<PAGE 1> UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549-1004 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1995 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ________________ to ________________ Commission File Number 1-7316 COMMONWEALTH ENERGY SYSTEM (Exact name of registrant as specified in its Declaration of Trust) Massachusetts 04-1662010 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Main Street, Cambridge, Massachusetts 02142-9150 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (617) 225-4000 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 [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock August 1, 1995 Common Shares of Beneficial Interest, $4 par value 10,706,391 shares <PAGE 2> PART I. - FINANCIAL INFORMATION Item 1. Financial Statements COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES CONDENSED BALANCE SHEETS JUNE 30, 1995 AND DECEMBER 31, 1994 ASSETS (Unaudited) June 30, December 31, 1995 1994 (Dollars in Thousands) PROPERTY, PLANT AND EQUIPMENT, at original cost Electric $1 059 780 $1 047 140 Gas 337 346 338 111 Other 60 137 59 213 1 457 263 1 444 464 Less - Accumulated depreciation and amortization 484 552 461 310 972 711 983 154 Add - Construction work in progress and nuclear fuel in process 30 582 15 974 1 003 293 999 128 LEASED PROPERTY, net 15 544 15 729 EQUITY IN CORPORATE JOINT VENTURES Nuclear electric power companies (2.5% to 4.5%) 9 921 9 818 Other investments 3 623 3 830 13 544 13 648 CURRENT ASSETS Cash and cash equivalents 3 382 7 722 Accounts receivable 82 211 92 157 Unbilled revenues 11 849 33 161 Inventories, at average cost 25 486 33 586 Prepaid taxes and other 6 438 14 664 129 366 181 290 DEFERRED CHARGES 161 694 134 921 $1 323 441 $1 344 716 <PAGE 3> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES CONDENSED BALANCE SHEETS JUNE 30, 1995 AND DECEMBER 31, 1994 CAPITALIZATION AND LIABILITIES (Unaudited) June 30, December 31, 1995 1994 (Dollars in Thousands) CAPITALIZATION Common share investment - Common shares, $4 par value - Authorized - 18,000,000 shares Outstanding - 10,644,264 in 1995 and 10,525,897 in 1994 $ 42 577 $ 42 103 Amounts paid in excess of par value 107 492 103 168 Retained earnings 228 599 217 726 378 668 362 997 Redeemable preferred shares, less current sinking fund requirements 14 410 14 660 Long-term debt, including premiums, less current sinking fund requirements and maturing debt 396 732 418 307 789 810 795 964 CAPITAL LEASE OBLIGATIONS 13 805 14 098 CURRENT LIABILITIES Interim Financing - Notes payable to banks 23 150 44 850 Maturing long-term debt 35 000 25 000 58 150 69 850 Other Current Liabilities - Current sinking fund requirements 6 793 6 793 Accounts payable 113 901 117 953 Accrued taxes 12 294 17 947 Other 38 711 38 504 171 699 181 197 229 849 251 047 DEFERRED CREDITS Accumulated deferred income taxes 163 548 160 944 Unamortized investment tax credits and other 126 429 122 663 289 977 283 607 COMMITMENTS AND CONTINGENCIES $1 323 441 $1 344 716 See accompanying notes. <PAGE 4> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES CONDENSED STATEMENTS OF INCOME FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1995 AND 1994 (Unaudited) Three Months Ended Six Months Ended 1995 1994 1995 1994 (Dollars in Thousands) OPERATING REVENUES Electric $137 482 $147 836 $288 995 $319 079 Gas 67 072 62 757 175 050 198 306 Steam and other 3 539 3 039 9 272 9 153 208 093 213 632 473 317 526 538 OPERATING EXPENSES Fuel and purchased power 76 252 79 891 163 468 182 020 Cost of gas sold 39 419 36 515 90 555 107 922 Other operation and maintenance 62 800 65 174 124 691 127 897 Depreciation 11 244 10 350 24 995 23 239 Taxes - Local property and other 5 864 5 716 14 227 13 604 Federal and state income (4 040) 1 785 8 817 19 520 191 539 199 431 426 753 474 202 OPERATING INCOME 16 554 14 201 46 564 52 336 OTHER INCOME 1 184 198 3 087 808 INCOME BEFORE INTEREST CHARGES 17 738 14 399 49 651 53 144 INTEREST CHARGES Long-term debt 9 772 9 852 19 571 19 702 Other interest charges 1 884 931 3 317 1 974 Allowance for borrowed funds used during construction (348) (144) (600) (243) 11 308 10 639 22 288 21 433 NET INCOME 6 430 3 760 27 363 31 711 Dividends on preferred shares 282 297 564 594 EARNINGS APPLICABLE TO COMMON SHARES $ 6 148 $ 3 463 $ 26 799 $ 31 117 AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 10 624 812 10 382 879 10 595 564 10 355 670 EARNINGS PER COMMON SHARE $ .58 $ .32 $2.53 $3.00 DIVIDENDS DECLARED PER COMMON SHARE $ .75 $ .75 $1.50 $1.50 See accompanying notes. <PAGE 5> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES CONDENSED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1995 AND 1994 (Unaudited) 1995 1994 (Dollars in Thousands) OPERATING ACTIVITIES Net income $ 27 363 $ 31 711 Effects of noncash items - Depreciation and amortization 30 987 29 937 Deferred income taxes and investment tax credits, net (577) 1 093 Earnings from corporate joint ventures (763) (849) Dividends from corporate joint ventures 867 543 Change in working capital, exclusive of cash, cash equivalents and interim financing 38 086 68 541 All other operating items (20 887) (24 208) Net cash provided by operating activities 75 076 106 768 INVESTING ACTIVITIES Additions to property, plant and equipment (exclusive of AFUDC) - Electric (26 927) (11 771) Gas (6 150) (8 303) Other (522) (80) Allowance for borrowed funds used during construction (600) (243) Net cash used for investing activities (34 199) (20 397) FINANCING ACTIVITIES Sale of common shares 4 798 4 648 Payment of dividends (16 490) (16 156) Payment of short-term borrowings (21 700) (71 975) Long-term debt issue refunded (10 000) - Sinking funds payments (1 825) (1 825) Net cash used for financing activities (45 217) (85 308) Net increase (decrease) in cash and cash equivalents (4 340) 1 063 Cash at beginning of period 7 722 6 007 Cash and cash equivalents at end of period $ 3 382 $ 7 070 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest (net of capitalized amounts) $ 20 884 $ 20 570 Income taxes $ 4 545 $ 5 180 See accompanying notes. <PAGE 6> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES NOTES TO CONDENSED FINANCIAL STATEMENTS (1) Accounting Policies Commonwealth Energy System, the parent company, is referred to in this report as the "System" and, together with its subsidiaries, is collectively referred to as "the system." The system's significant accounting policies are described in Note 1 of Notes to Consolidated Financial Statements included in its 1994 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the system follows these same basic accounting policies but considers each interim period as an integral part of an annual period and makes allocations of certain expenses to interim periods based upon estimates of such expenses for the year. Regulated subsidiaries of the System have established various regulatory assets in cases where the Massachusetts Department of Public Utilities (DPU) and/or the Federal Energy Regulatory Commission (FERC) have permitted or are expected to permit recovery of specific costs over time. Similarly, the regulatory liabilities established by the system are required to be refunded to customers over time. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). SFAS 121 imposes stricter criteria for regulatory assets by requiring that such assets be probable of future recovery at each balance sheet date. Based on the current regulatory framework, the system accounts for the economic effects of regulation in accordance with the provisions of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation" and does not expect that the adoption of SFAS 121, which the system expects to adopt on January 1, 1996, will have a material impact on its financial position or results of operations. However, this conclusion may change in the future if changes are made in the current regulatory framework or as competitive factors influence wholesale and retail pricing in this industry. The principal regulatory assets included in deferred charges at June 30, 1995 and December 31, 1994 were as follows: 1995 1994 (Dollars in Thousands) Purchased power contract buy-out $ 25 539 $ - Fuel charge stabilization 23 503 16 638 Postretirement benefit costs including pensions 23 354 20 129 Yankee Atomic unrecovered plant and decommissioning costs 16 168 18 368 Seabrook related costs 11 095 12 648 Deferred income taxes 9 626 5 537 FERC Order 636 transition costs 7 205 19 201 Pilgrim nuclear plant litigation costs 6 822 7 001 Cannon Street generating plant abandonment, net 4 400 4 400 Conservation and load management costs 3 394 3 773 Other 4 566 4 042 Total regulatory assets $135 672 $111 737 <PAGE 7> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES The regulatory liabilities, reflected in the accompanying balance sheets and principally related to deferred income taxes, were $26.5 million and $17.3 million at June 30, 1995 and December 31, 1994, respectively. Generally, expenses which relate to more than one interim period are allocated to other periods to more appropriately match revenues and expenses. Principal items of expense which are allocated other than on the basis of passage of time are depreciation and property taxes of the gas subsidiary, Commonwealth Gas Company (Commonwealth Gas). These expenses are recorded for interim reporting purposes based upon projected gas revenue. Income tax expense is recorded using the statutory rates in effect applied to book income subject to tax for each interim period. The unaudited financial statements for the periods ended June 30, 1995 and 1994, reflect, in the opinion of the System, all adjustments necessary to summarize fairly the results for such periods. In addition, certain prior period amounts are reclassified from time to time to conform with the presentation used in the current period's financial statements. The results for interim periods are not necessarily indicative of results for the entire year because of seasonal variations in the consumption of energy and Commonwealth Gas' seasonal rate structure. (2) Commitments and Contingencies (a) Construction The system is engaged in a continuous construction program presently estimated at $357.4 million for the five-year period 1995 through 1999. Of that amount, $87.7 million is estimated for 1995. The program is subject to periodic review and revision. (b) Decommissioning of Nuclear Power Plants The system, through Canal Electric Company (Canal), has a 3.52% joint- ownership interest in the Seabrook nuclear power plant. Canal and the other joint owners have established a decommissioning fund to cover post operational decommissioning costs. The estimated cost to decommission the plant is $386 million. Canal's share of this liability (approximately $13.6 million), less its share of the market value of the decommissioning trust (approximately $1.2 million), is approximately $12.4 million. Yankee Atomic Nuclear Power Plant In February 1992, the Board of Directors of Yankee Atomic Electric Company (Yankee Atomic) agreed to permanently discontinue power operation and decommission the Yankee Nuclear Power Station (the plant). At June 30, 1995, Cambridge Electric Light Company's (Cambridge Electric) and Common- wealth Electric Company's respective 2% and 2.5% investment in Yankee Atomic was approximately $1.1 million. The most recent cost estimate to perm- anently shut down the plant is approximately $359 million. The companies' share of this liability is $16.2 million and is currently reflected in the accompanying consolidated balance sheets as a liability and corresponding regulatory asset. <PAGE 8> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES Other Nuclear Plants Cambridge Electric also has equity ownership interests ranging from 2.5% to 4.5% in three operating nuclear generating facilities located in New England with contract expiration dates ranging from 2007 to 2012. Cambridge Electric is obligated to pay its proportionate share of the capacity and energy costs associated with these units, which include depreciation, operations and maintenance, a return on invested capital and the estimated cost of decommissioning the plants at the end of their estimated service lives. Cambridge Electric's estimated total decommissioning cost and associated market value share of decommissioning trust assets for these units is approximately $36 million and $13.3 million, respectively. (c) Maine Yankee Nuclear Power Plant One of the operating nuclear generating facilities that Cambridge Electric has an equity ownership interest in, the Maine Yankee Nuclear Power Plant, operated by Maine Yankee Atomic Power Company (Maine Yankee), has been experiencing degradation of its steam generator tubes, principally in the form of circumferential cracking, which until early 1995 was believed to be limited to a relatively small number of tubes. During a refueling and maintenance outage that began in early February 1995, Maine Yankee, through the use of new inspection methods, detected increased degradation involving approximately 60% of the tubes which was well beyond Maine Yankee's expectations. After carefully evaluating alternative courses of action to remedy this situation, Maine Yankee announced in late May that it will begin repairs by sleeving all 17,000 steam generator tubes. This repair technique is a proven safe and technologically sound option commonly used in plants throughout the United States and the world. The repairs are estimated to cost approximately $40 million including Cambridge Electric's share of $1.6 million. Repairs began in June and are expected to be completed by the end of this year. (d) FERC Order No. 636 In May 1995, the DPU allowed Commonwealth Gas to accelerate recovery of its FERC Order No. 636 transition costs that were incurred to date. These costs had been deferred and accumulated as a regulatory asset and were being recovered through the cost of gas adjustment (CGA) over a four-year period that began in November 1993. The costs are now being recovered through the CGA over a one-year period that began May 1, 1995. The accelerated recovery period was permitted by the DPU due to the minimal impact on customers' bills. Any further transition costs will be recovered by Commonwealth Gas through the CGA as incurred. At June 30, 1995, a regulatory asset totaling $7.2 million was reflected in deferred charges. In addition, a related liability of $7.2 million was reflected in deferred credits. <PAGE 9> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition Capital resources of the System and its subsidiaries are derived principally from retained earnings and equity funds provided through the System's Dividend Reinvestment and Common Share Purchase Plan (DRP). Supplemental interim funds are borrowed on a short-term basis and, when necessary, replaced with new equity and/or debt issues through permanent financing secured on an individual company basis. The system purchases 100% of all subsidiary common stock issues and provides, to the extent possible, a portion of the subsidiaries' short-term financing needs. These capital resources provide the funds required for the subsidiary companies' construction programs, current operations, debt service and other capital requirements. For the first six months of 1995, cash flows from operating activities amounted to approximately $75.1 million and reflect net income of $27.4 million and noncash items such as depreciation ($25 million), amortization ($6 million) and deferred income taxes (net of investment tax credits) which amounted to ($577,000). The change in working capital since December 31, 1994, exclusive of cash, cash equivalents and interim financing, amounted to $38.1 million and had a significant positive impact on cash flows from operating activities, reflecting lower levels of unbilled revenues ($21.3 million), accounts receivable ($9.9 million), inventories ($8.1 million) and prepaid taxes and other ($8.2 million), offset, in part, by lower levels of accrued taxes and accounts payable of $5.7 million and $4.1 million, respectively. In addition, the change in all other operating items for the current six months includes $25.5 million relating to Commonwealth Electric Company's (Commonwealth Electric) power contract buy-out with an independent power producer. This amount was paid in April 1995 and will be recovered with carrying charges over a seven-year period that began in April 1995. Construction expenditures for the first six months of 1995 were approximately $34.2 million, including an allowance for funds used during construction and nuclear fuel. Construction expenditures, preferred and common dividend requirements of the System ($16.5 million), the payment of short-term borrowings ($21.7 million) and the refunding of long-term debt ($10 million) were funded almost entirely with internally generated funds. Results of Operations The following is a discussion of certain significant factors which have affected operating revenues, expenses and net income during the periods included in the accompanying condensed statements of income. This discussion should be read in conjunction with the Notes to Condensed Financial Statements appearing elsewhere in this report. <PAGE 10> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES A summary of the period to period changes in the principal items included in the condensed statements of income for the three and six months ended June 30, 1995 and 1994 and unit sales for these periods is shown below: Three Months Six Months Ended June 30, Ended June 30, 1995 and 1994 1995 and 1994 Increase (Decrease) (Dollars in Thousands) Operating Revenues - Electric $(10 354) (7.0)% $(30 084) (9.4)% Gas 4 315 6.9 (23 256) (11.7) Steam and other 500 16.5 119 1.3 (5 539) (2.6) (53 221) (10.1) Operating Expenses - Fuel and purchased power (3 639) (4.6) (18 552) (10.2) Cost of gas sold 2 904 8.0 (17 367) (16.1) Other operation and maintenance (2 374) (3.6) (3 206) (2.5) Depreciation 894 8.6 1 756 7.6 Taxes - Local property and other 148 2.6 623 4.6 Federal and state income (5 825) (326.3) (10 703) (54.8) (7 892) (4.0) (47 449) (10.0) Operating Income 2 353 16.6 (5 772) (11.0) Other Income 986 498.0 2 279 282.1 Income Before Interest Charges 3 339 23.2 (3 493) (6.6) Interest Charges 669 6.3 855 4.0 Net Income 2 670 71.0 (4 348) (13.7) Dividends on preferred shares (15) (5.1) (30) (5.1) Earnings Applicable to Common Shares $ 2 685 77.5 $ (4 318) (13.9) Unit Sales Electric - Megawatthours (MWH) Retail 24 675 2.3 (21 283) (0.9) Wholesale (784 701) (74.8) (1 563 449) (70.4) (760 026) (35.9) (1 584 732) (35.4) Gas - Billions of British Thermal Units (BBTU) Firm 427 7.3 (2 545) (10.2) Interruptible and other (324) (14.8) 1 497 65.7 103 1.3 (1 048) (3.9) <PAGE 11> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES The following is a summary of electric and gas unit sales for the three and six-month periods ended June 30, 1995 and 1994: Three Months Ended Six Months Ended June 30, June 30, 1995 1994 1995 1994 Electric Sales - MWH Residential 392 619 386 628 850 110 891 517 Commercial 590 913 573 519 1 177 610 1 158 728 Industrial 105 941 104 840 202 250 201 397 Other 5 127 4 938 11 685 11 296 Total retail sales 1 094 600 1 069 925 2 241 655 2 262 938 Wholesale to other systems 263 853 1 048 554 656 310 2 219 759 Total 1 358 453 2 118 479 2 897 965 4 482 697 Gas Sales - BBTU Residential 3 459 3 238 12 863 14 361 Commercial 1 731 1 584 6 163 6 921 Industrial 765 711 2 239 2 394 Other 299 294 1 100 1 234 Total firm sales 6 254 5 827 22 365 24 910 Off-system sales 967 - 2 380 - Quasi-firm sales 520 - 870 - Interruptible sales 374 2 185 527 2 280 Total 8 115 8 012 26 142 27 190 Electric Operating Revenues, Fuel and Purchased Power Costs For the second quarter and first six months of 1995, electric operating revenues decreased approximately $10.4 million and $30.1 million, respec- tively, from the corresponding periods in 1994 due primarily to declines of $13.4 million and $29.8 million in wholesale sales. However, fluctuations in the level of wholesale sales have little, if any, impact on net income. During the current six-month period, the decrease in operating revenues also reflected a 4.6% decline in retail unit sales to residential customers reflecting the extremely mild weather conditions during the first quarter of 1995 compared to the record cold experienced during the same period in 1994. Unit sales to commercial and industrial customers changed marginally from the first half of 1994 since these customer sectors draw less energy for heating. During the current quarter, retail unit sales increased 2.3% as sales to all customer classes increased, partially offsetting the revenue decline caused by the lower wholesale sales. In addition, the current three and six-month periods include reductions in fuel and purchased power costs of $3.6 million and $18.6 million, respectively, due mainly to a lower level of fuel oil costs at Canal Electric Company's (Canal) Unit 1 that reflected an annual inspection and unscheduled turbine maintenance. Also contributing to this decrease was the reduced availability of Canal Unit 2 and a decline in power purchased from an independent power producer (IPP) reflecting the restructuring of a power contract that defers purchases for a six-year period that began in early 1995. Slightly offsetting these reduced power sources was greater generation from Seabrook and an increase in power purchases from several <PAGE 12> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES other non-utility generators. During the first quarter of 1995, Common- wealth Electric successfully terminated a long-term power contract with another IPP through a buy-out arrangement which will reduce future power costs. Commonwealth Electric and Cambridge Electric Light Company (Cambridge Electric) have also received approval from the Massachusetts Department of Public Utilities (DPU) to recover in revenues certain current costs associated with conservation and load management (C&LM) programs through the operation of a Conservation Charge decimal on a dollar-for-dollar basis. To the extent that these expenses increase or decrease from period to period based on customer participation, a corresponding change will occur in revenues. For the current six-month period, this item declined $1.3 million and $333,000 for Commonwealth Electric and Cambridge Electric, respectively. Historically, revenues collected through base rates have been designed to reimburse Commonwealth Electric and Cambridge Electric for all costs of operation other than fuel, the energy portion of purchased power, transmission and C&LM costs, and provide a fair return on capital invested in the business. However, as a result of a DPU-mandated recovery mechanism for capacity-related costs associated with certain long-term purchased power contracts, Commonwealth Electric and Cambridge Electric experience a revenue excess or shortfall when unit sales and/or the costs recoverable in base rates vary from test-period levels. This issue, which has had a significant impact on net income, was addressed in settlement agreements approved by the DPU in May 1995. (Refer to the "Rate Settlement Agreements" section for additional details.) In the current three and six-month periods, in accordance with the settlement agreements, approximately $1.7 million of these capacity-related costs were deferred for future recovery. During the current six-month period, the total undercollection of such capacity-related costs was $969,000 compared to $838,000 in 1994 as a result of this recovery mechanism. In the current three-month period, revenues included the recovery of approximately $63,000 in excess of such capacity-related costs compared to an undercollection of $942,000 in the same period for 1994. Net income would have been reduced by approximately $1 million in both the current three and six-month periods had the excess capacity-related costs not been deferred pursuant to the settlement agreements. Gas Operating Revenues and Cost of Gas Sold Gas operating revenues decreased $23.3 million (11.7%) during the first half of 1995 due mainly to a $17.4 million reduction in the cost of gas sold that reflected lower firm unit sales and lower gas costs offset, in part, by off-system and quasi-firm sales that began in 1994. Firm unit sales for the current six-month period decreased 10.2% reflecting declines to residential (10.4%), commercial (11%) and industrial (6.5%) customers due to the mild weather conditions experienced during the first quarter of 1995 compared to the record cold temperatures experienced for the same quarter of 1994 off- set, in part, by higher firm unit sales in all customer segments during the current quarter. For the first half of 1995, heating degree days totaled 3,806 compared to 4,242 for the same period in 1994, a decrease of 10.3%. <PAGE 13> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES Other Operating Expenses Other operation and maintenance decreased during the current quarter and first half of 1995 by 3.6% and 2.5%, respectively, due to lower C&LM costs ($1.3 million), a decline in the provision for bad debts reflecting improved collection experience ($555,000) and continued cost containment efforts offset, in part, by higher labor and benefit costs ($3.3 million) and increased maintenance costs relative to Canal Unit 1 ($2.2 million). The higher level of benefit costs reflects the full recognition of expenses relating to postretirement benefits other than pensions and the amortization of previously deferred postretirement benefits costs. (Refer to the "Rate Settlement Agreements" section for additional details.) Depreciation expense increased in both current periods due to a higher level of depreciable plant and, to a lesser degree, an adjustment to depreciation rates related to Canal Unit 1 during the second quarter. Local property and other taxes increased 2.6% and 4.6% in the current three and six-month periods due mainly to higher rates and assessments. The decrease in federal and state income taxes during the current periods reflects a significantly lower level of taxable income as well as an adjustment made in conjunction with the aforementioned settlement agreements. Other Income and Interest Charges Other income for the current three and six-month periods increased approximately $986,000 and $2.3 million, respectively, due primarily a higher level of interest income related to Commonwealth Electric's fuel charge stabilization deferral ($759,000) and carrying costs on the buy-out of a power contract ($684,000) with an independent power producer. The cost of the buy-out is being recovered from customers over a seven-year period. Other income for the current six-month period also reflects the partial reversal of a reserve related to certain costs associated with Commonwealth Electric's energy conservation program ($1.4 million), the recovery of which has since been approved by the DPU. Total interest charges for the current quarter and first six months of 1995 increased 6.3% and 4% due primarily to a higher level of interest on deferred gas costs ($995,000) offset, in part, by an increase in the debt component of allowance for funds used during construction ($357,000). Power Contract Arbitration On June 7, 1995, a three-member panel of arbitrators upheld the termination by Commonwealth Electric and Cambridge Electric (the Companies) of power contracts with Eastern Energy Corporation (Eastern), the developer of a proposed 300 MW coal-fired plant. In June 1989, the Companies agreed to buy 27% (50 MW and 33 MW, respectively) of the power to be produced by the proposed plant, originally scheduled to begin operation in January 1992. However, in May 1994, the Companies gave notice of termination of their power contracts with Eastern based upon its failure to meet the permitting, construction or operation milestones established by the contracts, obtain the required permits, commence construction or sell any additional power from the proposed plant. Efforts to reshape the power contracts to provide <PAGE 14> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES a satisfactory arrangement were unsuccessful. In a letter dated June 30, 1994, Eastern objected to the notices of termination and invoked arbitration seeking $52 million from the Companies. The panel's decision is binding and prevents Eastern from further litigating or contesting the termination of the contracts in any other forum. This action is expected to save the Companies' customers approximately $100 million over the next ten years and as much as $225 million over twenty years. Regulatory Matters Rate Settlement Agreements In May 1995, the DPU approved settlement proposals sponsored jointly by Commonwealth Electric, Cambridge Electric and the Attorney General of Massachusetts which resolved issues related to cost of service, rates, accounting matters and generating unit performance reviews. Commonwealth Electric's agreement: (1) implements a $2.7 million annual retail base rate decrease effective May 1, 1995 including its share of excess deferred tax reserves related to Seabrook Unit No. 1 refunded in May 1995 to Commonwealth Electric by Canal. Further, the settlement imposes a moratorium on retail rate filings until October 1998; (2) limits Commonwealth Electric's return on equity as defined in the settlement, for the period through December 31, 1997; (3) terminates several 1987-1994 generating unit performance review proceedings pending before the DPU; (4) amends Commonwealth Electric's current fuel charge stabilization mechanism to include deferral (without carrying charges) of certain long-term purchased power and transmission capacity costs within the original limits established for the fuel charge stabilization deferral ($16 million in any given calendar year and $40 million over the life of the mechanism); (5) requires Commonwealth Electric to fully expense costs relating to postretirement benefits other than pensions in accordance with Statement of Financial Accounting Standards No. 106 and amortize the current deferred balance of $8.6 million over a ten-year period; (6) provides eligible Economic Development Rate customers with a discount of up to 30% but also requires these customers to provide Commonwealth Electric with a five-year notice if they intend to self-generate or acquire electricity from another provider; and (7) prohibits Commonwealth Electric from seeking recovery of the costs incurred in realizing costs savings through a 1993 work force reduction and restructuring, totaling approximately $3 million. <PAGE 15> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES Cambridge Electric's agreement: (1) implements a $1.5 million refund to Cambridge Electric's customers through the Fuel Charge during the third and fourth quarters of 1995 including its share of excess deferred tax reserves related to Seabrook Unit No. 1 refunded in May 1995 to Cambridge Electric by Canal; (2) allows Cambridge Electric to defer certain long-term purchased power and transmission capacity costs in excess of the amount of such capacity costs currently included in Cambridge Electric's base rates up to an annual amount of $2 million for recovery in its next general retail base rate case; (3) prohibits Cambridge Electric from seeking recovery of costs it incurred in obtaining costs savings by work force reduction and restructuring, totaling approximately $400,000; and (4) includes the DPU's withdrawal of all related requests, appeals, motions or other issues raised by parties regarding certain generating unit performance reviews. The system's management is encouraged by the support provided through the Office of the Attorney General and believes that these settlements will eliminate the need for potentially costly litigation and regulatory proceedings and, by moderating rate impacts and enabling the system to remain competitive in a changing environment, are in the best interest of the system and its customers. Rate Tariff Filing In March 1995, Cambridge Electric filed four rate tariffs with the DPU to establish rates for its largest customers should they decide to generate their own power or purchase from another source while remaining in Cambridge. In an effort to protect its other customers from increased costs, Cambridge Electric has requested that these large customers pay their share of the costs that were incurred on their behalf to ensure that their energy needs will be met at all times. These costs include long-term power contracts entered into to meet projected energy requirements, investments in substations, underground and overhead lines and current and future decommissioning costs associated with nuclear plants. A ruling is expected from the DPU in 1995. Environmental Matters Commonwealth Gas is participating in the assessment of a number of former manufactured gas plant (MGP) sites and alleged MGP waste disposal locations to determine if and to what extent such sites have been contaminated and whether Commonwealth Gas may be responsible for remedial actions. Commonwealth Gas is also involved in certain other known or potentially contaminated sites where the associated costs may not be recoverable in rates. There were no significant new developments that occurred during the first half of 1995. For further information on these matters, refer to the System's 1994 Annual Report on Form 10-K. <PAGE 16> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES PART II - OTHER INFORMATION Item 1. Legal Proceedings The System is subject to legal claims and matters arising from its course of business, including its participation in a power contract arbitration proceeding involving the recovery of excess fuel charges billed to Commonwealth Electric Company for power purchases with Dartmouth Power Associates Limited Partnership. Also, Commonwealth Electric's and Cambridge Electric Light Company's decision to cancel power contracts with Eastern Energy Corporation was upheld by a binding arbitration panel decision in June 1995 (refer to "Power Contract Arbitration" in Part I, Item 2 - "Management's Discussion and Analysis of Results of Operations" section of this report). Item 2. Changes in the Rights of the Company's Security Holders None Item 3. Defaults by the Company on its Senior Securities None Item 4. Results of Votes of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 10 - Material Contracts 10.1.43.1 System Power Sales Agreement by and between The Connecticut Light and Power Co., Western Massachusetts Electric Co., and Public Service Company of New Hampshire, as sellers, and Commonwealth Electric Company, as buyer, of power for peaking capacity and related energy, dated January 13, 1995, as effective June 1, 1995 and extending to October 31, 2000 (Filed as Exhibit 2 to Commonwealth Electric Company's Form 10-Q (June 1995), File 2-7749.) 10.1.54.3 First Amendment, dated November 7, 1994, to Power Sale Agreement by and between Commonwealth Electric Company and Altresco Pittsfield, L.P. dated February 20, 1992 (Filed as Exhibit 3 to Commonwealth Electric Company's Form 10-Q (June 1995), File 2-7749.) 10.1.54.4 First Amendment, dated November 7, 1994, to Power Sale Agreement by and between Cambridge Electric Light Company and Altresco Pitts- field, L.P. dated February 20, 1992 (Filed as Exhibit 2 to Cambridge Electric Light Company's Form 10-Q (June 1995), File 2-7909.) <PAGE 17> COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES 10.1.51.1 Second Amendment, dated June 23, 1994, to Power Purchase Agreement by and between Commonwealth Electric Company and Dartmouth Power Associates, L.P. dated September 5, 1989 (Filed as Exhibit 4 to Commonwealth Electric Company's Form 10-Q (June 1995), File 2-7749.) Exhibit 27 - Financial Data Schedule Filed herewith as Exhibit 1 is the Financial Data Schedule for the six months ended June 30, 1995. (b) Reports on Form 8-K No reports on Form 8-K were filed during the three months ended June 30, 1995. <PAGE 18> COMMONWEALTH ENERGY SYSTEM SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMONWEALTH ENERGY SYSTEM (Registrant) Principal Financial Officer: JAMES D. RAPPOLI James D. Rappoli, Financial Vice President and Treasurer Principal Accounting Officer: JOHN A. WHALEN John A. Whalen, Comptroller Date: August 14, 1995