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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2005, and the nine months ended September 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 pending merger with Exelon Corporation, approved by shareholders in July 2005, with regulatory approvals ongoing.

Key Financial Metrics (Nine Months Ended Sept 30, 2005)

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 10% year-over-year to $9.1 billion, driven primarily by higher commodity prices for electricity and natural gas, and increased volumes due to weather conditions.
• Net Income Decline: Net income decreased 29% to $456 million. This decline was primarily due to a $197 million loss from discontinued operations at Power related to the sale of the Waterford generation facility, partially offset by higher earnings from continuing operations at Global and PSE&G.
• Discontinued Operations: Power recognized a $178 million loss on the disposal of the Waterford facility in the third quarter, completed in September 2005. Proceeds of approximately $320 million (including tax benefits) are expected to be used to retire debt.
• Commodity Price Impact: Significant increases in natural gas and electric prices (doubling in PJM over the last year) increased energy costs but also boosted revenues. This volatility increased margin posting requirements for Power, reducing operating cash flow by approximately $200 million compared to the prior year.
• Other Comprehensive Loss: Accumulated Other Comprehensive Loss (OCL) increased significantly due to unrealized losses on derivative contracts designated as hedges, reflecting the rise in commodity prices. Power's OCL increased from $49 million to $444 million.

Guidance, Outlook, and Risks

• Earnings Guidance: PSEG projects 2005 Income from Continuing Operations of $3.15 to $3.35 per share. For 2006, the projection is $3.45 to $3.75 per share, driven by anticipated higher margins at Power as existing contracts expire and higher market prices are realized.
• Mergers and Acquisitions: The merger with Exelon is expected to close in the first or second quarter of 2006, pending regulatory approvals from the FERC, New Jersey BPU, and Pennsylvania PUC. The merger could reduce 2005 results by $0.10 to $0.15 per share due to transaction costs.
• Liquidity and Credit: PSEG maintains approximately $1.6 billion in available liquidity under committed credit facilities. Power faces increased margin requirements due to commodity price volatility; however, management believes it has sufficient liquidity to meet these obligations. Credit ratings remain stable or on watch, with S&P placing PSEG on Credit Watch with developing implications due to the merger.
• Regulatory and Environmental Risks:
  • Passaic River: Ongoing EPA and NJDEP investigations regarding hazardous substances could result in material costs, though PSEG is working to resolve claims.
  • PSD/NSR Compliance: Power faces potential penalties and costs related to the Hudson coal unit's compliance with air pollution regulations, with a deadline of December 31, 2006, for equipment installation.
  • IRS Audit: The IRS is reviewing leveraged lease transactions; if challenged, it could result in approximately $650 million in currently payable deferred tax liabilities plus interest and penalties.
• Pension Liability: PSEG may be required to record a minimum pension liability by year-end 2005 if plan assets do not exceed the accumulated benefit obligation, which could materially decrease equity.

Investor Verification Checklist

• Merger Timeline: Verify the status of regulatory approvals (FERC, BPU, PAPUC) and the likelihood of closing in Q1 or Q2 2006.
• Waterford Disposal: Confirm the final proceeds from the Waterford sale and the specific debt retirement schedule.
• Commodity Hedging: Assess the impact of rising commodity prices on Power's margin requirements and the potential for further unrealized losses in OCL.
• IRS Leveraged Lease Audit: Monitor the outcome of the IRS review of leveraged leases and the potential for a $650 million tax liability.
• Pension Funding: Review year-end 2005 pension plan asset valuations to determine if a minimum pension liability charge will be required.
• Environmental Liabilities: Track developments in the Passaic River remediation and Hudson unit compliance costs.