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Business Context and Reporting Period

Company: Public Service Enterprise Group Inc. (PSEG) and its principal subsidiary, Public Service Electric and Gas Company (PSE&G).

Reporting Period: Quarterly Report (Form 10-Q) for the period ended September 30, 1998.

Overview: PSEG is a public utility holding company. PSE&G operates as a regulated electric and gas utility in New Jersey. The reporting period is significantly influenced by the New Jersey Energy Master Plan proceedings, which aim to deregulate the electric industry, and the implementation of New Jersey energy tax reform effective January 1, 1998.

Key Financial Metrics (Nine Months Ended Sept 30, 1998)

Note: PSEG Short-Term Debt includes $1,206M Commercial Paper/Loans and $419M Long-Term Debt due within one year. PSE&G Short-Term Debt includes $1,082M Commercial Paper/Loans and $100M Long-Term Debt due within one year.

Material Changes vs. Prior Period

• Revenue: PSEG total operating revenues decreased slightly by $51 million (1.1%) compared to the nine months ended Sept 30, 1997.
  • Electric: Increased $146 million (5%) due to warmer weather and higher sales.
  • Gas: Decreased $247 million (19%) primarily due to energy tax reform and milder winter weather.
  • Nonutility: Increased $50 million, driven by energy trading profits.
• Net Income: PSEG net income increased $86 million (21%) to $493 million. This was driven by higher PSE&G earnings and energy trading profits, partially offset by lower earnings from non-utility investments (PSEG Resources) due to equity market downturns.
  • 1997 Comparison: The 1997 period included a one-time $64 million charge related to the Salem litigation settlement, which boosted the year-over-year growth rate.
• Taxes: Income taxes increased significantly ($120 million for PSEG) due to the replacement of the New Jersey Gross Receipts Tax with the New Jersey Corporate Business Tax, which is recorded as an expense rather than a pass-through.
• Stock Repurchase: PSEG authorized and executed the repurchase of approximately 2.4 million shares of common stock at a cost of $91 million in anticipation of future securitization of stranded costs.

Guidance, Outlook, and Risks

Regulatory and Legislative Outlook

The New Jersey Board of Public Utilities (BPU) is finalizing the Energy Master Plan. An Administrative Law Judge recommended a 10-12% rate cut, securitization of up to $2.5 billion in stranded costs, and a seven-year transition period. PSEG and PSE&G have filed exceptions to this decision. Final legislative action on the "Energy Competition Act" is expected in Q4 1998. Failure to recover stranded costs could result in a material, non-cash charge to operations.

Management Commentary

• Weather Impact: Warmer weather in Q3 1998 boosted electric sales, while milder winter weather in early 1998 reduced gas sales.
• Non-Utility Performance: Earnings from PSEG Resources declined due to unrealized losses in its investment portfolio ($22 million for the nine months) caused by equity market volatility.
• Nuclear Operations: Salem Units 1 and 2 returned to service in 1998. The NRC removed Salem from its "Watch List" citing improved safety culture and performance.

Key Risks and Contingencies

• Year 2000 (Y2K): Estimated total cost is $92 million. $16 million was incurred in the first nine months of 1998. Management expects mission-critical systems to be ready by Jan 1, 2000, but risks remain regarding vendor readiness and potential operational disruptions.
• Environmental Liabilities: Ongoing remediation of former manufactured gas plants (estimated $20 million/year for ~30 years) and hazardous waste sites. New NJDEP regulations may increase costs.
• Market Risk: Exposure to commodity price volatility and credit risk from energy trading counterparties. Value-at-risk for commodities was $8 million as of Sept 30, 1998.
• Legal Proceedings: Pending shareholder derivative suits regarding nuclear operations and litigation against Westinghouse regarding Salem steam generators.

Investor Verification Checklist

• Stranded Cost Recovery: Verify the final outcome of the New Jersey Energy Master Plan and the Energy Competition Act to assess the probability of recovering $2.5 billion in stranded costs via securitization.
• Y2K Readiness: Confirm the status of vendor compliance and the completion of remediation for critical nuclear and grid control systems prior to Jan 1, 2000.
• Non-Utility Volatility: Monitor the performance of PSEG Resources' investment portfolio, which is sensitive to global equity market fluctuations.
• Regulatory Tax Impact: Review the finalization of the New Jersey Corporate Business Tax rates and the phase-out schedule of the Transitional Energy Facility Assessment (TEFA).
• Debt Structure: Assess the impact of the $525 million in deferrable interest subordinated debentures and the potential IRS challenge to their tax deductibility (referencing the Enron litigation).