<PAGE 1>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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
(Former name, address and fiscal year, if changed since last report)
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, 1997
Common Shares of Beneficial
Interest, $2 par value 21,531,784 shares
<PAGE 2>
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
JUNE 30, 1997 AND DECEMBER 31, 1996
ASSETS
(Dollars in thousands)
June 30, December 31,
1997 1996
(Unaudited)
PROPERTY, PLANT AND EQUIPMENT, at original cost
Electric $1,157,959 $1,150,818
Gas 362,292 357,403
Other 67,883 66,365
1,588,134 1,574,586
Less - Accumulated depreciation and
amortization 561,230 536,041
1,026,904 1,038,545
Add - Construction work in progress
and nuclear fuel in process 11,272 7,082
1,038,176 1,045,627
EQUITY IN CORPORATE JOINT VENTURES
Nuclear electric power companies (2.5%
to 4.5%) 10,553 10,046
Other investments 3,905 3,349
14,458 13,395
CURRENT ASSETS
Cash 4,348 1,495
Accounts receivable 99,524 117,008
Unbilled revenues 21,521 31,698
Inventories, at average cost 24,130 31,525
Prepaid taxes and other 13,547 14,765
163,070 196,491
DEFERRED CHARGES
Regulatory assets 150,541 154,291
Other 26,837 19,151
177,378 173,442
$1,393,082 $1,428,955
See accompanying notes.
<PAGE 3>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
JUNE 30, 1997 AND DECEMBER 31, 1996
CAPITALIZATION AND LIABILITIES
(Dollars in thousands)
June 30, December 31,
1997 1996
(Unaudited)
CAPITALIZATION
Common share investment -
Common shares, $2 par value -
Authorized - 50,000,000 shares
Outstanding - 21,531,784 in 1997 and
21,526,676 in 1996 $ 43,064 $ 43,059
Amounts paid in excess of par value 111,801 111,685
Retained earnings 268,479 260,950
423,344 415,694
Redeemable preferred shares, less current
sinking fund requirements 12,770 13,020
Long-term debt, including premiums, less current
sinking fund requirements and maturing debt 344,806 355,305
780,920 784,019
CAPITAL LEASE OBLIGATIONS 12,465 12,346
CURRENT LIABILITIES
Interim Financing -
Notes payable to banks 91,825 118,475
Maturing long-term debt 10,000 14,260
101,825 132,735
Other Current Liabilities -
Current sinking fund requirements 8,473 8,473
Accounts payable 72,522 90,269
Accrued taxes 5,905 16,970
Other 82,136 53,835
169,036 169,547
270,861 302,282
DEFERRED CREDITS
Accumulated deferred income taxes 183,092 174,877
Unamortized investment tax credits
and other 145,744 155,431
328,836 330,308
COMMITMENTS AND CONTINGENCIES
$1,393,082 $1,428,955
See accompanying notes.
<PAGE 4>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF INCOME
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
1997 1996 1997 1996
OPERATING REVENUES
Electric $157,251 $150,750 $334,055 $318,428
Gas 60,930 68,033 193,197 191,756
Steam and other 3,763 3,884 10,882 11,097
221,944 222,667 538,134 521,806
OPERATING EXPENSES
Fuel and purchased power 85,786 77,930 192,045 176,769
Cost of gas sold 30,627 38,193 102,737 99,806
Other operation and maintenance 79,593 64,915 140,187 126,168
Depreciation 12,808 11,844 28,320 26,511
Taxes -
Federal and state income (1,280) 5,491 15,394 22,888
Local property and other 6,617 5,853 15,766 14,387
214,151 204,046 494,449 466,529
OPERATING INCOME 7,793 18,621 43,685 54,752
OTHER INCOME 981 1,242 1,630 3,733
INCOME BEFORE INTEREST CHARGES 8,774 19,863 45,315 58,485
INTEREST CHARGES
Long-term debt 8,385 8,858 16,789 18,230
Other interest charges 1,813 1,618 3,618 3,066
Allowance for borrowed funds
used during construction (90) (76) (158) (181)
10,108 10,400 20,249 21,115
NET INCOME (LOSS) (1,334) 9,463 25,066 37,370
Dividends on preferred shares 251 267 503 534
EARNINGS (LOSS) APPLICABLE
TO COMMON SHARES $ (1,585) $ 9,196 $ 24,563 $ 36,836
AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 21,531,784 21,529,676 21,530,144 21,529,676
EARNINGS (LOSS) PER COMMON SHARE $(.07) $ .43 $1.14 $1.71
DIVIDENDS DECLARED PER
COMMON SHARE $.395 $.385 $.395 $.385
See accompanying notes.
<PAGE 5>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(Dollars in thousands)
(Unaudited)
1997 1996
OPERATING ACTIVITIES
Net income $ 25,066 $ 37,070
Effects of noncash items -
Depreciation and amortization 35,267 32,225
Deferred income taxes and investment
tax credits, net (1,283) 190
Earnings from corporate joint ventures (870) (892)
Dividends from corporate joint ventures 382 525
Change in working capital, exclusive of cash
and interim financing 35,763 (1,135)
All other operating items (10,403) (9,284)
Net cash provided by operating activities 83,922 58,999
INVESTING ACTIVITIES
Additions to property, plant and equipment
(exclusive of AFUDC) -
Electric (12,812) (19,123)
Gas (6,758) (3,233)
Other (921) (253)
Equity investment in corporate joint venture (575) -
Allowance for borrowed funds used during
construction (158) (181)
Net cash used for investing activities (21,224) (22,790)
FINANCING ACTIVITIES
Sale of common shares - 32
Payment of dividends (17,537) (17,112)
Proceeds from (payment of) short-term borrowings (26,650) 4,150
Long-term debt issues refunded (14,260) (23,230)
Sinking funds payments (1,398) (1,385)
Net cash used for financing activities (59,075) (37,545)
Net increase (decrease) in cash 2,853 (1,336)
Cash at beginning of period 1,495 4,319
Cash at end of period $ 4,348 $ 2,983
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of capitalized amounts) $ 19,550 $ 19,785
Income taxes $ 16,933 $ 17,173
See accompanying notes.
<PAGE 6>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) General Information
Commonwealth Energy System, the parent company, is referred to in this
report as the "System" and, together with its subsidiaries, is collec-
tively referred to as "the system." The System is an exempt public
utility holding company under the provisions of the Public Utility Holding
Company Act of 1935 with investments in four operating public utility
companies located in central, eastern and southeastern Massachusetts. In
addition, the System has interests in other utility and several non-
regulated companies.
The system has 1,915 regular employees including 1,130 (59%)
represented by various collective bargaining units. A contract with a
collective bargaining unit representing approximately 5% of regular
employees that was scheduled to expire in May 1997 was ratified in April
1997 and is effective through June 1, 2001.
During the second quarter of 1997, the system initiated a voluntary
personnel reduction program. For additional information, see the
"Personnel Reduction Program" section under Management's Discussion and
Analysis of Financial Condition and Results of Operations.
(2) Significant Accounting Policies
(a) Principles of Accounting
The system's significant accounting policies are described in Note 1
of Notes to Consolidated Financial Statements included in its 1996 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.
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, 1997
and 1996, reflect, in the opinion of the System, all adjustments (consist-
ing of only normal recurring accruals, except for those described in the
"Personnel Reduction Program" section under Management's Discussion and
Analysis of Financial Condition and Results of Operations) 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.
<PAGE 7>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The results for interim periods are not necessarily indicative of
results for the entire year because of seasonal variations in the
consumption of energy, Commonwealth Gas' seasonal rate structure and the
accrual of the costs associated with the aforementioned personnel
reduction program.
(b) Regulatory Assets and Liabilities
The system's operating utility companies are regulated as to rates,
accounting and other matters by various authorities, including the Federal
Energy Regulatory Commission (FERC) and the Massachusetts Department of
Public Utilities (DPU).
Based on the current regulatory framework, the system accounts for the
economic effects of regulation in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation." Regulated subsidiaries of
the System have established various regulatory assets in cases where the
DPU and/or the FERC have permitted or are expected to permit recovery of
specific costs over time. Similarly, regulatory liabilities established
by the system are required to be refunded to customers over time.
Effective January 1, 1996, the system adopted SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of." SFAS No. 121 imposes stricter criteria for regulatory
assets by requiring that such assets be probable of future recovery at
each balance sheet date. SFAS No. 121 did not have an impact on the
system's financial position upon adoption. This result may change as
modifications are made to the current regulatory framework due to ongoing
electric industry restructuring efforts in Massachusetts. If all or a
separable portion of the system's operations becomes no longer subject to
the provisions of SFAS No. 71, a write-off of related regulatory assets
and liabilities would be required, unless some form of transition cost
recovery continues through rates established and collected under cost-
based ratemaking for the system's remaining regulated operations. In
addition, the system would be required to determine any impairment to the
carrying costs of deregulated plant and inventory assets. However, on
December 30, 1996, the DPU issued an order containing "Model Rules" for
industry restructuring that management believes would essentially allow
full recovery of stranded costs. For additional information relating to
industry restructuring, see the "Electric Industry Restructuring" section
under Management's Discussion and Analysis of Financial Condition and
Results of Operations.
<PAGE 8>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The principal regulatory assets included in deferred charges were as
follows:
June 30, December 31,
1997 1996
(Dollars in Thousands)
Connecticut Yankee unrecovered plant and
decommissioning costs $ 30,585 $ 35,879
Fuel charge stabilization 29,508 21,504
Postretirement benefits costs including
pensions 24,810 25,051
Power contract buy-out 19,236 20,794
Deferred income taxes 13,679 13,597
FERC Order 636 transition costs 8,054 9,680
Yankee Atomic unrecovered plant and
decommissioning costs 6,673 7,798
Seabrook related costs 5,056 6,262
Other 12,940 13,726
$150,541 $154,291
On April 15, 1997, the DPU issued an accounting ruling allowing
Commonwealth Gas to include in cost-of-service postretirement benefits
costs and to amortize the deferred balance of $10.5 million at March 31,
1997 associated with these costs over a period not to exceed ten years
beginning in April 1997.
The regulatory liabilities, reflected in the accompanying Condensed
Balance Sheets and related to deferred income taxes, were $16 million and
$17.7 million at June 30, 1997 and December 31, 1996, respectively.
(3) Commitments and Contingencies
(a) Construction Program
The system is engaged in a continuous construction program presently
estimated at $298 million for the five-year period 1997 through 2001. Of
that amount, $68.2 million is estimated for 1997. The program is subject
to periodic review and revision.
(b) Maine Yankee Nuclear Power Plant
Cambridge Electric has a 4% equity ownership interest (approximately
$3 million at June 30, 1997), with a power entitlement of 31.2 MW, in a
nuclear power plant located in Wiscasset, Maine. The plant, operated by
Maine Yankee Atomic Power Company (Maine Yankee), experienced two outages
during 1996 and has remained out of service since the second outage which
began in December of 1996. On August 6, 1997, the Board of Directors of
Maine Yankee voted to permanently cease power operations and begin the
process of decommissioning the plant. The decision to shut down the plant
was based on an economic analysis of the costs, risks and uncertainties
associated with operating the plant compared to those associated with
<PAGE 9>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
closing and decommissioning the plant. Maine Yankee is in the process of
developing an updated decommissioning cost estimate and expects to file a
revised decommissioning cost study with FERC in the fall of 1997 as part
of a rate filing reflecting the permanent shutdown of the plant. As a
result, Cambridge Electric is unable to determine its obligation to Maine
Yankee at this time. Based upon regulatory precedent, Maine Yankee
believes that it would continue to collect from its power purchasers
(including Cambridge Electric) decommissioning costs, unrecovered plant
investment and other costs associated with the permanent closure of the
plant over the remaining period of the plant's operating license that
expires in 2008. Cambridge Electric does not believe the ultimate outcome
of the early closing of this plant would have a material adverse effect on
its operations and believes that recovery of these FERC-approved costs
would continue to be allowed in its rates at the retail level. Therefore,
Cambridge Electric will record a liability for its estimated share of
decommissioning costs and a corresponding regulatory asset in the third
quarter.
<PAGE 10>
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. 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.
During the first half of 1997, cash flows from operating activities
amounted to $83.9 million and reflect net income of $25.1 million and
noncash items including depreciation of $28.3 million and $5.3 million in
amortization and deferred income taxes. Working capital since December
31, 1996, exclusive of cash and interim financing, increased $35.8 million
reflecting lower levels of accounts receivable ($17.5 million) and
unbilled revenues ($10.2 million), a decrease in prepaid taxes (9.1
million), lower inventory levels ($7.4 million), an increase in refundable
gas costs ($10.9 million) and an accrual relating to a voluntary personnel
reduction program ($16.4 million) that is detailed later in this section.
These increases were offset by lower levels of accounts payable ($17.7
million), accrued taxes ($11 million) and other assets ($7.9 million).
Construction expenditures for the first half of 1997 were approxi-
mately $21.2 million, including an allowance for funds used during
construction (AFUDC) and nuclear fuel. Construction expenditures,
preferred and common dividend requirements of the System ($17.5 million),
the refunding of long-term debt ($14.3 million) and the payment of short-
term borrowings ($26.7 million) were funded entirely with internally-
generated funds.
On June 12, 1997, Commonwealth Gas received approval from the DPU for
a proposed financing plan which includes $35 million of long-term debt.
The proceeds from this financing, which is expected to be completed in the
third quarter, will be used to repay short-term debt incurred for the
purpose of temporarily financing additions to property, plant and
equipment and for general working capital needs.
Results of Operations
The following is a discussion of certain significant factors that 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 11>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
A summary of the period to period changes in the principal items
included in the accompanying condensed statements of income for the three
and six-month periods ended June 30, 1997 and 1996 and unit sales for
these periods is shown below:
Three Months Six Months
Ended June 30, Ended June 30,
1997 and 1996 1997 and 1996
Increase (Decrease)
(Dollars in thousands)
Operating Revenues -
Electric $ 6,501 4.3% $15,627 4.9%
Gas (7,103) (10.4) 1,441 0.8
Steam and other (121) (3.1) (215) (1.9)
(723) (0.3) 16,853 3.2
Operating Expenses -
Fuel and purchased power 8,036 10.3 15,276 8.6
Cost of gas sold (7,556) (19.8) 2,931 2.9
Other operation and maintenance 14,678 22.6 14,019 11.1
Depreciation 964 8.1 1,809 6.8
Taxes -
Federal and state income (6,771) (123.3) (7,494) (32.7)
Local property and other 764 13.1 1,379 9.6
10,105 5.0 27,920 6.0
Operating Income (10,828) (58.1) (11,067) (20.2)
Other Income (261) (21.1) (2,103) (56.3)
Income Before Interest Charges (11,089) (55.8) (13,170) (22.5)
Interest Charges (292) (2.8) (866) (4.1)
Net Income (10,797) (114.1) (12,304) (32.9)
Dividends on preferred shares (16) (6.0) (31) (5.8)
Earnings Applicable to Common Shares $(10,781) (117.2) $(12,273) (33.3)
Unit Sales
Electric - Megawatthours (MWH)
Retail 9,119 0.8 8,935 0.4
Wholesale 110,161 18.8 535,047 40.1
119,280 7.0 543,982 15.0
Gas - Billions of British Thermal
Units (BBTU)
Firm (98) (1.4) (1,035) (4.1)
Interruptible and other (399) (25.2) 106 4.5
(497) (5.9) (929) (3.4)
<PAGE 12>
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, 1997 and 1996:
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
Electric Sales - MWH
Residential 420,714 417,715 894,765 903,739
Commercial 601,114 596,162 1,190,702 1,179,886
Industrial 110,245 109,225 210,017 203,276
Other 5,256 5,108 11,921 11,569
Total retail sales 1,137,329 1,128,210 2,307,405 2,298,470
Wholesale sales 697,163 587,002 1,870,497 1,335,450
Total 1,834,492 1,715,212 4,177,902 3,633,920
Gas Sales - BBTU
Residential 3,775 3,719 13,657 14,143
Commercial 1,914 1,942 6,764 7,072
Industrial 697 857 2,270 2,531
Other 418 384 1,370 1,350
Total firm sales 6,804 6,902 24,061 25,096
Off-system sales 735 704 1,532 953
Quasi-firm sales 23 361 26 485
Interruptible sales 428 520 879 893
Total 7,990 8,487 26,498 27,427
Electric Operating Revenues, Fuel and Purchased Power Costs
Electric operating revenues increased $6.5 million (4.3%) and $15.6
million (4.9%) during the current quarter and first half of 1997 due mainly
to higher fuel and purchased power costs ($8 million and $15.3 million,
respectively).
Fuel and purchased power increased approximately $8 million (10.3%) and
$15.3 million (8.6%) during the current quarter and first half of 1997 due
primarily to higher wholesale unit sales reflecting the increased
availability of Canal Electric Company's Units 1 and 2 and higher costs for
replacement power reflecting the permanent shutdown of Connecticut Yankee
during 1996 and the absence of power from Maine Yankee which remained out
of service during the first half of 1997.
Gas Operating Revenues and Cost of Gas Sold
During the current quarter, gas operating revenues decreased $7.1
million (10.4%) due primarily to a decrease in the cost of gas sold ($7.6
million) and a lower level of conservation and load management costs ($1.1
million). Gas operating revenues for the first half of 1997 increased
approximately $1.4 million (0.8%) due mainly to a $2.9 million increase in
the cost of gas sold offset by a decrease in C&LM costs ($2 million).
Revenues for both the current quarter and year-to-date period also include
the recognition of margins earned on off-system contracts ($644,000).
<PAGE 13>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The decrease in unit sales to firm customers during the current quarter
(1.4%) and first half of 1997 (4.1%) reflects the milder weather conditions
experienced during the year. The fluctuations in interruptible and other
non-firm sales reflect the competitive market that exists today in the
natural gas industry.
Other Operating Expenses
For the current quarter and first half of 1997, other operation and
maintenance increased approximately $14.7 million (22.6%) and $14 million
(11.1%) reflecting the impact of a one-time charge related to the personnel
reduction program ($17.7 million) as further discussed below and storm
damage costs in connection with an April 1 blizzard ($2.0 million). The
impact of these factors was partially offset by the absence of costs
related to the 1996 labor dispute ($1.7 million) and, in the current
quarter, a decline in insurance and employee benefit costs ($709,000) and
lower C&LM costs ($593,000). The increase in the first half of 1997 was
also somewhat offset by a reduction in insurance and employee benefit costs
($645,000).
Depreciation expense increased $964,000 (8.1%) and $1.8 million (6.8%)
during the current three and six-month periods due primarily to a higher
level of depreciable plant, particularly Canal Unit 1. Federal and state
income taxes decreased significantly during the current periods due mainly
to the lower level of taxable income. Local property and other taxes were
higher during both periods due to higher property tax rates and assessments
within the system's service territory and an increase in the state
unemployment tax rate for Commonwealth Gas related to the 1996 labor
dispute.
Other Income and Interest Charges
During the current quarter and first half of 1997, other income
decreased $261,000 and $2.1 million as compared to the same periods in 1996
partly due to the absence of a gain relating to the 1996 sale of parcels of
land. The decline in the first half of 1997 is also due to the absence of
the 1996 reversal of a reserve for costs associated with Canal Electric's
postretirement benefits.
The declines in total interest charges for the current three and six-
month periods mainly reflect maturing long-term debt and scheduled sinking
fund payments partially offset by higher levels of short-term borrowings at
slightly higher interest rates.
Personnel Reduction Program
As initially discussed in the Company's 1996 Annual Report on Form 10-K
filed with the Securities and Exchange Commission, the System announced the
details of a system-wide voluntary Personnel Reduction Program (PRP) in May
1997. The goal of the PRP is to achieve a reduced, more efficient and more
productive workforce in response to the significant regulatory changes
facing the System's companies. This action follows the recent management
consolidation of the system's electric and gas operations. The expectation
is that the workforce will be reduced by 15% to 20%.
<PAGE 14>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The PRP is offered to substantially all regular and part-time employees
of the system. Eligibility for employees covered by collective bargaining
agreements is subject to negotiation. The election period is from May 13
through August 29, 1997. The system reserves the right to limit the number
of participants in the program to 300; however, the system expects the
final participation level to exceed this amount.
The program provides severance based on years of service, the
continuation of certain health and dental insurance for specified periods
and limited reimbursement for certain educational and/or outplacement
services.
Currently, approximately 17% of the system's employees have applied for
the PRP. The system estimates the cost of termination benefits as
described above, excluding generation-related costs that are being
addressed separately as part of the industry restructuring process, will
approximate $17.7 million which was recorded in the second quarter and had
an after-tax income impact of approximately $10.7 million ($.50 per common
share). The payback period is expected to be less than one year.
Electric Industry Restructuring
On December 30, 1996, the DPU issued a final order announcing its "Model
Rules and Legislative Proposal" as a guide in the creation of a competitive
market for electric generation in Massachusetts. Legislative proposals
concerning electric industry restructuring were filed by the former
Governor of the Commonwealth of Massachusetts on February 24, 1997, and by
the Massachusetts Legislature's Joint Committee on Electric Utility
Restructuring (the Committee) on March 20, 1997. Each of the plans
proposed by the DPU, the former Governor and the Committee is intended to
provide customers with the opportunity to achieve lower electric bills
beginning on the target date of January 1, 1998.
In its "Model Rules," the DPU has proposed that the minimum structural
reorganization needed to create a competitive market is the functional
separation of generation, transmission and distribution within one
integrated company, and the establishment of a separate marketing affiliate
if a company retains generation assets. Other elements of the DPU's Model
Rules provide that electric customers will be able to buy their power on
the open market; distribution services will remain a service that continues
to be provided exclusively by the existing local distribution companies in
clearly defined service territories; and customers will have three types of
electric generation choices. First, customers may enter into unregulated
agreements with a competitive supplier for the provision of generation.
Second, customers may continue to buy power directly from their electric
distribution company at a price regulated by the DPU, which is known as
standard offer service. Third, customers who have received generation from
a competitive supplier but who, for any reason, have stopped receiving such
generation will be able to receive default generation service, provided by
distribution companies at spot market prices.
<PAGE 15>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
In some regulatory jurisdictions, changes in the electric industry could
reduce the opportunity that currently exists for electric companies to
recover their investment in generating plant and other costs previously
approved by regulators and included in current rates. These potential
losses, which may result from subjecting electric company generation to the
pressures of a competitive market, are typically referred to as "stranded
costs." The single largest component of stranded costs, which are
significant to the system, relates to above-market purchased power
contracts with non-utility generators. However, the DPU has concluded that
it is in the public interest to provide electric companies a reasonable
opportunity to collect net, non-mitigable stranded costs. The DPU has
proposed that stranded costs associated with owned generation facilities,
regulatory assets, and purchased power obligations be collected over the
expected economic life of the generating facility, the current amortization
schedule of the regulatory asset, or the contractual term of the purchased
power obligation, respectively. The DPU's proposal requires that any
stranded cost recovery for an electric utility be subject to mitigation
efforts to reduce embedded costs over time. The Model Rules specify that
mitigation should include such measures as sales of capacity and energy
from owned generation, renegotiation or buy-out of purchased power
contracts, and sales and voluntary writedowns of assets.
The former Governor's restructuring proposal includes: a standard offer
generation service option for residential and small business customers for
a five-year period; recovery by electric utilities of net, non-mitigable
stranded costs over a 12-year period; the recovery of reasonable employee
transition costs for utility workers directly affected by electric industry
restructuring; and, at a minimum, the functional separation of generation,
transmission and distribution services. The former Governor's legislation
also provides a mechanism for electric utilities to reduce their stranded
costs by financing the renegotiation or buy-out of above-market purchased
power contracts. The bill authorizes the Massachusetts Industrial Finance
Agency to issue electric rate reduction bonds to electric utilities that
receive a financing order from the DPU. The criteria for eligibility to
apply for the financing order include: (1) DPU approval of a plan to
provide retail access and divestiture of non-nuclear generating assets; and
(2) demonstration that such contract buy-out or purchase, including the
cost of financing, will substantially reduce costs to ratepayers.
The Committee issued both a comprehensive report, which outlines options
for the Legislature's consideration as debate on restructuring continues,
and a set of recommendations and a legislative package that is designed to
implement electric industry restructuring in Massachusetts. Elements of
the Committee's legislative proposal include the functional separation of
utility companies into generation, transmission and distribution companies.
Transmission and distribution companies would remain regulated while
generation companies would be unregulated with pricing determined by the
market. The Committee's proposal establishes a retail access date of
January 1, 1998 or later, as determined by the DPU, calls for a 10% rate
reduction for all customers and allows for the recovery of certain net,
non-mitigable stranded costs over a ten-year period. The proposal also
encourages divestiture as a mitigation measure by authorizing companies to
securitize stranded costs through the issuance of rate reduction bonds only
<PAGE 16>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
where the company has divested itself of non-nuclear generation assets. On
May 6, 1997, the system submitted comments on the Committee's legislative
proposal making specific recommendations for changes with respect to
increasing the time frame for recovery of stranded costs including power
contracts, the increased use of securitization and other issues. The
Massachusetts Legislature, which will render the final passage of any
restructuring law, is now considering the legislative proposals of the DPU,
the former Governor and the Committee.
During the last several months, three Massachusetts electric utilities
announced negotiated settlement agreements with the Massachusetts Attorney
General's Office (Attorney General) that include divestiture of generating
assets, provision for a 10% reduction in customers' bills and recovery of
stranded costs through a non-bypassable access charge. One settlement
agreement has been approved by the DPU. Implementation of any
restructuring settlement may be affected by actions of the Massachusetts
Legislature.
The system has recently engaged in formal settlement discussions with
the Attorney General and has provided the Attorney General with information
to further the development of a comprehensive settlement. In the unlikely
event that the parties are unable to complete a settlement, the system
would file a full restructuring plan with the DPU.
On March 31, 1997, the system submitted a report to the DPU which
detailed the proposed auction process for selling its electric generation
assets and entitlements. The process will include a standard, sealed-bid
auction for generation assets and purchased power contracts with the
securitization of remaining obligations. The auction process would provide
a market-based approach to maximizing stranded cost mitigation and
minimizing the access charges that ratepayers will have to pay for stranded
cost recovery. The system anticipates that the bidding process will begin
shortly after Labor Day.
Gas Industry Restructuring
On July 18, 1997, the DPU requested that the Massachusetts gas utility
industry initiate a statewide restructuring. The ten utilities, including
Commonwealth Gas, are directed to begin a collaborative process that will
establish guiding principles and specific procedures for unbundling rates
and services for all customers. The process is required to begin on or
before August 15, 1997 and a report is to be submitted to the DPU no later
than November 15, 1997.
The DPU listed six principles that it considers important to the success
of a competitive natural gas market that will provide safe and reliable
service at the lowest possible cost to customers. The natural gas market
would: (1) provide the broadest possible choice; (2) provide all customers
with an opportunity to share in the benefits of increased competition; (3)
ensure full and fair competition in the gas supply market; (4) functionally
separate supply from local distribution services; (5) support and further
the goals of environmental regulation; and lastly (6) rely on incentive
regulation where a fully competitive market cannot or presently does not
exist.
<PAGE 17>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
In addition, the DPU outlined several specific issues that it expects
the collaborative to address: (1) services that can be offered on a
competitive basis; (2) terms and condition of service; (3) consumer
protections and social programs; (4) mitigation of gas-related and non-gas
related transition costs; (5) third-party supplier qualifications; and (6)
curtailment principles. The DPU also suggested that the collaborative
reconsider the pricing and provision of interruptible transportation
services.
Provisions of Statement of Financial Accounting Standards No. 71
As described in Note 2(b) of the Notes to Condensed Financial
Statements, the system complies with the provisions of Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects
of Certain Types of Regulation." In the event the system is somehow unable
to meet the criteria for following SFAS No. 71, the accounting impact would
be an extraordinary, non-cash charge to operations in an amount that could
be material. Criteria that could give rise to the discontinuance of SFAS
No. 71 include: 1) increasing competition restricting the system's ability
to establish prices to recover specific costs, and 2) a significant change
in the current manner in which rates are set by regulators. The system
periodically reviews these criteria to ensure that the continuing
application of SFAS No. 71 is appropriate. Recently, the Securities and
Exchange Commission has questioned the ability of certain utilities
continuing the application of SFAS No. 71 where legislation provided for
the transition to retail competition. The issue of when and how to
discontinue the application of SFAS No. 71 by utilities during transition
to competition has been referred to the Financial Accounting Standards
Board's Emerging Issues Task Force and guidance on this issue is expected
in the near future. Based on the current evaluation of the various factors
and conditions that are expected to impact future cost recovery, the system
believes that its regulatory assets, including those related to electric
generation, are probable of future recovery.
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. In April, Commonwealth Gas recorded an additional liability and
corresponding regulatory asset of $1.2 million due to an increase in the
site clean-up cost estimate for an MGP site for which Commonwealth Gas was
previously cited as a Potentially Responsible Party. The DPU has approved
recovery of costs associated with MGP sites. Commonwealth Gas is also
involved in certain other known or potentially contaminated sites where the
associated costs may not be recoverable in rates. For further information
on other related environmental matters, refer to the System's 1996 Annual
Report on Form 10-K.
<PAGE 18>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
New Accounting Standard
The System is required to adopt Statement of Financial Accounting
Standards No. 128 (SFAS 128) "Earnings per Share" for the year ended
December 31, 1997. SFAS 128 requires the presentation of both basic and
diluted earnings per share (EPS). Diluted EPS reflects the possible impact
on EPS that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity.
The System issued potential awards in the form of common shares to certain
key employees pursuant to its Long Term Incentive Compensation Plan during
the first quarter of 1997. If SFAS 128 had been adopted for the three and
six-months ended June 30, 1997, both basic and diluted EPS would be $(.07)
and $1.14, respectively.
<PAGE 19>
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 Cambridge Electric as an intervenor in a
pending appeal at the Massachusetts Supreme Judicial Court (SJC) filed
by the Massachusetts Institute of Technology involving a DPU decision
approving a customer transition charge for the recovery of stranded
investment costs. No schedule has been set for a decision from the
SJC. This issue is discussed more fully in the System's 1996 Annual
Report on Form 10-K. At this time, management is unable to predict
the outcome of this proceeding.
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 27 - Financial Data Schedule
Filed herewith as Exhibit 1 is the Financial Data Schedule for
the six months ended June 30, 1997.
Filed herewith as Exhibit 2 is the restated Financial Data
Schedule for the six months ended June 30, 1996.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
June 30, 1997.
<PAGE 20>
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 and
Accounting Officer
JAMES D. RAPPOLI
James D. Rappoli,
Financial Vice President
and Treasurer
Date: August 14, 1997