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 March 31, 1999 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 March 31, 1999. PART I FINANCIAL INFORMATION Item 1. Financial Statements - ---------------------------- THE NARRAGANSETT ELECTRIC COMPANY Statements of Income Periods Ended March 31 (Unaudited) Three Months Twelve Months ------------ ------------- 1999 1998 1999 1998 ---- ---- ---- ---- (In Thousands) Operating revenue $126,128 $119,976 $481,806 $508,548 -------- -------- -------- -------- Operating expenses: Fuel for generation and purchased electric energy: Contract termination charges from New England Power Company, an affiliate 35,647 33,855 119,548 33,855 Other New England Power Company 3,071 27,518 48,328 259,658 Other 37,526 98 87,004 215 Other operation 17,899 19,700 93,991 76,249 Maintenance 2,819 2,896 11,920 12,628 Depreciation 5,623 5,961 22,421 22,814 Taxes, other than federal income taxes 10,420 10,259 39,076 39,357 Federal income taxes 2,534 4,884 13,827 15,154 -------- -------- -------- -------- Total operating expenses 115,539 105,171 436,115 459,930 -------- -------- -------- -------- Operating income 10,589 14,805 45,691 48,618 Other income: Other income (expense), net (1,069) (989) 721 (683) -------- -------- -------- -------- Operating and other income 9,520 13,816 46,412 47,935 -------- -------- -------- -------- Interest: Interest on long-term debt 3,626 3,831 14,720 15,705 Other interest 877 618 3,874 2,700 Allowance for borrowed funds used during construction - credit (15) (32) (68) (108) -------- -------- -------- -------- Total interest 4,488 4,417 18,526 18,297 -------- -------- -------- -------- Net income $ 5,032 $ 9,399 $ 27,886 $ 29,638 ======== ======== ======== ======== Statements of Retained Earnings (In Thousands) Retained earnings at beginning of period $ 86,465 $129,567 $109,897 $123,738 Net income 5,032 9,399 27,886 29,638 Dividends declared on cumulative preferred stock (94) (190) (471) (1,609) Dividends declared on common stock - (28,879) (44,733) (40,204) Premium on redemption of preferred stock 15 - (1,161) (1,666) -------- -------- -------- -------- Retained earnings at end of period $ 91,418 $109,897 $ 91,418 $109,897 ======== ======== ======== ======== 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) March 31, December 31, ASSETS 1999 1998 ------ ---- ---- (In Thousands) Utility plant, at original cost $737,319 $732,077 Less accumulated provisions for depreciation 214,140 209,155 -------- -------- 523,179 522,922 Construction work in progress 1,689 2,566 -------- -------- Net utility plant 524,868 525,488 -------- -------- Current assets: Cash 2,230 2,957 Accounts receivable: From electric energy services 48,869 53,727 Other (including $189,000 and $4,444,000 from affiliates) 1,217 5,575 Less reserves for doubtful accounts 4,435 4,240 -------- -------- 45,651 55,062 Unbilled revenues 11,497 20,752 Fuel, materials, and supplies, at average cost 3,845 3,494 Prepaid and other current assets 643 739 -------- -------- Total current assets 63,866 83,004 -------- -------- Deferred charges and other assets 54,477 55,628 -------- -------- $643,211 $664,120 ======== ======== 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 81 81 Other paid-in capital 105,714 105,713 Retained earnings 91,418 86,465 Unrealized gain on securities, net 242 237 -------- -------- Total common equity 254,079 249,120 Cumulative preferred stock, par value $50 per share 7,238 7,238 Long-term debt 168,723 168,702 -------- -------- Total capitalization 430,040 425,060 -------- -------- Current liabilities: Long-term debt due in one year 8,000 8,000 Short-term debt to affiliates 24,375 26,675 Accounts payable (including $10,500,000 and $1,929,000 to affiliates) 34,952 28,260 Accrued liabilities: Taxes 13,341 10,031 Interest 3,073 4,553 Other accrued expenses 12,806 34,734 Customer deposits 6,142 6,116 Dividends payable 94 4,058 -------- -------- Total current liabilities 102,783 122,427 -------- -------- Deferred federal income taxes 80,754 81,045 Unamortized investment tax credits 6,412 6,533 Other reserves and deferred credits 23,222 29,055 -------- -------- $643,211 $664,120 ======== ======== The accompanying notes are an integral part of these financial statements. THE NARRAGANSETT ELECTRIC COMPANY Statements of Cash Flows Quarters Ended March 31 (Unaudited) 1999 1998 ---- ---- (In Thousands) Operating activities: Net income $ 5,032 $ 9,399 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 5,623 5,961 Deferred federal income taxes and investment tax credit, net (497) 3,416 Allowance for funds used during construction (15) (32) Decrease (increase) in accounts receivable, net and unbilled revenue 18,666 2,465 Decrease (increase) in fuel, materials, and supplies (351) (345) Decrease (increase) in prepaid and other current assets 96 781 Increase (decrease) in accounts payable 6,692 1,058 Increase (decrease) in other current liabilities (20,072) (4,996) Other, net (4,475) (105) -------- -------- Net cash provided by operating activities $ 10,699 $ 17,602 -------- -------- Investing activities: Plant expenditures, excluding allowance for funds used during construction $ (5,020) $ (5,175) Other investing activities (48) (80) -------- -------- Net cash provided by (used in) investing activities$ (5,068) $ (5,255) -------- -------- Financing activities: Dividends paid on common stock $ (3,964) $ (3,397) Dividends paid on preferred stock (94) (190) Long-term debt - retirements - (5,000) Preferred stock - retirements - (26) Changes in short-term debt (2,300) (3,925) -------- -------- Net cash provided by (used in) financing activities $ (6,358) $(12,538) -------- -------- Net increase (decrease) in cash and cash equivalents $ (727) $ (191) Cash and cash equivalents at beginning of period 2,957 3,122 -------- -------- Cash and cash equivalents at end of period $ 2,230 $ 2,931 ======== ======== The accompanying notes are an integral part of these financial statements. THE NARRAGANSETT ELECTRIC COMPANY Notes to Unaudited 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. A number of states, including Massachusetts, have enacted similar laws. 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 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, 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 - New Accounting Standards - --------------------------------- In June 1998, the Financial Accounting Standards Board 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 instruments. FAS 133 is effective for fiscal years beginning after June 15, 1999. Currently, the Company has no such holdings. Note C - ------ In the opinion of the Company, these financial 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 1998 Annual Report. THE NARRAGANSETT ELECTRIC COMPANY 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 1998 Annual Report on Form 10-K. Merger Agreements - ----------------- For a full discussion of New England Electric Systems' (NEES) merger agreements with The National Grid Group plc (National Grid) and Eastern Utilities Associates (EUA), see the Merger Agreements sections of the Company's Form 10-K for 1998 and the Company's 1998 Annual Report. Update of Merger Agreements with National Grid and EUA On April 9, 1999, NEES and National Grid received clearance under the Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976, as amended. In addition, shareholders of National Grid approved the proposed merger on April 22, 1999 with 99 percent of those voting approving the merger. On May 3, 1999, NEES received the approval of more than the required majority of outstanding shares for the merger with 75 percent of outstanding shares voting in favor of the merger. Of those shares voted, in excess of 94 percent voted in favor of the merger. NEES and National Grid have also filed for merger approval with the Securities and Exchange Commission (SEC), Federal Energy Regulatory Commission (FERC), and Nuclear Regulatory Commission (NRC). NEES and National Grid have also made filings in the states in which NEES subsidiaries operate where support or approval for the merger is required. On April 21, 1999, the New Hampshire Public Utilities Commission (NHPUC) issued an order finding that the NEES/National Grid merger filing did not satisfy the requirements for exemption from the NHPUC's formal review process. Hearings on the merger are scheduled for June 1999. On April 29, 1999, the Committee on Foreign Investment in the United States under the Exon-Florio Provisions of the Omnibus Trade and Competitiveness Act of 1988 concluded there were no issues of national security to warrant any investigation. The NEES/National Grid merger is expected to be completed by early 2000. On April 29, 1999, NEES and EUA also received clearance under HSR for the NEES acquisition of EUA. NEES and EUA have filed for merger approval with the FERC and the Commonwealth of Massachusetts. The acquisition of EUA also requires approval by the SEC and NRC, and approval by certain states in which EUA subsidiaries operate. On May 17, 1999, EUA shareholders approved the acquisition of EUA by NEES. The acquisition of EUA is expected to be completed by early 2000. Industry Restructuring - ---------------------- For a full discussion of industry restructuring activities in Rhode Island, the NEES companies' divestiture of its nonnuclear generating business, stranded cost recovery, accounting implications of industry restructuring and divestiture, and the impact of restructuring on the distribution business, see the "Industry Restructuring", "Accounting Implications", and "Impact of Restructuring on Distribution Business" sections of the Company's Form 10-K for 1998 and the Company's 1998 Annual Report. Year 2000 Readiness Disclosure - ------------------------------ Over the course of this year, most companies will face a potentially serious information systems (computer) problem because many software applications and operational programs written in the past may not properly recognize calendar dates associated with the year 2000 (Y2K). This could cause computers to either shut down or lead to incorrect calculations. During 1996, the NEES companies began the process of identifying the changes required to their computer software and hardware to mitigate Y2K issues. The NEES companies established a Y2K Project team to manage these issues, which has consisted of as many as 70 full-time equivalent staff at some points in time, primarily external consultants being overseen by an internal Y2K management team. To facilitate the Y2K Project, NEES entered into contracts with Keane, Inc. and IBM to provide personnel support to the Y2K Project. Through March 31, 1999, the NEES companies have spent approximately $ 17 million with these vendors, which is included in the cost figures disclosed below. The Y2K Project team reports project progress to a Y2K Executive Oversight Committee each month. The team also makes regular reports to NEES' Board of Directors and its Audit Committee. The NEES companies have separated their Y2K Project into four parts as shown below, along with the estimated completion dates for each part. Substantial Contingency Testing Completion Documentation, of Critical and Clean Category Specific Example Systems Management - -------- ---------------- ----------- ------------------- Mainframe/Midrange Accounting/Customer Completed Throughout 1999 systems service integrated systems Desktop systems Personal computers/ June 30, 1999 Throughout 1999 Department software/ Networks Operational/ Dispatching systems/ June 30, 1999 Throughout 1999 Embedded Transmission and systems Distribution systems/ Telephone systems External issues Electronic Data June 30, 1999 Throughout 1999 Interchange/Vendor communications The NEES companies are using a three-phase approach in coordinating their Y2K Project for system-related issues: (I) Assessment and Inventory, (II) Pilot Testing, and (III) Renovation, Conversion, or Replacement of Application and Operating Software Packages and Testing. Phase I, which was an initial assessment of all systems and devices for potential Y2K defects, was completed in mid-1997. These assessments included, but were not limited to, the review of program code for mainframe and midrange systems, analysis of personal computer hardware and network equipment for desktop systems, reaching consensus with key "data exchange" partners regarding the approach and execution of plans to address Y2K- related issues, and coordination with other New England Power Pool (NEPOOL) member utilities related to operational systems, such as transmission systems. Phase II, which consisted of renovation pilots for a cross-section of systems in order to facilitate the establishment of templates for Phase III work, was completed in late 1997. Phase III, which is currently ongoing, requires the renovation, conversion, or replacement of the remaining applications and operating software packages. Critical systems include major operational and informational systems such as the NEES companies' financial-related and customer information systems. These mission critical systems were first addressed at an individual component level, and then, upon satisfactory completion of that testing, reviewed at an integrated level, during which the Y2K Project team tested for Y2K problems which could be caused by various system interfaces. Additionally, contingency plans are being formulated for mission critical systems, as described below. The overall Y2K Project has also been designed such that Y2K- related work performed by external consultants is reviewed by NEES employees, and vice-versa. The Y2K Project team management periodically benchmarks its progress against the recommended progress schedule documented by the North American Electric Reliability Council (NERC), and is currently ahead of the recommended schedule. The NEES companies have also implemented a formalized communication process with third parties to give and receive information related to their progress in remediating their own Y2K issues, and to communicate the NEES companies' progress in addressing the Y2K issue. These third parties include major customers, suppliers, and significant businesses with which the NEES companies have data links (such as banks). The NEES companies have identified standard offer generation service providers, telecommunications companies, and the Independent System Operator- New England (ISO New England) as critical to business operations. The NEES companies have been in contact with all of these parties regarding the progress of their Y2K remediation efforts, and will continue to monitor their ongoing remediation efforts through continued communications. The NEES companies cannot predict the outcome of other companies' remediation efforts. Therefore, contingency plans are being developed, as described below. The NEES companies believe total costs associated with making the necessary modifications to all centralized and noncentralized systems will be approximately $28 million. These costs include the replacement of approximately one thousand desktop computers. In addition, the NEES companies are spending $7 million related to the replacement of the human resources and payroll system, in part due to the Y2K issue. As of March 31, 1999, total Y2K-related costs of approximately $30 million have been incurred, of which approximately $4 million has been capitalized. The NEES companies continually review their cost estimates based upon the overall Y2K Project status, and update these estimates as warranted. The NEES companies are in the process of developing Y2K contingency plans to allow for critical information and operating systems to function from January 1, 2000 forward. If required, these plans are intended to address both internal risks as well as potential external risks related to suppliers and customers. Part of the contingency planning for accounting and desktop systems will include taking extensive data back-ups prior to year-end closing. For operational systems, the NEES companies have in place an overall disaster recovery program, which already includes periodic disaster simulation training (for outages due to severe weather, for instance). As part of Y2K contingency planning, the NEES companies will review their disaster recovery plans, modifying them for Y2K-specific issues, such as a potential loss of telecommunication services. The NEES companies expect that these contingency plans will be in place by the third quarter of 1999. Interregional and regional contingency plans are being formulated that address emergency scenarios due to the interconnection of utility systems throughout the United States. At a regional level, the NEES companies are participating and cooperating with NEPOOL and ISO New England. Overall regional activities, including those of NEPOOL and ISO New England, will be coordinated by the Northeast Power Coordinating Council, whose activities will be incorporated into the interregional coordinating effort by NERC. The target for the completion of this planning process is mid-1999. The NEES companies have noted that the Y2K coordination efforts by ISO New England began in May 1998, resulting in a demanding and difficult schedule to attain regional and interregional target dates. The NEES companies believe that the contingency plans being developed both internally and on a regional level should substantially mitigate the risks of Y2K-related failures at NEES company facilities or those caused by the inability of entities, such as ISO New England, to maintain the short-term reliability of various generator and/or transmission lines on a regional or interregional basis. Such risks include temporary disruptions of electric service, which the NEES companies believe is the worst case Y2K scenario with a reasonable chance of occurring. In the event that a short-term disruption in service occurs, NEES does not expect that it would have a material impact on its financial position or results of operation. While the NEES companies believe that their overall Y2K program will satisfactorily address all critical operational and system-related issues, significant risks remain. These risks include, but are not limited to, the Y2K readiness of third parties, including other utilities, power suppliers, and ISO New England, cost and timeline estimates of remaining Y2K mitigation efforts, and the overall accuracy of assumptions made related to future events in the development of the Y2K mitigation effort. Earnings - -------- Net income for the first quarter of 1999 decreased $4 million compared to the corresponding period in 1998. The decrease is due primarily to reduced reimbursements associated with the Company's former 10 percent ownership of the Manchester Street generating station as a result of the sale of this facility in September 1998. Increased operation and maintenance expenses also contributed to the decrease in first quarter earnings. Operating Revenue - ----------------- Operating revenue increased $6 million in the first quarter of 1999 as compared with the corresponding period in 1998 due primarily to an increase in standard offer and access charge revenues as described in the "Operating Expenses" section. In addition, revenues were favorably affected by a refund made in January 1998 of past overrecoveries of postretirement benefits other than pension costs (PBOPs), the recovery of increased demand- side management spending, and the implementation of a fully reconciling transmission cost rate mechanism in the first quarter of 1999. In addition, kilowatthour deliveries increased 1.5 percent as a result of a continued strong economy and the effect of weather. Operating Expenses - ------------------ Operating expenses for the first quarter of 1999 increased $10 million compared with the corresponding period in 1998 primarily due to increased purchased electric energy of approximately $9 million and increased operation and maintenance costs of approximately $4 million. These increases were partially offset by reduced income taxes. The increase in purchased electric energy is principally due to the reduction in reimbursements received from NEP for costs associated with the Company's former 10 percent ownership of the Manchester Street generating station, as described in the "Earnings" section. All of the output of this generating unit had been previously supplied to New England Power Company (NEP). The increase is also due to an increase in standard offer purchased power costs due to a scheduled increase in standard offer rates, as well as a net increase in contract termination charges (CTC) of approximately $2 million. CTC expenses increased as a result of a $21 million payment made by the Company to NEP in accordance with an agreement reached with the Rhode Island Public Utilities Commission related to access charge overcollection. This payment reduces the Company's remaining fixed CTC obligation to NEP which will be recovered by the end of the year 2000. Partially offsetting this increase was a decrease in NEP's CTC rate from 2.8 cents per kWh, as originally established, to approximately 1.5 cents or less per kWh upon completion of the September 1 sale of NEP's nonnuclear generating business. Operation and maintenance expenses increased in the first quarter primarily due to increased transmission wheeling costs of $2.4 million, a portion of which is included in the transmission cost rate adjustment mechanism as described in the "Operating Revenue" section. In addition, as described earlier, the Company had made a refund of past overrecoveries of PBOP costs during the first quarter of 1998. This refund not only reduced revenues in the first quarter of 1998, but also reduced expenses. Utility Plant Expenditures and Financing - ---------------------------------------- Cash expenditures for utility plant totaled $5 million for the first three months of 1999. The funds necessary for utility plant expenditures during the period were primarily provided by net cash from operating activities, after the payment of dividends. At March 31, 1999, the Company had $24 million of short-term debt outstanding representing borrowings from affiliates. The Company's ability to issue short-term debt is limited by the need to obtain regulatory approval from the SEC under the Public Utility Holding Company Act of 1935. Approval has been granted for up to $100 million. As of March 31, 1999, the Company had lines of credit with banks totaling $41 million. There were no borrowings under these lines of credit at March 31, 1999. For the twelve-month period ending March 31, 1999, the ratio of earnings to fixed charges was 3.27. PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security-Holders - ------------------------------------------------------------ On March 17, 1999, the Annual Meeting of Stockholders was held. The following actions were taken by the unanimous vote of the 1,132,487 shares having general voting rights represented at the meeting: The number of directors for the ensuing year was fixed at seven. The following were elected as directors: Richard W. Frost Cheryl A. LaFleur Robert L. McCabe Lawrence J. Reilly Michael F. Ryan Richard P. Sergel Ronald L. Thomas PricewaterhouseCoopers was appointed as auditor for 1999. 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 February 1, 1999 containing Items 5 and 7. 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 March 31, 1999 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: May 17, 1999