1997 Annual Report
North Atlantic Energy Corporation
Index
Contents Page
Balance Sheets................................................... 2
Statements of Income............................................. 4
Statements of Cash Flows......................................... 5
Statements of Common Stockholder's Equity........................ 6
Notes to Financial Statements.................................... 7
Report of Independent Public Accountants......................... 24
Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 26
Selected Financial Data.......................................... 32
Statistics....................................................... 32
Statements of Quarterly Financial Data........................... 32
Bondholder Information........................................... Back Cover
PART I. FINANCIAL INFORMATION
NORTH ATLANTIC ENERGY CORPORATION
BALANCE SHEETS
- -----------------------------------------------------------------------------------------
At December 31, 1997 1996
- -----------------------------------------------------------------------------------------
(Thousands of Dollars)
ASSETS
- ------
Utility Plant, at original cost:
Electric (Note 1G)...................................... $ 779,111 $ 775,794
Less: Accumulated provision for depreciation......... 143,778 124,530
------------- -------------
635,333 651,264
Construction work in progress........................... 4,616 8,887
Nuclear fuel, net....................................... 27,413 31,765
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Total net utility plant............................. 667,362 691,916
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Other Property and Investments:
Nuclear decommissioning trusts, at market............... 26,547 19,744
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26,547 19,744
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Current Assets:
Cash.................................................... 13 299
Special deposits........................................ - 7,039
Receivables from affiliated companies................... 25,695 16,422
Taxes receivable........................................ 4,613 -
Materials and supplies, at average cost................. 13,003 13,093
Prepayments and other................................... 4,220 4,302
------------- -------------
47,544 41,155
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Deferred Charges:
Regulatory assets (Note 1H)............................. 269,484 259,881
Unamortized debt expense................................ 3,702 4,692
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273,186 264,573
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Total Assets........................................ $ 1,014,639 $ 1,017,388
============= =============
The accompanying notes are an integral part of these financial statements.
NORTH ATLANTIC ENERGY CORPORATION
BALANCE SHEETS
- -----------------------------------------------------------------------------------------
At December 31, 1997 1996
- -----------------------------------------------------------------------------------------
(Thousands of Dollars)
CAPITALIZATION AND LIABILITIES
- ------------------------------
Capitalization:
Common stock--$1 par value. Authorized
and outstanding 1,000 shares.......................... $ 1 $ 1
Capital surplus, paid in................................ 160,999 160,999
Retained earnings....................................... 58,702 53,749
------------- -------------
Total common stockholder's equity.............. 219,702 214,749
Long-term debt.......................................... 475,000 495,000
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Total capitalization........................... 694,702 709,749
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Current Liabilities:
Notes payable to affiliated company..................... 9,950 2,500
Long-term debt--current portion......................... 20,000 20,000
Accounts payable........................................ 7,912 20,714
Accounts payable to affiliated companies................ 6,040 5,073
Accrued interest........................................ 3,025 2,888
Accrued taxes........................................... - 3,486
Other................................................... 1,055 271
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47,982 54,932
------------- -------------
Deferred Credits:
Accumulated deferred income taxes....................... 216,701 196,650
Deferred obligation to affiliated company (Note 6)...... 32,472 33,284
Other................................................... 22,782 22,773
------------- -------------
271,955 252,707
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Commitments and Contingencies (Note 7)
------------- -------------
Total Capitalization and Liabilities........... $ 1,014,639 $ 1,017,388
============= =============
The accompanying notes are an integral part of these financial statements.
NORTH ATLANTIC ENERGY CORPORATION
STATEMENTS OF INCOME
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For the Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------------
(Thousands of Dollars)
Operating Revenues................................. $ 192,381 $ 162,152 $ 157,183
---------- ---------- ----------
Operating Expenses:
Operation --
Fuel.......................................... 13,405 15,013 12,030
Other......................................... 39,091 34,356 36,737
Maintenance...................................... 24,146 9,154 12,442
Depreciation..................................... 25,170 24,056 23,406
Amortization of regulatory assets, net........... 6,270 - -
Federal and state income taxes (Note 5).......... 14,845 12,341 10,187
Taxes other than income taxes.................... 12,393 12,343 10,987
---------- ---------- ----------
Total operating expenses................... 135,320 107,263 105,789
---------- ---------- ----------
Operating Income................................... 57,061 54,889 51,394
---------- ---------- ----------
Other Income:
Deferred Seabrook return--other funds............ 7,205 7,700 9,405
Other, net....................................... (747) 1,200 1,556
Income taxes..................................... 4,394 5,052 2,776
---------- ---------- ----------
Other income, net.......................... 10,852 13,952 13,737
---------- ---------- ----------
Income before interest charges............. 67,913 68,841 65,131
---------- ---------- ----------
Interest Charges:
Interest on long-term debt....................... 50,722 52,414 62,721
Other interest................................... 649 (697) (519)
Deferred Seabrook return--borrowed funds......... (13,411) (14,948) (21,512)
---------- ---------- ----------
Interest charges, net...................... 37,960 36,769 40,690
---------- ---------- ----------
Net Income......................................... $ 29,953 $ 32,072 $ 24,441
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
NORTH ATLANTIC ENERGY CORPORATION
STATEMENTS OF CASH FLOWS
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For the Years Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Operating Activities:
Net Income.................................................. $ 29,953 $ 32,072 $ 24,441
Adjustments to reconcile to net cash
from operating activities:
Depreciation.............................................. 25,170 24,056 23,406
Amortization of nuclear fuel.............................. 10,705 11,668 9,183
Deferred income taxes and investment tax credits, net..... 22,649 15,749 46,114
Deferred return - Seabrook................................ (20,616) (22,648) (30,917)
Sale of Seabrook 2 steam generator........................ - 20,931 -
Loss on reacquired debt................................... - - (31,886)
Other sources of cash..................................... 11,052 9,175 2,957
Other uses of cash........................................ (2,224) (2,582) (3,375)
Changes in working capital:
Receivables............................................... (9,273) 2,270 (4,709)
Materials and supplies.................................... 90 (824) (2,233)
Accounts payable.......................................... (11,835) 19,509 2,167
Accrued taxes............................................. (3,486) 2,140 (93)
Other working capital (excludes cash)..................... 3,429 (7,675) (12,161)
----------- ----------- -----------
Net cash flows from operating activities...................... 55,614 103,841 22,894
----------- ----------- -----------
Financing Activities:
Issuance of long-term debt.................................. - - 225,000
Net increase/(decrease) in short-term debt.................. 7,450 (5,500) 8,000
Reacquisitions and retirements of long-term debt............ (20,000) (45,000) (225,000)
Cash dividends on common stock.............................. (25,000) (38,000) (24,000)
----------- ----------- -----------
Net cash flows used for financing activities.................. (37,550) (88,500) (16,000)
----------- ----------- -----------
Investment Activities:
Investment in plant:
Electric utility plant.................................... (6,606) (5,921) (6,906)
Nuclear fuel.............................................. (6,147) (15,752) (16,609)
----------- ----------- -----------
Net cash flows used for investments in plant................ (12,753) (21,673) (23,515)
NU System Money Pool........................................ - 2,500 26,250
Investment in nuclear decommissioning trusts................ (5,597) (4,404) (3,824)
Other investment activities, net............................ - 222 -
----------- ----------- -----------
Net cash flows used for investments........................... (18,350) (23,355) (1,089)
----------- ----------- -----------
Net (Decrease)/Increase In Cash For The Period................ (286) (8,014) 5,805
Cash - beginning of period.................................... 299 8,313 2,508
----------- ----------- -----------
Cash - end of period.......................................... $ 13 $ 299 $ 8,313
=========== =========== ===========
Supplemental Cash Flow Information:
Cash paid/(refunded) during the year for:
Interest, net of amounts capitalized........................ $ 45,297 $ 46,322 $ 73,923
=========== =========== ===========
Income taxes................................................ $ - $ (13,160) $ (36,679)
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
NORTH ATLANTIC ENERGY CORPORATION
STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
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Capital Retained
Common Surplus, Earnings
Stock Paid In (a) Total
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(Thousands of Dollars)
Balance at January 1, 1995 ............. $ 1 $ 160,999 $ 59,236 $ 220,236
Net income for 1995................. 24,441 24,441
Cash dividends on common stock...... (24,000) (24,000)
---------- ---------- --------- ----------
Balance at December 31, 1995............ 1 160,999 59,677 220,677
Net income for 1996................. 32,072 32,072
Cash dividends on common stock...... (38,000) (38,000)
---------- ---------- --------- ----------
Balance at December 31, 1996............ 1 160,999 53,749 214,749
Net income for 1997................. 29,953 29,953
Cash dividends on common stock...... (25,000) (25,000)
---------- ---------- --------- ----------
Balance at December 31, 1997............ $ 1 $ 160,999 $ 58,702 $ 219,702
========== ========== ========= ==========
(a) All retained earnings are available for distribution, plus an allowance of
$10 million.
The accompanying notes are an integral part of these financial statements.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ABOUT NORTH ATLANTIC ENERGY CORPORATION
North Atlantic Energy Corporation (NAEC or the company), The
Connecticut Light and Power Company (CL&P), Public Service Company of
New Hampshire (PSNH), Western Massachusetts Electric Company (WMECO),
and Holyoke Water Power Company (HWP), are the operating subsidiaries
comprising the Northeast Utilities system (the NU system) and are
wholly owned by Northeast Utilities (NU).
The NU system furnishes franchised retail electric service in
Connecticut, New Hampshire, and western Massachusetts through CL&P,
PSNH, WMECO, and HWP. NAEC sells all of its entitlement to the
capacity and output of the Seabrook nuclear power plant, (Seabrook,
a 1,148-megawatt nuclear generating unit) to PSNH. In addition to its
franchised retail service, the NU system furnishes firm and other
wholesale electric services to various municipalities and other
utilities, and participates in limited retail access programs,
providing off-system retail electric service. The NU system serves
about 30 percent of New England's electric needs and is one of the
25 largest electric utility systems in the country as measured by
revenues.
Other wholly owned subsidiaries of NU provide support services for
the NU system companies and, in some cases, for other New England
utilities. Northeast Utilities Service Company (NUSCO) provides
centralized accounting, administrative, information resources,
engineering, financial, legal, operational, planning, purchasing and
other services to the NU system companies. North Atlantic Energy
Service Corporation (NAESCO) acts as agent for NAEC and CL&P and has
operational responsibility for Seabrook. Northeast Nuclear Energy
Company (NNECO) acts as agent for the NU system companies and other
New England utilities in operating the Millstone nuclear generating
facilities.
B. PRESENTATION
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities at the date of
the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates.
Certain reclassifications of prior years' data have been made to
conform with the current year's presentation.
All transactions among affiliated companies are on a recovery of cost
basis which may include amounts representing a return on equity and are
subject to approval by various federal and state regulatory agencies.
C. PUBLIC UTILITY REGULATION
NU is registered with the Securities and Exchange Commission (SEC) as a
holding company under the Public Utility Holding Company Act of 1935
(1935 Act), and it and its subsidiaries, including NAEC, are subject to
the provisions of the 1935 Act. Arrangements among the NU system
companies, outside agencies and other utilities covering
interconnections, interchange of electric power and sales of utility
property are subject to regulation by the Federal Energy Regulatory
Commission (FERC) and/or the SEC. NAEC is subject to further regulation
for rates, accounting and other matters by the FERC and/or applicable
state regulatory commissions.
For information regarding proposed changes in the nature of industry
regulation, see Note 7A, "Commitments and Contingencies - Restructuring
and Rate Matters."
D. NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board (FASB) issued a new accounting
standard in February 1997: Statement of Financial Accounting Standards
(SFAS) 129, "Disclosure of Information about Capital Structure." SFAS
129 establishes standards for disclosing information about an entity's
capital structure. NAEC's current disclosures are consistent with the
requirements of SFAS 129.
During June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income." SFAS 130 establishes standards for the reporting and
disclosure of comprehensive income. To date, NAEC has not had material
transactions that would be required to be reported as comprehensive
income. Management believes that the implementation of SFAS 130 will
not have a material impact on NAEC's current disclosures.
E. JOINTLY OWNED ELECTRIC UTILITY PLANT
NAEC has a 35.98 percent joint-ownership interest in Seabrook which
includes the 0.4 percent ownership interest in Seabrook 1 which NAEC
acquired from Vermont Electric Generation and Transmission Cooperative
in February 1994. NAEC sells all of its share of the power generated
by Seabrook to PSNH under two long-term contracts (the Seabrook Power
Contracts). As of December 31, 1997 and 1996, plant-in-service
included approximately $723.2 million and $718.7 million, respectively,
and the accumulated provision for depreciation included approximately
$116.1 million and $102.0 million, respectively, for NAEC's share of
Seabrook 1. NAEC's share of Seabrook 1 expenses is included in the
corresponding operating expenses on the accompanying Statements of
Income.
F. DEPRECIATION
The provision for depreciation is calculated using the straight-line
method based on estimated remaining lives of depreciable utility plant-
in-service, adjusted for salvage value and removal costs, as approved
by the appropriate regulatory agency. Except for major facilities,
depreciation rates are applied to the average plant-in-service during
the period. Major facilities are depreciated from the time they are
placed in service. When plant is retired from service, the original
cost of plant, including costs of removal, less salvage, is charged to
the accumulated provision for depreciation. The depreciation rates for
the several classes of electric plant-in-service are equivalent to a
composite rate of 3.5 percent in 1997, 3.4 percent in 1996 and
3.3 percent in 1995. See Note 2, "Nuclear Decommissioning," for
additional information on nuclear plant decommissioning.
G. SEABROOK POWER CONTRACTS
PSNH and NAEC have entered into two power contracts that obligate PSNH
to purchase NAEC's 35.98 percent ownership of the capacity and output
of Seabrook 1 for the term of Seabrook 1's Nuclear Regulatory
Commission (NRC) operating license. Under these contracts, PSNH is
obligated to pay NAEC's cost of service during this period, regardless
if Seabrook 1 is operating. NAEC's cost of service includes all of its
Seabrook-related costs, including operation and maintenance (O&M)
expenses, fuel expense, income and property tax expense, depreciation
expense, certain overhead and other costs and a return on its allowed
investment.
The Seabrook Power Contracts established the value of the initial
investment in Seabrook (initial investment) at $700-million. As
prescribed by the 1989 rate agreement with the State of New Hampshire
(Rate Agreement), as of May 1, 1996, NAEC phased into rates 100 percent
of the recoverable portion of its investment in Seabrook 1. From
June 5, 1992 (the date NU acquired PSNH and NAEC acquired Seabrook 1
from PSNH - the Acquisition Date) through November 1997, NAEC recorded
$203.9 million of deferred return on its investment in Seabrook 1. At
November 30, 1997, NAEC's utility plant included $84.1 million of
deferred return that was transferred as part of the Seabrook plant
assets to NAEC on the Acquisition Date. Beginning on December 1, 1997,
the deferred return, including the portion transferred to NAEC is
currently being billed through the Seabrook Power Contracts to PSNH,
and will be fully recovered from customers by May 2001. NAEC is
depreciating its initial investment over the term of Seabrook 1's
operating license (39 years), and any subsequent plant additions are
depreciated on a straight-line basis over the remaining term of the
Seabrook Power Contracts at the time the subsequent additions are
placed in service.
If Seabrook 1 is shut down prior to the expiration of the NRC operating
license, PSNH will be unconditionally required to pay NAEC termination
costs for 39 years, less the period during which Seabrook 1 has
operated. These termination costs will reimburse NAEC for its share of
Seabrook 1 shut-down and decommissioning costs, and will pay NAEC a
return of and on any undepreciated balance of its initial investment
over the remaining term of the Seabrook Power Contracts, and the return
of and on any capital additions to the plant made after the Acquisition
Date over a period of five years after shut down (net of any tax
benefits to NAEC attributable to the cancellation).
H. REGULATORY ACCOUNTING AND ASSETS
The accounting policies of the company and the accompanying financial
statements conform to generally accepted accounting principles
applicable to rate-regulated enterprises and reflect the effects of the
ratemaking process in accordance with SFAS 71, "Accounting for the
Effects of Certain Types of Regulation." Assuming a cost-of-service
based regulatory structure, regulators may permit incurred costs,
normally treated as expenses, to be deferred and recovered through
future revenues. Through their actions, regulators also may reduce or
eliminate the value of an asset, or create a liability. If any portion
of the company's operations no longer were subject to the provisions
of SFAS 71, as a result of a change in the cost-of-service based
regulatory structure or the effects of competition, the company would
be required to write off all of its related regulatory assets and
liabilities unless there is a formal transition plan which provides for
the recovery, through established rates, for the collection of approved
stranded costs and to maintain the cost-of-service basis for the
remaining regulated operations. At the time of transition, NAEC would
be required to determine any impairment to the carrying costs of
deregulated plant and inventory assets.
The issue of restructuring the electric utility industry in New
Hampshire is currently the focus of negotiations and proceedings
within the federal and state court systems. The outcome of these court
proceedings will impact NAEC due to NAEC's contractual relationship
with PSNH through the Seabrook Power Contracts. However, management
believes that NAEC's use of regulatory accounting remains appropriate
while this issue remains in litigation.
For more information on NAEC's regulatory environment and the potential
impacts of restructuring, see Note 7A, "Commitments and Contingencies -
Restructuring and Rate Matters," and Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A).
SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," requires the evaluation of long-
lived assets, including regulatory assets, for impairment when certain
events occur or when conditions exist that indicate the carrying
amounts of assets may not be recoverable. SFAS 121 requires that any
long-lived assets which are no longer probable of recovery through
future revenues be revalued based on estimated future cash flows.
If this revaluation is less than the book value of the asset, an
impairment loss would be charged to earnings. SFAS 121 did not have a
material impact on the company's financial position or results of
operations as of December 31, 1997. Management continues to believe
that it is probable that the company will recover its investments in
long-lived assets through future revenues. This conclusion may change
in the future as the implementation of restructuring plans within New
Hampshire will subject NAEC to competitive market conditions. As a
result, NAEC will be required to assess the carrying amounts of its
long-lived assets in accordance with SFAS 121.
The components of NAEC's regulatory assets are as follows:
At December 31, 1997 1996
(Thousands of Dollars)
Deferred costs-Seabrook 1
(Note 1K)............................ $199,753 $185,078
Income taxes, net (Note 1I)............ 48,736 47,185
Recoverable energy costs (Note 1J)..... 2,057 2,217
Unamortized loss on reacquired
debt................................. 18,938 25,401
$269,484 $259,881
I. INCOME TAXES
The tax effect of temporary differences (differences between the
periods in which transactions affect income in the financial
statements and the periods in which they affect the determination
of taxable income) is accounted for in accordance with the ratemaking
treatment of the applicable regulatory commissions. See Note 5, "Income
Tax Expense" for the components of income tax expense.
The tax effect of temporary differences, including timing differences
accrued under previously approved accounting standards, which give rise
to the accumulated deferred tax obligation is as follows:
At December 31, 1997 1996
(Thousands of Dollars)
Accelerated depreciation and
other plant-related differences ..... $159,251 $136,234
Regulatory assets - income tax
gross up ............................ 17,094 16,516
Other ................................. 40,356 43,900
$216,701 $196,650
J. RECOVERABLE ENERGY COSTS
Under the Energy Policy Act of 1992 (Energy Act), NAEC is assessed for
its proportionate share of the costs of decontaminating and
decommissioning uranium enrichment plants owned by the United States
Department of Energy (D&D assessment). The Energy Act requires that
regulators treat D&D assessments as a reasonable and necessary current
cost of fuel, to be fully recovered in rates, like any other fuel cost.
NAEC is currently recovering these costs through the Seabrook Power
Contracts. As of December 31, 1997, NAEC's total D&D deferral was
approximately $2.0 million.
K. DEFERRED COST - SEABROOK 1
As prescribed by the Rate Agreement as of May 1, 1996, NAEC phased
into rates 100 percent of the recoverable portion of its investment
in Seabrook 1. This plan is in compliance with SFAS 92, "Regulated
Enterprises - Accounting for Phase-In Plans." See Note 1G, "Summary
of Significant Accounting Policies - Seabrook Power Contracts," for
terms of Seabrook 1's phase-in. See Note 7A, "Commitments and
Contingencies - Restructuring and Rate Matters," for the possible
impacts of the NHPUC's decision related to industry restructuring.
L. MARKET RISK-MANAGEMENT POLICIES
NAEC utilizes market risk-management instruments to hedge well-defined
risks associated with variable interest rates. To qualify for hedge
treatment, the underlying hedged item must expose the company to risks
associated with market fluctuations and the market risk-management
instrument used must be designated as a hedge and must reduce the
company's exposure to market fluctuations throughout the period.
Amounts receivable or payable under interest-rate management
instruments are accrued and offset against interest expense. NAEC
does not use market risk-management instruments for speculative
purposes. For further information, see Note 8, "Market Risk
Management."
M. SPENT NUCLEAR FUEL
Under the Nuclear Waste Policy Act of 1982, NAEC must pay the United
States Department of Energy (DOE) for the disposal of spent nuclear
fuel and high-level radioactive waste. The DOE is responsible for the
selection and development of repositories for, and the disposal of,
spent nuclear fuel and high-level radioactive waste. Fees for nuclear
fuel burned on or after April 7, 1983, are billed currently to
customers and paid to the DOE on a quarterly basis.
The DOE was originally scheduled to begin accepting delivery of spent
fuel in 1998. However, delays in identifying a permanent storage site
have continually postponed plans for the DOE's long-term storage and
disposal site. Extended delays or a default by the DOE could lead to
consideration of costly alternatives. The company has primary
responsibility for the interim storage of its spent nuclear fuel.
Current capability to store spent fuel at Seabrook is estimated to be
adequate until the year 2010. Meeting spent fuel storage requirements
beyond this period could require new and separate storage facilities,
the costs for which have not been determined.
In November 1997, the U.S. District Court of Appeals for the D.C.
Circuit ruled that the lack of an interim storage facility does not
excuse the DOE from meeting its contractual obligation to begin
accepting spent nuclear fuel no later than January 31, 1998.
Currently, the DOE has not taken the spent nuclear fuel as scheduled,
and, as a result, may have to pay contract damages. The ultimate
outcome of this legal proceeding is uncertain at this time.
2. NUCLEAR DECOMMISSIONING
The Seabrook 1 nuclear power plant has a service life that is expected to
end in the year 2026. Upon retirement, this unit must be decommissioned.
A current decommissioning study concluded that complete and immediate
dismantlement at retirement continues to be the most viable and economic
method of decommissioning Seabrook 1. Decommissioning studies are reviewed
and updated periodically to reflect changes in decommissioning
requirements, costs, technology and inflation.
NAEC's 35.98 percent ownership of the estimated costs of decommissioning
Seabrook 1, in year-end 1997 dollars, is $170.2 million. Seabrook 1
decommissioning costs will be increased annually by an escalation rate.
Nuclear decommissioning costs are accrued over the expected service life
of the unit and are included in depreciation expense on the Statements of
Income. Nuclear decommissioning costs amounted to $4.5 million in 1997,
$3.5 million in 1996, and $3.0 million in 1995. Nuclear decommissioning,
as a cost of removal, is included in the accumulated provision for
depreciation on the Balance Sheets. At December 31, 1997 and 1996, the
balance in the accumulated reserve for depreciation amounted to $26.5
million and $19.7 million, respectively.
Under the terms of the Rate Agreement, PSNH is obligated to pay NAEC's
share of Seabrook 1's decommissioning costs, even if the unit is shut
down prior to the expiration of its operating license. NAEC's portion
of the cost of decommissioning Seabrook 1 is paid to an independent
decommissioning financing fund managed by the state of New Hampshire.
Funding of the estimated decommissioning costs assumes escalated
collections for Seabrook 1 and after-tax earnings on the Seabrook
decommissioning fund of 6.5 percent.
As of December 31, 1997, NAEC (including payments made prior to the
Acquisition Date by PSNH) had paid approximately $21.1 million into
Seabrook 1's decommissioning financing fund. Earnings on the
decommissioning financing fund increase the decommissioning trust
balance and the accumulated reserve for depreciation. Unrealized gains
and losses associated with the decommissioning financing fund also impact
the balance of the trust and the accumulated reserve for depreciation.
Changes in requirements or technology, the timing of funding or
dismantling, or adoption of a decommissioning method other than immediate
dismantlement would change decommissioning cost estimates and the amounts
required to be recovered. PSNH attempts to recover sufficient amounts
through its allowed rates to cover NAEC's expected decommissioning costs.
Only the portion of currently estimated total decommissioning cost that
has been accepted by regulatory agencies is reflected in PSNH's rates.
Based on present estimates and assuming Seabrook 1 operates to the end of
its licensing period, NAEC expects that the decommissioning financing fund
will be substantially funded when Seabrook 1 is retired from service.
Proposed Accounting: The staff of the SEC has questioned certain current
accounting practices of the electric utility industry, including NAEC,
regarding the recognition, measurement and classification of
decommissioning costs for nuclear generating units in the financial
statements. In response to these questions, the FASB has agreed to
review the accounting for closure and removal costs, including
decommissioning. If current electric utility industry accounting
practices for nuclear power plant decommissioning are changed, the
annual provision for decommissioning could increase relative to 1997,
and the estimated cost for decommissioning could be recorded as a
liability (rather than as accumulated depreciation), with recognition of
an increase in the cost of the related nuclear power plant. Management
believes that NAEC will continue to be allowed to recover decommissioning
costs through the Seabrook Power Contracts.
3. SHORT-TERM DEBT
The amount of short-term borrowings that may be incurred by NAEC is subject
to periodic approval by either the SEC under the 1935 Act or by its state
regulator. Under the SEC restrictions, NAEC was authorized, as of January
1, 1998, to incur short-term borrowings up to a maximum of $60 million.
Money Pool: Certain subsidiaries of NU, including NAEC, are members of
the Northeast Utilities System Money Pool (Pool). The Pool provides a
more efficient use of the cash resources of the system, and reduces outside
short-term borrowings. NUSCO administers the Pool as agent for the member
companies. Short-term borrowing needs of the member companies are first
met with available funds of other member companies, including funds
borrowed by NU parent. NU parent may lend to the Pool but may not borrow.
Funds may be withdrawn from or repaid to the Pool at any time without prior
notice. Investing and borrowing subsidiaries receive or pay interest based
on the average daily Federal Funds rate. However, borrowings based on loans
from NU parent bear interest at NU parent's cost and must be repaid based
upon the terms of NU parent's original borrowing. Effective during May
1997, NAEC became a full participant of the NU Money Pool. At December 31,
1997 and 1996, NAEC had $9.95 million and $2.5 million, respectively, of
borrowings outstanding from the Pool. The interest rate on borrowings from
the Pool at December 31, 1997 and 1996 was 5.8 percent and 6.3 percent,
respectively.
Maturities of NAEC's short-term debt obligations were for periods of three
months or less.
For further information on short-term debt, see the MD&A.
4. LONG-TERM DEBT
Details of long-term debt outstanding are:
December 31,
1997 1996
(Thousands of Dollars)
First Mortgage Bonds:
9.05% Series A, due 2002 ................. $295,000 $315,000
Notes:
Variable - Rate Facility, due 2000 ...... 200,000 200,000
Less: Amounts due within one year ........ 20,000 20,000
Long-term debt, net ................ $475,000 $495,000
Long-term debt maturities and cash sinking-fund requirements on debt
outstanding at December 31, 1997 is $20 million for the year 1998, $70
million for 1999, $270 million for 2000, $70 million for 2001, and $65
million for 2002.
Market risk management instruments with financial institutions effectively
fix the interest rate on NAEC's $200 million variable-rate bank note at
7.823 percent. For more information on the interest-rate management
instruments, see Note 8, "Market Risk Management."
The Series A Bonds are not redeemable prior to maturity except out of
proceeds of sales of property subject to the lien of the Series A First
Mortgage Bond Indenture (Indenture), at general redemption prices
established by the Indenture, and out of condemnation or insurance proceeds
and through the operation of the sinking fund. Essentially all of NAEC's
utility plant is subject to the lien of its Indenture.
5. INCOME TAX EXPENSE
The components of the federal and state income tax provisions charged to
operations are:
For the Years Ended December 31, 1997 1996 1995
(Thousands of Dollars)
Current income taxes:
Federal ................................. $(11,890) $(8,570) $(38,703)
State ................................... (309) 110 -
Total current............................. (12,199) (8,460) (38,703)
Deferred income taxes, net:
Federal .................................. 21,528 14,884 41,885
State .................................... 1,121 865 4,229
Total deferred ........................ 22,649 15,749 46,114
Total income tax expense .............. $10,450 $ 7,289 $ 7,411
The components of total income tax expense are classified as
follows:
For the Years Ended December 31, 1997 1996 1995
(Thousands of Dollars)
Income taxes charged to operating
expenses ................................ $14,844 $12,341 $10,187
Other income taxes ........................ (4,394) (5,052) (2,776)
Total income tax expense ................ $10,450 $ 7,289 $ 7,411
Deferred income taxes are comprised of the tax effects of temporary
differences as follows:
For the Years Ended December 31, 1997 1996 1995
(Thousands of Dollars)
Depreciation .............................. $20,823 $12,730 $24,444
Alternative minimum tax ................... - - -
Bond redemptions .......................... (2,351) (2,359) 12,087
Seabrook 1 return ......................... 3,338 5,438 8,109
Other ..................................... 839 (60) 1,474
Deferred income taxes, net ............ $22,649 $15,749 $46,114
A reconciliation between income tax expense and the expected tax expense at
the applicable statutory rate is as follows:
For the Years Ended December 31, 1997 1996 1995
(Thousands of Dollars)
Expected federal income tax
at 35 percent of
pretax income .......................... $14,141 $13,776 $11,148
Tax effect of differences:
Depreciation ............................ (1,049) (1,343) (2,159)
Deferred Seabrook 1 return .............. (2,522) (2,695) (3,292)
State income taxes,
net of federal benefit ................ 718 634 2,749
Sale of Seabrook 2 steam
generator ............................... - (2,516) -
Other, net ................................ (838) (567) (1,035)
Total income tax expense .................. $10,450 $ 7,289 $ 7,411
6. DEFERRED OBLIGATION TO AFFILIATED COMPANY
At the time PSNH emerged from bankruptcy on May 16, 1991, in accordance
with the phase-in under the Rate Agreement, it began accruing a deferred
return on the unphased-in portion of its Seabrook 1 investment. From
May 16, 1991 to the Acquisition Date, PSNH accrued a deferred return of
$50.9 million. On the Acquisition Date, PSNH transferred the $50.9 million
deferred return to NAEC as part of the Seabrook-related assets.
At the time PSNH transferred the deferred return to NAEC, it realized, for
income tax purposes, a gain that is deferred under the consolidated income
tax rules. Beginning December 1, 1997, this gain is being restored for
income tax purposes as the deferred return of $50.9 million, and the
associated income taxes of $33.2 million, are collected by NAEC through
the Seabrook Power Contracts. As NAEC recovers the $33.2 million in years
eight through ten of the Rate Agreement, it will be obligated to make
corresponding payments to PSNH.
See Note 1G, "Seabrook Power Contracts" for further information on the
phase-in of the Seabrook power plant and see Note 7A, "Commitments and
Contingencies - Restructuring and Rate Matters" for the possible impacts
on NAEC from the NHPUC's decision related to industry restructuring.
7. COMMITMENTS AND CONTINGENCIES
A. RESTRUCTURING AND RATE MATTERS
New Hampshire: The 1996 restructuring legislation that the NHPUC is
charged with implementing provides that the NHPUC may not adopt a
restructuring plan that imposes a severe financial hardship on a
utility. Management believes that PSNH is entitled to full recovery
of its prudently incurred costs, including regulatory assets and
strandable costs. It bases this belief both on the general nature
of public utility industry cost-of-service based regulation and the
specific circumstances of the resolution of PSNH's previous bankruptcy
proceedings and its acquisition by NU, including the recoveries
provided by the Rate Agreement and related agreements.
On February 28, 1997, the NHPUC issued its decision related to
restructuring the state's electric utility industry and setting interim
stranded cost charges for PSNH pursuant to legislation enacted in New
Hampshire in 1996. In the decision, the NHPUC announced a departure
from cost-based ratemaking and instead adopted a market-priced approach
to ratemaking and stranded cost recovery. Accordingly, unless the
NHPUC modifies its position or the litigation described below results
in necessary modifications to the final plan which leads management
to conclude that the ratemaking approach utilized in the NHPUC's
restructuring decision will not go into effect, PSNH no longer will be
subject to the provisions of SFAS 71. That would result in PSNH
writing off from its balance sheet substantially all of its regulatory
assets. The amount of the potential write-off triggered by the order
is currently estimated at over $400 million, after taxes. PSNH does
not believe that under the decision, it would be required to recognize
any additional loss resulting from the impairment of the value of its
other long-lived assets under the provisions of SFAS 121.
On March 3, 1997, PSNH, NU, NAEC and NUSCO filed for a temporary
restraining order, preliminary and permanent injunctive relief and for
declaratory judgment in the United States District Court for New
Hampshire (District Court). The case was subsequently transferred to
Rhode Island. On March 10, 1997, the Chief Judge of the Rhode Island
federal court issued a temporary restraining order which stayed the
NHPUC's February 28, 1997 decision to the extent it established a rate
setting methodology that is not designed to recover PSNH's costs of
providing service and would require PSNH to write off any regulatory
assets.
During 1997, a mediation process ended without a resolution. The
District Court has suspended the procedural schedule associated with
this court proceeding pending the resolution of appeals of certain
preliminary rulings by the U.S. Circuit Court of Appeals for the First
Circuit (First Circuit). On February 3, 1998, the First Circuit denied
the appeals taken by would-be intervenors in PSNH's federal court
proceeding concerning the NHPUC's final plan on restructuring. The
First Circuit affirmed a previous court decision stating that the
opposing interests in this case were adequately represented by the
NHPUC or by PSNH. As a result of this decision, the proceedings in
the District Court may resume. On February 17, 1998, the NHPUC filed
a petition for rehearing with the First Circuit. The temporary
restraining order issued by the District Court in March 1997 will
remain in effect until further orders by either court.
During 1997, the NHPUC reopened its proceeding to reconsider certain
limited matters in its restructuring orders. The scope of the PSNH-
specific re-hearing proceedings included alternative rate-setting
methodologies proposed by the intervenors; to decide the appropriate
methodology to be used to determine PSNH's interim stranded costs; and
to set PSNH's interim stranded cost charges utilizing the determined
methodology. In testimony filed with the NHPUC in November 1997, PSNH
proposed a new methodology to quantify its strandable costs. Under
this proposal, PSNH would divest all owned generation and purchased
power obligations via auction. To the extent that the auction fails to
produce sufficient revenues to cover the net book value of owned
generation and contractual payment obligations of purchased-power, the
difference would be recovered from customers through a non-bypassable
distribution charge. The new proposal also relies upon securitization
of certain assets to further reduce rates.
On December 15, 1997, the NHPUC officially announced that industry
restructuring would not take place on January 1, 1998. Management
believes that industry restructuring will not take place in New
Hampshire until the courts resolve the issues brought before them, or
the parties involved reach a settlement.
PSNH and NAEC are parties to a variety of financing agreements
providing that the credit thereunder can be terminated or accelerated
if they do not maintain specified minimum ratios of common equity to
capitalization (as defined in each agreement). In addition, PSNH and
NAEC are parties to a variety of financing agreements providing in
effect that the credit thereunder can be terminated or accelerated if
there are actions taken, either by PSNH or NAEC or by the state of New
Hampshire, that deprive PSNH and/or NAEC of the benefits of the Rate
Agreement and/or the Seabrook Power Contracts.
If the NHPUC's February 28, 1997 decision were to become effective, it
would, unless PSNH and NAEC receive waivers from their respective
lenders, result in (i) write-offs that would cause PSNH's common equity
to fall below the contractual minimums (ii) reductions in income that
would cause PSNH's income to fall below the contractual minimums, (iii)
potential violation of the contractual provisions with respect to
actions depriving PSNH and NAEC of the benefits of the Rate Agreement
and (iv) the potential for cross defaults to other PSNH and NAEC
financing documents. Substantially all of PSNH's and NAEC's debt
obligations would be affected.
If these events transpired and if the creditors holding PSNH and NAEC
debt obligations decide to exercise their rights to demand payment,
then either creditors or PSNH and NAEC could initiate proceedings under
Chapter 11 of the bankruptcy laws.
As a result of the NHPUC decision and the potential consequences
discussed above, the reports of our auditors on the individual
financial statements of PSNH and NAEC contain explanatory paragraphs.
Those explanatory paragraphs indicate that a substantial doubt exists
currently about the ability of PSNH and NAEC to continue as going
concerns. The accounts of PSNH and NAEC are included in the
consolidated financial statements of NU on the basis of a going
concern. While the effect of the implementation of that decision
would have a material adverse impact on NU's financial position,
results of operations, and cash flows, it would not in and of itself
result in defaults under borrowing or other financial agreements of NU
or its other subsidiaries.
B. ENVIRONMENTAL MATTERS
NAEC is subject to regulation by federal, state and local authorities
with respect to air and water quality, the handling and disposal of
toxic substances and hazardous and solid wastes, and the handling and
use of chemical products. NAEC has an active environmental auditing
and training program and believes that it is in substantial compliance
with current environmental laws and regulations. However, the NU
system is subject to certain pending enforcement actions and
governmental investigation in the environmental area. Management
cannot predict the outcome of these enforcement actions and
investigations.
Environmental requirements could hinder future construction. Changing
environmental requirements could also require extensive and costly
modifications to NAEC's existing investment in Seabrook 1 and could
raise operating costs significantly. As a result, NAEC may incur
significant additional environmental costs, greater than amounts
included in cost of removal and other reserves, in connection with the
generation of electricity and the storage, transportation, and disposal
of by-products and wastes. NAEC may also encounter significantly
increased costs to remedy the environmental effects of prior waste
handling activities. The cumulative long-term cost impact of
increasingly stringent environmental requirements cannot accurately be
estimated.
NAEC cannot estimate the potential liability for future claims,
including environmental remediation costs, that may be brought against
it. However, considering known facts, existing laws and regulatory
practices, management does not believe the matters disclosed above will
have a material effect on NAEC's financial position or future results
of operations.
C. NUCLEAR INSURANCE CONTINGENCIES
Under certain circumstances, in the event of a nuclear incident at one
of the nuclear facilities in the country covered by the federal
government's third-party liability indemnification program, an owner
of a nuclear unit could be assessed in proportion to its ownership
interest in each of its nuclear units up to $75.5 million. Payments of
this assessment would be limited to $10.0 million in any one year per
nuclear incident based upon the owner's pro rata ownership interest in
each of its nuclear units. In addition, the owner would be subject to
an additional five percent of $3.8 million, in proportion to its
ownership interests in each of its nuclear units, if the sum of all
claims and costs from any one nuclear incident exceeds the maximum
amount of financial protection. Based upon its ownership interest in
Seabrook 1, NAEC's maximum liability, including any additional
assessments, would be $28.5 million per incident, of which payments
would be limited to $3.6 million per year.
Insurance has been purchased to cover the primary cost of repair,
replacement or decontamination or premature decommissioning of utility
property resulting from insured occurrences at Seabrook station. NAEC
is subject to retroactive assessments if losses exceed the accumulated
funds available to the insurer. The maximum potential assessment
against NAEC with respect to losses arising during the current policy
year is approximately $2.6 million.
Insurance has been purchased to cover the excess cost of repair,
replacement or decontamination or premature decommissioning of utility
property resulting from insured occurrences. NAEC is subject to
retroactive assessments if losses exceed the accumulated funds
available to the insurer. The maximum potential assessment against
NAEC with respect to losses arising during current policy years is
approximately $3.8 million. The cost of a nuclear incident could
exceed available insurance proceeds.
Insurance has been purchased aggregating $200 million on an industry
basis for coverage of worker claims. All participating reactor
operators insured under this coverage are subject to retrospective
assessments of $3 million per reactor. The maximum potential
assessment against NAEC with respect to losses arising during the
current policy period is pproximately $1.1 million. Effective
January 1, 1998, a new worker policy was purchased which is not
subject to retrospective assessments.
Under the terms of the Seabrook Power Contracts, any nuclear insurance
assessments described above would be passed on to PSNH as a "cost of
service."
D. SEABROOK 1 CONSTRUCTION PROGRAM
The construction program for Seabrook 1 is subject to periodic review
and revision by management. NAEC currently forecasts construction
expenditures for its share of Seabrook 1 to be $35.0 million for the
years 1998-2002, including approximately $8.9 million for 1998. In
addition, NAEC estimates that its share of Seabrook 1 nuclear fuel
requirements will be approximately $51.5 million for the years 1998-
2002, including $12.9 million for 1998.
8. MARKET RISK MANAGEMENT
NAEC uses swap instruments with financial institutions to hedge against
interest rate risk associated with its $200 million variable rate bank
note. The interest-rate management instruments employed eliminate the
exposure associated with rising interest rates, and effectively fix the
interest rate for this borrowing arrangement. Under the agreements, NAEC
exchanges quarterly payments based on a differential between a fixed
contractual interest rate and the three-month LIBOR rate at a given time.
As of December 31, 1997, NAEC had outstanding agreements with a total
notional value of $200 million and a positive mark-to-market position of
approximately $104 thousand.
Credit Risk: These agreements have been made with various financial
institutions, each of which is rated "A3" or better by Moody's rating
group. NAEC will be exposed to credit risk on its respective market risk-
management instruments if the counterparties fail to perform their
obligations. However, management anticipates that the counterparties will
be able to fully satisfy their obligations under the agreements.
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each of the following financial instruments:
Cash and nuclear decommissioning fund: The carrying amounts approximate
fair value.
SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities," requires investments in debt and equity securities to be
presented at fair value. As a result of this requirement, the investments
held in NAEC's nuclear decommissioning fund were adjusted to market by
approximately $1.5 million as of December 31, 1997 and adjusted to market
by approximately $0.3 million as of December 31, 1996, with corresponding
offsets to the accumulated provision for depreciation. The amounts
adjusted in 1997 and 1996 represent cumulative gross unrealized holding
gains. The cumulative gross unrealized holding losses were immaterial for
1997 and 1996.
Long-term debt: The fair value of NAEC's fixed-rate security is based upon
the quoted market price for that issue or similar issue. The adjustable
rate security is assumed to have a fair value equal to its carrying amount.
The carrying amounts of NAEC's financial instruments and the estimated fair
values are as follows:
Carrying Fair
At December 31, 1997 Amount Value
(Thousands of Dollars)
First Mortgage Bonds ...................... $295,000 $301,599
Other long-term debt ...................... $200,000 $200,000
Carrying Fair
At December 31, 1996 Amount Value
(Thousands of Dollars)
First Mortgage Bonds ...................... $315,000 $316,197
Other long-term debt ...................... $200,000 $200,000
The fair values shown above have been reported to meet the disclosure
requirements and do not purport to represent the amounts at which those
obligations would be settled.
10. NUCLEAR PERFORMANCE
The three Millstone units are managed by NNECO. Millstone 1, 2, and 3 have
been out of service since November 4, 1995, February 21, 1996 and March 30,
1996, respectively, and are on the NRC's watch list. NU has restructured
its nuclear organization and is currently implementing comprehensive plans
to restart the units.
Subsequent to its January 31, 1996 announcement that Millstone had been
placed on its watch list, the NRC stated that the units cannot return to
service until independent, third-party verification teams have reviewed the
actions taken to improve the design, configuration, and employee concerns
issues that prompted the NRC to place the units on its watch list. The
actual date of the return to service for each of the units is dependent
upon the completion of independent inspections and reviews by the NRC and
a vote by the NRC commissioners. NU hopes to return Millstone 3 to
service in early spring of 1998 and Millstone 2 three to four months after
Millstone 3. Millstone 1 is currently in extended maintenance status.
To the Board of Directors
of North Atlantic Energy Corporation:
We have audited the accompanying balance sheets of North Atlantic Energy
Corporation (a New Hampshire corporation and a wholly owned subsidiary of
Northeast Utilities) as of December 31, 1997 and 1996, and the related
statements of income, common stockholder's equity, and cash flows for each of
the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of North Atlantic Energy
Corporation as of December 31, 1997 and 1996, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 7A, on February
28, 1997, the State of New Hampshire Public Utilities Commission (the NHPUC)
issued an order outlining its final plan to restructure the electric utility
industry. The final plan announced a departure from cost-based ratemaking for
Public Service Company of New Hampshire (PSNH). PSNH is the sole customer of
the Company. The final plan, if implemented, would require PSNH to discontinue
the application of Financial Accounting Standard No. 71, "Accounting for the
Effects of Certain Types of Regulation," (FAS 71). The effects of such a
discontinuation would cause PSNH and the Company to be in technical default
under their current financial covenants, which would, if not waived or
renegotiated, give rise to the rights of lenders to accelerate the repayment of
approximately $686 million of PSNH's indebtedness and approximately $495 million
of the Company's indebtedness. These conditions raise substantial doubt about
the Company's ability to continue as a going concern. The financial statements
referred to above do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Hartford, Connecticut
February 20, 1998
North Atlantic Energy Corporation
Management's Discussion and Analysis of Financial
Condition and Results of Operations
This section contains management's assessment of North Atlantic Energy
Corporation's (NAEC or the company) financial condition and the principal
factors having an impact on the results of operations. The company is a wholly-
owned subsidiary of Northeast Utilities (NU). This discussion should be read in
conjunction with the company's financial statements and notes to financial
statements.
FINANCIAL CONDITION
EARNINGS OVERVIEW
Public Service Company of New Hampshire (PSNH) and NAEC have entered into two
power contracts that unconditionally obligate PSNH to purchase NAEC's 35.98
percent ownership of the capacity and output of Seabrook Unit 1 (Seabrook or the
plant) for a period equal to the length of the Nuclear Regulatory Commission
(NRC) full-power operating license for Seabrook (through 2026) whether or not
Seabrook is operating and without regard to the cost of alternative sources of
power (the Power Contracts). In addition, PSNH will be obligated to pay
decommissioning and project cancellation costs after the termination of the
operating license. NAEC does not have any employees of its own and does not
operate Seabrook. North Atlantic Energy Service Corporation (NAESCO) is the
managing agent and represents the Seabrook joint owners, including NAEC, in the
operation of the plant.
The company's cost-of-service includes all of its prudently incurred Seabrook-
related costs, including operation and maintenance expense, fuel expense,
property tax expense, depreciation expense, certain overhead and other costs and
a phased-in return on its Seabrook investment.
The company's only assets are Seabrook and other Seabrook-related assets and its
only source of revenues are the Power Contracts. PSNH's obligations under the
Power Contracts are solely its own and have not been guaranteed by NU. The Power
Contracts contain no provisions entitling PSNH to terminate its obligations. If,
however, PSNH were to fail to perform its obligation under the Power Contracts,
the company would be required to find other purchasers for Seabrook power.
A temporary restraining order issued by a U.S. District Court is currently
blocking the New Hampshire Public Utilities Commission (NHPUC) from implementing
a February, 1997 restructuring order that would have resulted in a write-off by
PSNH of more than $400 million. Management hopes to negotiate an alternative
restructuring proposal in 1998 that will produce significant PSNH rate
reductions and allow retail customers to choose their electric suppliers, but
still give PSNH and NAEC an opportunity to maintain an adequate financial
condition and earn fair returns on their investments.
NAEC had net income of approximately $30 million in 1997 compared to
approximately $32 million in 1996. The decrease in net income for 1997 was
primarily due to deferred tax benefits in 1996 associated with the proceeds from
the sale of Seabrook Unit 2 steam generators, as well as lower earnings in
temporary cash investments in 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided from operations decreased by approximately $48 million in 1997,
compared to 1996, as a result of the pay down of the 1996 year end accounts
payable balance and proceeds in 1996 from the sale of the Seabrook Unit 2 steam
generators. The year end accounts payable balance was relatively high due to
purchases in preparation for the Seabrook outage that had been incurred but not
yet paid by the end of 1996. Cash used for financing activities decreased by
approximately $51 million in 1997, compared to 1996, primarily due to lower
reacquisitions and retirements of long-term debt, the utilization of the NU
system money pool in 1997 and lower cash dividends on common stock. Cash used
for investments decreased by approximately $5 million in 1997, compared to 1996,
primarily due to lower 1997 nuclear fuel expenditures.
Each major subsidiary of NU finances its own needs. Neither The Connecticut
Light and Power Company (CL&P) nor Western Massachusetts Electric Company
(WMECO) has any financing agreements containing cross defaults based on
financial defaults by NU, PSNH or NAEC. Similarly, neither PSNH nor NAEC has
any financing agreements containing cross defaults based on financial defaults
by NU, CL&P or WMECO. Nevertheless, it is possible that investors will take
negative operating results or regulatory developments at one company in the NU
system into account when evaluating other companies in the NU System. That
could, as a practical matter and despite the contractual and legal separations
among the NU companies, negatively affect each company's access to financial
markets.
PSNH RESTRUCTURING
In February, 1997, the NHPUC issued orders to restructure the state's electric
utility industry and set interim stranded cost charges for PSNH. In the orders,
the NHPUC announced a departure from cost-based ratemaking and adopted a market-
priced approach to stranded cost recovery. PSNH, NU, NAEC and Northeast
Utilities Service Company (NUSCO) filed for a temporary restraining order,
preliminary and permanent injunctive relief and a declaratory judgment in the
United States District Court of New Hampshire. The case subsequently was
transferred to the United States District Court of Rhode Island (District Court)
where a temporary restraining order was granted, staying, indefinitely, the
enforcement of the NHPUC's restructuring orders as they affected PSNH. Certain
appeals to the preliminary ruling have been denied and proceedings in the
District Court are expected to resume.
The NHPUC conducted rehearing proceedings in 1997 to decide the appropriate
methodology to be used to determine PSNH's interim stranded costs and to set
PSNH's interim stranded cost charges utilizing the determined methodology. The
NHPUC has not indicated when it will issue a decision in these proceedings. On
December 15, 1997, the NHPUC officially announced that industry restructuring
would not take place on January 1, 1998.
As part of the rehearing proceedings, PSNH proposed a new methodology to
quantify its stranded costs. Under this proposal, PSNH would divest its owned
generation and purchased power obligations via auction. To the extent that the
auction fails to produce sufficient revenues to cover the net book value of
owned generation and contractual payment obligations of purchased power, the
difference would be recovered from customers through a non-bypassable
distribution charge. The new proposal also relies upon securitization of
certain assets to further reduce rates.
On February 20, 1998, PSNH forwarded a settlement offer to representatives from
the state of New Hampshire that was consistent with PSNH's proposal in the
rehearing proceedings, including among other things, a 20 percent rate reduction
at the beginning of 1999, an auction of PSNH's non-nuclear generating units and
securitization of approximately $1.15 billion of PSNH's stranded costs.
See the "Notes to Financial Statements", Note 7A, for the potential accounting
impacts of restructuring.
SEABROOK PERFORMANCE
Seabrook operated at a capacity factor of 78.3 percent through December 1997,
compared to 96.8 percent for the same period in 1996. The lower 1997 capacity
factor is due primarily to the 50-day scheduled refueling and maintenance outage
which began on May 10, 1997, and an unplanned outage which began on December 5,
1997. The unplanned outage occurred when the unit was shut down to repair leaks
in a three inch stainless steel pipe in the residual heat removal system. The
pipe was replaced, but problems were subsequently discovered in the control
building air conditioning system. Design changes were implemented and the plant
returned to service on January 16, 1998.
SEABROOK DECOMMISSIONING
NAEC's estimated cost to decommission its share of Seabrook is approximately
$170 million in year end 1997 dollars. These costs are being recognized over
the life of the unit with a portion currently being recovered through PSNH's
rates. PSNH is obligated to pay NAEC's share of Seabrook's decommissioning
costs even if the unit is shut down prior to the expiration of its license. As
of December 31, 1997, the market value of the contributions already made to the
decommissioning trusts, including their investment returns, was approximately
$26 million.
See the "Notes to Financial Statements," Note 2, for further information on
nuclear decommissioning.
ENVIRONMENTAL MATTERS
NAEC is potentially liable for environmental cleanup costs at a number of sites
inside and outside its service territory. NAEC cannot estimate the potential
liability for these costs or for future claims, including environmental
remediation costs, that may be brought against it. However, considering known
facts, existing laws and regulatory practices, management does not believe that
these costs will have a material effect on NAEC's financial position or future
results of operations.
See the "Notes to Financial Statements," Note 7B, for further information on
environmental matters.
YEAR 2000 ISSUE
The Year 2000 issue exists because many computer systems and applications
currently use two-digit date fields to designate a year. As the change of the
century occurs, date-sensitive systems may recognize the year 2000 as 1900, or
not recognize it at all. This inability to recognize or properly treat the year
2000 may cause NU's systems to process critical financial and operation
information incorrectly. The company has assessed and continues to assess the
impact of the Year 2000 issue on its operating and reporting systems. The
assessment of the nuclear operating systems is continuing and is expected to be
completed in the summer of 1998.
The NU system will utilize both internal and external resources to reprogram, or
replace, and test the software for Year 2000 modifications. The total estimated
remaining cost of the Year 2000 project is estimated at $37 million and is being
funded through operating cash flows. This estimate does not include any costs
for the replacement or repair of equipment or devices that may be identified
during the assessment process. The majority of these costs will be expensed as
incurred over the next two years. To date, the NU system has incurred and
expensed approximately $4 million related to the assessment of, and preliminary
efforts in connection with, its Year 2000 project.
The costs of the project and the date on which the company plans to complete the
Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ materially from those plans. If the
NU system's remediation plan is not successful, there could be a significant
disruption of the NU system's operation.
RISK MANAGEMENT INSTRUMENTS
The following discussion about the company's risk-management activities includes
forward looking statements that involve risk and uncertainties. Actual results
could differ materially from those projected in the forward looking statements.
This analysis presents the hypothetical loss in earnings related to the interest
rate market risks not covered by the risk-management instruments at December 31,
1997. The company uses swaps to manage the market risk. The company does not
use these risk-management instruments for speculative purposes.
NAEC holds a variable rate long-term note, exposing the company to interest rate
risk. In order to hedge this risk, interest rate risk-management instruments
have been entered into on NAEC's $200 million variable rate note, effectively
fixing the interest on this note at 7.823 percent.
For further information on risk management instruments, see the "Notes to
Financial Statements," Note 8.
RESULTS OF OPERATIONS
Income Statement Variances
Increase/(Decrease)
Millions of Dollars
1997 over/(under)1996 1996 over/(under)1995
Amount Percent Amount Percent
Operating revenues $30 19% $ 5 3%
Fuel Expense (2) (11) 3 25
Other operation and
maintenance expense 20 45 (5) (12)
Amortization of Regulatory
Assets, net 6 (a) - -
Federal and State Income Taxes 3 43 - -
Deferred Seabrook return (other
and borrowed funds) (2) (9) (8) (27)
Other, net (2) (a) - -
Interest on Long-term Debt (2) (3) (10) (16)
Net income (2) (7) 8 31
(a) Percent greater than 100
OPERATING REVENUES
Operating revenues represent amounts billed to PSNH under the terms of the Power
Contracts and billings to PSNH for decommissioning expense.
Operating revenues increased in 1997 primarily due to higher operation and
maintenance expenses and the increased return associated with the phase-in of
the final 15 percent of the Seabrook plant investment in May, 1996.
Operating revenues increased in 1996, primarily due to the increased return
associated with the phase-in of the Seabrook investment, partially offset by a
lower return due to lower debt costs.
FUEL EXPENSE
Fuel expenses decreased in 1997, primarily due to lower Seabrook capacity
factors as a result of the Seabrook outages in 1997.
Fuel expenses increased in 1996, primarily due to higher Seabrook capacity
factors.
OTHER OPERATION AND MAINTENANCE EXPENSE
Other operation and maintenance expenses increased in 1997 primarily due to
higher costs associated with the Seabrook outages in 1997.
Other operation and maintenance expenses decreased in 1996, primarily due to a
planned refueling and maintenance outage in 1995.
AMORTIZATION OF REGULATORY ASSETS, NET
Amortization of Regulatory Assets, net increased in 1997 primarily due to the
beginning of the amortization of the Seabrook deferred return in December 1997.
FEDERAL AND STATE INCOME TAXES
Federal and State income taxes increased in 1997 primarily due to deferred tax
benefits in 1996 associated with proceeds from the sale of the Seabrook Unit 2
steam generators.
DEFERRED SEABROOK RETURN, NET
Deferred Seabrook return, net decreased in 1997 primarily due to the final
phase-in of Seabrook investment into rates in May, 1996.
Deferred Seabrook return, net decreased in 1996, primarily due to the additional
Seabrook investment phased into rates in May, 1996, and May, 1995, partially
offset by a one-time adjustment in June, 1995, to the deferred Seabrook return
balance.
OTHER, NET
Other, net decreased in 1997 primarily due to lower income from temporary cash
investments and the amortization of the Seabrook deferred charges associated
with the taxes on the purchased return.
INTEREST ON LONG-TERM DEBT
Although the change in 1997 was not significant, interest on long-term debt
decreased in 1996 primarily due to the 1995 refinancing of its $205 million
15.23-percent variable-rate bank note.
North Atlantic Energy Corporation
SELECTED FINANCIAL DATA (a) 1997 1996 1995 1994 1993
(Thousands of Dollars)
Operating Revenues...... $ 192,381 $ 162,152 $ 157,183 $145,751 $125,408
Operating Income........ $ 57,061 $ 54,889 $ 51,394 $ 42,950 $ 33,718
Net Income.............. $ 29,953 $ 32,072 $ 24,441 $ 30,535 $ 25,998
Cash Dividends on
Common Stock.......... $ 25,000 $ 38,000 $ 24,000 $ 10,000 $ -
Total Assets............ $1,014,639 $1,017,388 $1,014,649 $963,579 $900,821
Long-Term Debt (b)...... $ 495,000 $ 515,000 $ 560,000 $560,000 $560,000
STATISTICS 1997 1996 1995 1994 1993
Gross Electric Utility
Plant at December 31,
(Thousands of Dollars).. $811,140 $816,446 $806,892 $792,880 $789,127
kWh Sales (Millions) for
the twelve month period
ending December 31,... 2,859 3,542 3,016 2,229 3,218
STATEMENTS OF QUARTERLY FINANCIAL DATA (Unaudited) (Thousands of Dollars)
Quarter Ended (a)
1997 March 31 June 30 Sept. 30 Dec.31
Operating Revenues...... $41,976 $50,128 $45,943 $54,334
Operating Income........ $14,406 $14,183 $14,124 $14,348
Net Income.............. $ 7,240 $ 6,958 $ 8,086 $ 7,669
1996
Operating Revenues...... $36,663 $39,107 $41,565 $44,817
Operating Income........ $12,075 $13,786 $14,639 $14,389
Net Income.............. $ 7,190 $ 7,356 $ 9,918 $ 7,608
(a) Reclassifications of prior data have been made to conform with the current
presentation.
(b) Includes portion due within one year.