Company Profile Eastern Edison Company (Eastern Edison or the Company) is a retail electric utility company. Eastern Edison supplies retail electric service to approximately 178,000 customers in 22 cities and towns in southeastern Massachusetts. The largest communities served are the cities of Brockton and Fall River, Massachusetts. Eastern Edison is a wholly owned subsidiary of Eastern Utilities Associates (EUA). EUA owns directly all of the shares of common stock of Eastern Edison, Blackstone Valley Electric Company (Blackstone) and Newport Electric Corporation (Newport). Blackstone and Newport are retail electric utility companies operating in northern Rhode Island and south coastal Rhode Island, respectively. Eastern Edison owns all of the permanent securities of Montaup Electric Company (Montaup), a generation and transmission company, which supplies electricity to Eastern Edison, to Blackstone, to Newport and to two unaffiliated utilities for resale. EUA also owns directly all of the shares of common stock of EUA Cogenex Corporation (EUA Cogenex), EUA Energy Investment Corporation (EUA Energy), EUA Ocean State Corporation (EUA Ocean State) and EUA Service Corporation (EUA Service). EUA Service provides various accounting, financial, engineering, planning, data processing and other services to all EUA System companies. EUA Cogenex is an energy services company. EUA Energy was organized to invest in energy-related projects. EUA Ocean State owns a 29.9% interest in OSP's two gas-fired generating units. The holding company system of EUA, the three retail subsidiaries, Montaup, EUA Service, EUA Cogenex, EUA Energy and EUA Ocean State is referred to as the EUA System. MARKET FOR EASTERN EDISON'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS All of Eastern Edison's common stock is owned beneficially and of record by Eastern Utilities Associates (EUA). The dividends paid on Eastern Edison's common stock during the past two years are as follows: Dividends Paid Dividends Paid 1995 Per Share 1994 Per Share First Quarter $2.53 First Quarter $2.22 Second Quarter 0.43 Second Quarter 2.46 Third Quarter 0.46 Third Quarter 2.49 Fourth Quarter 0.45 Fourth Quarter 2.77 No dividends may be paid on Eastern Edison's common stock unless full dividends on Eastern Edison's outstanding Preferred Stock for all past and the current quarterly dividend periods have been paid or declared and set apart for payment, nor may any dividends be paid on Eastern Edison's common stock if Eastern Edison is in default on any sinking fund obligation provided for its Preferred Stock. See also Notes C, D and E of Notes to Consolidated Financial Statements. SELECTED CONSOLIDATED FINANCIAL DATA For the Years Ended December 31, (In Thousands) 1995 1994 1993 1992 1991 _______________________________________________________________________ Operating Revenues $420,069 $418,424 $417,021 $420,188 $414,609 Net Earnings 31,455 31,395 28,145 29,231 23,763 Total Assets 739,198 756,045 742,273 776,510 785,365 Capitalization: Long-Term Debt 222,313 229,224 264,134 269,995 304,991 Redeemable Preferred Stock-Net 26,218 25,257 24,824 28,171 29,558 Non-Redeemable Preferred Stock 8,949 8,949 Common Equity 244,368 225,064 223,005 220,257 211,126 Total Capitalization $492,899 $479,545 $511,963 $527,372 $554,624 ======== ======== ======== ======== ======== MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND REVIEW OF OPERATIONS Overview Consolidated Net Earnings for 1995 of $31.5 million were slightly higher than 1994 net earnings of $31.4 million. The 1995 net earnings include a one- time charge of approximately $1.5 million, on an after tax basis, related to the voluntary retirement incentive offer. Also impacting 1995 earnings was Montaup's $13.9 million annual wholesale rate reduction effective May 21, 1994. Offsetting these impacts somewhat were lower litigation expenses resulting from favorable court decisions rendered in 1995, lower interest expense and successful cost control efforts including ongoing savings of the voluntary retirement incentive (See below). 1994 Consolidated Net Earnings represented a $3.3 million increase over the prior year. Growth of 1.8% in primary kilowatthour (KWH) sales and lower long-term debt interest and preferred dividend requirements in 1994 as compared to 1993 were the major factors contributing to this increase. Early KWH sales gains in the year were offset somewhat by unusually mild weather in the fourth quarter. Voluntary Retirement Incentive Offer On March 15, 1995, EUA announced a corporate reorganization which, among other things, consolidated management of Eastern Edison, Blackstone and Newport. As part of the reorganization, a voluntary retirement incentive (VRI) was offered to 66 professionals of the EUA System including 22 employees of Eastern Edison and Montaup. Forty-nine of those eligible for the program, including 16 employees of Eastern Edison and Montaup, accepted the incentive and retired effective June 1, 1995. The cost to Eastern Edison of this incentive program amounted to a one-time $2.4 million pre-tax ($1.5 million after-tax) charge to second quarter 1995 earnings. The estimated payback period is approximately 18 months. Comparison of Financial Results Operating Revenues - 1995 vs 1994 Operating Revenues for 1995 increased by approximately $1.6 million as compared to 1994. This change is primarily due to increased purchased power and fuel expense recoveries aggregating $5.8 million and additional revenues related to the full year impact of Newport becoming an all-requirements customer of Montaup on May 21, 1994. Offsetting these increases somewhat were decreased conservation and load management (C&LM) expense recoveries of $3.9 million and the full year impact of Montaup's wholesale rate reduction implemented on May 21, 1994 which lowered 1995 revenues by approximately $4.9 million. Operating Revenues - 1994 vs 1993 Operating Revenues for 1994 increased by approximately $1.4 million from those of 1993. Contributing to this increase were the recoveries of increased fuel expense of approximately $2.9 million and higher primary KWH sales of 1.8% resulting in approximately $2.7 million of growth in base revenues. Offsetting these positive impacts somewhat was a decrease in revenues of approximately $3.2 million resulting from the net impact of Montaup's 1994 rate decrease. Expenses - 1995 vs 1994 The Company's most significant expense items continue to be fuel and purchased power expenses which together comprised about 58.9% of total operating expenses for 1995. Fuel expense increased by $3.4 million or 3.8% in 1995 as compared to 1994. This change was caused by an increase of 14.1% in the average cost of fuel offset by decreases in total energy generated and purchased of 11.1%. Purchased Power demand expense for 1995 increased $2.6 million to $125.6 million from 1994 amounts. This increase was due primarily to the impact of Newport's purchased power contracts assumed by Montaup effective May 21, 1994, coincident with Newport becoming an all-requirements customer of Montaup, aggregating approximately $4.8 million and increased billings from the Ocean State Power project and the Yankee nuclear units aggregating $5.2 million. These increases were offset somewhat by decreases of approximately $6.7 million resulting from purchase power contracts totaling 41 MW which expired in October 1994, and a net $700,000 reduction in purchases from other power suppliers. Other Operation and Maintenance expenses are comprised of two components, Direct Controllable and Indirect. Direct Controllable expenses include expense items such as salaries, fringe benefits, insurance, maintenance, etc. Indirect expenses include items over which the Company has limited short-term control and include such expense items as Montaup's joint ownership interests in generating facilities such as Seabrook Unit 1 and Millstone Unit 3, power contracts where transmission rental fees are fixed, conservation and load management expenses that are fully recovered in revenues and expenses related to accounting standards such as Statement of Financial Accounting Standard No. 106, "Employers' Accounting for Post Retirement Benefits-Retirement Benefits Other Than Pensions" (FAS106). Other Operation and Maintenance expenses for 1995 decreased by approximately $5.7 million or 5.6% from 1994 levels. This decrease is due primarily to lower C&LM expense totaling $4.3 million, decreased legal costs of approximately $2.1 million and successful cost control efforts. Offsetting these year-to date decreases somewhat were increases in Montaup power contract expenses and FAS106 expenses aggregating $1.4 million. Net interest charges decreased by $1.4 million in 1995 versus 1994. Other Interest expense provisions recorded in June 1994 aggregating $1.0 million related to Internal Revenue Service audits of prior years' consolidated income tax returns were primarily responsible for this change. Expenses - 1994 vs 1993 Fuel expense for 1994 increased $2.4 million from 1993. Approximately $2.1 million of 1994's increase in fuel expense relates to the assumed Newport contracts. A 4.8% decrease in the average cost of fuel in 1994 essentially offset the Company's 6.6% increase in total energy requirements. Purchased Power expense increased from 1993 by $1.6 million or 1.3%. This increase was primarily due to the impact of Montaup's assumption of Newport's purchased power contracts aggregating approximately $9.8 million. Offsetting this increase somewhat were expired purchased power contracts totaling approximately 41 MW and lower billings by Montaup suppliers aggregating approximately $8.6 million. Total Other Operating and Maintenance expenses decreased by approximately $1.7 million or 1.7% in 1994 due primarily to decreases in indirect expenses including approximately $2.3 million in maintenance expense of Montaup's jointly owned units and an additional $2.3 million reduction related to allocated charges from EUA Service Corporation recorded as other operating and maintenance expenses by the company. Partially offsetting these reductions were increases of $2.4 million in conservation and load management expenses and $400,000 of increased transmission and distribution expenses. Depreciation and Amortization expense decreased by $900,000 or 3.4% in 1994. The decrease was due primarily to Montaup's Seabrook Unit II loss amortization which was completed in 1993. Other Income & (Deductions) - Net increased $1.2 million or over 100% in 1994. The increase is due primarily to the recognition of approximately $900,000 of capitalized costs on nuclear fuel contract buy-out costs that had previously been deferred. Interest Expense on Long-Term Debt decreased by $4.1 million or 18.1% for 1994 as compared to 1993 primarily due to Eastern Edison's 1993 refinancing of $195 million of long-term debt at lower rates. Other Interest Expense increased $1.7 million or 58.1% in 1994 compared to 1993. The increase was a result of the recognition of approximately $1.0 million in interest related to Internal Revenue Service audits and the allocation methodology adopted in mid 1993 by EUA Service Corporation. Under this new methodology, EUA Service Corporation interest expenses are being allocated to other interest expense. They had previously been recorded as other operating expenses. Preferred Dividend Requirements decreased $1.0 million or 32.7% in 1994 due to a full-year impact of Eastern Edison's 1993 Preferred Stock financing activity. Electric Utility Industry Restructuring The electric industry is in a period of transition from a traditional rate regulated environment to a competitive marketplace. While competition in the wholesale electric market is not new, electric utilities are facing impending competition in the retail sector. In 1995, Eastern Edison, Blackstone and Newport participated with collaborative groups in their respective states consisting of other utilities, industrial users, environmental groups and consumer advocates in submitting similar sets of interdependent principles with their respective state regulatory commissions addressing electric utility industry restructuring. These filings were intended to be statements of the consensus position by the signatories of the principles that should underlie any electric industry restructuring proposal and include but are not limited to principles addressing stranded cost recovery, unbundling of services and demand side management programs. Each set of principles was submitted on the condition they be approved in full by the respective Commissions. The Rhode Island Public Utilities Commission (RIPUC) accepted all but one of the principles submitted by the Rhode Island Collaborative with minor modifications to certain language in others and added a new principle which supports negotiation (as opposed to litigation) to resolve conflicts as restructuring moves forward and directed the Rhode Island Collaborative to proceed with negotiations on the issues presented in the principles and to submit a progress report, which was submitted in February 1996. The one principle that was not accepted provided for subsidization of renewable energy sources. In February 1996 a bill was introduced in the Rhode Island legislature that, if enacted, would allow customer choice of electricity supplier commencing January 1, 1998 for large industrial customers and phasing in all customers by January 1, 2001. The proposed legislation also provides for recovery of "stranded investments" through a transition charge initially set at three cents per KWH. EUA believes that the development of the proposed legislation should have been conducted in a public forum so that all interested stakeholders could have participated. EUA believes that competition, if done right, can benefit customers, however, there are substantial issues about the proposed legislation which EUA is currently reviewing. The Massachusetts Department of Public Utilities (MDPU) issued an order enumerating principles, similar to those submitted by the Massachusetts Collaborative, that describe the key characteristics of a restructured electric industry and provides for, among other things, customer choice of electric service providers, services, pricing options and payment terms, an opportunity for customers to share in the benefits of increased competition, full and fair competition in the generation markets and incentive regulation for distribution services where competition cannot exist. This order sets out principles for the transition from a regulated to a competitive industry structure and identifies conditions for the transition process which will require investor- owned utilities to unbundle rates, provide consumers with accurate price signals and allow customers choice of generation services. The order also provides for the principle of recovery of net, non-mitigable stranded costs by investor-owned utilities resulting from the industry restructuring. Each Massachusetts investor-owned utility is required to file restructuring proposals for moving from the current regulated industry structure to a competitive generation market. The schedule for the filing requirement is staggered. The initial group of utilities was required to file their proposals in February 1996. The second group is required to file within three months of the MDPU's orders on the first group of submissions. Eastern Edison Company filed its proposal, "Choice and Competition" (see below) with the first group of proposals and is awaiting MDPU review. In January 1996, EUA unveiled its preliminary proposal for a restructured electric utility industry called "Choice and Competition" and began discussions with the Rhode Island and Massachusetts Collaboratives. The plan proposes, among other things: choice of power supplier by all customers as early as January 1998; open access transmission services; performance based rates for electric distribution services; all utility generation competing for power sales and; a transition charge allowing regional utilities the opportunity to recover, among other things, the costs of past commitments to nuclear and independent power. The company believes the plan, which requires participation by all New England parties, satisfies the principles adopted in both Rhode Island and Massachusetts, and provides a fair and equitable transition to a competitive electric utility marketplace for all parties. Historically, electric rates have been designed to recover a utility's full costs of providing electric service including recovery of investment in plant assets. Also, in a regulated environment, electric utilities are subject to certain accounting rules that are not applicable to other industries. These accounting rules allow regulated companies, in appropriate circumstances, to establish regulatory assets and liabilities, which defer the current financial impact of certain costs that are expected to be recovered in future rates. Eastern Edison believes that its operations continue to meet the criteria established in these accounting standards. Effects of legislation and/or regulatory initiatives or EUA's own initiatives such as "Choice and Competition" could ultimately cause Eastern Edison to no longer follow these accounting rules. In such an event, a non-cash write-off of regulatory assets and liabilities could be required at that time. In addition, if legislative or regulatory changes and/or competition result in electric rates which do not fully recover the Company's costs, a write-down of plant assets could be required pursuant to Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (FAS121) issued in March 1995, effective for fiscal year 1996. See "Notes to Consolidated Financial Statements", Note A for further discussion of FAS121. Rate Activity On March 21, 1994, Montaup filed an application with the Federal Energy Regulatory Commission (FERC) for authorization to reduce its wholesale rates by $10.1 million, or three percent. Montaup supplies electricity at wholesale to EUA's retail electric utilities - Eastern Edison, Blackstone and Newport - and to two non-affiliated municipal utilities. This application was designed to match more closely Montaup's revenues with its decreasing cost of doing business resulting from, among other things, a reduced rate base, lower interest costs and successful cost control efforts. On May 21, 1994, Montaup began billing the reduced rates, and on April 14, 1995, FERC approved a settlement agreement between Montaup and the intervenors in the case calling for an annual reduction of approximately $13.9 million (inclusive of the filed $10.1 million reduction). Montaup refunded to its customers the difference collected between the $10.1 million filed reduction and the $13.9 million settled reduction in April 1995. Montaup had previously reserved for that refund. Financial Condition and Liquidity Eastern Edison's and Montaup's need for permanent capital is primarily related to the construction of facilities required to meet the needs of existing and future customers. For 1995, 1994 and 1993, Eastern Edison's and Montaup's combined cash construction expenditures were $23.4 million, $23.6 million and $23.0 million, respectively. Internally generated funds provided approximately 236% of Eastern Edison's and Montaup's combined cash construction requirements in 1995. Cash construction expenditures are expected to be approximately $28.1 million, $25.9 million and $17.9 million in 1996, 1997 and 1998, respectively, and will be financed with internally generated funds. In the utility industry, cash construction requirements not met with internally generated funds are obtained through short-term borrowings which are ultimately funded with permanent capital. EUA System companies, including Eastern Edison and Montaup, maintain short-term lines of credit with various banks aggregating approximately $150 million. These credit lines are available to other affiliated companies under joint credit line arrangements. At December 31, 1995, unused short-term lines of credit amounted to approximately $111 million. At December 31, 1995, Eastern Edison had $4.2 million of outstanding short-term debt and Montaup had no outstanding short-term debt. In addition to construction expenditures, projected requirements for maturing long-term debt securities through 2000 are: $7 million in 1996 and $60 million in 1998. The Company has no sinking fund requirements until the year 2003. Environmental Matters Eastern Edison, Montaup and other companies owning generating units from which power is obtained are subject, like other electric utilities, to environmental and land use regulations at the federal, state and local levels. The United States Environmental Protection Agency (EPA), and certain state and local authorities, have jurisdiction over releases of pollutants, contaminants and hazardous substances into the environment and have broad authority to set rules and regulations in connection therewith, such as the Clean Air Act Amendments of 1990, which could require installation of pollution control devices and remedial actions. In 1994, an environmental audit program designed to ensure compliance with environmental laws and regulations and to identify and reduce liability was instituted by EUA. Because of the nature of Eastern Edison's and Montaup's business, various by-products and substances are produced or handled which are classified as hazardous under the rules and regulations promulgated by such authorities. Eastern Edison and Montaup generally provide for the disposal of such substances through licensed contractors, but these statutory provisions generally impose potential joint and several responsibility on the generators of the wastes for cleanup costs. Eastern Edison and Montaup have been notified with respect to a number of sites where they may be responsible for such costs, including sites where they may have joint and several liability with other responsible parties. It is the policy of the EUA System companies to notify liability insurers and to initiate claims, however, Eastern Edison and Montaup are unable to predict whether liability, if any, will be assumed by, or can be enforced against, the insurance carriers in these matters. As of December 31, 1995, Eastern Edison and Montaup had incurred costs of approximately $500,000, in connection with these sites. These amounts have been financed primarily by internally generated cash. Montaup is currently recovering certain of its incurred environmental costs in rates. Eastern Edison and Montaup estimate that additional costs of up to $500,000 may be incurred at these sites through 1997 by themselves and the other responsible parties. Estimates beyond 1997 cannot be made since site studies, which are the basis of these estimates, have not been completed. As a result of the recoverability in current rates of environmental costs, and the uncertainty regarding both its estimated liability, as well as potential contributions from insurance carriers, Eastern Edison and Montaup do not believe that the ultimate impact of environmental costs will be material to their financial position and thus, no loss provision is required at this time. A number of scientific studies in the past several years have examined the possibility of health effects from electric and magnetic fields (EMF) that are found everywhere there is electricity. Research to date has not conclusively established a direct causal relationship between EMF exposure and human health. Additional studies, which are intended to provide a better understanding of the subject, are continuing. Management cannot predict the ultimate outcome of the EMF issue. Other Montaup is recovering through rates its share of estimated decommissioning costs for the Millstone Unit 3 and Seabrook Unit 1 nuclear generating units. Montaup's share of the currently allowed estimated total costs to decommission Millstone Unit 3 is approximately $19.2 million in 1995 dollars and Seabrook Unit 1 is approximately $12.5 million in 1995 dollars. These figures are based on studies performed for the lead owners of the units. Montaup also pays into decommissioning reserves, pursuant to contractual arrangements, at other nuclear generating facilities in which it has an equity ownership interest or life-of-unit entitlement. Such expenses are currently recovered through rates. The Company occasionally makes forward-looking projections of expected future performance or statements of our plans and objectives. These forward- looking statements may be contained in filings with the Securities and Exchange Commission, press releases and oral statements. Actual results could differ materially from these statements, therefore, no assurances can be given that such forward-looking statements and estimates will be achieved. Managements' Discussion and Analysis of Financial Condition and Review of Operations provides a summary of information regarding the Company's financial condition and results of operation and should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements in arriving at a complete understanding of such matters. Eastern Edison Company and Subsidiary Consolidated Statement of Income Years Ended December 31, (In Thousands) 1995 1994 1993 Operating Revenues: From Affiliated Companies $ 133,388 $ 126,481 $ 121,934 Other 286,681 291,943 295,087 Total Operating Revenues 420,069 418,424 417,021 Operating Expenses: Fuel 90,881 87,522 85,066 Purchased Power - Demand 125,594 122,995 121,379 Other Operation and Maintenance 73,638 80,300 80,781 Voluntary Retirement Incentive 2,413 Affiliated Company Transactions 23,386 22,446 23,700 Depreciation and Amortization 26,039 25,546 26,450 Taxes - Other than Income 10,233 10,543 9,287 - Income 15,653 15,830 15,945 Total Operating Expenses 367,837 365,182 362,608 Operating Income 52,232 53,242 54,413 Equity in Earn. of Jointly Owned Companies 1,646 1,700 1,750 Allowance for Other Funds Used During Construction 473 263 289 Other Income (Deductions) - Net 407 897 (289) Income Before Interest Charges 54,758 56,102 56,163 Interest Charges: Interest on Long-Term Debt 18,277 18,488 22,584 Other Interest Expense 3,541 4,525 2,863 Allowance for Borrowed Funds Used During Construction (Credit) (503) (294) (385) Net Interest Charges 21,315 22,719 25,062 Net Income 33,443 33,383 31,101 Preferred Dividend Requirements 1,988 1,988 2,956 Consolidated Net Earnings Applicable to Common Stock $ 31,455 $ 31,395 $ 28,145 Consolidated Statement of Retained Earnings Years Ended December 31, (In Thousands) 1995 1994 1993 Retained Earnings - Beginning of Year $ 105,574 $ 103,515 $ 100,767 Net Income 33,443 33,383 31,101 Amort. of Preferred Stock Redemption Premium (961) (596) (597) Total 138,056 136,302 131,271 Dividends Paid: Preferred 1,988 1,988 2,977 Common 11,190 28,740 24,779 Retained Earnings - End of Year $ 124,878 $ 105,574 $ 103,515 The accompanying notes are an integral part of the financial statements. Eastern Edison Company and Subsidiary Consolidated Statements of Cash Flows Years Ended December 31, (In Thousands) 1995 1994 1993 CASH FLOW FROM OPERATING ACTIVITIES: Net Income $ 33,443 $ 33,383 $ 31,101 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and Amortization 29,852 28,981 29,477 Amortization of Nuclear Fuel 3,647 3,310 5,136 Deferred Taxes 2,694 5,500 2,981 Investment Tax Credit, Net (942) (348) (1,016) All. for Funds Used During Construction (473) (263) (289) Other - Net 1,219 (3,285) (3,331) Changes to Operating Assets and Liabilities: Accounts Receivable (7,055) (7,667) (7) Fuel, Materials and Supplies (1,678) 194 899 Accounts Payable 827 3,495 (792) Accrued Taxes 1,807 (2,814) 835 Other - Net (6,630) 4,485 (5,063) Net Cash Provided from Operating Activities 56,711 64,971 59,931 CASH FLOW FROM INVESTING ACTIVITIES: Construction Expenditures (23,423) (23,613) (22,967) Net Cash (Used in) Investing Activities (23,423) (23,613) (22,967) CASH FLOW FROM FINANCING ACTIVITIES: Issuances: Long-Term Debt 0 195,000 Preferred Stock 0 30,000 Long-Term Debt (35,000) 0 (205,000 Preferred Stock 0 (41,600) Premium on Reacquisition and Financing Expenses (62) (12,430) Common Stock Dividends Paid (11,190) (28,740) (24,779) Preferred Dividends Paid (1,988) (1,988) (2,977) Net Increase in Short Term Debt 4,158 Net Cash (Used in) Financing Activities (44,020) (30,790) (61,786) Net (Decrease) Increase in Cash and Temporary Cash Investments (10,732) 10,568 (24,822) Cash and Temporary Cash Investments at Beginning of Year 11,265 697 25,519 Cash and Temporary Cash Investments at End of Year $ 533 $ 11,265 $ 697 Cash paid during the year for: Interest (Net of Amts. Capitalized) $ 18,343 $ 18,406 $ 27,200 Income Taxes $ 9,044 $ 15,877 $ 13,372 The accompanying notes are an integral part of the financial statements. Eastern Edison Company and Subsidiary Consolidated Balance Sheets December 31, (In Thousands) ASSETS 1995 1994 Utility Plant and Other Investments: Utility Plant $ 798,706 $ 789,596 Less Accumulated Provision for Depreciation 241,673 228,241 Net Utility Plant 557,033 561,355 Non-Utility Property - Net 2,705 2,705 Investment in Jointly Owned Companies 13,223 13,488 Other Investments (at cost) 50 50 Total Utility Plant and Other Investments 573,011 577,598 Current Assets: Cash and Temporary Cash Investments 533 11,265 Accounts Receivable: Customers 25,730 25,896 Others 2,348 3,800 Accrued Unbilled Revenue 9,158 8,283 Associated Companies 25,861 18,061 Fuel (at average cost) 7,385 6,344 Plant Materials and Operating Supplies (at avg. cost) 3,937 3,300 Prepayments and Other Current Assets 4,170 5,952 Total Current Assets 79,122 82,901 Other Assets (Note A) 87,065 95,546 Total Assets $ 739,198 $ 756,045 LIABILITIES AND CAPITALIZATION Capitalization: Common Equity $ 244,368 $ 225,064 Redeemable Preferred Stock - Net 29,665 29,665 Preferred Stock Redemption Cost (3,447) (4,408) Long-term Debt - Net 222,313 229,224 Total Capitalization 492,899 479,545 Current Liabilities: Long-term Debt Due Within One Year 7,000 35,000 Notes Payable 4,158 Accounts Payable: Public 27,242 24,578 Associated Companies 3,913 5,749 Customer Deposits 1,103 1,101 Taxes Accrued 3,219 1,411 Interest Accrued 4,999 5,486 Other Current Liabilities 7,332 15,259 Total Current Liabilities 58,966 88,584 Deferred Credits: Unamortized Investment Credit 17,842 18,784 Other Deferred Credits 40,725 49,476 Total Deferred Credits 58,567 68,260 Accumulated Deferred Taxes 128,766 119,656 Commitments and Contingencies (Note J) Total Liabilities and Capitalization $ 739,198 $ 756,045 The accompanying notes are an integral part of the financial statements. Eastern Edison Company and Subsidiary Consolidated Statement of Capitalization December 31, (In Thousands) 1995 1994 Common Stock: $25 par value, authorized and outstanding 2,891,357 shares $ 72,284 $ 72,284 Other Paid-In Capital 47,249 47,249 Common Stock Expense (43) (43) Retained Earnings 124,878 105,574 Total Common Equity 244,368 225,064 Redeemable Preferred Stock: 6 5/8%, $100 par value, 300,000 shares <F1> 30,000 30,000 Expense, Net of Premium (335) (335) Preferred Stock Redemption Cost (3,447) (4,408) Total Redeemable Preferred Stock 26,218 25,257 Long-Term Debt: First Mortgage and Collateral Trust Bonds: 5 7/8% due 1998 20,000 20,000 6 7/8% due 2003 40,000 40,000 8% due 2023 40,000 40,000 5 3/4% due 1998 40,000 40,000 6.35% due 2003 8,000 8,000 4.875% due 1996 7,000 7,000 8.90% Secured Medium-Term Notes due 1995 10,000 7.78% Secured Medium-Term Notes due 2002 35,000 35,000 Pollution Control Revenue Bond: 5 7/8% due 2008 40,000 40,000 Unsecured Medium-Term Notes: 9-9 1/4% due 1995 - Series A 25,000 Unamortized (Discount) - Net (687) (776) 229,313 264,224 Less Portion Due Within One Year 7,000 35,000 Total Long-Term Debt 222,313 229,224 Total Capitalization $ 492,899 $ 479,545 <FN> <F1> Authorized and Outstanding. </FN> The accompanying notes are an integral part of the financial statements. EASTERN EDISON COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995, 1994, and 1993 (A) Nature of Operations and Summary of Significant Accounting Policies: General: Eastern Edison Company (Eastern Edison or the Company) and its wholly owned subsidiary, Montaup Electric Company (Montaup) are principally engaged in the generation, transmission, distribution and sale of electric energy. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The accounting policies and practices of Eastern Edison and of Montaup are subject to regulation by FERC and the MDPU with respect to their rates and accounting. Eastern Edison and Montaup conform with generally accepted accounting principles, as applied in the case of regulated public utilities, and conform with the accounting requirements and ratemaking practices of the regulatory authority having jurisdiction. Principles of Consolidation: The consolidated financial statements include the accounts of Eastern Edison and its subsidiary, Montaup. All material intercompany balances and transactions have been eliminated in consolidation. Reclassifications: Certain prior period amounts on the financial statements have been reclassified to conform with current presentation. Jointly Owned Companies: Montaup follows the equity method of accounting for its stock ownership investments in jointly owned companies including four regional nuclear generating companies. Montaup's investments in these nuclear generating companies range from 2.25 to 4.50 percent. Montaup is entitled to the electricity produced from these facilities based on its ownership interests and is billed pursuant to contractual agreements which are approved by FERC. One of the four nuclear generating facilities is being decommissioned, but Montaup is required to pay, and has received FERC authorization to recover, its proportionate share of any unrecovered costs and costs incurred after the plant's retirement. Montaup's share of all unrecovered assets and the total estimated costs to decommission the unit aggregated approximately $10.1 million at December 31, 1995 and is included with Other Liabilities on the Consolidated Balance Sheet. Also, due to recoverability, a regulatory asset has been recorded for the same amount and is included with Other Assets. Montaup also has a stock ownership investment of 3.27% in each of the two companies which own and operate certain interconnection facilities used to transmit hydroelectric power between the Hydro-Quebec Electric System and New England. Transactions with Affiliates: Eastern Edison is a wholly owned subsidiary of Eastern Utilities Associates (EUA). In addition to its investment in Eastern Edison, EUA has interests in two other retail companies, a service corporation, and three other non-utility companies. Transactions between Montaup and other affiliated companies include the following: sales of electricity by Montaup to Blackstone Valley Electric Company (Blackstone) and Newport Electric Corporation (Newport) aggregating approximately $133,841,000 in 1995, $126,237,000 in 1994, and $121,447,000 in 1993; accounting, engineering and other services rendered by EUA Service Corporation to Eastern Edison and Montaup of approximately $29,264,000, $27,365,000, and $27,418,000 in 1995, 1994 and 1993, respectively; and operating expense from the rental of transmission and generation facilities by Blackstone and Newport to Montaup aggregating approximately $4,351,000 in 1995, $3,627,000 in 1994, and $2,884,000 in 1993. Montaup rental of transmission facilities to Newport for the years 1995, 1994 and 1993 amounted to zero, $149,000 and $487,000, respectively. Transactions with affiliated companies are subject to review by applicable regulatory commissions. Utility Plant and Depreciation: Utility plant is stated at original cost. The cost of additions to utility plant includes contracted work, direct labor and material, allocable overhead, allowance for funds used during construction and indirect charges for engineering and supervision. For financial statement purposes, depreciation is computed on the straight-line method based on estimated useful lives of the various classes of property. Provisions for depreciation, on a consolidated basis, were equivalent to a composite rate of approximately 3.2% in 1995, 1994 and 1993 based on the average depreciable property balances at the beginning and end of each year. Electric Plant Held for Future Use: In January 1994 Montaup determined that it would not be economically feasible to bring its 42-year old, coal-fired Somerset Station Unit 5 generating unit into compliance with Clean Air Act Amendments of 1990 (Clean Air Act). The unit was placed in cold storage and its net investment, $5.4 million, was transferred to electric plant held for future use pending final determination by Montaup of its usefulness. Under terms of the settlement agreement filed with FERC, entered into by Montaup and the intervenors in Montaup's 1994 rate decrease application, Montaup continues to earn a return on the net investment of the unit. Other Assets: The components of Other Assets at December 31, 1995 and 1994 are detailed as follows: (in Thousands) 1995 1994 Regulatory Assets: Unamortized losses on reacquired debt $14,981 $16,693 Unrecovered plant and decommissioning cost 10,100 18,400 Deferred SFAS 109 costs (Note B) 44,387 39,506 Deferred SFAS 106 costs (Note J) 2,365 2,723 Other regulatory assets 4,790 7,280 Total regulatory assets 76,623 84,602 Other deferred charges and assets: Unamortized debt expenses 2,847 3,345 Other 7,595 7,599 Total Other Assets $87,065 $95,546 Regulatory Accounting: Eastern Edison and Montaup are subject to certain accounting rules that are not applicable to other industries. These accounting rules allow regulated companies, in appropriate circumstances, to establish regulatory assets and liabilities, which defer the current financial impact of certain costs that are expected to be recovered in future rates. Eastern Edison and Montaup believe that their operations continue to meet the criteria established in these accounting standards. Effects of legislation and/or regulatory initiatives or EUA's own initiatives such as "Choice and Competition" could ultimately cause Eastern Edison and Montaup to no longer follow these accounting rules. In such an event, a non-cash write-off of regulatory assets and liabilities could be required at that time. Allowance for Funds Used During Construction (AFUDC): AFUDC represents the estimated cost of borrowed and equity funds used to finance Eastern Edison's and Montaup's construction program. In accordance with regulatory accounting, AFUDC is capitalized, as a cost of utility plant, in the same manner as certain general and administrative costs. AFUDC is not an item of current cash income, but is recovered over the service life of utility plant in the form of increased revenues collected as a result of higher depreciation expense. The combined rate used in calculating AFUDC was 9.4% in 1995, 9.6% in 1994 and 9.3% in 1993. Operating Revenues: Revenues are based on billing rates authorized by applicable federal and state regulatory commissions. Eastern Edison follows the policy of accruing the estimated amount of unbilled base rate revenues for electricity provided at the end of the month to more closely match costs and revenues. Montaup recognizes revenues when billed. In addition, Eastern Edison and Montaup also record the difference between fuel costs incurred and fuel costs billed. Montaup also records the difference between purchased power costs incurred and billed. Income Taxes: The general policy of Eastern Edison and Montaup with respect to accounting for federal income taxes is to reflect in income the estimated amount of taxes currently payable, as determined from the EUA consolidated tax return on an allocated basis, and to provide for deferred taxes on certain items subject to temporary differences to the extent permitted by the various regulatory commissions. As permitted by the regulatory commissions, it is the policy of Eastern Edison and Montaup to defer recognition of the annual investment tax credits and to amortize these credits over the productive lives of the related assets. Cash and Temporary Cash Investments: Eastern Edison and Montaup consider all highly liquid investments and temporary cash investments with a maturity of three months or less, when acquired, to be cash equivalents. New Accounting Standard: In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (FAS 121), effective for fiscal year 1996. FAS 121 requires all regulatory assets, assets which were established as a result of high probability of recovery in a regulated environment, to continue to meet that high probability of recovery at each balance sheet date. Based on the current regulatory framework, management does not expect that adoption of this standard will have a material effect on Eastern Edison's financial position or results of operation. However, this assumption may change in the future as changes are made in the current regulatory framework or as competitive factors influence wholesale and retail pricing in the electric utility industry. (B) Income Taxes: Components of income tax expense for the years 1995, 1994, and 1993 are as follows: _________________________________________________________________ (In Thousands) 1995 1994 1993 Federal: Current $11,387 $ 9,143 $11,554 Deferred 3,679 4,697 2,841 Investment Tax Credit, Net (942) (348) (1,016) $14,124 13,492 13,379 State: Current 2,447 1,468 2,359 Deferred (918) 870 207 1,529 2,338 2,566 Charged to Operations 15,653 15,830 15,945 Charged to Other Income: Current 522 617 392 Deferred (67) (67) (67) Total $16,108 $16,380 $16,270 Total income tax expense was different than the amounts computed by applying federal income tax statutory rates to book income subject to tax for the following reasons: ________________________________________________________________ (In Thousands) 1995 1994 1993 Federal Income Tax Computed at Statutory Rates $17,343 $17,417 $16,580 (Decreases) Increases in Tax from: Equity Component of AFUDC (165) (92) (101) Consolidated Tax Savings (108) (651) (314) Depreciation Differences (264) (321) 851 Amortization and Utilization of ITC (942) (945) (1,066) State Taxes, Net of Federal Income Tax Benefit (2,625) 1,614 1,735 Cost of Removal 58 (226) (273) Other 2,811 (416) (1,142) Total Income Tax Expense $16,108 $16,380 $16,270 (B) Income Taxes -- Continued Eastern Edison and Montaup adopted Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes" (FAS109) which required recognition of deferred income taxes for temporary differences that are reported in different years for financial reporting and tax purposes using the liability method. Under the liability method, deferred tax liabilities or assets are computed using the tax rates that will be in effect when temporary differences reverse. Generally, for regulated companies, the change in tax rates may not be immediately recognized in operating results because of rate making treatment and provisions in the Tax Reform Act of 1986. At December 31, 1995 and 1994 no valuation allowance was deemed necessary for total deferred tax assets. The total deferred tax assets and liabilities at December 31, 1995 and 1994 are comprised as follows: Deferred Tax Deferred Tax Assets Liabilities ($000) ($000) 1995 1994 1995 1994 Plant Related Plant Related Differences $16,181 $16,221 Differences $146,632 $137,072 Alternative Refinancing Minimum Tax 4,470 4,479 Costs 1,691 1,772 Litigation Provisions 0 795 Pensions 940 1,233 Pensions 1,070 514 Other 1,060 1,866 Other 1,901 3,024 Total $22,781 $23,875 Total $151,164 $143,101 As of December 31, 1995 and 1994, the Company had recorded on its Consolidated Balance Sheet a regulatory liability to ratepayers of approximately $23.6 million and $25.2 million, respectively. This amount primarily represents excess deferred income taxes resulting from the reduction in the federal income tax rate and also includes deferred taxes provided on investment tax credits. Also at December 31, 1995 and 1994, a regulatory asset of approximately $44.4 million and $39.5 million, respectively, has been recorded, representing the cumulative amount of federal income taxes on temporary depreciation differences which were previously flowed through to ratepayers. Eastern Edison and Montaup have approximately $92,000 and $4.4 million, respectively, of alternative minimum tax credits which can be utilized to reduce the EUA System's consolidated regular tax liability and have no expiration. (C) Capital Stock: Under the terms and provisions of the issues of preferred stock of Eastern Edison, certain restrictions are placed upon the payment of dividends on common stock by Eastern Edison. At December 31, 1995 and 1994, the respective capitalization ratios were in excess of the minimum requirements which would make these restrictions effective. (D) Redeemable Preferred Stock Eastern Edison's 6-5/8% Preferred Stock issue is entitled to an annual mandatory sinking fund sufficient to redeem 15,000 shares commencing September 1, 2003. The redemption price is $100 per share plus accrued dividends. All outstanding shares of the 6-5/8% issue will be subject to mandatory redemption on September 1, 2008 at a price of $100 per share plus accrued dividends. In the event of liquidation, the holders of Eastern Edison's 6-5/8% Preferred Stock are entitled to $100 per share plus accrued dividends. (E) Retained Earnings: Under the provisions of Eastern Edison's Indenture securing the First Mortgage and Collateral Trust Bonds, retained earnings in the amount of $120,723,852 as of December 31, 1995 were unrestricted as to the payment of cash dividends on its Common Stock. (F) Long-Term Debt: The various mortgage bond issues of Eastern Edison are collateralized by substantially all of their utility plant. In addition, Eastern Edison's bonds are collateralized by securities of Montaup, which are wholly-owned by Eastern Edison, in the principal amount of approximately $236 million. The Company's aggregate amount of current cash sinking fund requirements and maturities of long-term debt, (excluding amounts that may be satisfied by available property additions) for each of the five years following 1995 are: $7 million in 1996, none in 1997, $60 million in 1998 and none in 1999 and 2000. (G) Lines of Credit: EUA System companies including Eastern Edison maintain short-term lines of credit with various banks aggregating approximately $150 million. At December 31, 1995, unused short-term lines of credit were approximately $111 million. These credit lines are available to other EUA System companies under joint credit line arrangements. In accordance with informal agreements with the various banks, commitment fees are required to maintain certain lines of credit. During 1995, the weighted average interest rate for short-term borrowings by the Company was 6.1%. (H) Jointly Owned Facilities: At December 31, 1995, in addition to the stock ownership interests discussed in Note A, Summary of Significant Accounting Policies - Jointly Owned Companies, Montaup had direct ownership interests in the following electric generating facilities (dollars in thousands): Accumulated Provision For Net Construc- Utility Depreciation Utility tion Percent Plant in and Plant in Work in Owned Service Amortization Service Progress Montaup: Canal Unit 2 50.00% $ 71,715 $42,657 $29,058 $2,085 Wyman Unit 4 1.96% 4,050 2,020 2,030 Seabrook Unit 1 2.90% 194,735 23,993 170,742 454 Millstone Unit 3 4.01% 178,231 40,482 137,749 42 The foregoing amounts represent Montaup's interest in each facility, including nuclear fuel where appropriate, and are included on the like- captioned lines on the Consolidated Balance Sheet. At December 31, 1995, Montaup's total net investment in nuclear fuel of the Seabrook and Millstone Units amounted to $3.0 million and $2.2 million, respectively. Montaup's shares of related operating and maintenance expenses with respect to units reflected in the table above are included in the corresponding operating expenses on the Consolidated Statement of Income. (I) Fair Value of Financial Instruments: The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate: Cash and Temporary Cash Investments: The carrying amount approximates fair value because of the short-term maturity of those instruments. Redeemable Preferred Stock and Long-Term Debt: The fair value of the Company's redeemable preferred stock and long-term debt were based on quoted market prices for such securities. The estimated fair values of the Company's financial instruments at December 31, 1995 are as follows (dollars in thousands): Carrying Fair Amount Value Cash and Temporary Cash Investments $ 11,265 $ 11,265 Redeemable Preferred Stock 30,000 31,800 Long-Term Debt $ 230,000 $233,292 (J) Commitments and Contingencies: The owners (or lead participants) of the nuclear units in which Montaup has an interest have made, or expect to make, various arrangements for the acquisition of uranium concentrate, the conversion, enrichment, fabrication and utilization of nuclear fuel and the disposition of that fuel after use. The owners (or lead participants) of United States nuclear units have entered into contracts with the Department of Energy (DOE) for disposal of spent nuclear fuel in accordance with the Nuclear Waste Policy Act (NWPA). The NWPA requires (subject to various contingencies) that the federal government design, license, construct and operate a permanent repository for high level radioactive wastes and spent nuclear fuel and establish a prescribed fee for the disposal of such wastes and nuclear fuel. The NWPA specifies that the DOE provide for the disposal of such waste and spent nuclear fuel starting in 1998. Objections on environmental and other grounds have been asserted against proposals for storage as well as disposal of spent nuclear fuel. The DOE now estimates that a permanent disposal site for spent fuel will not be ready to accept fuel for storage or disposal until as late as the year 2010. Montaup owns a 4.01% interest in Millstone Unit 3 and a 2.9% interest in Seabrook Unit 1. Northeast Utilities, the operator of the units, indicates that Millstone Unit 3 has sufficient on-site storage facilities which with rack additions can accommodate its spent fuel for the projected life of the unit. At the Seabrook Project, there is on-site storage capacity which, with rack additions, will be sufficient to at least the year 2011. The Energy Policy Act requires that a fund be created for the decommissioning and decontamination of the DOE uranium enrichment facilities. The fund will be financed in part by special assessments on nuclear power plants in which Montaup has an interest. These assessments are calculated based on the utilities' prior use of the government facilities and have been levied by the DOE, starting in September 1993, and will continue over 15 years. This cost is passed on to the joint owners or power buyers as an additional fuel charge on a monthly basis and is currently being recovered by Montaup through rates. Also, Montaup is recovering through rates its share of estimated decommissioning costs for Millstone Unit 3 and Seabrook Unit 1. Montaup's share of the current estimate of total costs to decommission Millstone Unit 3 is $19.2 million in 1995 dollars, and Seabrook Unit 1 is $12.5 million in 1995 dollars. These figures are based on studies performed for the lead owner of the units. Montaup also pays into decommissioning reserves pursuant to contractual arrangements with other nuclear generating facilities in which it has an equity ownership interest or life of the unit entitlement. Such expenses are currently recoverable through rates. Pensions: Eastern Edison and Montaup participate with the other EUA System companies in non-contributory defined benefit pension plans covering substantially all of their employees (Retirement Plan). Retirement Plan benefits are based on years of service and average compensation over the four years prior to retirement. It is the EUA System's policy to fund the Retirement Plan on a current basis in amounts determined to meet the funding standards established by the Employee Retirement Income Security Act of 1974. Net pension expense (income) for the Retirement Plan, including amounts related to the 1995 voluntary retirement incentive, was $632,566 in 1995, $249,858 in 1994 and $(326,517) in 1993 and included the following components: 1995 1994 1993 Service cost - benefits earned during the period $ 1,503,804 $ 1,783,085 $ 1,414,382 Interest cost on projected benefit obligation 5,574,660 5,217,393 5,133,080 Actual loss (return) on assets (22,158,215) 926,980 (10,891,951) Net amortization and deferrals 14,855,399 (7,677,600) 4,017,972 Net periodic pension (income) expense $ (224,352) $ 249,858 $ ( 326,517) Voluntary retirement incentive 856,918 Total periodic pension expense (income) $ 632,566 $ 249,858 $ (326,517) ========= ======== ========= Assumptions used to determine pension cost: 1995 1994 1993 Discount Rate 8.25% 7.25% 8.75% Compensation Increase Rate 4.75% 4.75% 6.00% Long-Term Return on Assets 9.50% 9.50% 10.00% The discount rate and compensation increase rate used to determine pension costs were changed effective January 1, 1996 to 7.25% and 4.25%, respectively. The funded status of the Retirement Plan cannot be presented separately for Eastern Edison and Montaup as they participate in the Retirement Plan with other subsidiaries of EUA. The one-time voluntary retirement incentive also resulted in approximately $800,000 of non-qualified pension benefits which were expensed in 1995. At December 31, 1995, approximately $449,000 is included in other liabilities for these unfunded benefits. EUA also maintains non-qualified supplemental retirement plans for certain officers of the EUA System (Supplemental Plans). Benefits provided under the Supplemental Plans are based primarily on compensation at retirement date. EUA maintains life insurance on the participants of the Supplemental Plans to fund in whole, or in part, its future liabilities under the Supplemental Plans. For the three years ended December 31, 1995, 1994 and 1993 expenses related to the supplemental plan were approximately $825,000, $266,000, and $1.3 million, respectively. Post-Retirement Benefits: Retired employees are entitled to participate in health care and life insurance benefit plans. Health care benefits are subject to deductibles and other limitations. Health care and life insurance benefits are partially funded by EUA System companies for all qualified employees. Eastern Edison and Montaup adopted FAS106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," as of January 1, 1993. This standard establishes accounting and reporting standards for such post- retirement benefits as health care and life insurance. Under FAS106 the present value of future benefits is recorded as a periodic expense over employee service periods through the date they become fully eligible for benefits. With respect to periods prior to adopting FAS106, EUA elected to recognize accrued costs (the Transition Obligation) over a period of 20 years, as permitted by FAS106. The resultant annual expense, including amortization of the Transition Obligation and net of amounts capitalized and deferred, was approximately $4.0 million in 1995, $3.4 million in 1994 and $3.4 million in 1993. The total cost of Post-Retirement Benefits other than Pensions for 1995, 1994 and 1993 includes the following components (in thousands): 1995 1994 1993 Service cost $ 565 $ 880 $ 767 Interest cost 2,926 3,252 3,556 Actual return on plan assets (388) (75) (41) Amortization of transition obligation 1,965 2,026 2,040 Net other amortization & deferrals (632) (50) (40) Net periodic post-retirement benefit costs 4,436 6,033 6,282 Voluntary retirement incentive 470 Total post-retirement benefit costs $ 4,906 $6,033 $6,282 Assumptions Discount rate 8.25% 7.25% 8.75% Health care cost trend rate-near-term 11.00% 13.00% 13.00% -long-term 5.00% 5.00% 6.25% Compensation increase rate 4.75% 4.75% 6.00% Rate of return on plan assets-union 8.50% 8.50% 8.50% - non-union 5.50% 5.50% 5.50% Reconciliation of funded status: 1995 1994 1993 Accumulated post-retirement benefit obligation (APBO): Retirees $(23,223) $(20,227) $(20,556) Active employee fully eligible for benefits (3,649) (4,116) (7,669) Other active employees (7,711) (9,255) (9,488) Total (34,583) (33,598) (37,713) Fair Value of assets (primarily notes and bonds) 3,830 2,169 747 Unrecognized transition obligation 27,726 30,007 31,674 Unrecognized net (gain) loss (2,142) (3,158) 2,597 (Accrued)/prepaid post-retirement benefit cost $ (5,169) $ (4,580) $ (2,695) The discount rate and compensation increase rate used to determine post- retirement benefit costs were changed effective January 1, 1996, to 7.25% and 4.25%, respectively and were used to calculate the funded status of Post- Retirement Benefits at December 31, 1995. Increasing the assumed health care cost trend rate by 1% each year would increase the total post-retirement benefit cost for 1995 by approximately $478,000 and increase the total accumulated post-retirement benefit obligation by approximately $3.7 million. Eastern Edison and Montaup have also established an irrevocable external Voluntary Employees' Beneficiary Association (VEBA) Trust Fund as required by the aforementioned regulatory decisions. Contributions to the VEBA fund commenced in March 1993 and contributions totaling approximately $3.2 million and $2.9 million were made during 1995 and 1994, respectively. Long-Term Purchased Power Contracts: Montaup is committed under long-term purchased power contracts, expiring on various dates through September 2021, to pay demand charges whether or not energy is received. Under terms in effect at December 31, 1995, the aggregate annual minimum commitments for such contracts are approximately $129 million in 1996 and 1997, $128 million in 1998, $127 million in 1999, $123 million in 2000 and will aggregate $1.4 billion for the ensuing years. In addition, the EUA System is required to pay additional amounts depending on the actual amount of energy received under such contracts. The demand costs associated with these contracts are reflected as Purchased Power-Demand on the Consolidated Statement of Income. Such costs are currently recoverable through rates. Environmental Matters: The Comprehensive Environmental Response, Compensation Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, and certain similar state statutes authorize various governmental authorities to seek court orders compelling responsible parties to take cleanup action at disposal sites which have been determined by such governmental authorities to present an imminent and substantial danger to the public and to the environment because of an actual or threatened release of hazardous substances. Because of the nature of the Eastern Edison business, various by-products and substances are produced or handled which are classified as hazardous under the rules and regulations promulgated by the United States Environmental Protection Agency (EPA) as well as state and local authorities. The Company generally provides for the disposal of such substances through licensed contractors, but these statutory provisions generally impose potential joint and several responsibility on the generators of the wastes for cleanup costs. Eastern Edison and Montaup have been notified with respect to a number of sites where they may be responsible for such costs, including sites where they may have joint and several liability with other responsible parties. It is the policy of Eastern Edison and Montaup to notify liability insurers and to initiate claims. However, it is not possible at this time to predict whether liability, if any, will be assumed by, or can be enforced against, the insurance carrier in these matters. As of December 31, 1995, Eastern Edison and Montaup have incurred costs of approximately $500,000 in connection with the foregoing environmental matters and estimate that additional expenditures may be incurred through 1997 up to $500,000. As a general matter Eastern Edison and Montaup will seek to recover costs relating to environmental proceedings in their rates. Montaup is currently recovering certain of the incurred costs in its rates. Estimated amounts after 1997 are not now determinable since site studies which are the basis of these estimates have not been completed. As a result of the recoverability in current rates, and the uncertainty regarding both its estimated liability, as well as potential contributions from insurance carriers and other responsible parties, Eastern Edison and Montaup do not believe that the ultimate impact of the environmental costs will be material to their financial position and thus, no loss provision is required at this time. The Clean Air Act Amendments of 1990 (Clean Air Act) created new regulatory programs and generally updated and strengthened air pollution control laws. These amendments will expand the regulatory role of the EPA regarding emissions from electric generating facilities and a host of other sources. Montaup generating facilities were first affected in 1995, when EPA regulations took effect for facilities owned by Montaup. Montaup's coal-fired Somerset Unit No. 6 is utilizing lower sulfur coal to meet the 1995 air standards. Eastern Edison does not anticipate the impact from the Amendments to be material to its financial position. In April 1992, the Northeast States for Coordinated Air Use Management (NESCAUM), an environmental advisory group for eight Northeast states including Massachusetts and Rhode Island issued recommendations for oxides of nitrogen controls for existing utility boilers required to meet the ozone non-attainment requirements of the Clean Air Act Amendments. The NESCAUM recommendations are more restrictive than EPA's requirements. The DEP has amended its regulations to require that Reasonably Available Control Technology (RACT) be implemented at all stationary sources potentially emitting 50 tons per year or more of oxides of nitrogen. Rhode Island has also issued similar regulations requiring that RACT be implemented at all stationary sources potentially emitting 50 tons or more per year of nitrogen oxide. Montaup has initiated compliance through, among other things, selective, noncatalytic reduction processes. A number of scientific studies in the past several years have examined the possibility of health effects from electric and magnetic fields (EMF) that are found wherever there is electricity. While some of the studies have indicated some association between exposure to EMF and health effects, many of the others have indicated no direct association. The research to date has not conclusively established a direct causal relationship between EMF exposure and human health. Additional studies, which are intended to provide a better understanding of EMF, are continuing. Some states have enacted regulations to limit the strength of EMF at the edge of transmission line rights-of way. Rhode Island has enacted a statute which authorizes and directs the Rhode Island Energy Facility Siting Board to establish rules and/or regulations governing construction of high voltage transmission lines of 69 KV or more. There is a bill pending in the Massachusetts legislature that would authorize the MDPU to examine the potential health effects of EMF. Management cannot predict the impact, if any, which legislation or other developments concerning EMF may have on Eastern Edison or Montaup. Guarantee of Financial Obligations: Montaup is a 3.27% equity participant in two companies which own and operate transmission facilities interconnecting New England and the Hydro Quebec system in Canada. Montaup has guaranteed approximately $5.2 million of the outstanding debt of these two companies. In addition, Montaup has a minimum rental commitment which totals approximately $13.5 million under a noncancellable transmission facilities support agreement for years subsequent to 1995. Other In December 1992, Montaup commenced a declaratory judgment action in which it sought to have the Massachusetts Superior Court determine its rights under the Power Purchase Agreement between it and Aquidneck Power Limited Partnership (Aquidneck). In April 1995, Montaup filed a motion for summary judgement, and in June 1995, the court granted Montaup's motion. In July, Aquidneck filed for appeal of the court's decision. Montaup, EUA and EUA Service intend to vigorously contest the appeal and continue to believe that Aquidneck's claims have no basis in law. Report of Independent Accountants To the Directors and Shareholder of Eastern Edison Company and Subsidiary: We have audited the accompanying consolidated balance sheets and consolidated statement of capitalization of Eastern Edison Company and its subsidiary (the Company) as of December 31, 1995 and 1994, and the related consolidated statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles. Coopers & Lybrand L.L.P. Boston, Massachusetts March 5, 1996