Company Profile Blackstone Valley Electric Company (Blackstone or the Company) is a retail electric utility company. Blackstone supplies retail electric service to approximately 86,000 customers in the cities of Central Falls, Pawtucket and Woonsocket, and four surrounding towns in northern Rhode Island. Blackstone is a wholly owned subsidiary of Eastern Utilities Associates (EUA). EUA owns directly all of the shares of common stock of Blackstone, Eastern Edison Company (Eastern Edison) and Newport Electric Corporation (Newport). These EUA subsidiaries are collectively referred to as the Retail Subsidiaries. Eastern Edison and Newport are retail electric utility companies operating in southeastern Massachusetts 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 Blackstone, to Eastern Edison, to Newport and to two unaffiliated utilities for resale. EUA also owns directly all of the shares of common stock of EUA Service Corporation (EUA Service), EUA Cogenex Corporation (EUA Cogenex), EUA Energy Investment Corporation (EUA Energy), EUA Ocean State Corporation (EUA Ocean State), EUA Energy Services, Inc. (EUA Energy Services) and EUA Telecommunications Corporation (EUA Telecommunications). 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 Ocean State Power's two gas-fired generating units in northern Rhode Island Island. EUA Energy Services markets energy and energy related services. EUA Telecommunications provides telecommunications and information services. The holding company system of EUA, the Retail Subsidiaries, Montaup, EUA Service, EUA Cogenex, EUA Energy, EUA Ocean State, EUA Energy Services, and EUA Telecommunications is referred to as the EUA System. The Core Electric Business consists of the Retail Subsidiaries and Montaup. (See Electric Utility Industry Restructuring for a discussion of changes taking place in the utility industry in the territories serviced by EUA's Core Electric Business.) Form 10-K A copy of EUA's, Eastern Edison's and Blackstone's Co-Registrant 1998 Annual Report on Form 10-K, which is filed with the Securities and Exchange Commission, is available without charge by contacting us at: EUA Service Corporation Post Office Box 2333 Boston, MA 02107 (617) 357-9590 Internet Address Visit EUA's Home Page on the worldwide web at: http://www.eua.com. MARKET FOR BLACKSTONE'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS All of Blackstone's common stock is owned beneficially and of record by EUA. The dividends paid on common stock during the past two years are as follows: Dividends Paid Dividends Paid 1998 Per Share 1997 Per Share First Quarter $1.90 First Quarter $4.75 Second Quarter 1.90 Second Quarter 4.75 Third Quarter 1.90 Third Quarter 4.75 Fourth Quarter -0- Fourth Quarter 4.75 No dividend may be paid on the common stock unless full dividends on the outstanding preferred stock for all past and the current quarterly dividend periods have been paid or declared and set apart for payment. Blackstone's First Mortgage Indenture and Deed of Trust securing its First Mortgage Bonds contains provisions which restrict the payment by Blackstone of cash dividends on its common stock. See Notes C and D of Notes to Financial Statements and Management's Discussion and Analysis of Financial Condition and Review of Operations under Financial Condition and Liquidity. SELECTED FINANCIAL DATA For the Years Ended December 31, (In Thousands) 1998 1997 1996 1995 1994 ____________________________________________________________________________________ Operating Revenues $130,202 $140,258 $136,911 $140,861 $140,611 Net Earnings 4,616 5,357 3,776 4,009 3,438 Total Assets 134,145 130,833 132,313 129,835 121,413 Capitalization: Long-Term Debt-Net 32,000 33,500 35,000 36,500 38,000 Non-Redeemable Preferred Stock (including premium) 6,130 6,130 6,130 6,130 6,130 Common Equity 41,658 38,092 36,232 37,045 37,180 Total Capitalization $ 79,788 $ 77,722 $ 77,362 $ 79,675 $ 81,310 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND REVIEW OF OPERATIONS Overview Net Earnings for 1998 decreased approximately $700,000 to $4.6 million as compared to 1997. Kilowatthour sales (kWh) of electricity were relatively unchanged in 1998 as compared to 1997. KWh sales increases in the second and third quarters of 1998 of 3.6% and 3.2%, respectively, were offset by sales decreases in the first and fourth quarters of 1998 of 1.7% and 4.5%, respectively, largely due to milder weather as compared to 1997. Net Earnings for 1997 increased approximately $1.6 million to $5.4 million compared to 1996. Net Earnings for 1997 include a one-time charge of approximately $260,000, on an after-tax basis, related to the costs of a voluntary retirement incentive offer (VRI) recorded in 1997, discussed below. Kilowatthour (kWh) sales of electricity for 1997 increased by 2.6% as compared to 1996, led by increased sales to residential and commercial customers of 4.8% and 2.6%, respectively. Proposed Merger Agreement On February 1, 1999, EUA and New England Electric System (NEES) announced a merger agreement under which NEES will acquire all outstanding shares of EUA for $31 per share in cash. The merger agreement, which is subject to the approval of EUA shareholders and various regulatory agencies, values the equity of EUA at approximately $634 million, which represents a 23% premium above the price of EUA shares on December 4, 1998, the last trading day before other regional merger announcements affected EUA's share price. The merger is expected to occur by early 2000. Comparison of Financial Results Operating Revenues Operating Revenues decreased by approximately $10.1 million or 7.2% in 1998 as compared to 1997. This change was due primarily to recoveries of decreased purchased power expenses (see below) resulting from rate reductions pursuant to electric industry restructuring legislation and approved settlements agreements. Offsetting this decrease somewhat was a 1.3% base rate increase pursuant to the Rhode Island Utility Restructuring Act of 1996 (URA) effective January 1, 1998. Operating Revenues increased by approximately $3.3 million or 2.4% in 1997 as compared to 1996. This change was primarily due to recoveries of increased conservation and load management (C&LM) expenses of approximately $800,000 (discussed below), and an approximate 1.9% base rate increase effective January 1, 1997 pursuant to the URA offset by recoveries of lower purchased power expense (see discussions below). 1997 Voluntary Retirement Incentive In June 1997, an early retirement offer was accepted by a group of employees who were eligible for, but not offered, a VRI offer completed in 1995. The pre-tax cost of the 1997 offer, recorded in that year's second quarter was approximately $400,000 (approximately $260,000 after-tax). Expenses Purchased Power expense, recovered through Blackstone's purchased power adjustment clause, represented 66% of total 1998 operating expense. Purchased Power expense decreased approximately $9.8 million or 10.8% in 1998 as compared to 1997. The Company's purchased power expense now reflects the contract termination charge and standard offer billings from Montaup effective January 1, 1998, pursuant to electric industry restructuring legislation and settlement agreements. Purchased Power expense decreased approximately $700,000 or less than 1% in 1997 as compared to 1996. 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 including expenses related to accounting standards such as Statement of Financial Accounting Standard No. 106, "Employers' Accounting for Post- Retirement Benefits Other Than Pensions" (FAS106). Other Operation and Maintenance (O&M) expenses, including affiliated company transactions, increased approximately $1.2 million or 5.2% in 1998 as compared to 1997. This increase was primarily due to increased C&LM expenses of approximately $400,000 consistent with provisions of electric utility industry restructuring legislation in Rhode Island, and increased customer accounts expense of approximately $500,000. Other O&M expenses for 1997, including affiliated company transactions, increased approximately $800,000 or 3.4% as compared to 1996. This change was primarily due to increased C&LM expenses in 1997. Taxes Other than Income decreased approximately $700,000 or 8.9% in 1998 as compared to 1997 due to lower Rhode Island Gross Receipts taxes as a result of decreased revenues in 1998 and the absence of Rhode Island Gross Receipts Tax rate billed to industrial customers of Blackstone since July of 1997. Taxes Other than Income decreased by approximately $200,000 or 2.0% in 1997 as compared to 1996. This decrease was due primarily to the 1% decrease in the Rhode Island Gross Receipts Tax rate billed to industrial customers in 1997. Blackstone's effective income tax rate for 1998 was approximately 39.7% compared to 38.1% in 1997. Provisions of restructuring settlement agreements which require acceleration of the catch-up of deferred tax deficiencies created under prior regulatory practices were responsible for this change. Other (Deductions) Income - Net decreased approximately $300,000 in 1998 as compared to 1997. The decrease is primarily due to the absence of interest income allocated to Blackstone by the EUA Service Corporation in 1997 related to the favorable resolution of a Massachusetts corporate income tax dispute. Other Income and (Deductions) - Net increased approximately $200,000 in 1997 compared to 1996, primarily due to increased interest income allocated to Blackstone by EUA Service Corporation in the first quarter of 1997 (discussed above). Net Interest charges decreased approximately $300,000 or 7.7% in 1998 as compared to 1997, primarily due to lower interest on long-term debt due to reductions in long-term debt balances resulting from normal required sinking fund payments and decreased intercompany interest expense. Net Interest charges for 1997 increased by approximately $300,000 or 8.5% as compared to 1996. This increase was primarily due to increased short-term borrowings and increased intercompany interest expense offset by lower interest on long-term debt due to reductions in long-term debt balances resulting from required sinking fund payments. Financial Condition and Liquidity The Company is required to make capital expenditures in order to meet the needs of its existing and future customers. For 1998, 1997 and 1996, the Company's cash construction expenditures were approximately $6.0 million, $3.8 million, and $4.2 million, respectively. Internally generated funds provided approximately 210%, 164%, and 104% of cash construction requirements in 1998, 1997 and 1996, respectively. Cash Construction expenditures are expected to be $8.7 million in 1999, $8.9 million in 2000, and $9.2 million in 2001, and are expected to be financed with internally generated funds. Traditionally, construction requirements in excess of internally generated funds are obtained through short-term borrowings which are ultimately funded with permanent capital. In July 1997, several EUA System companies, including Blackstone, entered into a three-year revolving credit agreement allowing for borrowings in aggregate of up to $145 million from all sources of short-term credit. As of December 31, 1998, various financial institutions have committed up to $75 million under the revolving credit facility. In addition to the $75 million available under the revolving credit facility, EUA System companies maintain short-term lines of credit with various banks totaling $90 million for an aggregate amount available of $165 million. At December 31, 1998, under the revolving credit agreement, the EUA System had unused short-term lines of credit of approximately $101.4 million. Blackstone had zero short-term borrowings outstanding at December 31, 1998 and $1.4 million at December 31, 1997. Blackstone's requirements for sinking fund payments and redemption of securities for the five years following 1998 are $1.5 million in each of 1999 and 2000, and $3.3 million in each of 2001, 2002 and 2003, none of which relate to the variable rate bonds. Blackstone is exposed to interest rate risk primarily related to its variable rate bonds. Refer to the Statements of Capitalization for a listing of Blackstone's long-term fixed and variable rate debt. Electric Utility Industry Restructuring Rhode Island legislation along with approved electric utility industry restructuring settlement agreements at both the state and federal levels, granted Blackstone's customers with choice of electricity supplier and rate reductions commencing January 1, 1998. Until a customer chooses an alternative supplier, that customer will receive standard offer service. Blackstone is required to arrange for standard offer service through December 31, 2009. Under the approved settlement agreements, Montaup had guaranteed standard offer supply at a fixed price schedule for the duration of the standard offer period and Blackstone agreed to subject its standard offer requirements to a competitive bidding process in which competitive suppliers would bid against the guaranteed price. Through its successful divestiture process, combined with a competitive bidding process conducted in late 1998, Montaup has assigned 100% of its standard offer obligation to purchasers of its generating assets. The guaranteed standard offer price will increase over time to encourage customers to leave standard offer service and enter the competitive power supply market. Provisions of the approved settlement agreements also allowed Montaup to replace its all-requirements wholesale contract with Blackstone with a contract termination charge (CTC) which permits Montaup to recover, among other things, its above market investments and commitments in generation assets. Montaup began billing the CTC to Blackstone coincident with retail access and Blackstone is recovering the CTC through a non-bypassable transition charge to all of its distribution customers. As part of the approved settlement agreements, Montaup agreed to divest its entire generation portfolio. The net proceeds of the sale, as defined in the settlement agreements, will be used to mitigate Montaup's CTC to its retail affiliates, including Blackstone, via a Residual Value Credit (RVC). The RVC will reduce the fixed component of the CTC by an amount equal to the net proceeds, with a return, over the period commencing on the date the RVC is implemented through December 31, 2009. On February 12, 1999, Montaup filed to implement the RVC effective April 1, 1999 and is awaiting approval. See "Generation Divestiture" below. Generation Divestiture Montaup now has agreements to sell all of its non-nuclear power generation assets and its 2.9% ownership share of the Seabrook Nuclear Station and has agreements to transfer all of its remaining purchased power contracts with the exception of its purchase power commitment with the Vermont Yankee Nuclear Station. On January 5, 1999, EUA announced that Montaup had agreed to transfer its remaining non-nuclear power purchase contracts, amounting to approximately 177 mw, to Constellation Power Source, Inc. Montaup previously entered into agreements to sell: its 160-mw Somerset, Massachusetts electric generating station for approximately $55 million to NRG Energy, Inc.; its 2.6% (16 mw) share of the W. F. Wyman Unit 4 in Yarmouth, Maine to the Florida based FPL Group for approximately $2.4 million; and its 2.9% share (34 mw) of the Seabrook Station nuclear power plant to the Great Bay Power Corporation, a subsidiary of BayCorp Holdings, Ltd. for $3.2 million. Montaup has also signed agreements for the transfer of power purchase contracts for approximately 170 mw between Montaup and Ocean State Power and for the buyout of its 11% (73 mw) power entitlement from the Pilgrim Nuclear Power Station in Plymouth, Massachusetts. All of the sale and contract transfer agreements are subject to federal and state regulatory approvals, including that of the Nuclear Regulatory Commission with respect to the Seabrook sale. Closing of the non-nuclear sale agreements are anticipated to take place in the first quarter of 1999. The Seabrook sale and Pilgrim buyout are expected to take place later in 1999. The sale of Montaup's 50% share (280 mw) of Unit 2 of the Canal Generating Station in Sandwich, Massachusetts to Southern Energy for $75 million, which was announced in May 1998, was completed on December 30, 1998, and the sale of two diesel-powered generating units (totaling approximately 16 mw) owned by Newport to Illinois-based Wabash Power Equipment Co. for $1.5 million closed on October 1, 1998. Montaup's remaining generating capacity includes approximately 46 mw from its 4.0% joint ownership share of Millstone 3 nuclear unit and 12 mw from its 2.25% equity ownership of the Vermont Yankee nuclear facility. Environmental Matters Blackstone and other electric utilities owning generating units from which power is obtained are subject to environmental and land use regulations at the federal, state and local levels. The federal 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, EUA instituted an environmental audit program designed for Montaup and the Retail Subsidiaries, including Blackstone, to ensure compliance with environmental laws and regulations and to identify and reduce liability with respect to those requirements. Because of the nature of Blackstone'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. Blackstone generally provides for the disposal of such substances through licensed contractors, but these statutory provisions may impose joint and several responsibility on the generators of the wastes for cleanup costs. Blackstone has been notified with respect to a number of sites where it may be responsible for such costs, including sites where it 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, Blackstone is 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, 1998, Blackstone had incurred costs of approximately $7.7 million in connection with these sites. These amounts have been financed primarily by internally generated cash. Blackstone is currently recovering certain of its incurred environmental costs in rates. 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, Blackstone does not believe that the ultimate impact of environmental costs will be material to its financial position and thus, no loss provision is required at this time. Blackstone estimates that additional costs of up to $1.8 million may be incurred at these sites through 1999. Estimates beyond 1999 cannot be made since site studies, which are the basis of these estimates, have not been completed. In addition to the previously discussed costs, Blackstone is currently litigating responsibility for clean-up costs and related interest aggregating $5.9 million. The cleanup costs were incurred by the Commonwealth of Massachusetts at a site in which Blackstone has been named as the responsible party. (See Note H of "Notes to Financial Statements" for further discussion.) 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. 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. Year 2000 Issue EUA is addressing the Year 2000 issue on an EUA System basis, which includes Blackstone. EUA's Year 2000 Program (the Program) is proceeding on schedule. The Program is addressing the potential impact on computer systems and embedded systems and components resulting from a common software program code convention that utilizes two digits instead of four to represent a year. If not addressed, the year 2000 may be systemically recognized as the year 1900, which could cause system or equipment failures or malfunctions, and ultimately result in disruptions to Company operations. EUA's State of Readiness: To address potential Year 2000 issues, EUA has divided the focus of its Year 2000 Program into three major categories of business activity: the generation and delivery of electricity to customers, the acquisition of goods and services (including purchased power), and, ongoing general and administrative activities relating to the corporate infrastructure and support functions, which includes among other things, billings and collections. EUA has adopted a four phase approach in addressing information technology (IT) issues. As of January 31, 1999, each phase was at the following percentage of completion: analysis - 100%; remediation - 79%; unit testing - 78%; and integrated testing - 11%. EUA is on schedule to achieve Year 2000 readiness for 100% of mission critical projects by June 30, 1999. For non-IT projects, approximately 90% are either Year 2000 ready or not affected by the Year 2000. The remaining items are in the process of being remediated and tested and are scheduled to be Year 2000 ready by June 30, 1999. EUA has an ongoing process to identify and assess the Year 2000 readiness of third parties with which it has a material relationship. Where necessary, contingency plans will be developed. This process is on schedule to be completed by June 30, 1999. Costs to Address EUA's Year 2000 Issues: Through December 31, 1998, EUA has incurred costs of approximately $3.0 million to address Year 2000 issues, including approximately $1.5 million of non-incremental labor, $1.2 million of capital expenditures and $300,000 of consulting and other costs. EUA estimates it will incur additional costs approximating $7.0 million during the period January 1, 1999 through March 31, 2000, to complete its resolution of Year 2000 issues including approximately $5.5 million of non-incremental labor, $500,000 of capital expenditures and $1.0 million of consulting and other costs. Because 70% of the total estimated costs associated with the Year 2000 issue relate to non-incremental internal labor, management continues to believe that the Year 2000 will not present a material incremental impact to future operating results or financial condition. Risks of EUA's Year 2000 Issues: EUA's first priority continues to be the minimization of any potential disruptions to electric service as a result of the Year 2000. The provision of electric service depends in large part on the viability of the New England power grid which is managed by ISO/NEPOOL. EUA is actively participating on ISO/NEPOOL's Year 2000 operating and oversight committees. EUA's assessment of its own transmission and distribution equipment and facilities indicated that the risk of failure of this equipment does not appear to be significant. However, due to the interconnectivity of the New England power grid, and the reliance on many other entities also connected to the grid, it is not possible to conclude with certainty that there will be no significant interruptions in service. In addition, dependable voice and data telecommunications are critical to EUA's ongoing operations. EUA's internal telecommunication systems are either Year 2000 ready now, or on schedule to become Year 2000 ready by June 30, 1999. EUA also relies heavily on external telecommunication systems, i.e., the local and regional telephone systems, and has identified these providers as critical vendors. EUA has made direct contact with representatives of the telephone companies on which EUA depends, each of which anticipates being Year 2000 ready and devoid of major system failures. No other significant reasonably likely failure scenarios stemming solely from Year 2000 related problems have been identified thus far. Accordingly, EUA does not currently believe that any Year 2000 related risks in and of themselves constitute reasonably likely worst case scenarios. Rather, EUA's most reasonably likely Year 2000 related worst case scenario would be the occurrence of isolated Year 2000 failures such as described above in conjunction with a severe winter storm. However, EUA believes that such Year 2000 failures would not likely affect whether the storm event would have a material impact on EUA's business or financial condition. Year 2000 Contingency Plans: Contingency planning teams consisting of managers and employees experienced in system reliability, disaster recovery and risk have been established and are responsible for developing contingency plans. The overall strategy will be to identify Year 2000 risks, both internal and external to EUA, that could have a material impact on EUA's operations or financial well being. Preliminary plans are expected by the end of the first quarter of 1999. Final plans are scheduled to be in place and ready to implement, if necessary, by June 30, 1999. Summary: The amount of effort and resources necessary to address Year 2000 issues and make EUA Year 2000 ready is significant. There are dedicated teams in place to ensure EUA's transition into the next century occurs with minimal disruption. EUA's Year 2000 program is on schedule and in accordance with timetables and progress points published by the North American Electric Reliability Council. In addition, EUA is utilizing outside technical consultants and other experts to help ensure EUA's Year 2000 program remains on schedule and effective. Management believes EUA's Year 2000 project is well managed and has the appropriate resources and plans in place to ensure the Company is positioned for a successful transition to the Year 2000. The foregoing constitutes a Year 2000 Statement and Readiness Disclosure subject to the protections afforded by the federal Year 2000 Information and Readiness Disclosure Act of 1998. New Accounting Standards In March 1998, The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1), effective in 1999. SOP 98-1 provides specific guidance on whether to capitalize or expense costs within its scope. The Company does not expect SOP 98-1 to have a material impact on its financial position or result of operations. In June 1998, the Financial Accounting Standards Board issued FAS133, "Accounting for Derivative Instruments and Hedging Activities," which is effective in 2000. This statement requires the recognition of all derivative instruments as either assets or liabilities in the statement of financial position and the measurement of those instruments at fair value. The Company is currently evaluating the impact FAS133 will have on its financial position or results of operations. Other Blackstone 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 SEC, press releases and oral statements. This report contains information about the Company's future business prospects including, without limitation, statements about the potential impact of Year 2000 issues on the Company's financial condition or results. These statements are considered "forward-looking" within the meaning of the Private Securities Litigation Reform Act. These statements are based on the Company's current plans and expectations and involve risks and uncertainties that could cause actual future activities and results of operations to be materially different from those set forth in the forward- looking statements. The Company expressly undertakes no duty to update any forward-looking statement. Management's 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 "Financial Statements" and "Notes to Financial Statements" in arriving at a more complete understanding of such matters. Financial Table of Contents Statements of Income. . . . . . . . . . . . . . . . . . . . . . . . . . 12 Statements of Retained Earnings. . . . . . . . . . . . . . . . . . . . . 12 Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . 13 Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Statements of Capitalization . . . . . . . . . . . . . . . . . . . . . . 15 Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . 17 Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . 31 [This page left blank intentionally] Blackstone Valley Electric Company Statements of Income Years Ended December 31, (In Thousands) 1998 1997 1996 Operating Revenues $ 130,202 $ 140,258 $ 136,911 Operating Expenses: Purchased Power (princ. from an affiliate) 80,552 90,327 91,016 Other Operation and Maintenance 12,069 11,682 11,781 Affiliated Company Transactions 11,730 10,943 10,092 Voluntary Retirement Incentive 0 363 0 Depreciation 6,252 5,725 5,594 Taxes - Other than Income 7,594 8,340 8,506 Income and Deferred Taxes 3,245 3,326 2,156 Total Operating Expenses 121,442 130,706 129,145 Operating Income 8,760 9,552 7,766 Allowance for Other Funds Used During Construction 50 Other (Deductions) Income - Net (71) 195 30 Income Before Interest Charges 8,689 9,747 7,846 Interest Charges: Interest on Long-Term Debt 3,030 3,186 3,313 Other Interest Expense 869 996 524 Allowance for Borrowed Funds Used During Construction (Credit) (115) (81) (56) Net Interest Charges 3,784 4,101 3,781 Net Income 4,905 5,646 4,065 Preferred Dividend Requirements 289 289 289 Net Earnings Applicable to Common Stock $ 4,616 $ 5,357 $ 3,776 Statements of Retained Earnings Years Ended December 31, (In Thousands) 1998 1997 1996 Retained Earnings - Beginning of Year $ 10,981 $ 9,121 $ 9,934 Net Income 4,905 5,646 4,065 Total 15,886 14,767 13,999 Dividends Paid: Preferred 289 289 289 Common 1,050 3,497 4,589 Retained Earnings - End of Year $ 14,547 $ 10,981 $ 9,121 The accompanying notes are an integral part of the financial statements. Blackstone Valley Electric Company Statements of Cash Flows Years Ended December 31, (In Thousands) 1998 1997 1996 CASH FLOW FROM OPERATING ACTIVITIES: Net Income $ 4,905 $ 5,646 $ 4,065 Adjustments to Reconcile Net Income to Net Cash Provided from Operating Activities: Depreciation and Amortization 6,905 6,184 5,976 Deferred Taxes 2,258 (1,667) (561) Investment Tax Credit, Net (178) (181) (182) Allowance for Funds Used During Construction (50) Other - Net (1,752) (1,768) (555) Net Changes in Operating Assets and Liabilities: Accounts Receivable (2,545) 238 2,389 Materials and Supplies (98) 113 66 Accounts Payable 5,034 (7,977) (383) Accrued Taxes (572) 650 (362) Other - Net (3,959) 6,762 740 Net Cash Provided from Operating Activities 9,998 8,000 11,143 CASH FLOW FROM INVESTING ACTIVITIES: Construction Expenditures (5,989) (3,769) (4,196) Net Cash (Used in) Investing Activities (5,989) (3,769) (4,196) CASH FLOW FROM FINANCING ACTIVITIES: Redemptions of Long-Term Debt (1,500) (1,500) (1,500) Common Share Dividends Paid (1,050) (3,497) (4,589) Preferred Dividends Paid (289) (289) (289) Net (Decrease) Increase in Short-Term Debt (1,400) 665 (524) Net Cash (Used in) Financing Activities (4,239) (4,621) (6,902) Net (Decrease) Increase in Cash (230) (390) 45 Cash and Temporary Cash Investments at Beginning of Year 408 798 753 Cash and Temporary Cash Investments at End of Year $ 178 $ 408 $ 798 Cash paid during the year for: Interest (Net of Amounts Capitalized) $ 3,243 $ 3,436 $ 3,390 Income Taxes $ 1,957 $ 4,906 $ 3,301 The accompanying notes are an integral part of the financial statements. Blackstone Valley Electric Company Balance Sheets December 31, (In Thousands) ASSETS 1998 1997 Utility Plant and Other Investments: Utility Plant $ 146,185 $ 141,609 Less Accumulated Provision for Depreciation 60,534 55,851 Net Utility Plant 85,651 85,758 Non-Utility Property - Net 196 45 Total Utility Plant and Other Investments 85,847 85,803 Current Assets: Cash and Temporary Cash Investments 178 408 Accounts Receivable: Customers, Net 10,228 11,394 Accrued Unbilled Revenue 2,606 1,584 Others 4,664 1,631 Associated Companies 169 513 Plant Materials and Operating Supplies (at average cost) 857 759 Other Current Assets 429 395 Total Current Assets 19,131 16,684 Other Assets (Note A) 29,167 28,346 Total Assets $ 134,145 $ 130,833 LIABILITIES AND CAPITALIZATION Capitalization: Common Equity $ 41,658 $ 38,092 Non-Redeemable Preferred Stock 6,130 6,130 Long-Term Debt 32,000 33,500 Total Capitalization 79,788 77,722 Current Liabilities: Long-Term Debt Due Within One Year 1,500 1,500 Notes Payable 0 1,400 Accounts Payable: Public 684 960 Associated Companies 13,642 8,332 Customer Deposits 926 1,049 Taxes Accrued 1,493 2,065 Dividends Accrued 72 72 Interest Accrued 779 842 Other Current Liabilities 4,278 8,017 Total Current Liabilities 23,374 24,237 Deferred Credits: Unamortized Investment Credit 2,202 2,380 Mendon Road Contingency Reserve (Note H) 7,409 7,065 Other Deferred Credits 8,087 7,532 Total Deferred Credits 17,698 16,977 Accumulated Deferred Taxes 13,285 11,897 Commitments and Contingencies (Note H) Total Liabilities and Capitalization $ 134,145 $ 130,833 The accompanying notes are an integral part of the financial statements. Blackstone Valley Electric Company Statements of Capitalization December 31, (In Thousands) 1998 1997 Common Stock, $50 par value, authorized 233,000 shares, issued and outstanding 184,062 shares $ 9,203 $ 9,203 Other Paid-in Capital 17,908 17,908 Retained Earnings 14,547 10,981 Total Common Equity 41,658 38,092 Non-Redeemable Cumulative Preferred Stock: 4.25%, $100 par value, 35,000 shares <F1> 3,500 3,500 5.60%, $100 par value, 25,000 shares <F2> 2,500 2,500 Premium 130 130 Total Non-Redeemable Cumulative Preferred Stock 6,130 6,130 Long-Term Debt: First Mortgage Bonds: 9 1/2% due 2004 (Series B) 9,000 10,500 10.35% due 2010 (Series C) 18,000 18,000 Variable Rate Demand Bonds Due 2014 <F2> 6,500 6,500 33,500 35,000 Less Portion Due Within One Year 1,500 1,500 Total Long-Term Debt 32,000 33,500 Total Capitalization $ 79,788 $ 77,722 <FN> <F1> Authorized, Issued and Outstanding. <F2> Weighted average interest rate was 3.6% for 1998 and 3.7% for 1997. </FN> The accompanying notes are an integral part of the financial statements. BLACKSTONE VALLEY ELECTRIC COMPANY NOTES TO FINANCIAL STATEMENTS December 31, 1998, 1997 and 1996 (A) Nature of Operations and Summary of Significant Accounting Policies: General: Blackstone Valley Electric Company (Blackstone or the Company) is principally engaged in the 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 Blackstone are subject to regulation by the Federal Energy Regulatory Commission (FERC) and the Rhode Island Public Utilities Commission (RIPUC) with respect to its rates and accounting. Blackstone conforms with generally accepted accounting principles, as applied in the case of regulated public utilities, and conforms with the accounting requirements and ratemaking practices of the RIPUC. A description of the significant accounting policies follows. Transactions with Affiliates: The Company is a wholly-owned subsidiary of EUA. In addition to its investment in the Company, EUA has interests in other retail and wholesale utility companies, a service corporation, and five other non- utility companies. Transactions between Blackstone and other affiliated companies include the following: purchased power costs billed by Montaup of approximately $80,505,000 in 1998, $90,276,000 in 1997, and $90,970,000 in 1996; accounting, engineering and other services rendered by EUA Service of approximately $13,254,000 in 1998, $12,608,000 in 1997, and $11,923,000 in 1996; and operating revenue from the rental of transmission facilities to Montaup of approximately $2,369,000 in 1998, $3,124,000 in 1997, and $2,501,000 in 1996. 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 were equivalent to a composite rate of approximately 4.2% in 1998 3.9%, in 1997 and 1996, based on the average depreciable property balances at the beginning and end of each year. (A) Nature of Operations and Summary of Significant Accounting Policies: (continued) Allowance for Funds Used During Construction (AFUDC): AFUDC represents the estimated cost of borrowed and equity funds used to finance the Company'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 rate used in calculating AFUDC was 7.1% in 1998 and 1997, and 9.4% in 1996. Operating Revenues: Revenues are based on billing rates authorized by the RIPUC. The Company follows the policy of accruing the estimated amount of unbilled base rate revenues for electricity provided at the end of each month to match costs and revenues more closely. In 1998, the Company began recording revenues in an amount management believes to be recoverable pursuant to provisions of approved settlement agreements and state legislation. Through 1997, the Company accrued the difference between fuel and purchased power costs incurred and fuel and purchased power costs billed to its customers. Income Taxes: The general policy of Blackstone with respect to accounting for federal and state 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 regulatory commissions. Blackstone has provided deferred income taxes on certain income and expense items that are accounted for in different periods for financial accounting purposes than for income tax purposes. Prior to 1987, AFUDC and certain costs for pensions, employee benefits and payroll-related insurances and payroll taxes applicable to construction activity, which were included in utility plant, were deducted for income tax purposes. Deferred taxes on these amounts and on certain differences created by the use of different depreciation methods in the years prior to 1981 have not been provided. The tax benefits on these items have been flowed through in accordance with approved rate orders of the RIPUC. As permitted by the regulatory commissions, it is the policy of the Company to defer recognition of annual investment tax credits and to amortize these credits over the productive lives of the related assets. Cash and Temporary Cash Investments: Blackstone considers all highly liquid investments and temporary cash investments with a maturity of three months or less when acquired to be cash equivalents. (A) Nature of Operations and Summary of Significant Accounting Policies: (continued) Other Assets: The components of Other Assets at December 31, 1998 and 1997 are detailed as follows: (In Thousands) 1998 1997 Regulatory Assets: Unamortized losses on reacquired debt $364 $ 394 Deferred SFAS 109 costs (Note B) 6,595 7,211 Deferred SFAS 106 costs (Note H) 581 727 Mendon Road Judgment (Note H) 6,154 6,154 Other regulatory assets 1,575 1,551 Total regulatory assets 15,269 16,037 Other deferred charges and assets: Unamortized debt expenses 536 587 Mendon Road Escrow (Note H) 7,408 7,065 Other 5,954 4,657 Total Other Assets $29,167 $28,346 Regulatory assets represent deferred costs for which future revenues are expected in accordance with regulators. These costs are expensed when the corresponding revenues are received in order to appropriately match revenues and expenses. Regulatory Accounting: Blackstone is 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. Blackstone believes that its operations continue to meet the criteria established in these accounting standards. (B) Income Taxes: Components of income and deferred tax expense for the years 1998, 1997, and 1996 are as follows: _________________________________________________________________________________ (In Thousands) 1998 1997 1996 Federal: Current $1,173 $5,202 $2,901 Deferred 2,172 (1,580) (531) Investment Tax Credit, Net (178) (181) (182) 3,167 3,441 2,188 State: Current 2 3 2 Deferred 76 (118) (34) 78 (115) (32) Charged to Operations 3,245 3,326 2,156 Charged to Other Income: Current (22) 143 40 Total $3,223 $3,469 $2,196 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) 1998 1997 1996 Federal Income Tax Computed at Statutory Rates $2,845 $3,190 $2,191 (Decreases) Increases in Tax from: Equity Component of AFUDC (17) Consolidated Tax Savings (32) Depreciation Differences 226 256 283 Amortization of ITC (178) (181) (182) State Taxes, Net of Federal Income Tax Benefit 51 (74) (21) Cost of Removal 284 285 Other (5) (7) (26) Total Income Tax Expense $3,223 $3,469 $2,196 (B) Income Taxes (continued) Blackstone 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 the 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. Total deferred tax assets and liabilities for 1998 and 1997 are comprised as follows: Deferred Tax Deferred Tax Assets Liabilities ($000) ($000) 1998 1997 1998 1997 Plant Related Plant Related Differences $14,017 $14,490 Differences $1,543 1,489 Deregulation 844 Employee Benefit Accruals 650 602 Refinancing Costs 127 138 Other 2,036 2,872 Employee Benefit Accruals 681 513 Other 1,845 1,719 Total $4,229 $4,963 Total $17,514 $16,860 Blackstone has recorded on its Balance Sheets as of December 31, 1998 and 1997 a regulatory liability to ratepayers of approximately $3.6 million and $3.4 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, 1998 and 1997, a regulatory asset of approximately $6.6 million and $7.2 million, respectively, has been recorded, representing the cumulative amount of federal income taxes on temporary depreciation differences which were previously flowed through to ratepayers. (C) Capital Stock: There were no changes in the number of shares of common or preferred stock during the years ended December 31, 1998, 1997, and 1996. In the event of involuntary liquidation, the holders of non-redeemable preferred stock of Blackstone are entitled to $100 per share plus accrued dividends. In the event of voluntary liquidation, or if redeemed at the option of the Company, each share of the non-redeemable preferred stock is entitled to accrued dividends and to: 4.25% issue, $104.40; 5.60% issue, $103.82. (C) Capital Stock (continued) Under the terms and provisions of the First Mortgage Indenture and of the issues of preferred stock of Blackstone, certain restrictions are placed upon the payment of dividends on common stock by the Company. At the years ended December 31, 1998 and 1997, the respective capitalization ratios were in excess of the minimum which would make these restrictions effective. (D) Retained Earnings: Under the provisions of Blackstone's First Mortgage Indenture, retained earnings in the amount of $9,551,081 were unrestricted as to the payment of cash dividends on its common stock at December 31, 1998. (E) Long-Term Debt: Blackstone's First Mortgage Bonds are collateralized by substantially all of its utility plant. Blackstone's Variable Rate Demand Bonds are collateralized by an irrevocable letter of credit which expires on January 21, 2000. The letter of credit permits extensions on an annual basis upon mutual agreement of the bank and Blackstone. The aggregate amount of Blackstone's cash sinking fund requirements and maturities for long-term debt for each of the five years following 1998 is $1.5 million in each of 1999 and 2000, and $3.3 million in each of 2001, 2002, and 2003. (F) Lines of Credit: In July 1997, several EUA System companies, including Blackstone, entered into a three-year revolving credit agreement allowing for borrowings in aggregate of up to $145 million from all sources of short-term credit. As of December 31, 1998, various financial institutions have committed up to $75 million under the revolving credit facility. In addition to the $75 million available under the revolving credit facility, EUA System companies maintain short-term lines of credit with various banks totaling $90 million for an aggregate amount available of $165 million. In accordance with the revolving credit agreement, commitment fees are required to maintain certain lines of credit. At December 31, 1998 under the revolving credit agreement, the EUA System had short-term borrowings available of approximately $101.4 million. Blackstone had zero short-term borrowings outstanding at December 31, 1998. During 1998, Blackstone's weighted average interest rate for short-term borrowings was 5.7%. (G) Fair Value of Financial Instruments: The following methods 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. Long-Term Debt: The fair value of the Company's long-term debt was based on quoted market prices for such securities. The estimated fair values of the Company's financial instruments at December 31, 1998 and 1997 were as follows (In Thousands): Carrying Amount Fair Value 1998 1997 1998 1997 Cash and Temporary Cash Investments $178 $408 $178 $408 Long-Term Debt $33,500 $35,000 $37,102 $36,363 (H) Commitments and Contingencies: Pensions: Blackstone participates with other EUA System companies in a non- contributory, defined benefit pension plan covering substantially all of their employees (Retirement Plan). Retirement Plan benefits are based on years of service and average compensation over the four years prior to retirement. It is the EUA System's policy to fund the Retirement Plan on a current basis in amounts determined to meet the funding standards established by the Employee Retirement Income Security Act of 1974. Total pension (income) expense for the Retirement Plan, including the amount related to the 1997 voluntary retirement incentive offer, for 1998, 1997 and 1996 included the following components ($ In Thousands): 1998 1997 1996 Service cost $639 $615 $616 Interest cost 2,457 2,361 2,264 Expected return on assets (3,820) (3,415) (3,122) Net amortization: Prior service cost 205 204 203 Net actuarial (gain) (93) (43) - Transition obligation (77) (77) (77) Total periodic pension (income) expense $(689) $(355) $(116) (H) Commitments and Contingencies (continued) Assumptions used to determine pension cost: Discount Rate 7.25% 7.50% 7.25% Compensation Increase Rate 4.25% 4.25% 4.25% Long-Term Return on Assets 9.50% 9.50% 9.50% The discount rate used to determine pension obligations, effective January 1, 1999 was changed from 7.25% to 6.75%. The projected benefit obligation, fair value of assets and funded status of the Retirement Plan cannot be presented separately for Blackstone as it participates in the Retirement Plan with other subsidiaries of EUA. The voluntary retirement incentive also resulted in approximately $281,000 of non-qualified pension benefits which were expensed in 1997. At December 31, 1998, approximately $160,000 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 years ended December 31, 1998, 1997 and 1996, Blackstone's portion of expenses related to the Supplemental Plans were approximately $220,000, $322,000, and $284,000, respectively. The Company also provides a defined contribution 401(k) savings plan for substantially all employees. The Company's matching percentage of employees' voluntary contributions to the plan, amounted to approximately $119,000 in 1998, $113,000 in 1997, and $111,000 in 1996. Post-Retirement Benefits: Retired employees are entitled to participate in health care and life insurance benefit plans. Health care benefits are subject to deductibles and other limitations. Health care and life insurance benefits are partially funded by Blackstone for all qualified employees. (H) Commitments and Contingencies (continued) The total cost of Post-Retirement Benefits other than Pensions, including the Company's allocated share of EUA Service Corporation costs and the amount related to the 1997 Voluntary Retirement Incentive offer, for 1998, 1997 and 1996 includes the following components ($ In Thousands): 1998 1997 1996 Service cost $209 $202 $216 Interest cost 1,074 1,050 1,060 Expected return on plan assets (350) (221) (133) Net Amortization: Net actuarial (gain) (185) (200) (147) Transition obligation 839 836 835 Net periodic post-retirement benefit cost 1,587 1,667 1,831 Voluntary retirement incentive 40 Total periodic post-retirement benefit costs $1,587 $1,707 $1,831 Assumptions: Discount rate 7.25% 7.50% 7.25% Health care cost trend rate-near-term 6.00% 7.00% 9.00% Health care cost trend rate-long-term 5.00% 5.00% 5.00% Compensation increase rate 4.25% 4.25% 4.25% Rate of return on plan assets 7.50% 7.75% 7.50% Reconciliation of Accumulated Post-Retirement Benefit Obligation (In Thousands) 1998 1997 Beginning of Year Benefit Obligation (January 1) $11,022 $11,002 Service Cost 86 86 Interest Cost 758 763 Participant Contributions 18 84 Actuarial Loss (Gain) 382 (351) Disbursements (659) (562) End of Year Benefit Obligation (December 31) $11,607 $11,022 Reconciliation of Fair Value Assets (In Thousands) 1998 1997 Beginning of Year Fair Value of Assets (January 1) $2,408 $1,573 Actual return on plan assets 393 154 Company contributions 1,159 1,159 Participant contributions 18 84 Disbursements (659) (562) End of Year Fair Value of Assets (December 31) $3,319 $ 2,408 (H) Commitments and Contingencies (continued) Reconciliation of Funded Status (In Thousands) 1998 1997 Accumulated post-retirement benefit obligation (APBO) $(11,607) $(11,022) Fair value of plan assets (FVA) 3,319 2,408 APBO (in excess of) less than FVA (Funded Status) (8,288) (8,614) Unrecognized net transition obligation (asset) 9,951 10,662 Unrecognized net actuarial loss/(gain) (5,513) (5,816) Net amount recognized $(3,850) $(3,768) Effect of 1% Change in Assumed Health Care Cost Trend Rate One-Percentage Point (In Thousands) Increase (Decrease) Effect on 1998 Service and $188 $(150) Interest Cost Components of Net-Periodic cost 1,430 (1,166) Effect on 1998 Accumulated Post-retirement Benefit Obligation The discount rate used to determine post-retirement benefit obligations, was changed from 7.25% to 6.75% effective January 1, 1999, and was used to calculate the funded status of Post-Retirement benefits at December 31, 1998. 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 public health and welfare and to the environment because of an actual or threatened release of hazardous substances. Due to the nature of Blackstone's business, various by-products and substances are produced or handled which are classified as hazardous under the rules and regulations promulgated by the EPA as well as state and local authorities. Blackstone 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. Blackstone has been notified with respect to a number of sites where it may be responsible for such costs, including sites where it may have joint and several liability with other responsible parties. It is the policy of Blackstone 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 carriers in these matters. On December 13, 1994, the United States District Court for the District of Massachusetts (District Court) issued a judgment against Blackstone, finding Blackstone liable to the Commonwealth of Massachusetts (Commonwealth) for the full amount of response costs incurred by the Commonwealth in the cleanup of a by-product of manufactured gas at a site on Mendon Road in Attleboro, Massachusetts. The judgment also found Blackstone liable for interest and litigation expenses calculated to the date of judgment. The total liability is approximately $5.9 million, including approximately $3.6 million in interest which has accumulated since 1985. Due to the uncertainty of the ultimate outcome of this proceeding and anticipated recoverability, Blackstone recorded the $5.9 million District Court judgment as a deferred debit. This amount is included with Other Assets on the Balance Sheet at December 31, 1998 and 1997. On January 20, 1995, Blackstone entered into an escrow agreement with the Commonwealth whereby Blackstone deposited $5.9 million with an escrow agent who transferred the funds into an interest bearing money market account. The distribution of the proceeds of the escrow account will be determined upon the final resolution of the judgment. No additional interest expense will accrue on the judgment amount. Blackstone appealed the District Court's judgment which was vacated by the First Circuit (Circuit Court) on October 6, 1995. The Circuit Court referred the matter to the EPA to determine whether the chemical substance, ferric ferrocyanide (FFC), contained within the by-product is a hazardous substance. If it were not, then Blackstone may not have to reimburse the Commonwealth for its clean up costs. Given the present posture of the case, Blackstone may not be liable to reimburse the Commonwealth for the Mendon Road cleanup costs if the EPA determines that FFC is not a hazardous substance. On January 9, 1997, Blackstone met with representatives of EPA and the Commonwealth to discuss the procedure EPA would follow in resolving the FFC issue. In January 1997, Blackstone submitted written comments which were followed by the Commonwealth's written reply in March 1997. Both parties submitted additional memoranda to EPA during remainder of the year. The EPA will now determine whether FFC is a hazardous substance. Further court proceedings are likely. On January 28, 1994, Blackstone filed a complaint in the Massachusetts District Court seeking, among other relief, contribution and reimbursement from Stone & Webster Inc. of New York City and several of its affiliated companies (Stone & Webster), and Valley Gas Company of Cumberland, Rhode Island (Valley) for any damages incurred by Blackstone regarding the Mendon Road site. On November 7, 1994, the Court denied motions to dismiss the complaint filed by Stone & Webster and Valley. This proceeding was stayed in December 1995 pending final EPA determination as to whether FFC is a hazardous substance. In addition, Blackstone has notified certain liability insurers and has filed claims with respect to the Mendon Road site, as well as other sites. Blackstone reached settlement with one carrier for reimbursement of legal costs related to the Mendon Road case. In January 1996, Blackstone received the proceeds of the settlement. As of December 31, 1998, Blackstone had incurred costs of approximately $7.7 million (excluding the $5.9 million Mendon Road judgment) in connection with the investigation and cleanup of these sites. These amounts have been financed primarily by internally generated cash. Blackstone is currently amortizing all of its incurred costs over a five-year period consistent with prior regulatory recovery periods and is recovering certain of those costs in rates. The Company estimates that additional costs of up to approximately $1.8 million (excluding the $5.9 million Mendon Road judgment) may be incurred at these sites through 1999 by it and the other responsible parties. Estimated amounts after 1999 are not now determinable since site studies, which are the basis of these estimates, have not been completed. As a result of the recoverability of cleanup costs in rates and the uncertainty regarding both its estimated liability, as well as potential contributions from insurance carriers and other responsible parties, Blackstone does not believe that the ultimate impact of the environmental costs will be material to its 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 wherever there is electricity. While some of the studies have indicated some association between exposure to EMF and health effects, many others have indicated no direct association. Some states have enacted regulations to limit the strength of EMF at the edge of transmission line rights-of-way. The Rhode Island legislature has enacted a statute which authorizes and directs the Rhode Island Energy Facility Siting Board to establish rules and regulations governing construction of high voltage transmission lines of 69 kv or more. In addition, an energy facility siting application, in Rhode Island must include, when applicable, any current independent scientific research pertaining to EMF exposure for review by the Board. Management cannot predict the impact, if any, that legislation or other developments concerning EMF may have on Blackstone. Other: Since early 1997, fourteen plaintiffs brought suit against numerous defendants, including EUA, for injuries and illness allegedly caused by exposure to asbestos over approximately a thirty-year period, at various premises, including some owned by EUA companies. The total damages claimed in all of these complaints is $34 million in compensatory and punitive damages, plus exemplary damages and interest and costs. Each complaint names between fifteen and twenty-eight defendants, including EUA. These complaints have been referred to the applicable insurance companies. Counsel has been retained by the insurers and is actively defending all cases. Four cases have been dismissed as against EUA companies. EUA cannot predict the ultimate outcome of this matter at this time. BLACKSTONE Quarterly Financial Information (unaudited) Operating Operating Net Net ($ in Thousands) Revenues Income Income Earnings For The Quarters Ended 1998: December 31 $33,049 $1,805 $ 940 $ 868 September 30 35,007 2,586 1,617 1,544 June 30 30,965 1,907 907 835 March 31 31,181 2,462 1,441 1,369 For The Quarters Ended 1997: December 31 $34,398 $2,770 $1,825 $1,753 September 30 37,179 2,196 1,113 1,040 June 30 34,150 2,074 1,011 939 March 31 34,531 2,512 1,697 1,625 Basic and Diluted Earnings per Average Common Share, Dividends Paid per Common Share and Common Share Market Price information is not meaningful as Blackstone's Common Stock is wholly-owned by Eastern Utilities Associates. Report of Independent Accountants To the Directors and Shareholder of Blackstone Valley Electric Company: In our opinion, the accompanying balance sheets and statements of capitalization present fairly, in all material respects, the financial position of Blackstone Valley Electric (the "Company") at December 31, 1998 and 1997, and its statements of income, retained earnings and cash flows present fairly its results of operations and cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, evidences supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Boston, Massachusetts March 5, 1999 [This page is left blank intentionally]