PEG

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2005, and the six months ended June 30, 2005, for Public Service Enterprise Group Incorporated (PSEG) and its principal 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 reportable segments: PSE&G (regulated utility), Power (wholesale generation and trading), and two subsidiaries of Energy Holdings (Global and Resources). A significant corporate event during the period was the shareholder approval of a merger with Exelon Corporation, which received FERC approval on June 30, 2005.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Loss in Q2 2005: PSEG reported a net loss of $82 million for the quarter, compared to net income of $124 million in Q2 2004. This was primarily driven by a $183 million loss from discontinued operations related to the sale of the Waterford generation facility.
• Discontinued Operations: Power recognized a $177 million pre-tax loss on the disposal of the Waterford facility in May 2005 due to a write-down to fair value less cost to sell. This resulted in a $183 million net loss from discontinued operations for the quarter and $190 million for the six months.
• Continuing Operations: Income from continuing operations decreased by $26 million ($0.11 per share) in the quarter and $16 million ($0.10 per share) for the six months compared to the prior year. Factors included lower earnings at PSE&G and Power, merger-related costs, and a $15 million write-off of a United Airlines lease investment at Resources.
• Revenue Growth: Operating revenues increased 7% in the quarter and 4% for the six months, driven by higher commodity prices and increased generation revenues, partially offset by lower delivery revenues at PSE&G.
• Cash Flow: Operating cash flow for the six months decreased by $260 million to $572 million, largely due to higher funding for employee benefit plans and timing differences in tax payments and asset sales.

Guidance, Outlook, and Risks

• Merger with Exelon: The merger is subject to regulatory approvals (BPU, PAPUC, DOJ). Completion is expected in the first or second quarter of 2006. Merger-related costs are expected to reduce 2005 results by $0.10 to $0.15 per share.
• 2005 Guidance:
  • PSEG: Projects Income from Continuing Operations of $3.15 to $3.35 per share for 2005.
  • PSE&G: Expects Income from Continuing Operations of $325 million to $345 million for 2005.
  • Power: Expects Income from Continuing Operations of $335 million to $385 million for 2005.
  • Energy Holdings: Expects Income from Continuing Operations of $135 million to $155 million for 2005.
• Key Risks and Contingencies:
  • Environmental Liabilities: Significant potential costs related to the Passaic River remediation (estimated $950 million total for all parties) and MGP remediation programs. PSE&G has accrued $334 million for MGP remediation.
  • Regulatory Risks: Outcomes of FERC proceedings regarding Reliability Must-Run (RMR) compensation and Regional Through and Out Rates (RTOR) could impact revenues.
  • Market Risks: Exposure to commodity price fluctuations, interest rates, and foreign currency exchange rates (particularly Brazilian Real, Polish Zloty, and Chilean Peso).
  • Legal Proceedings: Ongoing litigation regarding antitrust claims in Texas (TCE and Utility Choice suits) and environmental claims in Brazil and Peru.

Investor Verification Checklist

• Merger Status: Verify the timeline and conditions for regulatory approval of the Exelon merger, specifically the BPU and PAPUC proceedings.
• Waterford Disposal: Confirm the closing of the Waterford facility sale to American Electric Power and the realization of the projected $300 million in proceeds.
• Environmental Accruals: Review the adequacy of the $334 million accrual for MGP remediation and the potential exposure from the Passaic River study.
• Derivative Positions: Assess the impact of the $300 million net unrealized loss on mark-to-market energy contracts and the $128 million expected reclassification of hedge losses into earnings over the next 12 months.
• Credit Ratings: Monitor credit rating agency actions (S&P, Moody's, Fitch) regarding the "Credit Watch" or "Negative" outlooks assigned to PSEG and subsidiaries due to the merger.