-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Pcomjr2ieN/dN/Jb0sxIib2vOLIipWy8vWIqmC+occqV987QoabNtDh8QUKKn2+c e/dQYMe7+SSwt3I1MoLb/g== 0000071304-98-000032.txt : 19981116 0000071304-98-000032.hdr.sgml : 19981116 ACCESSION NUMBER: 0000071304-98-000032 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMONWEALTH ELECTRIC CO CENTRAL INDEX KEY: 0000071222 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 041659070 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 002-07749 FILM NUMBER: 98748165 BUSINESS ADDRESS: STREET 1: ONE MAIN ST CITY: CAMBRIDGE STATE: MA ZIP: 02142 BUSINESS PHONE: 6172254000 MAIL ADDRESS: STREET 1: P O BOX 9150 CITY: CAMBRIDGE STATE: MA ZIP: 02142-9150 FORMER COMPANY: FORMER CONFORMED NAME: NEW BEDFORD GAS & EDISON LIGHT CO DATE OF NAME CHANGE: 19810331 FORMER COMPANY: FORMER CONFORMED NAME: NEW BEDFORD GAS LIGHT CO DATE OF NAME CHANGE: 19701106 10-Q 1 COMMONWEALTH ELECTRIC COMPANY FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549-1004 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission File Number 2-7749 COMMONWEALTH ELECTRIC COMPANY (Exact name of registrant as specified in its charter) Massachusetts 04-1659070 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Main Street, Cambridge, Massachusetts 02142-9150 (Address of principal executive offices) (Zip Code) (617) 225-4000 (Registrant's telephone number, including area code) (Former name, address and fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days. YES [ X ] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock November 1, 1998 Common Stock, $25 par value 2,043,972 shares The Company meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q as a wholly-owned subsidiary and is therefore filing this Form with the reduced disclosure format. PART I - FINANCIAL INFORMATION Item 1. Financial Statements COMMONWEALTH ELECTRIC COMPANY CONDENSED BALANCE SHEETS SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 ASSETS (Dollars in thousands) September 30, December 31, 1998 1997 (Unaudited) PROPERTY, PLANT AND EQUIPMENT, at original cost $564,152 $550,449 Less - Accumulated depreciation 184,736 174,488 379,416 375,961 Add - Construction work in progress 2,677 4,010 382,093 379,971 INVESTMENTS Equity in nuclear electric power company 478 519 Other 14 14 492 533 CURRENT ASSETS Cash 1,735 1,496 Accounts receivable - Affiliates 2,798 1,753 Customers 42,047 45,199 Unbilled revenues 5,689 9,162 Prepaid property taxes 4,730 3,043 Inventories and other 5,159 4,349 62,158 65,002 DEFERRED CHARGES Regulatory assets 93,189 70,112 Other 4,688 3,601 97,877 73,713 $542,620 $519,219 See accompanying notes. COMMONWEALTH ELECTRIC COMPANY CONDENSED BALANCE SHEETS SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 CAPITALIZATION AND LIABILITIES (Dollars in thousands) September 30, December 31, 1998 1997 (Unaudited) CAPITALIZATION Common Equity - Common stock, $25 par value - Authorized and outstanding - 2,043,972 shares wholly-owned by Commonwealth Energy System (Parent) $ 51,099 $ 51,099 Amounts paid in excess of par value 97,112 97,112 Retained earnings 38,535 31,993 186,746 180,204 Long-term debt, less current sinking fund requirements 146,148 147,192 332,894 327,396 CURRENT LIABILITIES Interim Financing - Notes payable to banks 30,525 14,900 Advances from affiliates 10,065 5,315 40,590 20,215 Other Current Liabilities - Current sinking fund requirements 3,553 3,553 Accounts payable - Affiliates 8,627 12,007 Other 24,202 32,826 Accrued taxes - Local property and other 5,250 3,299 Income 18,005 19,114 Other 24,514 16,528 84,151 87,327 124,741 107,542 DEFERRED CREDITS Accumulated deferred income taxes 51,707 50,283 Unamortized investment tax credits 6,372 6,696 Other 26,906 27,302 84,985 84,281 COMMITMENTS AND CONTINGENCIES $542,620 $519,219 See accompanying notes. COMMONWEALTH ELECTRIC COMPANY CONDENSED STATEMENTS OF INCOME AND RETAINED EARNINGS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Dollars in thousands - unaudited) Three Months Ended Nine Months Ended 1998 1997 1998 1997 ELECTRIC OPERATING REVENUES $118,708 $120,058 $318,766 $348,824 OPERATING EXPENSES Electricity purchased for resale, transmission and fuel 74,652 75,975 203,013 226,303 Other operation and maintenance 22,558 20,028 62,223 71,251 Depreciation 4,506 4,419 13,530 13,257 Taxes - Income 4,069 5,206 8,120 7,309 Local property 1,702 1,480 4,765 4,632 Payroll and other 558 669 1,948 2,310 108,045 107,777 293,599 325,062 OPERATING INCOME 10,663 12,281 25,167 23,762 OTHER INCOME (EXPENSE) 131 7 296 (48) INCOME BEFORE INTEREST CHARGES 10,794 12,288 25,463 23,714 INTEREST CHARGES Long-term debt 3,321 3,405 9,963 10,201 Other interest charges 831 572 2,008 1,476 4,152 3,977 11,971 11,677 NET INCOME 6,642 8,311 13,492 12,037 RETAINED EARNINGS - Beginning of period 31,893 27,687 31,993 27,334 Dividends on common stock - (3,781) (6,950) (7,154) End of period $ 38,535 $ 32,217 $ 38,535 $ 32,217 See accompanying notes. COMMONWEALTH ELECTRIC COMPANY CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Dollars in thousands - unaudited) 1998 1997 OPERATING ACTIVITIES Net income $ 13,492 $ 12,037 Effects of noncash items - Depreciation and amortization 17,866 18,380 Deferred income taxes and investment tax credits, net 101 1,138 Change in working capital, exclusive of cash and interim financing (93) 4,015 Transition costs deferral (25,952) - Fuel charge stabilization deferral 1,465 (6,972) All other operating items (4,480) (6,585) Net cash provided by operating activities 2,399 22,013 INVESTING ACTIVITIES Additions to property, plant and equipment (inclusive of AFUDC) (14,541) (16,154) FINANCING ACTIVITIES Proceeds from short-term borrowings 15,625 1,600 Proceeds from affiliates 4,750 2,800 Payment of dividends (6,950) (7,154) Sinking funds payments (1,044) (1,045) Net cash provided by (used for) financing activities 12,381 (3,799) Net increase in cash 239 2,060 Cash at beginning of period 1,496 358 Cash at end of period $ 1,735 $ 2,418 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest (net of capitalized amounts) $ 12,721 $ 12,702 Income taxes $ 8,120 $ 2,825 See accompanying notes. COMMONWEALTH ELECTRIC COMPANY NOTES TO CONDENSED FINANCIAL STATEMENTS (1) General Information Commonwealth Electric Company (the Company) is a wholly-owned subsid- iary of Commonwealth Energy System. The parent company is referred to in this report as the "System" and together with its subsidiaries is collec- tively referred to as "the system." The System is an exempt public utility holding company under the provisions of the Public Utility Holding Company Act of 1935 and, in addition to its investment in the Company, has interests in other utility and several nonregulated companies. The Company has 697 regular employees including 483 (69%) who are represented by three collective bargaining units. One of these collective bargaining units, representing approximately 13% of regular employees, reached an agreement earlier this year on a new five-year contract that remains in effect until April 30, 2003. Agreements with two other bargaining units (representing approximately 56% of regular employees) will remain in effect until September 30, 2002 and October 31, 2001, respectively. Employee relations have generally been satisfactory. (2) Significant Accounting Policies (a) Principles of Accounting The Company's significant accounting policies are described in Note 2 of Notes to Financial Statements included in its 1997 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows these same basic accounting poli- cies but considers each interim period as an integral part of an annual period and makes allocations of certain expenses to interim periods based upon estimates of such expenses for the year. The unaudited financial statements for the periods ended September 30, 1998 and 1997 reflect, in the opinion of the Company, all adjustments (consisting of only normal recurring accruals, except for a one-time charge recorded in June 1997 as described in Management's Discussion and Analysis of Results of Operations) necessary to summarize fairly the results for such periods. In addition, certain prior period amounts are reclassified from time to time to conform with the presentation used in the current period's financial statements. Income tax expense is recorded using the statutory rates in effect applied to book income subject to tax recorded in the interim period. The results for interim periods are not necessarily indicative of results for the entire year because of seasonal variations in the con- sumption of energy. (b) Regulatory Assets and Liabilities The Company is regulated as to rates, accounting and other matters by various authorities including the Federal Energy Regulatory Commission (FERC) and the Massachusetts Department of Telecommunications and Energy (DTE). COMMONWEALTH ELECTRIC COMPANY Based on the current regulatory framework, the Company accounts for the economic effects of regulation in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." The Company has established various regulatory assets in cases where the DTE and/or the FERC have permitted or are expected to permit recovery of specific costs over time. Similarly, the regulatory liabilities established by the Company are required to be refunded to customers over time. In the event the criteria for applying SFAS No. 71 are no longer met, the accounting impact would be an extraordinary, noncash charge to operations of an amount that could be material. Criteria that give rise to the discontinuance of SFAS No. 71 include: 1) increasing competition that restricts the Company's ability to establish prices to recover specific costs, and 2) a significant change in the current manner in which rates are set by regulators from cost-based regulation to another form of regulation. These criteria are reviewed on a regular basis to ensure the continuing application of SFAS No. 71 is appropriate. Based on the current evaluation of the various factors and conditions that are expected to impact future cost recovery, the Company believes that its regulatory assets, including those related to genera- tion, are probable of future recovery. As a result of electric industry restructuring, the Company discontin- ued application of accounting principles applied to its investment in electric generation facilities effective March 1, 1998. The Company will not be required to write off any of its generation-related assets, including regulatory assets. These assets will be retained on the Company's Balance Sheets because the legislation and the DTE's plan for a restructured electric industry specifically provide for their recovery through a non-bypassable transition charge. The principal regulatory assets included in deferred charges were as follows: September 30, December 31, 1998 1997 (Dollars in thousands) Transition costs $28,125 - Fuel charge stabilization 27,283 $29,655 Power contract buy-out 16,116 17,609 Postretirement benefits costs 12,269 12,271 Pilgrim nuclear plant litigation costs 5,530 5,929 Yankee Atomic unrecovered plant and decommissioning costs 2,553 3,436 Other 1,313 1,212 $93,189 $70,112 COMMONWEALTH ELECTRIC COMPANY The regulatory liabilities, reflected in deferred credits in the accompanying Balance Sheets were as follows: September 30, December 31, 1998 1997 (Dollars in thousands) Excess Seabrook-related deferred income taxes $ 328 $ 698 Other deferred income taxes 1,875 1,875 Excess replacement power refunds 129 246 $ 2,332 $ 2,819 In November 1997, the Commonwealth of Massachusetts enacted a compre- hensive electric utility industry restructuring bill. On November 19, 1997, the Company, together with affiliates Cambridge Electric Light Company (Cambridge Electric) and Canal Electric Company (Canal), filed a restructuring plan with the DTE. The plan, approved by the DTE on February 27, 1998, provides that the Company and Cambridge Electric, beginning March 1, 1998, initiate a ten percent rate reduction for all customer classes and allow customers to choose their energy supplier. As part of the plan, the DTE authorized the recovery of certain strandable costs and provides that certain future costs may be deferred to achieve or maintain the rate reductions that the restructuring bill mandates. The legislation gives the DTE the authority to determine the amount of strandable costs that will be eligible for recovery. Costs that will qualify as strandable costs and be eligible for recovery include, but are not limited to, certain above market costs associated with generating facilities, costs associated with long-term commitments to purchase power at above market prices from independent power producers and regulatory assets and associated liabilities related to the generation portion of the electric business. The cost of transitioning to competition will be mitigated, in part, by the sale of the system's non-nuclear generating assets. The sale was approved by the DTE on October 30, 1998 and by the FERC on November 12, 1998 (see the "Industry Restructuring" section under Management's Discus- sion and Analysis of Results of Operations for further discussion of the sale). The net proceeds from the sale of these assets will be used to mitigate transition costs. The Company's ability to recover its transition costs will depend on several factors, including the aggregate amount of stranded costs the Company will be allowed to recover and the market price of electricity. Management believes that the Company will recover its transition costs. A change in any of the above listed factors could affect the recovery of transition costs and may result in a loss to the Company. For additional information relating to industry restructuring, see the "Industry Restruc- turing" section under Management's Discussion and Analysis and Results of Operations. (3) Commitments and Contingencies The Company is engaged in a continuous construction program presently estimated at $106 million for the five-year period 1998 through 2002. Of that amount, $23.8 million was estimated for 1998. As of September 30, COMMONWEALTH ELECTRIC COMPANY 1998, the Company's construction expenditures amounted to approximately $14.5 million, including an allowance for funds used during construction. The Company expects to finance these expenditures on an interim basis with internally-generated funds and short-term borrowings. The program is subject to periodic review and revision due to factors such as changes in business conditions, rates of customer growth, effects of inflation, maintenance of reliable and safe service, equipment delivery schedules, licensing delays, availability and cost of capital and environ- mental regulations. COMMONWEALTH ELECTRIC COMPANY Item 2. Management's Discussion and Analysis of Results of Operations The following is a discussion of certain significant factors which have affected operating revenues, expenses and net income during the periods included in the accompanying Condensed Statements of Income. This discussion should be read in conjunction with the Notes to Condensed Financial Statements appearing elsewhere in this report. A summary of the period to period changes in the principal items included in the Condensed Statements of Income for the three and nine months ended September 30, 1998 and 1997 and unit sales for these periods is shown below: Three Months Ended Nine Months Ended September 30, September 30, 1998 and 1997 1998 and 1997 Increase (Decrease) (Dollars in thousands) Electric Operating Revenues $ (1,350) (1.1)% $(30,058) (8.6)% Operating Expenses - Electricity purchased for resale, transmission and fuel (1,323) (1.7) (23,290) (10.3) Other operation and maintenance 2,530 12.6 (9,028) (12.7) Depreciation 87 2.0 273 2.1 Taxes - Federal and state income (1,137) (21.8) 811 11.1 Local property and other 111 5.2 (229) (3.3) 268 0.2 (31,463) (9.7) Operating Income (1,618) (13.2) 1,405 5.9 Other Income 124 1,771.4 344 716.7 Income Before Interest Charges (1,494) (12.2) 1,749 7.4 Interest Charges 175 4.4 294 2.5 Net Income $ (1,669) (20.1) $ 1,455 12.1 Unit Sales (Megawatthours or MWH) Retail 45,448 4.7 (1,736) (0.1) Wholesale 1,651 0.6 178,478 21.0 Total 47,099 3.7 176,742 5.1 The following is a summary of unit sales (in MWH) for the periods indicated: Three Months Nine Months Period Ended Total Retail Wholesale Total Retail Wholesale September 30, 1998 1,305,579 1,004,869 300,710 3,675,107 2,647,898 1,027,209 September 30, 1997 1,258,480 959,421 299,059 3,498,365 2,649,634 848,731 COMMONWEALTH ELECTRIC COMPANY Operating Revenues, Electricity Purchased for Resale, Transmission and Fuel Operating revenues for the third quarter and nine-month period of 1998 were $1.4 million and $30.1 million lower, respectively, than the correspond- ing periods in 1997, despite higher unit sales, due to the 10 percent rate reduction (further discussed below), decreases in electricity purchased for resale, fuel and transmission charges ($1.3 million and $23.3 million, respectively), and a lower level of revenues associated with demand-side management programs. The decline in these costs reflects a cost deferral of $3 million for the quarter and $26 million for the nine-month period in conjunction with the Company's restructuring plan as approved by the Massachu- setts Department of Telecommunications and Energy (DTE). As a result of industry restructuring, the Company has unbundled its rates, provided custom- ers with a 10 percent rate reduction as of March 1, 1998 and has afforded customers the opportunity to purchase generation supply in the competitive market consistent with the electric industry restructuring legislation further discussed below. Delivery rates are composed of a customer charge (to collect metering and billing costs), a distribution charge, a transition charge (to collect stranded costs), a transmission charge, an energy conservation charge (to collect costs for demand-side management programs) and a renewable energy charge. Electricity supply services provided by the Company include optional standard offer service and default service. Amounts collected through these various charges will be reconciled to actual expenditures on an on-going basis. Total unit sales for the current quarter increased primarily as a result of greater sales to the residential and commercial sectors. For the nine- month period, total unit sales reflect a significant increase in wholesale sales to other utilities. Other Operation and Maintenance The decline in other operation and maintenance for the current nine-month period primarily reflects the absence of a one-time charge ($8.4 million) related to the personnel reduction program (PRP) initiated in the second quarter of 1997 and the absence of storm damage costs related to an April 1997 blizzard ($2 million). Also contributing to the decrease in the current quarter and nine-month period were labor savings realized from the aforemen- tioned PRP ($193,000 and $2.4 million, respectively), a reduction in the provision for bad debts ($215,000 and $1.3 million, respectively), and a reduction in insurance and employee benefits costs ($1.8 million and $2.7 million, respectively. The impact of these factors was offset in the current quarter and nine-month period by higher costs relating to the outsourcing of the information technology, telecommunications and network services function ($1.5 million and $4.3 million, respectively) including costs associated with Year 2000 compliance, and higher costs related to conservation and load management programs ($2 million and $1.4 million, respectively). Depreciation and Taxes Depreciation expense increased due to a higher level of depreciable property, plant and equipment. Federal and state income taxes declined nearly 22% in the current quarter and increased over 11% in the nine-month period due to the change in pretax income. Local property and other taxes in the current quarter and nine-month period reflects lower payroll taxes ($111,000 and COMMONWEALTH ELECTRIC COMPANY $362,000, respectively) due to the PRP. Other Income and Interest Charges Other income increased in the current quarter and nine-month period due to interest accrued on the deferred transition costs associated with electric industry restructuring ($407,000 and $709,000, respectively) effective March 1, 1998. Total interest charges increased in the current quarter and nine-month period reflecting a greater level of short-term borrowings and slightly higher rates, offset somewhat by scheduled sinking fund payments on long-term debt. Industry Restructuring On November 25, 1997, the Governor of Massachusetts signed into law the Electric Industry Restructuring Act (the Act). This legislation provided, among other things, that customers of retail electric utility companies who take standard offer service receive a 10 percent rate reduction and be allowed to choose their energy supplier, effective March 1, 1998. The Act also provides that utilities be allowed full recovery of transition costs subject to review and an audit process. The rate reduction mandated by the legisla- tion increases to 15 percent effective September 1, 1999 for customers who continue to take standard offer service. A statewide ballot referendum that sought to repeal the legislation was defeated by a wide margin on November 3 of this year. The Company, together with Cambridge Electric and Canal, filed a compre- hensive electric restructuring plan with the DTE in November 1997, that was substantially approved by the DTE in February 1998. The divestiture of the Company's non-nuclear generation assets and the entitlements associated with its purchased power contracts is an integral part of the Company's restructur- ing plan and is consistent with the Act. While the Company is encouraged with the treatment afforded net non-mitigable transition costs (which, for the Company, are primarily the result of above-market purchased power contracts with non-utility generators) by the legislation and the DTE, the mandated rate reduction has had a significant impact on cash flows of the Company. However, the successful results of the generation auction, as discussed below, could significantly reduce the impact that the rate reductions will have on future cash flows. In March 1997, the Company, together with Cambridge Electric and Canal, had submitted a report to the DTE that detailed the proposed auction process for selling their electric generation assets and the entitlements associated with purchased power contracts. The auction process provided a market-based approach to maximizing stranded cost mitigation and minimizing the transition costs that retail customers will have to pay for stranded cost recovery. A request for bids from interested parties was issued in August 1997 and an Offering Memorandum followed in October 1997. Potential bidders examined all pertinent information related to the generating facilities and purchased power contracts in order to prepare and submit their first round of bids in mid- December. Final binding bids were submitted in May 1998. On May 27, 1998, the System announced that three of its subsidiary companies (Cambridge Electric, Canal and the Company) selected affiliates COMMONWEALTH ELECTRIC COMPANY of Southern Energy New England, L.L.C. (Southern Energy), an affiliate of The Southern Company of Atlanta, Georgia, to buy substantially all of their non- nuclear electric generating assets for approximately $462 million (subject to certain adjustments at closing). These facilities represent 984 megawatts (mw) of electric capacity and have an approximate book value of $79 million. The plants being sold include: Canal Unit 1 (566 mw) and a one-half interest in Canal Unit 2 (282.5 mw) located in Sandwich, MA and owned by Canal Electric; the Kendall Station facility (67 mw) and the adjacent Kendall Jets (46 mw), located in Cambridge, MA and owned by Cambridge Electric; five diesel generators (13.8 mw) in Oak Bluffs and West Tisbury on the island of Martha's Vineyard that are owned by the Company, and a 1.4 percent joint-ownership interest (8.9 mw) in Wyman Unit No. 4 located in Yarmouth, ME, also owned by the Company. The Company continues to evaluate bids related to the purchased power contracts. On July 31, 1998, a formal divestiture filing was submitted to the FERC and the DTE that requested approval of the sale of the Company's generating assets and further proposes (subject to completion of the sale) that the current 10 percent rate reduction increase, effective January 1, 1999, to 12.1 percent. In addition, the Company proposes to increase the retail price of standard offer service, starting January 1, 1999, from the present rate of 2.8 cents per kilowatthour (kwh) to 3.5 cents. At the same time that the price for standard offer service is increased, the transition charge for the Company's customers will decline from 4.08 cents per kwh to 3.13 cents. These proposed changes, which are intended to further reduce the cost of electricity to customers, to make the market increasingly more attractive for independent power suppliers to sell electricity directly to consumers, and to reduce the Company's cost deferrals associated with the pricing of standard offer service, are based on a specific allocation methodology for the net proceeds from the sale of the Canal units. On October 30, 1998, the DTE approved the system's sale of its generating assets to Southern Energy. The DTE, however, deferred ruling on the alloca- tion of proceeds from the sale of Canal Units 1 and 2 between the Company and Cambridge Electric and on the rate of return to be paid to customers on the net proceeds from the sale over an eleven-year period. These issues are not expected to impact the asset sale that is scheduled to close in the fourth quarter. The FERC approved the sale on November 12, 1998. Year 2000 The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer program that has date sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a temporary inability to process transactions or engage in normal business activities. The system has been involved in Year 2000 compliancy since 1996. The system, on a coordinated basis and with the assistance of RCG Informa- tion Technologies and other consultants, is addressing the Year 2000 issue. The system has inventoried and assessed all date sensitive information and COMMONWEALTH ELECTRIC COMPANY transaction processing computer systems and determined that a substantial portion of its software needed to be modified or replaced. Plans have been developed and are being implemented to correct and test all affected systems, with priorities assigned based on the importance of the activity. The system has identified the software and hardware installations that will be necessary. All installations are expected to be completed and tested by mid-1999. The system has also inventoried its non-information technology systems that may be date sensitive, (facilities, electric operations, energy supply/production and distribution), that use embedded technology such as micro-controllers and micro-processors. The system anticipates that these systems will be updated or replaced as necessary and tested by mid-1999. Modifying and testing the system's information and transaction processing systems from 1996 through 2000 is currently expected to cost $6 to $7 million, including approximately $900,000 incurred through 1997 and $1.6 million spent during the first nine months of 1998. Approximately $1.2 million is expected to be spent in the fourth quarter of this year and the balance of $2.5 to $3 million in 1999 and 2000. Year 2000 costs have been expensed as incurred and will continue to be funded from operations. The system has initiated formal communications with its significant suppliers to determine the extent to which the system may be vulnerable to their failure to correct their own Year 2000 issues. The system has not received enough responses to its survey to make an accurate assessment of the Year 2000 readiness of its suppliers. Failure of the system's significant suppliers to address Year 2000 issues could have a material adverse effect on the system's operations, although it is not possible at this time to quantify the amount of business that might be lost or the costs that could be incurred by the system. In addition, parts of the global infrastructure, including national banking systems, electrical power grids, gas pipelines, transportation facilities, communications and governmental activities, may not be fully functional after 1999. Infrastructure failures could significantly reduce the system's ability to acquire energy and its ability to serve its customers as effectively as they are now being served. The system is identifying elements of the infrastructure that are critical to its operations and is obtaining information as to the expected Year 2000 readiness of these elements. The system has started its contingency planning for critical operational areas that might be affected by the Year 2000 issue if compliance by the system is delayed. System electric and gas operations currently have emergen- cy operating plans as well as information technology disaster recovery plans as components of its standard operating procedures. These plans will be enhanced to identify potential Year 2000 risks to normal operations and the appropriate reaction to these potential failures including contingency plans that may be required for any third parties that fail to achieve Year 2000 compliance. All necessary contingency plans are expected to be completed by early 1999, although in certain cases, especially infrastructure failures, there may be no practical alternative course of action available to the system. The system is working with other energy industry entities, both regionally and nationally with respect to Year 2000 readiness and is cooperating in the development of local and wide-scale contingency planning. While the system believes its efforts to address the Year 2000 issue will COMMONWEALTH ELECTRIC COMPANY be successful in avoiding any material adverse effect on the system's opera- tions or financial condition, it recognizes that failing to resolve Year 2000 issues on a timely basis would, in a "most reasonably likely worst case scenario," significantly limit its ability to acquire and distribute energy and process its daily business transactions for a period of time, especially if such failure is coupled with third party or infrastructure failures. Similarly, the system could be significantly affected by the failure of one or more significant suppliers, customers or components of the infrastructure to conduct their respective operations after 1999. Adverse effects on the system could include, among other things, business disruption, increased costs, loss of business and other similar risks. The foregoing discussion regarding Year 2000 project timing, effective- ness, implementation and costs includes forward-looking statements that are based on management's current evaluation using available information. Factors that might cause material changes include, but are not limited to, the availability of key Year 2000 personnel, the readiness of third parties, and the system's ability to respond to unforeseen Year 2000 complications. New Accounting Standard In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts possibly including fixed-price power contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999 and may be implemented as of the beginning of any fiscal quarter after issuance but cannot be applied retroactively. SFAS No. 133 must be applied to derivative instruments and certain derivative instruments embedded in hybrid contracts that were issued, acquired or substantively modified after December 31, 1997 and, at the Company's election, before January 1, 1998. The Company has not yet quantified the impacts of adopting SFAS No. 133 on its financial statements and has not determined the timing of its method of adopting SFAS No. 133. Forward-Looking Statements This discussion contains statements which, to the extent it is not a recitation of historical fact, constitute "forward-looking statements" and is intended to be subject to the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995. A number of important factors affecting the Company's business and financial results could cause actual results to differ materially from those reflected in the forward-looking statements or projected amounts. Those factors include developments in the legislative, regulatory and competitive environment, certain environmental matters, demands for capital and the availability of cash from various sources. COMMONWEALTH ELECTRIC COMPANY PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not a party to any pending material legal proceeding. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule Filed herewith as Exhibit 1 is the Financial Data Schedule for the nine months ended September 30, 1998. (b) Reports on Form 8-K No reports on Form 8-K were filed during the three months ended September 30, 1998. COMMONWEALTH ELECTRIC COMPANY SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMONWEALTH ELECTRIC COMPANY (Registrant) Principal Financial and Accounting Officer: Date: November 13, 1998 JAMES D. RAPPOLI James D. Rappoli, Financial Vice President and Treasurer EX-27 2 FDS FOR COMMONWEALTH ELECTRIC CO. 9/30/98
UT This schedule contains summary financial information extracted from the balance sheet, statement of income and statement of cash flows contained in Form 10-Q of Commonwealth Electric Company for the nine months ended September 30, 1998 and is qualified in its entirety by reference to such financial statements. 0000071222 COMMONWEALTH ELECTRIC COMPANY 1,000 DEC-31-1998 SEP-30-1998 9-MOS PER-BOOK 382,093 492 62,158 97,877 0 542,620 51,099 97,112 38,535 186,746 0 0 146,148 40,590 0 0 3,553 0 0 0 165,583 542,620 318,766 8,120 285,479 293,599 25,167 296 25,463 11,971 13,492 0 13,492 6,950 9,963 2,399 0 0
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