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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine months ended September 30, 2006, for Public Service Enterprise Group Incorporated (PSEG) and its subsidiaries: Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power), and PSEG Energy Holdings L.L.C. (Energy Holdings). PSEG operates as a holding company with four principal segments: PSE&G (regulated utility), Power (wholesale generation and trading), and Energy Holdings (international projects and leveraged leases). A significant corporate event during the period was the termination of the merger agreement with Exelon Corporation on September 14, 2006.

Key Financial Metrics (Nine Months Ended Sept 30, 2006)

Material Changes vs. Prior Period

• Net Income Increase: Consolidated Net Income increased $330 million (72%) to $786 million. This was primarily driven by a $228 million after-tax gain on the sale of two generating stations in Poland (Elcho and Skawina) included in Discontinued Operations, partially offset by a $178 million after-tax loss on the sale of Rio Grande Energia (RGE) in Brazil.
• Continuing Operations Decline: Income from Continuing Operations decreased $81 million to $559 million. This decline was due to lower earnings at Energy Holdings (impacted by the RGE loss) and PSE&G (due to delayed rate relief and weather impacts), partially offset by a $91 million increase at Power driven by improved nuclear performance and higher realized prices.
• Operating Cash Flow: Operating cash flow increased significantly by $541 million to $1,444 million, largely due to decreases in accounts receivable and fuel inventory at Power resulting from lower commodity prices.
• Debt Reduction: Total Long-Term Debt decreased by $570 million to $10.7 billion, reflecting active debt paydowns and redemptions across subsidiaries.

Guidance, Outlook, and Risks

• 2006 Earnings Guidance: PSEG projects 2006 earnings from Continuing Operations to range from $3.45 to $3.75 per share. This excludes asset sales and merger-related costs.
  • PSE&G: Guidance lowered to $250–$270 million due to prolonged lack of rate relief.
  • Power: Guidance raised to $500–$550 million due to improved operations and strong energy markets.
  • Energy Holdings: Guidance raised to $185–$205 million, driven by strong performance in Texas.
• Dividends: The Board approved a quarterly dividend of $0.57 per share for Q4 2006, indicating an annual rate of $2.28.
• Regulatory Risks: PSE&G faces uncertainty regarding pending electric and gas rate cases. Settlements reached in October 2006 (post-period) provide for modest revenue increases but restrict further base rate changes until 2009.
• Environmental Liabilities: Significant contingencies exist regarding the Passaic River and Newark Bay Superfund sites. Costs for the Passaic River study are estimated to exceed initial projections, and the Newark Bay study costs are likely to be material but currently unquantifiable.
• Merger Termination: The termination of the Exelon merger has led to negative outlook revisions from S&P and Moody's, though ratings remain investment grade. This may increase the cost of capital.
• Accounting Changes: PSEG is evaluating the impact of SFAS 158 (pension/OPEB funding) and SFAS 157 (fair value measurements), which may materially impact the balance sheet in 2007.

Investor Verification Checklist

• Discontinued Operations Impact: Verify the sustainability of earnings by excluding the $228 million Poland gain and $178 million Brazil loss to assess core operational performance.
• Rate Case Outcomes: Monitor the final approval of the October 2006 settlements for PSE&G's gas and electric rate cases to confirm the projected revenue increases of $40 million and $47 million annually.
• Environmental Exposure: Track the EPA's progress on the Passaic River and Newark Bay studies to assess potential future accruals for remediation costs.
• Power's Margin Profile: Review Power's hedging strategy and realized prices, as margins are sensitive to the spread between contracted sales and fuel costs, particularly in the natural gas market.
• Debt Covenants: Confirm continued compliance with debt-to-capitalization covenants (PSEG at 52.8%, PSE&G at 45.3%, Power at 39.3%) following the merger termination and credit rating outlook changes.