** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 

**x****                             ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2007**

 

**or**

 

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom               to**

 

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

#### ** **

**SouthwesternPublic Service Company**

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

** **

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

 

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

 

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

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

LargeAccelerated Filer o                               AcceleratedFiler o                               Non-AcceleratedFiler x

 

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

 

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

 
| **Class**                   | ** ** | **Outstanding at April 27, 2007** |
|-----------------------------|------------|-------------------------------------------------------|
| Common  Stock, $1 par value |       | 100 shares                                            |

 

SouthwesternPublic Service Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with thereduced disclosure format specified in General Instruction H (2) to such Form10-Q.

 

 

**Tableof Contents**

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

 

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

 

2

----

 

**PART 1. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**SOUTHWESTERN PUBLIC SERVICECO.**

**STATEMENTS OF INCOME(UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| **Operating  revenues**                                                             |       | $                                                | 365,898    |   | $ | 412,809 |   |
|                                                                                |       |                                             |       |   |   |
| **Operating  expenses**                                                             | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Electric fuel and purchased power                                                   |       | 264,407                                          |       | 295,588 |   |
| Other operating and maintenance expenses                                            |       | 51,093                                           |       | 49,818 |   |
| Depreciation and amortization                                                       |       | 24,688                                           |       | 23,897 |   |
| Taxes (other than income taxes)                                                     |       | 11,562                                           |       | 13,322 |   |
| Total operating expenses                                                            |       | 351,750                                          |       | 382,625 |   |
|                                                                                |       |                                             |       |   |   |
| **Operating  income**                                                               |       | 14,148                                           |       | 30,184 |   |
|                                                                                |       |                                             |       |   |   |
| Interest and other income, net (see Note 8)                                         |       | 803                                              |       | 1,475 |   |
| Allowance for funds used during  construction – equity                         |       | —                                           |       | 118 |   |
|                                                                                |       |                                             |       |   |   |
| **Interest  charges and financing costs**                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Interest charges — including financing  costs of $585 and $1,528, respectively |       | 13,034                                           |       | 13,692 |   |
| Allowance for funds used during  construction – debt                           |       | (498                                             | )          | (681 | ) |
| Total interest charges and financing costs                                          |       | 12,536                                           |       | 13,011 |   |
|                                                                                |       |                                             |       |   |   |
| Income  before income taxes                                                         |       | 2,415                                            |       | 18,766 |   |
| Income taxes                                                                        |       | 750                                              |       | 6,889 |   |
| **Net  income**                                                                     |       | $                                                | 1,665      |   | $ | 11,877 |   |
|                                                                                     |            |                                                  |            |  |  |  |  |  |  |

 

See Notes to Financial Statements

 

3

----

 

**SOUTHWESTERN PUBLIC SERVICECO.**

**STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(Thousands of Dollars)**

 
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| **Operating activities**                                                           | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                                | 1,665      |   | $ | 11,877 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                      |       | 25,586                                           |       | 25,648 |   |
| Deferred income taxes                                                              |       | (1,044                                           | )          | (4,040 | ) |
| Amortization of investment tax credits                                             |       | (63                                              | )          | (63 | ) |
| Allowance for equity funds used during  construction                               |       | —                                           |       | (118 | ) |
| Net realized and unrealized hedging and derivative  transactions                   |       | 66                                               |       | 16 |   |
| Changes in operating assets and  liabilities:                                      |       |                                             |       |   |   |
| Recoverable electric energy costs                                                  |       | 56,253                                           |       | 13,261 |   |
| Accounts receivable                                                                |       | 8,577                                            |       | 36,783 |   |
| Accrued unbilled revenues                                                          |       | (18,507                                          | )          | 42,299 |   |
| Inventories                                                                        |       | (1,457                                           | )          | (1,111 | ) |
| Prepayments and other                                                              |       | 986                                              |       | 1,333 |   |
| Accounts payable                                                                   |       | (36,576                                          | )          | (32,210 | ) |
| Net regulatory assets and liabilities                                              |       | (1,178                                           | )          | (569 | ) |
| Other current liabilities                                                          |       | (16,455                                          | )          | (7,769 | ) |
| Change in other noncurrent assets                                                  |       | (2,063                                           | )          | (1,444 | ) |
| Change in other noncurrent liabilities                                             |       | 921                                              |       | 1,673 |   |
| Net cash provided by operating activities                                          |       | 16,711                                           |       | 85,566 |   |
|                                                                               |       |                                             |       |   |   |
| **Investing  activities**                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Capital/construction expenditures                                                  |       | (29,223                                          | )          | (25,696 | ) |
| Allowance for equity funds used during  construction                               |       | —                                           |       | 118 |   |
| Investments in utility money pool                                                  |       | (42,600                                          | )          | — |   |
| Repayments from utility money pool                                                 |       | 42,600                                           |       | — |   |
| Other investments                                                                  |       | 309                                              |       | 803 |   |
| Net cash used in investing activities                                              |       | (28,914                                          | )          | (24,775 | ) |
|                                                                               |       |                                             |       |   |   |
| **Financing  activities**                                                          | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Proceeds (payments) of short-term debt, net                                        |       | 21,500                                           |       | (45,915 | ) |
| Borrowings under utility money pool  arrangement                                   |       | 107,100                                          |       | 500 |   |
| Repayments under utility money pool  arrangement                                   |       | (97,900                                          | )          | (500 | ) |
| Dividends paid to parent                                                           |       | (18,581                                          | )          | (20,395 | ) |
| Net cash provided by (used in) financing  activities                               |       | 12,119                                           |       | (66,310 | ) |
|                                                                               |       |                                             |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (84                                              | )          | (5,519 | ) |
| Cash and cash equivalents at beginning of  period                                  |       | 297                                              |       | 9,407 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                | 213        |   | $ | 3,888 |   |
|                                                                               |       |                                             |       |   |   |
| Supplemental  disclosure of cash flow information:                                 |       |                                             |       |   |   |
| Cash paid for interest (net of amounts  capitalized)                               |       | $                                                | 6,793      |   | $ | 6,645 |   |
| Cash paid for income taxes (net of refunds  received)                              |       | 3,643                                            |       | 3,067 |   |
|                                                                               |       |                                             |       |   |   |
| Supplemental  disclosure of non-cash investing transactions:                       |       |                                             |       |   |   |
| Property, plant and equipment additions in  accounts payable                       |       | $                                                | 4,754      |   | $ | 2,108 |   |
|                                                                                    |            |                                                  |            |  |  |  |  |  |  |  |  |

 

See the Notes to Financial Statements

 

4

----

 

**SOUTHWESTERN PUBLIC SERVICE CO**.

**BALANCE SHEETS (UNAUDITED)**

**(Thousands of Dollars)**

** **
| ** **                                                                              | ** ** | **March 31,  2007** | ** ** | **Dec. 31,  2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
| **ASSETS**                                                                              | ** ** | ** **               | ** ** | ** **              | ** ** |
| Current  assets:                                                                        |       |                     |       |                    |       |
| Cash and cash equivalents                                                               |       | $                        | 213        |                    | $          | 297 |   |
| Accounts receivable, net of allowance for  bad debts of $2,531 and $2,686, respectively |       | 49,539                   |       | 56,616                  |       |
| Accounts receivable from affiliates                                                     |       | 7,308                    |       | 8,808                   |       |
| Accrued unbilled revenues                                                               |       | 81,312                   |       | 62,805                  |       |
| Recoverable electric energy costs                                                       |       | 26,847                   |       | 83,100                  |       |
| Materials and supplies inventories                                                      |       | 18,991                   |       | 17,547                  |       |
| Fuel inventories                                                                        |       | 4,108                    |       | 4,095                   |       |
| Derivative instruments valuation                                                        |       | 8,926                    |       | 8,926                   |       |
| Prepayments and other                                                                   |       | 7,418                    |       | 8,326                   |       |
| Total current assets                                                                    |       | 204,662                  |       | 250,520                 |       |
| Property,  plant and equipment, at cost:                                                |       |                     |       |                    |       |
| Electric utility plant                                                                  |       | 3,422,843                |       | 3,401,108               |       |
| Construction work in progress                                                           |       | 62,188                   |       | 53,051                  |       |
| Total property, plant and equipment                                                     |       | 3,485,031                |       | 3,454,159               |       |
| Less accumulated depreciation                                                           |       | (1,485,696               | )          | (1,462,787              | )          |
| Net property, plant and equipment                                                       |       | 1,999,335                |       | 1,991,372               |       |
| Other  assets:                                                                          |       |                     |       |                    |       |
| Prepaid pension asset                                                                   |       | 108,875                  |       | 106,193                 |       |
| Regulatory assets                                                                       |       | 161,912                  |       | 163,067                 |       |
| Derivative instruments valuation                                                        |       | 92,171                   |       | 94,402                  |       |
| Other investments                                                                       |       | 5,468                    |       | 5,846                   |       |
| Other                                                                                   |       | 7,120                    |       | 7,890                   |       |
| Total other assets                                                                      |       | 375,546                  |       | 377,398                 |       |
| Total assets                                                                            |       | $                        | 2,579,543  |                    | $          | 2,619,290 |   |
| ** **                                                                              | ** ** | ** **               | ** ** | ** **              | ** ** |
| **LIABILITIES  AND EQUITY**                                                             | ** ** | ** **               | ** ** | ** **              | ** ** |
| Current  liabilities:                                                                   |       |                     |       |                    |       |
| Short-term debt                                                                         |       | $                        | 72,500     |                    | $          | 51,000 |   |
| Borrowings under utility money pool,  weighted average yield of 5.40% at March 31, 2007 |       | 9,200                    |       | —                  |       |
| Accounts payable                                                                        |       | 131,486                  |       | 159,672                 |       |
| Accounts payable to affiliates                                                          |       | 8,883                    |       | 14,783                  |       |
| Accrued interest                                                                        |       | 17,237                   |       | 12,099                  |       |
| Dividends payable to parent                                                             |       | 17,318                   |       | 18,581                  |       |
| Taxes accrued                                                                           |       | 15,957                   |       | 33,122                  |       |
| Derivative instruments valuation                                                        |       | 4,327                    |       | 4,307                   |       |
| Deferred income taxes                                                                   |       | 2,660                    |       | 6,849                   |       |
| Other                                                                                   |       | 20,229                   |       | 24,944                  |       |
| Total current liabilities                                                               |       | 299,797                  |       | 325,357                 |       |
| Deferred  credits and other liabilities:                                                |       |                     |       |                    |       |
| Deferred income taxes                                                                   |       | 448,642                  |       | 451,108                 |       |
| Regulatory liabilities                                                                  |       | 142,509                  |       | 143,789                 |       |
| Derivative instruments valuation                                                        |       | 63,284                   |       | 64,187                  |       |
| Pension and employee benefit obligations                                                |       | 54,917                   |       | 54,647                  |       |
| Asset retirement obligations                                                            |       | 4,402                    |       | 4,341                   |       |
| Deferred investment tax credits                                                         |       | 3,153                    |       | 3,215                   |       |
| Other                                                                                   |       | 9,449                    |       | 3,329                   |       |
| Total deferred credits and other  liabilities                                           |       | 726,356                  |       | 724,616                 |       |
| Commitments  and contingencies (see Note 5)                                             |       |                     |       |                    |       |
| Capitalization:                                                                         |       |                     |       |                    |       |
| Long-term debt                                                                          |       | 773,935                  |       | 773,903                 |       |
| Common stock – authorized 200 shares of  $1.00 par value, outstanding 100 shares   |       | —                   |       | —                  |       |
| Additional paid in capital                                                              |       | 478,269                  |       | 478,269                 |       |
| Retained earnings                                                                       |       | 307,012                  |       | 323,008                 |       |
| Accumulated other comprehensive loss                                                    |       | (5,826                   | )          | (5,863                  | )          |
| Total common stockholder’s equity                                                  |       | 779,455                  |       | 795,414                 |       |
| Total liabilities and equity                                                            |       | $                        | 2,579,543  |                    | $          | 2,619,290 |   |
|                                                                                         |            |                          |            |                         |            |  |  |  |  |  |  |

** **

**See the Notes to Financial Statements**

** **

**5**

----

** **

**NOTES TO FINANCIALSTATEMENTS**

** **

In the opinionof management, the accompanying unaudited financial statements contain alladjustments necessary to present fairly the financial position of SPS as ofMarch 31, 2007, and Dec. 31, 2006; the results of its operations for thethree months ended March 31, 2007 and 2006; and its cash flows for thethree months ended March 31, 2007 and 2006. Due to the seasonality ofelectric sales of SPS, quarterly results are not necessarily an appropriatebase from which to project annual results.

 

**1. Significant Accounting Policies**

 

Except to theextent updated or described below, the significant accounting policies setforth in Note 1 to the financial statements in SPS’s Annual Report on Form 10-Kfor the year ended Dec. 31, 2006 appropriately represent, in all materialrespects, the current status of the footnotes and are incorporated herein byreference.

 

***Income Taxes****** —***Consistentwith prior periods and upon adoption of Financial Accounting Standard Board (***FASB) Interpretation No.***48– “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109”, SPS records interestand penalties related to income taxes as interest charges in the Statements ofIncome.

 

***Reclassifications****** —***Certainamounts in the Statements of Cash Flows have been reclassified fromprior-period presentation to conform to the 2007 presentation. Thereclassifications reflect the presentation of unbilled revenues, recoverablepurchased electric energy costs and regulatory assets and liabilities asseparate items rather than components of other assets and other liabilitieswithin net cash provided by operating activities. In addition, activity relatedto derivative transactions have been combined into net realized and unrealizedhedging and derivative transactions. These reclassifications did not affecttotal net cash provided by (used in) operating, investing or financingactivities within the Statements of Cash Flows.

 

**2.Recently Issued Accounting Pronouncements**

 

***FairValue Measurements (SFAS 157)****** —***In September 2006,the FASB issued Statement of Financial Accounting Standard (SFAS) 157,which provides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS 157 also emphasizes that fair value is amarket-based measurement, and sets out a fair value hierarchy with the highestpriority being quoted prices in active markets. Fair value measurements aredisclosed by level within that hierarchy. SFAS 157 is effective for financialstatements issued for fiscal years beginning after Nov. 15, 2007. SPS isevaluating the impact of SFAS 157 on its financial condition and results ofoperations and does not expect the impact of adoption to be material.

 

***The Fair Value Option for Financial Assets and FinancialLiabilities - Including an Amendment of FASB Statement No. 115 (SFAS 159)— ***In February2007, the FASB issued SFAS 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 159 will report unrealized gains and losses on 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 andliabilities. This statement is effective for fiscal years beginning after Nov.15, 2007. SPS is evaluating the impact of SFAS 159 on its financial conditionand results of operations and does not expect the impact of adoption to bematerial.

 

**3.Income Taxes**

 

***Accounting for Uncertainty inIncome Taxes — an interpretation of FASB Statement No. 109 (FIN 48)***— In July 2006, the FASB issued FASB Interpretation No. (FIN) 48. FIN 48prescribes how a company should recognize, measure, present and discloseuncertain tax positions that the company has taken or expects to take in itsincome tax returns. FIN 48 requires that only income tax benefits that meet the“more likely than not” recognition threshold be recognized or continue to berecognized on its effective date. As required, SPS adopted FIN 48 as of Jan. 1,2007 and the initial derecognition amounts were reported as a cumulative effectof a change in accounting principle. The cumulative effect of the change, whichis reported as an adjustment to the beginning balance of retained earnings, wasnot material. Following implementation, the ongoing recognition of changes inmeasurement of uncertain tax positions will be reflected as a component ofincome tax expense.

 

SPS is a member of the XcelEnergy affiliated group that files consolidated income tax returns. Xcel Energyhas been audited by the Internal Revenue Service (IRS) through tax year 2003,with a limited exception for 2003 research tax credits. The IRS commenced anexamination of Xcel Energy’s federal income tax returns for 2004 and 2005 (andresearch credits for 2003) in the third quarter of 2006, and that examinationis anticipated to be complete by March 31, 2008. As of March 31, 2007, the IRShad not proposed any material adjustments. As of March 31, 2007, Xcel Energy’s 2000 through 2002 federal income tax returnsremain open under applicable statutes of limitations.

 

6

----

 

Asof March 31, 2007, SPS’s earliest open tax years in which an audit can beinitiated by state taxing authorities under applicable statutes of limitationsis 2002.

 

The amount of unrecognizedtax benefits was $5.0 million and  $5.3million on Jan. 1, 2007 and March31, 2007, respectively.

 

Included inthe unrecognized tax benefit balance was $0.2 million and $0.2 million of taxpositions on Jan.1, 2007 and March 31, 2007 respectively, which if recognizedwould affect the annual effective tax rate. In addition the unrecognized taxbenefit balance included $4.8 million and $5.1 million of tax positions on Jan.1, 2007 and March 31, 2007, respectively, for which the ultimate deductibilityis highly certain but for which there is uncertainty about the timing of suchdeductibility. A change in the period of deductibility would not affect theeffective tax rate but would accelerate the payment of cash to the taxingauthority to an earlier period. The change in the unrecognized tax benefitbalance from Jan. 1, 2007 to March 31, 2007, was due to the addition of similaruncertain tax positions relating to first quarter activity.

 

SPS’ amount of unrecognized tax benefits couldsignificantly change in the next 12 months as the IRS and state tax auditsprogress. However, at this time due to the nature of the audit process, it isnot reasonably possible to estimate a range of the possible change.

 

The interest expenseliability related to unrecognized tax benefits on Jan. 1, 2007, was notmaterial. The change in the interest expense liability from Jan. 1,2007, to March 31, 2007, was not material. No amounts were accrued for penalties.

 

**4.****     Rate Matters**

 

***Pending and Recently Concluded RegulatoryProceedings — Federal Energy Regulatory Commission (FERC)***

*** ***

***WholesaleRate Complaints*** ***—***InNovember 2004, Golden Spread Electric, Lyntegar Electric, Farmer’sElectric, Lea County Electric, Central Valley Electric and Roosevelt CountyElectric, wholesale cooperative customers of SPS, filed a rate complaint at theFERC. The complaint alleged that SPS’ rates forwholesale service were excessive and that SPS had incorrectly calculatedmonthly fuel cost adjustments contained in SPS’ wholesale rate schedules. Amongother things, the complainants asserted that SPS was not properly calculatingthe fuel costs that are eligible for recovery to reflect fuel costs recoveredfrom certain wholesale sales to other utilities, and that SPS hadinappropriately allocated average fuel and purchased power costs to other ofSPS’ wholesale customers, effectively raising the fuel costs charges tocomplainants. Cap Rock Energy Corporation (Cap Rock), another full-requirementscustomer, Public Service Company of New Mexico (PNM) and Occidental PermianLtd. and Occidental Power Marketing, L.P. (Occidental) intervened in theproceeding.

 

On May 24, 2006, aFERC administrative law judge (ALJ) issued an initial recommended decision inthe proceeding. The FERC will review the initial recommendation and issue afinal order. SPS and others have filed exceptions to the ALJ’s initialrecommendation. The FERC’s order may or may not follow any of the ALJ’srecommendation. In the recommended decision, the ALJ found that SPS shouldrecalculate its wholesale fuel and purchased economic energy cost adjustmentclause (FCAC) billings for the period beginning Jan. 1, 1999, to reducethe fuel and purchased power costs recovered from the complaining customers byallocating incremental fuel costs incurred by SPS in making wholesale sales ofsystem firm capacity and associated energy to other firm customers atmarket-based rates during this period based on the view that such sales shouldbe treated as opportunity sales.

 

SPS believes the ALJerred on significant and material issues that contradict FERC policy orrules of law. Specifically, SPS believes, based on FERC rules andprecedent, that it has appropriately applied its FCAC tariff to the properclasses of customers. These market-based sales were of a long-term durationunder FERC precedent and were made from SPS’ entire system. Accordingly, SPSbelieves that the ALJ erred in concluding that these transactions wereopportunity sales, which require the assignment of incremental costs.

 

The FERC has approvedsystem average cost allocation treatment in previous filings by SPS for saleshaving similar service characteristics and previously accepted for filingcertain of the challenged agreements with average fuel cost pricing.

 

Moreover, SPS believesthat the ALJ’s recommendation constituted a violation of the Filed RateDoctrine in that it effectively results in a retroactive amendment to the SPSFERC-approved FCAC tariff provisions. Under existing regulations, the FERC maymodify a previously approved FCAC on a prospective basis. Accordingly, SPSbelieves it has applied its FCAC correctly and has sought review of therecommended decision by the FERC by filing a brief on the exceptions.

 

SPS has evaluated allsales made from Jan. 1, 1999 to Dec. 31, 2005. While SPS believes itshould ultimately prevail in this proceeding; however, if the FERC were toadopt the majority of the ALJ’s recommendations, SPS’ refund exposure could beapproximately $50 million. FERC action is pending. Additionally, SPS hasentered into settlement discussions with the wholesale cooperative customers. Duringthe three months ended March 31, 2007, SPS recognized an additional accrualbased upon estimates of this potential liability.

 

7

----

 

***WholesalePower Base Rate Application*** ***—***On Dec. 1, 2005, SPS filedfor a $2.5 million increase in wholesale power rates to certain electriccooperatives. On Jan. 31, 2006, the FERC conditionally accepted theproposed rates for filing, and the $2.5 million power rate increase becameeffective on July 1, 2006, subject to refund. The FERC also set the rateincrease request for hearing and settlement judge procedures. The case is presentlyin the settlement judge procedures and an agreement in principle has beenreached for base rates for the full-requirements customers and PNM. One otherwholesale customer has not settled. On Sept. 7, 2006, the offer of settlementwith respect to the full-requirements customer was filed for approval and onSept. 19, 2006, the offer of settlement with respect to PNM was filed forapproval. Subsequent to filing rebuttal testimony, on March 29, 2007, SPS andthe remaining wholesale customer entered into settlement negotiations. Thecurrent hearing schedule has been postponed.

 

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

*** ***

***Texas RetailBase Rate And Fuel Reconciliation Case****** —***On May 31, 2006, SPS filed a Texas retailelectric rate case requesting an increase in annual revenues of approximately$48 million, or 6.0 percent. The rate filing was based on a historical testyear, an electric rate base of $943 million, a requested return on equity (ROE)of 11.6 percent and a common equity ratio of 51.1 percent.

 

In addition, SPS submitted a fuel reconciliation filing, whichrequested approval of approximately $957 million of Texas-jurisdictional fueland purchased power costs for 2004 through 2005. The combined case was transferredto the Texas Office of Administrative Hearing. As a part of the fuelreconciliation case, fuel and purchased energy costs, which are recovered inTexas through a fixed-fuel and purchased energy recovery factor as a part ofSPS’ retail electric rates, were reviewed.

 

OnMarch 27, 2007, SPS and various intervenors filed a unanimous stipulationagreement related to the Texas retail rate case as well as the fuelreconciliation portion of the proceeding. The agreement includes the followingterms:

 

•                  The settlement provides foran annual base rate increase of $23 million or approximately 3 percent.

•                  The settlement is a “black box” agreement,with no stipulated ROE or capital structure.

•                  The settlement disallows approximately $27million of SPS’ 2004 and 2005 fuel expense.

•                  An additional $2.3 million will be deductedfrom the company’s next fuel reconciliation filing to be made in 2008,associated with the 2006-2007 fuel reconciliation period.

•                  All of SPS’ existinglong-term firm and interruptible capacity wholesale sales will be assignedsystem average cost for purposes of Texas retail ratemaking, except for salesto El Paso Electric (EPE), which will be determined by the PUCT separately.

•                  If the PUCT determines incremental fuel costassignment related to the EPE contract is appropriate, the settlement providesthat the fuel disallowance is limited to an annual amount of $6.3 million peryear, from the date of the PUCT's order through 2008.

•                  The settlement also creates standards forcost assignment that would apply to future wholesale sale transactions, andestablishes margin sharing of market based wholesale demand revenues.

•                  If SPS files a general rate case in 2008, thesettlement would allow for an interim rate increase associated with a purchasedpower agreement with Lea Power Partners of approximately $1.5 million per monthfrom the date of commercial operations. Interim rates would be subject to atrue up based on the outcome of the rate case proceeding and actual capacitycosts incurred.

 

Anestimated settlement allowance and reserve was established in 2006 and priorperiods, which approximated the settled amounts of previously deferred orrecovered fuel expense; therefore, no additional expense associated with thefuel reconciliation portions of the settlement was recognized in the quarter. OnMarch 27, 2007, the ALJ approved SPS’ request to implement the $23 million baserate increase, effective April 2007, on an interim basis until the PUCT acts onthe stipulation. It is expected that the PUCT will consider the settlement atthe same time as it considers the EPE wholesale cost assignment, which islikely to occur in the second quarter of 2007.

 

***Pending and Recently Concluded RegulatoryProceedings —***New Mexico Public Regulation Commission(NMPRC)

*** ***

***New Mexico Fuel Factor Continuation Filing***** —**On Aug. 18, 2005, SPS filedwith the NMPRC requesting continuation of the use of SPS’ fuel and purchasedpower cost adjustment clause (FPPCAC) and current monthly factor cost recoverymethodology. This filing was required by NMPRC rule. Testimony has been filedin the case by staff and intervenors objecting to SPS’ assignment of systemaverage 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 have requested disallowances for past periods, which in theaggregate total approximately $45 million. Other issues in the case include thetreatment of renewable energy certificates and sulfur dioxide allowance creditproceeds in relation to SPS’ New Mexico retail fuel and purchased powerrecovery clause. The hearing was held in April 2006, and the hearingexaminer’s recommended decision and a NMPRC decision is expected in the secondquarter of 2007. During the three months ended March 31, 2007, SPS recognizedan accrual based upon estimates of this potential liability.

 

8

----

 

**5.Commitments and Contingent Liabilities**

 

The circumstances setforth in Note 10 and 11 to the financial statements in SPS’s Annual Report onForm 10-K for the year ended Dec. 31, 2006 and Notes 4 and 5 to the financialstatements in this Quarterly Report on Form 10-Q, appropriately represent, inall material respects, the current status of commitments and contingentliabilities and are incorporated herein by reference. The following includeunresolved contingencies that are material to SPS’s financial position.

 

## **EnvironmentalContingencies**

## ** **

SPS has been,or is currently, involved with the cleanup of contamination from certainhazardous substances at several sites. In many situations, SPS believes it willrecover some portion of these costs through insurance claims. Additionally,where applicable, SPS is pursuing, or intends to pursue, recovery from otherpotentially responsible parties and through the rate regulatory process. Newand changing federal and state environmental mandates can also create addedfinancial liabilities for SPS, which are normally recovered through the rateregulatory process. To the extent any costs are not recovered through theoptions listed above, SPS would be required to recognize an expense.

 

***Site Remediation****—*SPSmust pay all or a portion of the cost to remediate sites where past activitiesof SPS and some other parties have caused environmental contamination. At March31, 2007, SPS was a party to third party and other sites, such as landfills, towhich SPS is alleged to be a potentially responsible party (PRP) that senthazardous materials and wastes.

 

SPS records a liabilitywhen enough information is obtained to develop an estimate of the cost ofenvironmental remediation and revises the estimate as information is received. Theestimated remediation cost may vary materially.

 

To estimate the cost toremediate these sites, assumptions are made when facts are not fully known. Forinstance, assumptions may be made about the nature and extent of sitecontamination, the extent of required cleanup efforts, costs of alternativecleanup methods and pollution-control technologies, the period over whichremediation will be performed and paid for, changes in environmentalremediation and pollution-control requirements, the potential effect oftechnological improvements, the number and financial strength of other PRPs andthe identification of new environmental cleanup sites.

 

Estimates are revised asfacts become known. At March 31, 2007, the liability for the cost ofremediating these sites was estimated to be $0.2 million, of which $0.1 millionwas considered to be a current liability. Some of the cost of remediation maybe recovered from:

 

•       insurance coverage;

•       other parties that have contributed to the contamination; and

•       customers.

 

Neither the totalremediation cost nor the final method of cost allocation among all PRPs of theunremediated sites has been determined. Estimates have been recorded for SPS’future costs for these sites.

 

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

 

***Asbestos Removal*****—**Someof SPS’ facilities contain asbestos. Most asbestos will remain undisturbeduntil the facilities that contain it are demolished or renovated. SPS hasrecorded an estimate for final removal of the asbestos as an asset retirementobligation. See additional discussion of asset retirement obligations in Note11 to the SPS Annual Report on Form 10-K for the year ended Dec. 31, 2006. Itmay be necessary to remove some asbestos to perform maintenance or makeimprovements to other equipment. The cost of removing asbestos as part of otherwork is immaterial and is recorded as incurred as operating expenses formaintenance projects, capital expenditures for construction projects or removalcosts for demolition projects.

 

***Cunningham StationGroundwater***— Cunningham Station is a naturalgas-fired power plant constructed in the 1960’s by SPS and has 28 water wellsinstalled on its water rights. The well field provides water for boiler makeup,cooling water and potable water. Following an acid release in 2002, groundwatersamples revealed elevated concentrations of inorganic salt compounds notrelated to the release. The contamination was identified in wells located nearthe plant buildings. The source of contamination is thought to be leakage fromponds that receive blow down water from the plant. In response to a request bythe New Mexico Environment Department (NMED), SPS prepared a corrective actionplan to address the groundwater contamination. Under the plan submitted to theNMED, SPS agreed to control leakage from the plant blow down ponds throughconstruction of a new lined pond, additional irrigation areas to minimizepercolation, and installation of additional wells to monitor groundwaterquality. On June 23, 2005, NMED issued a letter approving the corrective actionplan. The action plan is subject to continued compliance with New Mexicoregulations and oversight by the NMED. SPS is evaluating implementation of asimilar project at Maddox Station. These actions for Cunningham and Maddox are estimated to cost approximately $4.2 millionthrough 2008 and will be capitalized or expensed as incurred.

 

9

----

 

Constructionand liner installation of the new pond has been completed. A permit applicationfor discharges from the pond has been submitted to the NMED. It is expectedthat the pond will be ready to be placed into service when the NMED issuesCunningham a permit. The permitting process for Maddox has begun.

 

***Clean Air InterstateRule ***- In March 2005, the EnvironmentalProtection Agency (EPA) issued the Clean Air Interstate Rule (CAIR) tofurther regulate SO2 and nitrogenoxide (NOx) emissions. The objective of CAIR is to cap emissions of SO2 and NOx in the eastern United States,including Minnesota, Texas and Wisconsin, which are within Xcel Energy’sservice territory. Xcel Energy generating facilities in other states are notaffected. CAIR addresses the transportation of fine particulates, ozone andemission precursors to nonattainment downwind states. CAIR has a two-phasecompliance schedule, beginning in 2009 for NOx and 2010 for SO2, with a final compliancedeadline in 2015 for both emissions. Under CAIR, each affected state will beallocated an emissions budget for SO2and NOX that will result insignificant emission reductions. It will be based on stringent emissioncontrols and forms the basis for a cap-and-trade program. State emissionbudgets or caps decline over time. States can choose to implement an emissionsreduction program based on the EPA’s proposed model program, or they canpropose another method, which the EPA would need to approve.

 

On July 11, 2005, SPS, the City ofAmarillo, Texas and Occidental Permian LTD filed a lawsuit against the EPA anda request for reconsideration with the agency to exclude West Texas from theCAIR. El Paso Electric Co. joined in the request for reconsideration. XcelEnergy and SPS advocated that West Texas should be excluded from CAIR becauseit does not contribute significantly to nonattainment with the fine particulatematter National Ambient Air Quality Standard in any downwind jurisdiction.

 

OnMarch 15, 2006, the EPA denied the petition for reconsideration. On June 27,2006, Xcel Energy and the other parties filed a petition for review of thedenial of the petition for reconsideration, as well as a petition for review ofthe Federal Implementation Plan, with the United States Court of Appeals forthe District of Columbia Circuit. Pursuant to the court’s scheduling order,briefing is expected to be finalized in September 2007.

 

Under CAIR’s cap-and-trade structure, SPS can comply through capitalinvestments in emission controls or purchase of emission “allowances” fromother utilities making reductions on their systems. Based on the preliminaryanalysis of various scenarios of capital investment and allowance purchase, SPScurrently believes that following the installation of low NOx burners onHarrington 3 in 2006, additional capital investments, estimated at $23 million,will be remaining for NOx controls in the SPS region. Annual purchases of SO2allowances for are estimated in the range of $12 million to $26 million eachyear, beginning in 2012 for phase I, based on allowance costs and fuel qualityas of December 2006.

 

These cost estimates representone potential scenario on complying with CAIR, if West Texas is not excluded. Thereis uncertainty concerning implementation of CAIR. States are required todevelop implementation plans within 18 months of the issuance of the newrules and have a significant amount of discretion in the implementationdetails. Legal challenges to CAIR rules could alter their requirementsand/or schedule. The uncertainty associated with the final CAIRrules makes it difficult to project the ultimate amount and timing ofcapital expenditures and operating expenses.

 

While SPS expects to complywith the new rules through a combination of additional capital investmentsin emission controls at various facilities and purchases of emissionallowances, it is continuing to review the alternatives. Xcel Energy believesthe cost of any required capital investment or allowance purchases will berecoverable from customers.

 

***Clean Air MercuryRule*** — In March 2005, the EPA issued theClean Air Mercury Rule (CAMR), which regulates mercury emissions from power plantsfor the first time. The EPA’s CAMR  uses a national cap-and-trade system,where compliance may be achieved by either adding mercury controls orpurchasing allowances or a combination of both and is designed to achieve a 70percent reduction in mercury emissions. It affects all coal- and oil-firedgenerating units across the country that are greater than 25 MW. Compliancewith this rule occurs in two phases, with the first phase beginning in2010 and the second phase in 2018. States will be allocated mercury allowancesbased on coal type and their baseline heat input relative to other states. Eachelectric generating unit will be allocated mercury allowances based on itspercentage of total coal heat input for the state. Similar to CAIR, states canchoose to implement an emissions reduction program based on the EPA’s proposedmodel program, or they can propose another method, which the EPA would need toapprove.

 

Under CAMR, SPS can comply through capital investments in emissioncontrols or purchase of emission “allowances” from other utilities makingreductions on their systems. SPS’ preliminary analysis for phase I compliancesuggests capital costs of approximately $14.5 million and increased operatingand maintenance expenses of approximately $7.9 million, beginning in 2010. Furthertesting is planned during 2007 to confirm these costs or determine whetherdifferent measures will be necessary, which could result in higher costs. Additionalcosts will be incurred to meet phase II requirements in 2018.

 

***Regional Haze Rules***— On June 15, 2005, the EPA finalized amendments to the July 1999 regional hazerules. 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’

 

10

----

 

generating facilities will be subject to BART requirements. Some of thesefacilities are located in regions where CAIR is effective. The Texas Commissionon Environmental Quality has determined that facilities may use CAIR as asubstitute for BART for NOx and SO2. If West Texas is excluded fromCAIR by the D.C. Court of Appeals, then these facilities will be subject toBART requirements for NOx, SO2, and particulate matter (PM). Due tothe uncertainties of the litigation outcome, SPS is not able to estimate thecost impact at this time.

 

**Legal Contingencies**

** **

In the normalcourse of business, SPS is party to routine claims and litigation arising fromprior and current operations. SPS is actively defending these matters and hasrecorded a liability related to the probable cost of settlement or otherdisposition, when it can be reasonably estimated.

 

***Carbon Dioxide Emissions Lawsuit***—On July 21, 2004, the attorneys general of eight states and New York City,as well as several environmental groups, filed lawsuits in U.S. District Courtfor the Southern District of New York against five utilities, including XcelEnergy, to force reductions in carbon dioxide (CO2) emissions. Although SPS is not named as a party to thislitigation, the requested relief that Xcel Energy cap and reduce its CO2 emissions could have a materialadverse effect on SPS. The other utilities include American Electric Power Co.,Southern Co., Cinergy Corp. and Tennessee Valley Authority. CO2 is emitted whenever fossil fuel iscombusted, such as in automobiles, industrial operations and coal- or naturalgas-fired power plants. The lawsuits allege that CO2 emitted by each company is a public nuisance as defined understate and federal common law because it has contributed to global warming. Thelawsuits do not demand monetary damages. Instead, the lawsuits ask the court toorder each utility to cap and reduce its CO2 emissions. In October 2004, Xcel Energy and four otherutility companies filed a motion to dismiss the lawsuit, contending, amongother reasons, that the lawsuit is an attempt to usurp the policy-setting roleof the U.S. Congress and the president. On Sept. 19, 2005, the judge grantedthe defendants’ motion to dismiss on constitutional grounds. Plaintiffs filedan appeal to the Second Circuit Court of Appeals. Oral arguments were presentedon June 7, 2006 and a decision on the appeal is pending.

 

***Lamb County Electric Cooperative***- On July 24, 1995, Lamb County Electric Cooperative, Inc. (LCEC) petitionedthe PUCT for a cease and desist order against SPS alleging that SPS wasunlawfully providing service to oil field customers in LCEC’s certificatedarea. On May 23, 2003, the PUCT issued an order denying LCEC’s petition basedon its determination that SPS was granted a certificate in 1976 to serve thedisputed customers. LCEC appealed the decision to the District Court in TravisCounty, Texas and on Aug. 12, 2004, the District Court affirmed the decision ofthe PUCT. On Sept. 9, 2004, LCEC appealed the District Court’s decision to theCourt of Appeals for the Third Supreme Judicial District of the state of Texas,which appeal is currently pending. Oral arguments in the case were heard March23, 2005. SPS is awaiting the Court of Appeals decision.

 

On October 18,1996, LCEC filed a suit for damages against SPS in the District Court in LambCounty, Texas, based on the same facts as alleged in its petition for a ceaseand desist order at the PUCT. This suit has been dormant since it was filed,awaiting a final determination at the PUCT of the legality of SPS providingelectric service to the disputed customers. The PUCT order of May 23, 2003,found that SPS was legally serving the disputed customers thus collaterallydetermining the issue of liability contrary to LCEC’s position in the suit. Anadverse ruling on the appeal of the May 23, 2003 PUCT order could result in are-determination of the legality of SPS’ service to the disputed customers.

 

***Comer vs. Xcel Energy Inc. et al.***—On April 25, 2006, Xcel Energy received notice of a purported class actionlawsuit filed in United States District Court for the Southern District ofMississippi. Although SPS is not named as a party to this litigation, if thelitigation ultimately results in an unfavorable outcome for Xcel Energy, itcould have a material adverse effect on SPS. The lawsuit names more than 45oil, chemical and utility companies, including Xcel Energy, as defendants andalleges that defendants’ CO2 emissions “were a proximate and direct cause ofthe increase in the destructive capacity of Hurricane Katrina.”  Plaintiffs allege in support of their claim,several legal theories, including negligence and public and private nuisanceand seek damages related to the loss resulting from the hurricane. Xcel Energybelieves this lawsuit is without merit and intends to vigorously defend itselfagainst these claims. On July 19, 2006, Xcel Energy filed a motion to dismissthe lawsuit in its entirety.

 

**6.Short-Term Borrowings and Financing Activities**

 

As ofMarch 31, 2007, SPS had $72.5 million of short-term debt outstanding at aweighted average interest rate of 5.39 percent.

 

**7.****     DerivativeValuation and Financial Impacts**

 

SPS uses anumber of different derivative instruments in connection with its utilitycommodity price, interest rate, and limited short-term wholesale and commoditytrading activities, including forward contracts, futures, swaps and options.

 

All derivative instruments not qualifying for the normal purchases andnormal sales exception, as defined by SFAS 133-“Accounting for DerivativeInstruments and Hedging Activities,” as amended (SFAS 133), are recorded atfair value. The presentation of these derivative instruments is dependent onthe designation of a qualifying hedging relationship. The adjustment to fairvalue of derivative

 

11

----

 

instruments not designated in a qualifying hedging relationship arereflected in current earnings or as a regulatory balance. This classificationis dependent on the applicability of any regulatory mechanism in place. Thisincludes certain instruments used to mitigate market risk for SPS and allinstruments related to the commodity trading operations. The designation of acash flow hedge permits the classification of fair value to be recorded withinOther Comprehensive Income, to the extent effective. The designation of a fairvalue hedge permits a derivative instrument’s gains or losses to offset therelated results of the hedged item in the Statements of Income.

 

SPS records the fair value of its derivative instruments in its BalanceSheet as separate line items identified as Derivative Instruments Valuation inboth current and noncurrent assets and liabilities.

 

Qualifyinghedging relationships are designated as either a hedge of a forecastedtransaction or future cash flow (cash flow hedge), or a hedge of a recognizedasset, liability or firm commitment (fair value hedge). The types of qualifyinghedging transactions that SPS is currently engaged in are discussed below.

 

**CashFlow Hedges**

 

SPS enters intoderivative instruments to manage variability of future cash flows from changesin commodity prices and interest rates. These derivative instruments aredesignated as cash flow hedges for accounting purposes and changes in the fairvalue of these instruments are a component of Other Comprehensive Income ordeferred as a regulatory asset or liability. This classification is based onthe regulatory recovery mechanisms in place. Amounts deferred in these accountsare recorded in earnings as the hedged purchase or sales transaction issettled. This could include the purchase or sale of energy or energy-relatedproducts or the use of natural gas to generate electric energy.

 

As of March 31, 2007, SPShad no commodity-related contracts classified as cash flow hedges.

 

SPS enters into****variousinstruments that effectively fix the interest payments on certain floating ratedebt obligations or effectively fix the yield or price on a specified benchmarkinterest rate for a specific period. These derivative instruments aredesignated as cash flow hedges for accounting purposes and the change inthe fair value of these instruments is recorded as a component of OtherComprehensive Income.

 

As of March 31, 2007, SPS had net losses of approximately $0.6 millionin Accumulated Other Comprehensive Income related to interest rate cash flowhedge contracts that are expected to be recognized in earnings during the next12 months.

 

Gains orlosses on hedging transactions for the sales of energy or energy-relatedproducts are primarily recorded as a component of revenues, hedgingtransactions for fuel used in energy generation are recorded as a component offuel costs and interest rate hedging transactions are recorded as a componentof interest expense. SPS is allowed to recover in electric rates the costs ofcertain financial instruments acquired to reduce commodity cost volatility.There was no hedge ineffectiveness in the first quarter of 2007.

 

The impact ofthe components of hedges on SPS’ Accumulated Other Comprehensive Income,included as a component of stockholders’ equity, are detailed in the followingtable:

 

 
| ** **                                                                           | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(Millions of dollars)**                                                  | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                                           | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Accumulated  other comprehensive loss related to cash flow hedges at Jan. 1          |       | $                                                    | (5.9       | ) | $ | (4.8 | ) |
| After-tax  net unrealized gains related to derivatives accounted for as hedges       |       | —                                               |       | 0.4 |   |
| After-tax  net realized losses on derivative transactions reclassified into earnings |       | 0.1                                                  |       | — |   |
| Accumulated  other comprehensive loss related to cash flow hedges at March 31   |       | $                                                    | (5.8       | ) | $ | (4.4 | ) |

 

**DerivativesNot Qualifying for Hedge Accounting**

 

SPS hasextremely limited commodity trading operations that enter into derivativeinstruments. These derivative instruments are accounted for on a mark-to-marketbasis in the Statement of Income. The results of these transactions arerecorded as a component of Operating Revenues on the Statement of Income.

 

SPS may alsoenter into certain commodity-based derivative transactions, not included intrading operations, which do not qualify for hedge accounting treatment. Thesederivative instruments are accounted for on a mark-to-market basis inaccordance with SFAS 133.

 

12

----

 

**NormalPurchases or Normal Sales Contracts**

 

SPS enters into contracts forthe purchase and sale of various commodities for use in its businessoperations. SFAS 133 requires a company to evaluate these contracts todetermine whether the contracts are derivatives. Certain contracts that meetthe definition of a derivative may be exempted from SFAS 133 as normalpurchases or normal sales. Normal purchases and normal sales are contracts thatprovide for the purchase or sale of something other than a financial orderivative instrument that will be delivered in quantities expected to be usedor sold over a reasonable period in the normal course of business. In addition,normal purchases and normal sales contracts must have a price based on anunderlying that is clearly and closely related to the asset being purchased orsold. An underlying is a specified interest rate security price, commodity price,foreign exchange rate, index of prices or rates, or other variable, includingthe occurrence or nonoccurrence of a specified event, such as a scheduledpayment under a contract.

 

SPS evaluatesall of its contracts when such contracts are entered to determine if they arederivatives and, if so, if they qualify and meet the normal designationrequirements under SFAS 133. None of the derivative contracts entered intowithin the commodity trading operations qualify for a normal designation.

 

Normalpurchases and normal sales contracts are accounted for as executory contracts.

 

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

 

Interest and other income, net,for the three months ended March 31 consisted of the following:

 
| ** **                                 | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| **(Thousands of dollars)**       | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Interest income                            |       | $                                                | 846        |   | $ | 1,256 |   |
| Other  nonoperating income                 |       | 45                                               |       | 237 |   |
| Employee-related  insurance policy expense |       | (61                                              | )          | (18 | ) |
| Other  nonoperating expense                |       | (27                                              | )          | — |   |
| Total interest and other income, net       |       | $                                                | 803        |   | $ | 1,475 |   |

 

**9.****     SegmentInformation**

 

SPS has onereportable segment. SPS operates in the Regulated Electric Utility industry,providing wholesale and retail electric service in the states of Texas and NewMexico. Revenues from external customers were $365.9 million and $412.8 millionfor the three months ended March 31, 2007 and 2006, respectively.

 

**10. Comprehensive Income**

 

The componentsof total comprehensive income are shown below:

 
| ** **                                                                                        | ** ** | **Three months ended  March 31,** | ** ** |     |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|----------|
| **(Millions of dollars)**                                                               | ** ** | **2007**                                         | ** ** | **2006** | ** ** |   |
| Net income                                                                                        |       | $                                                | 1.7        |     | $ | 11.9 |   |   |
| Other  comprehensive income:                                                                      |       |                                             |       |     |   |   |
| After-tax net unrealized gains related to  derivatives accounted for as hedges (see Note 7)       |       | —                                           |       | 0.4      |   |   |
| After-tax net realized losses on derivative  transactions reclassified into earnings (see Note 7) |       | 0.1                                              |       | —   |   |   |
| Other  comprehensive income                                                                       |       | 0.1                                              |       | 0.4      |   |   |
| Comprehensive  income                                                                             |       | $                                                | 1.8        |     | $ | 12.3 |   |
|                                                                                                   |            |                                                  |            |          |  |  |  |  |  |

 

The accumulated othercomprehensive loss in stockholders’ equity at March 31, 2007 and Dec. 31,2006 relates to valuation adjustments on SPS’ derivative financial instrumentsand hedging activities.

 

13

----

 

**11.Benefit Plans and Other 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**

 
| ** **                                                    | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **2007** | ** ** | **2006** | ** ** |
| **(Thousands of dollars)**                          | ** ** | **Pension Benefits**                            | ** ** | **Postretirement Health  Care Benefits** | ** ** |
| **Xcel  Energy Inc.**                                         | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                  |       | $                                                    | 16,485     |   | $ | 16,434 |   | $ | 1,701 |   | $ | 1,837 |   |
| Interest  cost                                                |       | 39,598                                               |       | 39,509 |   | 13,603 |   | 13,183 |   |
| Expected  return on plan assets                               |       | (65,891                                              | )          | (66,481 | ) | (7,618 | ) | (6,268 | ) |
| Amortization  of transition obligation                        |       | —                                               |       | — |   | 3,611 |   | 3,645 |   |
| Amortization  of prior service cost (credit)                  |       | 6,487                                                |       | 7,427 |   | (545 | ) | (545 | ) |
| Amortization  of net loss                                     |       | 3,867                                                |       | 4,511 |   | 4,994 |   | 6,523 |   |
| Net periodic  benefit cost                                    |       | 546                                                  |       | 1,400 |   |   | 15,746 |   |   | 18,375 |   |
| Credits not recognized due to the effects  of regulation      |       | 2,680                                                |       | 2,425 |   | — |   | — |   |
| Additional cost recognized due to the  effects of regulation  |       | —                                               |       | — |   | 973 |   | 973 |   |
| Net benefit cost recognized for financial  reporting          |       | $                                                    | 3,226      |   | $ | 3,825 |   | $ | 16,719 |   | $ | 19,348 |   |
|                                                          |       |                                                 |       |   |   |   |   |   |   |
| **SPS**                                                       | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net benefit cost (credit) recognized for  financial reporting |       | $                                                    | (2,006     | ) | $ | (1,343 | ) | $ | 1,548 |   | $ | 1,705 |   |

 

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

** **

Discussion offinancial condition and liquidity for SPS is omitted per conditions set forthin general instructions H (1) (a) and (b) of Form 10-Q for wholly ownedsubsidiaries. It is replaced with management’s narrative analysis and theresults of operations set forth in general instructions H (2) (a) of Form 10-Qfor 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.

 

Except for thehistorical statements contained in this report, the matters discussed in thefollowing discussion and analysis are forward-looking statements that aresubject to certain risks, uncertainties and assumptions. Such forward-lookingstatements are intended to be identified in this document by the words “anticipate,”“estimate,” “expect,” “objective,” “outlook,” “possible,” “potential” andsimilar expressions. Actual results may vary materially. Factors that couldcause actual results to differ materially include, but are not limited to:

 

•              Economicconditions, including their impact on capital expenditures and the ability ofthe SPS to obtain financing on favorable terms, inflation rates and monetaryfluctuations;

•              Businessconditions in the energy business;

•              Demandfor electricity in the nonregulated marketplace;

•              Trade,monetary, fiscal, taxation and environmental policies of governments, agenciesand similar organizations in geographic areas where SPS has a financialinterest;

•              Customerbusiness conditions, including demand for their products or services and supplyof labor and materials used in creating their products and services;

•              Financialor regulatory accounting principles or policies imposed by the FinancialAccounting Standards Board, the Securities and Exchange Commission, the FederalEnergy Regulatory Commission and similar entities with regulatory oversight;

•              Availabilityor cost of capital such as changes in: interest rates; market perceptions ofthe utility industry, SPS, Xcel Energy or any of its other subsidiaries; orsecurity ratings;

 

14

----

 

•     Factorsaffecting utility operations such as unusual weather conditions; catastrophicweather-related damage; unscheduled generation outages, maintenance or repairs;unanticipated changes to fossil fuel or natural gas supply costs oravailability due to higher demand, shortages, transportation problems or otherdevelopments; environmental incidents; or electric transmission or natural gaspipeline constraints;

•     Employee workforce factors,including loss or retirement of key executives, collective bargainingagreements with union employees, or work stoppages;

•     Increased competition in the utility industry;

•     State and federal legislative and regulatoryinitiatives that affect cost and investment recovery, have an impact on ratestructures and affect the speed and degree to which competition enters theelectric markets; industry restructuring initiatives; transmission systemoperation and/or administration initiatives; recovery of investments made undertraditional regulation; nature of competitors entering the industry; retailwheeling; a new pricing structure; and former customers entering the generationmarket;

•     Rate-setting policies or procedures of regulatoryentities, including environmental externalities, which are values establishedby regulators assigning environmental costs to each method of electricitygeneration when evaluating generation resource options;

•     Social attitudes regarding the utility and powerindustries;

•     Cost and other effects of legal and administrativeproceedings, settlements, investigations and claims;

•     Technological developments that result incompetitive disadvantages and create the potential for impairment of existingassets;

•     Significant slowdown in growth or decline in theU.S. economy, delay in growth or recovery of the U.S. economy or increased costfor insurance premiums, security and other items;

•     Risks associated with implementation of newtechnologies; and

•     Other business or investment considerations thatmay be disclosed from time to time in SPS’ SEC filings, including “Risk Factors”in Item 1A of SPS’ Annual Report on Form 10-K for the year ended Dec. 31, 2006,or in other publicly disseminated written documents.

 

**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, 2006.Commodity price and interest rate risks for SPS are mitigated in most jurisdictionsdue to cost-based rate regulation. At March 31, 2007, there were nomaterial changes to the financial market risks that affect the quantitative andqualitative disclosures presented as of Dec. 31, 2006.

 

**RESULTSOF OPERATIONS**

 

SPS’ netincome was approximately $1.7 million for the first three months of 2007,compared with approximately $11.9 million for the first three months of 2006.

 

**ElectricUtility, Short-term Wholesale and Commodity Trading Margins**

 

Electricproduction expenses tend to vary with changing retail and wholesale salesrequirements and unit cost changes in fuel and purchased power. Due to fuelclause cost recovery mechanisms for retail customers, most fluctuations inenergy costs do not affect electric margin.

 

SPS has two distinct forms of wholesalemarketing activities:  short-termwholesale and commodity trading. Short-term wholesale refers to energy relatedpurchase and sales activity and the use of certain financial instrumentsassociated with the fuel required for and energy produced from SPS’ generationassets and energy and capacity purchased to serve native load. Commoditytrading is not associated with SPS’ generation assets or the energy andcapacity purchased to serve native load.

 

SPSconducts an inconsequential amount of commodity trading. Margins from commoditytrading activity are partially redistributed to Northern States Power Company,a Minnesota corporation, and Public Service Company of Colorado, both whollyowned subsidiaries of Xcel Energy, pursuant to the joint operating agreement(JOA) approved by the FERC. Margins received pursuant to the JOA are reflectedas part of Base Electric Utility Revenues. Short-term wholesale and commoditytrading margins reflect the impact of regulatory sharing or realized margins, ifapplicable. Commodity trading revenues are reported net of trading costs (i.e.,on a margin basis) in the Statements of Income. Commodity trading costs includepurchased power, transmission, broker fees and other related costs.

 

15

----

 

The following table details base electricutility and short-term wholesale activities:

 
| **(Millions of Dollars)**                      | ** ** | **Base  Electric  Utility** | ** ** | **Short-Term  Wholesale** | ** ** | **Commodity  Trading** | ** ** | **Consolidated  Totals** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|------------------------|------------|--------------------------|------------|
| **Three  months ended March 31, 2007**                   |       |                        |       |                      |       |                   |       |                     |       |
| Electric  utility revenues (excluding commodity trading) |       | $                           | 364        |                      | $          | 3                      |       | $                        | —     |   | $ | 367 |   |
| Fuel and  purchased power                                |       | (261                        | )          | (3                        | )          | —                 |       | (264                     | )          |
| Commodity  trading revenues                              |       | —                      |       | —                    |       | —                 |       | —                   |       |
| Commodity  trading costs                                 |       | —                      |       | —                    |       | (1                     | )          | (1                       | )          |
| Gross margin before operating expenses                   |       | $                           | 103        |                      | $          | —                 |       | $                        | (1         | ) | $ | 102 |   |
| Margin as a  percentage of revenues                      |       | 28.3                        | %          | —                    | %          | —                 | %          | 27.8                     | %          |
|                                                     |       |                        |       |                      |       |                   |       |                     |       |
| **Three  months ended March 31, 2006**                   |       |                        |       |                      |       |                   |       |                     |       |
| Electric  utility revenues (excluding commodity trading) |       | $                           | 411        |                      | $          | 2                      |       | $                        | —     |   | $ | 413 |   |
| Fuel and  purchased power                                |       | (294                        | )          | (2                        | )          | —                 |       | (296                     | )          |
| Commodity  trading revenues                              |       | —                      |       | —                    |       | —                 |       | —                   |       |
| Commodity  trading costs                                 |       | —                      |       | —                    |       | —                 |       | —                   |       |
| Gross margin before operating expenses                   |       | $                           | 117        |                      | $          | —                 |       | $                        | —     |   | $ | 117 |   |
| Margin as a  percentage of revenues                      |       | 28.5                        | %          | —                    | %          | —                 | %          | 28.3                     | %          |
|                                                          |            |                             |            |                           |            |                        |            |                          |            |  |  |  |  |  |  |  |  |

 

The followingsummarizes the components of the changes in base electric revenues and baseelectric margin for the three months ended March 31:

 

***Base Electric Revenues***

 
| **(Millions of dollars)**      | ** ** | **2007 vs. 2006** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|
| Fuel cost  recovery                      |       | $                           | (56        | ) |
| Firm  wholesale                          |       | 4                           |       |
| Transmission  revenues                   |       | 3                           |       |
| Sales growth  (excluding weather impact) |       | 1                           |       |
| Estimated  impact of weather             |       | 1                           |       |
| Total decrease in base electric revenues |       | $                           | (47        | ) |
|                                          |            |                             |            |  |  |

 

***Base Electric Margin***

 
| **(Millions of dollars)**      | ** ** | **2007 vs. 2006** | ** ** |
|------------------------------------------|------------|-----------------------------|------------|
| SPS  potential regulatory settlement     |       | $                           | (13        | ) |
| SPS 2006  favorable fuel recovery        |       | (7                          | )          |
| Firm  wholesale                          |       | 4                           |       |
| Sales growth  (excluding weather impact) |       | 1                           |       |
| Estimated  impact of weather             |       | 1                           |       |
| Total decrease in base electric margin   |       | $                           | (14        | ) |
|                                          |            |                             |            |  |  |

 

## **Non-FuelOperating Expense and Other Costs**

## ** **

***Other Operating and Maintenance Expenses -***Thefollowing summarizes the components of the changes in other operating andmaintenance expense for the three months ended March 31:

 
| **(Millions of dollars)**                         | ** ** | **2007 vs. 2006** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| Higher plant  outage costs                                  |       | $                      | 3          |   |
| Transmission  fee classification change                     |       | (1                     | )          |
| Other                                                       |       | (1                     | )          |
| Total increase in other operating and  maintenance expenses |       | $                      | 1          |   |
|                                                             |            |                        |            |  |  |

 

***Taxes (other than income taxes) -***Taxes(other than income taxes) decreased by approximately $1.8 million, or 13.2percent, for the first three months of 2007, compared with the first threemonths of 2006. The decrease was primarily due to the replacement of the Texasfranchise fee with a gross receipts tax.

 

16

----

 

***Interest and other income -***Interestand other income decreased by $0.7 million, or 45.6 percent, for the firstthree months of 2007, compared with the first three months of 2006. Thedecrease was primarily due to a decrease in the deferred recoverable energycosts interest charges in Texas.

 

***Income taxes -***Income taxes decreased by approximately $6.1million for the first three months of 2007 compared with the first three monthsof 2006. The effective tax rate was 31.1 percent for the first three months of2007, compared with 36.7 percent for the same period in 2006. The decreases inincome tax expense and the effective tax rate were primarily due to a decreasein pretax income.

 

***Regulation***

** **

**Summary of Recent Federal Regulatory Developments**

TheFERC has jurisdiction over rates for electric transmission service ininterstate commerce and electric energy sold at wholesale, hydro facilitylicensing, accounting practices and certain other activities of SPS. State andlocal agencies have jurisdiction over many of SPS’ activities, includingregulation of retail rates and environmental matters. In addition to the matters discussed below,see Note 4 to the financial statements for a discussion of other regulatorymatters.

 

***FERC Rules Implementing Energy PolicyAct of 2005 (Energy Act) —***  The Energy Act repealed the Public Utility Holding Company Actof 1935, effective Feb. 8, 2006. In addition, the Energy Act required theFERC to conduct several rulemakings to adopt new regulations to implementvarious aspects of the Energy Act. Since Aug. 2005, the FERC has completedor initiated  proceedings to modify itsregulations on a number of subjects. In addition to the previous disclosure in Item1 of SPS’ Form 10-K for the year ended Dec. 31, 2006, the FERC issued final rules making certain reliabilitystandards mandatory and subject to potential financial penalties up to $1million per day per violation for non-compliance effective June 1, 2007.

 

WhileSPS cannot predict the ultimate impact the new regulations will have on itsoperations or financial results, SPS is taking actions that are intended tocomply with and implement these new rules and regulations as they becomeeffective.

 

***Electric Transmission RateRegulation —*** The FERC also regulates therates charged and terms and conditions for electric transmission services. FERCpolicy encourages utilities to turn over the functional control over theirelectric transmission assets and the related responsibility for the sale ofelectric transmission services to a Regional Transmission Organization (RTO).SPS is a member of the Southwest Power Pool, Inc. (SPP). Each RTO separatelyfiles regional transmission tariff rates for approval by the FERC. All memberswithin that RTO are then subjected to those rates.

 

OnFeb. 15, 2007, the FERC issued final rules adopting revisions to its 1996 openaccess transmission rules. The final rules are effective May 14, 2007. SPS willbe required to complete several compliance actions.

 

Inaddition, in January 2007, the FERC issued interim and proposed rules to modifyits 2004 standards of conduct rules for electric and natural gas transmissionproviders, in response to a 2006 court appeal partially vacating the rules. Theproposed rules would modify the current FERC rules governing the functionalseparation of the SPS electric transmission function from the wholesale salesand marketing function. The proposed rules are pending final FERC action.

 

WhileSPS cannot predict the ultimate impact the new regulations will have on itsoperations or financial results, SPS is taking actions that are intended tocomply with and implement these new rules and regulations as they becomeeffective.

 

**Item 4. CONTROLS AND PROCEDURES**

 

**Disclosure Controls andProcedures**

** **

SPS maintainsa set of disclosure controls and procedures designed to ensure that informationrequired to be disclosed in reports that it files or submits under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rules andforms. In addition, the disclosure controls and procedures ensure thatinformation required to be disclosed 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 CFO, of the effectiveness of our disclosure controls andprocedures, the CEO and CFO have concluded that SPS’ disclosure controls andprocedures are effective.

 

17

----

 

**Internal Control Over FinancialReporting**

** **

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

 

#### **Part II. OTHERINFORMATION**

#### ** **

## **Item 1. LegalProceedings**

## ** **

In the normal course ofbusiness, various lawsuits and claims have arisen against SPS. Management,after consultation with legal counsel, has recorded an estimate of the probablecost of settlement or other disposition for such matters. See Notes 4 and 5 of theFinancial Statements in this Quarterly Report on Form 10-Q for furtherdiscussion of legal proceedings, including Regulatory Matters and Commitmentsand Contingent Liabilities, which are hereby incorporated by reference.Reference also is made to Item 3 and Note 11 of SPS’ Annual Report on Form10-K for the year ended Dec. 31, 2006 for a description of certain legalproceedings presently pending. Except as discussed herein, there are no newsignificant cases to report against SPS and there have been no notable changesin the previously reported proceedings.

 

**Item1A. Risk Factors**

 

SPS’ risk factors are documented in Item 1A of Part I of its 2006Annual Report on Form 10-K, which is incorporated herein by reference. Therehave been no material changes to the risk factors.

 

## **Item 6.Exhibits**

## ** **

The followingExhibits are filed with this report:

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

 

18

----

 

SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on April 27, 2007.

 
| Southwestern Public Service Co.            |
|--------------------------------------------|
| (Registrant)                               |
|                                       |
|                                       |
| /s/ TERESA S. MADDEN                       |   |
| Teresa S. Madden                           |
| Vice President and Controller              |
|                                       |
|                                       |
| /s/ BENJAMIN G.S. FOWKE III                |   |
| Benjamin G.S. Fowke III                    |
| Vice President and Chief Financial Officer |

 

19

----