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 June 30, 1997 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-7471 (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 (401-784-7000) 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 June 30, 1997. PART I FINANCIAL INFORMATION Item 1. Financial Statements - ---------------------------- THE NARRAGANSETT ELECTRIC COMPANY Statements of Income Periods Ended June 30 (Unaudited) Quarter Six Months -------- ---------- 1997 1996 1997 1996 ---- ---- ---- ---- (In Thousands) Operating revenue $119,894 $116,470 $251,360 $243,755 -------- -------- -------- -------- Operating expenses: Fuel for generation and purchased electric energy (principally from New England Power Company, an affiliate) 72,271 68,779 149,444 142,468 Other operation 17,477 18,156 35,303 35,259 Maintenance 3,032 2,967 5,747 6,954 Depreciation 5,599 7,220 11,703 14,357 Taxes, other than federal income taxes 9,205 9,972 19,473 20,053 Federal income taxes 2,491 1,131 6,468 4,133 -------- -------- -------- -------- Total operating expenses 110,075 108,225 228,138 223,224 -------- -------- -------- -------- Operating income 9,819 8,245 23,222 20,531 Other income: Other income (expense), net (127) (125) (1,183) (1,234) -------- -------- -------- -------- Operating and other income 9,692 8,120 22,039 19,297 -------- -------- -------- -------- Interest: Interest on long-term debt 4,190 4,304 8,495 8,596 Other interest 431 830 824 1,514 Allowance for borrowed funds used during construction - credit (14) (131) (58) (220) -------- -------- -------- -------- Total interest 4,607 5,003 9,261 9,890 -------- -------- -------- -------- Net income $ 5,085 $ 3,117 $ 12,778 $ 9,407 ======== ======== ======== ======== Statements of Retained Earnings Retained earnings at beginning of period $123,738 $111,716 $119,978 $108,227 Net income 5,085 3,117 12,778 9,407 Dividends declared on cumulative preferred stock (536) (536) (1,072) (1,072) Dividends declared on common stock (5,663) (3,114) (9,060) (5,379) -------- -------- -------- -------- Retained earnings at end of period $122,624 $111,183 $122,624 $111,183 ======== ======== ======== ======== 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 June 30 (Unaudited) 1997 1996 ---- ---- (In Thousands) Operating revenue $511,190 $501,422 -------- -------- Operating expenses: Fuel for generation and purchased electric energy (principally from New England Power Company, an affiliate) 304,036 291,225 Other operation 71,669 74,535 Maintenance 11,802 13,076 Depreciation 25,245 30,877 Taxes, other than federal income taxes 37,950 37,794 Federal income taxes 14,286 10,905 -------- -------- Total operating expenses 464,988 458,412 -------- -------- Operating income 46,202 43,010 Other income: Allowance for equity funds used during construction (322) Other income (expense), net (681) (960) -------- -------- Operating and other income 45,521 41,728 -------- -------- Interest: Interest on long-term debt 17,104 17,153 Other interest 2,193 3,515 Allowance for borrowed funds used during construction - credit (101) (1,433) -------- -------- Total interest 19,196 19,235 -------- -------- Net income $ 26,325 $ 22,493 ======== ======== Statements of Retained Earnings Retained earnings at beginning of period $111,183 $ 97,345 Net income 26,325 22,493 Dividends declared on cumulative preferred stock (2,143) (2,143) Dividends declared on common stock (12,741) (6,512) -------- -------- Retained earnings at end of period $122,624 $111,183 ======== ======== 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) June 30, December 31, ASSETS 1997 1996 ------ ---- ---- (In Thousands) Utility plant, at original cost $750,188 $742,481 Less accumulated provisions for depreciation 193,273 187,690 -------- -------- 556,915 554,791 Construction work in progress 6,836 5,392 -------- -------- Net utility plant 563,751 560,183 -------- -------- Current assets: Cash 1,385 1,727 Accounts receivable: From sales of electric energy 50,351 54,426 Other (including $1,296,000 and $1,253,000 from affiliates) 2,684 3,415 Less reserves for doubtful accounts 5,884 5,149 -------- -------- 47,151 52,692 Unbilled revenues 16,200 15,300 Fuel, materials and supplies, at average cost 4,208 4,300 Prepaid and other current assets 16,551 15,919 -------- -------- Total current assets 85,495 89,938 -------- -------- Deferred charges and other assets 54,672 56,881 -------- -------- $703,918 $707,002 ======== ======== 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 80,000 80,000 Retained earnings 122,624 119,978 -------- -------- Total common equity 259,418 256,772 Cumulative preferred stock 36,500 36,500 Long-term debt 173,574 178,517 -------- -------- Total capitalization 469,492 471,789 -------- -------- Current liabilities: Long-term debt due in one year 12,500 32,500 Short-term debt (including $5,725,000 and $5,300,000 to affiliates) 24,900 19,025 Accounts payable (including $47,929,000 and $40,425,000 to affiliates) 51,729 45,221 Accrued liabilities: Taxes 4,788 3,877 Interest 4,919 5,677 Other accrued expenses 18,521 11,949 Customer deposits 5,783 5,638 Dividends payable 6,198 2,801 -------- -------- Total current liabilities 129,338 126,688 -------- -------- Deferred federal income taxes 81,191 81,880 Unamortized investment tax credits 7,270 7,517 Other reserves and deferred credits 16,627 19,128 -------- -------- $703,918 $707,002 ======== ======== The accompanying notes are an integral part of these financial statements. THE NARRAGANSETT ELECTRIC COMPANY Statements of Cash Flows Six Months Ended June 30 (Unaudited) 1997 1996 ---- ---- (In Thousands) Operating Activities: Net income $ 12,778 $ 9,407 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 11,703 14,357 Deferred federal income taxes and investment tax credits, net (1,259) 165 Allowance for funds used during construction (58) (220) Decrease (increase) in accounts receivable, net and unbilled revenues 4,641 11,135 Decrease (increase) in fuel, materials, and supplies 92 162 Decrease (increase) in prepaid and other current assets (632) (1,107) Increase (decrease) in accounts payable 6,508 2,661 Increase (decrease) in other current liabilities 6,870 459 Other, net 260 500 -------- -------- Net cash provided by operating activities $ 40,903 $ 37,519 -------- -------- Investing Activities: Plant expenditures, excluding allowance for funds used during construction $(15,239) $(29,196) Other investing activities (146) -------- -------- Net cash used in investing activities $(15,385) $(29,196) -------- -------- Financing Activities: Dividends paid on common stock $ (5,663) $ (2,831) Dividends paid on preferred stock (1,072) (1,072) Long-term debt - issues 2,000 Long-term debt - retirements (25,000) (2,000) Changes in short-term debt 5,875 (5,300) Premium on reacquisition of long-term debt (260) -------- -------- Net cash provided by (used in) financing activities$(25,860) $ (9,463) -------- -------- Net increase (decrease) in cash and cash equivalents $ (342) $ (1,140) Cash and cash equivalents at beginning of period 1,727 1,999 -------- -------- Cash and cash equivalents at end of period $ 1,385 $ 859 ======== ======== The accompanying notes are an integral part of these financial statements. Note A - 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. The electric utility industry typically utilizes and/or generates in its operations a range of potentially hazardous products and by-products. The Company is a wholly-owned retail subsidiary of New England Electric System (NEES). NEES subsidiaries have an internal environmental audit program and an external waste disposal vendor audit and qualification program intended to enhance compliance with federal, state, and local requirements regarding the handling of potentially hazardous products and by-products. The Company has been named as a potentially responsible party (PRP) by either the United States Environmental Protection Agency or the Massachusetts Department of Environmental Protection for three sites (two of which are located in Massachusetts) at which hazardous waste is alleged to have been disposed. The Company is currently aware of other sites, and may in the future become aware of additional sites, that it may be held responsible for remediating. 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. Predicting the potential costs to investigate and remediate hazardous waste sites continues to be difficult. 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. 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 $11 million. An informal survey of other utilities conducted on behalf of NEES and its subsidiaries indicated costs in a similar range. The NEES companies have received recovery amounts from certain insurers, and, where appropriate, the Company intends to seek recovery from other insurers and from other PRPs, but it is uncertain whether, Note A - Hazardous Waste - Continued - ------------------------ and to what extent, such efforts will be successful. The Company believes that hazardous waste liabilities for all sites of which it is aware are not material to its financial position. In October 1996, the American Institute of Certified Public Accountants issued new accounting rules for Environmental Remediation Liabilities which become effective in 1997. These new rules do not have a material effect on the Company's financial position or results of operations. Note B - ------ 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 1996 Annual Report. Item 2. Management's Discussion and Analysis of Financial --------------------------------------------------------- Condition and Results of Operations ----------------------------------- This section contains management's assessment of The Narragansett Electric Company's (the Company) (a wholly-owned retail subsidiary of New England Electric System (NEES)) financial condition and the principal factors having an impact on the results of operations. This discussion should be read in conjunction with the Company's financial statements and footnotes and the 1996 Annual Report on Form 10-K. Earnings - -------- Net income for the second quarter and first six months of 1997 increased $2.0 million and $3.4 million, respectively, from the corresponding periods in 1996. These increases reflect an $11 million increase in base distribution rates that became effective on January 1, 1997. Industry Restructuring - ---------------------- For a full discussion of industry restructuring activities in Massachusetts, Rhode Island and New Hampshire, see "Industry Restructuring" in the Company's Form 10-K for 1996. Industry Restructuring Update As previously reported, the Rhode Island statute and related settlement covering customer choice and electric utility restructuring provide for full recovery of the costs of generating assets and oil and gas related assets (including regulatory assets) not recoverable through the divestiture of New England Power Company's (NEP) (a wholly-owned wholesale subsidiary of NEES) and the Company's generating business. A Rhode Island settlement reached in May 1997 among the Company, NEP, the Rhode Island Public Utilities Commission (RIPUC) and the Rhode Island Division of Public Utilities and Carriers to implement the stranded cost recovery provisions of the Utility Restructuring Act of 1996 is pending before the FERC. FERC action is expected later in 1997. The NEES companies have reached an agreement with all three of its unions regarding benefits and other assistance including early retirement and severance programs, to union employees that are affected by the restructuring of the electric utility industry and the NEES companies divestiture of its generation business. The NEES companies have also announced similar early retirement and severance programs for management employees. The NEES companies anticipate that industry restructuring and divestiture will lead to workforce reductions. The expected cost of such programs will be substantially recovered from the proceeds of the sale of the generating business. In July 1997, the Governor of Rhode Island signed in to law bills further implementing utility restructuring in Rhode Island. The Securitization Act establishes a framework at the RIPUC for utilities to seek approval for the issuance of bonds secured by customers obligations to pay stranded cost charges. The 1997 Amendments to the Utility Restructuring Act modify the law so that utilities will not have to transfer their transmission assets to another company and make other technical amendments. Accounting Implications Historically, electric utility rates have been based on a utility's costs. As a result, electric utilities are subject to certain accounting standards that are not applicable to other business enterprises in general. Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (FAS 71), requires regulated entities, in appropriate circumstances, to establish regulatory assets, and thereby defer the income statement impact of certain costs expected to be recovered in future rates. At December 31, 1996, the Company had approximately $44 million in net regulatory assets in compliance with FAS 71. The Company believes that the continuing rate-making policies and practices of the RIPUC and the terms of the Rhode Island statute will enable the Company to recover both its specific costs of providing ongoing distribution services and stranded costs billed to it by NEP. The Company believes that these factors will allow it to continue to apply FAS 71. However, despite the progress made to date, it is possible that the final restructuring plans ultimately ordered by regulatory bodies would not reflect full recovery of stranded costs, including a fair return on those costs as they are being recovered. In the event that future circumstances should cause the application of FAS 71 to be discontinued, a noncash write-off of previously established regulatory assets would be required. Year 2000 Computer Issues - ------------------------- In the next two-and-one-half years, most large companies will face a potentially serious information systems (computer) problem because most software application and operational programs written in the past will not properly recognize calendar dates beginning in the year 2000. This could force computers to either shut down or lead to incorrect calculations. The NEES companies began the process of identifying the changes required to their computer programs and hardware during 1996. The necessary modifications to the NEES companies' centralized financial, customer, and operational information systems are expected to be completed by the end of 1998. The NEES companies believe they will incur approximately $20 million of costs between now and January 1, 2000, associated with making the necessary modifications identified to date to the centralized systems. Noncentralized systems are currently being reviewed for Year 2000 problems. The NEES companies are unable to predict the costs to be incurred for correction of such noncentralized systems, but expect the scope and schedule for such work to be less complex than for its centralized information systems. Operating Revenue - ----------------- The following table summarizes the changes in operating revenue: Increase (Decrease) in Operating Revenue Second Quarter Six Months -------------- ------------ 1997 vs 1996 1997 vs 1996 ------------- ------------ (In Millions) Sales to ultimate customers - $(2) Rate changes $ 3 6 Fuel recovery 1 4 Demand Side Management (DSM) (1) - --- --- $ 3 $ 8 === === The increase in revenues due to rate changes reflects an $11 million increase in base rates, approved by the RIPUC, effective January 1, 1997 in accordance with the Utility Restructuring Act of 1996. The increase in fuel recovery revenues is due to increased replacement power fuel purchases by NEP due to the reduced generation of partially owned nuclear units. These costs are passed on to the Company through NEP's fuel clause. The Company, in turn, passes these costs on to its customers. Operating Expenses - ------------------ The following table summarizes the changes in operating expenses which are discussed below: Increase (Decrease) in Operating Expenses Second Quarter Six Months -------------- ------------ 1997 vs 1996 1997 vs 1996 -------------- ------------ (In Millions) Fuel for generation and purchased electric energy: Fuel $ 1 $ 4 Integrated facilities credit from NEP 2 3 Purchases and demand charges and other 1 - Other operation and maintenance: DSM (1) (1) Depreciation (2) (3) Taxes 1 2 --- --- $ 2 $ 5 === === For a discussion of fuel costs, see the "Operating Revenue" section. The decrease in depreciation and the decrease in the integrated facilities credits from NEP both reflect reduced dismantlement costs associated with the retired South Street generation plant. This decrease in depreciation expense was partially offset by new plant expenditures. Utility Plant Expenditures and Financings - ----------------------------------------- Cash expenditures for utility plant totaled $15 million in the first six months of 1997. The funds necessary for utility plant expenditures were primarily provided by net cash from operating activities, after the payment of dividends. The Company plans to issue $10 million of long-term debt in 1997. At June 30, 1997, the Company had $25 million of short-term debt outstanding of which $19 million represents commercial paper borrowings. The Company currently has lines of credit with banks totaling $41 million. There were no outstanding borrowings under these lines of credit at June 30, 1997. For the twelve-month period ending June 30, 1997, the ratio of earnings to fixed charges was 3.06. PART II. OTHER INFORMATION Item 1. Legal Proceedings - -------------------------- Information concerning the restructuring dockets before the Federal Energy Regulatory Commission, 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 statement on Form S-3, Commission file No. 33-61131. 12 Statement re computation of ratios The Company is filing Financial Data Schedules. The Company filed a report on Form 8-K dated July 14, 1997, containing Item 5, Other Events. 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 June 30, 1997 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: July 31, 1997