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, 1998 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, 1998. PART I FINANCIAL INFORMATION Item 1. Financial Statements - ---------------------------- THE NARRAGANSETT ELECTRIC COMPANY Statements of Income Periods Ended June 30 (Unaudited) Quarter Six Months -------- ---------- 1998 1997 1998 1997 ---- ---- ---- ---- (In Thousands) Operating revenue $117,295 $119,894 $237,271 $251,360 -------- -------- -------- -------- Operating expenses: Fuel for generation and purchased electric energy (principally from New England Power Company, an affiliate) 60,776 72,271 122,247 149,444 Other operation 26,427 17,477 46,127 35,303 Maintenance 3,055 3,032 5,951 5,747 Depreciation 5,962 5,599 11,923 11,703 Taxes, other than federal income taxes 10,143 9,205 20,402 19,473 Federal income taxes 2,167 2,491 7,051 6,468 -------- -------- -------- -------- Total operating expenses 108,530 110,075 213,701 228,138 -------- -------- -------- -------- Operating income 8,765 9,819 23,570 23,222 Other income: Other income (expense), net 255 (127) (734) (1,183) -------- -------- -------- -------- Operating and other income 9,020 9,692 22,836 22,039 -------- -------- -------- -------- Interest: Interest on long-term debt 3,780 4,190 7,611 8,495 Other interest 933 431 1,551 824 Allowance for borrowed funds used during construction - credit (28) (14) (60) (58) -------- -------- -------- -------- Total interest 4,685 4,607 9,102 9,261 -------- -------- -------- -------- Net income $ 4,335 $ 5,085 $ 13,734 $ 12,778 ======== ======== ======== ======== Statements of Retained Earnings Retained earnings at beginning of period $109,897 $123,738 $129,567 $119,978 Net income 4,335 5,085 13,734 12,778 Dividends declared on cumulative preferred stock (189) (536) (379) (1,072) Dividends declared on common stock (8,493) (5,663) (37,372) (9,060) -------- -------- -------- -------- Retained earnings at end of period $105,550 $122,624 $105,550 $122,624 ======== ======== ======== ======== 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) 1998 1997 ---- ---- (In Thousands) Operating revenue $505,949 $511,190 -------- -------- Operating expenses: Fuel for generation and purchased electric energy (principally from New England Power Company, an affiliate) 282,233 304,036 Other operation 85,199 71,669 Maintenance 12,651 11,802 Depreciation 23,177 25,245 Taxes, other than federal income taxes 40,295 37,950 Federal income taxes 14,830 14,286 -------- -------- Total operating expenses 458,385 464,988 -------- -------- Operating income 47,564 46,202 Other income: Other income (expense), net (301) (681) -------- -------- Operating and other income 47,263 45,521 -------- -------- Interest: Interest on long-term debt 15,295 17,104 Other interest 3,202 2,193 Allowance for borrowed funds used during construction - credit (122) (101) -------- -------- Total interest 18,375 19,196 -------- -------- Net income $ 28,888 $ 26,325 ======== ======== Statements of Retained Earnings Retained earnings at beginning of period $122,624 $111,183 Net income 28,888 26,325 Dividends declared on cumulative preferred stock (1,262) (2,143) Dividends declared on common stock (43,034) (12,741) Premium on redemption of preferred stock (1,666) - -------- -------- Retained earnings at end of period $105,550 $122,624 ======== ======== 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 1998 1997 ------ ---- ---- (In Thousands) Utility plant, at original cost $771,044 $760,923 Less accumulated provisions for depreciation 206,466 198,551 -------- -------- 564,578 562,372 Construction work in progress 1,627 5,739 -------- -------- Net utility plant 566,205 568,111 -------- -------- Current assets: Cash 2,659 3,122 Accounts receivable: From sales and deliveries of electric energy 49,691 54,109 Other (including $2,286,000 and $1,112,000 from affiliates) 4,281 2,571 Less reserves for doubtful accounts 5,144 4,707 -------- -------- 48,828 51,973 Unbilled revenues 18,387 15,997 Fuel, materials and supplies, at average cost 4,604 4,165 Prepaid and other current assets 12,449 14,202 -------- -------- Total current assets 86,927 89,459 -------- -------- Deferred charges and other assets 55,099 55,285 -------- -------- $708,231 $712,855 ======== ======== 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 36 36 Other paid-in capital 105,680 105,500 Retained earnings 105,550 129,567 Unrealized gain on securities, net 181 112 -------- -------- Total common equity 268,071 291,839 Cumulative preferred stock 12,774 12,800 Long-term debt 180,587 183,545 -------- -------- Total capitalization 461,432 488,184 -------- -------- Current liabilities: Long-term debt due in one year 3,000 5,000 Short-term debt (including $11,950,000 and $4,425,000 to affiliates) 39,000 16,350 Accounts payable (including $49,553,000 and $50,751,000 to affiliates) 55,630 56,048 Accrued liabilities: Taxes 1,321 4,314 Interest 4,703 4,810 Other accrued expenses 17,286 21,519 Customer deposits 6,113 5,982 Dividends payable 8,683 3,587 -------- -------- Total current liabilities 135,736 117,610 -------- -------- Deferred federal income taxes 87,028 82,871 Unamortized investment tax credits 6,778 7,023 Other reserves and deferred credits 17,257 17,167 -------- -------- $708,231 $712,855 ======== ======== 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) 1998 1997 ---- ---- (In Thousands) Operating Activities: Net income $ 13,734 $ 12,778 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 11,923 11,703 Deferred federal income taxes and investment tax credits, net 3,672 (1,259) Allowance for funds used during construction (60) (58) Decrease (increase) in accounts receivable, net and unbilled revenues 755 4,641 Decrease (increase) in fuel, materials, and supplies (439) 92 Decrease (increase) in prepaid and other current assets 1,753 (632) Increase (decrease) in accounts payable (418) 6,508 Increase (decrease) in other current liabilities (7,202) 6,870 Other, net 683 260 -------- -------- Net cash provided by operating activities $ 24,401 $ 40,903 -------- -------- Investing Activities: Plant expenditures, excluding allowance for funds used during construction $(10,013) $(15,239) Other investing activities - (146) -------- -------- Net cash used in investing activities $(10,013) $(15,385) -------- -------- Financing Activities: Capital contributions from parent $ 180 $ - Dividends paid on common stock (32,276) (5,663) Dividends paid on preferred stock (379) (1,072) Long-term debt - retirements (5,000) (25,000) Changes in short-term debt 22,650 5,875 Preferred stock - redemptions (26) - -------- -------- Net cash used in financing activities $(14,851) $(25,860) -------- -------- Net decrease in cash and cash equivalents $ (463) $ (342) Cash and cash equivalents at beginning of period 3,122 1,727 -------- -------- Cash and cash equivalents at end of period $ 2,659 $ 1,385 ======== ======== 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 Narragansett Electric Company (the Company) currently has in place an internal environmental audit program and an external waste disposal vendor audit and qualification program intended to enhance compliance with existing 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 possible hazardous waste 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 New England Electric System (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 recovered amounts from certain insurers and other third parties, and, where appropriate, the Company intends to seek recovery from other insurers and from other PRPs, but it is uncertain whether, 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. Note B - Comprehensive Income - ----------------------------- In the first quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (FAS 130). FAS 130 establishes standards for reporting comprehensive income and its components. Comprehensive income for the period is equal to net income plus "other comprehensive income," which, for the Company, consists of the change in unrealized holding gains on available-for-sale securities during the period. Other comprehensive income was immaterial for the Company for the quarters and six month periods ended June 30, 1998 and 1997, respectively. Note C - New Accounting Standards - --------------------------------- In 1997, the Financial Accounting Standards Board (FASB) released Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information (FAS 131), which goes into effect in 1998. FAS 131 requires the reporting in financial statements of certain new additional information about operating segments of a business. Application of FAS 131 is not required for interim reporting in the initial year of application. The Company is currently evaluating the impact that FAS 131 will have on its future reporting requirements. In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits (FAS 132), which revises disclosure requirements for pension and other postretirement benefits. The Company will adopt FAS 132 in its financial statements for the year ending December 31, 1998. The adoption of FAS 131 and FAS 132 will have no impact on the Company's operating results, financial position, or cash flows. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133), which establishes accounting and reporting standards for such items. FAS 133 is effective for fiscal years beginning after June 15, 1999. Currently, the Company has no such derivative holdings. Note D - ------ 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 1997 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) 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 1997 Annual Report on Form 10-K. Earnings - -------- Net income increased $1.0 million during the first six months of 1998 compared to the corresponding period in 1997 due to a retail rate increase going into effect in January 1998. Net income decreased $0.7 million for the second quarter due to increased operation and maintenance expense and an underrecovery of transmission wheeling expenses, which more than offset the January rate increase. This report contains statements that may be considered forward looking under the securities laws. Actual results may differ materially for reasons discussed in the "Industry Restructuring" section of the Company's Form 10-K for 1997 and the Company's 1997 Annual Report. Industry Restructuring - ---------------------- For a full discussion of industry restructuring activities in Massachusetts, Rhode Island, and New Hampshire, stranded cost recovery, the Company and New England Power Company's (NEP) proposed divestiture of their nonnuclear generating business, accounting implications of industry restructuring and divestiture, workforce reductions, and impact of industry restructuring on the distribution business, see the "Industry Restructuring" section in the Company's Form 10-K for 1997 and the Company's 1997 Annual Report. Divestiture of Generating Business The Company and NEP have received all state and federal regulatory approvals required for the sale of their nonnuclear generating business to USGen New England, Inc. (USGen). The Company's portion of the proceeds from the sale will equal the net book value of the Company's 10 percent investment in the Manchester Street power plant. USGen is awaiting final Federal Energy Regulatory Commission approval of exempt wholesale generator status for the facilities it is purchasing. The proposed sale is more fully described in the Company's Form 10-K for 1997 and the Company's 1997 Annual Report. Closing of the sale is expected in the third quarter of 1998. Risk Factors While the Company believes that the Rhode Island Settlement and the sale agreement with USGen and other developments constitute substantial progress in reducing the impacts associated with industry restructuring, significant risks remain. These include, but are not limited to: (i) the potential that ultimately the Rhode Island Settlement will not be implemented in the manner anticipated by the Company, (ii) the possibility of federal legislation that would increase the risk to investors above those contained in the Rhode Island Settlement and statute, and (iii) the failure to complete the sale of the nonnuclear generating business to USGen. The major risk factors affecting the Company relate to the possibility of adverse regulatory or judicial decisions or legislation which limit the level of revenues the Company is allowed to charge for its services or affect the costs the Company incurs. Year 2000 Computer Issues - ------------------------- For a full discussion of the Company's Year 2000 computer issues, including a description of the modification process, timeline, and estimated total costs, refer to the "Financial Review" section of the Company's 1997 Annual Report filed in conjunction with the Company's Form 10-K for 1997. Operating Revenue - ----------------- The following table summarizes the changes in operating revenue: Increase (Decrease) in Operating Revenue Second Quarter Six Months -------------- ------------ 1998 vs 1997 1998 vs 1997 -------------- ------------ (In Millions) Industry restructuring-related rate changes: Purchased power and transmission- related $(7) $(18) Distribution-related 2 4 PBOP rate decrease (1) (2) Deliveries to ultimate customers and other 3 2 --- ---- $(3) $(14) === ==== Historically, the Company purchased all of its electrical requirements from NEP, under the provisions of an all-requirements contract. In connection with an amendment to this contract, in January 1998 all of the Company's customers gained the right to choose their power supplier. NEP continues to supply power to the Company, at new lower rates, for customers who choose to continue to take power from the Company. All customers pay rates that include contract termination charges due NEP for its generation- related stranded costs. In connection with these changes, the revenues that the Company is billing to its customers related to NEP's purchased power costs are subject to true-up mechanisms. However, transmission-related costs billed by both NEP and the New England Power Pool are not subject to a true-up mechanism until 1999, and the Company incurred an underrecovery of such costs in the second quarter of 1998. Prior to January 1998, the Company had a purchased power cost adjustment mechanism and a fuel clause mechanism, which allowed NEP's billings to be passed on to customers. In accordance with the Rhode Island Restructuring Act of 1996, a $7 million increase in distribution rates was implemented for the Company, effective January 1, 1998. The Company also implemented a rate decrease related to a lower level of postretirement benefits other than pensions (PBOPs) expenses being incurred and also made refunds in January 1998 of past overrecoveries of PBOP costs, for which reserves had previously been established. Kilowatthour deliveries to ultimate customers increased 2.9 percent and 1.9 percent for the second quarter and first six months of 1998, respectively, as compared to the corresponding periods in 1997. Operating Expenses - ------------------ The following table summarizes the changes in operating expenses: Increase (Decrease) in Operating Expenses Second Quarter Six Months -------------- ------------ 1998 vs 1997 1998 vs 1997 -------------- ------------ (In Millions) Fuel, purchased power and operation and maintenance: Fuel, purchased power, generation and transmission-related $(5) $(17) PBOP expense (1) (2) Other 4 3 Taxes 1 2 --- ---- $(1) $(14) === ==== As noted above, effective January 1, 1998, NEP's billings to the Company were significantly changed in connection with the restructuring of the electric utility industry in Rhode Island. Not only were NEP's rates reduced, but the transmission portion of NEP's costs are now billed separately and recorded in operation and maintenance expense instead of as a component of purchased power expense. The increase in other operation and maintenance expense in the second quarter represents increased distribution expenses, which reflect accounting write-offs of approximately $2 million of certain previously capitalized plant items. On a year-to-date basis, this increase was offset by a reduction in the cost of PBOPs, for which refunds and a rate decrease were put into effect in the first quarter. Utility Plant Expenditures and Financings - ----------------------------------------- Plant expenditures for the first six months of 1998 amounted to $10 million. The funds necessary for utility plant expenditures were provided by net cash from operating activities, after the payment of dividends. In the first six months of 1998, the Company retired $5 million of mortgage bonds and increased its short-term debt outstanding by $23 million. The Company plans to issue an additional $15 million of long-term debt by the end of 1998 to refinance maturing bonds and to fund capital expenditures. At June 30, 1998, the Company had $39 million of short-term debt outstanding, including $27 million of 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, 1998. For the twelve-month period ending June 30, 1998, the ratio of earnings to fixed charges was 3.34. PART II. OTHER INFORMATION 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. 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, 1998 to be signed on its behalf by the undersigned thereunto duly authorized. THE NARRAGANSETT ELECTRIC COMPANY s/John G. Cochrane John G. Cochrane Treasurer, Authorized Officer, and Principal Financial Officer Date: August 7, 1998