NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) Accounting Policies and Responsibility for Financial Statements

In the opinion of the management of PNM Resources, Inc. (the "Holding Company") and Subsidiaries and Public Service Company of New Mexico ("PNM") and Subsidiaries, (collectively, the "Company") the accompanying unaudited interim consolidated financial statements present fairly the Company's financial position at March 31, 2004 and December 31, 2003, the consolidated results of its operations and comprehensive income for the three months ended March 31, 2004 and 2003 and the consolidated statements of cash flows for the three months ended March 31, 2004 and 2003. Accordingly, they are unaudited, and certain information and note disclosures normally included in the Company's annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations. Readers of these financial statements should refer to the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2003, that are included in the Company's Annual Reports on Form 10-K for the year ended December 31, 2003. The results of operations presented in the accompanying financial statements are not necessarily representative of operations for an entire year.

Presentation

The Notes to Consolidated Financial Statements of the Company are presented on a combined basis. The business of PNM constitutes substantially all of the business of PNM Resources, Inc. and Subsidiaries. Therefore, the financial results and results of operations of PNM are virtually identical to the consolidated results of the Holding Company and all its subsidiaries. For discussion purposes, this report will use the term "Company" when discussing matters of common applicability to the Holding Company and PNM. Readers of the Notes to Consolidated Financial Statements should assume that the information presented applies to the consolidated results of operations and financial position of both the Holding Company and its subsidiaries and PNM, except where the context or references clearly indicate otherwise. Discussions regarding specific contractual obligations generally reference the company that is legally obligated. In the case of contractual obligations of PNM, these obligations are consolidated with the Holding Company and its subsidiaries under generally accepted accounting principles ("GAAP"). Broader operational discussions refer to the Company.

Certain amounts in the 2003 consolidated financial statements and notes have been reclassified to conform to the 2004 financial statement presentation. Decommissioning Costs

Decommissiong Costs

Accounting for decommissioning costs for nuclear and fossil-fuel generation involves significant estimates related to costs to be incurred many years in the future after plant closure. Changes in these estimates could significantly impact the Company's financial position, results of operation and cash flows. The Company owns and leases nuclear and fossil-fuel facilities that are within and outside of its retail service areas. The Company adopted the accounting requirements of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") on January 1, 2003.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Under SFAS 143, the Company is only required to recognize and measure decommissioning liabilities for tangible long-lived assets for which a legal obligation exists. Adoption of the statement changed the Company's method of accounting for both nuclear generation decommissioning and fossil-fuel generation decommissioning. Nuclear decommissioning costs are based on site-specific estimates of the costs for removing all radioactive and other structures at the site. PVNGS Unit 3 is currently excluded from the Company's retail rates base while Units 1 and 2 are included in the Company's retail rates. The Company collects a provision for ultimate decommissioning of Units 1 and 2 in its rates and recognizes a corresponding expense and liability for these amounts. Fossil-fuel decommissioning costs are also approved by the PRC as a component of the Company's depreciation rates. The Company believes that it will continue to be able to collect for its legal asset retirement obligations for nuclear and fossil-fuel generation activities included in the ratemaking process.

Pension and Other Post-retirement Benefits

In 2003, the Company changed the actuarial valuation measurement date for the pension plan and other post-retirement benefits from September 30 to December 31 to better reflect the actual pension balances as of the Company's balance sheet dates.

Stock Options

The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Compensation cost for stock options, if any, is measured as the excess of the quoted market price of the Company's stock at the date of grant over the exercise price of the granted stock option. Restricted stock is recorded as compensation cost over the requisite vesting periods based on the market value on the date of grant.

Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"), established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. The Company has elected to retain its current method of accounting as described above, and has adopted the disclosure requirements of SFAS 123 only.

                                                   Three Months Ended
                                                        March 31,
                                                   2004           2003
                                               -------------  -------------
Net earnings.................................     $24,778        $48,170
Deduct:  Total stock-based employee
   compensation expense determined
   under fair value based method for all
   awards, net of related tax effects........        (666)          (511)
                                               -------------  -------------
Pro forma net earnings.......................     $24,112        $47,659
                                               =============  =============
Earnings per share:
    Basic - as reported......................     $  0.62        $  1.23
                                               =============  =============
    Basic - pro forma........................     $  0.60        $  1.22
                                               =============  =============
    Diluted - as reported....................     $  0.61        $  1.22
                                               =============  =============
    Diluted - pro forma......................     $  0.59        $  1.21
                                               =============  =============

(2) Segment Information

The Holding Company is an investor-owned holding company of energy and energy related businesses. Its principal subsidiary, PNM, is an integrated public utility primarily engaged in the generation, transmission and distribution of electricity; transmission, distribution and sale of natural gas within the State of New Mexico; and the sale and marketing of electricity in the Western United States. In addition, the Holding Company provides energy and technology related services through its wholly-owned subsidiary, Avistar Inc. ("Avistar").

As it currently operates, the Company's principal business segments, whose operating results are regularly reviewed by the Company's management, are Utility Operations and Wholesale Operations ("Wholesale"). Utility Operations includes Electric Services ("Electric"), Gas Services ("Gas") and Transmission Services ("Transmission"). In 2003, the Company began allocating its business and results between the Electric and Wholesale segments for financial reporting purposes based on the asset allocations as mandated in the most recent electric rate agreement. Certain prior period amounts have been reclassified to conform to the current year presentation. In addition, Transmission was reclassified from Electric and disclosed as its own business segment during the second quarter of 2003.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following segment presentation is based on the methodology that the Company's management uses for making operating decisions and assessing performance of its various business activities. As such, the following presentation reports operating results with regard to the effect of accounting or regulatory changes and similar one-time items not related to normal operations in the Corporate and Other segment.

In addition, adjustments related to Emerging Issues Task Force ("EITF") Issue 03-11 "Reporting Realized Gains and Losses on Derivative Instruments that are subject to FASB statement No. 133 and Not Held for Trading Purposes" are included in Corporate and Other. These accounting pronouncements require a net presentation of trading gains and losses and realized gains and loss for certain non-trading derivatives. Management evaluates wholesale operations on a gross presentation basis due to its net asset-backed marketing strategy and the importance the strategy places on the Company's ability to repurchase and remarket previously sold capacity. The Company has publicly referred to this as "velocity".

UTILITY OPERATIONS

Electric

Electric consists of the distribution and generation of electricity for retail electric customers in New Mexico. The Company provides retail electric service to a large area of north central New Mexico, including the cities of Albuquerque and Santa Fe, and certain other areas of New Mexico. Current customer rates for retail electric service are set by the New Mexico Public Regulation Commission ("PRC") based on the provisions of an electric rate agreement approved in January 2003.

Gas

Gas distributes natural gas to most of the major communities in New Mexico, including two of New Mexico's three largest metropolitan areas, Albuquerque and Santa Fe. The Company's customer base includes both sales-service customers and transportation-service customers. PNM purchases natural gas in the open market and resells it at cost to its sales-service customers. As a result, increases or decreases in gas revenues resulting from wholesale gas price fluctuations do not impact the Company's consolidated gross margin or earnings.

Transmission

The Company owns or leases transmission lines, interconnected with other utilities in New Mexico and south and east into Texas, west into Arizona, and north into Colorado and Utah. Transmission revenues consist of sales to third parties as well as to Electric and Wholesale.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

WHOLESALE OPERATIONS

Wholesale consists of the generation and sale of electricity into the wholesale market based on three product lines that include long-term contracts, forward sales and short-term sales. The source of these sales is supply created by selling the unused capacity and energy of jurisdictional assets as well as the capacity and energy of the Company's plants excluded from retail rates. Both regulated and unregulated generation is jointly dispatched in order to improve reliability, provide the most economical power to retail customers and maximize profits on any wholesale transactions.

Long-term contracts include sales to wholesale customers with multi-year arrangements. These contracts range from 2 to 17 years with an average of 7.5 years. Forward sales include third party purchases in the forward market that range from 1 month to 3 years. These transactions do not qualify as normal sales and purchases as defined in SFAS 133, "Accounting for Derivative Instruments and Hedging Activites", as amended, and thus are generally marked to market. Short-term sales generally include spot market, hour ahead, day ahead and week ahead contracts with terms of 30 days or less. Also included in short-term sales are sales of any excess generation not required to fulfill PNM's retail load and contractual commitments. Short-term sales also cover the revenue credit to retail customers as specified in the most recent electric rate agreement.

CORPORATE AND OTHER

The Holding Company performs substantially all of the corporate activities of PNM. These activities are billed to PNM on a cost basis to the extent they are for the corporate management of PNM and are allocated to the operating segments. The Holding Company's wholly-owned subsidiary, Avistar, was formed in August 1999 as a New Mexico corporation and is currently engaged in certain unregulated and non-utility businesses. In January 2002, Avistar was

(Intentionally left blank)

                                                                       Utility
                                      -----------------------------------------------------------------------
                                        Electric        Gas        Transmission    Eliminations     Total
                                      ------------- ------------ ---------------- --------------- -----------
                                                                  (In thousands)
2004:
Operating revenues:
   External customers................     $130,036    $ 175,874          $ 4,414        $     -    $ 310,324
   Intersegment revenues.............            -            -            7,896         (7,896)           -
Depreciation and amortization........       13,970        4,729            2,708              -       21,407
Interest income......................        6,841          939              106              -        7,886
Interest charges.....................        7,228        2,739            1,477              -       11,444
Total income tax expense.............        7,101        6,157              687              -       13,945
Operating income.....................       13,871       11,606            2,443              -       27,920
Segment net income...................       10,836        9,393            1,047              -       21,276

Total assets.........................    1,425,880      494,712          291,351              -    2,211,943
Gross property additions.............       13,634        6,241            4,272              -       24,147

                                                     Corporate
                                       Wholesale     and Other     Consolidated
                                      ------------- ------------ ----------------
                                                (In thousands)
2004:
Operating revenues:
   External customers................    $ 133,772      $  (443)(a)     $443,653
   Intersegment revenues.............            -            -                -
Depreciation and amortization........        3,754          976           26,137
Interest income......................        1,388          647            9,921
Interest charges.....................        3,394       (1,009)          13,829
Total income tax expense (benefit)...        3,024       (2,662)          14,307
Operating income (loss)..............        6,908       (1,294)          33,534
Segment net income (loss)............        4,615       (1,113)          24,778

Total assets.........................      423,220      711,375        3,346,538
Gross property additions.............        2,799        1,923           28,869

(a) Includes EITF 03-11 impact, under which wholesale revenues and the associated cost of energy of $0.6 million are reclassified to a net margin basis in accordance with GAAP.

                                                                      Utility
                                      -----------------------------------------------------------------------
                                         Electric        Gas       Transmission    Eliminations      Total
                                      ------------- ------------ ---------------- --------------- -----------
                                                                  (In thousands)
2003:
Operating revenues:
   External customers................    $ 126,204    $ 144,186         $  4,557        $     -    $ 274,947
   Intersegment revenues.............            -            -            7,636         (7,636)           -
Depreciation and amortization........       15,735        5,442            2,321              -       23,498
Interest income......................        7,455          777              (16)             -        8,216
Interest charges.....................        6,647        3,376            1,410              -       11,433
Total income tax expense.............        8,362        4,447              469              -       13,278
Operating income.....................       15,306        9,690            2,152              -       27,148
Segment net income...................       12,760        6,786              715              -       20,261

Total Assets.........................    1,429,291      509,111          275,301              -    2,213,703
Gross property additions.............       18,356        7,221            4,830              -       30,407

                                                     Corporate
                                        Wholesale    and Other      Consolidated
                                      ------------- ------------ ----------------
                                                (In thousands)
2003:
Operating revenues:
   External customers................    $ 110,617      $    60        $ 385,624
   Intersegment revenues.............            -            -                -
Depreciation and amortization........        3,491        1,385           28,374
Interest income......................        1,450        1,034           10,700
Interest charges.....................        3,548        3,252           18,233
Total income tax expense (benefit)...        1,190       (7,999)(a)        6,469
Operating income.....................        4,644        1,634           33,426
Segment net income (loss)............        1,815      (11,328)(a)       10,748

Total Assets.........................      425,372      739,554        3,378,629
Gross property additions.............        3,579        1,076           35,062

(a) Includes $10.1 million write-off of transition costs, net of tax benefit of $6.6 million, due to the repeal of deregulation in New Mexico.

(3) Fair Value of Financial Instruments

Natural Gas Contracts

Pursuant to a 1997 order issued by the New Mexico Public Utility Commission, the predecessor to the PRC, the Company is authorized to hedge certain portions of natural gas supply contracts to protect the Company's

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

natural gas customers from the risk of adverse price fluctuations in the natural gas market. All hedge gains and losses are recoverable through the Company's purchased gas adjustment clause ("PGAC") if deemed prudently incurred by the PRC. As a result, earnings are not affected by gains or losses generated by these instruments.

PNM purchased $2.8 million of natural gas options in the first quarter of 2004 to protect its natural gas customers from the risk of rising prices during the 2004-2005 heating season. In total, PNM plans to expend approximately $10.0 million in 2004 to purchase gas options that essentially cap the amount the Company would pay for each volume of gas subject to the options during the winter heating season. PNM expects to recover its option premiums as a component of the PGAC during the months of October 2004 through February 2005.

Electricity Contracts

The Company's Wholesale Operations have entered into various forward physical contracts for the purchase and sale of electricity with the intent to optimize its net generation position. These contracts do not qualify for normal purchase and sale designation pursuant to GAAP, and are considered derivatives and marked to market.

For the three months ended March 31, 2004, the Company's Wholesale Operations settled derivative forward contracts for the sale of electricity that generated $27.0 million of electric revenues by delivering 0.6 million megawatt hours ("MWh"). The Company settled derivative forward contracts for the purchase of electricity of $24.7 million or 0.6 million MWh to support these contractual sales and other open market sales opportunities. For the three months ended March 31, 2003, the Company's Wholesale Operations settled derivative forward contracts for the sale of electricity that generated $22.3 million of electric revenues by delivering 0.6 million MWh. The Company settled derivative forward contracts for the purchase of electricity of $22.3 million or 0.6 million MWh to support these contractual sales and other open market sales opportunities.

As of March 31, 2004, the Company had open derivative forward contract positions to buy $46.0 million and to sell $44.1 million of electricity. At March 31, 2004, the Company had a gross mark-to-market gain (asset position) on these derivative forward contracts of $7.5 million and a gross mark-to-market loss (liability position) of $6.3 million, with a net mark-to-market gain (asset position) of $1.2 million recorded in other current assets and liabilities, respectively. The change in mark-to-market valuation is recognized in earnings each period and is recorded in operating revenues.

The Company's Wholesale Operations also entered into forward physical contracts for the sale of the Company's electric capacity in excess of its retail and wholesale firm requirement needs, including reserves. In addition, the Company entered into forward physical contracts for the purchase of retail needs, including reserves, when resource shortfalls exist. The Company generally accounts for these financial instruments as normal sales and purchases as defined by SFAS 133, as amended. From time to time the Company makes forward purchases to serve its retail needs when the cost of purchased power is less than the incremental cost of its generation. At March 31, 2004, the Company had

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

open forward positions classified as normal sales of electricity of $207.7 million and normal purchases of electricity of $108.8 million, which will be reflected in the financial statements upon physical delivery.

The Company's Wholesale Operations, including both firm commitments and other wholesale sale activities, are managed through a net asset-backed strategy, whereby the Company's aggregate net open position is covered by its own excess generation capabilities. The Company is exposed to market risk if its generation capabilities were disrupted or if its retail load requirements were greater than anticipated. If the Company were required to cover all or a portion of its net open contract position, it would have to meet its commitments through market purchases.

The Company is exposed to credit risk in the event of non-performance or non-payment by counterparties of its financial and physical derivative instruments. The Company uses a credit management process to assess and monitor the financial conditions of counterparties. The Company's credit risk with its largest counterparty as of March 31, 2004 and December 31, 2003 was $29.5 million and $23.5 million, respectively.

(4) Earnings Per Share

In accordance with SFAS No. 128, "Earnings per Share" ("SFAS 128"), dual presentation of basic and diluted earnings per share has been presented in the Consolidated Statements of Earnings. The following reconciliation illustrates the impact on the share amounts of potential common shares and the earnings per share amounts (in thousands except per share amounts):

                                                              Three Months Ended
                                                                  March 31,
                                                          ---------------------------
                                                              2004          2003
                                                          ------------- -------------
Basic:
Net Earnings Before Cumulative Effect of a Change in
   Accounting Principle..................................     $24,778       $10,748
Cumulative Effect of a Change in Accounting Principle,
   net of tax of $24,524.................................           -        37,422
                                                          ------------- -------------
Net Earnings.............................................     $24,778       $48,170
                                                          ============= =============
Average Number of Common Shares Outstanding..............      40,259        39,118
                                                          ============= =============
Net Earnings per Share of Common Stock (Basic)...........      $ 0.62        $ 1.23
                                                          ============= =============
Earnings Before Cumulative Effect of a Change in
   Accounting Principle..................................        0.62          0.28
Cumulative Effect of a Change in Accounting Principle....           -          0.95
                                                          ------------- -------------
Net Earnings per Share of Common Stock (Basic)...........      $ 0.62        $ 1.23
                                                          ============= =============

                                                               Three Months Ended
                                                                    March 31,
                                                            --------------------------
                                                               2004          2003
                                                            ------------ -------------
Diluted:
Net Earnings Before Cumulative Effect of a Change in
   Accounting Principle...................................      $24,778       $10,748
Cumulative Effect of a Change in Accounting Principle,
   net of tax of $24,524..................................            -        37,422
                                                            ------------ -------------
Net Earnings..............................................      $24,778       $48,170
                                                            ============ =============
Average Number of Common Shares Outstanding...............       40,259        39,118
Dilutive Effect of Common Stock Equivalents (a)...........          492           247
                                                            ------------ -------------
Average Common and Common Equivalent Shares...............       40,751        39,365
                                                            ============ =============
Net Earnings per Share of Common Stock (Diluted)..........       $ 0.61        $ 1.22
                                                            ============ =============
Earnings Before Cumulative Effect of a Change
   in Accounting Principle................................         0.61          0.27
Cumulative Effect of a Change in Accounting Principle.....            -          0.95
                                                            ------------ -------------

Net Earnings per Share of Common Stock (Diluted)..........       $ 0.61        $ 1.22
                                                            ============ =============

(a) Excludes the effect of average anti-dilutive common stock equivalents related to out-of-the-money options of 282,224 and 1,879,087 shares for the three months ended March 31, 2004 and 2003, respectively.

(Intentionally left blank)

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(5) Pension and Other Post-Retirement Benefit Plans

The Company and its subsidiaries maintain a qualified defined benefit pension plan ("Pension Plan"), medical and dental benefits to eligible retirees ("Other Post-Retirement Benefits"), and an Executive Retirement Plan. The following table shows the net periodic benefit cost or income of the Company's Pension Plan, Other Post-Retirement Benefit Plans, and the Executive Retirement Plan for the three months ended March 31:

                                                                  Other Post-           Executive
                                            Pension Plan       Retirement Benefits  Retirement Program
                                        ---------- ---------- ---------- ---------- --------- ---------
                                           2004       2003       2004       2003      2004      2003
                                        ---------- ---------- ---------- ---------- --------- ---------
                                                                  (In thousands)
Components of Net Periodic
Benefit Cost/(Income)
    Service cost.......................   $ 1,085    $ 1,297    $   601    $   771    $   26    $   20
    Interest cost......................     7,340      7,022      1,826      1,960       310       308
    Expected return on assets..........    (9,843)    (8,777)    (1,232)    (1,148)        -         -
    Transition obligation..............         -          -        454        454         -         -
    Prior service cost amortization....        79         79     (1,049)      (648)       37        38
    Net loss amortization..............     1,157        978      1,234      1,031        33        22
                                        ---------- ---------- ---------- ---------- --------- ---------
  Net Periodic Benefit Cost/(Income)...   $  (182)   $   599    $ 1,834    $ 2,420    $  406    $  388
                                        ========== ========== ========== ========== ========= =========

For the three months ended March 31, 2004, the Company contributed $1.5 million to external trusts for the Other Post-Retirement Benefits. The Company expects to contribute an additional $4.7 million in 2004.

(6) Commitments and Contingencies

PVNGS Liability and Insurance Matters

The Palo Verde Nuclear Generating Station ("PVNGS") participants have financial protection for public liability resulting from nuclear energy hazards to the full limit of liability under federal law. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $300.0 million and the balance by an industry-wide retrospective assessment program. If losses at any nuclear power plant covered by the programs exceed the primary liability insurance limit, the Company could be assessed retrospective adjustments. Effective August 20, 2003, the maximum assessment per reactor under the program for each nuclear incident increased from approximately $88 million to approximately $101 million. The retrospective assessment is subject to an annual limit of $10.0 million per reactor per incident. Based upon the Company's 10.2% interest in the three PVNGS units, the Company's maximum potential assessment per incident for all three units is approximately $31 million, with an annual payment limitation of approximately $3 million per incident. If the funds provided by this retrospective assessment program prove to be insufficient, Congress could impose revenue-raising measures on the nuclear industry to pay claims.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Possible Price-Anderson Act Changes

Versions of comprehensive energy bills proposed for adoption by Congress contain provisions that would amend Federal Law (the "Price-Anderson Act") addressing public liability from nuclear energy hazards in ways that would increase the annual limit on retrospective assessments (see "PVNGS Liability and Insurance Matters" above) from $10 million to $15 million per reactor per incident with the Company's annual exposure per incident increasing from $3 million to $4.5 million.

The Company believes that such changes in applicable law, if enacted, would not result in a "deemed loss event" being declared by the equity investors in respect of the Company's sale and leaseback transactions of PVNGS Units 1 and 2.

Water Supply

Because of New Mexico's arid climate and current drought conditions, there is a growing concern in New Mexico about the use of water for power plants. The availability of sufficient water supplies to meet all the needs of the state, including growth, is a major issue. The Company has secured water rights in connection with the Afton and Lordsburg plants and water availability does not appear to be an issue for these plants at this time.

The Four Corners region, in which San Juan Generating Station ("SJGS") and Four Corners Power Plant ("Four Corners") are located, has been experiencing drought conditions that may affect the water supply for the Company's generation plants. If adequate precipitation is not received in the watershed that supplies the Four Corners areas, the plants may be affected in 2004 and the future. The United States Bureau of Reclamation ("USBR") has approved a supplemental contract for 8,300 acre feet per year for a one-year term ending December 31, 2004. Environmental approvals have been obtained for the supplemental contract. PNM has also signed a voluntary shortage sharing agreement with tribes and other water users in the San Juan Basin for a one-year term ending December 31, 2004. Environmental approvals for that agreement are pending. A similar agreement was entered into in 2003. Although PNM does not believe that its operations will be materially affected by the drought conditions at this time, it cannot forecast the weather situation or its ramifications, or how regulations and legislation may impact PNM's situation in the future, should the drought continue.

Dugan Production Corporation Litigation

In July 2002, Dugan Production Corp. filed a lawsuit in the County of San Juan, New Mexico, against the San Juan Coal Company ("SJCC"). In September 2002, the SJCC removed the lawsuit to the United States District Court for the District of New Mexico. The lawsuit seeks to enjoin the underground mining of coal from a portion of the land that is to be used for the underground mine. The plaintiff also seeks monetary damages.

The SJCC, through leases with the federal government and the State of New Mexico, owns coal interests with respect to the underground mine. The plaintiff, through leases with the federal government, the State of New Mexico and certain

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

private parties, claims to own certain oil and gas interests in portions of the land that is to be used for the underground mine. SJCC has entered into a settlement with the plaintiff and the United States Bureau of Land Management. The settlement will not have a material adverse impact on the Company or its operations. As part of the settlement, the lawsuit will be dismissed with prejudice.

Western United States Wholesale Power Market

Various circumstances, including electric power supply shortages, weather conditions, gas supply costs, transmission constraints, and alleged market manipulation by certain sellers, resulted in the well-publicized "California energy crisis" and in the bankruptcy filings of the California Power Exchange ("Cal PX") and of Pacific Gas and Electric Company ("PG&E"). However, since the third quarter of 2001, conditions in the Western wholesale power market have changed substantially because of regulatory actions, conservation measures, the construction of additional generation, a decline in natural gas prices relative to levels reached during the California energy crisis and regional economic conditions.

As a result of the foregoing conditions in the Western market, the Federal Energy Regulatory Commission ("FERC") and other federal and state governmental authorities are conducting investigations and other proceedings relevant to the Company and other sellers. The more significant of these in relation to the Company are summarized below.

California Refund Proceeding

San Diego Gas and Electric Company ("SDG&E") and other California buyers have filed a complaint with the FERC against sellers into the California wholesale electric market. Hearings were held in September 2002, and the administrative law judge ("ALJ") issued the "Proposed Findings on California Refund Liability" in December 2002, in which it was determined that the California Independent System Operator ("Cal ISO") had, for the most part, correctly calculated the amounts of the potential refunds owed by sellers. The ALJ identified what were termed "ballpark" figures for the amount of refunds due under the order in an appendix to the proposed findings document. PNM was identified as having a refund liability of approximately $4.3 million, while being owed approximately $7 million from the Cal ISO. Pursuant to the FERC's order, PNM filed, in conjunction with the competitive supplier group, initial comments in January 2003 to the ALJ's preliminary findings addressing errors the Company believes the ALJ made in the proposed findings, and filed reply comments in February 2003.

Prior to the December 2002 ALJ decision, the Ninth Circuit Court of Appeals ordered the FERC to allow the parties in the case to provide additional evidence regarding alleged market manipulation by sellers. Several California parties submitted additional evidence in March 2003 to support their position that virtually all market participants, including PNM, either engaged in specific market manipulation strategies or facilitated such strategies. PNM maintains that it did not engage in improper wholesale activities, and filed reply evidence in March 2003, denying the allegations against it.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In March 2003, the FERC issued an order substantially adopting the ALJ's findings in his December 2002 decision, but requiring a change to the formula used to calculate refunds. The FERC raised concerns that the indices for California gas prices, a major element in the formula, had been subject to potential manipulation and were unverifiable. The effect of this change, which is not yet final, would be to increase PNM's refund liability. In October 2003, the FERC issued its order on rehearing in which it affirmed its decision to change the gas price indices used to calculate the refund amounts. This has the effect of increasing the Company's amount of refund. The precise amounts, however, will not be certain until the Cal ISO and Cal PX recalculate refund amounts which FERC required that they do as soon as possible, but no later than five months after its October 2003 Order. The Cal ISO has advised FERC in an update report filed in February 2004 that it will not complete the recalculation of the refund amounts until August 2004. The Company is currently awaiting the filing of final refund information by the Cal ISO and Cal PX and is unable to predict the ultimate outcome of this FERC proceeding, or whether PNM will be directed to make any refunds as the result of the FERC order.

Pacific Northwest Refund Proceeding

In addition to the California refund proceedings, Puget Sound Energy, Inc. filed a complaint at the FERC alleging that spot market prices in the Pacific Northwest wholesale electric market were unjust and unreasonable. In September 2001, the ALJ issued a recommended decision and declined to order refunds associated with wholesale electric sales in the Pacific Northwest. In a ruling similar to the one issued in the California refund proceeding, the FERC allowed additional discovery to take place and the submission of additional evidence in the case in March 2003. In June 2003, the FERC issued an order terminating the proceeding and adopting the ALJ's recommendation that no refunds should be ordered. Several parties in the proceeding filed requests for rehearing and in November 2003, FERC denied rehearing and reaffirmed its prior ruling that refunds were not appropriate for spot market sales in the Pacific Northwest during the first half of 2001. In November 2003, the Port of Seattle filed an appeal of FERC's order denying rehearing in the Ninth Circuit Court of Appeals. As a participant in the proceedings before FERC, the Company is also participating in the appeal proceedings. The Company is unable to predict the ultimate outcome of this appeal, or whether PNM will ultimately be directed to make any refunds.

FERC Show Cause Orders

The FERC initiated a market manipulation investigation, partially in response to the bankruptcy filing of the Enron Corporation ("Enron") and to allegations that Enron may have engaged in manipulation of portions of the Western wholesale power market. In connection with that investigation, all sellers into Western electric and gas markets were required to submit data regarding short-term transactions in 2000-2001. In March 2003, the FERC staff issued its final report, which addressed various types of conduct that the FERC staff believed may have violated market monitoring protocols in the Cal ISO and Cal PX tariffs. Based on the final report, the FERC issued orders to certain companies, including Enron, requiring them to show cause why the FERC should not revoke their authorizations to sell electricity at market-based rates. In addition, the FERC staff recommended that the FERC issue orders requiring

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certain entities to show cause why they should not be required to disgorge profits associated with conduct deemed to violate the Cal ISO and Cal PX tariffs, or be subject to other remedial action.

In June 2003, the FERC issued two separate orders to show cause against PNM and over sixty other companies. In the first order (the "Gaming Practices Order"), the FERC asserted that certain entities, including PNM, appeared to have participated in activities that constitute gaming and/or anomalous market behavior in violation of the Cal ISO and Cal PX tariffs during the period January 1, 2000 to June 20, 2001. Specifically, PNM is alleged to have engaged in a practice termed "False Import," which FERC defined as the practice of exporting power generated by California and then reimported into California in order to avoid price caps on in-California generation. These allegations are based primarily on an initial Cal ISO report and the additional evidentiary submission by California parties. The Cal ISO was ordered to submit additional information on which the entities subject to the Show Cause Order should respond. For PNM, the potential disgorgement for alleged "False Import" transactions covers the period May 1, 2000 to October 1, 2000. After review of the additional Cal ISO data and consultation with PNM, the FERC trial staff filed a motion to dismiss PNM from the case in August 2003. In September 2003, the California parties filed their objection to the dismissal of PNM from the case. In January 2004, the FERC issued an order granting trial staff's motion to dismiss PNM from the Gaming Practices docket on grounds that FERC staff's investigation did not reveal that PNM engaged in the practice of "False Import." As a result, the Company has been dismissed from the Gaming Practices proceedings.

In the second order to show cause (the "Gaming Partnerships Order"), the FERC asserts that certain entities, including PNM, acted in concert with Enron and other market participants to engage in activities that constitute gaming and/or anomalous market behavior in violation of the Cal ISO and Cal PX tariffs during the period January 1, 2000 to June 20, 2001. Specifically, PNM is alleged to have entered into "partnerships, alliances or other arrangements" with thirteen of its customers that allegedly may have been used as market manipulation schemes. The precise basis for certain of the FERC's allegations is not clear from the Gaming Partnerships Order, although it appears that most arise out of PNM's provision of "parking and lending" services to the identified companies. The potential remedies include disgorgement of unjust profits, as well as non-monetary remedies such as revocation of a seller's market-based rate authority.

In September 2003, PNM filed its responses to the Gaming Partnerships Order indicating that it did not engage in the alleged "partnerships, alliances or other arrangements" with the alleged parties. In October 2003, PNM filed testimony and exhibits in the case reasserting its response previously filed. The FERC ALJ has set the case for hearing on June 28, 2004. In January 2004, the FERC issued an order granting FERC staff's motion to dismiss seven of the thirteen PNM customers on grounds that there was no evidence to conclude that these companies used their commercial relationship with PNM to game the California ISO and PX markets. In March 2004, FERC approved the settlements entered into by two of the thirteen PNM customers and dismissed another of PNM's customers from the proceeding. Of the three remaining PNM customers in the docket, the FERC staff has entered into settlement agreements with two of them. On February 27, 2004, the FERC staff and the California parties filed their

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testimony. The FERC staff did not identify any improper conduct by PNM. The California parties allege that PNM provided false information regarding parking transactions that allowed other parties to game the California market. They claim PNM should be required to disgorge unjust profits that they variously calculate at between approximately $6 million and $26 million in addition to non-monetary penalties. PNM believes that it has not engaged in improper conduct and intends to defend itself vigorously against these allegations. PNM continues to have discussions with the FERC staff regarding possible dismissal of the charges against PNM. The Company is unable to predict the outcome of this matter.

Investigation of Anomalous Bidding Behavior and Practices in the Western Markets

In June 2003, the FERC issued an order finding that certain bids into the Cal ISO and Cal PX markets during the period May 1 through October 1, 2000 appear to have been excessive, in violation of the prohibitions against anomalous market behavior in the market monitoring protocols of the Cal ISO and Cal PX tariffs. The order directed the FERC's Office of Market Oversight and Investigation ("OMOI") to conduct a further investigation into bids in excess of $250 per MW during that period. In July 2003, PNM received a data request from OMOI to all sellers into the Cal ISO and Cal PX markets that submitted bids in excess of $250 per MW to the Cal ISO and Cal PX during the period covered by the investigation. In July 2003, PNM submitted its response to OMOI's data request, in which PNM provided justification of its bidding strategies during that period. In July 2003, PNM joined with other sellers in filing a request for rehearing of the June 2003 order, challenging the FERC's determination that bids above $250 per MW into the Cal ISO and Cal PX markets during the period May 1 through October 1, 2000 were prima facie excessive or in violation of the Cal ISO and Cal PX tariffs. The request for hearing is currently pending before the FERC. PNM has received supplemental requests for information and data from OMOI, to which PNM responded. The investigation is currently pending and PNM cannot predict the outcome of OMOI's investigation, but intends to vigorously defend itself against any allegation of wrongdoing.

California Power Exchange and Pacific Gas and Electric Bankruptcies

In January and February 2001, Southern California Edison ("SCE") and PG&E, major purchasers of power from the Cal PX and Cal ISO, defaulted on payments due to Cal PX for power purchased from the Cal PX in 2000. These defaults caused the Cal PX to seek bankruptcy protection. PG&E subsequently also sought bankruptcy protection. PNM has filed its proofs of claims in the Cal PX and PG&E bankruptcy proceedings. Amounts due to PNM from the Cal PX or Cal ISO for power sold to them in 2000 and 2001 total approximately $7 million. The Company has provided allowances for the total amount due from the Cal PX and Cal ISO.

California Attorney General Complaint

In March 2002, the California Attorney General filed a complaint with the FERC against numerous sellers regarding prices for wholesale electric sales into the Cal ISO and Cal PX and to the California Department of Water Resources ("Cal DWR"). PNM was among the sellers identified in this complaint and filed its answer and motion to intervene. In its answer, PNM defended its pricing and

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challenged the theory of liability underlying the California Attorney General's complaint. In May 2002, the FERC entered an order denying the California Attorney General's request to initiate a refund proceeding, but directed sellers, including PNM, to comply with additional reporting requirements with regard to certain wholesale power transactions. PNM has made filings required by the May 2002 order. The California Attorney General filed a petition for review in the United States Court of Appeals for the Ninth Circuit. PNM intervened in the Ninth Circuit appeal and is participating as a party in that proceeding. The Ninth Circuit held oral arguments in the case in October 2003. The Company cannot predict the outcome of this appeal. As addressed below, the California Attorney General has also threatened litigation against PNM in state court in California based on similar allegations.

California Attorney General Threatened Litigation

The California Attorney General has filed several lawsuits in California state court against certain power marketers for alleged unfair trade practices involving overcharges for electricity. In April 2002, the California Attorney General notified PNM of his intention to file a complaint in California state court against PNM concerning PNM's alleged failure to file rates for wholesale electricity sold in California and for allegedly charging unjust and unreasonable rates in the California markets. The letter invited PNM to contact the California Attorney General's office before the complaint was filed, and PNM has met several times with representatives of the California Attorney General's office. Further discussions are contemplated. To date, a lawsuit has not been filed by the California Attorney General and the Company cannot predict if a lawsuit will be filed or the outcome of any such lawsuit.

California Antitrust Litigation

Several class action lawsuits have been filed in California state courts against electric generators and marketers, alleging that the defendants violated the law by manipulating the market to grossly inflate electricity prices. Named defendants in these lawsuits include Duke Energy Corporation ("Duke") and related entities along with other named sellers into the California market and numerous other "unidentified defendants." Certain of these lawsuits were consolidated for hearing in state court in San Diego, California. In May 2002, the Duke defendants served a cross-claim on PNM. Duke also cross-claimed against many of the other sellers into California. Duke asked for declaratory relief and for indemnification for any damages that might ultimately be imposed on Duke. Several defendants removed the case to federal court in California. The federal judge has entered an order remanding the matter to state court, but the effect of that ruling has been stayed pending appeal. PNM has joined with other cross-defendants in motions to dismiss the cross-claim. The Company believes it has meritorious defenses but cannot predict the outcome of this matter.

Block Forward Agreement Litigation

In February 2002, PNM was served with a declaratory relief complaint filed by the State of California in California state court. The state's declaratory relief complaint seeks a determination that the state is not liable for its commandeering of certain energy contracts known as "Block Forward

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Agreements". The Block Forward Agreements were a form of futures contracts for the purchase of electricity at below-market prices and served as security for payment by PG&E and SCE for their electricity purchases through the Cal PX. When PG&E and SCE defaulted on payment obligations incurred through the Cal PX, the Cal PX moved to liquidate the Block Forward Agreements to satisfy in part the obligations owed by PG&E and SCE. Before the Cal PX could liquidate the Block Forward Agreements, California commandeered them for its own purposes. In March 2001, PNM and other similarly situated sellers of electricity through the Cal PX filed claims for damages with the California state Victims Compensation and Government Claims Board ("Victims Claims Board") on the theory that the state, by commandeering the Block Forward Agreements, had deprived them of security to which they were entitled under the terms of the Cal PX's tariff. The Victims Claims Board denied PNM `s claim in March 2002. PNM filed a complaint against the State of California in California state court in September 2002, seeking damages for the state's commandeering of the Block Forward Agreements and requesting judicial coordination with the state's declaratory relief action filed in February 2002 on the basis that the two actions raise essentially the same issues. The judge delayed establishing a procedural schedule for the case pending a determination of the Cal PX's status in the litigation. The judge has since held that the Cal PX could represent the interests of Cal PX participants in the litigation. In March 2004, both the Cal PX and the State of California filed demurrers against each other's actions, alleging each other's actions failed to a state cause of action and that the issues raised in the other's case were identical to the issues raised in their own cases. In a hearing held in April 2004, the judge determined not to rule on the demurrers until the specific market participants named in the declaratory action proceeding affirmatively determined whether they would agree to be bound by any judgment reached in the Cal PX complaint action. The various parties are working to develop a procedure to determine what parties agree to be represented by the Cal PX in the proceedings, and be bound any judgment in the cases. A subsequent hearing before the judge is scheduled for May 2004. The Company cannot predict the outcome of this matter.

New Source Review Rules

In November 1999, the United States Department of Justice ("DOJ"), at the request of the United States Environmental Protection Agency ("EPA"), filed complaints against seven companies, alleging that the companies over the past 25 years had made modifications to their plants in violation of the New Source Review ("NSR") requirements and in some cases the New Source Performance Standard ("NSPS") regulations, which could result in the requirement to make costly environmental additions to older power plants. Whether or not the EPA will ultimately prevail is uncertain at this time. The EPA has reached settlements with several of the companies sued by the DOJ. In August 2003, in one of the pending enforcement cases against Ohio Edison Company, a federal district judge in Ohio ruled in favor of the EPA and against Ohio Edison. The judge accepted the legal theories advanced by the government and in particular found that eleven construction projects undertaken by the utility in that case between 1984 and 1998 were "modifications" of the plants within the meaning of the Clean Air Act, not "routine maintenance, repair or replacement" ("RMRR"). That case now proceeds to a remedy phase. By contrast, in a separate federal district court proceeding against Duke, the court has made certain rulings in summary judgment motions that appeared to potentially validate elements of the

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industry position. If the EPA prevails in the position advanced in the pending litigation, PNM may be required to make significant capital expenditures, which could have a material adverse effect on the Company's financial position and results of operations.

No complaint has been filed against PNM by the EPA, and the Company believes that all of the routine maintenance, repair, and replacement work undertaken at its power plants was and continues to be in accordance with the requirements of NSR and NSPS. However, in October 2000, the New Mexico Environmental Department ("NMED") made an information request of PNM, advising PNM that the NMED was in the process of assisting the EPA in the EPA's nationwide effort "of verifying that changes made at the country's utilities have not inadvertently triggered a modification under the Clean Air Act's Prevention of Significant Deterioration ("PSD") policies." PNM has responded to the NMED information request. In late June 2002, PNM received another information request from the NMED for a list of capital projects budgeted or completed in 2001 or 2002. PNM has responded to the additional NMED information request.

The National Energy Policy Development Group released the National Energy Policy in May 2001, which called for a review of the pending EPA enforcement actions. As a result of that review, in June 2002, the EPA announced its intention to pursue steps to increase energy efficiency, encourage emissions reductions and make improvements and reforms to the NSR program. The EPA announced that, among other things, the NSR program had impeded or resulted in the cancellation of projects that would maintain or improve reliability, efficiency and safety of existing power plants. The EPA's June 2002 announcement contemplated further rulemakings on NSR-related issues and expressly cautioned that the announcement was not intended to affect pending NSR enforcement actions. Thereafter, in December 2002, the EPA promulgated certain long-awaited revisions to the NSR rules, along with proposals to revise the RMRR exclusion contained in the regulations. In August 2003, the EPA issued its rule regarding RMRR. The new RMRR rule clarifies what constitutes RMRR of damaged or worn equipment, subject to safeguards to assure consistency with the Clean Air Act. It provides that replacements of equipment are routine only if the new equipment is (i) identical or functionally equivalent to the equipment being replaced;
(ii) does not cost more than 20% of the replacement value of the unit of which the equipment is a part; (iii) does not change the basic design parameters of the unit; and (iv) does not cause the unit to exceed any of its permitted emissions limits. Legal challenges to the RMRR rule have been filed by several states; other states have intervened in support of the rule. How such challenges will ultimately be resolved cannot be predicted but an appellate court order has stayed the effect of the RMRR rule pending the outcome of the litigation. The Company is unable to determine the impact of this matter.

Citizen Suit Under the Clean Air Act

Following required notification, the Grand Canyon Trust and the Sierra Club (collectively "GCT") filed a so-called "citizen suit" in federal district court in New Mexico against PNM (but not against the other SJGS co-owners) in May 2002. The suit alleged two violations of the Clean Air Act and related regulations and permits. First, GCT argued that the plant has violated, and is currently in violation of, the federal Prevention of Significant Deterioration ("PSD") rules, as well as the corresponding provisions of the New Mexico

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Administrative Code, at SJGS Units 3 and 4. Second, GCT alleged that the plant has "regularly violated" the 20% opacity limit contained in SJGS's operating permit and set forth in federal and state regulations at Units 1, 3 and 4. The lawsuit seeks penalties as well as injunctive and declaratory relief. PNM denied the material allegations in the complaint.

Both sides in the litigation filed motions for partial summary judgment and the court entered an order granting PNM's motion for summary judgment on the PSD issues, dismissing that portion of the case against PNM. A trial on certain preliminary liability issues on the opacity claims was held in November 2003. At this trial, the plaintiffs presented their case and PNM presented certain defenses, including that the measurement methods relied on by GCT are contradicted by other measurement methods or by other qualified scientific data. On February 2, 2004 the court entered a Memorandum Opinion on PNM's general defenses. The Memorandum Opinion rejected PNM's arguments concerning the proper method for determining opacity compliance, but allowed PNM to present evidence in the next part of the liability trial addressing and defending against liability for specific alleged opacity violations. A status conference was held on March 5, 2004. The court advised that the next phase of the liability trial would likely be scheduled in August or September 2004. A trial on remedy issues, if necessary, would be scheduled at a later date. PNM was directed to make a written settlement offer, no later than May 28, with the plaintiffs directed to respond by June 11, 2004. A settlement conference has been scheduled before the federal magistrate on July 1, 2004. At the direction of the Court, the Company is working with GCT to streamline the next phase of the trial. The Company may not be able to present sufficient evidence to meet its burden of proof as established by the Court on many of the alleged violations. As a result, the Company and GCT are considering a process whereby the Company would waive its right to present evidence regarding each alleged violation and instead the litigation would proceed to the liability phase where the Company would present its case that the alleged violations were not of such a nature as to require large penalties or injunctive relief. PNM's corporate policy continues to be to adhere to high environmental standards as evidenced by its ISO 14001 certification. The Company is, however, unable to predict the ultimate outcome of the matter.

On April 29, 2004, the Company received notice from GCT of intent to file another suit against SJGS for violations of the Clean Air Act and related regulations and permits. The notice alleges continuing violations of the opacity limit in the operating permit since May 16, 2002, the date of filing the original suit and the last day allowed by the Court for determining violations in the original suit. In addition the notice alleges failure to operate consistent with good air pollution control practices by burning coal with ash content in excess of boiler and emission control equipment design capacity and operating SJGS as a "load following" facility when it was designed as a "base load" power plant. Further, the notice alleges continuing violations for failure to submit true, accurate and complete compliance certifications since at least 1998 by not disclosing opacity and particulate matter violations. The notice alleges that PNM claimed water vapor as the cause of many violations of the opacity limit when it had no evidence to support the claim and that its Excess Emission Forms and quarterly reports for the last five years also assert excuses for opacity violations that are invalid. Finally, the notice alleges that PNM has not timely filed Excess Emission Forms for many deviations. The Company believes that it has meritorious defenses and will vigorously dispute the allegations. The Company cannot predict the ultimate outcome of the matter.

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Archeological Site Disturbance

The Company hired a contractor, Great Southwestern Construction, Inc. ("Great Southwestern"), to conduct certain "climb and tighten" activities on a number of electric transmission lines in New Mexico between July 2001 and December 2001. Those lines traverse a combination of federal, state, tribal and private properties in New Mexico. In late May 2002, the U.S. Forest Service ("USFS") notified PNM that apparent disturbances to archeological sites had been discovered in and around the rights-of-way for PNM's transmission lines in the Carson National Forest in New Mexico. Great Southwestern had performed "climb and tighten" activities on those transmission lines.

PNM has confirmed the existence of the disturbances, as well as disturbances associated with certain arroyos that may raise issues under section 404 of the Clean Water Act. PNM has given the Corps of Engineers notice concerning the disturbances in arroyos. The Corps of Engineers has acknowledged the Company's notice and asked PNM to cooperate in addressing these disturbances. The USFS verbally instructed PNM to undertake an assessment and possible related mitigation measures with respect to the archeological sites in question. PNM contracted for an archeological assessment and a proposed remediation plan with respect to the disturbances and has provided the assessment to the USFS and the federal Bureau of Land Management ("BLM"). The Santa Fe Forest issued a notice of non-compliance to PNM for alleged non-compliance with the terms and conditions of PNM's special use authorization relating to maintenance of PNM's power lines on USFS land.

A subsequent preliminary investigation into other transmission lines that were covered by the "climb and tighten" project indicated that there are disturbances on lands governed by other federal agencies and Indian tribes. PNM and Great Southwestern have provided notice of the potential disturbances to these other agencies and tribes. The Company had been informed that the USFS and BLM had commenced a criminal investigation into Great Southwestern's activities on this project. However, the Company received verbal confirmation that the USFS and the BLM have decided to decline criminal prosecution under the Archeological Resources Protection Act ("ARPA") against PNM and Great Southwestern. The State of New Mexico requested information from PNM concerning the location of potential disturbances on state lands. The Navajo Nation has also requested further information concerning disturbances on Navajo land, but has provided written declination of criminal charges under ARPA against PNM and Great Southwestern. The Navajo Nation has indicated that it may pursue civil damages under ARPA. PNM and Great Southwestern are seeking the consent of BLM and the USFS to address impacted drainages under these agencies jurisdiction. PNM has provided Great Southwestern with notice and a demand for indemnity. Zurich Insurance, the insurer for Great Southwestern, has denied coverage and indemnity to PNM for this claim but has agreed to share the cost of a portion of the investigation of this claim. PNM is considering its options regarding Zurich's denial of coverage. The Company is unable to predict the outcome of this matter and cannot estimate with any certainty the potential impact on the Company's operations.

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Excess Emissions Reports

As required by law, whenever there are excess emissions from SJGS, due to such causes as start-up, shutdown, upset, breakdown or certain other conditions, PNM makes filings with the NMED. For some three years, PNM has been in discussions with NMED concerning excess emissions reports for the period after January 1997. During this period, NMED investigated the circumstances of these excess emissions and whether these emissions involve any violation of applicable permits and regulations. PNM and NMED have entered into several agreements tolling the running of the statute of limitations in order to allow NMED to complete its review of these filings. The present tolling agreement expires July 1, 2004. By letter dated September 12, 2003, the NMED advised PNM that NMED would not excuse certain of the emissions exceeding the operating permit. The NMED also stated that PNM had violated the opacity limits in the operating permit and articulated a construction of the standards that NMED would apply in evaluating opacity exceedances. Attached to the September 12, 2003 letter was what was identified as a "draft" compliance order assessing unspecified civil penalties. The NMED invited PNM to enter into discussions concerning the contents of the letter and of the draft compliance order and PNM and NMED have entered into such discussions. PNM has submitted two letters providing responses to the draft and additional information. In addition, PNM has responded to a number of requests by the NMED for additional information. Discussions between the NMED and PNM are ongoing. The compliance order has not yet been finalized and no proceeding against PNM has yet been commenced by NMED. PNM disagrees with the construction of its operating permit that is contained in the September 12, 2003 letter, which represents a construction of the operating permit never previously advanced by NMED. PNM is unable to predict the outcome of this matter and cannot estimate the potential impact on the Company's operations.

Santa Fe Generating Station

PNM and the NMED conducted investigations of the gasoline and chlorinated solvent groundwater contamination detected beneath PNM's former Santa Fe Generating Station ("Santa Fe Station") site to determine the source of the contamination pursuant to a 1992 Settlement Agreement ("Settlement Agreement") between PNM and the NMED. The Settlement Agreement has been amended on several occasions to modify the scope of the investigation and remediation activities. No source of gasoline contamination in the groundwater was identified as originating from the site.

PNM is of the opinion that the data compiled indicates observed groundwater contamination originated from off-site sources. However, in August 2003, PNM elected to enter into a fifth amendment ("Fifth Amendment") to the Settlement Agreement with the NMED to avoid a prolonged legal dispute whereby PNM agreed to install additional remediation facilities consisting of an additional extraction well and two additional monitoring wells to address remaining gasoline contamination in the groundwater at and in the vicinity of the site. PNM will continue to operate the remediation facilities until the

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groundwater is cleaned up to applicable federal standards or until such time as the NMED determines that additional remediation is not required, whichever is earlier. The City of Santa Fe, the NMED and PNM entered into an amended Memorandum of Understanding relating to the continued operation of the Santa Fe Well and the remediation facilities called for under the latest Amended Settlement Agreement.

The Fifth Amendment notes the continued presence of chlorinated solvents in the groundwater under the former Santa Fe Station and provides that once the remediation standards are met, the NMED anticipates that it will not require PNM to undertake any further investigation or remediation with respect to chlorinated solvents. In the event that chlorinated solvent concentrations remain at levels requiring further action, the NMED will not require PNM to take any further action with respect to the chlorinated solvent contamination until the NMED has reviewed any new data relating to the chlorinated solvent contamination and undertaken a good faith investigation into other potential sources. The NMED has acknowledged that at least a portion of the chlorinated solvent contamination observed beneath the Santa Fe Station site has originated from off-site sources. In September 2003, PNM was verbally informed that the Superfund Oversight Section of the NMED is conducting an investigation into the chlorinated solvent contamination at the former Santa Fe Station site, including other possible sources for the chlorinated solvents in the groundwater. The NMED states that it expects to have the results of its investigation complete by September of 2004.

Natural Gas Royalties Qui Tam Litigation

In 1999, a complaint was served on the Company alleging violations of the False Claims Act by PNM and its subsidiaries, Gathering Company and Processing Company (collectively, the "Company" for purposes of this discussion), by purportedly failing to properly measure natural gas from Federal and tribal properties in New Mexico, and consequently, underpaying royalties owed to the Federal government. A private relator is pursuing the lawsuit. The complaint was served after the United States Department of Justice declined to intervene to pursue the lawsuit. The complaint seeks actual damages, treble damages, costs and attorneys fees, among other relief.

Currently the parties are engaged in discovery on the issue of whether the relator meets the requirements for bringing a claim under the False Claims Act. The Company expects to participate with other defendants in a motion to dismiss on the ground that the relator does not meet those requirements.

The Company is vigorously defending this lawsuit and is unable to estimate the potential liability, if any, or to predict the ultimate outcome of this lawsuit.

Richardson Matter

Another gas leaseholder, Richardson Operating Company ("Richardson"), has leases in the area of the underground coal mine described above and has asserted claims against SJCC. The Company understands that discussions with Richardson

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are ongoing, although no formal litigation has been filed. The Company is unable to predict the outcome of this matter.

Asbestos Cases

The Company was named in 2003 as one of a number of defendants in 21 personal injury lawsuits relating to alleged exposure to asbestos. All of these cases involve claims of individuals, or their descendents, who worked for contractors building, or working at, Company power plants. Some of the claims relate to construction activities during the 1950's and 1960's, while other claims generally allege exposure during the last 30 years. The Company has never manufactured, sold or distributed products containing asbestos. All of these cases involve multiple defendants. The Company was insured by a number of different insurance policies during the time period at issue in these cases. The Company intends to vigorously defend against these lawsuits. Although the Company is unable to fully predict the outcome of this litigation, the Company believes that it has adequate reserves and insurance coverage such that the outcome of these legal proceedings would not have a material impact on the financial condition of the Company.

San Angelo Electric Service Company ("SESCO") Matter

In October 2003, the Texas Commission on Environmental Quality ("TCEQ") requested information from PNM concerning any involvement that PNM had with the SESCO of San Angelo, Texas. PNM is informed that the TCEQ is conducting a site investigation of a SESCO facility in San Angelo, Texas pursuant to the Texas Solid Waste Act and that the SESCO site has been referred to the Superfund Site Discovery and Assessment Program. The primary concern appears to be polychlorinated biphenyls ("PCBs"). The TCEQ is conducting the site investigation to determine what remediation activities are required at the SESCO site and to identify potentially responsible parties ("PRPs"). In January 2004, PNM submitted its preliminary response to the TCEQ request for information. The response states that PNM previously had a "requirements" contract with SESCO for the repair of electric transformers. It appears that a number of transformers were sent to SESCO for repair. In addition, it appears that PNM sold a number of retired transformers to SESCO. An informational meeting took place in Austin, Texas on April 8, 2004 where the status of the SESCO site and the possible establishment of a PRP Committee was discussed. So far $1.8 million has been spent by the State and other companies on preliminary investigation and clean up. PNM is still investigating its role in the matter, and is unable to predict the outcome at this time.

Public Utility Holding Company Act of 1935 (PUHCA)

Since its formation as a holding company, PNM Resources has claimed the intrastate exemption from registration under PUHCA, including its most recent filing in February 2004. As the Holding Company mentioned in its 10-K, an order issued by the SEC late last year denied the exemption to Enron based on the interstate activities of its utility subsidiary, Portland General Electric. This order called into question the continuing availability of the intrastate exemption for companies with a certain level of interstate utility activities.

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In discussions with the Office of Public Utility Regulation of the SEC regarding its filing earlier this year, the Holding Company was informed that the SEC views the existing interstate activities of PNM to be significant enough to require registration based on the Enron decision. The Company will prepare to register, seeking the appropriate authorizations under PUHCA coincident with registration. This process will likely take several months. The Company intends to maintain its current claim of exemption in the interim. Other than some reorganizing of its corporate service functions the Company does not anticipate that registration will affect its operations. Other utility subsidiaries of registered holding companies successfully operate in New Mexico subject to the regulatory requirements of both PUHCA and the PRC. The regulatory conditions imposed upon the formation of the Holding Company are equivalent to those imposed by the PRC on utilities of registered companies.

Coal Combustion Waste Disposal

SJCC currently disposes of fly ash from SJGS in the surface mine pits adjacent to the plant. PNM and SJCC have been participating in various sessions sponsored by EPA to consider rulemaking for the disposal of coal combustion products, including disposal of fly ash from SJGS. The rulemaking would be pursuant to the Bevill Amendment of RCRA. Pursuant to that Act, EPA has also listed SJGS as a potential damage case due to claims by third parties that the plant and mine have contaminated water resources in the region. PNM and SJCC vigorously deny these allegations. EPA apparently is in the process of investigating the claims. PNM cannot predict the outcome of this matter but does not believe currently that it will have a material adverse impact on the Company or its operations.

Other

There are various claims and lawsuits pending against the Company. The Company is also subject to federal, state and local environmental laws and regulations, and is currently participating in the investigation and remediation of numerous sites. In addition, the Company periodically enters into financial commitments in connection with its business operations. It is not possible at this time for the Company to determine fully the effect of all litigation on its consolidated financial statements. However, the Company has recorded a liability where the litigation effects can be estimated and where an outcome is considered probable. The Company does not expect that any known lawsuits, environmental costs and commitments will have a material adverse effect on its financial condition or results of operations.

The Company is involved in various legal proceedings in the normal course of its business. The associated legal costs for these legal matters are accrued when incurred. It is also the Company's policy to accrue for legal costs expected to be incurred in connection with Statement of Financial Accounting Standards No. 5 "Accounting for Contingencies" ("SFAS 5") legal matters when it is probable that a SFAS 5 liability has been incurred and the amount of expected legal costs to be incurred is reasonably estimable. These estimates include costs for external counsel professional fees.

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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Risks and Uncertainties

The Company's future results may be affected by various factors outside of its control, including: changes in regional economic conditions; the outcome of labor negotiations with unionized employees; fluctuations in fuel, purchased power and gas prices; the actions of utility regulatory commissions; changes in law and environmental regulations; the success of its planned generation expansion; the cost and outcome of litigation and other legal proceedings and investigations; the performance of generation facilities and transmission systems; changes in accounting rules and standards; and external factors such as weather and water supply. Because of pending federal regulatory reforms, the public utility industry is undergoing a fundamental change. New Mexico has repealed the Electric Utility Industry Restructuring Act of 1999 and therefore has abandoned its plans to transform the industry from one of vertically-integrated monopolies to one with deregulated, competitive generation. However, the FERC has proposed a "Standard Market Design" ("SMD") to establish rules for a market-based approach for wholesale transactions over the transmission grid. The FERC's efforts have been opposed by a number of states, primarily in the West and in the Southeast in transmission market, because of concern that the SMD does not adequately take into account regional differences. Moreover, Congress is currently debating energy legislation which could affect the FERC's activities. In an attempt to ease concerns, on April 28, 2003, the FERC issued a White Paper on "Wholesale Power Market Platform" describing changes it intended to make to its SMD proposed rules. The Company's future results will be impacted by the form of the FERC rules, if adopted; the costs of complying with rules and legislation that may call for regulatory reforms for the industry; and the resulting market prices for electricity and natural gas. In addition, the Company is subject to a 2.5% retail electric rate reduction effective September 2005 and a retail electric rate freeze through 2007 so that the Company's financial results will depend on its ability to control costs and grow revenues, and the implications of uncontrollable factors such as weather, water supply, litigation and economic conditions.

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                                                     Three Months Ended
                                                          March 31,
                                                ------------------------------
                                                    2004            2003
                                                --------------  --------------
                                                        (In thousands)
Other income:
Interest income................................     $ 9,921         $10,700
Miscellaneous non-operating income.............       1,667             506
                                                --------------  --------------
                                                    $11,588         $11,206
                                                ==============  ==============
Other deductions:
Transition costs write-off.....................     $     -         $16,720
Miscellaneous non-operating deductions.........       3,372           1,192
                                                --------------  --------------
                                                    $ 3,372         $17,912
                                                ==============  ==============

The following table details the components of other income and deductions for PNM:

                                                      Three Months Ended
                                                           March 31,
                                                 -----------------------------
                                                     2004           2003
                                                 -------------- --------------
                                                         (In thousands)
Other income:
Interest income................................      $ 9,772        $10,117
Miscellaneous non-operating income.............        1,494            376
                                                 -------------- --------------
                                                     $11,266        $10,493
                                                 ============== ==============
Other deductions:
Transition costs write-off.....................       $    -        $16,720
Miscellaneous non-operating deductions.........        1,317          1,761
                                                 -------------- --------------
                                                      $1,317        $18,481
                                                 ============== ==============

(8) Variable Interests Entities

FASB Interpretation No. 46, Consolidation of Variable Interest Entities (Revised December 2003) ("FIN 46R") became effective January 1, 2004 for most types of variable interest entities, and March 31, 2004 for others. FIN46R expands the requirement of a business enterprise to consolidate an entity beyond the concept of a controlling interest. Under FIN46R, a business enterprise will consolidate an entity if that entity is a variable interest entity, the business enterprise is the primary beneficiary of the entity and the entity's risks are not effectively dispersed among all parties involved. A variable interest entity has certain characteristics that effectively demonstrate that the equity

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

investor does not have economic substance, bear the risks and receive the rewards of the entity or direct the entity's activities. The interpretation requires that an enterprise review all its variable interests and determine if consolidation is appropriate.

Under the model for consolidation promulgated by FIN 46R, a power purchase agreement ("PPA") may qualify as a variable interest if its terms expose the purchaser to variability in supply or operating costs and the contract is for a significant portion of the entity's generating capacity. The Company evaluated its PPA's under the provisions of FIN46R and determined that one purchase contract qualifies as a variable interest. The Company was unable to obtain the necessary information to determine if consolidation was necessary. These efforts included a formal written request to the operator of the entity supplying power under the PPA. Through these efforts, the Company was unable to obtain the necessary information citing legal and competitive reasons.

This variable interest PPA is a contract to purchase 132 MW of capacity and energy for 25 years expiring in June 2020. The contract contains a fixed capacity charge, fixed operations and maintenance ("O&M") charge and a variable energy charge that subjects the Company to the changes in the cost of fuel and O&M. For the three months ended March 31, 2004, the capacity charge was $1.2 million and the energy charges were $0.1 million compared to $1.3 million and $0.1 million, respectively for the prior year period. The contract is for the full output of a specific gas generating plant and is currently accounted for as an operating lease by the Company. Under this contract the Company is exposed to changes in the costs to produce energy and operate the plant.

The Company also has interests in other variable interest entities created before January 31, 2003, for which the Company is not the primary beneficiary. These arrangements include the Holding Company's investment in a limited partnership and PNM's two leases with special-purpose entities. The aggregate maximum loss exposure at March 31, 2004, that the Company could be required to record in its income statement as a result of these arrangements totals approximately $7.9 million. The creditors of these variable interest entities do not have recourse to the general credit of the Company in excess of the aggregate maximum loss exposure.

(9) New and Proposed Accounting Standards

FASB Staff Position No. 106-1 "Accounting and Disclosure Requirements Related to Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the Act")" ("FSP 106-1"). The Act introduces a prescription drug benefit under Medicare ("Medicare Part D") as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. FSP 106-1 permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act. Disclosures are required regardless of whether the sponsor elects deferral. FSP 106-1 was effective as of December 31, 2003. In March 2004, FASB issued proposed FAS 106-b, "Accounting and Disclosure Requirements Related to the Medicare

PNM RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Prescription Drug, Improvement and Modernization Act of 2003", which provides guidance on accounting for the effects of the Act and disclosure requirements regarding the effect of the federal subsidy provided by the Act. When effective, FSP 106-b will supersede FSP 106-1. Because of various uncertainties related to the Company's response to this legislation and the appropriate accounting methodology for this event, the Company continues to defer financial recognition of this legislation until the FASB issues final accounting guidance. When issued, that final guidance could require the Company to change previously reported information.

(10) Subsequent Events

On April 1, 2004, the Company repriced $146.0 million of tax exempt pollution control bonds, with a previous interest rate of 2.75%. The new interest rate is 2.10% for a term of 2 years. These bonds will reprice next on April 1, 2006.

On April 23, 2004, the Company entered into a rated commercial paper program. The Company may issue up to $300 million in commercial paper for up to 365 days. The commercial paper is unsecured and the proceeds will be used to retire borrowings under the previous unrated commercial paper program, retirement of other short-term borrowings and other short-term cash management needs. The Company's Credit Facility serves as a backstop for the outstanding commercial paper.

On April 29, 2004, the Company entered into three fixed to floating interest rate swaps. The notional principal amount is $150 million. The Company will receive a 4.40% fixed interest payment on a semi-annual basis and pay 6 month London Interbank Offered Rate ("LIBOR") plus 58.15 basis points through September 15, 2008. The initial floating rate is 1.95% and the first reset date is September 15, 2004.

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