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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

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

 

#### **For the quarterly periodended September 30, 2008**

#### ** **

**or**

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

 

#### **For the transitionperiod from          to          **

#### ** **

#### **CommissionFile Number: 001-03789**

#### ** **

**SouthwesternPublic Service Company**

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

** **

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

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. x Yes   o No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

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

 

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

 
| **Class**                  | ** ** | **Outstanding at Oct. 24, 2008** |
|----------------------------|------------|------------------------------------------------------|
| 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 such Form 10-Q.

 

 

Table of Contents

 

#### **TABLEOF CONTENTS**

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

 

This Form 10-Q is filedby Southwestern Public Service Co. (SPS). SPS is a wholly owned subsidiary ofXcel Energy Inc. (Xcel Energy). Additional information on Xcel Energy isavailable on various filings with the Securities and Exchange Commission (SEC).

 

2

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**PART 1. FINANCIAL INFORMATION**

 

**Item 1. FINANCIAL STATEMENTS**

 

**SOUTHWESTERN PUBLIC SERVICECO.**

**STATEMENTSOF INCOME (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                                             | ** ** | **Three Months Ended  Sept. 30,** | ** ** | **Nine Months Ended  Sept. 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2008**                                         | ** ** | **2007**                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                             | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating revenues**                                                                                 |       | $                                                | 610,763    |                                            | $          | 471,521 |   | $ | 1,567,433 |   | $ | 1,238,544 |   |
|                                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| **Operating expenses**                                                                                 | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Electric fuel and  purchased power                                                                     |       | 469,617                                          |       | 339,041                                         |       | 1,217,300 |   | 899,962 |   |
| Other operating and  maintenance expenses                                                              |       | 52,261                                           |       | 49,515                                          |       | 158,507 |   | 149,707 |   |
| Depreciation and  amortization                                                                         |       | 25,208                                           |       | 24,115                                          |       | 79,026 |   | 73,115 |   |
| Taxes (other than income  taxes)                                                                       |       | 11,072                                           |       | 10,117                                          |       | 31,175 |   | 30,920 |   |
| Total operating expenses                                                                               |       | 558,158                                          |       | 422,788                                         |       | 1,486,008 |   | 1,153,704 |   |
|                                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| **Operating income**                                                                                   |       | 52,605                                           |       | 48,733                                          |       | 81,425 |   | 84,840 |   |
|                                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Interest and other income,  net                                                                        |       | 1,738                                            |       | 834                                             |       | 3,967 |   | 2,164 |   |
|                                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| **Interest charges and financing  costs**                                                              | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest charges —  includes other financing costs of $597, $587, $1,778 and $1,762, respectively |       | 14,179                                           |       | 14,119                                          |       | 41,663 |   | 40,871 |   |
| Allowance for funds used  during construction — debt                                              |       | (638                                             | )          | (660                                            | )          | (1,898 | ) | (1,764 | ) |
| Total interest charges and  financing costs                                                            |       | 13,541                                           |       | 13,459                                          |       | 39,765 |   | 39,107 |   |
|                                                                                                   |       |                                             |       |                                            |       |   |   |   |   |
| Income before income taxes                                                                             |       | 40,802                                           |       | 36,108                                          |       | 45,627 |   | 47,897 |   |
| Income taxes                                                                                           |       | 17,166                                           |       | 14,956                                          |       | 19,287 |   | 19,461 |   |
| **Net income**                                                                                         |       | $                                                | 23,636     |                                            | $          | 21,152 |   | $ | 26,340 |   | $ | 28,436 |   |

 

See Notes to Financial Statements

 

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**SOUTHWESTERN PUBLIC SERVICE CO.**

**STATEMENTS OF CASH FLOWS(UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                         | ** ** | **Nine Months Ended Sept. 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Operating activities**                                                           |       |                                                |       |   |   |
| Net income                                                                         |       | $                                                   | 26,340     |   | $ | 28,436 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                                     |       | 82,271                                              |       | 75,831 |   |
| Deferred income taxes                                                              |       | 25,239                                              |       | 6,700 |   |
| Amortization of investment  tax credits                                            |       | (147                                                | )          | (188 | ) |
| Net realized and  unrealized hedging and derivative transactions                   |       | 201                                                 |       | 201 |   |
| Changes in operating  assets and liabilities:                                      |       |                                                |       |   |   |
| Accounts receivable                                                                |       | (18,748                                             | )          | (20,929 | ) |
| Accrued unbilled revenues                                                          |       | 1,289                                               |       | (50,234 | ) |
| Recoverable electric  energy costs                                                 |       | (27,690                                             | )          | 63,756 |   |
| Inventories                                                                        |       | (29,592                                             | )          | 1,197 |   |
| Prepayments and other                                                              |       | 2,712                                               |       | 1,428 |   |
| Accounts payable                                                                   |       | 2,227                                               |       | (22,106 | ) |
| Net regulatory assets and  liabilities                                             |       | (1,703                                              | )          | (6,923 | ) |
| Other current liabilities                                                          |       | 1,504                                               |       | (2,854 | ) |
| Change in other noncurrent  assets                                                 |       | (8,634                                              | )          | (5,758 | ) |
| Change in other noncurrent  liabilities                                            |       | 6,515                                               |       | (2,946 | ) |
| Net cash provided by  operating activities                                         |       | 61,784                                              |       | 65,611 |   |
|                                                                               |       |                                                |       |   |   |
| **Investing activities**                                                           |       |                                                |       |   |   |
| Utility  capital/construction expenditures                                         |       | (127,271                                            | )          | (101,584 | ) |
| Investments in utility  money pool arrangement                                     |       | —                                              |       | (95,000 | ) |
| Receipts from utility  money pool arrangement                                      |       | —                                              |       | 95,000 |   |
| Other investments                                                                  |       | 2,179                                               |       | 3,212 |   |
| Net cash used in investing  activities                                             |       | (125,092                                            | )          | (98,372 | ) |
|                                                                               |       |                                                |       |   |   |
| **Financing activities**                                                           |       |                                                |       |   |   |
| Repayment of short-term  borrowings – net                                     |       | (33,000                                             | )          | (1,000 | ) |
| Borrowings under utility  money pool arrangement                                   |       | 667,700                                             |       | 459,000 |   |
| Repayments under utility  money pool arrangement                                   |       | (577,200                                            | )          | (459,000 | ) |
| Borrowings under 5-year  unsecured credit facility                                 |       | —                                              |       | 125,000 |   |
| Capital contributions from  parent                                                 |       | 52,095                                              |       | 5,354 |   |
| Dividends paid to parent                                                           |       | (46,866                                             | )          | (52,825 | ) |
| Net cash provided by  financing activities                                         |       | 62,729                                              |       | 76,529 |   |
|                                                                               |       |                                                |       |   |   |
| Net (decrease) increase in  cash and cash equivalents                              |       | (579                                                | )          | 43,768 |   |
| Cash and cash equivalents  at beginning of period                                  |       | 714                                                 |       | 297 |   |
| Cash and cash equivalents  at end of period                                        |       | $                                                   | 135        |   | $ | 44,065 |   |
|                                                                               |       |                                                |       |   |   |
| Supplemental disclosure of  cash flow information:                                 |       |                                                |       |   |   |
| Cash paid for interest  (net of amounts capitalized)                               |       | $                                                   | 33,429     |   | $ | 35,499 |   |
| Cash paid for income taxes  (net of refunds received)                              |       | (9,416                                              | )          | 18,376 |   |
|                                                                               |       |                                                |       |   |   |
| Supplemental disclosure of  non-cash investing transactions:                       |       |                                                |       |   |   |
| Property, plant and  equipment additions in accounts payable                       |       | $                                                   | 1,215      |   | $ | 3,494 |   |

 

See the Notes to Financial Statements

 

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**SOUTHWESTERN PUBLIC SERVICE CO**.

**BALANCE SHEETS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                            | ** ** | **Sept. 30, 2008** | ** ** | **Dec. 31, 2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                       |       |                         |       |                        |       |
| Cash and cash equivalents                                                             |       | $                            | 135        |                        | $          | 714 |   |
| Accounts receivable, net                                                              |       | 84,708                       |       | 67,254                      |       |
| Accounts receivable from  affiliates                                                  |       | 10,050                       |       | 8,756                       |       |
| Accrued unbilled revenues                                                             |       | 107,036                      |       | 108,325                     |       |
| Recoverable electric  energy costs                                                    |       | 50,391                       |       | 22,701                      |       |
| Inventories                                                                           |       | 46,935                       |       | 17,343                      |       |
| Derivative instruments  valuation                                                     |       | 8,926                        |       | 8,926                       |       |
| Prepayments and other                                                                 |       | 4,737                        |       | 7,449                       |       |
| Deferred income taxes                                                                 |       | —                       |       | 2,970                       |       |
| Total current assets                                                                  |       | 312,918                      |       | 244,438                     |       |
|                                                                                  |       |                         |       |                        |       |
| Property, plant and  equipment, net                                                   |       | 2,091,051                    |       | 2,043,426                   |       |
|                                                                                  |       |                         |       |                        |       |
| Other assets:                                                                         |       |                         |       |                        |       |
| Prepaid pension asset                                                                 |       | 126,918                      |       | 117,948                     |       |
| Derivative instruments  valuation                                                     |       | 78,782                       |       | 85,477                      |       |
| Regulatory assets                                                                     |       | 113,763                      |       | 124,900                     |       |
| Other investments                                                                     |       | 291                          |       | 2,470                       |       |
| Deferred charges and other                                                            |       | 6,975                        |       | 6,855                       |       |
| Total other assets                                                                    |       | 326,729                      |       | 337,650                     |       |
| Total assets                                                                          |       | $                            | 2,730,698  |                        | $          | 2,625,514 |   |
|                                                                                  |       |                         |       |                        |       |
| **LIABILITIES AND EQUITY**                                                            |       |                         |       |                        |       |
| Current liabilities:                                                                  |       |                         |       |                        |       |
| Current portion of  long-term debt                                                    |       | $                            | 100,000    |                        | $          | — |   |
| Short-term debt                                                                       |       | 90,000                       |       | 123,000                     |       |
| Borrowings under utility  money pool arrangement                                      |       | 96,000                       |       | 5,500                       |       |
| Accounts payable                                                                      |       | 148,543                      |       | 153,130                     |       |
| Accounts payable to  affiliates                                                       |       | 10,218                       |       | 9,432                       |       |
| Taxes accrued                                                                         |       | 22,594                       |       | 22,902                      |       |
| Dividends payable to  parent                                                          |       | 14,929                       |       | 15,931                      |       |
| Accrued interest                                                                      |       | 17,654                       |       | 12,816                      |       |
| Deferred income taxes                                                                 |       | 3,449                        |       | —                      |       |
| Derivative instruments  valuation                                                     |       | 4,567                        |       | 4,468                       |       |
| Other                                                                                 |       | 21,035                       |       | 24,062                      |       |
| Total current liabilities                                                             |       | 528,989                      |       | 371,241                     |       |
|                                                                                  |       |                         |       |                        |       |
| Deferred credits and other  liabilities:                                              |       |                         |       |                        |       |
| Deferred income taxes                                                                 |       | 478,959                      |       | 462,228                     |       |
| Regulatory liabilities                                                                |       | 127,509                      |       | 133,025                     |       |
| Derivative instruments  valuation                                                     |       | 58,213                       |       | 60,918                      |       |
| Asset retirement  obligations                                                         |       | 3,233                        |       | 3,592                       |       |
| Deferred investment tax  credits                                                      |       | 2,848                        |       | 2,995                       |       |
| Pension and employee  benefit obligations                                             |       | 22,607                       |       | 23,871                      |       |
| Other                                                                                 |       | 15,686                       |       | 7,458                       |       |
| Total deferred credits and  other liabilities                                         |       | 709,055                      |       | 694,087                     |       |
|                                                                                  |       |                         |       |                        |       |
| Commitments and contingent  liabilities                                               |       |                         |       |                        |       |
| Capitalization:                                                                       |       |                         |       |                        |       |
| Long-term debt                                                                        |       | 674,131                      |       | 774,033                     |       |
| Common stock – authorized  200 shares of $1.00 par value, outstanding 100 shares |       | —                       |       | —                      |       |
| Additional paid in capital                                                            |       | 555,161                      |       | 503,066                     |       |
| Retained earnings                                                                     |       | 269,293                      |       | 289,092                     |       |
| Accumulated other  comprehensive loss                                                 |       | (5,931                       | )          | (6,005                      | )          |
| Total common stockholder’s  equity                                               |       | 818,523                      |       | 786,153                     |       |
| Total liabilities and  equity                                                         |       | $                            | 2,730,698  |                        | $          | 2,625,514 |   |

** **

**See the Notes to Financial Statements**

** **

**5**

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**Table of Contents**

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**SOUTHWESTERN PUBLICSERVICE CO.**

**NOTES TO FINANCIALSTATEMENTS (UNAUDITED)**

** **

In the opinion ofmanagement, the accompanying unaudited financial statements contain alladjustments necessary to present fairly the financial position of SPS as ofSept. 30, 2008, and Dec. 31, 2007; the results of its operations forthe three and nine months ended Sept. 30, 2008 and 2007; and its cashflows for the nine months ended Sept. 30, 2008 and 2007. All adjustmentsare of a normal, recurring nature, except as otherwise disclosed.  The Dec. 31, 2007 balance sheetinformation has been derived from the audited 2007 financial statements. Forfurther information, refer to the Financial Statements and notes thereto,included in the SPS Annual Report on Form 10-K for the year ended Dec. 31,2007, filed with the Securities and Exchange Commission on Feb. 20,2008.  Due to the seasonality of electricsales of SPS, interim results are not necessarily an appropriate base fromwhich to project annual results.

 

**1. Significant AccountingPolicies**

** **

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, 2007, appropriately represent, in all material respects,the current status of accounting policies and are incorporated herein byreference.

 

***Fair Value Measurements —***SPS presents cashequivalents and interest rate derivatives at estimated fair values in itsfinancial statements.  Cash equivalentsare recorded at cost plus accrued interest to approximate fair value.  Changes in the observed trading prices andliquidity of cash equivalents, including commercial paper and money marketfunds, are also monitored as additional support for determining fair value, andlosses are recorded in earnings if fair value falls below recorded cost.  For interest rate derivatives, quoted pricesbased primarily on observable market price curves are used as a primary inputto establish fair value.

 

**2. RecentlyIssued Accounting Pronouncements**

 

***Statement of FinancialAccounting Standards (SFAS) No. 157 Fair Value Measurements************(SFAS No. 157)****** —***InSeptember 2006, the Financial Accounting Standards Board (FASB) issuedSFAS No. 157, which provides a single definition of fair value,together with a framework for measuring it, and requires additional disclosureabout the use of fair value to measure assets and liabilities. SFAS No. 157also emphasizes that fair value is a market-based measurement, and sets out afair value hierarchy with the highest priority being quoted prices in activemarkets. Fair value measurements are disclosed by level within that hierarchy.SFAS No. 157 was effective for financial statements issued for fiscalyears beginning after Nov. 15, 2007.

 

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

 

***The Fair Value Option for Financial Assetsand Financial Liabilities — Including an Amendment of FASB Statement No. 115(SFAS No. 159)*** — In February 2007,the FASB issued SFAS No. 159, which provides companies with an option tomeasure, at specified election dates, many financial instruments and certainother items at fair value that are not currently measured at fair value. Acompany that adopts SFAS No. 159 will report unrealized gains and losseson items, for which the fair value option has been elected, in earnings at eachsubsequent reporting date. This statement also establishes presentation anddisclosure requirements designed to facilitate comparisons between entitiesthat choose different measurement attributes for similar types of assets and liabilities.This statement was effective for fiscal years beginning after Nov. 15,2007.  Effective Jan. 1, 2008, SPSadopted SFAS No. 159 and the adoption did not have a material impact onits financial statements.

 

***Business Combinations (SFAS No. 141(revised 2007)) —***In December 2007, theFASB issued SFAS No. 141R, which establishes principles and requirementsfor how an acquirer in a business combination recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest; recognizes and measures the goodwill acquiredin the business combination or a gain from a bargain purchase; and determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financial effects of the business combination. SFAS No. 141Ris to be applied prospectively to business combinations for which theacquisition date is on or after the beginning of an entity’s fiscal year thatbegins on or after Dec. 15, 2008. SPS will evaluate the impact of SFAS No. 141Ron its financial statements for any potential business combinations subsequentto Jan. 1, 2009.

 

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***Disclosures about DerivativeInstruments and Hedging Activities (SFAS No. 161)******—***In March 2008,the FASB issued SFAS No. 161, which is intended to enhance disclosures tohelp users of the financial statements better understand how derivativeinstruments and hedging activities affect an entity’s financial position,financial performance and cash flows. SFAS No. 161 amends and expands the disclosure requirements of SFASNo. 133, *Accounting for DerivativeInstruments and Hedging Activities*, to require disclosures ofobjectives and strategies for using derivatives, gains and losses on derivativeinstruments, and credit-risk-related contingent features in derivativeagreements.  SFAS No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after Nov. 15, 2008, with early application encouraged.  SPS is currently evaluating the impact ofadoption of SFAS No. 161 on its financial statements.

 

***The Hierarchy of Generally AcceptedAccounting Principles (GAAP) (SFAS No. 162)****** —***In May 2008,the FASB issued SFAS No. 162, which establishes the GAAPhierarchy, identifying the sources of accounting principles and the frameworkfor selecting the principles to be used in the preparation of financial statements.  SFAS No. 162 is effective Nov. 15,2008*.*SPS does not believe thatimplementation of SFAS No. 162 will have any material impact onits financial statements.

 

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

 

***Accounting for Income Tax Benefitsof Dividends on Share-Based Payment Awards (EITF No. 06-11)***— In June 2007,the EITF reached a consensus on EITF No. 06-11, which states that anentity should recognize a realized tax benefit associated with dividends onnonvested equity shares and nonvested equity share units charged to retainedearnings as an increase in additional paid in capital. The amount recognized inadditional paid in capital should be included in the pool of excess taxbenefits available to absorb potential future tax deficiencies on share-basedpayment awards. EITF No. 06-11 should be applied prospectively to incometax benefits of dividends on equity-classified share-based payment awards thatare declared in fiscal years beginning after Dec. 15, 2007. The adoptionof EITF No. 06-11 did not have a material impact on SPS’ financialstatements.

 

**3.  Selected BalanceSheet Data**

** **
| **(Thousands of Dollars)** | ** ** | **Sept. 30, 2008** | ** ** | **Dec. 31, 2007** | ** ** |
|--------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Accounts receivable, net:            |       |                         |       |                        |       |
| Accounts receivable                  |       | $                            | 88,471     |                        | $          | 70,420 |   |
| Less allowance for bad  debts        |       | (3,763                       | )          | (3,166                      | )          |
|                                 |       | $                            | 84,708     |                        | $          | 67,254 |   |
|                                 |       |                         |       |                        |       |
| Inventories:                         |       |                         |       |                        |       |
| Materials and supplies               |       | $                            | 16,750     |                        | $          | 14,039 |   |
| Fuel                                 |       | 30,185                       |       | 3,304                       |       |
|                                 |       | $                            | 46,935     |                        | $          | 17,343 |   |
|                                 |       |                         |       |                        |       |
| Property, plant and  equipment, net: |       |                         |       |                        |       |
| Electric utility plant               |       | $                            | 3,541,989  |                        | $          | 3,476,146 |   |
| Construction work in  progress       |       | 93,600                       |       | 78,436                      |       |
| Total property, plant and  equipment |       | 3,635,589                    |       | 3,554,582                   |       |
| Less accumulated  depreciation       |       | (1,544,538                   | )          | (1,511,156                  | )          |
|                                 |       | $                            | 2,091,051  |                        | $          | 2,043,426 |   |

 

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**4. Income Taxes**

** **

***Accounting for Uncertainty in Income Taxes— an interpretation of FASB Statement No. 109 (FIN 48)*******— SPS is a member of the Xcel Energyaffiliated group that files consolidated income tax returns. In the firstquarter of 2008, the Internal Revenue Service (IRS) completed an examination ofXcel Energy’s federal income tax returns for 2004 and 2005 (and researchcredits for 2003). The IRS did not propose any material adjustments for thosetax years. Tax year 2004 is the earliest open year and the statute oflimitations applicable to Xcel Energy’s 2004 federal income tax return remainsopen until Dec. 31, 2009. In the third quarter of 2008, the IRS commenced anexamination of tax years 2006 and 2007.

 

In the first quarter of2008, the state of Texas concluded an income tax audit through tax year2005.  No material adjustments were proposed for this audit. As ofSept. 30, 2008, SPS’ earliest open tax year in which an audit can beinitiated by state taxing authorities under applicable statutes of limitationsis 2004. There currently are no state income tax audits in progress.

 

The amount ofunrecognized tax benefits was $2.3 million and  $3.3 million on Dec. 31,2007 and Sept. 30, 2008, respectively. These unrecognized tax benefitamounts were reduced by the tax benefits associated with tax credit carryoversof $0.1 million as of Dec. 31, 2007 and Sept. 30, 2008.

 

The unrecognized taxbenefit balance included $0.3 million and $0.3 million of tax positions on Dec. 31,2007 and Sept. 30, 2008, respectively, which if recognized would affectthe annual effective tax rate. In addition, the unrecognized tax benefitbalance included $2.0 million and $3.0 million of tax positions on Dec. 31,2007 and Sept. 30, 2008, respectively, for which the ultimatedeductibility is highly certain but for which there is uncertainty about thetiming of such deductibility. A change in the period of deductibility would notaffect the effective tax rate but would accelerate the payment of cash to thetaxing authority to an earlier period.

 

The increase in theunrecognized tax benefit balance of $0.7 million from July 1, 2008 toSept. 30, 2008, was due to the addition of similar uncertain tax positionsrelated to ongoing activity. SPS’ amount of unrecognized tax benefits couldsignificantly change in the next 12 months as the IRS audit progresses and whenstate audits resume. However, at this time, it is not reasonably possible toestimate an overall range of possible change.

 

The liability for interest related to unrecognized taxbenefits is partially offset by the interest benefit associated with tax creditcarryovers. The liability for interest related to unrecognized tax benefits on Dec. 31,2007, was not material.  The change in the interest liability from Dec. 31,2007, to Sept. 30, 2008, was not material.  No amounts were accruedfor penalties as of Sept. 30, 2008.

 

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

 

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

 

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

*** ***

**Base Rate**

 

***Texas Retail Base Rate Case —***On June 12, 2008, SPS filed with thePUCT, and the 80 cities in SPS’ Texas service territory with original ratejurisdiction, a request for a Texas system retail electric general rateincrease.  The filing requests an overallincrease in annual revenues of approximately $61.3 million, or an increase of5.9 percent.  Base revenues are proposed to increase by $94.4 million,while fuel and purchased power revenues will decline by $33.1 million,primarily due to the fuel savings from SPS’ power purchases from the Hobbsgenerating facility, which is owned by Lea Power Partners, LLC (LPP).  Hobbs is a natural gascombined cycle 604-megawatt (MW) plant in New Mexico, which came on line in September 2008.

 

The rate filing is basedon a 2007 calendar year test year adjusted for known and measurable changes andincludes a requested rate of ROE of 11.25 percent, net rate base ofapproximately $989.4 million allocated to the Texas retail jurisdiction, and anequity ratio of 51.0 percent.

 

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In SPS’ last Texas ratecase, the parties agreed that SPS should seek, in this rate filing, interimrate relief of $18 million per year for the LPP purchase agreement.  The interim rates went into effect when theLPP plant came on line in September 2008. The deadline for the PUCT to act on SPS’ request is March 31, 2009.

 

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

 

OnOct. 13, 2008, the Officeof Public Utility Counsel (OPUC), the Association of XcelMunicipalities (AXM) and the Texas Industrial Energy Consumers (TIEC) filedtestimony on the revenue requirements portion of the case.

 

·                  The OPUCrecommended a reduction to SPS’ $94.4 million base revenue request of  $27.1 million based on an ROE of 9.95percent.

·                  The TIECrecommended a reduction of $28.6 million based on an ROE of 10.0 percent.

·                  The AXMrecommended a reduction of $71.7 million, based on an ROE of 9.5 percent.  AXM also recommended a $3 million disallowance of fuelcosts associated with the assignment of incremental cost to a wholesalecontract with EPE.

 

ThePUCT filed testimony on Oct. 21, 2008 recommending a reduction to SPS’$94.4 million base revenue request of $49.8 million based on an ROE of10.32 percent.

 

The remaining proceduralschedule is as follows:

 

·                  PUCT staff and intervenors cross-rebuttal testimony isexpected to be filed on Oct. 28, 2008;

·                  SPS rebuttal testimony is expected to be filed on Nov. 4,2008;

·                  The hearing on the merits is expected to begin on Nov. 12,2008; and

·                  Final order expected by March 31, 2009.

 

On June 2, 2008, SPSfiled an application for approval of an energy efficiency cost recovery factorrider.  On Sept. 15, 2008, the PUCTconcluded that the rule under which the application was filed does notapply to SPS, but that SPS should be allowed to seek recovery of the energyefficiency costs in this base rate case. On Oct. 3, 2008, SPS made a supplemental filing in the base ratecase to request recovery of the energy efficiency costs.

 

***John Deere Wind Complaint***** —** On June 27, 2007, several John Deere WindEnergy subsidiaries (JD Wind) filed a complaint against SPS disputing SPS’payments to JD Wind for energy produced from the JD Wind projects. SPSresponded that the payments to JD Wind for energy produced from its QualifyingFacility is appropriate and in accordance with SPS’ filed tariffs with thePUCT. The PUCT referred the complaint to the State Office of AdministrativeHearings.  On Aug. 14, 2008, JD Windfiled testimony claiming SPS has been underpaying JD Wind for its energy.  On Sept. 15, 2008, SPS and OccidentalPermian, Ltd., filed answering testimony. Hearings were held before anadministrative law judge (ALJ) on Oct. 13 through 16, 2008.  Thematter has yet to be briefed.  The ultimate outcome of this complaintproceeding is not known at this time.

 

**Electricand Resource Adjustment Clauses**

** **

***Transmission Cost Recovery (TCR) FactorRulemaking —***In November 2007, the PUCT adopted new rules relatingto TCR factor outside of a base rate case. The rule establishes themechanism by which SPS can request annual recovery of its reasonable andnecessary expenditures for transmission infrastructure improvement costs andchanges in wholesale transmission charges that are not included in existingrates. This new rule allows SPS more timely recovery of transmission costincreases between base rate cases.

 

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

*** ***

**BaseRate**

** **

***New Mexico Electric Rate Case —***In July 2007,SPS filed with the NMPRC requesting a New Mexico retail electric general rateincrease of $17.3 million annually, or 6.6 percent.  The rate filing was based on a 2006 test yearadjusted for known and measurable changes and included a requested ROE of11.0 percent, an electric rate base of approximately $307.3 millionand an equity ratio of 51.2 percent.

 

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OnAug. 26, 2008, the NMPRC issued its final order authorizing an overallrate increase of $10.8 million based on a 10.18 percent ROE.  This increase is based on a $7 millionelectric base rate increase and a rider to recover $3.8 million of restructuringcosts.  The NMPRC disallowed $3.5 millionin rate base for historical DSM expenditures and certain rate case and prepaidpension expenses.

 

SPSimplemented the base rates on Sept. 14, 2008. On Sept. 25, 2008, SPS filed for rehearing on certain issues.  On Oct. 14, 2008, the NMPRC denied SPS’motion for rehearing.

 

**Electric and Resource Adjustment Clauses**

 

***New Mexico Fuel Factor ContinuationFiling —***In August 2005, SPS filed with the NMPRCrequesting continuation of the use of SPS’ fuel and purchased power costadjustment clause (FPPCAC) and current monthly factor cost recoverymethodology. This filing was required by NMPRC rule.

 

Testimonywas filed in the case by staff and intervenors objecting to SPS’ assignment ofsystem average fuel costs to certain wholesale sales and the inclusion of certainpurchased power capacity and energy payments in the FPPCAC. The testimony alsoproposed limits on SPS’ future use of the FPPCAC. Related to these issues, someintervenors requested disallowances for past periods, which in the aggregatetotal approximately $45 million. This claim was for the period from Oct. 1,2001 through May 31, 2005 and does not include the value of incrementalcost assigned for wholesale transactions from that date forward. Other issuesin the case include the treatment of renewable energy certificates and sulfurdioxide (SO2)allowancecredit proceeds in relation to SPS’ New Mexico retail fuel and purchased powerrecovery clause.

 

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

 

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

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

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

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

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

 

A hearing on the merits of thesettlement was held in April 2008. On June 3, 2008, the hearing examiner certified the unanimousstipulation to the NMPRC.  The NMPRC helda hearing on Aug. 14, 2008 to enable the NMPRCto directly question the witnesses who supported the unanimousstipulation.  On Aug. 26, 2008, theNMPRC issued a final order approving the unanimous stipulation.

 

***Investigation of SPS Participationin Southwest Power Pool, Inc. (SPP)******—***In October 2007, theNMPRC issued an order initiating an investigation to consider the prudence andreasonableness of SPS’ participation in the SPP Regional TransmissionOrganization (RTO). The investigation will consider the costs and benefits ofRTO participation to SPS customers in New Mexico.  SPS filed its direct testimony on July 31,2008.

 

The following proceduralschedule has been established:

 

·                  Intervention deadline on Nov. 3,2008;

·                  Staff and intervenor direct testimony dueon Feb. 3, 2009;

·                  SPS rebuttal testimony due on March 6, 2009; and

·                  The hearing on the merits is expected to begin on March 31, 2009.

 

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

*** ***

***Wholesale Rate Complaints —***In November 2004,Golden Spread Electric, Lyntegar Electric, Farmer’s Electric, Lea CountyElectric, Central Valley Electric and Roosevelt County Electric, all wholesalecooperative customers of SPS, filed a rate complaint with the FERC allegingthat SPS’ rates for wholesale service were excessive and that SPS hadincorrectly calculated monthly fuel cost adjustment charges to such customers(the Complaint). Among other things, the complainants asserted that SPS hadinappropriately allocated average fuel and purchased power costs to otherwholesale customers, effectively raising the fuel cost charges to complainants.Cap Rock Energy Corporation (Cap Rock), another full-requirements customer ofSPS, Public Service Company of New Mexico (PNM) and OccidentalPermian Ltd. and Occidental Power Marketing, L.P. (Occidental), SPS’largest retail customer, intervened in the proceeding.

 

InMay 2006, a FERC ALJ issued an initial decision in the proceeding. The ALJfound that SPS should recalculate its wholesale fuel and purchased economicenergy cost adjustment clause (FCAC) billings for the period beginning Jan. 1,1999, to reduce the fuel and purchased power costs recovered from thecomplaining customers by deducting from such costs the incremental fuel costsattributed to SPS’ sales of system firm capacity and associated energy to otherwholesale customers served under market-based rates during this period based onthe view that such sales should be treated as opportunity sales made out oftemporarily excess capacity. In addition, the ALJ made recommendations on anumber of base rate issues including a 9.64 percent ROE and the use of a3-month coincident peak (3 CP) demand allocator.

 

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

 

·                     A $1.25 million paymentby SPS to Golden Spread related to resolve a dispute concerning the quantitiesGolden Spread was entitled to take under its existing partial requirementsagreement for the years 2006 and 2007. The Settlement caps those quantities forthe period 2008 through 2011. SPS is not required to make any fuel refunds toGolden Spread that were the subject of the Complaint under the terms of theSettlement.

 

·                     An extended partialrequirements contract at system average cost, with a capacity amount that rampsdown over the period 2012 through 2019 from 500 MW to 200 MW. The extendedagreement requires that the cost assignment treatment receive Texas and NewMexico state approvals and provides for alternative pricing terms andquantities to hold SPS harmless from cost disallowances in the event thatadverse regulatory treatment occurs or state approvals are not obtained. GoldenSpread agreed to hold SPS harmless from any future adverse regulatory treatmentregarding the proposed sale and SPS agreed to contingent payments ranging from$3 million to a maximum of $12 million, payable in 2012, in the eventthat there is an adverse cost assignment decision or a failure to obtain stateapprovals.

 

·                     Resolution of base rates inthe Complaint without any adjustment to the existing rates for the period January 2005through June 30, 2006. The Settlement also resolves all base rate issuesin SPS’ subsequent proceeding related to the period July 1, 2006 throughSept. 30, 2008, other than the method to be used to allocate demandrelated costs and provided for two sets of agreed on rates that are dependenton the ultimate resolution of that issue. If SPS prevails in its support of the12-month coincident peak (12 CP) demand allocation method, there would be no impactto earnings for this period.   Asdiscussed below, the ALJ issued an initial decision finding that SPS’ proposed12-CP demand methodology is appropriate and a hearing is not necessary.

 

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·                     For July 1, 2008 andbeyond, Golden Spread will be under a formula rate for power supply service.The rate will be based on actual data the most recent historic year adjustedfor known and measurable changes and trued up to the actual performance in the subsequentcalendar year. Initially, the formula will be based on a 10.25 percent ROEand either party will have a right to seek changes to the ROE beginning withthe 2009 formula rate filing. SPS and Golden Spread will share margins from itssales to West Texas Municipal Power Agency and El Paso Electric in that yearbut will assign system average fuel and energy costs to those agreements forpurposes of calculating Golden Spread’s monthly fuel cost.

 

***Order on Wholesale Rate Complaints******—***On April 21,2008, the FERC issued its Order on the Complaint (the Order) applied to theremaining non-settling parties.  TheOrder addresses base rate issues for the period from Jan. 1, 2005 through June 30,2006 for SPS’ full requirements customers who pay traditional cost-based ratesand requires certain refunds.

 

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

 

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

 

The FERC also ruled on two other FCA issues.  First, it required that wind contracts beevaluated on an individual contract basis rather than in aggregate.  Second, the FERC determined that an after thefact screen should be applied to all Qualifying Facility (QF) purchases todetermine if they are economic.  Whilethis review will require additional effort, it is not expected that this willresult in additional refunds as all of the individual wind contracts as well asthe QF purchases are typically economic when compared to market energy prices.

 

OnJuly 21, 2008, SPS submitted it compliance report to the FERC.  In the report, SPS has calculated the baserate refund for the 18-month period to be equal to $6.1 million and the fuelrefund to be equal to $4.4 million. Several wholesale customers have protested the calculations.  Once the final refund amounts are approved bythe FERC, interest will be added to the refund due the full requirementscustomers.  As of Sept. 30, 2008,SPS has accrued an amount sufficient to cover the estimated refund obligation.

 

***Wholesale 2005 Power Base Rate Application—***In December 2005, SPS filed for a $2.5 million increase inwholesale power rates to certain electric cooperatives. In January 2006,the FERC conditionally accepted the proposed rates for filing and the$2.5 million power rate increase became effective on July 1, 2006,subject to refund. The FERC also set the rate increase request for hearing andsettlement judge procedures. In September 2006, offers of settlement withrespect to the five full-requirements customers and with respect to PNM werefiled for approval. In September 2007, the FERC accepted the settlementwith the full-requirements customers. In September 2008, the FERC issuedan order accepting the contested partial settlement with PNM.

 

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Asnoted, the Power Base Rate Application relating to Golden Spread was settled inconjunction with the Complaint Settlement discussed above. Therefore, SPS hassettled with all parties in the Wholesale 2005 Power Base Rate Application,except for resolution with Golden Spread of the demand cost allocationmethodology.  SPS and thefull-requirements customers have requested that the demand allocation issue besummarily ruled on in SPS’ favor.  On Aug. 29,2008, the ALJ issued an initial decision finding that SPS’ proposed 12 CPdemand methodology is appropriate and a hearing is not necessary.  Therefore, SPS will owe no refunds to GoldenSpread as a result of the demand allocation methodology.  Golden Spread has accepted the recommendeddecision.  The initial decision is nowpending before the FERC for final action.

 

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

 

Theproposed rates would be updated annually each July 1 based on SPS’prior year actual costs and loads plus the revenue requirements associated withprojected current year transmission plant additions. The proposed ROE is12.7 percent, including a 50 basis point adder for SPS’ participation inthe SPP RTO. The proposed rates would provide first year incremental annualtransmission revenue for SPS of approximately $5.5 million.

 

InFebruary 2008, the FERC accepted the proposed rates, suspending theeffective date to July 6, 2008, and setting the rate filing for hearingsand settlement procedures. The FERC granted a 50 basis point adder to the ROEthat it will determine in this proceeding as a result of SPS’ participation inthe SPP RTO. The filed rates, updated for 2007 actual costs and projected 2008transmission plant additions, were placed into effect on July 6, 2008,subject to refund.  The SPS and SPP ratefilings are now in settlement procedures. The ultimate outcome of the rate filings is not known at this time.

 

***SPS 2008 Wholesale Rate Case —***On March 31, 2008, SPSfiled a wholesale rate case seeking an annual revenue increase of $14.9 millionor an overall 5.14 percent increase, based on 12.20 percentrequested ROE. On April 21, 2008, a motion for dismissal andprotest was filed by the four eastern New Mexico cooperatives.

 

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

 

InMay 2008, the FERC accepted the answer and ordered a nominal suspensionfor rates to go in to effect as of the date of commercial service of the LPPplant.  The LPP plant went intocommercial operation on Sept. 16, 2008 and the proposed rates went into effectat that time, subject to refund.  TheFERC set the rate filing for hearings and settlement procedures, and the caseis currently in settlement discussions. The ultimate outcome of the rate filings is not known at this time.

 

**6. Commitments andContingencies**

** **

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

 

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***Operating Leases*—****SPS began taking powerunder a purchased power agreement during the third quarter of 2008 that isbeing accounted for as an operating lease in accordance with EITF No. 01-8,*Determining Whether an Arrangement Containsa Lease,*and SFAS No. 13, *Accountingfor Leases*.  Futurecommitments under this purchase power agreement being accounted for as anoperating lease are:

 
| ** ** | ** ** | **Purchase Power  Agreement  Operating Leases** | ** ** |
|------------|------------|-----------------------------------------------------------|------------|
| ** ** | ** ** | **(Millions of Dollars)**                       | ** ** |
| 2008       |       | $13.0                                                     |       |   |
| 2009       |       | 44.4                                                      |       |   |
| 2010       |       | 44.4                                                      |       |   |
| 2011       |       | 44.4                                                      |       |   |
| 2012       |       | 44.4                                                      |       |   |
| Thereafter |       | 921.7                                                     |       |   |

 

***Variable Interest Entities (VIE)*—********SPS has certain long-term power purchaseagreements with independent power producing entities that contain tollingarrangements under which SPS procures the fuel required to produce the energypurchased.  SPS enters into theseagreements to meet electric system capacity and energy needs.  SPS is not subject to risk of loss from theoperations of these potential VIEs.  SPShas evaluated such entities for possible consolidation under “FASBInterpretation No. 46R Consolidation of Variable Interest Entities”.  We have concluded that SPS is not the primarybeneficiary of these entities, and therefore, these entities are not requiredto be consolidated in SPS’s financial statements.  See additional discussion of purchasedpower agreements in Note 12 of the SPS Annual Report on Form 10-K forthe year ended Dec. 31, 2007.

 

## **EnvironmentalContingencies**

## ** **

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

 

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

 

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

*** ***

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

 

## ***Other Environmental Requirements***

## ** **

***Clean Air Interstate Rule (CAIR)***—******In March 2005,the Environmental Protection Agency (EPA) issued the CAIR to further regulateSO2 and nitrogen oxide (NOx) emissions.  The objective of CAIR was to cap emissions ofSO2 and NOx in the eastern United States, including Texas.  In July 2008, a three-judge panel of theD.C. Circuit Court of Appeals vacated CAIR and remanded the rule to theEPA.  The EPA subsequently requested arehearing *en banc*, or by the fullcourt.   The D.C. Circuit Court ofAppeals has yet to rule on the EPA’s petition for rehearing.

 

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

 

***Regional Haze Rules ***—In June 2005, the EPA finalized amendments to the July 1999 regionalhaze rules. These amendments apply to the provisions of the regional haze rule thatrequire emission controls, known as best available retrofit technology (BART),for industrial facilities emitting air pollutants that reduce visibility bycausing or contributing to regional haze. Some of SPS’ generating facilities will be subject to BARTrequirements.  Some of these facilitiesare located in regions where CAIR is effective. The TCEQ had determined thatfacilities may use CAIR as a substitute for BART for NOx and SO2.  The TCEQ is currently reviewing thisdetermination in light of the D.C. Circuit Court of Appeals’ decision vacatingCAIR. The TCEQ has not indicated any desire to develop state rules at thistime.

 

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

 

**Legal Contingencies**

** **

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

 

**Environmental Litigation**

** **

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

 

***Comervs. Xcel Energy Inc. et al. —*********In April 2006,Xcel Energy received notice of a purported class action lawsuit filed in U.S.District Court in the Southern District of Mississippi.  The lawsuit names more than 45 oil, chemicaland utility companies, including Xcel Energy, the parent company of SPS, as defendants and alleges thatdefendants’ CO2emissions “were a proximate and direct cause of the increase in the destructivecapacity of Hurricane Katrina.” Plaintiffs allege in support of their claim, several legal theories,including negligence and public and private nuisance and seek damages relatedto the loss resulting from the hurricane. Xcel Energy believes this lawsuit is without merit and intends tovigorously defend itself against these claims. In August 2007, the court dismissed the lawsuit in its entiretyagainst all defendants on constitutional grounds.  In September 2007, plaintiffs filed anotice of appeal to the Fifth Circuit Court of Appeals. ***  ***Oralarguments were presented to the Court of Appeals on Aug. 6, 2008. On Sept. 26, 2008 the Court of Appealsnotified the parties that this matter was set for re-argument on Nov. 3,2008. No explanation was given for the decision.

 

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*** ***

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

## ** **

**Employment, Tort and Commercial Litigation**

 

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

 

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

 

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

 

***Commercial Paper —***AtSept. 30, 2008 and Dec. 31, 2007, SPS had commercial paperoutstanding of  $90.0 million and $123.0million, respectively.  The weightedaverage interest rates at Sept. 30, 2008 and Dec. 31, 2007 were 2.98percent and 5.58 percent, respectively.

 

***Money Pool*** — Xcel Energy has established a utility moneypool arrangement that allows for short-term loans between the utilitysubsidiaries and from the holding company to the utility subsidiaries atmarket-based interest rates. The utility money pool arrangement does not allowloans from the utility subsidiaries to the holding company. SPS has approval toborrow up to $100.0 million under the arrangement. At Sept. 30, 2008 and Dec. 31,2007, SPS had money pool borrowings of $96.0 million and $5.5 million,respectively.  The weighted averageinterest rates at Sept. 30, 2008 and Dec. 31, 2007 were 3.00 percentand 5.64 percent, respectively.

** **

***Credit Facilities***— On Oct. 10, 2008, SPS borrowed $125 million under the SPS $250 million creditagreement. SPS took this step to provide additional certainty of short-termfunding until liquidity improves in the A2/P2 commercial paper market.

** **

**8.****     DerivativeInstruments**

 

SPS uses derivative instruments in connection with its interest ratehedging, short-term wholesale, and commodity trading activities, includingforward contracts, futures, swaps and options. Qualifying hedging relationships are designated as either a hedge of aforecasted transaction or future cash flow (cash flow hedge), or a hedge of arecognized asset, liability or firm commitment (fair value hedge).  The types of qualifying hedging transactionsthat SPS is currently engaged in are discussed below.

 

**CashFlow Hedges**

 

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

 

***Interest Rate Cash Flow Hedges***— SPS enters into various instruments that effectively fix the interest paymentson certain floating rate debt obligations. These derivative instruments are designated as cash flow hedges foraccounting purposes.

 

At Sept. 30, 2008, SPS had $0.2 million of net losses inaccumulated other comprehensive income related to interest rate derivativesthat are expected to be recognized in earnings during the next 12 months.

 

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The following table showsthe major components of the derivative instruments valuation in the balancesheets at Sept. 30 and Dec. 31:

*** ***
| ** **                            | ** ** | **Sept. 30, 2008**                          | ** ** | **Dec. 31, 2007**                                | ** ** |
|---------------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(Thousands of Dollars)**  | ** ** | **Derivative  Instruments  Valuation -  Assets** | ** ** | **Derivative  Instruments  Valuation -  Liabilities** | ** ** | **Derivative  Instruments  Valuation -  Assets** | ** ** | **Derivative  Instruments  Valuation -  Liabilities** | ** ** |
| Long term  purchased power agreements |       | $                                                     | 87,708     |                                                       | $          | 56,728 |   | $ | 94,403 |   | $ | 59,419 |   |
| Interest  rate hedging instruments    |       | —                                                |       | 6,052                                                      |       | — |   | 5,967 |   |
| Total                                 |       | $                                                     | 87,708     |                                                       | $          | 62,780 |   | $ | 94,403 |   | $ | 65,386 |   |

 

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

 

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

 
| ** **                                                                              | ** ** | **Nine months ended Sept. 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Thousands of Dollars)**                                                    | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Accumulated  other comprehensive loss related to cash flow hedges at Jan. 1        |       | $                                                   | (6,005     | ) | $ | (5,860 | ) |
| After-tax  net unrealized (losses) gains related to derivatives accounted for as hedges |       | (55                                                 | )          | 117 |   |
| After-tax  net realized losses on derivative transactions reclassified into earnings    |       | 129                                                 |       | 128 |   |
| Accumulated  other comprehensive loss related to cash flow hedges at Sept. 30      |       | $                                                   | (5,931     | ) | $ | (5,615 | ) |

 

**9.Fair Value Measurements**

 

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

 

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

 

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

 

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

 

SPS had oneinterest rate derivative contract measured at fair value on a recurring basisas of Sept. 30, 2008.  SPS usesquoted prices, based primarily on observable benchmark interest rate forecasts,to measure the fair value of interest rate derivatives.  Given the observability of the primary inputsto pricing, the interest rate derivative liability of $6.1 million atSept. 30, 2008, was assigned a Level 2 under the SFAS No. 157hierarchy.

 

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

 

Interest and other income, netof nonoperating expenses, for the three and nine months ended Sept. 30consisted of the following:

 
| ** **                            | ** ** | **Three months ended  Sept. 30,** | ** ** | **Nine months ended  Sept. 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **(Thousands of Dollars)**  | ** ** | **2008**                                         | ** ** | **2007**                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                            | ** ** | ** **                                       | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  income                      |       | $                                                | 1,567      |                                            | $          | 730 |   | $ | 3,599 |   | $ | 2,184 |   |
| Other  nonoperating income            |       | 192                                              |       | 194                                             |       | 290 |   | 205 |   |
| Insurance  policy income (expenses)   |       | (21                                              | )          | (90                                             | )          | 78 |   | (225 | ) |
| Total  interest and other income, net |       | $                                                | 1,738      |                                            | $          | 834 |   | $ | 3,967 |   | $ | 2,164 |   |

 

**11. Segment Information**

 

SPS has onereportable segment.  SPS operates in theregulated electric utility industry, providing wholesale and retail electricservice in the states of Texas and New Mexico. Revenues from external customers were $610.8 million and $471.5 millionfor the three months ended Sept. 30, 2008 and 2007, respectively, and$1,567.4 million and $1,238.5 million for the nine months ended Sept. 30,2008 and 2007, respectively.

 

**12. Comprehensive Income**

 

The componentsof total comprehensive income are shown below:

 
| ** **                                                                              | ** ** | **Three months ended  Sept. 30,** | ** ** | **Nine months ended  Sept. 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| **(Thousands of Dollars)**                                                    | ** ** | **2008**                                         | ** ** | **2007**                                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                                                              |       | $                                                | 23,636     |                                            | $          | 21,152 |   | $ | 26,340 |   | $ | 28,436 |   |
| Other  comprehensive income (loss):                                                     |       |                                             |       |                                            |       |   |   |   |   |
| Unrealized  gain – marketable securities                                           |       | —                                           |       | —                                          |       | — |   | 4 |   |
| After-tax  net unrealized (losses) gains related to derivatives accounted for as hedges |       | (64                                              | )          | (390                                            | )          | (55 | ) | 117 |   |
| After-tax  net realized losses on derivative transactions reclassified into earnings    |       | 43                                               |       | 43                                              |       | 129 |   | 128 |   |
| Other  comprehensive (loss) income                                                      |       | (21                                              | )          | (347                                            | )          | 74 |   | 249 |   |
| Comprehensive  income                                                                   |       | $                                                | 23,615     |                                            | $          | 20,805 |   | $ | 26,414 |   | $ | 28,685 |   |

** **

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**Tableof Contents**

 

**13. Benefit Plans andOther Postretirement Benefits**

** **

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

 

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

 
| ** **                                                    | ** ** | **Three months ended Sept. 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008 (1)**                                    | ** ** | **2007 (1)** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **(Thousands of Dollars)**                          | ** ** | **Pension Benefits**                            | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel  Energy Inc.**                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                    | 15,851     |   | $ | 15,520 |   | $ | 1,338 |   | $ | 1,453 |   |
| Interest  cost                                                |       | 42,630                                               |       | 41,313 |   | 12,720 |   | 12,619 |   |
| Expected  return on plan assets                               |       | (68,584                                              | )          | (66,208 | ) | (7,963 | ) | (7,600 | ) |
| Amortization  of transition obligation                        |       | —                                               |       | — |   | 3,644 |   | 3,644 |   |
| Amortization  of prior service cost (credit)                  |       | 5,166                                                |       | 6,487 |   | (544 | ) | (545 | ) |
| Amortization  of net loss                                     |       | 3,185                                                |       | 4,211 |   | 2,875 |   | 3,550 |   |
| Net periodic  benefit (credit) cost                           |       | (1,752                                               | )          | 1,323 |   | 12,070 |   | 13,121 |   |
| Credits not  recognized due to the effects of regulation      |       | 2,258                                                |       | 2,787 |   | — |   | — |   |
| Additional  cost recognized due to the effects of regulation  |       | —                                               |       | — |   | 972 |   | 972 |   |
| Net benefit  cost recognized for financial reporting          |       | $                                                    | 506        |   | $ | 4,110 |   | $ | 13,042 |   | $ | 14,093 |   |
| **SPS**                                                       |       |                                                 |       |   |   |   |   |   |   |
| Net benefit  (credit) cost recognized for financial reporting |       | $                                                    | (2,620     | ) | $ | (1,909 | ) | $ | 871 |   | $ | 1,560 |   |

 

----

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

 
| ** **                                                    | ** ** | **Nine months ended Sept. 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008 (1)**                                   | ** ** | **2007 (1)** | ** ** | **2008** | ** ** | **2007** | ** ** |
| **(Thousands of Dollars)**                          | ** ** | **Pension Benefits**                           | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel  Energy Inc.**                                         | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                   | 47,553     |   | $ | 46,560 |   | $ | 4,013 |   | $ | 4,359 |   |
| Interest  cost                                                |       | 127,890                                             |       | 123,939 |   | 38,160 |   | 37,857 |   |
| Expected  return on plan assets                               |       | (205,753                                            | )          | (198,624 | ) | (23,888 | ) | (22,800 | ) |
| Amortization  of transition obligation                        |       | —                                              |       | — |   | 10,932 |   | 10,932 |   |
| Amortization  of prior service cost (credit)                  |       | 15,498                                              |       | 19,461 |   | (1,632 | ) | (1,635 | ) |
| Amortization  of net loss                                     |       | 9,555                                               |       | 12,633 |   | 8,624 |   | 10,650 |   |
| Net periodic  benefit (credit) cost                           |       | (5,257                                              | )          | 3,969 |   | 36,209 |   | 39,363 |   |
| Credits not  recognized due to the effects of regulation      |       | 6,775                                               |       | 8,361 |   | — |   | — |   |
| Additional  cost recognized due to the effects of regulation  |       | —                                              |       | — |   | 2,918 |   | 2,918 |   |
| Net benefit  cost recognized for financial reporting          |       | $                                                   | 1,518      |   | $ | 12,330 |   | $ | 39,127 |   | $ | 42,281 |   |
| **SPS**                                                       |       |                                                |       |   |   |   |   |   |   |
| Net benefit  (credit) cost recognized for financial reporting |       | $                                                   | (7,860     | ) | $ | (5,728 | ) | $ | 2,612 |   | $ | 4,679 |   |

 

----

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

 

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

** **

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

 

**Forward-LookingInformation**

 

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

 

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

 

**MarketRisks**

 

SPS is exposedto market risks, including changes in commodity prices and interest rates, asdisclosed in Item 7A — Quantitative and Qualitative Disclosures About MarketRisk in its Annual Report on Form 10-K for the year ended Dec. 31,2007 and in Item 1A — Risk Factors in this Quarterly Report on Form 10-Q.  Commodity price and interest rate risks forSPS are mitigated in most jurisdictions due to cost-based rate regulation.  Continued distress in the financial marketsmay impact the fair value of the debt and equity securities in SPS’s pensionand postretirement health care plan trusts, as well as SPS’s ability to earn areturn on short-term investments of excess cash.

 

**RESULTSOF OPERATIONS**

 

SPS’ net incomewas approximately $26.3 million for the first nine months of 2008, comparedwith net income of approximately $28.4 million for the first nine months of2007.

 

The followingsummarizes the components of the changes in base electric revenues and base electricmargin for the nine months ended Sept. 30:

 

***Base Electric Revenues***

 
| **(Millions of Dollars)**                              | ** ** | **2008 vs. 2007** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|
| Fuel and  purchased power cost recovery                          |       | $                           | 309        |   |
| Retail sales  growth (excluding weather impact)                  |       | 14                          |       |
| Firm  wholesale                                                  |       | 8                           |       |
| SPS  regulatory settlements                                      |       | 3                           |       |
| Increased  revenues due to leap year (weather-normalized impact) |       | 2                           |       |
| Retail  customer sales mix                                       |       | (7                          | )          |
| Total  increase in base electric revenues                        |       | $                           | 329        |   |

 

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

 
| **(Millions of Dollars)**                              | ** ** | **2008 vs. 2007** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------|------------|
| Retail sales  growth (excluding weather impact)                  |       | $                           | 14         |   |
| Firm  wholesale                                                  |       | 8                           |       |
| Retail fuel  recovery                                            |       | 4                           |       |
| Increased  revenues due to leap year (weather-normalized impact) |       | 2                           |       |
| Fuel  handling and procurement                                   |       | (8                          | )          |
| Retail  customer sales mix                                       |       | (7                          | )          |
| Purchased  capacity costs                                        |       | (3                          | )          |
| Other                                                            |       | 2                           |       |
| Total  increase in base electric margin                          |       | $                           | 12         |   |

 

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## **Table of Contents**

 

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

## ** **

***Other operating andmaintenance expenses****—*Other operating and maintenance expenses for the firstnine months of 2008 increased $8.8 million, or 5.9 percent, compared to firstnine months of 2007.  The followingsummarizes the components of the changes for the nine months endedSept. 30:

 
| **(Millions of Dollars)**                                    | ** ** | **2008 vs. 2007** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------|------------|
| Higher labor, contract  labor and consulting costs                     |       | $                           | 6          |   |
| Higher plant generation  costs                                         |       | 2                           |       |
| Higher license fees and  permits                                       |       | 1                           |       |
| Lower employee benefit  costs                                          |       | (5                          | )          |
| Other (including fleet,  insurance and materials and supplies   costs) |       | 5                           |       |
| Total increase in other  operating and maintenance expenses            |       | $                           | 9          |   |

 

***Income taxes***— Income tax expense decreased by approximately $0.2million for the first nine months of 2008 compared with the first nine monthsof 2007. The effective tax rate was 42.3 percent for the first nine months of2008, compared with 40.6 percent for the same period in 2007. The decrease inincome tax expense and the increase in the effective tax rate were primarilydue to a decrease in pretax income.

 

***Regulation***

** **

**Summary of Recent Regulatory Developments**

 

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

 

***FERC Tie Line Investigation —***In October 2007,the FERC Office of Enforcement, Division of Investigations (DOI), commenced anon-public investigation of use of network transmission service across theLamar Tie Line, a transmission facility that connects PSCo, an affiliate ofSPS, and SPS.  Xcel Energy is fullycooperating with the DOI investigation. In July 2008, the DOI issued a preliminary report alleging XcelEnergy violated FERC policies and rules and approved tariffs.  The report represents the preliminaryconclusions of the DOI and is subject to additional procedures.  The report does not constitute a finding bythe FERC, which may, among other things, accept, modify or reject any or all ofthe preliminary conclusions set forth in the report.  Xcel Energy disagrees with the preliminaryreport and has responded to the DOI allegations; SPS is not able to predict theoutcome of the investigation or what, if any, actions the FERC may take.  As previously discussed under “Item 1A – RiskFactors” in Xcel Energy’s 2007 Annual Report on Form 10-K, the EnergyPolicy Act of 2005 has increased the FERC’s civil penalty authority forviolation of FERC statutes, rules and orders.  Given the preliminary nature of this matter,Xcel Energy is unable to determine if the resolution of this matter will have amaterial adverse impact on operations, cash flows or financial condition.

 

***ElectricReliability Standards Matters*****—**In April 2008, a self-report was filed withSouthwest Power Pool (SPP) indicating that certain tests of generation stationbatteries had not been completed in accordance with Xcel Energy’s adoptedmaintenance plan for generation station relays and batteries.  In June 2008, PSCo was subject to anaudit of its compliance with North American Electric Reliability Corporation(NERC) and regional reliability standards by Western Electricity CoordinatingCouncil (WECC), the NERC Regional Entity for the PSCo system.  In response to information identified duringthe audit, Xcel Energy conducted a comprehensive review of the maintenancerecords for all relay devices on the SPS transmission system.  That review found SPS did not havedocumentation demonstrating that all relay devices on the SPS system had beenmaintained on the schedule in Xcel Energy’s adopted maintenance plan.  In June 2008, SPS filed a self-reportregarding the maintenance plan violations with the SPP, the NERC RegionalEntity for the SPS system.  In September 2008,as a result of a review of Xcel Energy’s procedures implementing certain NERCcritical infrastructure protection standards applicable to control centerseffective July 1, 2008, SPS filed a self-report with the SPP disclosingcertain deficiencies in requirements applicable to access to criticalinfrastructure assets for the period July to September 2008.  SPS filed a mitigation plan with the SPP within 30 days ofthe self-reports discussing how the deficiencies were correctedXcel Energy is uncertain if theself-reports will result in financial penalties being imposed on SPS.

 

21

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**OtherRegulatory Matters**

 

***Performance-Based Regulation andQuality of Service Requirements *****—** In Texas, SPSis subject to a quality of service plan requiring SPS to comply with electricservice reliability performance targets. In January 2008, the PUCT staffserved SPS with notice that it had initiated an investigation to determinewhether SPS is in compliance with the Texas Statutes and PUCT rules onreliability and continuity of service. SPS agreed to settle this compliance issue with a $48,000 penalty.

 

***Texas Energy EfficiencyCost Recovery Factor (EECRF) Rider***— On June 2, 2008, SPS filed with the PUCT forapproval of an EECRF Rider. PUCT regulations established the mechanism underwhich electric utilities may recover costs associated with providing energyefficiency programs.  That mechanism, anEECRF Rider, must be included in a utility’s tariff and may be established in autility’s base rate case or through a separate request seeking to establish anEECRF.  In accordance with this rule, SPShas removed its energy efficiency costs from its recent base rate proceeding,and has requested implementation of its EECRF Rider to recover the remainingunamortized balance of historic costs and its projected 2008 and 2009 energyefficiency costs.  SPS requests that therider be implemented on Jan. 1, 2009. On Sept. 15, 2008, the PUCT concluded that the rule under which theapplication was filed does not apply to SPS and the energy efficiency costscould be recovered in the pending Texas retail base rate case.

*** ***

***Texas InterruptibleCredit Option and Saver’s Switch —***On May 13, 2008, SPS filed an application withthe PUCT and each of the 80 municipalities in SPS Texas service territory withoriginal rate jurisdiction to revise its Interruptible Credit Option (ICO)tariff and to institute a new Saver’s Switch tariff for residential and smallcommercial customers.  The purpose ofthese programs is to mitigate peak demand on SPS’ system starting with the 2009summer peak.  The issue of cost recoverywill be handled in the Texas rate case. SPS filed its unopposed settlement and proposed final order in October 2008.  The tariffs will be effective Jan. 1,2009.

*** ***

***Texas Renewable Energy Zone*****s*** *— In 2007, thePUCT designated competitive renewable energy zones (CREZs), which are regionsof the state that are sufficient to develop renewable energy generationsources, such as wind.  Several CREZareas within the SPS service region were designated for potential development.A statewide study conducted by the Electric Reliability Council of Texas(ERCOT) identifies the Texas panhandle as having the top four of the state’sprimary areas for wind energy expansion. On Aug. 15, 2008, the PUCT issued a final order identifying atransmission plan to deliver approximately 18,000 MW of wind energy to loadcenters in ERCOT. The plan includes lines in the Texas Panhandle. Cost of thistransmission plan is almost $5 billion, not including collector lines, and itwill be paid for by ERCOT customers, not by SPS. A proceeding is now underwayat the PUCT to select transmission providers to construct CREZ lines andassociated facilities. This step is expected to be completed in the firstquarter 2009, after which transmission providers will begin preparing certificationapplications.

 

***New Mexico Energy Efficiency DisincentiveRulemaking*******—** During the last legislative session, increased energy efficiency goalsand more affirmative disincentive language were adopted.  The NMPRC is currently holding a rulemakingto update the energy efficiency rule, consistent with the legislative changes.

 

***LPP PurchasePower Agreement*****—**The LPP project is a natural gas combinedcycle 604 MW plant near Hobbs, New Mexico.  SPS has a purchase poweragreement, which was executed in 2006, that provides for SPS to have exclusiverights to dispatch the facility.  The LPP plant started commercialoperations on Sept. 16, 2008 at which time SPS began taking energy and theproposed rates went into effect, subject to refund.  The FERC set the rate filing for hearings andsettlement procedures and the case is currently in settlement discussions.  The ultimate outcome of the rate filings isnot known at this time.

** **

**Item 4. CONTROLS AND PROCEDURES**

 

**Disclosure Controls andProcedures**

** **

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

 

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**Internal Control Over FinancialReporting**

** **

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.

 

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

#### ** **

## **Item 1. LEGAL PROCEEDINGS**

## ** **

In the normal course of business, variouslawsuits and claims have arisen against SPS. Management, after consultationwith legal counsel, has recorded an estimate of the probable cost of settlementor other disposition for such matters. See Notes 5 and 6 of the financialstatements in this Quarterly Report on Form 10-Q for further discussion oflegal proceedings, including Regulatory Matters and Commitments and ContingentLiabilities, which are hereby incorporated by reference. Reference also is madeto Item 3 and Notes 11 and 12 of SPS’ Annual Report on Form 10-K forthe year ended Dec. 31, 2007 for a description of certain legalproceedings presently pending.

 

**Item 1A. RISK FACTORS**

 

SPS’risk factors are documented in Item 1A of Part I of its 2007 Annual Reporton Form 10-K, which is incorporated herein by reference. As a result ofdevelopments in the financial markets since the filing of the 2007 AnnualReport on Form 10-K, we are providing updates below of the risk factors asfollows.

 

***We are subject to credit risks.***

 

Creditrisk includes the risk that our retail customers will not pay their bills,which may lead to a reduction in liquidity and an eventual increase in baddebt.  Retail credit risk is comprised ofnumerous factors including the overall level of economic activity in ourvarious service territories and price of products and services provided.

 

Creditrisk also includes the risk that short-term wholesale and commodity tradingcounterparties that owe us money or product will breach their obligations.Should the counterparties to these arrangements fail to perform, we may beforced to enter into alternative arrangements. In that event, our financialresults could be adversely affected and we could incur losses.

 

SPSdoes have additional indirect credit exposures to various financial institutionsin the form of letters of credit provided as security by powersuppliers under various long-term physical purchasedpower contracts.    If any ofthe credit ratings of the letter of credit issuers were to drop below thedesignated investment grade rating stipulated in the underlying long termpurchased power contracts, the supplier would need to replace that securitywith an acceptable substitute.  If the security were not replaced, theparty would be in technical default under the contract, which would enableSPS to exercise its contractual rights.

 

***Economic conditions couldnegatively impact our business.***

 

Ouroperations are affected by local, national and worldwide economic conditions.The consequences of a prolonged recession may include a lower level of economicactivity and uncertainty regarding energy prices and the capital and commoditymarkets. A lower level of economic activity might result in a decline in energyconsumption, which may adversely affect our revenues and future growth.   Instability in the financial markets, as aresult of recession or otherwise, also may affect the cost of capital and ourability to raise capital, which are discussed in greater detail in the CapitalMarkets risk section in the 2007 Annual Report on Form 10-K.

 

Currenteconomic conditions may be exacerbated by insufficient financial sectorliquidity leading to potential increased unemployment, which may impactcustomers ability to pay timely, increase customer bankruptcies, and may leadto increased bad debt.   It is expectedthat commercial and industrial customers will be impacted first withresidential customers following, if such circumstances occur.  See credit risk section for more relatedinformation.

 

Furtherworldwide economic activity has an impact on the demand for basic commoditiesneeded for utility infrastructure, such as steel, copper, aluminum, etc., whichmay impact our ability to acquire sufficient supplies. Additionally, the costof those commodities may be higher than expected.

 

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## **Item 6. EXHIBITS**

## ** **

The following Exhibits arefiled with this report:

 
| *3.01 |   | Amended and Restated Articles of Incorporation dated Sept. 30, 1997 (Exhibit 3(a)(2) to Form 10-K (file no. 001-03789) dated March 3, 1998).                                                                 |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *3.02 |   | By-laws dated Sept. 29, 1997 (Exhibit 3(b)(2) to Form 10-K (file no. 001-03789) dated March 3, 1998).                                                                                                        |
| 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.                                                                                                                                     |

 

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**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 Oct. 24, 2008.

 

Southwestern Public ServiceCo.

(Registrant)

 

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

 

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