Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2010**

 

**or**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**Commission File Number: 001-03789**

 

**SouthwesternPublic Service Company**

(Exact name of registrant as specified in its charter)

 

| **New Mexico**                                                 | ** ** | **75-0575400**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

| **Tyler at Ninth**                       |       |       |
|------------------------------------------|------------|------------|
| **Amarillo, Texas**                      | ** ** | **79101**  |
| (Address of principal executive offices) |       | (Zip Code) |

 

**(303) 571-7511**

(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  x  Yes  o  No

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 and Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). o  Yes o  No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  o  Yes  x  No

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Class**                  | ** ** | **Outstanding at August 2, 2010** |
|----------------------------|------------|-------------------------------------------------------|
| Common Stock, $1 par value |       | 100 shares                                            |

 

Southwestern Public ServiceCompany meets the conditions set forth in General Instruction H (1)(a) and(b) of Form 10-Q and is therefore filing this Form 10-Q with thereduced disclosure format specified in General Instruction H (2) to suchForm 10-Q.

 

 

 

----

Table of Contents

 

**TABLE OFCONTENTS**

 
| **PART I  - FINANCIAL INFORMATION**     |   |                                                                                        |
|----------------------------------------------|--------|---------------------------------------------------------------------------------------------|
|                                         |   |                                                                                        |   |   |
| Item l.                                      |   | Financial Statements (Unaudited)                                                            |   | 3 |
| Item 2.                                      |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 17 |
| Item 4.                                      |   | Controls and  Procedures                                                                    |   | 20 |
|                                         |   |                                                                                        |   |   |
| **PART II  - OTHER INFORMATION**        |   |                                                                                        |
|                                         |   |                                                                                        |   |   |
| Item 1.                                      |   | Legal Proceedings                                                                           |   | 21 |
| Item 1A.                                     |   | Risk Factors                                                                                |   | 21 |
| Item 6.                                      |   | Exhibits                                                                                    |   | 22 |
|                                         |   |                                                                                        |   |   |
| **SIGNATURES**                               |   | 23                                                                                          |
|                                         |   |                                                                                        |   |   |
| Certifications Pursuant  to Section 302 |   | 1                                                                                           |
| Certifications Pursuant  to Section 906 |   | 1                                                                                           |
| Statement Pursuant to  Private Litigation    |   | 1                                                                                           |

 

This Form 10-Q is filedby Southwestern Public Service Company, a New Mexico corporation (SPS). SPS isa wholly owned subsidiary of Xcel Energy Inc. (Xcel Energy).  Additional information on Xcel Energy isavailable on various filings with the Securities and Exchange Commission (SEC).

 

2

----

Table of Contents

 

**PART I.FINANCIAL INFORMATION**

 

**Item 1.FINANCIAL STATEMENTS**

 

**SOUTHWESTERN PUBLIC SERVICE COMPANY**

**STATEMENTS OF INCOME (UNAUDITED)**

*(amounts in thousands of dollars)*

 
| ** **                                                                                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                             | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| **Operating revenues**                                                                                 |       | $                                    | 398,449    |                               | $          | 328,140 |   | $ | 779,931 |   | $ | 697,123 |   |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| **Operating expenses**                                                                                 |       |                                 |       |                               |       |   |   |   |   |
| Electric fuel and purchased power                                                                      |       | 243,509                              |       | 196,010                            |       | 499,703 |   | 443,519 |   |
| Other operating and maintenance expenses                                                               |       | 62,282                               |       | 53,956                             |       | 118,987 |   | 108,429 |   |
| Demand side management program expenses                                                                |       | 3,047                                |       | 2,621                              |       | 4,993 |   | 3,973 |   |
| Depreciation and amortization                                                                          |       | 25,654                               |       | 25,279                             |       | 51,308 |   | 50,554 |   |
| Taxes (other than income taxes)                                                                        |       | 9,906                                |       | 9,231                              |       | 20,061 |   | 19,773 |   |
| Total operating expenses                                                                               |       | 344,398                              |       | 287,097                            |       | 695,052 |   | 626,248 |   |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| **Operating income**                                                                                   |       | 54,051                               |       | 41,043                             |       | 84,879 |   | 70,875 |   |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| Other income (expense), net                                                                            |       | 119                                  |       | (323                               | )          | 113 |   | 42 |   |
| Allowance for funds used during construction –  equity                                            |       | 1,011                                |       | 975                                |       | 1,444 |   | 2,090 |   |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| **Interest charges and financing  costs**                                                              |       |                                 |       |                               |       |   |   |   |   |
| Interest charges – includes other financing costs  of $659, $657, $1,309 and $1,326, respectively |       | 15,736                               |       | 15,582                             |       | 31,882 |   | 33,682 |   |
| Allowance for funds used during construction –  debt                                              |       | (714                                 | )          | (675                               | )          | (1,260 | ) | (1,445 | ) |
| Total interest charges and financing costs                                                             |       | 15,022                               |       | 14,907                             |       | 30,622 |   | 32,237 |   |
|                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| **Income before income taxes**                                                                         |       | 40,159                               |       | 26,788                             |       | 55,814 |   | 40,770 |   |
| Income taxes                                                                                           |       | 15,763                               |       | 9,980                              |       | 23,719 |   | 14,780 |   |
| **Net income**                                                                                         |       | $                                    | 24,396     |                               | $          | 16,808 |   | $ | 32,095 |   | $ | 25,990 |   |

 

SeeNotes to Financial Statements

 

3

----

Table of Contents

 

**SOUTHWESTERN PUBLIC SERVICE COMPANY**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

*(amounts in thousands of dollars)*

* *
| ** **                                                                     | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                     | ** ** | **2010**                           | ** ** | **2009** | ** ** |
|                                                                           |       |                               |       |   |   |
| **Operating activities**                                                       | ** ** | ** **                         |       |   |   |
| Net income                                                                     |       | $                                  | 32,095     |   | $ | 25,990 |   |
| Adjustments to reconcile net income to cash  provided by operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                  |       | 52,437                             |       | 51,701 |   |
| Demand side management program expenses                                        |       | 951                                |       | 841 |   |
| Deferred income taxes                                                          |       | 17,929                             |       | (19,432 | ) |
| Amortization of investment tax credits                                         |       | (149                               | )          | (162 | ) |
| Allowance for equity funds used during  construction                           |       | (1,444                             | )          | (2,090 | ) |
| Net realized and unrealized hedging and derivative  transactions               |       | 133                                |       | (1,509 | ) |
| Changes in operating assets and liabilities:                                   |       |                               |       |   |   |
| Accounts receivable                                                            |       | (16,464                            | )          | (6,490 | ) |
| Accrued unbilled revenues                                                      |       | (15,831                            | )          | (10,842 | ) |
| Recoverable electric energy costs                                              |       | (1,454                             | )          | 2,018 |   |
| Inventories                                                                    |       | 3,106                              |       | 24,835 |   |
| Prepayments and other                                                          |       | (1,832                             | )          | 1,828 |   |
| Accounts payable                                                               |       | (3,697                             | )          | (25,550 | ) |
| Deferred electric energy costs                                                 |       | (25,481                            | )          | 92,428 |   |
| Net regulatory assets and liabilities                                          |       | 121                                |       | 3,655 |   |
| Other current liabilities                                                      |       | (3,897                             | )          | (5,567 | ) |
| Change in other noncurrent assets                                              |       | (1,579                             | )          | (5,064 | ) |
| Change in other noncurrent liabilities                                         |       | (1,811                             | )          | (17,291 | ) |
| Net cash provided by operating activities                                      |       | 33,133                             |       | 109,299 |   |
|                                                                           |       |                               |       |   |   |
| **Investing activities**                                                       |       |                               |       |   |   |
| Utility capital/construction expenditures                                      |       | (111,327                           | )          | (96,006 | ) |
| Allowance for equity funds used during  construction                           |       | 1,444                              |       | 2,090 |   |
| Investments in utility money pool arrangement                                  |       | (204,200                           | )          | (567,800 | ) |
| Receipts from utility money pool arrangement                                   |       | 281,200                            |       | 658,300 |   |
| Net cash used in investing activities                                          |       | (32,883                            | )          | (3,416 | ) |
|                                                                           |       |                               |       |   |   |
| **Financing activities**                                                       |       |                               |       |   |   |
| Proceeds of short-term borrowings, net                                         |       | 24,000                             |       | — |   |
| Borrowings under utility money pool arrangement                                |       | 19,000                             |       | — |   |
| Repayment of long-term debt                                                    |       | (25,000                            | )          | (100,027 | ) |
| Capital contributions from parent                                              |       | 8,802                              |       | 13,044 |   |
| Dividends paid to parent                                                       |       | (34,136                            | )          | (32,959 | ) |
| Net cash used in financing activities                                          |       | (7,334                             | )          | (119,942 | ) |
|                                                                           |       |                               |       |   |   |
| Net decrease in cash and cash equivalents                                      |       | (7,084                             | )          | (14,059 | ) |
| Cash and cash equivalents at beginning of period                               |       | 7,363                              |       | 130,795 |   |
| Cash and cash equivalents at end of period                                     |       | $                                  | 279        |   | $ | 116,736 |   |
|                                                                           |       |                               |       |   |   |
| Supplemental disclosure of cash flow information:                              |       |                               |       |   |   |
| Cash paid for interest, net of amounts capitalized                             |       | $                                  | (41,180    | ) | $ | (33,455 | ) |
| Cash paid for income taxes, net                                                |       | (9,885                             | )          | (34,363 | ) |
|                                                                           |       |                               |       |   |   |
| Supplemental disclosure of non-cash investing  transactions:                   |       |                               |       |   |   |
| Property, plant and equipment additions in  accounts payable                   |       | $                                  | 9,587      |   | $ | 3,751 |   |

* *

See Notes to Financial Statements

 

4

----

Tableof Contents

 

**SOUTHWESTERN PUBLIC SERVICE COMPANY**

**BALANCE SHEETS (UNAUDITED)**

*(amounts in thousands of dollars)*

 
| ** **                                                                            | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **Assets**                                                                            |       |                   |       |                   |       |
| Current assets                                                                        |       |                   |       |                   |       |
| Cash and cash equivalents                                                             |       | $                      | 279        |                   | $          | 7,363 |   |
| Investments in utility money pool arrangement                                         |       | —                 |       | 77,000                 |       |
| Accounts receivable, net                                                              |       | 56,753                 |       | 47,065                 |       |
| Accounts receivable from affiliates                                                   |       | 11,873                 |       | 5,097                  |       |
| Accrued unbilled revenues                                                             |       | 121,616                |       | 105,785                |       |
| Inventories                                                                           |       | 24,041                 |       | 27,147                 |       |
| Recoverable electric energy costs                                                     |       | 2,613                  |       | 1,159                  |       |
| Derivative instruments valuation                                                      |       | 7,892                  |       | 8,926                  |       |
| Deferred income taxes                                                                 |       | 21,552                 |       | 36,406                 |       |
| Prepayments and other                                                                 |       | 17,759                 |       | 15,927                 |       |
| Total current assets                                                                  |       | 264,378                |       | 331,875                |       |
|                                                                                  |       |                   |       |                   |       |
| Property, plant and equipment, net                                                    |       | 2,318,844              |       | 2,260,984              |       |
|                                                                                  |       |                   |       |                   |       |
| Other assets                                                                          |       |                   |       |                   |       |
| Regulatory assets                                                                     |       | 286,544                |       | 286,734                |       |
| Derivative instruments valuation                                                      |       | 68,680                 |       | 67,625                 |       |
| Other                                                                                 |       | 9,696                  |       | 8,783                  |       |
| Total other assets                                                                    |       | 364,920                |       | 363,142                |       |
| Total assets                                                                          |       | $                      | 2,948,142  |                   | $          | 2,956,001 |   |
|                                                                                  |       |                   |       |                   |       |
| **Liabilities and Equity**                                                            |       |                   |       |                   |       |
| Current liabilities                                                                   |       |                   |       |                   |       |
| Short-term debt                                                                       |       | $                      | 24,000     |                   | $          | — |   |
| Borrowings under utility money pool arrangement                                       |       | 19,000                 |       | —                 |       |
| Accounts payable                                                                      |       | 159,277                |       | 163,253                |       |
| Accounts payable to affiliates                                                        |       | 12,058                 |       | 14,625                 |       |
| Deferred electric energy costs                                                        |       | 34,302                 |       | 59,783                 |       |
| Taxes accrued                                                                         |       | 13,414                 |       | 18,209                 |       |
| Accrued interest                                                                      |       | 12,178                 |       | 12,371                 |       |
| Dividends payable                                                                     |       | 16,674                 |       | 17,240                 |       |
| Derivative instruments valuation                                                      |       | 3,601                  |       | 3,588                  |       |
| Other                                                                                 |       | 20,583                 |       | 20,125                 |       |
| Total current liabilities                                                             |       | 315,087                |       | 309,194                |       |
|                                                                                  |       |                   |       |                   |       |
| Deferred credits and other liabilities                                                |       |                   |       |                   |       |
| Deferred income taxes                                                                 |       | 535,856                |       | 533,241                |       |
| Deferred investment tax credits                                                       |       | 2,243                  |       | 2,392                  |       |
| Regulatory liabilities                                                                |       | 123,458                |       | 119,080                |       |
| Asset retirement obligations                                                          |       | 19,390                 |       | 18,757                 |       |
| Derivative instruments valuation                                                      |       | 46,792                 |       | 48,654                 |       |
| Pension and employee benefit obligations                                              |       | 42,419                 |       | 44,276                 |       |
| Other                                                                                 |       | 8,369                  |       | 8,450                  |       |
| Total deferred credits and other liabilities                                          |       | 778,527                |       | 774,850                |       |
|                                                                                  |       |                   |       |                   |       |
| Commitments and contingent liabilities                                                |       |                   |       |                   |       |
| Capitalization                                                                        |       |                   |       |                   |       |
| Long-term debt                                                                        |       | 897,606                |       | 922,447                |       |
| Common stock – authorized 200 shares of $1.00 par  value; outstanding 100 shares |       | —                 |       | —                 |       |
| Additional paid in capital                                                            |       | 701,750                |       | 692,948                |       |
| Retained earnings                                                                     |       | 256,934                |       | 258,409                |       |
| Accumulated other comprehensive loss                                                  |       | (1,762                 | )          | (1,847                 | )          |
| Total common stockholder’s equity                                                |       | 956,922                |       | 949,510                |       |
| Total liabilities and equity                                                          |       | $                      | 2,948,142  |                   | $          | 2,956,001 |   |

 

SeeNotes to Financial Statements

 

5

----

Tableof Contents

 

**SOUTHWESTERNPUBLIC SERVICE COMPANY**

**Notes to Financial Statements (UNAUDITED)**

 

In the opinion ofmanagement, the accompanying unaudited financial statements contain alladjustments necessary to present fairly, in accordance with accountingprinciples generally accepted in the United States of America (GAAP), thefinancial position of SPS as of June 30, 2010, and Dec. 31, 2009; theresults of its operations for the three and six months ended June 30, 2010and 2009; and its cash flows for the six months ended June 30, 2010 and2009.  All adjustments are of a normal,recurring nature, except as otherwise disclosed.  Management has also evaluated the impact ofevents occurring after June 30, 2010 up to the date of issuance of thesefinancial statements.  These statementscontain all necessary adjustments and disclosures resulting from thatevaluation.  The Dec. 31, 2009balance sheet information has been derived from the audited 2009 financialstatements.  These notes to the financialstatements have been prepared pursuant to the rules and regulations of theSEC for Quarterly Reports on Form 10-Q. Certain information and note disclosures normally included in financialstatements prepared in accordance with GAAP have been condensed or omittedpursuant to such rules and regulations. For further information, refer to the financial statements and notesthereto included in the SPS Annual Report on Form 10-K for the year endedDec. 31, 2009, filed with the SEC on March 1, 2010.  Due to the seasonality of SPS’s electricsales, interim results are not necessarily an appropriate base from which toproject annual results.

 

**1.****             ****Summary ofSignificant Accounting Policies**

 

Except to the extent updatedor described below, the significant accounting policies set forth in Note 1 tothe financial statements in SPS’ Annual Report on Form 10-K for the yearended Dec. 31, 2009, appropriately represent, in all material respects,the current status of accounting policies and are incorporated herein byreference.

 

***Reclassifications*** — Demand side managementprogram expenses for the six months ended June 30, 2009 were reclassifiedas a separate item from depreciation and amortization expenses within thestatements of cash flows.  Thereclassification did not have an impact on net cash provided by operatingactivities.

 

**2.****             ****AccountingPronouncements**

 

***Recently Adopted***

 

***Consolidation of Variable Interest Entities***— In June 2009, the Financial Accounting Standards Board (FASB)issued new guidance on consolidation of variable interest entities. Theguidance affects various elements of consolidation, including the determinationof whether an entity is a variable interest entity and whether an enterprise isa variable interest entity’s primary beneficiary. These updates to the FASBAccounting Standards Codification (ASC or Codification) are effective forinterim and annual periods beginning after Nov. 15, 2009.  SPS implemented the guidance on Jan. 1,2010, and the implementation did not have a material impact on its financialstatements.  For further information andrequired disclosures regarding variable interest entities, see Note 6 to thefinancial statements.

 

***Fair Value Measurement Disclosures*** — In January 2010, theFASB issued *Fair Value Measurements andDisclosures (Topic 820) — Improving Disclosures about Fair ValueMeasurements (Accounting Standards Update (ASU) No. 2010-06)*,which updates the Codification to require new disclosures for assets and liabilitiesmeasured at fair value. The requirements include expanded disclosure ofvaluation methodologies for fair value measurements, transfers between levelsof the fair value hierarchy, and gross rather than net presentation of certainchanges in Level 3 fair value measurements. The updates to theCodification contained in ASU No. 2010-06 were effective for interim andannual periods beginning after Dec. 15, 2009, except for requirementsrelated to gross presentation of certain changes in Level 3 fair valuemeasurements, which are effective for interim and annual periods beginningafter Dec. 15, 2010.  SPSimplemented the portions of the guidance required on Jan. 1, 2010, and theimplementation did not have a material impact on its financial statements.  For further information and requireddisclosures, see Note 9 to the financial statements.

 

6

----

Table of Contents

 

**3.****             ****SelectedBalance Sheet Data**

 
| **(Thousands of Dollars)**    | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| **Accounts receivable, net**            |       |                   |       |                        |       |
| Accounts receivable                     |       | $                      | 61,221     |                        | $          | 51,480 |   |
| Less allowance for bad debts            |       | (4,468                 | )          | (4,415                      | )          |
|                                    |       | $                      | 56,753     |                        | $          | 47,065 |   |
| **Inventories**                         |       |                   |       |                        |       |
| Materials and supplies                  |       | $                      | 16,338     |                        | $          | 15,737 |   |
| Fuel                                    |       | 7,703                  |       | 11,410                      |       |
|                                    |       | $                      | 24,041     |                        | $          | 27,147 |   |
| **Property, plant and equipment,  net** |       |                   |       |                        |       |
| Electric plant                          |       | $                      | 3,843,232  |                        | $          | 3,777,623 |   |
| Construction work in progress           |       | 127,412                |       | 95,652                      |       |
| Total property, plant and equipment     |       | 3,970,644              |       | 3,873,275                   |       |
| Less accumulated depreciation           |       | (1,651,800             | )          | (1,612,291                  | )          |
|                                    |       | $                      | 2,318,844  |                        | $          | 2,260,984 |   |

 

**4.****             ****IncomeTaxes**

 

***Medicare Part D Subsidy Reimbursements****—* In March 2010, thePatient Protection and Affordable Care Act was signed into law.  The lawincludes provisions to generate tax revenue to help offset the cost of the newlegislation.  One of these provisions reduces the deductibility of retireehealth care costs to the extent of federal subsidies received by plan sponsorsthat provide retiree prescription drug benefits equivalent to MedicarePart D coverage, beginning in 2013.  Based on this provision, SPS issubject to additional taxes and is required to reverse previously recorded taxbenefits in the period of enactment.

 

SPSexpensed approximately $1.9 million of previously recognized tax benefitsrelating to Medicare Part D subsidies during the first quarter of2010.  SPS does not expect the $1.9 million of additional tax expense torecur in future periods.  The 2010 effective tax rate (ETR) will increasedue to additional tax expense of approximately $0.5 million associated withcurrent year retiree health care accruals.

 

***Federal Audit*****—**SPS is a member of the Xcel Energy affiliatedgroup that files a consolidated federal income tax return. During thefirst quarter of 2010, the Internal Revenue Service (IRS) completed anexamination of Xcel Energy’s federal income tax returns of tax years 2006and 2007. The IRS did not propose any material adjustments for those tax years.The statute of limitations applicable to Xcel Energy’s 2006 federal incometax return expires on Aug. 28, 2010. The IRS audit of tax years 2008 and2009 is expected to begin during the fourth quarter of 2010.

 

***State Audits*****—**SPS is a member of the Xcel Energy affiliatedgroup that files consolidated state income tax returns. As of June 30,2010, SPS’s earliest open tax year that is subject to examination by statetaxing authorities under applicable statutes of limitations is 2005. During thesecond quarter of 2010, the state of Texas completed its audit of tax years2006 and 2007. No change in tax liability was proposed. There currently are nostate income tax audits in progress.

 

***Unrecognized Tax Benefits*****—**The unrecognized tax benefit balance includespermanent tax positions, which if recognized would affect the annual ETR. Inaddition, the unrecognized tax benefit balance includes temporary tax positionsfor which the ultimate deductibility is highly certain but for which there isuncertainty about the timing of such deductibility. A change in the period ofdeductibility would not affect the ETR but would accelerate the payment of cashto the taxing authority to an earlier period.

 

Areconciliation of the amount of unrecognized tax benefit is as follows:

 
| **(Millions of Dollars)**                | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Unrecognized tax benefit - Permanent tax positions |       | $                      | 0.2        |                   | $          | 0.2 |   |
| Unrecognized tax benefit - Temporary tax positions |       | 3.1                    |       | 2.7                    |       |
| Unrecognized tax benefit balance                   |       | $                      | 3.3        |                   | $          | 2.9 |   |

 

7

----

Table ofContents

 

Theincrease in the unrecognized tax benefit balance of $0.2 million from March 31,2010 to June 30, 2010 and $0.4 million from Dec. 31, 2009 to June 30,2010 was due to the addition of similar uncertain tax positions related toongoing activity. SPS’s amount of unrecognized tax benefits could significantlychange in the next 12 months when the IRS and state audits resume. At thistime, due to the uncertain nature of the audit process, it is not reasonablypossible to estimate an overall range of possible change.

 

**5.****             ****RateMatters**

 

Except to the extent noted below, the circumstances set forth in Note13 to the financial statements included in SPS’ Annual Report on Form 10-Kfor the year ended Dec. 31, 2009 appropriately represent, in all materialrespects, the current status of other rate matters, and are incorporated hereinby reference.

 

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

 

***Texas Retail Base Rate Case —***On May 17, 2010, SPSfiled a Texas rate case with the PUCT, seeking an annual base rate increase ofapproximately $62 million.  On a netbasis, the request seeks to increase customer bills by approximately $53.4million, or 7 percent.

 

The rate filing is based ona 2009 test year adjusted for known and measurable changes, a requested returnon equity (ROE) of 11.35 percent, an electric rate base of $1.031 billion andan equity ratio of 51.0 percent.

 

The following tablesummarizes the request:

 
| **(Millions of Dollars)** | ** ** | **Request** | ** ** |
|-------------------------------------|------------|-------------|------------|
| Proposed base rate increase         |       | $           | 62.0       |   |
| Franchise fee cost recovery         |       | 8.7         |       |
| Nitrogen oxide emission allowances  |       | 0.8         |       |
| Purchased capacity recovery factor  |       | (13.5       | )          |
| Transmission cost recovery factor   |       | (4.6        | )          |
| Adjusted rate increase              |       | $           | 53.4       |   |
|                                |       |        |       |
| Return on equity                    |       | 11.35       | %          |
| Equity ratio                        |       | 51.0        |       |
| Electric rate base                  |       | $           | 1,031      |   |

 

Thefiling with the PUCT also includes a request to reconcile SPS’ fuel andpurchased power costs for calendar years 2008 and 2009.  As of Dec. 31, 2009, SPS had a fuel costunder-recovery of approximately $3.3 million.

 

SPSexpects new rates to go into effect early in 2011, although fully litigatedcases would typically take longer for rates to be implemented.  The procedural schedule is as follows:

 

·                  Intervenor testimony due Sept. 16, 2010;

·                  Staff testimony due Sept. 23, 2010;

·                  SPS rebuttal testimony due Oct. 7, 2010;and

·                  Hearings are Oct. 19 through Nov. 5,2010.

 

***Lubbock ElectricDistribution Assets*******— In November 2009, SPS entered into anagreement with the city of Lubbock, Texas, in which SPS will sell its electricdistribution system assets within the city limits to the City of Lubbock forapproximately $87 million.  As part ofthis transaction, SPS will continue to provide the wholesale power to meet theelectric load for the customers that SPS currently serves.  The wholesale power agreements provide forformula rates that change annually based on the actual cost of service.  The formula rate with West Texas MunicipalPower Agency (WTMPA) reflects an initial 10.5 percent ROE.  All or portions of this transaction aresubject to review and approval by the PUCT, the New Mexico Public RegulationCommission (NMPRC) and the Federal Energy Regulatory Commission (FERC).  This transaction is expected to close late in2010.  It is anticipated that anyresulting gain on the sale of assets will be shared with retail customers inTexas, as determined in the above Texas retail base rate case.

 

8

----

Table of Contents

 

TheFERC accepted the amended WTMPA full-requirements contract in February 2010.  SPS filed its application before the PUCT in January 2010for the approvals related to the sale of distribution assets to Lubbock.  In June 2010, the parties to the Texasproceeding filed an uncontested settlement resolving all issues in the Texasproceeding relating to the transaction. The PUCT has placed this matter on its agenda for its July 30, 2010open meeting.  Also in June 2010,SPS filed its application in New Mexico for approval of the transaction.  A hearing examiner has adopted a proceduralschedule for a hearing on Sept. 14, 2010.

 

***Pending and Recently ConcludedRegulatory Proceedings — FERC***

 

***Wholesale Rate Complaints***— InNovember 2004, Golden Spread Electric, Lyntegar Electric, Farmer’sElectric, Lea County Electric, Central Valley Electric and Roosevelt CountyElectric, all wholesale cooperative customers of SPS, filed a rate complaintwith the FERC alleging that SPS’ rates for wholesale service were excessive andthat SPS had incorrectly calculated monthly fuel cost adjustment charges tosuch 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 the complainants.  Cap Rock Energy Corporation (Cap Rock),another full-requirements customer of SPS, Public Service Company of New Mexico(PNM) and Occidental Permian Ltd. and Occidental Power Marketing, L.P.(Occidental), SPS’ largest retail customer, intervened in the proceeding.

 

InApril 2008, the FERC issued its order on the complaint applied to theremaining non-settling parties.  Theorder addresses base rate issues for the period from Jan. 1, 2005 throughJune 30, 2006, for SPS’ full requirements customers who pay traditionalcost-based rates and require certain refunds. Several parties, including SPS, filed requests for rehearing on theorder.  In July 2008, SPS submittedits compliance report to the FERC and calculated the base rate refund for the18-month period to be $6.1 million and the fuel refund to be $4.4 million.  Several wholesale customers protested these calculations.  As of June 30, 2010, SPS has accrued anamount it believes is sufficient to cover the estimated refund obligationrelated to these complaints.  The statusof various settlements and the applicable regulatory approvals are discussedbelow.  At this time, PNM, which filed aseparate complaint, is the only party that has not settled.

 

***Golden Spread Complaint Settlement***— SPS reached asettlement with Golden Spread (which included Lyntegar Electric) and Occidentalin 2007 regarding base rate and fuel issues raised in the complaint describedabove as well as a subsequent rate proceeding. The FERC approved the settlement in April 2008 and the PUCT andNMPRC approvals were obtained in the first quarter of 2010 eliminating thepotential contingent payments by SPS resulting from an adverse cost assignmentdecision or a failure to obtain state approvals.

 

***New Mexico Cooperatives’ ComplaintSettlement***— In June 2010, the FERC approved thesettlement with Farmers’ Electric Cooperative of New Mexico, Lea CountyElectric Cooperative, Central Valley Electric Cooperative and Roosevelt CountyElectric Cooperative, and Occidental regarding the same base rate and fuelissues raised in the complaint described above. The settlement resolves all issues arising from the complaint docket andimplements a replacement contract with a formula production rate at10.5 percent ROE and extended the term of its requirements sale to thefour wholesale customers.

 

The four wholesale customers must reduce their system average costpower purchases by 90 to 100 megawatts (MW) in 2012, and implement stagedreductions in system average cost power purchases through the term of theagreement, which terminates on May 31, 2026.  The settlement made the replacement contractcontingent on certain state approvals. In the event not all state regulatory approvals are received, thesettlement includes a one time contingent payment of $12 million by SPS tothese wholesale customers.  Thesewholesale customers agreed to hold SPS harmless from any future adverseregulatory treatment regarding the proposed wholesale power sale.

 

SPS reached settlements that would obtain the needed state approvalsreferenced above.  No party has contestedthe PUCT approval, and it is expected that the PUCT will act on the settlementin August 2010.  The New Mexicoparties and NMPRC staff filed a stipulation to resolve the NMPRC proceeding.  The hearing examiner heard the stipulation andrecommended that the NMPRC approve the stipulation.  The NMPRC is expected to consider a finalorder in August 2010.  As a resultof the FERC approval of the settlement and resolution of the complaint with theNew Mexico cooperatives, SPS released previously established reserves of $11.5million in the second quarter of 2010.

 

***Cap Rock Complaint Settlement*******— Cap Rock isan intervenor in the complaint case.  Inthe second quarter of 2010, SPS and Cap Rock filed a settlement agreement withthe FERC regarding the same base rate and fuel issues described above.  Subject to FERC approval of the settlementagreement, SPS will pay Cap Rock $1 million to resolve all remaining base rateand fuel claims against SPS.  Cap Rockalso agrees that its production base rates will be converted to a formula ratedesign.  The settlement agreement wasalso contingent on FERC and PUCT approval of the Sharyland acquisition of CapRock, which was approved in June 2010 and July 2010, respectively.

 

9

----

Tableof Contents

 

**6.****             ****Commitmentsand Contingent Liabilities**

 

Exceptto the extent noted below and in Note 5 to the financial statements in thisQuarterly Report on Form 10-Q, the circumstances set forth in Notes 13 and14 to the financial statements in SPS’ Annual Report on Form 10-K for theyear ended Dec. 31, 2009, appropriately represent, in all materialrespects, the current status of commitments and contingent liabilities and areincorporated herein by reference.  Thefollowing include commitments, contingencies and unresolved contingencies thatare material to SPS’ financial position.

 

**Commitments**

 

***Variable Interest Entities*****— Effective Jan. 1,2010, SPS adopted new guidance on consolidation of variable interest entitiescontained in *ASC 810**Consolidation*.  The guidance requires enterprises to considerthe activities that most significantly impact an entity’s financialperformance, and power to direct those activities, when determining whether anentity is a variable interest entity and whether an enterprise is a variableinterest entity’s primary beneficiary.

 

*PurchasedPower Agreements*— SPS has entered into agreements with otherutilities and energy suppliers for purchased power to meet system load andenergy requirements, replace generation from company-owned units undermaintenance or during outages, and meet operating reserve obligations.

 

SPShas various pay-for-performance contracts with expiration dates through theyear 2033.  In general, these contractsprovide for energy payments based on actual power taken under the contracts aswell as capacity payments.  Capacitypayments are typically contingent on the independent power producing entitymeeting certain contract obligations, including plant availabilityrequirements.  Certain contractualpayments are adjusted based on market indices; however, the effects of priceadjustments are mitigated through purchased energy cost recovery mechanisms.

 

SPSis not subject to risk of loss from the operations of these entities, and nosignificant financial support has been, or is in the future required to beprovided other than contractual payments for energy and capacity set forth inpurchased power agreements.

 

Certainnatural gas purchased power agreements that either reimburse the independentpower producing entities for fuel costs, or contain tolling arrangements underwhich SPS procures the fuel required to produce the energy it purchases, havebeen determined to be variable interest entities.

 

SPShas evaluated each of these variable interest entities for possibleconsolidation, including review of qualitative factors such as the length andterms of the contract, control over operations and maintenance, historical andestimated future fuel and electricity prices, and financing activities.  SPS has concluded that these entities are notrequired to be consolidated in its financial statements because it does nothave the power to direct the activities that most significantly impact theentities’ economic performance.  As of June 30,2010 and Dec. 31, 2009, SPS had approximately 1,027 MW of capacity underlong-term purchased power agreements with entities that have been determined tobe variable interest entities.

 

*FuelContracts*— SPS purchases all of its coal requirements for itsHarrington and Tolk electric generating stations from TUCO, Inc. (TUCO)under contracts for those facilities that expire in 2016 and 2017,respectively.  TUCO arranges for thepurchase, receiving, transporting, unloading, handling, crushing, weighing, anddelivery of coal to meet SPS’ requirements. TUCO is responsible for negotiating and administering contracts withcoal suppliers, transporters and handlers.

 

Nosignificant financial support has been, or is in the future, required to beprovided to TUCO by SPS, other than contractual payments for deliveredcoal.  However, the fuel contracts havebeen determined to create a variable interest in TUCO due to SPS’ reimbursementof certain fuel procurement costs.  SPShas evaluated the TUCO coal supply contracts and has concluded that it is notthe primary beneficiary because SPS does not have the power to direct theactivities that most significantly impact TUCO’s economic performance.

 

**EnvironmentalContingencies**

 

SPS has been, or iscurrently, involved with the cleanup of contamination from certain hazardoussubstances at several sites.  In manysituations, SPS believes it will recover some portion of these costs throughinsurance claims.  Additionally, whereapplicable, SPS is pursuing, or intends to pursue, recovery from other potentiallyresponsible parties (PRPs) 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.

 

10

----

Tableof Contents

 

***Site Remediation****—*SPS must payall or a portion of the cost to remediate sites where past activities of SPS orother parties have caused environmental contamination.  Environmental contingencies could arise fromvarious situations, including third party sites, for which SPS is alleged to bea PRP that sent hazardous materials and wastes. At June 30, 2010, the liability for the cost of remediating thesesites was estimated to be $0.1 million.

 

***Third Party and Other Environmental Site Remediation***

 

***Asbestos Removal*****—**Some of SPS’facilities contain asbestos.  Mostasbestos will remain undisturbed until the facilities that contain it aredemolished or renovated.  SPS hasrecorded an estimate for final removal of the asbestos as an asset retirementobligation.  See additional discussion ofasset retirement obligations in Note 14 of the SPS Annual Report onForm 10-K for the year ended Dec. 31, 2009.  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 EnvironmentalRequirements***

 

***Environmental Protection Agency (EPA)Greenhouse Gas (GHG) Rulemaking***— On Dec. 7, 2009, inresponse to the U. S. Supreme Court’s decision in *Massachusettsv. EPA*, 549 U. S. 497 (2007), the EPA issued its “endangerment”finding that GHG emissions endanger public health and welfare and thatemissions from motor vehicles contribute to the GHGs in the atmosphere.  This endangerment finding created a mandatoryduty for the EPA to regulate GHGs from light duty vehicles.  The EPA finalized GHG efficiency standardsfor light duty vehicles in spring of 2010 and has promulgated permittingrequirements for GHGs for large new and modified stationary sources, such aspower plants.  These regulations willbecome applicable in 2011.

 

***Clean Air Interstate Rule (CAIR)*** — InMarch 2005, the EPA issued the CAIR to further regulate sulfur dioxide (SO2) and nitrogen oxide (NOx)emissions.  The objective of CAIR is tocap emissions of SO2 and NOx in the eastern United States,including Texas.  In 2008, the U. S.Court of Appeals for the District of Columbia vacated and remanded CAIR.  On July 6, 2010, the EPA issued theproposed Clean Air Transport Rule (CATR), which would replace CAIR byrequiring SO2 and NOx reductions in 31 states and theDistrict of Columbia.  The EPA isproposing to reduce these emissions through federal implementation plans foreach affected state.  The EPA’s preferredapproach would set emission limits for each state and allow limited interstateemissions trading.  As proposed, CATRwill impact operations in Texas in the form of ozone season NOx emissionallowances.  SPS is analyzing theproposed rule to determine whether emission reductions are needed fromfacilities.  Until CATR becomes final,Xcel Energy will continue activities to support CAIR compliance.

 

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 scheduled capital investments for NOx controls in the SPS region areestimated at $16.4 million.  For2009, the NOx allowance compliance costs were $1.7 million.  The estimated NOx allowance cost for 2010 is$1.2 million.  Annual purchases ofSO2 allowances are estimated in the range of$1.7 million to $7.7 million each year, beginning in 2013, forphase I.  Allowance cost estimatesfor SPS are based on fuel quality and current market data.  Xcel Energy believes the cost of any requiredcapital investment or allowance purchases will be recoverable from customers inrates.

 

***Clean Air Mercury Rule (CAMR)***— InMarch 2005, the EPA issued the CAMR, which regulated mercury emissionsfrom power plants.  The Texas Commissionon Environmental Quality (TCEQ) adopted by reference the EPA modelprogram.  In February 2008, the U.S. Court of Appeals for the District of Columbia vacated CAMR, which impactedfederal CAMR requirements, but not necessarily state-only mercury legislationand rules.  The EPA has agreed tofinalize Maximum Achievable Control Technology emission standards for allhazardous air pollutants from electric utility steam generating units byNovember 2011 to replace CAMR.  SPSanticipates that the EPA will require affected facilities to demonstratecompliance within 18 to 36 months thereafter.  At this time, Texas has not adopted anystate-only mercury requirements.

 

***Regional Haze Rules ***— In June 2005, the EPAfinalized amendments to the July 1999 regional haze rules.  These amendments apply to the provisions ofthe regional haze rule that require emission controls, known as bestavailable retrofit technology (BART), for industrial facilities emitting airpollutants that reduce visibility by causing or contributing to regionalhaze.  Some of SPS’ generating facilitieswill be subject to BART requirements. Some of these facilities are located in regions where CAIR iseffective.  The TCEQ had determined thatfacilities may use CAIR as a substitute for BART for NOx and SO2.

 

11

----

Table ofContents

 

***Proposed Coal Ash Regulation***—  In June 2010, the EPA published aproposed rule seeking comment on whether to regulate coal combustionbyproducts (often referred to as coal ash) as a special waste (subject tomany of the requirements for hazardous waste) or as a solid(nonhazardous) waste.  Coal ash is currently exempt from hazardouswaste regulation.  The EPA’s proposalwould result in more comprehensive and expensive requirements related tomanagement and disposal of coal ash. There is a 90-day comment deadline to submit comments on the rule, butrequests for extension of time to submit comments have been submitted to theEPA.  The EPA is also seekingcomment on what regulations are appropriate for the beneficial reuse ofcoal ash.  The timing, scope and potential cost of any final rule thatmight be implemented are not determinable at this time.

 

***Cunningham Draft Compliance Order***— OnFeb. 18, 2010, SPS received a draft compliance order from the New MexicoEnvironment Department (NMED) for Cunningham Station.  In the draft order, NMED alleges thatCunningham exceeded its permit limits for NOx on 7,336 occasions and failed toreport these exceedances as required by its permit.  The draft order included a proposed penaltyof $16.1 million.  SPS denies theseallegations and is negotiating with the NMED regarding the alleged violationsand proposed penalty prior to the issuance of a final order.

 

**LegalContingencies**

 

Lawsuitsand claims arise in the normal course of business. Management, afterconsultation with legal counsel, has recorded an estimate of the probable costof 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.

 

**EnvironmentalLitigation**

 

***Carbon Dioxide (CO******2******) Emissions Lawsuit —***In 2004, theattorneys 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 parentcompany of SPS, to force reductions in CO2 emissions.  The other utilities include American ElectricPower Co., Southern Co., Cinergy Corp. and Tennessee Valley Authority.  The lawsuits allege that CO2 emitted by each company is a publicnuisance.  The lawsuits do not demandmonetary damages.  Instead, the lawsuitsask the court to order each utility to cap and reduce its CO2 emissions. On Sept. 19, 2005, the court granted a motion to dismiss onconstitutional grounds.  On appeal in September 2009,the U. S. Court of Appeals for the Second Circuit reversed the lower courtdecision.  Defendants anticipate filing apetition for review with the U. S. Supreme Court.

 

***Comer vs. Xcel Energy Inc. etal. —***In 2006, Xcel Energy, the parent company of SPS,received notice of a purported class action lawsuit filed in U. S. DistrictCourt in the Southern District of Mississippi. The lawsuit names more than 45 oil, chemical and utility companies,including Xcel Energy, as defendants and alleges that defendants’ CO2 emissions “were a proximate and direct causeof the increase in the destructive capacity of Hurricane Katrina.”  Plaintiffs allege negligence and public andprivate nuisance and seek damages related to the loss resulting from thehurricane.  Xcel Energy believes thislawsuit is without merit and intends to vigorously defend itself against theseclaims.  In August 2007, the courtdismissed the lawsuit in its entirety against all defendants on constitutionalgrounds.  Plaintiffs filed a notice ofappeal to the U. S. Court of Appeals for the Fifth Circuit.  In October 2009, the U. S. Court ofAppeals for the Fifth Circuit reversed the district court decision, in part,concluding that the plaintiffs pleaded sufficient facts to overcome theconstitutional challenges that formed the basis for dismissal by the districtcourt.  A subsequent petition bydefendants, including Xcel Energy, for en banc review was granted.  On May 28, 2010, the U. S. Court ofAppeals for the Fifth Circuit ruled that it lacked an en banc quorum of nineactive members to hear the case.  It dismissedthe appeal, which resulted in the reinstatement of the district court’s opiniondismissing the case.

 

***Native Village of Kivalina vs. XcelEnergy Inc. et al. —***In 2008, the City and NativeVillage of Kivalina, Alaska, filed a lawsuit in U. S. District Court for theNorthern District of California against Xcel Energy, the parent company of SPS,and 23 other utilities, oil, gas and coal companies.  Plaintiffs claim that defendants’ emission ofCO2 and other GHGs contribute to global warming,which is harming their village.  XcelEnergy believes the claims asserted in this lawsuit are without merit andjoined with other utility defendants in filing a motion to dismiss onJune 30, 2008.  In October 2009,the U. S. District Court dismissed the lawsuit on constitutional grounds.  In November 2009, plaintiffs filed anotice of appeal to the U. S. Court of Appeals for the Ninth Circuit.  It is unknown when the Ninth Circuit willrender a final opinion.

 

12

----

Table of Contents

 

**7.****             ****Short-TermBorrowings and Other Financing Instruments**

 

***Commercial Paper —***The following table presentscommercial paper outstanding for SPS:

 
| **(Millions of Dollars)**           | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Commercial paper outstanding                  |       | $                      | 24         |                   | $          | — |   |
| Weighted average interest rate                |       | 0.41                   | %          | N/A                    | %          |
| Total commercial paper available for issuance |       | $                      | 248        |                   | $          | 248 |   |

 

***Money Pool*** — Xcel Energy and its utility subsidiaries have established a money poolarrangement that allows for short-term investments in and borrowings from theutility subsidiaries between each other. The holding company may make investments in the utility subsidiaries atmarket-based interest rates; however, the utility money pool arrangement doesnot allow the utility subsidiaries to make investments in the holding company.

 

The following table presentsthe money pool investments (borrowings) for SPS:

 
| **(Millions of Dollars)** | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|-------------------------------------|------------|------------------------|------------|------------------------|------------|
| Money pool (borrowings) investments |       | $                      | (19        | )                      | $          | 77 |   |
| Weighted average interest rate      |       | 0.40                   | %          | 0.36                   | %          |
| Money pool borrowing limit          |       | $                      | 100        |                   | $          | 100 |   |

 

**8.   Long-Term Borrowings and Other FinancingInstruments**

 

InFebruary 2010, SPS redeemed its $25.0 million pollution controlobligations, securing pollution control revenue bonds, due July 1, 2016.

 

**9.   Derivative Instruments and Fair ValueMeasurements**

 

SPSmay enter into derivative instruments, including forward contracts, futures,swaps and options, to reduce risk in connection with changes in interest ratesand electric utility commodity prices.

 

***Short-Term Wholesale and Commodity Trading Risk —***SPS conducts animmaterial amount of short-term wholesale and commodity trading activities,including the purchase and sale of electric capacity, energy and energy relatedinstruments.  SPS’ risk management policyallows management to conduct these activities within guidelines and limitationsas approved by its risk management committee, which is made up of managementpersonnel not directly involved in the activities governed by the policy.

 

***Interest Rate Derivatives —***SPS may enterinto various instruments that effectively fix the interest payments on certainfloating rate debt obligations or effectively fix the yield or price on aspecified benchmark interest rate for a specific period.  These derivative instruments are generallydesignated as cash flow hedges for accounting purposes.

 

AtJune 30, 2010, accumulated other comprehensive losses related to interestrate derivatives included $0.2 million of net losses expected to bereclassified into earnings during the next 12 months as the related hedgedinterest rate transactions impact earnings.

 

Accumulatedother comprehensive losses related to interest rate derivatives reclassifiedinto earnings during the three months ended June 30, 2010 and June 30,2009 were $0.1 million and $0.3 million, respectively.  Accumulated other comprehensive lossesrelated to interest rate derivatives reclassified into earnings during the sixmonths ended June 30, 2010 and June 30, 2009 were $0.1 million and$0.5 million, respectively.

 

***Commodity Derivatives —***SPS may enterinto derivative instruments to manage variability of future cash flows fromchanges in commodity prices in its electric utility operations.  This could include the purchase or sale ofenergy or energy-related products.  At June 30,2010 and Dec. 31, 2009, SPS held no commodity derivatives.  Changes in the fair value of non-tradingcommodity derivative instruments are recorded in other comprehensive income ordeferred as a regulatory asset or liability. The classification as a regulatory asset or liability is based on thecommission approved regulatory recovery mechanisms.

 

13

----

Table ofContents

 

Thefollowing table shows the major components of derivative instruments valuationin the balance sheets:

 
| ** **                           | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **Derivative**              | ** ** | **Derivative**              | ** ** | **Derivative** | ** ** | **Derivative** | ** ** |
| ** **                           | ** ** | **Instruments**             | ** ** | **Instruments**             | ** ** | **Instruments** | ** ** | **Instruments** | ** ** |
| ** **                           | ** ** | **Valuation -**        | ** ** | **Valuation -**        | ** ** | **Valuation -** | ** ** | **Valuation -** | ** ** |
| **(Thousands of Dollars)** | ** ** | **Assets**                  | ** ** | **Liabilities**             | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
| Long-term purchased power agreements |       | $                           | 76,572     |                        | $          | 50,393 |   | $ | 76,551 |   | $ | 52,242 |   |
|                                      |            |                             |            |                             |            |  |  |  |  |  |  |  |  |

 

In 2003, as a result ofimplementing new guidance on the normal purchase exception for derivativeaccounting contained in *ASC 815 Derivativesand Hedging*, SPS began recording several long-term purchased poweragreements at fair value due to accounting requirements related to underlyingprice adjustments.  As these purchasesare recovered through normal regulatory recovery mechanisms in the respectivejurisdictions, the changes in fair value for these contracts were offset byregulatory assets and liabilities. During 2006, SPS qualified these contracts under the normal purchaseexception.  Based on this qualification,the contracts are no longer adjusted to fair value and the previous carryingvalue of these contracts will be amortized over the remaining contract livesalong with the offsetting regulatory assets and liabilities.

 

***Financial Impact of Qualifying Cash FlowHedges —***The impact of qualifying interest rate cash flowhedges on SPS’ accumulated other comprehensive income, included as a componentof common stockholder’s equity, is detailed in the following table:

 
| ** **                                                                           | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| **(Thousands of Dollars)**                                                 | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| Accumulated other comprehensive loss related to  cash flow hedges at April 1    |       | $                                    | (1,804     | ) | $ | (5,400 | ) |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 42                                   |       | 161 |   |
| Accumulated other comprehensive loss related to  cash flow hedges at June 30    |       | $                                    | (1,762     | ) | $ | (5,239 | ) |

 
| ** **                                                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(Thousands of Dollars)**                                                 | ** ** | **2010**                           | ** ** | **2009** | ** ** |
| Accumulated other comprehensive loss related to  cash flow hedges at Jan. 1     |       | $                                  | (1,847     | ) | $ | (5,559 | ) |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 85                                 |       | 320 |   |
| Accumulated other comprehensive loss related to  cash flow hedges at June 30    |       | $                                  | (1,762     | ) | $ | (5,239 | ) |

 

***Fair Value Measurements***

 

*ASC 820Fair Value Measurements and Disclosures* provides a singledefinition of fair value and requires enhanced disclosures about assets andliabilities measured at fair value. A hierarchal framework for disclosing theobservability of the inputs utilized in measuring assets and liabilities atfair value is established by this guidance. The three levels in the hierarchyare 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 reported date.  The types of assets and liabilities includedin Level 3 are those with inputs requiring significant management judgment orestimation.

 

SPS had no assets orliabilities measured at fair value on a recurring basis as of June 30,2010 and Dec. 31, 2009.

 

14

----

 

Table of Contents

 

**10.   FinancialInstruments**

 

The estimated fair values ofSPS’ recorded financial instruments are as follows:

 
| ** **                           | ** ** | **June 30, 2010** | ** ** | **Dec. 31, 2009** | ** ** |
|--------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                           | ** ** | **Carrying**           | ** ** | ** **             | ** ** | **Carrying** | ** ** | ** ** | ** ** |
| **(Thousands of Dollars)** | ** ** | **Amount**             | ** ** | **Fair Value**         | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| Other investments                    |       | $                      | 248        |                   | $          | 248 |   | $ | 263 |   | $ | 263 |   |
| Long-term debt                       |       | 897,606                |       | 1,001,079              |       | 922,447 |   | 977,029 |   |
|                                      |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

The fair values of cash andcash equivalents, notes and accounts receivable and notes and accounts payableare not materially different from their carrying amounts.  The fair value of SPS’ long-term investmentsare estimated based on quoted market prices for those or similarinvestments.  The fair value of SPS’long-term debt is estimated based on the quoted market prices for the same orsimilar issues or the current rates for debt of the same remaining maturitiesand credit quality.

 

The fair value estimatespresented are based on information available to management as of June 30,2010 and Dec. 31, 2009.  These fairvalue estimates have not been comprehensively revalued for purposes of thesefinancial statements since that date and current estimates of fair value maydiffer significantly.

 

***Letters of Credit*** — SPS uses letters of credit,generally with terms of one year, to provide financial guarantees for certainoperating obligations.  At June 30,2010 there were no letters of credit outstanding.  At Dec. 31, 2009, there were $10.0million of letters of credit outstanding. The contract amounts of these letters of credit approximate their fairvalues and are subject to fees determined in the marketplace.

 

**11.   Other Income(Expense), Net**

 

Other income (expense), net,consisted of the following:

 
| ** **                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(Thousands of Dollars)** | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Interest income (expense)            |       | $                                    | 34         |                               | $          | (89 | ) | $ | 97 |   | $ | 192 |   |
| Other nonoperating income            |       | 10                                   |       | 1                                  |       | 11 |   | 5 |   |
| Insurance policy income (expense)    |       | 75                                   |       | (224                               | )          | 5 |   | (144 | ) |
| Other nonoperating expense           |       | —                               |       | (11                                | )          | — |   | (11 | ) |
| Other income (expense), net          |       | $                                    | 119        |                               | $          | (323 | ) | $ | 113 |   | $ | 42 |   |

 

**12.    SegmentInformation**

 

SPShas one reportable segment.  SPS operatesin the regulated electric industry, providing wholesale and retail electricservice in the states of Texas and New Mexico. Revenues from external customers were $398.4 million and $328.1 millionfor the three months ended June 30, 2010 and 2009, respectively, and$779.9 million and $697.1 million for the six months ended June 30, 2010and 2009, respectively.

 

**13.    ComprehensiveIncome**

 

The components of totalcomprehensive income are shown below:

 
| ** **                                                                           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| **(Thousands of Dollars)**                                                           | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income                                                                           |       | $                                    | 24,396     |                               | $          | 16,808 |   | $ | 32,095 |   | $ | 25,990 |   |
| Other comprehensive income:                                                          |       |                                 |       |                               |       |   |   |   |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings |       | 42                                   |       | 161                                |       | 85 |   | 320 |   |
| Comprehensive income                                                                 |       | $                                    | 24,438     |                               | $          | 16,969 |   | $ | 32,180 |   | $ | 26,310 |   |

 

15

----

Table of Contents

 

**14.    Benefit Plans and Other PostretirementBenefits**

 

Pension and otherpostretirement benefit disclosures below generally represent Xcel Energy consolidatedinformation unless specifically identified as being attributable to SPS.

 

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

 
| ** **                                                                                 | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                             | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                 | ** ** | ** **                           | ** ** | **Postretirement Health** | ** ** |
| **(Thousands of Dollars)**                                                       | ** ** | **Pension Benefits**                 | ** ** | **Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                                                       | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** |
| Service cost                                                                               |       | $                                    | 18,956     |   | $ | 16,744 |   | $ | 965 |   | $ | 1,057 |   |
| Interest cost                                                                              |       | 41,853                               |       | 43,046 |   | 10,861 |   | 13,050 |   |
| Expected return on plan assets                                                             |       | (58,035                              | )          | (64,909 | ) | (7,131 | ) | (5,993 | ) |
| Amortization of transition obligation                                                      |       | —                               |       | — |   | 3,611 |   | 3,726 |   |
| Amortization of prior service cost (credit)                                                |       | 5,164                                |       | 6,154 |   | (1,233 | ) | (711 | ) |
| Amortization of net loss                                                                   |       | 13,134                               |       | 3,299 |   | 3,113 |   | 4,779 |   |
| Net periodic benefit cost                                                                  |       | 21,072                               |       | 4,334 |   | 10,186 |   | 15,908 |   |
| Costs not recognized and additional cost recognized  due to the effects of regulation |       | (6,314                               | )          | (959 | ) | 973 |   | 973 |   |
| Net benefit cost recognized for financial  reporting                                       |       | $                                    | 14,758     |   | $ | 3,375 |   | $ | 11,159 |   | $ | 16,881 |   |
|                                                                                       |       |                                 |       |   |   |   |   |   |   |
| **SPS**                                                                                    |       |                                 |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for financial  reporting                              |       | $                                    | 1,709      |   | $ | (1,544 | ) | $ | 972 |   | $ | 1,309 |   |

 
| ** **                                                                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                           | ** ** | **2009** | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                 | ** ** | ** **                         | ** ** | **Postretirement Health** | ** ** |
| **(Thousands of Dollars)**                                                       | ** ** | **Pension Benefits**               | ** ** | **Care Benefits** | ** ** |
| **Xcel Energy Inc.**                                                                       | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                                               |       | $                                  | 36,574     |   | $ | 32,730 |   | $ | 2,003 |   | $ | 2,333 |   |
| Interest cost                                                                              |       | 82,505                             |       | 84,895 |   | 21,390 |   | 25,206 |   |
| Expected return on plan assets                                                             |       | (116,159                           | )          | (128,269 | ) | (14,265 | ) | (11,388 | ) |
| Amortization of transition obligation                                                      |       | —                             |       | — |   | 7,222 |   | 7,222 |   |
| Amortization of prior service cost (credit)                                                |       | 10,328                             |       | 12,309 |   | (2,466 | ) | (1,363 | ) |
| Amortization of net loss                                                                   |       | 24,158                             |       | 6,228 |   | 5,822 |   | 9,665 |   |
| Net periodic benefit cost                                                                  |       | 37,406                             |       | 7,893 |   | 19,706 |   | 31,675 |   |
| Costs not recognized and additional cost  recognized due to the effects of regulation |       | (13,640                            | )          | (1,446 | ) | 1,946 |   | 1,946 |   |
| Net benefit cost recognized for financial  reporting                                       |       | $                                  | 23,766     |   | $ | 6,447 |   | $ | 21,652 |   | $ | 33,621 |   |
|                                                                                       |       |                               |       |   |   |   |   |   |   |
| **SPS**                                                                                    |       |                               |       |   |   |   |   |   |   |
| Net benefit cost (credit) recognized for financial  reporting                              |       | $                                  | 2,897      |   | $ | (3,322 | ) | $ | 1,801 |   | $ | 2,500 |   |

 

16

----

Table ofContents

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

Discussion of financialcondition and liquidity for SPS is omitted per conditions set forth in generalinstructions H (1) (a) and (b) of Form 10-Q for whollyowned subsidiaries. It is replaced with management’s narrative analysis of theresults of operations set forth in general instructions H (2) (a) ofForm 10-Q for wholly owned subsidiaries (reduced disclosure format).

 

**Forward-LookingStatements**

 

The following discussion andanalysis by management focuses on those factors that had a material effect onSPS’ financial condition, results of operations, and cash flows during theperiods presented, or are expected to have a material impact in the future. Itshould be read in conjunction with the accompanying unaudited financialstatements and the related notes to the financial statements.  Due to the seasonality of SPS’ electricsales, such interim results are not necessarily an appropriate base from whichto project annual results.  Except forthe historical statements contained in this report, the matters discussed inthe following discussion and analysis are forward-looking statements that aresubject to certain risks, uncertainties and assumptions. Such forward-lookingstatements are intended to be identified in this document by the words “anticipate,”“believe,” “estimate,” “expect,” “intend,” “may,” “objective,” “outlook,” “plan,”“project,” “possible,” “potential,” “should” and similar expressions. Actualresults may vary materially. Forward-looking statements speak only as of thedate they are made, and we do not undertake any obligation to update them toreflect changes that occur after that date. Factors that could cause actualresults to differ materially include, but are not limited to: general economicconditions, including the availability of credit and its impact on capitalexpenditures and the ability of SPS to obtain financing on favorable terms;business conditions in the energy industry; actions of credit rating agencies;competitive factors, including the extent and timing of the entry of additionalcompetition in the markets served by SPS; unusual weather; effects ofgeopolitical events, including war and acts of terrorism; state, federal andforeign legislative and regulatory initiatives that affect cost and investmentrecovery, have an impact on rates or have an impact on asset operation orownership or impose environmental compliance conditions; structures that affectthe speed and degree to which competition enters the electric market; costs andother effects of legal and administrative proceedings, settlements,investigations and claims; environmental laws and regulations; actions ofaccounting regulatory bodies; the items described under Factors AffectingResults of Continuing Operations; and the other risk factors listed from timeto time by SPS in reports filed with the SEC, including “Risk Factors” in Item1A of SPS’ Form 10-K for the year ended Dec. 31, 2009, and Item 1Aand Exhibit 99.01 to this Quarterly Report on Form 10-Q for thequarter ended June 30, 2010.

 

**MarketRisks**

 

SPS is exposed to marketrisks, including changes in commodity prices and interest rates, as disclosedin Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in itsAnnual Report on Form 10-K for the year ended Dec. 31, 2009.  Commodity price and interest rate risks forSPS are mitigated in most jurisdictions due to cost-based rate regulation.

 

Distressin the financial markets may impact the fair value of the debt and equitysecurities in pension and postretirement health care plan trusts, as well asSPS’s ability to earn a return on short-term investments of excess cash.  As of June 30, 2010, there have been nomaterial changes to market risks from that set forth in SPS’s Annual Report onForm 10-K for the year ended Dec. 31, 2009.

 

**Results ofOperations**

 

SPS’ net income wasapproximately $32.1 million for the first six months of 2010, compared with netincome of approximately $26.0 million for the first six months of 2009.  The increase is due to new electric ratesthat went into effect in February 2009 and July 2009, the resolutionof certain fuel cost allocation issues in the second quarter, (see furtherdiscussion in Note 5. Rate Matters), and electric sales growth which werepartially offset by higher operating costs.

 

**Electric Revenues and Margin**

 

Electric fuel and purchasedpower expenses tend to vary with changing retail and wholesale salesrequirements and unit cost changes in fuel and purchased power.  The fuel and purchased power cost recoverymechanisms of the Texas and New Mexico jurisdictions may not allow for completerecovery of all expenses and, therefore, changes in fuel or purchased powercosts can impact earnings.

 

17

----

Tableof Contents

 

***Electric***—******The following tables detailthe electric revenues and margin:

 
| ** **                        | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------|------------|------------------------------------|------------|
| **(Millions of Dollars)**         | ** ** | **2010**                           | ** ** | **2009** | ** ** |
| Electric revenues                 |       | $                                  | 780        |   | $ | 697 |   |
| Electric fuel and purchased power |       | (500                               | )          | (444 | ) |
| Electric margin                   |       | $                                  | 280        |   | $ | 253 |   |

 

Thefollowing tables summarize the components of the changes in electric revenuesand electric margin:

 

***Electric Revenues***

*** ***
| **(Millions of Dollars)**                        | ** ** | **2010 vs. 2009** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|
| Fuel and purchased power cost recovery           |       | $                 | 72         |   |
| Fuel cost allocation regulatory accruals         |       | 11                |       |
| Sales mix and demand revenue                     |       | 8                 |       |
| Retail rate increases (New Mexico)               |       | 6                 |       |
| Estimated impact of weather                      |       | 4                 |       |
| Retail sales increase (excluding weather impact) |       | 4                 |       |
| Trading                                          |       | (3                | )          |
| Non-fuel riders                                  |       | (2                | )          |
| Other, net                                       |       | (17               | )          |
| Total increase in electric revenues              |       | $                 | 83         |   |

 

***Electric Margin***

*** ***
| **(Millions of Dollars)**                        | ** ** | **2010 vs. 2009** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|
| Fuel cost allocation regulatory accruals         |       | $                 | 11         |   |
| Sales mix and demand revenue                     |       | 8                 |       |
| Retail rate increases (New Mexico)               |       | 6                 |       |
| Estimated impact of weather                      |       | 4                 |       |
| Retail sales increase (excluding weather impact) |       | 4                 |       |
| Non-fuel riders                                  |       | (2                | )          |
| Transmission revenue, net of expense             |       | (1                | )          |
| Firm wholesale                                   |       | (1                | )          |
| Other, net                                       |       | (2                | )          |
| Total increase in electric margin                |       | $                 | 27         |   |

 

18

----

Table of Contents

 

**Non-FuelOperating Expense and Other Items**

 

***Other Operating and Maintenance Expenses****—*Other operating and maintenance expenses for the first six months of2010 increased $10.6 million, or 9.7 percent, compared to first six months of2009.  The following summarizes thecomponents of the changes for the six months ended June 30:

 
| **(Millions of Dollars)**                                    | ** ** | **2010 vs. 2009** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|
| Higher employee benefit costs                                |       | $                 | 4          |   |
| Higher labor costs                                           |       | 2                 |       |
| Higher plant generation costs                                |       | 2                 |       |
| Other, net (including contract labor and employee  expenses) |       | 3                 |       |
| Total increase in other operating and maintenance  expenses  |       | $                 | 11         |   |

 

***Allowance for Funds Used During Construction, Debt and Equity (AFUDC)***—AFUDCdecreased by approximately $0.8 million for the first six months of 2010compared with 2009.  This decrease wasprimarily due to lower AFUDC rates, primarily driven by lower interest rates.

 

***Interest Charges***— Interestcharges for the first six months of 2010 decreased by approximately $1.8million, or 5.3 percent, compared with 2009. The decrease was primarily due to retirement of long-term debt in March 2009and interest paid on partial refunds to wholesale customers in 2009.

 

***Income Taxes***— Income taxexpense increased by $8.9 million for the first six months of 2010, comparedwith the first six months of 2009.  The increase in income tax expense wasprimarily due to an increase in pretax income and a write-off of tax benefitspreviously recorded for Medicare Part D subsidies.  The effective taxrate was 42.5 percent for the first six months of 2010, compared with 36.3percent for the same period in 2009.  The higher effective tax rate forthe first six months of 2010 was primarily due to a higher forecasted annualeffective tax rate and the write-off of tax benefit for Medicare Part Dsubsidies in 2010.  Without this write-off, the effective tax rate for thefirst six months of 2010 would have been 39.2 percent.

 

**Factors Affecting Results of Continuing Operations**

 

**PublicUtility Regulation**

 

***Jones Certificate of Convenience andNecessity (CCN)*****—**SPS applied for a CCN in Texas with the PUCT.  The parties reached a settlement recommendingapproval.  The PUCT is expected to act inthe third quarter of 2010.  A similar CCNapproval application was made with the NMPRC. The matter has been referred to an ALJ and settlement revisions areanticipated.

 

***New Mexico Energy Efficiency Disincentive Rulemaking*******—** During the 2008 New Mexico legislativesession, increased energy efficiency goals and more affirmative disincentivelanguage were adopted.  In 2010, theNMPRC adopted an amended rule incorporating the legislative changes.  The rule has an interim mechanism thatprovides for recovery of disincentives and recently required utilities to filepermanent rate design or other means of removing disincentives by July 1,2010.

 

In June 2010, SPS filedits application for approval of its interim incentive.  That same month, an appeal of the rule wasfiled by the Attorney General with the New Mexico Supreme Court and the NewMexico Industrial Energy Consumers.  In July 2010,SPS filed its application regarding permanent solutions to removingdisincentives and requested direct lost margin recovery.

 

**Summary of Recent Federal RegulatoryDevelopments**

 

TheFERC has jurisdiction over rates for electric transmission service ininterstate commerce and electricity sold at wholesale, accounting practices andcertain other activities of SPS, including enforcement of North AmericanElectric Reliability Corporation (NERC) mandatory electric reliabilitystandards. 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 onForm 10-K for the year ended Dec. 31, 2009.  In addition to the matters discussed below,see Note 5 to the financial statements for a discussion of other regulatorymatters.

 

19

----

Table ofContents

 

***Southwest Power Pool, Inc. (SPP)Transmission Cost Recovery — ***TheSPP transmission tariff currently establishes the mechanism forrecovering costs associated with transmission projects. Currently, for base plan transmission projects, one-third of thecosts are collected on an SPP region-wide basis and the remaining two-thirdsare recovered from individual pricing zone(s) in SPP using a power flowanalysis.  For balanced portfolio projects, 100 percent of thecosts are recovered on an SPP region-wide basis.  In March 2010, theSPP board approved the tariff filing for this cost allocation methodology asfollows:

 

·                  For projectsrated at a voltage level less than 100 KV, all costs wouldbe recovered from the pricing zone of the project;

·                  For projectsrated at a voltage level between 100 KV and 300 KV, one-third of thecosts would be recovered on an SPP region-wide basis and two-thirds would berecovered from the pricing zone of the project; and

·                  For projectsrated at a voltage level greater than 300 KV, 100 percentof costs would be recovered on an SPP region-wide basis.

 

TheFERC approved the SPP transmission cost allocation plan, effective June 2010.  The SPP transmission cost allocationmethodology will allow the costs of priority projects constructed in the SPSrate zone to be regionalized, but SPS will share in the costs of priorityprojects built in other SPP rate zones.

 

***Electric Reliability Standards Compliance***

 

ComplianceAudits

In2008, SPS filed a self-report with the SPP regional entity relating to failureto complete certain generation station battery tests, relay maintenanceintervals and record keeping associated with certain Critical InfrastructureProtection (CIP) standards.  In 2009, SPSreached agreement with the SPP that would resolve all self reports by paymentof a non-material penalty.  In April 2010,SPS executed a definitive settlement agreement. The settlement agreement is pending approval at the NERC and will alsoneed to be approved by the FERC.

 

InMarch 2010, the SPP conducted a compliance spot check to evaluatecompliance with the NERC CIP standards, which were effective July 1,2008.  The draft non-public report issuedby the SPP in July 2010 found that that the SPS may not be in compliancewith several of the CIP standards.  XcelEnergy, the parent company of SPS, provided comments on the draft report,disagreeing with many of the conclusions and is awaiting issuance of the finalaudit report.  The CIP spot check reportfindings related to SPS will then proceed to the SPP enforcement process.  To what extent the SPP regional entity orNERC may seek to impose penalties for potential violations is unknown at thistime.

 

**Item 4. CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

SPSmaintains a set of disclosure controls and procedures designed to ensure thatinformation required to be disclosed in the reports that it files or submitsunder the Securities Exchange Act of 1934 is recorded, processed, summarized,and reported within the time periods specified in SEC rules and forms. Inaddition, the disclosure controls and procedures ensure that informationrequired to be disclosed is accumulated and communicated to management,including the chief executive officer (CEO) and chief financial officer (CFO),allowing timely decisions regarding required disclosure. As of June 30,2010, based on an evaluation carried out under the supervision and with theparticipation of SPS’s management, including the CEO and CFO, of theeffectiveness of its disclosure controls and the procedures, the CEO and CFOhave concluded that SPS’s disclosure controls and procedures were effective.

 

**Internal Control Over Financial Reporting**

 

No change in SPS’ internalcontrol over financial reporting has occurred during the most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, SPS’ internal control over financial reporting.

 

20

----

Table of Contents

 

**Part II.OTHER INFORMATION**

 

**Item 1.LEGAL PROCEEDINGS**

 

In the normal course ofbusiness, various lawsuits and claims have arisen against SPS. Afterconsultation with legal counsel, SPS has recorded an estimate of the probablecost of settlement or other disposition for such matters.

 

**Additional Information**

 

See Notes 5 and 6 of thefinancial 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 13 and 14 of SPS’ financialstatements in its Annual Report on Form 10-K for the year endedDec. 31, 2009 for a description of certain legal proceedings presentlypending.

 

**Item 1A****—****RISK FACTORS**

 

Exceptto the extent updated or described below, SPS’ risk factors are documented inItem 1A of Part I of its Annual Report on Form 10-K for the yearended Dec. 31, 2009, which is incorporated herein by reference.

 

***We may be subject to legislative andregulatory responses to climate change, with which compliance could bedifficult and costly.***

 

Legislativeand regulatory responses related to climate change and new interpretations ofexisting laws through climate change litigation create financial risk.Increased public awareness and concern may result in more regional and/orfederal requirements to reduce or mitigate the effects of GHGs. Numerous stateshave announced or adopted programs to stabilize and reduce GHG, and federallegislation has been introduced in both houses of Congress. Our electricgenerating facilities are likely to be subject to regulation under climatechange laws introduced at either the state or federal level within the next fewyears.

 

TheEPA has taken steps to regulate GHGs under the CAA. On Dec. 7, 2009, theEPA issued a finding that GHG emissions endanger public health and welfare, andthat motor vehicle emissions contribute to the GHGs in the atmosphere. Thisendangerment finding creates a mandatory duty for the EPA to regulate GHGs fromlight duty motor vehicles. The EPA finalized GHG efficiency standards for lightduty vehicles in spring 2010 and has promulgated permitting requirements forGHGs for large new and modified stationary sources, such as power plants.  These regulations will become applicable in2011.  We are also currently a party toclimate change lawsuits and may be subject to additional climate changelawsuits, including lawsuits similar to those described in Note 6,Commitments and Contingent Liabilities, in the notes to the financialstatements. While we believe such lawsuits are without merit, an adverseoutcome in any of these cases could require substantial capital expendituresthat cannot be determined at this time and could possibly require payment ofsubstantial penalties or damages. Defense costs associated with such litigationcan also be significant. Such payments or expenditures could affect results ofoperations, cash flows, and financial condition if such costs are not recoveredthrough regulated rates.

 

Manyof the federal and state climate change legislative proposals, such as theAmerican Clean Energy and Security Act and the proposed Kerry-Liebermanlegislation, use a cap and trade policy structure, in which GHG emissions froma broad cross-section of the economy would be subject to an overall cap. Underthe proposals, the cap becomes more stringent with the passage of time. Theproposals establish mechanisms for GHG sources, such as power plants, to obtain“allowances” or permits to emit GHGs during the course of a year. The sourcesmay use the allowances to cover their own emissions or sell them to other sourcesthat do not hold enough emission allowances for their own operations.Proponents of the cap and trade policy believe it will result in the most costeffective, flexible emission reductions. There are many uncertainties, however,regarding when and in what form climate change legislation will be enacted. Theimpact of legislation and regulations, including a cap and trade structure, onus and our customers will depend on a number of factors, including whether GHGsources in multiple sectors of the economy are regulated, the overall GHGemissions cap level, the degree to which GHG offsets are allowed, theallocation of emission allowances to specific sources and the indirect impactof carbon regulation on natural gas and coal prices. While we do not have operationsoutside of the United States, any international treaties or accords could havean impact to the extent they lead to future federal or state regulations.Another important factor is our ability to recover the costs incurred to complywith any regulatory requirements that are ultimately imposed. We may notrecover all costs related to complying with regulatory requirements imposed onus. If our regulators do not allow us to recover all or a part of the cost ofcapital investment or the O&M costs incurred to comply with the mandates,it could have a material adverse effect on our results of operations.

 

21

----

Tableof Contents

 

**Item 6.EXHIBITS**

 

----

* Indicates incorporationby reference

 
| 3.01*  |   | Amended and Restated  Articles of Incorporation dated Sept. 30, 1997 (Exhibit 3(a)(2) to  Form 10-K for the year ended Dec. 31, 1997 (file no. 001-03789)  dated March 3, 1998).                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.02*  |   | By-laws dated Sept. 29,  1997 (Exhibit 3(b)(2) to Form 10-K for the year ended  Dec. 31, 1997 (file no. 001-03789) dated March 3, 1998).                                                                                                     |
| 10.01* |   | Xcel Energy Executive  Annual Incentive Award Plan (as amended and restated effective Feb. 17,  2010) (incorporated by reference to Appendix A to Schedule 14A, Definitive  Proxy Statement to Xcel Energy Inc. (file no. 001-03034) dated April 6,  2010). |
| 10.02* |   | Xcel Energy 2005 Long-Term  Incentive Plan (as amended and restated effective Feb. 17, 2010)  (incorporated by reference to Appendix B to Schedule 14A, Definitive Proxy  Statement to Xcel Energy Inc. (file no. 001-03034) dated April 6, 2010).          |
| 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 to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorizedon August 2, 2010.

 

Southwestern Public ServiceCompany

(Registrant)

 

 
|   | /s/ TERESA S. MADDEN                        |
|--------|---------------------------------------------|
|   | Teresa S. Madden                            |
|   | Vice President and  Controller              |
|   |                                        |
|   |                                        |
|   | /s/ DAVID M. SPARBY                         |
|   | David M. Sparby                             |
|   | Vice President and Chief  Financial Officer |

 

23

----