<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 March 31, 1998
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 May 1, 1998
Common Shares of Beneficial
Interest, $2 par value 21,533,820 shares
<PAGE 2>
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
ASSETS
(Dollars in thousands)
March 31, December 31,
1998 1997
(Unaudited)
PROPERTY, PLANT AND EQUIPMENT, at original cost
Electric $1,178,184 $1,173,797
Gas 375,923 373,541
Other 73,788 72,475
1,627,895 1,619,813
Less - Accumulated depreciation and
amortization 596,677 577,962
1,031,218 1,041,851
Add - Construction work in progress
and nuclear fuel in process 10,188 8,057
1,041,406 1,049,908
EQUITY IN CORPORATE JOINT VENTURES
Nuclear electric power companies (2.5%
to 4.5%) 10,739 10,368
Other investments 3,301 3,399
14,040 13,767
CURRENT ASSETS
Cash 5,022 4,299
Accounts receivable 140,715 128,946
Unbilled revenues 13,590 32,029
Inventories, at average cost 23,629 32,644
Prepaid taxes and other 10,660 15,068
193,616 212,986
DEFERRED CHARGES
Regulatory assets 187,262 178,864
Other 28,368 29,525
215,630 208,389
$1,464,692 $1,485,050
See accompanying notes.
<PAGE 3>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
CAPITALIZATION AND LIABILITIES
(Dollars in thousands)
March 31, December 31,
1998 1997
(Unaudited)
CAPITALIZATION
Common share investment -
Common shares, $2 par value -
Authorized - 50,000,000 shares
Outstanding - 21,533,820 in 1998 and
21,531,784 in 1997 $ 43,068 $ 43,063
Amounts paid in excess of par value 111,991 111,912
Retained earnings 292,385 275,795
447,444 430,770
Redeemable preferred shares, less current
sinking fund requirements 12,140 12,200
Long-term debt, including premiums, less current
sinking fund requirements and maturing debt 353,262 364,311
812,846 807,281
CAPITAL LEASE OBLIGATIONS 11,530 12,272
CURRENT LIABILITIES
Interim Financing -
Notes payable to banks 74,925 94,075
Maturing long-term debt 29,000 19,000
103,925 113,075
Other Current Liabilities -
Current sinking fund requirements 8,473 8,473
Accounts payable 66,951 107,157
Accrued taxes 44,205 24,205
Other 75,493 58,922
195,122 198,757
299,047 311,832
DEFERRED CREDITS
Accumulated deferred income taxes 166,026 176,354
Nuclear units' purchased power contracts 63,004 69,659
Unamortized investment tax credits
and other 112,239 107,652
341,269 353,665
COMMITMENTS AND CONTINGENCIES
$1,464,692 $1,485,050
See accompanying notes.
<PAGE 4>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(Dollars in thousands - unaudited)
1998 1997
OPERATING REVENUES
Electric $155,804 $176,804
Gas 115,139 132,267
Steam and other 5,661 7,119
276,604 316,190
OPERATING EXPENSES
Fuel and purchased power 86,608 106,259
Cost of gas sold 55,377 72,110
Other operation and maintenance 58,490 60,594
Depreciation 16,179 15,512
Taxes -
Local property and other 8,790 9,149
Federal and state income 16,106 16,674
241,550 280,298
OPERATING INCOME 35,054 35,892
OTHER INCOME 695 649
INCOME BEFORE INTEREST CHARGES 35,749 36,541
INTEREST CHARGES
Long-term debt 8,517 8,404
Other interest charges 1,673 1,737
10,190 10,141
NET INCOME 25,559 26,400
Dividends on preferred shares 237 252
EARNINGS APPLICABLE TO COMMON SHARES $ 25,322 $ 26,148
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 21,532,463 21,530,378
BASIC AND DILUTED EARNINGS PER COMMON SHARE $1.18 $1.21
DIVIDENDS DECLARED PER COMMON SHARE $.405 $.395
See accompanying notes.
<PAGE 5>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(Dollars in thousands - unaudited)
1998 1997
OPERATING ACTIVITIES
Net income $ 25,559 $ 26,400
Effects of noncash items -
Depreciation and amortization 18,719 19,993
Deferred income taxes and investment
tax credits, net (341) 2,082
Earnings from corporate joint ventures (488) (456)
Dividends from corporate joint ventures 107 382
Change in working capital, exclusive of cash
and interim financing 16,458 21,411
Transition costs deferral (14,332) -
All other operating items (4,560) (14,446)
Net cash provided by operating activities 41,122 55,366
INVESTING ACTIVITIES
Additions to property, plant and equipment
(inclusive of AFUDC) -
Electric (6,369) (5,908)
Gas (2,875) (2,637)
Other (1,923) (651)
Net cash used for investing activities (11,167) (9,196)
FINANCING ACTIVITIES
Payment of dividends (8,969) (8,757)
Payment of short-term borrowings (19,150) (30,375)
Sinking funds payments (1,113) (1,104)
Net cash used for financing activities (29,232) (40,236)
Net increase in cash 723 5,934
Cash at beginning of period 4,299 1,495
Cash at end of period $ 5,022 $ 7,429
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of capitalized amounts) $ 10,509 $ 9,627
Income taxes $ 5,294 $ 4,112
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 1,698 regular employees including 1,066 (63%)
represented by various collective bargaining units. One of these collec-
tive bargaining units, representing approximately 5% of regular employees,
recently reached an agreement on a new five-year contract that remains in
effect until April 30, 2003. Upon expiration of another contract
(representing approximately 5% of regular employees) scheduled to expire
on September 1, 1998, a new agreement, which has already been ratified,
will become effective through March 1, 2001. A third agreement
(representing 2% of regular employees) is scheduled to expire in September
1998.
During the second quarter of 1997, the system initiated a voluntary
personnel reduction program. As a result of this program, the total
number of regular employees declined by approximately 15% since December
31, 1996.
Accounting Policies
(a) Principles of Accounting
The system's significant accounting policies are described in Note 2
of Notes to Consolidated Financial Statements included in its 1997 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 March 31,
1998 and 1997, reflect, in the opinion of the System, all adjustments
necessary to summarize fairly the results for such periods. In addition,
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
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.
(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
Telecommunications and Energy (DTE).
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
DTE and/or the 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 the event the criteria for applying SFAS No. 71 are no longer
met, the accounting impact would be an extraordinary, non-cash charge to
operations of an amount that could be material. Criteria that give rise
to the discontinuance of SFAS No. 71 include: 1) increasing competition
that restricts 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 from cost based regulation to another form of
regulation. These criteria are reviewed on a regular basis to ensure the
continuing application of SFAS No. 71 is appropriate. 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 generation, are probable of future
recovery.
As a result of electric industry restructuring, the system's retail
electric companies discontinued application of accounting principles
applied to their investment in electric generation facilities effective
March 1, 1998. The system will not be required to write off any of its
generation-related assets, including regulatory assets. These assets will
be retained on the Condensed Balance Sheets because the legislation and
the DTE's plan for a restructured electric industry specifically provide
for their recovery through a non-bypassable transition charge.
<PAGE 8>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The principal regulatory assets included in deferred charges were as
follows:
March 31, December 31,
1998 1997
(Dollars in thousands)
Maine Yankee unrecovered plant and
decommissioning costs $ 33,660 $ 34,908
Fuel charge stabilization 28,486 29,655
Connecticut Yankee unrecovered plant and
decommissioning costs 27,398 28,566
Postretirement benefits costs 25,048 25,475
Power contract buy-out 16,915 17,609
Transition costs 14,368 -
Deferred income taxes 13,130 13,089
FERC Order 636 transition costs 6,994 7,336
Yankee Atomic unrecovered plant and
decommissioning costs 5,738 6,184
Seabrook related costs 3,798 4,324
Other 11,727 11,718
$187,262 $178,864
The regulatory liabilities, reflected in deferred credits in the
accompanying Condensed Balance Sheets and related primarily to deferred
income taxes, were $13.6 million and $14.1 million at March 31, 1998 and
December 31, 1997, respectively.
In November 1997, the Commonwealth of Massachusetts enacted a
comprehensive electric utility industry restructuring bill. On November
19, 1997, the System's electric subsidiaries filed a restructuring plan
with the DTE. The plan, approved by the DTE on February 27, 1998,
describes the process by which the System's retail electric subsidiaries
began, on March 1, 1998, to initiate a ten percent rate reduction for all
customer classes and allow customers to choose their energy supplier. As
part of the plan, the DTE authorized the recovery of certain strandable
costs and provides that certain future costs may be deferred to achieve or
maintain the rate reductions that the restructuring bill requires. The
legislation gives the DTE the authority to determine the amount of
strandable costs that will be eligible for recovery. Costs that will
qualify as strandable costs and be eligible for recovery include, but are
not limited to, certain above market costs associated with generating
facilities, costs associated with long-term commitments to purchase power
at above market prices from independent power producers and regulatory
assets and associated liabilities related to the generation portion of the
electric business.
The cost of transitioning to competition will be mitigated, in part,
through the divestiture of the system's non-nuclear generating assets in
an auction process that is expected to be completed in 1998. Any net
proceeds in excess of book value received from the divestiture of these
assets will be used to mitigate transition costs.
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The system's ability to recover its transition costs will depend on
several factors, including the aggregate amount of transition costs the
system will be allowed to recover and the market price of electricity.
Management believes that the system will recover its transition costs. A
change in any of the above listed factors or in the current legislation
could affect the recovery of transition costs and may result in a loss to
the system. For additional information relating to industry
restructuring, see the "Industry Restructuring - Electric" section under
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
(3) Commitments and Contingencies
Capital Expenditures
Construction Program
The system is engaged in a continuous construction program presently
estimated at $248.6 million for the five-year period 1998 through 2002.
Of that amount, $60.7 million is estimated for 1998. The program is
subject to periodic review and revision.
Acquisition
The system, through its Advanced Energy Systems, Inc. subsidiary,
tentatively agreed to purchase a total energy plant that is owned by
Harvard University and located in the Longwood Medical Area of Boston for
$146.3 million. This transaction is expected to be closed in the second
quarter of 1998. Revenues from this facility for fiscal years ended June
30, 1997 and 1996 were $58 million and $53.9 million, respectively.
<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 three months of 1998, cash flows from operating
activities amounted to approximately $41.1 million and reflect net income
of $25.6 million and noncash items including depreciation of $16.2 million
and amortization of $2.5 million. The change in working capital since
December 31, 1997, exclusive of cash and interim financing, amounted to
$16.5 million and had a positive impact on cash flows from operating
activities, reflecting lower unbilled revenues ($18.4 million), inventory
levels ($9 million), and prepaid taxes ($5.4 million), coupled with a
higher level of accrued taxes ($20 million) and other current liabilities
($16.6 million). These factors were offset, in part, by a higher level of
accounts receivable ($11.8 million) and a decline in accounts payable
($40.2 million).
Construction expenditures for the first three months of 1998 were
approximately $11.2 million, including an allowance for funds used during
construction (AFUDC) and nuclear fuel. Construction expenditures,
preferred and common dividend requirements of the System ($9 million) and
the payment of short-term borrowings ($19.2 million) were funded entirely
with internally-generated funds.
The system, through its Advanced Energy Systems, Inc. subsidiary,
tentatively agreed to purchase a total energy plant (MATEP), that is owned
and operated by Harvard University and located in the Longwood Medical
Area of Boston for $146.3 million. A lender has been chosen to provide
the debt financing for this acquisition. In addition, the System will
provide the necessary equity infusion with the proceeds from a two-year
bank loan. It is projected that this new venture will increase system
revenues by approximately $45 million in 1998 and, on average, by
approximately $65 million in the years 1999 through 2002. This
transaction is expected to be closed in the second quarter of 1998.
Results of Operations
The following is a discussion of certain significant factors which
have affected operating revenues, expenses and net income during the
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COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
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.
A summary of the period to period changes in the principal items
included in the Condensed Statements of Income for the three months ended
March 31, 1998 and 1997 and unit sales for these periods are shown below:
Three Months
Ended March 31,
1998 and 1997
Increase (Decrease)
(Dollars in thousands)
Operating Revenues -
Electric $(21,000) (11.9)%
Gas (17,128) (12.9)
Steam and other (1,458) (20.5)
(39,586) (12.5)
Operating Expenses -
Fuel and purchased power (19,651) (18.5)
Cost of gas sold (16,733) (23.2)
Other operation and maintenance (2,104) (3.5)
Depreciation 667 4.3
Taxes -
Local property and other (359) (3.9)
Federal and state income (568) (3.4)
(38,748) (13.8)
Operating Income (838) (2.3)
Other Income 46 7.1
Income Before Interest Charges (792) (2.2)
Interest Charges 49 0.5
Net Income (841) (3.2)
Dividends on preferred shares (15) (6.0)
Earnings Applicable to Common Shares $ (826) (3.2)
Unit Sales -
Electric - Megawatthours (MWH)
Retail 6,971 0.6
Wholesale (33,007) (2.8)
(26,036) (1.1)
Gas - Billions of British Thermal Units (BBTU)
Firm (2,799) (16.2)
Interruptible and other 312 24.9
(2,487) (13.4)
<PAGE 12>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The following is a summary of electric unit sales and gas throughput
for the periods indicated:
Three Months Ended
March 31,
1998 1997
Electric Sales - MWH
Residential 472,219 474,051
Commercial 596,860 589,588
Industrial 101,280 99,772
Other 6,688 6,665
Total retail 1,177,047 1,170,076
Wholesale to other systems 1,140,327 1,173,334
Total 2,317,374 2,343,410
Gas Sales - BBTU
Residential 8,768 9,882
Commercial 4,052 4,850
Industrial 815 1,573
Other 823 952
Total firm 14,458 17,257
Off-system 1,037 797
Interruptible and other 526 454
Total 16,021 18,508
Transportation 2,367 1,194
Total throughput 18,388 19,702
Electric Revenues, Fuel and Purchased Power Costs
For the first quarter of 1998, electric operating revenues decreased
by approximately $21 million or 11.9% mainly due to lower fuel and
purchased power costs ($19.7 million) and a decrease in conservation and
load management (C&LM) costs ($1.4 million). During the quarter, the 18.5%
decrease in fuel and purchased power costs reflects lower fuel costs and a
$14.3 million deferral of costs in conjunction with the system's electric
restructuring plan as approved by the DTE. The system has unbundled its
rates, provided customers with a ten percent discount as of March 1, 1998
and affords customers the opportunity to purchase generation supply in the
competitive market consistent with the electric industry restructuring
legislation further discussed below. Delivery rates are composed of a
customer charge (to collect metering and billing costs), a distribution
charge, a transition charge (to collect stranded costs), a transmission
charge, an energy conservation charge (to collect costs for demand-side
management programs) and a renewable energy charge. Electricity supply
services provided by the system's retail subsidiaries include optional
standard offer service and default service. Amounts collected through
these various charges will be reconciled to actual expenditures on an on-
going basis.
Gas Revenues and Cost of Gas Sold
For the first three months of 1998, gas operating revenues decreased
by approximately $17.1 million or 12.9% due primarily to lower firm unit
sales (16.2%) and, to a lesser extent, lower gas costs.
<PAGE 13>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
The decrease in unit sales to firm customers reflects the impact of
the milder weather conditions experienced during the first quarter on all
customer segments. For the current quarter, heating degree days totaled
2,755 which is 7.1% lower than last year and 13.7% below the normal level
of 3,192. The fluctuation in interruptible and other sales reflects the
competitive market that exists today in the natural gas industry.
Other Operating Expenses
For the first three months of 1998, other operation and maintenance
decreased $2.1 million, or 3.5%, reflecting savings realized from a
personnel reduction program (PRP) that was initiated during the second
quarter of 1997 and lower conservation and load management costs ($1.4
million) partially offset by higher costs relating to information
technology, telecommunications and network services ($3.2 million) which
includes costs associated with Year 2000 compliance.
Depreciation increased 4.3% or $667,000 due to a higher level of
depreciable plant. The $359,000 (3.9%) decrease in local property and
other taxes was due primarily to a decrease in payroll taxes attributable
to savings realized from the aforementioned PRP. This decrease was
partially offset by higher property tax rates and assessments within the
system's service territory. Federal and state income taxes decreased
$568,000 (3.4%) and reflect the reduced level of pretax income.
Industry Restructuring - Electric
On November 25, 1997, the Governor of Massachusetts signed into law
the Electric Industry Restructuring Act (the Act). Provisions of this
legislation include, among other things, a 10 percent 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 of up
to 15 percent upon completion of divestiture of non-nuclear generating
assets and possible 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 transition
costs subject to review and an audit process.
The system filed a comprehensive electric restructuring plan with
the DTE in November 1997, that was substantially approved by the DTE in
February 1998. While the system is encouraged with the treatment afforded
stranded or transition cost recovery by the legislation and the DTE, the
mandated customer discount could have a significant impact on future cash
flows of the system.
It is now likely that a referendum will appear on the ballot in
November of this year that is seeking to repeal the legislation.
Management is unable to predict what the ultimate outcome of this challenge
will be.
In March 1997, the system submitted a report to the DTE that
detailed the proposed auction process for selling its electric generation
assets and entitlements. The process included a standard sealed-bid
<PAGE 14>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
auction for generation assets and entitlements from purchased power
contracts. The auction process provided a market-based approach to
maximizing stranded cost mitigation and minimizing the transition costs
that retail customers will have to pay for stranded cost recovery. A
request for bids from interested parties was issued last August followed by
an Offering Memorandum in October. Potential bidders examined all
pertinent information related to the generating facilities and purchased
power agreements in order to prepare and submit their first round of bids
in mid-December. In January 1998, the system selected a short list of
potential bidders, each of whom submitted a final binding bid on May 8,
1998. The ultimate selection of the winning bidder or bidders is expected
to be made after a two-week evaluation period. The closing process and the
required regulatory filings are expected to be completed in 1998.
Industry Restructuring - Gas
On July 18, 1997, the DTE 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 DTE 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 DTE 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 DTE also suggested that the collaborative
reconsider the pricing and provision of interruptible transportation
services.
On August 18, 1997, the DTE 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 DTE recognized that
each local distribution company will be filing a comprehensive unbundling
proposal at some later date. In the interim, the DTE 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.
Commonwealth Gas and eight other gas utilities initiated the
Massachusetts Gas Unbundling Collaborative (the Collaborative) on September
15, 1997, to explore and develop generic principles to achieve the goals
set forth by the DTE. Collaborative participants represented a broad array
<PAGE 15>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
of stakeholder interests including the utilities, natural gas marketers,
interstate pipelines, producers, energy consultants, labor unions, consumer
advocates and representatives for the DTE, the Massachusetts Attorney
General's Office, and the Massachusetts Division of Energy Resources.
On November 15, 1997, the Collaborative filed a status report with
the DTE that outlined its progress in moving the gas industry to a more
competitive structure that provides all customers with meaningful access to
competitive markets consistent with public-policy objectives. The status
report summarized the substantive issues that had been the subject of
Collaborative discussion, including: (1) the disposition of interstate
pipeline capacity; (2) the unbundling of rates; (3) customer enrollment,
billing, termination, and information exchange procedures; and, (4)
consumer protections, low-income discounts, and competitive supplier
registration. The status report also established a schedule to implement a
final unbundling plan by November 1, 1998.
In accordance with that schedule, the Collaborative submitted to the
DTE a Rate Unbundling Status Report on January 16, 1998. The report
detailed an overall process for developing unbundled rates consistent with
the DTE's rate structure goals of efficiency, fairness, simplicity,
continuity and earnings stability. In response to the Collaborative's
proposal, the DTE ordered Commonwealth Gas to submit, by April 15, 1998, a
consensus-based settlement, or partial settlement, of unbundled rate
tariffs designed according to the general concepts set forth in the report.
Subsequently, the DTE granted Commonwealth Gas a one-month extension to
reach a settlement with the Collaborative's participants.
On March 18, 1998, the Collaborative filed a second status report
that summarized the progress made by the Collaborative since it had last
updated the DTE on its activities. The Collaborative reported that it had
made substantial progress in the areas of rate unbundling and terms and
conditions for unbundled services. The report also described at least two
policy issues, capacity disposition and cost responsibility, on which the
Collaborative's participants require specific regulatory guidance before
completing a comprehensive framework for the transition to a more
competitive market structure. In response to the March report, the DTE
issued a Notice of Inquiry to address the Collaborative's unresolved
issues. On May 1, 1998, Commonwealth Gas filed initial written comments in
the proceeding arguing in favor of a mandatory capacity assignment
proposal.
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. The DTE 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 1997 Annual Report on Form 10-K.
<PAGE 16>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
New Accounting Standard
In April 1998, the American Institute of Certified Public
Accountants issued Statement of Position 98-5 "Reporting on the Costs of
Start-Up Activities" (SOP 98-5). SOP 98-5 provides guidance on the
financial reporting of start-up and organization costs and requires that
these costs be expensed as incurred. The impact of SOP 98-5 is not
expected to have a material impact on the system's results of operations or
financial condition.
Year 2000
The system has been involved in Year 2000 compliancy since 1996. A
complete inventory and review of software, information processing and
delivery systems has been completed, and work continues on computer systems
wherever necessary. While some computer systems have already been updated,
tested and placed in production, the system expects to complete the balance
of the modifications by early 1999.
Costs associated with Year 2000 compliancy are being expensed as
incurred. The total cost of this project is expected to be funded with
internally generated funds.
Management believes that, with appropriate modifications, the system
will be fully compliant regarding all Year 2000 issues and will continue to
provide its products and services uninterrupted through the millennium
change. Failure to become fully compliant could have a significant impact
on the system's operations.
Forward-Looking Statements
This discussion contains statements which, to the extent it is not a
recitation of historical fact, constitute "forward-looking statements" and
is intended to be subject to the safe harbor protection provided by the
Private Securities Litigation Reform Act of 1995. A number of important
factors affecting the System's business and financial results could cause
actual results to differ materially from those reflected in the forward-
looking statements or projected amounts. Those factors include
developments in the legislative, regulatory and competitive environment,
certain environmental matters, demands for capital and new business
development expenditures and the availability of cash from various sources.
<PAGE 17>
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 when Cambridge Electric was an intervenor
in an appeal at the Massachusetts Supreme Judicial Court (SJC) filed
by the Massachusetts Institute of Technology (MIT) involving a DTE
decision approving a customer transition charge (CTC) for the recovery
of stranded investment costs. By its terms, the CTC was terminated on
March 1, 1998, coincident with the retail access date established by
the Massachusetts Legislature in the Electric Industry Restructuring
Act. On September 18, 1997, the SJC remanded the CTC matter to the
DTE 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 DTE's subsidiary findings
precluded the SJC from undertaking a meaningful review of the DTE's
calculations that formed the basis of the CTC. The DTE is in the
process of determining whether to hear additional evidence in the
remand or to rely on the record and pleadings already filed. This
issue is discussed more fully in the System's 1997 Annual Report on
Form 10-K. At this time, management is unable to predict the ultimate
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
(a) The Annual Meeting of Shareholders was held on May 7, 1998.
(b) The three nominees, Sheldon A. Buckler, Betty L. Francis and
Michael C. Ruettgers, listed in the System's Notice of 1998 Annual
Meeting and Proxy Statement dated March 30, 1998 were elected to the
Board of Trustees of Commonwealth Energy System.
(c) As set forth in the System's Notice of 1998 Annual Meeting and
Proxy Statement dated March 30, 1998 as Item 2, a proposal to consent
to an amendment to Section 22 of the System's Declaration of Trust,
which sets forth the conditions under which presently authorized but
unissued Common Shares of the System may be issued by the Trustees
without the vote or written consent of a majority of the Common
Shareholders outstanding at the time, was voted on and approved at the
1998 Annual Shareholders' Meeting. There were 14,409,794 (66.9%)
Common Shares voted for this proposal, 953,847 (4.4%) Common Shares
voted against this proposal, 236,612 (1.1%) Common Shares abstained
and 5,933,567 (27.6%) Common Shares were not voted. The affirmative
vote of the holders of a majority of the outstanding Common Shares was
required for approval of this proposal.
<PAGE 18>
COMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES
(d) As set forth in the System's Notice of 1998 Annual Meeting and
Proxy Statement dated March 30, 1998 as Item 3, a proposal to adopt a
Restricted Common Share Plan for the Trustees of Commonwealth Energy
System was voted on and approved at the 1998 Annual Shareholders'
Meeting. There were 16,794,297 (78.0%) Common Shares voted for this
proposal, 1,074,885 (5.0%) Common Shares voted against this proposal,
278,085 (1.3%) Common Shares abstained and 3,386,553 (15.7%) Common
Shares were not voted.
(e) A shareholder proposal that was set forth in the System's Notice
of 1998 Annual Meeting and Proxy Statement requesting the Board of
Trustees to repeal the classified board and institute annual election
of trustees was postponed by the proponent as he was unable to attend
the 1998 Annual Shareholders' Meeting.
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 three months ended March 31, 1998.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
March 31, 1998.
<PAGE 19>
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: May 15, 1998