UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
OR
£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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Commission |
Registrants, State of Incorporation, |
I.R.S. Employer |
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001-09120 |
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED |
22-2625848 |
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001-00973 |
PUBLIC SERVICE ELECTRIC AND GAS COMPANY |
22-1212800 |
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000-49614 |
PSEG POWER LLC |
22-3663480 |
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000-32503 |
PSEG ENERGY HOLDINGS L.L.C. |
42-1544079 |
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. Yes S No £
Indicate by check mark whether each registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
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Public Service Enterprise Group Incorporated |
Large accelerated filer S |
Accelerated filer £ |
Non-accelerated filer £ |
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Public Service Electric and Gas Company |
Large accelerated filer £ |
Accelerated filer £ |
Non-accelerated filer S |
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PSEG Power LLC |
Large accelerated filer £ |
Accelerated filer £ |
Non-accelerated filer S |
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PSEG Energy Holdings L.L.C. |
Large accelerated filer £ |
Accelerated filer £ |
Non-accelerated filer S |
Indicate by check mark whether any of the registrants is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No S
As of October 31, 2007, Public Service Enterprise Group Incorporated had 254,313,179 outstanding shares of its sole class of Common Stock, without par value.
As of October 31, 2007, Public Service Electric and Gas Company had issued and outstanding 132,450,344 shares of Common Stock, without nominal or par value, all of which were privately held, beneficially and of record by Public Service Enterprise Group Incorporated.
PSEG Power LLC and PSEG Energy Holdings L.L.C. are wholly owned subsidiaries of Public Service Enterprise Group Incorporated and meet the conditions set forth in General Instruction H(1) (a) and (b) of Form 10-Q and are filing their respective Quarterly Reports on Form 10-Q with the reduced disclosure format authorized by General Instruction H.
TABLE OF CONTENTS
Page
ii
Item 1.
1
5
9
13
17
18
Note 3. Discontinued Operations, Dispositions and Impairments
21
24
25
35
38
39
41
43
44
46
47
49
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
52
52
58
68
73
73
Item 3.
73
Item 4.
79
Item 1.
81
Item 1A.
82
Item 5.
82
Item 6.
87
88 i
Certain of the matters discussed in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are
subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated. Such statements are based on management’s beliefs as well as assumptions made by and
information currently available to management. When used herein, the words “anticipate,” “intend,” “estimate,” “believe,” “expect,” “plan,” “hypothetical,” “potential,” “forecast,” “project,” variations of
such words and similar expressions are intended to identify forward-looking statements. Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG
Power LLC (Power) and PSEG Energy Holdings L.L.C. (Energy Holdings) undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information,
future events or otherwise. The following review should not be construed as a complete list of factors that could affect forward-looking statements. In addition to any assumptions and other factors referred
to specifically in connection with such forward-looking statements discussed above, factors that could cause actual results to differ materially from those contemplated in any forward-looking statements
include, among others, the following:
•
changes in energy policies and regulation, including market rules; • ability to attain satisfactory regulatory results; • ability to maintain operating performance and cash flow from investments at projected levels; • inability to effectively manage portfolios of electric generation assets, gas supply contracts and electric and gas supply obligations; • continued market based rate authority, including any necessary mitigation measures; • energy transmission constraints or lack thereof and the availability of transmission facilities; • adverse changes in the market for energy, capacity, natural gas, coal, nuclear fuel, emissions credits, congestion credits and other commodity prices, especially during significant price movements for
natural gas and power; • changes in the electric industry, including changes to regional transmission organizations and power pools; • changes in the number of market participants and the risk profiles of such participants; • adverse or unanticipated weather conditions that significantly impact costs and/or operations; • environmental regulations that significantly impact operations; • governmental and industry responses to global climate change; • changes in demand including the effects of conservation efforts and energy efficiency; • timing and success of efforts to develop generation, transmission and distribution projects; • credit, commodity, interest rate, counterparty and other financial market risks; • liquidity and the ability to access capital and maintain adequate credit ratings; • changes in rates of return on overall debt and equity markets that could adversely impact the value of pension and other postretirement benefits assets and liabilities and the Nuclear
Decommissioning Trust Funds; • effectiveness of risk management and internal control systems; • ability to realize tax benefits and favorably resolve tax audit claims; • ability to attract and retain management and other key employees; • changes in political conditions; • changes in technology that make generation, transmission and/or distribution assets less competitive; • continued availability of insurance coverage at commercially reasonable rates; • involvement in lawsuits, including liability claims and commercial disputes; ii
• acquisitions, divestitures, mergers, restructurings or strategic initiatives that change PSEG’s, PSE&G’s, Power’s and Energy Holdings’ strategy or structure; • general economic conditions, including inflation or deflation; • changes in tax laws and regulations; • substantial competition in the domestic and worldwide energy markets; • margin posting requirements, especially during significant price movements for natural gas and power; • availability of fuel and timely transportation at reasonable prices; • delays, cost escalations or unsuccessful construction and development; • changes in regulation and safety and security measures at nuclear facilities; • changes in foreign currency exchange rates; • deterioration in the credit of lessees and their ability to adequately service lease rentals; • changes to accounting standards or accounting principles generally accepted in the U.S., which may require adjustments to financial statements; • ability to recover investments or service debt as a result of any of the risks or uncertainties mentioned herein; and • acts of war or terrorism. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and PSEG, PSE&G, Power and Energy Holdings cannot assure you that the results or
developments anticipated by management will be realized, or even if realized, will have the expected consequences to, or effects on, PSEG, PSE&G, Power and Energy Holdings or their respective business
prospects, financial condition or results of operations. Undue reliance should not be placed on these forward-looking statements in making any investment decision. Each of PSEG, PSE&G, Power and
Energy Holdings expressly disclaims any obligation or undertaking to release publicly any updates or revisions to these forward-looking statements to reflect events or circumstances that occur or arise or
are anticipated to occur or arise after the date hereof. In making any investment decision regarding PSEG’s, PSE&G’s, Power’s and Energy Holdings’ securities, PSEG, PSE&G, Power and Energy Holdings
are not making, and you should not infer, any representation about the likely existence of any particular future set of facts or circumstances. The forward-looking statements contained in this report are
intended to qualify for the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. iii
PART I. FINANCIAL INFORMATION PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
For the Quarters
For the Nine Months
2007
2006
2007
2006
(Millions) OPERATING REVENUES
$
3,475
$
3,297
$
9,888
$
9,286 OPERATING EXPENSES Energy Costs
1,674
1,740
5,101
5,223 Operation and Maintenance
576
533
1,774
1,682 Write-down of Assets
12
—
12
263 Depreciation and Amortization
213
228
603
629 Taxes Other Than Income Taxes
31
32
104
100 Total Operating Expenses
2,506
2,533
7,594
7,897 Income from Equity Method Investments
33
30
86
93 OPERATING INCOME
1,002
794
2,380
1,482 Other Income
61
48
190
149 Other Deductions
(57
)
(41
)
(130
)
(84
) Interest Expense
(191
)
(199
)
(560
)
(587
) Preferred Stock Dividends
(1
)
(1
)
(3
)
(3
) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
814
601
1,877
957 Income Tax Expense
(314
)
(229
)
(750
)
(388
) INCOME FROM CONTINUING OPERATIONS
500
372
1,127
569 Income (Loss) from Discontinued Operations, including Gain on Disposal, net of tax (expense) benefit of ($3), $1, ($18) and ($132) for the quarters and
nine months ended 2007 and 2006, respectively
6
2
(17
)
217 NET INCOME
$
506
$
374
$
1,110
$
786 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (THOUSANDS): BASIC
254,272
251,747
253,603
251,471 DILUTED
254,545
252,329
253,983
252,161 EARNINGS PER SHARE: BASIC INCOME FROM CONTINUING OPERATIONS
$
1.97
$
1.47
$
4.45
$
2.26 NET INCOME
$
1.99
$
1.48
$
4.38
$
3.12 DILUTED INCOME FROM CONTINUING OPERATIONS
$
1.97
$
1.47
$
4.44
$
2.26 NET INCOME
$
1.99
$
1.48
$
4.37
$
3.12 DIVIDENDS PAID PER SHARE OF COMMON STOCK
$
0.585
$
0.57
$
1.755
$
1.71 See Notes to Condensed Consolidated Financial Statements. 1
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Ended
September 30,
Ended
September 30,
(Unaudited)
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
September 30,
December 31,
(Millions) ASSETS CURRENT ASSETS Cash and Cash Equivalents
$
421
$
125 Accounts Receivable, net of allowances of $55 and $52 in 2007 and 2006, respectively
1,520
1,359 Unbilled Revenues
237
328 Fuel
879
847 Materials and Supplies
318
290 Prepayments
233
72 Restricted Funds
80
79 Derivative Contracts
56
128 Assets of Discontinued Operations
297
622 Assets Held for Sale
—
40 Other
91
45 Total Current Assets
4,132
3,935 PROPERTY, PLANT AND EQUIPMENT
19,717
18,698 Less: Accumulated Depreciation and Amortization
(6,210
)
(5,831
) Net Property, Plant and Equipment
13,507
12,867 NONCURRENT ASSETS Regulatory Assets
5,134
5,694 Long-Term Investments
3,876
3,868 Nuclear Decommissioning Trust (NDT) Funds
1,311
1,256 Other Special Funds
158
147 Goodwill
422
406 Intangibles
47
46 Derivative Contracts
55
55 Other
267
296 Total Noncurrent Assets
11,270
11,768 TOTAL ASSETS
$
28,909
$
28,570 See Notes to Condensed Consolidated Financial Statements. 2
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
September 30,
December 31,
(Millions) LIABILITIES AND CAPITALIZATION CURRENT LIABILITIES Long-Term Debt Due Within One Year
$
1,022
$
849 Commercial Paper and Loans
204
381 Accounts Payable
916
960 Derivative Contracts
431
335 Accrued Interest
205
123 Accrued Taxes
68
149 Clean Energy Program
131
120 Liabilities of Discontinued Operations
134
134 Other
470
480 Total Current Liabilities
3,581
3,531 NONCURRENT LIABILITIES Deferred Income Taxes and Investment Tax Credits (ITC)
4,287
4,447 Regulatory Liabilities
446
646 Asset Retirement Obligations
537
509 Other Postretirement Benefit (OPEB) Costs
1,098
1,089 Accrued Pension Costs
318
327 Clean Energy Program
43
133 Environmental Costs
384
421 Derivative Contracts
150
204 Long-Term Accrued Taxes
538
— Other
156
170 Total Noncurrent Liabilities
7,957
7,946 COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5) CAPITALIZATION LONG-TERM DEBT Long-Term Debt
7,408
7,636 Securitization Debt
1,581
1,708 Project Level, Non-Recourse Debt
805
735 Debt Supporting Trust Preferred Securities
186
186 Total Long-Term Debt
9,980
10,265 SUBSIDIARY’S PREFERRED SECURITIES Preferred Stock Without Mandatory Redemption, $100 par value, 7,500,000 authorized; issued and outstanding, 2007 and 2006—795,234 shares
80
80 COMMON STOCKHOLDERS’ EQUITY Common Stock, no par, authorized 1,000,000,000 shares; issued; 2007—266,778,330 shares; 2006—266,372,440 shares
4,723
4,661 Treasury Stock, at cost; 2007—12,464,734 shares; 2006—13,727,032 shares
(471
)
(516
) Retained Earnings
3,186
2,711 Accumulated Other Comprehensive Loss
(127
)
(108
) Total Common Stockholders’ Equity
7,311
6,748 Total Capitalization
17,371
17,093 TOTAL LIABILITIES AND CAPITALIZATION
$
28,909
$
28,570 See Notes to Condensed Consolidated Financial Statements. 3
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
For The Nine Months
2007
2006
(Millions) CASH FLOWS FROM OPERATING ACTIVITIES Net Income
$
1,110
$
786 Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities: Gain on Disposition of Property, Plant and Equipment
(3
)
(228
) Gain on Disposal of Discontinued Operations, net of tax
—
(1
) Depreciation and Amortization
606
645 Amortization of Nuclear Fuel
73
73 Provision for Deferred Income Taxes (Other than Leases) and ITC
45
(5
) Non-Cash Employee Benefit Plan Costs
138
180 Leveraged Lease Income, Adjusted for Rents Received and Deferred Taxes
46
32 (Gain) Loss on Sale of Investments
(11
)
255 Equity in Earnings of Affiliates Less Dividends Received
(5
)
(45
) Foreign Currency Transaction Loss
9
4 Realized and Unrealized Losses (Gains) on Energy Contracts and Other Derivatives
16
(32
) (Under) Over Recovery of Electric Energy Costs (BGS and NTC) and Gas Costs
(38
)
112 Under Recovery of Societal Benefits Charge (SBC)
(29
)
(115
) Cost of Removal
(28
)
(26
) Net Realized Gains and Income from NDT Funds
(37
)
(54
) Other Non-Cash Charges
6
16 Net Change in Working Capital
(312
)
58 Employee Benefit Plan Funding and Related Payments
(76
)
(127
) Investment Income and Dividend Distributions from Partnerships
13
7 Other
16
(102
) Net Cash Provided By Operating Activities
1,539
1,433 CASH FLOWS FROM INVESTING ACTIVITIES Additions to Property, Plant and Equipment
(973
)
(748
) Proceeds from Sale of Discontinued Operations
325
494 Proceeds from Sale of Property, Plant and Equipment
43
3 Proceeds from the Sale of Investments and Return of Capital from Partnerships
15
186 Proceeds from NDT Funds Sales
1,275
1,056 Investment in NDT Funds
(1,295
)
(1,069
) Restricted Funds
(4
)
(22
) NDT Funds Interest and Dividends
35
29 Other
(10
)
18 Net Cash Used In Investing Activities
(589
)
(53
) CASH FLOWS FROM FINANCING ACTIVITIES Net Change in Commercial Paper and Loans
(177
)
452 Issuance of Long-Term Debt
350
— Issuance of Non-Recourse Debt
163
— Issuance of Common Stock
82
56 Redemption of Long-Term Debt
(488
)
(1,131
) Repayment of Non-Recourse Debt
(35
)
(37
) Repayment of Securitization Debt
(121
)
(115
) Redemption of Debt Underlying Trust Securities
—
(154
) Cash Dividends Paid on Common Stock
(445
)
(430
) Other
16
(26
) Net Cash Used In Financing Activities
(655
)
(1,385
) Effect of Exchange Rate Change
1
(2
) Net Increase (Decrease) in Cash and Cash Equivalents
296
(7
) Cash and Cash Equivalents at Beginning of Period
125
281 Cash and Cash Equivalents at End of Period
$
421
$
274 Supplemental Disclosure of Cash Flow Information: Income Taxes Paid
$
460
$
312 Interest Paid, Net of Amounts Capitalized
$
478
$
510 See Notes to Condensed Consolidated Financial Statements. 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Ended
September 30,
(Unaudited)
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
For The Quarters
Ended
For The Nine Months
Ended
2007
2006
2007
2006
(Millions) OPERATING REVENUES
$
2,106
$
1,971
$
6,340
$
5,754 OPERATING EXPENSES Energy Costs
1,341
1,250
4,083
3,725 Operation and Maintenance
308
278
947
855 Depreciation and Amortization
161
174
449
476 Taxes Other Than Income Taxes
31
32
104
100 Total Operating Expenses
1,841
1,734
5,583
5,156 OPERATING INCOME
265
237
757
598 Other Income
2
6
12
18 Other Deductions
(1
)
—
(3
)
(2
) Interest Expense
(85
)
(86
)
(250
)
(254
) INCOME BEFORE INCOME TAXES
181
157
516
360 Income Tax Expense
(74
)
(69
)
(214
)
(160
) NET INCOME
107
88
302
200 Preferred Stock Dividends
(1
)
(1
)
(3
)
(3
) EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
$
106
$
87
$
299
$
197 See disclosures regarding Public Service Electric and Gas Company included in the 5
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
September 30,
September 30,
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
September 30,
December 31,
(Millions) ASSETS CURRENT ASSETS Cash and Cash Equivalents
$
36
$
28 Accounts Receivable, net of allowances of $50 in 2007 and $46 in 2006
887
805 Unbilled Revenues
237
328 Materials and Supplies
58
50 Prepayments
193
14 Restricted Funds
10
12 Derivative Contracts
1
2 Other
44
36 Total Current Assets
1,466
1,275 PROPERTY, PLANT AND EQUIPMENT
11,493
11,061 Less: Accumulated Depreciation and Amortization
(3,972
)
(3,794
) Net Property, Plant and Equipment
7,521
7,267 NONCURRENT ASSETS Regulatory Assets
5,134
5,694 Long-Term Investments
151
149 Other Special Funds
56
53 Other
112
115 Total Noncurrent Assets
5,453
6,011 TOTAL ASSETS
$
14,440
$
14,553 See disclosures regarding Public Service Electric and Gas Company included in the 6
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
September 30,
December 31,
(Millions) LIABILITIES AND CAPITALIZATION CURRENT LIABILITIES Long-Term Debt Due Within One Year
$
177
$
284 Commercial Paper and Loans
204
31 Accounts Payable
326
254 Accounts Payable—Affiliated Companies, net
345
645 Accrued Interest
52
55 Clean Energy Program
131
120 Derivative Contracts
6
2 Other
300
322 Total Current Liabilities
1,541
1,713 NONCURRENT LIABILITIES Deferred Income Taxes and ITC
2,404
2,517 Other Postretirement Benefit (OPEB) Costs
899
898 Accrued Pension Costs
125
133 Regulatory Liabilities
446
646 Clean Energy Program
43
133 Environmental Costs
333
367 Asset Retirement Obligations
230
221 Derivative Contracts
28
18 Long-Term Accrued Taxes due Affiliate
61
— Other
8
6 Total Noncurrent Liabilities
4,577
4,939 COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5) CAPITALIZATION LONG-TERM DEBT Long-Term Debt
3,352
3,003 Securitization Debt
1,581
1,708 Total Long-Term Debt
4,933
4,711 PREFERRED SECURITIES Preferred Stock Without Mandatory Redemption, $100 par value, 7,500,000 authorized; issued and outstanding, 2007 and 2006— 795,234 shares
80
80 COMMON STOCKHOLDER’S EQUITY Common Stock; 150,000,000 shares authorized, 132,450,344 shares issued and outstanding
892
892 Contributed Capital
170
170 Basis Adjustment
986
986 Retained Earnings
1,260
1,061 Accumulated Other Comprehensive Income
1
1 Total Common Stockholder’s Equity
3,309
3,110 Total Capitalization
8,322
7,901 TOTAL LIABILITIES AND CAPITALIZATION
$
14,440
$
14,553 See disclosures regarding Public Service Electric and Gas Company included in the 7
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PUBLIC SERVICE ELECTRIC AND GAS COMPANY
For The Nine Months
Ended
2007
2006
(Millions) CASH FLOWS FROM OPERATING ACTIVITIES Net Income
$
302
$
200 Adjustments to Reconcile Net Income to Net Cash Flows from Depreciation and Amortization
449
476 Provision for Deferred Income Taxes and ITC
(114
)
(69
) Non-Cash Employee Benefit Plan Costs
104
128 Gain on Sale of Property, Plant and Equipment
(3
)
— Non-Cash Interest Expense
9
14 Cost of Removal
(28
)
(26
) Employee Benefit Plan Funding and Related Payments
(53
)
(81
) Over Recovery of Electric Energy Costs (BGS and NTC)
1
39 (Under) Over Recovery of Gas Costs
(39
)
73 Under Recovery of SBC
(29
)
(115
) Other Non-Cash Charges
(2
)
(3
) Net Changes in Certain Current Assets and Liabilities: Accounts Receivable and Unbilled Revenues
9
361 Materials and Supplies
(8
)
— Prepayments
(184
)
(106
) Accrued Taxes
(1
)
(25
) Accrued Interest
(3
)
(18
) Accounts Payable
72
4 Accounts Receivable/Payable-Affiliated Companies, net
(201
)
(337
) Other Current Assets and Liabilities
(35
)
(77
) Other
(2
)
(15
) Net Cash Provided By Operating Activities
244
423 CASH FLOWS FROM INVESTING ACTIVITIES Additions to Property, Plant and Equipment
(421
)
(392
) Proceeds from the Sale of Property, Plant and Equipment
3
— Restricted Funds
(1
)
(1
) Net Cash Used In Investing Activities
(419
)
(393
) CASH FLOWS FROM FINANCING ACTIVITIES Net Change in Short-Term Debt
173
327 Issuance of Long-Term Debt
350
— Redemption of Securitization Debt
(121
)
(115
) Redemption of Long-Term Debt
(113
)
(322
) Deferred Issuance Costs
(3
)
— Cash Dividends Paid on Common Stock
(100
)
— Preferred Stock Dividends
(3
)
(3
) Net Cash Provided by (Used In) Financing Activities
183
(113
) Net Increase (Decrease) In Cash and Cash Equivalents
8
(83
) Cash and Cash Equivalents at Beginning of Period
28
159 Cash and Cash Equivalents at End of Period
$
36
$
76 Supplemental Disclosure of Cash Flow Information: Income Taxes Paid
$
301
$
187 Interest Paid, Net of Amounts Capitalized
$
241
$
254 See disclosures regarding Public Service Electric and Gas Company included in the 8
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
September 30,
(Unaudited)
Operating Activities:
Notes to Condensed Consolidated Financial Statements.
PSEG POWER LLC
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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For The Quarters |
For The Nine |
||||||||||||||||||||||||||
2007 |
2006 |
2007 |
2006 |
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(Millions) |
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OPERATING REVENUES |
|
$ |
|
1,580 |
|
$ |
|
1,455 |
|
$ |
|
5,034 |
|
$ |
|
4,551 |
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OPERATING EXPENSES |
|
|
|
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|
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Energy Costs |
|
712 |
|
809 |
|
2,894 |
|
2,965 |
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Operation and Maintenance |
|
232 |
|
219 |
|
711 |
|
713 |
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Depreciation and Amortization |
|
36 |
|
36 |
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104 |
|
103 |
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||||||||||||||||||||
|
Total Operating Expenses |
|
980 |
|
1,064 |
|
3,709 |
|
3,781 |
||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
|
OPERATING INCOME |
|
600 |
|
391 |
|
1,325 |
|
770 |
||||||||||||||||||||
|
Other Income |
|
56 |
|
38 |
|
162 |
|
113 |
||||||||||||||||||||
|
Other Deductions |
|
(42 |
) |
|
|
(26 |
) |
|
|
(105 |
) |
|
|
(59 |
) |
|
||||||||||||
|
Interest Expense |
|
(43 |
) |
|
|
(39 |
) |
|
|
(119 |
) |
|
|
(107 |
) |
|
||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
|
INCOME FROM CONTINUING OPERATIONS |
|
571 |
|
364 |
|
1,263 |
|
717 |
||||||||||||||||||||
|
Income Tax Expense |
|
(233 |
) |
|
|
(157 |
) |
|
|
(519 |
) |
|
|
(304 |
) |
|
||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
|
INCOME FROM CONTINUING OPERATIONS |
|
338 |
|
207 |
|
744 |
|
413 |
||||||||||||||||||||
|
Income (Loss) from Discontinued Operations, net of tax (expense) benefit of $(1), $2, $5 and $14 for the quarters and nine months ended 2007 and 2006, respectively |
|
1 |
|
(2 |
) |
|
|
(8 |
) |
|
|
(19 |
) |
|
||||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
|
EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED |
|
$ |
|
339 |
|
$ |
|
205 |
|
$ |
|
736 |
|
$ |
|
394 |
||||||||||||
|
|
|
|
|
|
|
|
|
|
||||||||||||||||||||
See disclosures regarding PSEG Power LLC included in the
Notes to Condensed Consolidated Financial Statements.
9
PSEG POWER LLC
September 30,
December 31,
(Millions) ASSETS CURRENT ASSETS Cash and Cash Equivalents
$
9
$
13 Accounts Receivable
499
430 Accounts Receivable—Affiliated Companies, net
233
495 Short-Term Loan to Affiliate
37
— Fuel
877
846 Materials and Supplies
220
202 Energy Trading Contracts
27
55 Derivative Contracts
15
56 Assets of Discontinued Operations
—
325 Assets Held for Sale
—
40 Other
33
26 Total Current Assets
1,950
2,488 PROPERTY, PLANT AND EQUIPMENT
6,371
5,868 Less: Accumulated Depreciation and Amortization
(1,789
)
(1,638
) Net Property, Plant and Equipment
4,582
4,230 NONCURRENT ASSETS Nuclear Decommissioning Trust (NDT) Funds
1,311
1,256 Goodwill
16
16 Other Intangibles
34
35 Other Special Funds
44
42 Energy Trading Contracts
9
10 Derivative Contracts
4
19 Other
64
50 Total Noncurrent Assets
1,482
1,428 TOTAL ASSETS
$
8,014
$
8,146 See disclosures regarding PSEG Power LLC included in the 10
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PSEG POWER LLC
September 30,
December 31,
(Millions) LIABILITIES AND MEMBER’S EQUITY CURRENT LIABILITIES Accounts Payable
$
444
$
589 Short-Term Loan from Affiliate
—
54 Energy Trading Contracts
141
222 Derivative Contracts
251
90 Accrued Interest
80
34 Other
95
95 Total Current Liabilities
1,011
1,084 NONCURRENT LIABILITIES Deferred Income Taxes and Investment Tax Credits (ITC)
178
48 Asset Retirement Obligations
304
287 Other Postretirement Benefit (OPEB) Costs
143
138 Accrued Pension Costs
103
106 Energy Trading Contracts
11
19 Derivative Contracts
107
151 Environmental Costs
51
54 Long-Term Accrued Taxes due Affiliate
28
— Other
13
18 Total Noncurrent Liabilities
938
821 COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5) LONG-TERM DEBT Total Long-Term Debt
2,818
2,818 MEMBER’S EQUITY Contributed Capital
2,000
2,000 Basis Adjustment
(986
)
(986
) Retained Earnings
2,483
2,586 Accumulated Other Comprehensive Loss
(250
)
(177
) Total Member’s Equity
3,247
3,423 TOTAL LIABILITIES AND MEMBER’S EQUITY
$
8,014
$
8,146 See disclosures regarding PSEG Power LLC included in the 11
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PSEG POWER LLC
For The Nine Months
Ended
2007
2006
(Millions)
(Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income
$
736
$
394 Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities: Gain on Disposition of Property, Plant and Equipment
—
(1
) Depreciation and Amortization
104
116 Amortization of Nuclear Fuel
73
73 Interest Accretion on Asset Retirement Obligations
17
25 Provision for Deferred Income Taxes and ITC
191
74 Unrealized Losses on Energy Contracts and Other Derivatives
28
17 Non-Cash Employee Benefit Plan Costs
21
34 Net Realized Gains and Income from NDT Funds
(37
)
(54
) Net Change in Working Capital: Fuel, Materials and Supplies
(49
)
(57
) Accounts Receivable
(69
)
412 Accrued Interest
46
39 Accounts Payable
(181
)
(325
) Accounts Receivable/Payable-Affiliated Companies, net
191
303 Other Current Assets and Liabilities
(5
)
25 Employee Benefit Plan Funding and Related Payments
(13
)
(34
) Other
(5
)
(121
) Net Cash Provided By Operating Activities
1,048
920 CASH FLOWS FROM INVESTING ACTIVITIES Additions to Property, Plant and Equipment
(501
)
(316
) Proceeds from Sale of Discontinued Operations
325
— Sales of Property, Plant and Equipment
40
1 Proceeds from NDT Funds Sales
1,275
1,056 NDT Funds Interest and Dividends
35
29 Investment in NDT Funds
(1,295
)
(1,069
) Short-Term Loan—Affiliated Company, net
(37
)
— Other
(15
)
10 Net Cash Used In Investing Activities
(173
)
(289
) CASH FLOWS FROM FINANCING ACTIVITIES Cash Dividend Paid
(825
)
— Redemption of Long-Term Debt
—
(500
) Short-Term Loan—Affiliated Company, net
(54
)
(134
) Net Cash Used In Financing Activities
(879
)
(634
) Net Decrease in Cash and Cash Equivalents
(4
)
(3
) Cash and Cash Equivalents at Beginning of Period
13
8 Cash and Cash Equivalents at End of Period
$
9
$
5 Supplemental Disclosure of Cash Flow Information: Income Taxes Paid
$
266
$
200 Interest Paid, Net of Amounts Capitalized
$
89
$
92 See disclosures regarding PSEG Power LLC included in the 12
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
September 30,
Notes to Condensed Consolidated Financial Statements.
PSEG ENERGY HOLDINGS L.L.C.
For The Quarters
For The Nine Months
2007
2006
2007
2006
(Millions) OPERATING REVENUES Electric Generation and Distribution Revenues
$
338
$
343
$
830
$
896 Income from Leveraged and Operating Leases
31
38
96
115 Other
11
4
36
25 Total Operating Revenues
380
385
962
1,036 OPERATING EXPENSES Energy Costs
212
192
570
578 Operation and Maintenance
44
45
137
136 Write-down of Assets
12
—
12
263 Depreciation and Amortization
12
13
40
35 Total Operating Expenses
280
250
759
1,012 Income from Equity Method Investments
33
30
86
93 OPERATING INCOME
133
165
289
117 Other Income
5
13
23
30 Other Deductions
(11
)
(14
)
(15
)
(21
) Interest Expense
(44
)
(49
)
(124
)
(146
) INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST
83
115
173
(20
) Income Tax (Expense) Benefit
(17
)
(18
)
(48
)
36 Minority Interests in Earnings of Subsidiaries
—
—
2
(1
) INCOME FROM CONTINUING OPERATIONS
66
97
127
15 Income (Loss) from Discontinued Operations, net of tax expense of $2, $1, $23 and $4 for the quarters and nine months ended 2007 and 2006,
respectively
5
4
(9
)
8 Gain on Disposal of Discontinued Operations, net of tax expense of $142 for the nine months ended 2006
—
—
—
228 EARNINGS AVAILABLE TO PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED
$
71
$
101
$
118
$
251 See disclosures regarding PSEG Energy Holdings L.L.C. included in the 13
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Ended
September 30,
Ended
September 30,
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PSEG ENERGY HOLDINGS L.L.C.
September 30,
December 31,
(Millions) ASSETS CURRENT ASSETS Cash and Cash Equivalents
$
83
$
83 Accounts Receivable: Trade—net of allowances of $5 and $6 in 2007 and 2006, respectively
121
95 Other Accounts Receivable
12
28 Notes Receivable: Affiliated Companies
257
28 Other
38
— Inventory
39
39 Restricted Funds
70
67 Assets of Discontinued Operations
297
297 Derivative Contracts
13
14 Other
8
9 Total Current Assets
938
660 PROPERTY, PLANT AND EQUIPMENT
1,621
1,553 Less: Accumulated Depreciation and Amortization
(326
)
(288
) Net Property, Plant and Equipment
1,295
1,265 NONCURRENT ASSETS Leveraged Leases, net
2,796
2,810 Corporate Joint Ventures and Partnership Interests
880
868 Goodwill
406
390 Other Intangibles
13
11 Derivative Contracts
42
26 Other
106
134 Total Noncurrent Assets
4,243
4,239 TOTAL ASSETS
$
6,476
$
6,164 See disclosures regarding PSEG Energy Holdings L.L.C. included in the 14
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PSEG ENERGY HOLDINGS L.L.C.
September 30,
December 31,
(Millions) LIABILITIES AND MEMBER’S EQUITY CURRENT LIABILITIES Long-Term Debt Due Within One Year
$
322
$
42 Accounts Payable: Trade
77
52 Affiliated Companies
7
12 Derivative Contracts
31
16 Accrued Interest
52
26 Liabilities of Discontinued Operations
134
134 Other
61
66 Total Current Liabilities
684
348 NONCURRENT LIABILITIES Deferred Income Taxes and Investment and Energy Tax Credits
1,737
1,910 Derivative Contracts
2
11 Long-Term Accrued Taxes due to Affiliate
449
— Other
94
97 Total Noncurrent Liabilities
2,282
2,018 COMMITMENTS AND CONTINGENT LIABILITIES (See Note 5) MINORITY INTERESTS
26
26 LONG-TERM DEBT Project Level, Non-Recourse Debt
805
735 Senior Notes
943
1,149 Total Long-Term Debt
1,748
1,884 MEMBER’S EQUITY Ordinary Unit
1,048
1,193 Retained Earnings
534
592 Accumulated Other Comprehensive Income
154
103 Total Member’s Equity
1,736
1,888 TOTAL LIABILITIES AND MEMBER’S EQUITY
$
6,476
$
6,164 See disclosures regarding PSEG Energy Holdings L.L.C. included in the 15
CONDENSED CONSOLIDATED BALANCE SHEETS
2007
2006
(Unaudited)
Notes to Condensed Consolidated Financial Statements.
PSEG ENERGY HOLDINGS L.L.C.
For The Nine Months
2007
2006
(Millions) CASH FLOWS FROM OPERATING ACTIVITIES Net Income
$
118
$
251 Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities: Depreciation and Amortization
43
38 Demand Side Management Amortization
1
2 Deferred Income Taxes (Other than Leases)
(27
)
(8
) Leveraged Lease Income, Adjusted for Rents Received and
46
32 Equity in Earnings of Affiliates Less Than Dividends Received
(5
)
(45
) (Gain) Loss on Sale of Investments
(11
)
255 Gain on Sale of Discontinued Operations
—
(228
) Unrealized Gain on Investments
(2
)
— Foreign Currency Transaction Loss
9
4 Change in Fair Value of Derivative Financial Instruments
(12
)
(49
) Non-Cash Employee Benefit Plan Costs
1
2 Other Non-Cash (Credits) Charges
(2
)
3 Net Changes in Working Capital: Accounts Receivable
(38
)
12 Inventory
1
(15
) Accounts Payable
17
(3
) Accounts Receivable/Payable-Affiliated Companies, net
89
(90
) Other Current Assets and Liabilities
22
(32
) Investment Income and Dividend Distributions from Partnerships
13
7 Other
2
2 Net Cash Provided By Operating Activities
265
138 CASH FLOWS FROM INVESTING ACTIVITIES Additions to Property, Plant and Equipment
(34
)
(37
) Proceeds from Sale of Discontinued Operations
—
494 Proceeds from the Sale of Investments
15
186 Proceeds from Sale of Other Assets
14
— Short-Term Loan Receivable—Affiliated Company, net
(229
)
34 Restricted Funds
(3
)
(21
) Other
(8
)
3 Net Cash (Used In) Provided By Investing Activities
(245
)
659 CASH FLOWS FROM FINANCING ACTIVITIES Repayment of Non-Recourse Long-Term Debt
(35
)
(37
) Issuance of Non-Recourse Long-Term Debt
163
— Repayment of Senior Notes
—
(309
) Return of Contributed Capital
(145
)
(425
) Other
(4
)
(1
) Net Cash Used In Financing Activities
(21
)
(772
) Effect of Exchange Rate Change
1
(2
) Net Increase In Cash and Cash Equivalents
—
23 Cash and Cash Equivalents at Beginning of Period
83
61 Cash and Cash Equivalents at End of Period
$
83
$
84 Supplemental Disclosure of Cash Flow Information: Income Taxes Received
$
(93
)
$
(86
) Interest Paid, Net of Amounts Capitalized
$
102
$
108 See disclosures regarding PSEG Energy Holdings L.L.C. included in the 16
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Ended
September 30,
(Unaudited)
Deferred Income Taxes
Notes to Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS This combined Form 10-Q is separately filed by Public Service Enterprise Group Incorporated (PSEG), Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power) and PSEG
Energy Holdings L.L.C. (Energy Holdings). Information contained herein relating to any individual company is filed by such company on its own behalf. PSE&G, Power and Energy Holdings each make
representations only as to itself and make no representations as to any other company. Note 1. Organization and Basis of Presentation Organization PSEG PSEG has four principal direct wholly owned subsidiaries: PSE&G, Power, Energy Holdings and PSEG Services Corporation (Services). PSE&G PSE&G is an operating public utility engaged principally in the transmission of electric energy and distribution of electric energy and natural gas in certain areas of New Jersey. PSE&G is subject to
regulation by the New Jersey Board of Public Utilities (BPU) and the Federal Energy Regulatory Commission (FERC). PSE&G also owns PSE&G Transition Funding LLC (Transition Funding) and PSE&G Transition Funding II LLC (Transition Funding II), bankruptcy-remote entities that purchased certain transition
property from PSE&G and issued transition bonds secured by such property. The transition property consists principally of the rights to receive electricity consumption-based per kilowatt-hour (kWh) charges
from PSE&G electric distribution customers, which represent irrevocable rights to receive amounts sufficient to recover certain of PSE&G’s transition costs related to deregulation, as approved by the BPU. Power Power is a multi-regional, wholesale energy supply company that integrates its generating asset operations and gas supply commitments with its wholesale energy, fuel supply, energy trading and
marketing and risk management function through three principal direct wholly owned subsidiaries: PSEG Nuclear LLC (Nuclear), PSEG Fossil LLC (Fossil) and PSEG Energy Resources & Trade LLC
(ER&T). Nuclear and Fossil own and operate generation and generation-related facilities. ER&T is responsible for the day-to-day management of Power’s portfolio. Fossil, Nuclear and ER&T are subject to
regulation by FERC, and certain Fossil subsidiaries are also subject to state regulation. Nuclear is also subject to regulation by the Nuclear Regulatory Commission (NRC). Energy Holdings Energy Holdings has two principal, direct, wholly owned subsidiaries: PSEG Global L.L.C. (Global), which owns and operates international and domestic projects engaged in the generation and
distribution of energy and PSEG Resources L.L.C. (Resources), which has invested primarily in energy-related leveraged leases. Energy Holdings also owns Enterprise Group Development Corporation
(EGDC), a commercial real estate property management business. Services Services provides management and administrative and general services to PSEG and its subsidiaries. These include accounting, treasury, risk management, planning, information technology, tax, law,
corporate secretarial, human resources, investor relations, corporate communications and certain other services. Services charges PSEG and its subsidiaries for the cost of work performed and services
provided pursuant to the terms and conditions of intercompany service agreements. 17
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Basis of Presentation PSEG, PSE&G, Power and Energy Holdings The respective financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for Quarterly Reports on Form 10-Q.
Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed
or omitted pursuant to such rules and regulations. These Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements (Notes) should be read in conjunction
with, and update and supplement matters discussed in PSEG’s, PSE&G’s, Power’s and Energy Holdings’ respective Annual Reports on Form 10-K for the year ended December 31, 2006 and Quarterly
Reports on Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007, as well as in PSEG’s and Energy Holdings’ amended Quarterly Report on Form 10-Q/A for the quarter ended March 31,
2007. The unaudited condensed consolidated financial information furnished herein reflects all adjustments which are, in the opinion of management, necessary to fairly state the results for the interim
periods presented. All such adjustments are of a normal recurring nature. The year-end Condensed Consolidated Balance Sheets were derived from the audited Consolidated Financial Statements included
in the Annual Report on Form 10-K for the year ended December 31, 2006. Reclassifications PSEG, PSE&G, Power and Energy Holdings Certain reclassifications have been made to the prior quarter financial statements to conform to the current quarter presentation. The reclassifications relate primarily to PSE&G’s determination, during
the fourth quarter of 2006, that the revenues and expenses related to one of its contracts that had been recorded on a gross basis would more appropriately be recorded on a net basis in Operating Revenues
based upon the provisions of Emerging Issues Task Force (EITF) 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.” Therefore, prior amounts have been reclassified, resulting in
reductions of $46 million and $147 million in both Operating Revenues and Energy Costs for the quarter and nine months ended September 30, 2006, respectively, for PSEG and PSE&G, with no impact on
Operating Income. Note 2. Recent Accounting Standards The following accounting standards were issued by the Financial Accounting Standards Board (FASB), but have not yet been adopted by PSEG, PSE&G, Power and /or Energy Holdings. Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” (SFAS 157) PSEG, PSE&G, Power and Energy Holdings In September 2006, the FASB issued SFAS 157, which provides a single definition of fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.
Prior to SFAS 157, guidance for applying fair value was incorporated into several accounting pronouncements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific
measurement, and sets out a fair value hierarchy that distinguishes between assumptions based on market data obtained from independent sources (observable inputs) and those based on an entity’s own
assumptions (unobservable inputs). Under SFAS 157, fair value measurements are disclosed by level within that hierarchy, with the highest priority being quoted prices in active markets. While this
statement does not require any new fair value measurements, the application of this statement will change current practice for some fair value measurements. This statement also nullifies the guidance in footnote 3 of EITF Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy
Trading and Risk Management Activities” (EITF 02-3). The guidance in footnote 3 applies to derivative instruments measured at fair value at initial recognition, and it precludes immediate recognition in
earnings of an 18
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS unrealized gain or loss, measured as the difference between the transaction price and the fair value of the instrument at initial recognition, if the fair value of the instrument is determined using significant
unobservable inputs. Under EITF 02-3, an entity cannot recognize an unrealized gain or loss at inception of a derivative instrument unless the fair value of that instrument is obtained from a quoted market
price in an active market or is otherwise evidenced by comparison to other observable current market transactions or based on a valuation technique incorporating observable market data. SFAS 157
requires that the principles of fair value measurement apply for derivatives and other financial instruments at initial recognition and in all subsequent periods. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. PSEG, PSE&G, Power and Energy Holdings are currently assessing the potential impact of SFAS
157 on their respective consolidated financial positions and results of operations. SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159) PSEG, PSE&G, Power and Energy Holdings In February 2007, the FASB issued SFAS 159, which permits entities to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair
value. An entity will report unrealized gains and losses on items where the fair value option has been elected in earnings at each subsequent reporting date. The objective is to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.
The decision about whether to elect the fair value option is applied instrument by instrument, with a few exceptions; the decision is irrevocable; and the decision is required to be applied to entire
instruments and not to portions of instruments. The statement requires disclosures that facilitate comparisons (a) between entities that choose different measurement attributes for similar assets and liabilities and (b) between assets and liabilities in
the financial statements of an entity that selects different measurement attributes for similar assets and liabilities. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Upon implementation, an entity shall report the effect of the first remeasurement to fair value as
a cumulative effect adjustment to the opening balance of Retained Earnings. PSEG, PSE&G, Power and Energy Holdings are currently assessing the potential impact SFAS 159 may have on their respective
consolidated financial positions and results of operations. FASB Staff Position (FSP) No. FIN 39-1, “Amendment of FASB Interpretation No. 39” (FSP 39-1) PSEG and Power In April 2007, the FASB issued FSP 39-1, which permits an entity to offset cash collateral paid or received against fair value amounts recognized for derivative instruments held with the same
counterparty under the same master netting arrangement. Currently, PSEG and Power offset derivative contracts under master netting arrangements in accordance with FIN 39, “Offsetting of Amounts
Related to Certain Contracts,” but do not net these balances with cash collateral positions. Under this FSP, PSEG and Power would be required to net cash collateral with the corresponding net derivative
balance or elect to show all fair values gross. FSP 39-1 is effective for fiscal years beginning after November 15, 2007 and must be applied retroactively to all financial statements presented, unless it is impracticable to do so. PSEG and Power are
currently evaluating the potential impact of FSP 39-1 on their respective financial positions. PSEG and Power expect no impact to their respective results of operations. 19
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following new accounting standards were adopted by PSEG, PSE&G, Power and Energy Holdings during 2007. FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109” (FIN 48) PSEG, PSE&G, Power and Energy Holdings In July 2006, the FASB issued FIN 48, which prescribes a model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company
has taken or expects to take on a tax return. Under FIN 48, the financial statements reflect expected future tax consequences of such positions presuming the tax authorities’ full knowledge of the position
and all relevant facts. FIN 48 permits recognition of the benefit of tax positions only when it is “more likely-than-not” that the position is sustainable based on the merits of the position. It further limits the
amount of tax benefit to be recognized to the largest amount of benefit that is greater than 50% likely of being realized. FIN 48 also requires disclosures about uncertainties in income tax positions,
including a detailed roll-forward of unrecognized tax benefits taken that do not qualify for financial statement recognition. FIN 48 was effective January 1, 2007. In general, companies recorded the change in net assets that resulted from the application of FIN 48 as an adjustment to Retained Earnings. However, for PSE&G,
because any charges to income arising from the adoption of FIN 48 should be recoverable in future rates, the offset to any incremental PSE&G liability was recorded as a Regulatory Asset rather than an
adjustment to Retained Earnings. The following table presents the impact at January 1, 2007 on the Condensed Consolidated Balance Sheets for PSEG and its subsidiaries as a result of implementing FIN
48:
PSE&G
Power
Energy
PSEG
Balance Sheet
(Millions) Increase to Long-Term Accrued Taxes
$
26
$
21
$
355
$
402 Decrease to Accumulated Deferred Income Tax Liability
$
15
$
7
$
246
$
268 Increase to Regulatory Assets
$
11
$
—
$
—
$
11 Decrease to Retained Earnings
$
—
$
14
$
109
$
123 The after-tax expense resulting from the adoption of FIN 48 for the quarter and nine months ended September 30, 2007 are summarized as follows:
Quarter Ended
Nine Months Ended
(Millions) PSEG
$
6
$
16 Power
$
1
$
4 Energy Holdings
$
5
$
12 There was no impact on earnings for PSE&G. For additional information relating to the impacts of FIN 48, see Note 11. Income Taxes. In May 2007, the FASB issued FSP No. FIN 48-1, which provides guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously
unrecognized tax benefits. The adoption of this FSP did not have a material impact on the financial statements of PSEG, PSE&G, Power or Energy Holdings. FSP No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (FSP 13-2) PSEG and Energy Holdings In July 2006, the FASB issued FSP 13-2, which addressed how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the
accounting by a lessor for that lease. The FSP amended SFAS 13, “Accounting for Leases,” stating that a change in the timing of the above referenced cash flows must be reviewed at least annually or more
frequently, if events or circumstances indicate a change in timing is probable. If a change in timing has 20
(UNAUDITED)
Holdings
Consolidated
September 30, 2007
September 30, 2007
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS occurred, or is projected to occur, the rate of return and the allocation of income to positive investment years must be recalculated from the inception of the lease. The guidance in this FSP was adopted on January 1, 2007. The cumulative effect of applying the provisions of this FSP was reported as an adjustment to the beginning balance of Retained Earnings as
of the date of adoption. As a result of implementing FSP 13-2, upon adoption PSEG and Energy Holdings each recognized a reduction in Investment in Leveraged Leases of $69 million, a reduction in
Deferred Income Taxes of $2 million and a reduction in Retained Earnings of $67 million. The impact to earnings resulting from the adoption of FSP 13-2 for the quarter and nine months ended September 30, 2007 was an after-tax decrease of $3 million and $9 million, respectively, for both
PSEG and Energy Holdings. Note 3. Discontinued Operations, Dispositions and Impairments Discontinued Operations Power Lawrenceburg Energy Center (Lawrenceburg) On May 16, 2007, Power completed the sale of Lawrenceburg, a 1,096-megawatt (MW), gas-fired combined cycle electric generating plant located in Lawrenceburg, Indiana, to AEP Generating
Company, a subsidiary of American Electric Power Company, Inc. The sale price for the facility and inventory was $325 million. The transaction resulted in an after-tax charge to Power’s earnings of $208 million and was reflected as a charge to Discontinued
Operations in the fourth quarter of 2006. Lawrenceburg’s operating results for the quarter and nine months ended September 30, 2007 and 2006, which were reclassified to Discontinued Operations, are summarized below:
Quarters
Nine Months
2007
2006
2007
2006
(Millions) Operating Revenues
$
—
$
34
$
—
$
40 Income (Loss) Before Income Taxes
$
2
$
(4
)
$
(13
)
$
(33
) Net Income (Loss).
$
1
$
(2
)
$
(8
)
$
(19
) The carrying amounts of the assets of Lawrenceburg as of December 31, 2006 are summarized in the following table:
As of
(Millions) Current Assets
$
10 Noncurrent Assets
315 Total Assets of Discontinued Operations
$
325 Energy Holdings Electroandes S.A. (Electroandes) On September 19, 2007, Global entered into an agreement for the sale of Electroandes, a hydro-electric generation and transmission company in Peru that owns and operates four hydro-generation
plants with total capacity of 180 MW and 437 miles of electric transmission lines. The purchaser is a wholly owned subsidiary of Statkraft Norfund Power Invest of Norway. The sale was completed on
October 17, 2007 for a total purchase price of approximately $390 million (subject to working capital and other adjustments), including the assumption of approximately $105 million of debt. Net cash
proceeds, after taxes and including dividends 21
(UNAUDITED)
Ended
September 30,
Ended
September 30,
December 31,
2006
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS paid prior to closing, were approximately $220 million, which will result in an after-tax gain of approximately $65 million being recorded in the fourth quarter of 2007. The 2007 and 2006 operating results for Electroandes have been reclassified to Discontinued Operations. In conjunction with the reclassification to Discontinued Operations, Electroandes recorded a
$19 million income tax expense in the second quarter of 2007 related to the discontinuation of applying Accounting Principles Board (APB) Opinion No. 23, “Accounting for Income Taxes—Special Areas,”
as the income generated by Electroandes is no longer expected to be indefinitely reinvested. Electroandes’ operating results for the quarter and nine months ended September 30, 2007 and 2006 are summarized below:
Quarters
Nine Months
2007
2006
2007
2006
(Millions) Operating Revenues.
$
14
$
15
$
38
$
44 Income Before Income Taxes
$
7
$
5
$
14
$
14 Net Income (Loss)
$
5
$
4
$
(9
)
$
9 The carrying amounts of the assets of Electroandes as of September 30, 2007 and December 31, 2006 are summarized in the following table:
As of
As of
(Millions) Current Assets
$
23
$
25 Noncurrent Assets
274
272 Total Assets of Discontinued Operations
$
297
$
297 Current Liabilities.
$
7
$
9 Noncurrent Liabilities
127
125 Total Liabilities of Discontinued Operations
$
134
$
134 Elektrocieplownia Chorzow Elcho Sp. Z o.o. (Elcho) and Elektrownia Skawina SA (Skawina) On May 29, 2006, Global completed the sale of its interest in two coal-fired plants in Poland, Elcho and Skawina. Proceeds, net of transaction costs, were $476 million, resulting in a gain of $228 million
net of tax expense of $142 million. The 2006 operating results for Global’s assets in Poland have been reclassified to Discontinued Operations. Elcho’s and Skawina’s operating results for the nine months ended September 30, 2006 are summarized below:
Nine Months
Ended
Elcho
Skawina
(Millions) Operating Revenues.
$
39
$
44 (Loss) Income Before Income Taxes
$
(3
)
$
2 Net (Loss) Income
$
(2
)
$
1 Dispositions Power In December 2006, Power recorded a pre-tax impairment loss of $44 million to write down four turbines to their estimated realizable value and reclassified them to Assets Held for Sale on Power’s
Condensed 22
(UNAUDITED)
Ended
September 30,
Ended
September 30,
September 30,
2007
December 31,
2006
September 30,
2006
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheet. In April 2007, Power sold the four turbines to a third party and received proceeds of $40 million, which approximated the recorded book value. Energy Holdings Global Chilquinta Energia S.A. (Chilquinta) and Luz del Sur S.A.A. (LDS) In October 2007, Global entered into an agreement to sell its 50% ownership interest in Chilquinta, an electric distribution company in Chile, and its 38% ownership of LDS, an electric distribution
company in Peru to a subsidiary of AEI (formerly Ashmore Energy International), for approximately $685 million. Global expects to close the transaction by the end of 2007. Sempra Energy International Holdings BV (Sempra), Global’s partner in these investments, owns the remaining 50% of Chilquinta and an equal 38% stake in LDS (the remaining ownership of LDS is
publicly traded on the Lima stock exchange). Sempra has a contractual right of first refusal for a limited period of time to purchase, on the same terms, the shares that are subject to the agreement with
AEI. The tax expense resulting from the transaction is expected be equal to or slightly in excess of the pre-tax gain on the transaction. Net cash proceeds, after taxes, are expected to total between $480
million to $500 million. Thermal Energy Development Partnership, L.P. (Tracy Biomass) On December 22, 2006, Global entered into an agreement to sell its 34.5% interest in Tracy Biomass for $7 million. The sale closed on January 26, 2007 and resulted in a 2007 pre-tax gain of $7 million
($6 million after-tax). Rio Grande Energia S. A. (RGE) On May 10, 2006, Global entered into an agreement with Companhia Paulista de Force Luz (CPFL) to sell its 32% ownership interest in RGE, a Brazilian electric distribution company. The transaction
closed on June 23, 2006 and gross proceeds of $185 million were received. The transaction resulted in a pre-tax write-down of $263 million ($178 million after-tax), primarily related to the devaluation of the
Brazilian Real subsequent to Global’s acquisition of its interests in RGE in 1997. EGDC In August 2007, EGDC sold its Largo property for $12 million which approximated the recorded book value. EGDC received cash proceeds of $9 million and a note receivable for $3 million. Impairment Energy Holdings Venezuela PSEG has indirect ownership interests in two generating facilities in Maracay and Cagua, Venezuela that have a total capacity of 120 MW. The projects are owned and operated by Turboven Company
Inc. (Turboven), an entity which is jointly-owned by Global (50%) and Corporacion Industrial de Energia (CIE). Global also has a 9% indirect interest in Turbogeneradores de Maracay through a
partnership with CIE. During Global’s 2006 year-end review of its investments, management concluded that due to the current political situation in Venezuela, it was probable that Global would not be able to recover all of
its investment in its Venezuelan operations. Therefore, Global recorded an impairment loss of $4 million, after-tax, to write down these investments in the fourth quarter of 2006. In January 2007, the Venezuelan government announced its intention to nationalize certain sectors of Venezuelan industry and commerce, including certain foreign-owned energy and communications
companies. 23
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS In a subsequent press release, Turboven was named as one of the companies that Venezuela intended to nationalize. Since these announcements, Venezuela has proceeded to nationalize certain companies.
Global has entered into valuation discussions with the government of Venezuela as part of the nationalization efforts, which are ongoing. Based upon a recent review of the circumstances, an additional
impairment charge of $7 million, after tax, was recorded in September 2007. Note 4. Earnings Per Share (EPS) PSEG Diluted EPS is calculated by dividing Net Income by the weighted average number of shares of common stock outstanding, including shares issuable upon exercise of stock options outstanding under
PSEG’s stock option plans and upon payment of performance units. The following table shows the effect of these stock options and performance units on the weighted average number of shares outstanding
used in calculating diluted EPS:
Quarters Ended September 30,
Nine Months Ended September 30,
2007
2006
2007
2006
Basic
Diluted
Basic
Diluted
Basic
Diluted
Basic
Diluted EPS Numerator: Earnings (Millions) Continuing Operations
$
500
$
500
$
372
$
372
$
1,127
$
1,127
$
569
$
569 Discontinued Operations
6
6
2
2
(17
)
(17
)
217
217 Net Income
$
506
$
506
$
374
$
374
$
1,110
$
1,110
$
786
$
786 EPS Denominator (Thousands): Weighted Average Common Shares Outstanding
254,272
254,272
251,747
251,747
253,603
253,603
251,471
251,471 Effect of Stock Options
—
273
—
490
—
355
—
599 Effect of Stock Performance Units
—
—
—
92
—
25
—
91 Total Shares
254,272
254,545
251,747
252,329
253,603
253,983
251,471
252,161 Earnings Per Share: Continuing Operations
$
1.97
$
1.97
$
1.47
$
1.47
$
4.45
$
4.44
$
2.26
$
2.26 Discontinued Operations
0.02
0.02
0.01
0.01
(0.07
)
(0.07
)
0.86
0.86 Net Income
$
1.99
$
1.99
$
1.48
$
1.48
$
4.38
$
4.37
$
3.12
$
3.12 Dividend payments on common stock for the quarters ended September 30, 2007 and 2006 were $149 million ($0.585 per share) and $144 million ($0.57 per share), respectively. Dividend payments on
common stock for the nine months ended September 30, 2007 and 2006 were $445 million ($1.755 per share) and $430 million ($1.71 per share), respectively. 24
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 5. Commitments and Contingent Liabilities Guaranteed Obligations Power Power contracts for electricity, natural gas, oil, coal, pipeline capacity, transportation and emission allowances and engages in risk management activities through ER&T. These activities primarily involve
the purchase and sale of energy and related products under transportation, physical, financial and forward contracts at fixed and variable prices. These transactions are executed with numerous
counterparties and brokers. Counterparties and brokers may require guarantees, cash or cash-related instruments to be deposited on these transactions as described below. Power has unconditionally guaranteed payments by its subsidiaries, ER&T and PSEG Power New York Inc. (Power New York) in commodity-related transactions to support current exposure, interest
and other costs on sums due and payable in the ordinary course of business. These payment guarantees are provided to counterparties in order to obtain credit. Under these agreements, guarantees cover
lines of credit between entities and are often reciprocal in nature. The exposure between counterparties can move in either direction. The face value of the guarantees outstanding as of September 30, 2007
and December 31, 2006 was approximately $1.4 billion and $1.6 billion, respectively. In order for Power to incur a liability for the face value of the outstanding guarantees, ER&T and Power New York would have to fully utilize the credit granted to them by every counterparty to whom
Power has provided a guarantee and all of ER&T’s and Power New York’s contracts would have to be “out-of-the-money” (if the contracts are terminated, Power would owe money to the counterparties).
The probability of all contracts at ER&T and Power New York being simultaneously “out-of-the-money” is highly unlikely due to offsetting positions within the portfolio. For this reason, the current exposure
at any point in time is a more meaningful representation of the potential liability to Power under these guarantees if ER&T and/or Power New York were to default. This current exposure consists of the net
of accounts receivable and accounts payable and the forward value on open positions, less any margins posted. The current exposure from such liabilities was $483 million and $518 million as of September
30, 2007 and December 31, 2006, respectively. Power is subject to counterparty collateral calls related to commodity contracts and is subject to certain creditworthiness standards as guarantor under performance guarantees for ER&T’s agreements.
Changes in commodity prices, including fuel, emissions allowances and electricity, can have a material impact on margin requirements under such contracts. As of September 30, 2007 and December 31,
2006, Power had the following margin posted and received to satisfy collateral obligations and support various contractual and environmental obligations, which were primarily in the form of letters of
credit:
As of
As of
(Millions) Margin Posted
$
151
$
40 Margin Received
$
60
$
86 Power also routinely enters into exchange-traded futures and options transactions for electricity and natural gas as part of its operations. Generally, such future contracts require a deposit of cash
margin, the amount of which is subject to change based on market movement and in accordance with exchange rules. As of September 30, 2007 and December 31, 2006, Power had deposited margin of $121
million and $89 million, respectively. In the event of a deterioration of Power’s credit rating to below investment grade, which would represent a two level downgrade from its current ratings, many of these agreements allow the
counterparty to demand that ER&T provide further performance assurance. Exchange-traded transactions that are margined and monitored separately from physical trading activity may not be subject to
change in the event of a downgrade to Power’s rating. As of September 30, 2007, if Power were to lose its investment grade rating and, assuming all counterparties to which ER&T is “out-of-the-money” were
contractually entitled to 25
(UNAUDITED)
September 30,
2007
December 31,
2006
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS demand, and demanded, performance assurance, ER&T could be required to post additional collateral in an amount equal to $588 million. Power believes that it has sufficient liquidity to post such collateral,
if necessary. Energy Holdings Energy Holdings and/or Global have guaranteed certain obligations of their subsidiaries or affiliates, including the successful completion, performance or other obligations related to certain projects. Global also has a contingent guarantee that will expire in April 2011 related to debt service obligations associated with Chilquinta Energia S.A., an energy distribution company in Chile in which Global
owns 50%. As of September 30, 2007 and December 31, 2006, the contingent guarantee was $25 million. In September 2003, Energy Holdings completed the sale of PSEG Energy Technologies Inc. (Energy Technologies) and nearly all of its assets. However, Energy Holdings retained certain outstanding
construction and warranty obligations related to ongoing construction projects previously performed by Energy Technologies. These construction obligations have performance bonds issued by insurance
companies for which exposure is adequately supported by the outstanding letters of credit for PSEG Energy Technologies Asset Management Company LLC. As of September 30, 2007 and December 31,
2006, there were $14 million of such bonds outstanding, which are related to uncompleted construction projects. As of September 30, 2007 and December 31, 2006, there was an additional $2 million of
performance guarantees related to Energy Technologies. As of September 30, 2007 and December 31, 2006, Energy Holdings and/or Global had various other guarantees amounting to $20 million and $30 million, respectively. Environmental Matters Hazardous Substances Power Prevention of Significant Deterioration (PSD)/New Source Review (NSR) The PSD/NSR regulations, promulgated under the Clean Air Act (CAA), require major sources of certain air pollutants to obtain permits, install pollution control technology and obtain offsets, in
some circumstances, when those sources undergo a “major modification,” as defined in the regulations. The federal government may order companies that are not in compliance with the PSD/NSR
regulations to install the best available control technology at the affected plants and to pay monetary penalties of up to $27,500 for each day of continued violation. In
January 2002, Power reached an agreement with the New Jersey Department of
Environmental Protection (NJDEP) and the EPA to resolve allegations of noncompliance
with PSD/NSR regulations. Under that agreement, Power agreed to install advanced
air pollution controls to reduce emissions of Sulfur Dioxide (SO2), Nitrogen
Oxide (NOx), particulate matter and mercury from the coal-burning
units at the Mercer and Hudson generating stations to ensure compliance with
PSD/NSR. On
November 30, 2006, Power reached an agreement with the EPA and the NJDEP
on an amendment to its 2002 agreement intended to achieve the emissions reductions
targets of this agreement while providing more time to assess the feasibility
of installing additional advanced emissions controls at Hudson. The amended
agreement with the EPA and the NJDEP, which received final approval from
the U.S. District Court in New Jersey in May 2007, allows Power to continue
operating Hudson and extends for four years the deadline for installing environmental
controls beyond the previous December 31, 2006 deadline. Power is required
to undertake a number of technology projects, plant modifications and operating
procedure changes at Hudson and Mercer designed to meet targeted reductions
in emissions of NOx, SO2, particulate matter and mercury.
In July 2007, Power notified the EPA and the NJDEP that it will proceed with
the installation of the additional emissions controls at Hudson, which are
to be completed by the end of 2010. Under the program, Power has installed selective catalytic reductions at Mercer at a cost of $122 million. The cost of implementing the balance of the amended agreement is estimated at approximately
$475 million 26
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS to $525 million for Mercer and $700 million to $750 million for Hudson and will be incurred by the end of 2010. Pursuant to the agreement, Fossil purchased and retired emissions allowances by July 31,
2007, paid a $6 million civil penalty and will contribute $3 million for programs to reduce particulate emissions from diesel engines in New Jersey. In March 2007, Fossil entered into an engineering,
procurement and construction contract with a third party contractor to complete all back-end technology requirements for the Mercer station, as referenced above. Fossil signed a contract for construction
management related to the Hudson back-end technology construction in July 2007. As a result of the agreement, Power’s environmental reserves include $3 million to account for the particulate matter reduction program. PSEG and Power recorded the charge in Other Deductions on
their respective Condensed Consolidated Statements of Operations in the fourth quarter of 2006. Mercury Regulation New Jersey and Connecticut have adopted standards for the reduction of emissions of mercury from coal-fired electric generating units. The regulations in New Jersey require the units to meet certain
emissions limits or reduce emissions by 90% by December 15, 2007. Under the New Jersey regulations, companies that are parties to multi-pollutant reduction agreements are permitted to postpone such reductions on half of their coal-fired electric generating capacity
until December 15, 2012. With respect to Power’s New Jersey facilities, half of the reductions that are required by December 15, 2007 are expected to be achieved through the installation of carbon injection
technology at both Mercer Units, which was completed in January 2007. Because there is some uncertainty as to whether the system can consistently achieve the required reductions, Power has applied for a
facility-specific control plan. Power believes, but cannot guarantee, that this filing will allow for the continued operation of both Mercer Units while baghouses are installed. Installation of the baghouses is
scheduled to be completed by the end of 2008. At its Hudson plant, Power anticipates compliance consisting of the installation of a baghouse by the end of 2010. The mercury control technologies are also part of Power’s multi-pollutant reduction agreement, which resulted from the amended 2002 agreement that resolved issues arising out of the PSD and the
NSR air pollution control programs discussed above. Mercury emissions control standards effective in July 2008 in Connecticut require coal-fired power plants in Connecticut to achieve either an emissions limit or a 90% mercury removal efficiency
through technology installed to control mercury emissions. Power anticipates compliance at its Bridgeport Harbor Station resulting from the installation of a baghouse by the end of 2007. In February 2007, Pennsylvania finalized its “State-specific” requirements to reduce mercury emissions from coal-fired electric generating units. Currently, the regulations would not materially affect the
costs already identified in Power’s capital expenditures forecast. The estimated costs of technology believed to be capable of meeting these emissions limits at Power’s coal-fired unit in Connecticut and at its Mercer and Hudson Stations are included in Power’s
capital expenditures forecast. Total estimated costs for each project are between $150 million and $200 million. The costs for Mercer and Hudson are included in the cost estimates referred to in the
PSD/NSR discussion above. Natural Resource Damages PSEG, PSE&G and Power Passaic River The U.S. Environmental Protection Agency (EPA) has determined that a six-mile stretch of the Passaic River in the area of Newark, New Jersey is a “facility” within the meaning of that term under
the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). PSE&G and certain of its predecessors conducted industrial operations at properties adjacent to the Passaic River facility. The operations included one operating electric generating station (Essex Site),
one former generating station and four former manufactured gas plants (MGPs). PSE&G’s costs to clean up 27
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS former MGPs are recoverable from utility customers through the Societal Benefits Clause (SBC). PSE&G has sold the site of the former generating station and obtained releases and indemnities for liabilities
arising out of the site in connection with the sale. The Essex Site was transferred to Power in August 2000. Power assumed any environmental liabilities of PSE&G associated with the electric generating
stations that PSE&G transferred to it, including the Essex Site. In 2003, the EPA notified 41 potentially responsible parties (PRPs), including PSE&G and Power, that it was expanding its assessment of the Passaic River Study Area to the entire 17-mile tidal reach of
the lower Passaic River. The EPA further indicated, with respect to PSE&G, that it believed that hazardous substances had been released from the Essex Site and a former MGP located in Harrison, New
Jersey (Harrison Site), which also includes facilities for PSE&G’s ongoing gas operations. The EPA estimated that its study would require five to eight years to complete and would cost approximately $20
million, of which it would seek to recover $10 million from the PRPs, including PSE&G and Power. In 2006, the EPA notified the PRPs that the cost of its study will greatly exceed the $20 million initially
estimated and after discussion, approximately 70 PRPs, including PSE&G and Power, have agreed to assume responsibility for the study pursuant to an Administrative Order on Consent and to divide the
associated costs among themselves according to a mutually agreed-upon formula. The percentage allocable to Power and PSE&G varies depending on the number of PRPs who have agreed to divide the costs
but it currently approximates 6%. Power has provided notice to insurers concerning this potential claim. In June 2007, the EPA announced a Focused Feasibility Study (FFS) that proposes six options with estimated costs ranging from $900 million to $2.3 billion to address contamination cleanup in the
lower eight miles of the Passaic River in addition to a “No Action” alternative. The work contemplated by the FFS is not subject to the Administrative Order on Consent or the cost sharing agreement. CERCLA and the New Jersey Spill Compensation and Control Act (Spill Act) authorize federal and state trustees for natural resources to assess damages against persons who have discharged a
hazardous substance, causing an injury to natural resources. Pursuant to the Spill Act, the NJDEP requires persons conducting remediation to characterize injuries to natural resources and to address those
injuries through restoration or damages. The NJDEP has regulations in effect concerning site investigation and remediation that require an ecological evaluation of potential damages to natural resources in
connection with an environmental investigation of contaminated sites. In 2003, PSEG, PSE&G and 56 other PRPs received a Directive and Notice to Insurers from the NJDEP that directed the PRPs to
arrange for a natural resource damage assessment and interim compensatory restoration of natural resource injuries along the lower Passaic River and its tributaries pursuant to the Spill Act. The NJDEP
alleged in the Directive that it had determined that hazardous substances had been discharged from the Essex Site and the Harrison Site. The NJDEP announced that it had estimated the cost of interim
natural resource injury restoration activities along the lower Passaic River to approximate $950 million. On August 2, 2007, the National Oceanic and Atmospheric Administration of the United States
Department of Commerce sent a letter to PSE&G and other companies identified as PRPs notifying them that it intended to perform an assessment of injuries to natural resources and inviting the PRPs to
participate. The PRPs have not agreed to participate. Newark Bay Study Area The EPA sent PSE&G and eleven other entities notices that the EPA considered each of the entities to be a PRP with respect to contamination in the Newark Bay Study Area, which it defined as
Newark Bay and portions of the Hackensack River, the Arthur Kill and the Kill Van Kull. The notice letter requested that the PRPs participate and fund the EPA-approved study in the Newark Bay Study
Area and encouraged the PRPs to contact Occidental Chemical Corporation (OCC) to discuss participating in the Remedial Investigation/Feasibility Study (RI/FS) that OCC is conducting in the Newark
Bay Study Area. EPA considers the Newark Bay Study Area, along with the Passaic River Study Area, to be part of the Diamond Alkali Superfund Site. The notice states the EPA’s belief that hazardous
substances were released from sites owned by PSE&G and located on the Hackensack River. The sites included two operating electric generating stations (Hudson and Kearny Sites), and one former MGP.
PSE&G’s costs to clean up former MGPs are recoverable from utility customers through the SBC. The Hudson and Kearny Sites were transferred to Power in August 2000. Power assumed any environmental
liabilities of PSE&G associated with the electric 28
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS generating stations that PSE&G transferred to it, including the Hudson and Kearny Sites. Power has provided notice to insurers concerning this potential claim. PSE&G and Power are unable to estimate the
cost of the investigation at this time. Other On June 29, 2007, the State of New Jersey filed multiple lawsuits against parties, including PSE&G, who were alleged to be responsible for injuries to natural resources in New Jersey, including a site
being remediated under PSE&G’s MGP program. PSEG, PSE&G and Power cannot predict what further actions, if any, or the costs or the timing thereof, that may be required with respect to the Passaic
River, Newark Bay or other natural resource damages claims; however, such costs could be material. PSE&G MGP Remediation Program PSE&G is currently working with the NJDEP under a program to assess, investigate and remediate environmental conditions at PSE&G’s former MGP sites (Remediation Program). To date, 38 sites have
been identified as sites requiring some level of remedial action. In addition, the NJDEP has announced initiatives to accelerate the investigation and subsequent remediation of the riverbeds underlying
surface water bodies that have been impacted by hazardous substances from adjoining sites. Specifically, in 2005, the NJDEP initiated a program on the Delaware River aimed at identifying the 10 most
significant sites for cleanup. One of the sites identified is a former MGP facility located in Camden. The Remediation Program is periodically reviewed, and the estimated costs are revised by PSE&G based
on regulatory requirements, experience with the program and available remediation technologies. Since the inception of the Remediation Program in 1988 through September 30, 2007, PSE&G has had
expenditures of $411 million. Based on the most recent estimates, the cost of remediating all sites to completion, as well as the anticipated costs to address MGP-related material discovered in two rivers adjacent to two former
MGP sites, could range between $798 million and $838 million, including amounts spent to date. No amount within the range was considered to be most likely. Therefore, $387 million was accrued as of
September 30, 2007, which represents the difference between the low end of the total program cost estimate of $798 million and the total incurred costs through September 30, 2007 of $411 million. Of this
amount, $54 million was recorded in Other Current Liabilities and $333 million was reflected in Other Noncurrent Liabilities. The costs associated with the MGP Remediation Program have historically
been recovered through the SBC charges to PSE&G ratepayers. As such, a $387 million Regulatory Asset was recorded. Costs for the Remediation Program were $42 million for 2006. PSE&G anticipates spending $47 million in 2007, $50 million in 2008, and an average of approximately $40 million per year each year
thereafter through 2016. Power New Jersey Industrial Site Recovery Act (ISRA) Potential environmental liabilities related to subsurface contamination at certain generating stations have been identified. In the second quarter of 1999, in anticipation of the transfer of PSE&G’s
generation-related assets to Power, a study was conducted pursuant to ISRA, which applied to the sale of certain assets. Power had a $50 million liability as of September 30, 2007 and December 31, 2006
related to these obligations, which is included in Environmental Costs on Power’s and PSEG’s Condensed Consolidated Balance Sheets. Permit Renewals In June 2001, the NJDEP issued a renewed New Jersey Pollutant Discharge Elimination System (NJPDES) permit for Salem, expiring in July 2006, allowing for the continued operation of Salem with
its existing cooling water intake system. A renewal application prepared in accordance with Federal Water 29
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Pollution Control Act (FWPCA) Section 316(b) and the Phase II 316(b) rule was filed in January 2006 with the NJDEP, which allows the station to continue operating under its existing NJPDES permit
until a new permit is issued. Power’s application to renew Salem’s NJPDES permit demonstrates that the station satisfies FWPCA Section 316(b) and meets the Phase II 316(b) rule’s performance standards
for reduction of impingement and entrainment through the station’s existing cooling water intake technology and operations plus implemented restoration measures. The application further demonstrates
that even without the benefits of restoration, the station meets the Phase II 316(b) rule’s site-specific determination standards, both on a comparison of the costs and benefits of new intake technology as
well as a comparison of the costs to implement the technology at the facility to the cost estimates prepared by the EPA. The U.S. Court of Appeals for the Second Circuit (Second Circuit Court) issued a decision after Power filed its application that rejected the use of restoration and the site-specific cost-benefit test under
the Phase II 316(b) rule. On May 25, 2007, Power and other industry petitioners filed with the Second Circuit Court a request for a rehearing. In July 2007, the Second Circuit Court denied the request. Power will file a petition
requesting that the U.S. Supreme Court review the matter, but can not predict whether it will be granted. Although the rule applies to all of Power’s electric generating units that use surface waters for
once-through cooling purposes, the impact of the rule and the decision of the court cannot be determined at this time for all of Power’s facilities. Depending on the outcome of the petition to the Supreme
Court, or actions by the EPA to promulgate a revised rule, this decision could have a material impact on Power’s ability to renew its New Jersey and Connecticut permits at its larger once-through cooled
plants, including Salem, Hudson, Mercer, New Haven and Bridgeport, without making significant upgrades to their existing intake structures and cooling systems. If the NJDEP and the Connecticut
Department of Environmental Protection were to require installation of closed-cycle cooling or its equivalent at those five once-through cooled facilities, the related costs and impacts would be material to
Power’s financial position, results of operations and net cash flows. For example, Power’s application to renew the permit, filed in February 2006 with the NJDEP, estimated the costs associated with cooling
towers for Salem to be approximately $1 billion, of which Power’s share would be approximately $575 million. Potential costs associated with any closed-cycle cooling requirements are not included in
Power’s currently forecasted capital expenditures. Energy Holdings Bioenergie S.p.A. (Bioenergie) In May 2006, Global became the majority shareholder of Bioenergie (formerly known as Prisma 2000 S.p.A.). Among other holdings, Bioenergie holds 100% of the stock of San Marco Bioenergie
S.p.A. (San Marco), owner of a 20 MW biomass generation facility in Italy. Global also assumed operational responsibility for the facility in May 2006, which was previously operated by Carlo Gavazzi
Green Power pursuant to a Services Agreement with a Global subsidiary. Global’s total investment in Bioenergie is approximately $71 million. In August 2006, Global became aware that the Italian government was conducting a criminal investigation regarding allegations of violations of the San Marco facility’s air permit. The scope of the
investigation was subsequently expanded to include alleged violations of the facility’s waste recycling and waste storage permits. The Italian government has named five individuals as targets of the criminal
investigation, including three former San Marco employees and two former members of the facility’s Board of Directors. San Marco has not been named as a target. In December 2006 and January 2007, the facility was served with orders suspending its operations. San Marco has fully cooperated with the Prosecuting Attorney regarding the ongoing investigation
and has implemented the corrective actions designed to prevent recurrence of the violations. On April 26, 2007, the Prosecutor issued an order returning control of the plant to San Marco. The facility
became fully operational during the third quarter of 2007. 30
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS New Generation and Development Power Power
plans to modestly increase its generating capacity at Hope Creek and Salem
Unit 2 in 2008. Phase I of the Hope Creek turbine replacement increased the
capacity by 10 MW in 2005, and Phase II, which is expected to add approximately
125 MW of capacity, is expected to be completed in the second quarter of
2008 along with the Extended Power Uprate (EPU). Actions are expected to
be completed during the fourth quarter 2007 refueling outage at Hope Creek
to facilitate an online EPU implementation in the second quarter of 2008
upon receipt of NRC approval. Phase I of the Salem Unit 2 turbine upgrade
increased Power’s
share of the capacity by 14 MW in 2003. Phase II is currently scheduled for
the spring of 2008, concurrent with steam generator replacement and is anticipated
to increase Power’s share of the
capacity by an additional 15 MW. As of September 30, 2007, Power’s expenditures
for these projects were $191 million (including Interest Capitalized During
Construction (IDC) of $22 million) with an aggregate estimated share of total
costs for these projects of $211 million (including IDC of $23 million). Completion of the projects discussed above within the estimated time frames and cost estimates cannot be assured. Construction delays, cost increases, regulatory approvals and various other factors
could result in changes in the operational dates or ultimate costs to complete. Basic Generation Service (BGS) and Basic Gas Supply Service (BGSS) PSE&G and Power PSE&G is required to obtain all electric supply requirements through the annual New Jersey BGS auctions for customers who do not purchase electric supply from third-party suppliers. PSE&G enters into
the Supplier Master Agreement (SMA) with the winners of these BGS auctions within three business days following the BPU’s approval. PSE&G has entered into contracts with Power, as well as with other
winning BGS suppliers, to purchase BGS for PSE&G’s anticipated load requirements. The winners of the auction are responsible for fulfilling all the requirements of a PJM Interconnection, L.L.C. (PJM)
Load Serving Entity (LSE) including capacity, energy, ancillary services, transmission and any other services required by PJM. BGS suppliers assume any customer migration risk and must satisfy New
Jersey’s renewable portfolio standards. Through the BGS auctions, PSE&G has contracted for its anticipated BGS-Fixed Price load, as follows:
Term Ending
May
May
May
May Term
34 months
36 months
36 months
36 months Load (MW)
2,840
2,840
2,882
2,758 $ per kWh
$
0.05515
$
0.06541
$
0.10251
$
0.09888
(a)
Prices set in the February 2004 BGS auction. (b) Prices set in the February 2005 BGS auction. (c) Prices set in the February 2006 BGS auction. (d) Prices set in the February 2007 BGS auction. Power seeks to mitigate volatility in its results by contracting in advance for its anticipated electric output as well as its anticipated fuel needs. As part of its objective, Power has entered into contracts
to directly supply PSE&G and other New Jersey Electric Distribution Companies (EDCs) with a portion of their respective BGS requirements through the New Jersey BGS auction process, described above.
In addition to the BGS-related contracts, Power enters into firm supply contracts with EDCs, as well as other firm sales and commitments. 31
(UNAUDITED)
2007(a)
2008(b)
2009(c)
2010(d)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PSE&G has a full requirements contract with Power to meet the gas supply requirements of PSE&G’s gas customers. The contract extends through March 31, 2012, and year-to-year thereafter. Power has
also entered into contracts to supply energy, capacity and ancillary services to PSE&G through the BGS auction process. Power has entered into hedges for a portion of these anticipated BGSS obligations, as
permitted by the BPU. The BPU permits recovery of the cost of gas hedging up to 115 billion cubic feet or approximately 80% of PSE&G’s residential gas supply annually through the BGSS tariff. For
additional information, see Note 13. Related-Party Transactions. The BPU is currently conducting an audit of the gas procurement practices of all four New Jersey gas utilities, including PSE&G. The outcome of this proceeding cannot be predicted. Minimum Fuel Purchase Requirements Power Coal and Oil Power purchases coal and oil for certain of its fossil generation stations through various long-term commitments. The coal purchase commitments through 2009 amount to approximately 90% of its
average anticipated coal needs, including transportation. Total coal purchase commitments, including transportation, are approximately $1.1 billion extending through 2012. Nuclear Fuel Power has several long-term purchase contracts for the supply of nuclear fuel for the Salem and Hope Creek nuclear generating stations. Power has inventory and commitments to purchase sufficient
quantities of uranium (concentrates and uranium hexafluoride) to meet 100% of its total estimated requirements through 2011. Power has commitments for concentrates covering approximately 80% of its
estimated requirements for 2012, 30% from 2013 through 2014 and 20% through 2016. Additionally, Power has commitments for uranium hexafluoride to meet 45% of its estimated requirements for 2012
and 20% from 2013 through 2016. These commitments, based on current market prices, which have increased substantially over the past two to three years, total approximately $490 million ($355 million
Power’s estimated share). Power’s policy is to maintain certain levels of concentrates and uranium hexafluoride in inventory and to make periodic purchases to support such levels. As such, the
commitments referred to above include estimated quantities to be purchased that are in excess of contractual minimum quantities. Power also has commitments that provide 100% of its uranium enrichment requirements through 2010 that total approximately $230 million ($160 million Power’s estimated share). Power has commitments for the fabrication of fuel assemblies for reloads required through 2011 for Salem and through 2012 for Hope Creek that total approximately $125 million ($90 million Power’s
estimated share). Exelon Generation LLC (Exelon) has informed Power that the Peach Bottom plant has inventory and commitments to purchase sufficient quantities of uranium (concentrates and uranium
hexafluoride) to meet 100% of its total estimated requirements through 2010. Additionally, Exelon has commitments covering approximately 80% of its estimated requirements for 2011 and 45% for 2012. Exelon also has commitments that provide 100% of its uranium enrichment requirements for the Peach Bottom plant in 2008, 2010 and 2012. Additionally, Peach Bottom has a 93% commitment in
2009 and an 81% commitment in 2011. Exelon has commitments for the fabrication of fuel assemblies for reloads required through 2012 for Peach Bottom. In total, the Exelon commitment for nuclear fuel, conversion, enrichment and
fabrication totals $593 million ($297 million Power’s estimated share). Natural Gas In addition to its fuel requirements, Power has entered into various multi-year contracts for firm transportation and storage capacity for natural gas, primarily to meet its gas supply obligations to PSE&G. 32
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS As of September 30, 2007, the total minimum requirements under these contracts were approximately $1 billion through 2016. These purchase obligations are consistent with Power’s strategy to enter into contracts for its fuel supply in comparable volumes to its sales contracts. Energy Holdings The Texas generation facilities have entered into gas supply agreements for their anticipated fuel requirements to satisfy obligations under their forward energy sales contracts. As of September 30,
2007, the plants had fuel purchase commitments totaling $137 million to support all of their contracted energy sales. Operating Services Contract (OSC) Power On January 17, 2005, Nuclear entered into an OSC with Exelon relating to the operation of the Hope Creek and Salem nuclear generating stations. The OSC requires Exelon to provide key personnel
to oversee daily plant operations at the Hope Creek and Salem nuclear generating stations and to implement a management model that Exelon has used to manage its own nuclear facilities. Nuclear
continues as the license holder with exclusive legal authority to operate and maintain the plants, retains responsibility for management oversight and has full authority with respect to the marketing of its
share of the output from the facilities. Exelon is entitled to receive reimbursement of its costs in discharging its obligations, an annual operating services fee of $3 million and incentive fees up to $12 million
annually based on attainment of goals relating to safety, capacity factor and operation and maintenance expenses. On October 27, 2006, Nuclear informed Exelon that it was electing to continue the OSC for
up to two years beyond January 2007. In December 2006, Power announced its plans to resume direct management of the Salem and Hope Creek nuclear generating stations. As part of this plan, on January 1, 2007, the senior management
team at Salem and Hope Creek, which consisted of three senior executives from Exelon, became employees of Power. Power has continued to recruit additional employees to build its organizational
structure. Power is implementing a plan to fully resume functions that Exelon currently performs, which Power expects will put it in a position to terminate the OSC by the end of 2007. Maintenance Agreement Power Power entered into a long-term contractual services agreement with a vendor in September 2003 to provide the outage and service needs for certain of Power’s generating units at market rates. The
contract covers 25 years and could result in annual payments ranging from $10 million to $50 million for services, parts and materials rendered. Investment Tax Credits (ITC) PSEG and PSE&G As of June 1999, the Internal Revenue Service (IRS) had issued several private letter rulings (PLRs) that concluded that the refunding of excess deferred tax and ITC balances to utility customers was
permitted only over the related assets’ regulatory lives, which for PSE&G, were terminated upon New Jersey’s electric industry deregulation. Based on this fact, PSEG and PSE&G reversed the deferred tax
and ITC liability relating to PSE&G’s generation assets that were transferred to Power, and recorded a $235 million reduction of the extraordinary charge in 1999 due to the restructuring of the utility
industry in New Jersey. Subsequently, PSE&G was directed by the BPU to seek a PLR from the IRS to determine if the ITC included in the impairment write-down of generation assets could be credited to
customers without violating the tax normalization rules of the Internal Revenue Code. PSE&G filed a PLR request with the IRS in 2002. 33
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS On May 11, 2006, the IRS issued a PLR to PSE&G, which concluded that none of the generation ITC could be passed to utility customers without violating the normalization rules. On May 16, 2006, the
BPU voted in favor of a special investigation and hearing before the BPU concerning PSE&G’s actions leading up to receiving the PLR, specifically its failure to abide by a BPU order to withdraw the
request. An order detailing such special investigation has not yet been issued and no investigation has begun. On October 13, 2006, the Appellate Division of the Superior Court of New Jersey granted PSE&G’s motion to dismiss PSE&G’s appeal of the BPU’s order to withdraw the PLR since PSE&G has already
received the PLR. The court also determined that if the BPU seeks to take future action against PSE&G based on the alleged violation of its order, PSE&G can restart the appeal. While the holding in the PLR is favorable for PSE&G, an outstanding Treasury regulation project could overturn the holding in the PLR if the Treasury were to alter a position set out in certain
December 21, 2005 proposed regulations. PSEG and PSE&G cannot determine the final outcome of this matter until the final Treasury regulations are issued. BPU Deferral Audit PSEG and PSE&G The BPU Energy and Audit Division conducts audits of deferred balances under various adjustment clauses. A draft Deferral Audit—Phase II report relating to the 12-month period ended July 31, 2003
was released by the consultant to the BPU in April 2005. The draft report addresses the SBC, Market Transition Charge (MTC) and Non-Utility Generation (NUG) deferred balances. The BPU released
the report on May 13, 2005. While the consultant to the BPU found that the Phase II deferral balances complied in all material respects with the BPU Orders regarding such deferrals, the consultant noted that the BPU Staff had
raised certain questions with respect to the reconciliation method PSE&G had employed in calculating the overrecovery of its MTC and other charges during the Phase I and Phase II four-year transition
period. The amount in dispute is approximately $130 million. On January 31, 2007, PSE&G requested that the matter be transmitted to the Office of Administrative Law for the development of an evidentiary record and an initial decision. The BPU granted the
request on February 7, 2007. On May 25, 2007, PSE&G filed a Motion for Summary Judgment requesting dismissal of the matter. On September 28, 2007, the Administrative Law Judge issued an initial
decision denying PSE&G’s motion and ordering the filing of testimony and evidentiary hearings. The BPU Staff and New Jersey Public Advocate’s Division of Rate Counsel have both asserted in briefs that
$130 million be refunded to ratepayers. While PSE&G believes the MTC methodology it used was fully litigated and resolved, by the prior BPU Orders in its previous electric base rate case, deferral audit and deferral proceedings, PSE&G
cannot predict the impact of the outcome of this proceeding. New Jersey Clean Energy Program PSE&G The BPU has approved a funding requirement for each New Jersey utility applicable to its Renewable Energy and Energy Efficiency programs for the years 2005 to 2008. The sum of PSE&G’s electric
and gas funding requirement was $90 million and $72 million for the nine months ended September 30, 2007 and 2006, respectively. The remaining liability has been recorded at a discounted present value
with an offsetting Regulatory Asset, since the costs associated with this program are expected to be recovered from PSE&G ratepayers through the SBC. The liability for the funding requirement as of
September 30, 2007 and December 31, 2006 was $174 million and $253 million, respectively. 34
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Leveraged Lease Investments PSEG and Energy Holdings On November 16, 2006, the IRS issued a report with respect to its audit of PSEG’s corporate tax returns for tax years 1997 through 2000, which disallowed all deductions associated with certain of
Resources’ lease transactions that are similar to a type that the IRS publicly announced its intention to challenge. In addition, the IRS imposed a 20% penalty for substantial understatement of tax liability.
In February 2007, PSEG filed a protest to the Office of Appeals of the IRS. As of September 30, 2007 and December 31, 2006, Resources’ total gross investment in such transactions was approximately $1.5
billion. If all deductions associated with these lease transactions, entered into by PSEG between 1997 and 2002, are successfully challenged by the IRS, it would have a material adverse impact on PSEG’s and
Energy Holdings’ financial position, results of operations and net cash flows and could impact future returns on these transactions. PSEG believes that its tax position related to these transactions is properly
based on applicable statutes, regulations and case law and will aggressively contest the IRS’ disallowance. PSEG believes that it is more likely than not that it will prevail with respect to the IRS’ challenge,
although no assurances can be given. If the IRS’ disallowance of tax benefits associated with all of these lease transactions was sustained, $853 million of PSEG’s deferred tax liabilities that have been recorded under leveraged lease
accounting through September 30, 2007 would become currently payable. In addition, as of September 30, 2007 interest of approximately $166 million, after-tax, and penalties of $165 million may become
payable, with potential additional interest and penalties of approximately $17 million accruing quarterly. Energy Holdings’ management has assessed the probability of various outcomes to this matter and
recorded the tax effect to be realized in accordance with FIN 48. For additional information and guidance for leveraged leases, see Note 2. Recent Accounting Standards. Superintendencia Nacional de Administracion Tributaria (SUNAT) Energy Holdings Luz del Sur S.A.A. (LDS) In January 2007, SUNAT, the governing taxing authority in Peru, filed two tax assessments against LDS totaling $18 million, of which Global’s share would be $7 million based on its 38% interest in
LDS. The assessments relate to deductions LDS claimed beginning in 2000 for certain operating fees it paid to International Technical Operators under a technical services agreement for certain bad debt
deductions and certain other matters. The assessments include interest and penalties claimed by SUNAT. LDS believes that most of such deductions were appropriate and filed an appeal in February 2007.
LDS believes it has valid legal defenses to these claims and that it should be successful in contesting these material items/disallowances; however, no assurances can be given regarding the outcome of this
matter. Note 6. Financial Risk Management Activities PSEG, PSE&G, Power and Energy Holdings The operations of PSEG, PSE&G, Power and Energy Holdings are exposed to market risks from changes in commodity prices, foreign currency exchange rates, interest rates and equity prices that could
affect their results of operations and financial conditions. PSEG, PSE&G, Power and Energy Holdings manage exposure to these market risks through their regular operating and financing activities and,
when deemed appropriate, hedge these risks through the use of derivative financial instruments. PSEG, PSE&G, Power and Energy Holdings use the term ‘hedge’ to mean a strategy designed to manage risks
of volatility in prices or rate movements on certain assets, liabilities or anticipated transactions and by creating a relationship in which gains or losses on derivative instruments are expected to
counterbalance the gains or losses on the assets, liabilities or anticipated transactions exposed to such market risks. Each of PSEG, PSE&G, Power and Energy Holdings uses derivative instruments as risk
management tools consistent with its respective business plan and prudent business practices. 35
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Derivative Instruments and Hedging Activities Commodity Contracts Power Power actively transacts in energy and energy-related products, including electricity, natural gas, electric capacity, firm transmission rights (FTRs), coal, oil and emission allowances in the spot, forward
and futures markets, primarily in the Northeastern and Mid Atlantic United States. Power maintains a strategy of entering into positions to optimize the value of its portfolio and reduce earnings volatility of generation assets, gas supply contracts and its electric and gas supply
obligations. Power engages in physical and financial transactions in the electricity wholesale markets and executes an overall risk management strategy seeking to mitigate the effects of adverse movements
in the fuel and electricity markets. These contracts also involve financial transactions including swaps, options, futures and FTRs. Higher market prices for electricity and capacity at September 30, 2007
versus December 31, 2006 have resulted in additional unrealized losses on many of these contracts leading to an increase in Accumulated Other Comprehensive Loss (OCL). Power marks its derivative
energy-related contracts to market in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended (SFAS 133) with changes in fair value charged to the
Condensed Consolidated Statements of Operations (except certain contracts that are designated as effective hedges or contracts that qualify for the normal purchases and normal sales exception). Wherever
possible, fair values for these contracts are obtained from quoted market sources. For contracts where no quoted market exists, modeling techniques are employed using assumptions reflective of current
market rates, yield curves and forward prices, as applicable, to interpolate certain prices. The effect of using such modeling techniques is not material to Power’s financial results. Cash Flow Hedges Power uses forward sale and purchase contracts, swaps and FTR contracts to hedge forecasted energy sales from its generation stations and to hedge related load obligations. Power also enters into
swaps and futures transactions to hedge the price of fuel to meet its fuel purchase requirements. These derivative transactions are designated and effective as cash flow hedges under SFAS 133. As of
September 30, 2007, the fair value of these hedges was $(338) million and along with realized losses on hedges of $(4) million retained in OCL, resulted in $(201) million after-tax recorded in OCL. As of
December 31, 2006, the fair value of these hedges was $(166) million. These hedges, along with realized losses on hedges of $(19) million retained in OCL, resulted in a $(108) million after-tax balance in
OCL. The increase of $93 million in OCL during the nine months ended September 30, 2007 was caused mainly by higher electricity market prices. During the 12 months ending September 30, 2008, $144
million after-tax of net unrealized and realized losses on these commodity derivatives is expected to be reclassified to earnings. Approximately $50 million of after-tax unrealized losses on these commodity
derivatives in OCL is expected to be reclassified to earnings for the 12 months ending September 30, 2009. Ineffectiveness associated with these hedges, as defined in SFAS 133, was $(3) million as of
September 30, 2007. The expiration date of the longest-dated cash flow hedge is in 2010. Other Derivatives Power also enters into certain other contracts that are derivatives, but do not qualify for hedge accounting under SFAS 133. These contracts are used primarily for fuel purchases for generation and
BGSS requirements and for electricity purchases for contractual sales obligations and a minor portion is used in Power’s Nuclear Decommissioning Trust Funds. Therefore, the changes in fair market value
of these derivative contracts are recorded in Energy Costs, Operating Revenues, Other Income or Other Deductions, as appropriate, on the Condensed Consolidated Statements of Operations. The net fair
value of these instruments as of September 30, 2007 was $(10) million. The net fair value of these instruments as of December 31, 2006 was $(2) million. 36
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Energy Holdings Other Derivatives The Texas generation facilities enter into electricity forward and capacity sales contracts to sell portions of their 2,000 MW capacity through 2010, with the balance sold into the daily spot market. The
Texas generation facilities also enter into gas purchase contracts to specifically match the generation requirements to support the electricity forward sales contracts. Although these contracts fix the amount
of revenue, fuel costs and cash flows, and thereby provide financial stability to the Texas generation facilities, these contracts are, based on their terms, derivatives that do not meet the specific accounting
criteria in SFAS 133 to qualify for the normal purchases and normal sales exception, or to be designated as a hedge for accounting purposes. As a result, these contracts must be recorded at fair value. The
net fair value of the open positions was $55 million and $38 million as of September 30, 2007 and December 31, 2006, respectively. Interest Rates PSEG, PSE&G, Power and Energy Holdings PSEG, PSE&G, Power and Energy Holdings are subject to the risk of fluctuating interest rates in the normal course of business. PSEG’s policy is to manage interest rate risk through the use of fixed and
floating rate debt and interest rate derivatives. Fair Value Hedges PSEG and Power In March 2004, Power issued $250 million of 3.75% Senior Notes due April 2009. PSEG used an interest rate swap to convert Power’s fixed-rate debt into variable-rate debt. The interest rate swap is
designated and effective as a fair value hedge. The fair value changes of the interest rate swap are fully offset by the fair value changes in the underlying debt. As of September 30, 2007 and December 31,
2006, the fair value of the hedge was $(4) million and $(9) million, respectively. Cash Flow Hedges PSEG, PSE&G and Energy Holdings PSEG, PSE&G and Energy Holdings use interest rate swaps and other interest rate derivatives to manage their exposures to the variability of cash flows, primarily related to variable-rate debt
instruments. The interest rate derivatives used are designated and effective as cash flow hedges. Except for PSE&G’s cash flow hedges, the fair value changes of these derivatives are initially recorded in OCL.
As of September 30, 2007, the fair value of these cash flow hedges was $(3) million and $(3) million at PSE&G and Energy Holdings, respectively. As of December 31, 2006, the fair value of these cash flow
hedges was $(4) million, primarily at PSE&G. The $(3) million and $(4) million at PSE&G as of September 30, 2007 and December 31, 2006, respectively, is not included in OCL, as it is deferred as a
Regulatory Asset and is expected to be recovered from PSE&G’s customers. During the 12 months ending September 30, 2008, approximately $1 million of net unrealized losses (net of taxes) on interest rate
derivatives is expected to be reclassified to earnings at Energy Holdings. During the next 12 months, less than $1 million of unrealized losses (net of taxes) on interest rate derivatives in OCL is expected to
be reclassified at PSEG. As of September 30, 2007, there was no hedge ineffectiveness associated with these hedges. Foreign Currencies Energy Holdings Global is exposed to foreign currency risk and other foreign operation risks that arise from investments in foreign subsidiaries and affiliates. A key component of its risks is that some of its foreign
subsidiaries and affiliates have functional currencies other than the consolidated reporting currency, the U.S. Dollar. Additionally, Global and certain of its foreign subsidiaries and affiliates have entered
into monetary 37
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS obligations and maintain receipts/receivables in U.S. Dollars or currencies other than their own functional currencies. Global, a U.S. Dollar functional currency entity, is primarily exposed to changes in the
Peruvian Nuevo Sol and the Chilean Peso and to a lesser extent, the Euro. Changes in valuation of these currencies can impact the value of Global’s investments, results of operations, financial condition
and cash flows. Global has attempted to limit potential foreign exchange exposure by entering into revenue contracts that adjust for changes in foreign exchange rates. Global may also use foreign currency
forward, swap and option agreements to manage risk related to certain foreign currency fluctuations. Although the Chilean Peso and the Peruvian Nuevo Sol had originally depreciated relative to the U.S. Dollar after Global’s initial investments, the currencies have appreciated significantly over the
past few years. The net cumulative foreign currency revaluations have increased the total amount of Energy Holdings’ Member’s Equity by $189 million as of September 30, 2007. Hedges of Net Investments in Foreign Operations Energy Holdings In March and April 2004, Energy Holdings entered into four cross-currency interest rate swap agreements. The swaps are designed to hedge the net investment in a foreign subsidiary associated with
the exposure in the U.S. Dollar to Chilean Peso exchange rate. The fair value of the cross-currency swaps was $(30) million and $(25) million as of September 30, 2007 and December 31, 2006, respectively.
The change in fair value of the majority of the swaps is recorded in Cumulative Translation Adjustment within OCL. As a result, Energy Holdings’ Member’s Equity was reduced by $27 million as of
September 30, 2007. Note 7. Comprehensive Income (Loss), Net of Tax
PSE&G
Power
Energy
Other(A)
Consolidated
(Millions) For the Quarter Ended September 30, 2007: Net Income (Loss)
$
107
$
339
$
71
$
(11
)
$
506 Other Comprehensive Income
—
52
32
2
86 Comprehensive Income (Loss)
$
107
$
391
$
103
$
(9
)
$
592 For the Quarter Ended September 30, 2006: Net Income (Loss)
$
88
$
205
$
101
$
(20
)
$
374 Other Comprehensive Income (Loss).
1
204
1
—
206 Comprehensive Income (Loss)
$
89
$
409
$
102
$
(20
)
$
580 For the Nine Months Ended September 30, 2007: Net Income (Loss)
$
302
$
736
$
118
$
(46
)
$
1,110 Other Comprehensive (Loss) Income.
—
(73
)
51
3
(19
) Comprehensive Income (Loss)
$
302
$
663
$
169
$
(43
)
$
1,091 For the Nine Months Ended September 30, 2006: Net Income (Loss)
$
200
$
394
$
251
$
(59
)
$
786 Other Comprehensive Income
1
383
192
—
576 Comprehensive Income (Loss)
$
201
$
777
$
443
$
(59
)
$
1,362 38
(UNAUDITED)
Holdings
Total
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Accumulated Other Comprehensive Income (Loss)
Balance as of
PSE&G
Power
Energy
Other (A)
Balance as of
(Millions) For the Nine Months Ended Derivative Contracts.
$
(114
)
$
—
$
(92
)
$
(1
)
$
—
$
(207
) Pension and OPEB Plans.
(214
)
—
8
—
2
(204
) Currency Translation Adjustment
110
—
—
52
—
162 NDT Funds
108
—
11
—
—
119 Other
2
—
—
—
1
3
$
(108
)
$
—
$
(73
)
$
51
$
3
$
(127
)
Balance as of
PSE&G
Power
Energy
Other (A)
Balance as of
(Millions) For the Nine Months Ended Derivative Contracts
$
(626
)
$
—
$
374
$
54
$
—
$
(198
) Pension and OPEB Plans
(11
)
1
1
—
—
(9
) Currency Translation Adjustment
(44
)
—
—
138
—
94 NDT Funds
72
—
8
—
—
80
$
(609
)
$
1
$
383
$
192
$
—
$
(33
)
(A)
Other primarily consists of activity at PSEG (as parent company), Services and intercompany eliminations.
Note 8. Changes in Capitalization PSEG In May 2007, PSEG redeemed the outstanding $375 million of its Floating Rate Notes Due 2008 at 100% of the principal amount. For the nine months ended September 30, 2007, PSEG issued 1,077,122 shares of its common stock in connection with settling stock options under its Long-Term Incentive Plan (LTIP) for $48 million. For the nine months ended September 30, 2007, PSEG issued 405,890 shares of its common stock under its Dividend Reinvestment and Stock Purchase Plan (DRASPP) and Employee Stock Purchase
Plan (ESPP) for $34 million. PSE&G On January 2, 2007, PSE&G repaid at maturity $113 million of its 6.25% Series WW First and Refunding Mortgage Bonds. On May 14, 2007, PSE&G issued $350 million of 5.80% Secured Medium Term Notes Series E due 2037. The proceeds were used to reduce short-term debt. In September 2007, PSE&G paid cash dividends to PSEG of $100 million. In September 2007, June 2007 and March 2007, PSE&G Transition Funding LLC (Transition Funding) repaid $43 million, $36 million and $38 million, respectively, of its transition bonds. In June 2007, PSE&G Transition Funding II LLC (Transition Funding II) repaid $4 million of its transition bonds. 39
(UNAUDITED)
December 31,
2006
Holdings
September 30,
2007
September 30, 2007:
December 31,
2005
Holdings
September 30,
2006
September 30, 2006:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Power Power paid cash dividends to PSEG of $125 million, $450 million and $250 million in March 2007, June 2007 and September 2007, respectively. Energy Holdings In March 2007, Energy Holdings made a cash distribution to PSEG of $145 million in the form of a return of capital. In August 2007, Sociedad Austral de Electricidad S.A., a wholly owned subsidiary of Global, issued 3.80% bonds (approximately 7%, including current inflationary adjustment) for net proceeds of $163
million with a final maturity of June 30, 2028. The proceeds were used principally to repay loans due to Energy Holdings which then loaned the funds to PSEG for short-term funding. During the first nine months of 2007, Energy Holdings’ subsidiaries repaid $35 million of non-recourse debt, including $31 million by Global, primarily related to the Texas generation facilities, $2
million by Resources and $2 million by EGDC. 40
(UNAUDITED)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 9. Other Income and Deductions
PSE&G
Power
Energy
Other(A)
Consolidated
(Millions) Other Income: For the Quarter Ended September 30, 2007: Interest and Dividend Income
$
2
$
5
$
2
$
(2
)
$
7 NDT Fund Realized Gains
—
37
—
—
37 NDT Interest and Dividend Income
—
12
—
—
12 Gain on Sale of Property, Plant and Equipment
2
—
—
—
2 Change in Derivative Fair Value
—
—
2
—
2 Other
(2
)
2
1
—
1 Total Other Income
$
2
$
56
$
5
$
(2
)
$
61 For the Quarter Ended September 30, 2006: Interest and Dividend Income
$
3
$
3
$
13
$
(9
)
$
10 NDT Fund Realized Gains
—
20
—
—
20 NDT Interest and Dividend Income
—
10
—
—
10 Other
3
5
—
—
8 Total Other Income
$
6
$
38
$
13
$
(9
)
$
48 For the Nine Months Ended September 30, 2007: Interest and Dividend Income
$
8
$
20
$
7
$
(9
)
$
26 NDT Fund Realized Gains
—
102
—
—
102 NDT Interest and Dividend Income
—
37
—
—
37 Arbitration Award (Konya-Ilgin)
—
—
9
—
9 Change in Derivative Fair Value
—
—
3
—
3 Gain on Sale of Property, Plant and Equipment
2
—
—
—
2 Minority Interest
—
—
—
2
2 Other
2
3
4
—
9 Total Other Income
$
12
$
162
$
23
$
(7
)
$
190 For the Nine Months Ended September 30, 2006: Interest and Dividend Income
$
9
$
10
$
22
$
(12
)
$
29 NDT Fund Realized Gains
—
69
—
—
69 NDT Interest and Dividend Income
—
29
—
—
29 Foreign Currency Gains
—
—
2
—
2 Change in Derivative Fair Value
—
—
2
—
2 Other
9
5
4
—
18 Total Other Income
$
18
$
113
$
30
$
(12
)
$
149 41
(UNAUDITED)
Holdings
Total
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PSE&G
Power
Energy
Other(A)
Consolidated
(Millions) Other Deductions:
For the Quarter Ended September 30, 2007: NDT Fund Realized Losses and Expenses
$
—
$
26
$
—
$
—
$
26 Other-Than-Temporary Impairment of Investments
—
16
—
—
16 Donations
1
—
—
1
2 Foreign Currency Losses
—
—
6
—
6 Change in Derivative Fair Value
—
—
4
—
4 Other
—
—
1
2
3 Total Other Deductions
$
1
$
42
$
11
$
3
$
57 For the Quarter Ended September 30, 2006: Donations
$
—
$
—
$
—
$
1
$
1 NDT Fund Realized Losses and Expenses
—
12
—
—
12 Foreign Currency Losses
—
—
2
—
2 Change in Derivative Fair Value
—
—
—
—
— Loss on Extinguishment of Debt
—
—
12
—
12 Environmental Reserves
—
14
—
—
14 Total Other Deductions
$
—
$
26
$
14
$
1
$
41 For the Nine Months Ended September 30, 2007: Donations
$
2
$
—
$
—
$
6
$
8 NDT Fund Realized Losses and Expenses
—
62
—
—
62 Other-Than-Temporary Impairment of Investments
—
40
—
—
40 Foreign Currency Losses
—
—
9
—
9 Change in Derivative Fair Value
—
—
5
—
5 Loss on Disposition of Assets
—
2
—
—
2 Other
1
1
1
1
4
(UNAUDITED)
Holdings
Total