The information contained in this Item 2 updates, and should be read in conjunction with, the information set forth in Part II, Item 7 of our 2007 Form 10-K.

Certain matters discussed in this Quarterly Report on Form 10-Q other than statements of historical information are "forward-looking statements." The Private Securities Litigation Reform Act of 1995 has established that these statements qualify for safe harbors from liability. Forward-looking statements may include words like we "believe", "anticipate", "target", "expect", "pro forma", "estimate", "intend" and words of similar meaning. Forward-looking statements describe our future plans, objectives, expectations or goals. Such statements address future events and conditions concerning and include, but are not limited to such things as:

• capital expenditures,

• earnings,

• liquidity and capital resources,

• litigation,

• accounting matters,

• possible corporate restructurings, acquisitions and dispositions,

• compliance with debt and other restrictive covenants,

• interest rates and dividends,

• environmental matters,

• nuclear operations, and

• the overall economy of our service area.

These forward-looking statements involve known and unknown risks that may cause our actual results in future periods to differ materially from those expressed in any forward-looking statement. Factors that would cause or contribute to such differences include, but are not limited to, such things as:

• our rates in Texas following the Texas Freeze Period ending June 30, 2010,

• our rates in New Mexico including the impact of the 2007 New Mexico Stipulation which requires a rate case to be filed by May 30, 2009,

• any changes in our New Mexico fuel and purchase power adjustment clause after the 2009 continuation filing,

• loss of margins on off-system sales due to changes in wholesale power prices or availability of competitive generation resources,

• ability of our operating partners to maintain plant operations and manage operation and maintenance costs at Palo Verde and Four Corners plants including additional costs associated with the degraded cornerstone status of Palo Verde,

• reductions in output at generation plants operated by the Company,

• unscheduled outages including outages at Palo Verde,

• the size of our construction program and our ability to complete construction on budget and on a timely basis,

• electric utility deregulation or re-regulation,

• regulated and competitive markets,

• ongoing municipal, state and federal activities,

• changes in accounting requirements and other accounting matters,

• changing weather trends,

• rates, cost recoveries and other regulatory matters including the ability to recover fuel costs on a timely basis,

• changes in environmental regulations,

• political, legislative, judicial and regulatory developments,

• the impact of lawsuits filed against us,

• the impact of changes in interest rates,

• changes in, and the assumptions used for, pension and other post-retirement and post-employment benefit liability calculations, as well as actual and assumed investment returns on pension plan assets,

• the impact of changing cost escalation and other assumptions on our nuclear decommissioning liability for Palo Verde,

• Texas, New Mexico and electric industry utility service reliability standards,

• homeland security considerations,

• coal, uranium, natural gas, oil and wholesale electricity prices and availability, and

• other circumstances affecting anticipated operations, sales and costs.

These lists are not all-inclusive because it is not possible to predict all factors. A discussion of some of these factors is included in this document under the headings "Risk Factors" and in the 2007 Form 10-K under the headings "Management's Discussion and Analysis" "-Summary of Critical Accounting Policies and Estimates" and "-Liquidity and Capital Resources." This report should be read in its entirety. No one section of this report deals with all aspects of the subject matter. Any forward-looking statement speaks only as of the date such statement was made, and we are not obligated to update any forward-looking statement to reflect events or circumstances after the date on which such statement was made except as required by applicable laws or regulations.

The preparation of our financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the periods presented and actual results could differ in future periods from those estimates. Critical accounting policies and estimates are both important to the portrayal of our financial condition and results of operations and require complex, subjective judgments and are more fully described in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2007 Form 10-K.

We own approximately 633 MW (undivided interest) of generating capacity in the three generating units at the Palo Verde nuclear power station. The operation of Palo Verde affects our ability to make off-system sales, impacts our fuel costs to native load customers and represents a significant portion of our non-fuel operating expenses. APS is the operating agent for Palo Verde, and we have limited ability under the ANPP Participation Agreement to influence operations and costs at Palo Verde. Palo Verde generation accounted for over 57% of total Company generation in the first nine months of 2008 and 2007. Megawatt-hours (MWh) generated by Palo Verde increased 10.6% in the third quarter of 2008 and 4.1% in the nine months ended September 30, 2008 compared to the same periods in 2007.

Palo Verde operation and maintenance expenses increased $0.6 million in the third quarter of 2008 compared to the third quarter of 2007 reflecting increased operating costs at the plant offset by a $2.6 million credit adjustment for 2007 operations expense. In the nine months ended September 30, 2008 Palo Verde operations and maintenance expenses increased $9.3 million after the $2.6 million credit adjustment to 2007 operations expense in the third quarter of 2008, compared to the same period in 2007. This increase is primarily due to increased maintenance costs incurred during the 2008 spring refueling outage at Palo Verde Unit 2 and increased operating costs at all three units in response to an enhanced inspection regimen by the Nuclear Regulatory Commission ("NRC"). The NRC has placed Palo Verde Unit 3 in the "multiple/repetitive degraded cornerstone" column of the NRC's action matrix which has resulted in an enhanced NRC inspection regimen for the entire plant. On February 15, 2008, the NRC issued a "Revised Palo Verde Nuclear Generating Station Confirmatory Action Letter" which requires that Palo Verde submit a plan to the NRC to remedy the issues identified by the NRC. On March 31, 2008, APS, the operator of Palo Verde, issued its response to the NRC in which APS committed to specific tasks, with due dates, to address those issues. The NRC has stated that Palo Verde has made significant progress correcting the identified issues; however, Unit 3 will remain in the "multiple/repetitive degraded cornerstone" column of the NRC's action matrix until all identified issues are resolved. The enhanced inspection regimen and corrective actions has resulted in increased operating costs at the plant and we are currently unable to predict the impact that the NRC's increased oversight may have on Palo Verde's operations and the cost of operations.

In January 2006, we filed a complaint with the FERC to interpret the terms of a Power Exchange and Transmission Agreement (the "Transmission Agreement") entered into with Tucson Electric Power Company ("TEP") in 1982. TEP filed a complaint with the FERC one day later raising virtually identical issues. TEP claimed that, under the Transmission Agreement, it was entitled to up to 400 MW of firm transmission rights on our transmission system that would enable it to transmit power from a new generating station (the Luna Energy Facility ("LEF") located near Deming, New Mexico) to Springerville or Greenlee in Arizona. We asserted that TEP's rights under the Transmission Agreement do not include transmission rights necessary to transmit such power as contemplated by TEP and that TEP must acquire any such rights in the open market from us at applicable tariff rates or from other transmission providers. On April 24, 2006, the FERC ruled in our favor, finding that TEP does not have the transmission rights under the Transmission Agreement to transmit power from the LEF to Arizona. The ruling was based on written evidence presented and without an evidentiary hearing. TEP's request for a rehearing of the FERC's decision was granted in part and denied in part in an order issued October 4, 2006, and hearings on the disputed issues were held before an Administrative Law Judge.

An initial decision was issued by the Administrative Law Judge on September 6, 2007. The Administrative Law Judge found that the Transmission Agreement allows TEP to transmit power from the LEF to Arizona but limits that transmission to 200 MW on any segment of the circuit and to non-firm service on the segment from Luna to Greenlee. We and TEP have filed exceptions to the initial decision. The FERC will issue a final decision on the merits after review of the initial decision and the briefs on exceptions and replies to exceptions. While we believe that we will prevail on all points, we cannot predict the outcome of this case. During 2006, 2007, and the first nine months of 2008, TEP paid us $10.3 million for transmission service relating to the LEF. We have established a reserve for rate refund for $7.2 million related to this issue. If the FERC rules in TEP's favor, we may be required to refund all of the $10.3 million we have received from TEP for transmission service relating to the LEF and may lose the opportunity to receive compensation from TEP for such transmission service in the future. An adverse ruling by the FERC could have a negative effect on our results of operations and cash flows.

We have a $4.0 million investment in certain auction rate debt securities. These securities provided for interest rates to be reset on a short-term basis which historically provided a liquid market to sell the securities to meet cash requirements. The auction rate securities were purchased as a temporary investment, and we have classified them as trading securities. The auction rate securities had successful auctions through January 2008. However, beginning on February 13, 2008, auctions for these investments have not been successful, resulting in the inability to liquidate these investments. These investments continue to pay interest. The fair value of these securities as of September 30, 2008 was based upon the average of (i) a discounted cash flow model valuation (income approach), where the expected cash flows of the securities were discounted to the present using a yield that incorporated estimated compensation for illiquidity; and (ii) a market comparables method (market approach), where the securities were valued based on indications from the secondary market, of what discount buyers demand when purchasing similar auction rate securities. The Company's ultimate gain or loss on these securities will be determined when they are sold.

                                    Summary

The following is an overview of our results of operations for the three, nine
and twelve month periods ended September 30, 2008 and 2007. Income for the
three, nine and twelve month periods ended September 30, 2008 and 2007 is shown
below:



                                         Three Months Ended       Nine Months Ended       Twelve Months Ended
                                           September 30,            September 30,            September 30,
                                          2008         2007        2008        2007        2008          2007
Net income before extraordinary item
(in thousands)                         $    33,074   $ 36,088   $   66,796   $ 60,806   $    80,743    $ 70,564
Basic earnings per share before
extraordinary item                            0.74       0.79         1.49       1.33          1.80        1.54

The following table and accompanying explanations show the primary factors affecting the after-tax change in income before extraordinary item between the 2008 and 2007 periods presented (in thousands):

                                               Three Months         Nine Months         Twelve Months
                                                  Ended                Ended                Ended
September 30, 2007 net income before
extraordinary item                            $       36,088       $      60,806       $        70,564
Change in (net of tax):
Increased (decreased) off-system sales
margins retained                                       1,506               2,488                (1,129 )
Deregulated Palo Verde Unit 3 proxy
market pricing (a)                                     1,151               6,435                 5,552
Increased transmission wheeling revenue
(b)                                                    1,072               3,302                 3,790
Increased AFUDC and capitalized interest
(c)                                                      939               3,301                 5,551
Increased (decreased) retail non-fuel
base revenues (d)                                     (2,239 )             6,200                11,642
Increased interest on long-term debt (e)              (2,094 )            (3,762 )              (3,983 )
Decreased interest and investment income
(f)                                                   (1,800 )            (2,958 )              (2,870 )
Increased depreciation and amortization                 (890 )            (2,942 )              (3,164 )
Increased operations and maintenance at
coal and gas-fired generating plants (g)                (511 )            (3,492 )              (4,539 )
Increased Palo Verde operations and
maintenance expense (h)                                 (370 )            (5,839 )              (9,278 )
Other                                                    222               3,257                 8,607

September 30, 2008 net income before
extraordinary item                            $       33,074       $      66,796       $        80,743

(a) Deregulated Palo Verde Unit 3 proxy market pricing reflects higher proxy market prices for deregulated Palo Verde Unit 3 power sold to retail customers in all three periods.

(b) Increased revenues for transmission wheeling for all periods in 2008 are largely due to wheeling power in southern New Mexico and Arizona.

(c) AFUDC (allowance for funds used during construction) increased for all periods in 2008 due to increased construction work in progress subject to AFUDC. Capitalized interest increased for the nine and twelve month periods in 2008 due to increased nuclear fuel balances subject to capitalized interest. AFUDC also increased for the twelve months ended September 30, 2008 compared to the same period last year due to the re-application of SFAS No. 71 to our Texas jurisdiction beginning December 31, 2006.

(d) Non-fuel retail base revenues exclude fuel recovered through New Mexico base rates. Non-fuel retail base revenues decreased for the three months ending September 30, 2008 compared to the same period last year due to a 3.3% decrease in kWh sales due to cooler than normal weather in 2008. Non-fuel retail base revenues increased for the nine and twelve month periods ending September 30, 2008 compared to the same periods last year largely due to increased revenues from small commercial and industrial customers and other public authorities due to increased kWh sales in each of these classes.

(e) Interest expense on long-term debt increased for all periods in 2008 due to the issuance of $150 million of 7.5% Senior Notes in June 2008 and to a smaller extent higher interest rates on auction rate pollution control bonds.

(f) Lower interest and investment income are primarily due to impairments of equity investments in our Palo Verde decommissioning trust funds and a decrease in the fair value of our investments in auction rate securities.

(g) Operation and maintenance costs increased at our fossil-fueled generating plants as planned major maintenance was performed at Four Corners Unit 5 and Newman Unit 3 in 2008. In the first nine months of 2007 no major maintenance was performed at our fossil-fueled generating units.

(h) Palo Verde non-fuel operations and maintenance expenses increased for the three, nine, and twelve months ended September 30, 2008 compared to the same periods last year due to higher maintenance costs at Palo Verde Unit 2 associated with refueling the unit and increased operating costs at all three units in 2008. Palo Verde non-fuel operations and maintenance expenses also increased for the twelve months ended September 30, 2008 compared to the twelve months ended September 30, 2007 due to higher maintenance costs at Palo Verde Unit 3 associated with the steam generator replacement and refueling in the fourth quarter of 2007. A $2.6 million credit adjustment to operations expense was recognized in the third quarter of 2008 which reduced the increases in Palo Verde expenses.

The following discussion includes detailed descriptions of factors affecting individual line items in the results of operations. The amounts presented below are presented on a pre-tax basis.

Operating revenues

We realize revenue from the sale of electricity to retail customers at regulated rates and the sale of energy in the wholesale power market generally at market based prices. Sales for resale (which are wholesale sales within our service territory) accounted for less than 1% of revenues. Off-system sales are wholesale sales into markets outside our service territory. Off-system sales are primarily made in off-peak periods when we have competitive generation capacity available after meeting our regulated service obligations. Under the terms of our rate agreements in Texas and New Mexico, we share 25% of our off-system sales margins with our customers in Texas and New Mexico (effective July 1, 2005 and July 1, 2007, respectively). We are also sharing 25% of our off-system sales margins with our sales for resale customer under the terms of a new contract which was effective April 1, 2008. In July 2010, off-system sales margins shared with customers increases to 90%.

Revenues from the sale of electricity include fuel costs that are recovered from our customers through fuel adjustment mechanisms. A significant portion of fuel costs are also recovered through base rates in New Mexico. We record deferred fuel revenues for the difference between actual fuel costs and recoverable fuel revenues until such amounts are collected from or refunded to customers. "Non-fuel base revenues" refers to our revenues from the sale of electricity excluding such fuel costs.

Retail non-fuel base revenue percentages by customer class are presented below:

                                         Three Months Ended           Nine Months Ended          Twelve Months Ended
                                            September 30,               September 30,               September 30,
                                         2008           2007         2008          2007          2008           2007
Residential                                  43 %           44 %         40 %          41 %          39 %           40 %
Commercial and industrial, small             36             35           37            36            37             36
Commercial and industrial, large              7              7            8             8             8              9
Sales to public authorities                  14             14           15            15            16             15

Total retail non-fuel base revenues         100 %          100 %        100 %         100 %         100 %          100 %

No retail customer accounted for more than 2% of our base revenues during such periods. As shown in the table above, residential and small commercial customers comprise more than 75% of our revenues. While this customer base is more stable, it is also more sensitive to changes in weather conditions. As a result, our business is seasonal, with higher kWh sales and revenues during the summer cooling season.

Weather significantly impacts our residential, small commercial and industrial customers, and to a lesser extent, our sales to public authorities. For the quarter ended September 30, 2008, retail non-fuel base revenues were negatively impacted by cooler than normal summer weather in 2008. Heating and cooling degree days can be used to evaluate the effect of weather on energy use. For each degree the average outdoor temperature varies from a standard of 65 degrees Fahrenheit a degree day is recorded. The table below shows heating and cooling degree days compared to a 10-year average.

                                        Three Months Ended                Nine Months Ended                Twelve Months Ended
                                          September 30,        10-Year      September 30,       10-Year       September 30,        10-Year
                                        2008         2007      Average     2008        2007     Average     2008         2007      Average*
Heating degree days                           1           -          1      1,275       1,375     1,271       2,186        2,355      2,329
Cooling degree days                       1,147        1,504     1,415      2,160       2,361     2,401       2,311        2,433      2,525

* Calendar year basis.

Customer growth is a key driver in our retail sales growth. The average number of retail customers grew between 1.9% to 2.3% for the three, nine, and twelve months ended September 30, 2008 when compared to the same periods last year. See the tables presented on pages 41, 42, and 43 which provide detail on the average number of retail customers and the related revenues and kWh sales.

Retail non-fuel base revenues. Retail non-fuel base revenues decreased by $3.6 million or 2.6% for the three months ended September 30, 2008 when compared to the same period last year due to cooler than normal weather in the third quarter of 2008 than in the third quarter of 2007. In the three months ended September 30, 2008, cooling degree days were 24% below the same period in 2007 and 19% below the 10-year average. As a result, residential non-fuel base revenues decreased $3.0 million, or 5.0% and residential kWh sales decreased 5.5% in the third quarter of 2008 compared to the same period in 2007. Non-fuel base revenues from small commercial and industrial customers and other public authority customers were also impacted by the weather and decreased $0.1 million each. Non-fuel base revenues from large commercial and industrial customers decreased $0.3 million or 3.3% reflecting the impact of losing several customers and the transfer of several customers to the small commercial and industrial class. The decrease in retail kWh sales was partially offset by a 1.9% increase in the average number of customers in the third quarter of 2008 compared to the same period in 2007.

Retail non-fuel base revenues for the nine months ended September 30, 2008 increased by $9.8 million, or 2.8%, compared to the same period in 2007. KWh sales grew 1.6%, compared to the same period in 2007 reflecting a 2.0% increase in the average number of customers served. Small commercial and industrial customer non-fuel base revenues increased $6.9 million, or 5.5% largely due to a 2.7% increase in kWh sales which reflects a 5.4% increase in the average number of customers served and a rate increase in New Mexico in July 2007. Non-fuel base revenues from sales to public authorities increased $3.7 million, or 7.0%. KWh sales to other public authorities increased 5.2% reflecting a significant increase in sales to military facilities, colleges and universities. Non-fuel base revenues from public authorities also increased due to a rate increase in New Mexico in July 2007. Residential non-fuel base revenues increased $0.6 million, or 0.4% reflecting the cooler than normal weather in the third quarter of 2008 and a 1.6% increase in the average number of customers served. During the nine months ended September 30, 2008, cooling degree days were 9% lower and heating degree days were 7% lower than in the nine months ended September 30, 2007. As a result, retail kWh sales from residential customers and small commercial and industrial customers were negatively impacted. Non-fuel base revenues from residential customers also benefited from the non-fuel base rate increase in New Mexico effective July 1, 2007. Non-fuel base revenues from large commercial and industrial customers decreased $1.3 million or 4.6% reflecting the impact of losing several customers and the transfer of several other customers to the small commercial and industrial classes.

Retail non-fuel base revenues increased by $18.5 million, or 4.1%, for the twelve months ended September 30, 2008 when compared to the same period last year. KWh sales grew 2.1%, compared to the same period in 2007 reflecting a 2.3% increase in the average number of customers served. Small commercial and industrial customer non-fuel base revenues increased $10.7 million, or 6.5% largely due to a 3.5% increase in kWh sales which reflects a 6.8% increase in the average number of customers served and a rate increase in New Mexico in July 2007. Non-fuel base revenues from sales to public authorities increased $7.2 million, or 10.4%. KWh sales to other public authorities increased 5.6% reflecting a significant increase in sales to military facilities, colleges and universities. Non-fuel base revenues from public authorities also increased due to a rate increase in New Mexico in July 2007. Residential non-fuel base revenues increased $2.7 million, or 1.5% as the result of a 1.3% increase in residential kWh sales and a rate increase in New Mexico in July 2007. Non-fuel base revenues from

large commercial and industrial customers decreased $2.1 million or 5.3% . . .