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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 1999, for Public Service Enterprise Group Inc. (PSEG) and its primary subsidiary, Public Service Electric and Gas Company (PSE&G). The reporting period is defined by the New Jersey Energy Master Plan Proceedings, which mandated the deregulation of the electric generation industry. Effective April 1, 1999, PSE&G discontinued the application of SFAS 71 (regulated accounting) for its electric generation business, transitioning to competitive market accounting. This shift resulted in a significant restructuring of the company's financial reporting and asset valuation.

Key Financial Metrics

Material Changes vs. Prior Period

• Extraordinary Charge: The primary driver of the net loss was a one-time, after-tax extraordinary charge of $790 million recorded in Q2 1999. This charge resulted from the impairment of PSE&G's electric generation assets (nuclear and fossil) due to the discontinuation of regulated accounting (SFAS 71) and the transition to a competitive market.
• Asset Write-Down: The net book value of generating stations was reduced by approximately $5.0 billion (pretax) or $3.09 billion (after-tax). This was partially offset by the creation of a $4.058 billion regulatory asset for stranded costs expected to be recovered via securitization.
• Revenue Growth: Excluding the extraordinary item, operating performance improved. Total operating revenues increased 5.4% year-over-year for the quarter and 7.0% for the six-month period, driven by favorable weather, economic factors in New Jersey, and profits from wholesale energy activities.
• Depreciation Reduction: Depreciation and amortization expenses decreased significantly (28% for the quarter) due to the lower net book value of generation assets following the impairment write-down.
• Foreign Currency Impact: Net foreign currency devaluations, primarily due to the Brazilian Real, reduced total stockholders' equity by $170 million as of June 30, 1999.

Guidance, Outlook, and Risks

• Regulatory Transition: PSE&G is implementing a 5% rate reduction effective August 1, 1999, with further reductions scheduled through 2003. The company anticipates completing the sale of its generation assets to a new subsidiary, PSEG Power, in Q4 1999 for approximately $2.443 billion.
• Securitization: PSE&G is pursuing the issuance of up to $2.525 billion in transition bonds to recover stranded costs. Proceeds are expected in Fall 1999, subject to regulatory approval.
• Market Risk: With the elimination of the Levelized Energy Adjustment Clause (LEAC), PSEG is now fully exposed to wholesale electricity price volatility. Value-at-risk for commodity instruments increased to $11 million (95% confidence, one-week horizon) due to recent price spikes in the PJM market.
• Year 2000 Readiness: The company estimates total Y2K costs of $83 million. As of June 30, 1999, over 99% of critical systems were remediated, with remaining nuclear facility systems scheduled for completion by November 1999.
• Environmental Liabilities: Significant contingent liabilities exist regarding the Passaic River site and manufactured gas plant remediation. Costs for the latter are estimated at approximately $20 million per year over 30 years.

Investor Verification Checklist

• Securitization Approval: Verify the issuance of the BPU Finance Order authorizing the $2.525 billion transition bond charge.
• Asset Sale Closing: Confirm the regulatory approvals (BPU, FERC, NRC) required to close the sale of generation assets to PSEG Power in Q4 1999.
• Wholesale Price Exposure: Monitor PJM spot prices and PSEG Power's ability to hedge against price volatility now that the LEAC mechanism is discontinued.
• Foreign Currency Exposure: Assess the impact of further devaluation of the Brazilian Real on PSEG Global's investments and debt obligations.
• Year 2000 Contingency: Review the final status of nuclear facility system remediation prior to the year-end rollover.