<PAGE 1> UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549-1004 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1994 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission File Number 2-7749 COMMONWEALTH ELECTRIC COMPANY (Exact name of registrant as specified in its charter) Massachusetts 04-1659070 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Main Street, Cambridge, Massachusetts 02142-9150 (Address of principal executive offices) (Zip Code) (617) 225-4000 (Registrant's telephone number, including area code) (Former name, address and fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock November 1, 1994 Common Stock, $25 par value 2,043,972 shares The Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q as a wholly-owned subsidiary and is therefore filing this Form with the reduced disclosure format. <PAGE 2> PART I - FINANCIAL INFORMATION Item 1. Financial Statements COMMONWEALTH ELECTRIC COMPANY CONDENSED BALANCE SHEETS SEPTEMBER 30, 1994 AND DECEMBER 31, 1993 ASSETS (Unaudited) September 30, December 31, 1994 1993 (Dollars in Thousands) PROPERTY, PLANT AND EQUIPMENT, at original cost $489 864 $475 348 Less - Accumulated depreciation 142 032 133 349 347 832 341 999 Add - Construction work in progress 4 387 5 478 352 219 347 477 INVESTMENTS Equity in nuclear electric power company 638 601 Other 14 14 652 615 CURRENT ASSETS Cash 1 660 2 794 Advances to affiliates 3 915 4 485 Accounts receivable - Affiliates 1 544 2 413 Customers 34 473 38 743 Unbilled revenues 8 987 9 332 Prepaid property taxes 4 109 2 538 Inventories and other 6 639 6 787 61 327 67 092 DEFERRED CHARGES 49 178 34 619 $463 376 $449 803 <PAGE 3> COMMONWEALTH ELECTRIC COMPANY CONDENSED BALANCE SHEETS SEPTEMBER 30, 1994 AND DECEMBER 31, 1993 CAPITALIZATION AND LIABILITIES (Unaudited) September 30, December 31, 1994 1993 (Dollars in Thousands) CAPITALIZATION Common Equity - Common stock, $25 par value - Authorized and outstanding - 2,043,972 shares wholly-owned by Commonwealth Energy System (Parent) $ 51 099 $ 51 099 Amounts paid in excess of par value 97 112 97 112 Retained earnings 19 705 15 118 167 916 163 329 Long-term debt, less current sinking fund requirements 157 814 158 858 325 730 322 187 CURRENT LIABILITIES Current sinking fund requirements 1 053 1 053 Accounts payable - Affiliates 6 851 10 088 Other 26 913 22 044 Accrued taxes - Local property and other 4 765 3 017 Income 7 301 2 337 Other 12 613 13 125 59 496 51 664 DEFERRED CREDITS Accumulated deferred income taxes 40 886 39 396 Unamortized investment tax credits 8 098 8 430 Other 29 166 28 126 78 150 75 952 COMMITMENTS AND CONTINGENCIES $463 376 $449 803 See accompanying notes. <PAGE 4> COMMONWEALTH ELECTRIC COMPANY CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1994 AND 1993 (Unaudited) Three Months Ended Nine Months Ended 1994 1993 1994 1993 (Dollars in Thousands) ELECTRIC OPERATING REVENUES $119 559 $114 829 $336 293 $319 146 OPERATING EXPENSES Electricity purchased for resale, transmission and fuel 77 372 74 332 222 414 211 385 Other operation and maintenance 20 159 19 546 61 954 65 485 Depreciation 3 999 3 867 11 997 11 583 Taxes - Income 4 264 4 446 8 285 5 084 Local property 1 388 1 297 3 912 3 732 Payroll and other 595 614 2 223 2 455 107 777 104 102 310 785 299 724 OPERATING INCOME 11 782 10 727 25 508 19 422 OTHER INCOME (EXPENSE) Allowance for equity funds used during construction 63 - 192 - Other, net (1 249) 157 (1 083) 153 (1 186) 157 (891) 153 INCOME BEFORE INTEREST CHARGES 10 596 10 884 24 617 19 575 INTEREST CHARGES Long-term debt 3 620 3 570 10 710 9 682 Other interest charges 123 200 348 1 123 Allowance for borrowed funds used during construction (73) (51) (226) (105) 3 670 3 719 10 832 10 700 NET INCOME 6 926 7 165 13 785 8 875 RETAINED EARNINGS - Beginning of period 14 823 11 291 15 118 14 882 Dividends on common stock (2 044) - (9 198) (5 301) RETAINED EARNINGS - End of period $ 19 705 $ 18 456 $ 19 705 $ 18 456 See accompanying notes. <PAGE 5> COMMONWEALTH ELECTRIC COMPANY CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1994 AND 1993 (Unaudited) 1994 1993 (Dollars in Thousands) OPERATING ACTIVITIES Net income $ 13 785 $ 8 875 Effects of non-cash items - Depreciation and amortization 13 790 12 644 Deferred income taxes and investment tax credits, net (1 053) 1 303 Allowance for equity funds used during construction (192) - Change in working capital, exclusive of cash and advances to affiliates 11 893 24 125 Fuel charge stabilization deferral (11 470) - All other operating items (3 314) (10 458) Net cash provided by operating activities 23 439 36 489 INVESTING ACTIVITIES Additions to property, plant and equipment (exclusive of AFUDC) (14 675) (12 230) Allowance for borrowed funds used during construction (226) (105) Payments from (advances to) affiliates 570 (15 580) Net cash used for investing activities (14 331) (27 915) FINANCING ACTIVITIES Long-term debt issues - 65 000 Sale of common stock - 35 000 Payment of short-term borrowings - (67 275) Payment to affiliates - (11 840) Long-term debt issues refunded - (21 300) Payment of dividends (9 198) (5 301) Sinking funds payments (1 044) (1 058) Net cash used for financing activities (10 242) (6 774) Net increase (decrease) in cash (1 134) 1 800 Cash at beginning of period 2 794 507 Cash at end of period $ 1 660 $ 2 307 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest (net of capitalized amounts) $ 11 759 $ 10 906 Income taxes $ 2 163 $ 947 See accompanying notes. <PAGE 6> COMMONWEALTH ELECTRIC COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (1) Accounting Policies Commonwealth Electric Company (the Company) is a wholly-owned subsidiary of Commonwealth Energy System. The parent company is referred to in this report as the "System" and, together with its subsidiaries, is collectively referred to as "the system." The Company's significant accounting policies are described in Note 1 of Notes to Financial Statements included in its 1993 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows these same basic accounting policies but considers each interim period as an integral part of an annual period and makes allocations of certain expenses to interim periods based upon estimates of such expenses for the year. The Company has established various regulatory assets in cases where the Massachusetts Department of Public Utilities (DPU) and/or the Federal Energy Regulatory Commission have permitted, or are expected to permit, recovery of specific costs over time. Similarly, certain regulatory liabilities established by the Company are required to be refunded to customers over time. As of September 30, 1994, principal regulatory assets included in deferred charges were $11.5 million associated with a rate stabilization plan, $10 million for postretirement benefits costs including pensions, $7.3 million for unrecovered plant and decommission- ing costs for the Yankee Atomic nuclear plant, $7.1 million in litigation costs associated with a settlement agreement with Boston Edison Company relative to the Pilgrim nuclear power plant, $4 million for unrecovered costs associated with a conservation and load management program and $4.4 million in abandonment costs for the Cannon Street generating station. The principal regulatory liability, reflected in deferred credits, was $4 million related to income taxes. Generally, expenses which relate to more than one interim period are allocated to other periods to more appropriately match revenues and expenses. Income tax expense is recorded using the statutory rates in effect applied to book income subject to tax recorded in the interim period. The unaudited financial statements for the periods ended September 30, 1994 and 1993 reflect, in the opinion of the Company, all adjustments (consisting of only normal recurring accruals) necessary to summarize fairly the results for such periods. In addition, certain prior period amounts are reclassified from time to time to conform with the presenta- tion used in the current period's financial statements. The results for interim periods are not necessarily indicative of results for the entire year because of seasonal variations in the con- sumption of energy. <PAGE 7> COMMONWEALTH ELECTRIC COMPANY (2) Commitments and Contingencies (a) Construction and Financing Programs The Company is engaged in a continuous construction program present- ly estimated at $141 million for the five-year period 1994 through 1998. Of that amount, $24.8 million is estimated for 1994. As of September 30, 1994, the Company's construction expenditures amounted to approximately $15.1 million, including an allowance for funds used during construction. The Company expects to finance these expenditures on an interim basis with internally-generated funds and short-term borrowings which are ultimately expected to be repaid with the proceeds from sales of long- term debt and equity securities. The program is subject to periodic review and revision due to factors such as changes in business conditions, rates of customer growth, effects of inflation, maintenance of reliable and safe service, equipment delivery schedules, licensing delays, availability and cost of capital and environmental regulations. (b) Rate Stabilization Plan The Company implemented a Fuel Charge (FC) rate settlement on April 1, 1994 that will stabilize its quarterly FC rate during the years 1994 through 1996 at 6.5 cents per KWH and no greater than 6.7 cents per KWH during 1997. The settlement results in billings at a significantly lower rate than would have otherwise been in effect and could save customers between 1.75% and 5% on their annual electric bills from 1994 through 1997. This rate stabilization results from the use of a cost deferral mechanism that was sponsored jointly by the Company and the Massachusetts Attorney General and approved by the DPU. The deferred costs are being reflected as a regulatory asset to be recovered, with carrying charges, over the subsequent six-year period beginning in 1998 pursuant to a recovery schedule subject to DPU review. The deferred amount, excluding carrying charges, is restricted to a maximum of $40 million during the settlement period (1994 through 1997) and is further limited to an annual cost deferral of $16 million which is the amount the Company anticipates will be deferred in 1994. As of September 30, 1994, the Company has deferred $11.5 million, including carrying charges. The rate stabilization mechanism is part of a long-term plan to con- trol the Company's retail rates. This plan will help to eliminate the disincentive for economic development resulting from a volatile and unpredictable FC rate. The stabilized FC rate will enable current and prospective customers to better plan their business and personal finances in a more efficient and effective manner. In addition to the Massachu- setts Attorney General, this proposal has been widely supported by various business and customer groups and other political interests. (c) Decommissioning of Yankee Atomic Nuclear Power Plant In February 1992, the Board of Directors of Yankee Atomic Electric Company (Yankee Atomic) agreed to permanently discontinue power operation and decommission the Yankee Nuclear Power Station (the plant). At September 30, 1994, the Company's 2.5% investment in the plant is approx- <PAGE 8> COMMONWEALTH ELECTRIC COMPANY imately $638,000. The estimated decommissioning costs include its unrecovered share of all costs associated with the shutdown of the plant, recovery of its plant investment, and decommissioning and closing the plant. The amount currently reflected in the accompanying Balance Sheets as a liability and a corresponding regulatory asset is $7.3 million. The market value of the Company's share of assets in the plant's decommis- sioning fund at September 30, 1994 is approximately $2.6 million. On October 26, 1994, Yankee Atomic filed with the Nuclear Regulatory Commission a revised estimate to decommission the plant of $370 million (in 1994 dollars). The total cost to permanently shut down the plant is approximately $438.6 million. The Company's share of this liability is approximately $11 million. The Company is reviewing Yankee Atomic's filing and adjustments to the liability and regulatory asset accounts will be made as appropriate during the fourth quarter of 1994. <PAGE 9> COMMONWEALTH ELECTRIC COMPANY Item 2. Management's Discussion and Analysis of Results of Operations The following is a discussion of certain significant factors which have affected operating revenues, expenses and net income during the periods included in the accompanying condensed statements of income. This discussion should be read in conjunction with the Notes to Condensed Financial Statements appearing elsewhere in this report. A summary of the period to period changes in the principal items included in the condensed statements of income for the three and nine months ended September 30, 1994 and 1993 is shown below: Three Months Ended Nine Months Ended September 30, September 30, 1994 and 1993 1994 and 1993 Increase (Decrease) (Dollars in Thousands) Electric Operating Revenues $ 4 730 4.1% $ 17 147 5.4% Operating Expenses Electricity purchased for resale, transmission and fuel 3 040 4.1 11 029 5.2 Other operation and maintenance 613 3.1 (3 531) (5.4) Depreciation 132 3.4 414 3.6 Taxes - Federal and state income (182) (4.1) 3 201 63.0 Local property and other 72 3.8 (52) (0.8) 3 675 3.5 11 061 3.7 Operating Income 1 055 9.8 6 086 31.3 Other Income (1 343)(855.4) (1 044) (682.4) Income Before Interest Charges (288) (2.6) 5 042 25.8 Interest Charges (49) (1.3) 132 1.2 Net Income $ (239) (3.3) $ 4 910 55.3 Retail Unit Sales MWH Increase 36 712 4.2 99 548 4.1 The following is a summary of unit sales for the periods indicated: Unit Sales (MWH) Three Months Nine Months Period Ended Total Retail Wholesale Total Retail Wholesale September 30, 1994 1 130 798 907 842 222 956 3 501 018 2 529 024 971 994 September 30, 1993 1 228 566 871 130 357 436 3 274 444 2 429 476 844 968 <PAGE 10> COMMONWEALTH ELECTRIC COMPANY Operating Revenues Operating revenues for the first nine months of 1994 increased by $17.1 million or 5.4% from the corresponding period in 1993 due to the higher cost of electricity purchased for resale, transmission and fuel ($11 million), a 4.1% increase in retail unit sales ($3.6 million), greater recovery of capacity-related costs associated with certain purchased power contracts ($1.9 million) and a higher level of lost base revenues related to conservation and load management (C&LM) programs ($720,000). The recovery of lost base revenues is allowed by the Massachusetts Department of Public Utilities (DPU) to encourage effective implementation of C&LM programs. To the extent that current costs associated with C&LM programs increase or decrease from period to period based on customer participation, a corresponding change will occur in revenues. Current three and nine-month C&LM costs were higher by $151,000 and $139,000, respectively, when compared with the corresponding periods of the prior year. For the current quarter, operating revenues increased $4.7 million or 4.1% when compared to the same period in 1993 due to an increase in the cost of electricity purchased for resale, transmission and fuel ($3 million), a 4.2% increase in retail unit sales ($1.3 million) and increased recovery of lost base revenues related to C&LM programs ($313,000). Also included in revenues for the three and nine-month periods ended September 30, 1994 were wholesale sales to NEPOOL and to non-associate utili- ties of $4.4 million and $19.7 million, respectively, a $3.3 million decrease and a $900,000 increase from the corresponding periods of 1993 reflecting the changing capacity needs of non-affiliated utilities and the New England Power Pool. Increasingly, the Company is able to sell its excess capacity at competitive terms and rates to satisfy various short-term requests for power from other regional utilities. Increased emphasis on the marketing of excess power supplies yielded estimated savings of $157,000 and $958,000 for the three and nine months ended September 30, 1994 as compared to $131,000 and $267,000 for the respective periods last year. Fluctuations in the level of wholesale electric sales have no impact on net income. Electricity Purchased for Resale, Transmission and Fuel Electricity purchased for resale, transmission and fuel costs per KWH sold was slightly lower in the current nine-month period (6.4 cents) than the same period of a year ago (6.5 cents) reflecting the moderating impact of the deferral of $11.1 million of costs due to the Company's rate stabilization mechanism that was implemented on April 1, 1994. The cost per KWH would have been 6.7 cents in the current nine-month period if the rate stabilization mechanism was not in effect. Electricity purchased for resale reflects continuing contractual obligations to purchase higher-cost power procured in the 1980s when the Company's customer base grew dramatically and forecasts predicted continued growth and, to a lesser extent, higher fuel costs at Canal Electric Company. The Company is currently involved in the renegotiation of various power contracts which include price restructuring, buy-outs and/or generating unit shutdowns that could also reduce its cost of power. For the three months ended September 30, 1994 and 1993, the per KWH cost was 6.8 cents and 6.1 cents, respectively, primarily reflecting the higher fuel costs at Canal. <PAGE 11> COMMONWEALTH ELECTRIC COMPANY The cost of electricity purchased for resale for the nine-month periods ended September 30, 1994 and 1993 also included $1.5 million and $3.4 million of capacity-related costs associated with certain purchased power contracts that were not recovered in revenues due to the recovery mechanism established by the DPU. The impact of this under-recovery reduced net income by $922,000 and $2.1 million for the respective nine-month periods. For the three-month periods ended September 30, 1994 and 1993, the Company overcollected its costs by $798,000 and $772,000 resulting in higher net income of $485,000 and $469,000, respectively. (Refer to the "Power Contracts" section to follow.) For the current nine-month period, retail energy unit sales for each customer segment showed improvement due to the first quarter's colder than normal weather conditions, an improving economy and a 1.2% increase in the number of customers. Other Operation and Maintenance Other operation and maintenance declined by $3.5 million or 5.4% in the first nine months of 1994 primarily due to savings of approximately $1.5 million that resulted from a second quarter 1993 work force reduction and the absence of $1.8 million of severance pay incurred in 1993. Other factors contributing to the decrease included lower affiliate services company charges ($1.1 million) also due to the work force reduction, and a decline in the provision for bad debts ($1.2 million) due to improved collection experience. Maintenance costs decreased $732,000 primarily due to a reduction in outside contractor charges for tree trimming and maintenance-related projects. The $613,000 increase in other operation and maintenance for the three months ended September 30, 1994 was due to increases in payroll costs ($620,000) and insurance and benefits costs ($474,000) offset in part, by a decline in the provision for bad debts ($451,000). Depreciation and Taxes Depreciation expense increased due to a higher level of depreciable property, plant and equipment. The change in local property and other taxes for the three and nine-month periods reflects higher property tax rates ($90,000 and $180,000) offset by a reduction in payroll taxes of $18,000 and $231,000. The change in federal and state income taxes for the current nine- month period reflects the level of pretax income. The decrease in the current quarter is primarily due to the absence of a retroactive adjustment made in the third quarter of 1993 to reflect the increase in the federal tax rate to 35% and, to a lesser extent, the level of pretax income. Other Income and Interest Charges The decrease in other income in both the three and nine-month periods was primarily due to a reserve related to a settlement negotiated with an outside party for certain costs associated with the Company's energy conservation program. Somewhat moderating the overall decrease in other income during the current three and nine-month periods were carrying costs ($237,000 and $346,000, respectively) on the fuel charge stabilization deferral and an allowance for funds used during construction ($63,000 and $192,000). In addition, for the nine-month period, other income reflects a higher level of interest on advances to affiliated companies ($51,000) and increased income <PAGE 12> COMMONWEALTH ELECTRIC COMPANY from non-utility operations ($70,000) primarily reflecting the absence in 1994 of losses ($48,000 recorded in January 1993) associated with the Company's equity investment in Yankee Atomic Electric Company and the disposition of the Cannon Street Generating Station oil inventory ($28,000). Total interest charges increased slightly for the current nine-month period reflecting the issuance of $65 million in long-term debt in late March 1993 ($1 million) offset by a $774,000 decline in short-term interest costs primarily reflecting the absence of short-term bank borrowings this year compared to an average level of $21 million for the first nine months of 1993. For the current quarter, total interest charges decreased due primarily to a decline in short-term expense ($77,000), somewhat offset by a $50,000 increase in long-term expense due to the aforementioned financing activity. Power Contracts The Company has long-term contracts for the purchase of electricity from various sources. Generally, these contracts are for fixed periods and require that the Company pay a demand charge for its capacity entitlement in each unit and an energy charge to cover the cost of fuel. The Company collects a portion of its capacity-related purchased power costs associated with certain long-term power arrangements through its base rates. The recovery mechanism for these costs uses a per KWH factor which is calculated using historical (test-period) capacity costs and unit sales. This factor is then applied to current monthly KWH sales. When current period capacity costs and/or unit sales vary from test-period levels, the Company experiences a revenue excess or shortfall. All other capacity and energy-related purchased power costs are recovered through the Company's Fuel Charge. Power Contract Negotiations On May 2, 1994, the Company and its affiliate Cambridge Electric Light Company (Cambridge Electric) gave notice of termination of power purchase agreements with Eastern Energy Corp. (Eastern), the developer of a proposed 300 MW coal-fired plant in New Bedford, Massachusetts. In June 1989, in order to meet rising energy requirements, the Company and Cambridge Electric agreed to buy 27% (50 MW and 33 MW, respectively) of the power to be produced by the proposed plant, originally scheduled to begin operation in January 1992. That date and later revised scheduled operating dates have not been achieved, and the proposed plant has still not received the necessary permits. Efforts to reshape the Eastern power purchase agreements to provide a satisfactory arrangement were unsuccessful. The companies' actions are based on Eastern's failure to meet its contractual obligations. In a letter dated June 30, 1994, Eastern objected to the notice of termination and provided to the Company and Cambridge Electric written notice of arbitration and its designation of an arbitrator pursuant to the 1989 agreements. The companies responded by designating their arbitrator, and the parties are now in the process of selecting a third, neutral arbitrator through the Boston, Massachusetts office of the American Arbitration Association. An arbitrator decision on the legality of the companies' termination action is expected in 1995. The Company has filed for regulatory approval of restructured power sale agreements with two other non-utility generators allowing the Company to eliminate or reduce purchased power from the units. Also, the Company has reached an agreement in principle on an innovative power contract with another <PAGE 13> COMMONWEALTH ELECTRIC COMPANY New England utility that is expected to produce long-term customer savings beginning in 1995. This agreement will allow the Company to purchase peaking unit capacity during the periods when it might otherwise have incurred deficiency charges from the New England Power Pool, or have been required to purchase capacity from other regional utilities at much higher prices. This contract provides for cost-effective resources to cover power needs in a changing environment. <PAGE 14> COMMONWEALTH ELECTRIC COMPANY PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not a party to any pending material legal proceeding. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Incorporated herein by reference: Exhibit 10 Material Contracts. 10.2 Other Agreements. 10.2.3.10 Twenty-Eighth Agreement Amending New England Power Pool Agreement dated September 1, 1971, as amended September 15, 1992 (Exhibit 1 to Commonwealth Energy System's Form 10-Q (September 1994), File No. 1-7316). 10.2.3.11 Twenty-Ninth Agreement Amending New England Power Pool Agreement dated September 1, 1971, as amended May 1, 1993 (Exhibit 2 to Commonwealth Energy System's Form 10-Q (September 1994), File No. 1-7316). Filed herewith: Exhibit 27 Financial Data Schedule for the nine months ended September 30, 1994 (Filed herewith as Exhibit 1) (b) Reports on Form 8-K No reports on Form 8-K were filed during the three months ended September 30, 1994. <PAGE 15> COMMONWEALTH ELECTRIC COMPANY SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMONWEALTH ELECTRIC COMPANY (Registrant) Principal Financial Officer: JAMES D. RAPPOLI James D. Rappoli, Financial Vice President and Treasurer Principal Accounting Officer: JOHN A. WHALEN John A. Whalen, Comptroller Date: November 14, 1994