PEG

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2008, for Public Service Enterprise Group Incorporated (PSEG) and its principal subsidiaries: PSEG Power LLC (Power) and Public Service Electric and Gas Company (PSE&G). PSEG operates as a holding company with four reportable segments: Power (wholesale generation and trading), PSE&G (regulated utility in New Jersey), PSEG Global (domestic and international generation), and PSEG Resources (leveraged lease investments).

Key Financial Metrics (Six Months Ended June 30, 2008)

Material Changes vs. Prior Period

• Significant Tax Charges: PSEG recorded a net after-tax charge of approximately $490 million in the second quarter of 2008 related to leveraged lease transactions at the Resources segment. This included a $355 million charge under FSP 13-2 (reducing operating revenues by $485 million) and a $135 million increase to the interest reserve under FIN 48. These charges turned a potential profit into a loss from continuing operations for the quarter ($166 million loss vs. $281 million income in Q2 2007).
• Power Segment Performance: Excluding the Resources charges, Power reported strong results with Net Income of $515 million for the six months ended June 30, 2008, up $118 million from the prior year. This was driven by higher generation prices, increased sales volumes, and favorable mark-to-market gains, partially offset by higher fuel costs (natural gas and coal) and other-than-temporary impairments (OTTI) in Nuclear Decommissioning Trust Funds.
• PSE&G Performance: Net Income decreased slightly to $189 million for the six months ended June 30, 2008, compared to $195 million in 2007. Higher commodity revenues were largely offset by higher energy costs passed through to customers.
• Discontinued Operations: PSEG reported income from discontinued operations of $30 million for the six months ended June 30, 2008, primarily related to the SAESA Group (Chile), which was sold in July 2008 for a gain of approximately $180 million (after-tax).

Guidance, Outlook, and Risks

• Outlook: Management expects continued strong cash from operations to fund dividends and capital expenditures. PSEG anticipates having approximately $2.5 billion of discretionary cash through the end of 2011, assuming potential tax payments of $900 million to $950 million related to leveraged lease transactions.
• Dividends: The Board approved a quarterly dividend of $0.3225 per share for the third quarter of 2008, indicating an annual rate of $1.29 per share. A stock repurchase program of up to $750 million was authorized in July 2008.
• Key Risks:
  • Tax Litigation: Significant uncertainty remains regarding the IRS challenge to leveraged lease deductions. If fully sustained, approximately $1.166 billion could become payable, though PSEG anticipates a resolution consistent with current reserves.
  • Regulatory: Risks include changes in PJM capacity market rules (RPM), potential refunds of capacity payments, and the outcome of the Supreme Court review regarding cooling water intake structures (Section 316(b) of the Clean Water Act), which could require costly upgrades.
  • Commodity Prices: Volatility in natural gas and coal prices impacts generation costs and margin requirements. Higher prices have increased margin posting requirements for Power.

Investor Verification Checklist

• Leveraged Lease Tax Exposure: Verify the status of the IRS audit and the potential cash impact of the $900 million to $950 million estimated payment.
• Power Segment Margins: Monitor the impact of rising fuel costs and PJM capacity market rule changes on Power's profitability.
• Environmental Compliance: Track the outcome of the Supreme Court case regarding cooling water intake structures and potential capital requirements for Salem, Hudson, and Mercer plants.
• Discontinued Operations: Confirm the final closing and cash proceeds from the SAESA Group sale.
• Liquidity: Review the utilization of credit facilities and margin posting requirements given the volatility in energy markets.