**Table of Contents**

** **

** **

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|--------------------------------------------------------------------------------------------------------|

 

#### **For thequarterly period ended June 30, 2008**

#### ** **

**or**

 

| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------|

 

#### **For thetransition periodfrom          to         **

#### ** **

#### **Commission File Number: 001-03789**

#### ** **

**SouthwesternPublic Service Company**

**(Exact name of registrant asspecified in its charter)**

** **

| **New Mexico**                  | ** ** | **75-0575400**                       |
|---------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)  |       |                                 |
|                            |       |                                 |
| **Tyler at Sixth,**             | ** ** | ** **                           |
| **Amarillo, Texas**             | ** ** | **79101**                            |
| (Address of principal executive |       | (Zip Code)                           |
| offices)                        |       |                                 |

 

Registrant’s telephone number, including areacode **(303) 571-7511**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. xYes   o No

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 
| Large  accelerated filer o                    |   | Accelerated  filer o         |
|-----------------------------------------------|--------|-----------------------------------|
|                                          |   |                              |
| Non-accelerated  filer x                      |   | Smaller  reporting company o |
| (Do not check if a smaller reporting company) |   |                              |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes  o   No  x

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 
| **Class**                  | ** ** | **Outstanding at Aug. 4, 2008** |
|----------------------------|------------|-----------------------------------------------------|
| Common Stock, $1 par value |       | 100 shares                                          |

 

SouthwesternPublic Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Qwith the reduced disclosure format specified in General Instruction H (2) tosuch Form 10-Q.

 

 

 

----

Tableof Contents

 

**Tableof Contents**

 
|                                        | **PART I - FINANCIAL INFORMATION**                                                     |   |
|---------------------------------------------|---------------------------------------------------------------------------------------------|--------|
|                                        |                                                                                        |   |
| Item l.                                     | Financial Statements (Unaudited)                                                            |   |
| Item 2.                                     | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
| Item 4.                                     | Controls and Procedures                                                                     |   |
|                                        |                                                                                        |   |
|                                        | **PART II - OTHER INFORMATION**                                                        |   |
|                                        |                                                                                        |   |
| Item 1.                                     | Legal Proceedings                                                                           |   |
| Item 1A.                                    | Risk Factors                                                                                |   |
| Item 6.                                     | Exhibits                                                                                    |   |
|                                        |                                                                                        |   |
| SIGNATURES                                  |                                                                                        |   |
|                                        |                                                                                        |   |
| Certifications Pursuant to Section 302 |                                                                                        |   |
| Certifications Pursuant to Section 906 |                                                                                        |   |
| Statement Pursuant to  Private Litigation   |                                                                                        |   |
|                                             |                                                                                             |        |  |

 

This Form 10-Qis filed by Southwestern Public Service Co. (SPS). SPS is a wholly ownedsubsidiary of Xcel Energy Inc. (Xcel Energy). Additional information on Xcel Energyis available on various filings with the Securities and Exchange Commission(SEC).

 

2

----

Tableof Contents

 

**PART 1. FINANCIAL INFORMATION**

 

**Item 1. FINANCIAL STATEMENTS**

 

**SOUTHWESTERN PUBLIC SERVICECO.**

**STATEMENTS OF INCOME(UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating revenues**                                                                                 |       | $                                               | 537,873    |                                          | $          | 401,125 |   | $ | 956,670 |   | $ | 767,023 |   |
|                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Operating expenses**                                                                                 | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Electric fuel and purchased power                                                                      |       | 425,991                                         |       | 296,514                                       |       | 747,683 |   | 560,921 |   |
| Other operating and maintenance expenses                                                               |       | 54,821                                          |       | 49,099                                        |       | 106,246 |   | 100,192 |   |
| Depreciation and amortization                                                                          |       | 28,852                                          |       | 24,312                                        |       | 53,818 |   | 49,000 |   |
| Taxes (other than income taxes)                                                                        |       | 9,780                                           |       | 9,241                                         |       | 20,103 |   | 20,803 |   |
| Total operating expenses                                                                               |       | 519,444                                         |       | 379,166                                       |       | 927,850 |   | 730,916 |   |
|                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Operating income**                                                                                   |       | 18,429                                          |       | 21,959                                        |       | 28,820 |   | 36,107 |   |
|                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Interest and other income, net                                                                         |       | 1,367                                           |       | 527                                           |       | 2,230 |   | 1,330 |   |
|                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| **Interest charges and financing costs**                                                               | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest charges — includes other financing  costs of $590, $590, $1,181 and $1,175, respectively |       | 13,553                                          |       | 13,718                                        |       | 27,484 |   | 26,752 |   |
| Allowance for funds used during  construction — debt                                              |       | (604                                            | )          | (606                                          | )          | (1,260 | ) | (1,104 | ) |
| Total interest charges and financing costs                                                             |       | 12,949                                          |       | 13,112                                        |       | 26,224 |   | 25,648 |   |
|                                                                                                   |       |                                            |       |                                          |       |   |   |   |   |
| Income before income taxes                                                                             |       | 6,847                                           |       | 9,374                                         |       | 4,826 |   | 11,789 |   |
| Income taxes                                                                                           |       | 2,877                                           |       | 3,755                                         |       | 2,121 |   | 4,505 |   |
| **Net income**                                                                                         |       | $                                               | 3,970      |                                          | $          | 5,619 |   | $ | 2,705 |   | $ | 7,284 |   |

 

See Notes to Financial Statements

 

3

----

Tableof Contents

 

**SOUTHWESTERN PUBLIC SERVICE CO.**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| **Operating activities**                                                           |       |                                              |       |   |   |
| Net income                                                                         |       | $                                                 | 2,705      |   | $ | 7,284 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation and amortization                                                      |       | 56,733                                            |       | 50,800 |   |
| Deferred income taxes                                                              |       | 13,791                                            |       | (1,832 | ) |
| Amortization of investment tax credits                                             |       | (110                                              | )          | (125 | ) |
| Net realized and unrealized hedging and derivative  transactions                   |       | 134                                               |       | 133 |   |
| Changes in operating assets and  liabilities:                                      |       |                                              |       |   |   |
| Accounts receivable                                                                |       | (25,927                                           | )          | (3,812 | ) |
| Accrued unbilled revenues                                                          |       | (39,892                                           | )          | (51,738 | ) |
| Recoverable electric energy costs                                                  |       | (60,238                                           | )          | 65,504 |   |
| Inventories                                                                        |       | (5,084                                            | )          | (2,724 | ) |
| Prepayments and other                                                              |       | 3,505                                             |       | 2,986 |   |
| Accounts payable                                                                   |       | 80,165                                            |       | (11,533 | ) |
| Net regulatory assets and liabilities                                              |       | (1,056                                            | )          | (1,357 | ) |
| Other current liabilities                                                          |       | (13,828                                           | )          | (19,435 | ) |
| Change in other noncurrent assets                                                  |       | (5,398                                            | )          | (5,004 | ) |
| Change in other noncurrent liabilities                                             |       | 6,797                                             |       | (319 | ) |
| Net cash provided by operating activities                                          |       | 12,297                                            |       | 28,828 |   |
|                                                                               |       |                                              |       |   |   |
| **Investing activities**                                                           |       |                                              |       |   |   |
| Utility capital/construction expenditures                                          |       | (83,843                                           | )          | (66,104 | ) |
| Investments in utility money pool  arrangement                                     |       | —                                            |       | (81,800 | ) |
| Receipts from utility money pool  arrangement                                      |       | —                                            |       | 81,800 |   |
| Other investments                                                                  |       | 2,166                                             |       | 2,814 |   |
| Net cash used in investing activities                                              |       | (81,677                                           | )          | (63,290 | ) |
|                                                                               |       |                                              |       |   |   |
| **Financing activities**                                                           |       |                                              |       |   |   |
| Proceeds from (repayment of) short-term  borrowings – net                     |       | 76,000                                            |       | (17,000 | ) |
| Borrowings under utility money pool  arrangement                                   |       | 379,100                                           |       | 251,200 |   |
| Repayments under utility money pool  arrangement                                   |       | (354,600                                          | )          | (169,400 | ) |
| Capital contributions from parent                                                  |       | 2,095                                             |       | 5,354 |   |
| Dividends paid to parent                                                           |       | (31,753                                           | )          | (35,900 | ) |
| Net cash provided by financing activities                                          |       | 70,842                                            |       | 34,254 |   |
|                                                                               |       |                                              |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                              |       | 1,462                                             |       | (208 | ) |
| Cash and cash equivalents at beginning of  period                                  |       | 714                                               |       | 297 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                 | 2,176      |   | $ | 89 |   |
|                                                                               |       |                                              |       |   |   |
| Supplemental disclosure of cash flow  information:                                 |       |                                              |       |   |   |
| Cash paid for interest (net of amounts  capitalized)                               |       | $                                                 | 25,425     |   | $ | 24,162 |   |
| Cash paid for income taxes (net of refunds  received)                              |       | 10,007                                            |       | 15,982 |   |
|                                                                               |       |                                              |       |   |   |
| Supplemental disclosure of non-cash  investing transactions:                       |       |                                              |       |   |   |
| Property, plant and equipment additions in  accounts payable                       |       | $                                                 | 2,939      |   | $ | 3,904 |   |

 

See the Notes to Financial Statements

 

4

----

Tableof Contents

 

**SOUTHWESTERN PUBLIC SERVICE CO**.

**BALANCE SHEETS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                            | ** ** | **June 30, 2008** | ** ** | **Dec. 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                            | ** ** | ** **                  | ** ** | ** **                  | ** ** |
| Current assets:                                                                       |       |                        |       |                        |       |
| Cash and cash equivalents                                                             |       | $                           | 2,176      |                        | $          | 714 |   |
| Accounts receivable, net                                                              |       | 92,478                      |       | 67,254                      |       |
| Accounts receivable from affiliates                                                   |       | 9,459                       |       | 8,756                       |       |
| Accrued unbilled revenues                                                             |       | 148,217                     |       | 108,325                     |       |
| Recoverable electric energy costs                                                     |       | 82,939                      |       | 22,701                      |       |
| Inventories                                                                           |       | 22,427                      |       | 17,343                      |       |
| Derivative instruments valuation                                                      |       | 8,926                       |       | 8,926                       |       |
| Prepayments and other                                                                 |       | 3,944                       |       | 7,449                       |       |
| Deferred income taxes                                                                 |       | —                      |       | 2,970                       |       |
| Total current assets                                                                  |       | 370,566                     |       | 244,438                     |       |
|                                                                                  |       |                        |       |                        |       |
| Property, plant and equipment, net                                                    |       | 2,072,711                   |       | 2,043,426                   |       |
|                                                                                  |       |                        |       |                        |       |
| Other assets:                                                                         |       |                        |       |                        |       |
| Prepaid pension asset                                                                 |       | 123,928                     |       | 117,948                     |       |
| Derivative instruments valuation                                                      |       | 81,013                      |       | 85,477                      |       |
| Regulatory assets                                                                     |       | 115,728                     |       | 124,900                     |       |
| Other investments                                                                     |       | 304                         |       | 2,470                       |       |
| Deferred charges and other                                                            |       | 6,578                       |       | 6,855                       |       |
| Total other assets                                                                    |       | 327,551                     |       | 337,650                     |       |
| Total assets                                                                          |       | $                           | 2,770,828  |                        | $          | 2,625,514 |   |
|                                                                                  |       |                        |       |                        |       |
| **LIABILITIES AND EQUITY**                                                            |       |                        |       |                        |       |
| Current liabilities:                                                                  |       |                        |       |                        |       |
| Current portion of long-term debt                                                     |       | $                           | 100,000    |                        | $          | — |   |
| Short-term debt                                                                       |       | 199,000                     |       | 123,000                     |       |
| Borrowings under utility money pool  arrangement                                      |       | 30,000                      |       | 5,500                       |       |
| Accounts payable                                                                      |       | 219,058                     |       | 153,130                     |       |
| Accounts payable to affiliates                                                        |       | 19,364                      |       | 9,432                       |       |
| Taxes accrued                                                                         |       | 11,778                      |       | 22,902                      |       |
| Dividends payable to parent                                                           |       | 15,112                      |       | 15,931                      |       |
| Accrued interest                                                                      |       | 12,548                      |       | 12,816                      |       |
| Deferred income taxes                                                                 |       | 14,977                      |       | —                      |       |
| Derivative instruments valuation                                                      |       | 4,745                       |       | 4,468                       |       |
| Other                                                                                 |       | 21,626                      |       | 24,062                      |       |
| Total current liabilities                                                             |       | 648,208                     |       | 371,241                     |       |
|                                                                                  |       |                        |       |                        |       |
| Deferred credits and other liabilities:                                               |       |                        |       |                        |       |
| Deferred income taxes                                                                 |       | 456,564                     |       | 462,228                     |       |
| Regulatory liabilities                                                                |       | 128,642                     |       | 133,025                     |       |
| Derivative instruments valuation                                                      |       | 58,832                      |       | 60,918                      |       |
| Asset retirement obligations                                                          |       | 3,186                       |       | 3,592                       |       |
| Deferred investment tax credits                                                       |       | 2,885                       |       | 2,995                       |       |
| Pension and employee benefit obligations                                              |       | 23,164                      |       | 23,871                      |       |
| Other                                                                                 |       | 15,411                      |       | 7,458                       |       |
| Total deferred credits and other  liabilities                                         |       | 688,684                     |       | 694,087                     |       |
|                                                                                  |       |                        |       |                        |       |
| Commitments and contingent liabilities                                                |       |                        |       |                        |       |
| Capitalization:                                                                       |       |                        |       |                        |       |
| Long-term debt                                                                        |       | 674,098                     |       | 774,033                     |       |
| Common stock – authorized 200 shares of  $1.00 par value, outstanding 100 shares |       | —                      |       | —                      |       |
| Additional paid in capital                                                            |       | 505,161                     |       | 503,066                     |       |
| Retained earnings                                                                     |       | 260,587                     |       | 289,092                     |       |
| Accumulated other comprehensive loss                                                  |       | (5,910                      | )          | (6,005                      | )          |
| Total common stockholder’s equity                                                |       | 759,838                     |       | 786,153                     |       |
| Total liabilities and equity                                                          |       | $                           | 2,770,828  |                        | $          | 2,625,514 |   |

** **

**See the Notes to Financial Statements**

 

5

----

**Table of Contents**

** **

**SOUTHWESTERN PUBLIC SERVICECO.**

**NOTES TO FINANCIALSTATEMENTS (UNAUDITED)**

** **

In the opinionof management, the accompanying unaudited financial statements contain alladjustments necessary to present fairly the financial position of SPS as of June 30,2008, and Dec. 31, 2007; the results of its operations for the three andsix months ended June 30, 2008 and 2007; and its cash flows for the sixmonths ended June 30, 2008 and 2007. Due to the seasonality of electricsales of SPS, interim results are not necessarily an appropriate base fromwhich to project annual results.

 

**1.Significant Accounting Policies**

 

Except to theextent updated or described below, the significant accounting policies setforth in Note 1 to the financial statements in SPS’ Annual Report on Form 10-Kfor the year ended Dec. 31, 2007, appropriately represent, in all materialrespects, the current status of accounting policies and are incorporated hereinby reference.

 

***Fair Value Measurements —***SPSpresents interest rate derivatives at estimated fair values in its financialstatements, utilizing broker quotes to establish fair value.

 

**2.   Recently Issued Accounting Pronouncements**

 

***Statement of FinancialAccounting Standards (SFAS) No. 157 Fair Value Measurements************(SFAS No. 157)****** —***In September 2006,the Financial Accounting Standards Board (FASB) issued SFAS No. 157,which provides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS No. 157 also emphasizes that fairvalue is a market-based measurement, and sets out a fair value hierarchy withthe highest priority being quoted prices in active markets. Fair valuemeasurements are disclosed by level within that hierarchy. SFAS No. 157was effective for financial statements issued for fiscal years beginning after Nov. 15,2007.

 

Asof Jan. 1, 2008, SPS adopted SFAS No. 157 for all assets andliabilities measured at fair value except for non-financial assets andnon-financial liabilities measured at fair value on a non-recurring basis, aspermitted by FASB Staff Position No. 157-2.  The adoption did not have a material impacton its financial statements.  Foradditional discussion and SFAS No. 157 required disclosures see Note 9 tothe financial statements.

 

***The Fair Value Option for Financial Assetsand Financial Liabilities - Including an Amendment of FASB Statement No. 115(SFAS No. 159)*** — In February 2007, the FASB issuedSFAS No. 159, which provides companies with an option to measure, at specifiedelection dates, many financial instruments and certain other items at fairvalue that are not currently measured at fair value. A company that adopts SFASNo. 159 will report unrealized gains and losses on items, for which thefair value option has been elected, in earnings at each subsequent reportingdate. This statement also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between entities that choose differentmeasurement attributes for similar types of assets and liabilities. Thisstatement was effective for fiscal years beginning after Nov. 15,2007.  Effective Jan. 1, 2008, SPSadopted SFAS No. 159 and the adoption did not have a material impact onits financial statements.

 

***BusinessCombinations (SFAS No. 141 (revised 2007)) —***InDecember 2007, the FASB issued SFAS No. 141R, which establishesprinciples and requirements for how an acquirer in a business combinationrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any noncontrolling interest; recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase; and determines what information to disclose to enable usersof the financial statements to evaluate the nature and financial effects of thebusiness combination. SFAS No. 141R is to be applied prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of an entity’s fiscal year that begins on or after Dec. 15, 2008.SPS will evaluate the impact of SFAS No. 141R on its financial statementsfor any potential business combinations subsequent to Jan. 1, 2009.

 

***Disclosures aboutDerivative Instruments and Hedging Activities (SFAS No. 161)**—***In March 2008, theFASB issued SFAS No. 161, which is intended to enhance disclosures to helpusers of the financial statements better understand how derivative instrumentsand hedging activities affect an entity’s financial position, financialperformance and cash flows.  SFAS No. 161amends and expands the disclosure requirements of SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*, to require disclosures of objectives and strategies forusing derivatives, gains and losses on derivative instruments, and credit-risk-relatedcontingent features in derivative agreements. SFAS No. 161 is effective for financial 

 

6

----

Tableof Contents

 

statements issued for fiscal years and interim periods beginning after Nov. 15,2008, with early application encouraged. SPS is currently evaluating the impact of adoption of SFAS No. 161on its financial statements.

 

***The Hierarchy of Generally AcceptedAccounting Principles (GAAP) (SFAS No. 162)  —***In May 2008, the FASBissued SFAS No. 162, which establishesthe GAAP hierarchy, identifying the sources of accounting principles and theframework for selecting the principles to be used in the preparation of financialstatements.  SFAS No. 162 iseffective 60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411, *The Meaning of Present Fairly in Conformity with Generally AcceptedAccounting Principles.*SPS does not believe thatimplementation of SFAS No. 162 willhave any impact on its financial statements.

 

***Accounting forDeferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements (Emerging Issues Task Force (EITF)Issue No. 06-4)*** — In June 2006, the EITFreached a consensus on EITF No. 06-4, which provides guidance on therecognition of a liability and related compensation costs for endorsementsplit-dollar life insurance policies that provide a benefit to an employee thatextends to postretirement periods. Therefore, this EITF would not apply to asplit-dollar life insurance arrangement that provides a specified benefit to anemployee that is limited to the employee’s active service period with anemployer.  EITF No. 06-4 waseffective for fiscal years beginning after Dec. 15, 2007, with earlierapplication permitted.  Upon adoption ofEITF No. 06-4 on Jan. 1, 2008, SPS recorded a liability of $0.3million, net of tax, as a reduction of retained earnings.  Thereafter, changes in the liability arereflected in operating results.

 

***Accounting forIncome Tax Benefits of Dividends on Share-Based Payment Awards (EITF No. 06-11)***— In June 2007, the EITF reached a consensuson EITF No. 06-11, which states that an entity should recognize a realizedtax benefit associated with dividends on nonvested equity shares and nonvestedequity share units charged to retained earnings as an increase in additionalpaid in capital. The amount recognized in additional paid in capital should beincluded in the pool of excess tax benefits available to absorb potentialfuture tax deficiencies on share-based payment awards. EITF No. 06-11should be applied prospectively to income tax benefits of dividends onequity-classified share-based payment awards that are declared in fiscal yearsbeginning after Dec. 15, 2007. The adoption of EITF No. 06-11 did nothave a material impact on SPS’ financial statements.

 

**3. Selected Balance Sheet Data**

** **
| **(Thousands of Dollars)** | ** ** | **June 30, 2008** | ** ** | **Dec. 31, 2007** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Accounts receivable, net:            |       |                        |       |                        |       |
| Accounts receivable                  |       | $                           | 95,854     |                        | $          | 70,420 |   |
| Less allowance for bad debts         |       | (3,376                      | )          | (3,166                      | )          |
|                                 |       | $                           | 92,478     |                        | $          | 67,254 |   |
|                                 |       |                        |       |                        |       |
| Inventories:                         |       |                        |       |                        |       |
| Materials and supplies               |       | $                           | 17,547     |                        | $          | 14,039 |   |
| Fuel                                 |       | 4,880                       |       | 3,304                       |       |
|                                 |       | $                           | 22,427     |                        | $          | 17,343 |   |
|                                 |       |                        |       |                        |       |
| Property, plant and equipment, net:  |       |                        |       |                        |       |
| Electric utility plant               |       | $                           | 3,528,242  |                        | $          | 3,476,146 |   |
| Construction work in progress        |       | 86,693                      |       | 78,436                      |       |
| Total property, plant and equipment  |       | 3,614,935                   |       | 3,554,582                   |       |
| Less accumulated depreciation        |       | (1,542,224                  | )          | (1,511,156                  | )          |
|                                 |       | $                           | 2,072,711  |                        | $          | 2,043,426 |   |

 

**4. Income Taxes**

** **

***Accounting for Uncertainty in Income Taxes —an interpretation of FASB Statement No. 109 (FIN 48)***— SPS is a member of the Xcel Energy affiliated group that files consolidatedincome tax returns. In the first quarter of 2008, the Internal Revenue Service(IRS) completed an examination of Xcel Energy’s federal income tax returns for2004 and 2005 (and research credits for 2003). The IRS did not propose anymaterial adjustments for those tax years. Tax year 2004 is the earliest openyear and the statute of limitations applicable to Xcel Energy’s 2004 federalincome tax return remains open until Dec. 31, 2009. Xcel Energy expectsthe IRS to commence their examination of tax years 2006 and 2007 in the thirdquarter of 2008.

 

7

----

Tableof Contents

 

In the firstquarter of 2008, the state of Texas concluded an income tax audit through taxyear 2005.  No material adjustments wereproposed for this audit. As of June 30, 2008, SPS’ earliest open tax yearin which an audit can be initiated by state taxing authorities under applicablestatutes of limitations is 2004. There currently are no state income tax auditsin progress.

 

The amount ofunrecognized tax benefits was $2.3 million and $2.6 million on Dec. 31, 2007 and June 30, 2008, respectively.These unrecognized tax benefit amounts were reduced by the tax benefitsassociated with tax credit carryovers of $0.1 million as of Dec. 31, 2007and June 30, 2008.

 

Theunrecognized tax benefit balance included $0.3 million and $0.3 million of taxpositions on Dec. 31, 2007 and June 30, 2008, respectively, which ifrecognized would affect the annual effective tax rate. In addition, theunrecognized tax benefit balance included $2.0 million and $2.3 million of taxpositions on Dec. 31, 2007 and June 30, 2008, respectively, for whichthe ultimate deductibility is highly certain but for which there is uncertaintyabout the timing of such deductibility. A change in the period of deductibilitywould not affect the effective tax rate but would accelerate the payment ofcash to the taxing authority to an earlier period.

 

The increasein the unrecognized tax benefit balance of $0.1 million from April 1, 2008to June 30, 2008, was due to the addition of similar uncertain taxpositions related to ongoing activity. SPS’ amount of unrecognized tax benefitscould significantly change in the next 12 months when the IRS and state auditsresume. However, at this time, it is not reasonably possible to estimate anoverall range of possible change.

 

The liabilityfor interest related to unrecognized tax benefits is partially offset by the interestbenefit associated with tax credit carryovers. The liability for interestrelated to unrecognized tax benefits on Dec. 31, 2007, was notmaterial.  The change in the interestliability from Dec. 31, 2007, to June 30, 2008, was notmaterial.  No amounts were accrued forpenalties as of June 30, 2008.

 

**5.****     Rate Matters**

 

Except to the extent noted below, the circumstancesset forth in Note 11 to the financial statements included in SPS’ Annual Reporton Form 10-K for the year ended Dec. 31, 2007 appropriatelyrepresent, in all material respects, the current status of other rate matters,and are incorporated herein by reference. The following include unresolvedproceedings that are material to SPS’ financial position.

 

***Pending and Recently Concluded RegulatoryProceedings — Public Utility Commission of Texas (PUCT)***

*** ***

**Base Rate**

 

***Texas Retail BaseRate Case —***OnJune 12, 2008, SPS filed with the PUCT, and the 80 cities in SPS’ Texasservice territory with original rate jurisdiction, a request for a Texas systemretail electric general rate increase.

 

Thefiling requests an overall increase in annual revenues of approximately $61.3million, or an increase of 5.9 percent.  Base revenues are proposed toincrease by $94.4 million, while fuel and purchased power revenue will declineby $33.1 million, primarily due to the fuel savings from SPS’ power purchasesfrom the Hobbs generating facility, which is owned by Lea Power Partners, LLC(LPP).  The LPP project which hadbeen expected to come on line in the summer of 2008.  Hobbs is a natural gas combined cycle604-megawatt (MW) plant currently being constructed in New Mexico. The LPPproject had been expected to come on line in the summer of 2008.

 

Therate filing is based on a 2007 calendar year test year adjusted for known andmeasurable changes and includes a requested rate of ROE of 11.25 percent, netrate base of approximately $989.4 million allocated to the Texas retailjurisdiction, and an equity ratio of 51.0 percent.

 

InSPS’ last Texas rate case, the parties agreed that SPS seek, in this ratefiling, interim rate relief of $18 million per year for the LPP purchaseagreement.  The interim rates areproposed to go into effect when the LPP plant comes on line.  The deadline for the PUCT to act on SPS’request is March 31, 2009.

 

Thefiling with the PUCT also includes a request to reconcile (i.e. seek finalapproval for) $1.0 billion of SPS’ fuel and purchased power costs for calendaryears 2006 and 2007.

 

8

----

Tableof Contents

 

Thefollowing procedural schedule has been established:

 

·                  Intervenor direct testimony will be filed on Oct. 13,2008;

·                  PUCT staff testimony will be filed on Oct. 21,2008;

·                  PUCTstaff and intervenors cross-rebuttal testimony will be filed on Oct. 28,2008;

·                  SPSrebuttal testimony will be filed on Nov. 4, 2008;

·                  Thehearing on the merits will begin on Nov. 12, 2008; and

·                  Finalorder by March 31, 2009.

 

**Electricand Resource Adjustment Clauses**

** **

***Transmission CostRecovery (TCR) Factor Rulemaking —***In November 2007,the PUCT adopted new rules relating to TCR factor outside of a base ratecase. The rule establishes the mechanism by which SPS can request annualrecovery of its reasonable and necessary expenditures for transmissioninfrastructure improvement costs and changes in wholesale transmission chargesthat are not included in existing rates. This new rule allows SPS moretimely recovery of transmission cost increases in-between base rate cases.

 

***Pending and RecentlyConcluded Regulatory Proceedings — New Mexico Public Regulation Commission(NMPRC)***

*** ***

**BaseRate**

** **

***New Mexico ElectricRate Case —***In July 2007, SPS filed with theNMPRC requesting a New Mexico retail electric general rate increase of$17.3 million annually, or 6.6 percent.  The rate filing is based on a 2006 test yearadjusted for known and measurable changes and includes a requested ROE of11.0 percent, an electric rate base of approximately $307.3 millionand an equity ratio of 51.2 percent. In addition to the base rate costsdescribed above, SPS sought to implement a rate rider to recover costs for theLPP project, which had been expected to come on line on June 1, 2008.

 

In March 2008, SPS filed rebuttal testimony reducing the rateincrease request to $16.6 million, based on a 10.7 percent ROE.

 

In April 2008, hearings on SPS’ application were held, in whichthe parties agreed to move consideration of the LPP power purchaseagreement costs to a future rate proceeding to be initiated by SPS thisfall.  SPS is expected to start takingenergy beginning in late summer of 2008 when LPP reaches commercial operations.

 

On July 3, 2008, the hearing examiner recommended a $12.6 millionelectric rate increase, including a 10.14 percent ROE on a rate base ofapproximately $300.9 million.  Inaddition, the hearing examiner recommended the exclusion of approximately $3.5million of historical demand-side management costs from the New Mexico retailrate base and a reduction in certain test year expenses for preparing the ratecase, for power plant outage, maintenance work and for annual incentivecompensation.  The parties’ exceptions tothe recommendation were filed on July 16, 2008 and the responses toexceptions were filed on July 24, 2008. The deadline for the NMPRC to issue its order is Aug. 29, 2008.

 

**Electric and Resource Adjustment Clauses**

 

***New Mexico FuelFactor Continuation Filing —***In August 2005,SPS filed with the NMPRC requesting continuation of the use of SPS’ fuel andpurchased power cost adjustment clause (FPPCAC) and current monthly factor costrecovery methodology. This filing was required by NMPRC rule.

 

Testimony was filed in the case by staff and intervenors objecting toSPS’ assignment of system average fuel costs to certain wholesale sales and theinclusion of certain purchased power capacity and energy payments in theFPPCAC. The testimony also proposed limits on SPS’ future use of the FPPCAC.Related to these issues, some intervenors requested disallowances for pastperiods, which in the aggregate total approximately $45 million. Thisclaim was for the period from Oct. 1, 2001 through May 31, 2005 anddoes not include the value of incremental cost assigned for wholesaletransactions from that date forward. Other issues in the case include thetreatment of renewable energy certificates and sulfur dioxide (SO2)allowancecredit proceeds in relation to SPS’ New Mexico retail fuel and purchased powerrecovery clause.

 

InDecember 2007, SPS, the NMPRC, Occidental Permian Ltd. and the NewMexico Industrial Energy Consumers filed an uncontested settlement of thismatter with the NMPRC.

 

9

----

Table of Contents

 

·        The settlement resolves all issues in the fuelcontinuation proceeding for total consideration of $15 million, whichincludes customer refunds of $11.7 million.

·        At Dec. 31, 2007, a reserve had beenpreviously established for this potential exposure, with no further expenseaccrual required, assuming this settlement is approved.

·        The settlement would also provide forsignificantly greater certainty surrounding system average fuel cost assignmenton a going forward basis and reduce percentages of system average costwholesale sales between now and 2019 on a stepped down basis.

·        Under the terms of the settlement, SPSanticipates additional fuel cost disallowances in 2008 and a portion of 2009 ofapproximately $2 million per year. It does not anticipate any futuredisallowances beyond this period.

·        Finally, the settlement provides for SPS tocontinue its use of the FPPCAC subject to additional reporting provisions.

 

A hearing on the merits of the settlement washeld in April 2008.  On June 3,2008, the hearing examiner certified the unanimous stipulation to theNMPRC.  The unanimous stipulation ispending final review and approval by the NMPRC. The NMPRC has scheduled a hearing for Aug. 14, 2008 to enable thecommissioners to directly question the witnesses who supported the unanimousstipulation.

 

***Investigation of SPSParticipation in Southwest Power Pool, Inc. (SPP)**—***In October 2007, theNMPRC issued an order initiating an investigation to consider the prudence andreasonableness of SPS’ participation in the SPP Regional TransmissionOrganization (RTO). The investigation will consider the costs and benefits ofRTO participation to SPS customers in New Mexico. The order required SPS tofile direct testimony no later than 75 days after the completion of thehearing in the New Mexico electric rate case. SPS has been granted an extension and filed its direct testimony on July 31,2008 with the NMPRC.

 

***Pending and RecentlyConcluded Regulatory Proceedings — Federal Energy Regulatory Commission (FERC)***

*** ***

***Wholesale RateComplaints —***In November 2004, Golden SpreadElectric, Lyntegar Electric, Farmer’s Electric, Lea County Electric, CentralValley Electric and Roosevelt County Electric, all wholesale cooperativecustomers of SPS, filed a rate complaint with the FERC alleging that SPS’ ratesfor wholesale service were excessive and that SPS had incorrectly calculatedmonthly fuel cost adjustment charges to such customers (the Complaint). Amongother things, the complainants asserted that SPS had inappropriately allocatedaverage fuel and purchased power costs to other wholesale customers,effectively raising the fuel cost charges to complainants. Cap Rock EnergyCorporation (Cap Rock), another full-requirements customer of SPS, PublicService Company of New Mexico (PNM) and Occidental Permian Ltd. andOccidental Power Marketing, L.P. (Occidental), SPS’ largest retailcustomer, intervened in the proceeding.

 

In May 2006, a FERC administrative law judge (ALJ) issued aninitial decision in the proceeding. The ALJ found that SPS should recalculateits wholesale fuel and purchased economic energy cost adjustment clause (FCAC)billings for the period beginning Jan. 1, 1999, to reduce the fuel andpurchased power costs recovered from the complaining customers by deductingfrom such costs the incremental fuel costs attributed to SPS’ sales of systemfirm capacity and associated energy to other wholesale customers served undermarket-based rates during this period based on the view that such sales shouldbe treated as opportunity sales made out of temporarily excess capacity. Inaddition, the ALJ made recommendations on a number of base rate issuesincluding a 9.64 percent ROE and the use of a 3-month coincident peak (3CP) demand allocator.

 

***Golden SpreadComplaint Settlement***  ***—***In December 2007, SPS reached asettlement with Golden Spread (which now includes Lyntegar Electric) andOccidental regarding base rate and fuel issues raised in the complaintdescribed above as well as a subsequent rate proceeding. In December 2007,this comprehensive offer of settlement (the Settlement) was filed with theFERC. On April 21, 2008, the FERC approved the Settlement with a minormodification to the formula rate proposed by the FERC and accepted by theparties.  The Settlement provides for:

 

·              A $1.25 millionpayment by SPS to Golden Spread related to resolve a dispute concerning thequantities Golden Spread was entitled to take under its existing partialrequirements agreement for the years 2006 and 2007. The Settlement caps thosequantities for the period 2008 through 2011. SPS is not required to make anyfuel refunds to Golden Spread that were the subject of the Complaint under theterms of the Settlement.

 

·              An extended partialrequirements contract at system average cost, with a capacity amount that rampsdown over the period 2012 through 2019 from 500 MW to 200 MW. The extendedagreement requires that the cost assignment treatment receive Texas and New Mexicostate approvals and provides for alternative pricing terms and quantities tohold SPS harmless from cost disallowances in the event that adverse regulatorytreatment occurs or state approvals are not obtained. Golden Spread agreed tohold SPS harmless from any future adverse regulatory treatment regarding the 

 

10

----

Tableof Contents

 

proposed sale and SPS agreed to contingentpayments ranging from $3 million to a maximum of $12 million, payablein 2012, in the event that there is an adverse cost assignment decision or afailure to obtain state approvals.

 

·              Resolution of baserates in the Complaint without any adjustment to the existing rates for theperiod January 2005 through June 30, 2006. The Settlement alsoresolves all base rate issues in SPS’ subsequent proceeding related to theperiod July 1, 2006 through June 30, 2008, other than the method tobe used to allocate demand related costs and provided for two sets of agreed onrates that are dependent on the ultimate resolution of that issue. If SPSprevails in its support of the 12-month coincident peak (12 CP) demandallocation method, there would be no impact to earnings for this period. IfGolden Spread prevails, SPS would be required to refund Golden Spread and PNMapproximately $4 million for the period through the end of 2007.

 

·              For July 1,2008 and beyond, Golden Spread will be under a formula rate for power supplyservice. The rate will be based on actual data the most recent historic yearadjusted for known and measurable changes and trued up to the actualperformance in the subsequent calendar year. Initially, the formula will bebased on a 10.25 percent ROE and either party will have a right to seekchanges to the ROE beginning with the 2009 formula rate filing. SPS and GoldenSpread will share margins from its sales to West Texas Municipal Power Agencyand El Paso Electric in that year but will assign system average fuel andenergy costs to those agreements for purposes of calculating Golden Spread’smonthly fuel cost.

 

***Order on WholesaleRate Complaints******—***On April 21, 2008, the FERCissued its Order on the Complaint (the Order) applied to the remainingnon-settling parties.  The Orderaddresses base rate issues for the period from Jan. 1, 2005 through June 30,2006 for SPS’ full requirements customers who pay traditional cost-based ratesand requires certain refunds.

 

**Base Rates**:  The FERC determined: (1) the ROE shouldbe 9.33 percent; (2) rates should be based on a 12 CP allocator; and (3) thetreatment of market based rate contracts in the test year should be to creditrevenues to the cost of service rather than allocating costs to the agreements.The revenue requirement established by the FERC results in proposed revenuesthat are estimated to be approximately $25 million, or approximately $6.9million below the level charged these customers during this 18-month period.Rates for full requirements customers, the New Mexico Cooperatives and CapRock, as well as an interruptible contract with PNM for the period beginning inJuly 1, 2006, are the subject of settlements that have either beenapproved or are pending before FERC. These settlements are described in Wholesale 2005 Power Base RateApplication below.

 

**Fuel Clause**:  The FERC determined that the method forcalculating fuel and purchased energy cost charges to the complaining customeris to deduct from such costs incremental fuel and purchased energy costs, whichit is attributing to SPS’ market based intersystem sales on the basis thatthese are “opportunity” sales under its precedent.  The FERC ordered that refunds of fuel costcharges based on this method of determining the FCAC should begin as of Jan. 1,2005 (the refund effective date in the case). The FERC ordered SPS to file a compliance filing calculating its refundobligation within 30 days of the date of the Order and implement theinstructions in the order in calculating its FCAC charges going forward from thatdate.  While the order is subject tointerpretation with respect to aspects of the calculation of the refundobligation, SPS does not expect its refund obligation to its full requirementscustomers from Jan. 1, 2005 through March 31, 2008, to exceed $11million. PNM has filed a separate complaint that any refund obligation to PNMwill be determined in that docket.  SPSis reviewing the Order and has not yet determined whether to seek rehearing.

 

The FERC also ruled on two other FCAissues.  First, it required that windcontracts be evaluated on an individual contract basis rather than inaggregate.  Second, the FERC determinedthat an after the fact screen should be applied to all Qualifying Facility (QF)purchases to determine if they are economic. While this review will require additional effort, it is not expectedthat this will result in additional refunds as all of the individual windcontracts as well as the QF purchases are typically economic when compared tomarket energy prices.

 

As of June 30, 2008, SPS has accrued an amount sufficient to coverthe estimated refund obligation. On July 21, 2008, SPS submitted itcompliance report to the FERC.  In thereport, SPS has calculated the base rate refund for the 18-month period to beequal to $6.1 million and the fuel refund to be equal to $4.4 million.  Once the final refund amounts are approved bythe FERC, interest will be added to the refund due the full requirementscustomers.

 

***Wholesale 2005 PowerBase Rate Application —***In December 2005, SPSfiled for a $2.5 million increase in wholesale power rates to certainelectric cooperatives. In January 2006, the FERC conditionally acceptedthe proposed rates for filing and the $2.5 million power rate increasebecame effective on July 1, 2006, subject to refund. The FERC also set therate increase request for hearing and settlement judge procedures. In September 2006,offers of settlement with respect to the five 

 

11

----

Tableof Contents

 

full-requirements customers and with respect to PNM were filed forapproval. In September 2007, the FERC accepted the settlement with thefull-requirements customers. The PNM settlement is still pending before theFERC.

 

As noted, the Power Base Rate Application relating to Golden Spread wassettled in conjunction with the Complaint Settlement discussed above.Therefore, SPS has settled with all parties in the Wholesale 2005 Power BaseRate Application, except for resolution with Golden Spread of the demand costallocation methodology.  SPS and thefull-requirements customers have requested that the demand allocation issue besummarily ruled on in SPS’ favor.  Thejudge has suspended the procedural schedule, pending a ruling on the motion forsummary judgment.

 

***SPS FormulaTransmission Rate Case —***In December 2007,Xcel Energy submitted an application to implement a transmission formula ratefor the SPS zone of the Xcel Energy Open Access Transmission Tariff (OATT). Thechanged rates will affect all wholesale transmission service customers usingthe SPS transmission network under either the SPP Regional OATT or the XcelEnergy OATT.

 

The proposed rates would be updated annually each July 1 basedon SPS’ prior year actual costs and loads plus the revenue requirementsassociated with projected current year transmission plant additions. Theproposed ROE is 12.7 percent, including a 50 basis point adder for SPS’participation in the SPP RTO. The proposed rates would provide first yearincremental annual transmission revenue for SPS of approximately$5.5 million.

 

In February 2008, the FERC accepted the proposed rates, suspendingthe effective date to July 6, 2008, and setting the rate filing forhearings and settlement procedures. The FERC granted a 50 basis point adder tothe ROE that it will determine in this proceeding as a result of SPS’participation in the SPP RTO. The SPS and SPP rate filings are now insettlement procedures.  The ultimateoutcome of the rate filings is not known at this time.

 

***SPS 2008 Wholesale Rate Case —***OnMarch 31, 2008, SPS filed a wholesale rate case seeking an annual revenueincrease of $14.9 million or an overall 5.14 percent increase, based on 12.20 percent requested ROE. OnApril 21, 2008, a motion for dismissal and protest was filed by the foureastern New Mexico cooperatives.

 

In SPS’ answerto the motions to intervene and protest, SPS renewed its request for a nominalsuspension of 60 days and asked the FERC to consider such a nominal suspensionin exchange for SPS’ acceptance of two conditions.  The first condition was that SPS would agreeto a ROE of no more than 10.25 percent and second, SPS would agree to use a 12CP demand allocator for the period the rates will be in effect.  The SPS answer results in an annual revenueincrease of $9.9 million or an overall 3.4 percent increase.

 

In May 2008,the FERC accepted the answer and ordered a nominal suspension for rates to goin to effect as of the date of commercial service of the LPP plant.  The LPP plant is expected to be in commercialoperation in late summer of 2008.

 

**6. Commitments andContingencies**

** **

Except to the extentnoted below, the circumstances set forth in Notes 11 and 12 to the financialstatements in SPS’ Annual Report on Form 10-K for the year ended Dec. 31,2007 and Note 5 to the financial statements in this Quarterly Report on Form 10-Q,appropriately represent, in all material respects, the current status ofcommitments and contingent liabilities and are incorporated herein byreference. The following include unresolved contingencies that are material toSPS’ financial position.

 

## **EnvironmentalContingencies**

## ** **

SPS has been,or is currently, involved with the cleanup of contamination from certainhazardous substances at several sites. In many situations, SPS believes it willrecover some portion of these costs through insurance claims.  Additionally, where applicable, SPS ispursuing, or intends to pursue, recovery from other potentially responsibleparties (PRP) and through the rate regulatory process.  New and changing federal and stateenvironmental mandates can also create added financial liabilities for SPS,which are normally recovered through the rate regulatory process.  To the extent any costs are not recoveredthrough the options listed above, SPS would be required to recognize anexpense.

 

***Site Remediation****—*SPSmust pay all or a portion of the cost to remediate sites where past activitiesof SPS or other parties have caused environmental contamination.  At June 30, 2008, SPS was a party tothird party and other sites, such as landfills, to which SPS is alleged to be aPRP that sent hazardous materials and wastes. At June 30, 2008, the liability for the cost of remediating thesesites was estimated to be $0.1 million.

 

12

----

Tableof Contents

* *

***Third Party and Other Environmental SiteRemediation***

 

***Asbestos Removal*****—**Someof SPS’ facilities contain asbestos. Most asbestos will remain undisturbed until the facilities that containit are demolished or renovated.  SPS hasrecorded an estimate for final removal of the asbestos as an asset retirementobligation.  See additional discussion ofasset retirement obligations in Note 12 of the SPS Annual Report on Form 10-Kfor the year ended Dec. 31, 2007.  It may be necessary to remove some asbestosto perform maintenance or make improvements to other equipment.  The cost of removing asbestos as part ofother work is immaterial and is recorded as incurred as operating expenses formaintenance projects, capital expenditures for construction projects or removalcosts for demolition projects.

 

## ***Other Environmental Requirements***

## ** **

***Clean Air Interstate Rule ***—******In March 2005,the Environmental Protection Agency (EPA) issued the Clean Air Interstate Rule (CAIR)to further regulate SO2 and nitrogen oxide (NOx) emissions.  The objective of CAIR is to cap emissions ofSO2 and NOx in the eastern United States, including Texas.  CAIR addresses the transportation of fineparticulates, ozone and emission precursors to nonattainment downwindstates.  CAIR has a two-phase complianceschedule, beginning in 2009 for NOx and 2010 for SO2 with a finalcompliance deadline in 2015 for both emissions. Under CAIR, each affected state will be allocated an emissions budgetfor SO2 and NOx that will result in significant emission reductions.It will be based on stringent emission controls and forms the basis for acap-and-trade program.  State emissionbudgets or caps decline over time. States can choose to implement an emissions reduction program based onthe EPA’s proposed model program, or they can propose another method, which theEPA would need to approve.

 

InJuly 2005, SPS, the City of Amarillo, Texas and Occidental Permian LTDfiled a lawsuit against the EPA and a request for reconsideration with theagency to exclude West Texas from CAIR. El Paso Electric Co. joined in the request for reconsideration.  Xcel Energy and SPS advocated that West Texasshould be excluded from CAIR because it does not contribute significantly tononattainment with the fine particulate matter standards in any downwindjurisdiction.

 

InMarch 2006, the EPA denied the petition for reconsideration.  In June 2006, Xcel Energy and the otherparties filed a petition for review of the denial of the petition forreconsideration, as well as a petition for review of the Federal ImplementationPlan, with the D.C. Circuit Court of Appeals.  On July 11, 2008, the court issued an opinion upholding the EPA’sdecision to include West Texas in the CAIR region, but vacating CAIR in itsentirety on several other grounds and remanding the rule to EPA.   SPS is currently analyzing the opinion andits implications, and will update the following discussion of CAIR pendingfurther review.

 

UnderCAIR’s cap-and-trade structure, SPS can comply through capital investments inemission controls or purchase of emission “allowances” from other utilitiesmaking reductions on their systems.  Theremaining capital investments for NOx controls in the SPS region are estimatedat $12 million.  Annual purchases of SO2allowances are estimated in the range of $5 million to $25 million each year,beginning in 2012 for phase I, based on allowance costs and fuel quality as of March 2007.

 

SPSbelieves the cost of any required capital investment or allowance purchaseswill be recoverable from customers in rates. SPS will continue to review these cost projections in light of the court’sopinion vacating CAIR.

 

***Clean Air Mercury Rule ***—In March 2005, the EPA issued the Clean Air Mercury Rule (CAMR),which regulated mercury emissions from power plants. The Texas Commission of Environmental Quality(TCEQ) has adopted by reference the EPA model program.  In February 2008, the D.C. Circuit Courtof Appeals vacated CAMR, which impacts federal CAMR requirements but notnecessarily state-only rules.   Given the many uncertainties createdby the court’s opinion, it is not possible at this time to provide an accuratesummary of applicable federal mercury requirements or cost estimates.

 

***Regional Haze Rules ***—In June 2005, the EPA finalized amendments to the July 1999 regionalhaze rules. These amendments apply to the provisions of the regional haze rule thatrequire emission controls, known as best available retrofit technology (BART),for industrial facilities emitting air pollutants that reduce visibility bycausing or contributing to regional haze. Some of SPS’ generating facilities will be subject to BARTrequirements.  Some of these facilitiesare located in regions where CAIR is effective. The TCEQ has determined thatfacilities may use CAIR as a substitute for BART for NOx and SO2.  The TCEQ is currently reviewing thisdetermination in light of the D.C. Circuit Court of Appeals’ decision vacatingCAIR.

 

***Maddox StationGroundwater******  —*** The New Mexico EnvironmentDepartment (NMED) is requiring wastewater activity at Maddox Station to bepermitted. SPS is engineering wastewater management facilities and submittedthe permit application in July 2008. The estimated cost of the project is$1.8 million with an anticipated completion date in the third quarter of 2009.

 

13

----

Tableof Contents

 

**LegalContingencies**

** **

Lawsuits and claims arise in the normal course of business. Management,after consultation with legal counsel, has recorded an estimate of the probablecost of settlement or other disposition of them. The ultimate outcome of thesematters cannot presently be determined. Accordingly, the ultimate resolution ofthese matters could have a material adverse effect on SPS’ financial positionand results of operations.

 

**Environmental Litigation**

** **

***Carbon Dioxide EmissionsLawsuit******—***In July 2004,the attorneys general of eight states and New York City, as well as severalenvironmental groups, filed lawsuits in U.S. District Court in the SouthernDistrict of New York against five utilities, including Xcel Energy, the parent company of SPS, to force reductions in carbon dioxide (CO2)emissions.  The other utilities includeAmerican Electric Power Co., Southern Co., Cinergy Corp. and Tennessee ValleyAuthority.  The lawsuits allege that CO2 emitted byeach company is a public nuisance as defined under state and federal common lawbecause it has contributed to global warming. The lawsuits do not demand monetary damages. Instead, the lawsuits askthe court to order each utility to cap and reduce its CO2emissions.  In October 2004, XcelEnergy and the other defendants filed a motion to dismiss the lawsuit.  On Sept. 19, 2005, the court granted themotion to dismiss on constitutional grounds. Plaintiffs filed an appeal to the Second Circuit Court of Appeals.  In June 2007, the Second Circuit Courtof Appeals issued an order requesting the parties to file a letter briefregarding the impact of the United States Supreme Court’s decision inMassachusetts v. EPA, 127 S.Ct. 1438 (April 2, 2007) on the issues raisedby the parties on appeal.  Among otherthings, in its decision in Massachusetts v. EPA, the United States SupremeCourt held that CO2 emissionsare a “pollutant” subject to regulation by the EPA under the Clean AirAct.  In response to the request of theSecond Circuit Court of Appeals, in June 2007, the defendant utilitiesfiled a letter brief stating the position that the United States Supreme Court’sdecision supports the arguments raised by the utilities on appeal.  The Court of Appeals has taken the matterunder advisement ***and isexpected to issue an opinion in due course.***

 

## ***Comer vs.Xcel Energy Inc. et al.******—*****In April 2006,Xcel Energy received notice of a purported class action lawsuit filed in U.S.District Court in the Southern District of Mississippi.  The lawsuit names more than 45 oil, chemicaland utility companies, including Xcel Energy, the parent company of SPS,as defendants and alleges that defendants’ CO2 emissions “were a proximate and direct cause of theincrease in the destructive capacity of Hurricane Katrina.”  Plaintiffs allege in support of their claim,several legal theories, including negligence and public and private nuisanceand seek damages related to the loss resulting from the hurricane.  Xcel Energy believes this lawsuit is withoutmerit and intends to vigorously defend itself against these claims.  In August 2007, the court dismissed thelawsuit in its entirety against all defendants on constitutional grounds.  In September 2007, plaintiffs filed anotice of appeal to the Fifth Circuit Court of Appeals. ***  ***Oral arguments will be presented to the Court of Appeals on Aug. 6,2008. It is uncertain when the Court will reach a decision.

## ** **

## ***NativeVillage of Kivalina vs. Xcel Energy Inc. et al. —*** In February 2008,the City and Native Village of Kivalina, Alaska, filed a lawsuit in U.S. District Court for the Northern District ofCaliforniaagainst Xcel Energy, the parent company of SPS, and23 other oil, gas and coal companies. The suit was brought on behalf of approximately 400 native Alaskans, theInupiat Eskimo, who claim that Defendants’ emission of CO2 and othergreenhouse gases contribute to global warming, which is harming theirvillage.  Plaintiffs claim that as aconsequence, the entire village must be relocated at a cost of between $95million and $400 million.  Plaintiffsassert a nuisance claim under federal and state common law, as well as a claimasserting “concert of action” in which defendants are alleged to have engagedin tortious acts in concert with each other. XcelEnergy was not named in the civil conspiracy claim.  Xcel Energy believes the claims asserted inthis lawsuit are without merit and joined with other utility defendants infiling a motion to dismiss on June 30, 2008.

## ** **

**Employment, Tort and Commercial Litigation**

 

***LambCounty Electric Cooperative (LCEC) —***In 1995, LCECpetitioned the PUCT for a cease and desist order against SPS alleging SPS wasunlawfully providing service to oil field customers in LCEC’s certificatedarea.  In May 2003, the PUCT issuedan order denying LCEC’s petition based on its determination that SPS in 1976was granted a certificate to serve the disputed customers.  LCEC appealed the decision to the DistrictCourt in Travis County, Texas.  In August 2004,the court affirmed the decision of the PUCT. In September 2004, LCEC appealed the District Court’s decision tothe Court of Appeals for the Third Supreme Judicial District of the state ofTexas.  This appeal is currently pending.

 

14

----

Table of Contents

 

In 1996, LCEC filed asuit for damages against SPS in the District Court in Lamb County, Texas, basedon the same facts alleged in the petition for a cease and desist order at thePUCT.  This suit has been dormant sinceit was filed, awaiting a final determination of the legality of SPS providingelectric service to the disputed customers. The PUCT order from May 2003, which found SPS was legally servingthe disputed customers, collaterally determines the issue of liability contraryto LCEC’s position in the suit.  Anadverse ruling on the appeal of May 2003 PUCT order could result in adifferent determination of the legality of SPS’ service to the disputedcustomers.

 

**7.   Short-Term Borrowings and Other FinancingInstruments**

 

***Commercial Paper —***AtJune 30, 2008 and Dec. 31, 2007, SPS had commercial paper outstandingof  $199.0 million and $123.0 million,respectively.  The weighted averageinterest rates at June 30, 2008 and Dec. 31, 2007 were 2.97 percentand 5.58 percent, respectively.

 

***Money Pool*** — Xcel Energy has established a utility moneypool arrangement that allows for short-term loans between the utilitysubsidiaries and from the holding company to the utility subsidiaries atmarket-based interest rates. The utility money pool arrangement does not allowloans from the utility subsidiaries to the holding company. SPS has approval toborrow up to $100 million under the arrangement. At June 30, 2008 and Dec. 31,2007, SPS had money pool borrowings of $30.0 million and $5.5 million,respectively.  The weighted averageinterest rates at June 30, 2008 and Dec. 31, 2007 were 3.06 percentand 5.64 percent, respectively.

 

**8.****     DerivativeInstruments**

 

SPS uses derivative instruments in connection with its utilitycommodity price, interest rate, short-term wholesale and commodity tradingactivities, including forward contracts, futures, swaps and options.  Qualifying hedging relationships aredesignated as a hedge of a forecasted transaction or future cash flow (cashflow hedge).  The types of qualifyinghedging transactions that SPS is currently engaged in are discussed below.

 

**CashFlow Hedges**

 

***Commodity Cash FlowHedges******—***SPS enters into derivative instruments tomanage variability of future cash flows from changes in commodity prices.  These derivative instruments are designatedas cash flow hedges for accounting purposes. At June 30, 2008, SPS had no commodity-related contracts designatedas cash flow hedges.

 

***Interest Rate Cash Flow Hedges***— SPS enters into interest rate swap instruments that effectively fix theinterest payments on certain floating rate debt obligations.  These derivative instruments are designatedas cash flow hedges for accounting purposes.

 

At June 30, 2008, SPS had net losses of $0.2 million inaccumulated other comprehensive income that is expected to be recognized inearnings during the next 12 months.

 

The following tableshows the major components of the derivative instruments valuation in thebalance sheets at June 30 and Dec. 31:

*** ***
| ** **                           | ** ** | **June 30, 2008**                           | ** ** | **Dec. 31, 2007**                                | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(Thousands of Dollars)** | ** ** | **Derivative  Instruments  Valuation -  Assets** | ** ** | **Derivative  Instruments  Valuation -  Liabilities** | ** ** | **Derivative  Instruments  Valuation -  Assets** | ** ** | **Derivative  Instruments  Valuation -  Liabilities** | ** ** |
| Long term purchased power agreements |       | $                                                     | 89,939     |                                                       | $          | 57,625 |   | $ | 94,403 |   | $ | 59,419 |   |
| Interest rate hedging instruments    |       | —                                                |       | 5,952                                                      |       | — |   | 5,967 |   |
| Total                                |       | $                                                     | 89,939     |                                                       | $          | 63,577 |   | $ | 94,403 |   | $ | 65,386 |   |

 

In 2003, as a result of FASBStatement 133 Implementation Issue No. C20, SPS began recording several long-termpurchased power agreements at fair value due to accounting requirements relatedto underlying price adjustments. As these purchases are recovered throughnormal regulatory recovery mechanisms in the respective jurisdictions, thechanges in fair value for these contracts were offset by regulatory assets andliabilities. During the first quarter of 2006, SPS qualified these contractsunder the normal purchase exception. Based on this qualification, the contractsare no longer adjusted to fair value and the previous carrying value of thesecontracts will be amortized over the remaining contract lives along with theoffsetting regulatory assets and liabilities.

 

15

----

Tableof Contents

 

The impact ofqualifying cash flow hedges on SPS’ accumulated other comprehensive income,included as a component of common stockholders’ equity, is detailed in thefollowing table:

 
| ** **                                                                           | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| **(Thousands of Dollars)**                                                 | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| Accumulated other comprehensive loss  related to cash flow hedges at Jan. 1     |       | $                                                 | (6,005     | ) | $ | (5,860 | ) |
| After-tax net unrealized gains related to  derivatives accounted for as hedges       |       | 9                                                 |       | 507 |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 86                                                |       | 85 |   |
| Accumulated other comprehensive loss  related to cash flow hedges at June 30    |       | $                                                 | (5,910     | ) | $ | (5,268 | ) |

 

**9.Fair Value Measurements**

 

Effective Jan. 1,2008, SPS adopted SFAS No. 157 for recurring fair value measurements.  SFAS No. 157 provides a singledefinition of fair value and requires enhanced disclosures about assets andliabilities measured at fair value. SFAS No. 157 establishes a hierarchalframework for disclosing the observability of the inputs utilized in measuringassets and liabilities at fair value. The three levels defined by the SFAS No. 157hierarchy and examples of each level are as follows:

 

Level 1 – Quoted prices areavailable in active markets for identical assets or liabilities as of thereported date. The types of assets and liabilities included in Level 1 arehighly liquid and actively traded instruments with quoted prices.

 

Level 2 – Pricing inputs areother than quoted prices in active markets, but are either directly orindirectly observable as of the reported date. The types of assets and liabilities included in Level 2 are typicallyeither comparable to actively traded securities or contracts or priced withmodels using highly observable inputs.

 

Level 3 – Significant inputsto pricing have little or no observability as of the reporting date.  The types of assets and liabilities includedin Level 3 are those with inputs requiring significant management judgment orestimation.

 

SPS had oneinterest rate derivative contract measured at fair value on a recurring basisas of June 30, 2008.  SPS usesbroker quotes, based primarily on observable benchmark interest rate forecasts,to measure the fair value of interest rate derivatives.  Given the observability of the primary inputsto pricing, the interest rate derivative liability of $6.0 million at June 30,2008, was assigned a Level 2 under the SFAS No. 157 hierarchy.

 

**10.Detail of Interest and Other Income, Net**

 

Interest and other income, netof nonoperating expenses, for the three and six months ended June 30consisted of the following:

 
| ** **                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Thousands of dollars)** | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                           | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                      |       | $                                               | 1,207      |                                          | $          | 608 |   | $ | 2,033 |   | $ | 1,454 |   |
| Other nonoperating income            |       | 51                                              |       | 2                                             |       | 98 |   | 47 |   |
| Insurance policy income (expenses)   |       | 109                                             |       | (74                                           | )          | 99 |   | (135 | ) |
| Other nonoperating expense           |       | —                                          |       | (9                                            | )          | — |   | (36 | ) |
| Total interest and other income, net |       | $                                               | 1,367      |                                          | $          | 527 |   | $ | 2,230 |   | $ | 1,330 |   |

 

**11. Segment Information**

 

SPS has onereportable segment.  SPS operates in theregulated electric utility industry, providing wholesale and retail electricservice in the states of Texas and New Mexico. Revenues from external customers were $537.9 million and $401.1 millionfor the three months ended June 30, 2008 and 2007, respectively, and$956.7 million and $767.0 million for the six months ended June 30, 2008and 2007, respectively.

 

16

----

Tableof Contents

 

**12. Comprehensive Income**

 

The componentsof total comprehensive income are shown below:

 
| ** **                                                                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **(Millions of dollars)**                                                  | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                                           |       | $                                               | 3,970      |                                          | $          | 5,619 |   | $ | 2,705 |   | $ | 7,284 |   |
| Other comprehensive income:                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Unrealized gain – marketable securities                                         |       | —                                          |       | —                                        |       | — |   | 4 |   |
| After-tax net unrealized gains related to  derivatives accounted for as hedges       |       | 751                                             |       | 516                                           |       | 9 |   | 507 |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 43                                              |       | 43                                            |       | 86 |   | 85 |   |
| Other comprehensive income                                                           |       | 794                                             |       | 559                                           |       | 95 |   | 596 |   |
| Comprehensive income                                                                 |       | $                                               | 4,764      |                                          | $          | 6,178 |   | $ | 2,800 |   | $ | 7,880 |   |

** **

**13. Benefit Plans andOther Postretirement Benefits**

** **

Pension and otherpostretirement benefit disclosures below generally represent Xcel Energyconsolidated information unless specifically identified as being attributableto SPS.

 

**Componentsof Net Periodic Benefit Cost (Credit)**

 
| ** **                                                    | ** ** | **Three months ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008 (1)**                                   | ** ** | **2007 (1)** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **(Thousands of Dollars)**                          | ** ** | **Pension Benefits**                           | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                          | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                   | 14,929     |   | $ | 14,555 |   | $ | 1,211 |   | $ | 1,205 |   |
| Interest cost                                                 |       | 44,677                                              |       | 43,028 |   | 12,894 |   | 11,635 |   |
| Expected return on plan assets                                |       | (68,697                                             | )          | (66,525 | ) | (8,425 | ) | (7,582 | ) |
| Amortization of transition obligation                         |       | —                                              |       | — |   | 3,644 |   | 3,677 |   |
| Amortization of prior service cost (credit)                   |       | 5,166                                               |       | 6,487 |   | (544 | ) | (545 | ) |
| Amortization of net loss                                      |       | 3,511                                               |       | 4,555 |   | 3,031 |   | 2,106 |   |
| Net periodic benefit cost (credit)                            |       | (414                                                | )          | 2,100 |   | 11,811 |   | 10,496 |   |
| Credits not recognized due to the effects  of regulation      |       | 1,925                                               |       | 2,894 |   | — |   | — |   |
| Additional cost recognized due to the  effects of regulation  |       | —                                              |       | — |   | 973 |   | 973 |   |
| Net benefit cost recognized for financial  reporting          |       | $                                                   | 1,511      |   | $ | 4,994 |   | $ | 12,784 |   | $ | 11,469 |   |
| **SPS**                                                       |       |                                                |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for  financial reporting |       | $                                                   | (2,486     | ) | $ | (1,813 | ) | $ | 866 |   | $ | 1,571 |   |

 

----

(1)  Includes qualified andnon-qualified pension net periodic benefit cost.

 

17

----

Tableof Contents

 
| ** **                                                    | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008 (1)**                                 | ** ** | **2007 (1)** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **(Thousands of Dollars)**                          | ** ** | **Pension Benefits**                         | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                 | 31,702     |   | $ | 31,040 |   | $ | 2,675 |   | $ | 2,906 |   |
| Interest cost                                                 |       | 85,260                                            |       | 82,626 |   | 25,440 |   | 25,238 |   |
| Expected return on plan assets                                |       | (137,169                                          | )          | (132,416 | ) | (15,925 | ) | (15,200 | ) |
| Amortization of transition obligation                         |       | —                                            |       | — |   | 7,288 |   | 7,288 |   |
| Amortization of prior service cost (credit)                   |       | 10,332                                            |       | 12,974 |   | (1,088 | ) | (1,090 | ) |
| Amortization of net loss                                      |       | 6,370                                             |       | 8,422 |   | 5,749 |   | 7,100 |   |
| Net periodic benefit cost (credit)                            |       | (3,505                                            | )          | 2,646 |   | 24,139 |   | 26,242 |   |
| Credits not recognized due to the effects  of regulation      |       | 4,517                                             |       | 5,574 |   | — |   | — |   |
| Additional cost recognized due to the  effects of regulation  |       | —                                            |       | — |   | 1,946 |   | 1,946 |   |
| Net benefit cost recognized for financial  reporting          |       | $                                                 | 1,012      |   | $ | 8,220 |   | $ | 26,085 |   | $ | 28,188 |   |
| **SPS**                                                       |       |                                              |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for  financial reporting |       | $                                                 | (5,240     | ) | $ | (3,819 | ) | $ | 1,741 |   | $ | 3,119 |   |

 

----

(1)  Includes qualified andnon-qualified pension net periodic benefit cost.

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

Discussion offinancial condition and liquidity for SPS is omitted per conditions set forthin general instructions H (1) (a) and (b) of Form 10-Q forwholly owned subsidiaries. It is replaced with management’s narrative analysisand the results of operations set forth in general instructions H (2) (a) ofForm 10-Q for wholly owned subsidiaries (reduced disclosure format).

 

**Forward-LookingInformation**

 

The followingdiscussion and analysis by management focuses on those factors that had amaterial effect on the financial condition and results of operations of SPSduring the periods presented, or are expected to have a material impact in thefuture. It should be read in conjunction with the accompanying unauditedfinancial statements and notes.

 

Exceptfor the historical statements contained in this report, the matters discussedin the following discussion and analysis are forward-looking statements thatare subject to certain risks, uncertainties and assumptions. Suchforward-looking statements are intended to be identified in this document bythe words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “objective,”“outlook,” “plan,” “project,” “possible,” “potential,” “should” and similarexpressions. Actual results may vary materially. Forward-lookingstatements speak only as of the date they are made, and we do not undertake anyobligation to update them to reflect changes that occur after that date. Factors that could cause actual results todiffer materially include, but are not limited to: general economic conditions,including the availability of credit and its impact on capital expenditures andthe ability of SPS to obtain financing on favorable terms; business conditionsin the energy industry; actions of credit rating agencies; competitive factors,including the extent and timing of the entry of additional competition in themarkets served by SPS; unusual weather; effects of geopolitical events,including war and acts of terrorism; state, federal and foreign legislative andregulatory initiatives that affect cost and investment recovery, have an impacton rates or have an impact on asset operation or ownership or imposeenvironmental compliance conditions;structures that affect the speed and degree to which competition enters theelectric market; costs and other effects of legal and administrativeproceedings, settlements, investigations and claims; actions of accountingregulatory bodies; the items described under Factors Affecting Results ofContinuing Operations; and the other risk factors listed from time to time bySPS in reports filed with the SEC, including “Risk Factors” in Item 1A of SPS’ Form 10-Kfor the year ended Dec. 31, 2007 and Exhibit 99.01 to this report on Form 10-Qfor the quarter ended June 30, 2008.

 

18

----

Tableof Contents

 

**MarketRisks**

 

SPS is exposedto market risks, including changes in commodity prices and interest rates, asdisclosed in Item 7A — Quantitative and Qualitative Disclosures About MarketRisk in its Annual Report on Form 10-K for the year ended Dec. 31,2007. Commodity price and interest rate risks for SPS are mitigated in mostjurisdictions due to cost-based rate regulation. At June 30, 2008, therewere no material changes to the financial market risks that affect thequantitative and qualitative disclosures presented as of Dec. 31, 2007.

 

**RESULTSOF OPERATIONS**

 

SPS’ netincome was approximately $2.7 million for the first six months of 2008,compared with net income of approximately $7.3 million for the first six monthsof 2007.

 

The followingsummarizes the components of the changes in base electric revenues and baseelectric margin for the six months ended June 30:

 

***Base Electric Revenues***

 
| **(Millions of Dollars)**                              | ** ** | **2008 vs. 2007** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|
| Fuel and purchased power cost recovery                           |       | $                           | 174        |   |
| Retail sales growth (excluding weather  impact)                  |       | 10                          |       |
| Firm wholesale                                                   |       | 6                           |       |
| Estimated impact of weather                                      |       | 3                           |       |
| SPS potential regulatory settlements                             |       | 2                           |       |
| Increased revenues due to leap year  (weather-normalized impact) |       | 2                           |       |
| Sales mix                                                        |       | (8                          | )          |
| Other                                                            |       | 1                           |       |
| Total increase in base electric revenues                         |       | $                           | 190        |   |

 

##### ***Base ElectricMargin***

 
| **(Millions of Dollars)**                              | ** ** | **2008 vs. 2007** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|
| Retail sales growth (excluding weather  impact)                  |       | $                           | 10         |   |
| Firm wholesale                                                   |       | 6                           |       |
| Increased revenues due to leap year  (weather-normalized impact) |       | 2                           |       |
| Fuel handling and procurement                                    |       | (8                          | )          |
| Sales mix                                                        |       | (8                          | )          |
| Purchased capacity costs                                         |       | (3                          | )          |
| Estimated impact of weather                                      |       | 3                           |       |
| Total increase in base electric margin                           |       | $                           | 2          |   |

 

## **Non-Fuel Operating Expense and Other Costs**

## ** **

***Other Operating and Maintenance Expenses****—*Other operating and maintenance expenses forthe first six months of 2008 increased $5.8 million, or 5.8 percent, comparedto first six months of 2007.  Thefollowing summarizes the components of the changes for the six months ended June 30:

 
| **(Millions of Dollars)**                         | ** ** | **2008 vs. 2007** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|
| Lower employee benefit costs                                |       | $                           | (3         | ) |
| Higher labor costs                                          |       | 4                           |       |
| Higher contract labor costs                                 |       | 1                           |       |
| Higher fleet costs                                          |       | 1                           |       |
| Higher plant generation costs                               |       | 1                           |       |
| Other                                                       |       | 2                           |       |
| Total increase in other operating and  maintenance expenses |       | $                           | 6          |   |

 

***Income taxes***- Income tax expense decreased by approximately $2.4 million for thefirst six months of 2008 compared with the first six months of 2007. Theeffective tax rate was 43.9 percent for the first six months of 2008, comparedwith 38.2 percent for the same period in 2007. The decrease in income taxexpense and the increase in the effective tax rate were primarily due to adecrease in pretax income.

 

19

----

Tableof Contents

 

***Regulation***

** **

**Summary of Recent Regulatory Developments**

 

TheFERC has jurisdiction over rates for electric transmission service ininterstate commerce and electricity sold at wholesale, hydro facilitylicensing, natural gas transportation, accounting practices and certain otheractivities of SPS. State and local agencies have jurisdiction over many of SPS’activities, including regulation of retail rates and environmental matters. Seeadditional discussion in the summary of recent federal regulatory developmentsand public utility regulation sections of the SPS Annual Report on Form 10-Kfor the year ended Dec. 31, 2007.  In addition to the matters discussed below,see Note 5 to the financial statements for a discussion of other regulatorymatters.

 

***FERC Tie Line Investigation —***InOctober 2007, the FERC Office of Enforcement, Division of Investigations(DOI), commenced a non-public investigation of use of network transmissionservice across the Lamar Tie Line, a transmission facility that connects PSCo,an affiliate of SPS, and SPS.  XcelEnergy is fully cooperating with the DOI investigation.  In July 2008, the DOI issued apreliminary report alleging Xcel Energy violated FERC policies and rules andapproved tariffs.  The report representsthe preliminary conclusions of the DOI and is subject to additionalprocedures.  The report does notconstitute a finding by the FERC, which may, among other things, accept, modifyor reject any or all of the preliminary conclusions set forth in thereport.  Xcel Energy disagrees with thepreliminary report and will vigorously contest the allegations; SPS is not ableto predict the outcome of the investigation or what, if any, actions the FERCmay take.  As previously discussed under “Item1A – Risk Factors” in Xcel Energy’s 2007 Annual Report on Form 10-K, theEnergy Policy Act of 2005 has increased the FERC’s civil penalty authority forviolation of FERC statutes, rules and orders.  Given the preliminary nature of this matter,Xcel Energy is unable to determine if the resolution of this matter will have amaterial adverse impact on operations, cash flows or financial condition.

 

***Electric Reliability Standards Matters*—**In June 2008, PSCo was subject to anaudit of its compliance with North American Electric Reliability Council (NERC)and regional reliability standards by Western Electricity Coordinating Council(WECC), the NERC Regional Entity for the PSCo system.  In response to information identified induring the audit, Xcel Energy conducted a comprehensive review of the maintenancerecords for all relay devices on the SPS transmission system.  That review found SPS did not havedocumentation demonstrating that all relay devices on the SPS system had beenmaintained on the schedule in Xcel Energy’s adopted maintenance plan.  In June 2008, SPS filed a self-reportregarding the maintenance plan violations with the Southwest Power Pool (SPP),the NERC Regional Entity for the SPS system. Xcel Energy is uncertain if the self-report will result in financialpenalties being imposed on SPS.

 

**Other Regulatory Matters**

 

***Performance-BasedRegulation and Quality of Service Requirements *—**In Texas, SPS is subject to a quality of service plan requiring SPS to complywith electric service reliability performance targets. In January 2008, thePUCT staff served SPS with notice that it had initiated an investigation todetermine whether SPS is in compliance with the Texas Statutes and PUCT rules onreliability and continuity of service. If SPS is found not to be in compliance, the PUCT may initiate anenforcement action and impose administrative penalties up to $25,000 per day.SPS is currently awaiting any PUCT action.

 

***LPP Purchase PowerAgreement****—* TheLPP project is a natural gas combined cycle 604 MW plant under constructionnear Hobbs, New Mexico.  SPS has a purchase power agreement, which wasexecuted in 2006, that provides for SPS to have exclusive rights to dispatchthe facility.  SPS expects to begin taking energy from the plantbeginning late summer of 2008 when LPP reaches commercial operation.  SPShas alleged that certain defaults have been triggered under the power purchaseagreement, about which LPP and SPS are currently engaged indiscussions.  However, SPS still expects that LPP will commence fullcommercial operation later this summer.

 

***Texas Energy EfficiencyCost Recovery Factor Rider***— On June 2, 2008 SPSfiled with the PUCT for approval of an Energy Efficiency Cost Recovery Factor(EECRF) Rider. PUCT regulations established the mechanism under which electricutilities may recover costs associated with providing energy efficiencyprograms.  That mechanism, an EECRFRider, must be included in a utility’s tariff and may be established in autility’s base rate case or through a separate request seeking to establish anEECRF.  In accordance with this rule, SPShas removed its energy efficiency costs from its recent base rate proceeding,and has requested implementation of its EECRF Rider to recover the remainingunamortized balance of historic costs and its projected 2008 and 2009 energyefficiency costs.  SPS requests that therider be implemented on Jan. 1, 2009. On July 3, 2008, the Allianceof Xcel Municipalities filed to intervene and has requested a hearing and thatthe case be consolidated with the Texas rate case.

 

20

----

Tableof Contents

 

***New Mexico EnergyEfficiency Disincentive Rulemaking*******—**During the last legislative session, increased energy efficiency goals and moreaffirmative disincentive language were adopted. The NMPRC is currently holding a rulemaking to update the energyefficiency rule, consistent with the legislative changes.

 

***Peak Day PartnerProgram*******—** Due to the delay of LPP, SPS received approvalin both Texas and New Mexico to accept bids from large customers to voluntarilyreduce their loads during peak periods.  The program is only effective until the commercial operation date ofLPP.

 

***Texas InterruptibleCredit Option and Saver’s Switch***— On May 13,2008, SPS filed an application with the PUCT and each of the 80 municipalitiesin SPS Texas service territory with original rate jurisdiction to revise itsInterruptible Credit Option (ICO) tariff and to institute a new Saver’s Switchtariff for residential and small commercial customers.  The purpose of these programs is to mitigatepeak demand on SPS’ system starting with the 2009 summer peak.  The issue of cost recovery will be handled inthe Texas rate case. Three parties have intervened, one of whom has requested ahearing on SPS’ application and has also requested that the case beconsolidated with the Texas rate case.

*** ***

**Item 4. CONTROLS ANDPROCEDURES**

 

**Disclosure Controls andProcedures**

** **

SPS maintainsa set of disclosure controls and procedures designed to ensure that informationrequired to be disclosed in reports that it files or submits under theSecurities Exchange Act of 1934 (Exchange Act) is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed byus in reports under the Exchange Act is accumulated and communicated tomanagement, including the chief executive officer (CEO) and chief financialofficer (CFO), allowing timely decisions regarding required disclosure. As ofthe end of the period covered by this report, based on an evaluation carriedout under the supervision and with the participation of SPS’ management,including the CEO and the CFO, of the effectiveness of our disclosure controlsand procedures, the CEO and CFO have concluded that SPS’ disclosure controlsand procedures are effective.

 

**Internal Control Over Financial Reporting**

** **

No change inSPS’ internal control over financial reporting has occurred during the mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, SPS’ internal control over financial reporting.

 

#### **Part II.OTHER INFORMATION**

#### ** **

## **Item 1. LEGALPROCEEDINGS**

## ** **

In the normal course ofbusiness, various lawsuits and claims have arisen against SPS. Management,after consultation with legal counsel, has recorded an estimate of the probablecost of settlement or other disposition for such matters. See Notes 5 and 6 ofthe financial statements in this Quarterly Report on Form 10-Q for furtherdiscussion of legal proceedings, including Regulatory Matters and Commitmentsand Contingent Liabilities, which are hereby incorporated by reference.Reference also is made to Item 3 and Notes 11 and 12 of SPS’ Annual Reporton Form 10-K for the year ended Dec. 31, 2007 for a description ofcertain legal proceedings presently pending.

 

**Item 1A. RISK FACTORS**

 

SPS’ risk factors are documented in Item 1A of Part I of its 2007Annual Report on Form 10-K, which is incorporated herein by reference.There have been no material changes to the risk factors.

 

21

----

## **Table of Contents**

 

## **Item 6.EXHIBITS**

## ** **

The followingExhibits are filed with this report:

 

| 31.01 |   | Principal Executive Officer’s and Principal Financial Officer’s certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.01 |   | Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                          |
| 99.01 |   | Statement  pursuant to Private Securities Litigation Reform Act of 1995.                                                                                                                                     |

 

22

----

Tableof Contents

 

**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on Aug. 4, 2008.

 

SouthwesternPublic Service Co.

(Registrant)

 

 
|   | /s/ TERESA  S. MADDEN                       |
|--------|---------------------------------------------|
|   | Teresa S.  Madden                           |
|   | Vice  President and Controller              |
|   |                                        |
|   |                                        |
|   | /s/ BENJAMIN  G.S. FOWKE III                |
|   | Benjamin G.S. Fowke III                     |
|   | Vice  President and Chief Financial Officer |

 

23

----