SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1994 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-898 (LOGO) THE NARRAGANSETT ELECTRIC COMPANY (Exact name of registrant as specified in charter) Rhode Island 05-0187805 (State or other (I.R.S. Employer jurisdiction of Identification No.) incorporation or organization) 280 Melrose Street, Providence, R.I. 02901 (Address of principal executive offices) Registrant's telephone number, including area code (401-941-1400) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Common stock, par value $50 per share, authorized and outstanding: 1,132,487 shares at September 30, 1994. PART I FINANCIAL INFORMATION Item 1. Financial Statements - ---------------------------- THE NARRAGANSETT ELECTRIC COMPANY Statements of Income Periods Ended September 30 (Unaudited) Quarter Nine Months ------- ----------- 1994 1993 1994 1993 ---- ---- ---- ---- (In Thousands) Operating revenue $137,014 $136,174 $366,275 $367,850 -------- -------- -------- -------- Operating expenses: Purchased electric energy, principally from New England Power Company, an affiliate84,859 89,381 228,436 237,380 Other operation 19,126 17,659 52,454 53,639 Maintenance 3,112 2,608 9,339 9,430 Depreciation 6,650 4,652 19,980 13,727 Taxes, other than federal income taxes 8,975 9,198 27,414 27,452 Federal income taxes 3,355 2,915 4,594 4,304 -------- -------- -------- -------- Total operating expenses 126,077 126,413 342,217 345,932 -------- -------- -------- -------- Operating income 10,937 9,761 24,058 21,918 Other income: Allowance for equity funds used during construction 343 139 961 294 Other income (expense) - net (194) 23 (1,246) (1,017) -------- -------- -------- -------- Operating and other income 11,086 9,923 23,773 21,195 -------- -------- -------- -------- Interest: Interest on long-term debt 3,675 3,261 10,489 9,454 Other interest 685 387 1,913 1,364 Allowance for borrowed funds used during construction - credit (504) (160) (1,160) (351) -------- -------- -------- -------- Total interest 3,856 3,488 11,242 10,467 -------- -------- -------- -------- Net income $ 7,230 $ 6,435 $ 12,531 $ 10,728 ======== ======== ======== ======== Statements of Retained Earnings Retained earnings at beginning of period$ 84,755 $ 74,326 $ 81,659 $ 74,207 Net income 7,230 6,435 12,531 10,728 Dividends declared on cumulative preferred stock (535) (619) (1,607) (1,396) Dividends declared on common stock (1,132) (566) (2,265) (3,963) Premium on redemption of preferred stock (361) (361) -------- -------- -------- -------- Retained earnings at end of period $ 90,318 $ 79,215 $ 90,318 $ 79,215 ======== ======== ======== ======== The accompanying notes are an integral part of these financial statements. Per share data is not relevant because the Company's common stock is wholly owned by New England Electric System. THE NARRAGANSETT ELECTRIC COMPANY Statements of Income Twelve Months Ended September 30 (Unaudited) 1994 1993 ---- ---- (In Thousands) Operating revenue $481,453 $484,787 -------- -------- Operating expenses: Purchased electric energy, principally from New England Power Company, an affiliate 301,952 310,343 Other operation 72,537 71,214 Maintenance 12,088 12,294 Depreciation 23,898 18,906 Taxes, other than federal income taxes 35,808 35,955 Federal income taxes 4,465 5,968 -------- -------- Total operating expenses 450,748 454,680 -------- -------- Operating income 30,705 30,107 Other income: Allowance for equity funds used during construction 1,210 303 Other income (expense) - net (863) (902) -------- -------- Operating and other income 31,052 29,508 -------- -------- Interest: Interest on long-term debt 13,751 12,728 Other interest 2,623 1,687 Allowance for borrowed funds used during construction - credit (1,399) (469) -------- -------- Total interest 14,975 13,946 -------- -------- Net income $ 16,077 $ 15,562 ======== ======== Statements of Retained Earnings Retained earnings at beginning of period $ 79,215 $ 71,460 Net income 16,077 15,562 Dividends declared on cumulative preferred stock (2,143) (1,784) Dividends declared on common stock (2,831) (5,662) Premium on redemption of preferred stock (361) -------- -------- Retained earnings at end of period $ 90,318 $ 79,215 ======== ======== The accompanying notes are an integral part of these financial statements. Per share data is not relevant because the Company's common stock is wholly owned by New England Electric System. THE NARRAGANSETT ELECTRIC COMPANY Balance Sheets (Unaudited) September 30, December 31, ASSETS 1994 1993 ------ ---- ---- (In Thousands) Utility plant, at original cost $596,058 $534,569 Less accumulated provisions for depreciation 163,077 156,652 -------- -------- 432,981 377,917 Construction work in progress 37,520 43,660 -------- -------- Net utility plant 470,501 421,577 -------- -------- Current assets: Cash 328 838 Accounts receivable: From sales of electric energy 50,549 55,795 Other (including $6,941,000 and $1,087,000 from affiliates) 22,462 11,701 Less reserves for doubtful accounts 4,377 3,800 -------- -------- 68,634 63,696 Unbilled revenues 13,175 Fuel, materials and supplies, at average cost 6,331 4,572 Prepaid and other current assets 12,232 11,515 -------- -------- Total current assets 100,700 80,621 -------- -------- Deferred charges and other assets 55,381 53,709 -------- -------- $626,582 $555,907 ======== ======== CAPITALIZATION AND LIABILITIES ------------------------------ Capitalization: Common stock, par value $50 per share, authorized and outstanding 1,132,487 shares $ 56,624 $ 56,624 Premiums on preferred stocks 170 170 Other paid-in capital 45,000 45,000 Retained earnings 90,318 81,659 -------- -------- Total common equity 192,112 183,453 Cumulative preferred stock 36,500 36,500 Long-term debt 178,893 155,972 -------- -------- Total capitalization 407,505 375,925 -------- -------- Current liabilities: Short-term debt (including $23,625,000 and $19,725,000 to affiliates) 33,625 19,725 Accounts payable (including $48,903,000 and $43,468,000 to affiliates) 55,708 51,005 Accrued liabilities: Taxes 1,979 1,712 Interest 3,134 4,921 Other accrued expenses 29,520 11,798 Customer deposits 5,524 5,622 Dividends payable 1,668 1,102 -------- -------- Total current liabilities 131,158 95,885 -------- -------- Deferred federal income taxes 67,013 63,494 Unamortized investment tax credits 8,645 9,026 Other reserves and deferred credits 12,261 11,577 -------- -------- $626,582 $555,907 ======== ======== The accompanying notes are an integral part of these financial statements. THE NARRAGANSETT ELECTRIC COMPANY Statements of Cash Flows Nine Months Ended September 30 (Unaudited) 1994 1993 ---- ---- (In Thousands) Operating Activities: Net income $ 12,531 $ 10,728 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 19,980 13,727 Deferred federal income taxes and investment tax credit - net 1,198 1,562 Allowance for funds used during construction (2,121) (645) Amortization of unbilled revenues 4,105 Early retirement program 2,705 Decrease (increase) in accounts receivable, net, and unbilled revenues (18,113) (7,863) Decrease (increase) in fuel, materials, and supplies (1,759) 606 Increase (decrease) in accounts payable 4,703 3,145 Increase (decrease) in other current liabilities 11,999 (1,367) Other, net 998 (2,455) -------- -------- Net cash provided by operating activities $ 33,521 $ 20,143 -------- -------- Investing Activities: Plant expenditures, excluding allowance for funds used during construction $(66,725) $(45,398) Other investing activities (900) -------- -------- Net cash used in investing activities $(67,625) $(45,398) -------- -------- Financing Activities: Dividends paid on common stock $ (1,699) $ (5,095) Dividends paid on preferred stock (1,607) (1,233) Preferred stock - issues 20,000 Preferred stock - retirements (10,000) Premium on redemption of preferred stock (361) Long-term debt - issues 23,000 27,500 Long-term debt - retirements (14,900) Premium on reacquisition of long-term debt (652) Changes in short-term debt 13,900 10,700 -------- -------- Net cash provided by financing activities $ 33,594 $ 25,959 -------- -------- Net increase (decrease) in cash and cash equivalents $ (510) $ 704 Cash and cash equivalents at beginning of period 838 830 -------- -------- Cash and cash equivalents at end of period $ 328 $ 1,534 ======== ======== Supplementary Information: Interest paid less amounts capitalized $ 12,286 $ 11,122 -------- -------- Federal income taxes paid $ 703 $ 2,934 -------- -------- The accompanying notes are an integral part of these financial statements. Note A - ------ A 1986 Rhode Island Supreme Court decision held that the Rhode Island Public Utilities Commission's (RIPUC) rate-making powers include the authority to order refunds of amounts earned in excess of an allowed return. As a result, the RIPUC monitors the Company's earnings on a continuous basis. Note B - Hazardous Waste - ------------------------ The Federal Comprehensive Environmental Response, Compensation and Liability Act, more commonly known as the "Superfund" law, imposes strict, joint and several liability, regardless of fault, for remediation of property contaminated with hazardous substances. Parties liable include past and present site owners and operators, transporters that brought wastes to the site, and entities that generated or arranged for disposal or treatment of wastes ultimately disposed of at the site. The electric utility industry typically utilizes and/or generates in its operations a range of potentially hazardous products and by-products. These products or by-products may not have previously been considered hazardous, and may not currently be considered hazardous, but may be identified as such by federal, state, or local authorities in the future. The New England Electric System (NEES) subsidiaries currently have in place an environmental audit program intended to enhance compliance with existing federal, state, and local requirements regarding the handling of potentially hazardous products and by-products. Federal and state environmental agencies have contacted the Company regarding liability for cleanup of sites alleged to contain hazardous waste or substances. The Company has been named as a potentially responsible party (PRP) by either the U.S. Environmental Protection Agency or the Massachusetts Department of Environmental Protection at two sites (one of which is located in Massachusetts) at which hazardous waste is alleged to have been disposed. The Company is also aware of other sites for which it may be held responsible for remediating and it is likely that, in the future, the Company will become involved in additional proceedings demanding contribution for the cost of remediating additional hazardous waste sites. Gas was manufactured from coal in Rhode Island in the past. The Company is aware of five sites on which gas was manufactured or manufactured gas was stored that were owned either by the Company Note B - Hazardous Waste - Continued - ------------------------ or by its predecessor companies. It is not known to what extent the Company would be held liable for hazardous wastes, if any, left at these manufactured gas locations. There are significant uncertainties as to the potential costs to investigate and, when necessary, remediate any given hazardous waste site. Factors such as the evolving nature of remediation technology and regulatory requirements and the particular characteristics of each site, including, for example, the size of the site, the nature and amount of waste disposed at the site, and the surrounding geography and land use, make precise estimates difficult. A preliminary review by a consultant hired by the NEES companies of the potential cost of investigating and, if necessary, remediating Rhode Island manufactured gas sites resulted in costs per site ranging from less than $1 million to $8 million. An informal survey of other utilities conducted on behalf of NEES and its subsidiaries indicated costs in a similar range. There are also significant uncertainties as to the portion, if any, of the investigation and remediation costs of any particular hazardous waste site that may ultimately be borne by the Company. The Company believes that hazardous waste liabilities for all sites of which it is aware will not be material (10 percent of common equity) to its financial position. Where appropriate, the Company intends to seek recovery from its insurers and from other PRPs, but it is uncertain whether, and to what extent, such efforts will be successful. Note C - ------ In the opinion of the Company, these statements reflect all adjustments (which include normal recurring adjustments) necessary for a fair statement of the results of its operations for the periods presented and should be considered in conjunction with the notes to the financial statements in the Company's 1993 Annual Report. Item 2. Management's Discussion and Analysis of Financial --------------------------------------------------------- Condition and Results of Operations ----------------------------------- Earnings - -------- Net income for the third quarter and first nine months of 1994 increased by $1 million and $2 million, respectively, as compared to the same periods last year. The increase in earnings for the quarter reflects increased kilowatthour (KWH) sales billed to ultimate customers and the commencement of recognition of revenue for electricity delivered but not yet billed (unbilled revenue) pursuant to a rate agreement (see Rate Activity section). The increase in KWH sales reflects weather conditions and an improving economy. Earnings in the first nine months of 1993 included a one-time charge of $3 million after tax ($5 million before tax) associated with an early retirement offer and special severance program. Excluding the effect of this 1993 charge, earnings for the first nine months of 1994 decreased by $1 million as compared to the corresponding periods last year. This decrease is primarily due to increases in other operation expenses, partially offset by the net increase in third quarter earnings. Rate Activity - ------------- In July 1994, the Rhode Island Public Utilities Commission (RIPUC) approved a rate agreement between the Company and the Rhode Island Division of Public Utilities and Carriers that provides for a 5 percent base rate discount, excluding fuel costs, for the Company's large commercial and industrial customers who sign an agreement to give a five year notice to the Company before they purchase power from another supplier or generate any additional power themselves. The notice provision may be reduced from five to three years under certain conditions. The amount of the discount, if all eligible customers sign agreements, is approximately $4 million per year. Customers representing approximately 63 percent of all eligible revenues have signed agreements. The agreement also provides for the Company to recognize unbilled revenues for accounting purposes. Unbilled revenues at December 31, 1993 of approximately $14 million are being amortized to income over a twenty-one month period beginning April 1994 through December 1995. In addition, the Company now recognizes seasonal fluctuations in unbilled revenues on a quarterly basis. The Company began recording the effects of this rate agreement in the third quarter of 1994. Effective March 1993, the RIPUC approved a new purchased power cost adjustment mechanism for the recovery of all of the Company's purchased power costs, excluding fuel and oil conservation adjustment charges which continue to be recovered through separate adjustment mechanisms. Under the new mechanism any over or under- collections of purchased power expense will ultimately be passed on to customers including the effects of peak-demand billing fluctuations. The Company accrues the effects of this new mechanism on its books on a current basis. In August 1994, the RIPUC gave notice that it intends to open a proceeding to consider the effect of fuel adjustment clauses on utility incentives to reduce costs. Effective January 1993, the RIPUC approved a $1.5 million increase in rates for the Company, representing the first step of a three year phase-in of the Company's recovery of costs associated with postretirement benefits other than pensions (PBOPs). A second $1.5 million increase took effect January 1994 and the third and final step increase is anticipated to go into effect in January 1995. A 1986 Rhode Island Supreme Court decision held that the RIPUC's rate-making powers include the authority to order refunds of amounts earned in excess of an allowed return. As a result, the RIPUC monitors the Company's earnings on a continuous basis. Demand-Side Management Programs - ------------------------------- The Company files its conservation and load management program, also referred to in the industry as demand-side management (DSM) program, regularly with the RIPUC and has received approval to recover in rates estimated DSM expenditures on a current basis. The rates provide for reconciling estimated expenditures to actual DSM expenditures, with interest. Expenditures subject to the reconciliation mechanism were $5.6 million in the first nine months of 1994 and $12 million for the full year 1993. Since 1990, the Company has been allowed to earn incentives based on the results of its DSM program. Before incentives are recorded, the Company must be able to demonstrate to the RIPUC the electricity savings produced by its DSM program. The Company recorded $0.5 million of before-tax incentives in 1993. No incentives were recorded during the first nine months of 1994. The Company has received orders from the RIPUC that will give it the opportunity to continue to earn incentives based on 1994 DSM program results. Operating Revenue - ----------------- Operating revenue for the nine months ended September 30, 1994 decreased by $2 million from the corresponding period in 1993. The following table summarizes the changes in operating revenue: Increase (Decrease) in Operating Revenue Third Quarter Nine Months ------------- ------------ 1994 vs 1993 1994 vs 1993 ------------- ------------ (In Millions) Fuel recovery $(2) $(4) DSM recovery - (2) Service extension discounts (1) (1) Unbilled revenues recognized under rate agreement 4 4 Seasonal fluctuation in accrued unbilled revenue (1) (1) Sales increase and other 1 2 --- --- $ 1 $(2) === === KWH sales billed to ultimate customers in the third quarter and first nine months of 1994 increased by 1.8 and 1.2 percent, respectively, as compared to the corresponding prior periods. This increase in KWH sales is primarily due to weather conditions and an improving economy, partially offset by a loss of sales attributable to the May 1994 plant closing of one of the Company's largest customers. Revenues from this customer, excluding fuel and purchased power costs, were approximately $1.4 million on an annual basis. In spite of the loss of a large customer, KWH sales are expected to increase approximately 1 percent over 1993. In addition, there was one less billing day due to meter reading schedules in the first nine months of 1994 compared to 1993. General rate changes reflect rate discounts recorded in the third quarter to large commercial and industrial customers retroactive to May 15, 1994, in connection with the Company's recently implemented rate agreement. For a discussion of unbilled revenues see the Rate Activity section. Operating Expenses - ------------------ The following table summarizes the changes in total operating expenses discussed below: Increase (Decrease) in Operating Expenses Third Quarter Nine Months ------------- ------------ 1994 vs 1993 1994 vs 1993 ------------- ------------ (In Millions) Purchased electric energy: Fuel costs $(2) $(4) Integrated facilities credits from NEP (2) (6) Purchases and demand charges from NEP - 1 Other operation and maintenance: DSM - (2) Other 2 1 Depreciation 2 6 --- --- $ - $(4) === === The entire output of the Company's generating capacity has in the past, and continues to be made available to New England Power Company (NEP). The Company receives a credit on its purchased power bill from NEP for its fuel costs and other generation and transmission costs. The change in the above table reflects increased credits for dismantlement costs being incurred on the Company's previously retired South Street generating facility. The increase in other operation and maintenance expense in the third quarter and first nine months of 1994 is primarily due to increased computer system development costs, increased retiree benefit costs, increased workers' compensation claims, and general increases in other areas. The increase for the nine month period was partially offset by a one-time charge of $5 million recorded in the first quarter of 1993 associated with an early retirement offer and special severance program implemented in 1993. The increase in depreciation expense in the third quarter and first nine months of 1994 reflects increased charges for dismantlement costs for the previously retired South Street generating station. Allowance For Funds Used During Construction (AFDC) - --------------------------------------------------- AFDC increased for the third quarter and first nine months of 1994 due to increased construction work in progress, principally associated with the repowering of the Manchester Street Station (see Repowering of Manchester Street Station section). Hazardous Waste - --------------- The Federal Comprehensive Environmental Response, Compensation and Liability Act, more commonly known as the "Superfund" law, imposes strict, joint and several liability, regardless of fault, for remediation of property contaminated with hazardous substances. Parties liable include past and present site owners and operators, transporters that brought wastes to the site, and entities that generated or arranged for disposal or treatment of wastes ultimately disposed of at the site. The electric utility industry typically utilizes and/or generates in its operations a range of potentially hazardous products and by-products. These products or by-products may not have previously been considered hazardous, and may not currently be considered hazardous, but may be identified as such by federal, state, or local authorities in the future. The New England Electric System (NEES) subsidiaries currently have in place an environmental audit program intended to enhance compliance with existing federal, state, and local requirements regarding the handling of potentially hazardous products and by-products. Federal and state environmental agencies have contacted the Company regarding liability for cleanup of sites alleged to contain hazardous waste or substances. The Company has been named as a potentially responsible party (PRP) by either the U.S. Environmental Protection Agency (EPA) or the Massachusetts Department of Environmental Protection at two sites (one of which is located in Massachusetts) at which hazardous waste is alleged to have been disposed. The Company is also aware of other sites for which it may be held responsible for remediating and it is likely that, in the future, the Company will become involved in additional proceedings demanding contribution for the cost of remediating additional hazardous waste sites. Gas was manufactured from coal in Rhode Island in the past. The Company is aware of five sites on which gas was manufactured or manufactured gas was stored that were owned either by the Company or by its predecessor companies. It is not known to what extent the Company would be held liable for hazardous wastes, if any, left at these manufactured gas locations. There are significant uncertainties as to the potential costs to investigate and, when necessary, remediate any given hazardous waste site. Factors such as the evolving nature of remediation technology and regulatory requirements and the particular characteristics of each site, including, for example, the size of the site, the nature and amount of waste disposed at the site, and the surrounding geography and land use, make precise estimates difficult. A preliminary review by a consultant hired by the NEES companies of the potential cost of investigating and, if necessary, remediating Rhode Island manufactured gas sites resulted in costs per site ranging from less than $1 million to $8 million. An informal survey of other utilities conducted on behalf of NEES and its subsidiaries indicated costs in a similar range. There are also significant uncertainties as to the portion, if any, of the investigation and remediation costs of any particular hazardous waste site that may ultimately be borne by the Company. The Company believes that hazardous waste liabilities for all sites of which it is aware will not be material (10 percent of common equity) to its financial position. Where appropriate, the Company intends to seek recovery from its insurers and from other PRPs, but it is uncertain whether, and to what extent, such efforts will be successful. Electric and Magnetic Fields (EMF) - --------------------------------- In recent years, concerns have been raised about whether EMF, which occur near transmission and distribution lines as well as near household wiring and appliances, cause or contribute to adverse health effects. Numerous studies on the effects of these fields, some of them sponsored by electric utilities (including NEES companies), have been conducted and are continuing. Some of the studies have suggested associations between certain EMF and various types of cancer, while other studies have not substantiated such associations. In February 1993, the EPA called for significant additional research on EMF. In July 1994, a study by a University of Southern California professor suggested an association between EMF and Alzheimer's disease. It is impossible to predict the ultimate impact on the Company and the electric utility industry if further investigations were to demonstrate that the present electricity delivery system is contributing to increased risk of cancer or other health problems. Many utilities, including the NEES companies, have been contacted by customers regarding a potential relationship between EMF and adverse health effects. To date, no court in the United States has ruled that EMF from electrical facilities cause adverse health effects and no utility has been found liable for personal injuries alleged to have been caused by EMF. In any event, the NEES companies believe that they have adequate insurance coverage. Several state courts have recognized a cause of action for damage to property values in transmission line condemnation cases based on the fear that power lines cause cancer. It is difficult to predict what impact there would be on the Company if this cause of action is recognized in Rhode Island and in contexts other than condemnation cases. A lawsuit concerning the proposed expansion of a transmission line was filed on April 28, 1994 against the Company, NEES, and New England Power Service Company (NEPSCo), in the Superior Court of Rhode Island by certain residents of property which borders existing transmission lines in East Greenwich, Rhode Island. The plaintiffs alleged that fear of health risks from exposure to high voltage power lines had devalued their property and ask for unspecified damages. All claims in this case relating to damages from existing lines were dismissed with prejudice. The Company has been informed that another resident is contemplating a similar suit. The Company recently received approval from the Rhode Island Energy Facility Siting Board to construct a new line and relocate an existing line on the existing right of way. Bills had been introduced in the Rhode Island legislature to require that transmission lines be placed underground. In July 1993, two bills passed by the legislature restricting the construction of overhead transmission lines were vetoed by the governor. A similar bill was introduced in 1994 and was rejected by the legislature. Competitive Conditions - ---------------------- The electric utility business is being subjected to increasing competitive pressures, stemming from a combination of trends, including increasing electric rates, improved technologies, and new regulations and legislation intended to foster competition. To date, this competition has been most prominent in the bulk power market in which non-utility generating sources have noticeably increased their market share. This change indirectly affects the Company as it purchases all of its energy requirements from NEP. Electric utilities are also facing increased competition in the retail market. Currently, retail competition comes primarily from alternative fuel suppliers (including natural gas companies) for heating and cooling, customer-owned generation to displace purchases from electric utilities, and direct competition among electric utilities to attract major new manufacturing facilities to their service territories. Some state regulatory agencies, other entities, and individuals have developed proposals under which electric utilities and non-utility generators may sell electricity to retail customers of other electric utilities without regard to franchised service territories. For example, the California Public Utilities Commission recently announced a proposal that would give certain large retail customers, by the year 1996, and all other retail customers, by the year 2002, the option of selecting their electricity provider. Power purchased from another provider would still be delivered over the local utility's transmission network which, under the proposal, would be subject to broader access. Other states (including several New England states), federal agencies regulating the NEES companies, and state and federal legislative bodies have considered or are in the process of considering options to foster increased competition. The NEES companies are responding to current and anticipated competitive pressures in a variety of other ways, including cost control and a corporate reorganization into separate retail and wholesale business units. The retail business unit's response to competition includes the development of comprehensive value-added services customized to customers' needs and the offering of economic development rates to encourage businesses to locate in the Company's service territory. In addition, pursuant to its recent rate agreement approved by the RIPUC, the Company is offering a discount from base rates in return for a contract requiring the customer to provide five years written notice before purchasing electricity from others or generating any additional electricity for the customer's own use (the notice provision may be reduced from five to three years under certain conditions). The discount is available to customers with average monthly peak demands over 200 kilowatts. Customers representing approximately 63 percent of all eligible revenues have signed agreements. Since a large part of the Company's costs represent the cost of power purchased from NEP, its competitive position is affected by NEP's ability to control costs. NEP is controlling costs and positioning itself for increased competition through such means as terminating certain purchased power and gas pipeline contracts, shutdowns of uneconomic generating stations, and rapid amortization of certain plant assets. Observers of the electric utility business have recommended various (and sometimes conflicting) strategies for electric utilities to deal with these competitive pressures. These suggestions include business combinations with other companies, restructurings involving separation or sales of portions of the retail and/or wholesale businesses, and diversification into unrelated businesses. For example, the NEES companies have proposed one possible framework for increasing customer choice of suppliers and achieving environmental goals, while preserving shareholder value. This increase in customer choice could decrease the value of generation related assets and purchased power contracts. However, the replacement value of transmission assets likely far exceeds their historic cost. The NEES companies have suggested that utilities should have the ability to offset this decrease in the value of generation related assets by realizing the higher value of transmission assets. As one part of this possible framework, the NEES companies have stated that, in order to accomplish this realization, they would be willing to consider selling their transmission system at replacement cost to entities not in the generation business. This sale would facilitate the transition to a fully competitive generating market. As part of their routine long-term planning process, the NEES companies may, from time to time, be engaged in analysis, either internally or with third parties, of these and other strategies. The Federal Energy Regulatory Commission (FERC) ruled in 1992, in a proceeding not involving NEES subsidiaries, that a utility may recover from a wholesale requirements customer, any legitimate, prudent, and verifiable costs that the utility had incurred based on a reasonable expectation that it would continue to sell requirements service to the customer. The FERC has referred to such costs as "stranded costs". On appeal, the United States Court of Appeals for the District of Columbia Circuit has questioned whether allowing utilities to recover stranded costs is anti- competitive and the Court remanded the case back to the FERC for further proceedings and development of the competitive issues. In a separate development, the FERC issued a notice of proposed rule- making on the recovery of investment costs stranded as a result of increased competition. Electric utility rates are generally based on a utility's costs. Therefore, electric utilities are subject to certain accounting standards that are not applicable to other business enterprises in general. These accounting rules require regulated entities, in appropriate circumstances, to establish regulatory assets and liabilities, which defer the income statement impact of certain costs that are expected to be recovered in future rates. The effects of competition could ultimately cause the operations of the Company, or a portion thereof, to cease meeting the criteria for application of these accounting rules. While the Company does not expect to cease meeting these criteria in the near future, if this were to occur, accounting standards of enterprises in general would apply and immediate recognition of any previously deferred costs would be necessary in the year in which these criteria were no longer applicable. In addition, if, because of competition, utilities are unable to recover all of their costs in rates, it may be necessary to write off those costs that are not recoverable. Utility Plant Expenditures and Financing - ---------------------------------------- Cash expenditures for utility plant totaled $67 million in the first nine months of 1994, including $28 million related to the Manchester Street Station Repowering Project. The funds necessary for utility plant expenditures were primarily provided by net cash from operating activities, after the payment of dividends and the proceeds of long-term and short-term debt issues. The Company issued $23 million of bonds during the first nine months of 1994, bearing interest rates ranging from 6.91 to 8.16 percent. In addition, the Company issued $10 million of long-term debt in November 1994 at an interest rate of 8.33 percent and plans to issue an additional $7 million of long-term debt by the end of 1994 or early 1995. At September 30, 1994, the Company had $34 million of short- term debt outstanding of which $24 million was to affiliates. The Company currently has lines of credit with banks totaling $41 million. Outstanding borrowings under these lines of credit at September 30, 1994 were $10 million. For the twelve-month period ending September 30, 1994, the ratio of earnings to fixed charges was 2.24. Repowering of Manchester Street Station - --------------------------------------- The Company's major construction project is the repowering of Manchester Street Station, a 140 megawatt electric generating station in Providence, Rhode Island which is jointly owned by the Company (10 percent) and NEP (90 percent). Repowering will more than triple the power generation capacity of Manchester Street Station and substantially increase the plant's thermal efficiency. The total cost for the generating station, scheduled for completion in late 1995, is estimated to be approximately $525 million, including AFDC. In addition, related transmission work was estimated to cost $75 million. At September 30, 1994, a total of $310 million, including AFDC, had been spent on the project including the related transmission work ($63 million by the Company). The transmission facilities were in service at September 30, 1994, although all costs related to such work had not yet been incurred. Substantial commitments have been made relative to future planned expenditures for this project. PART II. OTHER INFORMATION Item 1. Legal Proceedings - -------------------------- Information concerning dismissal of a lawsuit filed against the Company on October 28, 1994, by residents of property which borders the Company's existing transmission lines in East Greenwich, Rhode Island, discussed in Part I of this report in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference and made a part hereof. Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- The Company is filing the following revised exhibit for incorporation by reference into its registration statements on Form S-3, Commission File Nos. 33-49455 and 33-50015: 12 Statement re computation of ratios The Company is filing Financial Data Schedules. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q for the quarter ended September 30, 1994 to be signed on its behalf by the undersigned thereunto duly authorized. THE NARRAGANSETT ELECTRIC COMPANY s/ Howard W. McDowell Howard W. McDowell Controller, Authorized Officer, and Principal Accounting Officer Date: November 10, 1994