Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, for Northeast Utilities (NU) and its subsidiaries: The Connecticut Light and Power Company (CL&P), Public Service Company of New Hampshire (PSNH), and Western Massachusetts Electric Company (WMECO). The company is a regulated utility holding company operating in Connecticut, New Hampshire, and Massachusetts. The reporting period is characterized by the strategic exit from competitive energy businesses (NU Enterprises), including the sale of the retail marketing business to Hess Corporation in June 2006 and the pending sale of competitive generation assets (NGC and Mt. Tom) to Energy Capital Partners (ECP), which closed in November 2006.
Key Financial Metrics (Nine Months Ended Sept 30, 2006)
| Metric | 2006 (9 Months) | 2005 (9 Months) |
|---|---|---|
| Operating Revenues | $5,402.5 million | $5,519.5 million |
| Net Income | $123.6 million | $(239.9 million) Loss |
| Earnings Per Share (Diluted) | $0.80 | $(1.85) |
| Operating Cash Flow | $380.3 million | $352.8 million |
| Capital Expenditures | $600.3 million | $521.5 million |
| Total Assets | $11,492.5 million | $12,569.1 million |
| Long-Term Debt | $2,956.6 million | $3,027.3 million |
| Cash and Cash Equivalents | $50.5 million | $45.8 million |
Material Changes vs. Prior Period
- Turnaround in Profitability: NU reported a net income of $123.6 million for the first nine months of 2006, a significant improvement from a net loss of $239.9 million in the same period of 2005. The 2005 loss was driven by $359.7 million in wholesale contract market changes and significant restructuring charges associated with exiting competitive businesses.
- Regulatory Tax Benefit: A major driver of 2006 earnings was a $74 million reduction in income tax expense for CL&P. This resulted from a Private Letter Ruling (PLR) from the IRS and a subsequent DPUC determination allowing the release of unamortized investment tax credits and excess deferred income taxes related to sold generation assets.
- Divestitures: The company completed the sale of its retail marketing business to Hess Corporation on June 1, 2006. The retail business incurred a loss of $71.3 million for the nine months ended September 30, 2006. Additionally, the company reached an agreement to sell its competitive generation assets (NGC and Mt. Tom) for $1.34 billion, expecting to record an after-tax gain of approximately $300 million in the fourth quarter of 2006.
- Revenue Decline: Operating revenues decreased by $117 million year-over-year, primarily due to the divestiture of competitive businesses ($626 million decrease), partially offset by higher distribution revenues ($472 million) driven by the pass-through of higher energy supply costs.
Guidance, Outlook, and Risks
- 2006 Earnings Guidance: NU projects combined earnings for the Utility Group and parent/affiliates of between $1.57 and $1.70 per share for 2006. This includes the one-time $74 million tax benefit. Excluding this benefit, earnings are projected at $0.32 per share for the first nine months.
- 2007 Earnings Guidance: NU projects combined earnings for the Utility Group and parent/affiliates of between $1.30 and $1.55 per share for 2007. This assumes breakeven results for NU Enterprises.
- Liquidity Outlook: Liquidity is expected to be significantly enhanced in the fourth quarter of 2006 due to the sale of NGC and Mt. Tom, which generated approximately $1 billion in cash inflows. The company expects to pay approximately $490 million in taxes related to the sale in Q1 2007 and use the remaining proceeds to fund capital expenditures and reduce short-term debt.
- Key Risks:
- Regulatory Risk: Ongoing proceedings regarding decommissioning costs for Connecticut Yankee Atomic Power Company (CYAPC) and rate cases in Connecticut, New Hampshire, and Massachusetts.
- Market Risk: Remaining exposure to wholesale energy contracts in PJM and New York, which are marked-to-market and subject to commodity price volatility.
- Collateral Calls: If NU's credit ratings were downgraded to sub-investment grade, Select Energy could be required to post approximately $217 million in collateral or letters of credit.
Investor Verification Checklist
- Tax Benefit Sustainability: Verify the permanence of the $74 million tax benefit from the IRS PLR and its impact on future effective tax rates.
- Divestiture Closing: Confirm the final closing details and tax implications of the NGC and Mt. Tom sale to ECP, specifically the timing of the $490 million tax payment.
- Wholesale Contract Exposure: Review the remaining portfolio of wholesale contracts in PJM and New York and the potential costs to exit or settle these obligations.
- Regulatory Rate Cases: Monitor the status of rate cases for CL&P (postponed to mid-2007), PSNH, and WMECO, as well as the FERC decision on transmission Return on Equity (ROE).
- Capital Expenditure Funding: Assess the company's ability to fund the projected $4.9 billion capital program for 2007-2011, particularly the heavy investment in transmission infrastructure.