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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1999, for Public Service Enterprise Group Inc. (PSEG) and its primary subsidiary, Public Service Electric and Gas Company (PSE&G). PSEG is a holding company with operations in regulated utility services (electric and gas) and non-utility energy businesses. The reporting period is defined by significant regulatory changes in New Jersey, specifically the enactment of the New Jersey Electric Discount and Energy Competition Act on February 9, 1999, which mandates the opening of retail energy markets to competition starting August 1, 1999.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 8.2% to $1,795 million, driven by a 7% increase in electric revenues and a 14% increase in gas revenues. This growth was primarily attributed to colder weather in the first quarter of 1999 and positive economic factors in New Jersey.
• Expense Increases: Operation and Maintenance expenses rose 22% ($71 million) due to higher wholesale power costs, transmission/distribution costs, and increased Other Post Employment Benefits (OPEB). Gas purchased costs increased 8% due to higher sales volumes.
• Net Income Decline: Despite revenue growth, consolidated net income decreased slightly by 1.6% ($3 million) to $188 million. This was largely due to a $17 million decrease in earnings from PSEG Energy Holdings (non-utility segment), offsetting gains in the utility segment.
• Foreign Currency Impact: The devaluation of the Brazilian Real (approx. 30% vs. USD) resulted in a $164 million charge to cumulative foreign currency translation adjustment, reducing total assets by $168 million, though it did not impact net income for the quarter.
• Share Repurchases: PSEG repurchased 11.3 million shares of common stock at a cost of $442 million, contributing to a 4% increase in earnings per share.

Guidance, Outlook, and Risks

Regulatory Outlook and Restructuring

The New Jersey Board of Public Utilities (BPU) issued a Summary Order on April 21, 1999, adopting a plan to restructure PSE&G. Key elements include:

• Asset Separation: PSE&G must transfer generation-related assets to a separate unregulated subsidiary (Genco) owned by PSEG at a price of $2.443 billion.
• Stranded Costs: PSE&G is authorized to securitize up to $2.4 billion of stranded costs and recover an additional $540 million through a market transition charge.
• Rate Reductions: Customers will receive rate reductions starting at 5% in August 1999, increasing to an average of 13.9% by August 2002.
• Accounting Impact: PSE&G anticipates recording a net extraordinary charge to earnings in the range of $500 million to $700 million in the second quarter of 1999 to reflect unrecoverable costs once SFAS 71 (regulatory accounting) is discontinued for the generation business.

Key Risks and Contingencies

• Market Volatility: With the elimination of the Levelized Energy Adjustment Clause (LEAC), PSEG's generation business will be exposed to full market risks for fuel and replacement power costs. Extreme price movements in the PJM market could materially impact financial results.
• Environmental Liabilities: Significant uncertainties exist regarding the Passaic River site remediation and the Manufactured Gas Plant Remediation Program, with potential costs estimated at $20 million annually over 30 years.
• Year 2000 Compliance: Total estimated costs for Year 2000 readiness are $83 million. While 85% of critical systems are ready, failure of key vendors or PJM partners could have a material adverse impact.
• Foreign Operations: Continued devaluation of foreign currencies, particularly the Brazilian Real, poses a risk to asset values and future earnings from international investments.

Investor Verification Checklist

• Q2 1999 Earnings Impact: Verify the magnitude of the anticipated $500-$700 million extraordinary charge related to the deregulation of electric generation.
• Securitization Execution: Monitor the issuance of transition bonds and the actual proceeds received from the securitization of stranded costs.
• Dividend Sustainability: Confirm management's assertion that the current dividend level ($0.54/share) can be maintained despite the regulatory restructuring and potential earnings volatility.
• Year 2000 Readiness: Track the completion status of critical system remediation and the readiness of key vendors and PJM partners by January 1, 2000.
• Foreign Currency Exposure: Assess the impact of further devaluation of the Brazilian Real on PSEG Global's assets and future cash flows.