to the antenna.We are pursuing additional investments in this area.Meadows is part owner of a financial services subsidiary which continued to grow in real estate financing and investment activities.

Its savings and loan in Chicago grew from$215 million to$310 million in assets.They are expanding into other financial services, including mort-gage servicing, and are evaluating insurance investments.

Our real estate projects generated$91 million of revenues in 1986, and werc profitable.

Most of our real estate projects involve"pre-development" of affordable new residential and commercial areas near major cities in the Southwest.

Meadows'nvestments result in utility load-building Meadows'ew expanded program of direct business investments in New Mexico is designed to contribute to New Mexico's economic diversifica-tion and increase economic activity in PNM's utility service areas:~The Montana de Fibra fiberboard plant had revenues of$16 million in 1986, but continued to operate at~(above)Jack Nicklaus and Roger Rankin, vice president of Meadows, discuss Mr.Nicklaus'esigns of two 18.hole golf courses for The Ranch at Santa Fe.Initial development is under-way for The Ranch at Santa Fe and its executive forum, The Santa Fe Center.~(left)Bill Black, president of Montana de Fibra, inspects the plant's fiberboard press, which produced a company record of high quality medium.density fiberboard in 1986.The Las Vegas.New Mexico plant manufactures wood panels that are principally used in furniture cabinets.MdF's markets reach as far as Italy and Taiwan.a loss.Worldwide shipments of medium-density ftberboard werc strong, but prices were weak.Even so, this plant contributes substantially to the local economy.~Investments in small New Mexico venture capital companies.

~Investments in New Mexico real estate development projects.~The Ranch at Santa Fe and its cen-ter of learning-The Santa Fe Center, where executives from around the world will gather for seminars and conferences to explore international issues.15 Natural resources unii improves operations

~(above)Bob Rountree, chairman of Sunbelt (seated), and Al Robison, president and chief operating officer of Sunbelt.make the strategic decisions necessary to manage a portfotio of natural resources operations.

ince 1979 our natural resources subsidiary, Sunbelt Mining Company, Inc., has grown from a small coal mining operation into an organization that explores, acquires, develops, and markets mineral and energy resources in the Southwest, as well as in new markets in the Midwest and Florida.Coal is mined in New lVlexico and Oklahoma Sunbelt's major New Mexico property is the De-Na-Zin/

Gateway coal mine in northwestern New Mexico.This mine produces 225,000 tons per year for the San Juan Generating Station, under a supply contract which expires in 1991.Additionally, Sunbelt-along with Arch Mineral Corporation-controls over 500 million tons of low-cost, surface-mineable coal adjacent to the De-Na-Zin/Gateway operation.

Sunbelt and Arch Mineral are working together to develop these resources for the proposed Dinch power project.A subsidiary of Sunbelt owns and 16 r i(~(above)Sunbelt's De.Na.ZirVGateway coal mine near Farmington, New Mexico, produces low.sulfur coal for the San Juan Generating Station.~(left)Contract barges move coal from our OMahoma mines to a utility customer in Florida.(tl-)operates one of the largest surface coal mining operations in Oklahoma.In 1986, operations were centralized from several Oklahoma sites and the mines'quipment was improved.We could also benefit from a new Okla-homa law requiring Oklahoma utili-ties to buy at least 10 percent of their coal from Oklahoma mines.Precious metals properties are slated for sale After a reassessment of their precious metals holdings, Sunbelt's subsidiaries decided to reduce investments in this industry.New developments add to Sunbelt's role Totah Power Development Com-pany, Inc.was recently organized as a Sunbelt subsidiary to provide the vehicle for PNM's participation in the Dinch Power Project.A gas proc-essing company was purchased in December.Natural gas is processed at this operation and liquid by-prod-ucts are removed and sold.These two developments represent new areas of investment emphasis.NATURAL RESOURCES SITES De-Na.ZIn/Gateway Mine Near Farmington, New Mexico Rogers ill Mine Near Tulsa, Oklahoma Gold Properties Northern California Western Nevada 17 An expression of ihanks I 7 r r~I ic yE~(top)Albuquerque, New Mexico's largest city, is home to many PNM employees.

~(above)Ray Hoffman proves that you don'have to live in a city or town to be a volunteer.

Supervisor of the Gas Company's isolated Dogie Canyon Compressor Station, Ray volunteers as a grounds keeper and Santa Claus at the Largo Canyon School.(But don't tell the school's ten kids!)~(righl)Sherry Leeson tutors English by phone to high school students in a program established by an Albuquerque high school in 1986.l8 s chairman of this cor-poration, I am exceptionally proud of our employees'edication to service excellence

-both on and off the job.In these two pages we share with you just a few examples of our many outstanding employees.

Through their efforts, the communities that we call home are a richer place in which to work and play.Your Company encourages employees to become active, vital members of their communities.

As an example, a Company-sponsored program, Volunteers Interested in People, asks for-and receives-employees'elp in a wide range of volunteer service activities.

More than 230 employees said YES in 1986 by helping people with disabili-ties, working in hospitals, judging science fairs, and supporting senior citizens'ctivities.

The VIP'Weatherization Program was a major undertaking this past year.In replac-ing broken windows, in weather-stripping and caulking around doors and windows, and making other energy conservation repairs, the VIP's made many needy Albuquer-que residents warmer during the winter months.

~(top)Santa Parra and Paul Schwarz served as key organizers for the 1986 Greater Albuquer.que United Way Campaign, Tihrough their hard work and the generosity of fellow employees, they helped raise more than$234,000.~(above left)Mana De Rios shares her time with Albuquerque's non-profit blood bank, the Junior League.and the Volunteer Center of Albuquer.que, which matches skills of volunteers with the needs of local non.profit organizations

~(above right)Mike McEuen wears several volunteer"caps" Mike is involved with the Red Cross, Protect Share, Health Care for the Homeless, and the Feed the Hungry Program in downtown Albuquerque.

~(from left to right)Fred Wilier, Cheryl Wilson, Jeff Archuleta, and Tim Gordon are members of the San Juan Generating Station's volunteer fire company.Fire company vol'unteers are on call around the dock,~(nght)Ron Edgington, on behalf of the Cystic Fibrosis Society, ran 3.150 stairs in two hours in the annual"Pit Climb" at the Umversity of New Mexico Arena.19 A good place jo do business-A good place 4o live Iii,;III'tii,,:IIItiiiiil+i,'Qj]jar, ijjj~iTIIIIICItiiii~i'i'i'iiiti~tKIIÃiti 3 6+3 6+3 3 6+c+g 0/))Yi~(top)New Mexico is a haven for America'retirees, who find a variety of housing as well as a mild dimate.These apartments are"The Islands of Rio Rancho" located west of the Rio Grande near Albuquerque.

Rio Rancho is one of the fastest growing areas in PNM's service territory, attracting retirees and first time home buyers.~(above)Albuquerque's tribute to the Doge's Palace of Venice, the New Mexico Title Building, underwent a major renovation in 1 982 which restored its arches and intricate carvings.The building, listed on the National Historical Regis.ter, is just one of many striking office buildings in downtown Albuquerque.

~(above right)Once unique to the Southwest, New Mexico's culinary specialties are now available nationwide.

Tortilla chips, green chile, and spicy condiments are produced at the family owned Bueno Foods, in Albuquerque's south valley.Pictured here are Joseph Baca, chairman of the board, and Jackie Baca, president.

~(right)The Biophysics Group at the Los A!amos National Laboratory has advanced the technology of Flow Cytometers.

Using lasers to detect disease, and in particular.

cancer.this technology has spurred international attention and collaboration.

New Mexico is home to two of the nation's largest centers of scientific research'.

Los Alamos National Laboratory and Sandia National Laboratory in Albuquerque.

20-v I

~(above)General Electric's TF 39 jet engine powers the C.5B, the largest aircraft in the worfd.Parts for these and other engines are made at GE's aircraft engine plant in AIbuquerque.

~(above left)One of only two such plants in the nation, this Greyhound plant at Roswell manufactures buses that viitl travel the world's highways.ur corporation was born, and continues to grow, in a provoca-tive land called New Mexico.It is the 47th of the 50 United States, but it is also a state of mind: There is a con-stant, underlying excitement about what we find here-and what we are stimulated to seek.It is a good place to do business;a good place to live.On these pages PNM salutes the businesses, the culture, and the arts of New Mexico...a place we'e very proud to call home.Froin the beginning, many of those who have explored New Mexico have also stayed.First the Anasazi...then Native Americans...the Spanish...

the new American ranchers, farmers, and merchants.

More recently, the scientists, engineers, and entrepre-neurs who followed the sun to these exciting new horizons.New Mexico is a world-famous incubator of ideas in science and technology, with one of the highest concentrations of doctorate degrees in the 50 states.All have found the excitement of this land.They see its beauty as well as its opportunity, and look to make the most of both.They dream big-and work hard.Their work involves a variety of outputs, from tortilla chips to computer chips.Buses.High-tech medical equipment.

Lumber and fiberboard.

Gas, oil, and minerals.And hundreds of other products, services, and ideas.PNM serves nearly all of the busi-nesses and institutions pictured here.We'e proud that our reliable, afford-able service makes it possible for these people and their organizations to work toward their visions of growth, prosperity, and"the good life" that New Mexico offers.21 "Mew Mexican-means unique L~(top)New Mexico's International Space Hall of Fame at Alamogordo offers a look at yesterday-and a glimpse of tomorrow.The museumis located near White Sands Missile Range, home to much of the nation's rocket research.~(above)The architecturally striking Santa Fe Opera attracts many of the world's most talented artists.Renowned for imaginative stagings of traditional productions of Mozart, Wagner, Verdi, and Puccini, the Opera has held world premiers of many contemporary operas.22 ew Mexico's blend of three great cultures has created a culture all its own-"New Mexican".-rooted in our peoples'istinctively different worlds of yesterday, reflec-tive of the land we live in today, shar-ing the hopes we have for tomorrow.Perhaps because much of our land remains undisturbed, we are more conscious of our past than are the citizens of many other states.New Mexico is home to many enchanting museums.Recently, The New Mexico Museum of Natural History was dedicated.

It is the first natural history museum to open in the nation in 50 years.Our colorful history was prelude to our diverse present.The places, things, and events pictured here rep-resent our varied lifestyle.

We share this good life within a dynamic economy, and welcome a future built upon a unique way of life.

~(above left)As many as 400 colorful hot.air balloons ascend during the International Balloon Fiesta every October.Participants from nearly 40 countries gather for this event in Albuquerque, the largest of its kind in the world.~(above)New Mexico's State Fair is among the nation's top five in terms of attendance, with one of the largest cash purses on the professional rodeo circuit.Our electric utility helped plan a compfete renovation of the fairground's efectrical system in 1986.~(left)Indian dancers from all over the country come to the New Mexico State Fair to share their ancient traditions.

These dancers are from Zuni Pueblo, one of New Mexico's 19 pueblos.~(below left)After successful showings in New York, Toronto, and other major cities, MAYA-Treasures olan Ancient Citrilizafen has returned to The Albuquerque Museum.Organized and assembled by the museum, this rare collection of Mayan artifacts was gathered with the help of Mexico, Guatemala, and Befize.23 Ari born from ihe inspiraiion of a land and iis people~~s tI)8'I'()j/+g8%gggg~t4 i~g~ng 1;by Evelyn RDMtttbctg tart with a land famous for its diversity:

Natural features unique to the Southwest, like arroyos and mountains.

Plants from every life zone: Cacti, evergreens, sagebrush, oak trees, yucca, and alpine wild-flowers.Endless skies, etching into our memories their blazing sunsets and star-studded midnights.

Add three cultures, each seeking to preserve its heritage while also discovering

-and blending with-24 the others.The result is a society of artists and art-lovers...also known as New Mexico.It's doubtful that any other state has as many career artists per capita,"Sunday painters," galleries, or collections.

From the rock-paintings of ancient peoples to the"detonography" of today, our art has reflected the variety of this place and its peoples.Every form of art has found a home in New Mexico.Indeed, some of our place-names are almost synon-ymous with art: Taos.Santa Fe.Albuquerque.

But in almost any part of the state, at almost any time of the year, one can view art, as well as study, buy, sell, and even live it.The art, like the place, takes on a million forms and hues.And PNM is proud to have a role in this exciting place, among these exciting peoples.

r iI~Qgr Q~~" i~71~rf:r.yr I ff rIit tfi I Mask ptrotos by saty Andersen Brucecounesy ot Museran oi fnternatcnat Fdk Art.Grard Founcbtm cotecaon and fnternatcnal Feet An Fcundatm~santa Fe~(above)These masks are among the many collections of traditional arts, antiquities, and folk arts housedin the Museum of New Mexico, a collection of five museums located throughout Santa Fe.(left to right)Clown Mask,"Tiger" Mask, Ceremonial Dance Mask.Negrito Mask, Tastoan Devil Mask, Morochino Mask by Ruperto AbrahanMoor Mask, all from Mexico;Mask with Three Faces from Bolivia.~(left)New Mexico, Iong a haven for the tradi.tional arts, is equally hospitable to new ones.Albuquerque artist Evelyn Rosenberg devel.oped"Detonography", which combines plaster casts.stainless steel plates, and sheets of plastic explosive.

~(far left)One discovers the Santuario de Chi.mayo on the high road to Taos.With its simple lines and earthen tones, the chapel is a destina.tion for religious pilgrims and a striking example of the Hispanic adobe architecture prevalent throughout the state.AntdOPe Head Wittt Federnai: by Georya QKOetfeCOurteey ACA Gafterree.

NeW lfbrk o I~(above)Painting by Georgia O'Keeffe, a major influence in 20th century American art and a long time resident of Abiquiu, New Mexico.Life Magazine observed, after her death at 98, that she"loved New Mexico's stones, bones and douds."~(left)Margaret Tafoya, of the Santa Clara Pueblo, and other Native American artisans continue New Mexico's heritage in a modern world.In the tradition of her ancestors, Margaret gathers her own day from a nearby mesa before shaping, firing, and painting her nationally admired pottery.25 p A 0 p 0 A A 0 D 0 a a%fice-BXCAK 5X(R a a--0 D 0 0 0-a A A Q Q a 0-0 0 0 Ialmxelllmhaog"IRlsadRIRI@msKIS Management's Discussion and Analysis of Financial Condition and Results of Operations Selected Financial Data Management's Responsibility for Financial Statements Auditorsl Report Consolidated Statement of Earnings Consolidated Statement of Retained Earnings Consolidated Balance Sheet Consolidated Statement of Changes in Financial Position Notes to Consolidated Financial Statements Quarterly Operating Results Stock/Dividend Data Comparative Operating Statistics 27 32 33 33 34 35 36 37 45 45 46 26 Public Service Company of New Mexico and Subsidiaries

~~~DKNBiilCM6 co Nhma@5emStei)

GM8 CP~D~~iKl5XiS The following is management's assessment of the Company's finan-cial condition and the significant factors which influenc the results of operations.

This discussion should bc read in conjunction with thc Company's consolidated financial statements.

The Liquidity and Capital Resources section and the Results of Operations section do not reflect any potential restructuring of the Company discussed under thc Company's Response to Marketing and Regulatory Challenges section.Liquidity and Capital Resources Utility Construction Program Commitments Decline With the commercial operation of the Palo Vcrdc Nuclear Generating Station (Palo Vcrdc)Units 1 and 2 in 1986, the Company's utility construction cxpcnditurcs continue to decline rclativc to the levels experienced during the late 1970s and early 1980s.Over the next five years (1987-1991), the Company expects to spend$576 million for clcctric, gas, and water utility construction.

This projection includes$42 million in"allowance for funds used during construction" (AFUDC), a non-cash item that reflects the Company's costs of debt and equity capital used to finance utility construction.

The$576 million projection also includes$57 million for nuclear fuel.Actual utility construction spending during 1986 and the Company's projections for 1987-1991 (in millions of dollars)are shown below: 1986 1987 1988 1989 1990 1991 Cash AFUDC Total$151$112$107 S 99 S 97$119 49 28 4 3 3 4$200$140$111$102$100$123 Net Earnings Applicable to Common Stock Dollars in Millions 150 These estimates arc under continuing review and subject to adjustment.

$88$116'109$122$133 Capital Requirements:

A Five Year Projection Capital rcquircmcnts are met with a combination of externally-raised funds and internally-generated funds from operations.

The Company estimates its utility capital requirements for the next five years (1987-1991) at$641 million.This total includes$96 million that will be applied to the payinent of long-term debt maturities and to the mandatory redemptions of preferred stock.$19$13$29'76'77'78'79'80'81'82'83'84'85'86'fncfudes safe of retained economic interest in coal leases which contributed

$18.8 million and$24.1 million to earnings, respectively, in 1981 and 1983 The level of internally-generated funds depends on rate relief granted by both the New Mexico Public Service Commission (NMPSC)and the Federal Energy Regulatory Commission (FERC).The level also dcpcnds on the Company's ability to sell significant amounts of additional power not currently under contract.The price that the Company will receive for this power is expected to bc advcrscly affected by the existing soft market for wholesale and off-system power sales.27 Public Service Company of New Mexico and Subsidiaries It is projected that the non-utility subsidiaries will provide a substan-tial portion of their capital requirements from internally-generated sources.To thc extent that external debt financing may be required, such borrowings will bc made independently by the subsidiaries from third-party sources and will be nonrecourse to thc Company.How will the Company Meet its 1987 Utility Capital Requirements?

The Company expects to meet its 1987 utility external financing requirements through the issuance of approximately

$12 million of common stock under the Company's stock plans, incurrence of short-tenn debt, and use of funds currently invested on a temporary basis.Stock plans previously provided a significant portion of the Company's capital requirements.

It is anticipated that stock plans will no longer provide significant capital since, in the future, stock for the plans will principally bc obtained from open-market purchases rather than from the issuance of new shares.rate reductions, over time, will increase the camings of non-utility business units and will reduce the cost of service to our utility customers through a corresponding loivering of future revenue requirements.

While the Tax Reform Act of 1986 reduces the corporate federal income tax rate from 46 percent to 34 percent, effective July I, 1987, seveml other provisions, including the repeal of the investment tax credit on ncw construction, less favorable depreciation rates, the enactment of the corporate alternative minimum tax, and the taxing of revenues for utility services rendered but not yet billed, will have a somewhat negative impact on the Company's cash flow.Capital Structure on December 31, 1986 As a result of thc retirement of first mortgage bonds and cumulative preferred stock discussed above, the Company's capital structure on December 31, 1986 consisted of: Uquidity Thc Company's management measures liquidity in a number of ways in evaluating the Company's ability to maintain financial strength.Cash dcrivcd from operations is an important indicator.

The level of cash and,temporary cash investments, less short-term borrowings, is another.'A third measure is the Company's ability to raise needed capital from outside sources.The sale and leaseback of the Company's interests in Palo Verde Units I and 2 directly and indirectly influences thc Company's overall cash position.Tire Company is required to make lease payments totaling,$

84.6 million per year over thc approximate 29 year term of thcsc leases.However, thc proceeds from thc sale and lcasebacks allowed the Company to reduce a significant portion of its highest cost first"mortgage debt and preferred stock.(Scc the accompanying charts detailing the Company's capital structure).

The Company has saved$46.7 million in interest and dividend payments annually, has reduced the need for short-term borrowings, and has increased interest income from temporary cash investments.

The Company had$259 million in cash and temporary cash invest-ments at the cnd of 1986, compared with$384 million at the end of 1985.At thc cnd of 1986, the Company had available, for short-term bormwings, unused bank lines of credit of about$225 million.The Company can raise external capital by issuing first mortgage bonds or prefcmed stock-provided certain earnings tests are mct.Tests applying to the issuance of additional first mortgage bonds and preferred stock are specified in the mortgage indenture and the Company's Restated Articles of Incorpomtion, respectively.

As of December 31, 1986, these tests did not restrict the Company's ability to issue additional first mortgage bonds or preferred stock in amounts adequate for currently projected future funding rcquircments.

Thc Company currently has no plans to issue additional first mortgage bonds or preferred stock.1986 Capital Structure 2.8'Yi 42.5%compared with 1985: 1985 Capital Structure 5.1%48.7'/i 51.8<4.5%41.7i/i The Effects of the New Tax Law are Mixed The Tax Reform Act of 1986 is not expected to have a pronounced short-term effect on the Company.The Company's regulated busi-nesses arc gcncrally protected under the Act from rapid shifts in either earnings or revenue requirements due to any potential reduc-tions in existing deferred income tax balances.It is expected that tax 28 0 Long.term Debt.Less Current Maturities 0 Preferred Stock With Mandatory Redemption Requirements D Preferred Stock Without Mandatory Redemption Requirements D Common Stock Equity Public Service Company of Ncw Mexico and Subsidiaries Results of Operations Nct earnings applicable to coinmon stock during the last thrcc years 1986 1985 1984 S133 million$122 million$109 million 1 OI'r or S3.29 per share$3.30 per share$3.11 per share (The 1986 and 1985 clings reflect thc operation of the gas utility assets acquired in January 1985.The following discussion highlights significant items which affected the amount of reported earnings.Electric Revenues Increased$35 million;Gas Revenues Oecreased S29 million Electric operating revenues increased$35.0 million in 1986 over 1985 primarily because of a 3.9 percent increase in energy sales to retail rcsidcntial, commercial, and industrial customers.

Rcvcnucs from wholcsalc customers incrc~d$11.0 million in 1986 primarily as a result of increased revenues from San Diego Gas and Electric Company for the increased capacity made available to it by the Company.However, energy sales to fimi and contingent wholesale customers dcclincd 24.8 pcrccnt from 1985 as a result of lower-cost energy,.available to these utilities mainly from oil-and gas-fired power plants.The decrease in electric operating revenues in 1985 was caused by dccrcascd sales to wholcsalc customers, resulting from a reduction in contractual cncrgy demands of four non-affiliated utilitics during 1985.Total Kwhr Sales Kwhr in Millions~other contracted Ener97 saks~Sales lor Resale~tndustrtat tt Other Retail II Commercrat 5761 CJRestdentlat 5402 4367 4528 3595 7202 7 37 6884 6491 6728 Gas operating revenues dcclincd$29.1 million in 1986 although only eleven Inonths of gas operations were included in 1985 results.The primary reasons for this decline are lower gas purchase costs which are recovered through a purchased gas adjustment clause and a decrease in volumes pure}fused by industrial customers.

However, the nct gas revenues (gas revenues less gas purchased for resale)are up by$7.9 million over 1985.Thc decked consuinption by industrial customers was duc partially to a NMPSC order which requires Ncw Mexico gas utilitics to offer gas carriage scrvicc to qualifying customers at sct rates on an available capacity basis.Fuel and Purchased Power Expense Increased Slightly in 1986 Rel and purchased power expense, which is partially offset by off-systein cncrgy sales to other utilities, increased$3.9 million in 1986 after having declined$49.5 million in 1985.The 1986 increase is due to a soft off-system energy sales market, a result of incxpcnsive oil and gas generation availability.

The 1985 decrease was due to a 200 MW block energy sale which extends through 1989, significantly offsetting fuel and purchased power expenses.Other Operation Expenses Increased-Largely the Result of Lease Payments Other operation expenses increased$69.5 million in 1986 due pri-marily to the incurrence of lease payincnts of$39.6 million for Pilo Verde Units 1 and 2 and operation expenses of$9.9 inillion incurred for these units which began commercial operation in 1986.Other'76 77'78'79'80'81'82'83'84'85'86 29 Pubfic Service Company of New Mexico and Subsidiaries Operating Expenses Dollars In Millions 300 C3 eas~tease Expense'3 Other Eteetrte 8 Water$272$318$62$99$81$125$146$193$202$203'76'77'78'79'80'81'82'83'84'85'86'Exclusive of fuel and purchased power and gas purchased for resale expenses.'Operating lease expenses incurred for Palo Verde Units and EIP transmission line.Allowance for Funds Used During Construction Decreased AFUDC, a non-cash item, decreased$32.0 million in 1986 as a result of lower average construction work in progress balances result-ing largely from the commercial operation of Palo Verde Units I and 2 in 1986.Deferred Carrying Costs on Uncommitted Electric Generating Capacity Increased Since 1982, the Company has deferred carrying costs associated with specifically identified uncommitted generating capacity in accord-ance with a NMPSC order.This non-cash deferral increased$13.0 million in 1986 over 1985 due primarily to an incite~in uncommit-ted gcncrating capacity resulting from thc commercial operation of Palo Vcrdc Units I and 2.operation expenses for 1985 incrcascd$53.8 million over 1984 primarily as a result of the addition of gas operations in January 1985 which accounted for$41.5 million of thc increase.The remainder of this increase was due primarily to lease payments for an electric transmission facility leased in 1985.Operating Income Taxes Decreased in 1986 Operating income taxes decreased$28.6 million in 1986 due pri-marily to thc liow-through of tax benefits such as those associated with start-up activities at Palo Verde, losses on hedging transactions, and premiums incurred in the retirement of$212.2 million of the Company's first mortgage bonds.These tax benefits, primarily accounted for by thc flow-through method in accordance with reg-ulatory orders of the NMPSC, provided nct earnings of$41.6 million (or$1.03 pcr share), and are not expected to recur at the same high level in future years.A$10.5 million decrease in operating income tax cxpcnse in 1985 resulted primarily from tax benefits related to start-up activities at Palo Verde.Equity in Earnings of Unconsolidated Affiliates Showed a Loss in 1986 Thc results of operations from unconsolidated affiliates showed a loss in 1986 mainly due to a write-off of a venture capital investment of$6.0 million.In addition, earnings from real estate operations dcclincd as a result of dcprcsscd market conditions in Texas and Oklahoma.Other Income Increased in 1986 Other income increased$10.1 million in 1986 over 1985 principally as a result of increased interest income from the investment of procccds from the sale and le~backs of the Company's interest in Palo Vcnle Units I and 2.In 1985, other income declined$14.8 million largely as the result of operating costs associated with com-mercial operation of a medium-density fibcrboaid manufacturing plant by a subsidiary of thc Company.The losses experienced by thc fiberboard plant continued in 1986.Interest Charges and Preferred Dividend Requirements Decreased in 1986 as a Result of Retirements Proceeds from the sale and lcascbacks of the Company's interest in Palo Verde Units I and 2 allowed the Company to retire$212.2 million of first mortgage bonds and$89.8 million of preferred stock in 1986.As a result, interest charges and preferred dividend require-ments decreased$24.0 million and$5.7 million, respectively, from 1985.Interest on long-term debt increased$13.5 million in 1985 largely as a result of the issuance of notes for the gas property acquisition in 1985.The Company's Response to Marketing and Regulatory Challenges Thc Governor of New Mexico has recently announced an initiative by thc Company relating to a potential restructuring.

The restructur-ing would include steps in addition to the holding company forma-tion previously proposed.The additional steps may entail separation of the Company's electric utility operations into generation and distribution entities.Under this arrangement, thc generation entity would bc committed to supply the projected power needs of thc distribution entity under a long-term contract.The gas and water utilitics could also be scparatcd into new entities.The Company anticipates that these additional restructuring steps, if ultimately implcmcnted, could result in a retail electric rate reduction.

We are presently discussing restructuring proposals with New Mexico state officials and other interested parties.Uncommitted Capacity is of Concern from a Marketing and Earnings Perspective The initiative is intended to respond generally to competitive pres-sures experienced by thc Company in the marketing of power, and morc specifically to a number of problems facing the Company.One of the Company's major concerns results from the fact that its existing and projected load requirements are substantially lower than those predicted at the time commitments were made to construct new gcncrating units.The Company, therefore, now has substantial gen-eration capacity in excess of its requirements for its firm customers (uncommitted capacity).

The Inventory of Capacity ratemaking methodology, first implemented in 1982, was a regulatory at tempt to address this situation.

30 Public Service Company of New Mexico and Subsidiaries 2,500 Electric Resources:

Contracted and Uncontracted (Capacity at Time of Peak)Megawatts~Forecasted Uncontrscted Ca pacttyr~Contracted to Other Utilities~Forecasted System Load, Including Required Reserves',500 1>000'87'88'89'90'91'92'92'94'95'98'PNM has the opportunity to recover costs of forecasted uncontracted capacity through competitive market sales revenues.'Capacity and reserves necessary to meet the needs of both New Mexico retail customers and firm wholesale customers.

As of Dccembcr 31, 1986, wc had 1,565 megawatts of owned and leased generating capacity plus 113 megawatts being purchased from other owners of San Juan Unit 4.An additional 130 megawatts will be added following the date Ptio Verde Unit 3 is placed in service (currently scheduled for thc third quarter of 1987).The Company estimates that it will have 552 megawatts of uncommitted capacity available to be sold at thc time of its summer peak of 1987, increasing to 705 megawatts in 1991.Over the next five years, 36 percent of thc energy associated with uncommitted capacity is contracted for sale to other utilitics.

How-ever, our ability to sell the remaining uncommitted capacity or energy will bc affcctcd by transmission availability and levels of competition in the off-system market.Competition in thc off-system inarkct has intensified due, in part, to thc availability of excess capacity from other utilitics, a decree in oil and natural gas prices, and the emergence of co-generation and self-generation as competing energy sources.Projected levels of uncoinmittcd capacity will make the Company dependent on thc inventorying methodology for a substantial portion of its future earnings.We project that the inventorying methodology would defer approximately

$248 million of nct carrying charges over thc next five years.Earnings attributable to thc inventorying meth-odology'amounted to 10.7 pcrccnt of our 1986 net e~ings.Focus on Inventorying Methodology and Palo Verde Costs Future earnings may be adversely affected by various devclopmcnts relating to the inventorying methodology.

Initiatives by the Financial Accounting Standards Board (FASB)regarding phase-in plans may adversely affect the viability of the inventorying methodology.

In addition, the NMPSC has scheduled a proceeding to obtain pro-posals for alternatives to the inventorying methodology.

See note (I)to the consolidated financial statements.

Additionally, the NMPSC has initiated an investigation of Palo Vcrdc project managcincnt and construction costs.Thc investigation's pur-pose is to determine the prudence of the Company's incurred Pilo Verde costs and to quantify thc costs resulting from imprudence, if any.An accounting standanl recently adopted by the FASH would require the Company to charge disallowed costs, if any, to expense at the time such disallowance is dctcrmincd to bc probable.Sce notes (1)and (ll)to thc consolidated financial statements.

Our Natural Gas Business Also Faces Challenges NMPSC regulations currently limit our ability to compete effectively with altcrnativc carriers and to manage our supply requirements under changing market conditions.

We have filed an application with thc NMPSC sccking modifications of those regulations.

Summary: The Company is Evaluating Alternatives Thc Company has considered various rcsponscs to the above issues.The likelihood of our long-tenn dependence on thc inventorying inethodology for a substantial portion of the Company's earnings, assuming the inethodology continues, and uncertainties as to thc continuation of thc methodology, have caused us to evaluate alter-natives.The prospect of lengthy adversarial proceedings concerning thc prudence of Pilo Verde costs, pressure on the Company within the State of New Mexico to reduce and stabilize retail rates, and intensified competition in the marketing of power, have likewise caused the examination of alternatives.

The result of this examination to date has been the Company's initiative relating to the potential separation of the electric generation and distribution assets into distinct entities.Details of any additional restructuring, including the legal form of the potential new entities, are currently under consideration.

Assuming separation into a NMPSC-regulated distribution entity and a FERC-regulated generation entity, the Company anticipates that the inventorying methodology may no longer be appropriate.

Also, thc review by the NMPSC of the piudencc of Palo Verde costs would be obviated since the Company's interest in Palo Verde would then be a part of the FERC-regulated generation entity.Implementa-tion of any such restructuring will bc subject to numerous conditions, including rcquircd regulatory and other approvals.

31 Public Service Company of New Mexico and Subsidiaries Selected Financial Data 1986 1985 1984 1983 1982 Total Operating Revenues Net Earnings Earnings per Common Share Total Assets Preferred Stock with Mandatory Redemption Requirements Long-Term Debt, less Current Maturities (In thousands except per share amounts and ratios)S 697,995$689,982$445,328$397,474 S 151,005$146,310$132,840$140,519 S 3.29 S 3.30 S 3.11 S 3.53$2,756,144$3,010,238$2,598,744$2,486,429 S 66, 147$119,080$121,080$123,700 S 901,511$1,143,355$1,030,557$974,290$426,543 S 115,822$3.22$2,145,984$125,000$811,653 Common Stock Data: Dividends paid per common share Dividend pay-out ratio Market price per common share at year end Book value per common share at year end Average number of common shares outstanding Return on average common equity Ratio of Earnings to Fixed Charges (S.E.C.Method)S 2.92 88.8/o S 33.000 S.26.51 40,401 12.8/o 2.51$2.89$2.85$87.6'/o 91 7o/o S 29.500$24.375$$25.73$25.28$37,059 35,011 13.2'lo 12.5'lo 2.63 2.32 2.81 79.6'/o 25.375 25.20 32,956 14 3o/o 2.81$2.77 86.0'/o$26.000$24.35 28,508 13.6'/o 2.70 Capitalization:

Common stock equity Preferred stock: Lon 42.1/o 41.7o/o 41 5o/o 42.8'/o 51.6o/o 2.8 3.1 42.5 4.5 5.1 48.7 100.0'/o Without mandatory redemption requirements 5.2 5.8 With mandatory redemption requirements 6.0 6.9 g-term debt, less current matudties 47.3 44.5 100 0 lo 100.0o%%d 100 0'/o 100 0'/o The selected financial data should be read in conjunction with the consolidated financial statements and notes to consolidated financial statements contained elsewhere in this report.32 Public Service Company of New Mexico and Subsidiaries Management's Responsibility for Financial Statements Auditors'eport Thc managcmcnt of Public Service Company of New Mexico is responsible for the preparation and presentation of thc accompanying consolidated financial statcincnts.

The consolidated financial state-ments have been prepared in conformity with gcnemlly accepted accounting principles and include amounts that are based on informed estiinatcs and judgements of management.

Managcincnt inaintains a systcin of internal accounting controls which it believes is adequate to provide reasonable assurance tlrat assets are safeguarded, transactions are executed in accordance with managcinent authorization and the financial records are reliable for preparing the consolidated financial statements.

The system of inter-nal accounting controls is supported by written policics and pro-cedures, a staff of internal auditors who conduct comprehensive internal audits and by the sclcction and training of qualiTied pcrsonncl.

Thc Board of Directors, through its Audit Conunittec comprised cntircly of outside directors, mccts periodically with managcinent, internal auditors and the Company's indepcndcnt auditors to discuss auditing, internal control and financial reporting matters.To ensure their independencc, both the internal auditors and indcpcndcnt auditors have full and free access to the Audit Committcc.

Thc independent auditors, Peat, Marwick, Mitchell&Co., are engaged to examine the Company's consolidated financial statcmcnts in accordance with generally accepted auditing standards.

The Board of Directors and StockhoMcrs Public Service Company of New Mexico: We have examined the consolidated balance sheet of Public Service Company of Ncw Mexico and subsidiaries as of December 31, 1986 and 1985 and the related consolidated statements of earnings, retained clings and changes in financial position for each of the years in the three-year period ended Deceinbcr 31, 1986.Our exam-inations were made in accordance with gcncmlly accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considcrcd neces-sary in the circumstances.

In our opinion, the aforcmcntioned consolidated financial statements prcscnt fairly the financial position of Public Service Company of Ncw Mexico and subsidiaries at December 31, 1986 and 1985 and the results of their operations and changes in their financial position for each of thc years in the thrcc-year period ended Deccmbcr 31, 1986, in confomiity with generally accepted accounting principles applied on a consistent basis.PEAT, MARWICK, MITCHELL&CO.Albuquerque, New Mexico February 19, 1987 33 Public Service Company of New Mexico and Subsidiaries Consolidated Statement of Earnings 0 crating Revenues: Year Ended December 31 1986 1985 1984 (In thousands except per share amounts)Electric Gas (note 10)Water Total operating revenues Operating Expenses: S 443,084 244,666 10,245 697,995$408,101 273,737 8,144 689,982$438,974 6,354 445,328 Fuel and purchased power Gas purchased for resale Other operation expenses Maintenance and repairs Depreciation and amortization Taxes, other than income taxes Income taxes (note 5)Total operating expenses Operating income Other Income and Deductions, net of taxes (note 5): 50,318 149,685 191)604 41,879 60,249 30,511 (6,727)517,519 180,476 46,456 186,691 122,085 42,691 55,366 29,729 21,850 95,904 68,278 34,075 48,975 19,246 32,356 185,114 146,494 504,888 288,834 Allowance for equity funds used during construction Deterred carrying costs on uncommitted electric generating capacity Equity in earnings (loss)of unconsolidated affiliates Other Net other income and deductions Income betore interest charges Interest Charges: Interest on Iong-term debt Other interest charges Allowance for borrowed funds used during construction Net interest charges Net Earnings Preferred Stock Dividend Requirements Net Earnings Applicable to Common Stock 34,926 16,191 (1,567)4,193 53,743 234,219 57,848 3,230 5,815 (5,889)61,004 246,118 50,735 2,924 7,975 8,865 70,499 216,993 87,961 9,147 (13,894)83,214 151,005 18,187 111,974 10,779 (22,945)99,808 146,310 23,901 98,463 8,421 (22,731)84,153 132,840 23,990 S 132,818$122,409$108,850 Average Number of Common Shares Outstanding 40,401 37,059 35,011 Earnings per Share of Common Stock Dividends Paid per Share of Common Stock S 3.29$3.30$3.11 S 2.92$2.89$2.85 Consolidated Statement of Retained Earnings Year Ended December 31 1986 1985 1984 Balance at Beginning of Year Net Earnings Dividends:

Cumulative preferred stock Common stock Balance at End of Year (In thousands)

S 198,703$182,964 151,005 146,310 (18,187)(23,901)(118,105)(106,670)S 213,416$198,703$173,420 132,840 (23,990)(99,306)$182,964 See accompanying notes to consolidated financial statements.

34 Pubiic Service Company of New Mexico and Subsidiaries Consolidated Balance Sheet Assets Utility Plant, at Original Cost (notes 3, 7 and 11): December 31 1986 1985 (In thousands)

Electric plant in service Gas plant in service Water plant in service Common plant in service Less accumulated depreciation and amortization Construction work in progress Plant held for future use Nuclear fuel, net of accumulated amortization Net utility plant Other Property and Investments:

Non-utility property, at cost, net of accumulated depreciation, partially pledged Investment in unconsolidated affiliates Other, at cost Total other property and investments Current Assets: Cash Temporary cash investments Receivables, net Fuel, materials and supplies, at average cost Gas in underground storage, at last-in, first-out cost Prepaid expenses Total current assets Deferred Charges$1,499,548 327,188 38,834 44,820 1,910,390 463,470 1,446,920 321,164 74, 132 60,763 1,902,979 166,609 108,700 15,793 291,102 3,578 255,857 122,556 58,326 12,037 8,202 460,556 101,507$1,442,532 311,049 36,155 41,622 1,831,358 413,366 1,417,992 630,761 68,095 54,609 2,171,457 85,785 122,925 21,566 230,276 7,974 375,767 112,963 42,002 12,112 6,778 557,596 50,909 Ca italization and Liabilities

$2,756,144$3,010,238 Capitalization:

Common stock equity (note 2): Common stock outstanding

-41,313 358 shares in 1986 and 37 965 868 shares in 1985 Additional paid-in capital Retained earnings Total common stock equity Cumulative preferred stock without mandatory redemption requirements (note 2)Cumulative preferred stock with mandatory redemption requirements (note 2)Long-term debt, less current maturities (note 3)Total capitalization Current Liabilities:

Short-term debt (note 4)Accounts payable Current maturities of long-term debt (note 3)Accrued interest and taxes Other current liabilities Total current liabilities Deferred Credits: Accumulated deterred investment tax credits (note 5)Accumulated deferred income taxes (note 5)Other deterred credits Total deferred credits Commitments, Contingencies and Subsequent Event (notes 7, 8, 9, 11 and 13)See accompanying notes to consolidated financial statements.

S 206,567 675,353 213,416 1,095,336 59,000 66,147 901,511 2,121,994 32,622 88,081 45,907 29,646 39,774 236,030 184,888 123,751 89,481 398,120 S2,756,144

$189,829 588,415 198,703 976,947 106,000 119,080 1,143,355 2,345,382 49,435 97,179 77.723 81,924 32,100 338,361 146,456 120,472 59,567 326,495$3,010,238 35 Pubiic Service Company of New Mexico and Subsidiaries Consotidated Statement of Changes in Financiai Position Funds Generated Internally:

Net earnings Charges (credits)to earnings not requiring funds: Depreciation and amortization Provision for non-current deferred income taxes, net Investment tax credits, net Allowance for equity funds used during construction Deferred carrying costs on uncommitted electric generating capacity Earnings of unconsolidated affiliates Funds derived from operations Less cash dividends Total funds generated internally Funds Obtained from (Applied to)Outside Sources: 78,432 3,279 38,432 (34,926)(16,191)3, 121 223,152 136,292 86,860 64,068 5,614 44,651 (57,848)(3,230)(11,545)188,020 130,571 57,449 52,844 27,175 17,306 (50,735)(2,924)(14,153)162,353 123,296 39,057 Year Ended December 31 1986 1985 1984 (In thousands)

S'l51,005$146,310$132,840 Sale of common stock Safe of first mortgage bonds Proceeds from pollution control revenue bonds Reacquisition of preferred stock Reacquisition of first mortgage bonds Bond and preferred stock reacquisition premiums Loss on hedging transactions Increases in other long.term debt Decieases in other long-term debt Increase (decrease) in short-term debt, net Proceeds from sale of utility plant, net Decrease (increase) in working capital, other than short-term debt Other 103,676 4,037{89,825)(212,247)(44,781)(17,597)141,529 (175,948)(16,813)429,612 11,522 12,425 47,975 52,146 145,696 (84,129)19,122 363,421 (169,983)119 48,123 65,000 14,583 31,377 (54,266)(95,977)214,443 2,091 Total funds obtained from outside sources Total funds generated Construction Expenditures, Investments and Acquisition:

Utility plant additions Increase in other property and investments Acquisition of non-current New Mexico gas properties:

Property, plant and equipment Other assets Deferred credits Total construction expenditures, investments and acquisition 145,590 374,367 225,374 S 232,450$431,816$264,431 S 163,489 68,961$203,347 15,227$224,599 39,832 225,719 5,329{17,806)S 232,450 S 431,816$264,431 See accompanying notes to consolidated financial statements.

36 Public Service Company of New Mexico and Subsidiaries Notes to Consolidated Financial Statements December 31, 1986, 1985 and 1984 1986 1985 1984 Electric plant Gas plant Water plant Common plant 3.23o/o 3 17o/o 2.034/o 9.464/o 3.26/o 3.29/o 3.00o/o 2.09/o 2.04/o 9.38/o 7.28/o Thc provision for depreciation of certain cquipmcnt, including amor-tization applicable to capital lcascs, is charged to clearing accounts (1)Summary of Significant Accounting Policies System of Accounts The Coinpany maintains its accounts for utility operations primarily in accordance with the uniform systems of accounts prescribed by the Fcdcral Energy Regulatory Coinmission (FERC)and the National Association of Regulatory Utility Commissioners (NARUC), and adopted by thc Ncw Mexico Public Service Commission (NMPSC).As a result of the rateinaking process, the application of generally accepted accounting principles by the Coinpany differs in certain respects from thc application by non-regulated busincsscs.

Such diffcrcnccs generally regard the time at which certain items enter into thc dctcrmination of net earnings in order to follow the principle of matching costs and revenues.Certain prior year amounts have bccn reclassified for comparability.

Thc gas gathering subsidiary is classified as non-utility in thc accom-panying consolidated financial statements.

All prior periods included in this report have bccn reclassified accordingly.

Principles of Consolidation Thc consolidated financial stateincnts include the accounts of Public Scrvicc Company, of New Mexico and subsidiaries over which it cxcrcises control.All significant intercompany transactions and bal-ances have been eliminated.

Investmcnts in unconsolidated affiliates are accounted for by the equity method.Utility Plant Utility plant is stated at original cost, which includes payroll-related costs such as taxes, pension and other fringe benefits, administrative costs and an allowance for funds used during construction.

It is Coinpany policy to charge repairs and minor replacements of property to maintenance expense and to charge major replaccmcnts to utility plant.Gains or losses resulting from retirements or other dispositions of operating property in the normal course of business are credited or charged to the accumulated provision for dcprcciation.

Depreciation and Amortization Provision for dcprcciation of utility plant is made at annual straight-line rates approved by the NMPSC.The average depreciation rates used are as follows: and subsequently allocated to operating expenses or construction projects based on the usc of the equipmcnt.

Depreciation of non-utility property is computed on thc straight-line method.Amortization of nuclear fuel is computed based on thc units of production method.Allowance for Funds Used During Construction (AFUDC)As provided by the uniform systems of accounts, AFUDC, a non-cash item, is charged to utility plant.AFUDC represents the cost of borrowed funds (allowance for borrowed funds used during construc-tion)and a return on other funds (allowance for equity funds used during construction).

Thc Company capitalizes AFUDC on con-struction work in progress (CWIP)to the extent allowed by reg-ulatory agencies.The Company also capitalizes AFUDC on its plant held for future use as allowed by the NMPSC.AFUDC is computed using the maximum rate, net of taxes, permit-ted by FERC.The rates used were 8.97 pcrccnt, 9.22 percent and 9.34 percent for 1986, 1985 and 1984, respectively, compounded semi-annually.

Deferred Carrying Costs on Uncommitted Electric Generating Capacity Effective in 1982, the Company received approval of the NMPSC to implcmcnt an electric utility ratemaking methodology called Inventory of Capacity.Under this methodology, the Company records as income and as a deferred charge an amount equivalent to carrying charges associated with specifically identified uncommitted gcncrating capacity.When off-system cncrgy sales are made from such capacity, the net proceeds are deducted from the deferred carrying charges.The net dcferrals each year are limited to a specified pcrccntage of the cost of uncommitted gcncrating capacity.Under existing orders of the NMPSC, all charges remaining after off-systcm energy sale credits will be recovered over the useful life of the generating facility when the uncommitted capacity is used to meet NMPSC jurisdictional load.Through 1986, deferred carrying charges have totaled$76.6 million, of which$40.0 million has bccn recovcmd from off-system energy sales,$4.0 million has been recovered in rates charged to retail cus-tomers and$7.6 million was recovered through thc sales of portions of San Juan Unit 4, leaving$25.0 million in defcrrcd charges to be recovered over the useful life of the gcncrating facilities.

A potential change in financial accounting standards and reevalua-tion by the NMPSC in 1988 will cause the above-described method-ology to be reconsidered.

A potential restructuring being studied by thc Company may cause such methodology to be inappropriate.

Sce note (13).Financial Accounting Standards for Regulated Enterprises In Dcccmbcr 1985, the Financial Accounting Standards Board (FASH)proposed an amendment to Statement of Financial Account-ing Standards (SFAS)No.71, Accounting for thc Effect of Certain T//pes of Regulation.

A portion of the amendment relating to account-ing for phase-in plans (such as the Inventory of Capacity ratemaking 37 Public Service Company of New Mexico and Subsidiaries methodology), if approved as proposed, would have required thc Company to obtain NMPSC approval for significant revisions to the Inventory of Capacity ratemaking methodology.

If such revisions were not approved by the NMPSC, the Company would have been required to write off amounts previously deferred under the Inventory of Capacity ratemaking methodology and would have restated the financial statements for prior years, reducing net earnings for 1982 through 1986 by a total of up to$25.0 million.In addition, the Company's financial statements for future years would reflect charges to expcnsc for those costs yet to be incuncd that would otherwise have been deferred under the existing methodology.

The pro posed amendmcnt also provided for changes in the accounting for costs disallowed by regulators and for abandoned plants.Following a public comment period and hearings, the FASB indicated its inten-tion to issue a ncw exposure draft of its proposed amendment relating to thc accounting for phase-in plans, rather than to issue the amend-ment as originally proposed.The amounts, if any, which the Com-pany will be required to charge to expense in the future will not be determinable until a final amendment is issued by the FASH and then considered by the Company and the NMPSC.In December 1986, the FASB issued SFAS No.90 which amends SFAS No.71 and requires that any disallowed costs be charged to expense at the time such disallowance is determined to be probable.SFAS No.90 also provides that if the cost of an abandoned plant exceeds'he present value of future rcvcnucs expected to be provided to recover the cost of thc abandoned plant, a loss shall be recorded in the amount of such excess.The Company cumentiy has no such costs disallowed by the NMPSC, which would be impacted by SFAS No.90.See note (11).Fuel, Purchased Power and Gas Purchase Costs Economy and other near-term energy transactions are shown as a reduction of fuel and purchased power expenses.The Company uses thc deferral method of accounting for thc portion of fuel, purchased power and gas purchase costs which are reflected in subsequent periods under fuel and purchased gas adjustment clauses.Future recovery of these costs is based on orders issued by the regulatory commissions.

Amortization of Debt Discount, Premium and Expense Discount, premium and expense related to the issuance and retire-ment of long-term debt are amortized over the lives of the respective issues.Income Taxes Certain revenue and expense items in the Consolidated Statement of Earnings afc recorded for financial reporting purposes in a year different from the year in which they are recorded for income tax purposes.Deferred income taxes are provided on these timing differences to thc extent allowed for ratemaking purposes.This method, known as tax normalization, is used primarily for dif-fcrcnces attributable to deferred fuel costs, thc usc of liberalized depreciation and accelerated cost recovery methods, pension costs and receipt of advance lease payments.Certain other timing dif-ferences result in reductions of income tax expense in the current year as required by thc NMPSC.This flow-through method is used for minor diffeicnccs between book and tax depreciation, certain cap-italized construction costs including start-up costs at Palo Verde Nuclear Generating Station (PVNGS), premiums on retirement of first mortgage bonds, losses on hedging transactions and for pollu-tion control facilitics which are amortized over five years for tax puiposes.Rates subject to FERC jurisdiction allow recovery of amounts necessary to provide additional tax normalization of the timing differences described above which arc accounted for under the flow-through method for other customers.

Provision has been made for additional deferred income taxes attributable to amounts collected under these rates.Deferred taxes arc provided on all non-permanent differences between book and taxable income attributable to non-utility opera-tions.These differences consist primarily of interest and other cxpcnses which are capitalized for book purposes and income which is taxable in periods other than when lccognized for financial report-ing purposes.The Company defers investment tax credits related to utility assets and amortizes them over the estimated useful lives of the related assets.Investment tax credits generated by non-utility properties are recognized as reductions of current income tax expense.Revenues Revenues are iccognizcd based on cycle billings rendered to custom-ers monthly.The Company does not accrue icvcnues for service provided but not billed at the end of a fiscal period.(2)Common Stock and Cumulative Preferred Stock The number of authorized shares of common stock with par value of$5 pcr share is 80,000,000 shaics.The Board of Directors has periodically reserved common stock for the Shareholder's Dividend Reinvestment Plan, the Employee Stock Purchase Plan, the Master Employee Savings Plans and the Consumer Stock Plan (Stock Plans), with 2,637,801 shares remaining unissued at December 31, 1986.However, it is anticipated that shares for Stock Plans (except the Consumer Stock Plan)will be obtained from open-market purchases after April 1987.The number of authorized shares of cumulative preferred stock is 10,000,000 shaics.Information concerning the cumulative preferred stock at Dccembcr 31, 1986 is shown on the following page: 38, PubIic Service Company of New Mexico and Subsidiaries Stated Value Shares Outstanding Stated Aggregate Redemption Stated Value Price (In thousands)

Without Mandatory Redemption Requirements:

1965 Series, 4.58%8.48%Series 8.80%Series With Mandatory Redemption Requirements:

8.75%Series 12.52%Series 14.75%Series Redeemable within One Year: 8.75%Series 12.52%Series 14.75%Series$100 100 100$100 50 100 100 50 100 130,000 200,000 260,000 590,000 360,800 700,000 31,750 1,092,550 (26,000)(46,660)(31,750)(104,410)988,140$102.00 106.00 106.20$105.80 109.85 100.00 50.00 100.00$13,000 20,000 26,000$59,000$36,080 35,000 3.175 74,255 (2,600)(2,333)~(3.175 (8,108)$66,147 The Company, upon thirty days'otice, may redeem the cumulative preferred'stock at stated redemption prices plus accrued and unpaid dividends.

Redemption prices are at reduced premiums in future years.No redemptions may bc made prior to October 15, 1991, except for use of sinking fund and optional redemptions, for the 12.52%.Series.

Mandatory redemption requirements and planned optional redemp-tions for 1987 through 1991 arc$8,108,000,$3,613,000,$3,633,000,$3,633,000 and$3,633,000, respectively.

In 1986, thc Company redeemed or purchased approximately

$89.8 million of the Company's cumulative preferred stock, including the 9.16%Series, 9.2%Series, 10.12%Series and a portion of thc 14.75%Series.Changes in common stock, additional paid-in capital and cumulative preferred stock are as follows: Cumulative Preferred Stock Common Stock Number Aggregate of Par Shares Value Additional Paid-In Capital Without Mandatory Redemption Requirements Number Aggregate of Stated Shares Value With Mandatory Redemption Requirements Number Aggregate of Stated Shares Value Balance at December 31, 1983 Stock Plans Redemption of stock Balance at December 31, 1984 Stock Plans Redeemable within one year Balance at December 31, 1985 Public issue of stock Stock Plans Redemption of stock Redeemable within one year Balance at December 31, 1986 33,932,809 2,194,380$169,664 10,972 (Dollars in thousands)

$511,975 1,660,000 37,151 507$106,000 1,587,000~26.200)$123,700 (2,620)36,127,189 1,838,679 180,636 9,193 549,633 38,782 1,660,000 106,000 1,560,800 (20,000)121,080 (2,000)37,965,868 1,800,000 1,547,490 189,829 9,000 7,738 588,415 44,256 42,682 1,660,000 106,000 1,540,800, 119,080 (448,250)(104,410)(1,070,000)

(47,000)590,000$59,000 988,140 (44,825)(8,108)$66,147 41,313,358

$206,567$675,353 Charter provisions relating to the cumulative prcferful stock and thc indenture securing the first mortgage bonds impose certain restrictions upon the payment of cash dividends on common stock of the Company.At December 31, 1986, there werc no retained earnings restricted under such provisions.

39 Public Service Company of New Mexico and Subsidiaries (3)Long-Term Debt The details of the Company's outstanding long-term debt are as follows: Issue and Final Maturity Interest Rates 1986 (In thousands) 1985 First Mortgage Bonds: 1986 through 1991 1992 through 1996 1997 through 2001 2002 through 2006 2007 through 2011 2012 through 2016 1993 through 2013-pollution control series, securing pollution control revenue bonds Funds held by trustee Total First Mortgage Bonds Pollution Control Revenue Bonds: 2003 through 2013 2009 Funds Held by Trustee Secured Notes (1986 through 1987)Other, Including Unamortized Premium and Discount Total Long-Term Debt Current Maturities Long-Term Debt, less Current Maturities 4/s%to 4/s%13'/s%5/s%to 8'/s%7/2%to 10'/s%8'/s%to 17'h%12/s%to 13'/s%5.9%to 10/s%10%to 10'/4%variable rate 8%S 16,936 30,022 47)565 85,875 89,837 7,443 437,045 (5,163)709,560 100,000 37,300 (13,448)40,203 73,803 947,418 (45,907)$901,511$17,233 65,000 48,294 86,697 151,848 125,000 437,045~6,593)924,524 100,000 37,300 (14,738)90,892 83,100 1,221,078 (77,723)$1,143,355 In 1986, proceeds from sale and leaseback transactions of thc Com-pany's interests in PVNGS Units I and 2 allowed the Company to redeem or purchase approximately

$212 million of the Company's first mortgage bonds.Also, thc Company converted, pursuant to mandatory conversion provisions, thc$23 million principal amount of 1984 Series A Pollution Control Revenue Bonds, secured by first mortgage bonds, from a variable rate to a fixed rate of 7.75 percent per annum.Substantially all utility plant is pledged to secure the first mortgage bonds.A portion of certain series of long-term debt will be redeemed serially prior to their due dates.The aggregate amounts (in thou-sands)of maturitics through 1991 on long-term debt outstanding at December 31, 1986, are as follows: 1987$45,907 1988$41,874 1989$15,634 1990$10,042 1991$15,576 Long-term debt includes certain issues which, although current by their terms, can be refinanced by existing long-term credit arrangements.

(4)Short-Term Debt Thc Company's interim financing requirements are met through the issuance of commercial paper and notes payable to banks which, rcspectivcly, amounted to approximately

$19.7 million and$12.9 million at Dcccinber 31, 1986, and approximately

$32.0 million and$17.4 million at Deccmbcr 31, 1985.At December 31, 1986, the Company had unused credit commitments from various banks total-ing approximately

$225 million.These credit arrangemcnts are used to support the issuance of commercial paper and to provide for short-tcrm borrowings.

The Company gcncrally pays commitmcnt fees or maintains cash balances on deposit with banks to assure availability of its credit commitments.

These commitmcnts consist of both lines of credit and revolving credit agrccmcnts ranging in duration from onc to six years.40 Public Service Company of New Mexico and Subsidiaries (5)Income Taxes Income taxes consist of the following components:

Current Federal income tax Current State income tax Deferred Federal income tax Deferred State income tax Investment tax credit utilized and deferred Amortization of accumulated investment tax credits Total income taxes Charged (credited) to operating expenses Charged to other income and deductions Total income taxes 1986 S 57,012 23,869 (8,985)(2,645)42,992 (5,176)$107,067 S (6,727)113,794$107,067 1985 (In thousands)

$19,500 12,633 25,399 2,804 41,939 (3,332)$98,943$21,850 77,093$98,943$1,878 2,519 20,365 3,966 20,726 (3,060)$46,394$32,356 14,038$46,394 Deferred income taxes result from certain timing differences be-tween the recognition of income and cxpcnsc for tax and financial reporting purposes, as described in note (I).The major sources of these differences for which deferred taxes have been piovidcd and the tax effect of each are as follows: Deferred fuel costs Depreciation and cost recovery timing differences Pension cost timing differences Provision for refunds Charitable contribution carryfofward Receipt of advance lease payments Other Total deferred taxes 1986 S (3,074)18,800 (4,101)584 (31)007)7,168 S (11,630)1985 (In thousands)

$3,504 23,822 2,621 (458)(1,286)$28,203 1984$1,251 24,000 (7,071)2,301 3,850$24,331 The Company's effective income tax rate was less than thc Federal income tax statutory rate for each of the years shown.The differences are attributable to the following factors: Federal income tax statutory rate Allowance for funds used during construction Deferred carrying costs on uncommitted electric generating capacity Premiums on retirement of first mortgage bonds Losses on hedging transactions PVNGS start-up costs Capital gains rate net of minimum tax Investment tax credits Reversal of flow-through items resulting from sate of PVNGS Gains on the sale of PVNGS, deferred for financial reporting purposes State income tax Other Company's effective tax rate 1986 46 0%(8.7)(2.9)(5 7)(2.8)(4.2)(6 1)(2 0)21.4 6.7 4.4 (4 6)41 5%1985 46.0%(15.2)(6)(3.5)(3.8)(1.5)17.5 3.4 (2.0)40.3%1984.46:0'lo (18.9)(8)(6)(4.1)2.0 2.3 25.9%

Public Service Company of New Mexico and Subsidiaries The cumulative net amount of income tax timing differences upon which deferred income taxes have not been provided is estimated to be approximately

$66.5 million and$51.7 million as of December 31, 1986 and 1985, respectively.

Such amounts exclude AFUDC and deferred carrying costs on uncommitted electric gener-ating capacity which are recorded on a net of tax basis.(6)Pension Plan Vested benefits Non-vested benefits Accumulated benefit obligation Effect of future compensation levels Projected benefit obligation Fair value of plan assets Unfunded excess of projected benefit obligations over plan assets$70,089 7,790 77,879 48,399 126,278 111,774$14,504 Service cost Interest cost Actual return on plan assets Other Net periodic pension cost Termination loss Curtailment gain Total pension cost$4,878 8,668 (12,163)872 2,255 10,640 (2,868)$10,027 Total pension cost, part of which was charged to utility plant, was approximately

$8.2 million in 1985 and$5.6 million in 1984.The following sets forth the plan's funded status and amounts recog-nized in the Company's Consolidated Balance Sheet at December 31, 1986 (in thousands):

The Company and its subsidiaries have a pension plan covering substantially all of their employees, including officers.The plan is non-contributory and provides for benefits to be paid to eligible cmployccs at retirement based primarily upon years of service with the Company and their compensation rates near retirement.

The Company's policy is to fund actuarially dctermincd contributions.

Contributions to the plan reflect benefits attributed to employees'ears of service to date and also for services expected to be provided in the future.Plan assets primarily consist of common and preferred stocks, fixed income securities (primarily U.S.obligations) and real estate.In 1986, the Company rcduccd its workforce by 367 positions in a program that included early retirements, voluntary and involun-tary separation packages and layoffs.The effect of this reduction is rcflcctcd in thc termination loss and curtailment gain shown in the table below.Effective January I, 1986, the Company adopted the principles of SFAS No.87 and 88 for nct periodic pension cost calculation for 1986.The effect of the adoption of SFAS No.87 was to reduce pension cost by approximately

$7.3 million for 1986.Prior to 1986, net periodic pension cost was based on the provisions of APB Opin-ion No.8.In 1985, prior to adoption of SFAS No.87, the Company changed its actuarial method from the Entry Age Normal Cost Method with Frozen Past Service Liability to thc Projected Unit Credit Method which is now required by SFAS No.87.The effect of such change was to rcducc the contribution by approximately

$3.4 million in 1985.The components of nct periodic pension cost and total pension cost (in thousands) for 1986 include: The unfunded excess consists of thc following:

Net unrecognized loss from past experience different from assumed Unamortized asset at transition, being amortized over 16 years Pension liability Included in the balance sheet$21,931 (17,454)10,027$14,504 Thc weighted average discount rate used to measure the projected benefit obligation is 8.5 percent;the weighted average discount rate used to ineasuie the net periodic pension cost is 9.75 percent;the rate of increase in future compensation levels based on agc-related scales is 6.2 percent;and the expected long-term nte of return on plan assets is 10.0 pcrccnt.The Company also has undivided interests in transmission facilities which are not significant.

It is estimated that the Company's utility construction expenditures for 1987 will approximate

$140 million, including expenditures on the jointly-owned projects.In connection therewith, substantial com-mitments have been made.(7)Construction Program and Jointly.Owned Plants Thc Company operates and jointly owns the steam turbo-clcctric San Juan Generating Station.At December 31, 1986, the Company owned an undivided 50 percent interest in the first three units of the San Juan Generating Station and about 55.5 percent of Unit 4.Thc Company has been participating with several other utilitics in thc construction of three generating units at the Paulo Verde Nuclear Generating Station.The first unit commenced commercial operation on January 28, 1986, and the second unit commenced commercial opcntion on September 19, 1986.In 1985 and 1986, thc Company complctcd sale and leaseback tnnsactions for its undivided interests in Units I and 2 and certain related common facilitics.

As a result, the Company received approximately

$900.5 million from thcsc sales.At December 31, 1986, thc Company owned an undivided 10.2 percent interest in Unit 3, which is expected to be complctcd in the third quarter of 1987.42 Public Service Company of New Mexico and Subsidiaries At December 31, 1986, the Company's ownership interest and investments in jointly-owned generating facilities are: Station (Fuel 7ype)Plant In Service Accumulated Depreciation Construction Work in Progress Composite Ownership Interest San Juan Generating Station (Coal)Palo Verde Nuclear Generating Station Unit 3 (Nuclear)'our Corners Generating Station Units 4 and 5 (Coal)$794,137$5,973$89,123$163,885$91$15,051 (In thousands)

$10,476$269,936$10,642 51 6%10.2%13.0%'Includes the Company's remaining interest in common facilities for all PVNGS units.(8)Long-Term Power Purchase Contracts The Company has entered into contracts for the purchase of electric power.Under one of these contracts, which expires in 1995, the Company is obligated to pay certain minimum amounts and a vari-able component representing the expenses associated with the energy purchased and debt service costs associated with capital improve-ments.Total obligations under this contract during 1986 ainountcd to$39.2 million.The minimum payment for each of the next five years under this contract is approximately

$28.0 million annually.(9)Lease Commitments The Company classifies its leases in accordance with generally accepted accounting principles.

The Company lcascs certain nuclear generating facilities, transmission facilities, office buildings and other cquipmcnt under operating leases.In 1985 and 1986, thc Com-pany completed sale and leaseback transactions for its undivided interests in PVNGS Units I and 2 and certain related common facili-ties.The aggregate semi-annual lease payments for thcsc leases are approximately

$42.3 million over a base lease term of approximately 29 years.Each PVNGS lease contains rcncwal and fair market value purchase options at the end of the base lease term.Total net leased property under capital leases at December 31, 1986 and 1985 was approximately

$5.4 million and$7.1 million, respectively.

Rture minimum lease payments at December 31, 1986 arc: Operating lease expense was$59,104,000 in 1986,$15,312,000 in 1985 and$6,047,000 in 1984.As of December 31, 1986, the aggre-gate minimum payments to bc received in future periods under non-cancelable subleases are approximately

$4,057,000.

Year Ended December 31 1985 1984 Operating revenues Net earnings Earnings per share of common stock$728,607$149,281$3.38$795,500$142,705$3.39 (10)Gas Utility Asset Acquisition On January 28, 1985, the Company acquired the New Mexico natural gas utility assets of Southern Union Company.The acquisition was in connection with the settlement of antitrust litigation brought against Southern Union by the Company and others.The assets were pur-chased for net book value, net of liabilities assumed, which was approximately

$208.4 million, less$51.5 million, representing the amount of the settlement to all plaintiffs.

The acquisition was accounted for as a purchase and, accordingly, the Company's financial statements reflect the assets, liabilities and oper-ating results from the acquisition date forward.The following unaudited pro forma information shows the results of operations for thc years cndcd December 31, 1985 and 1984 as though the acquisition had occurred at the beginning of each period presented (in thousands except per share amounts): 1987 1988 1989 1990 1991 Later years Total minimum lease payments Less amount representing interest and executory costs Present value of net minimum lease payments Capital Operating Leases Leases (In thousands)

$3,618$98,695 3,310 98,048 2,951 97,458 1,096 96,972 20 96,706 27 2,168,642 11,022$2,656,521 2,551$8,471 (11)Palo Verde Nuclear Generating Station As stated in note (7), the Company has been participating with other utilities in the construction of three units of PVNGS.In 1985 and 1986, the Company completed sale and leaseback transactions for its undivided interest in PVNGS Units 1 and 2.PVNGS Units I and 2 were declared in commercial service in 1986.Unit 3 is scheduled to achieve firm power operation in the third quarter of 1987.Under the Inventory of Capacity ratemaking methodology, PVNGS is not currently in the ratebase and is not scheduled to begin entering ratebase until the 1990s.During 1984, the NMPSC along with other state regulatory commis-43 Public Senrlce Company of New Mexico and Subsidiaries sions initiated an independent audit of PVNGS project management and construction costs.Legal challenges were made by the Company and another participant, and a third participant and its commission reached a settlement on its share of PVNGS costs.Subsequently, thc four state audit was terminated in September 1986.On January 14, 1987, the NMPSC issued an order docketing a case to investigate thc prudence of the Company's share of the PVNGS costs.A hearing on this matter has been scheduled for February 1988.Management is unable to predict what findings the NMPSC will make as a result of that hearing.Management believes that PVNGS was managed and constructed in a prudent manner and that any rcvicw by the NMPSC will not prevent the Company from recovering its investment.

Sce note (13).Thc Federal Price-Anderson Act currently limits the public liability for claims that could arise from a nuclear incident to a maximum amount of$700 million, as of February 10, 1987, for each nuclear reactor licensed for operation by the Nuclear Regulatory Commis-sion (NRC).The PVNGS participants have purchased primary insur-ance for this exposure in thc maximum available amount, presently$160 million, with thc reniaining

$540 million being provided by secondary financial protection as required by thc Price-Anderson Act and the NRC.Under the provisions of this secondary program, thc Company could bc assessed up to$1,020,000 per nuclear incident involving any participating licensed reactor in the United States, subject to a niaximum of$2,040,000 in any year in the event of morc than one incident.These figures will increase by$510,000 and$1,020,000, res pcctivcly, when Unit 3 receives its lmv-power operat-ing license (now anticipated in March 1987).In addition, to cover possible damage to the PVNGS facilitics, the PVNGS participants maintain nuclear property damage and decontamination insurance in the aggrcgatc amount of$1.23 billion, as of February 10, 1987.Insurance to cover a portion of the additional expense of rcplaccmcnt power tcsultIng from an accident-related outage of PVNGS Units I or 2 is also provided.Although the Company does not yct have an approved plan for decommissioning of PVNGS, the Company has filed a deconunis-sioning plan wi(h the NMPSC, which includes the establishinent of a decommissioning trust, and expects a decision in thc first half of 1987.The Company estimates the decommissioning cost for its share of PVNGS Units I and 2 to be$365,000 per unit per year.Thc Company belicvcs that all costs associated with nuclear plant decom-missioning will bc rccovcrablc through rates charged to customers.

(12)Segment Information The financial information pertaining to thc Company's clcctric, gas and other operations for the ye~ended Deccmbcr 31, 1986 and 1985 arc as follows: 1986 Electric Gas Other Total 1985 Electric Gas Other Total Operating revenues Operating expenses excluding income taxes Pre-tax operating income Operating income tax Operating income 295,799 223,205 5,242 524,246 227,228 250,899 4,891 483,018 147,285 (8,224)21,461 5,003 (606)2,103 173,749 (6,727)S 155,509 S 22,067 S 2,900 S 180,476 180,873 17,931 22,838 2,965 3 253 206 964 954 21,850$162,942$19,873$2,299$185,114 (In thousands)

S 443,084$244,666 S 10,245 S 697,995$408,101$273,737$8,144$689,982 Depreciation expense Utility construction expenditures Identifiable assets: Net utility plant Other Total assets S 50,567 S 8,916$766 S 60,249 S 178,230 S 19,689 S 2,112 S 200,031$1,643,227$226,430 S 33,322$1,902,979 427,598 78,260 347,307 853,165$2,070,825$304,690$380,629$2,756,144$47,113$7,515$738$55,366 S 242,559$17,675 S 1,697$261,931$1,923,939$216,178$31,340$2,171,457 460,514 92,352 285,915 838,781$2,384,453$308,530$317,255$3,010,238 Prior to 1985, the Company had no material segments other than electric operations.

(13)Subsequent Event Subsequent to Deccinber 31, 1986, a potential rcstiucturing of thc Company was announced which would include the formation of a holding company and the possible separation of thc Company's electric utility operations into a generation entity regulated by thc FERC and a distribution entity regulated by the NMPSC.Under this arrangement, thc gcncmtion entity would bc committed to supply thc projected power nccds of the distribution entity under a long-tcmi contract.Although details of any icstnicturing are subject to further study, it is anticipated that such restructuring, if implemcntcd, may cause the Inventory of Capacity ratcinaking methodology to no Public Service Company of New Mexico and Subsidiaries longer bc appropriate.

The rcvicw of the prudcncy of PVNGS costs by thc NMPSC would also bc inappropriate, since the gcncration entity would not bc regulated by thc NMPSC.The implementation of any restructuring would be subject to numer-ous conditions, including required regulatory and other approvals.

Thc effect of the restructuring on the financial statements is not dctemiinable pending resolution of the ultimate structure.

Quarterly Operating Results Thc unaudited operating results (in thousands except pcr sharc amounts)by quarters for 1986 and 1985 are as follows: Quarter Ended 1986 December 31 September 30 June 30 March 31 1985 December 31 September 30 June 30'arch.31 Operating Revenues$178,604 157,421 162,591 199,379$174,766 166,650 159,969 188,597 Operating Income$48,593 48,546 41,059 42,278$53,360 52,822 37,683 41,249 Net Earnings$45,512 40,068 32,727 32,698$46,205 43,131 26,400 30,574 Earnings per Share$1.03.90.67.68$1.07 1.00.55.68 In thc opinion of managcmcnt of the Coinpany, all adjustments (consisting of normal recurring accruals)ncccssary for a fair state-ment of thc results of operations for such periods have bccn included.Stock/Dividend Data Common Stock: Range of sales prices of thc Company's common stock, reported as composite transactions (Symbol: PNM), and dividends paid on com-mon stock for 1986 and 1985, by quarters, arc as follows: Range of Sales Prices High Low Dividends per Share 1986 Fourth Quarter Third Quarter Second Quarter First Quarter Fiscal Year 1985 Fourth Quarter Third Quarter Second Quarter First Quarter Fiscal Year 36/>>377/e 37'/s 35%37%3(P/>>29'/2 28'/>>25s/>>30s/>>33 321/2 301/2 28 28 26s/s 25'/2 25 23'/e 23'/rr$0.73 0.73 0.73 0.73$2.92$0.73 0.72 0.72 0.72$2.89 The payment of future dividends will depend upon earnings, the financial condition of the Company, market requireinents and other factors.Cumulative Preferred Stock: While isolated sales of thc Company's cuinulativc prcferrcd stock have occurred in the past, thc Company is not aware of any active tmding market for its cuinulativc prefcrrcd stock.Quarterly cash dividends werc paid on each series of the Company's cumulative prefcrrcd stock at their stated mtes during 1986 and 1985.45 Public Service Company oi New Mexico and Subsidiaries Comparative Operating Statistics Electric Service: Energy Sales-kWhr (in thousands):

Residential Commercial Industrial Other ultimate customers Total sales to ultimate customers Sales for resale Other contracted energy sales*Total kWhr sales Electric Revenues (in thousands:

Residential Commercial Industrial Other ultimate customers Total revenues from ultimate customers Sales for resale Total revenues from energy sales Miscellaneous electric revenues 1986 1,353,933 1,828,799 842,030 208,534 4,233,296 869,017 1,625,217 6,727,530 S 126,053 163,820 59,253 14,622 363,748 71,412 435,160 7,924 1985 1,319,529 1,765,077 788,880 206,356 4,079,842 1,156,268 2,200,952 7,437,062$119,026 152,921 53,127 14,293 339,367 60,421 399,788 8,313 1984 1,279,917 1,706,044 762,117 184,725 3,932,803 2,384,535 885,116 7,202,454$107,395 134,532 50,439 11,950 304,316 131,013 435,329 3,645 1983 1,205,046 1,600,199 742,272 185,824 3,733,341 2,371,860 778,311 6,883,512$90,020 107,729 44,166 10,913 252,828 136,273 389,101 2,846 1982 1,134,827 1,515,664 784,158 215,853 3,650,502 2,840,957 6,491,459$91,065 110,745 51,714 14,775 268,299 149,115 417,414 2,743 Total electric revenues Customers at Year-End: S 443,084$408,101$438,974$391,947$420,157 Residential Commercial Industrial Other ultimate customers Total ultimate customers Sales for resale Total customers Reliable Net Capability

-kW Coincidential Peak Demand-kW Average Fuel Cost per Million BTU BTU per kWhr of Net Generation 237,759 28,735 415 213 267,122 6 267,128 1,565,000 916,000 S 1.1710 11,608 227,420 27,053 428 216 255,117 6 255,123 1,305,000 861,000 S 1.2233 11,214 217,614 25,614 436 194 243,858 6 243,864 1,337,000 976,000$1.0970 11,023 208,368 24,259 438 186 233,251 5 233,256 1,343,000 998,000$0.9957 11,296 199,679 22,148 453 185 222,465 6 222,471 1,473,000 957,000 S 1.1502 11,296 Water Service: Water Sales-Gallons (in thousands Revenues in thousands Customers at Year-End 2,535I 656 2,387,468 2,392,085 S 10,245$8,144$6,354 18,820 18,240 17,717 2,315,980 2,842,381$5,527$6,386 16,721 20,432*'Other contracted energy sales to utilities are accounted for as a reduction of fuel and purchased power expense rather than as operating revenue.Such energy sales generated$77.8 million,$86.0 million,$22.9 million and$20.8 million in 1986, 1985, 1984 and 1983, respectively."Includes 4,508 customers for the Las Vegas water system which was contributed to the City of Las Vegas on December 30, 1982.46 Pub!le Service Company ot New Mexico and Subsidiaries Comparative Operating Statistics 1986 1985*Gas Service: Gas Sales-Decatherms in thousands:

Residential Commercial Industrial Other ultimate customers Total sales to ultimate customers Sales for resale Total gas sales Gas Revenues in thousands:

Residential Commercial Industrial Other ultimate customers 22,076 10,762 7,248 10,899 50,985 1,535 52,520$117,011 45,867 25,193 37,435 19,232 9,642 13,806 10,779 53,459 1,702 55,161$111,427 45,519 48,933 44,719 Total revenues from ultimate customers Sales for resale Total revenues from gas sales Miscellaneous gas revenues Total gas revenues Customers at Year-End: 225,506 5,675 231)181 13,485 250,598 6,638 257,236 16,501$244,666$273,737 Residential Commercial Industrial Other ultimate customers Total ultimate customers Sales for resale Total customers 290,175 28,218 155 3,776 322,324 11 322,335 283,530 27,435 170 3,860 314,995 10 315,005"Effective from acquisition date, January 28, 1985.Certain amounts have been reclassified for comparability.

47 Public Service Company of New Mexico and Subsidiaries Stockholder Information Stock Plans The Company's four Common Stock Plans were an important source of external funding for 1986.$51 million was generated, providing thc Company with approximately 35 percent of its total external financing needs.Thc plans are Thc Dividend Reinvestment Plan, The Employee Stock Purchase Plan, Thc Master Employee Savings Plan, and The Consumer Stock Plan.Participation in the plans is made only by means of the appropriate prospectus.

Prospectuses are available by writing to the Company or telephoning (505)848-2122 (local), I-800432%94 (New Mexico), or I-800-545M25 (outside New Mexico).Stockholder Communications Due to Securities and Exchange Commission regulations, the Company is obligated to mail financial information to each shareholder account of record.If a single household owns stock under several accounts, however, each account at the same address will be individually mailed all financial information.

Upon written notification to the Company, duplicate mailings to the same address can be eliminated.

Certificate Re istration In uiries To notify the Company of any changes of address, changes in certificate registration, or lost ccrtificatcs, please write to: Public Service Company of Ncw Mexico Stockholder Services Alvarado Square-MS 0082 Albuquerque, NM 87158 Questions and Comments Thc Company welcomes any questions and comments shareholders may have regarding PNM or any information appearing in the Annual and Quarterly Reports.Please direct any correspondencc to: Stockholder Information Karen A.Knight Assistant Sccrctary and Manager, Stockholder Services Alvarado Square-MS 0082 Albuquerque, NM 87158 Financial Information Valerie C.Chccscman Director, Investor Relations Alvarado Square-MS 0260 Albuquerque, NM 87158 Stockholder Meetings Beginning in October senior managcmcnt of PNM began a scrics of meetings with Ncw Mexico shareholders.

The meetings provided a forum for investors and presented updates on Company events.Approximately 900 shareholders attended.Morc meetings are planned in 1987.48 Geographic Distribution of PNM Shareholders (Accounts of Record)312 M9 3131 223 2629 1199 1512 2119 1766 101 205 124 m K9 614 516 76 149 181 739 850 3151 628 1423 349 175 272 Alaska Hawaa Q~@26 Form 10-K Rr copies of the Company's 10-K filed with the Securities and Exchange Commission, please contact J.B.Mulcock, Jr., Sccrctary, Public Service Company of Ncw Mexico, Alvarado Square, Albu-querque, NM 87158.Stock Exchange Listing Common Stock of thc Company is listed on the New York Stock Exchange under thc symbol PNM.Transfer Agents Common Stock Public Service Company of Ncw Mexico Stockholder Services Harris Trust Company of New York Preferred Stock Public Service Company of Ncw Mexico Stockholder Services~Re istrars First National Bank in Albuqueiquc Harris Trust Company in Ncw York 1985-1986 PNM Common Stock Price (Weekly Closing Price)Dollars J F M A M J J A S 0 N D J F M A M J J A S 0 N D i985 1986 Qnnlgggi@QJLgCoebgjg Board of Directors PNM Corporate PNM Electric John P.Bundrant" President and Chief Operating Oflicer Electric Operations Public Service Company of New Mexico Ashton EL Collins.Jr.President Reddy Communications, lnc.Albuquerque, NM Jerry D.Geist'*t Chairman and President Public Service Company of Ncw Mexico Claude E.Leyendecker" Chairman of the Board and Chief Executive Oflicer United Ncw Mexico Bank a!Mimbres Valley Dcming, NM Arturo G.Ortega*Attorney at Law Ortega.&Snead, P.A.Albuquerque, NM Robert R.Rehder'rofessor of Management Robert O.Anderson Graduate School of Management University of New Mexico Albuquerque, NMlRobert B.Rountree~*t Senior Vice President Public Service Company of Ncw Mexico Russell H.Stephens'etired Realtor, Rociada, NM E.R.Wood"t President Wood&Hill Corpomtion Santa Pc, NM Hickum L Galles.Jr.Director Emeritus Chairman of the Board Galles Chevrolet Company Albuquerque, NM*Member of Audit Committee~*Member of Executive Committcc tMember of Meadows Board of Directors Jerry D.Geist Chairman and President James B.Mulcock.Jr.t Senior Vice President, Corporate Alfairs and Secretary Albert J.Roblsont Senior Vice President and Chief Financial Oflicer Robert B.Rountree Senior Vice President Billy D.Lackey Vice President and Corporate Controller Joellyn K.Murphy Vice President, Regulatory and Business Policy Luther W.Reynolds Vice President and'Aeasurer Gas Company of New Mexico JohnT.Ackerman President and Chief Operating Oflicer, Gas Operations D.A."Zan" James Vice President, Marketing, Rates and Regulatory Affairs Donald A.Blackwall Vice President, Finance and Planning Theodore H.Morse Vice President, Engineering

&Operations HenryO.Pocock Vice President, Human Resources and Administrative Support Daniel W.McFearln Vice President, Controller and Assistant Secretary Paragon Resources, Inc.John P.Bundrant Chairman Jack L.Wllklns President Alfred C.Underwood Vice President John P.Bundrant President and Chief Operating Officer, Electric Operations William M.Egllnton Senior Vice President, Operations Jack L.Wilklns Senior Vice President, Power Supply William C.Wygant Senior Vice President, Admimstmtion Jeff E.Sterba Vice President, Revenue Management PNM Subsldlariesi Meadows Resources.

Inc.Robert B.Rountree Chairman James F.Jennings.Jr.t President and Chief Executive Officer Max H.Maerkl Senior Vice President Roger C.Rankin Vice President Charles R.Mollo Vice President John H.von Rusten Vice President and Controller John W.Prelslngt President A.Johnson and Co., Inc.New York, NY Sunbelt Mining Company, Inc.Robert EL Rountree Chairman Albert J.Roblson President and Chief Operating Oflicer Martin A.Cllfton Vice President, Finance Charles E.Hunter Vice President, San Juan Division Terry D.Bauer Vice President, Corporate/

Engineering Services J.Douglas Ingram Vice President, Operations Public Service Company of New Mexico Alvarado Square, Albuquerque, New Mexico 87158 BULK RATE U.S.POSTAGE PAID PORTLAND OREGON PERMIT 2917 Attention Postmaster:

Address correction requested F(', DESIGN: SHELDON Coll.ER+ASSOCIATES INC.0 MAJOR PHOTOGRAPHY:

OVAK ARSLANIAN 0 Contributing Photography:

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