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, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-3446
(LOGO) NEW ENGLAND ELECTRIC SYSTEM
(Exact name of registrant as specified in charter)
MASSACHUSETTS 04-1663060
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
25 Research Drive, Westborough, Massachusetts 01582
(Address of principal executive offices)
Registrant's telephone number, including area code
(508-389-2000)
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 Shares, par value $1 per share, authorized and
outstanding: 59,842,597 shares at September 30, 1998.
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
NEW ENGLAND ELECTRIC SYSTEM AND SUBSIDIARIES
Statements of Consolidated Income
Periods Ended September 30
(Unaudited)
Quarter Nine Months
------- -----------
1998 1997 1998 1997
---- ---- ---- ----
(In Thousands)
Operating revenue $630,558 $628,606 $1,822,129$1,844,377
-------- -------- --------------------
Operating expenses:
Fuel for generation 64,107 86,006 227,320 271,068
Purchased electric energy 155,878 134,813 400,946 406,526
Other operation 174,024 128,275 477,092 393,270
Maintenance 11,927 32,994 88,949 103,533
Depreciation and amortization 52,475 63,019 164,333 188,164
Taxes, other than income taxes 36,591 36,914 113,948 112,865
Income taxes 43,292 42,061 102,981 102,882
-------- -------- --------------------
Total operating expenses 538,294 524,082 1,575,5691,578,308
-------- -------- --------------------
Operating income 92,264 104,524 246,560 266,069
Other income:
Equity in income of generating companies3,410 2,484 8,454 7,615
Other income (expense), net 5,148 (4,483) 5,140 (9,243)
-------- -------- --------------------
Operating and other income 100,822 102,525 260,154 264,441
-------- -------- --------------------
Interest:
Interest on long-term debt 22,218 26,081 71,681 80,362
Other interest 9,671 5,639 24,841 13,247
Allowance for borrowed funds used during
construction (464) (368) (1,379) (1,408)
-------- -------- --------------------
Total interest 31,425 31,352 95,143 92,201
-------- -------- --------------------
Income after interest 69,397 71,173 165,011 172,240
Preferred dividends and net loss
on reacquisition of preferred stock 1,678 1,833 2,820 5,499
Minority interests 1,526 1,594 4,711 4,943
-------- -------- --------------------
Net income $ 66,193 $ 67,746 $ 157,480$ 161,798
======== ======== ====================
Average common shares - Basic 61,811,783 64,945,26363,279,656 64,961,433
Average common shares - Diluted 61,872,341 64,972,875 63,347,844 64,998,530
Per share data:
Net income - Basic $1.06 $1.04 $2.49 $2.49
Net income - Diluted $1.07 $1.04 $2.49 $2.49
Dividends declared $ .59 $ .59 $1.77 $1.77
Statements of Consolidated Retained Earnings
Retained earnings at beginning of period $ 970,833 $904,825 $ 954,518$ 887,292
Net income 66,193 67,746 157,480 161,798
Dividends declared on common shares (35,757) (38,214) (110,729)(114,733)
---------- -------- -------------------
Retained earnings at end of period $1,001,269 $934,357 $1,001,269$ 934,357
========== ======== ===================
The accompanying notes are an integral part of these financial statements.
NEW ENGLAND ELECTRIC SYSTEM AND SUBSIDIARIES
Statements of Consolidated Income
Twelve Months Ended September 30
(Unaudited)
1998 1997
---- ----
(In Thousands)
Operating revenue $2,480,343 $2,440,888
---------- ----------
Operating expenses:
Fuel for generation 328,713 366,559
Purchased electric energy 522,649 539,043
Other operation 640,480 526,289
Maintenance 128,788 132,833
Depreciation and amortization 212,661 239,160
Taxes, other than income taxes 147,577 145,831
Income taxes 152,123 138,458
---------- ----------
Total operating expenses 2,132,991 2,088,173
---------- ----------
Operating income 347,352 352,715
Other income:
Equity in income of generating companies 11,079 9,897
Other income (expense), net (1,372) (16,768)
---------- ----------
Operating and other income 357,059 345,844
---------- ----------
Interest:
Interest on long-term debt 98,630 108,242
Other interest 28,533 17,329
Allowance for borrowed funds used during construction (1,879) (2,195)
---------- ----------
Total interest 125,284 123,376
---------- ----------
Income after interest 231,775 222,468
Preferred dividends and net gain/loss on
reacquisiton of preferred stock 9,640 5,964
Minority interests 6,415 6,642
---------- ----------
Net income $ 215,720 $ 209,862
========== ==========
Average common shares - Basic 63,641,444 64,963,505
Average common shares - Diluted 63,717,563 65,011,617
Per share data:
Net income - Basic and Diluted $3.39 $3.23
Dividends declared $2.36 $2.36
Statements of Consolidated Retained Earnings
Retained earnings at beginning of period $ 934,357 $ 877,065
Net income 215,720 209,862
Dividends declared on common shares (148,808) (153,020)
Premium on redemption of preferred stock - 450
---------- ---------
Retained earnings at end of period $1,001,269 $ 934,357
========== =========
The accompanying notes are an integral part of these financial statements.
NEW ENGLAND ELECTRIC SYSTEM AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
ASSETS 1998 1997
------ ---- ----
(In Thousands)
Utility plant, at original cost $4,098,221 $5,860,101
Less accumulated provisions for depreciation
and amortization 1,662,255 1,995,017
---------- ----------
2,435,966 3,865,084
Construction work in progress 50,964 48,708
---------- ----------
Net utility plant 2,486,930 3,913,792
---------- ----------
Oil and gas properties, at full cost - 1,299,817
Less accumulated provision for amortization - 1,128,659
---------- ----------
Net oil and gas properties - 171,158
---------- ----------
Investments:
Nuclear power companies, at equity 48,203 49,825
Other subsidiaries, at equity 2,387 37,418
Other investments 145,993 117,645
---------- ----------
Total investments 196,583 204,888
---------- ----------
Current assets:
Cash, and temporary cash investments 494,312 14,264
Accounts receivable, less reserves of $20,332,000 and
$17,834,000 275,730 257,185
Unbilled revenues 76,564 71,260
Fuel, materials and supplies, at average cost 42,085 66,509
Prepaid and other current assets 41,098 64,265
---------- ----------
Total current assets 929,789 473,483
---------- ----------
Regulatory assets 1,649,713 534,147
Deferred charges and other assets 45,723 14,179
---------- ----------
$5,308,738 $5,311,647
========== ==========
CAPITALIZATION AND LIABILITIES
------------------------------
Capitalization:
Common share equity:
Common shares, par value $1 per share:
Authorized - 150,000,000 shares
Issued - 64,969,652 shares
Outstanding - 59,842,597 shares and 64,537,777 shares $ 64,970 $ 64,970
Paid-in capital 736,744 736,605
Retained earnings 1,001,269 954,518
Treasury stock - 5,127,055 shares and 431,875 shares (206,113) (16,415)
Unrealized gain on securities, net 6,061 4,764
---------- ----------
Total common share equity 1,602,931 1,744,442
Minority interests in consolidated subsidiaries 40,860 43,062
Cumulative preferred stock of subsidiaries 33,914 39,113
Long-term debt 1,034,854 1,487,481
---------- ----------
Total capitalization 2,712,559 3,314,098
---------- ----------
Current liabilities:
Long-term debt due within one year 46,000 89,910
Short-term debt - 251,950
Accounts payable 194,667 136,218
Accrued taxes 221,770 14,831
Accrued interest 12,431 24,969
Dividends payable 34,491 36,162
Other current liabilities 245,654 120,002
---------- ----------
Total current liabilities 755,013 674,042
---------- ----------
Deferred federal and state income taxes 464,601 720,375
Unamortized investment tax credits 65,589 90,018
Accrued Yankee nuclear plant costs 261,278 299,564
Purchased power obligations 863,367 -
Other reserves and deferred credits 186,331 213,550
---------- ----------
$5,308,738 $5,311,647
========== ==========
The accompanying notes are an integral part of these financial statements.
NEW ENGLAND ELECTRIC SYSTEM AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended September 30
(Unaudited)
1998 1997
---- ----
(In Thousands)
Operating Activities:
Net income $ 157,480 $ 161,798
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 167,363 190,651
Deferred income taxes and investment tax credits, net (279,373) (30,812)
Allowance for funds used during construction (1,379) (1,408)
Minority interests 4,711 4,943
Buyout of purchased power contracts (333,520) -
Decrease (increase) in accounts receivable, net
and unbilled revenues (14,566) 39,957
Decrease (increase) in fuel, materials, and supplies (22,887) 1,204
Decrease (increase) in prepaid and other current assets 18,691 13,673
Increase (decrease) in accounts payable 52,907 (15,642)
Increase (decrease) in other current liabilities 233,245 29,911
Other, net (53,476) 39,651
----------- ---------
Net cash provided by (used in)
operating activities $ (70,804) $ 433,926
----------- ---------
Investing Activities:
Proceeds from sale of generating assets $ 1,728,588 $ -
Plant expenditures, excluding allowance for
funds used during construction (133,557) (152,445)
Oil and gas exploration and development - (9,676)
Proceeds from sale of New England Energy Incorporated
oil and gas properties 50,000 -
Other investing activities (29,358) (13,517)
----------- ---------
Net cash provided by (used in)
investing activities $ 1,615,673 $(175,638)
----------- ---------
Financing Activities:
Dividends paid to minority interests $ (6,704) $ (5,279)
Dividends paid on NEES common shares (110,979) (114,660)
Changes in short-term debt (251,950) (5,350)
Long-term debt - issues 30,000 3,000
Long-term debt - retirements (528,750) (132,845)
Return of capital to minority interests and
related premium (1,681) -
Repurchase of common shares (189,604) (5,089)
Preferred stock - reacquisition (5,153) -
----------- ---------
Net cash used in financing activities $(1,064,821) $(260,223)
----------- ---------
Net increase (decrease) in cash and cash equivalents $ 480,048 $ (1,935)
Cash and cash equivalents at beginning of period 14,264 8,477
----------- ---------
Cash and cash equivalents at end of period $ 494,312 $ 6,542
=========== =========
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.
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. New England Electric System (NEES)
subsidiaries currently have 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.
NEES and/or its subsidiaries have been named as potentially
responsible parties (PRPs) by either the United States
Environmental Protection Agency or the Massachusetts Department of
Environmental Protection for 20 sites at which hazardous waste is
alleged to have been disposed. Private parties have also contacted
or initiated legal proceedings against NEES and certain
subsidiaries regarding hazardous waste cleanup. The most prevalent
types of hazardous waste sites with which NEES and its subsidiaries
have been associated are manufactured gas locations. (Until the
early 1970s, NEES was a combined electric and gas holding company
system.) NEES is aware of approximately 40 such manufactured gas
locations, mostly located in Massachusetts. The NEES companies
have been identified as PRPs at 10 of these manufactured gas
locations, which are included in the 20 PRP sites discussed above.
NEES is engaged in various phases of investigation and remediation
work at approximately 20 of the manufactured gas locations. NEES
and its subsidiaries are currently aware of other possible
hazardous waste sites, and may in the future become aware of
additional sites, that they may be held responsible for
remediating.
In 1993, the Massachusetts Department of Public Utilities
approved a settlement agreement regarding the rate recovery of
remediation costs of former manufactured gas sites and certain
other hazardous waste sites located in Massachusetts. Under that
agreement, qualified remedial costs related to these sites are paid
out of a special fund established on Massachusetts Electric
Company's (Massachusetts Electric) books. Massachusetts Electric
made an initial $30 million contribution to the fund. Rate-
recoverable contributions of $3 million, adjusted since 1993 for
inflation, are added annually to the fund along with interest and
any recoveries from insurance carriers and other third parties. At
September 30, 1998, the fund had a balance of $46 million.
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 NEES or its
subsidiaries. The NEES companies have recovered amounts from
certain insurers and other third parties, and, where appropriate,
intend to seek recovery from other insurers and from other PRPs,
but it is uncertain whether, and to what extent, such efforts will
be successful. At September 30, 1998, NEES had total reserves for
environmental response costs of $56 million. This represents an
increase from the $44 million balance at the end of 1997. Since
most of the sites for which increased reserves were recognized are
covered by rate agreements, this increase in the reserves did not
have an adverse effect on net income. NEES believes that hazardous
waste liabilities for all sites of which it is aware, and which are
not covered by a rate agreement, are not material to its financial
position.
Note B - Divestiture of Generating Business
- -------------------------------------------
On September 1, 1998, NEES subsidiaries New England Power
Company (NEP) and The Narragansett Electric Company (Narragansett
Electric) completed the sale of substantially all of their
nonnuclear generating business to USGen. The NEES companies
received $1.59 billion for the sale. In addition, the NEES
companies were reimbursed approximately $140 million for costs
associated with early retirements and special severance programs
for employees affected by industry restructuring, and the value of
inventories. For more information on the terms and events leading
to the sale, the accounting implications of the sale, and the
assets sold, see NEES' Annual Report on Form 10-K for the year
ended December 31, 1997.
As part of the sale, USGen purchased NEP's entitlement to
approximately 1,100 megawatts of power procured under long-term
contracts. Pursuant to the transfer agreement, under certain
conditions involving formal assignment of the contracts to USGen
and a release of NEP from further obligations to the power
supplier, NEP is required to make a lump sum payment of the present
value of its monthly fixed contribution obligations. On or prior
to the closing date, NEP paid approximately $340 million towards
the above-market costs of two of the power contracts. NEP is
required to make fixed contributions averaging $9.5 million per
month through January 2008 towards the above-market cost of the
other contracts. USGen is responsible for the balance of the costs
under the purchased power contracts. All of the payments are
recoverable from customers as part of industry restructuring
settlements reached by NEP with various parties and approved by
state and Federal regulators. The present value of the future
monthly fixed contributions, amounting to $863 million, are
recorded as a liability on the balance sheet. This liability, as
well as the lump sum payments previously made, net of amortization,
are also recorded as a regulatory asset on the balance sheet.
In order to satisfy certain terms of its mortgage indenture,
NEP was required to defease or retire all of its $641 million of
mortgage bonds outstanding at the time of the sale of its
nonnuclear generating business. With respect to $372 million of
mortgage bonds securing the issuance of a like amount of pollution
control revenue bonds (PCRBs) issued by public agencies, NEP
retired the mortgage bonds, leaving the underlying PCRBs
outstanding as unsecured obligations of NEP. Pursuant to a tender
offer, NEP purchased $183 million of bonds. Provisions for the
payment of the remaining mortgage bonds were made by depositing
with trustees U.S. treasury obligations sufficient to pay principal
and interest to the maturity date, or, in the alternative,
principal, interest and premium to the first date on which the
bonds could be redeemed. Both the U.S. treasury obligations and
defeased bonds were removed from the September 30, 1998 balance
sheet.
Note C - Regulatory Asset Recovery
- ----------------------------------
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 these charges because they are
expected to be included in future customer charges. In 1997, the
Emerging Issues Task Force of the Financial Accounting Standards
Board concluded that a utility who had received approval to recover
so-called "stranded costs" through regulated transmission and
distribution rates would be permitted to continue to apply FAS 71
to the recovery of stranded costs.
In accordance with industry restructuring settlement agreements
reached in Massachusetts, Rhode Island and New Hampshire, NEP has
been permitted to recover its investments as of December 31, 1995
in the Millstone 3 and Seabrook 1 nuclear facilities, assuming
these facilities had zero market value. Recent sales of nuclear
units, (which have required the prefunding of decommissioning
liabilities by the seller,) have tended to confirm lower market
values for nuclear facilities. Consistent with these provisions of
the settlement agreements, and now that the divestiture of the
nonnuclear generating business has occurred, NEP recorded an
impairment writedown in its reserve for depreciation and
established an offsetting regulatory asset on the September 30,
1998 balance sheet for $348 million and $41 million, which
represent the net book value at December 31, 1995, less applicable
depreciation subsequent to that date, of Millstone 3 and Seabrook
1, respectively. Nevertheless, NEP will endeavor to sell, or
otherwise transfer, its interest in these nuclear plants. Should
these efforts yield a positive market value, NEP will credit any
such value to customers.
NEP has received authorization from the Federal Energy
Regulatory Commission (FERC) to recover through contract
termination charges substantially all of the costs associated with
its former generating business not recovered through the sale of
that business. As a result, NEES has recorded a regulatory asset
for the costs which are recoverable from customers through contract
termination charges. The regulatory asset includes the following
major components: the loss on the sale of NEES' oil and gas
business and the unrecovered plant costs in operating nuclear
plants, reduced by the gain from the sale of NEP's nonnuclear
generating business, all of which will be recovered by the end of
2000; and costs associated with permanently closed nuclear power
plants and the above-market costs associated with purchased power
contracts, which are being recovered over a much longer period of
time as such costs are actually incurred. At September 30, 1998,
regulatory assets totaled approximately $1.6 billion, of which $863
million related to the above-market costs of purchased power
contracts. All but approximately $100 million of the regulatory
assets are recoverable under NEP's contract termination charge.
It is possible that future regulatory rules or other
circumstances could cause the application of FAS 71 to be
discontinued, which would result in a noncash write-off of
previously established regulatory assets, including those being
recovered through NEP's contract termination charge.
Note D - Nuclear Units
- ----------------------
Nuclear Units Permanently Shut Down
Three regional nuclear generating companies in which NEP has a
minority interest own nuclear generating units which have been
permanently shut down. These three units are as follows:
NEP's Investment Future Estimated
Unit Percent Amount($) Date Retired Billings to NEP($)
- -----------------------------------------------------------------------------
Yankee Atomic 30 6 million Feb 1992 33 million
Connecticut Yankee 15 15 million Dec 1996 83 million
Maine Yankee 20 16 million Aug 1997 145 million
- -----------------------------------------------------------------------------
In the case of each of these units, NEP has recorded an
estimate of the total future payment obligation as a liability and
an offsetting regulatory asset, reflecting estimated future
billings from the companies. In a 1993 decision, the FERC allowed
Yankee Atomic to recover its undepreciated investment in the plant
as well as unfunded nuclear decommissioning costs and other costs.
NEP's industry restructuring settlements allow it to recover all
costs that the FERC allows these Yankee companies to bill to NEP.
Connecticut Yankee and Maine Yankee have both filed similar
requests with the FERC. Several parties have intervened in
opposition to both filings. On August 31, 1998, a FERC
Administrative Law Judge (ALJ) issued an initial decision which
would allow for full recovery of Connecticut Yankee's unrecovered
investment, but precluded a return on that investment. The ALJ's
initial decision is subject to review and approval by the FERC.
Connecticut Yankee, NEP, and other parties have filed exceptions to
the ALJ's decision with the FERC. Should the FERC uphold the
ALJ's initial decision in its current form, NEP's share of the loss
of the return component would total approximately $12 million to
$15 million before taxes.
The Citizen's Awareness Network and Nuclear Information and
Resource Service have indicated their intention to file a request
with the Nuclear Regulatory Commission (NRC) designed to overturn
a current NRC rule on decommissioning. NEP cannot predict what
impact, if any, these activities, if successful, would have on the
cost of decommissioning the plants.
At Maine Yankee, the NRC issued a notice of violation on
October 8, 1998 for issues identified prior to the shut down of the
plant in August 1997. The NRC did not assess any civil penalties
related to the notice of violation.
In the 1970s, NEP and several other shareholders (Sponsors) of
Maine Yankee entered into 27 contracts (Secondary Purchase
Agreements) under which they sold portions of their entitlements to
Maine Yankee power output through 2002 to various entities,
primarily municipal and cooperative systems in New England
(Secondary Purchasers). Virtually all of the Secondary Purchasers
have ceased making payments under the Secondary Purchase Agreements
and have demanded arbitration, claiming that such agreements excuse
further payments upon plant shutdown. The motion of the Secondary
Purchasers to compel arbitration was denied by the Maine Superior
Court on the grounds that the FERC has jurisdiction. The Secondary
Purchasers are appealing this decision to the Maine Supreme
Judicial Court. NEP has asked the FERC to enforce NEP's rights
under the agreements. In the event that no further payments are
forthcoming from Secondary Purchasers, NEP, as a primary obligor to
Maine Yankee, would be required to pay an additional $7 million of
future shutdown costs. These costs are not included in the $145
million estimate disclosed in the table above. Shutdown costs are
recoverable from customers under the industry restructuring
settlements.
A Maine statute provides that if both Maine Yankee and its
decommissioning trust fund have insufficient assets to pay for the
plant decommissioning, the owners of Maine Yankee are jointly and
severally liable for the shortfall.
Operating Nuclear Units
NEP has minority interests in three other nuclear generating
units, Vermont Yankee, Millstone 3, and Seabrook 1. Uncertainties
regarding the future of nuclear generating stations, particularly
older units, such as Vermont Yankee, are increasing rapidly and
could adversely affect their service lives, availability, and
costs. These uncertainties stem from a combination of factors,
including the acceleration of competitive pressures in the power
generation industry and increased NRC scrutiny. NEP performs
periodic economic viability reviews of operating nuclear units in
which it holds ownership interests.
Millstone 3
In April 1996, the NRC ordered Millstone 3, which had
experienced numerous technical and nontechnical problems, to shut
down pending verification that the unit's operations were in
accordance with NRC regulations and the unit's operating license.
In July 1998, Millstone 3 returned to full operation. Millstone 3
remains on the NRC "Watch List," signifying that it continues to
warrant increased NRC attention. Millstone 3 is operated by a
subsidiary of Northeast Utilities (NU). NEP is not an owner of the
Millstone 2 nuclear generating unit, which is temporarily shut down
under NRC orders, or the Millstone 1 nuclear generating unit, which
has been permanently shut down.
During the Millstone 3 outage, NEP incurred an estimated $45
million in incremental replacement power costs. Through February
1998, when most of NEP's power sales were subject to a fuel clause,
NEP recovered its incremental replacement power costs from
customers through its fuel clause. Starting in March 1998, most of
NEP's power sales are at a stated rate which is not subject to a
fuel clause. However, certain true-up mechanisms exist in lieu of
the fuel clause, which cover most of these costs.
Several criminal investigations related to Millstone 3 are
ongoing. In December 1997, the NRC assessed civil penalties
totaling $2.1 million for numerous violations at the three
Millstone units. NEP's share of this fine was less than $100,000.
On September 24, 1998, NU, the Connecticut Department of
Environmental Protection and the Connecticut Attorney General
reached a stipulated agreement for alleged wastewater discharge
violations at the Millstone units. As part of the agreement, NU
will pay a civil penalty of $700,000, and an additional $500,000 to
fund three environmental projects. NEP's share of this fine will
be immaterial.
In August 1997, NEP sued NU in Massachusetts Superior Court for
damages resulting from the tortious conduct of NU that caused the
shutdown of Millstone 3. NEP's damages include the costs of
replacement power during the outage and costs necessary to return
Millstone 3 to safe operation. NEP also seeks punitive damages.
NEP also sent a demand for arbitration to Connecticut Light & Power
Company (CL&P) and Western Massachusetts Electric Company (WMEC),
both subsidiaries of NU, seeking damages resulting from their
breach of obligations under an agreement with NEP and others
regarding the operation and ownership of Millstone 3. The
arbitration is scheduled for October 1999. NU moved to dismiss
NEP's suit, or, in the alternative, stay the suit pending
arbitration of NEP's claims against CL&P and WMEC. NU also moved
to consolidate NEP's suit with suits filed by other joint owners in
Massachusetts Superior Court. On July 3, 1998, the court denied
NU's motion to dismiss and its motion to stay pending arbitration.
On July 21, 1998, NEP amended its complaint by, among other
things, adding NU's Trustees as defendants. The Worcester Superior
Court granted NEP's motion for a trial in June 1999, subject to
revision if the cases are consolidated. No ruling has been made on
NU's motion to consolidate.
Nuclear Decommissioning
In New Hampshire, legislation was recently enacted which makes
owners of Seabrook 1, of which NEP owns a 10 percent interest,
proportional guarantors for decommissioning costs in the event that
an owner without a franchise service territory fails to fund its
share of decommissioning costs. Currently, a single owner of an
approximate 12 percent share of Seabrook 1 has no franchise service
territory. For more information on nuclear decommissioning, refer
to the NEES Annual Report on Form 10-K for 1997.
The New Hampshire Nuclear Decommissioning Finance Committee is
reviewing Seabrook Station's decommissioning estimate and
associated annual funding levels. Among the items being considered
is the imposition of joint and several liability among the Seabrook
joint owners for decommissioning funding. NEP cannot predict what
additional liability, if any, may be imposed on it.
The Nuclear Waste Policy Act of 1982 establishes that the
federal government (through the Department of Energy (DOE)) is
responsible for the disposal of spent nuclear fuel. The federal
government requires NEP to pay a fee based on its share of the net
generation from the Millstone 3 and Seabrook 1 nuclear units.
Through February 1998, NEP recovered this fee through its fuel
clause. Subsequently, most of these costs are recovered through
NEP's restructuring settlement in lieu of the fuel clause. Similar
costs are incurred by the Vermont Yankee nuclear generating unit.
These costs are billed to NEP and also recovered from customers
through the same mechanism. In November 1997, ruling on a lawsuit
brought against the DOE by numerous utilities and state regulatory
commissions, the Court of Appeals for the District of Columbia (the
Appeals Court) held that the DOE was obligated to begin disposing
of utilities' spent nuclear fuel by January 31, 1998. The DOE
failed to meet this deadline, and is not scheduled to have a
temporary or permanent repository for spent nuclear fuel for
several years. In February 1998, Maine Yankee petitioned the
Appeals Court to compel the DOE to remove Maine Yankee's spent fuel
from the site. In May 1998, the Appeals Court rejected the
petitions of Maine Yankee and the other utilities and state
regulatory commissions, stating that the issue of damages was a
contractual matter. The operators of the units in which NEP has an
obligation, including Maine Yankee, Connecticut Yankee, and Yankee
Atomic, continue to pursue damage claims against the DOE in the
Federal Court of Claims (Claims Court). On October 30, 1998, the
Claims Court ruled that the DOE violated a commitment to remove
spent fuel from Yankee Atomic. The Claims Court issued similar
rulings in November 1998 related to cases brought by Connecticut
Yankee and Maine Yankee. Further proceedings will be scheduled by
the Claims Court to decide the amount of damages.
Note E - Town of Norwood
- ------------------------
On September 29, 1998, the United States District Court for the
District of Massachusetts dismissed the lawsuit filed by the Town
of Norwood, Massachusetts against NEES and NEP in April 1997. NEP
had been a wholesale power supplier for Norwood pursuant to rates
approved by the FERC. In the lawsuit, Norwood had alleged that
NEP's divestiture of its power generating assets would violate the
terms of a 1983 power contract. Norwood also alleged that the
divestiture and recovery of stranded investment costs contravened
federal antitrust laws. The District Court judge granted NEES' and
NEP's motion for dismissal on the grounds that the contract did not
require NEP to retain its generating units, that the FERC-approved
filed rates govern these matters and that Norwood had adequate
opportunity at the FERC to litigate these matters. Norwood has
filed a motion to alter or amend the order of dismissal.
In March 1998, Norwood gave notice of its intent to terminate
its contract with NEP, without accepting responsibility for its
share of NEP's stranded costs, and began taking power from another
supplier commencing in April 1998. In May 1998, the FERC ruled
that NEP could assess a contract termination charge to any of NEP's
unaffiliated customers that choose to terminate their wholesale
power contracts early. Norwood claimed that the contract
termination charge approved by the FERC did not apply to Norwood;
however, in denying Norwood's motion for rehearing, the FERC ruled
that the charge did apply to Norwood. On October 2, 1998, Norwood
appealed this decision to the First Circuit Court of Appeals (First
Circuit). NEP's billings to Norwood for this charge through
September 1998 have been approximately $4 million. Norwood has not
paid any of these billings. NEP intends to pursue collection
action to recover these amounts.
Norwood appealed the FERC's orders approving the divestiture
and the Massachusetts and Rhode Island industry restructuring
settlement agreements (including modification of NEP's contracts
with Massachusetts Electric and Narragansett Electric) to the First
Circuit on July 31, 1998 and August 7, 1998, respectively. The
FERC had found that the challenged orders do not apply to Norwood.
On October 20, 1998, the First Circuit consolidated all three
of Norwood's appeals from the FERC's orders. These consolidated
appeals will likely be consolidated with two other appeals that
were filed on August 6, 1998 with the Second Circuit of Appeals and
transferred to the First Circuit on October 13, 1998. Both
appeals, filed by the Northeast Center for Social Issue Studies,
challenge the FERC's approval of NEP's sale of its hydroelectric
facilities.
Note F - Hydro-Quebec Arbitration
- ---------------------------------
In 1996, various New England utilities which are members of the
New England Power Pool, including NEP, submitted a dispute to
arbitration regarding their Firm Energy Purchased Power Contract
with Hydro-Quebec. In June 1997, Hydro-Quebec presented a damage
claim of approximately $37 million for past damages, of which NEP's
share would have been approximately $6 million to $9 million. The
claims involved a dispute over the components of a pricing formula
and additional costs under the contract. With respect to ongoing
claims, NEP paid Hydro-Quebec the higher amount (additional costs
of approximately $3 million per year) from July 1996 until
September 1, 1998 under protest and subject to refund. The contract
was transferred to USGen on September 1, 1998 in conjunction with
the sale of the nonnuclear generating business. In October 1997,
an arbitrator ruled in favor of the New England utilities in all
respects. Hydro-Quebec has not yet refunded any monies and has
appealed the decision. In June 1998, the United States District
Court (District Court) issued an order affirming the 1997
arbitration decision in favor of NEP and the other utilities.
Hydro-Quebec is appealing this order to the Court of Appeals for
the First Circuit.
On July 31, 1998, in a separate proceeding, an arbitrator
denied the request of NEP and the other utilities that they be
allowed to withhold payment of disputed amounts from Hydro-Quebec
during the pendency of Hydro-Quebec's appeal. NEP and the other
utilities have filed a petition with the District Court to vacate
this decision, and Hydro-Quebec has petitioned the District Court
to confirm it.
Note G - Average Common Shares
- ------------------------------
The following table summarizes the reconciling amounts between
basic and diluted earnings per share (EPS) computations, in
compliance with Statement of Financial Accounting Standards No.
128, Earnings per Share, which became effective during 1997, and
requires restatement for all prior-period EPS data presented.
Quarter Ended Nine Months Ended Twelve Months Ended
- -------------------------------------------------------------------------------------------
Period Ended September 30, 1998 1997 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------
Income after interest
and minority
interest (000s) $67,871 $69,579 $160,300 $167,297 $225,360 $215,826
Less: preferred stock
dividends and net
gain/loss on
reacquisition of
preferred stock of
subsidiaries (000s) $ 1,678 $ 1,833 $ 2,820 $ 5,499 $ 9,640 $ 5,964
Income available to
common shareholders
(000s) $66,193 $67,746 $157,480 $161,798 $215,720 $209,862
Basic EPS $ 1.06 $ 1.04 $ 2.49 $ 2.49 $ 3.39 $ 3.23
Diluted EPS $ 1.07 $ 1.04 $ 2.49 $ 2.49 $ 3.39 $ 3.23
- -------------------------------------------------------------------------------------------
Average common
shares outstanding
for Basic EPS 61,811,783 64,945,263 63,279,65664,961,43363,641,44464,963,505
Effect of Dilutive
Securities
Average potential
common shares related
to share-based compen-
sation plans 60,558 27,612 68,188 37,097 76,119 48,112
- -------------------------------------------------------------------------------------------
Average common shares
outstanding for
Diluted EPS 61,872,341 64,972,875 63,347,84464,998,53063,717,56365,011,617
- -------------------------------------------------------------------------------------------
Note H - Comprehensive Income
- -----------------------------
In the first quarter of 1998, NEES 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 NEES, consists of the change in unrealized
holding gains on available-for-sale securities during the period.
Total comprehensive income is calculated for all applicable periods
in the table below:
Periods Ended September 30,
-------------------------------------
Three Months Nine Months
------------ -----------
1998 1997 1998 1997
---- ---- ---- ----
(In Thousands)
Net income $66,193 $67,746 $157,480 $161,798
Other comprehensive income,
net of tax:
Holding gains/(losses) (1,306) 1,194 1,618 3,878
Less: Reclassification adjustments
for realized gains previously
included in comprehensive income 321 108 321 108
------- ------- -------- --------
Total comprehensive income $64,566 $68,832 $158,777 $165,568
======= ======= ======== ========
Note I - 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. NEES 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. NEES 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
NEES' 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 instruments. NEES, through its wholly
owned indirect subsidiary, AllEnergy Marketing Company, L.L.C.,
(AllEnergy) uses derivative instruments to manage exposure from
fluctuations in commodity prices. At this time, AllEnergy has only
held exchange-traded futures contracts to manage risks associated
with natural gas, propane, and oil price risks. FAS 133 requires
recognition of all derivatives as either assets or liabilities on
the balance sheet and measurement of those instruments at fair
value. If certain conditions are met, derivatives may be treated
as hedges under FAS 133 for income statement purposes. Gains or
losses on a derivative which qualifies as a hedge are deferred
until recognized in the income statement in the same period as the
hedged item is recognized in the income statement. To the extent
the derivative is not effective in offsetting changes in fair value
of the hedged item, that portion of the gain or loss is reported in
earnings immediately. As of September 30, 1998, all of AllEnergy's
existing futures contracts, with limited exceptions, qualified as
hedges under Statement of Financial Accounting Standards No. 80,
Accounting for Futures Contracts. The futures contracts which do
not qualify as hedges are marked-to-market on a monthly basis, and
are immaterial to NEES. FAS 133 is effective for fiscal years
beginning after June 15, 1999.
Note J
- ------
In the opinion of NEES, 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 consolidated financial statements in NEES' 1997 Annual
Report.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
- -----------------------------------------------------------------
This section contains management's assessment of New England
Electric System's (NEES) financial condition and the principal
factors having an impact on the results of operations. This
discussion should be read in conjunction with the consolidated
financial statements and footnotes and the 1997 Annual Report on
Form 10-K.
Earnings
- --------
Earnings for the third quarter of 1998 were $1.07 per share on
61.9 million average diluted common shares, compared to $1.04 per
share on 65.0 million average diluted common shares for the third
quarter of 1997. Earnings were $2.49 per share for both the nine
months ended September 30, 1998 and 1997 on 63.3 million and 65.0
million average diluted common shares, respectively.
Third quarter 1998 earnings increased as a result of a
combination of increased kilowatthour (kWh) deliveries to ultimate
customers, reduced operation and maintenance expenses, and a
reduction in common shares outstanding as a result of share buyback
programs commenced in late 1997. These gains were partially offset
by revenue declines due to the restructuring of the utility
business in Massachusetts, Rhode Island, and New Hampshire.
Year-to-date earnings reflect the same factors affecting the
third quarter. NEES estimates that industry restructuring reduced
third quarter and year-to-date earnings by approximately $.30 per
share and $.60 per share, respectively.
With the introduction of industry restructuring and customer
choice of power supplier, a fundamental change has occurred in the
electric utility business. NEES believes that through its
restructuring settlements at the Federal and state level, the state
laws passed in the jurisdictions in which it does business, and the
sale of its nonnuclear generation business, the major impacts of
restructuring (particularly, the recovery of stranded costs) have
been favorably resolved. Possible remaining risks include the
potential that the settlements will not be implemented in the
manner anticipated by NEES or that Federal legislation could be
enacted that would increase the risk to shareholders above those
contained in the settlements and state legislation. With respect
to future earnings, now that the divestiture of the nonnuclear
generating business has occurred, the settlement agreements limit
the return on equity earned on the NEES companies' remaining
generating assets to 9.7 percent, before mitigation incentives,
which is significantly lower than earned by the generating business
in recent years. Return on equity is also capped for the majority
of NEES' electricity delivery business at 11.75 percent, excluding
certain incentive mechanisms. Beginning on September 1, 1998, the
sale date of the nonnuclear generating business, NEES' earnings
became further dependent on the return on the reinvestment of the
sale proceeds, whether through retirement of debt, the repurchase
of NEES shares, investments in new ventures, or otherwise. This
reinvestment return is expected, at least in the near term, to be
considerably less than the return historically earned by the
generating business.
This report contains statements that may be considered forward
looking under the securities laws. Actual results may differ
materially. See the above discussion for factors which could cause
the results to differ.
Industry Restructuring
- ----------------------
For a full discussion of industry restructuring activities in
Massachusetts, Rhode Island, and New Hampshire, stranded cost
recovery, accounting implications of industry restructuring and
divestiture, workforce reductions, and impact of industry
restructuring on the distribution business, see the "Industry
Restructuring" section of the NEES Form 10-K for 1997 and the NEES
1997 Annual Report.
Industry Restructuring Update
New Hampshire
On July 13, 1998, the New Hampshire Public Utility Commission
(NHPUC), approved the comprehensive settlement agreement reached
between Granite State Electric Company (Granite State Electric),
New England Power Company (NEP), the Governor's office of the State
of New Hampshire, and a number of other parties. The Federal
Energy Regulatory Commission (FERC) had previously approved a
wholesale settlement in April, 1998. On July 27, 1998, NEP filed
with the FERC to amend the wholesale settlement to conform to the
settlement approved by the NHPUC. The settlement provided choice
of power supplier to Granite State Electric's customers as of July
1, 1998. The principal terms of the settlement are substantially
similar to the settlements reached in Massachusetts and Rhode
Island.
Divestiture of Generating Business
On September 1, 1998, NEES subsidiaries NEP and The
Narragansett Electric Company (Narragansett Electric) completed the
sale of substantially all of their nonnuclear generating business
to USGen New England, Inc. (USGen), an indirect wholly owned
subsidiary of PG&E Corporation. The NEES companies received $1.59
billion for the sale. In addition, the NEES companies were
reimbursed approximately $140 million for costs associated with
early retirements and special severance programs for employees
affected by industry restructuring, and the value of inventories.
For more information on the terms and events leading to the sale,
the accounting implications of the sale, and the assets sold, see
NEES' Annual Report on Form 10-K for the year ended December 31,
1997.
As part of the sale, USGen purchased NEP's entitlement to
approximately 1,100 megawatts of power procured under long-term
contracts. Pursuant to the transfer agreement, under certain
conditions involving formal assignment of the contracts to USGen
and a release of NEP from further obligations to the power
supplier, NEP is required to make a lump sum payment of the present
value of its monthly fixed contribution obligations. On or prior
to the closing date, NEP paid approximately $340 million towards
the above-market costs of two of the power contracts. NEP is
required to make fixed contributions averaging $9.5 million per
month through January 2008 towards the above-market cost of the
other contracts. USGen is responsible for the balance of the
costs under the purchased power contracts. All of the payments are
recoverable from customers as part of industry restructuring
settlements reached by NEP with various parties and approved by
state and Federal regulators. The present value of the future
monthly fixed contributions, amounting to $863 million, are
recorded as a liability on the balance sheet. This liability, as
well as the lump sum payments previously made, net of amortization,
are also recorded as a regulatory asset on the balance sheet.
In order to satisfy certain terms of its mortgage indenture,
NEP was required to defease or retire all of its $641 million of
mortgage bonds outstanding at the time of the sale of its
nonnuclear generating business. With respect to $372 million of
mortgage bonds securing the issuance of a like amount of pollution
control revenue bonds (PCRBs) issued by public agencies, NEP
retired the mortgage bonds, leaving the underlying PCRBs
outstanding as unsecured obligations of NEP. Pursuant to a tender
offer, NEP purchased $183 million of bonds. Provisions for the
payment of the remaining mortgage bonds were made by depositing
with trustees U.S. treasury obligations sufficient to pay principal
and interest to the maturity date, or, in the alternative,
principal, interest and premium to the first date on which the
bonds could be redeemed. Both the U.S. treasury obligations and
defeased bonds were removed from the September 30, 1998 balance
sheet.
Regulatory Asset Recovery
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 these charges because they are
expected to be included in future customer charges. In 1997, the
Emerging Issues Task Force of the Financial Accounting Standards
Board concluded that a utility who had received approval to recover
so-called "stranded costs" through regulated transmission and
distribution rates would be permitted to continue to apply FAS 71
to the recovery of stranded costs.
In accordance with industry restructuring settlement agreements
reached in Massachusetts, Rhode Island, and New Hampshire, NEP has
been permitted to recover its investments as of December 31, 1995
in the Millstone 3 and Seabrook 1 nuclear facilities, assuming
these facilities had zero market value. Recent sales of nuclear
units, (which have required the prefunding of decommissioning
liabilities by the seller,) have tended to confirm lower market
values for nuclear facilities. Consistent with these provisions of
the settlement agreements, and now that the divestiture of the
nonnuclear generating business has occurred, NEP recorded an
impairment writedown in its reserve for depreciation and
established an offsetting regulatory asset on the September 30,
1998 balance sheet for $348 million and $41 million, which
represent the net book value at December 31, 1995, less applicable
depreciation subsequent to that date, of Millstone 3 and Seabrook
1, respectively. Nevertheless, NEP will endeavor to sell, or
otherwise transfer, its interest in these nuclear plants. Should
these efforts yield a positive market value, NEP will credit any
such value to customers.
NEP has received authorization from the FERC to recover through
contract termination charges substantially all of the costs
associated with its former generating business not recovered
through the sale of that business. As a result, NEES has recorded
a regulatory asset for the costs which are recoverable from
customers through contract termination charges. The regulatory
asset includes the following major components: the loss on the
sale of NEES' oil and gas business and the unrecovered plant costs
in operating nuclear plants, reduced by the gain from the sale of
NEP's nonnuclear generating business, all of which will be
recovered by the end of 2000; and costs associated with permanently
closed nuclear power plants and the above-market costs associated
with purchased power contracts, which are being recovered over a
much longer period of time as such costs are actually incurred. At
September 30, 1998, regulatory assets totaled approximately $1.6
billion, of which $863 million related to the above-market costs of
purchased power contracts. All but approximately $100 million of
the regulatory assets are recoverable under NEP's contract
termination charge.
It is possible that future regulatory rules or other
circumstances could cause the application of FAS 71 to be
discontinued, which would result in a noncash write-off of
previously established regulatory assets, including those being
recovered through NEP's contract termination charge.
Year 2000 Computer Issues
- -------------------------
Over the next 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. This team reports project
progress to a recently formed 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 Fourth quarter Throughout 1999
Systems service integrated 1998
systems
Desktop Systems Personal computers/ Mid-1999 Throughout 1999
Department software/
Networks
Operational/ Dispatching systems/ Mid-1999 Throughout 1999
Embedded Transmission and
Systems Distribution systems/
Telephone systems
External Issues Electronic Data Mid-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. 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.
The NEES companies have also implemented a formalized
communication process with third parties to 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 cannot predict the
outcome of other companies' remediation efforts.
The NEES companies believe total costs associated with making
the necessary modifications to all centralized and noncentralized
systems will be approximately $25 million. In addition, the NEES
companies are spending $4 million related to the implementation of
a new human resources and payroll system, the replacement of which
is in part due to the Y2K issue. To date, total Y2K-related costs
of $19 million have been incurred, of which $1 million has been
capitalized.
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 both 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. The NEES companies expect that these
contingency plans will be in place by mid-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 the New England Power Pool (NEPOOL) and the
Independent System Operator of the NEPOOL area (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 the North American Electric
Reliability Council. 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 only in May
1998, resulting in a demanding and difficult schedule to attain
regional and interregional target dates.
The NEES companies believe the worst case scenario with a
reasonable chance of occurring is temporary disruptions of electric
service. This scenario could result from a failure to adequately
remediate Y2K problems at NEES company facilities or could be
caused by the inability of entities, such as ISO New England, to
maintain the short-term reliability of various generators and/or
transmission lines on a regional or superregional basis. The NEES
companies believe that the contingency plans being developed both
internally and on a regional level, as described above, should
substantially mitigate the risks of this potential scenario. 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 and results of operations.
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 and power suppliers, 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.
AllEnergy Acquisition
- ---------------------
On July 9, 1998, AllEnergy Marketing Company, L.L.C.
(AllEnergy), a wholly owned indirect subsidiary of NEES, acquired
substantially all of the assets of PAL Energy Corporation (PAL).
PAL is a full service distributor of petroleum-based products, and
is headquartered in Palmyra, NY. For the twelve-month period ended
August 31, 1997, PAL had revenues of approximately $125 million.
Operating Revenue
- -----------------
The following table summarizes the changes in operating
revenue:
Increase (Decrease) in Operating Revenue
Third Quarter Nine Months
------------- ------------
1998 vs 1997 1998 vs 1997
------------- ------------
(In Millions)
Industry restructuring-related
rate changes:
Generation-related $(44) $(90)
Distribution-related 13 32
Fuel cost-related 1 (29)
Massachusetts Electric and Nantucket
Electric Purchased Power Cost
Adjustment (PPCA) mechanism (3) 9
Oil and gas-related revenue (12) (48)
AllEnergy revenue 45 103
Increase in kWh deliveries 6 5
Other (4) (4)
---- ----
$ 2 $(22)
==== ====
Generation-related rate reductions reflect rate reductions to
customers as part of industry restructuring and the implementation
of customer choice of power supplier in Rhode Island on January 1,
1998, in Massachusetts on March 1, 1998, and in New Hampshire on
July 1, 1998. These rate reductions also include the effect of
various true-up mechanisms. These true-up mechanisms cover a
number of items including stranded cost recovery billings, fuel
expense, nuclear operating costs and decommissioning costs and the
non-fuel component of purchased power expense.
The increase in distribution revenues reflects a $45 million
rate increase at Massachusetts Electric Company (Massachusetts
Electric) in accordance with the provisions of the industry
restructuring settlement in Massachusetts, which became effective
March 1, 1998. The revenue increase also reflects a $7 million
increase in distribution rates for Narragansett Electric that
became effective January 1, 1998 pursuant to Rhode Island's Utility
Restructuring Act of 1996.
For a discussion of fuel recovery during 1998, see the fuel
costs discussion in the "Operating Expenses" section.
The increase in revenues related to Massachusetts Electric's
and Nantucket Electric Company's (Nantucket Electric) PPCA
mechanism during 1998 reflects the end of this mechanism in
accordance with the Massachusetts industry restructuring
settlement. During the third quarter of 1997, approximately $3
million of additional revenue was recognized, whereas for the nine-
months ended September 30, 1997, PPCA net refund provisions of
approximately $9 million had been accrued, and reversed into
revenue in the fourth quarter of 1997.
The decrease in oil and gas-related revenues reflects the sale
of New England Energy Incorporated's (NEEI) oil and gas properties
effective January 1, 1998.
The inclusion of the AllEnergy revenue figure in the above
table is due to AllEnergy becoming a wholly owned and fully
consolidated subsidiary of NEES in the fourth quarter of 1997.
NEES had previously accounted for its 50 percent ownership interest
under the equity method of accounting, as a component of other
income. For the third quarter and first nine months of 1997, total
AllEnergy revenues were $11 million and $41 million, respectively.
KWh deliveries increased 5.4 percent and 1.8 percent for the
third quarter and first nine months of 1998, respectively. The
year-to-date increase is driven almost entirely by the third
quarter increase, which is attributable to a combination of warmer
weather in the third quarter of 1998 as compared to the same period
in 1997 and a strong regional economy.
The decrease in other revenues for the third quarter and year-
to-date period is primarily due to a decrease in demand-side-
management related revenues, a decrease in revenues associated with
postretirement benefit costs other than pensions, and various other
revenue decreases.
Operating Expenses
- ------------------
The following table summarizes the changes in operating
expenses:
Increase (Decrease) in Operating Expenses
Third Quarter Nine Months
------------- ------------
1998 vs 1997 1998 vs 1997
------------- ------------
(In Millions)
Fuel costs $ 2 $(28)
Purchased energy, excluding fuel (3) (21)
Operation and maintenance:
AllEnergy 50 117
NEP PBOP amortization (2) (14)
Other (23) (34)
Depreciation and amortization:
Utility plant 2 24
Oil and gas properties (13) (48)
Taxes 1 1
---- ----
$ 14 $ (3)
==== ====
The decrease in fuel costs for the year-to-date-period
primarily represents the effect of the sale of NEES' nonnuclear
generating business to USGen on September 1, 1998 and reduced
wholesale sales to other utilities and lower coal and oil prices.
The decrease in purchased power costs, excluding fuel, during
the third quarter and year-to-date period reflects reduced charges
from the Maine Yankee nuclear power plant, which was closed in mid-
1997 and the transfer of NEP's purchased power contracts, in
conjunction with the sale of the nonnuclear generating business to
USGen on September 1, 1998. These decreases were partially offset
by monthly contractual payments to USGen for the above-market
portion of transferred purchased power contracts.
As previously described, the inclusion of AllEnergy costs in
the above table is due to AllEnergy becoming a wholly owned and
fully consolidated subsidiary of NEES in the fourth quarter of
1997. For the third quarter and the first nine months of 1997,
total AllEnergy expenses were $16 million and $52 million,
respectively.
The decrease in operation and maintenance expense associated
with postretirement benefits other than pensions (PBOP)
amortization reflects the completion of the accelerated PBOP
amortization in 1997 under the terms of a 1995 rate agreement.
This decrease in expense is offset by a corresponding increase in
the accelerated amortization of Millstone 3 which is described in
the depreciation and amortization expense section below.
The decrease in other operation and maintenance expense during
the third quarter and year-to-date period is due primarily to the
sale of the nonnuclear generating business and lower charges from
the partially owned Seabrook 1 and Millstone 3 nuclear generating
facilities, partially offset by increased transmission wheeling
costs. For the year-to-date period, the decrease also reflects
lower charges related to PBOPs and 1997 charges for NEP's share of
the costs of the restoration to service of previously idled
generating facilities in response to a tightened regional power
supply.
The decrease in oil and gas property depreciation and
amortization expense during 1998 reflects the end of the
amortization of oil and gas costs as a result of the sale of NEEI's
oil and gas properties effective January 1, 1998.
The increase in utility plant depreciation and amortization
expense is primarily due to the $11 million increase in annual
depreciation expense provided for in the Massachusetts industry
restructuring settlement, amortization of depreciation related to
new distribution and transmission-related utility plant
expenditures, and the accelerated amortization of NEP's investment
in the Millstone 3 nuclear unit, a portion of which was
attributable to the completion of the PBOP amortization discussed
above. This accelerated amortization is recorded as a regulatory
liability. This increase was partially offset in the third quarter
by reduced generation-related depreciation resulting from the sale
of the nonnuclear generating business on September 1, 1998.
Liquidity and Capital Resources
- -------------------------------
Plant expenditures for the first nine months of 1998 amounted
to $134 million. The funds necessary for utility plant expenditures
during the period were primarily provided by proceeds from the sale
of the nonnuclear generating business.
The financing activities of NEES subsidiaries for the first
nine months of 1998 are summarized as follows:
Issues Retirements
------ -----------
(In Millions)
Long-term debt
- --------------
NEP $ - $328
Massachusetts Electric 25 30
Narragansett Electric - 10
Granite State Electric 5 -
Nantucket Electric - 1
NEEI - 122
Hydro-Transmission Companies - 9
Narragansett Energy Resources Company - 29
--- ----
$30 $529
=== ====
On August 26, 1998, the NEES Board of Directors authorized the
purchase from time to time of up to an additional five million NEES
common shares over the five million common share buyback
authorization announced in August 1997, through open market
purchases. Through September 30, 1998, NEES purchased
approximately 5.3 million shares under the repurchase program.
At September 30, 1998, NEES and its consolidated subsidiaries
had lines of credit and standby bond purchase facilities with banks
totaling $1.0 billion. These lines and facilities were used for
liquidity support for $372 million of NEP mortgage bonds in tax-
exempt commercial paper mode.
As part of NEES' plan to divest its generating business, NEEI
sold its oil and gas properties effective January 1, 1998, for
approximately $50 million. NEEI's loss on the sale of
approximately $120 million, before tax, has been reimbursed by NEP.
This loss has been recorded as a regulatory asset, which is
recoverable under the terms of the restructuring settlements
reached in Massachusetts, Rhode Island, and New Hampshire.
NEP prepaid approximately $190 million and $150 million in May
1998 and August 1998, respectively, in conjunction with the
amendment of two long-term purchased power contracts. These
balances, net of amortization, are recorded as regulatory assets on
the balance sheet.
NEES also paid off all $252 million of its short-term debt
outstanding.
In September 1998, Narragansett Electric repurchased preferred
stock with a par value of $5.2 million.
In October 1998, Massachusetts Electric repurchased or redeemed
preferred stock with a par value of $5.1 million, and NEP redeemed
preferred stock with a par value of $8.7 million.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
- --------------------------
Information concerning a lawsuit brought by the Company's
subsidiary, New England Power Company (NEP) against Northeast
Utilities on August 7, 1997 in Massachusetts Superior Court,
Worcester County concerning the Millstone 3 nuclear unit, discussed
in this report in Note B of Notes to Unaudited Financial
Statements, is incorporated herein and made a part hereof.
Information concerning an arbitration between NEP and
Connecticut Light & Power Company and Western Massachusetts
Electric Company concerning the Millstone 3 nuclear unit, discussed
in this report in Note B of Notes to Unaudited Financial
Statements, is incorporated herein and made a part hereof.
Information concerning a dispute between NEP and secondary
purchasers of Maine Yankee power output, discussed in this report
in Note B of Notes to Unaudited Financial Statements, is
incorporated herein and made a part hereof.
Information concerning dismissal of a lawsuit brought against
NEP by the Town of Norwood, Massachusetts and appeals of related
Federal Energy Regulatory Commission orders, discussed in this
report in Note C of Notes to the Unaudited Financial Statements, is
incorporated herein and made a part hereof.
Information concerning two arbitration decisions and related
appeals regarding NEP's purchased power contract with Hydro-Quebec,
discussed in this report in Note D of Notes to Unaudited Financial
Statements, is incorporated herein and made a part hereof.
Item 5. Other Information
- --------------------------
Under recent changes in the Federal proxy rules, the Company's
proxy statement for the 1999 Annual Meeting of Shareholders will
include discretionary authority by management to vote on any non-
Rule 14a-8 shareholder proposal (one that is not included in the
Company's proxy statement) that the Company receives after February
1, 1999.
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
The Company filed a report on Form 8-K dated September 1, 1998,
containing Items 2, 5, and 7, and including proforma financial
statements.
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, 1998 to be signed on its behalf by
the undersigned thereunto duly authorized.
NEW ENGLAND ELECTRIC SYSTEM
s/John G. Cochrane
John G. Cochrane
Treasurer, Authorized Officer,
and Chief Accounting Officer
Date: November 12, 1998
The name "New England Electric System" means the trustee or
trustees for the time being (as trustee or trustees but not
personally) under an agreement and declaration of trust dated
January 2, 1926, as amended, which is hereby referred to, and a
copy of which as amended has been filed with the Secretary of the
Commonwealth of Massachusetts. Any agreement, obligation or
liability made, entered into or incurred by or on behalf of New
England Electric System binds only its trust estate, and no
shareholder, director, trustee, officer or agent thereof assumes or
shall be held to any liability therefor.