<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 of the
Securities Exchange Act of 1934
Date of Earliest Event Reported: February 23, 1999
NEW ENGLAND ELECTRIC SYSTEM
(exact name of registrant as specified in charter)
Massachusetts 1-3446 04-1663060
(state or other (Commission (I.R.S. Employer
jurisdiction of File No.) Identification No.)
incorporation)
25 Research Drive, Westborough, Massachusetts 01582
(Address of principal executive offices)
(508) 389-2000
(Registrant's telephone number, including area code)
<PAGE>
Item 7. Financial Statements, Pro Forma Financial Information
and Exhibits
- --------------------------------------------------------------
Exhibits
The 1998 New England Electric System Annual Report to
Shareholders, is filed with this report.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this Current Report on
Form 8-K to be signed on its behalf by the undersigned thereunto
duly authorized.
NEW ENGLAND ELECTRIC SYSTEM
s/Michael E. Jesanis
By
Michael E. Jesanis
Senior Vice President and
Chief Financial Officer
Date: March 25, 1999
The name "New England Electric System" means the trustee or
trustees for the time being (as trustee or trustees but not
personally) under an agreement and declaration of trust dated
January 2, 1926, as amended, which is hereby referred to, and a
copy of which as amended has been filed with the Secretary of The
Commonwealth of Massachusetts. Any agreement, obligation or
liability made, entered into or incurred by or on behalf of New
England Electric System binds only its trust estate, and no
shareholder, director, trustee, officer or agent thereof assumes
or shall be held to any liability therefor.
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EXHIBIT INDEX
Exhibit No. Description Page
- ----------- ----------- ----
13 1998 New England Electric Filed
System Annual Report to herewith
Shareholders
<PAGE>
[COVER PHOTO]
19
98 Annual Report
{FOLLOWING TEXT VERTICALLY PLACED ON LEFT OF COVER PHOTO]
New England Electric System
[NEES LOGO]
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[TABLE BELOW PLACED ONE THIRD OF WAY DOWN OF INSIDE FRONT COVER,
ALIGNED ON RIGHT]
Financial Results
1998 1997
---------------
Earnings per average share $ 3.04 $ 3.39
Dividends declared per share $ 2.36 $ 2.36
Average number of shares
outstanding (in 000s) 62,456 64,952
Market price per share at year end $48 1/8 $42 3/4
Growth in kilowatthour (kWh)
deliveries to ultimate customers 1.5% 2.0%
Electric Utilities Return on Equity (%)
NEES 11.4%
National Median 11.3%
New England/New York Median 10.3%
[FOLLOWING TWO PARAGRAPHS ARE HORIZONTALLY ALIGNED WITH COLORED
VERTICAL BAR DIVIDING THE LEFT (FIRST PARAGRAPH) FROM THE RIGHT
(SECOND PARAGRAPH)]
New England Electric System (NEES) is a public utility holding company
headquartered in Westborough, Massachusetts. Its regulated subsidiaries are
engaged in the transmission, distribution, and sale of electricity. NEES'
electricity distribution subsidiaries serve 1.4 million customers in
Massachusetts, Rhode Island, and New Hampshire. Unregulated subsidiaries are
engaged in the marketing of energy commodities and services and the
construction and leasing of telecommunications infrastructure.
On the cover: The skilled people who maintain our electricity delivery system
include Linda Schonrog, John Shaw, and David Petty, shown here at a Providence
substation.
<PAGE>
[LARGE FONT OF FOLLOWING TEXT PLACED ON GHOSTED VERSION OF COVER
PHOTO]
The agreement to merge with National Grid is one of many
[SMALL PHOTO OF TWO LINE WORKERS ON LEFT MARGIN HERE] bold
decisions NEES has made in this century to enhance shareholder
value. The merger will provide [SMALL PHOTO OF TWO LINE WORKERS
CENTERED HERE] you with a 25 percent* premium on your investment.
At the same time, [SMALL PHOTO OF LINE WORKER ON LEFT MARGIN
HERE] it will give NEES new resources to remain a successful
company and to help make the region's competitive electricity
market work.
[STANDARD SIZE FONT OF FOLLOWING TEXT CENTERED AT BOTTOM OF PAGE]
(*over the $43 share price on December 11, 1998, the last trading
day before the merger was announced)
<PAGE>
To Our Fellow Shareholders
The past year has been a time of dramatic change for NEES. We
completed the sale of our generating business and became one of
the nation's first electric utilities whose primary focus is on
the "wires business." We helped bring about lower rates and
choice of energy suppliers for all customers in Massachusetts and
Rhode Island and for our customers in New Hampshire, ahead of
most of the nation. We announced a merger agreement that will
make NEES a wholly owned subsidiary of The National Grid Group
plc of the United Kingdom, enhancing our capabilities and
resources. And, in a smaller transaction, we announced a merger
agreement in which NEES would acquire Eastern Utilities
Associates, a neighboring utility.
The merger agreements, which are independent of one another,
will achieve our goal to expand the scale of our transmission and
distribution business. In addition, the National Grid merger will
fundamentally change our ownership structure.
NEES/National Grid merger
On December 14, 1998, we announced the historic merger with
The National Grid Group plc. National Grid is the owner and
operator of the England and Wales high-voltage transmission
network, including interconnections with Scotland and France. It
is listed on the London Stock Exchange with a market
capitalization of about $12 billion. National Grid has joint
ventures and partnerships with companies in Argentina, Zambia,
and India, and holds an interest in Energis, which operates a
fiber optic telecommunications network in England and Wales.
Under the merger agreement, National Grid will acquire all of
the outstanding shares of NEES for $53.75 per share (subject to
upward adjustment, as explained on page 10). That figure values
the equity of NEES at approximately $3.2 billion and represents a
25 percent premium above the $43 closing price of NEES shares on
December 11, 1998 (the last day of trading on the New York Stock
Exchange before the merger was announced.) National Grid would
also assume NEES' $1 billion of debt.
Once the merger is completed and National Grid acquires all of
the outstanding NEES shares, those shares will no longer be
publicly traded. At the appropriate time, we will send you
information on how to turn in your shares for the $53.75 per
share cash payment.
[FOLLOWING TEXT AT BOTTOM OF FIRST COLUMN REFERRING TO PHOTO OF
ALFRED D. HOUSTON AND RICHARD P. SERGEL AT BOTTOM OF SECOND
COLUMN]
Alfred D. Houston, chairman, (left) and
Richard P. Sergel, president and chief executive officer
The proposed merger is a cash transaction that under IRS rules
is taxable. The NEES Board of Directors approved the National
<PAGE>
Grid merger because they unanimously decided it was in the best
interest of our shareholders. The Board considered all the
options available to NEES, including continuing as a standalone
company and other merger options, and concluded that the merger
offered the highest value to shareholders, even taking into
account the IRS rules. You will have the freedom of reinvesting
your proceeds in an investment appropriate to your circumstances.
The merger also requires the approval of our shareholders,
National Grid shareholders, and various government and regulatory
bodies. We hope to obtain all the necessary approvals and
complete the merger no later than early 2000. A proxy statement
will be sent to you, with more complete information and a form
for voting on the proposed merger. We encourage you to read the
material carefully before casting your vote.
Many benefits
Among the many options reviewed, the National Grid offer to
purchase NEES provided the best value for shareholders while also
offering benefits to customers and employees.
For you, our shareholders, the NEES/National Grid merger
offers a substantial premium over the value of your NEES shares
on December 11, 1998. The terms fulfill our commitment to you to
enhance the value of your investment in NEES during a period of
dramatic change in the electric industry.
[PHOTO OF ALFRED D. HOUSTON AND RICHARD P. SERGEL APPEARS HERE
UNDERNEATH SECOND OF TWO COLUMNS OF TEXT]
The merger will end a long and valued relationship - and in some
cases, strong emotional ties - between NEES and the people who
have owned NEES shares through the years, but we feel, in both
our minds and hearts, that this merger is in keeping with our
long history of putting your interests at the forefront of our
decision making. There have been similarly bold actions in the
past on your behalf, some of which are highlighted on the
following pages.
For employees, this merger will have minimal impact on our
day-to-day work in the short term. Jobs will be preserved within
New England. Our employees will benefit from new opportunities as
the base of U.S. operations for a global business.
For customers, the merger will mean a seamless continuation of
high-quality service from the women and men in the familiar
yellow NEES companies' trucks and at the busy customer service
workstations. The prices charged to customers will continue to be
among the lowest in the region. Customers will benefit from
National Grid's decade of experience in operating a transmission
network in a competitive market.
We are excited by this proposed merger and the opportunities
it affords NEES and our region.
<PAGE>
NEES/EUA merger
We are pursuing local consolidation as well. On February 1,
1999, we announced that we had reached an agreement to acquire
Eastern Utilities Associates (EUA), a neighboring electric
utility with 300,000 customers in Massachusetts and Rhode Island.
This merger would bring together two low-cost companies to
achieve even greater cost savings for customers. The combination
will serve more electricity customers in both Massachusetts and
Rhode Island than any other company. We will acquire EUA for $31
per share, or $634 million, and will assume EUA's $400 million of
debt. (The $31 per share is subject to upward adjustment, as
explained on page 10.) We expect the deal to close by early 2000.
The NEES/EUA merger requires the approval of EUA shareholders and
state and federal regulators. It does not require NEES
shareholder approval, as it does not involve NEES shares.
National Grid supports the NEES/EUA merger, as it advances our
common goal of growing our energy delivery business to achieve
more efficiencies.
Achievements
NEES produced good financial results for you in 1998, despite
lower electric rates due to industry restructuring in the region,
the effects of divesting our generation business (historically,
our most profitable enterprise), and other factors. Earnings per
share were $3.04, compared with $3.39 in 1997. Return on equity
was 11.4 percent, compared with the 1998 industry average of 11.3
percent and 12.8 percent earned by NEES in 1997. Your dividends
held steady at $2.36 per year.
We completed the sale of our generating business to USGen New
England, Inc. in September for $1.59 billion, and used most of
the proceeds to retire or reduce debt, buy out contracts with
independent power producers, repurchase NEES shares, and pay
income taxes related to the sale. The remainder was put in
short-term investments, so we can withdraw the money when needed
for a variety of purposes, including the EUA acquisition. The
generation sale halved our stranded investment and is a key
contributor to our having the lowest electricity delivery charge
among major utilities in the states we serve.
Among other 1998 achievements, our New Hampshire subsidiary
Granite State Electric became the only electric utility in that
state whose customers have a choice of energy suppliers, when in
July the Public Utilities Commission approved the comprehensive
settlement agreement reached by our subsidiary, the Governor's
office, and other interested parties.
In Massachusetts, voters strongly endorsed (71 percent) the
Electric Utility Industry Restructuring Act in a November
referendum. We were part of a broad-based coalition of
businesses, individuals, trade organizations, environmentalists,
and other parties who sought to retain this carefully crafted
statute.
<PAGE>
Watershed year
We can best describe 1998 as a watershed year for NEES, filled
with accomplishment, change, and promise for the future as part
of a much larger, international company. We thank you for your
confidence over the years as we look toward a new era for NEES.
s/Alfred D. Houston s/Richard P. Sergel
Alfred D. Houston Richard P. Sergel
Chairman President and
Chief Executive Officer
February 23, 1999
<PAGE>
Turning Points
The decision to merge with National Grid is a striking
strategic move for NEES. As we mark this fundamental turning
point for 1998, we highlight a few of the past decisions in which
NEES met the challenges of the times to the benefit of
shareholders.
Long distance hydropower
NEES traces its origins to 1907, a time when electricity use
was growing rapidly. Two daring entrepreneurs, Henry I. Harriman
and Malcolm G. Chace, adopted a plan to build a dam and hydro
station at Vernon, Vermont and send power to Massachusetts
industries, 60 miles away. Their company was to be one of the
nation's first independent power producers. With some difficulty,
they found financial support for the ambitious project, although
no one had ever transmitted power that far in the icy eastern
part of the country. Harriman and Chace also overcame the
resistance to rights-of-way for their transmission line and of
local utilities that didn't want newcomers competing for their
customers. When the power began to flow, formerly skeptical
manufacturers lined up for service. Long-distance transmission in
New England was launched.
[SEPIA PHOTO CIRCA 1907 OF BUILDING OF DAM AND HYDRO STATION
APPEARS HERE]
Breaking into retail
By the prosperous 1920s, demand for electricity was soaring
and wealthy investors were buying up and merging small retail
utilities to create huge systems. Harriman and Chace did not have
financing to outbid rivals for those retail companies. The needed
cash was supplied by a four-party agreement that soon was taken
over by International Paper, and the renamed New England Power
Association (NEPA) began to aggressively buy retail companies.
NEPA began to build the retail system that is the NEES of today
and that is the foundation of its core electricity delivery
business.
[SEPIA PHOTO CIRCA 1920 OF LINE CREW APPEARS HERE]
The building boom
In the post-World War II years, economic prosperity and new
uses of electricity such as water heating, cooking, and
television had pushed growth of residential demand to more than 7
percent per year. To respond, NEES added more than 50 percent to
its physical plant between the end of the war and 1960.
[SEPIA PHOTO POST WORLD WAR II OF CONSTRUCTION OF GENERATING
FACILITY APPEARS HERE]
<PAGE>
Consolidation
By the early 1960s, cooperative long-term planning and sales
of wholesale power between companies had strengthened the
region's electric system. In 1962, NEES completed the process of
simplifying its organization with mergers that led to the
creation of NEES' single largest retail operating company,
Massachusetts Electric Company. Massachusetts Electric traces its
roots to nearly 100 small companies, each serving one or a few
towns. The mergers streamlined administration and operations,
reduced costs, and created a more efficient company. The
consolidation of 1962 dovetailed with promotional efforts to
attract industrial development and grow residential use with
all-electric homes.
[OLD LOGO OF NEW ENGLAND ELECTRIC SYSTEM APPEARS HERE]
[EXPLANATORY TEXT FOR FULL-PAGE COLOR PHOTO OF NEXT PAGE APPEARS
HERE]
Facing Page: This gas-insulated switchgear (GIS) substation in Providence is
more compact and less prone to damage from natural causes than traditional
oil-insulated substations.
[FULL-PAGE COLOR PHOTO TAKEN IN GAS-INSULATED SWITCHGEAR
SUBSTATION WITH TWO CREW MEMBERS APPEARS HERE WITH FOLLOWING TEXT
SUPERIMPOSED IN GOLD-TINTED TEXT BOX]
NEES has embraced new technology that
provide cost and environmental benefits.
Coal conversion
During the 1960s, NEES used mostly coal to fire its steam
plants. When oil markets became flooded with supplies from the
Middle East and South America, NEES decided to switch to oil at
those plants. The company achieved some of the lowest fuel costs
in the region. In 1970, however, new environmental regulations
specifying low-sulfur oil pushed costs upward.
[SEPIA PHOTO LATE 1940S OFF-LOADING COAL AT GENERATING FACILITY
APPEARS HERE]
When the 1973 OPEC oil embargo led to scarce supplies and
skyrocketing prices, NEES joined the national effort to reduce
reliance on imported oil. An innovative, long-range plan called
NEESPLAN was announced in 1979. It called for energy
conservation, renewables - and conversion of most of NEES'
oil-fired generating units to coal. After lengthy negotiations
with environmental interests and regulators, NEES converted three
Brayton Point Station units and later three Salem Harbor Station
units. The conversions reaped long-running financial benefits for
customers and shareholders, as oil continued to be priced higher
than coal. The company's diversification of its fuel mix proved
to be a significant strength. It moderated the effect on NEES of
sudden price increases in any one fuel or generation source.
<PAGE>
Leadership in energy conservation
A second key component of NEESPLAN was energy conservation and
load management (now often called demand-side management or DSM).
Utilities in the 1970s found power plants more difficult and
expensive to build, due to increasingly stringent environmental
regulations and pressures. NEES was among the first to realize
that this situation was permanent. To meet growing electricity
demand, NEES, teaming with a leading environmental organization,
the Conservation Law Foundation, dramatically expanded its
programs in the late 1980s to reach all customers. NEES put forth
another pathbreaking idea: utilities should earn a profit from
successful energy efficiency programs. State approvals came in
1989-90. Through year-end 1998, DSM incentives had earned more
than $60 million for NEES shareholders. DSM is now an established
part of the services NEES provides for customers, and a
continuing element of the company's environmental commitment.
[SEPIA-TONED PHOTO OF ENERGY EFFICIENT LIGHTING APPEARS HERE]
Seabrook solution
In 1986, construction of Seabrook nuclear unit 1 was
completed, but licensing and commercial operation remained in
doubt. Delays in obtaining an operating license from the Nuclear
Regulatory Commission were increasing costs day by day. Many of
the joint owners were having financial difficulties, and the lead
owner had filed for bankruptcy. NEES had invested approximately
$543 million for its 10 percent share of Seabrook. NEES refused
to wait for events to play themselves out and run the risk of
large, additional financial burdens on customers and shareholders
if the plant never operated. NEES worked out a rate settlement in
1988 with regulators that called for a writeoff of $179 million
(after tax) of its Seabrook investment in exchange for putting
the balance of its investment in Seabrook and fuel exploration
costs into rates. This eliminated major uncertainties that could
have jeopardized the company's financial standing. The investment
community responded positively to NEES' intelligent compromise.
Two years later, when Seabrook 1 went on line, NEES was able to
reverse a substantial portion of the writeoff.
[SEPIA-TONED PHOTO OF SEABROOK NUCLEAR REACTOR DOME APPEARS HERE]
[EXPLANATORY TEXT FOR FULL-PAGE COLOR PHOTO OF NEXT PAGE APPEARS
HERE]
Facing Page: At our new, centralized warehouse in Franklin, Mass., Erin
Penders and Jim Wilbur use bar-code tracking soft-ware and handheld computers
to fulfill orders for materials such as cable and insulators.
[FULL-PAGE COLOR PHOTO OF ERIN PENDERS ON FORKLIFT AND JIM WILBUR
ON FLOOR OF FRANKLIN WAREHOUSE APPEARS HERE WITH FOLLOWING TEXT
SUPERIMPOSED IN GOLD-TINTED TEXT BOX]
Efficiency and cost control are
NEES hallmarks.
<PAGE>
Industry restructuring
The passage of the Public Utility Regulatory Policies Act of
1978 led to the growth of the independent power industry and to
increasing competition in electric generation. Demand for
independent access to retail customers led to a regulatory
movement to "deregulate" the sale of power to customers. NEES
recognized early that the restructuring process created
substantial risk for utilities and their shareholders, who had
invested in generation to meet their obligation to serve
customers. NEES led the electric utility industry in successfully
arguing that markets should be open to competition but that these
historically allowed costs to serve customers, which could be
"stranded" in a competitive generation marketplace, should be
recovered in a transition charge to customers. Stranded cost
recovery was incorporated into agreements and statutes in all
three states that NEES serves. Potential losses to shareholders
were averted at the same time that significantly lower rates were
provided to customers.
[SEPIA-TONED PHOTO OF PETER FLYNN PRESENTATION ABOUT CHOICE
APPEARS HERE]
Generation divestiture
Recovery of stranded costs came at a steep price. In 1996, to
gain support for its restructuring plans that included stranded
cost recovery, NEES became the first U.S. utility to agree to
divest its generating business to determine the level of stranded
costs to be recovered. The plants commanded 45 percent more than
their book value, effectively recouping NEES shareholder
investments in power plants, while reducing by about half the
transition charges to be paid by customers.
[SEPIA-TONED PHOTO OF MANCHESTER STREET GENERATING PLANT APPEARS
HERE]
Growing through mergers
NEES, like other utilities, has realized that to succeed as an
energy delivery company in a changed industry, increased scope
and scale are critical. To achieve both, NEES agreed in December
1998 to merge with an international transmission leader, The
National Grid Group plc, which is based in Coventry, England.
When the merger is approved, NEES will serve as National Grid's
base of U.S. operations and will become a wholly owned
subsidiary. The merger will give NEES shareholders a 25 percent
premium on their investment compared with the December 11, 1998
share price. NEES and its customers will benefit from National
Grid's financial and technical resources and its experience in
running a transmission grid in a competitive market. Closer to
home, NEES signed a merger agreement in February 1999 to acquire
its neighbor, Eastern Utilities Associates. This will increase
NEES' customer base by 20 percent when the acquisition is
approved.
[NATIONAL GRID LOGO APPEARS HERE]
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Meeting new challenges
NEES, by both anticipating and adapting to the challenges of
each era, has proven to be a resilient institution. Throughout
our long history, we have been willing to make tough decisions to
enhance shareholder value while meeting our responsibility of
providing reliable, affordable electric service to customers. We
appreciate your confidence in NEES, and look forward to the
challenges of the next century.
[EXPLANATORY TEXT FOR FULL-PAGE COLOR PHOTO OF NEXT PAGE APPEARS
HERE]
Facing Page: Installing electrical cable in Worcester, Mass. are underground
crew members (left to right) Jim Ritchie, Kevin Peltier, and Larry McLear.
[FULL-PAGE COLOR PHOTO OF THREE UNDERGROUND CREW MEMBERS
INSTALLING ELECTRICAL CABLE WITH TRUCK AND UNION STATION,
WORCESTER, MA IN BACKGROUND APPEARS HERE WITH FOLLOWING TEXT
SUPERIMPOSED IN GOLD-TINTED TEXT BOX]
Our communities depend on us for reliable,
affordable, safe electricity service.
<PAGE>
Financial Review
Introduction
1998 was a year of unprecedented change for the electric
utility industry and for New England Electric System (NEES).
Prior to 1998, the NEES companies provided their customers
bundled electric service (i.e. production and delivery) within
exclusive franchise service territories. By mid-1998, all NEES
customers were provided the right to purchase electricity from
the power supplier of their choice. NEES remains obligated to
deliver that electricity over its transmission and distribution
systems. In September 1998, NEES completed the divestiture of
substantially all of its nonnuclear generating business. In
December 1998, NEES agreed to a merger with The National Grid
Group plc (National Grid), whose principal subsidiary operates
the transmission system in England and Wales.
On February 1, 1999, NEES entered into an agreement to acquire
Eastern Utilities Associates (EUA), a utility holding company
serving approximately 300,000 customers in Massachusetts and
Rhode Island.
Merger Agreement with National Grid
On December 11, 1998, NEES, National Grid, and NGG Holdings
LLC (Holdings), a directly and indirectly wholly owned subsidiary
of National Grid, entered into an Agreement and Plan of Merger
(Merger Agreement). Pursuant to the Merger Agreement, Holdings
will merge with and into NEES (the Merger), with NEES becoming a
wholly owned subsidiary of National Grid. NEES shareholders will
receive $53.75 per share in cash, which will be increased at a
rate of $.003288 each day beginning six months after shareholder
approval of the Merger until the Merger is completed, up to a
maximum price of $54.35 per share.
The Merger is subject to approval by a majority vote of NEES
shareholders as well as National Grid shareholder approval. In
addition, the Merger is subject to a number of regulatory and
other approvals and consents, including approvals by the
Securities and Exchange Commission (SEC), Federal Energy
Regulatory Commission (FERC), and Nuclear Regulatory Commission
(NRC), support or approval from the states in which NEES
operates, and approval under both the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the Exon-Florio
Provisions of the Omnibus Trade and Competitiveness Act of 1988.
National Grid has obtained governmental clearance in the United
Kingdom for the Merger. The Merger is expected to be completed by
early 2000.
[GRAPH APPEARS HERE, NEES YEAR-END SHARE PRICE ($)]
Merger Agreement with Eastern Utilities Associates
On February 1, 1999, NEES, EUA, and Research Drive LLC
(Research Drive), a directly and indirectly wholly owned
subsidiary of NEES, entered into an Agreement and Plan of Merger
(EUA Agreement). Pursuant to the EUA Agreement, Research Drive
will merge with and into EUA, with EUA becoming a wholly owned
subsidiary of NEES. EUA shareholders will receive $31.00 per
<PAGE>
share in cash, which will be increased at a rate of $.003 each
day beginning six months after EUA shareholder approval of the
EUA acquisition until the acquisition is completed or until April
30, 2000, whichever is earlier.
The acquisition of EUA is subject to approval by a two-thirds
vote of EUA shareholders. In addition, the acquisition is subject
to a number of regulatory and other approvals and consents,
including approvals by the SEC, FERC, and NRC, support or
approval from the states in which EUA operates, and approval
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended. The EUA acquisition is expected to be completed by
early 2000.
Industry Restructuring
During 1998, pursuant to legislation enacted in Massachusetts,
Rhode Island, and New Hampshire, and settlement agreements
approved by state and federal regulators (the Settlement
Agreements), all NEES customers were provided the right to
purchase electricity from the power supplier of their choice.
Customers who do not choose a power supplier are able, for a
period of time, to continue to purchase their electricity from
the NEES companies at a transition rate ("standard offer
generation service") which, when combined with delivery charges,
results in total rate reductions ranging from 8 to 24 percent
compared with the rates that had been in effect prior to the
introduction of customer choice. Substantially all of the
obligations of the NEES companies to provide standard offer
generation service are backed by contracts with USGen New
England, Inc. (USGen), an indirect wholly owned subsidiary of
PG&E Corporation, and other power suppliers.
Pursuant to the Settlement Agreements, the NEES companies had
agreed to sell their nonnuclear generating business. On September
1, 1998, NEES subsidiaries New England Power Company (NEP) and
The Narragansett Electric Company (Narragansett Electric)
(collectively, the Sellers) completed the sale of substantially
all of their nonnuclear generating business to USGen. The assets
sold include three fossil-fueled and 15 hydroelectric generating
stations, totaling approximately 4,000 megawatts (MW) of
capacity, as well as NEES' 100 percent interest in Narragansett
Energy Resources Company (NERC), a 20 percent general partner in
the Ocean State Power project, all of which had a book value of
approximately $1.1 billion. The NEES companies received $1.59
billion for the sale. In addition, the NEES companies were
reimbursed approximately $140 million for costs associated with
early retirements and special severance programs for employees
affected by industry restructuring, and the value of inventories.
USGen assumed responsibility for environmental conditions at the
Sellers' nonnuclear generating stations. USGen also assumed the
Sellers' obligations under long-term fuel and fuel transportation
contracts, and certain collective bargaining agreements.
<PAGE>
As part of the sale, NEP also signed a purchased power
transfer agreement through which USGen purchased NEP's
entitlement to approximately 1,100 MW of power procured under
long-term contracts in exchange for monthly fixed payments by NEP
averaging $9.5 million per month through January 2008 (having a
net present value of $833 million) toward the above market cost
of those contracts. In some cases, these transfers involved
formal assignment of the contracts to USGen and a release of NEP
from further obligations to the power supplier, while others did
not. For those that involved formal assignment, NEP was required
to make a lump sum payment equivalent to the present value of the
monthly fixed payment obligations of those contracts. On or prior
to the closing date, NEP made lump sum payments totaling
approximately $340 million and was released from further
obligations relating to two of the contracts. These lump sum
payments are separate from the $833 million figure referred to
above.
As part of the divestiture plan, in February 1998, New
England Energy Incorporated (NEEI), a wholly owned subsidiary of
NEES, whose costs had been supported by the generating business,
sold its oil and gas properties for approximately $50 million.
NEEI's loss on the sale of approximately $120 million, before
tax, has been reimbursed by NEP.
NEP agreed under the Settlement Agreements to endeavor to sell
its minority interest in three nuclear power plants and a 60 MW
interest in a fossil-fueled generating station in Maine.
The Settlement Agreements provide that the costs of NEP's
generating investments and related contractual commitments that
were not recovered from the divestiture of those investments
("stranded costs") are to be recovered from NEP's wholesale
customers through contract termination charges (CTC). The
affiliated wholesale customers, in turn, are recovering those
costs through their delivery charges to distribution customers.
Under the Settlement Agreements, the recovery of NEP's stranded
costs is divided into several categories. Unrecovered costs
associated with generating plants (nuclear and nonnuclear) and
most regulatory assets will be fully recovered through the CTC by
the end of 2000 and earn a return on equity averaging 9.7
percent. NEP's obligation relating to the above-market cost of
purchased power contracts and nuclear decommissioning costs are
recovered through the CTC over a longer period of time, as such
costs are actually incurred. The CTC rate was originally set at
2.8 cents per kilowatthour (kWh), and subsequently reduced to
approximately 1.5 cents or less per kWh upon completion of the
sale of NEP's nonnuclear generating business. As the CTC rate
declines, NEP, under certain of the Settlement Agreements, earns
incentives based on successful mitigation of its stranded costs.
These incentives supplement NEP's return on equity. Finally, the
Settlement Agreements provide that until such time as NEP divests
its operating nuclear interests, NEP will share with customers,
through the CTC, 80 percent of the revenues and operating costs
related to the units, with shareholders retaining the balance.
<PAGE>
Accounting Implications
Historically, electric utility rates have been based on a
utility's costs. As a result, electric utilities are subject to
certain accounting standards that are not applicable to other
business enterprises in general. Statement of Financial
Accounting Standards No. 71, Accounting for the Effects of
Certain Types of Regulation (FAS 71), requires regulated
entities, in appropriate circumstances, to establish regulatory
assets, and thereby defer the income statement impact of these
charges because they are expected to be included in future
customer charges. In 1997, the Emerging Issues Task Force (EITF)
of the Financial Accounting Standards Board (FASB) concluded that
a utility that had received approval to recover stranded costs
through regulated transmission and distribution rates would be
permitted to continue to apply FAS 71 to the recovery of stranded
costs.
[GRAPH APPEARS HERE, COST PER KWH DELIVERED TO ULTIMATE
CUSTOMERS]
NEP has received authorization from the FERC to recover
through the CTC substantially all of the costs associated with
its former generating business not recovered through the sale of
that business. Additionally, FERC Order No. 888 enables
transmission companies to recover their specific costs of
providing transmission service. Therefore, substantially all of
NEP's business, including the recovery of its stranded costs,
remains under cost-based rate regulation. Under existing
ratemaking practices, NEES' distribution companies will have the
ability to recover through rates their specific costs of
providing ongoing distribution services. NEES believes these
factors and the EITF conclusion allow its principal utility
subsidiaries to continue to apply FAS 71. Because of the nuclear
cost-sharing provisions related to NEP's CTC, NEP ceased applying
FAS 71 in 1997 to 20 percent of its ongoing nuclear operations,
the impact of which is immaterial.
Currently, there is much regulatory and other movement toward
establishing performance-based rates. It is possible that the
adoption of performance-based rates, future regulatory rules, or
other circumstances could cause the application of FAS 71 to be
discontinued. This discontinuation would result in a noncash
write-off of previously established regulatory assets, including
those being recovered through NEP's CTC. In addition, reserves
for depreciation may also have to be increased to comply with
unregulated accounting practices.
As a result of applying FAS 71, NEES has recorded a regulatory
asset for the costs that are recoverable from customers through
the CTC. The regulatory asset reflects the loss on the sale of
NEES' oil and gas business and the unrecovered plant costs in
operating nuclear plants (assuming no market value), the costs
associated with permanently closed nuclear power plants, and the
<PAGE>
present value of the payments associated with the above-market
costs of purchased power contracts, reduced by the gain from the
sale of NEP's nonnuclear generating business. At December 31,
1998, the regulatory asset related to the CTC was approximately
$1.5 billion, of which $1.2 billion related to the above-market
costs of purchased power contracts.
[GRAPH APPEARS HERE, TOTAL NUMBER OF NEES EMPLOYEES]
As described above, the CTC regulatory asset includes the
unrecovered plant costs associated with NEP's interest in
operating nuclear plants. This balance sheet treatment is due to
NEP's conclusion that its interests in the Millstone 3 and
Seabrook 1 nuclear generating units have little, if any, market
value. Three proposed sales of nuclear units by other utilities
have required the seller to set aside amounts for decommissioning
in excess of the proceeds from the sale of the units. Two of
these proposed sales were agreed upon prior to the end of the
third quarter of 1998. As a result, at the end of the third
quarter of 1998, NEP recorded an impairment writedown in its
reserve for depreciation of approximately $390 million, which
represents the net book value at December 31, 1995, less
applicable depreciation subsequent to that date, of Millstone 3
and Seabrook 1. Because the Settlement Agreements permit NEP to
recover its pre-1996 investment as well as decommissioning
expenses through the CTC, NEP established a regulatory asset in
an amount equal to the impairment writedown. Should NEP's efforts
to sell its nuclear interests result in a gain over the amounts
remaining in the plant account, such gain will be credited to
customers through the CTC.
Impact of Restructuring on Distribution Business
The Settlement Agreement applying to Massachusetts (The
Massachusetts Settlement) also establishes distribution rates for
NEES' Massachusetts subsidiaries Massachusetts Electric Company
(Massachusetts Electric) and Nantucket Electric Company
(Nantucket Electric). On March 1, 1998, Massachusetts Electric's
distribution rates were set at a level approximately $45 million
above the level embedded in its previously bundled rates, with
such rates then frozen through the year 2000. This increase
reflects changes to the distribution cost of service, including
an $11 million increase in annual depreciation expense, a $3
million annual contribution to a storm fund, and increased annual
amortization of unfunded deferred income taxes of approximately
$1 million over six years. Through the year 2000, Massachusetts
Electric's return on equity is subject to a floor of 6 percent
and a ceiling of 11 percent. Earnings over the ceiling will be
shared equally between customers and shareholders up to a maximum
of 12.5 percent. This sharing results in an effective cap on
Massachusetts Electric's return on equity of 11.75 percent,
excluding certain limited incentive opportunities. To the extent
that earnings fall below the floor, Massachusetts Electric will
be authorized to surcharge customers for the shortfall.
<PAGE>
Under the Rhode Island statute, Narragansett Electric
increased distribution rates by approximately $7 million and $11
million in 1998 and 1997, respectively. The statute does not
limit Narragansett Electric's ability to seek approval from state
regulators to increase rates in the future.
Overview of Financial Results
Earnings were $3.04 per diluted share in 1998 compared with
$3.39 and $3.22 per diluted share in 1997 and 1996, respectively.
The return on common equity was 11.4 percent in 1998, 12.8
percent in 1997, and 12.6 percent in 1996. The market price of
NEES common shares was 48 1/8 per share at the end of 1998
compared with 42 3/4 per share and 34 7/8 per share at the end of
1997 and 1996, respectively.
The decrease in 1998 earnings reflects significant revenue
reductions due to the restructuring of the utility business in
Massachusetts, Rhode Island, and New Hampshire, the effect of the
divestiture of NEES' nonnuclear generating business, increased
investments in unregulated ventures, and costs incurred in
connection with the development of the Merger Agreement between
NEES and National Grid. The decrease in earnings was partially
offset by increased kWh deliveries to ultimate customers, a
reduction in costs associated with nuclear operations, and a
reduction in core business operation and maintenance expense as a
result of workforce reductions. 1998 earnings were also
positively affected by a share repurchase program.
The increase in 1997 earnings reflected increased revenues due
to increased kWh deliveries as well as rate increases and
reversals of prior period refund accruals. Also contributing to
the higher earnings was a decrease in the nonfuel component of
purchased power expense. Partially offsetting the higher earnings
were increased operation and maintenance expenses, increased
expenses associated with NEES' unregulated ventures, and costs
incurred to repurchase a portion of the preferred stock of NEES
subsidiaries.
Outlook
NEES believes its 1999 earnings will be reduced by a full
year's effect of industry restructuring. NEES earnings will be
negatively affected by the return on the reinvestment of the sale
proceeds, which is expected, at least in the near term, to be
considerably less than the return historically earned in the
generating business. Further, the Settlement Agreements related
to recovery of stranded costs limit the return on equity earned
on the unrecovered investment in NEES' generating business to 9.7
percent, before mitigation incentives, which is significantly
lower than that earned by the generating business in recent
years. Finally, through the year 2000, the return on equity for
NEES' principal distribution subsidiary is capped at 11.75
percent, plus certain incentives.
<PAGE>
This report contains statements that may be considered forward
looking under the securities laws. Actual results may differ
materially for the reasons discussed in this Financial Review.
For a more detailed discussion of the Merger Agreement between
NEES and National Grid, refer to the proxy statement being
delivered to all shareholders.
Operating Revenue
Operating revenue decreased $82 million in 1998 and reflects a
reduction in generation-related revenues, decreased oil and
gas-related revenues, and the reversal in 1997 of certain refund
reserves related to rate adjustment mechanisms. These decreases
were partially offset by distribution rate increases, increased
kWh deliveries, and increased revenues resulting from the
inclusion of NEES subsidiary AllEnergy Marketing Company,
L.L.C.'s (AllEnergy) operating revenues in 1998.
The reduction in generation-related revenues reflects the
effects of industry restructuring and the implementation of
customer choice of power supplier in Rhode Island, Massachusetts,
and New Hampshire on January 1, 1998, March 1, 1998, and July 1,
1998, respectively. The reductions include the effect of a
true-up mechanism for stranded cost recovery billings including
nuclear decommissioning costs.
The decrease in oil and gas-related revenues reflects the sale
of NEEI's oil and gas properties at the beginning of 1998. Oil
and gas-related revenues totaled $41 million in 1997. Rate
adjustment mechanisms referred to above relate to Massachusetts
Electric and Nantucket Electric reversing previously reserved
amounts into revenue in the fourth quarter of 1997. These
previously reserved amounts related to their purchased power cost
adjustment (PPCA) mechanisms, which were eliminated in accordance
with the provisions of the Massachusetts Settlement.
Distribution rate increases include a $45 million rate
increase at Massachusetts Electric, effective March 1, 1998, in
accordance with the provisions of the Massachusetts Settlement,
and a $7 million increase at Narragansett Electric, effective
January 1, 1998, pursuant to Rhode Island's Utility Restructuring
Act of 1996.
[GRAPH APPEARS HERE, RETURN ON COMMON EQUITY (%)]
In 1998, kWh deliveries to ultimate customers increased 1.5
percent, reflecting a strong economy. For the year as a whole,
weather had a negative impact on 1998 deliveries when compared
with 1997.
AllEnergy's 1998 revenues of $171 million are included in
NEES' consolidated operating revenues as a result of AllEnergy
becoming a wholly owned and fully consolidated subsidiary of NEES
in the fourth quarter of 1997. NEES had previously accounted for
<PAGE>
its 50 percent ownership interest under the equity method of
accounting, as a component of other income. AllEnergy's 1997
revenues were $70 million. AllEnergy is an energy marketing
company which offers energy commodities (natural gas, propane,
and oil) and related value-added services to customers in the
emerging competitive energy markets in the Northeast.
Operating revenue for NEES increased $152 million in 1997
compared with 1996, and reflected higher kWh deliveries, a
Narragansett Electric base rate increase, transmission rate
increases in mid-1996, increased revenues related to rate
adjustment mechanisms, and increased fuel revenues.
Kwh deliveries to ultimate customers increased 2.0 percent in
1997, and reflected the effects of an improving regional economy.
Rate adjustment mechanisms included the 1997 reversal of PPCA
reserves into revenue, as discussed above.
NEES' distribution companies (Massachusetts Electric,
Nantucket Electric, Narragansett Electric, and Granite State
Electric Company (Granite State Electric)) received approval from
their respective regulatory agencies to recover demand-side
management (DSM) program expenditures in rates on a current basis
through 1998. These expenditures were $59 million, $63 million,
and $59 million in 1998, 1997, and 1996, respectively.
Narragansett Electric and Granite State Electric have received
approvals from their respective state regulatory agencies to
recover their 1999 DSM program expenditures. The Massachusetts
Settlement and statute provide for recovery of DSM-related costs.
The Massachusetts Department of Telecommunications and Energy
approved Massachusetts Electric's and Nantucket Electric's DSM
program expenditure recovery plans through 2002. Since 1990, the
distribution companies have been allowed to earn incentives based
on the results of their DSM programs and have recorded before-tax
incentives of $7.2 million, $7.6 million, and $6.0 million in
1998, 1997, and 1996, respectively.
Operating Expenses
Operating expenses decreased $24 million in 1998, and reflect
decreased fuel and nonfuel-related purchased power expenses,
decreased depreciation and amortization expenses, and decreased
taxes, other than income taxes partially offset by increased
operation and maintenance expenses.
In 1998, total fuel and purchased power costs decreased due to
the effect of the sale of NEES' nonnuclear generating business to
USGen on September 1, 1998. The decrease reflects reduced charges
from the Maine Yankee nuclear power plant, which was closed in
mid-1997 and the transfer of NEP's purchased power contracts, in
conjunction with the sale of the nonnuclear generating business
to USGen. These decreases were partially offset by fixed monthly
contractual payments toward the above-market cost of the
transferred purchased power contracts, as well as the cost of
power for standard offer generation service.
<PAGE>
The decrease in depreciation and amortization expense in 1998
reflects the sale of NEEI's oil and gas properties at the
beginning of 1998 and the sale of the nonnuclear generating
business on September 1, 1998. These decreases were partially
offset by an $11 million increase in annual depreciation expense
provided for in the Massachusetts Settlement, depreciation
related to new distribution-related and transmission-related
utility plant expenditures, the accelerated amortization of NEP's
investment in the Millstone 3 nuclear generating unit prior to
its impairment writedown, and amortization of regulatory assets.
See the "Accounting Implications" section above for a discussion
of the latter two issues.
In 1998, the increase in operation and maintenance expenses is
primarily due to the inclusion of AllEnergy's operating expenses
of $190 million in NEES' consolidated operating expenses, due to
AllEnergy becoming a wholly owned and fully consolidated
subsidiary of NEES in the fourth quarter of 1997, as discussed
above. AllEnergy's operating expenses were $87 million in 1997.
AllEnergy's operating expenses are primarily cost of goods sold
in connection with energy commodity sales. This increase was
partially offset by the effect of the sale of the nonnuclear
generating business, lower charges from the partially owned
Seabrook 1 and Millstone 3 nuclear generating facilities, and
lower charges related to postretirement benefits other than
pensions (PBOPs), reflecting the completion of the accelerated
amortization of NEP's deferred PBOP costs in 1997 under the terms
of a 1995 rate agreement.
The decrease in taxes, other than income taxes in 1998 is
primarily due to reduced property taxes resulting from the sale
of the nonnuclear generating business.
Operating expenses increased $133 million in 1997 compared
with 1996. This increase reflected increased fuel costs,
including the fuel component of purchased power expense, and
increased operation and maintenance expenses, partially offset by
decreased depreciation and amortization expense. The increase in
the fuel component of purchased power expense was partially
offset by a reduction in the nonfuel component.
Fuel costs, including the fuel component of purchased power
expense, increased in 1997 primarily due to increased wholesale
sales to other utilities and increased replacement power costs
due to the reduced generation from partially owned nuclear units.
In 1997, the increase in operation and maintenance expenses
reflected increased costs of partially owned nuclear plants,
transmission wheeling costs, start-up costs associated with the
new regional transmission control organization, increased
distribution system-related costs, and the NEES companies' share
of costs associated with the restoration to service of previously
idled generating facilities throughout New England, in response
to a tightening regional power supply. The increase also
reflected increased general and administrative costs, including
accelerated PBOP amortization, as discussed above.
<PAGE>
The decrease in depreciation and amortization expense in 1997
reflected the completion of the amortization of NEP's pre-1988
investment in the Seabrook 1 nuclear unit and NEP's investment in
the canceled Seabrook 2 nuclear unit.
The decrease in the nonfuel component of purchased power
expense, which amounted to $6 million in 1997, reflected reduced
charges from the Connecticut Yankee nuclear power plant which was
permanently shut down in late 1996 and the expiration of certain
purchased power contracts, partially offset by increased charges
from the Maine Yankee nuclear power plant which was permanently
shut down in mid-1997.
Other Income
The change in other income in 1998 primarily represents
increased interest income as a result of the investment of the
proceeds from the sale of the nonnuclear generating business on
September 1, 1998, as well as the inclusion of AllEnergy's losses
in other income during most of 1997. AllEnergy became a wholly
owned and fully consolidated subsidiary of NEES in the fourth
quarter of 1997, as discussed above.
The decrease in other income in 1997 compared with 1996
reflected expenses associated with NEES' unregulated ventures.
Nuclear Units
Nuclear Units Permanently Shut Down
Three regional nuclear generating companies in which NEP has a
minority interest own nuclear generating units that have been
permanently shut down. These three units are as follows:
<TABLE>
<CAPTION>
Future
Estimated
NEP's Billings
Investment Date to NEP
Unit % $ (millions) Retired $ (millions)
- ----------------------------------------------------------------
<S> <C> <C> <C> <C>
Yankee Atomic 30 6 Feb 1992 24
Connecticut Yankee 15 16 Dec 1996 75
Maine Yankee 20 16 Aug 1997 143
</TABLE>
In the case of each of these units, NEP has recorded a
liability and an offsetting regulatory asset reflecting the
estimated future billings from the companies. In a 1993 decision,
the FERC allowed Yankee Atomic to recover its undepreciated
investment in the plant as well as unfunded nuclear
decommissioning costs and other costs. Connecticut Yankee and
Maine Yankee have both filed similar requests with the FERC.
Several parties have intervened in opposition to both filings. In
August 1998, a FERC Administrative Law Judge (ALJ) issued an
initial decision which would allow for full recovery of
<PAGE>
Connecticut Yankee's unrecovered investment, but precluded a
return on that investment. Connecticut Yankee, NEP, and other
parties have filed with the FERC exceptions to the ALJ's
decision. Should the FERC uphold the ALJ's initial decision in
its current form, NEP's share of the loss of the return component
would total approximately $12 million to $15 million before
taxes. In January 1999, parties in the Maine Yankee proceeding
filed a comprehensive settlement agreement with the FERC, under
which Maine Yankee would recover all unamortized investment in
the plant, including a return on its equity investment of 6.5
percent, as well as decommissioning costs and other costs. This
settlement agreement requires FERC approval. NEP's industry
restructuring settlements allow it to recover all costs that the
FERC allows these Yankee companies to bill to NEP.
NEP and several other shareholders (Sponsors) of Maine Yankee
are parties to 27 contracts (Secondary Purchase Agreements) under
which they sold portions of their entitlements to Maine Yankee
power output through 2002 to various entities, primarily
municipal and cooperative systems in New England (Secondary
Purchasers). Virtually all of the Secondary Purchasers had ceased
making payments under the Secondary Purchase Agreements, claiming
that such agreements excuse further payments upon plant shutdown.
In February 1999, a settlement agreement which fully resolves the
dispute between the Sponsors and Secondary Purchasers was filed
with the FERC, under which the Secondary Purchasers would be
required to make certain payments to Maine Yankee, and, in turn,
to NEP, related to both past and future obligations under the
Secondary Purchase Agreements. This settlement agreement requires
FERC approval. Shutdown costs are recoverable from customers
under the Settlement Agreements.
A Maine statute provides that if both Maine Yankee and its
decommissioning trust fund have insufficient assets to pay for
the plant decommissioning, the owners of Maine Yankee are jointly
and severally liable for the shortfall.
Operating Nuclear Units
NEP has minority interests in three other nuclear generating
units: Vermont Yankee, Millstone 3, and Seabrook 1. Uncertainties
regarding the future of nuclear generating stations, particularly
older units, such as Vermont Yankee, are increasing rapidly and
could adversely affect their service lives, availability, and
costs. These uncertainties stem from a combination of factors,
including the acceleration of competitive pressures in the power
generation industry and increased NRC scrutiny. NEP performs
periodic economic viability reviews of operating nuclear units in
which it holds ownership interests.
Millstone 3
In July 1998, Millstone 3 returned to full operation after
being shut down since April 1996. Millstone 3 remains on the NRC
"Watch List," signifying that it continues to warrant increased
NRC attention. Millstone 3 is operated by a subsidiary of
<PAGE>
Northeast Utilities (NU). NEP is not an owner of the Millstone 2
nuclear generating unit, which is temporarily shut down under NRC
orders, or the Millstone 1 nuclear generating unit, which has
been permanently shut down. A criminal investigation related to
Millstone 3 is ongoing.
In August 1997, NEP sued NU in Massachusetts Superior Court
for damages resulting from the tortious conduct of NU that caused
the shutdown of Millstone 3. NEP's damages include the costs of
replacement power during the outage, costs necessary to return
Millstone 3 to safe operation, and other additional costs. Most
of NEP's incremental replacement power costs have been recovered
from customers, either through fuel adjustment clauses or through
provisions in the Settlement Agreements. NEP also seeks punitive
damages. NEP also sent a demand for arbitration to Connecticut
Light & Power Company and Western Massachusetts Electric Company,
both subsidiaries of NU, seeking damages resulting from their
breach of obligations under an agreement with NEP and others
regarding the operation and ownership of Millstone 3. The
arbitration is scheduled for October 1999. In July 1998, the
court denied NU's motion to dismiss and its motion to stay
pending arbitration. NEP subsequently amended its complaint by,
among other things, adding NU's Trustees as defendants. In
December 1998, NU moved for summary judgement. NEP's suit has
been consolidated with suits filed by other joint owners. The
court is in the process of scheduling a trial date. Some or all
of the damages awarded from the lawsuit would be refunded to
customers.
Hazardous Waste
The electric utility industry typically utilizes and/or
generates in its operations a range of potentially hazardous
products and by-products. The most prevalent types of hazardous
waste sites with which NEES and its subsidiaries have been
associated are manufactured gas locations. (Until the early
1970s, NEES was a combined electric and gas holding company
system.) NEES is aware of approximately 40 such manufactured gas
locations, including 10 for which the NEES companies have been
identified by either federal or state regulatory agencies as
potentially responsible parties, mostly located in Massachusetts.
NEES has reported the existence of all manufactured gas locations
of which it is aware to state environmental regulatory agencies.
NEES is engaged in various phases of investigation and
remediation work at approximately 20 of the manufactured gas
locations. NEES and its subsidiaries are currently aware of other
possible hazardous waste sites, and may in the future become
aware of additional sites, that they may be held responsible for
remediating.
In 1993, the Massachusetts Department of Public Utilities
approved a settlement agreement that provides for rate recovery
of remediation costs of former manufactured gas sites and certain
other hazardous waste sites located in Massachusetts. A more
detailed discussion of this settlement agreement and of potential
hazardous waste liabilities is contained in Note E of the Notes
<PAGE>
to the Financial Statements. Predicting the potential costs to
investigate and remediate hazardous waste sites continues to be
difficult. At December 31, 1998, NEES had total reserves for
environmental response costs of $53 million. NEES believes that
hazardous waste liabilities for all sites of which it is aware,
and which are not covered by a rate agreement, are not material
to its financial position.
Year 2000 Readiness Disclosure
Over the next year, most companies will face a potentially
serious information systems (computer) problem because many
software applications and operational programs written in the
past may not properly recognize calendar dates associated with
the year 2000 (Y2K). This could cause computers to either shut
down or lead to incorrect calculations.
During 1996, the NEES companies began the process of
identifying the changes required to their computer software and
hardware to mitigate Y2K issues. The NEES companies established a
Y2K Project team to manage these issues. This team reports
project progress to a Y2K Executive Oversight Committee each
month. The team also makes regular reports to NEES' Board of
Directors and its Audit Committee. The NEES companies have
separated their Y2K Project into four parts as shown on the next
page, along with the estimated completion dates for each part.
<TABLE>
<CAPTION>
Substantial Contingency Testing,
Completion Documentation,
of Critical and Clean
Category Specific Example Systems Management
- -------- ---------------- ----------- -------------------
<S> <C> <C> <C>
Mainframe/Midrange Accounting/Customer Completed Throughout 1999
systems service integrated
systems
Desktop systems Personal computers/ June 30, 1999 Throughout 1999
Department software/
Networks
Operational/ Dispatching systems/ June 30, 1999 Throughout 1999
Embedded Transmission and
systems Distribution systems/
Telephone systems
External issues Electronic Data June 30, 1999 Throughout 1999
Interchange/Vendor
communications
</TABLE>
The NEES companies are using a three-phase approach in
coordinating their Y2K Project for system-related issues: (I)
Assessment and Inventory, (II) Pilot Testing, and (III)
Renovation, Conversion, or Replacement of Application and
Operating Software Packages and Testing. Phase I, which was an
initial assessment of all systems and devices for potential Y2K
defects, was completed in mid-1997. Phase II, which consisted of
renovation pilots for a cross-section of systems in order to
facilitate the establishment of templates for Phase III work, was
<PAGE>
completed in late 1997. Phase III, which is currently ongoing,
requires the renovation, conversion, or replacement of the
remaining applications and operating software packages.
The NEES companies have also implemented a formalized
communication process with third parties to give and receive
information related to their progress in remediating their own
Y2K issues, and to communicate the NEES companies' progress in
addressing the Y2K issue. These third parties include major
customers, suppliers, and significant businesses with which the
NEES companies have data links (such as banks). The NEES
companies cannot predict the outcome of other companies'
remediation efforts.
The NEES companies believe total costs associated with making
the necessary modifications to all centralized and noncentralized
systems will be approximately $28 million. In addition, the NEES
companies are spending $4 million related to the replacement of
the human resources and payroll system, in part due to the Y2K
issue. To date, total Y2K-related costs of $25 million have been
incurred, of which $3 million has been capitalized.
The NEES companies are in the process of developing Y2K
contingency plans to allow for critical information and operating
systems to function from January 1, 2000 forward. If required,
these plans are intended to address both internal risks as well
as potential external risks related to suppliers and customers.
Part of the contingency planning for accounting and desktop
systems will include taking extensive data back-ups prior to
year-end closing. For operational systems, the NEES companies
have in place an overall disaster recovery program, which already
includes periodic disaster simulation training (for outages due
to severe weather, for instance). As part of Y2K contingency
planning, the NEES companies will review their disaster recovery
plans, modifying them for Y2K-specific issues. The NEES companies
expect that these contingency plans will be in place by the third
quarter of 1999.
Interregional and regional contingency plans are being
formulated that address emergency scenarios due to the
interconnection of utility systems throughout the United States.
At a regional level, the NEES companies are participating and
cooperating with the New England Power Pool (NEPOOL) and the
Independent System Operator of the NEPOOL area (ISO New England).
Overall regional activities, including those of NEPOOL and ISO
New England, will be coordinated by the Northeast Power
Coordinating Council, whose activities will be incorporated into
the interregional coordinating effort by the North American
Electric Reliability Council. The target for the completion of
this planning process is mid-1999. The NEES companies have noted
that the Y2K coordination efforts by ISO New England began in May
1998, resulting in a demanding and difficult schedule to attain
regional and interregional target dates.
<PAGE>
The NEES companies believe the worst case scenario with a
reasonable chance of occurring is temporary disruptions of
electric service. This scenario could result from a failure to
adequately remediate Y2K problems at NEES company facilities or
could be caused by the inability of entities, such as ISO New
England, to maintain the short-term reliability of various
generators and/or transmission lines on a regional or
interregional basis. The NEES companies believe that the
contingency plans being developed both internally and on a
regional level, as described above, should substantially mitigate
the risks of this potential scenario. In the event that a
short-term disruption in service occurs, NEES does not expect
that it would have a material impact on its financial position
and results of operations.
While the NEES companies believe that their overall Y2K
program will satisfactorily address all critical operational and
system-related issues, significant risks remain. These risks
include, but are not limited to, the Y2K readiness of third
parties, including other utilities and power suppliers, cost and
timeline estimates of remaining Y2K mitigation efforts, and the
overall accuracy of assumptions made related to future events in
the development of the Y2K mitigation effort.
New Accounting Standards
In 1997, the FASB released Statement of Financial Accounting
Standards No. 131, Disclosure about Segments of an Enterprise and
Related Information (FAS 131), which went into effect in 1998.
FAS 131 requires the reporting in financial statements of certain
new additional information about operating segments of a
business. FAS 131 does not currently impact NEES' reporting
requirements.
In February 1998, the FASB issued Statement of Financial
Accounting Standards No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits (FAS 132), which
revises disclosure requirements for pension and other
postretirement benefits. NEES has adopted FAS 132 in its
financial statements for the year ended December 31, 1998.
The adoption of FAS 131 and FAS 132 has no impact on NEES'
operating results, financial position, or cash flows.
In June 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133), which establishes
accounting and reporting standards for such instruments. NEES,
through its wholly owned indirect subsidiary, AllEnergy, uses
derivative instruments to manage exposure from fluctuations in
commodity prices. At this time, AllEnergy uses derivative
instruments to manage risks associated with natural gas, propane,
and oil prices. FAS 133 requires recognition of all derivatives
as either assets or liabilities on the balance sheet and requires
measurement of those instruments at fair value. If certain
conditions are met, derivatives may be treated as hedges under
FAS 133 for income statement purposes. Gains or losses on a
<PAGE>
derivative that qualifies as a hedge are deferred until
recognized in the income statement in the same period as the
hedged item is recognized in the income statement. To the extent
these conditions are not met, that portion of the gain or loss is
reported in earnings immediately. As of December 31, 1998, all of
AllEnergy's existing futures contracts qualified as hedges under
Statement of Financial Accounting Standards No. 80, Accounting
for Futures Contracts (FAS 80), with limited exceptions, and are
expected to qualify as hedges under FAS 133. The derivative
instruments that do not qualify as hedges under FAS 80 and are
recognized in income immediately are immaterial to NEES. FAS 133
is effective for fiscal years beginning after June 15, 1999.
Risk Management
NEES' major financial market risk exposure is changing
interest rates. Changing interest rates will affect interest paid
on variable rate debt and the fair value of fixed rate debt. NEES
manages interest rate risk through a combination of both fixed
rate and variable rate debt instruments. The table below presents
the average rate on NEES long-term debt at December 31, 1998, the
amounts maturing during each of the next five years, and the fair
value of NEES debt at December 31, 1998.
<TABLE>
<CAPTION>
Variable Fixed
Long-Term Long-Term
--------- ---------
<S> <C> <C>
Weighted
Average Rates 3.28% 7.64%
Maturities (millions of dollars)
1999 $ - $ 36
2000 - 49
2001 - 18
2002 - 52
2003 - 65
Cumulative thereafter 372 503
---- ----
Total $372 $723
---- ----
Fair Value $372 $805
---- ----
</TABLE>
See the "Industry Restructuring" section above for a
discussion of NEP's purchased power transfer agreement with
USGen. NEP retained one purchased power contract, with Vermont
Yankee, which carries fixed payment requirements of approximately
$35 million in 1999, $30 million in 2000, $35 million in 2001 and
2002, $30 million in 2003, and approximately $300 million
thereafter.
<PAGE>
Liquidity and Capital Resources
Plant expenditures for 1998 totaled $182 million. The funds
necessary for utility plant expenditures were primarily provided
by internally generated funds and the proceeds from the sale of
the nonnuclear generating business. Cash expenditures for utility
plant and investments by NEES' unregulated subsidiaries for 1999
are estimated to be approximately $280 million. Internally
generated funds are expected to meet approximately 75 percent of
capital expenditure requirements for 1999.
The average interest rate on the long-term debt issued in 1998
is 6.41 percent. The retirement of NEP, Narragansett Electric,
NERC, and NEEI debt in the table below was in connection with the
divestiture of NEP's nonnuclear generating business. NEES also
paid off all $252 million of its short-term debt outstanding at
December 31, 1997.
The long-term debt financing activities of the NEES
subsidiaries for 1998 and the projected long-term debt financings
for 1999 are summarized as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
(millions of dollars) Issues Retirements Retirements
- ----------------------------------------------------------------
<S> <C> <C> <C>
NEP $ - $328 $ -
Massachusetts
Electric 50 40 15
Narragansett
Electric - 12 8
Granite State
Electric 5 - -
Nantucket Electric - 1 1
Hydro-Transmission
companies - 12 12
NERC - 29 -
NEEI - 122 -
- ----------------------------------------------------------------
$55 $544 $36
- ----------------------------------------------------------------
</TABLE>
NEES purchased approximately 5.7 million common shares in 1998
under a repurchase program authorized by the NEES Board of
Directors in 1997 and 1998. It is unlikely that NEES will
repurchase additional shares in 1999.
During 1998, Narragansett Electric repurchased preferred stock
with a par value of $5.6 million, Massachusetts Electric
repurchased or redeemed preferred stock with a par value of $5
million, and NEP repurchased or redeemed preferred stock with a
par value of $9 million.
<PAGE>
At December 31, 1998, NEES and its consolidated subsidiaries
had lines of credit and standby bond purchase facilities with
banks totaling approximately $900 million. These lines and
facilities were used at December 31, 1998 for liquidity support
for $372 million of NEP bonds in tax-exempt commercial paper
mode. Fees are paid on the lines and facilities in lieu of
compensating balances.
On February 12, 1999, NEES and AllEnergy acquired Griffith
Consumers Company (Griffith Consumers), a full-service
distributor of residential and commercial heating oil in
Washington D.C., and in parts of Maryland, Delaware, Virginia,
and West Virginia. In addition to heating oil sales, Griffith
Consumers provides related repair, maintenance, and installation
services. Griffith Consumers' annual revenue is approximately
$100 million.
<PAGE>
Statements
New England Electric System and Subsidiaries
Selected Financial Data
Year ended December 31 (dollar amounts expressed in millions,
except per share data)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Operating revenue:
Electric utility revenue $2,244 $2,450 $2,318 $2,242 $2,203
Unregulated subsidiary revenue 177 12 - - -
Oil and gas sales - 41 33 30 40
------- ------- ------- ------- -------
Total operating revenue $2,421 $2,503 $2,351 $2,272 $2,243
Net income $ 190 $ 220 $ 209 $ 205 $ 199
Average common shares (000s)
Basic 62,359 64,899 64,960 64,970 64,970
Diluted 62,456 64,952 64,986 64,986 64,988
Per share data:
Net income - Basic $ 3.05 $ 3.39 $ 3.22 $ 3.15 $ 3.07
Net income - Diluted $ 3.04 $ 3.39 $ 3.22 $ 3.15 $ 3.07
Dividends declared $ 2.36 $ 2.36 $ 2.36 $2.345 $2.285
Book Value at year end $26.53 $27.03 $25.98 $25.13 $24.33
Return on average common equity 11.4% 12.8% 12.6% 12.8% 12.7%
Total assets $5,071 $5,312 $5,223 $5,191 $5,085
Capitalization:
Common share equity $1,570 $1,744 $1,685 $1,632 $1,581
Minority interests 39 43 46 49 55
Cumulative preferred stock 19 39 126 147 147
Long-term debt 1,056 1,488 1,615 1,675 1,520
------- ------- ------- ------- -------
Total capitalization $2,684 $3,314 $3,472 $3,503 $3,303
Deliveries to ultimate
customers (millions of kWh) 22,422 22,097 21,674 21,311 21,155
Number of employees 3,540 4,665 4,787 4,832 4,990
Number of ultimate customers
(in thousands) 1,363 1,349 1,333 1,314 1,300
------- ------- ------ ------- -------
</TABLE>
<PAGE>
New England Electric System and Subsidiaries
Statements of Consolidated Income
Year ended December 31 (thousands of dollars, except per share data)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Operating revenue $2,420,533 $2,502,591 $2,350,698
---------- ---------- ----------
Operating expenses:
Fuel for generation 229,722 372,461 334,994
Purchased electric energy 633,347 528,229 509,400
Other operation 675,806 556,658 501,090
Maintenance 109,040 143,372 127,785
Depreciation and amortization 206,662 236,492 246,379
Taxes, other than income taxes 134,763 146,494 143,733
Income taxes 122,354 152,024 139,199
---------- ---------- ----------
Total operating expenses 2,111,694 2,135,730 2,002,580
---------- ---------- ----------
Operating income 308,839 366,861 348,118
Other income:
Allowance for equity funds used
during construction 633 - -
Equity in income of generating companies 9,437 10,240 10,334
Other income (expense), net (3,262) (15,755) (8,166)
---------- ---------- ----------
Operating and other income 315,647 361,346 350,286
---------- ---------- ----------
Interest:
Interest on long-term debt 89,805 107,311 110,479
Other interest 27,822 16,939 19,527
Allowance for borrowed funds
used during construction (1,754) (1,908) (2,246)
---------- ---------- ----------
Total interest 115,873 122,342 127,760
---------- ---------- ----------
Income after interest 199,774 239,004 222,526
Preferred dividends and net gain/loss
on reacquisition of preferred
stock of subsidiaries 3,454 12,319 6,463
Minority interests 6,278 6,647 7,127
---------- ---------- ----------
Net income $ 190,042 $ 220,038 $ 208,936
---------- ---------- ----------
Average common shares - Basic 62,359,122 64,899,322 64,960,496
Average common shares - Diluted 62,456,103 64,952,185 64,986,136
Per share data:
Net income - Basic $ 3.05 $ 3.39 $ 3.22
Net income - Diluted $ 3.04 $ 3.39 $ 3.22
Dividends declared $ 2.36 $ 2.36 $ 2.36
---------- ---------- ----------
</TABLE>
Statements of Consolidated Retained Earnings
Year ended December 31 (thousands of dollars)
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Retained earnings at beginning of year $ 954,518 $ 887,292 $ 831,529
Net income 190,042 220,038 208,936
Dividends declared on common shares (145,648) (152,812) (153,173)
---------- ---------- ----------
Retained earnings at end of year $ 998,912 $ 954,518 $ 887,292
---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
New England Electric System and Subsidiaries
Consolidated Balance Sheets
At December 31 (thousands of dollars)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Assets
Utility plant, at original cost $4,130,102 $5,860,101
Less accumulated provisions for depreciation
and amortization 1,694,653 1,995,017
---------- ----------
2,435,449 3,865,084
Construction work in progress 52,977 48,708
---------- ----------
Net utility plant 2,488,426 3,913,792
---------- ----------
Oil and gas properties, at full cost (Note A) - 1,299,817
Less accumulated provision for amortization - 1,128,659
---------- ----------
Net oil and gas properties - 171,158
---------- ----------
Investments:
Nuclear power companies, at equity (Note E) 48,538 49,825
Other subsidiaries, at equity 2,374 37,418
Other investments 169,196 117,645
---------- ----------
Total investments 220,108 204,888
---------- ----------
Current assets:
Cash 187,673 14,264
Marketable securities 57,915 -
Accounts receivable, less reserves
of $18,196 and $17,834 294,943 257,185
Unbilled revenues 87,467 71,260
Fuel, materials, and supplies, at average cost 38,339 66,509
Prepaid and other current assets 57,081 64,265
---------- ----------
Total current assets 723,418 473,483
---------- ----------
Regulatory assets (Note C) 1,599,657 532,213
Deferred charges and other assets 38,926 16,113
---------- ----------
$5,070,535 $5,311,647
---------- ----------
Capitalization and liabilities
Capitalization (see accompanying statements):
Common share equity $1,570,003 $1,744,442
Minority interests in consolidated subsidiaries 38,742 43,062
Cumulative preferred stock of subsidiaries 19,480 39,113
Long-term debt 1,055,740 1,487,481
---------- ----------
Total capitalization 2,683,965 3,314,098
---------- ----------
Current liabilities:
Long-term debt due within one year 36,307 89,910
Short-term debt - 251,950
Accounts payable 204,992 136,218
Accrued taxes 24,196 14,831
Accrued interest 16,680 24,969
Dividends payable 34,412 36,162
Other current liabilities (Note H) 142,975 120,002
---------- ----------
Total current liabilities 459,562 674,042
---------- ----------
Deferred federal and state income taxes 472,140 720,375
Unamortized investment tax credits 65,292 90,018
Accrued Yankee nuclear plant costs (Note E) 242,138 299,564
Purchased power obligations 832,668 -
Other reserves and deferred credits 314,770 213,550
Commitments and contingencies (Note E)
---------- ----------
$5,070,535 $5,311,647
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
New England Electric System and Subsidiaries
Consolidated Statements of Cash Flows
Year ended December 31 (thousands of dollars)
<TABLE>
<CAPTION>
1998 1997 1996
----------- --------- ---------
<S> <C> <C> <C>
Operating activities
Net income $ 190,042 $ 220,038 $ 208,936
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 211,069 239,654 250,508
Deferred income taxes and
investment tax credits, net (273,448) (31,178) (30,328)
Allowance for funds used during
construction (2,387) (1,908) (2,246)
Buyout of purchased power contracts (326,590) - -
Minority interests 6,278 6,647 7,127
Decrease (increase) in accounts
receivable, net and unbilled revenues (44,682) 4,217 30,770
Decrease (increase) in fuel,
materials, and supplies (19,141) 10,664 126
Decrease (increase) in prepaid
and other current assets 2,708 24,729 (7,209)
Increase (decrease) in accounts payable 63,232 (15,710) (9,568)
Increase (decrease) in other current
liabilities 22,241 (2,718) 33,999
Other, net 13,481 66,678 40,455
----------- --------- ---------
Net cash provided by (used in)
operating activities $ (157,197) $ 521,113 $ 522,570
----------- --------- ---------
Investing activities
Proceeds from sale of generating assets $ 1,728,588 $ - $ -
Plant expenditures, excluding allowance
for funds used during construction (181,941) (203,095) (234,409)
Oil and gas exploration and development - (13,156) (20,371)
Proceeds from sale of New England Energy
Incorporated oil and gas property 50,000 - -
Purchase of available-for-sale
securities, net (57,915) - -
Other investing activities (46,718) (22,669) (10,309)
----------- --------- ---------
Net cash provided by (used in)
investing activities $ 1,492,014 $(238,920) $(265,089)
----------- --------- ---------
Financing activities
Dividends paid to minority interests $ (6,704) $ (6,809) $ (8,878)
Dividends paid on NEES common shares (147,350) (152,763) (153,759)
Short-term debt (251,950) 105,900 (59,862)
Long-term debt - issues 55,000 25,000 97,850
Long-term debt - retirements (543,630) (142,205) (106,811)
Preferred stock - redemptions (19,614) (87,221) (20,900)
Premium on reacquisition of long-term debt (22,116) (2,163) -
Return of capital to minority interests
and related premium (3,786) (3,348) (1,633)
Repurchase of common shares (221,258) (12,797) (2,075)
----------- --------- ---------
Net cash provided by (used in)
financing activities $(1,161,408) $(276,406) $(256,068)
----------- --------- ---------
Net increase in cash and cash
equivalents $ 173,409 $ 5,787 $ 1,413
Cash and cash equivalents at
beginning of year 14,264 8,477 7,064
----------- --------- ---------
Cash and cash equivalents at end of year $ 187,673 $ 14,264 $ 8,477
----------- --------- ---------
Supplementary information
Interest paid less amounts capitalized $ 114,316 $ 115,545 $ 119,710
----------- --------- ---------
Federal and state income taxes paid $ 399,754 $ 174,000 $ 168,255
----------- --------- ---------
Dividends received from investments
at equity $ 12,387 $ 10,802 $ 12,987
----------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
New England Electric System and Subsidiaries
Consolidated Statements of Capitalization
At December 31 (thousands of dollars)
<TABLE>
<CAPTION>
Common share equity 1998 1997
---------- ----------
<S> <C> <C>
Common shares, par value $1 per share
Authorized - 150,000,000 shares
Issued - 64,969,652 shares $ 64,970 $ 64,970
Paid-in capital 736,744 736,605
Retained earnings 998,912 954,518
Treasury stock - 5,798,637 and 431,875 shares,
respectively (237,767) (16,415)
Accumulated other comprehensive
income, net 7,144 4,764
---------- ----------
Total common share equity $1,570,003 $1,744,442
---------- ----------
</TABLE>
<TABLE>
<CAPTION>
Shares outstanding
------------------
Cumulative preferred stock of
subsidiaries 1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
$100 par value
4.44% to 4.76% 52,745 106,400 $ 5,275 $10,640
6.00% to 6.99% 69,672 108,690 6,967 10,869
$50 par value
4.50% to 6.95% 144,766 256,000 7,238 12,800
$25 par value
6.84% - 192,160 - 4,804
------- ------- ------- -------
Total cumulative preferred stock
of subsidiaries (annual dividend
requirement of $1,091 for 1998
and $2,284 for 1997) 267,183 663,250 $19,480 $39,113
------- ------- ------- -------
</TABLE>
<TABLE>
<CAPTION>
Long-term debt (Note I) Maturity Rate 1998 1997
----------------- ----------------------- ----------
<S> <C> <C> <C> <C>
Mortgage bonds 1998 through 2000 6.040%-8.280%$ 59,000 $199,000
2002 through 2005 6.240%-8.520% 156,500 191,500
2006 through 2015 5.720%-7.250% 80,000 93,500
2021 through 2028 6.910%-9.125% 252,200 393,700
2018 through 2022 Variable - 371,850
Pollution control revenue bonds
New England Power Company 2018 through 2022 Variable 371,850 -
Notes
Granite State Electric Company 2001 through 2028 7.300%-9.440% 20,000 15,000
Nantucket Electric Company 1998 through 2017 4.600%-8.500% 29,265 30,735
New England Energy Incorporated 1998 through 2002 Variable - 122,000
Hydro-Transmission companies 2001 through 2015 8.820%-9.410% 124,970 136,490
Narragansett Energy Resources
Company 2010 7.250% - 28,640
AllEnergy Marketing
Company, L.L.C. 2001 through 2003 0.000%-8.000% 1,135 -
Unamortized discounts and premiums, net (2,873) (5,024)
--------------------
Total long-term debt 1,092,047 1,577,391
--------------------
Long-term debt due in one year (36,307) (89,910)
--------------------
$1,055,740$1,487,481
--------------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
New England Electric System and Subsidiaries
Statements of Consolidated Comprehensive Income
At December 31 (thousands of dollars)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net income $190,042 $220,038 $208,936
Other comprehensive income,
net of tax:
Unrealized gains, net of tax
expense of $2,762, $3,053 and $0,
respectively 5,466 4,731 -
Less: Reclassification adjustments
for realized gains/(losses)
included in net income
net of tax expense/(benefit) of $109,
$(21), and $0, respectively 169 (33) -
Minimum pension liability adjustment,
net of tax expense of $1,570, $0, and $0,
respectively (2,917) - -
-------- -------- --------
Total comprehensive income $192,422 $224,802 $208,936
-------- -------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
Notes
New England Electric System and Subsidiaries
Notes to Consolidated Financial Statements
Note A - Significant Accounting Policies
1. Nature of operations
New England Electric System (NEES) is a public utility holding
company headquartered in Westborough, Massachusetts. NEES'
regulated subsidiaries are engaged in the transmission,
distribution, and sale of electricity. NEES' electricity
distribution subsidiaries serve 1.4 million customers in
Massachusetts, Rhode Island, and New Hampshir. Unregulated
subsidiaries are engaged in the marketing of energy commodities
and services and the construction and leasing of
telecommunications infrastructure.
The NEES system provides electric service to distribution
customers through separate distribution subsidiaries:
Massachusetts Electric Company (Massachusetts Electric) and
Nantucket Electric Company (Nantucket Electric), which operate in
Massachusetts; The Narragansett Electric Company (Narragansett
Electric), which operates in Rhode Island; and Granite State
Electric Company (Granite State Electric), which operates in New
Hampshire.
2. Basis of consolidation and financial statement presentation
The consolidated financial statements include the accounts of
NEES and all subsidiaries except New England Electric
Transmission Corporation, which is recorded under the equity
method. Presentation of this subsidiary on the equity basis is
not material to the consolidated financial statements. New
England Power Company (NEP) has a minority interest in four
regional nuclear generating companies (Yankees). NEP accounts for
these ownership interests under the equity method. During 1997,
NEES increased its ownership from 50 percent to 100 percent of
AllEnergy Marketing Company, L.L.C. (AllEnergy), an energy
marketing enterprise.
NEES owns 50.4 percent of the outstanding common stock of both
New England Hydro-Transmission Electric Company, Inc. and New
England Hydro-Transmission Corporation (Hydro-Transmission
companies). The consolidated financial statements include 100
percent of the assets, liabilities, and earnings of the
Hydro-Transmission companies. Minority interests, which represent
the minority stockholders' proportionate share of the equity and
income of the Hydro-Transmission companies, have been separately
disclosed on the NEES consolidated balance sheets and income
statements.
NEP is also a 12 percent and 10 percent joint owner,
respectively, of the Millstone 3 and Seabrook 1 nuclear
generating units, each 1,150 megawatts (MW). NEP's share of the
related expenses for these units is included in "Operating
expenses."
<PAGE>
The accounts of NEES and its utility subsidiaries are
maintained in accordance with the Uniform System of Accounts
prescribed by regulatory bodies having jurisdiction. All
significant intercompany transactions between consolidated
subsidiaries have been eliminated.
In preparing the financial statements, management is required
to make estimates that affect the reported amounts of assets and
liabilities and disclosures of asset recovery and contingent
liabilities as of the date of the balance sheets, and revenues
and expenses for the period. These estimates may differ from
actual amounts if future circumstances cause a change in the
assumptions used to calculate these estimates.
3. Electric sales revenue
All of NEES' distribution subsidiaries accrue revenues for
electricity delivered but not yet billed (unbilled revenues),
with the exception of Granite State Electric. Accrued revenues
were also recorded in accordance with rate adjustment mechanisms,
which included Massachusetts Electric's and Nantucket Electric's
purchased power cost adjustment (PPCA) mechanisms. Upon approval
of the Massachusetts Settlement in November 1997, the PPCA
mechanisms were eliminated as of July 31, 1996. Pending final
approval of the settlement, Massachusetts Electric and Nantucket
Electric had accrued refund reserves of $9 million for the last
five months of 1996 and an additional $9 million in the first
nine months of 1997. Upon final approval of the settlement, these
refund reserves were reversed in the fourth quarter of 1997.
4. Allowance for funds used during construction (AFDC)
The utility subsidiaries capitalize AFDC as part of
construction costs. AFDC represents the composite interest and
equity costs of capital funds used to finance that portion of
construction costs not yet eligible for inclusion in rate base.
AFDC is capitalized in "Utility plant" with offsetting noncash
credits to "Other income" and "Interest." This method is in
accordance with an established rate-making practice under which a
utility is permitted a return on, and the recovery of, prudently
incurred capital costs through their ultimate inclusion in rate
base and in the provision for depreciation.
<PAGE>
5. Depreciation and amortization
The depreciation and amortization expense included in the
statements of consolidated income is composed of the following:
<TABLE>
<CAPTION>
Year ended December 31 (thousands of dollars) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Depreciation - transmission and
distribution related $112,254 $ 99,114 $ 93,897
Depreciation - all other 53,293 72,896 77,296
Nuclear decommissioning costs (see Note E-4) 2,719 2,638 2,629
Amortization:
Oil and gas properties (see Note A-6) - 46,718 49,163
Investment in Seabrook 1
pursuant to rate settlement - - 15,210
Seabrook 2 property losses - 113 6,280
Millstone 3 accelerated amortization,
pursuant to 1995 rate settlement 22,040 15,013 1,904
Regulatory assets covered by
CTC (see Note C) 16,356 - -
-------- -------- --------
Total depreciation and amortization
expense $206,662 $236,492 $246,379
-------- -------- --------
</TABLE>
Depreciation is provided annually on a straight-line basis.
The provision for depreciation as a percentage of weighted
average depreciable transmission and distribution property was
3.4 percent in 1998, 3.2 percent in 1997, and 3.1 percent in
1996. In 1996, New England Energy Incorporated (NEEI), a wholly
owned subsidiary of NEES, reduced amortization expense of its oil
and gas properties by $13 million to correct amounts recorded in
the years 1990 through 1996. Amortization of Seabrook and
Millstone 3 investments above normal depreciation accruals was in
accordance with rate settlement agreements.
6. Oil and gas investments
NEEI participated in a rate-regulated domestic oil and gas
exploration, development, and production program through a
partnership with a nonaffiliated oil company. Losses from this
program, calculated under the full cost method of accounting,
have been charged to NEP, and ultimately to distribution
customers, in accordance with Securities and Exchange Commission
(SEC) and Federal Energy Regulatory Commission (FERC) approvals.
Such losses were $11 million and $22 million in 1997 and 1996,
respectively. In February 1998, NEEI sold its oil and gas
properties for $50 million. NEEI's loss on the sale of
approximately $120 million, before tax, has been reimbursed by
NEP, and is being recovered through contract termination charges
(CTC). See Note C for a discussion of regulatory asset recovery.
7. Cash
NEES and its subsidiaries classify short-term investments with
an original maturity of 90 days or less as cash.
<PAGE>
8. Marketable securities
At December 31, 1998, marketable securities consist primarily
of corporate debt, mortgage-backed government securities, and
collateralized mortgage obligations. Marketable securities have
been categorized as available-for-sale and, as a result, are
carried at fair value, based generally on quoted market prices.
At December 31, 1998, NEES had marketable securities with a fair
value of approximately $58 million. Fair value closely
approximated cost. Marketable securities are available for
current operations and are classified as current assets, and have
contractual maturities of less than two years. During 1998, the
proceeds received from the sales of securities held as
available-for-sale totaled approximately $64 million, which
resulted in immaterial realized gains and losses.
9. Average common shares
The following table summarizes the reconciling amounts between
basic and diluted earnings per share (EPS) computations, in
compliance with Statement of Financial Accounting Standards No.
128, Earnings per Share, which became effective during 1997, and
requires restatement for all prior-period EPS data presented.
<TABLE>
<CAPTION>
Year ended December 31 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income after interest and
minority interest (000s) $193,496 $232,357 $215,399
Less: preferred stock dividends and
net gain/loss on reacquisition of
preferred stock of subsidiaries (000s) $ 3,454 $ 12,319 $ 6,463
Income available to common
shareholders (000s) $190,042 $220,038 $208,936
Basic EPS $ 3.05 $ 3.39 $ 3.22
Diluted EPS $ 3.04 $ 3.39 $ 3.22
-------- -------- --------
Average common shares outstanding for
Basic EPS 62,359,122 64,899,322 64,960,496
Effect of Dilutive Securities
Average potential common shares related
to share-based compensation plans 96,981 52,863 25,640
---------- ---------- ----------
Average common shares outstanding for
Diluted EPS 62,456,103 64,952,185 64,986,136
---------- ---------- ----------
</TABLE>
10. New accounting standards
In 1997, the Financial Accounting Standards Board (FASB)
released Statement of Financial Accounting Standards No. 131,
Disclosure about Segments of an Enterprise and Related
Information (FAS 131), which went into effect in 1998. FAS 131
requires the reporting in financial statements of certain new
additional information about operating segments of a business.
FAS 131 does not currently impact NEES' reporting requirements.
<PAGE>
In February 1998, the FASB issued Statement of Financial
Accounting Standards No. 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits (FAS 132), which
revises disclosure requirements for pension and other
postretirement benefits. NEES has adopted FAS 132 in its
financial statements for the year ending December 31, 1998. The
adoption of FAS 131 and FAS 132 has no impact on NEES' operating
results, financial position, or cash flows.
11. Derivative instruments
NEES, through its wholly owned indirect subsidiary, AllEnergy,
uses derivative instruments to manage exposure in fluctuations in
commodity prices. At this time, AllEnergy uses derivative
instruments to manage risks associated with natural gas, propane,
and oil prices. Hedge criteria used and accounting for hedge
transactions are in accordance with Statement of Financial
Accounting Standards No. 80, Accounting for Futures Contracts
(FAS 80). FAS 80 states that in order to qualify as a hedge,
price movements in commodity derivatives must be highly
correlated with the underlying hedged commodity and must reduce
exposure to market fluctuations throughout the hedged period. Any
gain or loss on a derivative that qualifies as a hedge under FAS
80 is deferred until recognized in the income statement in the
same period as the hedged item is recognized in the income
statement.
In June 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133), which establishes
accounting and reporting standards for such instruments. FAS 133
requires recognition of all derivatives as either assets or
liabilities on the balance sheet and requires measurement of
those instruments at fair value. If certain conditions are met,
derivatives may be treated as hedges and accounted for in the
income statement in the same manner as under FAS 80. To the
extent these conditions are not met, that portion of the gain or
loss is reported in earnings immediately. FAS 133 is effective
for fiscal years beginning after June 15, 1999. As of December
31, 1998, all of AllEnergy's derivative instruments qualified as
hedges under FAS 80, with limited exceptions, and are expected to
qualify as hedges under FAS 133. The derivative instruments that
do not qualify as hedges under FAS 80 and are recognized in
income immediately are immaterial to NEES.
Note B - Merger Agreements
Merger Agreement with National Grid
On December 11, 1998, NEES, The National Grid Group plc
(National Grid), and NGG Holdings LLC (Holdings), a directly and
indirectly wholly owned subsidiary of National Grid, entered into
an Agreement and Plan of Merger (Merger Agreement). Pursuant to
the Merger Agreement, Holdings will merge with and into NEES (the
Merger), with NEES becoming a wholly owned subsidiary of National
Grid. NEES shareholders will receive $53.75 per share in cash,
which will be increased at a rate of $.003288 each day beginning
six months after shareholder approval of the Merger until the
Merger is completed, up to a maximum price of $54.35 per share.
<PAGE>
The Merger is subject to approval by a majority vote of NEES
shareholders as well as National Grid shareholder approval. In
addition, the Merger is subject to a number of regulatory and
other approvals and consents, including approvals by the SEC,
FERC, and Nuclear Regulatory Commission (NRC), support or
approval from the states in which NEES operates, and approval
under both the Hart-Scott-Rodino Antitrust Improvements Act of
1976, as amended, and the Exon-Florio Provisions of the Omnibus
Trade and Competitiveness Act of 1988. National Grid has obtained
governmental clearance in the United Kingdom for the Merger. The
Merger is expected to be completed by early 2000.
Merger Agreement with Eastern Utilities Associates
On February 1, 1999, NEES, Eastern Utilities Associates (EUA),
and Research Drive LLC (Research Drive), a directly and
indirectly wholly owned subsidiary of NEES, entered into an
Agreement and Plan of Merger (EUA Agreement). Pursuant to the EUA
Agreement, Research Drive will merge with and into EUA, with EUA
becoming a wholly owned subsidiary of NEES. EUA shareholders will
receive $31.00 per share in cash, which will be increased at a
rate of $.003 each day beginning six months after EUA shareholder
approval of the EUA acquisition until the acquisition is
completed or until April 30, 2000, whichever is earlier.
The acquisition of EUA is subject to approval by a two-thirds
vote of EUA shareholders. In addition, the acquisition is subject
to a number of regulatory and other approvals and consents,
including approvals by the SEC, FERC, and NRC, support or
approval from the states in which EUA operates, and approval
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976,
as amended. The EUA acquisition is expected to be completed by
early 2000.
Note C - Industry Restructuring
During 1998, pursuant to legislation enacted in Massachusetts,
Rhode Island, and New Hampshire, and settlement agreements
approved by state and federal regulators (the Settlement
Agreements), all NEES customers were provided the right to
purchase electricity from the power supplier of their choice.
Customers who do not choose a power supplier are able, for a
period of time, to continue to purchase their electricity from
the NEES companies at a transition rate ("standard offer
generation service") which, when combined with delivery charges,
results in total rate reductions ranging from 8 to 24 percent
compared with rates that had been in effect prior to the
introduction of customer choice. Substantially all of the
obligations of the NEES companies to provide standard offer
generation service are backed by contracts with USGen New
England, Inc. (USGen), an indirect wholly owned subsidiary of
PG&E Corporation, and other power suppliers.
The Settlement Agreements provide that the costs of NEP's
generating investments and related contractual commitments that
were not recovered from the divestiture of those investments
("stranded costs"), are to be recovered from NEP's wholesale
<PAGE>
customers through CTCs. The affiliated wholesale customers, in
turn, are recovering those costs through their delivery charges
to distribution customers. Under the Settlement Agreements, the
recovery of NEP's stranded costs is divided into several
categories. Unrecovered costs associated with generating plants
(nuclear and nonnuclear) and most regulatory assets will be fully
recovered through the CTC by the end of 2000 and earn a return on
equity averaging 9.7 percent. NEP's obligation relating to the
above-market cost of purchased power contracts and nuclear
decommissioning costs are recovered through the CTC over a longer
period of time, as such costs are actually incurred. The CTC rate
was originally set at 2.8 cents per kilowatthour (kWh), and
subsequently reduced to approximately 1.5 cents or less per kWh
upon completion of the sale of NEP's nonnuclear generating
business. As the CTC rate declines, NEP, under certain of the
Settlement Agreements, earns incentives based on successful
mitigation of its stranded costs. These incentives supplement
NEP's return on equity. Finally, the Settlement Agreements
provide that until such time as NEP divests its operating nuclear
interests, NEP will share with customers, through the CTC, 80
percent of the revenues and operating costs related to the units,
with shareholders retaining the balance.
Accounting Implications
Historically, electric utility rates have been based on a
utility's costs. As a result, electric utilities are subject to
certain accounting standards that are not applicable to other
business enterprises in general. Statement of Financial
Accounting Standards No. 71, Accounting for the Effects of
Certain Types of Regulation (FAS 71), requires regulated
entities, in appropriate circumstances, to establish regulatory
assets, and thereby defer the income statement impact of these
charges because they are expected to be included in future
customer charges. In 1997, the Emerging Issues Task Force (EITF)
of the Financial Accounting Standards Board concluded that a
utility that had received approval to recover stranded costs
through regulated transmission and distribution rates would be
permitted to continue to apply FAS 71 to the recovery of stranded
costs.
NEP has received authorization from the FERC to recover
through the CTC substantially all of the costs associated with
its former generating business not recovered through the sale of
that business. Additionally, FERC Order No. 888 enables
transmission companies to recover their specific costs of
providing transmission service. Therefore, substantially all of
NEP's business, including the recovery of its stranded costs,
remains under cost-based rate regulation. Under existing
ratemaking practices, NEES' distribution companies will have the
ability to recover through rates their specific costs of
providing ongoing distribution services. NEES believes these
factors and the EITF conclusion allow its principal utility
subsidiaries to continue to apply FAS 71. Because of the nuclear
cost-sharing provisions related to NEP's CTC, NEP ceased applying
FAS 71 in 1997 to 20 percent of its ongoing nuclear operations,
the impact of which is immaterial.
<PAGE>
Currently, there is much regulatory and other movement toward
establishing performance-based rates. It is possible that the
adoption of performance-based rates, future regulatory rules, or
other circumstances could cause the application of FAS 71 to be
discontinued. This discontinuation would result in a noncash
write-off of previously established regulatory assets, including
those being recovered through NEP's CTC. In addition, reserves
for depreciation may also have to be increased to comply with
unregulated accounting practices.
As a result of applying FAS 71, NEES has recorded a regulatory
asset for the costs that are recoverable from customers through
the CTC. The regulatory asset reflects the loss on the sale of
NEES' oil and gas business and the unrecovered plant costs in
operating nuclear plants (assuming no market value), the costs
associated with permanently closed nuclear power plants, and the
present value of the payments associated with the above-market
cost of purchased power contracts, reduced by the gain from the
sale of NEP's nonnuclear generating business. At December 31,
1998, the regulatory asset related to the CTC was approximately
$1.5 billion, of which $1.2 billion related to the above-market
costs of purchased power contracts. All but approximately $60
million of total net regulatory assets are recoverable under
NEP's CTC. These costs relate primarily to NEES' distribution
subsidiaries and consist primarily of $48 million of deferred FAS
109 costs (see Note G), and $23 million of unamortized loss on
reacquired debt, partially offset by net regulatory liabilities
classified in current assets and liabilities.
As described above, the CTC regulatory asset includes the
unrecovered plant costs associated with NEP's interest in
operating nuclear plants. This balance sheet treatment is due to
NEP's conclusion that its interests in the Millstone 3 and
Seabrook 1 nuclear generating units have little, if any, market
value. Three proposed sales of nuclear units by other utilities
have required the seller to set aside amounts for decommissioning
in excess of the proceeds from the sale of the units. Two of
these proposed sales were agreed upon prior to the end of the
third quarter of 1998. As a result, at the end of the third
quarter of 1998, NEP recorded an impairment writedown in its
reserve for depreciation of approximately $390 million, which
represents the net book value at December 31, 1995, less
applicable depreciation subsequent to that date, of Millstone 3
and Seabrook 1. Because the Settlement Agreements permit NEP to
recover its pre-1996 investment as well as decommissioning
expenses through the CTC, NEP established a regulatory asset in
an amount equal to the impairment writedown. Should NEP's efforts
to sell its nuclear interests result in a gain over the amounts
remaining in the plant account, such gain will be credited to
customers through the CTC.
<PAGE>
Note D - Divestiture of Generating Business
On September 1, 1998, NEES subsidiaries NEP and Narragansett
Electric (collectively, the Sellers) completed the sale of
substantially all of their nonnuclear generating business to
USGen. The assets sold include three fossil-fueled and 15
hydroelectric generating stations, totaling approximately 4,000
MW of capacity, as well as NEES' 100 percent interest in
Narragansett Energy Resources Company, a 20 percent general
partner in the Ocean State Power project, all of which had a book
value of approximately $1.1 billion. The NEES companies received
$1.59 billion for the sale. The gain on the sale is passed on to
customers as a reduction in CTCs, as described in Note C above.
In addition, the NEES companies were reimbursed approximately
$140 million for costs associated with early retirements and
special severance programs for employees affected by industry
restructuring, and the value of inventories. USGen assumed
responsibility for environmental conditions at the Sellers'
nonnuclear generating stations. USGen also assumed the Sellers'
obligations under long-term fuel and fuel transportation
contracts, and certain collective bargaining agreements.
As part of the sale, NEP also signed a purchased power
transfer agreement through which USGen purchased NEP's
entitlement to approximately 1,100 MW of power procured under
long-term contracts in exchange for monthly fixed payments by NEP
averaging $9.5 million per month through January 2008 (having a
net present value of $833 million) toward the above-market cost
of those contracts. In some cases, these transfers involved
formal assignment of the contracts to USGen and a release of NEP
from further obligations to the power supplier, while others did
not. For those that involved formal assignment, NEP was required
to make a lump sum payment equivalent to the present value of the
monthly fixed payment obligations of those contracts. On or prior
to the closing date, NEP made lump sum payments totaling
approximately $340 million and was released from further
obligations relating to two of the contracts. These lump sum
payments are separate from the $833 million figure referred to
above. USGen is responsible for the balance of the costs under
the purchased power contracts. The present value of the future
monthly fixed payments is recorded as a liability on the balance
sheet. This liability, as well as the lump sum payments
previously made, net of amortization, are also recorded as a
regulatory asset on the balance sheet.
As part of the divestiture plan, in February 1998, NEEI sold
its oil and gas properties for approximately $50 million. NEEI's
loss on the sale of approximately $120 million, before tax, has
been reimbursed by NEP.
In addition, NEP agreed under the Settlement Agreements to
endeavor to sell its minority interest in three nuclear power
plants and a 60 MW interest in a fossil-fueled generating station
in Maine.
<PAGE>
Note E - Commitments and Contingencies
1. Plant expenditures
The NEES subsidiaries' cash expenditures for utility plant and
investments by NEES' unregulated subsidiaries are estimated to be
$280 million in 1999. At December 31, 1998, substantial
commitments had been made relative to future planned
expenditures.
2. Long-term contracts for the purchase of electricity
Historically, NEP purchased a portion of its electricity
requirements pursuant to long-term contracts with owners of
various generating units. These contracts expire in various years
from 1998 to 2029. See Note D for a discussion of USGen's
purchase of NEP's entitlement to approximately 1,100 MW of power
procured under long-term contracts.
NEP retained one purchased power contract, with Vermont
Yankee, which requires minimum fixed payments, even when the
supplier is unable to deliver power, to cover a proportionate
share of the capital and fixed operating costs of the unit. This
contract has fixed payment requirements of approximately $35
million in 1999, $30 million in 2000, $35 million in 2001 and
2002, $30 million in 2003, and approximately $300 million
thereafter. NEP holds an ownership interest in Vermont Yankee.
3. Hazardous waste
The Federal Comprehensive Environmental Response, Compensation
and Liability Act, more commonly known as the "Superfund" law,
imposes strict, joint and several liability, regardless of fault,
for remediation of property contaminated with hazardous
substances. A number of states, including Massachusetts, have
enacted similar laws.
The electric utility industry typically utilizes and/or
generates in its operations a range of potentially hazardous
products and by-products. NEES subsidiaries currently have in
place an internal environmental audit program and an external
waste disposal vendor audit and qualification program intended to
enhance compliance with existing federal, state, and local
requirements regarding the handling of potentially hazardous
products and by-products.
NEES and/or its subsidiaries have been named as potentially
responsible parties (PRPs) by either the United States
Environmental Protection Agency or the Massachusetts Department
of Environmental Protection for 20 sites at which hazardous waste
is alleged to have been disposed. Private parties have also
contacted or initiated legal proceedings against NEES and certain
subsidiaries regarding hazardous waste cleanup. The most
prevalent types of hazardous waste sites with which NEES and its
subsidiaries have been associated are manufactured gas locations.
(Until the early 1970s, NEES was a combined electric and gas
holding company system.) NEES is aware of approximately 40 such
manufactured gas locations, including 10 for which the NEES
companies have been identified by either federal or state
regulatory agencies as PRPs, mostly located in Massachusetts.
<PAGE>
NEES has reported the existence of all manufactured gas locations
of which it is aware to state environmental regulatory agencies.
NEES is engaged in various phases of investigation and
remediation work at approximately 20 of the manufactured gas
locations. NEES and its subsidiaries are currently aware of other
possible hazardous waste sites, and may in the future become
aware of additional sites, that they may be held responsible for
remediating.
In 1993, the Massachusetts Department of Public Utilities
approved a settlement agreement that provides for the rate
recovery of remediation costs of former manufactured gas sites
and certain other hazardous waste sites located in Massachusetts.
Under that agreement, qualified costs related to these sites are
paid out of a special fund established on Massachusetts
Electric's books. Rate-recoverable contributions of $3 million,
adjusted since 1993 for inflation, are added annually to the fund
along with interest, lease payments, and any recoveries from
insurance carriers and other third parties. At December 31, 1998,
the fund had a balance of $47 million.
Predicting the potential costs to investigate and remediate
hazardous waste sites continues to be difficult. There are also
significant uncertainties as to the portion, if any, of the
investigation and remediation costs of any particular hazardous
waste site that may ultimately be borne by NEES or its
subsidiaries. The NEES companies have recovered amounts from
certain insurers, and, where appropriate, intend to seek recovery
from other insurers and from other PRPs, but it is uncertain
whether, and to what extent, such efforts will be successful. At
December 31, 1998, NEES had total reserves for environmental
response costs of $53 million, which includes reserves
established in connection with the Massachusetts Electric
hazardous waste fund referred to above. NEES believes that
hazardous waste liabilities for all sites of which it is aware,
and which are not covered by a rate agreement, are not material
to its financial position.
4. Nuclear units
Nuclear Units Permanently Shut Down
Three regional nuclear generating companies in which NEP has a
minority interest own nuclear generating units that have been
permanently shut down. These three units are as follows:
<TABLE>
<CAPTION>
Future
Estimated
NEP's Billings
Investment Date to NEP
Unit % $ (millions) Retired $ (millions)
- -----------------------------------------------------------------
<S> <C> <C> <C> <C>
Yankee Atomic 30 6 Feb 1992 24
Connecticut Yankee 15 16 Dec 1996 75
Maine Yankee 20 16 Aug 1997 143
</TABLE>
<PAGE>
In the case of each of these units, NEP has recorded a
liability and an offsetting regulatory asset reflecting the
estimated future billings from the companies. In a 1993 decision,
the FERC allowed Yankee Atomic to recover its undepreciated
investment in the plant as well as unfunded nuclear
decommissioning costs and other costs. Connecticut Yankee and
Maine Yankee have both filed similar requests with the FERC.
Several parties have intervened in opposition to both filings. In
August 1998, a FERC Administrative Law Judge (ALJ) issued an
initial decision which would allow for full recovery of
Connecticut Yankee's unrecovered investment, but precluded a
return on that investment. Connecticut Yankee, NEP, and other
parties have filed with the FERC exceptions to the ALJ's
decision. Should the FERC uphold the ALJ's initial decision in
its current form, NEP's share of the loss of the return component
would total approximately $12 million to $15 million before
taxes. In January 1999, parties in the Maine Yankee proceeding
filed a comprehensive settlement agreement with the FERC, under
which Maine Yankee would recover all unamortized investment in
the plant, including a return on its equity investment of 6.5
percent, as well as decommissioning costs and other costs. This
settlement agreement requires FERC approval. NEP's industry
restructuring settlements allow it to recover all costs that the
FERC allows these Yankee companies to bill to NEP.
NEP and several other shareholders (Sponsors) of Maine Yankee
are parties to 27 contracts (Secondary Purchase Agreements) under
which they sold portions of their entitlements to Maine Yankee
power output through 2002 to various entities, primarily
municipal and cooperative systems in New England (Secondary
Purchasers). Virtually all of the Secondary Purchasers had ceased
making payments under the Secondary Purchase Agreements, claiming
that such agreements excuse further payments upon plant shutdown.
In February 1999, a settlement agreement which fully resolves the
dispute between the Sponsors and Secondary Purchasers was filed
with the FERC, under which the Secondary Purchasers would be
required to make certain payments to Maine Yankee, and, in turn,
to NEP, related to both past and future obligations under the
Secondary Purchase Agreements. This settlement agreement requires
FERC approval. Shutdown costs are recoverable from customers
under the Settlement Agreements.
A Maine statute provides that if both Maine Yankee and its
decommissioning trust fund have insufficient assets to pay for
the plant decommissioning, the owners of Maine Yankee are jointly
and severally liable for the shortfall.
Operating Nuclear Units
NEP has minority interests in three other nuclear generating
units: Vermont Yankee, Millstone 3, and Seabrook 1. Uncertainties
regarding the future of nuclear generating stations, particularly
older units, such as Vermont Yankee, are increasing rapidly and
could adversely affect their service lives, availability, and
<PAGE>
costs. These uncertainties stem from a combination of factors,
including the acceleration of competitive pressures in the power
generation industry and increased NRC scrutiny. NEP performs
periodic economic viability reviews of operating nuclear units in
which it holds ownership interests.
Millstone 3
In July 1998, Millstone 3 returned to full operation after
being shut down since April 1996. Millstone 3 remains on the NRC
"Watch List," signifying that it continues to warrant increased
NRC attention. Millstone 3 is operated by a subsidiary of
Northeast Utilities (NU). NEP is not an owner of the Millstone 2
nuclear generating unit, which is temporarily shut down under NRC
orders, or the Millstone 1 nuclear generating unit, which has
been permanently shut down. A criminal investigation related to
Millstone 3 is ongoing.
In August 1997, NEP sued NU in Massachusetts Superior Court
for damages resulting from the tortious conduct of NU that caused
the shutdown of Millstone 3. NEP's damages include the costs of
replacement power during the outage, costs necessary to return
Millstone 3 to safe operation, and other additional costs. Most
of NEP's incremental replacement power costs have been recovered
from customers, either through fuel adjustment clauses or through
provisions in the Settlement Agreements. NEP also seeks punitive
damages. NEP also sent a demand for arbitration to Connecticut
Light & Power Company and Western Massachusetts Electric Company,
both subsidiaries of NU, seeking damages resulting from their
breach of obligations under an agreement with NEP and others
regarding the operation and ownership of Millstone 3. The
arbitration is scheduled for October 1999. In July 1998, the
court denied NU's motion to dismiss and its motion to stay
pending arbitration. NEP subsequently amended its complaint by,
among other things, adding NU's Trustees as defendants. In
December 1998, NU moved for summary judgement. NEP's suit has
been consolidated with suits filed by other joint owners. The
court is in the process of scheduling a trial date. Some or all
of the damages awarded from the lawsuit would be refunded to
customers.
Nuclear Decommissioning
NEP is liable for its share of decommissioning costs for
Millstone 3, Seabrook 1, and all of the Yankees. Decommissioning
costs include not only estimated costs to decontaminate the units
as required by the NRC, but also costs to dismantle the
uncontaminated portion of the units. NEP records decommissioning
costs on its books consistent with its rate recovery. NEP is
recovering its share of projected decommissioning costs for
Millstone 3 and Seabrook 1 through depreciation expense. In
addition, NEP is paying its portion of projected decommissioning
costs for all of the Yankees through purchased power expense.
Such costs reflect estimates of total decommissioning costs
approved by the FERC.
<PAGE>
In New Hampshire, legislation was recently enacted which makes
owners of Seabrook 1, in which NEP owns a 10 percent interest,
proportional guarantors for decommissioning costs in the event
that an owner without a franchise service territory fails to fund
its share of decommissioning costs. Currently, a single owner of
an approximate 12 percent share of Seabrook 1 has no franchise
service territory.
The New Hampshire Nuclear Decommissioning Finance Committee is
reviewing Seabrook Station's decommissioning estimate and
associated annual funding levels. Among the items being
considered is the imposition of joint and several liability among
the Seabrook joint owners for decommissioning funding. NEP cannot
predict what additional liability, if any, may be imposed on it.
The Nuclear Waste Policy Act of 1982 establishes that the
federal government (through the Department of Energy (DOE)) is
responsible for the disposal of spent nuclear fuel. The federal
government requires NEP to pay a fee based on its share of the
net generation from the Millstone 3 and Seabrook 1 nuclear
generating units. Prior to 1998, NEP recovered this fee through
its fuel clause. Under the Settlement Agreements, substantially
all of these costs are recovered through CTCs. Similar costs are
billed to NEP by Vermont Yankee and also recovered from customers
through the same mechanism. In November 1997, ruling on a lawsuit
brought against the DOE by numerous utilities and state
regulatory commissions, the U.S. Court of Appeals for the
District of Columbia (the Appeals Court) held that the DOE was
obligated to begin disposing of utilities' spent nuclear fuel by
January 31, 1998. The DOE failed to meet this deadline, and is
not expected to have a temporary or permanent repository for
spent nuclear fuel for many years. In February 1998, Maine Yankee
petitioned the Appeals Court to compel the DOE to remove Maine
Yankee's spent fuel from the site. In May 1998, the Appeals Court
rejected the petitions of Maine Yankee and the other utilities
and state regulatory commissions, stating that the issue of
damages was a contractual matter. The operators of the units in
which NEP has an obligation, including Maine Yankee, Connecticut
Yankee, and Yankee Atomic, continue to pursue damage claims
against the DOE in the Federal Court of Claims (Claims Court). In
October 1998, the Claims Court ruled that the DOE violated a
commitment to remove spent fuel from Yankee Atomic. The Claims
Court issued similar rulings in November 1998 related to cases
brought by Connecticut Yankee and Maine Yankee. Further
proceedings will be scheduled by the Claims Court to decide the
amount of damages.
<PAGE>
Decommissioning Trust Funds
Each nuclear unit in which NEP has an ownership interest has
established a decommissioning trust fund or escrow fund into
which payments are being made to meet the projected costs of
decommissioning. The table below lists information on each
operating nuclear plant in which NEP has an ownership interest.
<TABLE>
<CAPTION>
NEP's share of (millions of dollars)
-------------------------------------------
Nep's Estimated Decommissioning
Ownership Net Decommissioning Fund License
Unit Interest (%) Plant Assets Cost (in 1998 $) Balances* Expiration
- ---- -------------------------------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Vermont Yankee 20 34 105 38 2012
Millstone 3 12 9** 67 21 2025
Seabrook 1 10 15** 50 10 2026
<FN>
* Certain additional amounts are anticipated to be available through tax deductions.
** Represents post-December 1995 spending. See Note C for a discussion of an impairment
writedown and establishment of an offsetting regulatory asset.
</FN>
</TABLE>
There is no assurance that decommissioning costs actually
incurred by Vermont Yankee, Millstone 3, or Seabrook 1 will not
substantially exceed these amounts. For example, decommissioning
cost estimates assume the availability of permanent repositories
for both low-level and high-level nuclear waste; those
repositories do not currently exist. The temporary low-level
repository located in Barnwell, South Carolina may become
unavailable, which could increase the cost of decommissioning the
Yankee Atomic, Connecticut Yankee, and Maine Yankee plants. If
any of the operating units were shut down prior to the end of
their operating licenses, which NEP believes is likely, the funds
collected for decommissioning to that point would be
insufficient. Under the Settlement Agreements discussed in Note
C, NEP will recover decommissioning costs through CTCs.
Nuclear Insurance
The Price-Anderson Act limits the amount of liability claims
that would have to be paid in the event of a single incident at a
nuclear plant to $9.7 billion (based upon 108 licensed reactors).
The maximum amount of commercially available insurance coverage
to pay such claims is $200 million. The remaining $9.5 billion
would be provided by an assessment of up to $88.1 million per
incident levied on each of the participating nuclear units in the
United States, subject to a maximum assessment of $10 million per
incident per nuclear unit in any year. The maximum assessment,
which was most recently adjusted in 1998, is adjusted for
inflation at least every five years. NEP's current interest in
Vermont Yankee, Millstone 3, and Seabrook 1 would subject NEP to
a $35.4 million maximum assessment per incident. NEP's payment of
<PAGE>
any such assessment would be limited to a maximum of $4.0 million
per year. As a result of the permanent cessation of power
operation of the Yankee Atomic, Connecticut Yankee, and Maine
Yankee plants, these units have received from the NRC an
exemption from participating in the secondary financial
protection system under the Price-Anderson Act. However, these
plants must continue to maintain $100 million of commercially
available nuclear liability insurance coverage.
Each of the nuclear units in which NEP has either an ownership
or purchased power interest also carries nuclear property
insurance to cover the costs of property damage, decontamination,
and premature decommissioning resulting from a nuclear incident.
These policies may require additional premium assessments if
losses relating to nuclear incidents at units covered by this
insurance occur in a prior six-year period. NEP's maximum
potential exposure for these assessments, either directly or
indirectly, is approximately $4.6 million with respect to the
current policy period.
5. Town of Norwood dispute
In September 1998, the United States District Court (District
Court) for the District of Massachusetts dismissed the lawsuit
filed in April 1997 by the Town of Norwood, Massachusetts against
NEES and NEP. NEP had been a wholesale power supplier for Norwood
pursuant to rates approved by the FERC. In the lawsuit, Norwood
had alleged that NEP's divestiture of its power generating assets
would violate the terms of a 1983 power contract. Norwood also
alleged that the divestiture and recovery of stranded investment
costs contravened federal antitrust laws. The District Court
judge granted NEES' and NEP's motion for dismissal on the grounds
that the contract did not require NEP to retain its generating
units, that the FERC-approved filed rates govern these matters,
and that Norwood had adequate opportunity at the FERC to litigate
these matters. Norwood filed a motion to alter or amend the order
of dismissal, which was denied. In December 1998, Norwood filed a
second motion to amend judgement and also filed an appeal with
the First Circuit Court of Appeals (First Circuit).
In March 1998, Norwood gave notice of its intent to terminate
its contract with NEP, without accepting responsibility for its
share of NEP's stranded costs, and began taking power from
another supplier commencing in April 1998. In May 1998, the FERC
ruled that NEP could assess a CTC to any of NEP's unaffiliated
customers that choose to terminate their wholesale power
contracts early. Norwood claimed that the CTC approved by the
FERC did not apply to Norwood; however, in denying Norwood's
motion for rehearing, the FERC ruled that the charge did apply to
Norwood. Norwood has appealed this decision to the First Circuit.
NEP's billings to Norwood for this charge through December 1998
have been approximately $6 million, which remain unpaid. NEP
filed a collection action with the Massachusetts Superior Court
in December 1998 to recover these amounts. Norwood filed a motion
to dismiss or stay in January 1999.
<PAGE>
Norwood also appealed the FERC's orders approving the
divestiture and the Massachusetts and Rhode Island industry
restructuring settlement agreements (including modification of
NEP's contracts with Massachusetts Electric and Narragansett
Electric) to the First Circuit, despite the FERC's finding that
those settlement agreements do not apply to Norwood.
The First Circuit has consolidated all three of Norwood's
appeals from the FERC's orders with two other appeals filed by
the Northeast Center for Social Issue Studies, which challenge
the FERC's approval of NEP's sale of its hydroelectric
facilities. The case is to be fully briefed by May 1999.
Note F - Employee Benefits
Pension Plans
The NEES companies' retirement plans are noncontributory
defined-benefit plans covering substantially all employees. The
plans provide pension benefits based on the employee's
compensation during the five years prior to retirement. Absent
unusual circumstances, the NEES companies' funding policy is to
contribute each year the net periodic pension cost for that year.
However, the contribution for any year will not be less than the
minimum contribution required by federal law or greater than the
maximum tax deductible amount.
The plans' funded status at December 31, 1998 and 1997 were
calculated using the assumed rates from 1999 and 1998,
respectively, and the 1983 Group Annuity Mortality table.
Plan assets are composed primarily of corporate equity, debt
securities, and cash equivalents.
In addition to its regular pension funds shown in the table
below, NEES and its subsidiaries have a separate trust fund,
commonly referred to as a Rabbi Trust, for certain supplemental
pensions and deferred compensation for key executives and
employees. The Rabbi Trust is currently invested in municipal
bonds, equities, and NEES common shares. At December 31, 1998 and
1997, the Rabbi Trust held 184,233 and 148,875 NEES common
shares, respectively, which are accounted for as treasury stock.
At the end of 1998 and 1997, the difference between cost and the
market value of investments, other than NEES shares, in the Rabbi
Trust was approximately $10.1 million, after tax, and $4.8
million, after tax, respectively. These amounts represent
unrealized gains in Rabbi Trust investments. The market value of
such external investments was $64 million and $53 million at
December 31, 1998 and 1997, respectively.
Postretirement Benefit Plans Other than Pensions (PBOPs)
The NEES subsidiaries provide health care and life insurance
coverage to eligible retired employees. Eligibility is based on
certain age and length of service requirements and in some cases
retirees must contribute to the cost of their coverage.
<PAGE>
The plans' funded status at December 31, 1998 and 1997 were
calculated using the assumed rates in effect for 1999 and 1998,
respectively.
The assumptions used in the health care cost trends have a
significant effect on the amounts reported. A one percentage
point change in the assumed rates would increase the accumulated
postretirement benefit obligation (APBO) as of December 31, 1998
by approximately $43 million or decrease APBO by approximately
$39 million, and change the net periodic cost for 1998 by
approximately $4 million.
The NEES subsidiaries fund the annual tax-deductible
contributions. Plan assets are invested in equity and debt
securities and cash equivalents.
Net pension cost and total cost of PBOPs for 1998, 1997, and
1996 included the following components:
<TABLE>
<CAPTION> Postretirement Benefits
Pensions Other than Pensions
- -----------------------------------------------------------------------------------------
Year ended December 31 1998 1997 1996 1998 1997 1996
(thousands of dollars)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Service cost - benefits
earned during the period $ 14,903$ 15,019 $ 14,918 $ 6,397 $ 6,527 $ 6,794
Plus (less):
Interest cost on
projected benefit
obligation 55,210 52,497 51,461 23,611 24,249 24,667
Return on plan assets at
expected long-term rate (60,235)(55,606) (52,085) (18,916) (16,397)(12,958)
Amortization of transition
obligation (788) (766) (766) 16,897 18,397 18,397
Amortization of prior
service cost 1,109 1,629 1,624 57 61 61
Amortization of net
(gain)/loss 1,889 717 2,029 (7,843) (7,348) (5,359)
Curtailment (gain)/loss (9,300) - - 56,124 - -
- -----------------------------------------------------------------------------------------
Benefit cost $ 2,788$ 13,490 $ 17,181 $ 76,327 $ 25,489$ 31,602
- -----------------------------------------------------------------------------------------
Special termination
benefits not included above$ 63,980$ - $ - $ 4,335 $ -$ -
- -----------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The following table sets forth benefits earned and the plans' funded
status:
<TABLE>
<CAPTION>
Postretirement Benefits
Pension Other than Pensions
- -----------------------------------------------------------------------------
At December 31 1998 1997 1998 1997
(millions of dollars)
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Benefit obligation $843 $819 $365 $348
Unrecognized prior service costs (6) (8) (1) (1)
Transition liability not yet
recognized (amortized) (2) (4) (194) (276)
Additional minimum liability 7 4 - -
- -----------------------------------------------------------------------------
842 811 170 71
- -----------------------------------------------------------------------------
Plan assets at fair value 837 834 258 239
Transition asset not yet
recognized (amortized) (6) (8) - -
Net (gain) not yet
recognized (amortized) (92) (52) (151) (153)
- -----------------------------------------------------------------------------
739 774 107 86
- -----------------------------------------------------------------------------
Accrued pension/(prepaid) payments
recorded on books $103 $ 37 $ 63 $(15)
- -----------------------------------------------------------------------------
</TABLE>
The following provides a reconciliation of benefit obligations and plan
assets:
<TABLE>
<CAPTION> Pension Postretirement Benefits
Benefits Other than Pensions
--------------------------------------
(millions of dollars) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Changes in benefit obligation
Benefit obligation at January 1 $819 $807 $348 $369
Service cost 14 15 6 7
Interest cost 55 53 24 24
Actuarial (gain)/loss (5) 59 8 (38)
Benefits paid from plan assets (94) (47) (16) (14)
Special termination benefits 64 - 4 -
Curtailment (11) - (9) -
Plan Amendments 1 - - -
Dispositions (Yankee Atomic) - (68) - -
---- ---- ---- ----
Benefit obligation at December 31 $843 $819 $365 $348
---- ---- ---- ----
Reconciliation of change
in plan assets
Fair value of plan assets at January 1 $834 $812 $239 $202
Actual return on plan assets during year 93 130 33 38
Company contributions 4 8 2 13
Benefits paid from plan assets (94) (47) (16) (14)
Dispositions (Yankee Atomic) - (69) - -
---- ---- ---- ----
Fair value of plan assets at
December 31 $837 $834 $258 $239
---- ---- ---- ----
</TABLE>
Pension plans with benefit obligations in excess of the fair
value of plan assets had aggregate benefit obligations of $66
million and $62 million and plan assets with a fair value of $0
and $0 at December 31, 1998 and 1997, respectively. All PBOP
plans for 1998 and 1997 had aggregate benefit obligations in
excess of the fair value of plan assets, the amounts of which are
disclosed in the table above.
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31 1999 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Assumptions used to determine
pension cost:
Discount rate 6.75% 6.75% 7.25% 7.25%
Average rate of increase in future
compensation levels 4.13% 4.13% 4.13% 4.13%
Expected long-term rate of return
on assets 8.50% 8.50% 8.50% 8.50%
Assumptions used to determine
postretirement benefit cost:
Discount rate 6.75% 6.75% 7.25% 7.25%
Expected long-term rate of
return on assets 8.25% 8.25% 8.25% 8.25%
Health care cost rate - 1996 to 1999 5.25% 5.25% 8.00% 8.00%
Health care cost rate - 2000 to 2004 5.25% 5.25% 6.25% 6.25%
Health care cost rate - 2005 and beyond 5.25% 5.25% 5.25% 5.25%
</TABLE>
Early retirement and special severance programs
In 1998, NEES subsidiary companies offered a voluntary early
retirement program to all employees who were at least 55 years
old with 10 years of service. This program was part of an
organizational review with the goal of streamlining operations
and reducing the work force to reflect the sale of the nonnuclear
generating business. The early retirement offer was accepted by
758 employees. A special severance program was also utilized in
1998 for employees affected by the organizational restructuring,
but who were not eligible for, or did not accept, the early
retirement offer. The cost of these programs was in part
reimbursed by USGen at the closing of the sale of the nonnuclear
generating business and will be recovered in part from customers
as a component of stranded cost recovery.
Stock-based compensation
At December 31, 1998, NEES has three stock-based compensation
plans and measures its compensation cost for those plans using
the method of accounting prescribed by Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations. The compensation cost charged
against income for these plans was $6.1 million, $3.3 million,
and $3.7 million for 1998, 1997, and 1996, respectively. If
compensation cost for stock-based compensation had been accounted
for under Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, the cost figures shown
above would have been decreased, before taxes, by approximately
$1 million and $300,000 in 1998 and 1997, respectively, and had
no impact on earnings in 1996. These changes would have increased
earnings per average diluted common share by $.01 in 1998, and
had no impact on earnings per share in 1997 and 1996.
<PAGE>
Note G - Income Taxes
Total income taxes in the statements of consolidated income
are as follows:
<TABLE>
<CAPTION>
Year ended December 31
(thousands of dollars) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income taxes charged to operations $122,354 $152,024 $139,199
Income taxes charged to "Other income" (18,936) (7,268) (3,018)
-------- -------- --------
Total income taxes $103,418 $144,756 $136,181
-------- -------- --------
</TABLE>
Total income taxes, as shown above, consist of the following components:
<TABLE>
<CAPTION>
Year ended December 31
(thousands of dollars) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Current income taxes $376,866 $175,934 $166,509
Deferred income taxes (248,722) (29,260) (28,652)
Investment tax credits, net (24,726) (1,918) (1,676)
-------- -------- --------
Total income taxes $103,418 $144,756 $136,181
-------- -------- --------
</TABLE>
Total income taxes, as shown above, consist of federal and state components
as follows:
<TABLE>
<CAPTION>
Year ended December 31
(thousands of dollars) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Federal income taxes $ 81,963 $118,317 $111,573
State income taxes 21,455 26,439 24,608
-------- -------- --------
Total income taxes $103,418 $144,756 $136,181
-------- -------- --------
</TABLE>
Investment tax credits (ITC) of subsidiaries are deferred and
amortized over the estimated lives of the property giving rise to
the credits. Although ITC were generally eliminated by the 1986
tax legislation, additional carryforward amounts continue to be
recognized. The increase in amortization of ITC in 1998 results
from the recognition in income of unamortized ITC relating to the
generating assets divested during 1998.
With regulatory approval, the subsidiaries have adopted
comprehensive interperiod tax allocation (normalization) for
temporary book/tax differences.
<PAGE>
Total income taxes differ from the amounts computed by
applying the federal statutory tax rates to income before taxes.
The reasons for the differences are as follows:
<TABLE>
<CAPTION>
Year ended December 31 (thousands of dollars) 1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Computed tax at statutory rate $103,920 $131,989 $123,053
Increases (reductions) in tax resulting from:
Amortization of ITC, net (18,682) (4,469) (4,347)
State income tax, net of federal income
tax benefit 13,946 17,185 15,995
All other differences 4,234 51 1,480
-------- -------- --------
Total income taxes $103,418 $144,756 $136,181
-------- -------- --------
</TABLE>
The following table identifies the major components of total deferred income
taxes:
<TABLE>
<CAPTION>
At December 31 (millions of dollars) 1998 1997
------ ------
<S> <C> <C>
Deferred tax asset:
Plant related $ 88 $ 99
ITC 28 39
All other 118 152
------ ------
234 290
------ ------
Deferred tax liability:
Plant related (384) (821)
Equity AFDC (38) (51)
All other (284) (138)
------ ------
(706) (1,010)
------ ------
Net deferred tax liability $ (472) $ (720)
------ ------
</TABLE>
There were no valuation allowances for deferred tax assets
deemed necessary.
Federal income tax returns for NEES and its subsidiaries have
been examined and reported on by the Internal Revenue Service
through 1993.
Note H - Short-Term Borrowings and Other Current Liabilities
At December 31, 1998, NEES and its consolidated subsidiaries
had lines of credit and standby bond purchase facilities with
banks totaling approximately $900 million. These lines and
facilities were used at December 31, 1998 for liquidity support
for $372 million of NEP bonds in tax-exempt commercial paper mode
(see Note I). Fees are paid on the lines and facilities in lieu
of compensating balances.
<PAGE>
The components of other current liabilities are as follows:
<TABLE>
<CAPTION>
At December 31 (thousands of dollars) 1998 1997
-------- --------
<S> <C> <C>
Accrued wages and benefits $ 23,875 $ 58,281
Rate adjustment mechanisms 79,952 27,152
Customer deposits 10,999 11,059
Other 28,149 23,510
-------- --------
$142,975 $120,002
-------- --------
</TABLE>
Note I - Long-Term Debt
Substantially all of the properties of Massachusetts Electric
and Narragansett Electric are subject to the lien of mortgage
indentures under which mortgage bonds have been issued.
The aggregate payments to retire maturing long-term debt are as
follows:
<TABLE>
<CAPTION>
(thousands of dollars) 1999 2000 2001 2002 2003
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Maturing long-term debt $24,480 $37,485 $ 6,495 $41,500 $54,010
Mandatory prepayments 11,827 11,825 11,095 10,593 10,510
------- ------- ------- ------- -------
Total $36,307 $49,310 $17,590 $52,093 $64,520
------- ------- ------- ------- -------
</TABLE>
At December 31, 1998, interest rates on NEP's variable rate
bonds ranged from 3.05 percent to 3.45 percent.
At December 31, 1998, the NEES subsidiaries' long-term debt
had a carrying value of approximately $1,095,000,000 and a fair
value of approximately $1,177,000,000. The fair value of debt
that reprices frequently at market rates approximates carrying
value. The fair market value of the NEES subsidiaries' long-term
debt was estimated based on the quoted prices for similar issues
or on the current rates offered to the NEES companies for debt of
the same remaining maturity.
<PAGE>
In order to satisfy certain terms of its mortgage indenture,
NEP defeased or retired all $641 million of its mortgage bonds
outstanding at the time of the sale of its nonnuclear generating
business. NEP retired $372 million of mortgage bonds securing the
issuance of a like amount of pollution control revenue bonds
(PCRBs), leaving the underlying PCRBs outstanding as unsecured
obligations of NEP. Pursuant to a tender offer, NEP purchased
$183 million of bonds. Provisions for the payment of the
remaining mortgage bonds were made by depositing with trustees
approximately $97 million of U.S. treasury obligations sufficient
to pay principal, interest, and premium, as applicable, to the
maturity date, or to the first date on which the bonds could be
redeemed. Both the U.S. treasury obligations and defeased bonds
were removed from the balance sheet effective September 30, 1998.
Note J - Supplementary Quarterly Financial Information
(unaudited)
<TABLE>
<CAPTION>
1998 Quarter ended Mar 31 June 30 Sept 30 Dec 31
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(thousands of dollars,
except per share amounts)
Operating revenue $619,563 $572,008 $630,558 $598,404
Operating income $ 87,146 $ 67,150 $ 92,264 $ 62,279
Net income $ 56,878 $ 34,409 $ 66,193 $ 32,562
Net income per average common
share, basic $ .88 $ .55 $ 1.06 $ .56
Net income per average common
share, diluted $ .88 $ .54 $ 1.07 $ .55
-------- -------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
1997 Quarter ended Mar 31 June 30 Sept 30 Dec 31
-------- -------- -------- -------
<S> <C> <C> <C> <C>
(thousands of dollars,
except per share amounts)
Operating revenue $638,146 $577,625 $628,606 $658,214
Operating income $ 94,962 $ 66,583 $104,524 $100,792
Net income $ 61,820 $ 32,232 $ 67,746 $ 58,240
Net income per average common
share, basic and diluted $ .95 $ .50 $ 1.04 $ .90
-------- -------- -------- -------
</TABLE>
<PAGE>
Report of Management
The management of New England Electric System is responsible
for the integrity of the consolidated financial statements
included in this Annual Report. The financial statements were
prepared in accordance with generally accepted accounting
principles using management's informed best estimates and
judgments where appropriate to fairly present the financial
condition of the NEES companies and their results of operations.
The information included elsewhere in this report is consistent
with the financial statements.
The NEES companies maintain an accounting system and system of
internal controls which are designed to provide reasonable
assurance as to the reliability of the financial records, the
protection of assets, and the prevention of any material
misstatement of the financial statements. The NEES companies'
accounting controls have been designed to provide reasonable
assurance that errors or irregularities, which could be material
to the financial statements, are prevented or detected by
employees within a timely period as they perform their assigned
functions. The NEES companies' internal auditing staff
independently assesses the effectiveness of internal controls and
recommends improvements where appropriate.
PricewaterhouseCoopers LLP, the NEES companies' independent
accountants, are engaged to audit and express their opinion on
the financial statements. Their audit includes a review of
internal controls to the extent required by generally accepted
auditing standards.
The Audit Committee, composed solely of outside directors,
meets periodically with management, the internal auditor, and the
independent accountants to ensure that each is carrying out its
responsibilities and to discuss auditing, internal accounting
control, and financial reporting matters. Both the internal
auditor and the independent accountants have free access to the
Audit Committee, without management present, to discuss the
results of their audit work.
s/Richard P. Sergel s/Michael E. Jesanis
Richard P. Sergel Michael E. Jesanis
President and Senior Vice President
Chief Executive Officer and Chief Financial Officer
<PAGE>
Report of Independent Accountants
To the Board of Directors and Shareholders of New England
Electric System:
In our opinion, the accompanying consolidated balance sheets
and consolidated statements of capitalization and the related
consolidated statements of income and comprehensive income, of
retained earnings, and of cash flows present fairly, in all
material respects, the financial position of New England Electric
System and its subsidiaries (the "Company") at December 31, 1998
and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998
in conformity with generally accepted accounting principles.
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 of these statements in accordance with generally
accepted auditing standards which 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,
assessing the accounting principles used and significant
estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for the opinion expressed above.
s/PricewaterhouseCoopers LLP
February 23, 1999
<PAGE>
Shareholder Information
For information or assistance with your share account, write or
call Shareholder Services at:
Bank of New York
Shareholder Relations Dept - 11E
P.O. Box 11258
Church Street Station
New York, NY 10286
Toll-free number: 1-800-466-7215
Fax: 212-815-4023
E-mail: [email protected]
If you have questions about the merger with National Grid or the
proxy process, write or call:
Innisfree M&A Incorporated
501 Madison Avenue, 20th floor
New York, NY 10022
Toll-free number: 1-877-750-5836
Dividend reinvestment
Shareholders of New England Electric System common shares who
hold their shares in registered form are eligible to participate
in the Dividend Reinvestment and Common Share Purchase Plan. The
Plan provides participants the opportunity to reinvest their
dividends and send in optional cash payments to purchase
additional common shares. These shares will be newly issued
shares or shares purchased in the open market. The Company will
pay all brokerage commissions and service charges associated with
the Plan. For more information on the Plan, please contact Bank
of New York at the toll-free number 1-800-466-7215.
Direct deposit of dividends
Shareholders who hold New England Electric System common
shares in their own name may request to have their dividends
directly deposited into their checking or savings account. This
service is provided without fees. If you participate in Direct
Deposit, you will receive a credit advice for your records. To
sign up for this service, please call Bank of New York at the
toll-free number to request an authorization form.
Change of address
Please contact Bank of New York at the toll-free number to
notify us of your address change.
Note:
Upon completion of the merger of NEES and National Grid, NEES
shares will no longer be publicly traded. At the appropriate
time, NEES will send you information on how to turn in your
shares for the cash payment.
<PAGE>
Form 10-K
Copies of the Annual Report on Form 10-K to the Securities and
Exchange Commission for 1998 are available upon request at no
charge by contacting:
Merrill IR Edge
33 Boston Post Road, Suite 270
Marlborough, MA 01752
Telephone: 508-786-1907
Fax: 508-786-1915
E-mail: [email protected]
Stock exchange listings
New England Electric System common shares are listed on the
New York Stock Exchange and the Boston Stock Exchange under the
symbol NES.
Transfer agent
Certificates for transfer should be mailed to our transfer
agent at:
Bank of New York
Receive and Deliver Department - 11W
P.O. Box 11002
Church Street Station
New York, NY 10286
<TABLE>
<CAPTION>
New England Electric System common shares
1998 1997
---- ----
Price Range ($) Price Range ($)
-------------- --------------
High Low Dividend High Low Dividend
Declared $ Declared $
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
First Quarter 45.8125 41.0000 .590 35.6250 33.375 .590
Second Quarter 45.5625 40.6250 .590 37.1250 33.250 .590
Third Quarter 43.6250 39.0000 .590 39.6875 36.250 .590
Fourth Quarter 49.1250 40.3125 .590 43.3125 37.250 .590
- ----------------------------------------------------------------------------------------
</TABLE>
The total number of shareholders at December 31, 1998 was 44,291
<PAGE>
NEES Officers
As of January 1, 1999
Alfred D. Houston
Chairman
Richard P. Sergel
President and Chief Executive Officer
Cheryl A. LaFleur
Senior Vice President, General Counsel, and Secretary
Michael E. Jesanis
Senior Vice President and Chief Financial Officer
David C. Kennedy
Vice President
John G. Cochrane
Treasurer (Elected Vice President and Treasurer,
effective March 1, 1999)
Executive Officers of Major Subsidiaries
As of January 1, 1999
Peter G. Flynn
President of New England Power Company
William H. Heil
Chairman and Chief Executive Officer of AllEnergy Marketing
Company, L.L.C.
Robert L. McCabe
Chairman of the electricity distribution subsidiaries
(Massachusetts Electric Company, Nantucket Electric Company, The
Narragansett Electric Company, and Granite State Electric
Company)
Anthony C. Pini
President of NEES Communications, Inc.
Lawrence J. Reilly
President and Chief Executive Officer of the electricity
distribution subsidiaries
[PHOTO OF NEES OFFICERS]
NEES Officers (left to right) Cheryl LaFleur, Al Houston, Rick Sergel, Mike
Jesanis, Dave Kennedy, John Cochrane
<PAGE>
[MAP OF SERVICE AREAS]
NEES Subsidiaries
As of January 1, 1999
Massachusetts Electric Company
55 Bearfoot Road, Northborough, Massachusetts 01532
The Narragansett Electric Company
280 Melrose Street, Providence, Rhode Island 02901
Granite State Electric Company
9 Lowell Road, Salem, New Hampshire 03079
Nantucket Electric Company
25 Research Drive, Westborough, Massachusetts 01582
AllEnergy Marketing Company, L.L.C.
95 Sawyer Road, Waltham, Massachusetts 02154
Granite State Energy, Inc.
4 Park Street, Concord, New Hampshire 03301
NEES Energy, Inc.
25 Research Drive, Westborough, Massachusetts 01582
New England Power Company
25 Research Drive, Westborough, Massachusetts 01582
NEES Communications, Inc.
25 Research Drive, Westborough, Massachusetts 01582
NEES Global, Inc.
25 Research Drive, Westborough, Massachusetts 01582
New England Electric Transmission Corporation
4 Park Street, Concord, New Hampshire 03301
New England Hydro-Transmission Corporation
9 Lowell Road, Salem, New Hampshire 03079
New England Hydro-Transmission Electric Company, Inc.
25 Research Drive, Westborough, Massachusetts 01582
New England Power Service Company
25 Research Drive, Westborough, Massachusetts 01582
New England Water Heater Co., Inc.
40 Washington Street, Wellesley, Massachusetts 02181
<PAGE>
NEES Directors
As of January 1, 1999
Joan T. Bok
Chairman Emeritus, New England Electric System, Westborough,
Massachusetts
- - Corporate Responsibility Committee
- - Executive Committee
William M. Bulger
President, University of Massachusetts, Boston, Massachusetts
- - Audit Committee
Alfred D. Houston
Chairman, New England Electric System, Westborough, Massachusetts
- - Corporate Responsibility Committee
- - Executive Committee
Paul L. Joskow
Professor of Economics and Management, Massachusetts Institute of
Technology, Cambridge, Massachusetts
- - Audit Committee
- - Corporate Governance Committee
- - Executive Committee
John M. Kucharski
Chairman of the Board, EG&G, Inc., Wellesley, Massachusetts
- - Compensation Committee
Edward H. Ladd
Chairman, Standish, Ayer & Wood, Inc., investment counselors,
Boston, Massachusetts
- - Corporate Governance Committee
- - Executive Committee
Joshua A. McClure
Former President, American Custom Kitchens, Inc., Providence,
Rhode Island
- - Corporate Responsibility Committee
George M. Sage
President and Treasurer, Bonanza Bus Lines, Inc., Providence,
Rhode Island
- - Compensation Committee
- - Corporate Governance Committee
- - Executive Committee
Richard P. Sergel
President and Chief Executive Officer, New England Electric
System, Westborough, Massachusetts
- - Corporate Responsibility Committee
- - Executive Committee
Charles E. Soule
Former President and Chief Executive Officer, Paul Revere
Insurance Group, Worcester, Massachusetts
- - Audit Committee
<PAGE>
Anne Wexler
Chairman, The Wexler Group, management consultants, Washington,
D.C.
- - Compensation Committee
- - Corporate Governance Committee
- - Executive Committee
James Q. Wilson
Professor Emeritus of Management, University of California at Los
Angeles
- - Corporate Responsibility Committee
James R. Winoker
Chief Executive Officer, Belvoir Properties, Inc., Providence,
Rhode Island
- - Audit Committee
- - Corporate Responsibility Committee
[THE FOLLOWING TEXT APPEARS TO THE LOWER RIGHT OF NEES DIRECTORS'
PHOTO]
The name "New England Electric System" means the trustee or trustees for the
time being (as trustee or trustees but not personally) under an Agreement and
Declaration of Trust dated January 2, 1926, as amended, which is hereby
referred to, and a copy of which, as amended, has been filed with the
Secretary of the Commonwealth of Massachusetts. Any agreement, obligation, or
liability made, entered into, or incurred by or on behalf of New England
Electric System binds only its trust estate, and no shareholder, director,
trustee, officer, or agent thereof assumes or shall be held to any liability
therefor.
This report is not to be considered as an offer to sell or buy or solicitation
of an offer to sell or buy any security.
[PHOTO OF NEES DIRECTORS STANDING ON STAIRCASE APPEARS AT BOTTOM
LEFT TWO-THIRDS OF INSIDE BACK COVER]
Row closest to railing (top to bottom): George M. Sage, William M. Bulger,
James R. Winoker, Joan T. Bok, Joshua A. McClure, Anne Wexler, Paul L. Joskow.
Interior row (top to bottom): Edward H. Ladd, Alfred D. Houston, John M.
Kucharski, Charles E. Soule, James Q. Wilson, Richard P. Sergel.
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New England Electric System
25 Research Drive
Westborough, Massachusetts 01582
Telephone 508.389.2000
www.nees.com
Design NEES Electronic Publishing Group
