ES

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2006, for Northeast Utilities (NU) and its subsidiaries: The Connecticut Light and Power Company (CL&P), Public Service Company of New Hampshire (PSNH), and Western Massachusetts Electric Company (WMECO). The company is a regulated utility holding company operating in Connecticut, New Hampshire, and Massachusetts. A primary strategic focus during this period was the exit from competitive energy businesses (NU Enterprises), including the sale of its retail marketing business to Hess Corporation on June 1, 2006, and the agreement to sell its competitive generation assets to Energy Capital Partners (ECP) in July 2006.

Key Financial Metrics (Six Months Ended June 30, 2006)

Material Changes vs. Prior Period

• Turnaround in Profitability: NU reported a net income of $12.1 million for the first half of 2006, a significant improvement from a net loss of $145.4 million in the same period of 2005. The 2005 loss was driven by $195.7 million in after-tax charges related to impairments and mark-to-market adjustments from exiting wholesale marketing and energy services businesses.
• Utility Group Performance: The regulated Utility Group (electric distribution, transmission, and gas) generated net income of $88.1 million in the first half of 2006, compared to $75.6 million in 2005. Earnings were boosted by higher transmission investment returns and a tax settlement in Connecticut.
• NU Enterprises Losses: The competitive energy segment (NU Enterprises) recorded a net loss of $76.9 million in the first half of 2006, compared to a loss of $214.5 million in 2005. The 2006 loss included a $33.3 million after-tax charge to write down the retail marketing business to fair value less cost to sell prior to its sale.
• Revenue Composition: Operating revenues increased slightly by 1% year-over-year. This was due to higher regulated distribution and transmission revenues (driven by cost pass-throughs and rate increases) offset by a significant decline in NU Enterprises revenues due to divestitures.
• Cash Flow Decline: Operating cash flows decreased by $65.3 million to $213.1 million. This was primarily due to higher regulatory refunds to customers, increased recoverable energy costs paid but not yet recovered, and a $55 million federal income tax payment related to the 2005 tax return.

Guidance, Outlook, and Risks

• Earnings Guidance Revision: NU revised its 2006 combined earnings guidance for the Utility Group and parent company upward to between $1.57 and $1.70 per share (previously $1.09 to $1.22). This increase is largely due to a one-time $74 million reduction in income tax expense for CL&P resulting from an IRS Private Letter Ruling (PLR).
• Divestiture Outlook: The company expects to record an after-tax gain of approximately $300 million (approx. $1.95 per share) in the fourth quarter of 2006 upon the closing of the sale of its competitive generation business (NGC and Mt. Tom) to ECP. Upon completion, NU will have divested substantially all NU Enterprises assets.
• Capital Expenditures: Total capital expenditures are projected to reach approximately $900 million in 2006, with a heavy focus on transmission infrastructure upgrades in Connecticut.
• Regulatory Risks:
  • FERC Proceedings: Ongoing proceedings regarding decommissioning cost recovery for Connecticut Yankee Atomic Power Company (CYAPC) and Yankee Atomic Electric Company (YAEC) pose risks to cost recovery.
  • Rate Cases: PSNH completed recovery of non-securitized stranded costs, leading to a 15.5% overall rate decrease effective July 1, 2006. CL&P postponed its distribution rate case filing until mid-2007.
• Legal Contingencies: NU is involved in litigation with Consolidated Edison, Inc. regarding a failed 1999 merger. NU claims approximately $32 million in costs, while Con Edison claims damages of at least $314 million. The outcome remains uncertain.
• Environmental Compliance: PSNH faces an estimated $250 million cost to install wet scrubber technology at its coal-fired plants to comply with New Hampshire mercury emission legislation by 2013.

Investor Verification Checklist

• Divestiture Closing: Verify the closing of the $1.34 billion sale of NGC and Mt. Tom to ECP and the realization of the projected $300 million after-tax gain.
• Tax Ruling Impact: Confirm the recognition of the $74 million tax benefit in CL&P's third-quarter results as projected.
• Wholesale Contract Exit: Monitor the exit strategy for remaining wholesale marketing contracts, particularly the long-term New York contract expiring in 2013, and associated mark-to-market volatility.
• Transmission Project Costs: Track capital expenditure overruns and regulatory approval for cost recovery on major transmission projects (e.g., Bethel to Norwalk, Middletown to Norwalk).
• Con Edison Litigation: Review updates on the summary judgment motion regarding Con Edison's $314 million damage claim.
• PSNH Cash Flow: Assess the impact of the reduced Stranded Cost Recovery Charge (SCRC) rates on PSNH's future operating cash flows.