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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549-1004
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 2-7749
COMMONWEALTH ELECTRIC COMPANY
(Exact name of registrant as specified in its charter)
Massachusetts 04-1659070
(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)
(617) 225-4000
(Registrant's telephone number, including area code)
(Former name, address and fiscal year, if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports),and (2) has been subject to such
filing requirements for the past 90 days. YES [ X ] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock November 1, 1998
Common Stock, $25 par value 2,043,972 shares
The Company meets the conditions set forth in General Instruction H(1)(a) and
(b) of Form 10-Q as a wholly-owned subsidiary and is therefore filing this
Form with the reduced disclosure format.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
COMMONWEALTH ELECTRIC COMPANY
CONDENSED BALANCE SHEETS
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
ASSETS
(Dollars in thousands)
September 30, December 31,
1998 1997
(Unaudited)
PROPERTY, PLANT AND EQUIPMENT, at original cost $564,152 $550,449
Less - Accumulated depreciation 184,736 174,488
379,416 375,961
Add - Construction work in progress 2,677 4,010
382,093 379,971
INVESTMENTS
Equity in nuclear electric power company 478 519
Other 14 14
492 533
CURRENT ASSETS
Cash 1,735 1,496
Accounts receivable -
Affiliates 2,798 1,753
Customers 42,047 45,199
Unbilled revenues 5,689 9,162
Prepaid property taxes 4,730 3,043
Inventories and other 5,159 4,349
62,158 65,002
DEFERRED CHARGES
Regulatory assets 93,189 70,112
Other 4,688 3,601
97,877 73,713
$542,620 $519,219
See accompanying notes.
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COMMONWEALTH ELECTRIC COMPANY
CONDENSED BALANCE SHEETS
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
CAPITALIZATION AND LIABILITIES
(Dollars in thousands)
September 30, December 31,
1998 1997
(Unaudited)
CAPITALIZATION
Common Equity -
Common stock, $25 par value -
Authorized and outstanding -
2,043,972 shares wholly-owned by
Commonwealth Energy System (Parent) $ 51,099 $ 51,099
Amounts paid in excess of par value 97,112 97,112
Retained earnings 38,535 31,993
186,746 180,204
Long-term debt, less current sinking
fund requirements 146,148 147,192
332,894 327,396
CURRENT LIABILITIES
Interim Financing -
Notes payable to banks 30,525 14,900
Advances from affiliates 10,065 5,315
40,590 20,215
Other Current Liabilities -
Current sinking fund requirements 3,553 3,553
Accounts payable -
Affiliates 8,627 12,007
Other 24,202 32,826
Accrued taxes -
Local property and other 5,250 3,299
Income 18,005 19,114
Other 24,514 16,528
84,151 87,327
124,741 107,542
DEFERRED CREDITS
Accumulated deferred income taxes 51,707 50,283
Unamortized investment tax credits 6,372 6,696
Other 26,906 27,302
84,985 84,281
COMMITMENTS AND CONTINGENCIES
$542,620 $519,219
See accompanying notes.
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COMMONWEALTH ELECTRIC COMPANY
CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Dollars in thousands - unaudited)
Three Months Ended Nine Months Ended
1998 1997 1998 1997
ELECTRIC OPERATING REVENUES $118,708 $120,058 $318,766 $348,824
OPERATING EXPENSES
Electricity purchased for
resale, transmission and fuel 74,652 75,975 203,013 226,303
Other operation and maintenance 22,558 20,028 62,223 71,251
Depreciation 4,506 4,419 13,530 13,257
Taxes -
Income 4,069 5,206 8,120 7,309
Local property 1,702 1,480 4,765 4,632
Payroll and other 558 669 1,948 2,310
108,045 107,777 293,599 325,062
OPERATING INCOME 10,663 12,281 25,167 23,762
OTHER INCOME (EXPENSE) 131 7 296 (48)
INCOME BEFORE INTEREST CHARGES 10,794 12,288 25,463 23,714
INTEREST CHARGES
Long-term debt 3,321 3,405 9,963 10,201
Other interest charges 831 572 2,008 1,476
4,152 3,977 11,971 11,677
NET INCOME 6,642 8,311 13,492 12,037
RETAINED EARNINGS -
Beginning of period 31,893 27,687 31,993 27,334
Dividends on common stock - (3,781) (6,950) (7,154)
End of period $ 38,535 $ 32,217 $ 38,535 $ 32,217
See accompanying notes.
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COMMONWEALTH ELECTRIC COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(Dollars in thousands - unaudited)
1998 1997
OPERATING ACTIVITIES
Net income $ 13,492 $ 12,037
Effects of noncash items -
Depreciation and amortization 17,866 18,380
Deferred income taxes and investment
tax credits, net 101 1,138
Change in working capital, exclusive of cash
and interim financing (93) 4,015
Transition costs deferral (25,952) -
Fuel charge stabilization deferral 1,465 (6,972)
All other operating items (4,480) (6,585)
Net cash provided by operating activities 2,399 22,013
INVESTING ACTIVITIES
Additions to property, plant and equipment
(inclusive of AFUDC) (14,541) (16,154)
FINANCING ACTIVITIES
Proceeds from short-term borrowings 15,625 1,600
Proceeds from affiliates 4,750 2,800
Payment of dividends (6,950) (7,154)
Sinking funds payments (1,044) (1,045)
Net cash provided by (used for) financing activities 12,381 (3,799)
Net increase in cash 239 2,060
Cash at beginning of period 1,496 358
Cash at end of period $ 1,735 $ 2,418
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest (net of capitalized amounts) $ 12,721 $ 12,702
Income taxes $ 8,120 $ 2,825
See accompanying notes.
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COMMONWEALTH ELECTRIC COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) General Information
Commonwealth Electric Company (the Company) is a wholly-owned subsid-
iary of 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 and, in addition to its investment in the Company, has
interests in other utility and several nonregulated companies.
The Company has 697 regular employees including 483 (69%) who are
represented by three collective bargaining units. One of these collective
bargaining units, representing approximately 13% of regular employees,
reached an agreement earlier this year on a new five-year contract that
remains in effect until April 30, 2003. Agreements with two other
bargaining units (representing approximately 56% of regular employees)
will remain in effect until September 30, 2002 and October 31, 2001,
respectively. Employee relations have generally been satisfactory.
(2) Significant Accounting Policies
(a) Principles of Accounting
The Company's significant accounting policies are described in Note 2
of Notes to Financial Statements included in its 1997 Annual Report on
Form 10-K filed with the Securities and Exchange Commission. For interim
reporting purposes, the Company follows these same basic accounting poli-
cies 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.
The unaudited financial statements for the periods ended September 30,
1998 and 1997 reflect, in the opinion of the Company, all adjustments
(consisting of only normal recurring accruals, except for a one-time
charge recorded in June 1997 as described in Management's Discussion and
Analysis of Results of Operations) necessary to summarize fairly the
results for such periods. In addition, certain prior period amounts are
reclassified from time to time to conform with the presentation used in
the current period's financial statements.
Income tax expense is recorded using the statutory rates in effect
applied to book income subject to tax recorded in the interim period.
The results for interim periods are not necessarily indicative of
results for the entire year because of seasonal variations in the con-
sumption of energy.
(b) Regulatory Assets and Liabilities
The Company is 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).
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COMMONWEALTH ELECTRIC COMPANY
Based on the current regulatory framework, the Company 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." The Company has 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 Company 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, noncash 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 Company'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 Company
believes that its regulatory assets, including those related to genera-
tion, are probable of future recovery.
As a result of electric industry restructuring, the Company discontin-
ued application of accounting principles applied to its investment in
electric generation facilities effective March 1, 1998. The Company will
not be required to write off any of its generation-related assets,
including regulatory assets. These assets will be retained on the
Company's 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.
The principal regulatory assets included in deferred charges were as
follows:
September 30, December 31,
1998 1997
(Dollars in thousands)
Transition costs $28,125 -
Fuel charge stabilization 27,283 $29,655
Power contract buy-out 16,116 17,609
Postretirement benefits costs 12,269 12,271
Pilgrim nuclear plant litigation costs 5,530 5,929
Yankee Atomic unrecovered plant
and decommissioning costs 2,553 3,436
Other 1,313 1,212
$93,189 $70,112
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COMMONWEALTH ELECTRIC COMPANY
The regulatory liabilities, reflected in deferred credits in the
accompanying Balance Sheets were as follows:
September 30, December 31,
1998 1997
(Dollars in thousands)
Excess Seabrook-related deferred income taxes $ 328 $ 698
Other deferred income taxes 1,875 1,875
Excess replacement power refunds 129 246
$ 2,332 $ 2,819
In November 1997, the Commonwealth of Massachusetts enacted a compre-
hensive electric utility industry restructuring bill. On November 19,
1997, the Company, together with affiliates Cambridge Electric Light
Company (Cambridge Electric) and Canal Electric Company (Canal), filed a
restructuring plan with the DTE. The plan, approved by the DTE on
February 27, 1998, provides that the Company and Cambridge Electric,
beginning March 1, 1998, 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 mandates. 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,
by the sale of the system's non-nuclear generating assets. The sale was
approved by the DTE on October 30, 1998 and by the FERC on November 12,
1998 (see the "Industry Restructuring" section under Management's Discus-
sion and Analysis of Results of Operations for further discussion of the
sale). The net proceeds from the sale of these assets will be used to
mitigate transition costs.
The Company's ability to recover its transition costs will depend on
several factors, including the aggregate amount of stranded costs the
Company will be allowed to recover and the market price of electricity.
Management believes that the Company will recover its transition costs.
A change in any of the above listed factors could affect the recovery of
transition costs and may result in a loss to the Company. For additional
information relating to industry restructuring, see the "Industry Restruc-
turing" section under Management's Discussion and Analysis and Results of
Operations.
(3) Commitments and Contingencies
The Company is engaged in a continuous construction program presently
estimated at $106 million for the five-year period 1998 through 2002. Of
that amount, $23.8 million was estimated for 1998. As of September 30,
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COMMONWEALTH ELECTRIC COMPANY
1998, the Company's construction expenditures amounted to approximately
$14.5 million, including an allowance for funds used during construction.
The Company expects to finance these expenditures on an interim basis with
internally-generated funds and short-term borrowings.
The program is subject to periodic review and revision due to factors
such as changes in business conditions, rates of customer growth, effects
of inflation, maintenance of reliable and safe service, equipment delivery
schedules, licensing delays, availability and cost of capital and environ-
mental regulations.
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COMMONWEALTH ELECTRIC COMPANY
Item 2. Management's Discussion and Analysis of Results of Operations
The following is a discussion of certain significant factors which have
affected operating revenues, expenses and net income during the periods
included in the accompanying Condensed Statements of Income. This discussion
should be read in conjunction with the Notes to Condensed Financial Statements
appearing elsewhere in this report.
A summary of the period to period changes in the principal items included
in the Condensed Statements of Income for the three and nine months ended
September 30, 1998 and 1997 and unit sales for these periods is shown below:
Three Months Ended Nine Months Ended
September 30, September 30,
1998 and 1997 1998 and 1997
Increase (Decrease)
(Dollars in thousands)
Electric Operating Revenues $ (1,350) (1.1)% $(30,058) (8.6)%
Operating Expenses -
Electricity purchased for resale,
transmission and fuel (1,323) (1.7) (23,290) (10.3)
Other operation and maintenance 2,530 12.6 (9,028) (12.7)
Depreciation 87 2.0 273 2.1
Taxes -
Federal and state income (1,137) (21.8) 811 11.1
Local property and other 111 5.2 (229) (3.3)
268 0.2 (31,463) (9.7)
Operating Income (1,618) (13.2) 1,405 5.9
Other Income 124 1,771.4 344 716.7
Income Before Interest Charges (1,494) (12.2) 1,749 7.4
Interest Charges 175 4.4 294 2.5
Net Income $ (1,669) (20.1) $ 1,455 12.1
Unit Sales (Megawatthours or MWH)
Retail 45,448 4.7 (1,736) (0.1)
Wholesale 1,651 0.6 178,478 21.0
Total 47,099 3.7 176,742 5.1
The following is a summary of unit sales (in MWH) for the periods
indicated:
Three Months Nine Months
Period Ended Total Retail Wholesale Total Retail Wholesale
September 30,
1998 1,305,579 1,004,869 300,710 3,675,107 2,647,898 1,027,209
September 30,
1997 1,258,480 959,421 299,059 3,498,365 2,649,634 848,731
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COMMONWEALTH ELECTRIC COMPANY
Operating Revenues, Electricity Purchased for Resale, Transmission and Fuel
Operating revenues for the third quarter and nine-month period of 1998
were $1.4 million and $30.1 million lower, respectively, than the correspond-
ing periods in 1997, despite higher unit sales, due to the 10 percent rate
reduction (further discussed below), decreases in electricity purchased for
resale, fuel and transmission charges ($1.3 million and $23.3 million,
respectively), and a lower level of revenues associated with demand-side
management programs. The decline in these costs reflects a cost deferral of
$3 million for the quarter and $26 million for the nine-month period in
conjunction with the Company's restructuring plan as approved by the Massachu-
setts Department of Telecommunications and Energy (DTE). As a result of
industry restructuring, the Company has unbundled its rates, provided custom-
ers with a 10 percent rate reduction as of March 1, 1998 and has afforded
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 Company 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.
Total unit sales for the current quarter increased primarily as a result
of greater sales to the residential and commercial sectors. For the nine-
month period, total unit sales reflect a significant increase in wholesale
sales to other utilities.
Other Operation and Maintenance
The decline in other operation and maintenance for the current nine-month
period primarily reflects the absence of a one-time charge ($8.4 million)
related to the personnel reduction program (PRP) initiated in the second
quarter of 1997 and the absence of storm damage costs related to an April 1997
blizzard ($2 million). Also contributing to the decrease in the current
quarter and nine-month period were labor savings realized from the aforemen-
tioned PRP ($193,000 and $2.4 million, respectively), a reduction in the
provision for bad debts ($215,000 and $1.3 million, respectively), and a
reduction in insurance and employee benefits costs ($1.8 million and $2.7
million, respectively. The impact of these factors was offset in the current
quarter and nine-month period by higher costs relating to the outsourcing of
the information technology, telecommunications and network services function
($1.5 million and $4.3 million, respectively) including costs associated with
Year 2000 compliance, and higher costs related to conservation and load
management programs ($2 million and $1.4 million, respectively).
Depreciation and Taxes
Depreciation expense increased due to a higher level of depreciable
property, plant and equipment. Federal and state income taxes declined nearly
22% in the current quarter and increased over 11% in the nine-month period due
to the change in pretax income. Local property and other taxes in the current
quarter and nine-month period reflects lower payroll taxes ($111,000 and
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COMMONWEALTH ELECTRIC COMPANY
$362,000, respectively) due to the PRP.
Other Income and Interest Charges
Other income increased in the current quarter and nine-month period due to
interest accrued on the deferred transition costs associated with electric
industry restructuring ($407,000 and $709,000, respectively) effective
March 1, 1998.
Total interest charges increased in the current quarter and nine-month
period reflecting a greater level of short-term borrowings and slightly higher
rates, offset somewhat by scheduled sinking fund payments on long-term debt.
Industry Restructuring
On November 25, 1997, the Governor of Massachusetts signed into law the
Electric Industry Restructuring Act (the Act). This legislation provided,
among other things, that customers of retail electric utility companies who
take standard offer service receive a 10 percent rate reduction and be allowed
to choose their energy supplier, effective March 1, 1998. The Act also
provides that utilities be allowed full recovery of transition costs subject
to review and an audit process. The rate reduction mandated by the legisla-
tion increases to 15 percent effective September 1, 1999 for customers who
continue to take standard offer service. A statewide ballot referendum that
sought to repeal the legislation was defeated by a wide margin on November 3
of this year.
The Company, together with Cambridge Electric and Canal, filed a compre-
hensive electric restructuring plan with the DTE in November 1997, that was
substantially approved by the DTE in February 1998. The divestiture of the
Company's non-nuclear generation assets and the entitlements associated with
its purchased power contracts is an integral part of the Company's restructur-
ing plan and is consistent with the Act. While the Company is encouraged with
the treatment afforded net non-mitigable transition costs (which, for the
Company, are primarily the result of above-market purchased power contracts
with non-utility generators) by the legislation and the DTE, the mandated rate
reduction has had a significant impact on cash flows of the Company. However,
the successful results of the generation auction, as discussed below, could
significantly reduce the impact that the rate reductions will have on future
cash flows.
In March 1997, the Company, together with Cambridge Electric and Canal,
had submitted a report to the DTE that detailed the proposed auction process
for selling their electric generation assets and the entitlements associated
with 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 in August 1997 and an
Offering Memorandum followed in October 1997. Potential bidders examined all
pertinent information related to the generating facilities and purchased power
contracts in order to prepare and submit their first round of bids in mid-
December. Final binding bids were submitted in May 1998.
On May 27, 1998, the System announced that three of its subsidiary
companies (Cambridge Electric, Canal and the Company) selected affiliates
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COMMONWEALTH ELECTRIC COMPANY
of Southern Energy New England, L.L.C. (Southern Energy), an affiliate of The
Southern Company of Atlanta, Georgia, to buy substantially all of their non-
nuclear electric generating assets for approximately $462 million (subject to
certain adjustments at closing). These facilities represent 984 megawatts
(mw) of electric capacity and have an approximate book value of $79 million.
The plants being sold include: Canal Unit 1 (566 mw) and a one-half
interest in Canal Unit 2 (282.5 mw) located in Sandwich, MA and owned by Canal
Electric; the Kendall Station facility (67 mw) and the adjacent Kendall Jets
(46 mw), located in Cambridge, MA and owned by Cambridge Electric; five diesel
generators (13.8 mw) in Oak Bluffs and West Tisbury on the island of Martha's
Vineyard that are owned by the Company, and a 1.4 percent joint-ownership
interest (8.9 mw) in Wyman Unit No. 4 located in Yarmouth, ME, also owned by
the Company.
The Company continues to evaluate bids related to the purchased power
contracts.
On July 31, 1998, a formal divestiture filing was submitted to the FERC
and the DTE that requested approval of the sale of the Company's generating
assets and further proposes (subject to completion of the sale) that the
current 10 percent rate reduction increase, effective January 1, 1999, to 12.1
percent. In addition, the Company proposes to increase the retail price of
standard offer service, starting January 1, 1999, from the present rate of 2.8
cents per kilowatthour (kwh) to 3.5 cents. At the same time that the price
for standard offer service is increased, the transition charge for the
Company's customers will decline from 4.08 cents per kwh to 3.13 cents. These
proposed changes, which are intended to further reduce the cost of electricity
to customers, to make the market increasingly more attractive for independent
power suppliers to sell electricity directly to consumers, and to reduce the
Company's cost deferrals associated with the pricing of standard offer
service, are based on a specific allocation methodology for the net proceeds
from the sale of the Canal units.
On October 30, 1998, the DTE approved the system's sale of its generating
assets to Southern Energy. The DTE, however, deferred ruling on the alloca-
tion of proceeds from the sale of Canal Units 1 and 2 between the Company and
Cambridge Electric and on the rate of return to be paid to customers on the
net proceeds from the sale over an eleven-year period. These issues are not
expected to impact the asset sale that is scheduled to close in the fourth
quarter. The FERC approved the sale on November 12, 1998.
Year 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any computer
program that has date sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a temporary
inability to process transactions or engage in normal business activities.
The system has been involved in Year 2000 compliancy since 1996.
The system, on a coordinated basis and with the assistance of RCG Informa-
tion Technologies and other consultants, is addressing the Year 2000 issue.
The system has inventoried and assessed all date sensitive information and
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COMMONWEALTH ELECTRIC COMPANY
transaction processing computer systems and determined that a substantial
portion of its software needed to be modified or replaced. Plans have been
developed and are being implemented to correct and test all affected systems,
with priorities assigned based on the importance of the activity. The system
has identified the software and hardware installations that will be necessary.
All installations are expected to be completed and tested by mid-1999. The
system has also inventoried its non-information technology systems that may be
date sensitive, (facilities, electric operations, energy supply/production and
distribution), that use embedded technology such as micro-controllers and
micro-processors. The system anticipates that these systems will be updated
or replaced as necessary and tested by mid-1999.
Modifying and testing the system's information and transaction processing
systems from 1996 through 2000 is currently expected to cost $6 to $7 million,
including approximately $900,000 incurred through 1997 and $1.6 million spent
during the first nine months of 1998. Approximately $1.2 million is expected
to be spent in the fourth quarter of this year and the balance of $2.5 to $3
million in 1999 and 2000. Year 2000 costs have been expensed as incurred and
will continue to be funded from operations.
The system has initiated formal communications with its significant
suppliers to determine the extent to which the system may be vulnerable to
their failure to correct their own Year 2000 issues. The system has not
received enough responses to its survey to make an accurate assessment of the
Year 2000 readiness of its suppliers. Failure of the system's significant
suppliers to address Year 2000 issues could have a material adverse effect on
the system's operations, although it is not possible at this time to quantify
the amount of business that might be lost or the costs that could be incurred
by the system.
In addition, parts of the global infrastructure, including national
banking systems, electrical power grids, gas pipelines, transportation
facilities, communications and governmental activities, may not be fully
functional after 1999. Infrastructure failures could significantly reduce the
system's ability to acquire energy and its ability to serve its customers as
effectively as they are now being served. The system is identifying elements
of the infrastructure that are critical to its operations and is obtaining
information as to the expected Year 2000 readiness of these elements.
The system has started its contingency planning for critical operational
areas that might be affected by the Year 2000 issue if compliance by the
system is delayed. System electric and gas operations currently have emergen-
cy operating plans as well as information technology disaster recovery plans
as components of its standard operating procedures. These plans will be
enhanced to identify potential Year 2000 risks to normal operations and the
appropriate reaction to these potential failures including contingency plans
that may be required for any third parties that fail to achieve Year 2000
compliance. All necessary contingency plans are expected to be completed by
early 1999, although in certain cases, especially infrastructure failures,
there may be no practical alternative course of action available to the
system.
The system is working with other energy industry entities, both regionally
and nationally with respect to Year 2000 readiness and is cooperating in the
development of local and wide-scale contingency planning.
While the system believes its efforts to address the Year 2000 issue will
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COMMONWEALTH ELECTRIC COMPANY
be successful in avoiding any material adverse effect on the system's opera-
tions or financial condition, it recognizes that failing to resolve Year 2000
issues on a timely basis would, in a "most reasonably likely worst case
scenario," significantly limit its ability to acquire and distribute energy
and process its daily business transactions for a period of time, especially
if such failure is coupled with third party or infrastructure failures.
Similarly, the system could be significantly affected by the failure of one or
more significant suppliers, customers or components of the infrastructure to
conduct their respective operations after 1999. Adverse effects on the system
could include, among other things, business disruption, increased costs, loss
of business and other similar risks.
The foregoing discussion regarding Year 2000 project timing, effective-
ness, implementation and costs includes forward-looking statements that are
based on management's current evaluation using available information. Factors
that might cause material changes include, but are not limited to, the
availability of key Year 2000 personnel, the readiness of third parties, and
the system's ability to respond to unforeseen Year 2000 complications.
New Accounting Standard
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts possibly
including fixed-price power contracts) be recorded on the balance sheet as
either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate and assess the
effectiveness of transactions that receive hedge accounting.
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999
and may be implemented as of the beginning of any fiscal quarter after
issuance but cannot be applied retroactively. SFAS No. 133 must be applied to
derivative instruments and certain derivative instruments embedded in hybrid
contracts that were issued, acquired or substantively modified after December
31, 1997 and, at the Company's election, before January 1, 1998.
The Company has not yet quantified the impacts of adopting SFAS No. 133 on
its financial statements and has not determined the timing of its method of
adopting SFAS No. 133.
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 Company'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 the availability of cash from various
sources.
<PAGE>
<PAGE 16>
COMMONWEALTH ELECTRIC COMPANY
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not a party to any pending material legal proceeding.
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 nine months ended September 30, 1998.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
September 30, 1998.
<PAGE>
<PAGE 17>
COMMONWEALTH ELECTRIC COMPANY
SIGNATURE
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 ELECTRIC COMPANY
(Registrant)
Principal Financial and
Accounting Officer:
Date: November 13, 1998 JAMES D. RAPPOLI
James D. Rappoli,
Financial Vice President
and Treasurer
<TABLE> <S> <C>
<ARTICLE> UT
<LEGEND>
This schedule contains summary financial information extracted from the
balance sheet, statement of income and statement of cash flows contained in
Form 10-Q of Commonwealth Electric Company for the nine months ended September
30, 1998 and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
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<NAME> COMMONWEALTH ELECTRIC COMPANY
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