Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2004, and the nine months ended September 30, 2004, for Public Service Enterprise Group Inc. (PSEG) and its principal subsidiaries: Public Service Electric and Gas Company (PSE&G), PSEG Power LLC (Power), and PSEG Energy Holdings LLC (Energy Holdings). PSEG operates as a holding company with four reportable segments: PSE&G (regulated utility), Power (wholesale generation and trading), and Energy Holdings (international projects and leveraged leases). The financial statements for PSEG and Energy Holdings for the comparable 2003 periods have been restated to correct foreign currency translation adjustments and other errors.
Key Financial Metrics (Nine Months Ended Sept 30, 2004)
| Metric | 2004 (Restated) | 2003 (Restated) |
|---|---|---|
| Operating Revenues | $8,258 million | $8,468 million |
| Net Income | $639 million | $1,021 million |
| Income from Continuing Operations | $634 million | $688 million |
| Diluted EPS (Continuing Ops) | $2.67 | $3.04 |
| Operating Cash Flow | $1,259 million | $828 million |
| Total Assets | $28,462 million | $28,074 million |
| Total Long-Term Debt | $12,996 million | $12,945 million |
| Cash and Cash Equivalents | $316 million | $452 million |
Material Changes vs. Prior Period
- Revenue Decline: Consolidated operating revenues decreased by $210 million (2%) compared to the prior year, primarily driven by a $506 million decrease in Power's revenues due to lower load served under fixed-priced Basic Generation Service (BGS) contracts and the adoption of EITF 03-11, which requires net reporting of derivative gains/losses.
- Net Income Decrease: Net income fell by $382 million. This was largely due to lower earnings at Power (decreased load, higher replacement power costs, and loss of Market Transition Charge revenues) and Energy Holdings (lower project income and lease income). These decreases were partially offset by improved earnings at PSE&G due to increased electric base rates.
- Operating Cash Flow Increase: Operating cash flow increased significantly by $431 million, driven by higher net income at PSE&G and Energy Holdings, and reduced benefit plan contributions.
- Segment Performance:
- PSE&G: Net income increased to $281 million from $192 million, aided by rate increases and lower energy costs relative to volumes.
- Power: Net income decreased to $292 million from $766 million (2003 included a $370 million one-time benefit from SFAS 143 adoption). Excluding the one-time item, earnings were pressured by outages and market conditions.
- Energy Holdings: Net income decreased to $110 million from $125 million, impacted by the consolidation of Texas Independent Energy (TIE) and lower lease income.
Guidance, Outlook, and Risks
- Earnings Guidance: PSEG projects 2004 Income from Continuing Operations to range from $3.15 to $3.35 per share. For 2005, the range remains $3.15 to $3.35 per share, assuming improved operations at Power's facilities and higher market prices, offset by higher O&M expenses and lower Nuclear Decommissioning Trust (NDT) Fund income.
- Operational Challenges: Power's results were negatively impacted by unanticipated outages at Hope Creek and Salem nuclear stations and the Hudson and Mercer fossil stations. An extended outage at Hope Creek commencing in October 2004 is expected to increase replacement power costs by approximately $12 million in Q4.
- Regulatory and Legal Risks:
- Environmental: Significant uncertainty remains regarding the Passaic River site remediation costs, with NJDEP estimating interim restoration costs at $950 million. PSE&G has accrued $335 million for its MGP remediation program.
- International: Energy Holdings faces risks from foreign currency devaluations (notably the Brazilian Real) and regulatory issues in Poland (ELCHO) and Peru (LDS tax dispute).
- Rating Actions: Several rating agencies (S&P, Moody's, Fitch) placed PSEG, PSE&G, and Power on negative outlook or downgraded ratings in mid-2004, citing market volatility and operational issues.
- Accounting Changes: The adoption of EITF 03-11 reduced reported revenues and energy costs for Power by netting derivative gains and losses. The adoption of SFAS 143 in 2003 resulted in a $370 million one-time benefit that is not present in 2004.
Investor Verification Checklist
- Restatement Impact: Verify the specific adjustments made to 2003 financials regarding foreign currency translation for Energy Holdings' investment in Rio Grande Energia (RGE).
- Power Outage Costs: Monitor the duration and cost impact of the Hope Creek nuclear outage and the Hudson/Mercer fossil outages on Q4 and 2005 earnings.
- Environmental Liabilities: Review the status of the Passaic River remediation negotiations and the potential for costs exceeding the current $335 million accrual.
- Debt Covenants: Confirm compliance with debt-to-capitalization covenants, particularly for Power (50.0% vs 65.0% limit) and PSEG (58.3% vs 70.0% limit), given the negative credit outlooks.
- International Exposure: Assess the impact of foreign currency fluctuations on Energy Holdings' earnings, specifically the Brazilian Real and Polish Zloty.
- Market Transition Charge (MTC): Note that MTC revenues ceased in August 2003; verify that 2004 guidance does not rely on this revenue stream.