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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2010, for Public Service Enterprise Group Incorporated (PSEG) and its wholly-owned subsidiaries, PSEG Power LLC (Power) and Public Service Electric and Gas Company (PSE&G). PSEG operates as a holding company with a diversified energy portfolio in the Northeastern and Mid-Atlantic United States, comprising wholesale energy supply (Power), regulated utility transmission and distribution (PSE&G), and energy-related leveraged leases (Energy Holdings).

Key Financial Metrics (Six Months Ended June 30, 2010)

Material Changes vs. Prior Period

• Revenue Decline: Operating revenues decreased by $345 million (5%) compared to the prior year, driven primarily by lower gas sales volumes due to milder weather and economic conditions, as well as customer migration from Basic Generation Service (BGS) contracts to lower-priced third-party suppliers.
• Net Income Decrease: Net income fell by $40 million (5%). Key drivers included a $122 million pre-tax charge recorded in June related to an agreement to refund Market Transition Charge (MTC) collections to customers over two years, and unfavorable results from wholesale energy supply contracts.
• Cash Flow Reduction: Operating cash flow decreased by $269 million, largely due to lower margins on generation and gas sales and a net cash collateral outflow at Power compared to the prior year.
• Segment Performance:
  • Power: Net income increased slightly by $7 million ($568M vs $561M) due to favorable Nuclear Decommissioning Trust (NDT) fund activity and higher generation volumes, offset by lower gas sales.
  • PSE&G: Net income decreased by $47 million ($121M vs $168M), primarily impacted by the $122 million MTC refund charge.
  • Energy Holdings: Net income decreased by $12 million ($19M vs $31M) due to lower gains on leveraged lease sales and an asset impairment charge.

Guidance, Outlook, Risks, and Unusual Items

• Regulatory Developments: The New Jersey Board of Public Utilities (BPU) approved a base rate case settlement in June 2010, increasing annual electric and gas revenues by $73.5 million and $26.5 million, respectively. However, the BPU also approved the $122 million MTC refund.
• Environmental Risks: Significant uncertainty remains regarding EPA rules on coal combustion residuals, the Clean Air Transport Rule (limiting SO2 and NOx emissions), and greenhouse gas permitting. Compliance costs could be material.
• Tax Contingencies: PSEG faces a significant tax dispute regarding leveraged lease deductions. As of June 30, 2010, approximately $550 million would be payable if all deductions were conceded. PSEG has deposited $320 million with the IRS, reducing potential cash exposure to $230 million. An additional earnings charge of $120 million to $140 million could occur if the IRS position is fully upheld.
• Market Risks: Lower natural gas prices have reduced electricity market prices, compressing margins on nuclear and coal generation. Customer migration from BGS contracts continues to impact volumes.
• Dividends: The Board increased the quarterly dividend to $0.3425 per share, indicating an annualized rate of $1.37.

Investor Verification Checklist

• MTC Refund Impact: Verify the cash flow implications of the $122 million refund obligation over the next two years.
• Leveraged Lease Tax Exposure: Monitor the status of the IRS audit on leveraged leases and the potential for additional tax payments or earnings charges beyond the current reserve.
• Environmental Compliance Costs: Assess the potential capital expenditure requirements for new EPA rules (Clean Air Transport Rule, Coal Combustion Residuals) and their impact on future earnings.
• Customer Migration Trends: Track the rate of customer migration from BGS contracts to third-party suppliers and its effect on Power's wholesale revenue stability.
• Liquidity Position: Review the reduction in cash and cash equivalents from $350 million to $57 million and the reliance on credit facilities ($2.9 billion available) to fund operations and capital expenditures.