Lease Commitments

3 Months Ended

Mar. 31, 2019

The Company enters into various lease agreements to meet its business needs and to satisfy the needs of its customers. Historically, the Company’s leases were classified as operating leases which included leases for generating capacity from PVNGS Units 1 and 2, certain rights-of-way agreements for transmission lines and facilities, vehicle and equipment leases necessary to construct and maintain the Company’s assets and building and office equipment leases. In February 2016, the FASB issued ASU 2016-02 - Leases (Topic 842) to provide guidance on the recognition, measurement, presentation, and disclosure of leases. Among other things, ASU 2016-02 requires that all leases be recorded on the balance sheets by recognizing a present value liability for future cash flows of the lease agreement and a corresponding right-of-use asset. The Company adopted Topic 842 on January 1, 2019, its required effective date. The Company elected to use many of the practical expedients available upon adoption of the standard. As a result, the Company will continue to classify its leases existing as of December 31, 2018 as operating leases until they expire or are modified. In addition, the Company elected the practical expedient to not reevaluate the accounting for land easements and rights-of-way agreements existing at December 31, 2018. The Company also elected the use of the practical expedient to apply the requirements of the new standard on its effective date and has not restated prior periods to conform to the new guidance. Adoption of the lease standard has a material impact on the Company’s Condensed Consolidated Balance Sheets but does not have a material impact on the Condensed Consolidated Statements of Earnings or the Condensed Consolidated Statements of Cash Flows.

Effective January 1, 2019, the Company accounts for contracts that convey the use and control of identified assets for a period of time as leases. The Company classifies leases as operating or financing by evaluating the terms of the lease agreement. Agreements under which the Company is likely to utilize substantially all of the economic value or life of the asset or which the Company is likely to own at the end of the lease term, either through purchase or transfer of ownership, are classified as financing leases. Leases not meeting these criteria are accounted for as operating leases. Agreements under which the Company is a lessor are insignificant. Leases with terms that are expected to exceed one year are recognized on the Company’s Condensed Consolidated Balance sheet by recording a lease liability and corresponding right-of-use asset. PNMR, PNM, and TNMP determine present value for their leases using their incremental borrowing rates at the commencement date of the lease or, when readily available, the rate implicit in the agreement. However, in most cases the implicit interest rate is not available in the Company’s lease agreements. Operating lease expense is recognized within operating expenses according to the use of the asset on a straight-line basis. Financing lease costs are recognized by amortizing the right-of-use asset on a straight-line basis and by recording interest expense on the lease liability. Financing lease right-of-use assets amortization is reflected in depreciation and amortization and interest on financing lease liabilities is reflected as interest charges on the Company’s Condensed Consolidated Statements of Earnings.

PVNGS

PNM leases interests in Units 1 and 2 of PVNGS. The PVNGS leases were entered into in 1985 and 1986 and initially were scheduled to expire on January 15, 2015 for the four Unit 1 leases and January 15, 2016 for the four Unit 2 leases. Following procedures set forth in the PVNGS leases, PNM notified four of the lessors under the Unit 1 leases and one lessor under the Unit 2 lease that it would elect to renew those leases on the expiration date of the original leases. The four Unit 1 leases now expire on January 15, 2023 and the one Unit 2 lease now expires on January 15, 2024. The annual lease payments during the renewal periods aggregate $16.5 million for PVNGS Unit 1 and $1.6 million for Unit 2.

The terms of each of the extended leases do not provide for additional renewal options beyond their currently scheduled expiration dates. PNM has the option to purchase the assets underlying each of the extended leases at their fair market value or to return the lease interests to the lessors on the expiration dates. Under the terms of the extended leases, PNM has until January 15, 2020 for the Unit 1 leases and January 15, 2021 for the Unit 2 lease to provide notices to the lessors of PNM’s intent to exercise the purchase options or to return the leased assets to the lessors. PNM’s elections are independent for each lease and are irrevocable. In the proceeding addressing PNM’s 2017 IRP (Note 12), PNM agreed to promptly notify the NMPRC of a decision to extend the Unit 1 or 2 leases, or to exercise its option to purchase the leased assets at fair market value upon the expiration of leases. If PNM elects to exercise its purchase option under any of the leases, the leases provide an appraisal process to determine fair market value. If PNM elects to return the assets underlying the extended leases, PNM will retain certain obligations related to PNVGS, including costs to decommission the facility. PNM would seek to recover its undepreciated investments at the end of the PVNGS leases as well as any future obligations related to PNM’s leased capacity from NM retail customers. Any transfer of the assets underlying the leases will be required to comply with NRC licensing requirements.

On April 22, 2019, NEE and other parties, which consist primarily of environmental not-for-profit organizations, filed a joint petition for expedited investigation with the NMPRC. The joint petition requests the NMPRC open an investigation regarding PNM’s option to purchase the assets underlying the PVNGS Unit 1 and 2 leases that will expire in January 2023 and 2024. PNM cannot predict the outcome of this matter.

PNM elected to purchase the assets underlying the other three PVNGS Unit 2 leases at the end of their original lease terms. PNM and the lessors under those leases entered into agreements that established the purchase price, representing the fair market value, to be paid by PNM. On January 15, 2016, PNM paid $78.1 million to the lessor under one lease for 31.25 MW of the entitlement from PVNGS Unit 2 and $85.2 million to the lessors under the other two leases for 32.76 MW of the entitlement from PVNGS Unit 2. See Note 12 for information concerning the NMPRC’s treatment of the purchased assets and extended leases in PNM’s NM 2015 Rate Case, including PNM’s pending appeal to the NM Supreme Court of certain matters in the NM 2015 Rate Case.

Covenants in PNM’s PVNGS Units 1 and 2 lease agreements limit PNM’s ability, without consent of the owner participants in the lease transactions, (i) to enter into any merger or consolidation, or (ii) except in connection with normal dividend policy, to convey, transfer, lease or dividend more than 5% of its assets in any single transaction or series of related transactions. PNM is exposed to losses under the PVNGS lease arrangements upon the occurrence of certain events that PNM does not consider to be reasonably likely to occur. Under certain circumstances (for example, the NRC issuing specified violation orders with respect to PVNGS or the occurrence of specified nuclear events), PNM would be required to make specified payments to the lessors, and take title to the leased interests. If such an event had occurred as of March 31, 2019, amounts due to the lessors under the circumstances described above would be up to $161.2 million, payable on July 15, 2019 in addition to the scheduled lease payments due on July 15, 2019. In such event, PNM would record the acquired assets at the lower of their fair value or the amount paid.

Land Easements and Rights-of-Ways

Many of PNM’s electric transmission and distribution facilities are located on lands that require the grant of rights-of-way from governmental entities, Native American tribes, or private parties. PNM has completed several renewals of rights-of-way, the largest of which is a renewal with the Navajo Nation. PNM is obligated to pay the Navajo Nation annual payments of $6.0 million, subject to adjustment each year based on the Consumer Price Index, through 2029. PNM’s April 2018 payment for the amount due under the Navajo Nation right-of-way lease was $6.9 million, which included amounts due under the Consumer Price Index adjustment, and was used to determine PNM’s operating lease liability as of January 1, 2019 and is included in the table of future lease payments shown below. Changes in the Consumer Price Index subsequent to January 1, 2019 are considered variable lease payments.

Fleet Vehicles and Equipment

As of December 31, 2018, all of the Company’s leases of fleet vehicles and equipment are classified as operating leases. Historically, the Company has utilized substantially all of the economic value of its fleet and equipment leases by the end of the lease term. The Company generally has the contractual ability to return its fleet vehicle and equipment leases to the lessor after one-year provided the lessor can recover remaining amounts owed under the agreement from third-parties or through make-whole provisions in the contract but does not typically exercise this right. As a result, fleet vehicle and equipment leases commencing on or after January 1, 2019 are classified as financing leases. The Company’s fleet vehicle and equipment lease agreements include non-lease components for insignificant administrative and other costs that are billed over the life of the agreement. The Company has elected to combine these fees with the lease components of the agreement. Certain of the Company’s fleet vehicle and equipment leases contain residual value guarantees. At March 31, 2019, residual value guarantees on fleet vehicle and equipment leases are $0.5 million, $1.1 million, and $1.6 million for PNM, TNMP, and PNMR.

Other

The Company holds a number of office space and office equipment leases. The Company’s current office space leases, all of which existed as of December 31, 2018, are classified as operating leases. These agreements include non-lease components for costs such as common area maintenance fees, which the Company has elected to combine with the lease component of the agreements. Certain of the Company’s office space leases are held between the Company’s consolidated subsidiaries and have been eliminated on consolidation. See Note 15. The Company’s office equipment leases are primarily for copiers and other graphics equipment. The Company classifies its office equipment leases existing as of December 31, 2018 as operating leases. Office equipment leases commencing on or after January 1, 2019 are classified as financing leases.

Information related to the Company’s operating leases recorded on the Condensed Consolidated Balance Sheets, including amounts recognized upon adoption of ASU 2016-02, is presented below:



	March 31, 2019						January 1, 2019
	PNM		TNMP		PNMR Consolidated		PNM		TNMP		PNMR Consolidated
	(In thousands)
Operating leases:
Operating lease assets, net of amortization	$	137,756	$	12,160	$	150,426	$	143,816	$	12,942	$	157,440
Current portion of operating lease liabilities	22,762		3,023		26,197		21,589		3,132		25,189
Long-term portion of operating lease liabilities	115,436		9,088		124,937		124,891		9,787		135,174

As discussed above, the Company classifies its fleet vehicle and equipment leases and its office equipment leases commencing on or after January 1, 2019 as financing leases. Information related to the Company’s financing leases recorded on the Condensed Consolidated Balance Sheets is presented below:



	March 31, 2019
	PNM			TNMP			PNMR Consolidated
	(In thousands)
Financing leases:
Non-utility property	$	1,635		$	1,268		$	2,904
Accumulated depreciation	(37		)	(40		)	(78		)
Non-utility property, net	$	1,598		$	1,228		$	2,826

Other current liabilities	$	233		$	217		$	450
Other deferred credits	1,083			1,006			2,089

Information concerning the weighted average remaining lease terms and the weighted average discount rates used to determine the Company’s lease liabilities is presented below:



	March 31, 2019
	PNM		TNMP		PNMR Consolidated
Weighted average remaining lease term (In years):
Operating leases	7.18		4.67		6.95
Financing leases	5.72		5.75		5.74

Weighted average discount rate:
Operating leases	3.88	%	3.88	%	3.88	%
Financing leases	4.34	%	4.55	%	4.43	%

Information for the components of lease expense is as follows:



	Three Months Ended March 31, 2019
	PNM		TNMP		PNMR Consolidated
	(In thousands)
Total operating lease expense	$	7,231	$	241	$	7,611

Financing lease expense:
Amortization of right-of-use assets	66		58		125
Interest on lease liabilities	16		17		32
Total financing lease expense	82		75		157

Variable lease expense	—		—		—
Short-term lease expense	74		3		94
Total lease expense for the period	$	7,387	$	319	$	7,862

Supplemental cash flow information related to the Company’s leases is as follows:



	Three Months Ending March 31, 2019
	PNM		TNMP		PNMR Consolidated
	(In thousands)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	9,452	$	284	$	9,891
Operating cash flows from financing leases	16		17		32
Finance cash flows from financing leases	25		33		58

Non-cash information related to right-of-use assets obtained in exchange for lease obligations:
Operating leases	$	143,816	$	12,942	$	157,440
Financing leases	1,635		1,268		2,904

Excluded from the lease expense and cash flow information tables above are $0.4 million, $0.7 million, and $1.1 million of capitalized operating lease costs, and less than $0.1 million of capitalized financing lease costs at PNM, TNMP, and PNMR. These capitalized costs are reflected as investing activities on the Company’s Condensed Consolidated Statements of Cash Flows.

Future expected lease payments as of March 31, 2019 and December 31, 2018 are shown below:



	As of March 31, 2019
	PNM				TNMP				PNMR Consolidated
	Financing		Operating		Financing		Operating		Financing		Operating
	(In thousands)
Remainder of 2019	$	266	$	17,917	$	209	$	2,622	$	475	$	20,980
2020	344		27,045		269		2,993		613		30,555
2021	332		26,505		259		2,398		591		29,158
2022	319		26,235		249		1,846		568		28,255
2023	307		17,457		181		1,281		488		18,879
Later years	224		42,328		214		1,151		438		43,490
Total minimum lease payments	1,792		157,487		1,381		12,291		3,173		171,317
Less: Imputed interest	476		19,289		158		180		634		20,183
Lease liabilities as of March 31, 2019	$	1,316	$	138,198	$	1,223	$	12,111	$	2,539	$	151,134



	As of December 31, 2018
	Operating leases
	PNM		TNMP		PNMR Consolidated
	(In thousands)
Remainder of 2019	$	27,691	$	3,664	$	31,772
2020	27,000		3,102		30,404
2021	26,462		2,324		29,012
2022	26,217		1,795		28,175
2023	17,447		1,279		18,868
Later years	42,329		1,150		43,489
Total minimum lease payments	167,146		13,314		181,720

The above tables include $9.9 million, $12.2 million, and $22.1 million for PNM, TNMP, and PNMR at March 31, 2019 and $7.5 million, $11.0 million, and $18.5 million for PNM, TNMP, and PNMR at December 31, 2018 for expected future payments on fleet vehicle and equipment leases that could be avoided if the leases were returned and the lessor is able to recover estimated market value for the equipment from third parties. The Company’s contractual commitments for leases that have not yet commenced are insignificant.

Lease Commitments