EX-13.3 6 psnhedgar.txt PSNH 2003 ANNUAL REPORT EXHIBIT 13.3 2003 Annual Report Public Service Company of New Hampshire Index Contents Page -------- ---- Management's Discussion and Analysis of Financial Condition and Results of Operations.............................. 1 Independent Auditors' Report....................................... 12 Consolidated Balance Sheets........................................ 14-15 Consolidated Statements of Income.................................. 16 Consolidated Statements of Comprehensive Income.................... 16 Consolidated Statements of Common Stockholder's Equity............. 17 Consolidated Statements of Cash Flows.............................. 18 Notes to Consolidated Financial Statements......................... 19 Consolidated Quarterly Financial Data (Unaudited).................. 32 Selected Consolidated Financial Data (Unaudited)................... 32 Consolidated Statistics (Unaudited)................................ 33 Bondholder Information............................................. Back Cover MANAGEMENT'S DISCUSSION AND ANALYSIS FINANCIAL CONDITION AND BUSINESS ANALYSIS ------------------------------------------------------------------------------- OVERVIEW Public Service Company of New Hampshire (PSNH or the company), a wholly owned subsidiary of Northeast Utilities (NU), earned $45.6 million in 2003, compared with $62.9 million in 2002 and $81.8 million in 2001. The 2003 decline in earnings is due to a lower level of regulatory assets earning a return, the positive resolution of certain contingencies related to a regulatory proceeding decided in 2002, and higher pension costs. The lower 2002 net income was largely due to an after-tax gain of $15.5 million PSNH recorded in 2001 as a result of the sale of PSNH's share of the Millstone 3 nuclear unit (Millstone). NU's other subsidiaries include The Connecticut Light and Power Company (CL&P), Western Massachusetts Electric Company, Yankee Energy System, Inc., North Atlantic Energy Corporation (NAEC), Select Energy, Inc., Northeast Generation Company, Northeast Generation Services Company, and Select Energy Services, Inc. PSNH purchased all of NAEC's entitlement to the capacity and output of the Seabrook nuclear unit (Seabrook) under two full cost recovery contracts (Seabrook Power Contracts) through the sale of Seabrook on November 1, 2002. During 2003, pre-tax pension expense for PSNH increased $6.2 million, from $0.6 million in 2002 to $6.8 million in 2003. Of the $6.8 million and $0.6 million of pension expense recorded during 2003 and 2002, $4.8 million and $0.4 million, respectively, were recognized in the consolidated statements of income. The remaining $2 million in 2003 and $0.2 million in 2002 relate to employees working on capital projects and were reflected as capital expenditures. The pre-tax $4.4 million increase in pension expense was reflected evenly throughout 2003, resulting in a decline of $0.7 million in net income per quarter during 2003. PSNH's revenues for 2003 decreased to $888.2 million from $947.2 million in 2002. The decrease in revenues is primarily due to lower wholesale revenues as a result of NAEC's sale of its share of Seabrook in November 2002, the cancellation of the Seabrook Power Contracts and PSNH's related loss of Seabrook output, some of which was sold. The reduction in wholesale revenues was partially offset by increases in electric sales in 2003 as compared to 2002. As a result of an adjustment to estimated unbilled electric revenues resulting from a process to validate and update the assumptions used to estimate unbilled revenues, 2003 PSNH retail electric sales increased 4.7 percent compared to 2002. Absent that adjustment, PSNH retail electric sales increased 4 percent. The adjustment to PSNH's estimated unbilled revenues increased PSNH's net income by $3.3 million for 2003. For further information regarding the estimate of unbilled revenues, see "Critical Accounting Policies and Estimates - Unbilled Revenues," included in this Management's Discussion and Analysis. FUTURE OUTLOOK PSNH is expected to have reduced earnings in 2004 compared to 2003 partially as a result of a continued increase in pension expense. In 2004, PSNH is projecting to record pre-tax pension expense of approximately $10.6 million as compared to pension expense of $6.8 million in 2003. Pension expense is annually adjusted during the second quarter based on updated actuarial valuations, and the 2004 estimate may change. PSNH's 2004 earnings will also be impacted by uncertainties over the outcome of a pending PSNH rate case before the New Hampshire Public Utilities Commission (NHPUC) and the outcome of the transmission rate case before the Federal Energy Regulatory Commission (FERC). Management expects both cases to be decided in the second half of 2004. LIQUIDITY PSNH's net cash flows provided by operating activities totaled $82.2 million in 2003 as compared to $325 million in 2002 and $271.7 million in 2001. Cash flows provided by operating activities in 2003 decreased due to decreases in working capital items. Seabrook was sold on November 1, 2002 and taxes of $93 million were paid in March of 2003. The decrease in these working capital items were offset by an increase in regulatory recoveries in 2003 as compared to 2002, primarily associated with PSNH's Stranded Cost Recovery Charge (SCRC). For a description of the costs recovered through this mechanism, see Note 1G, "Summary of Significant Accounting Policies - Regulatory Accounting," to the consolidated financial statements. Cash flows provided by operating activities increased in 2002 primarily due to changes in working capital, primarily accrued taxes and accounts payable, partially offset by the decrease in net income in 2002. The increase in accrued taxes relates primarily to the refund PSNH received from NAEC related to the gain on the sale of Seabrook. There was a comparable level of investing and financing activity in 2003 as compared to 2002, except for $37 million for the repurchase of common shares and the issuance of rate reduction bonds in 2002. The level of common dividends totaled $16.8 million in 2003, $45 million in 2002 and $27 million in 2001. There was a lower level of financing activities in 2002 as compared to 2001, primarily due to the issuance and retirements of long-term debt and rate reduction bonds. Aside from the rate reduction bonds outstanding, no PSNH debt issues mature during the eight-year period of 2004 through 2011. Capital spending at PSNH totaled $105.6 million in 2003, compared with $108.7 million in 2002. In 2003, PSNH spent over $20 million to buy down contracts with 14 small power producers and funded $30.1 million to acquire the assets of Connecticut Valley Electric Company (CVEC) and buy out a related wholesale power contract. The $30.1 million was placed in escrow at December 31, 2003 and is included in special deposits on the accompanying consolidated balance sheets. PSNH expects to increase its capital spending to approximately $160 million in 2004, assuming it receives satisfactory regulatory approval for a $70 million conversion of a 50 megawatt generating unit at its Schiller Station to burn wood chips. Such a level of spending is likely to require PSNH to issue in 2004 its first new debt since it exited bankruptcy in 1991. In November 2003, PSNH renewed a $300 million credit line under terms similar to the previous arrangement that expired in November 2003. PSNH can borrow up to $100 million and had $10 million in borrowings outstanding on this credit line at December 31, 2003. Rate reduction bonds are included on the consolidated balance sheets of PSNH, even though the debt is non-recourse to PSNH. At December 31, 2003, PSNH had a total of $472.2 million in rate reduction bonds outstanding, compared with $510.8 million outstanding at December 31, 2002. All outstanding rate reduction bonds of PSNH are scheduled to fully amortize by May 1, 2013. Interest on the bonds totaled $29.1 million in 2003, compared with $30.5 million in 2002 and $20.7 million in 2001, the year of issuance. Cash flows from the amortization of rate reduction bonds totaled $40 million in 2003, compared with $42.7 million in 2002 and $26.8 million in 2001. Over the next several years, retirement of rate reduction bonds will increase, and interest payments will steadily decrease, resulting in no material changes to debt service costs on the existing issues. PSNH fully recovers the amortization and interest payments from customers through stranded cost revenues each year, and the bonds have no impact on net income. Moreover, as the rate reduction bonds are non-recourse, the three rating agencies that rate the debt of PSNH do not reflect the revenues, expenses, or outstanding securities related to the rate reduction bonds in establishing the credit ratings of PSNH. The retirement of rate reduction bonds does not equal the amortization of rate reduction bonds because the retirement represents principal payments, while the amortization represents amounts recovered from customers for future principal payments. The timing of recovery does not exactly match the expected principal payments. BUSINESS DEVELOPMENT AND CAPITAL EXPENDITURES PSNH capital spending totaled $105.6 million in 2003 and is projected to total $160 million in 2004. The primary reason for the increase is PSNH's proposal to convert a 50 megawatt oil and coal burning unit at Schiller Station in Portsmouth, New Hampshire to burn wood chips. The $70 million project will commence if PSNH receives satisfactory approval from the NHPUC. PSNH believes that the conversion can be accomplished without impacting retail rates because of certain government incentives to promote renewable resource projects. Another reason for the projected increase in capital spending is PSNH's transmission projects. Effective January 1, 2004, PSNH completed the purchase of the electric system and retail franchise of CVEC, a subsidiary of Central Vermont Public Service Corporation (CVPS), for $30.1 million. CVEC's 11,000 customers in western New Hampshire have been added to PSNH's customer base of more than 460,000 customers. The purchase price included the book value of CVEC's plant assets of approximately $9 million and an additional $21 million to terminate an above-market wholesale power purchase agreement CVEC had with CVPS. CVEC is expected to add approximately $1.1 million to PSNH's annual earnings. REGIONAL TRANSMISSION ORGANIZATION The FERC has required all transmission owning utilities, including PSNH, to voluntarily form regional transmission organizations (RTOs) or to state why this process has not begun. On October 31, 2003, the New England Independent System Operator (ISO-NE), along with NU (including PSNH), and six other New England transmission companies filed a proposal with the FERC to create a RTO for New England. The RTO is intended to strengthen the independent and efficient management of the region's power system while ensuring that customers in New England continue to have the most reliable system possible to realize the benefits of a competitive wholesale energy market. ISO-NE, as a RTO, will have a new independent governance structure and will also become the transmission provider for New England by exercising operational control over New England's transmission facilities pursuant to a detailed contractual arrangement with the New England transmission owners. Under this contractual arrangement, the RTO will have clear authority to direct the transmission owners to operate their facilities in a manner that preserves system reliability, including requiring transmission owners to expand existing transmission lines or build new ones when needed for reliability. Transmission owners will retain their rights over revenue requirements, rates and rate designs. The filing requests that the FERC approve the RTO arrangements for an effective date of March 1, 2004. In a separate filing made on November 4, 2003, NU including PSNH, along with six other New England transmission owners requested, consistent with the FERC's pricing policy for RTOs and Order-2000-compliant independent system operators, that the FERC approve a single return on equity (ROE) for regional and local rates that would consist of a base ROE as well as incentive adders of 50 basis points for joining a RTO and 100 basis points for constructing new transmission facilities approved by the RTO. If the FERC approves the request, then the transmission owners would receive a 13.3 percent ROE for existing transmission facilities and a 14.3 percent ROE for new transmission facilities. The outcome of this request and its impact on PSNH cannot be determined at this time. RESTRUCTURING AND RATE MATTERS On August 26, 2003, NU's electric operating companies, including PSNH, filed their first transmission rate case at the FERC since 1995. In the filing, NU requested implementation of a formula rate that would allow recovery of increasing transmission expenditures on a timelier basis and that the changes, including a $23.7 million annual rate increase through 2004, take effect on October 27, 2003. NU requested that the FERC maintain NU's existing 11.75 percent ROE until a ROE for the New England RTO is established by the FERC. On October 22, 2003, the FERC accepted this filing implementing the proposed rates subject to refund effective on October 28, 2003. A final decision in the rate case is expected in 2004. Increasing transmission rates are generally recovered from distribution companies through FERC-approved transmission rates. Electric distribution companies pass through higher transmission rates to retail customers as approved by the NHPUC. PSNH requested a tracking mechanism from the NHPUC when it filed its rate case on December 29, 2003, which will allow it to recover changes in transmission expenses on a timely basis. Transition Energy Service: In accordance with the "Agreement to Settle PSNH Restructuring" (Restructuring Settlement) and state law, PSNH must file for updated transition energy service (TS) rates annually. The TS rate recovers PSNH's generation and purchased power costs, including a return on PSNH's generation investment. During the February 1, 2004 through January 31, 2005 time period when current rates will be effective, PSNH will defer any difference between its TS revenues and the actual costs incurred. On December 19, 2003, the NHPUC approved a $0.0536 per kilowatt-hour (kWh) TS rate effective February 1, 2004. Delivery Rate Case: PSNH's delivery rates were fixed by the Restructuring Settlement until February 1, 2004. Consistent with the requirements of the Restructuring Settlement and state law, PSNH filed a delivery service rate case and tariffs with the NHPUC on December 29, 2003 to increase electricity delivery rates by approximately $21 million, or approximately 2.6 percent, effective February 1, 2004. In addition, PSNH is requesting that recovery of FERC-regulated transmission costs be adjusted annually through a tracking mechanism. The NHPUC suspended the proposed rate increase until the conclusion of the delivery rate case. Hearings are expected in August 2004, and a decision is expected in the third quarter of 2004 with rates retroactively applied to February 1, 2004. SCRC Reconciliation Filings: On an annual basis, PSNH files with the NHPUC a SCRC reconciliation filing for the preceding calendar year. This filing includes the reconciliation of stranded cost revenues with stranded costs, and TS revenues with TS costs. The NHPUC reviews the filing, including a prudence review of PSNH's generation operations. On May 1, 2003, PSNH filed with the NHPUC an SCRC reconciliation filing for the period January 1, 2002, through December 31, 2002. This filing included the reconciliation of stranded cost revenues with stranded costs and a net proceeds calculation related to the sale of NAEC's share of Seabrook and the subsequent transfer of those net proceeds to PSNH. Upon the completion of discovery and technical sessions with the NHPUC staff and the New Hampshire Office of the Consumer Advocate (OCA), PSNH, the NHPUC Staff and the OCA entered into a stipulation and settlement agreement that was filed with the NHPUC on September 15, 2003. An order from the NHPUC approving the settlement agreement on October 24, 2003 did not have a material impact on PSNH's net income or financial position. The 2003 SCRC filing is expected to be filed on May 1, 2004. Management does not expect the review of the 2003 SCRC filing to have a material effect on PSNH's net income or financial position. The recovery of stranded costs is expected to be a significant source of cash flow for PSNH through 2007. On May 22, 2003, the NHPUC issued an order approving a settlement between PSNH, owners of 14 small hydroelectric power producers, the NHPUC staff and the OCA calling for the termination of PSNH's obligations to purchase power from the hydroelectric units at above market prices. On May 30, 2003, under the terms of this settlement, PSNH made lump sum payments to those owners amounting to $20.4 million. The buyout payments were recorded as regulatory assets and will be recovered, including a return, over the initial term of the obligations as Part 2 stranded costs. PSNH is entitled to retain 20 percent of the estimated savings from the buyouts. PSNH is expected to recover $21 million of the purchase price of CVEC over the next three to four years. For information regarding commitments and contingencies related to restructuring and rate matters, see Note 7A, "Commitments and Contingencies - Restructuring and Rate Matters," to the consolidated financial statements. NUCLEAR GENERATION ASSET DIVESTITURES Millstone: On March 31, 2001, PSNH sold its ownership interest in Millstone. Vermont Yankee: On July 31, 2002, Vermont Yankee Nuclear Power Corporation (VYNPC) consummated the sale of its nuclear generating unit. In November 2003, PSNH sold back to VYNPC its shares of stock for approximately $0.4 million. PSNH continues to purchase approximately 4 percent of the plant's output under a new contract. Nuclear Decommissioning and Plant Closure Costs: Although the purchasers of PSNH's ownership shares of the Millstone and Vermont Yankee plants assumed the obligation of decommissioning those plants, PSNH still has significant decommissioning and plant closure cost obligations to the companies that own the Yankee Atomic, Connecticut Yankee (CY) and Maine Yankee plants (collectively Yankee Companies). Each plant has been shut down and is undergoing decommissioning. The Yankee Companies collect decommissioning and closure costs through wholesale FERC-approved rates charged under a power purchase agreement with PSNH. PSNH in turn passes these costs on to its customers through state regulatory commission-approved retail rates. A portion of the decommissioning and closure costs have already been collected, but a substantial portion related to the decommissioning of CY has not yet been filed at and approved for collection by the FERC. The cost estimate for CY that has not yet been approved for recovery by FERC at December 31, 2003 is $26.3 million. PSNH cannot at this time predict the timing or outcome of the FERC proceeding required for the collection of these remaining decommissioning and closure costs or the Bechtel Power Corporation litigation referred to in Note 7E, "Commitments and Contingencies - Nuclear Decommissioning and Plant Closure Costs," to the consolidated financial statements. Although management believes that these costs will ultimately be recovered from PSNH's customers, there is a risk that the FERC may not allow these costs, the estimates of which have increased significantly in 2003 and 2002, to be recovered in wholesale rates. If FERC does not allow these costs to be recovered in wholesale rates, PSNH would expect the state regulatory commissions to disallow these costs in retail rates as well. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates, assumptions and at times difficult, subjective or complex judgments. Changes in these estimates, assumptions and judgments, in and of themselves, could materially impact the financial statements of PSNH. Management communicates to and discusses with NU's Audit Committee of the Board of Trustees all critical accounting policies and estimates. The following are the accounting policies and estimates that management believes are the most critical in nature. Presentation: In accordance with current accounting pronouncements, PSNH's consolidated financial statements include all subsidiaries which control is maintained and all variable interest entities for which PSNH is the primary beneficiary, as defined. All intercompany transactions between these subsidiaries are eliminated as part of the consolidation process. PSNH has less than 50 percent ownership interests in the Connecticut Yankee Atomic Power Company, Yankee Atomic Electric Company, and Maine Yankee Atomic Power Company. PSNH does not control these companies and does not consolidate them in its financial statements. PSNH accounts for the investments in these companies using the equity method. Under the equity method, PSNH records its ownership share of the earnings or losses at these companies. Determining whether or not PSNH should apply the equity method of accounting for an investee company requires management judgment. The required adoption date of Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46, "Consolidation of Variable Interest Entities" was delayed from July 1, 2003 to December 31, 2003 for PSNH. However, PSNH elected to adopt FIN 46 at the original adoption date. The adoption of FIN 46 had no impact on PSNH. In December 2003, the FASB issued a revised version of FIN 46 (FIN 46R). FIN 46R is effective for PSNH for the first quarter of 2004, but is not expected to have an impact on PSNH's consolidated financial statements. Revenue Recognition: PSNH retail revenues are based on rates approved by the NHPUC. These regulated rates are applied to customers' use of energy to calculate a bill. In general, rates can only be changed through formal proceedings with the NHPUC. PSNH utilizes regulatory commission-approved tracking mechanisms to track the recovery of certain incurred costs. The tracking mechanisms allow for rates to be changed periodically, with overcollections refunded to customers or underrecollections collected from customers in future periods. The determination of the energy sales to individual customers is based on the reading of meters, which occurs on a systematic basis throughout the month. Billed revenues are based on these meter readings. At the end of each month, amounts of energy delivered to customers since the date of the last meter reading are estimated, and an estimated amount of unbilled revenues is recorded. Wholesale transmission revenues are based on rates and formulas that are approved by the FERC. Most of PSNH's wholesale transmission revenues are collected through a combination of the New England Regional Network Service (RNS) tariff and PSNH's Local Network Service (LNS) tariff. The RNS tariff, which is administered by ISO-NE, recovers the revenue requirements associated with transmission facilities that are deemed by the FERC to be Pool Transmission Facilities. The LNS tariff which was accepted by the FERC on October 22, 2003, provides for the recovery of PSNH's total transmission revenue requirements, net of revenue credits received from various rate components, including revenues received under the RNS rates. The settlement of wholesale non-trading derivative contracts for the sale of energy by PSNH that are not related to customers' needs are recorded in operating expenses. Unbilled Revenues: Unbilled revenues represent an estimate of electricity delivered to customers that has not been billed. Unbilled revenues represent assets on the balance sheet that become accounts receivable in the following month as customers are billed. The estimate of unbilled revenues is sensitive to numerous factors that can significantly impact the amount of revenues recorded. Estimating the impact of these factors is complex and requires management's judgment. The estimate of unbilled revenues is important to PSNH's consolidated financial statements as adjustments to that estimate could significantly impact operating revenues and earnings. Two potential methods for estimating unbilled revenues are the requirements and the cycle method. PSNH estimates unbilled revenues monthly using the requirements method. The requirements method utilizes the total monthly volume of electricity delivered to the system and applies a delivery efficiency (DE) factor to reduce the total monthly volume by an estimate of delivery losses in order to calculate total estimated monthly sales to customers. The total estimated monthly sales amount less total monthly billed sales amount results in a monthly estimate of unbilled sales. Unbilled revenues are estimated by applying an average rate to the estimate of unbilled sales. Differences between the actual DE factor and the estimated DE factor can have a significant impact on estimated unbilled revenue amounts. In 2003, the unbilled sales estimates for PSNH were tested using the cycle method. The cycle method uses the billed sales from each meter reading cycle and an estimate of unbilled days in each month based on the meter reading schedule. The cycle method is historically more accurate than the requirements method when used in a mostly weather-neutral month. The cycle method resulted in adjustments to the estimate of unbilled revenues that had a positive after-tax earnings impact on PSNH of $3.3 million in 2003. The testing of the requirements method with the cycle method will be done on at least an annual basis using a weather-neutral month. Derivative Accounting: Effective January 1, 2001, PSNH adopted Statement of Financial Accounting Standards (SFAS) No. 133, as amended. Many PSNH contracts for the purchase or sale of energy or energy-related products are derivatives. The application of derivative accounting under SFAS No. 133, as amended, is complex and requires management judgment in the following respects: identification of derivatives and embedded derivatives, election, and designation of the normal purchases and sales exception, and determining the fair value of derivatives. All of these judgments, depending upon their timing and effect, can have a significant impact on PSNH's consolidated balance sheet. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," which amended existing derivative accounting guidance. This new statement incorporates interpretations that were included in previous Derivative Implementation Group guidance, clarifies certain conditions, and amends other existing pronouncements. It was effective for contracts entered into or modified after June 30, 2003. Management has determined that the adoption of SFAS No. 149 resulted in fair value accounting for certain PSNH contracts that are subject to unplanned netting and do not meet the definition of capacity contracts. These non-trading derivative contracts are recorded at fair value at December 31, 2003 as derivative assets and liabilities with offsetting amounts recorded as regulatory liabilities and assets because the contracts are part of providing regulated electric service. Emerging Issues Task Force (EITF) Issue No. 03-11 "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133, and 'Not Held for Trading Purposes' as Defined in EITF Issue No. 02-3," was derived from EITF Issue No. 02-3, which requires net reporting in the income statement of energy trading activities. Issue No. 03-11 addresses income statement classification of revenues related to derivatives that physically deliver and are not related to energy trading activities. Prior to Issue No. 03-11, there was no specific accounting guidance that addressed the classification in the income statement of PSNH's power supply contracts, some of which are non-trading derivatives. On July 31, 2003, the EITF reached a consensus in Issue No. 03-11 that determining whether realized gains and losses on contracts that physically deliver and are not held for trading purposes should be reported on a net (sales and purchases both in expenses) or gross (sales in revenues and purchases in expenses) basis is a matter of judgment that depends on the relevant facts and circumstances. The EITF indicated that existing accounting guidance should be considered and provided no new guidance in Issue No. 03-11. In Issue No. 03-11, the EITF did not provide transition guidance, which management could have interpreted as becoming applicable on October 1, 2003 for revenues from that date forward. However, management applied its conclusion on net or gross reporting to all periods presented to enhance comparability. Though previously reported on a gross basis, after reviewing the relevant facts and circumstances, PSNH reported the settlement of all short-term sales contracts that are part of procurement activities on a net basis in expenses. PSNH applied this new classification to revenues for all years presented in order to enhance comparability. These non-requirements sales that amounted to $48.9 million for the first nine months of 2003 and $99.6 million and $207.2 million for the years ended December 31, 2002 and 2001, respectively, were reflected as revenues in quarterly reporting but are now included in expenses. PSNH holds financial transmission rights (FTR) contracts to mitigate the risk associated with the congestion price differences associated with LMP in New England. FTR contracts held by PSNH were recorded at a fair value of $0.1 million. Management believes the amount to be paid for the FTR contracts best represents their fair value. If new markets for these contracts develop, then there may be an impact on PSNH's consolidated financial statements in future periods. Regulatory Accounting: The accounting policies of PSNH historically reflect the effects of the rate-making process in accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The generation, transmission and distribution businesses of PSNH continue to be cost-of- service rate regulated, and management believes the application of SFAS No. 71 to those businesses continues to be appropriate. Management must reaffirm this conclusion at each balance sheet date. If, as a result of a change in circumstances, it is determined that any portion of the company no longer meets the criteria of regulatory accounting under SFAS No. 71, that portion of the company will have to discontinue regulatory accounting and write-off their regulatory assets and liabilities. Such a write-off could have a material impact on PSNH's consolidated financial statements. The application of SFAS No. 71 results in recording regulatory assets and liabilities. Regulatory assets represent the deferral of incurred costs that are probable of future recovery in customer rates. In some cases, PSNH records regulatory assets before approval for recovery has been received from the NHPUC. Management must use judgment to conclude that costs deferred as regulatory assets are probable of future recovery. Management bases its conclusion on certain factors, including changes in the regulatory environment, recent rate orders issued by the NHPUC and the status of any potential new legislation. Regulatory liabilities represent revenues received from customers to fund expected costs that have not yet been incurred or probable future refunds to customers. Management uses its best judgment when recording regulatory assets and liabilities; however, the NHPUC can reach different conclusions about the recovery of costs, and those conclusions could have a material impact on PSNH's consolidated financial statements. Management believes it is probable that PSNH will recover the regulatory assets that have been recorded. Pension and Postretirement Benefits Other Than Pensions (PBOP): PSNH participates in a uniform noncontributory defined benefit retirement plan (Pension Plan) covering substantially all regular PSNH employees. PSNH also participates in a postretirement benefit plan (PBOP Plan) to provide certain health care benefits, primarily medical and dental, and life insurance benefits through a benefit plan to retired employees. For each of these plans, the development of the benefit obligation, fair value of plan assets, funded status and net periodic benefit credit or cost is based on several significant assumptions. If these assumptions were changed, the resulting change in benefit obligations, fair values of plan assets, funded status and net periodic benefit credits or costs could have a material impact on PSNH's consolidated financial statements. Results: Pre-tax periodic pension expense/income for the Pension Plan, excluding settlements, curtailments and special termination benefits, totaled $6.8 million in expense, $0.6 million in expense and $3.9 million in income for the years ended December 31, 2003, 2002 and 2001, respectively. The pension expense/income amounts exclude one-time items recorded under SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," associated with early termination programs. Net SFAS No. 88 items totaled $1.3 million in expense for the year ended December 31, 2001. The pre-tax net PBOP Plan cost, excluding settlements, curtailments and special termination benefits, totaled $6.2 million, $5.3 million and $4.3 million for the years ended December 31, 2003, 2002 and 2001, respectively. Long-Term Rate of Return Assumptions: In developing the expected long-term rate of return assumptions, PSNH evaluated input from actuaries, consultants and economists, as well as long-term inflation assumptions and PSNH's historical 20-year compounded return of approximately 11 percent. PSNH's expected long-term rate of return on assets is based on certain target asset allocation assumptions and expected long-term rates of return. The Pension Plan's and PBOP Plan's target asset allocation assumptions and expected long- term rates of return assumptions by asset category are as follows:
----------------------------------------------------------------------------------------------------------------- At December 31, ----------------------------------------------------------------------------------------------------------------- Pension Benefits Postretirement Benefits ----------------------------------------------------------------------------------------------------------------- 2003 2002 2003 2002 ----------------------------------------------------------------------------------------------------------------- Target Assumed Target Assumed Target Assumed Target Assumed Asset Rate of Asset Rate of Asset Rate of Asset Rate of Asset Category Allocation Return Allocation Return Allocation Return Allocation Return ----------------------------------------------------------------------------------------------------------------- Equity securities: United States 45.00% 9.25% 45.00% 9.75% 55.00% 9.25% 55.00% 9.75% Non-United States 14.00% 9.25% 14.00% 9.75% 11.00% 9.25% - - Emerging markets 3.00% 10.25% 3.00% 10.75% 2.00% 10.25% - - Private 8.00% 14.25% 8.00% 14.75% - - - - Debt Securities: Fixed income 20.00% 5.50% 20.00% 6.25% 27.00% 5.50% 45.00% 6.25% High yield fixed income 5.00% 7.50% 5.00% 7.50% 5.00% 7.50% - - Real estate 5.00% 7.50% 5.00% 7.50% - - - - -----------------------------------------------------------------------------------------------------------------
The actual asset allocations at December 31, 2003 and 2002 approximated these target asset allocations. PSNH regularly reviews the actual asset allocations and periodically rebalances the investments to the targeted asset allocations when appropriate. For information regarding actual asset allocations, see Note 5, "Pension Benefits and Postretirement Benefits Other Than Pensions," to the consolidated financial statements. PSNH reduced the long-term rate of return assumption 50 basis points from 9.25 percent to 8.75 percent in 2003 for the Pension Plan and PBOP Plan due to lower expected market returns. PSNH believes that 8.75 percent is a reasonable long-term rate of return on Pension Plan and PBOP Plan assets for 2003, and PSNH expects to use 8.75 percent in 2004. PSNH will continue to evaluate the actuarial assumptions, including the expected rate of return, at least annually, and will adjust the appropriate assumptions as necessary. Actuarial Determination of Income and Expense: PSNH bases the actuarial determination of Pension Plan and PBOP Plan income/expense on a market- related valuation of assets, which reduces year-to-year volatility. This market-related valuation calculation recognizes investment gains or losses over a four-year period from the year in which they occur. Investment gains or losses for this purpose are the difference between the expected return calculated using the market-related value of assets and the actual return based on the fair value of assets. Since the market-related valuation calculation recognizes gains or losses over a four-year period, the future value of the market-related assets will be impacted as previously deferred gains or losses are recognized. There will be no impact on the fair value of Pension Plan and PBOP Plan assets. At December 31, 2003, the Pension Plan had cumulative unrecognized investment losses of $10.5 million, which will increase pension expense over the next four years by reducing the expected return on Pension Plan assets. At December 31, 2003, the Pension Plan also had cumulative unrecognized actuarial losses of $26.8 million, which will increase pension expense over the expected future working lifetime of active Pension Plan participants, or approximately 13 years. The combined total of unrecognized investment and actuarial losses at December 31, 2003 is $37.3 million. These losses impact the determination of pension expense and the actuarially determined prepaid pension amount recorded on the consolidated balance sheets but have no impact on expected Pension Plan funding. At December 31, 2003, the PBOP Plan had cumulative unrecognized investment losses of $1.5 million, which will increase PBOP Plan cost over the next four years by reducing the expected return on plan assets. At December 31, 2003, the PBOP Plan also had cumulative unrecognized actuarial losses of $13.2 million, which will increase PBOP Plan expense over the expected future working lifetime of active PBOP Plan participants, or approximately 13 years. The combined total of unrecognized investment and actuarial losses at December 31, 2003 is $14.7 million. These losses impact the determination of PBOP Plan cost and the actuarially determined accrued PBOP Plan cost recorded on the consolidated balance sheets. Discount Rate: The discount rate that is utilized in determining future pension and PBOP obligations is based on a basket of long-term bonds that receive one of the two highest ratings given by a recognized rating agency. To compensate for the Pension Plan's longer duration 25 basis points were added to the benchmark. The discount rate determined on this basis has decreased from 6.75 percent at December 31, 2002 to 6.25 percent at December 31, 2003. Expected Pension Expense: Due to the effect of the unrecognized actuarial losses and based on an expected rate of return on Pension Plan assets of 8.75 percent, a discount rate of 6.25 percent and various other assumptions, PSNH estimates that expected contributions to and pension expense for the Pension Plan will be as follows (in millions): ---------------------------------------------------------- Expected Year Contributions Pension Expense ---------------------------------------------------------- 2004 $ - $10.6 2005 $ - $11.9 2006 $ - $11.9 ---------------------------------------------------------- Future actual pension expense/income will depend on future investment performance, changes in future discount rates and various other factors related to the populations participating in the Pension Plan. Sensitivity Analysis: The following represents the increase/(decrease) to the Pension Plan's reported cost and increases to the PBOP Plan's reported cost as a result of the change in the following assumptions by 50 basis points (in millions): --------------------------------------------------------------------- At December 31, --------------------------------------------------------------------- Pension Plan Postretirement Plan --------------------------------------------------------------------- Assumption Change 2003 2002 2003 2002 --------------------------------------------------------------------- Lower long-term rate of return $ 1.1 $ 1.1 $0.2 $0.2 Lower discount rate $ 1.9 $ 1.7 $0.2 $0.2 Lower compensation increase $(1.0) $(0.8) N/A N/A --------------------------------------------------------------------- Plan Assets: The value of the Pension Plan assets has increased from $163.5 million at December 31, 2002 to $191.9 million at December 31, 2003. The investment performance returns, despite declining discount rates, have decreased the underfunded status of the Pension Plan on a projected benefit obligation (PBO) basis from $97.4 million at December 31, 2002 to $97.1 million at December 31, 2003. The PBO includes expectations of future employee compensation increases. The accumulated benefit obligation (ABO) of the Pension Plan was $51.7 million more than Pension Plan assets at December 31, 2003 and $54.9 million more than Pension Plan assets at December 31, 2002. The ABO is the obligation for employee service and compensation provided through December 31, 2003. If the ABO for the entire Pension Plan exceeds all Pension Plan assets at a future plan measurement date, NU will record an additional minimum liability of which PSNH will be allocated its proportionate share. PSNH has not made employer contributions since 1991. The value of PBOP Plan assets has increased from $24.4 million at December 31, 2002 to $29.7 million at December 31, 2003. The investment performance returns, despite declining discount rates, have decreased the underfunded status of the PBOP Plan on an accumulated projected benefit obligation basis from $39.3 million at December 31, 2002 to $37.1 million at December 31, 2003. PSNH has made a contribution each year equal to the PBOP Plan's postretirement benefit cost, excluding curtailments, settlements and special termination benefits. Health Care Cost: The health care cost trend assumption used to project increases in medical costs is 9 percent for 2003, decreasing one percentage point per year to an ultimate rate of 5 percent in 2007. The effect of increasing the health care cost trend by one percentage point would have increased 2003 service and interest cost components of the PBOP Plan cost by $0.1 million in 2003 and 2002. Accounting for the Effect of Medicare Changes on PBOP: On December 8, 2003, the President signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit and by adding a federal subsidy to qualifying plan sponsors of retiree health care benefit plans. Management believes that PSNH currently qualifies. Specific authoritative accounting guidance on how to account for the effect the Medicare federal subsidy has on PSNH's PBOP Plan has not been issued by the FASB. FASB Staff Position (FSP) No. FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003," required PSNH to make an election for 2003 financial reporting. The election was to either defer the impact of the subsidy until the FASB issues guidance or to reflect the impact of the subsidy on December 31, 2003 reported amounts. PSNH chose to reflect the impact on December 31, 2003 reported amounts. Reflecting the impact of the Medicare change decreased the PBOP benefit obligation by approximately $4.4 million and increased actuarial gains by approximately $4.4 million with no impact on 2003 expenses, assets, or liabilities. The $4.4 million actuarial gain will be amortized as a reduction to PBOP expense over 13 years beginning in 2004. PBOP expense in 2004 will also reflect a lower interest cost due to the reduction in the December 31, 2003 benefit obligation. Management estimates that the reduction in PBOP expense in 2004 will be approximately $0.3 million. When accounting guidance is issued by the FASB, it may require PSNH to change the accounting described above and change the information included in this annual report. Income Taxes: Income tax expense is calculated each year in each of the jurisdictions in which PSNH operates. This process involves estimating PSNH's actual current tax exposures as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction and expenses for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are included in PSNH's consolidated balance sheets. Adjustments made to income taxes could significantly affect PSNH's consolidated financial statements. Management must also assess the likelihood that deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. PSNH accounts for deferred taxes under SFAS No. 109, "Accounting for Income Taxes." For temporary differences recorded as deferred tax liabilities that will be recovered in rates in the future, PSNH has established a regulatory asset. The regulatory asset amounted to $44.2 million and $96.5 million at December 31, 2003 and 2002, respectively. Regulatory agencies in certain jurisdictions in which PSNH companies operate require the tax effect of specific temporary differences to be "flowed through" to utility customers. Flow through treatment means that deferred tax expense is not recorded on the consolidated statements of income. Instead, the tax effect of the temporary difference impacts both amounts for income tax expense currently included in customers' rates and the company's net income. Flow through treatment can result in effective income tax rates that are significantly different than expected income tax rates. Recording deferred taxes on flow through items is required by SFAS No. 109, and the offset to the deferred tax amounts is the regulatory asset referred to above. A reconciliation from expected tax expense at the statutory federal income tax rate to actual tax expense recorded is included in Note 12, "Income Tax Expense," to the consolidated financial statements. The estimates that are made by management in order to record income tax expense, accrued taxes and deferred taxes are compared each year to the actual tax amounts filed on PSNH's income tax returns. The income tax returns were filed in the fall of 2003 for the 2002 tax year. In the fourth quarter, PSNH recorded differences between income tax expense, accrued taxes and deferred taxes on its consolidated financial statements and the amounts that were on its income tax returns. Recording these differences in income tax expense resulted in a positive impact of approximately $2.1 million on PSNH's 2003 earnings. Depreciation: Depreciation expense is calculated based on an asset's useful life, and judgment is involved when estimating the useful lives of certain assets. A change in the estimated useful lives of these assets could have a material impact on PSNH's consolidated financial statements absent timely rate relief for PSNH's assets. Accounting for Environmental Reserves: Environmental reserves are accrued using a probabilistic model approach when assessments indicate that it is probable that a liability has been incurred and an amount can be reasonably estimated. Adjustments made to environmental liabilities could have a significant effect on earnings. The probabilistic model approach estimates the liability based on the most likely action plan from a variety of available remediation options, ranging from no action to remedies ranging from establishing institutional controls to full site remediation and long- term monitoring. The probabilistic model approach estimates the liabilities associated with each possible action plan based on findings through various phases of site assessments. These estimates are based on currently available information from presently enacted state and federal environmental laws and regulations and several cost estimates from outside engineering and remediation contractors. These amounts also take into consideration prior experience in remediating contaminated sites and data released by the United States Environmental Protection Agency and other organizations. These estimates are subjective in nature partly because there are usually several different remediation options from which to choose when working on a specific site. These estimates are subject to revisions in future periods based on actual costs or new information concerning either the level of contamination at the site or newly enacted laws and regulations. The amounts recorded as environmental liabilities on the consolidated balance sheets represent management's best estimate of the liability for environmental costs based on current site information from site assessments and remediation estimates. These liabilities are estimated on an undiscounted basis. Under current rate-making policy, PSNH has a regulatory recovery mechanism in place for environmental costs. Accordingly, regulatory assets have been recorded for certain of PSNH's environmental liabilities. As of December 31, 2003 and 2002, $7.6 million and $4.9 million, respectively, have been recorded as regulatory assets on the accompanying consolidated balance sheets. Asset Retirement Obligations: PSNH adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" on January 1, 2003. SFAS No. 143 requires that legal obligations associated with the retirement of property, plant and equipment be recorded as a liability on the balance sheet at fair value when incurred and when a reasonable estimate of the fair value can be made. SFAS No. 143 defines an asset retirement obligation (ARO) as a legal obligation that is required to be settled due to an existing or enacted law, statute, ordinance or a written or oral promise to remove an asset. AROs may stem from environmental laws, state laws and regulations, easement agreements, building codes, contracts, franchise grants and agreements, oral promises made upon which third parties have relied, or the dismantlement, restoration, or reclamation of properties. Upon adoption of SFAS No. 143, certain removal obligations were identified that management believes are AROs but either have not been incurred or are not material. These removal obligations arise in the ordinary course of business or have a low probability of occurring. The types of obligations primarily relate to transmission and distribution lines and poles, telecommunication towers, transmission cables and certain FERC or state regulatory agency re-licensing issues. There was no impact to PSNH's earnings upon adoption of SFAS No. 143; however, if there are changes in certain laws and regulations, orders, interpretations or contracts entered into by PSNH there may be future AROs that need to be recorded. Under SFAS No. 71, regulated utilities, including PSNH, currently recover amounts in rates for future costs of removal of plant assets. Future removals of assets do not represent legal obligations and are not AROs. Historically, these amounts were included as a component of accumulated depreciation until spent. At December 31, 2003 and 2002, these amounts totaling $88 million and $67 million, respectively, were reclassified to regulatory liabilities on the accompanying consolidated balance sheets. In June 2003, the FASB issued a proposed FSP, "Applicability of SFAS No. 143, 'Accounting for Asset Retirement Obligations', to Legislative Requirements on Property Owners to Remove and Dispose of Asbestos or Asbestos-Containing Materials." In the FSP, the FASB staff concludes that current legislation creates a legal obligation for the owner of a building to remove and dispose of asbestos-containing materials. In the FSP, the FASB staff also concludes that this legal obligation constitutes an ARO that should be recognized as a liability under SFAS No. 143. This FSP changes a FASB staff interpretation of SFAS No. 143 that an obligating event did not occur until a building containing asbestos was demolished. In November 2003, the FASB indicated that, based on the diverse views it received in comment letters on the proposed FSP, it was considering a proposal for a FASB agenda project to address this issue. If this FSP is adopted in its current form, then PSNH would be required to record an ARO. Management has not estimated this potential ARO at December 31, 2003. Special Purpose Entities: During 2001 and 2002, to facilitate the issuance of rate reduction bonds intended to finance certain stranded costs, PSNH established two SPEs: PSNH Funding LLC and PSNH Funding LLC 2 (the funding companies). The funding companies were created as part of a state-sponsored securitization program. The funding companies are restricted from engaging in non-related activities and are required to operate in a manner intended to reduce the likelihood that they would be included in PSNH's bankruptcy estate if it ever became involved in a bankruptcy proceeding. The funding companies and the securitization amounts are consolidated in the accompanying consolidated financial statements. For further information regarding the matters in this "Critical Accounting Policies and Estimates" section see Note 1, "Summary of Significant Accounting Policies," Note 5, "Pension Benefits and Postretirement Benefits Other Than Pensions," Note 12, "Income Tax Expense," and Note 7B, "Commitments and Contingencies - Environmental Matters," to the consolidated financial statements. OTHER MATTERS Commitments and Contingencies: For further information regarding other commitments and contingencies, see Note 7, "Commitments and Contingencies," to the consolidated financial statements. Contractual Obligations and Commercial Commitments: Information regarding PSNH's contractual obligations and commercial commitments at December 31, 2003 is summarized through 2008 and thereafter as follows:
------------------------------------------------------------------------------------------------------ (Millions of Dollars) 2004 2005 2006 2007 2008 Thereafter ------------------------------------------------------------------------------------------------------ Notes payable to banks (a) $ 10.0 $ - $ - $ - $ - $ - Long-term Debt(a) - - - - - 407.3 - Capital leases (b) (c) 0.5 0.5 0.3 0.2 0.2 - Operating leases (c) (d) 4.6 3.9 3.6 2.6 2.1 3.6 Long-term contractual arrangements (c) (d) 136.6 138.0 139.0 66.8 40.6 392.2 ------------------------------------------------------------------------------------------------------ Totals $151.7 $142.4 $142.9 $69.6 $42.9 $803.1 ------------------------------------------------------------------------------------------------------
(a) Included in PSNH's debt agreements are usual and customary positive, negative and financial covenants. Non-compliance with certain covenants, for example the timely payment of principal and interest, may constitute an event of default, which could cause an acceleration of principal in the absence of receipt by the company of a waiver or amendment. Such acceleration would change the obligations outlined in the table of contractual obligations and commercial commitments. (b) The capital lease obligations include imputed interest of $0.7 million. (c) PSNH has no provisions in its capital or operating lease agreements or agreements related to its long-term contractual arrangements that could trigger a change in terms and conditions, such as acceleration of payment obligations. (d) Amounts are not included on PSNH's consolidated balance sheets. Rate reduction bond amounts are non-recourse to PSNH, have no required payments over the next five years and are not included in this table. Additionally, this table does not include notes payable to affiliated companies totaling $48.9 million at December 31, 2003 and PSNH's expected contribution to the PBOP Plan in 2004 of $7 million. For further information regarding PSNH's contractual obligations and commercial commitments, see Note 3, "Short-Term Debt," Note 9, "Leases," Note 7D, "Commitments and Contingencies - Long-Term Contractual Arrangements," and Note 11, "Long-Term Debt," to the consolidated financial statements. Forward Looking Statements: This discussion and analysis includes forward looking statements, which are statements of future expectations and not facts including, but not limited to, statements regarding future earnings, refinancings, regulatory proceedings, the use of proceeds from restructuring, and the recovery of operating costs. Words such as estimates, expects, anticipates, intends, plans, and similar expressions identify forward looking statements. Actual results or outcomes could differ materially as a result of further actions by state and federal regulatory bodies, competition and industry restructuring, changes in economic conditions, changes in weather patterns, changes in laws, developments in legal or public policy doctrines, technological developments, volatility in electric commodity markets, and other presently unknown or unforeseen factors. Website: Additional financial information is available through NU's website at www.nu.com. RESULTS OF OPERATIONS The following table provides the variances in income statement line items for the consolidated statements of income included in this annual report for the past two years.
--------------------------------------------------------------------------------------------------- 2003 over/(under) 2002 2002 over/(under) 2001 Income Statement Variances ---------------------- ------------------------ (Millions of Dollars) Amount Percent Amount Percent --------------------------------------------------------------------------------------------------- Operating Revenues $ (59) (6)% $ (17) (2)% Operating Expenses: Fuel, purchased and net interchange power 112 39 (218) (43) Other operation 16 13 3 2 Maintenance 1 1 8 14 Depreciation 2 6 1 3 Amortization of regulatory assets, net (158) (81) 158 (a) Amortization of rate reduction bonds (3) (6) 16 59 Taxes other than income taxes (1) (2) (4) (11) --------------------------------------------------------------------------------------------------- Total operating expenses (31) (4) (36) (4) --------------------------------------------------------------------------------------------------- Operating Income (28) (18) 19 14 Interest expense, net (4) (8) (2) (4) Other (loss)/income, net (4) (a) (38) (a) --------------------------------------------------------------------------------------------------- Income before income tax expense (28) (27) (17) (14) Income tax expense (11) (26) 2 4 --------------------------------------------------------------------------------------------------- Net Income $ (17) (27)% $ (19) (23)% ===================================================================================================
(a) Percent greater than 100. OPERATING REVENUES Operating revenues decreased $59 million in 2003 compared with the same period of 2002 primarily due to lower regulated wholesale revenues resulting from the impact of less owned generation since the sale of Seabrook ($114 million), partially offset by higher retail revenues ($56 million). Retail revenues were higher primarily due to higher retail sales volumes ($37 million) and higher TS revenues. Retail kWh sales increased 4.7 percent for the year 2003. Operating revenues decreased $17 million in 2002 primarily due to lower retail revenues. Retail revenues decreased $24 million primarily due to the May 2001 rate decrease. Retail kWh sales were essentially flat with a 0.1 percent decrease. FUEL, PURCHASED AND NET INTERCHANGE POWER Fuel, purchased and net interchange power expense increased $112 million in 2003 primarily due to the absence of the 2002 gain on the sale of utility plant resulting from the sale of Seabrook recorded on NAEC's books, which was transferred to PSNH through the Seabrook Power Contracts ($167 million), partially offset by lower fuel expense resulting from lower regulated wholesale transactions. Fuel, purchased and net interchange power expense decreased $218 million in 2002 primarily due to the gain on the sale of utility plant resulting from the sale of Seabrook recorded on NAEC's books, which was transferred to PSNH through the Seabrook Power Contracts ($167 million) and lower purchased power from NAEC ($67 million). OTHER OPERATION AND MAINTENANCE Other operation and maintenance (O&M) expenses increased $17 million in 2003 primarily due to higher pension costs ($8 million) and higher conservation and customer assistance programs expense ($8 million). Other O&M expenses increased $11 million in 2002 primarily due to higher fossil/hydro production expense ($8 million) and higher transmission and distribution expense ($3 million). DEPRECIATION Depreciation increased $2 million in 2003 primarily due to additions to distribution, generation, and general plant assets. Depreciation increased $1 million in 2002 primarily due to the construction of the new corporate headquarters. AMORTIZATION OF REGULATORY ASSETS, NET Amortization of regulatory assets, net decreased $158 million in 2003 primarily due to the 2002 amortization of stranded costs upon the sale of Seabrook ($167 million), partially offset by an increase in the recovery of stranded costs ($4 million) resulting from the SCRC reconciliation of stranded cost revenues against actual stranded costs. Amortization of regulatory assets, net increased $158 million in 2002 primarily due to recovery of stranded costs associated with the sale of the Seabrook Station. AMORTIZATION OF RATE REDUCTION BONDS Amortization of rate reduction bonds decreased $3 million in 2003 due to the repayment of principle and associated reduction of securitized regulatory assets. Amortization of rate reduction bonds increased $16 million in 2002 due to the issuance of rate reduction bonds in 2002 and April 2001. TAXES OTHER THAN INCOME TAXES Taxes other than income taxes decreased $1 million in 2003 primarily due to lower property tax. Taxes other than income taxes decreased $4 million in 2002 primarily due to the discontinuance of New Hampshire franchise taxes in 2001. INTEREST EXPENSE, NET Interest expense, net decreased $4 million in 2003 due to lower interest on rate reduction bonds due to lower debt levels ($1 million) and lower interest rates. Interest expense, net decreased $2 million in 2002 primarily due to the December 2001 refinancing of long-term debt at lower rates. OTHER (LOSS)/INCOME, NET Other (loss)/income, net decreased $4 million in 2003 primarily due to increased service fees associated with rate reduction bonds and lower gains on the disposition of property in 2003. Other (loss)/income, net decreased $38 million in 2002 as a result of PSNH's sale of its ownership in Millstone 3 in 2001 ($26 million), a gain on the disposition of property in 2001 ($4 million) and lower dividend income in 2002 ($2 million). INCOME TAX EXPENSE Income tax expense decreased $11 million in 2003 primarily as a result of lower book taxable income as compared to 2002. For further information regarding income tax expense, see Note 12, "Income Tax Expense," to the consolidated financial statements. Income tax expense increased $2 million in 2002 primarily as a result of reduced investment tax credit amortization, partially offset by the tax consequences of lower acquisition premium amortization. COMPANY REPORT ------------------------------------------------------------------------------- Management is responsible for the preparation, integrity, and fair presentation of the accompanying consolidated financial statements of Public Service Company of New Hampshire and subsidiaries and other sections of this annual report. These financial statements, which were audited by Deloitte & Touche LLP, have been prepared in conformity with accounting principles generally accepted in the United States of America using estimates and judgments, where required, and giving consideration to materiality. The company has endeavored to establish a control environment that encourages the maintenance of high standards of conduct in all of its business activities. Management is responsible for maintaining a system of internal control over financial reporting that is designed to provide reasonable assurance, at an appropriate cost-benefit relationship, to the company's management and Board of Trustees of Northeast Utilities regarding the preparation of reliable published financial statements. The system is supported by an organization of trained management personnel, policies and procedures, and a comprehensive program of internal audits. Through established programs, the company regularly communicates to its management employees their internal control responsibilities and obtains information regarding compliance with policies prohibiting conflicts of interest and policies segregating information between regulated and unregulated subsidiary companies. The company has standards of business conduct for all employees, as well as a code of ethics for senior financial officers. The Audit Committee of the Board of Trustees of Northeast Utilities is composed entirely of independent trustees and includes two members that the Board of Trustees considers "audit committee financial experts." The Audit Committee meets regularly with management, the internal auditors and the independent auditors to review the activities of each and to discuss audit matters, financial reporting matters, and the system of internal controls over financial reporting. The Audit Committee also meets periodically with the internal auditors and the independent auditors without management present. Because of inherent limitations in any system of internal controls, errors or irregularities may occur and not be detected. The company believes, however, that its system of internal controls over financial reporting and control environment provide reasonable assurance that its assets are safeguarded from loss or unauthorized use and that its financial records, which are the basis for the preparation of all financial statements, are reliable. Additionally, management believes that its disclosure controls and procedures are in place and operating effectively. Disclosure controls and procedures are designed to ensure that information included in reports such as this annual report is recorded, processed, summarized, and reported within the time periods required and that the information disclosed is accumulated and reviewed by management for discussion and approval. INDEPENDENT AUDITORS' REPORT ------------------------------------------------------------------------------- To the Board of Directors of Public Service Company of New Hampshire: We have audited the accompanying consolidated balance sheets of Public Service Company of New Hampshire and subsidiaries (a New Hampshire corporation and a wholly owned subsidiary of Northeast Utilities) (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of income, comprehensive income, common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Public Service Company of New Hampshire and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1C to the consolidated financial statements, in 2003, the Company adopted Emerging Issues Task Force Issue 03-11, Reporting Realized Gains and Losses on Derivative Instruments that are Subject to FASB Statement No. 133 and not "Held for Trading Purposes" as Defined in Issue No. 02-3, and retroactively, restated the 2002 and 2001 consolidated financial statements. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Hartford, Connecticut February 23, 2004 PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
----------------------------------------------------------------------------------------- At December 31, 2003 2002 ----------------------------------------------------------------------------------------- (Thousands of Dollars) ASSETS ------ Current Assets: Cash $ 2,737 $ 5,319 Special deposits 30,104 - Receivables, net less provision for uncollectible accounts of $1,590 in 2003 and $1,990 in 2002 67,121 68,204 Accounts receivable from affiliated companies 11,291 9,667 Unbilled revenues 39,220 32,004 Notes receivable from affiliated companies - 23,000 Fuel, materials and supplies, at average cost 54,533 49,182 Derivative assets 1,510 - Prepayments and other 9,945 10,032 ------------- ------------- 216,461 197,408 ------------- ------------- Property, Plant and Equipment: Electric utility 1,517,513 1,431,774 Other 5,707 6,195 ------------- ------------- 1,523,220 1,437,969 Less: Accumulated depreciation 635,029 648,800 ------------- ------------- 888,191 789,169 Construction work in progress 37,401 50,547 ------------- ------------- 925,592 839,716 ------------- ------------- Deferred Debits and Other Assets: Regulatory assets 969,434 1,026,043 Other 60,324 92,280 ------------- ------------- 1,029,758 1,118,323 ------------- ------------- Total Assets $ 2,171,811 $ 2,155,447 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------------------- At December 31, 2003 2002 -------------------------------------------------------------------------------------------- (Thousands of Dollars) LIABILITIES AND CAPITALIZATION ------------------------------ Current Liabilities: Notes payable to banks $ 10,000 $ - Notes payable to affiliated companies 48,900 - Accounts payable 48,408 54,588 Accounts payable to affiliated companies 13,911 4,008 Accrued taxes 2,543 65,317 Accrued interest 10,894 11,333 Unremitted rate reduction bond collections 11,051 25,555 Derivative liabilities 1,414 - Other 16,689 12,674 -------------- ------------- 163,810 173,475 -------------- ------------- Rate Reduction Bonds 472,222 510,841 -------------- ------------- Deferred Credits and Other Liabilities: Accumulated deferred income taxes 338,930 359,910 Accumulated deferred investment tax credits 2,096 2,680 Deferred contractual obligations 64,237 56,165 Regulatory liabilities 272,081 254,064 Accrued pension 44,766 37,933 Other 26,124 31,264 -------------- ------------- 748,234 742,016 -------------- ------------- Capitalization: Long-Term Debt 407,285 407,285 -------------- ------------- Common Stockholder's Equity: Common stock, $1 par value - authorized 100,000,000 shares; 301 shares outstanding in 2003 and 2002 - - Capital surplus, paid in 156,555 126,937 Retained earnings 223,822 194,998 Accumulated other comprehensive loss (117) (105) -------------- ------------- Common Stockholder's Equity 380,260 321,830 -------------- ------------- Total Capitalization 787,545 729,115 -------------- ------------- Commitments and Contingencies (Note 7) Total Liabilities and Capitalization $ 2,171,811 $ 2,155,447 ============== =============
The accompanying notes are an integral part of these consolidated financial statements. PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
----------------------------------------------------------------------------------------------------------- For the Years Ended December 31, 2003 2002 2001 ----------------------------------------------------------------------------------------------------------- (Thousands of Dollars) Operating Revenues $ 888,186 $ 947,178 $ 964,415 ----------- ----------- ------------ Operating Expenses: Operation - Fuel, purchased and net interchange power 400,518 288,427 506,397 Other 142,550 126,506 123,533 Maintenance 64,872 64,146 56,276 Depreciation 43,322 40,941 39,741 Amortization of regulatory assets, net 37,861 196,246 38,629 Amortization of rate reduction bonds 40,040 42,714 26,816 Taxes other than income taxes 33,407 34,226 38,375 ----------- ----------- ------------ Total operating expenses 762,570 793,206 829,767 ----------- ----------- ------------ Operating Income 125,616 153,972 134,648 Interest Expense: Interest on long-term debt 15,408 16,752 29,308 Interest on rate reduction bonds 29,081 30,499 20,721 Other interest 727 1,874 915 ----------- ----------- ------------ Interest expense, net 45,216 49,125 50,944 ----------- ----------- ------------ Other (Loss)/Income, Net (5,003) (1,671) 36,643 ----------- ----------- ------------ Income Before Income Tax Expense 75,397 103,176 120,347 Income Tax Expense 29,773 40,279 38,571 ----------- ----------- ------------ Net Income $ 45,624 $ 62,897 $ 81,776 =========== =========== ============ CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Net Income $ 45,624 $ 62,897 $ 81,776 ----------- ----------- ------------ Other comprehensive income/(loss), net of tax: Unrealized gains/(losses) on securities 128 (620) (801) Minimum supplemental executive retirement pension liability adjustments (140) 109 - ----------- ----------- ------------ Other comprehensive loss, net of tax (12) (511) (801) ----------- ----------- ------------ Comprehensive Income $ 45,612 $ 62,386 $ 80,975 =========== =========== ============
The accompanying notes are an integral part of these consolidated financial statements. PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDER'S EQUITY
-------------------------------------------------------------------------------------------------------------------- Accumulated Common Stock Capital Other ---------------- Surplus, Retained Comprehensive Total Shares Amount Paid In Earnings Income/(Loss) (a) -------------------------------------------------------------------------------------------------------------------- (Thousands of Dollars, except share information) Balance at January 1, 2001 1,000 $ 1 $ 424,909 $123,177 $1,207 $549,294 Net income for 2001 81,776 81,776 Cash dividends on preferred stock (1,286) (1,286) Cash dividends on common stock (27,000) (27,000) Repurchase of common stock (612) (1) (259,999) (260,000) Capital stock expenses, net 90 90 Allocation of benefits - ESOP (248) (248) Other comprehensive loss (801) (801) ----- ---- --------- -------- ------ -------- Balance at December 31, 2001 388 - 165,000 176,419 406 341,825 Net income for 2002 62,897 62,897 Cash dividends on common stock (45,000) (45,000) Repurchase of common stock (87) (37,000) (37,000) Allocation of benefits - ESOP (1,063) 682 (381) Other comprehensive loss (511) (511) ----- ---- --------- -------- ------ -------- Balance at December 31, 2002 301 - 126,937 194,998 (105) 321,830 Net income for 2003 45,624 45,624 Cash dividends on common stock (16,800) (16,800) Allocation of benefits - ESOP (382) (382) Capital contribution from NU parent 30,000 30,000 Other comprehensive loss (12) (12) ----- ---- --------- -------- ------ -------- Balance at December 31, 2003 301 $ - $ 156,555 $223,822 $ (117) $380,260 ===== ==== ========= ======== ====== ========
(a) The Federal Power Act, the Public Utility Holding Act of 1935 (the 1935 Act), and certain state statutes limit the payment of dividends by the company to its retained earnings balance. The Utility Group credit agreement also limits dividend payments subject to the requirements that the company's total debt to total capitalization ratio does not exceed 65 percent. At December 31, 2003, retained earnings available for payment of dividends is restricted to $84.0 million. The accompanying notes are an integral part of these consolidated financial statements. PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------------------------------------- For the Years Ended December 31, 2003 2002 2001 --------------------------------------------------------------------------------------------------------------- (Thousands of Dollars) Operating activities: Net income $ 45,624 $ 62,897 $ 81,776 Adjustments to reconcile to net cash flows provided by operating activities: Depreciation 43,322 40,941 39,741 Deferred income taxes and investment tax credits, net (6,670) (79,866) 195,422 Amortization of regulatory assets, net 37,861 196,246 38,629 Amortization of rate reduction bonds 40,040 42,714 26,816 Amortization of recoverable energy costs 23,388 9,859 (21,234) Regulatory recoveries 10,778 (34,315) (133,954) Other sources of cash 23,723 23,708 113,626 Other uses of cash (52,769) (18,137) (42,060) Changes in current assets and liabilities: Receivables and unbilled revenues, net (7,757) 2,989 3,212 Fuel, materials and supplies (5,351) (7,135) (13,287) Other current assets (excludes cash) 87 179 14,576 Accounts payable 3,723 7,583 (48,888) Accrued taxes (62,774) 63,036 1,624 Other current liabilities (10,981) 14,253 15,716 ---------- ---------- ---------- Net cash flows provided by operating activities 82,244 324,952 271,715 ---------- ---------- ---------- Investing Activities: Investments in plant (105,626) (108,729) (91,770) NU system Money Pool borrowing/(lending) 71,900 (46,000) 23,000 Investments in nuclear decommissioning trusts - - (137) Net proceeds from sale of utility plant - - 24,888 Buyout/buydown of IPP contracts (20,437) (5,152) (48,164) CVEC acquisition special deposit (30,104) - - Other investment activities 15,066 (8,269) (30,906) ---------- ---------- ---------- Net cash flows used in investing activities (69,201) (168,150) (123,089) ---------- ---------- ---------- Financing Activities: Repurchase of common stock - (37,000) (260,000) Issuance of long-term debt - - 287,485 Issuance of rate reduction bonds - 50,000 525,000 Retirement of rate reduction bonds (38,619) (46,540) (17,619) Increase/(decrease) in short-term debt 10,000 (60,500) 60,500 Reacquisitions and retirements of long-term debt - - (287,485) Reacquisitions and retirements of preferred stock - - (24,268) Buydown of capital lease obligation - - (497,508) Capital contribution from Northeast Utilities 30,000 - - Cash dividends on preferred stock - - (1,286) Cash dividends on common stock (16,800) (45,000) (27,000) Other financing activities (206) (13,922) (21,448) ---------- ---------- ---------- Net cash flows used in financing activities (15,625) (152,962) (263,629) ---------- ---------- ---------- Net (decrease)/increase in cash (2,582) 3,840 (115,003) Cash - beginning of year 5,319 1,479 116,482 ---------- ---------- ---------- Cash - end of year $ 2,737 $ 5,319 $ 1,479 ========== ========== ========== Supplemental Cash Flow Information: Cash paid during the year for: Interest, net of amounts capitalized $ 45,639 $ 47,506 $ 47,369 ========== ========== ========== Income taxes $ 97,165 $ 56,458 $ 168,021 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------------------------------------------- A. ABOUT PUBLIC SERVICE COMPANY OF NEW HAMPSHIRE Public Service Company of New Hampshire (PSNH or the company) is a wholly owned subsidiary of Northeast Utilities (NU). PSNH is registered with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. NU is registered with the SEC as a holding company under the Public Utility Holding Company Act of 1935 (1935 Act), and NU, including PSNH, is subject to the provisions of the 1935 Act. Arrangements among PSNH, other NU companies, outside agencies, and other utilities covering interconnections, interchange of electric power and sales of utility property, are subject to regulation by the Federal Energy Regulatory Commission (FERC) and/or the SEC. PSNH is subject to further regulation for rates, accounting and other matters by the FERC and the New Hampshire Public Utilities Commission (NHPUC). PSNH, The Connecticut Light and Power Company (CL&P), and Western Massachusetts Electric Company (WMECO), furnish franchised retail electric service in New Hampshire, Connecticut and Massachusetts, respectively. Several wholly owned subsidiaries of NU provide support services for NU's companies, including PSNH. Northeast Utilities Service Company (NUSCO) provides centralized accounting, administrative, engineering, financial, information technology, legal, operational, planning, purchasing, and other services to NU's companies. B. PRESENTATION The consolidated financial statements of PSNH and of its subsidiaries, as applicable, include the accounts of all their respective subsidiaries. Intercompany transactions have been eliminated in consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain reclassifications of prior years' data have been made to conform with the current year's presentation. Reclassifications were made to cost of removal, regulatory asset and liability amounts and special deposits on the accompanying consolidated balance sheets and operating revenues and fuel, purchased and net interchange power on the accompanying consolidated statements of income. Reclassifications have also been made to the accompanying consolidated statements of cash flows. C. NEW ACCOUNTING STANDARDS Derivative Accounting: Effective January 1, 2001, PSNH adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," which amends SFAS No. 133. This new statement incorporates interpretations that were included in previous Derivative Implementation Group guidance, clarifies certain conditions, and amends other existing pronouncements. It is effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 resulted in fair value accounting for certain PSNH contracts that are subject to unplanned netting and do not meet the definition of capacity contracts. These non-trading derivative contracts are recorded at fair value at December 31, 2003, as derivative assets and liabilities with offsetting amounts recorded as regulatory liabilities and assets because the contracts are part of providing regulated electric or gas service. In August of 2003, the FASB ratified the consensus reached by its Emerging Issues Task Force (EITF) in July 2003 on EITF Issue No. 03-11, "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not `Held for Trading Purposes' as Defined in Issue No. 02-3." Prior to Issue No. 03-11, no specific guidance existed to address the classification in the income statement of derivative contracts that are not held for trading purposes. The consensus states that determining whether realized gains and losses on contracts that physically deliver and are not held for trading purposes should be reported on a net or gross basis is a matter of judgment that depends on the relevant facts and circumstances. PSNH has derivative sales contracts, and though these contracts may result in physical delivery, management has determined, based on the relevant facts and circumstances, that because these transactions are part of PSNH's procurement activities, inclusion in operating expenses better depicts these sales activities. At December 31, 2003, settlements of these derivative contracts that are not held for trading purposes, though previously reported on a gross basis, are reported on a net basis in expenses. Sales amounting to $48.9 million for the first nine months of 2003 were reflected as revenues in quarterly reporting but are now included in expenses. In Issue No. 03-11, the EITF did not provide transition guidance, which management could have interpreted as becoming applicable on October 1, 2003 for revenues from that date forward. However, management applied its conclusion on net or gross reporting to all periods presented to enhance comparability. Operating revenues and fuel, purchased and net interchange power for the year ended December 31, 2003 reflect net reporting. The adoption of net reporting had no effect on net income. The impact on previously reported 2002 and 2001 amounts is as follows: --------------------------------------------------------------------- For the Years Ended December 31, --------------------------------------------------------------------- (Millions of Dollars) 2002 2001 --------------------------------------------------------------------- Operating Revenues: As previously reported $1,046.8 $1,171.6 Impact of reclassifications (99.6) (207.2) --------------------------------------------------------------------- As currently reported $ 947.2 $ 964.4 --------------------------------------------------------------------- Fuel, Purchased and Net Interchange Power: As previously reported $ 388.0 $ 713.6 Impact of reclassifications (99.6) (207.2) --------------------------------------------------------------------- As currently reported $ 288.4 $ 506.4 --------------------------------------------------------------------- Employers' Disclosures about Pensions and Other Postretirement Benefits: In December 2003, the FASB issued SFAS No. 132 (Revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits," (SFAS No. 132R). This statement revises employers' disclosures about pension plans and other postretirement benefit plans, requires additional disclosures about the assets, obligations, cash flows, and the net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans and requires companies to disclose various elements of pension and postretirement benefit costs in interim period financial statements. The revisions in SFAS No. 132R are effective for 2003, and PSNH included the disclosures required by SFAS No. 132R in this annual report. For the required disclosures, see Note 5, "Pension Benefits and Postretirement Benefits Other Than Pensions," to the consolidated financial statements. Liabilities and Equity: In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards on how to classify and measure certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and was otherwise effective for PSNH for the third quarter of 2003. The adoption of SFAS No. 150 did not have an impact on PSNH's consolidated financial statements. Consolidation of Variable Interest Entities: In December 2003, the FASB issued a revised version of FASB Interpretation No. (FIN) 46 "Consolidation of Variable Interest Entities," (FIN 46R). FIN 46R is effective for PSNH for the first quarter of 2004 but is not expected to have an impact on PSNH's consolidated financial statements. D. GUARANTEES At December 31, 2003, NU had outstanding guarantees to PSNH of $4.4 million. PSNH has no guarantees outstanding at December 31, 2003. E. REVENUES PSNH retail revenues are based on rates approved by the NHPUC. These regulated rates are applied to customers' use of energy to calculate a bill. In general, rates can only be changed through formal proceedings with the NHPUC. NHPUC utilizes regulatory commission-approved tracking mechanisms to track the recovery of certain incurred costs. The tracking mechanisms allow for rates to be changed periodically, with overcollections refunded to customers or underrecollections collected from customers in future periods. Unbilled revenues represent an estimate of electricity delivered to customers that has not been billed. Unbilled revenues represent assets on the balance sheet that become accounts receivable in the following month as customers are billed. Billed revenues are based on meter readings. Unbilled revenues are estimated monthly using the requirements method. The requirements method utilizes the total monthly volume of electricity or gas delivered to the system and applies a delivery efficiency factor to reduce the total monthly volume by an estimate of delivery losses in order to calculate total estimated monthly sales to customers. The total estimated monthly sales amount less total monthly billed sales amount results in a monthly estimate of unbilled sales. Unbilled revenues are estimated by applying an average rate to the estimate of unbilled sales. In 2003, the unbilled sales estimates for PSNH were tested using the cycle method. The cycle method uses the billed sales from each meter reading cycle and an estimate of unbilled days in each month based on the meter reading schedule. The cycle method is historically more accurate than the requirements method when used in a mostly weather-neutral month. The cycle method resulted in adjustments to the estimate of unbilled revenues that had a positive after-tax earnings impact on PSNH of $3.3 million in 2003. Wholesale transmission revenues are based on rates and formulas that are approved by the FERC. Most of PSNH's wholesale transmission revenues are collected through a combination of the New England Regional Network Service (RNS) tariff and PSNH's Local Network Service (LNS) tariff. The RNS tariff, which is administered by the New England Independent System Operator, recovers the revenue requirements associated with transmission facilities that are deemed by the FERC to be Pool Transmission Facilities. The LNS tariff which was accepted by the FERC on October 22, 2003, provides for the recovery of PSNH's total transmission revenue requirements, net of revenue credits received from various rate components, including revenues received under the RNS rates. F. ACCOUNTING FOR ENERGY CONTRACTS The accounting treatment for energy contracts entered into varies between contracts and depends on the intended use of the particular contract and on whether or not the contracts are derivatives. Non-derivative contracts that are entered into for the normal purchase or sale of energy to customers that will result in physical delivery are recorded at the point of delivery under accrual accounting. Derivative contracts that are entered into for the normal purchase and sale of energy and meet the normal purchase and sale exception to derivative accounting, as defined in SFAS No. 133 and amended by SFAS No. 149 (normal), are also recorded at the point of delivery under accrual accounting. Both non-derivative contracts and derivative contracts that are normal are recorded in revenues when these contracts represent sales, and recorded in fuel, purchased and net interchange power when these contracts represent purchases, except for sales contracts that relate to procurement activities. These contracts are recorded in fuel, purchased and net interchange power when settled. Derivative contracts that are not held for trading purposes and that do not qualify as normal purchases and sales or hedges are non-trading derivative contracts. These contracts are recorded on the consolidated balance sheets at fair value, and since management believes that these costs will continue to be recovered or refunded in rates, the changes in fair value are offset by regulatory assets and liabilities. For further information regarding these contracts and their accounting, see Note 4, "Derivative Instruments and Risk Management Activities," to the consolidated financial statements. G. REGULATORY ACCOUNTING The accounting policies of PSNH conform to accounting principles generally accepted in the United States of America applicable to rate-regulated enterprises and historically reflect the effects of the rate-making process in accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The transmission, distribution and generation businesses of PSNH continue to be cost-of-service rate regulated. The state's electric utility industry restructuring laws have been modified to delay the sale of PSNH's fossil and hydroelectric generation assets until at least April of 2006. There has been no regulatory action to the contrary, and management currently has no plans to divest these generation assets. As the NHPUC has allowed and is expected to continue to allow rate recovery of a return on and recovery of these assets, as well as all operating expenses, PSNH meets the criteria for the application of SFAS No. 71. Stranded costs related to generation assets, to the extent not currently recovered in rates, are deferred as Part 3 stranded costs under the "Agreement to Settle PSNH Restructuring" (Restructuring Settlement). Part 3 stranded costs are nonsecuritized regulatory assets which must be recovered by a recovery end date determined in accordance with the Restructuring Settlement or be written off. Management believes the application of SFAS No. 71 to the portions of the aforementioned businesses continues to be appropriate. Management also believes it is probable that PSNH will recover their investments in long- lived assets, including regulatory assets. In addition, all material net regulatory assets are earning an equity return, except for securitized regulatory assets, which are not supported by equity. The components of regulatory assets are as follows: ---------------------------------------------------------------- At December 31, ---------------------------------------------------------------- (Millions of Dollars) 2003 2002 ---------------------------------------------------------------- Recoverable nuclear costs $ 33.3 $ 36.8 Securitized assets 465.3 505.4 Income taxes, net 44.2 96.5 Unrecovered contractual obligations 69.9 58.7 Recoverable energy costs 218.3 241.7 Other 138.4 87.0 ---------------------------------------------------------------- Totals $969.4 $1,026.1 ---------------------------------------------------------------- Recoverable Nuclear Costs: In March 2001, PSNH recorded a regulatory asset in conjunction with the sale of the Millstone nuclear units (Millstone) with an unamortized balance of $33.3 million and $36.8 million at December 31, 2003 and 2002, respectively, which is included in recoverable nuclear costs. Securitized Assets: In April 2001, PSNH issued rate reduction certificates in the amount of $525 million. PSNH used the majority of this amount to buy down its power contract with North Atlantic Energy Corporation (NAEC). The remaining balance is $427 million and $460 million at December 31, 2003 and 2002, respectively. In January 2002, PSNH issued an additional $50 million in rate reduction certificates and used the proceeds from this issuance to repay short-term debt that was incurred to buy out a purchased-power contract in December 2001. The remaining balance is $38 million and $46 million at December 31, 2003 and 2002, respectively. Securitized assets are being recovered over the amortization period of their associated rate reduction bonds. All outstanding rate reduction bonds of PSNH are scheduled to fully amortize by May 1, 2013. Income Taxes, Net: The tax effect of temporary differences (differences between the periods in which transactions affect income in the financial statements and the periods in which they affect the determination of taxable income) is accounted for in accordance with the rate-making treatment of the NHPUC and SFAS No. 109. Differences in income taxes between SFAS No. 109 and the rate-making treatment of the NHPUC are recorded as regulatory assets. For further information regarding income taxes, see Note 1H, "Summary of Significant Accounting Policies - Income Taxes," and Note 12, "Income Tax Expense," to the consolidated financial statements. Unrecovered Contractual Obligations: PSNH, under the terms of contracts with the Yankee Companies, is responsible for their proportionate share of the remaining costs of the units, including decommissioning. These amounts are recorded as unrecovered contractual obligations and are recovered as stranded costs. During 2002, PSNH was notified by the Yankee Companies that the estimated cost of decommissioning their units had increased over prior estimates due to higher anticipated costs for spent fuel storage, security and liability and property insurance. In December 2002, PSNH recorded an additional $23.6 million in deferred contractual obligations and a corresponding increase in the unrecovered contractual obligations regulatory asset as a result of these increased costs. In November 2003, the Connecticut Yankee Atomic Power Company (CYAPC) prepared an updated estimate of the cost of decommissioning its nuclear unit. PSNH's aggregate share of the estimated increased cost is $17.1 million. PSNH recorded an additional $17.1 million in deferred contractual obligations and a corresponding increase in the unrecovered contractual obligations regulatory asset as a result of these increased costs. Recoverable Energy Costs: In conjunction with the implementation of restructuring under the Restructuring Settlement on May 1, 2001, PSNH's fuel and purchased-power adjustment clause (FPPAC) was discontinued. At December 31, 2003 and 2002, PSNH had $162.2 million and $179.6 million, respectively, of recoverable energy costs deferred under the FPPAC, including previous deferrals of purchases from IPPs. Under the Restructuring Settlement, the FPPAC deferrals are recovered as a Part 3 stranded cost through a stranded cost recovery charge (SCRC). Also included in PSNH's recoverable energy costs are costs associated with certain contractual purchases from IPPs that had previously been included in the FPPAC. These costs are treated as Part 3 stranded costs and amounted to $56.1 million and $62.1 million at December 31, 2003 and 2002, respectively. PSNH's recoverable energy costs are Part 3 stranded costs which are nonsecuritized regulatory assets which must be recovered by a recovery end date to be determined in accordance with the Restructuring Settlement or which will be written off. Based on current projections, PSNH expects to fully recover all of its Part 3 stranded costs by the recovery end date. Regulatory Liabilities: PSNH maintained $272.1 million and $254.1 million of regulatory liabilities at December 31, 2003 and 2002, respectively. These amounts are comprised of the following: ---------------------------------------------------------------- At December 31, ---------------------------------------------------------------- (Millions of Dollars) 2003 2002 ---------------------------------------------------------------- Cost of removal $ 88.0 $ 67.0 SCRC overcollections 160.4 166.2 Regulatory liabilities offsetting derivative assets 1.5 - Other regulatory liabilities 22.2 20.9 ---------------------------------------------------------------- Totals $272.1 $254.1 ---------------------------------------------------------------- Under SFAS No. 71, PSNH currently recovers amounts in rates for future costs of removal of plant assets. Historically, these amounts were included as a component of accumulated depreciation until spent. These amounts were reclassified to regulatory liabilities on the accompanying consolidated balance sheets. The SCRC allows PSNH to recover its stranded costs. The regulatory liabilities offsetting derivative assets relate to the fair value of purchase and sales contracts used for market discovery of future procurement activities that will benefit ratepayers in the future. PSNH also has financial transmission rights (FTR) contracts which are derivative assets offset by a regulatory liability. H. INCOME TAXES The tax effect of temporary differences (differences between the periods in which transactions affect income in the financial statements and the periods in which they affect the determination of taxable income) is accounted for in accordance with the rate-making treatment of the applicable regulatory commissions and SFAS No. 109. The tax effects of temporary differences that give rise to the net accumulated deferred tax obligation are as follows: ---------------------------------------------------------------- At December 31, ---------------------------------------------------------------- (Millions of Dollars) 2003 2002 ---------------------------------------------------------------- Deferred tax liabilities: Accelerated depreciation and other plant-related differences $117.6 $100.0 Regulatory amounts: Securitized contract termination costs and other 173.3 183.0 Deferrals of fuel and small power producer costs 91.9 94.0 Income tax gross-up 17.8 38.0 Other 68.7 66.1 ---------------------------------------------------------------- Total deferred tax liabilities 469.3 481.1 ---------------------------------------------------------------- Deferred tax assets: Regulatory deferrals 96.7 90.2 Employee benefits 21.0 18.7 Income tax gross-up 1.0 1.2 Other 11.7 11.1 ---------------------------------------------------------------- Total deferred tax assets 130.4 121.2 ---------------------------------------------------------------- Totals $338.9 $359.9 ---------------------------------------------------------------- NU and its subsidiaries, including PSNH, file a consolidated federal income tax return. Likewise NU and its subsidiaries, including PSNH, file state income tax returns, with some filing in more than one state. NU and its subsidiaries, including PSNH, are parties to a tax allocation agreement under which each taxable subsidiary pays a quarterly estimate (or settlement) of no more than it would have otherwise paid had it filed a stand-alone tax return. Generally these quarterly estimated payments are settled to actual payments within three months after filing the associated return. Subsidiaries generating tax losses are similarly paid for their losses when utilized. In 2000, NU requested from the Internal Revenue Service (IRS) a Private Letter Ruling (PLR) regarding the treatment of unamortized investment tax credits (ITC) and excess deferred income taxes (EDIT) related to generation assets that have been sold. EDIT are temporary differences between book and taxable income that were recorded when the federal statutory tax rate was higher than it is now or when those differences were expected to be resolved. The PLR addresses whether or not EDIT and ITC can be returned to customers, which without a PLR management believes would represent a violation of current tax law. The IRS declared a moratorium on issuing PLRs until final regulations on the return of EDIT and ITC to regulated customers are issued by the Treasury Department. Proposed regulations were issued in March 2003, and a hearing took place in June 2003. The proposed new regulations would allow the return of EDIT and ITC to regulated customers without violating the tax law. Also, under the proposed regulations, a company could elect to apply the regulation retroactively. The Treasury Department is currently deliberating the comments received at the hearing. If final regulations consistent with the proposed regulations are issued, then there could be an impact on PSNH's financial statements. I. DEPRECIATION The provision for depreciation on utility assets is calculated using the straight-line method based on the estimated remaining useful lives of depreciable plant-in-service, which range primarily from 14 years to 75 years, adjusted for salvage value and removal costs, as approved by the appropriate regulatory agency where applicable. Depreciation rates are applied to plant-in-service from the time it is placed in service. When plant is retired from service, the original cost of the plant, including costs of removal less salvage, is charged to the accumulated provision for depreciation. Cost of removal is now classified as a regulatory liability. The depreciation rates for the several classes of electric utility plant-in- service are equivalent to a composite rate of 3 percent in 2003, 2002 and 2001. J. EQUITY INVESTMENTS AND JOINTLY OWNED ELECTRIC UTILITY PLANT Regional Nuclear Companies: At December 31, 2003, PSNH owns common stock in three regional nuclear companies (Yankee Companies). PSNH's ownership interests in the Yankee Companies at December 31, 2003, which are accounted for on the equity method are 5 percent of the CYAPC, 7 percent of the Yankee Atomic Electric Company (YAEC) and 5 percent of the Maine Yankee Atomic Power Company (MYAPC). Effective November 7, 2003, PSNH sold its collective 4.3 percent ownership interest in Vermont Yankee Nuclear Power Corporation (VYNPC). PSNH's total equity investment in the Yankee Companies at December 31, 2003 and 2002 is $4.6 million and $8 million respectively. Each of the remaining Yankee Companies owns a single nuclear generating plant which is being decommissioned. K. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION The allowance for funds used during construction (AFUDC) is a non-cash item that is included in the cost of utility plant and represents the cost of borrowed and equity funds used to finance construction. The portion of AFUDC attributable to borrowed funds is recorded as a reduction of other interest expense, and the cost of equity funds is recorded as other income on the consolidated statements of income: ----------------------------------------------------------- For the Years Ended December 31, ----------------------------------------------------------- (Millions of Dollars, except percentages) 2003 2002 2001 ----------------------------------------------------------- Borrowed funds $0.6 $1.0 $0.9 Equity funds 0.6 0.6 1.7 ----------------------------------------------------------- Totals $1.2 $1.6 $2.6 ----------------------------------------------------------- Average AFUDC rates 3.9% 4.7% 8.8% ----------------------------------------------------------- L. ASSET RETIREMENT OBLIGATIONS In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement requires that legal obligations associated with the retirement of property, plant and equipment be recognized as a liability at fair value when incurred and when a reasonable estimate of the fair value of the liability can be made. SFAS No. 143 was effective on January 1, 2003, for PSNH. Management has completed its review process for potential asset retirement obligations (ARO) and has not identified any material AROs that have been incurred. However, management identified certain removal obligations that arise in the ordinary course of business or have a low probability of occurring. These types of obligations primarily relate to transmission and distribution lines and poles, telecommunication towers, transmission cables and certain FERC or state regulatory agency re-licensing issues. These obligations are AROs that have not been incurred or are not material in nature. A portion of PSNH's rates is intended to recover the cost of removal of certain utility assets. The amounts recovered do not represent AROs. At December 31, 2003 and 2002, cost of removal was approximately $88 million and $67 million, respectively. M. MATERIALS AND SUPPLIES Materials and supplies include materials purchased primarily for construction, operation and maintenance (O&M) purposes. Materials and supplies are valued at the lower of average cost or market. N. SPECIAL DEPOSITS Special deposits represents $30.1 million in escrow that PSNH funded to acquire Connecticut Valley Electric Company, Inc. on January 1, 2004. O. OTHER (LOSS)/INCOME The pre-tax components of PSNH's other (loss)/income items are as follows: --------------------------------------------------------------------- For the Years Ended December 31, --------------------------------------------------------------------- (Millions of Dollars) 2003 2002 2001 --------------------------------------------------------------------- Gain related to Millstone sale $ - $ - $25.9 Investment income 0.1 1.2 2.3 Charitable donations (0.4) (0.4) (0.7) Other (4.7) (2.5) 9.1 --------------------------------------------------------------------- Totals $(5.0) $(1.7) $36.6 --------------------------------------------------------------------- 2. SEABROOK POWER CONTRACTS ------------------------------------------------------------------------------- PSNH and NAEC had entered into two power contracts that previously obligated PSNH to purchase NAEC's 35.98 percent ownership of the capacity and output of Seabrook for the term of Seabrook's operating license. NAEC's cost of service included all of its Seabrook-related costs, including O&M expenses, fuel expense, income and property tax expense, depreciation expense, certain overhead and other costs, and a return on its allowed investment. With the implementation of the Settlement Agreement, PSNH and NAEC restructured the power contracts and bought down the value of the Seabrook plant asset, as defined within the Settlement Agreement, to $100 million. On November 1, 2002, NAEC consummated the sale of its investment in Seabrook and refunded the remaining proceeds from the sale to PSNH through the Seabrook Power Contracts. With the sale of NAEC's ownership interest in Seabrook, sales of capacity and output under the Seabrook Power Contracts ended. 3. SHORT-TERM DEBT ------------------------------------------------------------------------------- Limits: The amount of short-term borrowings that may be incurred by PSNH is subject to periodic approval by either the SEC under the 1935 Act or by the NHPUC. On June 30, 2003, the SEC granted authorization allowing PSNH to incur total short-term borrowings up to a maximum of $100 million through June 30, 2006, with authorization for borrowings from the NU Money Pool (Pool) granted through June 30, 2004. PSNH is authorized by the NHPUC to incur short-term borrowings up to a maximum of $100 million. Credit Agreement: On November 10, 2003, PSNH, CL&P, WMECO and Yankee Gas entered into a 364-day unsecured revolving credit facility for $300 million. This facility replaces a similar credit facility that expired on November 11, 2003 and PSNH may draw up to $100 million under this facility. Unless extended, the credit facility will expire on November 8, 2004. At December 31, 2003 and 2002, there were $10 million and no borrowings, respectively, under these credit facilities. Under the aforementioned credit agreement, PSNH may borrow at fixed or variable rates plus an applicable margin based upon certain debt ratings, as rated by the lower of Standard and Poor's or Moody's Investors Service. The weighted average interest rate on PSNH's notes payable to banks outstanding on December 31, 2003 was 2 percent. Under the credit agreement, PSNH must comply with certain financial and non- financial covenants as are customarily included in such agreements, including but not limited to, consolidated debt ratios and interest coverage ratios. The most restrictive financial covenant is the interest coverage ratio. PSNH currently is and expects to remain in compliance with these covenants. Pool: PSNH is a member of the Pool. The Pool provides a more efficient use of the cash resources of NU and reduces outside short-term borrowings. NUSCO administers the Pool as agent for the member companies. Short-term borrowing needs of the member companies are first met with available funds of other member companies, including funds borrowed by NU parent. NU parent may lend to the Pool but may not borrow. Funds may be withdrawn from or repaid to the Pool at any time without prior notice. Investing and borrowing subsidiaries receive or pay interest based on the average daily federal funds rate. Borrowings based on loans from NU parent, however, bear interest at NU parent's cost and must be repaid based upon the terms of NU parent's original borrowing. At December 31, 2003 and 2002, PSNH had borrowings of $48.9 million and lendings of $23 million to the Pool, respectively. The interest rate on borrowings from and lendings to the Pool at December 31, 2003 and 2002 was 1 percent and 1.2 percent, respectively. 4. DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT ACTIVITIES ------------------------------------------------------------------------------- A. DERIVATIVE INSTRUMENTS Effective January 1, 2001, PSNH adopted SFAS No. 133, as amended. Derivatives that do not meet the definition of a cash flow hedge and cannot be designated as being used for normal purchases or normal sales are also recorded at fair value with changes in fair value included in earnings unless recorded as a regulatory asset or liability. Derivative contracts that are entered into as a normal purchase or sale and will result in physical delivery, and are documented as such, are recorded under accrual accounting. For information regarding accounting changes related to derivative instruments, see Note 1C, "Summary of Significant Accounting Policies - New Accounting Standards," to the consolidated financial statements. In 2003, there were changes to interpretations of as well as an amendment to SFAS No. 133, and the FASB continues to consider changes that could affect the way PSNH records and discloses derivative and hedging activities. PSNH has energy contracts that are subject to unplanned netting and do not meet the definition of capacity contracts. These non-trading derivative contracts were recorded at fair value at December 31, 2003 as derivative assets of approximately $1.4 million and derivative liabilities with a fair value of approximately $1.4 million with offsetting regulatory assets and regulatory liabilities, respectively. To mitigate the risk associated with certain supply contracts, PSNH purchased FTRs. FTRs are derivatives that cannot qualify for the normal purchases and sales exception. The fair value of these FTR non-trading derivatives at December 31, 2003 was an asset of $0.1 million. PSNH had no non-trading derivatives at December 31, 2002 that were required to be recorded at fair value. B. RISK MANAGEMENT ACTIVITIES PSNH is subject to credit risk from certain long-term or high-volume supply contracts with energy marketing companies. Credit risks and market risks at PSNH are monitored regularly by a Risk Oversight Council operating outside of the business units that create or actively manage these risk exposures to ensure compliance with NU's stated risk management policies. 5. PENSION BENEFITS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS ------------------------------------------------------------------------------- Pension Benefits: PSNH participates in a uniform noncontributory defined benefit retirement plan (Pension Plan) covering substantially all regular NU employees. Benefits are based on years of service and the employees' highest eligible compensation during 60 consecutive months of employment. Pre-tax pension expense/(income) was $6.8 million of expense in 2003, $0.6 million of expense in 2002, and $3.9 million of income in 2001. These amounts exclude pension settlements, curtailments and net special termination expense of $1.3 million in 2001. PSNH uses a December 31 measurement date for the Pension Plan. Pension expense/(income)attributable to earnings is as follows: ------------------------------------------------------------------------- For the Years Ended December 31, ------------------------------------------------------------------------- (Millions of Dollars) 2003 2002 2001 ------------------------------------------------------------------------- Pension expense/(income) before settlements, curtailments and special termination benefits $ 6.8 $ 0.6 $(3.9) Net pension expense/(income) capitalized as utility plant (2.0) (0.2) (1.4) ------------------------------------------------------------------------- Net pension expense/(income) before settlements, curtailments and special termination benefits 4.8 0.4 (2.5) Settlements, curtailments and special termination benefits reflected in earnings - - 1.2 ------------------------------------------------------------------------- Total pension expense/(income) included in earnings $ 4.8 $ 0.4 $(1.3) ------------------------------------------------------------------------- Pension Settlements, Curtailments and Special Termination Benefits: There were no settlements, curtailments or special termination benefits in 2002 and 2003. In conjunction with the Voluntary Separation Program (VSP) that was announced in December 2000, PSNH recorded $0.5 million in settlement income and $0.3 million in curtailment income in 2001. The VSP was intended to reduce the generation-related support staff between March 1, 2001 and February 28, 2002, and was available to non-bargaining unit employees who, by February 1, 2002, were at least age 50, with a minimum of five years of credited service, and at December 15, 2000, were assigned to certain groups and in eligible job classifications. One component of the VSP included special pension termination benefits equal to the greater of 5 years added to both age and credited service of eligible participants or two weeks of pay for each year of service subject to a minimum level of 12 weeks and a maximum of 52 weeks for eligible participants. The special pension termination benefits expense associated with the VSP totaled $2.1 million in 2001. The net total of the settlement and curtailment income and the special termination benefits expense was $1.3 million, of which $1.2 million of costs were included in operating expenses, $0.1 million was deferred as a regulatory liability and is expected to be returned to customers. Postretirement Benefits Other Than Pensions (PBOP): PSNH also provides certain health care benefits, primarily medical and dental, and life insurance benefits through a benefit plan to retired employees (PBOP Plan). These benefits are available for employees retiring from PSNH who have met specified service requirements. For current employees and certain retirees, the total benefit is limited to two times the 1993 per retiree health care cost. These costs are charged to expense over the estimated work life of the employee. PSNH uses a December 31 measurement date for the PBOP Plan. PSNH annually funds postretirement costs through external trusts with amounts that have been rate-recovered and which also are tax deductible. In 2002, the PBOP Plan was amended to change the claims experience basis, to increase minimum retiree contributions and to reduce the cap on the company's subsidy to the dental plan. These amendments resulted in a $4.6 million decrease in PSNH's benefit obligation under the PBOP Plan at December 31, 2002. Impact of New Medicare Changes on PBOP: On December 8, 2003, the President signed into law a bill that expands Medicare, primarily by adding a prescription drug benefit starting in 2006 for Medicare-eligible retirees as well as a federal subsidy to plan sponsors of retiree health care benefit plans who provide a prescription drug benefit at least actuarially equivalent to the new Medicare benefit. Based on the current PBOP Plan provisions, PSNH's actuaries believe that PSNH will qualify for this federal subsidy because the actuarial value of PSNH's PBOP Plan is estimated to be 60 percent greater than that of the standard Medicare benefit. PSNH will directly benefit from the federal subsidy for retirees who retired before 1993. For other retirees, management does not believe that PSNH will benefit from the subsidy because PSNH's cost support for these retirees is capped at a fixed dollar commitment. The aggregate effect of recognizing the Medicare change is a decrease to the PBOP benefit obligation of $4.4 million. This amount includes the present value of the future government subsidy, which was estimated by discounting the expected payments using the actuarial assumptions used to determine the PBOP liability at December 31, 2003. Also included in the $4.4 million estimate is a decrease in the assumed participation in NU's retiree health plan from 95 percent to 85 percent for future retirees, which reflects the expectation that the Medicare prescription benefit will produce insurer- sponsored health plans that are more financially attractive to future retirees. The per capita claims cost estimate was not changed. Management reduced the PBOP benefit obligation as of December 31, 2003 by $4.4 million and recorded this amount as an actuarial gain within unrecognized net loss/(gain) in the tables that follow. The $4.4 million actuarial gain will be amortized beginning in 2004 as a reduction to PBOP expense over the future working lifetime of employees covered under the plan (approximately 13 years). PBOP expense in 2004 will also reflect a lower interest cost due to the reduction in the December 31, 2003 benefit obligation. Specific authoritative guidance on accounting for the effect of the Medicare federal subsidy on PBOP plans and amounts is pending from the FASB. When issued, that guidance could require PSNH to change the accounting described above and change the information reported herein. PBOP Settlements, Curtailments and Special Termination Benefits: There were no settlements, curtailments or special termination benefits in 2002 and 2003. In 2001, PSNH recorded PBOP special termination benefits expense totaling $0.2 million in connection with the VSP. This amount was recorded as a regulatory asset and collected through regulated utility rates in 2002. The following table represents information on the plans' benefit obligation, fair value of plan assets, and the respective plans' funded status:
---------------------------------------------------------------------------------------------------------- At December 31, ---------------------------------------------------------------------------------------------------------- Pension Benefits Postretirement Benefits ---------------------------------------------------------------------------------------------------------- (Millions of Dollars) 2003 2002 2003 2002 ---------------------------------------------------------------------------------------------------------- Change in benefit obligation Benefit obligation at beginning of year $(260.9) $(227.9) $(63.7) $(65.4) Service cost (6.4) (5.8) (1.1) (1.1) Interest cost (17.3) (16.8) (4.5) (4.6) Medicare impact - - 4.4 - Plan amendment - (1.8) - 4.6 Transfers - (0.5) - - Actuarial loss (17.3) (20.6) (8.5) (4.1) Benefits paid - excluding lump sum payments 12.9 12.3 6.6 6.9 Benefits paid - lump sum payments - 0.2 - - Curtailments and settlements - - - - Special termination benefits - - - - ---------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $(289.0) $(260.9) $(66.8) $(63.7) ---------------------------------------------------------------------------------------------------------- Change in plan assets Fair value of plan assets at beginning of year $ 163.5 $ 196.6 $ 24.4 $ 28.4 Actual return on plan assets 41.3 (21.1) 5.7 (2.5) Employer contribution - - 6.2 5.4 Plan asset transfer in - 0.5 - - Benefits paid - excluding lump sum payments (12.9) (12.3) (6.6) (6.9) Benefits paid - lump sum payments - (0.2) - - ---------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $ 191.9 $ 163.5 $ 29.7 $ 24.4 ---------------------------------------------------------------------------------------------------------- Funded status at December 31 $ (97.1) $ (97.4) $(37.1) $(39.3) Unrecognized transition (asset)/obligation 2.0 2.3 22.4 24.8 Unrecognized prior service cost 13.0 14.5 - - Unrecognized net loss/(gain) 37.3 42.7 14.7 14.4 ---------------------------------------------------------------------------------------------------------- Prepaid/(accrued) benefit cost $ (44.8) $ (37.9) $ - $ (0.1) ----------------------------------------------------------------------------------------------------------
The accumulated benefit obligation for the Pension Plan was $243.6 million and $218.4 million at December 31, 2003 and 2002, respectively. Plan assets for the entire Pension Plan on an NU consolidated basis are approximately $240 million more than the accumulated benefit obligation at December 31, 2003. The following actuarial assumptions were used in calculating the plans' year end funded status: ------------------------------------------------------------------------------- At December 31, ------------------------------------------------------------------------------- Balance Sheets Pension Benefits Postretirement Benefits ------------------------------------------------------------------------------- 2003 2002 2003 2002 ------------------------------------------------------------------------------- Discount rate 6.25% 6.75% 6.25% 6.75% Compensation/progression rate 3.75% 4.00% N/A N/A Health care cost trend rate N/A N/A 9.00% 10.00% ------------------------------------------------------------------------------- The components of net periodic (income)/expense are as follows:
----------------------------------------------------------------------------------------------------------------------- For the Years Ended December 31, ----------------------------------------------------------------------------------------------------------------------- Pension Benefits Postretirement Benefits ----------------------------------------------------------------------------------------------------------------------- (Millions of Dollars) 2003 2002 2001 2003 2002 2001 ----------------------------------------------------------------------------------------------------------------------- Service cost $ 6.4 $ 5.8 $ 5.0 $ 1.1 $ 1.1 $ 1.1 Interest cost 17.3 16.8 15.8 4.5 4.6 4.3 Expected return on plan assets (18.2) (20.3) (20.9) (2.6) (2.9) (2.9) Amortization of unrecognized net transition (asset)/obligation 0.3 0.3 0.3 2.5 2.8 2.9 Amortization of prior service cost 1.5 1.4 1.3 - - - Amortization of actuarial gain (0.5) (3.4) (5.4) - - - Other amortization, net - - - 0.7 (0.3) (1.1) ----------------------------------------------------------------------------------------------------------------------- Net periodic (income)/expense - before settlements, curtailments and special termination benefits 6.8 0.6 (3.9) 6.2 5.3 4.3 ----------------------------------------------------------------------------------------------------------------------- Settlement income - - (0.5) - - - Curtailment income - - (0.3) - - - Special termination benefits expense - - 2.1 - - 0.2 ----------------------------------------------------------------------------------------------------------------------- Total - settlements, curtailments and special termination benefits - - 1.3 - - 0.2 ---------------------------------------------------------------------------------------------------------------------- Total - net periodic (income)/expense $ 6.8 $ 0.6 $ (2.6) $ 6.2 $ 5.3 $ 4.5 -----------------------------------------------------------------------------------------------------------------------
For calculating pension and postretirement benefit income and expense amounts, the following assumptions were used:
----------------------------------------------------------------------------------------- For the Years Ended December 31, ----------------------------------------------------------------------------------------- Statements of Income Pension Benefits Postretirement Benefits ----------------------------------------------------------------------------------------- 2003 2002 2001 2003 2002 2001 ----------------------------------------------------------------------------------------- Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50% Expected long-term rate of return 8.75% 9.25% 9.50% 8.75% 9.25% 9.50% Compensation/progression rate 4.00% 4.25% 4.50% N/A N/A N/A -----------------------------------------------------------------------------------------
The following table represents the PBOP assumed health care cost trend rate for the next year and the assumed ultimate trend rate: -------------------------------------------------------------------- Year Following December 31, --------------------------------------------------------------------- 2003 2002 --------------------------------------------------------------------- Health care cost trend rate assumed for next year 8.00% 9.00% Rate to which health care cost trend rate is assumed to decline (the ultimate trend rate) 5.00% 5.00% Year that the rate reaches the ultimate trend rate 2007 2007 --------------------------------------------------------------------- The annual per capita cost of covered health care benefits was assumed to decrease by one percentage point each year through 2007. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. The effect of changing the assumed health care cost trend rate by one percentage point in each year would have the following effects: --------------------------------------------------------------------- One Percentage One Percentage (Millions of Dollars) Point Increase Point Decrease --------------------------------------------------------------------- Effect on total service and interest cost components $ 0.1 $(0.1) Effect on postretirement benefit obligation $ 2.0 $(1.8) --------------------------------------------------------------------- PSNH's investment strategy for its Pension Plan and PBOP Plan is to maximize the long-term rate of return on those plans' assets within an acceptable level of risk. The investment strategy establishes target allocations, which are regularly reviewed and periodically rebalanced. PSNH's expected long- term rates of return on Pension Plan assets and PBOP Plan assets are based on these target asset allocation assumptions and related expected long-term rates of return. In developing its expected long-term rate of return assumptions for the Pension Plan and the PBOP Plan, PSNH also evaluated input from actuaries, consultants and economists as well as long-term inflation assumptions and PSNH's historical 20-year compounded return of approximately 11 percent. The Pension Plan's and PBOP Plan's target asset allocation assumptions and expected long-term rate of return assumptions by asset category are as follows:
----------------------------------------------------------------------------------------------------------------- At December 31, ----------------------------------------------------------------------------------------------------------------- Pension Benefits Postretirement Benefits ----------------------------------------------------------------------------------------------------------------- 2003 2002 2003 2002 ----------------------------------------------------------------------------------------------------------------- Target Assumed Target Assumed Target Assumed Target Assumed Asset Rate of Asset Rate of Asset Rate of Asset Rate of Asset Category Allocation Return Allocation Return Allocation Return Allocation Return ----------------------------------------------------------------------------------------------------------------- Equity securities: United States 45.00% 9.25% 45.00% 9.75% 55.00% 9.25% 55.00% 9.75% Non-United States 14.00% 9.25% 14.00% 9.75% 11.00% 9.25% - - Emerging markets 3.00% 10.25% 3.00% 10.75% 2.00% 10.25% - - Private 8.00% 14.25% 8.00% 14.75% - - - - Debt Securities: Fixed income 20.00% 5.50% 20.00% 6.25% 27.00% 5.50% 45.00% 6.25% High yield fixed income 5.00% 7.50% 5.00% 7.50% 5.00% 7.50% - - Real estate 5.00% 7.50% 5.00% 7.50% - - - - -----------------------------------------------------------------------------------------------------------------
The actual asset allocations at December 31, 2003 and 2002, approximated these target asset allocations. The plans' actual weighted-average asset allocations by asset category are as follows: -------------------------------------------------------------------------- At December 31, -------------------------------------------------------------------------- Postretirement Pension Benefits Benefits -------------------------------------------------------------------------- Asset Category 2003 2002 2003 2002 -------------------------------------------------------------------------- Equity securities: United States 47.00% 46.00% 59.00% 55.00% Non-United States 18.00% 17.00% 12.00% - Emerging markets 3.00% 3.00% 1.00% - Private 3.00% 3.00% - - Debt Securities: Fixed income 19.00% 21.00% 25.00% 45.00% High yield fixed income 5.00% 5.00% 3.00% - Real estate 5.00% 5.00% - - ------------------------------------------------------------------------- Total 100.00% 100.00% 100.00% 100.00% -------------------------------------------------------------------------- Currently, PSNH's policy is to annually fund an amount at least equal to that which will satisfy the requirements of the Employee Retirement Income Security Act and Internal Revenue Code. PSNH does not expect to make any contributions to the Pension Plan in 2004 and expects to make $7 million in contributions to the PBOP Plan in 2004. Postretirement health plan assets for non-union employees are subject to federal income taxes. 6. NUCLEAR GENERATION ASSET DIVESTITURES ------------------------------------------------------------------------------- Seabrook: On November 1, 2002, NAEC consummated the sale of its 35.98 percent combined ownership interest in Seabrook to a subsidiary of FPL Group, Inc. (FPL). CL&P, NAEC and certain other of the joint owners collectively sold 88.2 percent of Seabrook to FPL. NAEC received approximately $331 million of total cash proceeds from the sale of Seabrook. A portion of this cash was used to repay all $90 million of NAEC's outstanding debt and other short-term debt, to return a portion of NAEC's equity to NU and was used to pay approximately $93 million in taxes. The remaining proceeds received by NAEC were refunded to PSNH through the Seabrook Power Contracts. As part of the sale, FPL assumed responsibility for decommissioning Seabrook. VYNPC: On July 31, 2002, VYNPC consummated the sale of its nuclear generating plant to a subsidiary of Entergy Corporation (Entergy) for approximately $180 million. As part of the sale, Entergy assumed responsibility for decommissioning VYNPC's nuclear generating unit. On November 7, 2003, PSNH sold its 4.3 percent ownership interest in VYNPC. PSNH will continue to buy approximately 4 percent of the plant's output through March 2012 at a range of fixed prices. 7. COMMITMENTS AND CONTINGENCIES ------------------------------------------------------------------------------- A. RESTRUCTURING AND RATE MATTERS SCRC Reconciliation Filing: On an annual basis, PSNH files with the NHPUC an SCRC reconciliation filing for the preceding calendar year. This filing includes the reconciliation of stranded cost revenues with stranded costs, and transition energy service (TS) revenues with TS costs. The NHPUC reviews the filing, including a prudence review of PSNH's generation operations. The 2003 SCRC filing is expected to be filed on May 1, 2004. Management does not expect the review of the 2003 SCRC filing to have a material effect on PSNH's net income or financial position. B. ENVIRONMENTAL MATTERS General: PSNH is subject to environmental laws and regulations intended to mitigate or remove the effect of past operations and improve or maintain the quality of the environment. These laws and regulations require the removal or the remedy of the effect on the environment of the disposal or release of certain specified hazardous substances at current and former operating sites. As such, PSNH has an active environmental auditing and training program and believes that it is substantially in compliance with all enacted laws and regulations. Environmental reserves are accrued using a probabilistic model approach when assessments indicate that it is probable that a liability has been incurred and an amount can be reasonably estimated. The probabilistic model approach estimates the liability based on the most likely action plan from a variety of available remediation options, ranging from no action to several different remedies ranging from establishing institutional controls to full site remediation and monitoring. These estimates are subjective in nature as they take into consideration several different remediation options at each specific site. The reliability and precision of these estimates can be affected by several factors including new information concerning either the level of contamination at the site, recently enacted laws and regulations or a change in cost estimates due to certain economic factors. The amounts recorded as environmental liabilities on the consolidated balance sheets represent management's best estimate of the liability for environmental costs and takes into consideration site assessment and remediation costs. Based on currently available information for estimated site assessment and remediation costs at December 31, 2003 and 2002, PSNH had $9.8 million and $10.8 million, respectively, recorded as environmental reserves. A reconciliation of the total amount reserved at December 31, 2003 and 2002 is as follows: -------------------------------------------------------------------- (Millions of Dollars) For the Years Ended December 31, -------------------------------------------------------------------- 2003 2002 -------------------------------------------------------------------- Balance at beginning of year $10.8 $11.4 Additions and adjustments 0.8 1.1 Payments (1.8) (1.7) -------------------------------------------------------------------- Balance at end of year $ 9.8 $10.8 -------------------------------------------------------------------- These liabilities are estimated on an undiscounted basis and do not assume that any amounts are recoverable from insurance companies or other third parties. The environmental reserve includes sites at different stages of discovery and remediation and does not include any unasserted claims. At December 31, 2003, there are two sites for which there are unasserted claims; however, any related remediation costs are not probable or estimable at this time. PSNH's environmental liability also takes into account recurring costs of managing hazardous substances and pollutants, mandated expenditures to remediate previously contaminated sites and any other infrequent and non- recurring clean up costs. PSNH currently has 15 sites included in the environmental reserve. Of those 15 sites, seven sites are in the remediation or long-term monitoring phase, three sites have had site assessments completed and the remaining five sites are in the preliminary stages of site assessment. In addition, capital expenditures related to environmental matters are expected to total approximately $84 million in aggregate for the years 2004 through 2008. Of the $84 million, $70 million relates to the proposed conversion of a 50 megawatt oil and coal burning unit at Schiller Station to a wood burning unit. The remainder primarily relates to other environmental remediation programs including programs associated with PSNH's hydroelectric generation assets. MGP Sites: Manufactured gas plant (MGP) sites comprise the largest portion of PSNH's environmental liability. MGPs are sites that manufactured gas from coal and produced certain byproducts that may pose risk to human health and the environment. At December 31, 2003 and 2002, $9.1 million and $8.7 million, respectively, represent amounts for the site assessment and remediation of MGPs. At December 31, 2003 and 2002, the two largest MGP sites comprise approximately 87 percent and 94 percent, respectively, of the total MGP environmental liability. PSNH currently has seven MGP sites included in its environmental liability and one contingent MGP site of which management is aware and for which costs are not probable or estimable at this time. Of the seven MGP sites, three are currently undergoing remediation with the remainder in the site assessment stage. CERCLA Matters: The Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and its' amendments or state equivalents impose joint and several strict liabilities, regardless of fault, upon generators of hazardous substances resulting in removal and remediation costs and environmental damages. Liabilities under these laws can be material and in some instances may be imposed without regard to fault or for past acts that may have been lawful at the time they occurred. PSNH has two superfund sites under CERCLA for which it has been notified that it is a potentially responsible party (PRP). For sites where there are other PRPs and PSNH is not managing the site assessment and remediation, the liability accrued represents PSNH's estimate of what it will need to pay to settle its obligations with respect to the site. It is possible that new information or future developments could require a reassessment of the potential exposure to related environmental matters. As this information becomes available management will continue to assess the potential exposure and adjust the reserves as necessary. Rate Recovery: PSNH has a rate recovery mechanism for environmental costs. C. NUCLEAR INSURANCE CONTINGENCIES In conjunction with the divestiture of Millstone in 2001 and Seabrook in 2002, PSNH terminated its nuclear insurance related to these plants, and PSNH has no further exposure for potential assessments related to Millstone and Seabrook. However, through its continuing association with Nuclear Electric Insurance Limited (NEIL) and CYAPC, NU is subject to potential retrospective assessments totaling $0.8 million under its respective NEIL insurance policies. D. LONG-TERM CONTRACTUAL ARRANGEMENTS VYNPC: Previously, under the terms of its agreement, PSNH paid its ownership (or entitlement) shares of costs, which included depreciation, O&M expenses, taxes, the estimated cost of decommissioning, and a return on invested capital to VYNPC and recorded these costs as purchased-power expenses. On July 31, 2002, VYNPC consummated the sale of its nuclear generating unit to a subsidiary of Entergy for approximately $180 million. Under the terms of the sale, PSNH will continue to buy approximately 4 percent of the plant's output through March 2012 at a range of fixed prices. The total cost of purchases under contracts with VYNPC amounted to $7.5 million in 2003, $6.9 million in 2002 and $6.5 million in 2001. Electricity Procurement Obligations: PSNH has entered into various arrangements for the purchase of electricity. The total cost of purchases under these arrangements amounted to $122.8 million in 2003, $121.2 million in 2002, and $144.4 million in 2001. These amounts are for independent power producer contracts and do not include PSNH's short-term power supply management. Hydro-Quebec: Along with other New England utilities, PSNH has entered into an agreement to support transmission and terminal facilities to import electricity from the Hydro-Quebec system in Canada. PSNH is obligated to pay, over a 30-year period ending in 2020, its proportionate share of the annual O&M expenses and capital costs of those facilities. Estimated Future Annual Costs: The estimated future annual costs of PSNH's significant long-term contractual arrangements are as follows: ------------------------------------------------------------------------------- (Millions of Dollars) 2004 2005 2006 2007 2008 Thereafter ------------------------------------------------------------------------------- VYNPC $ 7.4 $ 6.8 $ 7.1 $ 6.9 $ 7.0 $ 56.0 Electricity Procurement Contracts 121.3 123.6 124.8 53.6 27.6 240.2 Hydro-Quebec 7.9 7.6 7.1 6.3 6.0 96.0 ------------------------------------------------------------------------------- Totals $136.6 $138.0 $139.0 $66.8 $40.6 $392.2 ------------------------------------------------------------------------------- E. NUCLEAR DECOMMISSIONING AND PLANT CLOSURE COSTS In conjunction with the Millstone and VYNPC nuclear generation asset divestitures, the applicable liabilities and nuclear decommissioning trusts were transferred to the purchasers, and the purchasers agreed to assume responsibility for decommissioning their respective units. PSNH still has significant decommissioning and plant closure cost obligations to the Yankee Companies that own the Yankee Atomic, Connecticut Yankee (CY) and Maine Yankee nuclear power plants. Each plant has been shut down and is undergoing decommissioning. The Yankee Companies collect decommissioning and closure costs through wholesale FERC-approved rates charged under power purchase agreements to PSNH. PSNH in turn passes these costs on to its customers through state regulatory commission-approved retail rates. A portion of the decommissioning and closure costs have already been collected, but a substantial portion related to the decommissioning of CY has not yet been filed at and approved for collection by the FERC. During 2002, PSNH was notified by CYAPC and YAEC that the estimated cost of decommissioning these units and other closure costs increased over prior estimates due to higher anticipated costs for spent fuel storage, security and liability and property insurance. PSNH's share of this increase is $24.9 million. Following FERC rate cases by the Yankee Companies, PSNH expects to recover the higher decommissioning costs from its retail customers. In June 2003, CYAPC notified NU that it had terminated its contract with Bechtel Power Corporation (Bechtel) for the decommissioning of the CY nuclear power plant. CYAPC terminated the contract based on its determination that Bechtel's decommissioning work has been incomplete and untimely and that Bechtel refused to perform the remaining decommissioning work. Bechtel has filed a counterclaim against CYAPC asserting a number of claims and seeking a variety of remedies, including monetary and punitive damages and the rescission of the contract. Bechtel has amended its complaint to add claims for wrongful termination. In November 2003, CYAPC prepared an updated estimate of the cost of decommissioning its nuclear unit. PSNH's aggregate share of the estimated increased cost primarily related to the termination of Bechtel, is $17.1 million. CYAPC is seeking recovery of additional decommissioning costs and other damages from Bechtel and, if necessary, its surety. In pursuing this recovery through pending litigation, CYAPC is also exploring options to structure an appropriate rate application to be filed with the FERC, with any resulting adjustments being charged to the owners of the nuclear unit, including PSNH. The timing, amount and outcome of these filings cannot be predicted at this time. PSNH cannot at this time predict the timing or outcome of the FERC proceeding required for the collection of these remaining decommissioning and closure costs. Although management believes that these costs will ultimately be recovered from PSNH's customers, there is a risk that the FERC may not allow these costs, the estimates of which have increased significantly in 2003 and 2002, to be recovered in wholesale rates. If FERC does not allow these costs to be recovered in wholesale rates, PSNH would expect the state regulatory commissions to disallow these costs in retail rates as well. At December 31, 2003 and 2002, PSNH's remaining estimated obligations for decommissioning and closure costs for the shut down units owned by CYAPC, YAEC and MYAPC were $64.2 million and $56.2 million, respectively. 8. FAIR VALUE OF FINANCIAL INSTRUMENTS ------------------------------------------------------------------------------- The following methods and assumptions were used to estimate the fair value of each of the following financial instruments: Long-Term Debt and Rate Reduction Bonds: The fair value of PSNH's fixed-rate securities is based upon the quoted market price for those issues or similar issues. Adjustable rate securities are assumed to have a fair value equal to their carrying value. The carrying amounts of PSNH's financial instruments and the estimated fair values are as follows: --------------------------------------------------------------------- At December 31, 2003 --------------------------------------------------------------------- (Millions of Dollars) Carrying Amount Fair Value --------------------------------------------------------------------- Long-term debt - Other long-term debt $407.3 $425.6 Rate reduction bonds 472.2 517.3 --------------------------------------------------------------------- --------------------------------------------------------------------- At December 31, 2002 --------------------------------------------------------------------- (Millions of Dollars) Carrying Amount Fair Value --------------------------------------------------------------------- Long-term debt - Other long-term debt $407.3 $421.6 Rate reduction bonds 510.8 565.4 --------------------------------------------------------------------- Other Financial Instruments: The carrying value of financial instruments included in current assets and current liabilities, including investments in securitizable assets, approximates their fair value. 9. LEASES ------------------------------------------------------------------------------- PSNH has entered into lease agreements, some of which are capital leases, for the use of data processing and office equipment, vehicles, and office space. The provisions of these lease agreements generally provide for renewal options. Capital lease rental payments charged to operating expense were $0.5 million in 2003, $0.4 million in 2002, and $0.7 million in 2001. Interest included in capital lease rental payments was $0.3 million in 2003, 2002, and 2001. Operating lease rental payments charged to expense were $1.8 million in 2003, $2.6 million in 2002, and $3.9 million in 2001. Future minimum rental payments excluding executory costs, such as property taxes, state use taxes, insurance, and maintenance, under long-term noncancelable leases, at December 31, 2003 are as follows: --------------------------------------------------------------------- (Millions of Dollars) Capital Operating Year Leases Leases --------------------------------------------------------------------- 2004 $0.5 $ 4.6 2005 0.5 3.9 2006 0.3 3.6 2007 0.2 2.6 2008 0.2 2.1 Thereafter - 3.6 --------------------------------------------------------------------- Future minimum lease payments $1.7 $20.4 Less amount representing interest 0.7 --------------------------------------------------------------------- Present value of future minimum lease payments $1.0 --------------------------------------------------------------------- 10. ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS) ------------------------------------------------------------------------------- The accumulated balance for each other comprehensive income/(loss) item is as follows: ----------------------------------------------------------------------- Current December 31, Period December 31, (Millions of Dollars) 2002 Change 2003 ----------------------------------------------------------------------- Unrealized gains/(losses) on securities $ - $ 0.1 $ 0.1 Minimum supplemental executive retirement pension liability adjustments (0.1) (0.1) (0.2) ----------------------------------------------------------------------- Accumulated other comprehensive loss $(0.1) $ - $(0.1) ----------------------------------------------------------------------- ----------------------------------------------------------------------- Current December 31, Period December 31, (Millions of Dollars) 2001 Change 2002 ----------------------------------------------------------------------- Unrealized gains/(losses) on securities $ 0.6 $(0.6) $ - Minimum supplemental executive retirement pension liability adjustments (0.2) 0.1 (0.1) ----------------------------------------------------------------------- Accumulated other comprehensive income/(loss) $ 0.4 $(0.5) $(0.1) ----------------------------------------------------------------------- The changes in the components of other comprehensive income/(loss) are reported net of the following income tax effects: ----------------------------------------------------------------------- (Millions of Dollars) 2003 2002 2001 ----------------------------------------------------------------------- Unrealized (losses)/gains on securities $(0.1) $0.3 $0.4 Minimum supplemental executive retirement pension liability adjustments - - - ----------------------------------------------------------------------- Accumulated other comprehensive (loss)/income $(0.1) $0.3 $0.4 ----------------------------------------------------------------------- 11. LONG-TERM DEBT ------------------------------------------------------------------------------- Details of long-term debt outstanding are as follows: ----------------------------------------------------------------------- At December 31, 2003 2002 ----------------------------------------------------------------------- (Millions of Dollars) Pollution Control Revenue Bonds: 6.00% Tax-Exempt, Series D, due 2021 $ 75.0 $ 75.0 6.00% Tax-Exempt, Series E, due 2021 44.8 44.8 Adjustable Rate, Series A, due 2021 89.3 89.3 Adjustable Rate, Series B, due 2021 89.3 89.3 5.45% Tax-Exempt, Series C, due 2021 108.9 108.9 ----------------------------------------------------------------------- Long-term debt $407.3 $407.3 ----------------------------------------------------------------------- There are no cash sinking fund requirements or debt maturities for the years 2004 through 2008. There are annual renewal and replacement fund requirements equal to 2.25 percent of the average of net depreciable utility property owned by PSNH in 1992, plus cumulative gross property additions thereafter. PSNH expects to meet these future fund requirements by certifying property additions. Any deficiency would need to be satisfied by the deposit of cash or bonds. Essentially, all utility plant of PSNH is subject to the liens of the company's first mortgage bond indenture. PSNH entered into financing arrangements with the Business Finance Authority (BFA) of the state of New Hampshire, pursuant to which, the BFA issued five series of Pollution Control Revenue Bonds (PCRBs) as described above and loaned the proceeds to PSNH. PSNH's obligation to repay each series of PCRBs is secured by bond insurance and first mortgage bonds. Each such series of first mortgage bonds contains similar terms and provisions as the applicable series of PCRBs. For financial reporting purposes, these first mortgage bonds would not be considered outstanding unless PSNH failed to meet its obligations under the PCRBs. The average effective interest rate on the variable-rate pollution control notes was 1 percent in 2003 and 1.4 percent in 2002. 12. INCOME TAX EXPENSE ------------------------------------------------------------------------------- The components of the federal and state income tax provisions were charged/(credited) to operations as follows: --------------------------------------------------------------------- For the Years Ended December 31, 2003 2002 2001 --------------------------------------------------------------------- (Millions of Dollars) Current income taxes: Federal $27.9 $101.1 $(143.5) State 8.5 19.0 (13.4) --------------------------------------------------------------------- Total current 36.4 120.1 (156.9) --------------------------------------------------------------------- Deferred income taxes, net: Federal (3.8) (65.0) 197.3 State (2.3) (5.5) 13.5 --------------------------------------------------------------------- Total deferred (6.1) (70.5) 210.8 --------------------------------------------------------------------- Investment tax credits, net (0.5) (9.3) (15.3) --------------------------------------------------------------------- Total income tax expense $29.8 $ 40.3 $ 38.6 --------------------------------------------------------------------- Deferred income taxes are comprised of the tax effects of temporary differences as follows: --------------------------------------------------------------------- For the Years Ended December 31, 2003 2002 2001 --------------------------------------------------------------------- (Millions of Dollars) Depreciation $12.2 $ 7.7 $ 1.9 Net regulatory deferral (8.2) (65.3) (5.4) Regulatory disallowance - - 2.3 Contractual settlements - - 6.7 Contract termination costs, net of amortization (9.7) (13.5) 196.6 Other (0.4) 0.6 8.7 --------------------------------------------------------------------- Deferred income taxes, net $(6.1) $(70.5) $210.8 --------------------------------------------------------------------- A reconciliation between income tax expense and the expected tax expense at the statutory rate is as follows: --------------------------------------------------------------------- For the Years Ended December 31, 2003 2002 2001 --------------------------------------------------------------------- (Millions of Dollars) Expected federal income tax $26.3 $36.1 $42.1 Tax effect of differences: Depreciation 1.1 1.9 0.5 Amortization of regulatory assets 1.8 1.2 5.1 Investment tax credit amortization (0.5) (9.3) (15.3) State income taxes, net of federal benefit 4.1 8.8 0.1 Other, net (3.0) 1.6 6.1 --------------------------------------------------------------------- Total income tax expense $29.8 $40.3 $38.6 --------------------------------------------------------------------- 13. SEGMENT INFORMATION ------------------------------------------------------------------------------- NU is organized between the Utility Group and NU Enterprises based on each segments' regulatory environment or lack thereof. PSNH is included in the utility group segment of NU and has no other reportable segments. ------------------------------------------------------------------------------- Consolidated Quarterly Financial Data (Unaudited) ------------------------------------------------------------------------------- (Thousands of Dollars) Quarter Ended (a) ------------------------------------------------------------------------------- 2003 March 31, June 30, September 30, December 31, ------------------------------------------------------------------------------- Operating Revenues $230,768 $203,364 $235,972 $218,082 Operating Income $ 31,383 $ 29,668 $ 34,774 $ 29,791 Net Income $ 10,827 $ 11,054 $ 12,613 $ 11,130 ------------------------------------------------------------------------------- 2002 ------------------------------------------------------------------------------- Operating Revenues $228,028 $230,382 $272,189 $216,579 Operating Income $ 30,750 $ 37,004 $ 40,929 $ 45,289 Net Income $ 11,729 $ 15,231 $ 19,482 $ 16,455 -------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------- Selected Consolidated Financial Data (Unaudited) ---------------------------------------------------------------------------------------------------------------------------- (Thousands of Dollars) 2003 2002 2001 2000 1999 ---------------------------------------------------------------------------------------------------------------------------- Operating Revenues (b) $ 888,186 $ 947,178 $ 964,415 $1,291,280 $1,160,572 Net Income/(Loss) 45,624 62,897 81,776 (146,666) 84,209 Cash Dividends on Common Stock 16,800 45,000 27,000 50,000 - Gross Property, Plant and Equipment (c) 1,560,621 1,488,516 1,499,137 1,535,343 2,283,187 Total Assets (d) 2,171,811 2,155,447 2,094,514 2,082,296 2,622,433 Rate Reduction Bonds 472,222 510,841 507,381 - - Long-Term Debt (e) 407,285 407,285 407,285 407,285 516,485 Preferred Stock Not Subject to Mandatory Redemption - - - 24,268 50,000 Obligations Under Seabrook Power Contracts and Other Capital Leases (e) 986 1,192 110,275 629,230 726,153 ----------------------------------------------------------------------------------------------------------------------------
(a) Certain reclassifications of prior years' data have been made to conform with the current year's presentation. Operating revenue amounts have been reclassified from those reported in 2002 and from those reported in the first three quarters of 2003 on the reports on Form 10-Q because of the adoption of EITF Issue No. 03-11. Quarterly operating revenues as previously reported for 2003 and 2002 are as follows (thousands of dollars): ------------------------------------------------- Operating Revenues ------------------------------------------------- Quarter Ended 2003 2002 ------------------------------------------------- March 31 $256,895 $242,381 June 30 220,264 248,914 September 30 241,829 324,818 December 31 N/A 230,625 ------------------------------------------------- (b) Operating revenue amounts have been reclassified from those reported in 2002 and 2001 related to the adoption of EITF Issue No. 03-11. (c) Amount includes construction work in progress. (d) Total assets were not adjusted for cost of removal prior to 2002. (e) Includes portions due within one year.
----------------------------------------------------------------------------------------------------------------------------- Consolidated Statistics (Unaudited) ----------------------------------------------------------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ----------------------------------------------------------------------------------------------------------------------------- Revenues: (Thousands) Residential $351,622 $325,912 $323,642 $ 355,176 $ 356,970 Commercial 318,081 297,196 297,632 306,386 302,135 Industrial 159,560 150,582 175,575 195,058 188,622 Other Utilities 38,622 152,131 144,350 394,080 266,118 Streetlighting and Railroads 4,801 4,820 5,227 5,925 5,927 Non-franchised Sales - - - - 18,963 Miscellaneous 15,500 16,537 17,989 34,655 21,837 ----------------------------------------------------------------------------------------------------------------------------- Total $888,186 $947,178 $964,415 $1,291,280 $1,160,572 ----------------------------------------------------------------------------------------------------------------------------- Sales: (kWh - Millions) Residential 2,944 2,765 2,592 2,474 2,447 Commercial 3,100 2,969 2,873 2,614 2,536 Industrial 1,684 1,646 1,926 2,026 1,952 Other Utilities 674 4,034 4,086 10,007 5,869 Streetlighting and Railroads 23 23 23 22 22 Non-franchised Sales - - - - 6 ----------------------------------------------------------------------------------------------------------------------------- Total 8,425 11,437 11,500 17,143 12,832 ----------------------------------------------------------------------------------------------------------------------------- Customers: (Average) Residential 388,133 382,481 376,832 372,286 367,119 Commercial 63,324 61,775 59,538 58,279 57,203 Industrial 2,758 2,818 2,863 2,887 2,896 Other 554 540 517 485 476 ----------------------------------------------------------------------------------------------------------------------------- Total 454,769 447,614 439,750 433,937 427,694 ----------------------------------------------------------------------------------------------------------------------------- Average Annual Use Per Residential Customer (kWh) 7,584 7,208 6,868 6,644 6,665 ----------------------------------------------------------------------------------------------------------------------------- Average Annual Bill Per Residential Customer $906.29 $849.10 $859.87 $954.08 $972.42 ----------------------------------------------------------------------------------------------------------------------------- Average Revenue Per kWh: Residential 11.95 cents 11.78 cents 12.52 cents 14.36 cents 14.59 cents Commercial 10.26 10.01 10.36 11.72 11.91 Industrial 9.48 9.15 9.12 9.63 9.66 ----------------------------------------------------------------------------------------------------------------------------- Employees 1,282 1,243 1,241 1,227 1,258 =============================================================================================================================