<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 September 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 November 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
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
ASSETS
(Dollars in thousands)
September 30, December 31,
1997 1996
(Unaudited)
PROPERTY, PLANT AND EQUIPMENT, at original cost
Electric $1,163,660 $1,150,818
Gas 367,505 357,403
Other 73,309 66,365
1,604,474 1,574,586
Less - Accumulated depreciation and
amortization 570,711 536,041
1,033,763 1,038,545
Add - Construction work in progress
and nuclear fuel in process 12,084 7,082
1,045,847 1,045,627
EQUITY IN CORPORATE JOINT VENTURES
Nuclear electric power companies (2.5%
to 4.5%) 10,751 10,046
Other investments 3,715 3,349
14,466 13,395
CURRENT ASSETS
Cash 5,069 1,495
Accounts receivable 86,210 117,008
Unbilled revenues 19,726 31,698
Inventories, at average cost 34,427 31,525
Prepaid taxes and other 20,325 14,765
165,757 196,491
DEFERRED CHARGES
Regulatory assets 184,681 154,291
Other 26,210 19,151
210,891 173,442
$1,436,961 $1,428,955
See accompanying notes.
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
CAPITALIZATION AND LIABILITIES
(Dollars in thousands)
September 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 111,838 111,685
Retained earnings 266,861 260,950
421,763 415,694
Redeemable preferred shares, less current
sinking fund requirements 12,200 13,020
Long-term debt, including premiums, less current
sinking fund requirements and maturing debt 379,458 355,305
813,421 784,019
CAPITAL LEASE OBLIGATIONS 12,037 12,346
CURRENT LIABILITIES
Interim Financing -
Notes payable to banks 61,050 118,475
Maturing long-term debt 10,000 14,260
71,050 132,735
Other Current Liabilities -
Current sinking fund requirements 8,473 8,473
Accounts payable 80,296 90,269
Accrued taxes 18,922 16,970
Other 68,267 53,835
175,958 169,547
247,008 302,282
DEFERRED CREDITS
Accumulated deferred income taxes 183,197 174,877
Unamortized investment tax credits
and other 181,298 155,431
364,495 330,308
COMMITMENTS AND CONTINGENCIES
$1,436,961 $1,428,955
See accompanying notes.
<PAGE 4>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(Dollars in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
1997 1996 1997 1996
OPERATING REVENUES
Electric $177,723 $175,689 $511,778 $494,117
Gas 41,870 48,761 235,067 240,517
Steam and other 2,522 2,459 13,404 13,556
222,115 226,909 760,249 748,190
OPERATING EXPENSES
Fuel and purchased power 97,275 94,245 289,320 271,014
Cost of gas sold 25,390 30,334 128,127 130,140
Other operation and maintenance 59,809 63,269 199,996 189,437
Depreciation 12,078 11,340 40,398 37,851
Taxes -
Federal and state income 6,163 4,788 19,907 27,676
Local property and other 4,513 5,332 21,929 19,719
205,228 209,308 699,677 675,837
OPERATING INCOME 16,887 17,601 60,572 72,353
OTHER INCOME 340 1,237 1,970 4,970
INCOME BEFORE INTEREST CHARGES 17,227 18,838 62,542 77,323
INTEREST CHARGES
Long-term debt 8,123 8,809 24,912 27,039
Other interest charges 2,077 1,724 5,695 4,790
Allowance for borrowed funds
used during construction (120) (55) (278) (236)
10,080 10,478 30,329 31,593
NET INCOME 7,147 8,360 32,213 45,730
Dividends on preferred shares 248 263 751 797
EARNINGS APPLICABLE TO
COMMON SHARES $ 6,899 $ 8,097 $ 31,462 $ 44,933
AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 21,531,784 21,529,676 21,530,378 21,529,676
EARNINGS PER COMMON SHARE $ .32 $ .37 $1.46 $2.08
DIVIDENDS DECLARED PER
COMMON SHARE $.395 $.385 $1.185 $1.155
See accompanying notes.
<PAGE 5>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(Dollars in thousands)
(Unaudited)
1997 1996
OPERATING ACTIVITIES
Net income $ 32,213 $ 45,730
Effects of noncash items -
Depreciation and amortization 50,000 46,748
Deferred income taxes and investment
tax credits, net (2,174) (1,618)
Earnings from corporate joint ventures (1,229) (1,333)
Dividends from corporate joint ventures 545 949
Change in working capital, exclusive of cash
and interim financing 40,719 (18,813)
All other operating items (13,474) (6,956)
Net cash provided by operating activities 106,600 64,707
INVESTING ACTIVITIES
Additions to property, plant and equipment
(exclusive of AFUDC) -
Electric (22,842) (27,707)
Gas (11,567) (6,316)
Other (2,461) (992)
Equity investment in corporate joint venture (575) -
Allowance for borrowed funds used during
construction (278) (236)
Net cash used for investing activities (37,723) (35,251)
FINANCING ACTIVITIES
Sale of common shares - 32
Payment of dividends (26,302) (25,664)
Proceeds from (payment of) short-term borrowings (57,425) 23,225
Long-term debt issues 35,000 -
Long-term debt issues refunded (14,260) (23,230)
Sinking funds payments (2,316) (2,295)
Net cash used for financing activities (65,303) (27,932)
Net increase in cash 3,574 1,524
Cash at beginning of period 1,495 4,319
Cash at end of period $ 5,069 $ 5,843
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of capitalized amounts) $ 29,082 $ 30,885
Income taxes $ 17,154 $ 10,110
See accompanying notes.
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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
nonregulated companies.
The system has 1,769 regular employees including 1,070 (61%)
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 May 31, 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 September 30,
1997 and 1996, reflect, in the opinion of the System, all adjustments
(consisting 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.
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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,
pending Massachusetts legislation provides for recovery of stranded costs,
subject to review. 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.
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The principal regulatory assets included in deferred charges were as
follows:
September 30, December 31,
1997 1996
(Dollars in thousands)
Maine Yankee unrecovered plant and
decommissioning costs $ 37,596 $ -
Connecticut Yankee unrecovered plant and
decommissioning costs 30,021 35,879
Fuel charge stabilization 30,270 21,504
Postretirement benefits costs including
pensions 24,919 25,051
Power contract buy-out 18,432 20,794
Deferred income taxes 13,720 13,597
FERC Order 636 transition costs 7,685 9,680
Yankee Atomic unrecovered plant and
decommissioning costs 6,080 7,798
Seabrook related costs 4,655 6,262
Other 11,303 13,726
$184,681 $154,291
On April 15, 1997, the DPU issued an accounting ruling allowing
Commonwealth Gas to include postretirement benefits costs in cost-of-
service 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 $15.3 million
and $17.7 million at September 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 Light Company (Cambridge Electric) has a 4% equity
ownership interest (approximately $3 million at September 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), has been out of service since an outage that 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
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
associated with operating the plant compared to those associated with
closing and decommissioning the plant. Based upon regulatory precedent,
Maine Yankee believes that it will be permitted to 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 will 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 recorded 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.
For the first nine months of 1997, cash flows from operating activi-
ties amounted to $106.6 million and reflect net income of $32.2 million
and noncash items including depreciation of $40.4 million and amortization
of $9.6 million. Since December 31, 1996, cash flows relating to the
change in working capital, exclusive of cash and interim financing,
increased $40.7 million reflecting lower levels of accounts receivable
($30.8 million) and unbilled revenues ($12 million), and increases in
prepaid taxes ($5.9 million), inventory levels ($2.9 million), accrued
property taxes ($8.3 million) and other current liabilities ($14.4
million) that includes an accrual relating to a voluntary personnel
reduction program ($8.3 million). Offsetting these increases were lower
levels of accounts payable ($10 million) and accrued income taxes ($6.3
million).
Through September 30, 1997 construction expenditures were approxi-
mately $37.1 million, including an allowance for funds used during
construction (AFUDC) and nuclear fuel. Construction expenditures,
preferred and common dividend requirements of the System ($26.3 million)
and the retirement of long-term debt including sinking funds ($16.6
million) were funded entirely with internally-generated funds.
Internally-generated funds and proceeds from an external financing
(discussed below) were used to reduce short-term borrowings ($57.4
million).
On September 26, 1997, Commonwealth Gas issued $10 million of First
Mortgage Sinking Fund Bonds (Series L, 6.54% due 2007) and $25 million of
First Mortgage Bonds (Series M, 7.04% due 2017). The proceeds of $35
million were used to retire short-term debt that had been incurred to
temporarily finance additions to property, plant and equipment and for
general working capital needs. This financing had been approved by the
DPU on June 12, 1997.
Results of Operations
The following is a discussion of major 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.
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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 nine-month periods ended September 30, 1997 and 1996 and unit sales
for these periods is shown below:
Three Months Nine Months
Ended September 30, Ended September 30,
1997 and 1996 1997 and 1996
Increase (Decrease)
(Dollars in thousands)
Operating Revenues -
Electric $ 2,034 1.2% $17,661 3.6%
Gas (6,891) (14.1) (5,450) (2.3)
Steam and other 63 2.6 (152) (1.1)
(4,794) (2.1) 12,059 1.6
Operating Expenses -
Fuel and purchased power 3,030 3.2 18,306 6.8
Cost of gas sold (4,944) (16.3) (2,013) (1.5)
Other operation and maintenance (3,460) (5.5) 10,559 5.6
Depreciation 738 6.5 2,547 6.7
Taxes -
Federal and state income (275) (5.7) (7,769) (28.1)
Local property and other 831 15.6 2,210 11.2
(4,080) (1.9) 23,840 3.5
Operating Income (714) (4.1) (11,781) (16.3)
Other Income (897) (72.5) (3,000) (60.4)
Income Before Interest Charges (1,611) (8.6) (14,781) (19.1)
Interest Charges (398) (3.8) (1,264) (4.0)
Net Income (1,213) (14.5) (13,517) (29.6)
Dividends on preferred shares (15) (5.7) (46) (5.8)
Earnings Applicable to Common Shares $ (1,198) (14.8) $(13,471) (30.0)
Unit Sales
Electric - Megawatthours (MWH)
Retail 62,564 5.0 71,499 2.0
Wholesale 215,182 26.6 750,229 35.0
277,746 13.5 821,728 14.5
Gas - Billions of British Thermal
Units (BBTU)
Firm (688) (18.5) (1,723) (6.0)
Interruptible and other (508) (33.2) (402) (10.4)
(1,196) (22.8) (2,125) (6.5)
<PAGE 12>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The following is a summary of electric and gas unit sales for the three
and nine-month periods ended September 30, 1997 and 1996:
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
Electric Sales - MWH
Residential 482,030 462,966 1,376,795 1,366,705
Commercial 700,817 663,155 1,891,519 1,843,041
Industrial 117,416 111,410 327,433 314,686
Other 5,398 5,566 17,319 17,135
Total retail sales 1,305,661 1,243,097 3,613,066 3,541,567
Wholesale 1,024,012 808,830 2,894,509 2,144,280
Total sales 2,329,673 2,051,927 6,507,575 5,685,847
Gas Sales - BBTU
Residential 1,466 1,713 15,123 15,856
Commercial 1,012 1,108 7,776 8,180
Industrial 393 717 2,663 3,248
Other 156 177 1,526 1,527
Total firm sales 3,027 3,715 27,088 28,811
Off-system 475 723 2,007 1,676
Quasi-firm 20 307 46 792
Interruptible 525 498 1,404 1,391
Total sales 4,047 5,243 30,545 32,670
Electric Operating Revenues, Fuel and Purchased Power Costs
During the third quarter and first nine months of 1997, electric
operating revenues increased $2 million (1.2%) and $17.7 million (3.6%),
respectively, due to a greater level of wholesale sales reflecting the
changing capacity needs of non-affiliated utilities and the New England
Power Pool, higher retail unit sales and higher fuel and purchased power
costs ($3 million and $18.3 million, respectively). Offsetting these
factors was the absence of a $4 million refund associated with a 1996 power
contract settlement agreement.
The increase in fuel and purchased power costs during the current
quarter and first nine months of 1997 was 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 has been out of service since December 1996.
Retail electric unit sales continued to improve during the current
quarter, reflecting increases to all customer segments including
residential (4.1%), commercial (5.7%) and industrial (5.4%).
Gas Operating Revenues and Cost of Gas Sold
Gas operating revenues for the third quarter of 1997 decreased
approximately $6.9 million or 14.1% due primarily to a 22.8% decline in
total unit sales. Through the first nine months of this year, operating
revenues decreased $5.4 million due to a 6.5% decline in total unit sales
<PAGE 13>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
and lower conservation and load management (C&LM) costs ($2 million).
Revenues for the current nine-month period also include the recognition of
margins earned on off-system contracts ($644,000).
The decline in firm unit sales for the first nine months of 1997
reflects decreases to all customer segments including residential (4.6%),
commercial (4.9%) and industrial (18%) reflecting milder weather
experienced in this region during the first quarter as compared to a colder
period in 1996. Degree days for the current nine-month period totaled
4,147, 7% lower than last year and 3.5% below the normal level of 4,299.
The significant fluctuations in non-firm sales for both the current quarter
and year-to-date period reflect the competitive environment that currently
exists in the natural gas industry. A portion of the margin realized on
these sales reduces the cost of gas sold to firm customers.
Other Operating Expenses
For the third quarter of 1997, other operation and maintenance decreased
$3.5 million or 5.5% due to the absence of costs relating to a labor
dispute ($2.5 million) and storm damage from Hurricane Eduoard ($1.9
million) both of which occurred in 1996. Also contributing to the decline
for the quarter were lower payroll costs reflecting the decrease in the
number of employees, offset, in part, by higher insurance costs
($1 million), higher maintenance costs relating to the Kendall Station
generator ($523,000) and gas distribution lines ($403,000) and higher C&LM
costs ($389,000).
Other operation and maintenance for the first nine months of 1997
increased $10.6 million or 5.6% due to a one-time charge related to a
Personnel Reduction Program ($17.7 million) (as further discussed below)
and storm damage costs associated with an April 1 blizzard ($1.9 million).
The impact of these factors was offset, in part, by the absence of costs
related to the 1996 labor dispute ($3.3 million) and storm damage ($1.9
million) from Hurricane Eduoard as well as payroll savings related to the
decrease in the number of employees.
Depreciation expense increased $738,000 (6.5%) and $2.5 million (6.7%)
during the current three and nine-month periods due primarily to a higher
level of depreciable plant reflecting the costs associated with the
conversion of Canal Unit 2 to burn natural gas as well as oil. 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
payroll-related taxes for Commonwealth Gas due to the 1996 labor dispute.
Other Income and Interest Charges
For the first nine months of 1997, other income decreased $3 million due
primarily to the absence of a 1996 reversal of a reserve for costs
associated with postretirement benefits ($1.8 million) following Federal
Energy Regulatory Commission acceptance of rate schedules that provided for
the recovery of these costs over a six-month period that began in March
1996, the absence of a 1996 gain relating to the sale of parcels of land in
<PAGE 14>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
1996 ($664,000) and lower interest and dividends ($404,000, including
$279,000 relating to interest on deferred gas costs).
The declines in total interest charges for the quarter and nine-month
periods mainly reflect maturing long-term debt and scheduled sinking fund
payments partially offset by higher average levels of borrowings.
Personnel Reduction Program
As initially discussed in the System'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. This action followed the consolidation of the system's
electric and gas operations. The expectation is that the system's
workforce will be reduced by 15% to 20%.
The PRP was offered to substantially all regular and part-time employees
of the system. Eligibility for employees covered by collective bargaining
agreements was subject to negotiation.
The program provides severance based on years of service, the continu-
ation of certain health and dental insurance for specified periods and
limited reimbursement for certain educational and/or outplacement services.
To date, approximately 13% of system employees have voluntarily
terminated employment with the system as a result of the PRP. The System
estimates that 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 cents 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 Governor of
the Commonwealth of Massachusetts on February 24, 1997, and by the
Massachusetts Legislature's Joint Committee on Electric Utility
Restructuring on March 20, 1997 that ultimately evolved into the proposal
issued on August 4, 1997 by the Senate Chairman of the Joint Committee on
Government Regulations. Additionally, during the past year, three
Massachusetts electric utilities announced negotiated restructuring
settlements with the Massachusetts Attorney General. Generally, these
original proposals and settlement agreements included, among other things,
provisions for a 10% reduction in customer charges, divestiture of non-
nuclear generating assets, recovery of stranded costs through a non-
bypassable access charge and an implementation date of January 1, 1998.
Subsequently, on October 3, 1997, the House Chairman of the Joint
<PAGE 15>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Committee on Government Regulations issued another proposal that included,
among other things, a provision calling for a 15% reduction in rates for
customers taking standard offer service from the utility over a seven-year
period, the establishment of an auditing board within the DPU that would
review the stranded costs that would be included in each company's non-
bypassable access charge, unbundled rates as of January 1, 1998 and
implementation of customer choice of energy supplier by March 1, 1998.
On October 29, 1997, a joint proposal was filed by the chairpersons of
the Joint Committee on Government Regulations which essentially reflected
the provisions previously proposed. This proposal was then forwarded to
the Ways and Means Committee of the House of Representatives for further
review and amendment. The House Ways and Means Committee then sent the
amended legislative proposal to the House of Representatives (the House).
On November 10, 1997, after a considerable number of additional amendments
were made by members of the House, the legislation was passed in the House
by a vote of 157 to 3. Provisions of this legislation include, among other
things, a 10% discount on standard offer service and retail choice of
energy supplier effective March 1, 1998, with a subsequent increase in the
discount on standard offer service to 15% upon completion of divestiture of
non-nuclear generating assets and securitization of net non-mitigable
stranded costs (which, for the system, are primarily the result of above-
market purchased power contracts with non-utility generators); and,
recovery of stranded costs subject to review and an audit process. A
Senate version of electric industry restructuring legislation is expected
shortly.
The proposed legislation is lengthy, complex and subject to change
before it is finalized. The system cannot yet determine the final impact
on its operations and financial condition. The final legislation must also
be approved by the Massachusetts House and Senate and signed by the
Governor of Massachusetts. While the system is encouraged by the
legislation's treatment of stranded cost recovery, the mandated customer
discount could have a significant impact on future cash flows. The system
is preparing a proposed restructuring plan in anticipation of final
legislation being enacted.
Auction Process
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 includes a standard, sealed-bid
auction for generation assets and purchased power contracts. 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. A request for bids from interested parties
was issued during August and in October an Offering Memorandum was issued.
The system expects that the final bidders will be chosen by year-end and
that the entire process, including regulatory approvals, will be completed
no later than the end of 1998.
<PAGE 16>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
Gas Industry Restructuring
On July 18, 1997, the DPU directed the ten Massachusetts gas utilities,
including Commonwealth Gas, to initiate a collaborative process that will
establish guiding principles and specific procedures for unbundling rates
and services for all customers. The process has begun with meetings among
the various interested parties. A report is scheduled to be submitted to
the DPU in mid-November.
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.
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 conditions 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.
On August 18, 1997, the DPU noted that the development of unbundling
principles and procedures constitutes only a part of the effort necessary
to develop full customer choice for gas service. The DPU recognized that
each local distribution company will be filing a comprehensive unbundling
proposal at some later date. In the interim, the DPU directed those
companies that do not currently have unbundled rates, including
Commonwealth Gas, to have such rates in effect no later than November 1,
1998.
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
monitors 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
<PAGE 17>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
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 was referred to
the Financial Accounting Standards Board's Emerging Issues Task Force and
guidance was issued in July 1997. Based on the current evaluation of the
various factors and conditions that are expected to impact future cost
recovery, the system believes that its utility operations remain subject to
SFAS No. 71 and its regulatory assets, including those related to electric
generation, remain 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.
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
nine-months ended September 30, 1997, both basic and diluted EPS would be
$.32 and $1.46, respectively.
<PAGE 18>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Cambridge Electric is an intervenor in a pending appeal at the
Massachusetts Supreme Judicial Court (SJC) filed by the Massachusetts
Institute of Technology (MIT) involving a DPU decision approving a
customer transition charge (CTC) for the recovery of stranded
investment costs. On September 18, 1997, the SJC announced its
decision remanding the matter to the DPU for further consideration.
The SJC stated that, although recovery of prudent and verifiable
stranded costs by utility companies is in the public interest and
consistent with the Public Utility Regulatory Policies Act, the
insufficiencies of the DPU's subsidiary findings precluded the SJC
from undertaking a meaningful review of the DPU's calculations that
formed the basis of the customer transition charge. Among the issues
that the SJC directed the DPU to consider further are: the methodology
for calculation of stranded costs, why 75% of stranded costs were
allocated to MIT rather than 100%, the prudence of the stranded costs
incurred by Cambridge Electric, and whether Cambridge Electric took
the necessary mitigation efforts to reduce stranded costs. With the
SJC's remand of the order to the DPU, the parties have been discussing
a standstill agreement. The standstill agreement would not resolve
questions about the ultimate level of CTC payments or what the final
determination will be with respect to the CTC upon remand to the DPU.
The standstill agreement, if finalized and approved by the SJC, would
govern the obligations of MIT to pay the CTC, subject to
reconciliation, during the term of the DPU's remand proceeding. This
issue is discussed more fully in Cambridge Electric'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
<PAGE 19>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
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 nine months ended September 30, 1997.
Filed herewith as Exhibit 2 is the restated Financial Data
Schedule for the nine months ended September 30, 1996.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
September 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: November 14, 1997